Cover Paper (Agenda Paper 23)

Background

The Board is examining how companies should account for combinations of businesses under common control (“BCUCC”), which are currently outside the scope of IFRS 3. The staff are working towards publishing a discussion paper in the first half of 2020.

Potential equity investors in BCUCC (Agenda Paper 23A)

Background

At its March and April 2019 meetings, the Board discussed information needs of lenders and other creditors of the receiving entity, and of potential equity investors in a group restructuring in preparation for a sale of the combining entities in an initial public offering (IPO). The Board noted that the outcome of the credit analysis would not depend greatly on whether a current value approach or a form of predecessor approach is applied to account for a business combination under common control and tentatively decided that it does not need to pursue a single measurement approach for all transactions in the scope of the project. Specifically, the Board could pursue:

• a current value approach based on the acquisition method for some or all transactions that affect non-controlling shareholders of the receiving entity; and
• a different approach, such as a form of predecessor approach, for transactions that do not affect such shareholders.

Staff analysis

Transactions that affect non-controlling interests

The staff’s research and outreach indicate that information needs of potential equity investors do not differ from information needs of existing equity investors. This is because all equity investors are, or could be, exposed to risks and benefits arising from claims on the reporting entity’s residual net assets and that determines both their information needs and analytical approaches. Moreover, an entity or an individual can simultaneously be both an existing and potential equity investor if that entity or individual is considering whether to increase its existing equity investment in a particular entity.

The staff’s research and outreach further indicate that in estimating total return on the investment, equity investors and analysts employ a variety of equity valuation models, including discounted cash flow-based models, economic profit-based models, adjusted present value models, multiples-based models and real options models. An equity investor can select one or more of those models to price a share that it holds or a potential new share or rely on price target reports prepared by equity analysts based on those valuation models. The output from valuation models can often be combined with qualitative analysis to determine the expected total return for a security. However in all cases, the same information is used in each particular valuation model regardless of whether valuation is performed by a retail investor or a professional institutional investor or an analyst and regardless of whether those parties focus on publicly traded or private equity instruments or on a particular industry. 

The Board has already decided in developing IFRS 3 that the acquisition method provides most useful information about business combinations that are not under common control. That conclusion was reaffirmed in the post-implementation review (PIR) of IFRS 3 that stated that ‘comments received confirm that fair value is the best approach for measuring the assets acquired and the liabilities assumed in a business combination’.

Transactions that do not affect non-controlling interests

The question arises what information would be useful for potential equity investors for transactions within the scope of the project that do not affect non-controlling shareholders of the receiving entity.

Information needs of potential equity investors in transactions that do not affect non-controlling shareholders were already discussed in March 2019. That paper argued that a form of predecessor approach would provide useful information in the context of a group restructuring between wholly owned entities in preparation for an IPO.

The staff note that transactions between wholly owned entities in preparation for a sale, for example in an IPO, represent a sub-set of transactions that do not affect non-controlling shareholders of the receiving entity. The staff analysed transactions undertaken in preparation for an IPO as an example to illustrate why a form of predecessor approach would provide useful information to potential equity investors about transactions between wholly owned entities. However, the staff did not suggest that the use of a predecessor approach should be limited to transactions between wholly owned entities undertaken in preparation for an IPO.

In June 2019, the staff provided further analysis of transactions that do not affect non-controlling shareholders. The staff argued that:

• transactions that do not result in non-controlling shareholders of the receiving entity acquiring residual interest (equity claim) in transferred entities or businesses are different from both: (i) transactions within the scope of the project that result in non-controlling shareholders acquiring such residual interest; and (ii) business combinations not under common control; and
• a current value approach based on the acquisition method may not work well for those transactions.

In June 2019, the staff reviewed national requirements and guidance on business combinations under common control and group restructurings, guidance published by accounting firms and responses received in recent consultation on the topic. The staff noted that the effect of the transaction on ownership interests or rights of owners was a common condition in determining the appropriate accounting treatment for business combinations under common control and group restructurings. The staff also noted that the concept of ‘looking through’ the combining entities onto the effects on their owners is already adopted in the application guidance in IFRS 3 on identifying the acquirer.

Based on the staff’s research and analysis presented in June, the staff argued that if non-controlling shareholders do not acquire a residual interest (equity claim) in the transferred entities or businesses, the transaction is not an acquisition. Therefore, if a current value approach based on the acquisition method were applied to such transactions, identifying an acquirer would not always be possible or would not result in useful information. Instead, a form of predecessor approach would provide useful information about those transactions.

The staff further note that IFRS 3 generally does not deal with cases where the controlling party is the sole existing shareholder and potential equity investors are the only ‘equity type’ primary users that rely on the information provided in general purpose financial statements. Therefore, applying the requirements of that Standard may be not appropriate in the absence of non-controlling shareholders.

The staff did not make any recommendations and the Board is not asked for a decision in this session.

How measurement approaches could apply (Agenda Paper 23B)

This paper provides the Board with an overview of how alternative measurement approaches could apply, and of the questions the Board will need to consider in developing those approaches. The paper is for information only and is intended to provide context for the Board’s decision at a future meeting on when alternative measurement approaches should apply.

Board discussion

The Board discussed the papers together. The intention of this meeting was to bring possible scenarios and different outcomes to the discussion, as the Discussion Paper will not be published until the first half of 2020.

Amongst different elements in the area of business combinations, non-controlling interests (NCI) was highlighted by the majority of the Board members. They all agreed that NCI should be preserved by making the purpose and possible consequences of the transaction clearer.

Some Board members were happy with the paper presented, whilst others mentioned the need to increase the clarity around equity holders (reference was made to IFRS 3:10).

Another Board member mentioned the relationship between entities under common control before the transaction, as it quite often brings synergy to the new combined business. In this regard, other Board members have mentioned that better analysis was needed in order to clarify whether the outcome of the BCUCC would impact on the subsequent business. Ultimately, the presentation in the face of the financial statements and in the notes needs to be clear so not to mislead investors.

The meeting was open to comments and considerations and Board members debated the importance of fair value compared to the consideration paid and ultimately challenged the gain as a result of the transaction, in the sense that this needs to be supported by the future economic benefits of the business and therefore the basis and rationale need to be clear to the investors (equity or non-equity).

No decisions were made.