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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Disclosure non-financial assets and liabilities example

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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11 Best fair value measurements under IFRS 13

11 Best fair value measurements under IFRS 13

Several IFRS standards provide guidance regarding the scope and application of the fair value option for assets and liabilities. Here they are from 1 to 11…….

1 Investments in associates and joint ventures

Investments held by venture capital organizations and the like are exempt from IAS 28’s requirements only when they are measured at fair value through profit or loss (FVPL) in accordance with IFRS 9. Changes in the fair value (FV) of such investments are recognized in profit or loss in the period of change.

The IASB acknowledged that FV information is often readily available in venture capital organizations and entities in similar industries, even for start-up and non-listed entities, as the methods and basis for fair value measurement are well established. The IASB also confirmed that the reference to well-established practice is to emphasize that the exemption applies generally to those investments for which fair value is readily available.

2 Intangible assets

Subsequent to initial recognition of intangible assets, an entity may adopt either the cost model or the revaluation model as its accounting policy. The policy should be applied to the whole of a class of intangible assets and not merely to individual assets within a class11 Best fair value measurements under IFRS 13, unless there is no active market for an individual asset.

The revaluation model may only be adopted if the intangible assets are traded in an active market; hence it is not frequently used. Further, the revaluation model may not be applied to intangible assets that have not previously been recognized as assets. For example, over the years an entity might have accumulated for nominal consideration a number of licenses of a kind that are traded on an active market. 11 Best fair value measurements under IFRS 13

The entity may not have recognized an intangible asset as the licenses were individually immaterial when acquired. If market prices for such licenses significantly increased, the value of the licenses held by the entity would substantially increase. In this case, the entity would be prohibited by IAS 38 from applying the revaluation model to the licenses, because they were not previously recognized as an asset.

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M and A

M and A or Mergers and Acquisitions

in IFRS language Business Combinations.

1 Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or merger 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 Simple case – Straightforward business combination below). However, a business combination (M and A) may be structured, and an entity may obtain control of that structure, in a variety of ways.

Examples of business combinations structurings

Examples of ways an entity may obtain control

A business becomes the subsidiary of an acquirer

The entity transfers cash, cash equivalents or other assets(including net assets that constitute a business)

Net assets of one or more businesses are legally merged with an acquirer

The entity incurs liabilities

One combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners

The entity issues shares

The entity transfers more than one type of consideration, or

Two or more entities transfer their net assets, or the owners of those entities transfer their equity interests to a newly created entity, which in exchange issues shares, or

The entity does not transfer consideration and obtains control for example by contract alone Some examples of this:

  • ‘dual listed companies’ or ‘stapled entity structures’
  • acquiree repurchases a sufficient number of its own shares for an existing shareholder to obtain control
  • a condition in the shareholder agreement that prevents the majority shareholder exercising control of the entity has expired, or
  • a call option over a controlling interest that becomes exercisable.

A group of former owners of one of the combining entities obtains control of the combined entity, i.e. former owners, as a group, retain control of the entity they previously owned.

Therefore, identifying a business combination transaction requires the determination of whether:

  • what is acquired constitutes a ‘business’ as defined in IFRS3, and
  • control has been obtained.

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Disclosures Principles of consolidation and equity accounting for IAS 1

Disclosures Principles of consolidation and equity accounting

This is a separated part of the example accounting policies, it is separated because of the size of this note and the specific nature of principles of consolidation and equity accounting.

Example accounting policies – Introduction

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 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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IAS 1 Common control transactions v Newco formation

Common control transactions v Newco formation

are two different events, that sometimes interactCommon control transactions v Newco formation

  • Common control transactions represent the transfer of assets or an exchange of equity interests among entities under the same parent’s control. “Control” can be established through a majority voting interest, as well as variable interests and contractual arrangements. Entities that are consolidated by the same parent—or that would be consolidated, if consolidated financial statements were required to be prepared by the parent or controlling party—are considered to be under common control.Determining whether common control exists requires judgment and could have broad implications for financial reporting, deals and tax. Just a few examples are:
    • A reporting entity charters a newly formed entity to effect a transaction.
    • A ‘Never-Neverland‘-domiciled company transfers assets to a subsidiary domiciled in a different jurisdiction.
    • Two companies under common control combine to form one legal entity.
    • Prior to spin-off of a subsidiary by a parent entity, another wholly owned subsidiary transfers net assets to the “SpinCo.”
    • As part of a reorganization, a parent entity merges with and into a wholly owned subsidiary.
  • Newco formations may be used in Business Combinations or businesses controlled by the same party (or parties). Just a few examples are: Common control transactions v Newco formation
    • A Newco can be formed by the controlling party (for example, to facilitate subsequent disposal of the newly created group through an initial public offering (IPO) or a spin-off or by a third-party acquirer (for example to raise funds to effect the acquisition); Common control transactions v Newco formation
    • A Newco can pay cash or shares to effect an acquisition; and
    • A Newco can be formed to acquire just one business or more than one business.

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IAS 36 Other impairment issues

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:

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IFRS 9 Proper accounting for Related Company Loans

IFRS 9 Proper accounting for Related Company Loans – IFRS 9 Financial Instruments makes no distinction between unrelated third party and related party transactions. Entities that prepare stand-alone financial statements are required to apply the full provisions of the standard to all transactions within its scope.

This means related company loan receivables must be classified and measured in accordance with the requirements of IFRS 9, including where relevant, applying the Expected Credit Loss (ECL) model for impairment. IFRS 9 Proper accounting for Related Company Loans

Applying IFRS 9 to related company loans can present a number of application challenges as they are often advanced on terms that are not arms-length or sometimes advanced on an informal basis without any terms … Read more

9 Best practical Impairment related company loans

9 Best practical Impairment related company loans – What are related company loans?

Technically not the most difficult question one would think, BUT………

Entities must first consider whether the loan is within the scope of IFRS 9 or another standard. This is because IFRS 9: 2.1(a) scopes out ‘interests in subsidiaries, associates and joint ventures’ that are accounted for in accordance with IAS 27 Separate Financial Statements or IAS 28 Investments in Associates and Joint Ventures i.e. at cost less impairment or using the equity method.

In many cases, it will be clear that the loan is a Read more