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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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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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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Example Disclosure financial instruments

Example Disclosure financial instruments

The guidance for this example disclosure financial instruments is found here.

7 Financial assets and financial liabilities

This note provides information about the group’s financial instruments, including:

  • an overview of all financial instruments held by the group
  • specific information about each type of financial instrument
  • accounting policies
  • information about determining the fair value of the instruments, including judgements and estimation uncertainty involved.

The group holds the following financial instruments: [IFRS 7.8]

Amounts in CU’000

Notes

2020

2019

Financial assets

Financial assets at amortised cost

– Trade receivables

7(a)

15,662

8,220

– Other financial assets at amortised cost

7(b)

4,598

3,471

– Cash and cash equivalents

7(e)

55,083

30,299

Financial assets at fair value through other comprehensive income (FVOCI)

7(c)

6,782

7,148

Financial assets at fair value through profit or loss (FVPL)

7(d)

13,690

11,895

Derivative financial instruments

– Used for hedging

12(a)

2,162

2,129

97,975

63,162

Example Disclosure financial instruments

Financial liabilities

Liabilities at amortised cost

– Trade and other payables1

7(f)

13,700

10,281

– Borrowings

7(g)

97,515

84,595

– Lease liabilities

8(b)

11,501

11,291

Derivative financial instruments

– Used for hedging

12(a)

766

777

Held for trading at FVPL

12(a)

610

621

124,092

107,565

The group’s exposure to various risks associated with the financial instruments is discussed in note 12. The maximum exposure to credit risk at the end of the reporting period is the carrying amount of each class of financial assets mentioned above. [IFRS 7.36(a), IFRS 7.31, IFRS 7.34(c)]

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Ordinary shares issued and EPS

Ordinary shares issued and EPS

Ordinary shares issued and EPS summarises the effects of three events involving share issued on EPS calculations including comprehensive examples:

Ordinary shares issued to settle liabilities

This chapter deals with ordinary shares issued to fully or partially extinguish a financial or non-financial liability, as a result of a renegotiation of the terms of the liabilities.

This chapter does not deal with:

EPS implications

Generally, ordinary shares issued to settle liabilities impact only basic EPS.

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Contingently issuable ordinary shares for IAS 33 EPS

Contingently issuable ordinary shares

For EPS purposes, contingently issuable ordinary shares are ordinary shares issuable for little or no cash or other consideration on the satisfaction of specified conditions in a contingent share agreement. [IAS 33 Definition]

This narrative builds on the basic principles introduced in EPS or earnings per share, and sets out the specific basic and diluted EPS implications of the following types of instrument(s).

These conditions do not include service conditions under IFRS 2 Share-based Payment and the passage of time. Therefore, shares that are issuable subject only to the passage of time, and unvested shares and options that require only service for vesting, are not considered contingently issuable. A different set of requirements applies to shares that are subject only to a service condition for vesting (see Unvested ordinary shares and EPS). [IAS 33.21(g), IAS 33.24, IAS 33.48]

Contingently issuable ordinary shares, as discussed in this chapter, are commonly seen in the context of share-based payment arrangements with performance conditions (including market and non-market performance conditions), or contingent consideration in business combinations. Additional considerations in the context of share-based payment arrangements are set out in EPS Impact and Share-based payments.

Although it is not specifically defined in IAS 33, a related class of instruments is contingently issuable POSs (see Contingently issuable ordinary shares).

EPS implications

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EPS Calculation – IAS 33 Best complete read

EPS Calculation

Here is full example of an EPS Calculation. This narrative builds on the basic principles introduced in the narrative EPS, and sets out the specific basic and diluted EPS calculation rules as per IAS 33 Earnings per share.

Case

Company P earns a consolidated net profit of 4,600,000 during the year ended 31 December Year 1 and 5,600,000 during the year ended 31 December Year 2. The total number of ordinary shares outstanding on 1 January Year 1 is 3,000,000.

Various POSs are issued before 1 January Year 1 and during the years ended 31 December Year 1 and Year 2. During this period, the outstanding number of ordinary shares also changes.

The statement of changes in equity below summarises only the actual movements in the outstanding number of ordinary shares, followed by detailed information about such movements and POSs outstanding during the periods.

EPS Calculation

Details of the instruments and ordinary share transactions during Year 1 and Year 2

1. Convertible preference shares

At 1 January Year 1, P has 500,000 outstanding convertible preference shares. Dividends on these shares are discretionary and non-cumulative. Each preference share is convertible into two ordinary shares at the holder’s option.

The preference shares are classified as equity in P’s financial statements.

On 15 October Year 1, a dividend of 1.20 per preference share is declared. The dividend is paid in cash on 15 December Year 1. Preference dividends are not tax-deductible.

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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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Example accounting policies

Example accounting policies

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. First there is a section providing guidance on what the requirements are, followed by a comprehensive example, easy to tailor to the specific needs of your company.Example accounting policies

Example accounting policies guidance

Whether to disclose an accounting policy

1. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in the reported financial performance and financial position. Disclosure of particular accounting policies is especially useful to users where those policies are selected from alternatives allowed in IFRS. [IAS 1.119]

2. Some IFRSs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, IAS 16 Property, Plant and Equipment requires disclosure of the measurement bases used for classes of property, plant and equipment and IFRS 3 Business Combinations requires disclosure of the measurement basis used for non-controlling interest acquired during the period.

3. In this guidance, policies are disclosed that are specific to the entity and relevant for an understanding of individual line items in the financial statements, together with the notes for those line items. Other, more general policies are disclosed in the note 25 in the example below. Where permitted by local requirements, entities could consider moving these non-entity-specific policies into an Appendix.

Change in accounting policy – new and revised accounting standards

4. Where an entity has changed any of its accounting policies, either as a result of a new or revised accounting standard or voluntarily, it must explain the change in its notes. Additional disclosures are required where a policy is changed retrospectively, see note 26 for further information. [IAS 8.28]

5. New or revised accounting standards and interpretations only need to be disclosed if they resulted in a change in accounting policy which had an impact in the current year or could impact on future periods. There is no need to disclose pronouncements that did not have any impact on the entity’s accounting policies and amounts recognised in the financial statements. [IAS 8.28]

6. For the purpose of this edition, it is assumed that RePort Co. PLC did not have to make any changes to its accounting policies, as it is not affected by the interest rate benchmark reforms, and the other amendments summarised in Appendix D are only clarifications that did not require any changes. However, this assumption will not necessarily apply to all entities. Where there has been a change in policy, this will need to be explained, see note 26 for further information.

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Disclosure financial assets and liabilities

Disclosure financial assets and liabilities

– provides a narrative providing guidance on users of financial statements’ needs to present financial disclosures in the notes to the financial statements grouped in more logical orders. But there is and never will be a one-size fits all.

Here it has been decided to separately disclose financial assets and liabilities and non-financial assets and liabilities, because of the distinct different nature of these classes of assets and liabilities and the resulting different types of disclosures, risks and tabulations.

Disclosure financial assets and liabilities guidance

Disclosing financial assets and liabilities (financial instruments) in one note

Users of financial reports have indicated that they would like to be able to quickly access all of the information about the entity’s financial assets and liabilities in one location in the financial report. The notes are therefore structured such that financial items and non-financial items are discussed separately. However, this is not a mandatory requirement in the accounting standards.

Accounting policies, estimates and judgements

For readers of Financial Statements it is helpful if information about accounting policies that are specific to the entityDisclosure financial assets and liabilitiesand about significant estimates and judgements is disclosed with the relevant line items, rather than in separate notes. However, this format is also not mandatory. For general commentary regarding the disclosures of accounting policies refer to note 25. Commentary about the disclosure of significant estimates and judgements is provided in note 11.

Scope of accounting standard for disclosure of financial instruments

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IFRS 7 does not apply to the following items as they are not financial instruments as defined in paragraph 11 of IAS 32:

  1. prepayments made (right to receive future good or service, not cash or a financial asset)
  2. tax receivables and payables and similar items (statutory rights or obligations, not contractual), or
  3. contract liabilities (obligation to deliver good or service, not cash or financial asset).

While contract assets are also not financial assets, they are explicitly included in the scope of IFRS 7 for the purpose of the credit risk disclosures. Liabilities for sales returns and volume discounts (see note 7(f)) may be considered financial liabilities on the basis that they require payments to the customer. However, they should be excluded from financial liabilities if the arrangement is executory. the Reporting entity Plc determined this to be the case. [IFRS 7.5A]

Classification of preference shares

Preference shares must be analysed carefully to determine if they contain features that cause the instrument not to meet the definition of an equity instrument. If such shares meet the definition of equity, the entity may elect to carry them at FVOCI without recycling to profit or loss if not held for trading.

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