«Business combinations and changes in ownership interests A guide to the revised IFRS 3 and IAS 27 Audit.Tax.Consulting.Financial Advisory. Contacts ...»
8.5.6 Employee benefits The acquirer should recognise and measure a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with IAS 19 Employee Benefits. [IFRS 3(2008).26] 8.5.7 Indemnification assets 18.104.22.168 Initial measurement The seller in a business combination may contractually indemnify the acquirer for the outcome of a contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller may indemnify the acquirer against losses above a certain amount on a liability arising from a particular contingency, such as legal action or income tax uncertainty. As a result, the acquirer obtains an indemnification asset. [IFRS 3(2008).27]
Assets, liabilities and non-controlling interests
IFRS 3(2008) requires the acquirer to recognise an indemnification asset at the same time that it recognises the indemnified item and that the indemnification asset be measured on the same basis as the indemnified item, assuming that there is no uncertainty over the recovery of the indemnification asset. Therefore, if the indemnification relates to an asset or liability that is recognised at the acquisition date and that is measured at fair value, the acquirer should recognise the indemnification asset at the acquisition date measured at its fair value. [IFRS 3(2008).27] For an indemnification asset measured at fair value, the effects of uncertainty about future cash flows because of collectibility considerations are included in the fair value measure and a separate valuation allowance is not necessary. [IFRS 3(2008).27] In some circumstances, the indemnification may relate to an asset or liability that is an exception to the recognition or measurement principles. For example, an indemnification may relate to a contingent liability that is not recognised at the acquisition date because its fair value is not reliably measurable at that date. Alternatively, an indemnification may relate to an asset or liability (e.g. one that results from an employee benefit that is measured on a basis other than acquisition-date fair value. In those circumstances, the indemnification asset is recognised and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified amount. [IFRS 3(2008).28] The requirement that an indemnification asset be measured using assumptions consistent with the measurement of the indemnified item does not necessarily mean that the indemnification asset and indemnified item are measured at the same amount. For instance, an indemnity may be capped at a certain amount, be determined as a portion of any final settlement amount, represent an amount over a particular amount, or be recovered in a later time period than when the indemnified item is settled. In these cases, it is likely that the indemnified item will be recognised at a different amount to the indemnification asset because the cash outflows and inflows will be different.
However, the recognition and measurement of the asset and liability will be determined on a consistent basis, by reference to any relevant Standards. Therefore, an indemnification asset in
• an employee benefit will be measured using the principles of IAS 19;
• a liability recognised as a provision will be measured in accordance with IAS 37; and
• an income tax exposure, will be measured by reference to IAS 12.
22.214.171.124 Subsequent measurement At the end of each subsequent reporting period, the acquirer should measure an indemnification asset that was recognised at the acquisition date on the same basis as the indemnified liability or asset, subject to any contractual limitations on its amount and, for an indemnification asset that is not subsequently measured at its fair value, management’s assessment of the collectibility of the indemnification asset. The acquirer should derecognise the indemnification asset only when it collects the asset, sells it or otherwise loses the right to it. [IFRS 3(2008).57] The effect of the requirements for indemnification assets is to achieve matching of the asset recognised with the item that is the subject of the indemnity. In most cases, it is expected that remeasurement of both asset and liability would be in profit or loss, although IFRS 3(2008) does not provide for this.
Identifying and measuring consideration
9. Identifying and measuring consideration 9.1 Consideration transferred IFRS 3(2008) requires the consideration transferred in a business combination to be measured at fair
value. This is calculated as the sum of the acquisition-date fair values of:
[IFRS 3(2008).37] • the assets transferred by the acquirer;
• the liabilities incurred by the acquirer to former owners of the acquiree; and • the equity interests issued by the acquirer.
However, any portion of the acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees that is included in the consideration transferred in the business combination should be measured in accordance with IFRS 2 Share-based Payment (see section 9.3.4).
[IFRS 3(2008).37] Potential forms of consideration include cash, other assets, a business or a subsidiary of the acquirer, contingent consideration (see section 9.2), ordinary or preference equity instruments, options, warrants and member interests of mutual entities. [IFRS 3(2008).37] The consideration transferred may include assets or liabilities of the acquirer with carrying amounts that differ from their fair values at the acquisition date (e.g. non-monetary assets or a business of the acquirer). If so, the acquirer should remeasure the transferred assets or liabilities to their fair values as of the acquisition date and recognise any resulting gains or losses in profit or loss. [IFRS 3(2008).38] The recognition of a gain or loss on assets or liabilities transferred is a further application of the principle that crossing an accounting boundary involves a disposal, which is discussed in section 2.2 of this guide. It is also consistent with the definition of cost in the IASB Glossary which defines cost as ‘the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition …’. In the case of a subsidiary, this would imply the date of acquisition of the subsidiary.
However, sometimes the transferred assets or liabilities remain within the combined entity after the business combination (e.g. because the assets and liabilities were transferred to the acquiree rather than to its former owners), and the acquirer therefore retains control of them. In that situation, the acquirer should measure those assets and liabilities at their carrying amount immediately before the acquisition date. No gain or loss should be recognised in profit or loss in respect of assets or liabilities controlled by the acquirer both before and after the business combination. [IFRS 3(2008).38]
The implication of not remeasuring assets and liabilities that remain within the group to fair value is that goodwill will be correspondingly lower than the situation where assets and liabilities are transferred outside the group and remeasured to fair value.
9.2 Contingent consideration 9.2.1 Recognition at acquisition date The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. [IFRS 3(2008).39] Contingent consideration is defined as follows.
‘Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration may also give the acquirer the right to the return of previously transferred consideration if specified conditions are met.’ [IFRS 3(2008)(Appendix A)] Contingent consideration is recognised as part of the consideration transferred in exchange for the acquiree, measured at its acquisition-date fair value. [IFRS 3(2008).39] An obligation to pay contingent consideration is classified as a liability or as equity on the basis of the definitions of an equity instrument and a financial liability in paragraph 11 of IAS 32 Financial Instruments: Presentation. [IFRS 3(2008).40] Where the purchase agreement includes a right to the return of previously-transferred consideration if specified conditions for a repayment are met, that right to return is classified as an asset by the acquirer. [IFRS 3(2008).40] Example 9.2.1 Contingent consideration
A acquires B. The consideration is payable in 3 tranches:
• an immediate payment of CU1m;
• a further payment of CU0.5m after one year if profit before interest and tax for the first year following acquisition exceeds CU200,000; and
• a further payment of CU0.5m after two years if profit before interest and tax for the second year following acquisition exceeds CU220,000.
Identifying and measuring consideration The two payments that are conditional upon reaching earnings targets are contingent consideration. At the date of acquisition, the fair value of these two payments is assessed as CU250,000.
Consequently, on the date of acquisition, consideration of CU1,250,000 is recognised.
9.2.2 Subsequent accounting As noted above, contingent consideration is measured at its acquisition-date fair value. IFRS 3(2008) has introduced a new approach to the accounting for changes in the value of contingent consideration subsequent to the acquisition date.
126.96.36.199 Changes based on additional information about facts and circumstances at the acquisition date Changes that are the result of the acquirer obtaining additional information about facts and circumstances that existed at the acquisition date, and that occur within the measurement period (which may be a maximum of one year from the acquisition date), are recognised as adjustments against the original accounting for the acquisition (and so may impact goodwill) – see section 11.3.
188.8.131.52 Post-combination changes
Changes resulting from events after the acquisition date (e.g. meeting an earnings target, reaching a specified share price or reaching a milestone on a research and development project) are not measurement period adjustments. Such changes are therefore accounted for separately from the business combination. The acquirer accounts for changes in the fair value of contingent
consideration that are not measurement period adjustments as follows:
[IFRS 3(2008).58] (a) contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity; and (b) contingent consideration classified as an asset or a liability that:
(i) is a financial instrument and is within the scope of IAS 39 is measured at fair value, with any resulting gain or loss recognised either in profit or loss or in other comprehensive income in accordance with IAS 39; and
9.2.3 Implications The requirements in respect of contingent consideration represent a fundamental change to
IFRS 3(2004) in two respects:
• under IFRS 3(2004), contingent consideration was only recognised at the date of acquisition where it met both a ‘probable’ test and a ‘reliably measurable’ test. If either test was only met after the date of acquisition, the additional consideration was recognised at that later date and treated as an adjustment to goodwill. IFRS 3(2008) requires contingent consideration to be measured at fair value at the date of acquisition irrespective of the level of probability or measurement reliability, in order to provide a complete picture of liabilities;
• once the fair value of the contingent consideration at the acquisition date has been determined, any subsequent adjustments which do not reflect fair value at the acquisition date, or which occur outside the measurement period, are treated in accordance with other Standards – typically this means remeasurement of financial liabilities through profit or loss.
Importantly, contingent consideration arising in relation to business combinations that occur prior to the initial application of the IFRS 3(2008) will continue to be accounted for under IFRS 3(2004), meaning that retrospective adjustments to the initial accounting for these business combinations will still be possible. The treatment of contingent consideration relating to business combinations that occurred prior to the implementation of IFRS 3(2008) is considered in section 15.3.1.
9.3 Determining what is part of the business combination transaction 9.3.1 Principles to determine what is part of the business combination The acquirer and the acquiree may have a pre-existing relationship or other arrangement before negotiations for the business combination begin, or they may enter into an arrangement during the negotiations that is separate from the business combination. [IFRS 3(2008).51] In either situation, the acquirer is required to identify any amounts that are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, i.e. amounts that are not part of the exchange for the acquiree. [IFRS 3(2008).51] The acquirer is required to recognise as part of applying the acquisition method only the consideration transferred for the acquiree, and the assets acquired and liabilities assumed in exchange for the acquiree. Separate transactions are accounted for in accordance with the relevant Standards. [IFRS 3(2008).51] A transaction entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer or the combined entity, rather than primarily for the benefit of the acquiree (or its former owners) before the combination, is likely to be a separate transaction. [IFRS 3(2008).52]
Identifying and measuring consideration
An acquirer should consider the following factors, which are neither mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for the acquiree or whether the transaction is separate from the business combination.