1. IFRS 3: Business Combinations
IFRS Webcast 1 September 2010
Jane Meade RSM Bird Cameron
Jude Doliente RSM Prince

2. Agenda for Today’s Webcast
Overview of main provisions of IFRS 3
Focus on complex areas in practice:
Identifying the acquirer
Determining acquisition date
Purchase price allocation
Step acquisitions
Transactions between entities under common control
1 September 2010

3. Overview of IFRS 3 - Scope
Applies to transactions or other events that meet the definition of a business combination
Does not apply to:
formation of a joint venture
acquisition of asset or group of assets that does not constitute a business
a combination of entities or businesses under common control
1 September 2010

4. Overview of IFRS 3 – what is a business?
Business Combination:
Business:
“A transaction or other event in which an acquirer obtains control of one or more businesses.”
“an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants”
AG B7 “A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business”
AG B12 “In the absence of evidence to the contrary, a particular set of assets and activities in which goodwill is present shall be presumed to be a business. However, a business need not have goodwill”
1 September 2010

5. Overview of IFRS 3 – Acquisition method
“An entity shall account for each business combination by applying the acquisition method” :
Identifying the acquirer
Determining the acquisition date
Recognising and measuring identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree
Recognising and measuring any goodwill or gain from a bargain purchase
1 September 2010

6. Identify the Acquirer
Acquirer is the entity that obtains control of the acquiree
use guidance in IAS if not clear:
usually the entity that transfers cash or other assets or incurs liabilities
or issues equity interests
however – reverse acquisition – entity issuing shares is the acquiree
relative voting rights in combined entity: acquirer usually retains or receives largest portion of voting rights or largest minority voting interest
composition of governing body: acquirer usually has ability to elect, appoint or remove board of combined entity
composition of senior management: acquirer’s former management usually dominated management of combined entity
terms of exchange of equity interests: acquirer usually pays premium over pre-combination FV of equity interests
1 September 2010

7. Identify the Acquirer – reverse acquisition
Eg private operating entity wants to become a publicly listed entity without listing its shares => arranges for a publicly listed entity to acquire its shares in exchange for shares in that listed entity
listed entity = legal acquirer but acquiree for accounting purposes
private entity = legal acquiree but acquirer for accounting purposes
Note:
listed entity must be a business
new entity formed to effect a business combination is not necessarily the acquirer
1 September 2010

8. Reverse acquisition (cont.)
Shareholders
Legal acquirer
Accounting acquiree
Public Co
Shares
Accounting acquirer (eg private entity) usually issues no consideration for acquiree.
Acquiree issues its shares to owners of accounting acquirer
acquisition date FV of consideration transferred is based on number of equity interests legal subsidiary would have had to issue to give owners of legal parent same % interest in combined entity that results from reverse acquisition
FV of number of equity instruments calculated this way is used as FV of consideration transferred in exchange for acquiree
Shareholders
Private Co
Legal acquiree
Accounting acquirer
1 September 2010

9. Reverse acquisition (cont.)
S/H
100 shares A
S/H
40% A
100 shares A
FV = 12
A 2
S/H
60%
150 shares
150 shares
100%
60 shares
60 shares B
S/H
60 shares B B
FV = 40
1 September 2010

10. Cost of Reverse Acquisition
Cost = fair value of shares that B would have had to issue to A’s shareholders in exchange for their shares in A that would give them the same % interest in the combined entity as a result of the reverse acquisition
1 September 2010

11. Reverse acquisition (cont.)
B 1
S/H
60 shares
A 1
S/H
60% B
100 shares
40% A B2
S/H
40%
40 shares
A 2
S/H
60%
150 shares
100%
100%
60 shares A B
Cost = 40 shares at 40cu
= 1600cu
1 September 2010

12. Cost of Reverse Acquisition
What if the fair value of B’s shares is not clearly evident?
1 September 2010

13. Cost of Reverse Acquisition
Use the total FV of A’s shares on issue before business combination:
COST = cu
= 1200 cu
1 September 2010

14. Reverse acquisitions of a ‘shell company’
Private entity arranges to have itself ‘acquired’ by a publicly listed shell as a means of getting itself listed
Shell company will usually not meet the definition of ‘business’
Not a reverse acquisition under IFRS 3
Not a business combination under IFRS 3 (goodwill cannot be recognised)
Common view: continue financial statements of accounting acquirer (legal subsidiary) + deemed issue of shares (a share-based payment for net assets of accounting acquiree)
1 September 2010

15. Reverse acquisitions of a ‘shell company’
10,000 shares A
A 1
S/H
FV = 12
(market price)
10,000 shares 5% A
A 2
S/H
95%
190,000 shares
190,000 shares
9,500 shares
100%
9,500 shares B
S/H
9,500 shares B
FV = 230
(valuation) B
1 September 2010

16. Reverse acquisitions of a ‘shell company’
Substance: B has control and is the continuing entity
B is deemed under IFRS2 to have issued shares in exchange for assets of A (being 85,000cu cash) + listing
Can’t measure listing reliably => under IFRS 2, measure SBP transaction at FV of equities deemed to be issued
B would have had to issue 500 shares to A’s shareholders to give them a 5% interest in the combined entity
FV of equities issued = 500 x 230cu = 115,000cu
Dr: Cash 85,000
Dr: Expenses 30,000 *
Cr: Equity 115,000
* : this is an expense of attaining the listing, rather than goodwill
If FV of A’s shares used, equity = 120,000 cu
A 1
S/H
10,000 shares 5% A
A 2
S/H
95%
190,000 shares
100%
9,500 shares B
1 September 2010

17. Determining the acquisition date
Date on which acquirer obtains control of acquiree
Generally date that acquirer legally transfers consideration, acquires assets and assumes liability <=> closing date
Control may be obtained earlier or later
Eg if written agreement provides that acquirer obtains control before closing date
Note: beware contracts that seek to “artificially” create acquisition date – eg “effective date of transaction”, entitlement to profits after effective date
Look for factors that indicate control has passed – eg decision-making etc.
1 September 2010

18. Purchase Price Allocation (PPA)
Purchase Price Allocation (“PPA”) is the dissection of the price paid for a business or company between the individual assets and liabilities of that entity.
IFRS 3 p. 10, “the acquirer shall recognise, separately from goodwill the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree.
1 September 2010

19. PPA Process identify the acquirer determine the acquisition date
determine the fair value of consideration transferred
determine the fair value of identifiable tangible assets acquired and liabilities assumed
recognise and measure the identifiable intangible assets acquired
value non controlling interests; and
recognise and measure goodwill or a gain from a bargain purchase
and b) have already been discussed. c) is generally straightforward – reverse acquisitions complex – already discussed
Now we will focus on d) to g)
1 September 2010

20. PPA-General Principles
Recognition
Must meet the definitions of assets and liabilities, and
Must be part of what the acquirer and the acquiree (or former owners) exchanged in the business combination
Measurement
Identifiable assets and liabilities shall be measured at their acquisition-date fair values.
1 September 2010

21. PPA – Exceptions to Principles
Recognition
Measurement
Contingent Liabilities √
Income Taxes
Employee Benefits
Indemnification Assets
Reacquired Rights
Assets Held for Sale
Share-based payments
1 September 2010

22. Purchase Price Allocation – Intangible Assets
Non monetary assets without physical substance.
Need to be identified to be distinguished from goodwill.
Criteria for Identification
Separability or
Contractual or legal rights
1 September 2010

23. PPA - Intangibles (IFRS 3IE)
Group of intangibles
Some
Examples
Primary Criterion
Marketing-related
Trademarks, service marks, trade dress, internet domain names
Contractual-legal
Customer-related
Customer lists, order backlog, customer contracts, non contractual customer relationships
Separability or contractual-legal
Artistic-related
Plays, ballets, operas, musical work, books, videos, pictures, ad jingles
Contract-based
Licensing agreements, lease agreements, construction permits, employment contracts, use rights such as drilling, water and route authority
Contractual
Technology-based
Patented technology, R&D, unpatented technology,
databases, trade secrets such as secret processes and formulas
1 September 2010

24. PPA – Non-controlling interest (NCI)
NCI Measurement Options
Fair Value method-NCI measured at fair value
Proportionate
share method-NCI measured at proportionate share of net identifiable assets
Goodwill
Higher
Lower
Net assets at combination date
Total charge for goodwill impairment
1 September 2010

25. Measure goodwill less = Goodwill Fair value of consideration paid
Fair value of acquiree as a whole (100%)
less
Aggregate fair value of identifiable net assets acquired (100%) =
Goodwill
Fair value of consideration paid
Excludes transaction costs
Amount of any
NCI
This shows the measurement of goodwill – note that the FV of the acquiree includes consideration, NCI (measured 1 of 2 optional ways) and FV of previously held interest (we will discuss this in step acquisitions). Transaction costs are expensed.
Fair value of previously held equity interest
1 September 2010 25 25

26. Step Acquisition - principles
The change from a non-controlling investment in an entity to obtaining control is a significant change.
The acquirer exchanges its status from an owner of an investment for a controlling financial interest with the right to direct management of the acquiree.
This significant change warrants a change in the classification and measurement of that investment.
1 September 2010

27. Step acquisition - procedures
Upon obtaining control, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition- date fair value and recognise the resulting gain or loss.
Any item in other comprehensive income will be recycled to the profit and loss statement.
Goodwill or gain from a bargain purchase will be calculated based on paragraph 32 of IFRS 3.
1 September 2010

28. Step acquisition Control is obtained
Remeasure 35% of interest at fair value
Recognise gain or loss in P/L
Recycle comprehensive income items, if any
Goodwill/Gain=Consideration paid for 40% + fair value of 35% + 25% of NCI (measured at fair value or proportionate share) - identifiable net assets of subsidiary
Step acquisition
Investment at 15% accounted as AFS or FVTPL under IAS 39
+20%=35%
Investment accounted for
under IAS 28 as an associate
+40%=75%
1 September 2010

29. Step acquisition - Example
Big has a 35% investment in Small and is accounted for as an associate in accordance with IAS 28 and has a carrying value of $35m. Big purchases an additional 40% interest of Small for $60m cash. The fair value of the previously held equity interest was $45m. The aggregate net assets of Small was measured to be $120m under IFRS 3.
Required: Ignoring tax effects, and assuming NCI is accounted using the proportionate share method, preparing the consolidation entry.
1 September 2010

30. Step Acquisition - Example
1 September 2010

31. Step acquisition – Example
Other cases:
Case
Accounting Treatment
1. Assume, 1 year later that Big company acquires additional 10% of the minority interest?
Guidance from IAS 27 p Any difference between NCI adjustment and consideration paid is recognised directly in equity attributed to parent owners.
2. Assume 2 years later, that Big company sells 50% of its interest in small Company?
Guidance from IAS 27 p
1 September 2010

32. Entities under common control
A business combination involving entities or business under common control is a business combination in which all of the combining entities or businesses are ultimately controlled by the same part or parties both before and after the business combination, and that control is not transitory.
1 September 2010

33. Accounting for business combinations under common control
Scoped out of IFRS 3. No prescription from the IASB.
Reference is made to IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors)
In the absence of guidance in IFRS, management shall use its judgment in developing and applying an accounting policy that is relevant and reliable.
Two possible options until IASB finalises prescription:
Pooling of interest method
Acquisition method
1 September 2010

34. Q & A session