IFRS 3 Business Combinations - Unibg COURSE 2013.pdf · in IFRS 3 Use IAS 27 to determine who has control Existence of large minority voting interest in combined entity Relative voting

IFRS Course IFRS 3 – Business Combinations

Università degli Studi di Bergamo

Livio Ferrini

Bergamo, 1 March 2013

What will you learn?

By completing this module,

you will be able to: 1) Explain the definition of a business

combination

2) Describe the steps in the

acquisition accounting process

3) Explain how IFRS 3 applies after the business combination

4) Evaluate the quality of disclosures

IFRS Course 2013 – Business Combinations 2 © 2013 KPMG S.p.A., an Italian limited liability share capital company and a member firm of the KPMG network of independent member firms

affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

Agenda

Scope and definitions The acquisition accounting process After the business combination Know your journals Disclosure The closing

IFRS Course 2013 – Business Combinations 3

© 2013 KPMG S.p.A., an Italian limited liability share capital company and a member firm of the KPMG network of independent member firms


What is a business combination?

A business combination is a

transaction or other event in

which an acquirer obtains

control of one or more

businesses




When does IFRS 3 apply?

IFRS 3 applies to all business combinations

Formation of a

joint venture

Acquisition of asset /

group of assets that is

not a business

Common control

transactions

IFRS 3 does not apply to:

Cost allocated to

identifiable assets /

liabilities on basis of

relative fair values




What is a business?

A business is an integrated set of activities and assets capable of

being managed to provide a return to investors via dividends,

lower costs or other economic benefits

Inputs Processes Ability to create

outputs

Rebuttable presumption that a group of assets

in which goodwill is present is a business




What is a business?


In certain transactions, it may be difficult to conclude whether the definition of a

business has been met. Indicators to be considered include, but are not limited to,

the following:

♦ Integration: A collection of assets without connecting activities is unlikely to be a business

♦ Taking over contracts with employees: If employment contracts are transferred to acquirer, this may be an indicator that a business has been acquired

♦ Outsourcing: Taking over outsourced revenue-generating activities of the acquiree could indicate that the processes and activities necessary to generate revenues are in place and that the group of assets acquired is a business

♦ Exclusion of some components of a business: Generally, exclusion of some components of a business does not preclude classification of an acquisition as a business combination. However, judgment is required



A question for you: Definition

♦ Lila-Production acquires a production plant (machines and tools) and some inventory from a third party

♦ Lila-Production integrates its existing production line into the production plant but does not take over employees, operational processes and distribution networks

Is this transaction a business combination?




A question for you: Solution

♦ Lila-Production acquires a production plant (machines and tools) and some inventory from a third party

♦ Lila-Production integrates its existing production line into the production plant but does not take over employees, operational processes and distribution networks

Is this transaction a business combination?

♦ Lila-Production acquires some inputs (machines, tools, inventory) but does not take over any other element that would make the acquired set a business.

♦ Some key inputs such as a distribution network or employees are missing.

♦ There are no processes.

♦ As a consequence, the transaction is not a business combination.


Agenda





Steps to acquisition accounting

Step 1: Identify the acquirer

Step 2: Determine the acquisition date

Step 3: Identify and measure consideration transferred

Step 4: Identify and measure identifiable net assets

Step 5: Measure NCI

Step 6: Determine goodwill or gain on a bargain purchase

Step 7: Recognise any measurement period adjustments

NCI = non-controlling interests




Overview of the acquisition method

Option to measure

NCI at acquisition

date

Fair value

of net

identifiable

assets

NCI

Considera-

tion

transferred

Goodwill




Interest %

100%

20%

50%

0%

Control

Joint control

Significant influence

No influence

Step 1:

Identify the acquirer

The acquirer is the entity that obtains control of the business




Step 1:

Identify the acquirer

The acquirer is the entity that obtains control of the business

Consider

additional

factors identified

in IFRS 3

Use IAS 27 to

determine who

has control Existence of large minority

voting interest in

combined entity

Relative voting rights in

combined entity

Composition of governing

body and senior management

of combined entity

Terms of exchange of

equity instruments

Relative size of entities




Step 2:

Determine the acquisition date

The acquisition date is the date on which

acquirer obtains control of acquiree

Date on which fair values of

identifiable assets acquired and

liabilities assumed determined and

goodwill is measured

Date from which comprehensive

income of is included in consolidated

financial statements of acquirer




A question for you: Acquisition date

♦ Star-Search and Lila-NewPlanet are the dominant traders in the Outer Regions

♦ On 1 June Lila-NewPlanet makes a bid for Star-Search and agrees the terms of the acquisition and purchase price

♦ Immediately thereafter, the Planet Lila Council announces that the proposed transaction is to be scrutinised as it may violate intergalactic competition laws

♦ The finalisation of the acquisition is subject to Planet Lila Council’s approval

What is the acquisition date?




A question for you: Acquisition date

♦ Star-Search and Lila-NewPlanet are the dominant traders in the Outer Regions

♦ On 1 June Lila-NewPlanet makes a bid for Star-Search and agrees the terms of the acquisition and purchase price

♦ Immediately thereafter, the Planet Lila Council announces that the proposed transaction is to be scrutinised as it may violate intergalactic competition laws

♦ The finalisation of the acquisition is subject to Planet Lila Council’s approval

What is the acquisition date?

♦ The acquisition date cannot be earlier than the date that approval is obtained from the competition authority, as this is a substantive hurdle to be overcome before Lila-NewPlanet controls Star-Search




Step 3:

Identify and measure consideration transferred

Assets transferred Liabilities incurred to

previous owners

Equity instruments

issued

Consideration transferred is measured at fair value

at the acquisition date, and includes:

Acquisition-related costs excluded from consideration transferred,

and expensed as incurred

Costs related to issue of equity or debt recognised

in accordance with financial instruments standards




Contingent consideration

Recognised at fair

value at acquisition

date

Classified as liability

or equity according to

IAS 32 or relevant

IFRSs

May be an asset

Contingent consideration is obligation of acquirer to transfer additional

assets / equity interests to former owners as part of exchange for control

if specified future events occur/conditions are met




A question for you: Contingent consideration

♦ When obtaining control of Lila-Domestic, Lila-Droid pays consideration of L$ 120,000

♦ Lila-Droid also agrees to pay an additional amount equal to 5% of the following year’s profit in excess of L$ 30,000

♦ Lila-Domestic historically has made profits of L$ 20,000 – L$ 30,000 each year

♦ Fair value of contingent consideration at acquisition date is L$ 100, but it is not considered probable that Lila-Domestic will meet the post-acquisition threshold

What amount should Lila-Droid recognise at the acquisition date as part of consideration transferred?




A question for you: Contingent consideration

♦ When obtaining control of Lila-Domestic, Lila-Droid pays consideration of L$ 120,000

♦ Lila-Droid also agrees to pay an additional amount equal to 5% of the following year’s profit in excess of L$ 30,000

♦ Lila-Domestic historically has made profits of L$ 20,000 – L$ 30,000 each year

♦ Fair value of contingent consideration at acquisition date is L$ 100, but it is not considered probable that Lila-Domestic will meet the post-acquisition threshold

♦ Lila-Droid should recognise 100 as part of consideration transferred at the acquisition date. This is irrespective of whether the payment is probable. In this example, it does not seem as though payment of contingent consideration is probable given that Lila-Domestic has historically made profits of 20,000 – 30,000, and the contingent consideration is for payments in excess of L$ 30,000. Irrespective of that fact, Lila-Droid recognises the fair value of contingent consideration, which reflects the scenario-weighted measure of such payments.




Determining what is part of the business

combination

Transaction entered into primarily

for benefit of acquiree /

former owner

Likely to be part of the

business combination

Transaction entered into primarily

for benefit of combined entity

Likely to be separate from the

business combination

Tra

nsacti

on

s t

hat

are

sep

ara

te f

rom

th

e

bu

sin

ess

co

mb

inati

on

Settlement of pre-existing relationships

Remuneration of employees or former owners of the acquiree for future

services

Reimbursement of the acquiree or its previous owners for paying the

acquirer’s acquisition related costs




Payments to employees who are former owners of

acquiree

Automatic forfeiture of payments when employment is terminated?

Remuneration for

future services Additional factors to consider

Duration of

continuing

employment

Incremental

payments to

employees

Level of

remuneration

Formula for

determining

consideration

Linkage to

valuation

Number of

shares owned

Other

agreements and

issues

yes no




A question for you:

Contingent payment to employees

♦ In connection with the acquisition of Lila-Domestic, Lila-Droid offers cash bonus to certain senior-level employees of Lila-Domestic who also previously were shareholders of Lila-Domestic

♦ Payment is contingent on them remaining employed by the group for 2 years after the acquisition

♦ The amount of the bonus is determined based on a multiple of earnings

Is this contingent payment part of the consideration transferred?




A question for you:

Contingent payment to employees

♦ In connection with the acquisition of Lila-Domestic, Lila-Droid offers cash bonus to certain senior-level employees of Lila-Domestic who also previously were shareholders of Lila-Domestic

♦ Payment is contingent on them remaining employed by the group for 2 years after the acquisition

♦ The amount of the bonus is determined based on a multiple of earnings

Is this contingent payment part of the consideration transferred?

♦ The bonuses represent compensation for post-combination services, as the right to a bonus is forfeited if an employee leaves. An evaluation of the other factors would not overcome this conclusion




Step 4:

Measure identifiable net assets

Recognition

Measurement

Must meet definition of asset / liability at acquisition date

Must be exchanged as part of acquisition

Measured at fair value at acquisition date

Classification

and designation

Made at acquisition date,

irrespective of classification made by acquiree

Exception for leases and insurance contracts acquired




Which of the following liabilities will be

recognised in the acquisition accounting?

Cost of a contemplated restructuring of the acquiree

Upgrade of the acquiree’s plant or store locations

to meet specifications of the acquirer

Cost of consultants engaged to identify combined entity goals

Payment due to CEO of acquiree resulting from a change

in a control clause in his employment contract




Fair value measurement in a business

combination

Market approach Income approach Cost approach

Fair value is amount for which an asset could be exchanged or liability

settled between knowledgeable, willing parties in an arm’s length transaction

i.e. from the

perspective of an

hypothetical market

participant




Intangible assets (1)

All identifiable intangible assets

recognised separately from goodwill

Separable Arises from contractual or other

legal rights or

Measured at fair value

without consideration

of intended use




Intangible assets (2)

Customer-related

Artistic-related Technology-based

In-process research

and development

Marketing related

Contract-based




Fair value of other assets and liabilities

Property plant

and equipment

Deferred revenue

Lands and buildings:

Usually by reference to market-based evidence

Plant and equipment:

Usually by appraisal

Incremental cost, including a normal profit margin,

of fulfilling contract

Inventories

Finished goods and work in progress:

Estimated selling price less costs to complete and

dispose of with reasonable profit allowance

Raw materials:

Usually by reference to market-based evidence




Exceptions to recognition and measurement

principles

Exception to

recognition

principle

Contingent

liabilities

Exception to

recognition and

measurement

principle

Deferred taxes and

tax uncertainties

Indemnification

assets

Employee benefits

Exception to

measurement

principle

Reacquired rights

Share-based

payment awards

Assets held for sale

or distribution




Exception to recognition principle

Contingent liability recognised if:

Present obligation

from past event

Fair value can be

measured reliably &

Contingent liability that is a possible obligation is not recognised




Exceptions to recognition and measurement

principle

Deferred taxes and

tax uncertainties

Recognise and

measure in

accordance with

IAS 12

Indemnification

assets

Recognise and

measure on same

basis as related

liability

Employee benefits

Recognise and

measure in

accordance with

IAS 19




A question for you: Indemnification asset

♦ The sellers of Lila-Domestic agree to indemnify Lila-Droid for the outcome of an existing lawsuit

♦ There are no expected collectibility issues in respect of this indemnification

♦ The lawsuit is considered a present obligation at the acquisition date, the fair value of which is L$ 1,250

How should Lila-Droid account for the liability and the related indemnification asset?




A question for you: Indemnification asset

♦ The sellers of Lila-Domestic agree to indemnify Lila-Droid for the outcome of an existing lawsuit

♦ There are no expected collectibility issues in respect of this indemnification

♦ The lawsuit is considered a present obligation at the acquisition date, the fair value of which is L$ 1,250

How should Lila-Droid account for the liability and the related indemnification asset?

♦ As there is a present obligation, Lila-Droid should recognise the fair value of the contingent liability of L$ 1,250 as part of the acquisition accounting. Further, Lila-Droid also should recognise an indemnification asset of L$ 1,250 as part of the acquisition accounting.




Exceptions to measurement principle

Reacquired rights

Fair value based

on remaining

contractual

periods

Share-based

payments

Measure in

accordance with

IFRS 2

Assets held for sale

or distribution

Measure in

accordance with

IFRS 5




Step 5: Measure NCI

NCI are measured either at:

Their proportionate

interests in fair value

of identifiable net

assets

Fair value

Election made on a

transaction-by-

transaction basis




Step 6:

Determine goodwill or gain on bargain purchase

Goodwill Considera-

tion

transferred

NCI at FV

Fair value of

net

identifiable

assets

Goodwill Considera-

tion

transferred

Fair value of

net

identifiable

assets

1 –

proportion

of NCI

Option 1: NCI measured at fair value

Option 2: NCI measured at their proportionate interest in identifiable net assets




A question for you: Goodwill

♦ Lila-Tech acquires 60% of New-Lila for cash consideration of L$ 1,000. This business combination occurs after the end of the reporting period

♦ The fair value of New-Lila’s net identifiable assets is L$ 1,500

♦ The fair value of New Lila’s NCI is L$ 650

What is the difference in goodwill if NCI is measured at fair value vs at its proportionate interest




Solution: Goodwill

Goodwill

150

Considera

-tion

transferred

1,000

NCI at FV

650

Fair value

of net

identifiable

assets

1,500

Goodwill

100

Considera-

tion

transferred

1,000

NCI

600 Fair value

of net

identifiable

assets

1,500

NCI at fair value NCI at proportionate interest




Recognise gain in profit or loss

Gain on bargain purchase

The acquisition equation results in a gain on bargain purchase

Reassess identification and measurement




Step 7:

Recognise any measurement period adjustments

Ends when

information obtained

or determined not

available

Cannot exceed one

year

If new information

obtained about facts

and circumstances

that existed at

acquisition date

Measurement period is period after acquisition date when entity

can adjust preliminary business combination accounting


Agenda





Follow other IFRSs except for:

Indemnification assets

Measure on same basis as related

liability

Contingent consideration

Profit / loss if classified as a

liability / asset; no remeasurement if

classified as equity

Contingent liabilities

Measure at greater of amount under

IAS 37 and amount recognised

originally in acquisition accounting

Reacquired rights

Amortise over remaining contractual

term; no consideration of renewals




A question for you: Subsequent measurement of

contingent consideration

♦ Fair value of contingent consideration in a previous “A question for you” was determined to be L$ 100 and recognised as a liability at the acquisition date

♦ Six months later, Lila-Domestic’s earnings are far off the expected forecast of reaching L$ 30,000. The fair value of the contingent consideration has fallen to nil

How should Lila-Droid record the change in the fair value of the contingent consideration?




A question for you: Subsequent measurement of

contingent consideration

♦ Fair value of contingent consideration in a previous “A question for you” was determined to be L$ 100 and recognised as a liability at the acquisition date

♦ Six months later, Lila-Domestic’s earnings are far off the expected forecast of reaching L$ 30,000. The fair value of the contingent consideration has fallen to nil

How should Lila-Droid record the change in the fair value of the contingent consideration?

♦ As the contingent consideration resulted in recognition of a liability, the liability is remeasured to fair value with the remeasurement effect recognised in profit or loss at each reporting date


Agenda



Agenda





Know your journals

♦ Acquisition accounting




Case A

♦ Lila-Group acquires 60% of Lila-Stars for a cash consideration of L$ 600

♦ NCI accounted for at proportionate interest

Know your journals

♦ At the date of acquisition Lila Stars is subject to legal action by a customer who is claiming L$ 500 for rectification costs resulting from faulty goods. Lila-Stars accepts the amount of costs claimed, but believes that the probability of being considered liable to be only 10 percent. If not liable, then Lila-Stars will incur no costs. At the date of acquisition Lila-Group concurs with such assessment and recognizes the contingent liability measured at (500 x 10 percent) + (0 x 90 percent) as part of the purchase accounting, even though Lila-Stars had not recognized a provision for this contingent liability




♦ Lila-Stars’ Statement of Financial Position before acquisition is as follows:

Assets Liabilities

Fixed assets 400 Accounts Payable 550

Accounts Receivable 400 Equity 400

Inventory 100

Cash Funds 50

Total Assets 950 Total Liabilities 950

Know your journals




♦ At acquisition date, Fair value of assets and liabilities of Lila-Stars compared to Accounting values are as follows:

Accounting value Fair value

Assets

Fixed assets 400 550

Intangible - 100

Accounts Receivable 400 400

Inventory 100 200

Cash Equivalents 50 50

Total Assets 950 1.300

Liabilities

Accounts Payable 550 550

Contingent Liabilities - 50

Total Liabilities 550 600

Know your journals




♦ At acquisition date, Fair value of assets and liabilities of Lila-Stars are as follows:

Assets 1.300

Liabilities (600)

Net Assets 700

Note: deferred taxation is not considered for the purposes of this example

Know your journals




♦ NCIs are accounted for as 40% of L$700 = L$280

♦ Group goodwill is calculated by comparing the Acquisition Cost with the fair value of net assets acquired by Lila-Group:

Acquisition Cost 600

Group Net Assets (420) (700-280)

Group Goodwill 180

Know your journals




♦ Statement of Financial Position recap:

_________________ ________________________

Group Goodwill 180 Controlling Interest 600

Net Assets 700 NCI 280

Know your journals




Case B

♦ Lila-Group acquires 60% of Lila-Star for a cash consideration of L$ 600

♦ NCI accounted for at fair value (=L$ 350)

Know your journals




Caso B

♦ Statement of Financial Position recap:

_____________________ _________________________

Net Assets 700 Controlling Interest 600

Goodwill 250 NCI 350

Know your journals


Agenda





Disclosure

♦Extensive disclosures




Disclosure

♦ An acquirer shall disclose information that enables users of such financial statements to evaluate the nature and financial effects of business combinations that occurred:

- during the current reporting period

- after the end of the reporting period but before the financial statements are authorised for issue

♦ An acquirer shall disclose information that enables users of its financial statements to evaluate the financial effects of adjustments recognised in the current reporting period that relate to business combinations that occurred in the period or in previous periods




Disclosure

Further disclosures…

♦ the name and a description of the acquiree

♦ the acquisition date

♦ the percentage of voting equity instruments acquired

♦ the primary reasons for the business combination and a description of how the acquirer obtained control of the acquiree


♦ a qualitative description of the factors that make up the goodwill recognised, such as expected synergies from combining operations of the acquiree and the acquirer, intangible assets that do not qualify for separate recognition or other factors

♦ if applicable, the reasons why the initial accounting for the business combination is incomplete



Disclosure

Further disclosures…

♦ The acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of each major class of consideration, such as:

- cash

- other tangible or intangible assets, including a business or subsidiary of the acquirer

- liabilities incurred, for example, a liability for contingent consideration


- equity interests of the acquirer, including the number of instruments or interests issued or issuable and the method of determining the fair value of those instruments or interests

… and further, extensive disclosure is required!

Agenda





Which statements are true of a business?

A business must have inputs

A business must have a process or processes

A business must have outputs

There is a rebuttable presumption that a group of assets in which

goodwill is present is a business




Which of the following represents a business

combination under IFRS 3?

A business combination in which separate entities are brought

together to form a joint venture

Settlement of a pre-existing supplier contract

The acquisition of an asset or a group of assets that constitutes a

business

Business combinations involving entities or business under common

control




Which of the following items impact the

calculation of goodwill?

Consideration transferred

Transaction costs

Recognised amount of identifiable net assets

NCI




Which statements are true in respect of NCI?

NCI can be measured at their proportionate interest

in the fair value of the acquiree’s identifiable net assets

NCI can be measured fair value

An entity chooses an accounting policy,

and measures all NCI in the same manner

An entity elects an approach, on a transaction-by-transaction basis,

to measuring NCI


1) A business combination occurs only when an acquirer obtains control over a business

2) The general measurement principle in the acquisition accounting is fair value

3) There are a number of exceptions to this general principle

4) NCI can be measured at fair value or its proportionate interest in the net identifiable assets acquired, on a transaction-by-transaction basis

5) Extensive disclosures required

IFRS Course 2013 – Business Combinations 70 © 2013 KPMG S.p.A., an Italian limited liability share capital company and a member firm of the KPMG network of independent member firms


© 2013 KPMG S.p.A., an Italian limited liability share

capital company and a member firm of the KPMG

network of independent member firms affiliated with

KPMG International Cooperative (“KPMG

International”), a Swiss entity. All rights reserved.

Printed in Italy.

The KPMG name, logo and “cutting through

complexity” are registered trademarks or trademarks of

KPMG International. IFRS Course 2013 – Business Combinations 71

Documents

IFRS 3 Business Combinations - Unibg COURSE 2013.pdf · in IFRS 3 Use IAS 27 to determine who has control Existence of large minority voting interest in combined entity Relative voting