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The New Revised IFRS 3 Business Combinations International Accounting Training Webinar – 13 July 2010

The New Revised IFRS 3 Business Combinations International Accounting Training Webinar – 13 July 2010. Presented by Aletta Boshoff Technical Director, Australia & New Zealand (aboshoff@nexiaaustralia.com.au). Roadmap for this session. Part A – Background to development of IFRS 3 Revised

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The New Revised IFRS 3 Business Combinations International Accounting Training Webinar – 13 July 2010

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  1. The New Revised IFRS 3 Business CombinationsInternational Accounting Training Webinar – 13 July 2010 Presented by Aletta Boshoff Technical Director, Australia & New Zealand (aboshoff@nexiaaustralia.com.au)

  2. Roadmap for this session • Part A – Background to development of IFRS 3 Revised • Part B- What has changed in IFRS 3 Revised? • Part C - What has changed in IAS 27 Revised Consolidated and Separate Financial Statements?

  3. Part ABackground to the Development of IFRS 3 Revised (IFRS 3R)

  4. What is the core principle of IFRS 3 and IFRS 3 Revised? An acquirer of a business recognises the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enable users to evaluate the nature and financial effects of the acquisition

  5. IFRS 3 and IFRS 3 Revised requires the application of the acquisition method!

  6. Why a IFRS 3 Revised? IFRS 3R establishes principles for recognising and measuring: the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree IFRS 3R establishes principles for recognising and measuring goodwill or a gain from a bargain purchase Heaps of application guidance!

  7. Basic facts about IFRS 3 Revised Released Jan 2008 by the IASB First jointly IASB/FASB released standard - US equivalent SFAS 141 Business Combinations Effective for acquisitions on or after annual reporting periods beginning on or after 1 July 2009 Earlier application allowed provided that IAS 27 (Revised) is applied at the same time

  8. Part BWhat has change in IFRS 3 Revised?

  9. Change No 1The scope was broadened The scope of IFRS 3R was broadened to cover: business combinations involving only mutual entities, and business combinations achieved by contract alone What is not covered within IFRS 3R? Formation of joint ventures Acquisition of asset or group of assets that does not constitute a business Combination of entities under common control

  10. Change No 2Broader definition of what constitutes a ‘business combination’ What is a business combination? A transaction or other event in which an acquirer obtains control of one or more businesses Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in IFRS 3R

  11. Change No 2Broader definition of what constitutes a ‘business combination’ Do the assets acquired and liabilities assumed constitute a business? No Yes Business combination & IFRS 3R applicable. Asset acquisition Acquisition method

  12. Change No 2Broader definition of what constitutes a ‘business combination’ A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of: providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members or participants Assets and activities need not be conducted and managed as a business as at acquisition date, so long as they can be in the future

  13. Example ADoes this constitute a business combination? IT department is a cost centre to K&K Co a legal firm IT Outsourced Ltd, specialises in the provision of IT services to legal firms. K&K Co sells its IT department to IT Outsourced Ltd, consisting of plant and equipment, working capital and staff Assets and staff transferred to IT Outsourced Ltd is capable of being operated as a business

  14. Example BDoes this constitute a business combination? Company E’s contains assets of: Electricity grids $10,000,000 Tracking system $2,500,000 Working capital $500,000 Company A acquires from Company E the electricity grids and the tracking system for $14,000,000. Consider the relevant industry, certain industries requires relative low inputs of working capital and labour.

  15. Change No 3Limits the scope of reverse acquisitions The accounting acquiree must meet the definition of a business A Pty Ltd reversing into a listed cash shell with no business activities, is no longer a reverse acquisition

  16. Change No 4Transaction costs to be expensed Acquisition-related costs are expensed in the periods in which the costs are incurred and the services are received Examples: Finder’s fees, advisory, legal, accounting, valuation and other professional or consulting fees, costs of internal acquisition department, etc One exception: Costs of issuing debt/equity will continue to be offset against the proceeds in accordance with IAS 32 & IAS 39

  17. Change No 5Introduction of application guidance re acquisition-date fair values of asset and liabilities The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values For example, application guidance in relation to the following: separate valuation allowances re assets with uncertain cash flows; assets subject to operating leases in which the acquiree is the lessor; and assets that the acquirer intends not to use or to use in a way that is different from the way other market participants would use them

  18. Change No 6Option to “gross-up” goodwill for non-controlling interest The acquirer shall measure any non-controlling interest (formerly known as minority interest) in the acquiree either at: fair value, or the NCI’s proportionate share of the acquiree’s identifiable net assets

  19. Example CMeasurement of non-controlling interest (NCI) Co Z acquires 80% of Co Y for $100,000 Carrying value of Co Y net assets at time of acquisition equals $80,000 FV of Co Y net assets at time of acquisition equals $80,000

  20. Example CMeasurement of non-controlling interest (NCI) How would we currently (IFRS 3) measure the goodwill and NCI? Consideration 100,000 FV of assets acquired (80% of 80,000) (64,000) Goodwill 36,000 Current journal entry? Dr Net assets 80,000 Dr Goodwil 36,000 Cr Consideration 100,000 Cr NCI (20% of 80,000) 16,000 This is one of the options allowed in IFRS 3R!!!!!!

  21. Example CMeasurement of non-controlling interest (NCI) Now also another option to measure goodwill and NCI in terms of IFRS 3R FV of consideration Plus FV of NCI Less FV of net identifiable assets Equals Goodwill

  22. Example CMeasurement of non-controlling interest (NCI) FV of consideration 100,000 Plus FV of NCI (100,000 x 20/80) 25,000 Less FV of net identifiable assets (80,000) Goodwill45,000 Journal entry in terms of this option? Dr Net assets 80,000 Dr Goodwill 45,000 Cr Consideration 100,000 Cr NCI 25,000

  23. Example CMeasurement of non-controlling interest (NCI)

  24. Change No 7More intangible assets being recognised Why? Requirement to be reliably measurable has been removed

  25. Change No 8Possible profit implications when obtaining control of company in which a NCI was held In a business combination achieved in stages, the acquirer shall: remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss What does this mean? Possible to generate a profit by obtaining control of an entity previously held as an investment or an associate

  26. Example DObtaining control of company in which a NCI was held In 2000, Co X acquires a 10% holding in Co A for a cost of $1,000 In 2009, Co X acquires the remaining 90% of Co A for $18,000 The fair value of the net tangible assets of Co A at date of acquisition in 2009 was $10,000 Co X accounted for investment in Co A at cost (IAS 27R.38)

  27. Example DObtaining control of company in which a NCI was held Consideration consists of: FV at 2009 of the 10% holding 2,000 * Cost of 90% holding 18,000 20,000 * 18,000 (Cost of 90% holding) x 10/90 = 2,000 Goodwill is: Consideration 20,000 Less FV of net assets acquired (10,000) Goodwill 10,000

  28. What journal entry did we process with the purchase of the original 10% investment in Co A? Dr Investment in Co A 1,000 Cr Cash 1,000 What journal entry do we need to process with the purchase of the additional 90% investment in Co A? Dr Net assets @ FVs 10,000 Dr Goodwill 10,000 Cr Cash 18,000 Cr Investment in Co A 1,000 Cr Profit 1,000 Example DObtaining control of company in which a NCI was held

  29. How can we prove the profit of 1,000? The profit relates to the initial 10% investment in Co A. Cost price in 2000 1,000 Fair value in 2009 2,000 Profit 1,000 Example DObtaining control of company in which a NCI was held

  30. Example EObtaining control of company in which a NCI was held In 2000, Co X acquires a 10% holding in Co A for a cost of $1,000 In 2009, Co X acquires the remaining 90% of Co A for $18,000 The fair value of the net tangible assets of Co A at date of acquisition in 2009 was $10,000 Co X accounted for investment in Co A in terms of AASB 139 (IAS 27R.38) Available-for sale asset (AASB 139)

  31. Example EObtaining control of company in which a NCI was held Consideration consists of: FV at 2009 of the 10% holding 2,000 * Cost of 90% holding 18,000 20,000 18,000 (Cost of 90% holding) x 10/90 = 2,000 Goodwill is: Consideration 20,000 Less FV of net assets acquired (10,000) Goodwill 10,000

  32. What journal entry did we process with the purchase of the original 10% investment in Co A? Dr Investment in Co A 1,000 Cr Cash 1,000 What journal entries did we process in relation to the original 10% investment? Dr Investment in Co A 1,000 Cr Revaluation reserve 1,000 Example EObtaining control of company in which a NCI was held

  33. What journal entry do we need to process with the purchase of the additional 90% investment in Co A? Dr Net assets @ FVs 10,000 Dr Goodwill 10,000 Cr Cash 18,000 Cr Investment in Co A 2,000 Dr Revaluation reserve 1,000 Cr Profit 1,000 (As per IFRS 3.42) Example EObtaining control of company in which a NCI was held

  34. Please Note! No profit implications or additional goodwill with the acquisition of additional holdings in a controlled entity. What does this mean? 60% Subsidiary + Additional 20% in Subsidiary = No profit or additional goodwill.

  35. Example FAcquisition of additional holdings Big Ltd has 51% holding in Little Ltd with carrying amount of $51,000 Big Ltd further acquires 29% of Little Ltd for $58,000 Big Ltd accounts for the investment in Little Ltd at cost What do we already have in the consolidated financial statements of Big Ltd? Net assets 100,000 (51,000 x 100/51) NCI 49,000 (100,000 x 49%)

  36. Example FAcquisition of additional holdings What journal do we process re the acquisition of an additional 29% interest in this subsidiary? Dr NCI 29,000 * Dr Equity 29,000 # Cr Cash 58 000 * 100,000 x 29% = 29,000 # 58,000 – decrease in NCI (29,000) = 29,000

  37. Change No 9Adjustments to contingent consideration > 12 months after acquisition date = Recognised in P/L Consideration transferred by the acquirer, including contingent consideration, must be measured and recognised at fair value at the acquisition date Provisional amounts determined at acquisition date. Provisional accounting applies for 12 months: That is, adjustments can be made if it relates to a condition that existed at acquisition date. Subsequent adjustment 12 months after acquisition date: directly to P/L, and no adjustment to goodwill.

  38. Example GContingent consideration Co A paid $150 to acquire Co B Fair value of the net assets of Co B is $100 If Co B meets profit targets over a three year period, Company A will pay another $50 at the end of year 3 The likelihood of Company B meeting the profit targets is 75% Discount rate is 10%

  39. Example GContingent consideration Calculation of the PV of the contingent consideration PV of contingent consideration = $50*75%/1.10^3 = $28 Initial journal entry (At date of acquisition) Dr Net assets 100 Dr Goodwill 78 Cr Cash 150 Cr Contingent liability 28

  40. Example GContingent consideration Journal entry at end of Year 2 The balance of the liability is $50*0.75/1.1 = $34 Now, the likelihood of Company B meeting its profit target is 25%. FV of the liability = $50*0.25/1.1 = $11

  41. Change No 10Income Taxes

  42. Example HMeasurement period - Income tax On 1/1/10 ABC Ltd acquired Z Ltd for $1,000,000 Z Ltd has $500,000 of tax losses On acquisition date, it is less than probable that the tax losses will be utilised therefore no DTA was booked On 1/1/12 it is now probable that the losses will be utilised

  43. Example HMeasurement period - Income tax

  44. Change No 11Indemnification Assets Indemnification assets are recognised at fair value on the same basis as the related liability for the indemnified item Examples: Uncertain tax positions Environmental liabilities Legal matters

  45. Example IMeasurement period - Indemnification assets Company A acquired Company B Company B is currently undergoing a tax audit. Original owners of Company B has agreed to reimburse Company A for any future tax expense incurred as a result of the current tax audit It has been estimated that there is a 40% chance that Company A will have to pay $500,000 as a result of the tax audit in 3 years time Discount rate is 10%

  46. Example IMeasurement period - Indemnification assets Dr Indemnification asset 150,263 Cr Contingent liability 150,263 (40% X 500,000)/1.1^3

  47. Example IMeasurement period - Indemnification assets At the end of year 2 there is only 30% chance. DR P&L $45,455 CR Indemnification asset $45,455 [(40% x 500,000/1.1) – (30% x 500,000/1.1)] DR Contingent liability $45,455 CR P&L $45,455 [(40% x 500,000/1.1) – (30% x 500,000/1.1)]

  48. Change No 12Determining what is part of the business combination transaction The following are examples of separate transactions that are not to be included in applying the acquisition method: a transaction that in effect settles pre-existing relationships between the acquirer and acquiree; a transaction that remunerates employees or former owners of the acquiree for future services; and a transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs

  49. Part CWhat has changed in IAS 27 Revised?

  50. Change No 1No profit implications when change in interest without losing control Requirements were added to specify that changes in a parent’s ownership interest in a subsidiary that do not result in a loss of control must be accounted for as equity transactions Previous IAS 27 did not have requirements for such transactions

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