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IASB issues a revised standard on business combinations

10 Jan 2008

The IASB has published a revised IFRS 3 'Business Combinations' and related revisions to IAS 27 'Consolidated and Separate Financial Statements'.

There are also consequential amendments to other standards, most notably IAS 28 Investments in Associates and IAS 31 Interests in Joint Ventures. The amendments result from proposals that were in an Exposure Draft published by the Board in June 2005.

The amendments are effective for annual periods beginning on or after 1 July 2009. Earlier application is permitted but only back to an annual reporting period that begins on or after 30 June 2007. Click for IASB Press Release (PDF 60k).

Some of the significant amendments to IFRS 3
  1. Acquisition costs. Costs of issuing debt or equity instruments are accounted for under 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; advisory, legal, accounting, valuation, and other professional or consulting fees; and general administrative costs, including the costs of maintaining an internal acquisitions department.
  2. Contingent consideration. 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.
  3. Goodwill and noncontrolling interest. An option is added to IFRS 3 to permit an entity to recognise 100% of the goodwill of the acquired entity, not just the acquiring entity's portion of the goodwill, with the increased amount of goodwill also increasing the noncontrolling interest [new term for 'minority interest'] in the net assets of the acquired entity. This is known as the 'full goodwill method'. Such noncontrolling interest is reported as part of consolidated equity. The 'full goodwill' option may be elected on a transaction-by-transaction basis.

Example: P pays 800 to purchase 80% of the shares of S. Fair value of 100% of S's identifiable net assets is 600. If P elects to measure noncontrolling interests as their proportionate interest in the net assets of S of 120 (20% x 600), the consolidated financial statements show goodwill of 320 (800 +120 - 600). If P elects to measure noncontrolling interests at fair value and determines that fair value to be 185, then goodwill of 385 is recognised (800 + 185 - 600). The fair value of the 20% noncontrolling interest in S will not necessarily be proportionate to the price paid by P for its 80%, primarily due to control premium or discount as explained in paragraph B45 of IFRS 3.

  • 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 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.
  • Intangible assets. Must always be recognised and measured. There is no 'reliable measurement' exception.
  • Step acquisition. 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.
  • Partial disposal of an investment in a subsidiary while control is retained. This is accounted for as an equity transaction with owners, and gain or loss is not recognised.
  • Partial disposal of an investment in a subsidiary that results in loss of control. Loss of control triggers remeasurement of the residual holding to fair value. Any difference between fair value and carrying amount is a gain or loss on the disposal, recognised in profit or loss. Thereafter, apply IAS 28, IAS 31, or IAS 39, as appropriate, to the remaining holding.
  • 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.
  • Scope changes. The revised IFRS 3 applies to combinations of mutual entities and combinations without consideration (dual listed shares). These are excluded from the existing IFRS 3. The revised IFRS 3 does not apply to combinations of entities under common control. The IASB added to its agenda a separate agenda project on common control transactions in December 2007.
  • Transitional requirements. The revised Standard must generally be applied on a prospective basis, with some exceptions. The prospective application will impact post-transition changes in ownership interests in subsidiaries and deferred taxes, but will not impact accounting for contingent consideration related to business combinations with an acquisition date prior to the date of transition.
Some of the significant amendments to IAS 27, IAS 28, and IAS 31
  1. Partial disposals of subsidiaries. Items 5 and 6 above in changes to IFRS 3 are also changes in IAS 27.
  2. Partial disposals of associates and joint ventures. If an investor loses significant influence over an associate, it derecognises that associate and recognises in profit or loss the difference between the sum of the proceeds received and any retained interest, and the carrying amount of the investment in the associate at the date significant influence is lost. Similar treatment when an investor loses joint control over a jointly controlled entity.
  3. Attributing income to the NCI. Total comprehensive income is allocated to the noncontrolling interest (NCI) even if this results in the NCI having a deficit balance.

The revised IFRS 3 resulted from a joint project with the US Financial Accounting Standards Board. FASB issued a similar standard in December 2007 (SFAS 141(R)) – see our News Story of 5 December 2007.

The revisions will result in a high degree of convergence between IFRSs and US GAAP in these areas, although some potentially significant differences remain. Among the differences: the FASB standard requires (rather than permits) the full goodwill method. There are also differences in scope, the definition of control, and how fair values, contingencies, and employee benefit obligations are measured, as well as several disclosure differences. A booklet of illustrative examples issued along with the revised IFRS 3 and IAS 27 includes a comparison with SFAS 141(R).

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