Introduction
Accounting for a business combination under IFRS 3 (Business Combinations) raises new issues for companies used to the requirements of a different GAAP regime. For quoted companies in Europe, and beyond, IFRS is already with us and even if most companies have yet to report accounts prepared in accordance with IFRS, they must account for any future business combinations, and indeed any completed since 31 March 2004, under IFRS. This article considers some key issues for goodwill and intangibles seen when implementing IFRS 3 for business combinations for the first time.

What did we buy?
The acquiring entity must recognise all the identifiable assets, liabilities and contingent liabilities of the acquired entity, irrespective of whether they were recognised in that entity's balance sheet, at fair value where it can be measured, where it is probable that:

· future economic benefits from a tangible asset will flow to the acquirer
· an outflow of resources will be required to settle a liability

In the case of intangible assets and contingent liabilities, it is sufficient that they are identifiable and that their fair values can be measured reliably. If so, they must be recognised. The recent announcement of the purchase of RAC by Aviva will undoubtedly require a valuation of the RAC brand as well other brands and intangibles that may be relevant. With net assets on their 2004 balance sheet of some £500m and a purchase price of £1.1bn, the RAC brand is clearly of considerable value.

What happened to goodwill?
Acquired goodwill represents the difference between the purchase consideration and the total of the fair values of all the acquired assets and liabilities. IFRS 3 actually defines goodwill in these terms: - "Goodwill represents a payment made by the acquiring entity in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised". With the recognition of most intangible assets, we expect that amounts allocated to goodwill will be much smaller than in the past. The expectation of the market and investors is that goodwill will be a relatively small component of the total purchase price. They are likely to be very uncomfortable with any deals with a large unexplained goodwill component which suggests that the price may have been too high.

If the residual goodwill turns out to be negative, the standard actually requires that the fair values be reassessed, presumably on the grounds that such an outcome is too good to be true. If it is true, however, then the negative goodwill is taken straight to profit.

After the dust has settled
The valuation of assets and liabilities at the acquisition date is not the end of the story. Most of the fair value adjustments disappear fairly rapidly. For instance, a fair value adjustment to finished goods stock should be written off to P&L over the period during which that stock is consumed (i.e. sold).

The intangible assets have to be assigned useful lives. If there is no foreseeable limit to the period of future cash flows from the asset, it should be assigned an indefinite life, in which case there is no amortisation charge. This is usually the case for brands and mastheads. For all other intangible assets, the useful life is defined by the period of future cash flows and may depend in many factors including technological advances, length of patent protection and so on. Such assets must be amortised over that life, normally on a straight line basis.

For intangibles with indefinite lives, it is necessary to review annually the value of intangibles for any impairment. If the calculated fair value of the intangible is lower than its book value, that value must be written down to the impaired value. If, in future years, the fair value increases again, the write down can be reversed.

Goodwill is always considered to have an indefinite life and is also subject to annual impairment testing, but this differs from that for intangibles in two respects. Firstly, any impairment of goodwill is deemed to be permanent and cannot be reversed in the future. Secondly, goodwill does not, directly, generate cash flows. It must be assigned to a cash generating unit and it is the total value of all the assets, including goodwill, of the cash generating unit that is compared to its fair value. In the event of a shortfall, the goodwill is reduced in value by a charge to profit.

Goodwill should be assigned to cash generating units at the level at which management monitors goodwill. In practice, management frequently doesn't manage goodwill other than at group level, so that the reporting segments define the upper limits for cash generating units. If it can be argued that the cash flows within a segment are inter-related, for instance if the segment comprises vertically production and sales and distribution units, it should be possible to assign goodwill at the segment level.

Conclusion
In many ways, accounting for business combinations under IFRS will not be significantly different from previous practice. Where it is going to be different, management will need to exercise fine judgement, not least because transactions will come under closer scrutiny from analysts and investors.

Identifying intangible assets and contingent liabilities will be a key area. Valuations of these assets and liabilities will need to be supported and consideration given to the use of appropriate internal, or external, expertise to provide supporting evidence.

Goodwill which remains will give rise to questions about the price agreed for the deal, while any impairment of that goodwill in the future will be read as an indication of a poor deal.