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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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[IAS 27(2008).14] • However, the proportions of profit or loss and changes in equity allocated to the parent and non-controlling interests are determined on the basis of present ownership, and do not reflect any exercise or conversion of potential voting rights. [IAS 27(2008).19] In assessing whether potential voting rights contribute to control, all of the facts and circumstances that affect those rights should be considered (including the terms of exercise of the rights and any other contractual arrangements), except the intention of management and the financial ability to exercise or convert such rights. [IAS 27(2008).15] The effect of these requirements is that where one entity, by using the threat of exercise or conversion of potential voting rights, is able to ensure that its wishes are followed, then it has the power to direct the actions of others who are affected by a change in voting power.

–  –  –

Five examples illustrating aspects of potential voting rights are set out in the implementation guidance accompanying IAS 27(2008).

Example 6.1.

3A Options are out of the money [IAS 27(2008).IG8] Entities A and B own 80 per cent and 20 per cent respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Entity C. Entity A sells one-half of its interest to Entity D and buys call options from Entity D that are exercisable at any time at a premium to the market price when issued, and if exercised would give Entity A its original 80 per cent ownership interest and voting rights.

Though the options are out of the money, they are currently exercisable and give Entity A the power to continue to set the operating and financial policies of Entity C, because Entity A could exercise its options now. The existence of the potential voting rights, as well as the other factors described in paragraph 13 of IAS 27, are considered and it is determined that Entity A controls Entity C.

Example 6.1.

3B Possibility of exercise or conversion [IAS 27(2008).IG8] Entities A, B and C own 40 per cent, 30 per cent and 30 per cent respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Entity D. Entity A also owns call options that are exercisable at any time at the fair value of the underlying shares and if exercised would give it an additional 20 per cent of the voting rights in Entity D and reduce Entity B’s and Entity C’s interests to 20 per cent each. If the options are exercised, Entity A will have control over more than one-half of the voting power. The existence of the potential voting rights, as well as the other factors described in paragraph 13 of IAS 27 and paragraphs 6 and 7 of IAS 28, are considered and it is determined that Entity A controls Entity D.

Identifying the acquirer

–  –  –

Other rights that have the potential to increase an entity’s voting power or reduce another entity’s voting power [IAS 27(2008).IG8] Entities A, B and C own 25 per cent, 35 per cent and 40 per cent respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Entity D. Entities B and C also have share warrants that are exercisable at any time at a fixed price and provide potential voting rights. Entity A has a call option to purchase these share warrants at any time for a nominal amount. If the call option is exercised, Entity A would have the potential to increase its ownership interest, and thereby its voting rights, in Entity D to 51 per cent (and dilute Entity B’s interest to 23 per cent and Entity C’s interest to 26 per cent).

Although the share warrants are not owned by Entity A, they are considered in assessing control because they are currently exercisable by Entities B and C. Normally, if an action (e.g.

purchase or exercise of another right) is required before an entity has ownership of a potential voting right, the potential voting right is not regarded as held by the entity. However, the share warrants are, in substance, held by Entity A, because the terms of the call option are designed to ensure Entity A’s position. The combination of the call option and share warrants gives Entity A the power to set the operating and financial policies of Entity D, because Entity A could currently exercise the option and share warrants. The other factors described in paragraph 13 of IAS 27 and paragraphs 6 and 7 of IAS 28 are also considered, and it is determined that Entity A, not Entity B or C, controls Entity D.

–  –  –

Management intention [IAS 27(2008).IG8] Entities A, B and C each own 33h per cent of the ordinary shares that carry voting rights at a general meeting of shareholders of Entity D. Entities A, B and C each have the right to appoint two directors to the board of Entity D. Entity A also owns call options that are exercisable at a fixed price at any time and if exercised would give it all the voting rights in Entity D. The management of Entity A does not intend to exercise the call options, even if Entities B and C do not vote in the same manner as Entity A. The existence of the potential voting rights, as well as the other factors described in paragraph 13 of IAS 27 and paragraphs 6 and 7 of IAS 28, are considered and it is determined that Entity A controls Entity D. The intention of Entity A’s management does not influence the assessment.





–  –  –

[IAS 27(2008).IG8] Entities A and B own 55 per cent and 45 per cent respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Entity C. Entity B also holds debt instruments that are convertible into ordinary shares of Entity C. The debt can be converted at a substantial price, in comparison with Entity B’s net assets, at any time and if converted would require Entity B to borrow additional funds to make the payment. If the debt were to be converted, Entity B would hold 70 per cent of the voting rights and Entity A’s interest would reduce to 30 per cent.

Although the debt instruments are convertible at a substantial price, they are currently convertible and the conversion feature gives Entity B the power to set the operating and financial policies of Entity C. The existence of the potential voting rights, as well as the other factors described in paragraph 13 of IAS 27, are considered and it is determined that Entity B, not Entity A, controls Entity C. The financial ability of Entity B to pay the conversion price does not influence the assessment.

6.1.4 Special purpose entities When assessing whether control exists, consideration should also be given to the guidance in SIC-12 Consolidation – Special Purpose Entities [SIC-12.10] which cites the following circumstances as

indicative of control:

(a) the activities of the acquiree are conducted on behalf of the entity according to its specific business needs so that the entity obtains benefits from the acquiree’s operations;

(b) the entity has the decision-making powers to obtain the majority of benefits or has delegated those powers through an ‘autopilot’ mechanism;

(c) the entity has rights to obtain the majority of benefits and, therefore, may be exposed to risks from the acquiree’s activities; or (d) the entity retains the majority of residual or ownership risks related to the acquiree or its assets in order to obtain benefits from its activities.

6.1.5 Venture capital organisations For the avoidance of doubt, IAS 27(2008) states that an entity which meets the definition of a subsidiary may not be excluded from consolidation simply because the investor is a venture capital organisation, mutual fund, unit trust or similar entity. [IAS 27(2008).16] The requirement to consolidate due to the existence of control thus overrides any concern (frequently raised in connection with these types of entity) that the fair value of the subsidiary may be a more meaningful method of measuring its performance than underlying net assets.

Identifying the acquirer

6.2 Additional guidance in marginal cases Where application of IAS 27(2008) does not clearly indicate which of the combining entities is the acquirer, a number of additional factors for consideration are set out in IFRS 3(2008).B14 – B18 as follows.

–  –  –

Consideration primarily cash, other assets Usually the entity that transfers the cash or other or incurring liabilities. assets, or incurs the liabilities. [IFRS 3(2008).B14]

–  –  –

New entity formed which transfers cash, New entity may be the acquirer (see section 6.3).

other assets or incurs liabilities. [IFRS 3(2008).B18]

–  –  –

Identifying the acquirer Where a new entity A is formed to effect a combination between two or more entities, say B and C,

IFRS 3 identifies two distinct scenarios:

[IFRS 3(2008).B18] • where A issues equity instruments in itself in exchange for equity instruments in B and C, then either B or C should be identified as the acquirer by applying the guidance in IAS 27 and IFRS 3; and • where A transfers cash (or other assets) in exchange for equity instruments in B and C (e.g.

from the proceeds of a debt issue to new investors or to existing investors holding a minority interest in B or C), then A may be identified as the acquirer.

–  –  –

New entity issues equity instruments B and C are existing entities, and combine through a new entity A which issues new equity shares in itself in the proportion four-fifths to the equity shareholders of B and one-fifth to the equity shareholders of C.

On the basis of the relative voting rights, and in the absence of other factors suggesting otherwise, B is identified as the acquirer.

Accounting for the combination is developed on the principle that the consolidated financial statements of the A group are presented on the same basis as if B had legally acquired C, noting that A lacks commercial substance because it is effectively a legal mechanism to achieve this outcome. Accordingly, the combination of A and B will be accounted for as a capital

restructuring whereby:

• the net assets of B remain at their previous carrying amounts;

• the consolidated statement of comprehensive income of the A group, including comparatives, will be based on the reporting period of B and will include the precombination results of B;

• the equity of the group will be that of B plus the fair value of A; and

• the share capital of the group, if any, will be that of A the legal parent.

The combination of the A group and C will be a ‘normal’ acquisition whereby:

• the identifiable net assets of C are fair valued on acquisition; and

• the consolidated statement of comprehensive income of the A group will only include C’s post-acquisition results.

–  –  –

Example 6.3.

1B New entity transfers cash B and C are existing entities, and combine through a new entity A. The equity investors in A are a private equity business that own 60% of A and the former equity investors in C who own 40%. A pays cash to acquire the equity interests of B, and issues equity interests in A to acquire C.

C is not identified as the acquirer since the equity investors in C do not hold a majority of the equity shares in A. In this case, A is identified as the acquirer.

The combination of A and B, and A and C, are ‘normal’ acquisitions whereby:

• the identifiable net assets of both B and C are fair valued on acquisition; and

• the consolidated statement of comprehensive income of the A group will include only the post-combination results of B and C.

6.3.2 Mutual entities Section 4.2.3 sets out the definition of a mutual entity.

Since a combination of mutual entities involves an exchange (albeit typically of membership interests), IFRS 3(2008) allows no exemption from its general requirements in respect of applying the acquisition method. Consequently, an acquirer must be identified in any combination of mutual entities. [IFRS 3(2008).BC104] The Board further concluded that the guidance on identifying the acquirer in IFRS 3 is applicable to mutual entities and no additional guidance is needed. [IFRS 3(2008).BC105] However, additional guidance is provided to assist in measuring the fair value of equity or membership interests exchanged in paragraphs B47 – B49 of IFRS 3(2008). This guidance is considered in section 10.2.3 of this guide.

Determining the acquisition date

7. Determining the acquisition date 7.1 Definition of acquisition date The acquisition date is defined as the date on which the acquirer obtains control of the acquiree.

[IFRS 3(2008)(Appendix A)] This is consistent with the definition in IFRS 3(2004). However, the additional guidance given in IFRS 3(2004) on successive share purchases and dates of exchange, which was necessary in the context of that Standard’s approach to step acquisitions, is rendered redundant. This is due to the 2008 Standard’s stipulation that a business combination occurs, and goodwill is identified, only on the date that control is achieved.

7.2 Relationship to the timing of the payment of consideration



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