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Business combinations under common control

Date recorded:

Approach for transactions that affect non-controlling interest (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 Business Combinations. The staff are working towards publishing a discussion paper in the first half of 2020.

In April and May 2018, the Board discussed current value approaches for business combinations under common control (BCUCC) that affect non-controlling interest (NCI) in the receiving entity. In June 2018, the Board directed the staff to develop an approach based on the acquisition method set out in IFRS 3 and to consider whether and how that method should be modified to provide the most useful information about BCUCC that affect NCI in the receiving entity (transactions that affect NCI). In December 2018, the Board discussed the staff’s analysis on whether a current value approach should be applied to all transactions that affect NCI or just some transactions that affect NCI.

In this March 2019 session, the staff are not asking the Board to make decisions and the purpose of this session is to provide an overview of the staff’s approach to developing measurement alternatives for transactions within the scope of the BCUCC project. In particular, it explains how information needs of different types of primary users of receiving entity’s financial statements are being considered in the project (Paper 23A).

Paper 23A Recap of staff’s approach

The paper recaps and reminds the Board the project focuses on the information needs of the primary user of the receiving entity’s financial statements. The project does not consider accounting by the controlling party, the transferor or the transferee as those parties are already covered by existing IFRS standards.

The paper focuses on the information needs of four classes of primary users of the receiving entity’s financial statements in a BCUCC: existing NCI; the controlling party; lenders and other creditors; and Prospective equity investors.

The staff explore using a current value approach based on the acquisition method in IFRS 3 and a predecessor carrying amounts approach using the predecessor carrying amounts of the acquired business.

Paper 23B Lenders and Other Creditors in BCUCC

As a reminder, in December 2018 meeting, the Board considered information needs of existing non-controlling shareholders (NCI) in a receiving entity in a business combination under common control. That paper argued that although in principle a current value approach based on IFRS 3’s acquisition method would best meet information needs of NCI in the receiving entity a different approach, such as a predecessor approach, may be more appropriate for some transactions that affect NCI, for cost-benefit reasons. This paper explores information needs of existing and potential lenders and other creditors and discusses the implications of that analysis for accounting for business combinations under common control. It is structured around four key areas:

  1. Nature of claims held by lenders and other creditors – the claims of a lender or creditor claims differ from those of NCI. The instruments held by lenders and creditors typically give them a contractual right to cash flows and have a contractual maturity. NCI instruments typically have discretionary cash flows and are perpetual. In the event of liquidation or bankruptcy, the claims of lenders and creditors typically ran above those of NCI.
  2. Assessing the entity’s ability to service and raise debt - The goal of credit analysis is the assessment of the liquidity risk (as defined in IFRS 7) of the borrower which differs from the goal of equity analysis that ultimately focuses on valuation. As a result, core prediction models used in credit analysis tend to display the following characteristics: (a) predominance of cash flow analysis; and (b) focus on the total gross debt.
  3. Predominance of cash flow analysis - based on the findings in the staff’s research and outreach, cash flow analysis seems predominant in credit analysis, including in the ratio analysis performed by debt investors and credit analysts. Profitability ratios are also used in credit analysis, but they tend to play a secondary or complementary role compared to cash flow analysis.
  4. Focus on the total gross debt - research and outreach conducted by the staff suggests that in assessing the total gross debt of the entity, debt investors and credit analysts are more interested in information about the nominal amounts due rather than in the fair value of the debt due to the focus on cash flows in the credit analysis. Accordingly, the carrying amounts of debt included in the receiving entity’s statement of financial position applying either a current value approach or a predecessor approach will generally not be sufficient for credit analysis. Debt investors and credit analysts would be looking to supplement that information by information provided in the notes to financial statements or through other sources of information.

Staff observations

The staff acknowledge that although analysis of cash flows and debt play a predominant role in credit analysis debt investors and credit analysts also consider the broader context, including calculating profitability ratios. Such additional ratios considered by debt investors and credit analysts can be affected by whether a current value approach or a predecessor approach is used to account for a business combination under common control. However, the findings in the staff’s outreach suggest that those ratios are only used to assess a broader context and do not tend to affect the overall outcome of credit analysis.

The staff think that the Board could pursue different approaches for business combinations under common control that affect NCI in the receiving entity and those that affect lenders and other creditors in the receiving entity. Specifically, they outline in their paper, the Board could pursue:

  • a) a current value approach for all or some transactions that affect NCI in the receiving entity (discussed in December 2018 Agenda Paper 23 Approach for transactions that affect non-controlling interest); and
  • b) a different approach, such as a predecessor approach, for transactions that affect lenders and other creditors in the receiving entity but do not affect NCI.

Board discussion

The Board and staff discussed the staff’s observations in paper 23 of applying a predecessor approach to transactions between wholly owned entities and a current value approach to at least some transactions that affect NCI in the receiving entity.

A number of Board members expressed the view it is perhaps over simplistic to think you can have one or the other approach and need to perhaps think about more than one predecessor approach might be required. One Board member challenged the staff whether they had undertaken any research why some companies do an acquisition approach and some do a predecessor approach. The staff agreed to look at this and report back in a future meeting.

With regards to Paper 23B, the Board challenged the staff to think about how they have expressed the point regarding the information needs of debt investors versus equity investors, rather than changing the outcome. The paper sets out the needs to investors being in conflict with debt investors, however it is important to express that information needs to debt investors is a subset of equity investors. When they are both considered, you only really need to consider the information needs of equity investors to satisfy the information needs of debt investors.

Board decision and next steps

No formal agreement of next steps, but staff will take away the observations and report back in a future meeting.

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