Contingent liability

Accounting for mergers – Best 2 Read

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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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Disclosure non-financial assets and liabilities example

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Disclosure non-financial assets and liabilities example

The guidance for this disclosure example is provided here.

8 Non-financial assets and liabilities

This note provides information about the group’s non-financial assets and liabilities, including:

  • specific information about each type of non-financial asset and non-financial liability
    • property, plant and equipment (note 8(a))
    • leases (note 8(b))
    • investment properties (note 8(c))
    • intangible assets (note 8(d))
    • deferred tax balances (note 8(e))
    • inventories (note 8(f))
    • other assets, including assets classified as held for sale (note 8(g))
    • employee benefit obligations (note 8(h))
    • provisions (note 8(i))
  • accounting policies
  • information about determining the fair value of the assets and liabilities, including judgements and estimation uncertainty involved (note 8(j)).

8(a) Property, plant and equipment

Amounts in CU’000

Freehold land

Buildings

Furniture, fittings and equipment

Machinery and vehicles

Assets under construction

Total

At 1 January 2019

Cost or fair value

11,350

28,050

27,510

70,860

–

137,770

Accumulated depreciation

–

–

-7,600

-37,025

–

-44,625

Net carrying amount

11,350

28,050

19,910

33,835

–

93,145

Movements in 2019

Exchange differences

–

–

-43

-150

–

-193

Revaluation surplus

2,700

3,140

–

–

–

5,840

Additions

2,874

1,490

2,940

4,198

3,100

14,602

Assets classified as held for sale and other disposals

-424

–

-525

-2,215

–

3,164

Depreciation charge

–

-1,540

-2,030

-4,580

–

8,150

Closing net carrying amount

16,500

31,140

20,252

31,088

3,100

102,080

At 31 December 2019

Cost or fair value

16,500

31,140

29,882

72,693

3,100

153,315

Accumulated depreciation

–

–

-9,630

-41,605

–

-51,235

Net carrying amount

16,500

31,140

20,252

31,088

3,100

102,080

Movements in 2020

Exchange differences

–

–

-230

-570

–

-800

Revaluation surplus

3,320

3,923

–

–

–

7,243

Acquisition of subsidiary

800

3,400

1,890

5,720

–

11,810

Additions

2,500

2,682

5,313

11,972

3,450

25,917

Assets classified as held for sale and other disposals

-550

–

-5,985

-1,680

–

-8,215

Transfers

–

–

950

2,150

-3,100

–

Depreciation charge

–

-1,750

-2,340

-4,380

–

-8,470

Impairment loss (ii)

–

-465

-30

-180

–

-675

Closing net carrying amount

22,570

38,930

19,820

44,120

3,450

128,890

At 31 December 2020

Cost or fair value

22,570

38,930

31,790

90,285

3,450

187,025

Accumulated depreciation

–

–

-11,970

-46,165

–

-58,135

Net carrying amount

22,570

38,930

19,820

44,120

3,450

128,890
(i) Non-current assets pledged as security

Refer to note 24 for information on non-current assets pledged as security by the group.

(ii) Impairment loss and compensation

The impairment loss relates to assets that were damaged by a fire – refer to note 4(b) for details. The whole amount was recognised as administrative expense in profit or loss, as there was no amount included in the asset revaluation surplus relating to the relevant assets. [IAS 36.130(a)]

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Definition of provision – IAS 37 Complete easy read

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Definition of provision

The definition of provision is key to IAS 37. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want.

As part of the attempt of IASB to further restrict this type of earnings management within IFRSs, IASB adopted an update of IAS 37 in April 2001 originating from September 1998. IAS 37 was further updated for Onerous contracts – Costs of fulfilling a contract in May 2020.

IAS 37: ‘Onerous Contracts – Cost of Fulfilling a Contract’

lAS 37 defines an onerous contract as one in which the unavoidable costs of meeting the entity’s obligations exceed the economic benefits to be received under that contract. Unavoidable costs are the lower of the net cost of exiting the contract and the costs to fulfil the contract. The amendment clarifies the meaning of ‘costs to fulfil a contract’.

The amendment explains that the direct cost of fulfilling a contract comprises:

  • the incremental costs of fulfilling that contract (for example, direct labour and materials); and
  • an allocation of other costs that relate directly to fulfilling contracts (for example, an allocation ofthe depreciation charge for an item of PP&E used to fulfil the contract).

The amendment also clarifies that, before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets used in fulfilling the contract, rather than on assets dedicated to that contract.

The amendment could result in the recognition of more onerous contract provisions, because previously some entities only included incremental costs in the costs to fulfil a contract.

The key definition of provision

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Provisions and contingent liabilities – 2 know it all!

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Provisions and contingent liabilities A provision shall be recognised when: Provisions and contingent liabilities an entity has a present obligation (legal or constructive) as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognised. But a disclosure for a contingent liability could be required (see below). This is what it is about, make your decision supportable! Provisions Provisions are liabilities of uncertain timing or amount. This uncertainty makes them different from accruals or payables, where the timing and amount are known or … Read more

Leveraged buyout IFRS 3 best reporting

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Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting 1 The process and business reason The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more

IAS 36 Other impairment issues

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IAS 36 Other impairment issues – When looking at the step-by-step IAS 36 impairment approach it comes down to the following broadly organised steps: IAS 36 How Impairment test What?? – Determining the scope and structure of the impairment review, explained here, If and when? – Determining if and when a quantitative impairment test is necessary, explained here, IAS 36 How Impairment test or understanding the mechanics of the impairment test and how to recognise or reverse any impairment loss, if necessary, which is explained here IAS 36 Other impairment issues discusses other common application issues encountered when applying IAS 36, including those related to: the ‘deferred tax and goodwill problem’ non-controlling interests equity accounting the interaction between IAS 36 and … Read more

Accounting policies

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Accounting policies: The specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements.

Recognition

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Recognition – The process of capturing, for inclusion in the statement of financial position or the statement(s) of financial performance, an item that meets the definition of an element. It involves depicting the item (either alone or as part of a line item) in words and by a monetary amount, and including that amount in totals in the relevant statement. Conceptually the process of recognising a element/item/transaction/event in the financial statements is discussed in the Conceptual Framework  caption 5.1 – 5.25.  To summarise the concept of recognition here is caption 5.1: ‘Recognition is the process of capturing for inclusion in the statement of financial position or the statement(s) of financial performance an item that meets the definition of one of … Read more

Obligating event

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An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. A legal obligation is an obligation that derives from: a) a contract (through its explicit or implicit terms); b) legislation; or c) other operation of law. A constructive obligation is an obligation that derives from an entity’s actions where: a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.