Ceasing to be a subsidiary

Chapter 33 – Business Combinations Page 436 Illustration 10 Assuming the same facts as in Illustration 7 and that goodwill in the acquisition was measured at CU4.8 million. The finalisation of the fair value of the trademarks will result in an increase in their carrying amount at the acquisition date of CU100,000, so goodwill should be reduced by the same amount. The 2007 comparative figures in the 2008 financial statements should be restated by these amounts. Note also that the 2007 amortisation should be increased by CU5,000 CU100,00010 years × 612months and the 2007 profit reduced or loss increased by the same amount. 9 Disclosures A business combination may result in substantial changes to both the nature of a group and its performance in future periods. IFRS 3, therefore, requires the disclosure of information to assist in a user’s understanding of the nature and financial effect of a business combination that occurs either during the current reporting period or after the end of the reporting period but before the financial statements are authorised for issue. [IFRS 3.59] In addition, information should be disclosed so that users of the financial statements are able to evaluate the financial effect of adjustments made in the current reporting period in respect of business combinations that took place in the current or previous reporting periods. [IFRS 3.61] To meet the objective of these disclosures, IFRS 3 sets out detailed requirements in the Application Guidance accompanying it. If these specific disclosures do not meet the objectives set out above, then an entity should provide additional information. The first group of disclosures has the objective of requiring information about combinations that occurred during the period. The name and a description of an acquiree should be presented along with the acquisition date, the percentage of voting equity acquired and the consideration transferred. The consideration transferred should be broken down into its various elements, for example cash and the issue of shares. A narrative explanation is required to explain the reason for the business combination, the factors that make up goodwill and any intangible assets that did not qualify for separate recognition. More detailed disclosures are required in respect of any contingent consideration and indemnification assets. Ongoing disclosures are also required in relation to the continuing existence of contingent consideration. The amounts recognised as at the acquisition date for each major class of assets acquired and liabilities assumed should be disclosed. If a gain on a bargain purchase was achieved on the acquisition, the amount recognised in profit or loss should be clearly identified and a description of why a gain was achieved. Where less than 100 per cent ownership has been acquired in a business combination, the amount of the non-controlling interest in the acquiree at the acquisition date should be disclosed, together with the measurement basis used. If fair value is used, then the valuation techniques should also be disclosed. The amounts of the acquiree’s revenue and profit or loss included in the consolidated statement of comprehensive income in the year of acquisition should be disclosed, together with the revenue and profit or loss which would have been included if the acquisition dates of all the business combinations during the period had been the first day of the period. Where a Chapter 33 – Business Combinations Page 437 business acquired has been fully integrated into existing operations, it may not be practicable to separate out its results and therefore this fact should be disclosed. These disclosures should provide information to users about the likely future performance of the enlarged group. The disclosures set out above may be aggregated for business combinations that individually will not have a substantial effect on the business. Where provisional values have been recognised in the financial statements of the period in which the business combination arose, this fact should be explained along with the reasons why amounts could not be finalised. The provisional values should be quantified. Additional information is required as to the financial effect that gains, losses and other adjustments relating to the business combinations in the current and previous periods have had in the current period. This information should include, for example, the effect of any gains that have been recognised in respect of the identifiable assets and liabilities of the acquiree or the correction of errors. A full reconciliation of movements to the carrying amount of goodwill should be presented; this will include, for example, goodwill recognised during the period and any reductions in the carrying amount as a result of impairment losses. Additional disclosures regarding the recoverable amount of goodwill are required by IAS 36. 10 Chapter Review This chapter has covered:  the objective and scope of IFRS 3;  the definitions which are critically important to the understanding of the requirements of IFRS 3;  the steps in the acquisition method of accounting: identify the acquirer, determine the acquisition date, recognise and measure the identifiable assets acquired, the liabilities assumed and the non-controlling interest;  the recognition and measurement of goodwill and gains from bargain purchases;  initial accounting and subsequent adjustments; and  the disclosure requirements of IFRS 3. Chapter 33 – Business Combinations Page 438 11 Self Test Questions Chapter 33 1. A parent entity is acquiring a majority holding in an entity whose shares are dealt in on a recognised market. Under IFRS3 Business combinations, which TWO of the following measurement bases may be used in measuring the non-controlling interest at the acquisition date? A The nominal value of the shares in the acquiree not acquired B The fair value of the shares in the acquiree not acquired C The non-controlling interest in the acquirees assets and liabilities at book value D The non-controlling interest in the acquirees assets and liabilities at fair value 2. In a business combination, an acquirers interest in the fair value of the net assets acquired exceeds the consideration transferred in the combination. Under IFRS3 Business combinations, the acquirer should select one answer A recognise the excess immediately in profit or loss B recognise the excess immediately in other comprehensive income C reassess the recognition and measurement of the net assets acquired and the consideration transferred, then recognise any excess immediately in profit or loss D reassess the recognition and measurement of the net assets acquired and the consideration transferred, then recognise any excess immediately in other comprehensive income 3. Should the following costs be included in the consideration transferred in a business combination, according to IFRS3 Business combinations? 1 Costs of maintaining an acquisitions department. 2 Fees paid to accountants to effect the combination. Cost 1 Cost 2 A No No B No Yes C Yes No D Yes Yes Chapter 33 – Business Combinations Page 439 4. Are the following statements about an acquisition true or false, according to IFRS3 Business combinations? 1 The acquirer should recognise the acquirees contingent liabilities if certain conditions are met. 2 The acquirer should recognise the acquirees contingent assets if certain conditions are met. Statement 1 Statement 2 A False False B False True C True False D True True 5. The Pendle Company acquired a 30 equity interest in The Terata Company many years ago. In the current accounting period it acquired a further 40 equity interest in Terata. Are the following statements true or false, according to IFRS3 Business combinations? 1 Pendles pre-existing 30 equity interest in Terata should be remeasured at fair value at the acquisition date. 2 Pendles net assets should be remeasured at fair value at the acquisition date. Statement 1 Statement 2 A False False B False True C True False D True True 6. On 1 July 20X7 The Magna Company acquired 100 of The Natural Company for a consideration transferred of CU160 million. At the acquisition date the carrying amount of Naturals net assets was CU100 million. At the acquisition date a provisional fair value of CU120 million was attributed to the net assets. An additional valuation received on 31 May 20X8 increased this provisional fair value to CU135 million and on 30 July 20X8 this fair value was finalised at CU140 million. What amount should Magna present for goodwill in its statement of financial position at 31 December 20X8, according to IFRS3 Business combinations? A CU25 million B CU40 million C CU20 million D CU60 million Chapter 33 – Business Combinations Page 440 7. The Lampard Company acquired a 70 interest in The Ohau Company for CU1,960,000 when the fair value of Ohaus identifiable assets and liabilities was CU700,000 and elected to measure the non-controlling interest at its share of the identifiable net assets. Annual impairment reviews of goodwill have not resulted in any impairment losses being recognised. Ohaus current statement of financial position shows share capital of CU100,000, a revaluation reserve of CU300,000 and retained earnings of CU1,400,000. Under IFRS3 Business combinations, what figure in respect of goodwill should now be carried in Lampards consolidated statement of financial position? A CU1,470,000 B CU160,000 C CU1,260,000 D CU700,000 8. The National Company acquired 80 of The Local Company for a consideration transferred of CU100 million. The consideration was estimated to include a control premium of CU24 million. Locals net assets were CU85 million at the acquisition date. Are the following statements true or false, according to IFRS3 Business combinations? 1 Goodwill should be measured at CU32 million if the non-controlling interest is measured at its share of Locals net assets. 2 Goodwill should be measured at CU34 million if the non-controlling interest is measured at fair value. Statement 1 Statement 2 A False False B False True C True False D True True Chapter 33 – Business Combinations Page 441 9. The Mooneye Company acquired a 70 interest in The Swain Company for CU1,420,000 when the fair value of Swains identifiable assets and liabilities was CU1,200,000. Mooneye acquired a 65 interest in The Hadji Company for CU300,000 when the fair value of Hadjis identifiable assets and liabilities was CU640,000. Mooneye measures non-controlling interests at the relevant share of the identifiable net assets at the acquisition date. Neither Swain nor Hadji had any contingent liabilities at the acquisition date and the above fair values were the same as the carrying amounts in their financial statements. Annual impairment reviews have not resulted in any impairment losses being recognised. Under IFRS3 Business combinations, what figures in respect of goodwill and of gains on bargain purchases should be included in Mooneyes consolidated statement of financial position? A Goodwill: CU580,000 Gains on the bargain purchases: CU116,000 B Goodwill: Nil Gains on the bargain purchases: CU116,000 C Goodwill: Nil Gains on the bargain purchases: Nil D Goodwill: CU580,000 Gains on the bargain purchases: Nil 10. On 1 October 20X7 The Tingling Company acquired 100 of The Greenbank Company when the fair value of Greenbanks net assets was CU116 million and their carrying amount was CU120 million. The consideration transferred comprised CU200 million in cash transferred at the acquisition date, plus another CU60 million in cash to be transferred 11 months after the acquisition date if a specified profit target was met by Greenbank. At the acquisition date there was only a low probability of the profit target being met, so the fair value of the additional consideration liability was CU10 million. In the event, the profit target was met and the CU60 million cash was transferred. What amount should Tingling present for goodwill in its statement of consolidated financial position at 31 December 20X8, according to IFRS3 Business combinations? A CU94 million B CU80 million C CU84 million D CU144 million Chapter 33 – Business Combinations Page 442 11. 100 of the equity share capital of The Raukatau Company was acquired by The Sweet Company on 30 June 20X7. Sweet issued 500,000 new CU1 ordinary shares which had a fair value of CU8 each at the acquisition date. In addition the acquisition resulted in Sweet incurring fees payable to external advisers of CU200,000 and share issue costs of CU180,000. In accordance with IFRS3 Business combinations, goodwill at the acquisition date is measured by subtracting the identifiable assets acquired and the liabilities assumed from A CU4.00 million B CU4.18 million C CU4.20 million D CU4.38 million 12. The Gebbies Company acquired 100 of The Okalua Company for a consideration transferred of CU112 million. At the acquisition date the carrying amount of Okaluas net assets was CU100 million and their fair value was CU120 million. How should the difference between the consideration transferred and the net assets acquired be presented in Gebbiess financial statements, according to IFRS3 Business combinations? A Gain on bargain purchase of CU8 million recognised in other comprehensive income B Gain on bargain purchase of CU8 million deducted from other intangibles assets C Gain on bargain purchase of CU8 million recognised in profit or loss D Goodwill of CU12 million as an intangible asset Chapter 34 – Associates Page 443 Chapter 34 ASSOCIATES 1 Business Context Investments can take a number of different forms. Typically where one entity acquires the majority of the voting rights of another, it gains control. However, outright control is not always the most appropriate form of investment for an entity to have. There may be circumstances where, although an entity does not have the expertise to efficiently control another entity, the business in which it operates is still of significant importance to it. In such circumstances an investor may instead decide to obtain sufficient ownership of the entity to have the power to influence decisions of its governing body its board of directors but not to have control over it. Investments that meet these criteria will generally be classed as associates. As the investor has what is described as significant influence over the investee, it is appropriate to report its share of the investee’s results rather than just the dividends receivable; after all, it is partly answerable for the investee’s performance. 2 Chapter Objectives IAS 27 Consolidated and separate financial statements and IFRS 3 Business combinations deal with the parent-subsidiary relationship where the investee is under the control of the investor. They cover the requirements in relation to the bringing together of two parties and the subsequent presentation in the consolidated financial statements on the basis that the two entities are treated as a single economic entity. This chapter deals with the financial reporting by an investing entity when it has significant influence over its investee. In such circumstances the investee is described as an associate of the investor. On completion of this chapter you should be able to:  understand the objectives and scope of IAS 28 Investments in associates;  interpret the important terminology and definitions which relate to such investments;  understand the key principles relating to the recognition and measurement of such investments;  demonstrate knowledge of the principal disclosure requirements of IAS 28; and  apply knowledge and understanding of IAS 28 in particular circumstances through basic calculations. 3 Objectives, Scope and Definitions of IAS 28 IAS 28 sets out the accounting requirements when an entity has an investment in an associate. The standard does not apply where the investor is a venture capital organisation or where the investment is owned by a mutual fund or unit trust or similarly structured entity and such investments have been accounted for using a fair value approach under IAS 39 Financial instruments: recognition and measurement. [IAS 28.1] An associate is defined as an entity over which the investor has significant influence. For an investment to meet the definition of an associate, it should not be a subsidiary, where the investor has control, or a joint venture, where the investor has joint control. [IAS 28.2] Chapter 34 – Associates Page 444 Significant influence is defined as the power to participate in the financial and operating policy decisions of the investee without having control or joint control over those policies. [IAS 28.2] The assessment of significant influence is a matter of judgement. IAS 28 includes practical guidance to assist management in making that assessment. For example, where an investor has at least 20 of the voting power in another entity, IAS 28 presumes that this size of holding is enough to give rise to significant influence over that entity. Conversely, where less than 20 of the voting rights are held, the investor is presumed not to have significant influence over the investee. However, the nature of each investment should be carefully assessed as both of these presumptions may be overruled. It is important to consider not only an investor’s current shareholding but also any potential holding which could result from share options or warrants that are immediately exercisable i.e. the right to acquire shares immediately. IAS 28 provides a list of factors that normally indicate that significant influence is present. These factors include:  where the investor has a representative on the board of directors or on an equivalent body;  where the investor actively participates in the policy-making processes of the entity, including the level of dividends to be paid;  where a number of significant transactions take place between the investor and the investee;  where members of management move between the two entities; or  where the investor provides essential technical information to the entity. There are exceptions from compliance with IAS 28. Where the investment is classified as ‘held for sale’ in accordance with IFRS 5 Non-current assets held for sale and discontinued operations, it should be treated in accordance with that standard. IAS 28 does not apply if the investor is not required to prepare consolidated financial statements under IAS 27. [IAS 28.13, 28.14] In addition, an exception applies where the investor is a wholly owned subsidiary or partially owned but the minority interest shareholders have been notified of the intention not to apply the requirements of IAS 28 and they have not objected and the investor does not have debt or equity instruments traded in a public market nor is in the process of issuing debt or equity in a public market and the investor’s parent prepares consolidated financial statements that are publicly available and are prepared in accordance with IFRS. [IAS 28.13] 4 Equity Method of Accounting for Associates Subject to the exceptions referred to above, associates should be accounted for using the equity method. If the relationship changes such that the investor gains control, or joint control, over the entity, then it should be treated in accordance with IAS 27 or IAS 31 Interests in joint ventures respectively. If the ability to exercise significant influence is lost, then the investment should cease to be equity accounted for and the requirements of IAS 39 should be applied. [IAS 28.13, 28.18] On the date on which an entity loses significant influence, any retained interest in the investment should be measured at fair value. At this date, the investor should also recognise in profit or loss the difference between the carrying amount of the investment held prior to the significant influence being lost and the fair value of any retained investment plus any proceeds received. [IAS 28.18, 28.19] Chapter 34 – Associates Page 445 Under the equity method of accounting, the investment in the associate is initially recognised at cost and is subsequently adjusted in each period for changes in the investor’s share of net assets of the associate. The investor’s reported profit or loss for the period will include its share of the associate’s reported profit or loss for the period, presented as a single line item. [IAS 28.2] Where the parent and a number of its subsidiaries have an interest in a single entity, the group’s share in the investment is determined by adding together all the interests held by group entities. An investor’s interest in an associate should be presented in the statement of financial position as a single line under non-current assets. [IAS 28.38] Illustration 1 Pecs has a number of wholly owned subsidiaries and a 40 interest in the share capital of Abs. These shares were acquired three years ago when the balance on Abs’ retained earnings was CU100. Pecs Abs Group CU CU Investment in Abs 120 - Other assets 1,080 650 1,200 650 Liabilities 200 150 1,000 500 Share capital 300 100 Retained earnings 700 400 1,000 500 The consolidated statement of financial position of Pecs should incorporate Abs using the equity method of accounting. The carrying amount of the investment is calculated as: Cost of investment CU120 Share of post acquisition retained earnings 40 x 400 – 100 CU120 CU240 Consolidated statement of financial position Pecs Group CU Investment in Abs 240 Other assets 1,080 1,320 Liabilities 200 1,120 Share capital 300 Pecs 700 plus share of Abs’ Retained earnings 820 post acquisition profit 120 1,120