To: International Accounting Standards Board (IASB)
Subcommittee on Corporate Accounting
Committee on Financial and Capital Markets
Keidanren
We appreciate the opportunity to submit public comments on Business Combinations—Disclosures, Goodwill and Impairment (proposed amendments to IFRS 3 and IAS 36; hereinafter, the "Exposure Draft"). Our comments are as follows:
General Remarks
We disagree with the proposals in the Exposure Draft. The accounting requirements proposed in the Exposure Draft would in general impose an extremely high practical burden on entities. If, despite this, they were to be incorporated into practice, they would result in piecemeal, incomplete information being disclosed at inappropriate times, thereby failing to provide information that is useful for users' investment decision-making. In fact, these requirements would mislead or confuse users, and we therefore consider them to be harmful. The IASB's purpose for amending these standards cannot be met by the proposals in this Exposure Draft.
Even without the IASB making detailed stipulations, entities voluntarily disclose and explain information about material business combinations including their post-acquisition visions and business strategies, having considered the appropriate timing and other issues. If the standard were to be finalized in the direction of this Exposure Draft, it is likely that not a few entities would hesitate to enter into business combinations themselves, which could constrain their growth and the free conduct of business.
In addition, the content of the notes (expected synergies, KPIs, etc.) for business combinations required by the proposal in this Exposure Draft has an extremely large strategic element for management. Therefore, such information lacks the comparability required for notes to financial statements, and it is difficult to verify the appropriateness of such content by a third party, and thus does not fit with notes to financial statements. In order to encourage appropriate and flexible disclosure, including creative and ingenious disclosure on the part of entities in response to circumstances, the content should be disclosed outside of the financial statements, and we are opposed to the basic concept of this Exposure Draft, which assumes that notes to financial statements are required.
IFRS 3 and SFAS 141R are important deliverables of the joint project between the IASB and the FASB, and we believe that they are currently in a highly consistent state. We are concerned that the IASB's proposal in this Exposure Draft will not only upset the balance between the two standards, but also put IFRS adopters at a competitive disadvantage by forcing them to disclose information that is not disclosed by leading companies in the global capital markets.
These concerns are definitely not issues that can be resolved simply through partial amendment of the proposals in this Exposure Draft. The IASB needs to fundamentally reconsider its approach, including starting this project all over again from scratch.
As one of its reasons for publishing this Exposure Draft, the IASB cited the issue of recognition of goodwill impairment being too little, too late. However, seeking to solve this "too little, too late issue" only by improving the impairment test and related disclosure is not rational as these methods are neither effective nor efficient. To begin with, a portion of the monitoring metrics and other information used in the impairment test is non-financial information and should inherently be disclosed outside of the framework of financial statements. For a fundamental resolution, an improvement of the "subsequent accounting for goodwill" is essential, and the reintroduction of amortization (that is, the "amortization and impairment approach") is the best solution.
Below are our responses to the questions raised in the Exposure Draft.
Specific Remarks
Question 1
(a)
We disagree. We are concerned that disclosure of information about the performance of a business combination as proposed in the Exposure Draft would confuse and mislead information users, rather than being useful. We also anticipate significant increases in costs for preparers (including the negative effects on entities caused by disclosure) and in the practical burden on auditors. Despite this, however, the information to be disclosed cannot be described as genuinely useful for investors' decision-making, so the cost effectiveness of the disclosure proposed in the Exposure Draft is extremely low.
Forward-looking information is usually disclosed as accounting estimates reflected in financial statements, but the proposal in the Exposure Draft would directly disclose forward-looking information in financial statements without any accounting process. Therefore, although both forecasts are disclosed within the framework of the same financial statements, the accuracy of them is clearly inconsistent, and the disclosure information required by the proposal will not only not be useful for users' decision-making, but also has an unexpected impact on market sentiment, leading to a significant risk of misinterpretation by market participants.
In a business combination transaction, the information available to the acquirer at the time of acquisition is limited, and not all information is available to the acquirer at the time of acquisition. In addition, the objectives and goals at the time of acquisition may be revised and significantly reoriented based on new information that becomes available after the acquisition. The proposal in the Exposure Draft requires preparers to continue to explain their objectives and goals "as of the acquisition date" despite the drastic changes happened in the business environment, and it is quite possible that the disclosure information required by the Exposure Draft will diverge from the actual situation of the entity. The disclosure information required by the Exposure Draft is not only not useful to users but also confusing, even though it reduces the scope of flexible and effective accountability and causes practical difficulties and unnecessary cost increases for preparers.
When business combinations are undertaken, alternative plans are often considered in advance, including a potential exit strategy or restructuring should post-acquisition business operations or expectations diverge from the baseline plan and forecasts. There is a risk that, despite this, entities may be evaluated only on whether or not their baseline plan was achieved.
In addition, for preparers of financial statements, most acquisition-related monitoring metrics and similar data are commercially sensitive information. We are concerned that the disclosures the IASB is proposing could therefore prove useful to other companies, causing competitive disadvantage to the disclosing entity and harming its corporate value. The applicability of the exemption as proposed in the Exposure Draft is quite limited and does not adequately address this concern. Indeed, it would be difficult to make use of the exemption at all, given the heavy burden on the preparer in terms of accountability when using it (including an explanation to auditors).
If the IASB does establish disclosure requirements with regard to business combinations, careful deliberation is essential in light of the practical work to be imposed on entities to determine the point at which the relevant targets should be disclosed and the reasons for disclosure. The balance of related costs and benefits should also be taken into account, and the standards should not be amended in haste.
(b)
Disclosure of information regarding business combinations should be included in the framework outside the financial statements. We believe that the quality of accountability to users will be greatly enhanced by disclosures outside the financial statements that allow for more flexible and timely disclosure of information in response to circumstances, compared to disclosures within the financial statements.
Plenty of information is already provided within financial statements in line with disclosure requirements relating to segment information and goodwill, while press releases, presentations for investors, and the like provide communication. It is debatable whether all analysts and investors require disclosure of information that has been audited; we believe that users' needs could be met through disclosure outside the financial statements.
It is highly likely that the additional disclosure requirements the IASB is proposing will end up increasing preparers' burden of disclosure for no good reason.
Question 2
(a)
We oppose the proposed disclosure requirements for "strategic business combinations." The costs and benefits of disclosure of "strategic business combinations" are out of balance because, despite the heavy disclosure burden on entities, it does not provide investors with information that is useful to understand and appropriate to the actual situation of the entity.
This question has forced us to answer on the assumption that the "strategic business combination" note will be introduced, and we agree with the said assumption. However, in the world of principle-based IFRS, we should be cautious about incorporating the concept of numerical standards as a threshold approach. It is essential that management should also be able to recognize a "strategic business combination" determined by the threshold approach as an essentially significant business combination, i.e., the design should not deviate from the concept of the management approach in practical terms.
(b)
If the IASB does stipulate disclosure requirements, it is essential to balance users' information needs with the cost burden for preparers, and we agree with quantitative and qualitative thresholds being set as criteria for measuring the materiality of business combinations. However, setting a numerical criterion within the standard itself would have a considerable impact, and there is a risk that it would encourage superficial judgment, so it should be deliberated carefully.
Whether a business combination is strategically significant or not depends on the circumstances of each individual entity and cannot be simply compared. However, in order to more accurately reflect the actual situation of business combinations in each entity, it is essential that each entity be able to determine materiality using a combination of "quantitative thresholds" and "qualitative thresholds."
With regard to quantitative thresholds, we are opposed to using an absolute amount of operating profit or loss (or any other category of profit on the income statement) for the most recent annual reporting period. Profits are unsuitable as a metric. Unlike revenue or total assets, they fluctuate across a wide range, so transient factors could mean that, depending on the year, a very small-scale business combination ends up being treated as a strategic business combination. It can also be assumed that even revenue or total assets could experience wide fluctuations temporarily as a result of transient factors, so entities should be allowed to use not only the financial results for the most recent annual reporting period, but the average financial results over several annual reporting periods. Moreover, in order to limit the requirement for disclosure to business combinations that are indeed strategic, the percentage should be set no lower than the threshold of 10% presented in the proposed amendments.
With regard to qualitative thresholds, B67C(c) refers to "the acquirer entering a new major line of business or geographical area of operations," but as these terms are not clearly defined, potentially leading to differing interpretations, we are concerned that comparability among entities may be impaired. There is a risk that, for certain entities, business combinations that are neither strategic nor material may end up qualifying as strategic, and for that reason, this qualitative threshold should be deleted. Application of this qualitative threshold would be particularly difficult for entities that repeatedly invest in a diverse array of new businesses (e.g., Sogo Shosha*, the general trading companies typical in Japan).
* Sogo Shosha is a uniquely Japanese business category and engages in both wholesale and intermediary operations as well as in business investment domestically and internationally. Their business domain is quite broad: energy, metals, infrastructure, machinery, chemicals, and lifestyle industries (food, textiles, information and telecommunication services, finance and real estate).
The Exposure Draft proposes that a business combination meeting any one of the quantitative or qualitative criteria would be defined as a strategic business combination, but we are concerned that a business combination of limited materiality could meet the qualitative criteria, and therefore become subject to mandatory disclosure as a strategic business combination. Investments in new lines of business are often launched on a limited scale as pilots, rather than being "strategic." If a potential new business is publicized externally, the acquiring entity will face even fiercer competition in that line of business and may be unable to achieve the outcomes it had expected. Accordingly, the IASB should ensure that the standard requires disclosure only for genuinely material business combinations by making financial materiality part of the qualitative criteria too.
Question 3
(a)
The eligibility for exemption proposed in the Exposure Draft is extremely limited and does not adequately address preparers' concerns with regard to commercial sensitivity. The criterion for the proposed exemption is too demanding, allowing very little scope for application of the exemption in practice.
Information about synergies and targets is sensitive; its disclosure risks not only resulting in the key objectives for the business combination becoming unachievable, but even in the acquiring entity's very survival being jeopardized. Allowing such a situation to occur would seriously harm the interests of both the entity and investors. Particularly careful deliberation is therefore essential when mandating the disclosure (including setting any exemption).
The Exposure Draft proposes that sensitive information, such as that relating to synergies and the targets of a business combination, should be eligible for exemption only if disclosure can be expected to prejudice seriously the achievement of any of the acquirer's key objectives, but entities should not be required to make such expectations themselves.
The extent and scope of the effect from disclosure of highly confidential information such as that relating to the synergies and targets of a business combination can vary due to factors beyond an entity's control. For example, disclosure of information about employee redundancies could reduce employee motivation or negatively affect relationships with business partners, brands, or investment partners. It would be difficult to analyze such effects and predict whether they would be sufficient to seriously prejudice key objectives. With regard to cost-related targets, too, it can be difficult for an entity to adequately predict how competitors may behave.
From the auditing point of view, we believe that the requirement to audit the rationale behind an entity's expectation of serious prejudice would impose an excessive burden of responsibility on auditors. When it comes to such matters as defining "seriously," it is probable that opinions would vary and we believe that this could even give rise to expectation gaps among investors.
The requirement for preparers applying the exemption to identify and describe the seriously prejudicial effect they expect from both qualitative and quantitative perspectives, and the need to prove to the auditors that disclosure would be impossible even at a sufficiently aggregated level. This would increase the burden of accountability on the part of the preparer, while also making the actual applicability of the exemption extremely limited.
To make the exemption provisions practical for preparers, it is essential to expand the scope of them, such as
- Make information eligible for exemption also in cases where the entity itself has a duty of confidentiality with regard to items of information subject to disclosure, whether in accordance with laws and regulations, or due to a court order, or an order issued by the authorities.
- Make information eligible for exemption also in cases where the entity has a duty of confidentiality with regard to information subject to disclosure due to a contract with a third party (including the acquiree).
With regard to disclosure of the reason for applying the exemption, given the lack of application guidance or other information giving specific examples of appropriate reasons, we believe that there are no adequate concrete criteria for judging whether a preparer's application of the exemption is appropriate that would stand up to auditing. It can be assumed that when entities are considering whether to apply the exemption, the information subject to disclosure is often highly commercially sensitive. The reason for applying the exemption would usually be known by a certain team in charge of contract negotiations regarding the business combination, and that team may be prevented by a non-disclosure agreement from disclosing the information to the auditors or teams dealing directly with the auditors. If that possibility is taken into account, it is unreasonable to require the preparer to take responsibility for explaining the reason for applying the exemption to the auditors and reaching an agreement with them. It is also highly likely that the lack of specific application guidance would cause extra differences of opinion to arise between the preparer and the auditors, resulting in time being spent on unproductive debate.
In BC87(a) and (b) the IASB states that the exemption may be applied to disclosure of the acquisition-date targets for a business combination and a qualitative statement of the extent to which the targets are being met following the acquisition. In BC88(b), however, the IASB proposes not to exempt disclosure of "the actual performance being reviewed to determine whether acquisition-date key objectives and the related targets are being met" (referred to hereafter as "actual performance"). In this regard, there is a risk that disclosing only actual performance, while exempting targets and qualitative statements assessing progress in meeting such targets, could mislead investors. For example, when entities have been combined through a merger or similar, internal monitoring in practice usually entails monitoring performance as a single combined corporate unit with no distinction between the entity that conducted the merger and the merged entity. As this is purely to review the performance of the combined entity, it does not necessarily indicate progress in meeting the original objectives of acquiring the merged entity. Even in cases such as this, the Exposure Draft does not permit the exemption to be applied, proposing disclosure of actual performance following a business combination. However, there is a considerable risk that this would not only be incompatible with achievement of this Exposure Draft's purpose, but would also be seriously misleading for investors. In light of the foregoing, the IASB should consider changing its proposals, including setting an additional exemption for actual performance and not requiring disclosure in cases where entities have been combined for reasons such as mergers, at least.
We are opposed to any requirement for continued monitoring of eligibility for exemption in the years following a business combination. The Exposure Draft states that entities must conduct monitoring to confirm that they continue to fulfill the criterion for exemption throughout each annual reporting period, but changes in an entity's fulfillment of the criterion in question are rare. The benefits of annual monitoring of what takes place infrequently do not justify the costs, so we recommend that, when an entity has applied the exemption in the first annual reporting period following a business combination, it should not be required to conduct monitoring in the subsequent years.
(b)
In general, it is highly likely that preparers will apply the exemption for commercially sensitive information. However, given that there is no fixed application guidance, holding discussions with the auditors and proving to them why the exemption can be applied will be an extremely cumbersome process and may well increase the burden of unnecessary costs for the preparer. In the first place, we believe it is practically difficult for auditors to objectively judge the reasonableness of the reasons for the entity's judgment.
In order to avoid confusion in practice and to ensure the effectiveness of the exemption provisions, it is essential to make the audit response more concrete and clear, for example, by stipulating that the audit procedures do not include a reasonableness judgment.
Question 4
(a)
We disagree because it is uncertain that disclosing this information would be useful. The proposed additional disclosure of information relating to the performance of a business combination would not provide information useful for assessing the extent to which acquisition-date objectives are being met. Moreover, if the information to be disclosed would be of the same level of detail and scope as that reviewed by key management personnel, such information is already provided to users in line with non-IFRS 3 disclosure requirements (i.e., disclosure of segment information and goodwill).
Business results disclosed at the level of detail and scope reviewed by key management personnel (i.e., large units such as segments/CGUs) include variables unrelated to the outcomes of a business combination. Users would therefore be unable to tell whether information disclosed as business results represented the outcomes of a business combination or other factors, and it is highly likely that they would be unable to understand what they really want to know: the extent to which the original objectives of the business combination were being met. But it would be unreasonable to seek to resolve this issue by giving key management personnel more detailed information so they can assess the outcomes of the business combination separately, thereby formally imposing an additional requirement on them to review acquisition-date targets. By their very nature, the outcomes of a business combination may be impossible to assess in isolation.
It is proposed that an entity would be required to disclose information about the performance of the business combination until the end of the second fiscal year after the acquisition year, even if no key management personnel's review is performed. If the original objectives and goals have changed significantly due to changes in the business environment, etc., the notes would not be in line with the actual status of the business combination and would be of little use to users, as well as would unnecessarily increase the practical burden of preparers. Therefore, this provision should be deleted.
(b)
It is unreasonable that the requirement for the scope of disclosure depends on whether or not information is being reviewed by key management personnel. Even if key management personnel continue to review certain information, disclosure should not be required once it is no longer strategically important.
Question 5
We oppose the additional requirement for disclosure of quantitative information about expected synergies. Disclosures of qualitative and quantitative information about synergies are commercially sensitive and could cause economic disadvantage to the preparer. As we stated in response to Question 3 (a), the criterion for exemption is extremely limited and does not adequately address preparers' concerns with regard to commercial sensitivity. Moreover, despite the potentially hazardous nature of the information that could provide competitors with key business strategy, the level of disclosure proposed is too detailed.
In addition, it is unreasonable to expect that an acquiring entity should be able to reliably estimate the synergies expected from a business combination at the date of acquisition. An entity obtains detailed information about synergies gradually during the process of post-merger integration (PMI); even at the PMI stage, measurement of synergies in financial terms is extremely difficult. It is also difficult for entities to substantiate the rationale behind their estimates relating to synergies. Furthermore, plans made prior to acquiring a business can change suddenly after the acquisition as a result of management decisions or external factors. It is also highly likely that combining an existing business with an acquired business will quickly result in the prospective performance of the business combination becoming unclear.
It is generally assumed that synergies are included in goodwill. In practice, however, goodwill is only ever calculated as a residual, and given that from a conceptual point of view goodwill includes not only synergies, but also other unidentifiable intangible assets, synergies cannot be directly measured. Quantifying synergies would significantly increase the costs of preparing financial statements and the information obtained as a result would immediately become out of date, so these costs would far outweigh the benefits.
In many cases, synergies contain particularly delicate information such as employee redundancies. In this regard, the Exposure Draft proposes that the exemption may be applied only when disclosure can be expected to prejudice seriously the achievement of key objectives. But realistically, if information relating to redundancies were to be disclosed, it is difficult to reasonably predict the extent to which this might affect employee motivation and what effect that might have on the achievement of key objectives. It is also possible that the information could be used externally in a form unanticipated by the entity, resulting in a seriously negative effect on the achievement of key objectives. Information about synergies is forward-looking sensitive information, and expanding the scope of information disclosed risks negatively impacting entities, thereby also harming investors. If disclosure of this information is to be required, it is essential to bear in mind the possibility of such impacts and act carefully with due consideration for the practical work involved by, for example, making it easier to apply the exemption.
With regard to the estimated financial amounts of synergies, it is extremely difficult to estimate such amounts reliably in practice and estimation would involve substantial costs. Financial estimates of synergies by assessment agencies (or entities) generally differ greatly. And it is even more difficult to divide synergies into categories such as revenue synergies or cost synergies, and estimate the costs to achieve these synergies. If an entity discloses synergies as required in the amended standard, it will become impossible to explain the difference compared with the amount of goodwill. If the amount of goodwill is greater than that of the synergies, the entity will be deemed to have purchased the acquiree at a high price and that could lead to the argument that the difference in value should be subject to immediate impairment.
For many investments, goodwill includes elements other than synergies. For example, if the acquiree is highly profitable, goodwill can arise even without factoring in synergies. There are some investments for which goodwill consists almost entirely of elements other than synergies. As information obtained by the acquirer when undertaking a business combination is basically restricted, it can be assumed that there are a considerable number of cases in which synergies are reassessed after the business combination takes place. Moreover, details of goodwill such as its financial amount are determined over time based on purchase price allocation (PPA) and similar methods following the acquisition. In light of these facts, therefore, we believe that disclosing quantitative information on synergies expected at the time of business combination would actually mislead investors rather than helping them. If disclosure is to be required, we believe the IASB needs to reconsider the point in time at which the information should be disclosed.
It is difficult for preparers to provide the necessary evidence documents for auditing purposes, and for auditors, auditing the appropriateness of the amount relating to synergies is challenging (even with the help of a separate assessment agency); we therefore believe that the practical burden would increase considerably for both parties.
On the other hand, the definitions in the current proposal are vague, so it is not clear what exactly needs to be measured and disclosed when disclosing quantitative information relating to synergies. There is a risk that, without definitions, there could be confusion in practice—for example when entities are deciding what to disclose or auditors are undertaking auditing work—and investors' decision-making could also be negatively impacted. It is essential to define key concepts to ensure shared viewpoints among stakeholders. In addition, steps should be taken to make it easier to understand how to apply the standard by providing additional guidance and illustrative examples to clarify which are the synergies for which quantitative disclosure is to be required.
If a synergy is important, it is disclosed in the notes on analysis of goodwill impairment as part of key assumptions, in which case information is already provided to users.
In the first place, the disclosure requirement regarding the period of synergies proposed by the Exposure Draft suggests that the useful life of goodwill can be estimated in some business combination transactions, which is inconsistent with the notion that the useful life of goodwill cannot be reasonably estimated, which is the basis for the non-amortization treatment of goodwill.
Question 6
(a)
The addition of paragraph 80B alone is sufficient; we disagree with the proposed addition of paragraphs 80A and 83(b).
Paragraphs 80A and 83(b) use two differing terms—"key management personnel" and "management"—but the difference between the two is unclear, and we believe this would cause confusion for preparers. "Key management personnel" is defined in IAS 24, but it is not clear what "management" refers to. Surely there is no great difference between "management" and "key management personnel" in actual practice.
Question 7
We agree with (a) because we believe this proposal would reduce the need for management to amend financial budgets or forecasts, thereby mitigating the associated costs and complexity.
However, the content of the proposal loosens the limitation on positive cash flows due to improvements in asset performance and other factors, and we believe that this response is inconsistent with the resolution of the "too little, too late issue." We are concerned about the inconsistency between the purpose of the changes to the impairment test set forth in this Exposure Draft and the actual proposal. We hope that the IASB, as an accounting standard setter, will not take an ad hoc approach, but rather take a logical and consistent approach that will be acceptable to all concerned parties.
We agree with (b) because this proposal takes into consideration the practical work actually involved in the impairment test and is likely to alleviate the practical burden.
Question 8
We oppose these proposals because demand for information about subsidiaries without public accountability is extremely limited and if users did require such information, their requests could be handled individually (in all likelihood, this would enable the balance between benefits and costs to be considered while providing information better suited to each user's purpose).
Adding requirements for subsidiaries without public accountability to disclose quantitative information about expected synergies and information about the contribution of the acquired business is also inappropriate in terms of maintaining balance between information needs and the practical burden on preparers.
Question 9
As noted above, we are opposed to the proposed content of the Exposure Draft as a whole. Assuming that the proposed content of the Exposure Draft is fundamentally improved, we respond to Question 9 as follows.
Sufficient preparation time is needed to respond to the revised disclosure standards for business combinations. Depending on the content of the proposed improvements and the timing of the mandatory application period to be set, we believe it is necessary to consider relief measures for first-time application.