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«Business combinations and changes in ownership interests A guide to the revised IFRS 3 and IAS 27 Audit.Tax.Consulting.Financial Advisory. Contacts ...»

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The effect of the DLC merger is that BHP Billiton Plc and its subsidiaries (the BHP Billiton Plc Group) and BHP Billiton Limited and its subsidiaries (the BHP Billiton Limited Group) operate together as a single economic entity (the BHP Billiton Group).

Business combinations with no transfer of consideration

Under the arrangements:

• the shareholders of BHP Billiton Plc and BHP Billiton Limited have a common economic interest in both Groups.

• the shareholders of BHP Billiton Plc and BHP Billiton Limited take key decisions, including the election of Directors, through a joint electoral procedure under which the shareholders of the two Companies effectively vote on a joint basis.

• BHP Billiton Plc and BHP Billiton Limited have a common Board of Directors, a unified management structure and joint objectives.

• dividends and capital distributions made by the two Companies are equalised.

• BHP Billiton Plc and BHP Billiton Limited each executed a deed poll guarantee, guaranteeing (subject to certain exceptions) the contractual obligations (whether actual or contingent, primary or secondary) of the other incurred after 29 June 2001 together with specified obligations existing at that date.

If either BHP Billiton Plc or BHP Billiton Limited proposes to pay a dividend to its shareholders, then the other Company must pay a matching cash dividend of an equivalent amount per share to its shareholders. If either Company is prohibited by law or is otherwise unable to declare, pay or otherwise make all or any portion of such a matching dividend, then BHP Billiton Plc or BHP Billiton Limited will, so far as it is practicable to do so, enter into such transactions with each other as the Boards agree to be necessary or desirable so as to enable both Companies to pay dividends as nearly as practicable at the same time.

The DLC merger did not involve the change of legal ownership of any assets of BHP Billiton Plc or BHP Billiton Limited, any change of ownership of any existing shares or securities of BHP Billiton Plc or BHP Billiton Limited, the issue of any shares or securities or any payment by way of consideration, save for the issue by each Company of one special voting share to a trustee company which is the means by which the joint electoral procedure is operated. In addition, to achieve a position where the economic and voting interests of one share in BHP Billiton Plc and one share in BHP Billiton Limited were identical, BHP Billiton Limited made a bonus issue of ordinary shares to the holders of its ordinary shares.

13.2.2 Accounting for a combination by contract

IFRS 3 requires one of the combining entities to be identified as the acquirer, and one to be identified as the acquiree – see chapter 6 for guidance. In reaching the conclusion that combinations

achieved by contract alone should not be excluded from the scope of IFRS 3, the Board noted that:

[IFRS 3(2008).BC79] • such business combinations do not involve the payment of readily measurable consideration and, in rare circumstances, it might be difficult to identify the acquirer;

–  –  –

• difficulties in identifying the acquirer are not a sufficient reason to justify a different accounting treatment, and no further guidance is necessary for identifying the acquirer; and

• the acquisition method is already being applied for such combinations in the United States and insurmountable issues have not been encountered.

Under IFRS 3(2004), combinations achieved by contract alone were outside the scope of the Standard. Accordingly, they were often accounted for as poolings of interests.

13.3 Application of the acquisition method to a combination in which no consideration is transferred 13.3.1 Deemed consideration In a business combination achieved without the transfer of consideration, the acquirer substitutes the acquisition-date fair value of its interest in the acquiree for the acquisition-date fair value of the consideration transferred to measure goodwill or a gain on a bargain purchase.

[IFRS 3(2008).33 & B46] The acquirer measures the fair value of its interest in the acquiree using one or more valuation techniques that are appropriate in the circumstances and for which sufficient data is available.

If more than one valuation technique is used, the acquirer should evaluate the results of the techniques considering the relevance and reliability of the inputs used and the extent of the available data. [IFRS 3(2008).B46] The acquirer’s interest in the acquiree may be limited to its right to equalisation payments. In practice, the fair value may be negligible.

13.3.2 Amount attributed to non-controlling interests The amount attributed to non-controlling interests in a business combination achieved by contract alone is dealt with in IFRS 3(2008).44, which states as follows: ‘In a business combination achieved by contract alone, the acquirer shall attribute to the owners of the acquiree the amount of the acquiree’s net assets recognised in accordance with this IFRS. In other words, the equity interests in the acquiree held by parties other than the acquirer are a non-controlling interest in the acquirer’s post-combination financial statements even if the result is that all of the equity interests in the acquiree are attributed to the non-controlling interest.’ [IFRS 3(2008).44] Reverse acquisitions

14. Reverse acquisitions

14.1 Identifying a reverse acquisition 14.1.1 Meaning of reverse acquisition A reverse acquisition occurs when the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes on the basis of the guidance in chapter 6. The entity whose equity interests are acquired (the legal acquiree) must be the acquirer for accounting purposes for the transaction to be considered a reverse acquisition. [IFRS 3(2008).B19] Example 14.1.1 Private entity reversing into a public entity [IFRS 3(2008).B19] Reverse acquisitions sometimes occur when a private operating entity wants to become a public entity but does not want to register its equity shares. To accomplish that, the private entity will arrange for a public entity to acquire its equity interests in exchange for equity interests of the public entity. In this example, the public entity is the legal acquirer because it issued its equity interests, and the private entity is the legal acquiree because its equity interests were acquired.

However, application of the guidance in chapter 6 results in identifying:

(a) the listed entity as the acquiree for accounting purposes (the accounting acquiree); and (b) the private entity as the acquirer for accounting purposes (the accounting acquirer).

14.1.2 Acquiree must meet the definition of a business IFRS 3(2008) limits business combinations to circumstances where the acquiree is a business.

[IFRS 3(2008).3] It follows, for reverse acquisitions, that the accounting acquiree must meet the definition of a business for the transaction to be accounted for as a reverse acquisition.

[IFRS 3(2008).B19] This restriction appears to exclude from the scope of IFRS 3(2008) two circumstances that, in

the past, were identified as reverse acquisitions:

• a private entity reversing into a publicly-listed ‘cash shell’ (i.e. an entity with a public listing but with no ongoing business activities; and

• a new entity becoming the new parent of an existing group through an exchange of equity instruments.

–  –  –

Under IFRS 3(2008), such transactions should not be described as reverse acquisitions.

An appropriate accounting policy may describe them as ‘capital restructurings’ or ‘reverse asset acquisitions’. Such an accounting policy may result in consolidated financial statements that are similar to those produced under reverse acquisition accounting.

14.1.3 More complex cases

The guidance on identifying the acquirer in chapter 6 is relevant in a reverse acquisition transaction. Beyond this, IFRS 3(2008) does not provide detailed guidance for more complex arrangements (e.g. where the accounting acquirer had a previously-held interest in the accounting acquiree). It is suggested that the two primary factors that might lead to the

conclusion that the transaction involves a reverse acquisition are:

• the former shareholders of the entity whose shares are acquired own the majority of shares, and control the majority of votes, in the combined entity; and

• the management of the combined entity is drawn predominantly from the entity whose shares are acquired.

14.2 Accounting for a reverse acquisition There are no substantive differences between the accounting treatment prescribed for reverse acquisitions under IFRS 3(2004) and under IFRS 3(2008). Both versions of IFRS 3 aim to achieve an accounting outcome that reflects the consolidated financial statements as if the accounting acquirer had legally acquired the accounting acquiree. In other words, the legal form of the business combination should not impact the accounting for the substance of the business combination.

14.2.1 Accounting periods

Consolidated financial statements prepared following a reverse acquisition are issued under the name of the legal parent (accounting acquiree) but described in the notes as a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment, which is to adjust retroactively the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. That adjustment is required to reflect the capital of the legal parent (the accounting acquiree). Comparative information presented in those consolidated financial statements also is retroactively adjusted to reflect the legal capital of the legal parent (accounting acquiree).

[IFRS 3(2008).B21] Separate entity financial statements for the legal parent, if required, would be prepared on a stand-alone basis. Where the entity was formed shortly before the combination, its entity financial statements would cover only its actual accounting period.

Reverse acquisitions 14.2.2 Detailed accounting entries IFRS 3(2008).B19 – B27 contains detailed guidance on the preparation of consolidated financial statements for a reverse acquisition. For understanding, this guidance is set out below as a comparison with a ‘conventional acquisition’ (i.e. a business combination where the accounting acquirer and the legal acquirer are the same entity). The terminology used for a reverse acquisition is that the accounting acquirer is the legal subsidiary, and the accounting acquiree is the legal parent.

–  –  –

Reverse acquisitions 14.2.3 Presentation of equity and comparative information Pre-combination net income and net assets are those of the legal subsidiary (accounting acquirer), and present no particular problems.

Pre-combination equity is, in theory, the pre-combination equity of the legal subsidiary but adjusted retroactively to reflect the legal capital of the legal parent. IFRS 3(2008) describes the position at the

date of combination as follows:

[IFRS 3(2008).B22(c) & (d)]

• the consolidated financial statements reflect the retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination; and

• the amount recognised as issued equity interests in the consolidated financial statements is determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the requirements of IFRS 3(2008). However, the equity structure (i.e. the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition.

Applying this guidance to periods before the combination:

• the total amount shown as equity is the total shown as equity in the legal subsidiary; and

• the amount shown as equity instruments (i.e. share capital) is the amount shown in the legal subsidiary adjusted by the exchange ratio. In the case of share capital with a fixed nominal value, the result may be higher or lower than the legal subsidiary’s actual share capital pre-combination. The resulting adjustment is reflected as a reduction in, or addition to, equity.

–  –  –

On the date that the statements of financial position were drawn up, Company A issued 500 new shares in exchange for the entire share capital of Company B.

Since the equity holders of Company B obtain a 5/6ths share of the equity of Company A, Company B is identified as the acquirer. Since Company A issued 500 shares in itself in exchange for 300 shares in Company B, the exchange ratio is 5/3rds

–  –  –

Reverse acquisitions Share capital at the date of combination is 600, being the actual Company A shares in issue.

Share capital pre-combination is CU500, being the issued shares of Company B (CU300) adjusted for the exchange ratio.

Issued equity instruments at the date of combination is the issued equity instruments of Company B (CU300) plus the consideration transferred (CU5,000). Issued equity instruments pre-combination are those of Company B (CU300).

Retained earnings at the date of combination, and pre-combination, are those of Company B (CU500).

The balance of other reserves pre-combination (CU200 debit) represents the capitalisation of reserves into share capital (500 shares in Company A issued in exchange for 300 shares in Company B).

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