«Business combinations and changes in ownership interests A guide to the revised IFRS 3 and IAS 27 Audit.Tax.Consulting.Financial Advisory. Contacts ...»
22.214.171.124 Subsequent remeasurement As noted above, contingent liabilities recognised in a business combination are initially measured at their acquisition-date fair values. After initial recognition and until the liability is settled, cancelled or expires, the acquirer should measure a contingent liability recognised in a business combination at
the higher of:
[IFRS 3(2008).56] (a) the amount that would be recognised in accordance with IAS 37; and (b) the amount initially recognised less, if appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.
This requirement does not apply to contracts accounted for in accordance with IAS 39.
1.4 Contingent warranty payment Company A acquired Company B in a prior reporting period. At the time of the business combination, Company A recognised a contingent liability of CU41 in respect of a warranty claim in progress against Company B. At 31 December 20X5, the revised estimate of the liability is CU32 and the amount has met the recognition criteria of IAS 37 to be recognised as a provision.
IFRS 3(2008) requires the acquirer to measure contingent liabilities subsequent to the date of acquisition at the higher of the amount that would be recognised in accordance with IAS 37, and the amount initially recognised, less any appropriate cumulative amortisation in accordance with IAS 18. These requirements should be applied only for the period in which the item is considered to be a contingent liability, and usually will result in the contingent liability being carried at the value attributed to it in the initial business combination.
In this case, the contingent liability has subsequently met the requirements to be reclassified as a provision, and will be measured in accordance with IAS 37 rather than IFRS 3(2008).
Accordingly, the liability is measured at 31 December 20X5 at CU32, and the decrease in the recognised liability is recognised through profit or loss during the year ended 31 December 20X5.
Assets, liabilities and non-controlling interests 8.5.2 Pre-existing relationships and reacquired rights 126.96.36.199 Overview IFRS 3(2008) deals with reacquired rights and the wider issue of pre-existing relationships in three
• first, the section on identifying and measuring assets acquired includes a requirement to identify and recognise reacquired rights;
• second, the section on determining what is part of the business combination requires an adjustment to be made to the purchase consideration for transactions that in effect settle pre-existing relationships between the acquirer and the acquiree; and • third, the section on subsequent measurement and accounting includes a requirement in respect of reacquired rights.
188.8.131.52 Recognition of reacquired rights as an intangible asset As part of a business combination, an acquirer may reacquire a right that it had previously granted to the acquiree to use one or more of the acquirer’s recognised or unrecognised assets. Examples of reacquired rights include a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement. A reacquired right is an intangible asset that the acquirer recognises separately from goodwill. [IFRS 3(2008).B35] There are two specific requirements regarding the measurement of a reacquired right.
• Ignoring the potential for contract renewal The acquirer is required to measure the value of a reacquired right recognised as an intangible asset on the basis of the remaining contractual term of the related contract, regardless of whether market participants would consider potential contractual renewals in determining its fair value. [IFRS 3(2008).29] • Recognition of a settlement gain or loss If the terms of the contract giving rise to a reacquired right are favourable or unfavourable to the acquirer relative to the terms of current market transactions for the same or similar items, the acquirer should recognise a settlement gain or loss. [IFRS 3(2008).B36] The consequence of this requirement is that the consideration for the business combination is adjusted down (and that amount recognised as an expense) where part of the consideration effectively settles an unfavourable exposure from the acquirer’s perspective, and adjusted up (a gain) where the consideration is lower due to the effective settlement of a favourable arrangement from the acquirer’s perspective. The measurement of any such gain or loss is described in section 184.108.40.206.
The effect of these requirements is that the amount recognised for the reacquired right asset is based on the ‘at market’ valuation of the contract, but only by reference to the contracted term of the right.
220.127.116.11 Measurement of gain or loss on settlement of a pre-existing relationship The acquirer and acquiree may have a relationship that existed before they contemplated the business combination, referred to as a ‘pre-existing relationship’. A pre-existing relationship between the acquirer and the acquiree may be contractual (e.g. vendor and customer, or licensor and licensee) or non-contractual (e.g. plaintiff and defendant). [IFRS 3(2008).B51] If the business combination in effect settles a pre-existing relationship, the acquirer recognises a gain
or loss, measured as follows:
[IFRS 3(2008).B52] (a) for a pre-existing non-contractual relationship (such as a lawsuit), fair value;
(b) for a pre-existing contractual relationship, the lesser of (i) and (ii):
(i) the amount by which the contract is favourable or unfavourable from the perspective of the acquirer when compared with terms for current market transactions for the same or similar items. (An unfavourable contract is a contract that is unfavourable in terms of current market terms. It is not necessarily an onerous contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it); and (ii) the amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavourable.
If (ii) is less than (i), the difference is included as part of the business combination accounting.
The amount of gain or loss recognised may depend in part on whether the acquirer had previously recognised a related asset or liability, and the reported gain or loss therefore may differ from the amount calculated by applying the above requirements. [IFRS 3(2008).B52] A pre-existing relationship may be a contract that the acquirer recognises as a reacquired right. If the contract includes terms that are favourable or unfavourable when compared with pricing for current market transactions for the same or similar items, the acquirer recognises, separately from the business combination, a gain or loss for the effective settlement of the contract, measured in accordance with IFRS 3(2008).B52. [IFRS 3(2008).B53] Assets, liabilities and non-controlling interests Summary of accounting for a pre-existing relationship
2.3A Settlement of a pre-existing relationship - contractual supply agreement [IFRS 3(2008).IE54-IE57] AC purchases electronic components from TC under a five-year supply contract at fixed rates.
Currently, the fixed rates are higher than the rates at which AC could purchase similar electronic components from another supplier. The supply contract allows AC to terminate the contract before the end of the initial five-year term but only by paying a CU6 million penalty. With three years remaining under the supply contract, AC pays CU50 million to acquire TC, which is the fair value of TC based on what other market participants would be willing to pay.
Included in the total fair value of TC is CU8 million related to the fair value of the supply contract with AC. The CU8 million represents a CU3 million component that is ‘at market’ because the pricing is comparable to pricing for current market transactions for the same or similar items (selling effort, customer relationships and so on) and a CU5 million component for pricing that is unfavourable to AC because it exceeds the price of current market transactions for similar items. TC has no other identifiable assets or liabilities related to the supply contract, and AC has not recognised any assets or liabilities related to the supply contract before the business combination.
In this example, AC calculates a loss of CU5 million (the lesser of the CU6 million stated settlement amount and the amount by which the contract is unfavourable to the acquirer) separately from the business combination. The CU3 million ‘at-market’ component of the contract is part of goodwill.
The consequence of recognising a CU5 million loss is that the purchase consideration used to calculate goodwill is adjusted down from CU50 million to CU45 million. No intangible asset is recognised in this example since the supply contract is not the reacquisition of a right granted by AC for the use of its assets. Rather, the business combination transaction results in the effective settlement of a pre-existing contractual supply arrangement between AC and TC.
Whether AC had recognised previously an amount in its financial statements related to a preexisting relationship will affect the amount recognised as a gain or loss for the effective settlement of the relationship. Suppose that IFRSs had required AC to recognise a CU6 million liability for the supply contract before the business combination, perhaps because it met the definition of an onerous contract under IAS 37. In that situation, AC recognises a CU1 million settlement gain on the contract in profit or loss at the acquisition date (the CU5 million measured loss on the contract less the CU6 million loss previously recognised). In other words, AC has in effect settled a recognised liability of CU6 million for CU5 million, resulting in a gain of CU1 million.
Assets, liabilities and non-controlling interests Example 8.5.
2.3B Reacquired right at market terms X grants a franchise right to Y to operate under X’s name in the northeast region of the country in which it operates. Two years later, X decides to expand its business and enters into an agreement to acquire 100% of Y for CU50,000. Y’s business consists of the franchise right (fair value CU20,000), a customer list (fair value CU10,000), some operating assets and liabilities (net fair value CU15,000), an assembled workforce (recognised as part of goodwill) and processes. At the time of the acquisition, the franchise right is at market terms and, therefore, X does not recognise an off-market settlement gain or loss. Assume that the franchise right has a fixed term and is not renewable.
Under IFRS 3(2008), X recognises an identified intangible asset for the reacquired right at its fair value of CU20,000. This right will be amortised over the remaining term of the franchise agreement.
Goodwill will therefore be CU5,000 (CU50,000 less (20,000 + 10,000 + 15,000)).
2.3C Reacquired right at off-market terms Facts as in example 18.104.22.168B, except that the franchise right contract terms are favourable to X compared to market terms at the acquisition date by CU3,000.
As before, X recognises an identified intangible asset for the reacquired right at its fair value of CU20,000. This right will be amortised over the remaining term of the franchise agreement.
In addition, X recognises a gain of CU3,000 for the effective settlement of the contract and consequently increases the consideration used in the acquisition accounting to CU53,000.
Goodwill will therefore be CU8,000 (CU53,000 less (20,000 + 10,000 + 15,000)).
22.214.171.124 Subsequent measurement A reacquired right recognised as an intangible asset should be amortised over the remaining contractual period of the contract in which the right was granted. An acquirer that subsequently sells a reacquired right to a third party should include the carrying amount of the intangible asset in determining the gain or loss on the sale. [IFRS 3(2008).55] In such cases, care should be taken to ensure that the intangible asset being sold is the same asset that was previously reacquired.
Thus, the reacquisition through a business combination of a ‘master franchise agreement’, and the subsequent granting of sub-franchises for specific geographical areas to third parties, would be dealt with separately and the master franchise agreement retained in the acquirer’s statement of financial position.
8.5.3 Share-based payment awards Where an acquirer issues share-based payment awards to replace those of an acquiree, it is
necessary to allocate the replacement awards between:
• the element which represents purchase consideration for accrued share rights earned before the acquisition; and • the element which represents compensation for post-acquisition services.
As an exception to the fair value measurement principle, any liability or equity instrument recognised by the acquirer is based on a ‘market-based measure’ determined in accordance with IFRS 2 Sharebased Payment. Share-based payments are dealt with fully in section 9.3.4 below.
8.5.4 Assets held for sale
The acquirer should measure an acquired non-current asset (or disposal group) that is classified as held for sale at the acquisition date in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations at fair value less costs to sell in accordance with paragraphs 15 -18 of that Standard. [IFRS 3(2008).31] 8.5.5 Income taxes IFRS 3(2008) requires the acquirer to recognise and measure a deferred tax asset or liability arising from the assets acquired and liabilities assumed in a business combination in accordance with IAS 12 Income Taxes. [IFRS 3(2008).24] The acquirer should account for potential tax effects of temporary differences and carry forwards of an acquiree that exist at the acquisition date or that arise as a result of the acquisition in accordance with IAS 12. [IFRS 3(2008).25] Amendments to IAS 12 relating to the post-acquisition recognition of deferred tax assets are discussed in section 11.3.6. Transitional arrangements are discussed in section 15.3.3.