Www.efrag.org Consolidation and Business Combinations Changes to IFRS 3, IAS 27, IAS 37 ASEM IFRS SEMINAR Shanghai, 25-26 March 2006 Reinhard Biebel, EFRAG

www.efrag.org

Consolidation and Business CombinationsChanges to IFRS 3, IAS 27, IAS 37

ASEM IFRS SEMINARShanghai, 25-26 March 2006

Reinhard Biebel, EFRAG Deputy Technical Director

©EFRAG 2006 2 AISAM SEMINAR 25-26 March 2006

Consolidation - Combination

Acquisition

Common Control

Joint Venture

Hostile take-over

Merger

Need for consolidated information

De facto Control


Racing ahead …

IAS 22(revised 1993)minor changesSIC 9, 22 & 28

31 March IFRS 3minor changes 2004-2005

30 June ED IFRS 3

? common control fresh-start (true

mergers)

1993

1996-1999

2004

2005

????


ED IFRS 3 – Phase II

Issued 30 June 2005

Joint project with US standard setter FASB Objective = improvement and convergence IASB/FASB

Consequential amendments to IAS 27, 37 and 19

Completely new method of treating: Business combinations

Minority interests (now: non-controlling interests)

Contingent assets and liabilities


ED IFRS 3: Changes to terminology

Minority-interests

Non-controlling interest (NCI)


ED IFRS 3: Changes to definitions

Business combination [IFRS 3]

The bringing together of separate entities or businesses into one reporting entity

Business combination [ED IFRS 3]

A business combination is a transaction or other event in which an acquirer obtains control of one or more

businesses


Control under IAS 27

IASB Statement, IASB Update October 2005:

“IAS 27 contemplates that there are circumstances in which one entity can control another entity without owning more than half the voting power.”


Acquisition method

Amendment: Purchase Method Acquisition Method

1. Identify acquirer

2. Determine the acquisition date

3. Measure the fair value of the acquiree

4. Recognise and measure identifiable assets acquired and liabilities assumed at fair value

1+2 similar to current IFRS 3

3+4 amended to reflect the transition to full fair value


ED IFRS 3: Significant changes

IFRS 3 ED IFRS 3

Business combination recognised and measured at the acquiror’s accumulated cost at the acquisition date (aggregate of the fair values of assets given, liabilities assumed, and equity instruments issued)

Business combination recognised and measured at fair value of the acquiree at the acquisition date

Even if achieved in stages or if less than 100% of the equity interests are owned

Direct costs of acquisition recognised in the cost of the business combination

Direct costs of acquisition recognised separately, i.e. typically in profit or loss


IFRS 3 ED IFRS 3

Contingent consideration only recognised in the cost of acquisition at the acquisition date, if payment is probable and can be measured reliably

Contingent consideration measured at fair value at the date of acquisition

Subsequent changes in contingent consideration affect goodwill (+/÷)

Subsequent changes in contingent consideration classified as liabilities are recognised in accordance with IAS 39, IAS 37 or other relevant IFRS and typically affect profit or loss

Large number of disclosures required

More new disclosure requirements

ED IFRS 3: Significant changes


ED IFRS 3: Significant changes - goodwill gross up

Acquired business measured at fair value as a whole

100% goodwill recognised Consistent with treatment of other assets

Goodwill allocated between acquirer and non-controlling interest (was minority interest)

Allocation of goodwill to acquirer based on: Fair value of acquirer’s equity interest LESS

Fair value of share of net assets acquired

Balance to NCI


ED IFRS 3: Goodwill example

P acquires 75% (750 000 shares) of S for CU7.5m

Shares in S trading about A$8 per share Expectation of synergies

Independent valuation value of S = CU9.7m

Fair value of net assets acquired = CU8m

Current requirements IFRS 3

Consideration 7,5

Share of identifiable A+L (75% 8m)

(6,0)

Goodwill as per IFRS 3 1,5


Goodwill 1,5

Net assets 8,0

Minority interest 2,0


ED IFRS 3: Goodwill example


Goodwill 1,5

Net assets 8,0

Minority interest (MI) 2,0

ED IFRS 3

Fair value of S 9,7

Fair value of net assets (8,0)

Goodwill 1,7

ED IFRS 3 - allocate to P

Consideration 7,5

Share of identifiable A+L (75% 8m)

(6,0)

GW allocated to P 1,5

=> Balance to NCI 0,2ED IFRS 3

Goodwill 1,7

Net assets 8,0

Non-controlling interest (NCI)

2,2


Step acquisitions

Change in accounting for step acquisitions

A owns an investment in B

B = associated comp to A (i.e. A doesn’t control B)

If A increase its stake & gains control over B it must Determine fair value of associate

Recognise profit/loss in income statement

Follow the provisions of IFRS 3• Cost would include fair value of B


Step acquisition – illustration

A owns 35% stake in B at 31 Dec 2007 Book value at 31 Dec 2007 = CU2,500 Buying additional 40% on 31 Dec 2007 at

CU4,000 Fair value (FV) of total B = CU10,000

31 Dec 2007 A recognise gain of CU1,000 [(35%*CU10,000)-

CU2,500] A accounts for 40% purchase under ED IFRS 3

FV of all of B = CU10,000 and FV of 75% of B = CU7,500 Subsequent purchases = equity transaction


ED IFRS 3: Acquisition costs

Direct acquisition

costs

•Recognised in profit or loss

•Represent payment for services (e.g. legal costs. auditor, bank)

•Do not represent assets of acquirer

•Impact on goodwill


Contingent consideration

Fair value of consideration paid includes fair value of contingent consideration at acquisition date Classify as debt or equity per IAS 32

Examples Financial or non-financial hurdles

Share-based payment


Contingent consideration

Measurement period* adjustments 12 months from date of acquisition (no change)

New information about facts existing at acquisition date

Post measurement period Equity not remeasured

Otherwise re-measure No impact on business combination

* Measurement period = reasonable time to obtain information about facts and circumstances existing at acquisition date. Limited to on year.


Contingent consideration - example

Contingent consideration of CU6m payable if certain profit targets met

Fair value on acquisition date is CU4m

Subsequent changes reported in I/S As likelihood of meeting target increases, so does liability

When target met, liability is recorded at CU6m CU2m will have been recorded in I/S

No impact to accounting for business combination


Other changes

Date of acquisition

Recognition of intangibles – probability and reliability criterion!

Treatment of negative goodwill

…


Board members view on ED IFRS 3

Proposed effective date 1 January 2007

Quite a few IASB Board Members have

dissenting opinions (alternative views) Recognise goodwill at 100% 5 dissenters

Increase/decrease in stake after control3 dissenters

Definition of ‘business combination’ 2 dissenters

Widening of scope 1 dissenter

Direct cost to be recognised in I/S 2 dissenters

Removal of ’reliable measurement’-criteria re. intangible assets in Business Combinations 1 dissenter

Important joint project with FASB


EFRAG position on ED IFRS 3

Reasons for not supporting the EDs:

introduction of radical new and untested concepts,

the reasons for issuing the proposals and the assumed benefits,

the increased use of fair value without a conceptual debate,

the accounting for business combinations at fair value,

the application of an economic entity view,

the proposed full goodwill method,

the proposed treatment of acquisitions in steps,

the extended scope without providing a solution for true

mergers.

This does not pre-empt an assessment regarding endorsement


Business Combinations II:Changes to other standards


Other standards affected

IAS 27 Consolidated and Separate Financial Statements

IAS 37 Provisions, Contingent Liabilities and Contingent Assets

IAS 19 Employee Benefits

Purpose of proposed changes: to align ongoing accounting with that required on a

business combination (e.g. re contingencies)

to align IFRS with US GAAP in certain areas (e.g. restructuring)


ED IAS 27: “non-controlling interest” (NCI)

‘ Minority interest’ ‘non-controlling interest’

Non-controlling interest classified as equity Transactions with NCI = equity transactions

Gains/losses recorded in P&L only on loss of control

Losses applicable to NCI are allocated to NCI - any guarantees/support arrangements accounted for separately currently, losses not allocated to minority unless binding

obligation on them to make good losses incurred which they are able to meet


Increase from 80% to 100% Transaction with EQ holders

=> No change to goodwill

(already at 100%) No gain/loss recorded Consideration paid/payable

debited to EQ Current position – no

detailed guidance Typically recognise additional

goodwill Different views

internationally how to measure additional GW what to do about fair value

changes re assets / liabilities

ED IAS 27: Increased stake in sub

ED IAS 27 D C

NCI (share of consolidated equity) 20

Equity* 10

Cash/creditors 30

A owns 80% of B Consolidated equity of B = 100 A’s share = 80, NCI = 20 A buys remaining 20% for 30

Debit of 10 = excess price

parent paid to acquire NCI*The draft doesn’t explain where these debits/credits should be recognised


Decrease from 80% to 60% Transaction with EQ holders

=> No change to goodwill

(already at 100%) No gain/loss recorded Consideration received /

receivable credited to EQ Current position – no

detailed guidance: Typically recognise gain or loss

on “part disposal” No real consensus on

reduction to goodwill?

ED IAS 27: Decreased stake in sub

ED IAS 27 D C

Cash/debtors 40

NCI (share of

consolidated equity)24

Equity 16

A owns 80% of B Consolidated equity of B = 120 A’s share = 96, NCI = 24 A sells 20% for 40 A retains control over B

Credit of 16 = gain from sale of NCI Currently gain/loss goes to P/L. Not

possible under the ED.


ED IAS 27: disposal of subsidiary

Disposal when loss of control Need not involve change in stake

On disposal, any continuing EQ interest to be remeasured to FV currently, typically roll forward

appropriate proportion of carrying amount

Gain/loss to income statement on disposal determined as FV of Proceeds + FV of any retained

investment MINUS Aggregate of parent’s interest in

carrying amount of net assets prior to disposal

ED IAS 27Cash/receivables 500

+ FV, remaining investment 400

Total 900

- Consolidated NA of B (800)

Gain on disposal 100

A owns 100% af B Consolidated equity of B = 800 A sells 60% and loses control Proceeds on sale of 60% = 500 FV of remaining 40% = 400

FV of remaining 40% (400) applied as cost of initial investment under IAS 28


‘ Contingent liabilities’ & ‘contingent assets’ cease to exist

If obligation exists = ‘non-financial liability’

If rights exist = asset

If obligation/rights don’t yet exist because conditional = ‘contingency’

ED IAS 37: change to terminology


ED IAS 37: New Recognition Criteria

100%

50%

0%

IAS

37

EDProbability

Example A has obligation to B 20% chance A will have to

pay CU1m 80% chance A will pay

nothing Currently: no provision

Proposed: recognise CU0,2m

liability (CU1m x 20%)

Similar applies to assets: if

rights exist, recognise asset

(IAS 38/IAS 37)

Result = more asset & liabilities on balance sheet

÷P

rob

ab

ility c

riterio

n o

mitte

d fro

m E

D


ED IAS 37: Measurement

Measurement principle

Move away from concept of ‘best estimate’ to more fair value based ’exit

value’

Future eventsTake into consideration if sufficiently

objective evidence exits

ReimbursementsMove away from ’virtually certain’. Recognise if unconditional right to

receive.

RestructuringsRecognise only when definition of

liability is satisfied. Specific guidance deleted.

Single obligation‘Most likely outcome’ not necessarily

consistent with the ED’s measurement objective


Conclusion

New proposals for accounting for Business Combinations are seen critical because of:

Increased use of fair value New an untested concepts Practicability concerns Usefulness of information Scope

IASB indicated to re-deliberate most of new conceptsFinal standard in 2007

Will IASB and FASB come up with a practical solution?


“xiè xie”

Documents

Www.efrag.org Consolidation and Business Combinations Changes to IFRS 3, IAS 27, IAS 37 ASEM IFRS SEMINAR Shanghai, 25-26 March 2006 Reinhard Biebel, EFRAG