«Business combinations and changes in ownership interests A guide to the revised IFRS 3 and IAS 27 Audit.Tax.Consulting.Financial Advisory. Contacts ...»
[IFRS 3(2008).B50] (a) The reasons for the transaction Understanding the reasons why the parties to the combination entered into a particular transaction or arrangement may provide insight into whether it is part of the consideration transferred and the assets acquired or liabilities assumed. For example, if a transaction is arranged 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, that portion of the transaction price paid (and any related assets or liabilities) is less likely to be part of the exchange for the acquiree. Accordingly, the acquirer would account for that portion separately from the business combination.
1A Acquirer pays vendor’s costs In some cases, the vendor and the acquirer may agree, for tax or other reasons, that the acquirer will pay selling expenses incurred by the vendor in the sale and purchase transaction. Although these amounts are not paid directly to the vendor, they will still form part of the purchase consideration for the business combination as the acquirer is acting on behalf of the vendor in making the payments, which are primarily for the benefit of the former owners. However, this principle would not apply to any costs incurred by the acquirer on its own behalf in making the acquisition, as these must be accounted for outside the business combination (see section 9.3.5) (b) Who initiated the transaction Understanding who initiated the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction or other event that is initiated by the acquirer may be entered into for the purpose of providing future economic benefits to the acquirer or combined entity with little or no benefit received by the acquiree or its former owners before the combination. On the other hand, a transaction or arrangement initiated by the acquiree or its former owners is less likely to be for the benefit of the acquirer or the combined entity and more likely to be part of the business combination transaction.
Identifying and measuring consideration
1B Acquisition from government with employee obligations An acquirer may acquire a business from government in a privatisation transaction. These legal arrangements sometimes have obligations that are effectively imposed upon the acquirer by the government (e.g. a requirement to retain a certain level of staff, maintain a presence in a certain geographical location, or to meet other government policy objectives). In some cases, these arrangements may impact the purchase consideration that the acquirer is prepared to pay, which might generally be higher if the obligations did not exist.
These transactions are generally initiated by the relevant government as the vendor for its own benefit (i.e. meeting the policy objectives). Therefore, no adjustment would be made to the purchase consideration as a result of the obligations. However, in some cases, a liability may be recognised as part of the business combination accounting where the relevant criteria are met.
(c) The timing of the transaction The timing of the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction between the acquirer and the acquiree that takes place during the negotiations of the terms of a business combination may have been entered into in contemplation of the business combination to provide future economic benefit to the acquirer or the combined entity. If so, the acquiree or its former owners are likely to receive little or no benefit from the transaction except for the benefits they receive as part of the combined entity.
The following are examples of separate transactions that are not to be included in applying the
[IFRS 3(2008).52] (a) a transaction that settles pre-existing relationships between the acquirer and the acquiree (see section 8.5.2 above);
(b) a transaction that remunerates employees or former owners of the acquiree for future services (see section 9.3.3 for contingent payments to employees or selling shareholders, and section 9.3.4 for share-based payment awards); and (c) a transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs (see section 9.3.5).
9.3.2 Settlement of a pre-existing relationship between the acquirer and acquiree in a business combination This is discussed in section 8.5.2 above, which deals with both reacquired rights and the wider issue of pre-existing relationships.
Identifying and measuring consideration 9.3.3 Arrangements for contingent payments to employees or selling shareholders The acquirer or vendor may make payments to the employees of the acquiree (who may or may not also be selling shareholders), which are contingent on a post-acquisition event such as a period of continuing service as an employee. In such cases, it is necessary to determine what element of the payment qualifies as consideration, and what element is for post-acquisition services. IFRS 3(2008) provides guidance as to how to make the allocation.
As discussed in section 9.3.1 above, understanding the reason why the acquisition agreement includes a provision for contingent payments, who initiated the arrangement, and when the parties entered into the arrangement may be helpful in assessing the nature of the arrangement.
[IFRS 3(2008).B54] The acquirer should consider the following indicators to determine whether an arrangement for payments to employees or selling shareholders is part of the exchange for the acquiree or a separate
[IFRS 3(2008).B55] (a) Continuing employment A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is remuneration for post-combination services. Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than remuneration.
(b) Duration of continuing employment If the period of required employment coincides with or is longer than the contingent payment period, that fact may indicate that the contingent payments are, in substance, remuneration.
(c) Level of remuneration Situations in which employee remuneration other than the contingent payments is at a reasonable level in comparison with that of other key employees in the combined entity may indicate that the contingent payments are additional consideration rather than remuneration.
(d) Incremental payments to employees If selling shareholders who do not become employees receive lower contingent payments on a per-share basis than the selling shareholders who become employees of the combined entity, that fact may indicate that the incremental amount of contingent payments to the selling shareholders who become employees is remuneration.
(e) Number of shares owned The relative number of shares owned by the selling shareholders who remain as key employees may be an indicator of the substance of the contingent consideration arrangement. If the selling shareholders who owned substantially all of the shares in the acquiree continue as key employees, that fact may indicate that the arrangement is, in substance, a profit-sharing arrangement intended to provide remuneration for post-combination services. If selling shareholders who continue as key employees owned only a small number of shares of the acquiree and all selling shareholders receive the same amount of contingent consideration on a per-share basis, that fact may indicate that the contingent payments are additional consideration.
Identifying and measuring consideration (f) Linkage to the valuation If the initial consideration transferred at the acquisition date is based on the low end of a range established in the valuation of the acquiree and the contingent formula relates to that valuation approach, that fact may suggest that the contingent payments are additional consideration. Alternatively, if the contingent payment formula is consistent with prior profitsharing arrangements, that fact may suggest that the substance of the arrangement is to provide remuneration.
(g) Formula for determining consideration The formula used to determine the contingent payment may be helpful in assessing the substance of the arrangement. For example, if a contingent payment is determined on the basis of a multiple of earnings (i.e. more than one year’s earnings), that might suggest that the obligation is contingent consideration in the business combination and that the formula is intended to establish or verify the fair value of the acquiree. In contrast, a contingent payment that is a specified percentage of earnings (i.e. a proportion of one year’s earnings) might suggest that the obligation to employees is a profit-sharing arrangement to remunerate employees for services rendered.
(h) Other agreements and issues The terms of other arrangements with selling shareholders (such as agreements not to compete, executory contracts, consulting contracts and property lease agreements) may indicate that contingent payments are attributable to something other than consideration for the acquiree. For example, in connection with the acquisition, the acquirer might enter into a property lease arrangement with a significant selling shareholder. If the lease payments specified in the lease contract are significantly below market, some or all of the contingent payments to the lessor (the selling shareholder) required by a separate arrangement might be, in substance, payments for the use of the leased property that the acquirer should recognise separately in its post-combination financial statements. In contrast, if the lease contract specifies lease payments that are consistent with market terms for the leased property, the arrangement for contingent payments to the selling shareholder may be contingent consideration in the business combination.
3A Contingent payments to employees recognised as a liability [IFRS 3(2008).IE58-IE59] TC appointed a candidate as its new CEO under a ten-year contract. The contract required TC to pay the candidate CU5 million if TC is acquired before the contract expires. AC acquires TC eight years later. The CEO was still employed at the acquisition date and will receive the additional payment under the existing contract.
In this example, TC entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of the CEO.
Thus, there is no evidence that the agreement was arranged primarily to provide benefits to AC or the combined entity. Therefore, the liability to pay CU5 million is included in the application of the acquisition method.
Identifying and measuring consideration
Contingent payments to employees recognised as post-acquisition remuneration Facts as in example 9.3.3A, except that TC entered into the agreement with the CEO at the suggestion of AC during the negotiations for the business combination, and the payment is contingent on the CEO remaining in employment for 3 years following a successful acquisition.
The primary purpose of the agreement appears to be to retain the services of the CEO. Since the CEO is not a shareholder, and the payment is contingent on continuing employment, the payment is accounted for as post-acquisition remuneration separately from the application of the acquisition method.
9.3.4 Acquirer share-based payment awards exchanged for awards held by the acquiree’s employees 18.104.22.168 Overview An acquirer may exchange its share-based payment awards (replacement awards) for awards held by employees of the acquiree. IFRS 3(2008) introduces a number of guidelines and examples for when to treat particular replacement share-based payment awards as part of the cost of the combination and when to treat the amounts as employee compensation.
Exchanges of share options or other share-based payment awards in conjunction with a business combination are accounted for as modifications of share-based payment awards in accordance with IFRS 2 Share-based Payment. [IFRS 3(2008).B56] IFRS 3 uses the term ‘market-based measure’ to describe the basis of measurement in IFRS 2.
22.214.171.124 Acquirer obliged to replace awards
Where the acquirer is obliged to replace the acquiree awards, either all or a portion of the marketbased measure of the acquirer’s replacement awards is included in measuring the consideration transferred in the business combination. [IFRS 3(2008).B56] The basis of allocating awards between consideration and post-combination service is described in section 126.96.36.199 below.
The acquirer is considered to be obliged to replace the acquiree awards if the acquiree or its employees have the ability to enforce replacement. For example, for the purposes of applying this requirement, the acquirer is considered to be obliged to replace the acquiree’s awards if the
replacement is required by:
[IFRS 3(2008).B56] (a) the terms of the acquisition agreement;
(b) the terms of the acquiree awards; or (c) applicable laws and regulations.
188.8.131.52 Acquirer makes voluntary awards If the acquiree’s awards expire as a consequence of a business combination and the acquirer replaces those awards even though it is not obliged to do so, all of the market-based measure of the replacement awards is recognised as remuneration cost in the post-combination financial statements. This means that none of the market-based measure of those awards is included in measuring the consideration transferred in the business combination. [IFRS 3(2008).B56] 184.108.40.206 Allocating awards to consideration and post-combination service The requirements of IFRS 3(2008) are best explained by working through an example.
Step 1 To determine the portion of a replacement award that is part of the consideration transferred for the acquiree and the portion that is remuneration for post-combination service, the acquirer measures both the replacement awards granted by the acquirer and the acquiree awards as of the acquisition date in accordance with IFRS 2. [IFRS 3(2008).B57]