IFRS 3 Business Combinations

What constitutes a business? an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, increased share prices, or other economic benefits to investors or other owners, members, or participants Guidance in Appendix B (paragraphs B5 B12) Goodwill business presumed (absent contrary evidence)

What is a business? INPUTS + PROCESSES OUTPUTS Non current assets Licenses Access to material and employees Systems allowing the production of outputs I4U Q2 2008 3

Scope exclusions IFRS 3 specifically excludes the following transactions or events despite the fact that they may adhere to the definition of a business: the formation of a joint arrangement in the financial statements of the joint arrangement itself (NEW) the acquisition of an asset or a group of assets that does not constitute a business. a combination of entities or businesses under common control

Is there a business combination? Identify the acquirer Determine the acquisition date - Control passes Recognise and measure consideration - Adjust for pre-existing relationships, share-based payments Recognise and measure identified assets/liabilities/nci - Option for NCI Account for the balancing number - Goodwill or Gain on a bargain purchase Subsequent re-measurement - Contingent consideration, reacquired rights, indemnities, etc

What forms part of a business combination? Settlement of pre-existing relationships Recognition of expense or intangible asset Payment for future services Detailed guidance consistent with current practice Reimburse acquiree for bearing acquisition costs Expensed Acquisition related costs Debt / equity issue costs per IAS 32/39 Other expensed as period costs

Identified assets and liabilities Recognition Measurement Principle Must meet the definition of assets and liabilities in the Framework Measure assets and liabilities at acquisition date fair values Exceptions (note: no exception for intangible assets) Contingent liabilities (measure at fair value) Reacquired rights Share-based payment awards Assets held for sale Income taxes, indemnification assets, employee benefits Guidance Reacquired rights Assets not intended to be used to highest and best use Operating leases

Example HOLD 5 year supply agreement at fixed rates Future- SUB R6m penalty if cancelled by Hold I4U Q2 2008 8

Example HOLD With 3 years to go, HOLD purchases Future-SUB for R50m Included in price is R8m representing the FV of the supply contract: R3m represents the at market component R5m = unfavorable element for HOLD Future- SUB

Example HOLD HOLD recognises the lower of: - R6m cancellation, OR - R5m unfavourable element Profit or loss Remaining R3m is recognised Future- SUB Goodwill 10

Non-controlling interest IFRS 3 (revised) - calculate only once when control acquired Minority share of FV of identified net assets acquired or Fair value Can be measured as a debit

Fair value of consideration transferred Calculating goodwill add Amount of any NCI add less Fair value of identifiable assets and liabilities acquired (100%) equals Goodwill / Gain from a bargain purchase Fair value of any previously held interest Measurement % net assets fair value Gain or loss recognised in profit or loss Goodwill only measured at the acquisition date Includes contingent consideration at fair value

Case Study Albert Ltd purchases 80% of Betty Ltd. Details are as follows: Fair value of consideration Fair value of identified net assets Fair value of NCI REQUIRED: Calculate the goodwill with the NCI at net asset value with the NCI at Fair Value 100m 90m 20m

Changes in Control Apply: IAS 39 IAS 28 IFRS 11 Business combination: - fair value existing holding gain/loss to P/L - recycle gains in equity - fair value acquired net assets - option to measure NCI - calculate goodwill Equity transaction: - no goodwill - no gain/loss Control 0% 50% 100%

Case Study In 2011: Purchase 30% Fair value of consideration 60m Fair value of net assets 100m Significant influence, therefore equity accounted (cumulative share of profits by 2014 = 14m) In 2014: Fair value of 30% holding 90m Purchase a further.. 50% Fair value of consideration 160m Fair value of net assets 170m Fair value of 20% NCI 60m

Goodwill Cash-generating units (CGUs) The smallest identifiable group of assets that generate cash inflows that are largely independent of the cash inflows from other groups of assets Allocate acquired goodwill amongst CGUs expected to benefit from the synergies of the combination CGUs (or groups of CGUs) to which goodwill is allocated for impairment testing must be Lowest level at which management monitor goodwill No larger than a segment (in accordance with IFRS 8)

IAS 36 Impairment Calculation Determine carrying amount of the CGU (including allocated goodwill) Determine Fair value less costs to sell and/or Value in use Compare higher of the two with carrying amount Any shortfall must be recognised as a recoverable amount write-down

IAS 36 Write-downs All write-downs are recognised immediately Where a write-down is required in relation to a CGU with allocated goodwill, the goodwill is first written down Any remaining write down is taken proportionately against the non-monetary assets NOTE: Write-downs of goodwill may not be reversed in future reporting periods

Measurement period Time Acquisition date Maximum of 12 months Measurement period Provisional accounting finalised Provisional amounts determined Adjustments: assess whether relates to events after acquisition date (timing, reason) qualifying amounts pushed back to acquisition date Subsequent adjustments: do not impact business combination accounting, i.e. no goodwill adjustment usually impact profit/loss includes contingent consideration, earn outs, deferred taxes

Subsequent re-measurement Contingent consideration Adjustments to profit or loss Post-acq events, eg meeting earn-out target: Equity no re-measurement Liability under IAS 39 follow IAS 39

Contingent Consideration Annual Improvements 2010 2012 Cycle: Contingent consideration that: is within the scope of IFRS 9 must be measured at fair value at each reporting date, and changes in fair value will be recognised in profit or loss in accordance with IFRS 9 is not within the scope of IFRS 9 must be measured at fair value at each reporting date and changes in fair value must be recognised in profit or loss.

Contingent Consideration If an entity does not yet apply IFRS 9, any reference to IFRS 9 should be read as a reference to IAS 39. Contingent consideration of an acquirer in a business combination has been scoped out of IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Contingent Consideration IAS 39 change Definitions of four categories of financial instruments A financial asset or financial liability at fair value through profit or loss is a financial asset or financial liability that meets either any of the following conditions. It is contingent consideration of an acquirer in a business combination to which IFRS 3 Business Combinations applies.

Contingent Consideration IFRS 9 change Investments in equity instruments At initial recognition, an entity may make an irrevocable election to present in other comprehensive income subsequent changes in the fair value of an investment in an equity instrument within the scope of this IFRS that is not held for trading and is also not contingent consideration of an acquirer in a business combination to which IFRS 3 Business Combinations applies.

Contingent Consideration IFRS 9 change Financial liabilities are typically measured at amortised cost, and thus an exception was added for: contingent consideration of an acquirer in a business combination to which IFRS 3 Business Combinations applies. Such contingent consideration must subsequently be measured at fair value.

Subsequent re-measurement Re-acquired rights included as an intangible asset Amortise over the contract period Contingent liabilities Higher of IAS 37 amount & amount initially recognised less any cumulative amortisation recognised in terms of IAS 18 Indemnification assets Track liability being indemnified Other standards IAS 36/38, IFRS 4, IAS 12, IFRS 2, IAS 27

Other changes from 2004 version Area Revised business definition Non-controlling interests Consequential amendments Overview may impact the classification of some transactions in marginal cases losses can be attributed to NCIs even if that would make the NCI have a debit balance numerous Standards and Interpretations amended to be consistent with the revised IFRS 3 and IAS 27 (terminology, requirements, etc) new requirements on loss of significant influence and joint control in IAS 28 and IAS 31 (fair value retained interest) impairment requirements and examples in IAS 36 show impact of NCI policy decision 30 IFRS 3 (Revised 2008)

Other changes from 2004 version Area New and amended disclosures Overview more information required on contingent consideration (including details, ranges, etc) transactions associated with business combinations to be disclosed (including acquisition costs expensed) non-controlling interests measurement basis, impact of equity transactions with NCIs, etc more information about step acquisitions details of gains/losses on loss of control of subsidiary changes in acquirer s and acquiree s deferred tax assets

Putting it all together a lot more profit volatility Share-based payment compensation expense Expensing of acquisition costs More intangibles recognised and amortised Pre-combination ownership interests marked to fair value Recognised in the income statement Post-combination changes in contingent consideration Settlement of preexisting relationships Post-combination recognition of deferred tax assets Losses to NCI even if it is in debit