The IFRS Interpretations Committee (“the Committee”) received a submission seeking clarification on the interaction of the requirements in IFRS 3 Business Combinations for identifying an acquirer with the requirements in IFRS 10 Consolidated Financial Statements for deciding whether control exists. The submitter sought clarification with respect to whether an acquirer identified for the purpose of IFRS 3 (2008) is a parent for the purpose of IFRS 10 in circumstances in which a business combination is achieved by contract alone, such as a stapling arrangement, with no entity in the business combination having control as defined in IFRS 10.

This issue was discussed by the Committee in January 2014, and it was tentatively decided that the issue would not be added to the Committee’s Agenda.

The purpose of this paper was to provide an analysis of the comment letters received on the tentative agenda decision and to ask the Committee whether it agreed with the staff recommendation that the agenda decision should be finalised.

Discussion

A Committee member commented that the interaction between IFRS 3 (2008) and IFRS 10 was not properly addressed in the agenda decision. She noted that the agenda decision did not address the issue of identifying the parent entity after day 1 in situations where a reassessment of control was required.

An IASB member present noted that the staff had prepared a good analysis of the issue in the agenda paper. He drew the Committee members’ attention to the fact that the agenda decision made reference to circumstances in which a business combination was achieved by contract alone, but questioned whether the same question would also be applicable in other circumstances; for example, in the case of a legal merger where two entities came together, not by contract, but through a decision of the shareholders. He questioned whether it would be helpful to widen the scope of the agenda decision to also provide guidance in the event of such combinations.

Another Committee member noted that he shared the concern expressed by the previous Committee member with respect to identifying the parent entity after day 1.

Another Committee member commented that the question that had actually been asked of the Committee was whether the interaction between IFRS 3 (2008) and IFRS 10 was the same as the interaction between IFRS 3 (2004) and IAS 27 Consolidated and Separate Financial Statements, which the IASB had commented on previously in an IASB update back in 2004, in which it clarified that the acquirer in a merger of equals under IFRS 3 (2004) was the parent under IAS 27. He noted that this had been used as the basis to prepare consolidated financial statements in such combinations, and that the analysis in the paper suggested that there was no reason to change this view under the current literature. He further noted that IFRS 3 (2008) contemplated business combinations where there was no control; however, IFRS 10 did not contemplate consolidation without control, and that while the agenda decision maintained the status quo for past practice, it failed to deal with the fundamental issue of the type of financial statements that should be prepared when a business combination was completed that did not involve control.

Another Committee member pointed out that in the majority of cases of combination by contract it was clear which entity was the parent. He noted that the issue being discussed only arose in situations where neither of the combining entities controlled the other, and that in such circumstances it had been decided by virtue of IFRS 3 that the entities would be part of the same reporting entity even though there was no cross ownership between the entities, and that one entity needed to be identified as the acquirer in accordance with IFRS 3. He noted that therefore, the actual question that the Committee should be considering was, in the situation where the financial statements of only 1 of the 2 entities was being prepared, could the argument ever be made that there was no need to consolidate, because neither entity controlled the other?

Following on from the comment made by the previous Committee member, another Committee member noted that the current accounting treatment had arisen because of the historical statement that was made by the IASB, that if an entity was an acquirer under IFRS 3, it was the parent under IAS 27. He noted that he did not see such a clear link between an entity being an acquirer under IFRS 3 and the conclusion that this would result in a parent/subsidiary relationship under IFRS 10, and added that one comment letter received questioned whether creating an artificial parent/subsidiary relationship when no control existed, would result in the most useful financial statements. He further noted that the agenda decision did not discuss the fundamental issue of whether the relationship established by virtue of IFRS 3 was the best way to present financial statements under IFRS 10.

In response to the above comment, a Committee member commented that the letter acknowledged that IFRS 3 applied to business combinations, even in circumstances where there was no control. He noted that what was being questioned in the letter was how one could end up with consolidated financial statements under IFRS 10, acknowledging that this might be possible on day 1 when the acquirer was deemed to be the parent; however, questioned how this would apply after day 1.

Another Committee member noted that he supported the conclusion reached by the staff in the agenda decision. He acknowledged that the accounting was not perfect, but noted that continuing with the status quo whereby the acquirer identified for the purposes of IFRS 3 was the parent for the purposes of IFRS 10 was an effective way of dealing with the issue. He recognised the tensions that arose in the equity section, but noted that the proposed agenda decision solved the potential problem without a range of other issues being opened up. He noted that this solution provided a sensible result for the relatively few transactions of this nature that occurred, and cautioned that if the Committee changed the status quo, it ran the risk of ending up with some accounting that might make less sense than what is done currently, or put current accounting offside.

Another Committee member noted that he also supported the agenda decision as drafted, and that while not perfect, the agenda decision reaffirmed established practice.

Another Committee member suggested the possibility of combined financial statements being prepared in such circumstances, rather than consolidated financial statements which assumed the existence of a parent / subsidiary relationship on the basis of control. She noted that the identified acquirer under IFRS 3 would record the assets and liabilities of the acquiree in accordance with the requirements of IFRS 3, and instead of the financial statements being labelled consolidated financial statements, they would be labelled combined financial statements, with the difference arising primarily in the presentation of the equity section.

Another Committee member raised the point that there was no requirement in IFRS for financial statements to be combined where no control relationship could be established, although further noted that it became a regulatory issue as to whether entities should be combined.

The Senior Director, Technical Activities acknowledged that the links between IFRS 3 (2008) and IFRS 10 were tenuous. He explained that the general structure for developing a standard was ‘1 - initial recognition, 2 - ongoing accounting, and 3 - derecognition’, and that IFRS 3 (2008) had the initial recognition and some of the ongoing accounting, and IFRS 10 contained the rest of the ongoing accounting and the derecognition. He noted that when the standards were drafted there was always an implicit link between the standards, because IFRS 3 requires that one looks to IFRS 10, and there was an assumption that a controlling party must be determined. He further noted that, with respect to continuous assessment, one should look to the wording in IFRS 10 that states that ‘an investor shall reassess whether it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements that gave control’, noting that therefore, if on day 2 nothing has changed, the entity has not moved from one standard to the other.

In bringing the discussion to a close, the Chairman asked the Committee members who could accept the proposed agenda decision. Nine Committee members out of the twelve Committee members present accepted the proposed agenda decision.