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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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Such a transaction is therefore accounted for as if the original asset (in the case of an increase in equity interest), or the residual asset (in the case of a reduction in equity interest), were disposed of for fair value, and immediately reacquired for the same fair value. The implications of this change of principle


• a previously-held interest (say, 10%) which is accounted for under IAS 39 Financial Instruments:

Recognition and Measurement, and which is increased to a controlling interest (say, 75%) through a business combination, is remeasured to fair value at acquisition date, and any gain recognised in profit or loss. Similarly, gains previously recognised in other comprehensive income are reclassified to profit or loss where required by the relevant IFRSs (see section 12.1);

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• on disposal of a controlling interest, any retained interest in the former subsidiary is measured at fair value on the date that control is lost. This fair value is reflected in the calculation of the gain or loss on disposal attributable to the parent, and becomes the initial carrying amount for subsequent accounting for the retained interest under IAS 28, IAS 31 or IAS 39 as appropriate (see section 12.4); and

• similar considerations apply to the partial disposal of an interest in an associate or a jointly controlled entity where the residual interest is accounted for as a financial asset under IAS 39 (see section 12.5).

Although the revised Standards expressly deal with the above situations, they do not deal with a ‘15% to 25%’ transaction – i.e. a transaction that takes an investment accounted for under IAS 39 to an associate interest accounted for under IAS 28 or a jointly controlled entity accounted for under IAS 31 (see section 12.2).

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3. Acquisition method of accounting IFRS 3(2008) requires that all business combinations be accounted for by applying the acquisition method. [IFRS 3(2008).4] In addition to determining whether a transaction or other event is a business combination (IFRS 3(2008).3), four stages in the application of the acquisition method are


[IFRS 3(2008).5] (a) identifying the acquirer;

(b) determining the acquisition date;

(c) recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and (d) recognising and measuring goodwill or a gain from a bargain purchase.

However, taking all of the requirements of the Standard into account, there are seven distinct steps to be considered and these are described in the chart on the next page, together with the chapter in which each is considered in this guide.

Acquisition method of accounting

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4. Scope IFRS 3(2008) applies to a transaction or other event that meets the definition of a business combination. [IFRS 3(2008).2] 4.1 Definition of a business combination A business combination is defined as follows.

‘A transaction or other event in which an acquirer obtains control of one or more businesses.

Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in this IFRS.’ [IFRS 3(2008) (Appendix A)] 4.2 Transactions outside the scope of IFRS 3(2008)

IFRS 3(2008) does not apply to the following transactions:

[IFRS 3(2008).2] • the formation of a joint venture;

• the acquisition of an asset or a group of assets that does not constitute a business (discussed in

chapter 5); and

• a combination between entities or businesses under common control (see section 4.2.2).

Business combinations involving mutual entities are within the scope of IFRS 3(2008), but were not in the scope of IFRS 3(2004) (see section 10.2.3). Similarly, combinations achieved by contract alone rather than through an exchange transaction are within the scope of IFRS 3(2008) but were excluded from IFRS 3(2004) (see chapter 13).

Scope of IFRS 3(2008) compared to IFRS 3(2004)

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4.2.1 Formation of a joint venture The Basis for Conclusions to IFRS 3(2008) suggests that further work would be necessary before the Board could proceed to provide guidance on accounting for the formation of a joint venture, and that the Board did not wish to delay the issue of IFRS 3(2008).

However, where a parent contributes a subsidiary to a joint venture arrangement, and receives in exchange an equity interest in the joint venture which qualifies as a jointly controlled entity under IAS 31, the transaction falls within the scope of IAS 27 so far as the parent is concerned, with the effect that the residual interest in the former subsidiary would be remeasured to fair value – see section 12.4. The IFRS 3 scope exemption would apply to the financial statements of the jointly controlled entity (i.e. entity B below).

Formation of a joint venture that is outside the scope of IFRS 3 but within the scope of IAS 27

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4.2.2 Common control transactions A combination of entities or businesses under common control (commonly referred to as a ‘common control transaction’) is ‘… a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the combination, and that control is not transitory’. [IFRS 3(2008).B1]

Examples of ultimate controlling parties include:

• an individual or a group of individuals who, as a result of contractual arrangements, collectively control an entity (even where those individuals are not subject to financial reporting requirements) [IFRS 3(2008).B2 – B3]; and • a parent entity (even where the controlled entity is excluded from the parent’s consolidated financial statements) [IFRS 3(2008).B4].

Scope There is currently no specific guidance on accounting for common control transactions under IFRSs. However, in December 2007 the IASB added a project on this topic to its agenda.

The project will examine the definition of common control and the methods of accounting for business combinations under common control in the acquirer’s consolidated and separate financial statements.

In the absence of specific guidance, entities involved in common control transactions should select an appropriate accounting policy using the ‘hierarchy’ described in paragraphs 10 – 12 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. As the hierarchy permits the consideration of pronouncements of other standard-setting bodies, the guidance on group reorganisations in both UK and US GAAP may be useful in some circumstances – this guidance produces a result that is similar to pooling.

A common control transaction

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4.2.3 Combinations involving mutual entities A mutual entity is defined as follows.

‘An entity, other than an investor-owned entity, that provides dividends, lower costs or other economic benefits directly to its owners, members or participants. For example, a mutual insurance company, a credit union and a co-operative entity are all mutual entities.’ [IFRS 3(2008) (Appendix A)]


The inclusion of credit unions and co-operatives in the definition of a mutual entity (and, consequently, within the scope of IFRS 3 (2008)) caused concern among many constituents, some of whom argued that applying the normal business combination requirements to combinations of credit unions could cause adverse economic consequences for those entities.

Other constituents argued that co-operatives do not fit within the definition of a mutual entity and that they were sufficiently different from other entities to justify different methods of combination accounting.

The IASB was not persuaded by these arguments and decided to include all combinations involving such entities within the scope of the revised IFRS 3(2008) without amendment, but with limited additional guidance as to how the relevant requirements should be applied.

Combinations involving mutual entities are considered in two sections in this guide:

• identification of the acquirer is considered in section 6.3.2; and

• measurement issues, including goodwill, are considered in section 10.2.3.

Identifying a business combination

5. Identifying a business combination The first stage in accounting for an acquisition is to determine whether a transaction or other event is a business combination, which requires that the assets acquired and liabilities assumed constitute a business. [IFRS 3(2008).3] The transaction or event should be analysed by applying the definition of a business combination, and the detailed guidance set out in paragraphs B5 – B12 of the Standard.

A business combination is defined as follows.

‘A transaction or other event in which an acquirer obtains control of one or more businesses.

Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in this IFRS.’ [IFRS 3(2008) (Appendix A)]

5.1 Acquirer obtains control as a result of a transaction or an event

To meet the definition of business combination, an acquirer must obtain control. This means that there must be a triggering economic event or transaction and not, for example, merely a decision to start preparing combined or consolidated financial statements for an existing group. [IFRS 3(2008).BC10]

Economic events that might result in an entity obtaining control include:

[IFRS 3(2008).B5] (a) transferring cash or other assets (including net assets that constitute a business);

(b) incurring liabilities;

(c) issuing equity instruments;

(d) a combination of the above;

(e) a transaction not involving consideration, such as a combination by contract alone (e.g. a dual listed structure – see chapter 13).

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Other examples of events that might result in an entity obtaining control:

• potential voting rights (options, convertible instruments, etc.) held by the entity in an investee becoming exercisable (see section 6.1.3);

• an investee undertaking a selective buy-back transaction which results in the entity achieving a majority ownership in the investee without changing the number of equity instruments held in that investee;

• the expiry of an agreement with other shareholders, where that agreement prevented the entity from controlling the investee (e.g. another shareholder had participative rights (right of veto) over major financing and operating policy decisions); and

• a ‘creep acquisition’ of equity instruments in an investee through a dividend reinvestment plan or bonus issue that increases the entity’s holding to a controlling level.

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The structure of a business combination may be determined by a variety of factors, including legal and tax strategies. Other factors might include market considerations and regulatory considerations.

Examples of structures include:

[IFRS 3(2008).B6] (a) one business becomes a subsidiary of another;

(b) two entities are legally merged into one entity;

(c) one entity transfers its net assets to another entity;

(d) an entity’s owners transfer their equity interests to the owners of another entity;

(e) two or more entities transfer their net assets, or the owners transfer their equity interests, to a newly-formed entity (sometimes termed a ‘roll-up’ or ‘put-together’ transaction); and (f) a group of former owners of one entity obtains control of a combined entity.

Identifying a business combination

Examples of other legal structures that might be used to effect business combinations include:

• transactions that involve dual listing and equalisation arrangements between two entities (see section 13.2);

• a contractual arrangement between two entities that has the effect of creating one entity in substance (i.e. a ‘stapling’ arrangement);

• a contractual arrangement that provides a third party with all economic returns, and responsibility for risks, in relation to an investee, even though the legal ownership of ordinary capital is with another entity (e.g. a ‘pass-through’ arrangement); and

• arrangements whereby an entity is the beneficial owner of an interest held in trust but the trustee is the legal owner of that interest.

5.3 Identifying a business A business is defined as follows.

‘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.’ [IFRS 3(2008)(Appendix A)] The application guidance in IFRS 3.B7 – B12, which is consistent with the previous version of IFRS 3, is a theoretical description of a business. While there are some useful clues, it does not provide a practical checklist for what constitutes a business.

5.3.1 Presence of goodwill Paragraph B12 provides an over-arching test based on the presence of goodwill.

‘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.’ [IFRS 3(2008).B12] No further guidance on identifying the presence of goodwill is provided in the Standard.

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