business combinations & consolidation presentation

BUSINESS COMBINATIONS & CONSOLIDATION

Advanced Accounting

IFRS 3: Business Combinations

A Business Combination is “the bringing together of separate businesses or entities into one reporting entity” (IASB)

IFRS 3 require that all business combinations be accounted for using the “purchase method”

Purchase method recognizes all intangible assets acquired in a business combination

The purchase method is part of the convergence project with FASB


An acquirer must be identified for every business combination

Acquirer is defined as, “the combining entity that obtains control of the other combining entities or businesses” (IASB)

The acquirer must measure the cost of the business combination including the following: “the fair values, at the date of exchange, of assets

given, liabilities incurred or assumed, and equity investments issued by the acquirer, in exchange for control of the acquiree; plus any costs directly attributable to the combination” (IASB)


The acquirer must separately recognize the acquiree’s identifiable assets, liabilities, and contingent liabilities at the acquisition date

These must satisfy certain recognition criteria even if they have been previously recognized in the acquiree’s financial statements: Any assets (other than intangible assets) where it is probable that

associated future economic benefits will flow to the acquirer and fair value of the asset can be measured reliably (IASB)

Liabilities (other than contingent liabilities) where it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and fair value of the liability can be measure reliably (IASB)

For intangible assets and contingent liabilities, the fair value must be able to be measured reliably (IASB)

These must be measured at the acquisition date, at their fair values, by the acquirer


Goodwill: If acquired in a business combination: Must be recognized as an asset from the acquisition date Initially, goodwill is a measure of the excess of the cost of the

business combination over the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities, and contingent liabilities (IASB) These were previously recognized above

It is prohibited to amortize goodwill Goodwill must be tested for impairment annually Must be tested more frequently if events or

circumstances indicate that the asset may be impaired (IASB)

This is in accordance with IAS 36 Impairment of Assets


In addition, goodwill can include: The fair value of the going concern element

of the acquiree The fair value of the expected synergies Overpayments by the acquirer Errors in measuring and recognizing fair

value of either the cost of the business combination or the acquiree’s identifiable assets, liabilities, and contingent liabilities (IASB)


If the net fair value of the acquiree’s identifiable assets, liabilities, and contingent liabilities exceeds the cost of the business combination: Acquirer must reassess the identification

and measurement of those identifiable assets, liabilities, and contingent liabilities

Any excess that remains after the reassessment must be recognized by the acquirer as profit or loss (IASB)


Business combinations may involve more than one exchange transaction

This may happen when “stages” of share purchases occur

Each of these “stage” transactions must be treated separately

Important to assess the cost of the transaction and fair value information at the date of each of these subsequent transactions

Goodwill determined for each separate transaction


If the acquirer does not obtain full consideration of the acquire, goodwill can be recorded in 2 ways:1. The difference between the consideration

paid and the purchaser’s share of identifiable net assets acquired (Partial Goodwill)

2. Full Goodwill: recognized for the non controlling interest in a subsidiary as well as the controlling interest

Goodwill Example

Partial Goodwill Identifiable net assets (fair value) = 1000 Non controlling interest (20% * 1000) = 200 Net assets required (1000 – 200) = 800 Purchase Consideration = 900 Goodwill (900 – 800) = 100

Full Goodwill Identifiable net assets (fair value) = 1000 Non controlling interest (measured at fair value) = 210 Net assets required (1000 – 210) = 790 Purchase consideration = 900 Goodwill = 110

Under full goodwill, non controlling interest is measured at fair value

Under partial goodwill, non controlling interest is the percentage not acquired (20%) multiplied by the identifiable net assets


• In many jurisdictions, the pooling of interest method is permitted under US GAAP, also known as united interest or merger accounting.

• Pooling of interest method is permitted by IAS 22 in instances were an acquirer could not be identified

• Under the purchase method of accounting, the acquirer's identifiable assets and liabilities should be measured at fair value at acquisition date

• It requires more effort than pooling of interest method and usually results in the recognition of goodwill or negative goodwill on acquisition


Acquirer measures cost of business combinations as the total FV at date of exchange of assets given, liabilities incurred and equity instruments issued by the acquirer in exchange of control of the acquirer and any costs directly attributable to the business combination inquired by acquirer.

If equity instruments are issued as consideration for the acquisition, the market price of those instruments would be the FV at the date of the transaction.

Cost of Business Combinations:


At the acquisition date the acquirer must allocate the cost of business combination by recognizing at FV the identifiable assets, liabilities, and contingent liabilities of the acquirer

Any difference between total of net assets and acquired and cost of acquisition is treated as goodwill or negative goodwill

Allocating Costs of Business Combinations:


When a company acquires intangible assets as part of a business combination, the intangible asset is recognized separately if it meets the following criteria

1. Separately identifiable2. Controlled by the acquirer3. Source of future economic benefit4. FV can be measured reliably

On initial recognition of an intangible assets at the date of the transaction, the cost of the intangible is measured at FV. The fair value of the intangible asset is the amount the entity would have paid for the asset in an arm’s length transaction between knowledgeable and willing parties, on the basis of best information available

Advice from an independent specialist with experience in the market can also be sought

Intangible Assets:


Has to be tested for impairment at least annually(According to IAS 36)

In determining of goodwill being impaired as a result of business combination, goodwill is allocated to a cash-generating unit.

To determine if a write-down is required, the recoverable amount of the cash-generating unit is compared to is carrying amount.

Recoverable amount= higher of FV-costs to sell, or value in use.

Goodwill:


Best estimable of FV-costs to sell is the agreed price in a binding sales agreement for that cash generating unit.

If there is no binding sales agreement, it would be the bid price for the same asset in an active market

If there is no active market, the FV (less costs to sell) would be based upon the best available information the entity would get for the asset in disposal.

If a write-down is required, it would be first allocated to the recognized goodwill of the cash-generating unit. Any additional write-down is done in a pro rata basis to the other assets in the cash generating unit.

Goodwill (Cont.):


Effective for business combinations for which the agreement date is on or after mach 31,2004

Entities may choose to apply to transactions prior to March 31 2004 if they have sufficient information to apply the standard.

If goodwill has been recognized prior to March 31, 2004 resulting from business combinations, the entity is required to:

1. Discontinue amortization of goodwill2. Eliminate carrying amount of goodwill of accumulated

amortization3. Test goodwill for impairment

For first time adopters of IFRS, IFRS 3 must be applied at transition date. Business combinations made prior are not required to be restated. If companies choose to do so, they must also restate any other business combinations occurred from the date of the first one to the date of adopting IFRS.

Effective Date of IFRS 3:

Implementation of IFRS

Reevaluation of Louis Vuitton brand at historical cost (Equal to the value retained by Christian Dior)

Accounting for goodwill against deferred taxes on brands

Eliminating the accumulated goodwill amortization

Reclassification of the goodwill to trademarks or other intangible assets

Accounting against goodwill “Other non-current liability” in relation to minority interest purchase commitments

http://uk.reuters.com/business/quotes/incomeStatement?stmtType=BAL&perType=INT&symbol=LVMH.PA

http://www.lvmh.com/comfi/pdf/LVMH_RA_2009_UK.pdf






Questions

The article from the NYSSCPA states that this particular topic has raised a lot of concerns and tension in terms of convergence. The article also states that while US GAAP and IFRS standards regarding business combinations are very similar, they are not exact copies. What do you think the major differences are between the GAAP and IFRS standards that is causing such controversy in the global accounting community?

The key differences between consolidation when using GAAP or IFRS involves the process of asserting control over the new combined company. IFRS has clearer rules on who takes control after a merger than GAAP does. There are also differences in rules for voting rights as well as for booking investments belonging to the combining companies.

Questions

What are some of the advantages/disadvantages of the fresh-start accounting method, and when should this method be used, as mentioned in The CPA Journal article?

The advantages of the fresh-start method are that it gives companies the opportunity to restructure and revalue their assets and liabilities using a fair value option. It is frequently used after a company declares bankruptcy. The disadvantages are that the company is likely not in a strong financial position (especially if they are coming off bankruptcy) and revaluing their assets using fair value could lead to even bigger losses if the market is down.

Questions

The ifrsaccounting.com article identifies many differences between GAAP and IFRS for business combinations and consolidated financial statements. The majority of these differences seem to be minimal. Do you believe a combination of these small differences could together create a material difference between IFRS and GAAP? What does this mean for convergence?

While the two systems are very similar, the small differences still create an issue that is keeping the two sides from coming to an agreement. A few of these differences can also still create a problem down the road- especially concerning convergence. There needs to be a clear ruling on things such as the rules governing control, goodwill, and a booking assets belonging to the converging companies.

business combinations & consolidation presentation

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