1. www.efrag.org Consolidation and Business Combinations Changes to IFRS 3, IAS 27, IAS 37 ASEM IFRS SEMINAR Shanghai, 25-26 March 2006 Reinhard Biebel, EFRAG Deputy Technical Director

2. © EFRAG 2006 2 AISAM SEMINAR 25-26 March 2006 Consolidation - Combination Acquisition Common Control Joint Venture Hostile take-over Merger Need for consolidated information De facto Control

3. © EFRAG 2006 3 AISAM SEMINAR 25-26 March 2006 Racing ahead … IAS 22(revised 1993) minor changes SIC 9, 22 & 28 31 March  IFRS 3 minor changes 2004-2005 30 June  ED IFRS 3 ?  common control fresh-start (true mergers) 1993 1996 -1999 2004 2005 ????

4. © EFRAG 2006 4 AISAM SEMINAR 25-26 March 2006 ED IFRS 3 – Phase II  Issued 30 June 2005  Joint project with US standard setter FASB  Objective = improvement and convergence IASB/FASB  Consequential amendments to IAS 27, 37 and 19  Completely new method of treating:  Business combinations  Minority interests (now: non-controlling interests)  Contingent assets and liabilities

5. © EFRAG 2006 5 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Changes to terminology Minority-interests Non-controlling interest (NCI)

6. © EFRAG 2006 6 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Changes to definitions Business combination [IFRS 3] The bringing together of separate entities or businesses into one reporting entity Business combination [ED IFRS 3] A business combination is a transaction or other event in which an acquirer obtains control of one or more businesses

7. © EFRAG 2006 7 AISAM SEMINAR 25-26 March 2006 Control under IAS 27 IASB Statement, IASB Update October 2005: “IAS 27 contemplates that there are circumstances in which one entity can control another entity without owning more than half the voting power.”

8. © EFRAG 2006 8 AISAM SEMINAR 25-26 March 2006 Acquisition method  Amendment: Purchase Method  Acquisition Method 1.Identify acquirer 2.Determine the acquisition date 3.Measure the fair value of the acquiree 4.Recognise and measure identifiable assets acquired and liabilities assumed at fair value  1+2  similar to current IFRS 3  3+4  amended to reflect the transition to full fair value

9. © EFRAG 2006 9 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Significant changes IFRS 3ED IFRS 3 Business combination recognised and measured at the acquiror’s accumulated cost at the acquisition date (aggregate of the fair values of assets given, liabilities assumed, and equity instruments issued) Business combination recognised and measured at fair value of the acquiree at the acquisition date Even if achieved in stages or if less than 100% of the equity interests are owned Direct costs of acquisition recognised in the cost of the business combination Direct costs of acquisition recognised separately, i.e. typically in profit or loss

10. © EFRAG 2006 10 AISAM SEMINAR 25-26 March 2006 IFRS 3ED IFRS 3 Contingent consideration only recognised in the cost of acquisition at the acquisition date, if payment is probable and can be measured reliably Contingent consideration measured at fair value at the date of acquisition Subsequent changes in contingent consideration affect goodwill (+/÷) Subsequent changes in contingent consideration classified as liabilities are recognised in accordance with IAS 39, IAS 37 or other relevant IFRS and typically affect profit or loss Large number of disclosures required More new disclosure requirements ED IFRS 3: Significant changes

11. © EFRAG 2006 11 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Significant changes - goodwill gross up  Acquired business measured at fair value as a whole  100% goodwill recognised  Consistent with treatment of other assets  Goodwill allocated between acquirer and non- controlling interest (was minority interest)  Allocation of goodwill to acquirer based on:  Fair value of acquirer’s equity interest LESS  Fair value of share of net assets acquired  Balance to NCI

12. © EFRAG 2006 12 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Goodwill example  P acquires 75% (750 000 shares) of S for CU7.5m  Shares in S trading about A$8 per share  Expectation of synergies  Independent valuation  value of S = CU9.7m  Fair value of net assets acquired = CU8m Current requirements IFRS 3 Consideration7,5 Share of identifiable A+L (75% 8m) (6,0) Goodwill as per IFRS 31,5 Current requirements IFRS 3 Goodwill1,5 Net assets8,0 Minority interest2,0

13. © EFRAG 2006 13 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Goodwill example Current requirements IFRS 3 Goodwill1,5 Net assets8,0 Minority interest (MI)2,0 ED IFRS 3 Fair value of S9,7 Fair value of net assets(8,0) Goodwill1,7 ED IFRS 3 - allocate to P Consideration7,5 Share of identifiable A+L (75% 8m) (6,0) GW allocated to P1,5 => Balance to NCI0,2 ED IFRS 3 Goodwill1,7 Net assets8,0 Non-controlling interest (NCI) 2,2

14. © EFRAG 2006 14 AISAM SEMINAR 25-26 March 2006 Step acquisitions  Change in accounting for step acquisitions  A owns an investment in B  B = associated comp to A (i.e. A doesn’t control B)  If A increase its stake & gains control over B it must  Determine fair value of associate  Recognise profit/loss in income statement  Follow the provisions of IFRS 3 Cost would include fair value of B

15. © EFRAG 2006 15 AISAM SEMINAR 25-26 March 2006 Step acquisition – illustration  A owns 35% stake in B at 31 Dec 2007  Book value at 31 Dec 2007 = CU2,500  Buying additional 40% on 31 Dec 2007 at CU4,000  Fair value (FV) of total B = CU10,000 31 Dec 2007  A recognise gain of CU1,000 [(35%*CU10,000)- CU2,500]  A accounts for 40% purchase under ED IFRS 3  FV of all of B = CU10,000 and FV of 75% of B = CU7,500  Subsequent purchases = equity transaction

16. © EFRAG 2006 16 AISAM SEMINAR 25-26 March 2006 ED IFRS 3: Acquisition costs Direct acquisition costs Recognised in profit or loss Represent payment for services (e.g. legal costs. auditor, bank) Do not represent assets of acquirer Impact on goodwill

17. © EFRAG 2006 17 AISAM SEMINAR 25-26 March 2006 Contingent consideration  Fair value of consideration paid includes fair value of contingent consideration at acquisition date  Classify as debt or equity per IAS 32  Examples  Financial or non-financial hurdles  Share-based payment

18. © EFRAG 2006 18 AISAM SEMINAR 25-26 March 2006 Contingent consideration  Measurement period* adjustments  12 months from date of acquisition (no change)  New information about facts existing at acquisition date  Post measurement period  Equity  not remeasured  Otherwise  re-measure  No impact on business combination * Measurement period = reasonable time to obtain information about facts and circumstances existing at acquisition date. Limited to on year.

19. © EFRAG 2006 19 AISAM SEMINAR 25-26 March 2006 Contingent consideration - example  Contingent consideration of CU6m payable if certain profit targets met  Fair value on acquisition date is CU4m  Subsequent changes reported in I/S  As likelihood of meeting target increases, so does liability  When target met, liability is recorded at CU6m  CU2m will have been recorded in I/S  No impact to accounting for business combination

20. © EFRAG 2006 20 AISAM SEMINAR 25-26 March 2006 Other changes  Date of acquisition  Recognition of intangibles – probability and reliability criterion!  Treatment of negative goodwill  …

21. © EFRAG 2006 21 AISAM SEMINAR 25-26 March 2006 Board members view on ED IFRS 3  Proposed effective date 1 January 2007  Quite a few IASB Board Members have dissenting opinions (alternative views)  Recognise goodwill at 100%5 dissenters  Increase/decrease in stake after control3 dissenters  Definition of ‘business combination’ 2 dissenters  Widening of scope1 dissenter  Direct cost to be recognised in I/S2 dissenters  Removal of ’reliable measurement’ -criteria re. intangible assets in Business Combinations1 dissenter  Important joint project with FASB

22. © EFRAG 2006 22 AISAM SEMINAR 25-26 March 2006 EFRAG position on ED IFRS 3 Reasons for not supporting the EDs:  introduction of radical new and untested concepts,  the reasons for issuing the proposals and the assumed benefits,  the increased use of fair value without a conceptual debate,  the accounting for business combinations at fair value,  the application of an economic entity view,  the proposed full goodwill method,  the proposed treatment of acquisitions in steps,  the extended scope without providing a solution for true mergers. This does not pre-empt an assessment regarding endorsement

23. © EFRAG 2006 23 AISAM SEMINAR 25-26 March 2006 Business Combinations II: Changes to other standards

24. © EFRAG 2006 24 AISAM SEMINAR 25-26 March 2006 Other standards affected  IAS 27 Consolidated and Separate Financial Statements  IAS 37 Provisions, Contingent Liabilities and Contingent Assets  IAS 19 Employee Benefits  Purpose of proposed changes:  to align ongoing accounting with that required on a business combination (e.g. re contingencies)  to align IFRS with US GAAP in certain areas (e.g. restructuring)

25. © EFRAG 2006 25 AISAM SEMINAR 25-26 March 2006 ED IAS 27: “non-controlling interest” (NCI)  ‘Minority interest’ ‘non-controlling interest’  Non-controlling interest classified as equity  Transactions with NCI = equity transactions  Gains/losses recorded in P&L only on loss of control  Losses applicable to NCI are allocated to NCI - any guarantees/support arrangements accounted for separately  currently, losses not allocated to minority unless binding obligation on them to make good losses incurred which they are able to meet

26. © EFRAG 2006 26 AISAM SEMINAR 25-26 March 2006  Increase from 80% to 100%  Transaction with EQ holders =>  No change to goodwill (already at 100%)  No gain/loss recorded  Consideration paid/payable debited to EQ  Current position – no detailed guidance  Typically recognise additional goodwill  Different views internationally  how to measure additional GW  what to do about fair value changes re assets / liabilities ED IAS 27: Increased stake in sub ED IAS 27DC NCI (share of consolidated equity) 20 Equity*10 Cash/creditors30  A owns 80% of B  Consolidated equity of B = 100  A’s share = 80, NCI = 20  A buys remaining 20% for 30  Debit of 10 = excess price parent paid to acquire NCI *The draft doesn’t explain where these debits/credits should be recognised

27. © EFRAG 2006 27 AISAM SEMINAR 25-26 March 2006  Decrease from 80% to 60%  Transaction with EQ holders =>  No change to goodwill (already at 100%)  No gain/loss recorded  Consideration received / receivable credited to EQ  Current position – no detailed guidance:  Typically recognise gain or loss on “part disposal”  No real consensus on reduction to goodwill? ED IAS 27: Decreased stake in sub ED IAS 27DC Cash/debtors40 NCI (share of consolidated equity) 24 Equity16  A owns 80% of B  Consolidated equity of B = 120  A’s share = 96, NCI = 24  A sells 20% for 40  A retains control over B  Credit of 16 = gain from sale of NCI  Currently gain/loss goes to P/L. Not possible under the ED.

28. © EFRAG 2006 28 AISAM SEMINAR 25-26 March 2006 ED IAS 27: disposal of subsidiary  Disposal  when loss of control  Need not involve change in stake  On disposal, any continuing EQ interest to be remeasured to FV  currently, typically roll forward appropriate proportion of carrying amount  Gain/loss to income statement on disposal determined as  FV of Proceeds + FV of any retained investment MINUS  Aggregate of parent’s interest in carrying amount of net assets prior to disposal ED IAS 27 Cash/receivables500 + FV, remaining investment400 Total900 - Consolidated NA of B(800) Gain on disposal100  A owns 100% af B  Consolidated equity of B = 800  A sells 60% and loses control  Proceeds on sale of 60% = 500  FV of remaining 40% = 400 FV of remaining 40% (400) applied as cost of initial investment under IAS 28

29. © EFRAG 2006 29 AISAM SEMINAR 25-26 March 2006  ‘Contingent liabilities’ & ‘contingent assets’ cease to exist  If obligation exists = ‘non-financial liability’  If rights exist = asset  If obligation/rights don’t yet exist because conditional = ‘contingency’ ED IAS 37: change to terminology

30. © EFRAG 2006 30 AISAM SEMINAR 25-26 March 2006 ED IAS 37: New Recognition Criteria 100% 50% 0% IAS 37 ED Probability Example  A has obligation to B  20% chance A will have to pay CU1m  80% chance A will pay nothing  Currently: no provision  Proposed: recognise CU0,2m liability (CU1m x 20%)  Similar applies to assets: if rights exist, recognise asset (IAS 38/IAS 37) Result = more asset & liabilities on balance sheet ÷ Probability criterion omitted from ED

31. © EFRAG 2006 31 AISAM SEMINAR 25-26 March 2006 ED IAS 37: Measurement Measurement principle Move away from concept of ‘best estimate’ to more fair value based ’exit value’ Future events Take into consideration if sufficiently objective evidence exits Reimbursements Move away from ’virtually certain’. Recognise if unconditional right to receive. Restructurings Recognise only when definition of liability is satisfied. Specific guidance deleted. Single obligation ‘Most likely outcome’ not necessarily consistent with the ED’s measurement objective

32. © EFRAG 2006 32 AISAM SEMINAR 25-26 March 2006 Conclusion New proposals for accounting for Business Combinations are seen critical because of:  Increased use of fair value  New an untested concepts  Practicability concerns  Usefulness of information  Scope IASB indicated to re-deliberate most of new concepts Final standard in 2007 Will IASB and FASB come up with a practical solution ?

33. © EFRAG 2006 33 AISAM SEMINAR 25-26 March 2006 “ xiè xie”