chapter 3 business combinations

Business CombinationsChapter 3

MGT 4110Fall 2011

Learning Objectives

• Define a business combination• Apply the acquisition method• Determine Goodwill • Related Goodwill issues; Goodwill impairment

and the impact of Goodwill on the Calculation of the Non Controlling Interest

• Determination of Acquirer and acquisition date

Business CombinationsDefinitions

• IFRS 3 at Appendix A defines a business combination as “a transaction or other event in which an acquirer obtains control over one or more businesses “including transactions sometimes referred to as mergers of equals

• 1582.03(e) a business combination is a transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as “true mergers” or “mergers of equals” are also business combinations as that term is used in this section.

Types of Business Combinations

• Acquire Assets• Acquire Shares

Assets

• The acquirer would record the assets in its books using the purchase price i.e. fair market value at the date of acquisition. If debt is acquired, the acquirer would record the net present value of the future cash flows related to that debt as a liability

Shares

• Acquire shares. There is a need to carefully consider the nature of the investment and the underlying intent of the acquirer. The combination of intent and structure will determine how to account for the combination.

IFRS 3

• Must use acquisition method• Identify and acquirer• Acquisition date is the day the acquirer

obtains control of the acquiree • Need to measure the fair value of the acquiree

as a whole at the acquisition date• Measure identifiable assets acquired and

liabilities assumed at fair value

IFRS 3

• Goodwill is reported separately from net assets

• NCI has two valuation options• 1) Fair value of shares owned• 2) Proportionate share of identifiable net

assets

ASPESection 1582

• ¨ An entity shall account for each business combination by applying the acquisition method.

• Applying the acquisition method requires: • (a) identifying the acquirer;• (b) determining the acquisition date;• (c) recognizing and measuring the identifiable assets

acquired, the liabilities assumed and any non-controlling interest in the acquiree; and

• (d) recognizing and measuring goodwill or a gain from a bargain purchase

ASPESection 1582

• The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.

• A non-controlling interest is the equity in a subsidiary not attributable, directly or indirectly, to a parent.

• For each business combination, the acquirer shall measure any non-controlling interest in the acquiree either at fair value or at the non-controlling interest's proportionate share of the acquiree's identifiable net assets.

Business CombinationExample Data

• P Co S Co• Current assets 1,400 800• Non CA – net 2,200 1,500• Current Liabilities 800 400• RE 1,800 1,020• CS 1,000 880

Business CombinationsExample Transactions

• Fair value of S Co NCA 2,000• Transaction 1• - purchase net assets of S Co for 2,400 by

issue 500 in new shares and long term debt of 1,900

• Transaction 2• - purchase 100% of shares of S co for 2,600.

700 in new shares and 1,900 in long term debt

Business CombinationsTransaction 1

• Assets acquired for share and debt consideration

• CA 1,400+800 = 2,200• NCA 2,200+800+500 = 3,500• 5,700• CL 800+ 400 = 1,200• LTD +1,900 = 1,900• 3,100• C/S = 1,800• RE = 1,800 • 3,600• 5,700


• Analysis of transaction• Investment proceeds 700+1900 = 2,600• Net Book value of S Co 1,020+880 = 1,900• Acquisition differential 700• Fair value adjustments• NCA 2,000 -1,500 500• Goodwill 200


• Journal entries• Investment 2,600• Long term debt 1,900• Share capital 700• To record investment


• Journal entry• CS S co 880• Re S co 1,020• NCA fair value change 500• Goodwill 200• Investment 2,600• To record elimination entry


• Acquire Investee with the issuance of Equity

• CA 1,400+ 800 = 2,200• NCA 2,200+1,500+500 = 4,200• Investment 2,600-2,600 = 0• Goodwill 200 = 200• 6,600• CL 800+400 = 1,200• LTD 1,900 = 1,900• 3,100• RE 1,800+1,020-1,020 = 1,800• CS 1,000+880-880 +700 = 1,700• 3,500• 6,600

Business CombinnationsHandbook Sections

• 1582 Business Combinations

• 1601 Consolidated Financial Statements

• 1602 Non-Controlling interest

• IFRS 3

• IAS 27

• IAS 27

Business CombinationsReporting Method

• 1582.04 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this section, which requires that the assets and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition

• 1582.05 An entity shall account for each business combination by applying the acquisition method

Business CombinationsAcquisition Date - Asset Recognition

• 1582.11 As at the acquisition date, the acquirer shall recognize, separately from goodwill, the indefinable assets acquired, the liabilities assumed and any non-controlling interest in the acquire

• Intangible assets must be recognized if they can be separately identified

• Assets and liabilities are to be classified• 1582.19 The acquirer shall measure the identifiable

assets acquired and the liabilities assumed at their acquisition-date fair values

Business CombinationsAcquirer IFRS - 3

acquiree The business or businesses that the acquirer obtains control of in a business combination.

acquirer The entity that obtains control of the acquiree.

acquisition date The date on which the acquirer obtains control of the acquiree.

Business CombinationAcquirer IFRS - 3

• The Acquirer is the entity that obtains control of the acquiree. If a business combination has occurred but applying the guidance in IAS 27 does not clearly indicate which of the combining entities is the acquirer, the factors in paragraphs B14–B18 shall be considered in making that determination.

• B14 In a business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities.

Business CombinationsGoodwill Defined

• 3604.08(g) defines it as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

• IFRS 3 An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.

• Goodwill is largely the amount paid for access to returns on investment that exceed portfolio investment rates.

Business CombinationsGoodwill - Calculated

• Goodwill – 1582.34• Goodwill is calculated as the excess of A over BA• The Aggregate of:• The consideration transferred measured in accordance with this section,

which generally requires acquisition-date fair values (1582.39)• The amount of any non-controlling interest in the acquire ( measured at

fair value) and• In a business acquired in stages, the acquisition date fair value of the

acquirers previously held equity interest in the acquire andB• The net of the acquisition-date amounts of the identifiable assets acquired

and the liabilities assumed measured in accordance with this section(1582.19)

IFRS 3Goodwill

• The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:

• (a) the aggregate of:• (i) the consideration transferred measured in accordance with this IFRS,

which generally requires acquisition-date fair value (see paragraph 37);• (ii) the amount of any non-controlling interest in the acquiree measured

in accordance with this IFRS; and• (iii) in a business combination achieved in stages (see paragraphs 41

and 42), the acquisition-date fair value of the acquirer's previously held equity interest in the acquiree.

• (b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this IFRS.

Business CombinationsAmalgamations

• In the basic form two companies combine to form a new company, the old companies cease to exist when the new one is formed

• Statutory amalgamations are those conducted according to provincial and or federal legislation

• You do not typically get any fair value increases in an amalgamation

• You can still identify an acquirer in an amalgamation

Business CombinationTransaction 3

• Amalgamation of two co’s into Newco

• CA 1,400+800 = 2,200• NCA 2,200+1,500 = 3,700• 5,900• CL 800+400 = 1,200• RE 1,800+1,020 = 2,820• CS 1,000+ 880 = 1,880• 5,900

Business transactions

• Review Problems

• Problem 3• Problem 7• Problem 12

Business CombinationsNon Controlling Interest

• The Non Controlling Interest ( NCI ) is that portion of the Investee not owned by the controlling interest

• The NCI share of net equity is a separate item on the balance sheet of the Consolidated Entity and it is disclosed as a separate line item in shareholders equity

• NCI is a calculated amount and only appears in the consolidated Financial statements

• The consolidated Income Statement measures the NCI allocation as a deduction from Consolidated Net Income

Goodwill Measurement Implications

• Once recorded it is no longer amortized• Impairment testing is required

Goodwill Impairment

• Goodwill is assigned to a Cash Generating Unit - CGU

• A CGU that has goodwill allocated to it is tested annually for impairment.

• The recoverable amount of the CGU is compared with its carrying amount, including goodwill, to determine if the unit and its goodwill are impaired

Recognizing Impairment

• When the recoverable amount is less than the carrying amount, an impairment loss is recognized

• The loss is assigned first to the carrying amount of the goodwill and then any excess is allocated to each asset in the CGU on the basis of its carrying amount

• No asset is written down below its carrying amount• The reduction in each asset is it impairment loss.• Losses are recognized in the income statement• Impairment losses for Goodwill are not reversible

Plant Property & Equipment

• Property, Plant and Equipment impairment losses are recognized using the revaluation model and are treated as revaluation write downs

• Impairment losses on other assets can be reversed, limited by the original carrying amount of the asset.

• New rates of amortization and depreciation need to be determined

Business CombinationsSummary – Key steps

• Key step is the determination of FVNIA• Starting point is the book value of NIA• Book values are adjusted to Fair values• Identify those fair value increments subject to

amortization and the related periods over which to amortize the fair value changes

• Book value of NIA = Stated equity ( CS/RE)