accounting for business combinations and consolidated financial statements

International Financial Reporting Standards

The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.

© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Accounting for business combinations

and consolidated financial statements

Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB,

30 April to 4 May 2012


The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation

ControlIFRS 10 Consolidated Financial Statements

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Objective

• Information about

• resources under the control of the group (assets) and

• claims against those resources

assists users to better assess the prospects for future net cash inflows to the group which is useful in making decisions about providing resources to the group.

• The global financial crisis highlighted the importance of enhancing disclosure requirements, in particular for special purpose or structured entities.

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Definition of control

• Single consolidation model for all entities, including structured entities

• Consolidation based on control – ‘power so as to benefit’ model

• Investor must have some exposure to risks and rewards

• Exposure is an indicator of control but not control of itself

• Power arises from rights—voting rights, potential voting rights, other contractual arrangements, or a combination thereof.

An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the

investee and has the ability to affect those returns through its power over the investee.

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Assessing control of an investee

• Consider the purpose and design• Identify the activities of the investee that significantly

affect the returns of the investee (relevant activities)• Identify how decisions about relevant activities are

made• Determine whether the rights of the investor give it the

ability to direct the relevant activities (see next slide)• Determine whether the investor is exposed, or has

rights, to the variability associated with the returns of the investee

• Determine whether the investor has the ability to use its power over the investee to affect its own returns

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Example:Control

In the absence of evidence to the contrary, in each scenario below, does A control Z?

i. A owns 100% of Z.

ii. A owns 51% of Z.

iii. A owns 50% of Z.

iv. A owns 50% of Z and holds currently exercisable ‘in the money’ options to acquire another 100 shares in Z.

v. Same as (iv) except B owns the options.

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Example:Structured entity

A pharmaceutical manufacturer (entity A) established a viral research centre (RC) at a university.

• A determined sole & unalterable purpose of RC = research & develop immunisation & cures for viruses that cause human suffering.

• RC is owned and staffed by the university.


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• All costs of establishing & running RC are paid by the university from the proceeds of a grant from A.

• the budget for the research centre is approved by A yearly in advance.

• A benefits from the research centre:

• by association with the university; and

• through exclusive right to patent any immunisations and cures developed.

Example:Structured entity continued


De facto control

• Entity can control with less than 50% of voting rights.

• Factors to consider include:

• size of the holding relative to the size and dispersion of other vote holders

• potential voting rights

• other contractual rights

• If the above not conclusive consider additional facts and circumstances that provide evidence of power (eg voting patterns at previous board meeting, etc)

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Example:de facto control

• Entity A owns 45 per cent of the ordinary shares of Entity B to which voting rights are attached.

• Entity A is the largest shareholder of Entity B.

• It also has the right to appoint the majority of the members of the Board of Directors (the management board) of Entity B in accordance with special rights given to Entity A in the founding document of the entity.

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Example:Assessing power

• Entity A and B each have 50% ownership interest in the trust.

• Entity A appointed as manager of trust.

• Manager: manages the assets of the trust, identifies development opportunities, manages development activity and manages leasing activity. Cannot be removed without cause.

• Relevant activities?

• Who directs?

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Trust

Entity A Entity B


Example:Delegated rights

Responsible entity:

• Broad decision making powers

• Removal by simple majority

• Remunerated via market-based fee - 1% of assets under management and 20% of profits over a hurdle

• Equity interest of 20%

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Investment trust

Responsible entity

Other investors

Investment portfolio


Potential voting rights

• Substantive potential voting rights (PVR) can give the holder power

• Consider the terms and conditions, including:

• Whether there are any barriers that prevent the holder from exercising

• Whether exercise of the rights would be beneficial to the holder

• Whether the rights are exercisable when decisions need to be made

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Agency relationships

• Consider all of the following factors:• scope of the decision-making authority• rights held by other parties (ie kick-out rights)• remuneration of the decision-maker• other interests that the decision maker holds in the

investee

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• Determining whether an investor controls an investee involves assessing whether the investor:

• has power over the investee

• exposure, or rights, to variable returns from its involvement with the investee

• the ability to use its power over the investee to affect the amount of the investor’s returns.

15Judgements and estimates


• Factors to consider when assessing whether control exists include, for example:

• assessing the purpose and design of the investee (eg are voting rights or contractual arrangements the dominant factor?)

• identifying relevant activities and how decisions about those activities are made

• assessing current ability to direct (practical ability to direct the relevant activities unilaterally?)

16Judgements and estimates continued




IFRS 3Business Combinations

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Introduction

• A business combination is a transaction or other event in which a reporting entity (the acquirer) obtains control of one or more businesses (the acquiree).

• IFRS 3 does not apply to the following:

• the formation of a joint venture

• the acquisition of an asset or group of assets that is not a business as defined

• a combination of entities or businesses under common control

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The acquisition method

• Business combinations are accounted for using the acquisition method, ie

• identifying the acquirer;

• determining the acquisition date;

• recognise and measure the identifiable assets acquired and the liabilities assumed and any non-controlling interest; and

• recognise and measure any goodwill or bargain purchase.

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Identifying the acquirer

• The acquirer is the entity that obtains control of another entity

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Example:Who is the acquirer?

• On 31/12/20X0 A has 100 shares in issue.

• On 1/1/20X1 A issued 200 new A shares to the owners of B in exchange for all of B’s shares.

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Determining the acquisition date

• The acquisition date is the date on which the acquirer obtains control

• often the date the consideration is transferred, assets are acquired and liabilities assumed—closing date

• may be other dates (earlier or later than the closing date) at which control is assumed

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• Recognition principle (IFRS 3.10–17):

• separate recognition of identifiable assets acquired, liabilities and contingent liabilities assumed (think Conceptual Framework)

• Measurement principle (IFRS 3.18–20):

• assets and liabilities that qualify for recognition are measured at their acquisition-date fair values

• measurement at fair value provides relevant information that is more comparable and understandable (IFRS 3.BC198)

23Recognition and measurement


• Reacquired rights

• measured at fair value based on remaining contractual term ignoring the fair value effect of renewal

• Share-based payment transactions

• replacement awards: measured in accordance with IFRS 2

• Assets held for sale

• measured in accordance with IFRS 5 (ie fair value less costs to sell)

24Exceptions to the measurement


• Income taxes

• deferred tax assets or liabilities arising from acquired assets or liabilities accounted for using IAS 12

• Employee benefits

• accounted for using IAS 19

• Indemnification assets

• may not be recognised at fair value if it relates to an item not recognised or measured in accordance with IFRS 3

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Exceptions to both the recognition and measurement principles


• The consideration transferred is measured at the fair value of the sum of assets transferred and liabilities assumed

• acquisition-related costs are excluded

• contingent consideration is included at its fair value at acquisition date (subsequent changes in fair value are not included in the consideration transferred at acquisition-date)

26Consideration transferred


Example:What is the cost of the Bus Com?

• Entity A acquires 75% of entity B in exchange for CU85,000 cash and 1,000 entity A shares (fair value = CU10,000) issued for the transfer.

• Entity A incurred CU5,000 advisory and legal costs directly attributable to the business combination and CU1,000 share issue expenses.

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Goodwill (an asset) is measured initially indirectly as the difference between the consideration transferred (see IFRS 3.37–40) excluding transaction costs in exchange for the acquiree’s identifiable assets, liabilities and contingent liabilities (measured as set out above)

28Goodwill


• If the value of acquired identifiable assets and liabilities exceeds the consideration transferred, the acquirer immediately recognises a gain (bargain purchase)

• Goodwill is not amortised, but is subject to an impairment test.

• If less than 100% of the equity interests of another entity is acquired in a business combination, non-controlling interest is recognised.

• Choice in each business combination to measure non-controlling interest either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

29Goodwill continued


• Comprehensive disclosure requirements designed to enable users to evaluate the nature and financial effects of business combinations (and any adjustments made to prior period business combinations).

• Refer to IFRS 3.B64–B67.

30Disclosure


• The main differences between IFRS 3 and Section 19 Business Combinations and Goodwill of the IFRS for SMEs include:

• the costs associated with acquisition are included in the consideration transferred rather than being expensed

• changes in the recognised amount of contingent consideration affect goodwill

• goodwill is amortised over its estimated useful life (or 10 years if a reliable estimate cannot be made)

• non-controlling interest must be measured using the proportionate share method

31Comparison to the IFRS for SMEs


• Determining whether a particular set of assets and activities is a business requires assessing their capabilities of being conducted and managed for the purpose of providing economic benefits.

• Identifying the acquirer in some business combinations that combine two or more entities can require judgement.



• Accounting for business combinations requires broad use of fair value estimates. Level 3 fair value measurement can require significant judgements and estimates (see IFRS 13).

• The acquiree’s identifiable intangible assets at the acquisition date are recognised separately and might include assets that have not been recognised by the acquiree.





IFRS 10Consolidated Financial

Statements

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Effective Date

• Aligned effective date for IFRS 10 and IFRS 12

• Annual periods beginning on or after 1 January 2013

• Earlier application permitted if applied as a package

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Introduction

• IFRS 10 establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities.

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• An entity that has one or more subsidiaries (a parent) must present consolidated financial statements.

• Two exceptions:• a parent if:

• its owners have been informed and do not object, • its securities are not publicly traded or in the process of

becoming publicly traded, and • its parent publishes IFRS-compliant financial statements

that are available to the public.

• Post-employment plans or other long-term employee benefit plans to which IAS 19 applies

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Who presents consolidated financial statements?


• Consolidated financial statements present the parent and all its subsidiaries as financial statements of a single economic entity

• uniform accounting policies

• same reporting periods

• eliminate intragroup transactions and balances

• non-controlling interest (the equity in a subsidiary that is not attributable, directly or indirectly, to the parent) is presented within equity, separately from the parent shareholders’ equity.

38Principle


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Example:Consolidation procedures

• On 1/1/20X1 entity A acquires 100% of entity B for

CU1,000 when B’s share capital & reserves = CU700 (net

FV of B’s assets & liabilities = CU800).

• B has no contingent liabilities. The CU100 difference

between CA & FV is i.r.o. a machine with 5 yrs remaining

useful life and nil residual value.

• B’s profit for the year ended 31/12/20X1 = CU400.

• In 20X1 A sold inventory which cost it 100 to B for 150. At

31/12/20X1 B’s inventory included CU60 inventory bought

from A.

• Ignore taxation effects.© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

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• The proforma journal entry at acquisition to eliminate

A’s investment in B; recognise goodwill; & eliminate B’s

share capital & reserves accumulated before it became

part of the group.

Property, plant & equipment 100

B’s at-acquisition share capital & reserves

700

Goodwill (asset) 200

A’s investment in B 1,000

Example:Consolidation procedures continued


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• Proforma journal entry to increase depreciation to

group values (remaining estimated useful life = 5

years):


Profit or loss 20



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• Proforma journal entry to eliminate intragroup sale of

inventory and the unrealise profit in inventories

(ignoring tax effects):

Profit or loss (revenue) 150

Profit or loss (COS) 150


Inventory (asset) 20



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• Non-controlling interest (NCI) in net assets consists of:

• the amount of the NCI recognised in accounting for Bus Com at date of acquisition; plus

• the NCI’s share of recognised changes in equity (ie recognised changes in Sub’s net assets) since the date of the combination.

Non-controlling interest (NCI)


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Example:NCI

• On 1/1/20X1 entity A acquires 75% of entity B for CU1,000 when B’s share capital & reserves = CU700 (net FV of B’s assets & liabilities = CU800).

• B has no contingent liabilities. The CU100 difference between CA & FV is i.r.o. a machine with 5 yrs remaining useful life and nil residual value.

• Ignore taxation effects. B’s profit for the year ended 31/12/20X1 = CU400.

• In 20X1 A sold inventory which cost it 100 to B for 150. At 31/12/20X1 B’s inventory included CU60 inventory bought from A.


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Eliminate Investment

• Proforma journal entry at acquisition is:

Property, plant & equip. 100

B’s at-acquisition share capital & reserves

700

Goodwill 400

Non-controlling interest 200

A’s investment in B 1,000

Example:NCI continued


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Adjust consolidated depreciation• Proforma journal entry to increase depreciation to

group values (remaining estimated useful life = 5 years):

Profit or loss 20




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Allocate profit• Proforma journal entry allocating the NCI their share of

B’s profit for the year:

NCI profit allocation 95

NCI (equity) 95

Calculation: Profit 400Depreciation adjust (20)

38025% attributable to NCI 95



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• Proforma journal entry to eliminate downstream intragroup sale of inventory and the unrealised profit in inventories (ignoring tax effects):

Profit or loss (revenue) 150



Inventory (asset) 20



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• Same as previous example except upstream sale of inventory (ie from B to A)

• Same proforma journal entries as in previous example and an additional journal entry (below) to eliminate from NCI their share of the unrealised profit:

NCI (equity) 5

NCI profit allocation 5

Example:NCI upstream sale


• If a parent no longer controls a subsidiary, the parent:

• Derecognises the assets and liabilities of the former subsidiary.

• Recognises any retained investment at fair value when control is lost. This investment is subsequently accounted for as a financial instrument or, if appropriate as an associate or joint venture.

• Recognises a gain or loss associated with loss of control.

50Loss of control


• Section 19 Business Combinations and Goodwill of the IFRS for SMEs differs from full IFRSs—in Section 19:

• goodwill is amortised over its estimated useful life (or 10 years if a reliable estimate cannot be made)

• non-controlling interest must be measured using the proportionate share method

• there is no specified maximum allowable difference between the reporting periods of the parent and the subsidiary.

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Comparison with the IFRS for SMEs




IFRS 12Disclosure of Interests in

Other Entities

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Introduction

• IFRS 12 applies to entities that have an interest in a subsidiary, a joint arrangement, an associate or an unconsolidated structured entity.

• It does not apply to (paragraph 6):• Post-employment plans to which IAS 19 applies.

• Entities’ separate financial statements to which IAS 27 applies.

• A joint arrangement where joint control does not exist (unless significant influence exists).

• An interest in another entity accounted for in terms of IFRS 9 (with exceptions).

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• Users have consistently requested improvements to the disclosure of a reporting entity’s interests in other entities.

• The global financial crisis also highlighted a lack of transparency about the risks to which a reporting entity was exposed from its involvement with structured entities.

• In response to input received from users and others, the IASB decided to address in IFRS 12 the need for improved disclosure of a reporting entity’s interests in other entities.

54Reasons for issuing IFRS 12


• IFRS 12 requires an entity to disclose information that

enables users of financial statements to evaluate:

• the nature of, and risks associated with, its interests

in other entities; and

• the effects of those interests on its financial

position, financial performance and cash flows.

• That evaluation assists users in making decisions about

providing resources to the entity.

55Objective


56 Disclosures

• significant judgements and assumptions made

• information about interests in:

• subsidiaries

• joint arrangements and associates

• unconsolidated structured entities

• any additional information that is necessary to meet the

disclosure objective

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Strike a balance between overburdening financial statements with excessive detail and obscuring information

as a result of too much aggregation


57Subsidiaries

• The composition of the group (including any

changes)

• Involvement of NCI in the group’s activities (including

profit and loss allocation and summarised financial

information for subsidiaries with large NCI)

• The effect of significant or unusual restrictions on

assets and liabilities

• The nature of, and changes in, the risks associated

with structured entities

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58Unconsolidated structured entities

Nature and extent of interests in unconsolidated structured entities• eg nature, purpose, size, activities and financing

• For sponsors not providing other risk disclosures• Type of income earned

• The carrying amount of all assets transferred

Nature of, and changes in, the risks associated with an entity’s interests• Carrying amount of the assets and liabilities recognised

• Maximum exposure to loss and comparison to carrying amounts

• Non-contractual support provided

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• An entity must disclose information about significant

judgements and assumptions it has made in

determining:

• control of another entity (see IFRS 10)

• Joint control (see IFRS 11) of an arrangement or

significant influence (see IAS 28) over an entity

• type of joint arrangement when the arrangement has

been structured through a separate vehicle



• For unconsolidated structured entities, a summary of

the amount that best represents the entity’s maximum

exposure to loss for its interest must be provided.



61Questions or comments?

Expressions of individual views

by members of the IASB and its

staff are encouraged.

The views expressed in this

presentation are those of the

presenter.

Official positions of the IASB on

accounting matters are

determined only after extensive

due process and deliberation.


© 2011 IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org

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The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January 2012 but not the IFRSs they will replace.

The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.

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© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org