Business Combination. CA Yagnesh Desai. Compiled by CA Yagnesh 1

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1 Business Combination CA Yagnesh Desai

2 Indicators Not necessarily Limits by the Standard Above 50 % Control Hence Consolidate Control Consolidate IFRS 3, IAS 27, SIC 12 Significant Influence Equity Method More than 20 % and up to 50 % Investment in Associates Significant Influence.IAS 28 No Significant Influence Cost Method or IAS 39 2 yagnesh@caymd.com Up to 20 % Other Fair value IAS 39

3 Method of Accounting Pooling of interest method Acquisition Method (Purchase method ) 3 yagnesh@caymd.com

4 Definitions 4 yagnesh@caymd.com

5 Identify the Acquirer Steps in Acquisition Method Recognising & Measuring Goodwill or gain in Bargain Purchase Recognizing & Measuring IA acquired, Liabilities Assumed & any NCI in acquiree Determine the Acquisition Date 5 yagnesh@caymd.com

6 6

7 Asset or a Business Is it a Business? Yes No Do We Have Control? No IAS 16 Yes IFRS 3 IAS 28 or IAS 31 7

8 Set of Activities and Assets What constitutes Business? 8 yagnesh@caymd.com

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10 Guidance by IAS 27 Power to Govern Financial & Operating Policies To Obtain Benefit 10

11 ? 11

12 Application of SIC 12 results in consolidation of many vehicles that would have otherwise resulted in Off Balance Sheet treatment 12 Where it has been Determined that an Entity is not a subsidiary under guidance in IAS 27 it may still be considered as subsidiary if it a SPE under SIC 12 SPV Under IFRS there is no specific definition of SPE. SIC 12 explains a number of situation that indicates there is relationship whereby the originator controls the SPE.

13 ? 13

14 Indicators of Acquirer When it is difficult to Identify Acquirer 14

15 Types of Business Combinations Acquirer Existing Entity 15

16 Types of Business Combination 16

17 A & B Transfer Net Assets to Newly Formed Entity - C A & B Shareholders of C 100 Shares 50 shares Who is the Acquirer? yagnesh@caymd.com 17

18 IF Shell Company Book Value Acquisition Method IF Not

19 Is the Acquirer Acquisition Method Acquisition Method 19

20 Determine Acquisition Date. Acquisition Date Obtains Control AlsoNormally the.. date on which Acquirer Transfers the Consideration Depending on Pertinent facts Acquisition Date could be earlier or later than the Closing Date 20

21 Reverse Acquisition Private Entity Listed Entity A B Legal Acquiree Accounting Acquirer Legal Acquirer Accounting Acquiree 21 Accounting is done from the perspective of Accounting Acquirer yagnesh@caymd.com

22 Steps in.method Fill The Gaps Recognising & Measuring Goodwill or Recognizing & Measuring IA acquired, Liabilities Assumed & any in acquiree Determine the Purchase Date!!! Identify the? 22

23 Acquisition Date Agenda -1 Recognise & Measure FV subject to Exceptions 1. Identifiable Assets, besides Goodwill 2. Liabilities Assumed & 3. Any NCI, If Any Provided 1. They Meet the Recognition Criteria laid down in Framework. AND 2. Exchanged in Business Combination Transaction & Not Separate Transaction 23 yagnesh@caymd.com

24 Recognition 24

25 Intangible Assets Other Than Goodwill Regardless of subsequent Use by Acquirer AND AND 25

26 Contractual 26

27 Separatedly Identifiable 27

28 Contractual 28

29 Separatedly Identifiable 29

30 Acquisition Date Agenda -2 Classify or Designate Identifiable & Liabilities Assumed With Exception of 1. On The Basis of : Contractual Terms, Economic Conditions, its operating or accounting policies & Other pertinent conditions at AD e.g. Financial Instruments IAS Lease Contract & Insurance Contract yagnesh@caymd.com Classification Based on conditions based etc on Inception Date unless modified as at AD

31 Acquisition Date Agenda - Measurement Identifiable Assets & Liabilities Assumed AT Fair Value as at Acquisition date with Limited Exceptions 31 yagnesh@caymd.com

32 Exceptions to AD Recognition Contingent Liabilities Even if Outflow is not probable. Recognition & Measurement 1.Income Taxes as per IAS 12 2.Employee Benefits IAS Indemnification Assets Measurement 1.Reacquired Rights 2,Share Based Payments 3,Assets held for sale 32 yagnesh@caymd.com Contingent Consideration

33 Operating Leases If Favourable If Not Favourable No Assets or Liabilities related to Operating Leases to be accounted for by Acquirer Acquirer shall recognise an Intangible Asset Favourable An acquirer shall recognise as a 33 Liability

34 What forms Part of Business Combination The acquirer is responsible for identifying amounts that are not part of the exchange for the acquiree. Identify the components that comprise the transaction in which the acquirer obtained control over the acquiree Substance over form. For Inclusion or Exclusion from business combination which of the parties to be benefited. Primarily for the benefit of Transaction likely to be * Acquirer or combined entity Separate transaction Acquiree or its former owners Part of the business combination 34

35 Examples of What do Not form Part of Business Combination.? (a)a transaction that in effect settles pre-existing relationships between the acquirer and acquiree; Non Contractual \ Contractual. (b) a transaction that remunerates employees or former owners of the acquiree for future services; and (c) a transaction that reimburses the acquiree or its former owners for paying the acquirer s acquisitionrelated costs. 35

36 Forms of Consideration Purchase of Assumption of 36

37 Business Combinations Affected By A L F A I R V A L U E 37 yagnesh@caymd.com

38 Acquisition-related costs, are the costs :- The acquirer incurs to effect a business combination. Like finder s fees; advisory, legal, accounting, valuation and other professional or consulting fees; general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities. These are expensed out and do not form part of Cost of Consideration of Business Combination. Exception Treated in accordance with IAS 39

39 Cost of Acquisition FV of Assets Given or Liabilities incurred- What treatment in profit or loss? The Equity Shares At? Any Directly Attributable Costs.? Any Answer? All at Acquisition Date. 39

40 To Sum Up But NOT Future Losses & Costs & General Admin Costs & Others Cost Not Attributable to BC 40

41 Block A 1. Consideration Measured at FV 2. Non Controlling Interest Goodwill Block B Identifiable Assets both Tangible & Intangible Minus Identifiable Liabilities 3. F V of Previously held Equity Interest in Acquiree = Net Assets 41

42 Good will Tested for Impairment Block A Block B Gain on Bargain Purchase Recognised in P & L Block A Block B 42 yagnesh@caymd.com

43 Non Controlling Interest in Acquiree Fair Value The NCI s Interest s Proportionate share in Acquiree s Identifiable Net Assets 43 yagnesh@caymd.com

44 ABC acquired 750,000 of the 10,00,000 equity shares of LMN. At a price of CU 5 each LMN s assets less liabilities was.. CU 4 Ml Estimated that the price paid included a premium per share of CU0.50 ( In order to gain control over LMN) 44 yagnesh@caymd.com

45 The fair value of the non-controlling interest is measured at CU1,125,000 (250,000 shares (CU ). Assets Account Dr.40,00,000 Goodwill..Dr ,75,000 NCI Cr...11,25,000 Consideration Cr 37,50,

46 The non-controlling interest s proportionate share of the acquiree s identifiable net assets is measured at CU1 million (CU4 million 25%). Assets Account Dr.40,00,000 Goodwill..Dr... 7,50,000 NCI Cr...10,00,000 Consideration Cr...37,50, yagnesh@caymd.com

47 A & B Enter into contract to govern. A is lager entity B is smaller one F V of B Is..100 B s Net Assets as per IFRS yagnesh@caymd.com

48 1 st Alternate : Measure Non Controlling Interest at Fair Value A1. Consideration. Nil A2. Non Controlling Interest A3. FV of Previously Held Equity. Nil Total Block A B. Net Assets Goodwill yagnesh@caymd.com

49 2 nd Alternate : Measure Non Controlling Interest at Proportionate Share of NCI A1. Consideration. Nil A2. Non Controlling Interest A3. FV of Previously Held Equity. Nil Total Block A...75 B. Net Assets Goodwill.... NIL 49 yagnesh@caymd.com

50 BC In Stages Step Acquisition Successive share purchases may have resulted in control being gained by the `acquirer Difference in Profit Or Loss with `some exceptions. Each share exchange transaction should be treated separately by the acquirer. Before qualifying as a business combination, the transaction may in fact be treated as an investment in an associate and be accounted for in accordance with IAS 28. yagnesh@caymd.com 50

51 The term negative goodwill OR excess of the acquirer s interest in the net fair value of the acquiree s identifiable assets, liabilities, and contingent liabilities over the cost. Dropped 51 yagnesh@caymd.com

52 Now Redefined as Bargain in Purchase 52

53 The identifiable net assets acquired Re- measure Any non-controlling interest in the acquiree Acquisition in Stages The consideration transferred. 53

54 Terms of an acquisition include the following : 1.If the acquiree s profit for the first full year following acquisition exceeds CU 2 Million, the acquirer will pay additional consideration of CU 6 Ml in cash three months after that year end. It is doubtful whether the acquiree will achieve this profit, hence the acquisition fair-value of this contingent consideration is CU 1,00, A contract exists whereby the acquirer will buy certain components from the acquirer over the next five years. The Contract was signed when the market price for these components were markedly higher than they are at the acquisition date. At the acquisition date the fair value of the amount by which the contract price are expected to exceed the market price over the next five years is CU 1.5 Million. yagnesh@caymd.com 54

55 1.The consideration transferred should be increased by the fair value of the Contingent consideration of CU 1,00,000., This amount should be recognised as the Liability. 2.The acquirer now controls the acquiree and can therefore cancel this contract: it is not part of business combination. CU 1.5 Ml of the consideration should be recognised as an expense. 55

56 X plc Acquiree $m FACTS Cost of acquisition 700 less fair value of net assets 300 less restructuring provision (70) Goodwill 470 === Income statement at year end Profit before amortization 140 Amortization of goodwill (47) BALANCE 93 Interest (13) ---- Profit before tax 80 56

57 Z Is Acquirer X is the Acquiree FV At the date of acquisition, IA Continent Liability $100 ml $30 ml At the date of the preparation of the financial statements, the value of the net assets of X had increased significantly. The intangible assets have a life of 10 years. How would the acquisition be accounted for under IFRS 3? yagnesh@caymd.com 57

58 Solution $m Cost of acquisition 700 less fair value of net assets (300) less fair value of intangibles (100) Contingent liabilities Goodwill 330 === Income statement at year-end Profit before amortization 140 Amortization of intangibles (10) Goodwill impairment 0 Net Profit 130 Interest (13) Profit before tax 117 The restructuring provision is not allowed under IFRS. The intangibles will have to be accounted for and amortized over 10 years. The contingent liabilities will need recording also. The net assets of X have increased significantly, and, yagnesh@caymd.com 58 therefore, it is unlikely that goodwill will be impaired at the financial year end.

59 ABC acquired an 80 % interest in DEF for CU 9,00,000. The carrying amounts and FV of DEF s identifiable assets and liabilities at the acquisition date were as follows : CV,000 FV,000 Tangible Non Current Assets Intangible Non Current Assets Current Assets Liabilities (300) (300) Contingent Liabilities 0 (30) Total ==== ==== Goodwill is calculated as under : Consideration Transferred 900 NCI ( 20 % of CU 570) Total 1,014 Less : FV of net assets acquired Goodwill 444 ==== yagnesh@caymd.com 59

60 Post Combining Accounting Adjustment to Provisional Fair Value Measurement Period Specific & General Guidance for Measurement & Accounting 60

61 Adjustment to Provisional Fair Value Within The Measurement Period Not Within Measurement Period 61 Yes No

62 Measurement Period Starts at Acquisition Date Ends As soon as the desired information is received. BUT will not exceed... One Year from the AD 62

63 XYZ acquired ABC on 30 th June By 31 December 2007 XYZ had provisional FV for the followings. 1.Trademark effective in certain foreign territories of CU 4,00,000. these had an average remaining useful life of 10 Years as at acquisition date. The acquisition date FV was finalized at CU 5,00,000 as at Trading rights in another foreign territories of CU 6,00,000. These had an average remaining useful life of 5 yrs at the acquisition date. The acquisition date FV was finalised on 30 th September 2008 at CU 3,00, XYZ Financial Statements as at Recognise as expenses : Amortization of Trademark Rights for 6 months based on provisional Values. 4.XYZ Financial statements for yagnesh@caymd.com 63

64 The finalization of FV of the trademark is made within the measurement period ( 12 Months), so it is related back to that date. The finalization in respect of the trading right is made after the end of that period, so it is recognised as expenses prospectively from 30 th September,2008. For the trademarks, the 2007 comparative figures will be restated for the revised amortization and carrying amount. yagnesh@caymd.com 64

65 Is Business Combination covered by one of the voluntary exemption of IFRS 1 -,i.e, on First Time Conversion? yagnesh@caymd.com 65

66 DISCLOSURES For each business combination, this information should be disclosed: (1) Names and descriptions of the combining entities (2) The acquisition date (3) The percentage of voting equity instruments acquired (4) The cost of the combination and a description of the components of that cost (5) Amounts recognized at the acquisition date for each class of the acquiree s assets, liabilities, and contingent liabilities and the carrying amounts of each of those classes immediately before the acquisition unless that is impracticable (6) The amount of any negative goodwill that has been shown in the income statement yagnesh@caymd.com 66

67 (7) The factors that contributed to the recognition of goodwill. (8) The amount of the acquiree s profit or loss since acquisition that has been included in the acquirer s profit or loss for the period, unless this is, again, impracticable. (9) The revenue of the combined entity for the period, as if the combination had occurred at the beginning of that period (10) The profit or loss of the combined entity for the period as if the combination had been effected at the beginning of the period. yagnesh@caymd.com 67

68 MULTIPLE-CHOICE QUESTIONS 1. Which of the following accounting methods must be applied to all business combinations under IFRS 3,Business Combinations? (a) Pooling of interests method. (b) Equity method. (c) Proportionate consolidation. (d) Purchase method. 68

69 2. Purchase accounting requires an acquirer and an acquiree to be identified for every business combinations. Where a new entity (H) is created to acquire two preexisting entities, S and A, which of these entities will be designated as the acquirer? (a) H. (b) S. (c) A. (d) A or S. yagnesh@caymd.com 69

70 3. Which of the following examples is unlikely to meet the definition of an intangible asset for the purpose of IFRS 3? (a) Marketing related, such as trademarks and internet domain names. (b) Customer related, such as customer lists and contracts. (c) Technology based, such as computer software and databases. (d) Pure research based, such as general expenditure on research. 70

71 4. An intangible asset with an indefinite life is one where (a) There is no foreseeable limit on the period over which the asset will generate cash flows. (b) The length of life is over 20 years. (c) The directors feel that the intangible asset will not lose value in the foreseeable future. (d) There is a contractual or legal arrangement that lasts for a period in excess of five years. Answer: yagnesh@caymd.com 71

72 5. An intangible asset with an indefinite life is accounted for as follows: (a) No amortization but annual impairment test. (b) Amortized and impairment tests annually. (c) Amortize and impairment tested if there is a trigger event. (d) Amortized and no impairment test. yagnesh@caymd.com 72

73 6. An acquirer should at the acquisition date recognize goodwill acquired in a business combination as an asset. Goodwill should be accounted for as follows: (a) Recognize as an intangible asset and amortize over its useful life. (b) Write off against retained earnings. (c) Recognize as an intangible asset and impairment test when a trigger event occurs. (d) Recognize as an intangible asset and annually impairment test (or more frequently if impairment is indicated). yagnesh@caymd.com 73

74 ILLUSTRATION LMN s acquisition of GHI for cash proceeded as follows: 23 January Approach made to the management of GHI seeking endorsement of the acquisition. 20 March Public offer made for 100% of equity shares of GHI, conditional on regulatory approval, shareholders approval and receiving acceptances representing 60% of GHI s shares. 14 June Regulatory approval received. 1 July Shareholder approval received. 30 July Acceptance received to date represent 50% of GHI s shares 15 August Acceptances received to date represent 95% of GHI s shares. 25 August Cash Paid put to GHI s Accepting shareholders. 13 November Cash paid out to the remaining shareholders under a compulsory share acquisition scheme. The acquisition date, being the date on which LMN obtains control over GHI, 30 July. yagnesh@caymd.com 74

75 Thank You

EN Official Journal of the European Union L 320/373

29.11.2008 EN Official Journal of the European Union L 320/373 INTERNATIONAL FINANCIAL REPORTING STANDARD 3 Business combinations OBJECTIVE 1 The objective of this IFRS is to specify the financial reporting