Adopting the pushdown accounting model in IFRS will lead to a tremendous improvement in the relevance of financial statements without compromising their reliability. In line with a new extensive project taken by the IASB, and in view of the distortion resulting from the current cost accounting approach, this accounting model is an essential solution to the inadequate presentation of the economic value of intangible assets, which can constitute a significant portion of the value of many companies. Under this accounting model, upon a change in control a one-time revaluation of the acquired company’s identifiable assets and liabilities and any goodwill are recognised in its own financial statements, which are derived from the new basis of accounting determined by the acquirer. Additionally, adopting this model will obviate the existing accounting loophole in structuring acquisition transactions using target companies.
The significant development of intangible capital in recent decades, against the background of accounting limitations on recognising intangible assets, has led to a severe erosion in the relevance of many companies’ financial statements over the years. This is particularly true for technology companies, where the accounting equity often reflects a very small or even tiny portion of their market value, reaching even more extreme situations in startup companies. However, this also applies to traditional industrial companies whose business activities in the new era rely heavily on intangible assets such as goodwill and brands. For example, many industrial companies outsource their production and essentially function as brand management companies from a business perspective.
Therefore, accounting principles should allow everything possible, within existing accounting conceptual constraints, to reduce the enormous and growing gap between accounting equity and market value. The search for appropriate accounting solutions in light of this relevance problem aligns with the IASB’s extensive project examining the accounting treatment for intangible assets, which began in 2024. This project aims to examine whether the current treatment under IAS 38 regarding intangible assets is relevant and faithfully represents the economic position of the business. The project includes a survey of investors for improvements in how companies report intangible assets.
Part of the solution to this acute problem that undermines the accounting under IFRS lies in the US GAAP model of pushdown accounting, which has been greatly expanded in the last decade. According to this model, in the case of a business combination, the acquired company (private or public) has the option to record a one-time revaluation of its assets and liabilities, including recognition of goodwill, in accordance with the amounts in which the acquisition is accounted for in the acquirer’s financial statements. The purpose of this special accounting model is to reflect the acquirer’s new fair value accounting directly in the individual financial statements of the acquired company.
The basic rationale of the model is to improve the relevance of the acquired company’s financial statements. Indeed, the faithful representation of the model is undeniable since the fair value amounts are sufficiently reliable to be recorded in the parent company’s consolidated financial statements. If those amounts are reliable enough to be included in the parent company’s financial statements, which could itself be a public company, there is no reason they shouldn’t be qualified for inclusion in the subsidiary’s financial statements, whose assets and liabilities are now being measured at fair value in the acquirer’s financial statements. It is important to emphasize that a transaction where control is obtained is fundamentally different from a common situation in which a public company has a market price that does not justify revaluing its assets, as this price reflects the value of a single share and does not necessarily represent the actual value of controlling shares.
It should be noted that in the past, this model was originally permitted only by the SEC as part of regulatory guidance for companies in an IPO process. According to the guidance, if an issuer was previously acquired in a transaction involving 95% or more of its shares, it was required to apply pushdown accounting. If 80-95% of its shares were acquired, it was merely an accounting policy choice. And if less than 80% of its shares were acquired, pushdown accounting could not be applied at all. Without delving into the problems inherent in these bright-line rules, in November 2014 the Financial Accounting Standards Board (FASB) published ASU 2014-17 that allows all acquired companies (private or public) to apply pushdown accounting upon a change in control (for example, based on acquiring over 50% of the voting rights). As a result, the SEC rescinded its previous guidance. While the FASB officially recognised this special accounting model and even expanded its application, it uncommonly left it as a matter of accounting policy choice. The guiding concept was that improving relevance was preferable to the potential impact on comparability among companies.
Reverse Reporting Interest: Profitability Over the Statement of Financial Position
While the US GAAP pushdown accounting model relates to a one-time revaluation of all identifiable assets and liabilities as well as recognition of goodwill, triggered by a change in control, the accounting treatment is anything but new to IFRS reporters. To implement the model, the acquired company records a one-time revaluation of its own identifiable assets and liabilities (including those not previously recognised in its financial statements) and recognizes any goodwill, just as the acquirer does. Indeed, the accounting treatment is similar to implementing the revaluation model for PP&E under IAS 16, creating a reserve that is never reclassified to profit or loss. It should be noted that besides the revaluation model already existing under IFRS for PP&E, other one-time fair value measurements exist in certain cases, such as deemed cost for first time IFRS adopters (IFRS 1) and theoretically it is even possible for intangible assets with an active market (IAS 38).
It is important to emphasize that this is not a matter of reporting expediency, and adoption of our proposed model will not necessarily play into the hands of management. This is because in many cases, especially for technology companies, it is not advantageous to record a one-time revaluation of assets, since it will increase amortization expense in subsequent years, and lead to the risk of recognising impairment losses on goodwill and other intangible assets. In other words, management understands that analysts and potential acquirers already assume the statement of financial position is irrelevant, and therefore management usually prefers to avoid negative impacts on future profitability. Moreover, recognizing such amortization could have negative implications on the ability to make a distribution from retained earnings.
Existing Accounting Loophole
Even more alarming, at least in some cases under IFRS, there is currently an accounting loophole, where companies interested in a one-time revaluation can easily structure the acquisition in a way that leads to a result essentially the same as pushdown accounting. This can be illustrated by the following simple example (ignoring tax effects):
Assume Company A wants to acquire all shares of Company B and to record a one-time revaluation in Company B’s own financial statements. For the acquisition, Company A establishes Company C (Newco) as a wholly owned subsidiary and transfers the required cash to Company C for the acquisition. Company C acquires Company B’s operations. In this case, Company C’s financial statements (which are essentially Company B’s) would measure Company B’s assets and liabilities at fair value and record its goodwill. This is because it is an ordinary business combination (between unrelated parties) where the acquisition method is applied, rather than a business combination under common control. This simple accounting manipulation works, of course, even when obtaining control of Company B without acquiring all its shares.
Thus, adopting the pushdown accounting model will obviate the accounting loophole that currently exists for companies in the process of public offerings. Assuming in the above example that after several years Company B considers going public, it is unreasonable that conducting the IPO through Company C would lead to measuring assets and liabilities at their revalued amount, while an IPO of Company B, which is effectively a mirror image of Company C, would result in a substantially lower amount. Implementing the pushdown accounting model in this case would lead to identical measurement of Company B’s assets and liabilities under both alternatives.
In our opinion, this important principle that obviates the accounting loophole should be applied even when an intermediate parent in a holding chain is acquired. For example, if Company A obtains control of Company B, which itself controls Company C, then Company C would also be required to apply pushdown accounting in its own financial statements. The fact that this model has been applied in the U.S. for many years can greatly assist with implementation for companies applying IFRS.
Time for Mandatory Application
In conclusion, we believe that as a reporting framework that prioritizes relevance, and against the background of the existing accounting distortion regarding intangible assets, the IFRS should adopt a mandatory application of the pushdown accounting model. We believe that management’s reporting interest to avoid amortization in order to increase future profits would not provide useful information to investors and should not be considered by the IASB when setting guidance, given the neutrality of the information reported, as stated in the Conceptual Framework.
Without delving into the problems inherent in the fact that in the U.S. implementing the model is currently subject to management choice, one cannot ignore that, somewhat oddly, the pushdown accounting model can be implemented under US GAAP, which is generally considered more conservative, while such implementation is prohibited under IFRS, which is considered more liberal and enthusiastic of the fair value model.
Such a move, if accompanied by improvements in the accounting treatment of research and development costs as intangible assets (see previous post on the subject), aligns with the IASB’s new project and can dramatically improve the relevance of companies’ financial statements in the new era.
(*) This paper was co-authored by Shlomi Shuv and Gil Katz, Partner, Department of Professional Practice, EY Israel