Accounting for Business combinations cash flows

Accounting for Business combinations cash flows

1. Presentation and disclosure of cash paid/acquired in a business combination

When an entity acquires a business and part or all of the consideration is in cash or cash equivalents, part of the net assets acquired may include the acquiree’s existing cash balance. This results in different amounts being presented in the statement of cash flows and the notes to the financial statements.

IAS 7.39 and 42 require the net cash flows arising from gaining or losing control of a business, to be classified as arising from investing activities. Consequently, the statement of cash flows will not include the gross cash flows arisingBusiness combinations cash flows from the acquisition, and will instead show a single net amount. IAS 7.40 then requires the gross amounts to be disclosed in the notes.

The disclosures required by IFRS 3 Business Combinations include:

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Capitalisation of expenditure – 1 Complete answer

Capitalisation of expenditure

Capitalisation of expenditure is only possible when one of the following situations occur:

  • Capital expenditure (including equipment repairs and maintenance)
  • Recording lease contracts – Right-of-Use Assets
  • Capitalisation of borrowing costs
  • Capitalisation of cloud computing costs
  • Capitalisation of intangible assets
  • Capitalisation of internally capitalized intangible assets
  • Research & development costs
  • Prepaid expenses

Capital expenditure (including equipment repairs and maintenance)

The cost of an item of property, plant and equipment under IAS 16 Property, plant and equipment shall be recognised as an asset if, and only if:

  • it is probable that future economic benefits associated with the item will flow to the entity; and
  • the cost of the item can be measured reliably. (IAS 16.7)

Investment property

Certain properties which are used on rental are classified as an investment property in which case IAS 40 Investment property will apply. Only tangible items which have a useful life of more than one period are classified as property, plant and equipment as per IAS 16. But refer to the words “more than one period” as more than one accounting period of 12 months.

Also, an entity shall determine a threshold limit commensurate to its size for recognizing a tangible item as property, plant and equipment. For example, a tangible item of insignificant amount although satisfying the definition of property, plant and equipment may be expensed.

Initial recognition of indirect costs

Items of property, plant and equipment may be acquired for safety or environmental reasons. The acquisition of such property plant and equipment, although not directly increasing the future economic benefits of any particular existing item of property, plant and equipment, may be necessary for an entity to obtain the future economic benefits from its other assets.

Such items of property plant and equipment qualify for recognition as assets because they enable an entity to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired.

Subsequent recognition of indirect costs

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Acquisitions and mergers as per IFRS 3

Acquisitions and mergers

Acquisitions and mergers are becoming more and more common as entities aim to achieve their growth objectives. IFRS 3 ‘Business Combinations’ contains the requirements for these transactions, which are challenging in practice.

This narrative sets out how an entity should determine if the transaction is a business combination, and whether it is within the scope of IFRS 3.

Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or Acquisitions and mergersmerger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination (see case below).

Case – Straightforward business combination

Entity T is a clothing manufacturer and has traded for a number of years. Entity T is deemed to be a business.

On 1 January 2020, Entity A pays CU 2,000 to acquire 100% of the ordinary voting shares of Entity T. No other type of shares has been issued by Entity T. On the same day, the three main executive directors of Entity A take on the same roles in Entity T.

Consider this…..

Entity A obtains control on 1 January 2020 by acquiring 100% of the voting rights. As Entity T is a business, this is a business combination in accordance with IFRS 3.

However, a business combination may be structured, and an entity may obtain control of that structure, in a variety of ways.

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Acquisitions and disposals – IFRS 3 Pharmaceutical and Life Sciences

Acquisitions and disposals – IFRS 3 Pharmaceutical and Life Sciences

Contingent consideration arrangements in acquisitions and disposals are common within the Pharmaceutical and Life Sciences industry as they can be a convenient way of validating a company’s value as well as sharing economic risk between the buyer and the seller.IFRS 3 Pharmaceutical and Life Sciences

In this industry, many acquisitions and disposals involve compounds or devices that have not yet received regulatory approval, which inherently increases the risk that the degree of commercial success of what is acquired or sold may not be known at the date of acquisition.

For example, a pharmaceutical company may prefer to pay the seller of a biotech company an upfront amount at the acquisition date and then pay an additional amount if one of the compounds acquired receives regulatory approval or reaches a specified sales target.

The acquirer’s accounting for contingent consideration is outlined in the business combination standards (IFRS 3).

The standard defines consideration transferred by the acquirer to include the acquisition date fair value of contingent consideration. Depending on the terms of the contingent consideration, the acquirer either recognises, at the acquisition date, a liability or equity, at fair value.

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Contingent

Contingent

Contingent is a word used regularly in IFRS Standards and it is used in a rather normal way, most of the times a s contingent being dependent on. Here are the IFRS Standards in which contingent is used and in which context.

IFRS 3 Business combinations

Buyer’s accounting for royalties and milestones payable to a seller in a business combination

Acquisitions and divestitures have been headline news in the pharmaceutical and life sciences industry lately. With expiring patents on blockbuster products and downward pricing pressure, many companies have increased their M&A activity and turned to acquisitions to expand research pipelines in order to fuel innovation. In addition, companies have also looked to sell businesses or assets as part of R&D portfolio decisions to streamline operations and focus their efforts on faster growing areas of the business.

A common theme in acquisitions is that part of the purchase consideration may be in the form of future payments, such as royalties (i.e., the buyer has an obligation to make future royalty payments to the seller) or milestones. Payments related to these contingent obligations are often triggered by regulatory approval of in-process research and development (IPR&D) projects, or based on future performance measures, such as a percentage of sales.

Because many acquisitions or licenses of intellectual property, particularly those still in development, include milestone or royalty payments to the seller/licensor, the accounting and valuation of those contingent payments is often complex.

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Accounting for mergers – Best 2 Read

Accounting for mergers

Mergers and acquisitions (business combinations) can have a fundamental impact on the acquirer’s operations, resources and strategies. For most entities such transactions are infrequent, and each is unique. IFRS 3 ‘Business Combinations’ contains the requirements for accounting for mergers, which are challenging in practice.

This narrative provides a high-level overview of IFRS 3 and explains the key steps in accounting for business combinations in accordance with this Standard. It also highlights some practical application issues dealing with:

  • how to avoid unintended accounting consequences when bringing two businesses together, and
  • deal terms and what effect they can have on accounting for business combinations.

The acquisition method in accounting for mergers

IFRS 3 establishes the accounting and reporting requirements (known as ‘the acquisition method’) for the acquirer in a business combination. The key steps in applying the acquisition method are summarised below:

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IFRS 3 What are the different classifications of software?

IFRS 3 What are the different classifications of software, well off course it depends.

Computer software can be classified as either a tangible asset, i.e. property, plant and equipment or an intangible asset, depending on the level of integration with the related hardware.

Software integrated in hardware

In cases where software is an integral part of the related hardware, i.e. the hardware cannot operate without the software, the software will be treated as property, plant and equipment together with the related hardware already recognised, which will normally be computer equipment, a laboratory computer equipment (e.g. computer hardware and related operating systems are recognised under PPE). In such a case, the Accounting Policy on Property, Plant and Equipment shall apply. IFRS Read more

Goodwill or bargain on acquisition

Goodwill or bargain on acquisition – in short

Goodwill is initially measured at cost, being the excess of the aggregate of the consideration transferred, the amount recognised for non-controlling interests and any fair value of the Group’s previously held equity interests in the acquiree over the identifiable net assets acquired and liabilities assumed.

If the sum of this consideration and other items is lower than the fair value of the net assets acquired, the difference is, after reassessment, recognised in profit or loss as a gain on bargain purchase.

Business combinations

Business combinations are accounted for using the acquisition method. Cost of an acquisition is measured at the fair value of the assets given and liabilities incurred or assumed at the date of exchange. Identifiable assets acquired and liabilities assumed in a business combination (including contingent liabilities) are measured initially at their fair values at the acquisition date. There are no non-controlling interest in the Group’s subsidiaries.

The Dorolco acquisition – On xx October 202x Dorco Loan PLC acquired 100% of the Dorolco operations, by acquiring 100% of all voting shares in the legal entities now part of this Group.

Assets acquired and liabilities assumed – Because the holding companies established in structuring the Dorolco acquisition have been incorporated on behalf of this transaction, the opening balance sheet as at xx October 202x shown in the Consolidated Financial Statements as comparatives to the balance sheet as at 31 December 202x is the balance sheet at incorporation date. Shares issued were paid on acquisition date, except for the share option plan shares issued at closing date (1,000,000 shares issued, of which as at 31 December 202x 155,000 were not yet granted and paid up).

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SPAC Merger under IFRS 3

SPAC Merger

Private operating companies seeking a ‘fast track’ stock exchange listing sometimes arrange to be acquired by a smaller listed company (sometimes described as a ‘shell’ company or Special Purpose Acquisition Company or SPAC that is also a ‘shell’ company, especially incorporated (and listed) to serve a reverse acquisition/SPAC Merger). This usually involves the listed company issuing its shares to the private company shareholders in exchange for their shares.

The listed company becomes the ‘legal parent’ of the operating company, which in turn becomes the ‘legal subsidiary’.

A transaction in which a company with substantial operations (‘operating company’) arranges to be acquired by a listed shell company should be analysed to determine if it is a business combination within the scope of IFRS 3.

US GAAP comparison

The registering of securities that are issued by a special-purpose acquisition company (SPAC) — A Form S-1 may be used for the initial registration and sale of shares of a SPAC, a newly formed company that will use the proceeds from the IPO to acquire a private operating company (which generally has not been identified at the time of the IPO). To complete the acquisition of a private operating company, the SPAC may file a proxy or registration statement. Within four days of the closing of the acquisition of the private operating company, the SPAC must file a “super Form 8-K” that includes all of the information required in a Form 10 registration statement of the private operating company.

Is the transaction a business combination?

Answering this question involves determining:

  • which company is the ‘accounting acquirer’ under IFRS 3, ie the company that obtains effective control over the other
  • whether or not the acquired company (ie the ‘accounting acquiree’ under IFRS 3) is a business.

In these transactions, the pre-combination shareholders of the operating company typically obtain a majority (controlling) interest, with the pre-combination shareholders of the listed shell company retaining a minority (non-controlling) interest (i.e. a SPAC Merger). This usually indicates that the operating company is the accounting acquirer.

If the listed company is the accounting acquiree, the next step is to determine whether it is a ‘business’ as defined in IFRS 3. In general, the listed company is not a business if its activities are limited to managing cash balances and filing obligations. Further analysis will be needed if the listed company undertakes other activities and holds other assets and liabilities. Determining whether the listed company is a business in these more complex situations typically requires judgement.

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