Way Forward

2. Way Forward Key aspects • What constitutes a business combination? • Who is the acquirer? • What is the date of acquisition? • What is the cost of acquisition? • Contingent consideration

3. Scope • Scope of IND AS 103 Transactions or events that meet the definition of a Business Combination Formation of a joint venture Acquisition of an asset or group of assets not constituting a business A combination of entities or businesses under common control

4. Definitions Key Definitions • Business combination • A transaction or other event in which an acquirer obtains control of one or more businesses. • Business • A business consists of inputs and processes applied to those inputs that have the ability to create outputs.

5. Identifying a Business Combination • An entity shall determine whether a transaction or other event is a business combination by applying the definition in this IND AS, which requires that the assets acquired and liabilities assumed constitute a business. • If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. • For example, acquisition of a ‘shell’ or ‘shelf’ company is not a business combination as defined in IND AS 103 because no business is being acquired.

6. Issues Asset purchases vs. business combinations • Substance over Legal Form • Many companies would rather the transaction be classified as an asset acquisition than a business combination • the accounting is easier. • can capitalize transaction costs; • don’t have to fair value all the assets acquired; and • don’t have to determine the fair value of contingent consideration. • No goodwill! • Because of this, purchase agreements often stipulate the transaction is an asset purchase rather than the acquisition of a business. • however If what is being acquired meets the definition of a business, it is a business combination, regardless of what the agreement says.

7. Common Control Transaction • B and C are wholly-owned subsidiaries of A. • A transfers its equity interest in B to C. In exchange, C issues further equity shares to A. • The transaction is a common control transaction since both B and C are under the common control of A.

8. Acquisition Method • All business combinations are accounted for using the acquisition method. • To apply acquisition method it is required to;

9. Issues – Identifying the Acquirer • Identifying the acquirer • Reverse Merger – The merger of a private operating entity into a nonoperating public shell corporation with nominal net assets typically results in (1) the owners of the private entity gaining control over the combined entity after the transaction, and (2) the shareholders of the former public shell corporation continuing only as passive investors.

10. Identifying the Acquirer • Guidance under IND AS 103 to identify the acquirer;

11. Determining the Acquisition Date • Date on which the acquirer obtains control of the acquiree. - Usually, the date on which the acquirer legally transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree - the “closing date”. Issues : The date of acquisition can be :- • Date on which acquirer legally transfers the consideration or • Acquires the assets of the acquiree and • Assumes the liabilities of the acquiree • Date of agreement for merger

12. Identifying and Measuring Consideration • Consideration should be measured at fair value. • Consideration is the sum of the acquisition-date fair values of: –The assets transferred –The liabilities incurred by the acquirer –The equity interests issued • Acquisition-related costs are generally expensed as incurred except for the costs that are incurred related to the issuance of debt or equity securities

13. Identifying and Measuring Consideration Contingent consideration • Recognize at acquisition-date fair value as part of the consideration transferred. • Obligation to pay contingent consideration is classified as a liability or equity • Subsequent measurement: – If classified as equity, no re-measurement. • Subsequent settlement shall be accounted for within equity. – If classified as liability and that liability is: • A financial instrument within the scope of IND AS 109, re-measure to fair value through earnings or comprehensive income each period until settled • Not within scope of IND 109, account for in accordance with IND AS 37 or other IND AS as appropriate

14. Recognition and Measurement Principles • For each business combination, the acquirer shall measure non-controlling interest either –at fair value, or –at non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. • Non-controlling interest could have a negative carrying balance. –If there are accumulated net losses attributable to noncontrolling interest.

15. Issues – Recognising and Measurement • Fair valuation of complexedinstruemnts paid as consideration • Identification and valuation of intangible assets • customer list, • a brand, or • a customer relationship? valuations typically involve sophisticated models using inputs that are unobservable (i.e. Level 3 fair value measurements) 3. Contingent consideration • This estimate of fair value should take into consideration the probabilities of payment and the time value of money. • Each reporting period, this contingent consideration needs to be remeasured at fair value, with the corresponding entry made to current period earnings. • Most contingent consideration is based on the future earnings of the company being acquired. This estimate involves significant management judgment, especially as the period of the contingency increases.

16. Issues – Recognising and Measurement 4. Measurement Period Adjustment Only items that existed at the acquisition date and were provisionally accounted for at that time qualify for a measurement period adjustment. 5. Multistage Acquisition • Valuation of Previously acquired stake • Computation of Goodwill

17. Measurement Considerations – Other Items

18. Disposal of controlling Interests • Increase/ decrease in ownership percentage of subsidiary (as long as parent retains control) –Recorded as equity transactions –No gain or loss is recognized • If the parent retains a non-controlling interest after control is lost: –Non-controlling interest is remeazured to fair value on the date control is lost –Recognize gain or loss in the income statement

19. Other Issues – Foreign Acquisition Cross Border Acquisitions Issue • GAAP differences and the impact on purchase price In theory, differences in accounting rules and principles should not impact a target’s underlying valuation. However, in practice buyers may focus on different metrics in applying valuation techniques to estimate a target’s value. • For example, private equity buyers and some corporate buyers may focus on a multiple of a target’s EBITDA, whereas other corporate buyers may focus on post-acquisition earnings per share. In both cases, differences between buyer and target accounting rules and policies may have a significant impact on a buyer’s financial reporting and the target’s valuation, and should be appropriately considered.

20. Other Issues – Foreign Acquisition • Revenue recognition Revenue recognition differences can vary industry to industry. revenue recognition guidance may vary between the two frameworks regardless of industry • Employee benefits expense Significant differences exist between U.S. GAAP and IND AS / IFRS and IGAAP - in the areas of accounting for pension and other employee benefits. For example, actuarial gains and losses are permanently recognized in other comprehensive income under IFRS. U.S. GAAP / I GAAP requires that these items be expensed immediately • Contingencies IFRS and U.S. GAAP/ IGAAP have different recognition and measurement thresholds for contingencies that could result in different expense recognition patterns. For example, a contingent liability may be recorded under IFRS when it is more likely than not that a liability has been incurred, whereas under U.S. GAAP/ I GAAP the loss must be probable.

21. Other Issues – Foreign Acquisition • Leases Form-based rules under U.S. GAAP drive lease classification, whereas IFRS / IGAAP focuses on the substance of the transaction. • Straightlining of lease IFRS requires straightline of escalation clause impact in the long term lease contracts, however IND AS exempts straightlining if the increase is inline with the Inflation Index.

22. Other Issues – Foreign Acquisition • Foreign currency risk • purchase price denominated in a foreign currency will expose the buyer to foreign currency movements during the pre-acquisition phase. • Forecasted interest rate risk associated with debt to be issued solely to fund an acquisition and foreign currency risk associated with a target’s forecasted sales or purchases. As these cash flow exposures are contingent upon the consummation of the acquisition, which typically includes many substantive contingencies prior to closing, such as regulatory approvals, shareholder approvals, completion of due diligence, material adverse change provisions, etc. In practice, companies are unable to assert that the forecasted acquisition is probable of occurring due to the presence of these contingencies. In addition, buyers are precluded from applying hedge accounting to hedges of foreign currency risk associated with the purchase price.

23. Other Issues • Accounting for partial acquisitions and disposals—it's not so simple! • Conflicts in the literature • Valuation considerations • Retained investments • Acquired assets not intended to be used: • You may need to record them, even if you don't use them! – DEFENSIVE ASSETS • Buyer’s intentions do not influence value. Assets are measured using market participant assumptions • Determining the useful life for a defensive asset • Subsequent measurement of defensive assets • Not all unused assets are defensive assets • Goodwill impairment testing

24. Consolidation • IND AS 110 establishes a single control model that applies to all entities including ‘structured entities’ (‘special purpose entities’ as they were previously referred to) • Control An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Thus, an investor controls an investee if and only if the investor has all of the following:  • Power over the investee  • Exposure, or rights, to variable returns from its involvement with the investee; and  • The ability to use its power over the investee to affect the amount of the investor’s returns.

25. Issues – Voting Rights • Structure entities Structured entity is an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. • Voting Rights –Majority of voting rights without power – In some cases, voting rights do not give the holder the power to direct the relevant activities.  • Relevant activities are directed by contract • Relevant activities are directed by government, judiciary, administrator, receiver, liquidator, or regulator  • Voting rights are not substantive • Voting rights have been delegated to a decision-maker, which holds the voting rights as an agent  • Voting rights are held as a de facto agent of another investor • Power without Majority Voting rights – De facto control • Potential voting rights held by the investor, other vote holders or other parties; • Rights arising from other contractual arrangements; and • Any additional facts and circumstances that indicate the investor has, or does not have, the current ability to direct the relevant activities at the time that decisions need to be made, including voting patterns at previous shareholders’ meetings.

26. Issues – Voting Rights • Potential Voting Rights • If an investor holds a majority of the voting rights, but those voting rights are subject to a substantive option held by another investor, the majority shareholder would likely not have power. • Exercise price or conversion price (In or out of money) • Financial ability • Evaluating whether rights are substantive or Protective • Veto right over annual budget — protective or not? An investor determined that approving the annual operating budget of an investee is the relevant activity. An investor has the right to veto this annual operating budget. • Other veto rights that are common, and are typically protective include veto rights over changes to:  • Amendments to articles of incorporation  • Location of investee headquarters  • Name of investee  Auditors  • Accounting principles for separate reporting of investee operations

27. Issues • Franchises – Franchisor’s rights are substantive or Protective 1) A franchise agreement for which the investee is the franchisee often gives the franchisor rights that are designed to protect the franchise brand. Franchise agreements typically give franchisors some decision-making rights with respect to the operations of the franchisee.  2) franchisors’ rights do not restrict the ability of parties other than the franchisor to make decisions that have a significant effect on the franchisee’s returns. 3) distinguish between having the current ability to make decisions that significantly affect the franchisee’s returns and having the ability to make decisions that protect the franchise brand. 4) franchisee has made a unilateral decision to operate its business in accordance with the terms of the franchise agreement. 5) Control over such fundamental decisions - may be determined by parties other than the franchisor and may significantly affect the returns of the franchisee.

28. Issues - Variable Returns • Returns that appear fixed may be variable • investor that holds a bond with fixed interest payments – actually a variable return as its subject to risk • Fixed performance fees earned for managing an investee’s assets • Evaluating whether derivatives provide an exposure to variable returns • the derivative is entered into to align the cashflow of the assets of the structured entities with those of the investors and so reduce the risks to which the investors in the structured entity are exposed.

29. Issues – power to effect the returns • Principal Agency relationship • This is especially common when an investee is set up and one of the investors (often the lead investor) is delegated powers by the other investors to carry out activities for the investee. • Rights held by other parties – Kick out rights • Evaluating whether a removal right is substantive • A removal right may not be exercisable until a date in the future. In such cases, judgement must be exercised to determine whether (or when) that right becomes substantive. • Similarly, when a removal right can only be exercised during a narrow period (e.g., for one day on the last day of the reporting period), judgement will also need to be applied to conclude whether the right is substantive or not.

30. Issues – De facto control • Related parties and de facto agents • Control of Specified Assets – Deemed Separate Entities • An investor shall treat a portion of an investee as a deemed separate entity with certain criterias • Specified assets of the investee are the only source of payments for specified liabilities. In substance, none of the returns from the specified assets can be used by remaining investee and none of the liabilities of the deemed separate entity are payable from the assets of the remaining investee. Thus, in substance, all the assets, liabilities and equity of that deemed separate entity are ring-fenced from the overall investee. Such a deemed separate entity is often called a ‘silo’. • Identifying whether a silo exists, and whether an investor controls a silo, can be complex • Real Estate Industry • Insurance (Who selects the investments?, Would other funds beyond the specified assets be necessary to fulfill the obligation to the policyholder in certain situations?, Is there an exact matching of the policy to the assets held (the insurer has no latitude)?

31. Foreign Exchange • The globalisation of markets for goods and services as well as capital makes it imperative for companies to engage in international trade, cross border alliances and joint ventures if they are to survive and grow in today’s competitive business environment. • The ways in which companies enter the international market are varied. 1) Directly undertake transactions of buying goods and services from overseas suppliers and selling goods and services to overseas customers. 2) Conducting their affairs through overseas subsidiaries, branches and associates.

32. The Functional Currency Approach ...

33. Issues – Foreign Exchange • Situation with Mix Indicators • Situation 1: functional currency of a real estate entity operating in Russia with leases denominated in US dollars • Situation 2: functional currency of an intermediate parent with some operating activities • Situation 3: – functional currency of an intermediate parent with no operating or financing activities of its own • Situation 4: functional currency of an offshore holding company • Situation 5: – functional currency of a foreign subsidiary importing products from parent for local distribution

34. Issues – Foreign Exchange • Different reporting dates • Entity A prepares its annual financial statements at 31 January • one of its subsidiaries, entity B, to prepare its financial statements at 31 December.

35. Questions