Financial Reporting
Revisions to IFRS3 Business Combinations and IAS27 Consolidated and Separate Financial Statements
Students studying for financial reporting papers need to be aware of the revisions to IFRS 3 ‘Business Combinations’ and IAS 27 ‘Consolidated and Separate Financial Statements’. If you are sitting for examinations with professional bodies who adopt the six-month issue rule, then the changes to IFRS 3 will be examinable from the December 2008 sittings as the revised standards were issued on 10 January 2008 and did contain some amendments from the previously issued Exposure Drafts. However, in practical terms the revisions are not due to take effect until 1 July 2009, although early adoption is permitted.
This article considers the technical revisions of both IFRS 3 and IAS 27 and incorporates a series of questions about the article at the end to test your understanding.
Some definitions to consider in relation to groups:
Consolidated financial statements are the financial statements of the group presented as those of a single economic entity.
Subsidiary is an entity, including an unincorporated entity such as a partnership that is controlled by another entity (known as the parent).
Parent is an entity that has one or more subsidiaries.
Control is the power to govern the financial and operating policies of an enterprise to as to obtain benefits from its activities.
The revised IFRS 3 defines a business combination as:
“a transaction or event in which an acquirer obtains control of one or more businesses. A business is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purposes of providing a return directly to the investors or other owners, members or participants”.
General accounting for a business combination
The ‘purchase’ method has been replaced by the ‘acquisition’ method. The acquisition method consists of:
- identifying the acquirer;
- determining the acquisition date and consideration transferred (purchase price)
- recognising and measuring the identifiable assets acquired and liabilities assumed;
- recognising and measuring any non-controlling interest* in the acquiree; and
- recognising goodwill or, in the case of a bargain purchase, a gain.
Assets and liabilities are measured at their acquisition-date fair value. Only in limited cases are exceptions to this rule available.
*‘Non-controlling interests’ is the new term for what was previously known as ‘minority interests’.
One notable feature of the changes has been in respect of the ‘incidental’ costs of the acquisition (the ‘consideration’). Before the changes to IFRS 3, transaction costs associated with a business combination (typically legal fees and accountancy fees for due diligence) were capitalised with the cost of the acquisition – thus forming part of the goodwill calculation. The IASB have concluded that these types of cost must now be expensed as these costs are not part of the fair value exchange between the buyer and seller of the business. This means, therefore, that in the year of acquisition, the acquirer’s income statement will show substantially higher legal and professional fees. However, this reduction in profits should be outweighed in future years because the annual impairment test on the goodwill will be based on a reduced initial balance.
Step acquisitions
Prior to the revisions to IFRS 3, it was a requirement to measure the assets and liabilities at fair value at every step of the transaction to calculate a ‘portion’ of goodwill. This requirement has now been removed. Instead you should measure goodwill as the difference, at the acquisition date, between the fair value of any interest in the business held before the acquisition, the consideration (the funds) transferred and the net assets acquired.
Partial acquisitions
Non-controlling interests are measured either as their proportionate interest in the net identifiable assets, as was the case before the revision to IFRS 3. Non-controlling interests can also be measured at fair value. This revision was made to bring IFRS 3 more in line with US GAAP.
Recognition of assets and liabilities subject to contingencies
There are a few (limited) changes to the assets and liabilities recognition under IFRS 3. There is a new requirement to recognise assets and liabilities that are subject to contingencies at fair value at the acquisition date. Any subsequent changes in fair value will be accounted for in accordance with other IFRS’s (which usually will be in profit or loss rather than as an adjustment to goodwill).
Partial disposal of a subsidiary whilst control is retained
Where a partial disposal of an investment in a subsidiary is disposed of whilst control is retained, then this is accounted for as an equity transaction with owners and a gain or loss is not recognised.
A partial disposal of an interest in a subsidiary where the parent loses control, but retains an interest and thus becomes (for example), an associate, will trigger recognition of a gain or loss on the entire interest. A realised gain or loss is recognised on the portion that has been disposed of; a holding gain is recognised on the interest retained, calculated as the difference between the fair value and the book value of the retained interest.
Acquisition of additional shares after control has been obtained
Where the parent acquires some, or all, of the non-controlling interest in a subsidiary, then this should be treated as a treasury share-type transaction and therefore should be accounted for as an equity transaction. There is an interpretation summary, IFRIC 11 ‘IFRS 2: Group and Treasury Share Transactions’ which gives guidance in this area. Students studying for financial reporting papers for the December 2008 sitting may well find IFRIC 11 helpful to their studies.
Goodwill – amendment to previously published exposure
Previously issued Exposure Drafts contained the requirement to measure goodwill using the full goodwill model. This is where goodwill is assumed at 100% by the parent, which would have resulted in a corresponding increase in the non-controlling interest. The IASB has decided not to proceed with the full goodwill model and instead allows preparers to choose to measure non-controlling interest in the identifiable net assets as their proportionate interest.
Conclusion
It is important that the revisions to IFRS 3 and IAS 27 are understood and applied in question practice. Students who do not have up to date material will need to ensure they are familiar with the revisions, especially those for whom the revisions will affect in the December 2008 sitting.
Quick test:
1. What are minority interests now known as?
2. What is the ‘purchase method of accounting’ now known as?
3. “Contingent consideration must be recognised and measured at fair value”. True
or false?
4. Acquisition costs should be included in the goodwill calculation? True or false?
5. What happens if the parent’s holding in a subsidiary changes but it does not lose
control?
Steve Collings FMAAT ACCA is Audit Manager at Leavitt Walmsley Associates Ltd and a partner in http://www.accountancystudents.co.uk. Any queries relating to this article can be forwarded direct to Steve Collings at
Answers to quick test:
1. Non-controlling interests.
2. The ‘acquisition method’.
3. True.
4. False. They are now expensed as they do not form part of the identifiable assets
and liabilities in the transactions.
5. The parent will account for the part-disposal as an equity transaction. Further
shares acquired in a subsidiary will be accounted for as a treasury share-type
transaction.
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