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ASEM IFRS SEMINAR Shanghai, 25-26 March 2006 . Consolidation and Business Combinations Changes to IFRS 3, IAS 27, IAS 37. Reinhard Biebel, EFRAG Deputy Technical Director. www.efrag.org. Consolidation - Combination. Acquisition. Merger. Common Control. Hostile take-over. De facto Control.

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ASEM IFRS SEMINAR

Shanghai, 25-26 March 2006

Consolidation and Business CombinationsChanges to IFRS 3, IAS 27, IAS 37

Reinhard Biebel, EFRAG Deputy Technical Director

www.efrag.org


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Consolidation - Combination

Acquisition

Merger

Common Control

Hostile take-over

De facto Control

Joint Venture

Need for consolidated information


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IAS 22(revised 1993)

minor changes

SIC 9, 22 & 28

31 March  IFRS 3

minor changes 2004-2005

30 June  ED IFRS 3

?  common control

fresh-start (true mergers)

Racing ahead …

1993

1996-1999

2004

2005

????


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ED IFRS 3 – Phase II

  • Issued 30 June 2005

  • Joint project with US standard setter FASB

    • Objective = improvement and convergence IASB/FASB

  • Consequential amendments to IAS 27, 37 and 19

  • Completely new method of treating:

    • Business combinations

    • Minority interests (now: non-controlling interests)

    • Contingent assets and liabilities


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ED IFRS 3: Changes to terminology

Minority-interests

Non-controlling interest (NCI)


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ED IFRS 3: Changes to definitions

Business combination [IFRS 3]

The bringing together of separate entities or businesses into one reporting entity

Business combination [ED IFRS 3]

A business combination is a transaction or other event in which an acquirer obtains control of one or more businesses


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Control under IAS 27

IASB Statement, IASB Update October 2005:

“IAS 27 contemplates that there are circumstances in which one entity can control another entity without owning more than half the voting power.”


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Acquisition method

  • Amendment: Purchase Method  Acquisition Method

  • Identify acquirer

  • Determine the acquisition date

  • Measure the fair value of the acquiree

  • Recognise and measure identifiable assets acquired and liabilities assumed at fair value

    • 1+2  similar to current IFRS 3

    • 3+4  amended to reflect the transition to full fair value




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ED IFRS 3: Significant changes - goodwill gross up

  • Acquired business measured at fair value as a whole

  • 100% goodwill recognised

    • Consistent with treatment of other assets

  • Goodwill allocated between acquirer and non-controlling interest (was minority interest)

  • Allocation of goodwill to acquirer based on:

    • Fair value of acquirer’s equity interest LESS

    • Fair value of share of net assets acquired

    • Balance to NCI


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ED IFRS 3: Goodwill example

  • P acquires 75% (750 000 shares) of S for CU7.5m

  • Shares in S trading about A$8 per share

    • Expectation of synergies

  • Independent valuation  value of S = CU9.7m

  • Fair value of net assets acquired = CU8m



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Step acquisitions

  • Change in accounting for step acquisitions

  • A owns an investment in B

  • B = associated comp to A (i.e. A doesn’t control B)

  • If A increase its stake & gains control over B it must

    • Determine fair value of associate

    • Recognise profit/loss in income statement

    • Follow the provisions of IFRS 3

      • Cost would include fair value of B


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Step acquisition – illustration

  • A owns 35% stake in B at 31 Dec 2007

  • Book value at 31 Dec 2007 = CU2,500

  • Buying additional 40% on 31 Dec 2007 at CU4,000

  • Fair value (FV) of total B = CU10,000

    31 Dec 2007

  • A recognise gain of CU1,000 [(35%*CU10,000)- CU2,500]

  • A accounts for 40% purchase under ED IFRS 3

    • FV of all of B = CU10,000 and FV of 75% of B = CU7,500

  • Subsequent purchases = equity transaction


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ED IFRS 3: Acquisition costs

  • Recognised in profit or loss

Direct acquisition costs

  • Represent payment for services (e.g. legal costs. auditor, bank)

  • Impact on goodwill

  • Do not represent assets of acquirer


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Contingent consideration

  • Fair value of consideration paid includes fair value of contingent consideration at acquisition date

    • Classify as debt or equity per IAS 32

  • Examples

    • Financial or non-financial hurdles

    • Share-based payment


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Contingent consideration

  • Measurement period* adjustments

    • 12 months from date of acquisition (no change)

    • New information about facts existing at acquisition date

  • Post measurement period

    • Equity  not remeasured

    • Otherwise  re-measure

      •  No impact on business combination

* Measurement period = reasonable time to obtain information about facts and circumstances existing at acquisition date. Limited to on year.


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Contingent consideration - example

  • Contingent consideration of CU6m payable if certain profit targets met

  • Fair value on acquisition date is CU4m

  • Subsequent changes reported in I/S

    • As likelihood of meeting target increases, so does liability

  • When target met, liability is recorded at CU6m

    • CU2m will have been recorded in I/S

    • No impact to accounting for business combination


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Other changes

  • Date of acquisition

  • Recognition of intangibles – probability and reliability criterion!

  • Treatment of negative goodwill


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Board members view on ED IFRS 3

  • Proposed effective date 1 January 2007

  • Quite a few IASB Board Members have dissenting opinions (alternative views)

    • Recognise goodwill at 100% 5 dissenters

    • Increase/decrease in stake after control 3 dissenters

    • Definition of ‘business combination’ 2 dissenters

    • Widening of scope 1 dissenter

    • Direct cost to be recognised in I/S 2 dissenters

    • Removal of ’reliable measurement’-criteria re. intangible assets in Business Combinations 1 dissenter

  • Important joint project with FASB


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EFRAG position on ED IFRS 3

Reasons for not supporting the EDs:

  • introduction of radical new and untested concepts,

  • the reasons for issuing the proposals and the assumed benefits,

  • the increased use of fair value without a conceptual debate,

  • the accounting for business combinations at fair value,

  • the application of an economic entity view,

  • the proposed full goodwill method,

  • the proposed treatment of acquisitions in steps,

  • the extended scope without providing a solution for true mergers.

    This does not pre-empt an assessment regarding endorsement


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Business Combinations II:Changes to other standards


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Other standards affected

  • IAS 27 Consolidated and Separate Financial Statements

  • IAS 37 Provisions, Contingent Liabilities and Contingent Assets

  • IAS 19 Employee Benefits

  • Purpose of proposed changes:

    • to align ongoing accounting with that required on a business combination (e.g. re contingencies)

    • to align IFRS with US GAAP in certain areas (e.g. restructuring)


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ED IAS 27: “non-controlling interest” (NCI)

  • ‘Minority interest’ ‘non-controlling interest’

  • Non-controlling interest classified as equity

    • Transactions with NCI = equity transactions

    • Gains/losses recorded in P&L only on loss of control

  • Losses applicable to NCI are allocated to NCI - any guarantees/support arrangements accounted for separately

    • currently, losses not allocated to minority unless binding obligation on them to make good losses incurred which they are able to meet


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ED IAS 27: Increased stake in sub

  • A owns 80% of B

  • Consolidated equity of B = 100

  • A’s share = 80, NCI = 20

  • A buys remaining 20% for 30

  • Increase from 80% to 100%

  • Transaction with EQ holders =>

    • No change to goodwill (already at 100%)

    • No gain/loss recorded

    • Consideration paid/payable debited to EQ

  • Current position – no detailed guidance

    • Typically recognise additional goodwill

  • Different views internationally

    • how to measure additional GW

    • what to do about fair value changes re assets / liabilities

  • Debit of 10 = excess price parent paid to acquire NCI

    *The draft doesn’t explain where these debits/credits should be recognised


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ED IAS 27: Decreased stake in sub

  • A owns 80% of B

  • Consolidated equity of B = 120

  • A’s share = 96, NCI = 24

  • A sells 20% for 40

  • A retains control over B

  • Decrease from 80% to 60%

  • Transaction with EQ holders =>

    • No change to goodwill (already at 100%)

    • No gain/loss recorded

    • Consideration received / receivable credited to EQ

  • Current position – no detailed guidance:

    • Typically recognise gain or loss on “part disposal”

  • No real consensus on reduction to goodwill?

  • Credit of 16 = gain from sale of NCI

  • Currently gain/loss goes to P/L. Not possible under the ED.


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Disposal  when loss of control

Need not involve change in stake

On disposal, any continuing EQ interest to be remeasured to FV

currently, typically roll forward appropriate proportion of carrying amount

Gain/loss to income statement on disposal determined as

FV of Proceeds + FV of any retained investment MINUS

Aggregate of parent’s interest in carrying amount of net assets prior to disposal

FV of remaining 40% (400) applied as cost of initial investment under IAS 28

ED IAS 27: disposal of subsidiary

  • A owns 100% af B

  • Consolidated equity of B = 800

  • A sells 60% and loses control

  • Proceeds on sale of 60% = 500

  • FV of remaining 40% = 400


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ED IAS 37: change to terminology

  • ‘Contingent liabilities’ & ‘contingent assets’ cease to exist

  • If obligation exists = ‘non-financial liability’

  • If rights exist = asset

  • If obligation/rights don’t yet exist because conditional = ‘contingency’


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ED IAS 37: New Recognition Criteria

Probability criterion omitted from ED

IAS 37

Probability

ED

Example

  • A has obligation to B

  • 20% chance A will have to pay CU1m

  • 80% chance A will pay nothing

    • Currently: no provision

    • Proposed: recognise CU0,2m liability (CU1m x 20%)

  • Similar applies to assets: if rights exist, recognise asset (IAS 38/IAS 37)

100%

50%

÷

0%

Result = more asset & liabilities on balance sheet


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ED IAS 37: Measurement

Measurement principle

Move away from concept of ‘best estimate’ to more fair value based ’exit value’

Single obligation

‘Most likely outcome’ not necessarily consistent with the ED’s measurement objective

Future events

Take into consideration if sufficiently objective evidence exits

Reimbursements

Move away from ’virtually certain’. Recognise if unconditional right to receive.

Restructurings

Recognise only when definition of liability is satisfied. Specific guidance deleted.


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Conclusion

New proposals for accounting for Business Combinations are seen critical because of:

  • Increased use of fair value

  • New an untested concepts

  • Practicability concerns

  • Usefulness of information

  • Scope

    IASB indicated to re-deliberate most of new concepts

    Final standard in 2007

    Will IASB and FASB come up with a practical solution?


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