Summary ICAEW ACA Corporate Reporting - Business combinations notes
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ICAEW Open Book - Auditing Standards
All you need to know regarding the business combinations (5/7) within the Corporate Reporting Advanced Level exam. Easy to use checklists perfect for the open book exam. The hard work has already been done for you!
As an associate, Co A must recognise the investment
There is no further adjustment to GW when Co A
using the equity method of accounting. This means
acquired a further 100k shares in Co B on X1 that in the consolidated SOFP, the investment in Co B is
(because going from 70% to 80%). Instead the shown at cost plus the group's share of post-acqn RE or
difference between the consideration paid and - The acquisition represents a step acq which crosses the control boundary as a previously held investment is
less the group's share of post-acqn losses (less any
the decrease in the NCI's share of NA is taken to increased to a controlling holding.
dividend received).
group reserves.
For the remaining X months of the yr, Co A
Co B became a sub partway
should be consolidated using the acquisition
through the year and only
method, and income and expenditures
the PorL since aqn is
included in the FS's on a line by line basis.
consolidated 100%.
GW arises at the date when control is achieved.
In the case of Parent and Co A this is on 1-Oct-
X4, when Parent's investment in Co A passes the
50% threshold.
^ŝŐŶŝĨŝĐĂŶƚŝŶĨůƵĞŶĐĞis
presumed to exist if an Until that date, Co B has been treated as an
investor holds 20% or more associate. Under the ĞƋƵŝƚLJĂĐĐŽƵŶƚŝŶŐ method
of the voting power of the the group's share of Co B's profits after tax is
investee unless it can be credited to the consolidated SPL, and the
shown that this is clearly not investment is measured at cost plus share of
the case. post-acquisition profits in the consolidated SOFP.
The NCI have a 25% share of profit of Co B for the
first 6 months of the year until disposal takes
As a significant interest in Co B is expected to be
- IF FVTOCI: A profit on the deemed disposal of place.
retained, Co B will be an associate following the
the previously held SH should be recognised in
part disposal. The loss of control triggers the
OCI. This is calculated by comparing the FV of the
need to re-measure GW and the retained interest
previously held equity with its CA at the date of
will therefore be valued not at NA value but at
disposal. Gains previously taken to other OCI
FV.
cannot be recycled to PorL.
ASSOCIATE TO SUB 80% SUB TO 100% SUB (NO STEP ACQUISITION)
Q1: "At 1-Jan-X0, Parent Co bought 40% of issued ord SC for £2.3m. On 1-Sept-X2, Parent Co bought As Co A has been recognised as a subsidiary for some time, the acquisition of a further 20% does
the remaining 60% of Co A's ord SC for £12.4m. YE 31-May." not 'cross an accounting boundary' nor result in any change in control. As a result, no gain or loss
- Co A should be treated as an associate only up to 1-Sept-X2, when control is achieved. Therefore will be recorded. The proposed FV exercise is therefore not required.
the equity method should credit the SPLOCI with only £102k (£1.02m Co A profit for the year given)
x 3/12 (ie YE Jun - 1 Sept) x 40% (old holding). The accounting entries required in the conslidated FS will be as follows:
- For the remaining 9 months of the year Co A should be consolidated using the acquisition method, DR NCI £2.8m (given as NCI at proportion of NA method)
and income and expenditures included in the FS's on a line by line basis. DR Shareholders equity (bal) £1.2m
- As Co A is 100% owned at the SOFP date there are no entries in respect of NCI. CR Cash (ie for the 20% additional shareholding) £4m
JUDGEMENT AREAS EXAMPLE 3: 0% TO 45% (BUT WITH OTHER FACTORS) TO MAKE IT A SUB
EXAMPLE 1: 70% TO 35% BUT ASSOCIATE AS 2/8 DIRECTORS "On 1-Jun-X4, Co A acquired 45% of Co B's issued ord SC and voting rights for £3m. Co B's
remaining ord shares are held equally by two individuals who founded the company. Co A has a call
"Parent Co continues to be represented by two directors on Sub's board to oversee its remaining option to acquire, from the two founding SH, a further 20% of Co B's ord SC and voting rights for
interest in the Co. (Sub's board consists of 8 directors)." £1.5m. Co B expects to exercise this option before 1-Jun-X9.
Co A is treated as a subsidiary for the 6 months until disposal takes place. This is because Parent Co
has a 75% stake in the Co until that date. Upon the sale of the shares on X1 the investment decreases
to 35%. Because Parent Co still has the ability to appoint directors to the board Sub should be treated The draft SH agreement states that the board of Co B will comprise the two founding SH and two
as an associate, and the equity accounting method used for the last 6 months of the year. individuals nominated by Co A. Decisions about major research and dev projects cannot be made
without the agreement of both the Co A-nominated directors.
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- However, there are other facts which may establish significant influence for Co A. Co B is engaged in developing practical applications for X, an innovative new material. We expect
- Together with unconnected Co, Co A could control the board of directors with majority decisions that the use of X will improve the durability and performance of a number of Co A's products.
as two of its board members are also on the Co A board.
- There are material transactions between the two companies - the filters for Co B's product are
Co B is expected to make a loss of £300k in the YE 31-Aug-X4 and the projected CA of its NA at date
specific to Co A's product and are provided by a 100% owned sub of Co A.
of acquisition (1-Jun-X$) are as follows: PPE: 150k, NCA: 50k, NA: 200k. FV = CA.
- Also, Co A continues to provide support services.
I believe that Co A's holding of 45% of Co B's ord SC gives it signif influence and so propose to
account it as an associate. So the key impact on the group FS's will be the recognition of the
investment at £3m."
EXAMPLE 4: 10% TO 34% BUT ASSOCIATE
"Co A buys 10% of Co B. Recognised at FVTOCI (irrevocable election). Bought further 40% shares (of - IFRS 10 states that "an investor with the current ability to direct the relevant activities has power,
X's 60% SH) (with call option to buy further 60% in years time). Co A appointed two reps to the Co B even if its rights have yet to be exercised.". It also requires an investor to consider potential voting
board as marketing and production directors. Since joining board, Co B's performance has improved rights in considering whether it has control and whether they are substantive ie, whether the holder
significantly." has the practical ability to exercise the right.
The issue here is whether the purchase of 40% of X's shares by Co A on X1 and the call option on X2 - Although Co A does not have the majority of the voting rights in Co B and there are other
establishes control by Co A over Co B and whether the investment is treated as an associate or a powerful investors, two factors in accordance with IFRS 10 suggest that Co A may still have control
sub in the consol. FS. and should therefore account for Co B as a sub rather than an associate (and so FD's proposal to
Associate? account for as an associate is incorrect):
- Co A holds 10% + 24% (40% x 60%) = 34% of the shares of Co B at X1. This would indicate that Co [1] It has the power to affect its returns from Co B through its control of Board decisions over
A has significant influence as this is presumed if an investor holds 20% or more of the voting power. R&D, arguably the most important decision in a research driven entity such as Co B.
Further evidence of significant influence is that Co A has a representative on the board of directors [2] It has the right to acquire further shares through its call option. The exercise of this option will
and is effectively two of the four board members. give it a majority holding of 65%.
- Also - Co B is a key supplier of Co A so there are material transactions between the investor and - Accounting for Co B as a sub means that 100% of its results, assets and liabilities will be
investee; and Y and Z have roles as directors with Co A so there is an interchange of management consolidated within the group FS and the 55% not owned by the group will be accounted for as
personnel between Co A and Co B. an NCI.
- Significant influence would require Co A to account for Co B as an associate and to equity - The acquisition will have a signif impact on the group statement of CF with the investment shown
account for the investment under IAS 28. within investing activities. GW calculated as:
Subsidiary?
Consideration £3m
- Co A has signed a call option which means that they will own 70% of the shares in Co B on X2.
NCI (55% x £200K) 110K
IFRS 10 requires an investor to consider potential voting rights in considering whether it has
Less NA (£200K)
control and whether it has the practical ability to exercise voting rights.
£2.91m
- Although Co A does not have the majority of the Voting rights, it seems likely that it may still
which will be included as an IA in the group FS and will need to be subjected to review for
have control at X1 as Co A has 2 our of 4 members of the board.
impairment.
Recommended FR treatment
- It would therefore seem likely that control is established. Co A should be accounted as a sub - As Co B is accounted for as a sub, its loss for the 3-months ending 31-Aug-X4 will be included in
which means that 100% of the NA and liabilities will be consolidated within the group FS's. The group PBT (although 55% will then be attributed to the NCI SH) - therefore adjustment required of
PorL account is consol. from date of control. £300k x 3/12 = £75k --> (75k) effect on consolidated PBT
- The acquisition represents a step acq which crosses the control boundary as a previously held
investment is increased to a controlling holding. - GW is not amortised but there will be a further reduction in profit if there are other IA for which
- A profit on the deemed disposal of the previously held SH should be recognised in OCI. This is amortisation is charged, e.g. the X project should be valued as a separable IA on acquisition if it
calculated by comparing the FV of the previously held equity with its CA at the date of disposal. could be sold separately from Co B and has stand-alone value.
Gains previously taken to other OCI cannot be recycled to PorL. - Given Co B's loss for the year, an impairment review should also be considered.
- GW is calculated by comparing the NA at the date control is established (X1) with the
consideration plus NCI, and the FV of the previously held equity.
, EXAMPLE 5: 5% TO ASSOCIATE 25% (INCL. DIVIDENDS)
"In 20X4, Co A bought 5% of the ordinary SC of Co B for £50m. This investment is recognised at cost CALCULATING INVESTMENT IN ASSOCIATE
(which approximates to its FV) in Co A's draft consolidated SOFP at 31-May-X7.
On 1-Feb-X7, Co A bought an additional 20% of the ordinary SC of Co B for £350m in cash. This
payment was DR to a suspense account. The additional investment entitles Co A to appoint a
director to Co B's board. The remaining 75% of Co B's shares are held equally by 3 institutional
investors, each of which is entitled to appoint a director to the Co B board.
Co B has made losses during its financial YE 30-Jun-X6 and 30-Jun-X7 but it has continued to pay
dividends throughout this period. Co B paid a dividend of 20p per share on 1-Oct-X6 and a dividend
of 40p per share on 30-Apr-X7."
Until 1-Feb-X7, the investment in Co B was recognised in the consolidated FS of Co A at cost in NCA
investments. Any dividends received from Co B were credited to investment income. On 1-Oct-X6
Co A received a dividend from Co B of 20p per share: £100K (20p x £10m SC x 5%). This was
correctly recognised in investment income.
However, a change of status of the investment took place on 1-Feb-X7 with the purchase of an
additional 20% of Co B's ord SC. Co A's holding of 25% appears to confer significant influence over
the operations of Co B and therefore Co B is an associate of Co A from 1-Feb-X7. Normally, a
holding of over 20% of the ord SC of another entity suggests significant influence, and this is
further reinforced by the power to appoint a director. It is clear that no party exerts control over
Co B and this factor also makes it more likely that Co A can exert significant influence.
As Co B is an associate, Co A must recognise the investment using the equity method of
accounting. This means that in the consolidated SOFP, the investment in Co B is shown at cost plus
the group's share of post-acqn retained profits or less the group's share of post-acqn losses (less
any dividend received). In the SPL Co A takes credit for its share of the associates PAT, or deducts
its share of the associates loss after tax.
Co B was an associate for 4 months of the financial year (1-Feb to 31-May X7). Co A recognises its
share of the loss for that period: £46.5m x 4/12 = £15.5m x 25% = £3.9m in consolidated profit or
loss.
Co A's share of the dividend of 40p per share paid by Co B on 30-Apr0X7 is: £10m x 25% x 40p =
£1m. This reduces the CA of the investment in the associate.
Therefore, the CA of the investment in Co B in Co A's consolidated SOFP at 31-May-X7 is calculated
as follows:
Original 5% investment at cost 50.0
20% investment at cost 250.0
Less share of post-acqn losses (3.9)
Less dividend received (1.0)
395.1
--> Add 350 to investment in associate in SOFP, Remove from 'suspense account' in SOFP
--> Remove 50 from investments in SOFP
--> Remove 3.9 from investment in associate in SOFP, Remove from reserves in equity (SOFP)
--> Remove 1.0 from investment in associate in SOFP, Remove from reserves in equity (SOFP)
EXAMPLE: ACQN TARGET DIFF YE DATE TO PARENT
IFRS 10 states that where a subsidiary prepares accounts to a different reporting date from the
parent, that subsidiary may prepare additional statements to the reporting date of the rest of the
group, or if this is not possible, the subsidiary's FS's may be used for consolidation provided that the
gap is three months or less and that adjustments are made for the effects of significant adjustments.
--> 1 month difference: consolidate as usual
, Ύ<
z
"Acquired 80k of the 100k equity shares of Co A. At acqn date the FV of Co A's NA Recognising GW in Indiv. FS
CALCULATING GOODWILL was £21m and the FV of the 20k noƚ acquired was £5m."
"Co A has recognised GW of £11.2m relating
--> If proportionate: NCI = £21m x 20% = £4.2m. If FV: NCI = £5m.
to Co B business and FD wants me to
--> If proportionate or FV: NA = £21m
recognise this in the Co B SOFP."
'tŝƐŵĞĂƐƵƌĞĚĂƚƚŚĞ&sŽĨĐŽŶƐŝĚĞƌĂƚŝŽŶƉĂŝĚůĞƐƐƚŚĞ&sŽĨƚŚĞEĂĐƋƵŝƌĞĚ͘Ύ
'tŝƐƐƵďũĞĐƚƚŽĂŶŶƵĂůŝŵƉĂŝƌŵĞŶƚƌĞǀŝĞǁƐ͘Ύ This is GW generated internally by Co B and it
is clear from IAS 38 that internally generated
GW should not be reflected within an entity's
FS.
Proportionate method No entry should be made. The GW will be
recognised on consolidation only as part of
the acquisition accounting entries in the
consolidated FS.
'tĂƌŝƐĞƐĂƚƚŚĞĚĂƚĞǁŚĞŶĐŽŶƚƌŽůŝƐĂĐŚŝĞǀĞĚ͘* In the case of Co A this is on XX, when Co A's investment in Co B passes the
50% threshold.
(g) "NCI in Co A at its FV of CU 20m"
(g) in SOFP: 10 SC + 16 SP + 64 RE at start
"You may assume the Ca of
assets and liabilities are equal
to their FV, except as
indicated in the info that |
follows" So, equity figure of |
9.90 taken from SOFP (g). |
3 x FV adjustments calc as earlier parts of Q
NCI is 0% so not included
25% TO 70% (AND EFFECT ON GW)
Until that date, Co B has been treated as an associate. Under the equity accouŶƚŝng method the group's share of Co B's profits GOODWILL IMPAIRMENT CHARGED TO OCI
after tax is credited to the consolidated SPL, and the investment is measured at cost plus share of post-acquisition profits in
The GW impairment should be charged to profit or loss rather than OCI. The
the consolidated SOFP. In the year ended X1 Co B is therefore treated as an associate for the period 1 Jul to 1 Oct X1 (ie acqn).
entries to correct are: DR Profit or loss £400,000 --> Added to costs as 'goodwill
70% TO 80% (CHANGE IN OWNERSHIP) AND EFFECT ON GW impairment' in SPL
CR Other comprehensive income £400,000
There is no further adjustment to GW when Co A acquired a further 100k shares in Co B on X1 (because going from 70% to
Being correct treatment of goodwill. This will impact on EPS.
80%). Instead the difference between the consideration paid and the decrease in the NCI's share of NA is taken to group
reserves.
GOODWILL AND SHARE ACQUISITIONS
- When an entity purchases the shares in a target and gains control, IFRS 3 requires that consolidated FS are produced and the target is introduced at FV,
including any attributable GW.
- The GW arising in this matter does not appear in any of the companies' individual FS, but arises as a consolidation adjustment in the consol FS.
- Tax authorities look at the individual FS of the companies within the group and tax the individual entities. As such, no GW is recognised for tax purposes.
The individual FS of the buyer will simply reflect an investment in shares in its SOFP, not the subsidiary assets, liabilities or GW.
- Under IAS 12 Income Taxes, a deferred tax liability or asset should be recognised for all taxable and deductible temporary differences, unless they arise
from (inter alia) GW arising in a business combination. As such, no deferred tax is recognised.
GOODWILL AND ASSET ACQUISITIONS
- The essential difference here is that the buyer has not purchased shares, but the assets and liabilities of the target. The assets and liabilities are measured
and introduced at FV, including any purchased GW. These are introduced directly into the individual FS of the buyer.
- It is this GW that the tax authorities will recognise as a purchased asset and on which they may charge tax.
- As tax relief is permitted over 15 years but GW is not amortised, then the tax base and the accounting base are not the same, therefore a taxable
temporary difference arises and DT recognised.
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