Accounting FOR Business Combination Reviewer PDF

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UNIVERSITY OF THE CORDILLERASUndergrad ReviewPractical Accounting IIBusiness Combinations / Consolidated Financial Statements Mark Alyson B. NginaIFRS 3 Business CombinationsA business combination is a transaction or event in which an acquirer obtains control of one or more businesses. A business is...

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UNIVERSITY OF THE CORDILLERAS Undergrad Review Practical Accounting II Business Combinations / Consolidated Financial Statements

Mark Alyson B. Ngina

IFRS 3 Business Combinations A business combination is a transaction or event in which an acquirer obtains control of one or more businesses. A business is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return directly to investors or other owners, members or participants. Core principle An acquirer of a business recognises the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enables users to evaluate the nature and financial effects of the acquisition. Applying the acquisition method Acquisition method. The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3) is used for all business combinations. Steps in applying the acquisition method are: 1. Identification of the 'acquirer' – the combining entity that obtains control of the acquiree 2. Determination of the 'acquisition date' – the date on which the acquirer obtains control of the acquiree 3. Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-controlling interest (NCI, formerly called minority interest) in the acquire 4. Recognition and measurement of goodwill or a gain from a bargain purchase Measurement of acquired assets and liabilities. Assets and liabilities are measured at their acquisition-date fair value (with a limited number of specified exceptions). Measurement of NCI. IFRS 3 allows an accounting policy choice, available on a transaction by transaction basis, to measure NCI either at: a. fair value (sometimes called the full goodwill method), or b. the NCI's proportionate share of net assets of the acquiree (option is available on a transaction by transaction basis). Acquired intangible assets. Must always be recognised and measured at fair value. There is no 'reliable measurement' exception. Goodwill Goodwill is measured as the difference between: a. the aggregate of (i) the acquisition-date fair value of the consideration transferred, (ii) the amount of any NCI, and (iii) in a business combination achieved in stages (see Below), the acquisition-date fair value of the acquirer's previously-held equity interest in the acquiree; and b. the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed (measured in accordance with IFRS 3). If the difference above is negative, the resulting gain is recognised as a bargain purchase in profit or loss. Business combination achieved in stages (step acquisitions) Prior to control being obtained, the investment is accounted for under IAS 28, IAS 31, or IAS 39, as appropriate. On the date that control is obtained, the fair values of the acquired entity's assets and liabilities, including goodwill, are measured (with the option to measure full goodwill or only the acquirer's percentage of goodwill). Any resulting adjustments to previously recognised assets and liabilities are recognised in profit or loss. Thus, attaining control triggers remeasurement. Provisional accounting If the initial accounting for a business combination can be determined only provisionally by the end of the first reporting period, account for the combination using provisional values. Adjustments to provisional values within one year relating to facts and circumstances that existed at the acquisition date. No adjustments after one year except to correct an error in accordance with IAS 8. Cost of an acquisition Measurement. Consideration for the acquisition includes the acquisition-date fair value of contingent consideration. Changes to contingent consideration resulting from events after the acquisition date must be recognised in profit or loss. Acquisition costs. Costs of issuing debt or equity instruments are accounted for under IAS 32 and IAS 39. All other costs associated with the acquisition must be expensed, including reimbursements to the acquiree for bearing some of the acquisition costs. Examples of costs to be expensed include finder's fees;

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advisory, legal, accounting, valuation and other professional or consulting fees; and general administrative costs, including the costs of maintaining an internal acquisitions department. Contingent consideration. Contingent consideration must be measured at fair value at the time of the business combination. If the amount of contingent consideration changes as a result of a post-acquisition event (such as meeting an earnings target), accounting for the change in consideration depends on whether the additional consideration is an equity instrument or cash or other assets paid or owed. If it is equity, the original amount is not remeasured. If the additional consideration is cash or other assets paid or owed, the changed amount is recognised in profit or loss. If the amount of consideration changes because of new information about the fair value of the amount of consideration at acquisition date (rather than because of a post-acquisition event) then retrospective restatement is required. Pre-existing relationships and reacquired rights If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the acquirer had granted the acquiree a right to use its intellectual property), this must be accounted for separately from the business combination. In most cases, this will lead to the recognition of a gain or loss for the amount of the consideration transferred to the vendor which effectively represents a 'settlement' of the pre-existing relationship. The amount of the gain or loss is measured as follows:  for pre-existing non-contractual relationships (for example, a lawsuit): by reference to fair value  for pre-existing contractual relationships: at the lesser of (a) the favourable/unfavourable contract position and (b) any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavourable. However, where the transaction effectively represents a reacquired right, an intangible asset is recognised and measured on the basis of the remaining contractual term of the related contract excluding any renewals. The asset is then subsequently amortised over the remaining contractual term, again excluding any renewals. Exception to the recognition and measurement principles The IFRS provides limited exceptions to these recognition and measurement principles: a) Leases and insurance contracts. Leases and insurance contracts are required to be classified on the basis of the contractual terms and other factors at the inception of the contract (or when the terms have changed) rather than on the basis of the factors that exist at the acquisition date. b) Contingent Liability. Only those contingent liabilities assumed in a business combination that are a present obligation and can be measured reliably are recognised. That is, it is not necessary that an outflow of future economic benefits is probable. c) Income tax, employee benefits, share-based payment, non-current assets held for sale. Assets and liabilities are required to be recognised or measured in accordance with their respective IFRS’s, rather than at fair value. d) Reacquired rights. The acquirer may reacquire a right that it had previously granted to the acquiree; for example, the right to use the acquirer's technology under a technology licensing agreement. The acquirer recognizes the reacquired intangible right as an asset and determines its fair value on the basis of the remaining contractual term of the contract, regardless of whether market participants would consider potential contractual renewals in determining its fair value. Subsequently, the reacquired right is amortized over the remaining contractual period. e) Indemnification asset. Indemnification assets are recognised and measured on a basis that is consistent with the item that is subject to the indemnification, even if that measure is not fair value. Disclosure The IFRS requires the acquirer to disclose information that enables users of its financial statements to evaluate the nature and financial effect of business combinations that occurred during the current reporting period or after the reporting date but before the financial statements are authorised for issue. After a business combination, the acquirer must disclose any adjustments recognised in the current reporting period that relate to business combinations that occurred in the current or previous reporting periods. IAS 27 Separate Financial Statements The objective of the Standard is to prescribe the accounting and disclosure requirements for investments in subsidiaries, joint ventures and associates when an entity prepares separate financial statements. The Standard shall be applied in accounting for investments in subsidiaries, joint ventures and associates when an entity elects, or is required by local regulations, to present separate financial statements. Separate financial statements are those presented by a parent (ie an investor with control of a subsidiary) or an investor with joint control of, or significant influence over, an investee, in which the investments are accounted for at cost or in accordance with IFRS 9 Financial Instruments. When an entity prepares separate financial statements, it shall account for investments in subsidiaries, joint ventures and associates either: a) at cost, or b) in accordance with IFRS 9. The entity shall apply the same accounting for each category of investments. Investments accounted for at cost shall be accounted for in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations when they are classified as held for sale (or included in a disposal group that is classified as

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held for sale). The measurement of investments accounted for in accordance with IFRS 9 is not changed in such circumstances. IFRS 10 Consolidated Financial Statements The objective of this IFRS is to establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities. To meet the objective, this IFRS: a) requires an entity (the parent) that controls one or more other entities (subsidiaries) to present consolidated financial statements; b) defines the principle of control, and establishes control as the basis for consolidation; c) sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee; and d) sets out the accounting requirements for the preparation of consolidated financial statements. Key Definitions: Consolidated financial statements Control of an investee Parent Power Protective rights Relevant activities

The financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee An entity that controls one or more entities Existing rights that give the current ability to direct the relevant activities Rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate Activities of the investee that significantly affect the investee's returns

Control An investor determines whether it is a parent by assessing whether it controls one or more investees. An investor considers all relevant facts and circumstances when assessing whether it controls an investee. An investor controls an investee if and only if the investor has all of the following elements: a) power over the investee, i.e. the investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee's returns) b) exposure, or rights, to variable returns from its involvement with the investee c) the ability to use its power over the investee to affect the amount of the investor's returns. Power arises from rights. Such rights can be straightforward (e.g. through voting rights) or be complex (e.g. embedded in contractual arrangements). An investor that holds only protective rights cannot have power over an investee and so cannot control an investee. An investor must be exposed, or have rights, to variable returns from its involvement with an investee to control the investee. Such returns must have the potential to vary as a result of the investee's performance and can be positive, negative, or both. A parent must not only have power over an investee and exposure or rights to variable returns from its involvement with the investee, a parent must also have the ability to use its power over the investee to affect its returns from its involvement with the investee. When assessing whether an investor controls an investee an investor with decision-making rights determines whether it acts as principal or as an agent of other parties. A number of factors are considered in making this assessment. For instance, the remuneration of the decision-maker is considered in determining whether it is an agent. Preparation of consolidated financial statements A parent prepares consolidated financial statements using uniform accounting policies for like transactions and other events in similar circumstances. However, a parent need not present consolidated financial statements if it meets all of the following conditions:  it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements  its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets)  it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market, and  its ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with IFRSs. Furthermore, post-employment benefit plans or other long-term employee benefit plans to which IAS 19 Employee Benefits applies are not required to apply the requirements of IFRS 10. Consolidation procedures Consolidated financial statements:  combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries  offset (eliminate) the carrying amount of the parent's investment in each subsidiary and the parent's portion of equity of each subsidiary (IFRS 3 Business Combinations explains how to account for any related goodwill)

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eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full). An entity must use uniform accounting policies for reporting like transactions and other events in similar circumstances. The parent and subsidiaries are required to have the same reporting dates, or consolidation based on additional financial information prepared by subsidiary, unless impracticable. Where impracticable, the most recent financial statements of the subsidiary are used, adjusted for the effects of significant transactions or events between the reporting dates of the subsidiary and consolidated financial statements. The difference between the date of the subsidiary's financial statements and that of the consolidated financial statements shall be no more than three months Non-controlling interests in subsidiaries must be presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. 

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Changes in the ownership interests A. No Loss of Control Changes in a parent’s ownership interest in a subsidiary that do not result in the parent losing control of the subsidiary are equity transactions (ie transactions with owners in their capacity as owners). B. Loss of control / Deconsolidation If a parent loses control of a subsidiary, the parent: a) derecognises the assets and liabilities of the former subsidiary from the consolidated statement of financial position. b) recognises any investment retained in the former subsidiary at its fair value when control is lost and subsequently accounts for it and for any amounts owed by or to the former subsidiary in accordance with relevant IFRSs. That fair value shall be regarded as the fair value on initial recognition of a financial asset in accordance with IFRS 9 or, when appropriate, the cost on initial recognition of an investment in an associate or joint venture. c) recognises the gain or loss associated with the loss of control attributable to the former controlling interest. Examples of loss of control 1. Liquidation, receivership and administration. When a subsidiary becomes a subject of insolvency proceedings involving the appointment of a receiver or liquidator, if the effect is that the shareholders cease to have the power to govern the financial and operating policies. Although this will often be the case in a liquidation, a receivership or administration order may not involve loss of control by shareholders. 2. Seizure of assets or operation. An example of loss of control is seizure of assets or operations of an foreign subsidiary by local government.

Note: Short-term restrictions on cash flows from a subsidiary and severe long-term restrictions impairing the ability to transfer funds to the parent does not necessarily precludes control. Acquiring additional shares in the subsidiary after control was obtained This is accounted for as an equity transaction with owners (like acquisition of 'treasury shares'). Goodwill is not remeasured. Disclosure The disclosure requirements for interests in subsidiaries are specified in IFRS 12 Disclosure of Interests in Other Entities.

Investment Joint Venture

Current IAS 31 Investment in Joint Venture

Subsidiary

IAS 27 Consolidated and Separate Financial Statements

Associate

IAS 28 Investment in Associate

January 1, 2013 IAS 28 Investment in Associates and Joint Venture IFRS 11 Joint Arrangements IFRS 12 Disclosure of Interest in Other Entities IFRS 10 Consolidated Financial Statement IAS 27 Separate Financial Statement IFRS 12 Disclosure of Interest in Other Entities IAS 28 Investment in Associate and Joint Venture IFRS 12 Disclosure of Interest in Other Entities

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Classifying Investments The Binfathi Group’s investment in Al-Taweel Limited 1. Binfathi has a 15% holding in the shares of Al-Taweel Limited. In addition, one of Binfathi’s subsidiaries, Gulfwings Inc., which is 60% owned, has a holding of 55% of the shares in Al-Taweel. Binfathi’s effective share of Al-Taweel Limited is, therefore, 48% (15% + (60% of 55%)). How should this investment be classified? a. A subsidiary b. An associate c. A jointly controlled company d. None of these categories A - Al-Taweel is a subsidiary through the Gulfwings’ majority holding of the share capital, and would be even if Binfathi did not have its 15% direct holding. 70% of the voting shares in Al-Taweel are controlled either directly or indirectly by Binfathi. It is not relevant that the existence of a non-controlling interest in the intermediate subsidiary reduces Binfathi’s effective share to below 50%. It is the chain of control that is significant. Thus, Binfathi should consolidate Al-Taweel and eliminate 52% as non-controlling interests. The Binfathi Group’s investme...