IFRS Course IFRS 3 – Business Combinations

IFRS Course

IFRS 3 – Business CombinationsUniversità degli Studi di Bergamo

Dott.ssa Roberta CucchiProf. Daniele Gervasio

Bergamo, 9 March 2017

2© 2017 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.

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


AgendaScope and definitions

The acquisition accounting process

After the business combination

Know your journals

Disclosure

The closing


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





Know your journals

Disclosure

The closing


Steps to acquisition accounting

NCI = non-controlling interests

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


Overview of the acquisition method

Option to measure NCI at acquisition

date

Fair value of net

identifiable assets

NCIConsideration transferredGoodwill


Step 1: - Identify the acquirer

The acquirer is the entity that obtains control of the business

Consider additional

factors identified in IFRS 3

Use IFRS 10 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 interests

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 profit or loss and other comprehensive income of the acquiree is included in the

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

Tran

sact

ions

that

are

se

para

te fr

om th

e bu

sine

ss c

ombi

natio

n 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


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 the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at

the measurements

i.e. market-based measurement


Intangible assets (1)

All identifiable intangible assets recognised separately from goodwill

Separable Arises from contractual or other legal rightsor

Measured at fair value without

consideration of intended use


Intangible assets (2)

Customer-related

Artistic-relatedTechnology-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 Consideration transferred NCI at FV

Fair value of net

identifiable assets

Goodwill Consideration transferred

Option 1: NCI measured at fair value

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

NCI based on net assets

Fair value of net

identifiable 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

Goodwill150

Considera-tion

transferred

1,000

NCI at FV

650Fair value

of net identifiable

assets

1,500

Goodwill100

Considera-tion

transferred

1,000

NCI

600Fair 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





Know your journals

Disclosure

The closing


Follow other IFRSs except for:

Indemnification assetsMeasure on same basis as related

liability

Contingent considerationProfit / loss if classified as a

liability / asset; no remeasurement if classified as equity

Contingent liabilitiesMeasure at greater of amount under IAS 37 and amount recognised originally in acquisition accounting

Reacquired rightsAmortise 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





Know your journals

Disclosure

The closing

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

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

Know your journals


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 valueAssetsFixed assets 400 550Intangible - 100Accounts Receivable 400 400 Inventory 100 200Cash Equivalents 50 50 Total Assets 950 1.300

LiabilitiesAccounts Payable 550 550Contingent Liabilities - 50Total Liabilities 550 600

Know your journals


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

Assets 1.300Liabilities (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 600Group 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


Case B

Statement of Financial Position recap:

_____________________ _________________________Net Assets 700 Controlling Interest 600

Goodwill 250 NCI 350

Know your journals





Know your journals

Disclosure

The closing


Disclosure

Extensive disclosures

IFRS Course 2016 – Business Combinations


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



DisclosureFurther 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



DisclosureFurther 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!





Know your journals

Disclosure

The closing


Check


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


Do not forget1) A business combination occurs only when an acquirer obtains control

over a business2) The general measurement principle in the acquisition accounting is fair

value3) There are a number of exceptions to this general principle4) NCI can be measured at fair value or its proportionate interest in the

net identifiable assets acquired, on a transaction-by-transaction basis5) Extensive disclosures required

Questions?

Thanks

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