Standards relevant to the preparation and presentation of consolidated fi leu | IFRS 3 Business Combination (deals with business combination generally) —— IFRS 10 Consolidated Financial Statements.Overview of the Scope of the IFRS 3 Purchasing Purchasing Tar pad Teed Ter aD Tera EIS Se Cee Rica) Transferring its net assets, fa igen Ru Rom Moe Ales aR MUR MPSS M oa MoCo ALLL other combining entities to a together form one or more newly formed entity LIU ery7. Acquires controlling interest in equity of ee een rile ac eu slly Tele a eee od Bee aa Rec cena R ing - Consolidated FS m7 Buys over net assets No Parent - Subsidiary relationship One legal and economic entity Do not require consolidated Lilet US) G1 CUWhere an acquirer obtains control of one or more businesses Examples: IFRS 3————- entities Economic ee a Consolidation is the process of preparing and presenting the financial statements of a group as an economic entity 2 No ledgers for group entity 2 Consolidation worksheets are prepared to: Combine parent's and subsidiaries financial statements Adjust or eliminate effects of intra-group transactions and balances Allocate profit to non-controlling interestsalntragroup transactions are eliminated to: Show the financial position, performance and cash flows of the economic (not legal) entity. Avoid double counting of transactions within the economic entity. Example: 5 Parent sold inventory to subsidiary for $2M & The original cost of inventory is $1M = Subsidiary eventually sold the inventory to external parties for $3M Q: What is the journal entry to eliminate intragroup sales transaction? Consolidation adjustment Dr Sales 2,000,000 Cr Cost of sales 2,000,000Extract of consolidated worksheet Sales $2,000,000 $3,000,000 2,000,000 $3,000,000 | $5,000,000 Cost of sales (1,000,000) (2,000,000) 2,000,000 (1,000,000) _| ($3,000,000) Gross profit $1,000,000 $1,000,000 $2,000,000 Note: Without elimination the consolidated sales and cost of sales figures will be overstated by $2 M.© Business combinations may take different forms ; however two characteristics are present: * 3 main attributes of control * Power over acquiree * Exposure or rights to variable returns of acquiree * Ability to use power to affect acquiree’s returns. + 2 vital characteristics of a business (IFRS3) * Integrated set of activities and assets * Capable of being conducted and managed to provide returns (ie. dividends) to investors and other stakeholders. Business combinations involving entities under common control is outside of scope of IFRS 3- IFRS 3 requires all business combinations to be accounted for using the acquisition method from the perspective of an acquirer. - An acquirer can obtain control in an acquiree through: Acquisition of assets and assumption of liabilities of acquiree. = Include assets and liabilities not previously recognised by acquiree: contingent liabilities, brand name, in-process R&D etc. Acquisition of controlling interest in the equity of acquiree « Effects: (2) accounted for as if they are effects of (1) Combination of (1) and (2)* » Effects: Accounted for as if they are effects of (1)© The procedures:» Reverse acquisition Legal parentis the acquiree and legal subsidiary is the acquirer Often initiated by the legal subsidiary Motive for entering into such an arrangement often to seek a backdoor listing - Exchange of shares in a reverse acquisition 1. Company A (Legal parent) takes > over shares of Company B from ———— owners: Oe ee — a —Z Company A issues own shares eee to owners of Company B as purchase consideration 3. Company B has the power and = — a to affect the returns of the legal parent after the share exchangeExample On 1 July 20x5, P (private), arranged to have all its shares acquired by L (public listed). The arrangement required L to issue 20 n_shares to P’s shareholders in exchange for the existing 6 million shares of P. Existing shareholders of L owned 5 million of L. After the issue of 20 million L shares, P’s shareholders now owned 80% (20 million shares out of a total of 25 million shares) of the issued shares of the combined entity. L’s shareholders owned 20% of the shares in the combined entity after the share issue. P’s shareholder act in concert to exercise control over the combined entity. L's shareholders P's shareholders milion shares) aa 0% (20 million shares) L | 100% P: [=] = — - *Fair value (FV) of the consideration transferred: ~ Determined on the acquisition date - Acquisition date is the date when the acquirer obtains control and not the date when consideration is transferred ~ Acquisition-related costs are not includedolf assets transferred or liabilities assumed are not carried at fair value in the acquirer's separate financial statements: Remeasure in fair value and recognize gain or loss in the acquirer’s separate financial statements Remeasured gain or loss is not recognized if the asset or liabilities remain in the combined entity’s financial statements olf transfer of monetary assets or liabilities are deferred, the time value of money should be recognized: The fair value will be the present value of the future cash outflows Eg. Future cash settlement of $1,000,000 is due 3 years later and 3% interest is levied Present value to be recognised = $1,000,000/(1+0.03)43 = $915,142o Fair value of equity interests issued is measured: ~ (1) By market price (e.g. published quoted prices of shares) © (2) With reference to either the acquisition date fair value of the acquirer OR acquire, whichever is more reliable. (For example, if market price is not available or not reliable for the acquiree, use the fair value of the acquirer) Issues X number of shares Conveys A number of shares to acquirer Total number of shares after issve: Y Gains control over aequiree FV of acquirer's equity: SZ FV of equity issued is (/¥ multiplied by $Z; or ./8 multiplied by $CP Lid acquires 100% of $ Co through an issue of 5,000,000 shares to the owners of $ Co. Number of existing shares 10,000,000 2,000,000 Number of new shares issued 5,000,000 - Market price per share $2.00 - Fair value of equity 30,000,000 9,000,000Situation 1: P Ltd’s market price is a reliable indicator Consideration transferred = 5,000,000 shares x $ 2.00 = $10,000,000 Situation 2: Fair value of S Co is a better estimate Consideration transferred = $9,000,000 Explanation: Since P Ltd is acquiring 100% of S Co, the fair value of the equity (FV of S Co. as a whole including the implicit goodwill) acquired by P is $9 millionContingent consideration Obligation (right) of the acquirer to transfer (receive) additional assets or equity interests to (from) acquiree’s former owner if specific event occurs - Eg. Event A: acquirer gets a refund of part of the consideration transferred if the acquiree does not achieve the target profit. » Fair value of contingent consideration or refund will change as new information arises Fair value of the contingent consideration has to be estimated (For event A) is deducted from consideration transferred Fair value of contingent consideration is adjusted retrospectively as a correction of error if events after acquisition reveal information that was missed or misapplied during the acquisition dateError: Discovery of fo on facts and circumstances existing as of = acquisition date | Acquisition 12 months ite End of measurement period Change in estimate: Creumstances > ———)> arising after acquisition date« All acquisition-related costs are expensed off « Costs of issuing debt are recognized in accordance with IAS 39 As yield adjustment to the cost of borrowing and are amortized over the tenure of the loan. Journal entry for the payment of debt issuance cost Dr Unamortized debt issuance costs Cr Cash + Costs of issuing equity are recognized in accordance with IAS 32 A reduction against equity Journal entry to record the payment of cost of issuing equity Dr Equity Cr CashBusiness Combinations are accounted under the acquisition method ‘There is an effective “acquisition” of the subsidiary's identifiable assets and liabilities at fair value There has been an exchange transaction at arm-length pricingFair value differential At acquisition date: + Fair value differential will be recognized in the consolidation worksheet In subsequent years: + Depreciation/amortization! cost of sale of asset will be based on the fair value recognized at the acquisition date These entries have to be re- enacted every year until the disposal of investment2 Classification of identifiable assets or liabilities is made with respect to: Information; Conditions; and Corporate policies existing as at acquisition date Example: Bond investment Classified as Reclassified as held-to- Available-for-sale maturity according to securities acquirer’s group policy Under acquiree’s financial statements Under consolidated financial statements- The recognition of fair value differential may give rise to future tax payable or future tax deduction tax effects need to be accounted for because the basis for taxation does not change in a business combination ie. The excess of fair value over book value of identifiable net assets will give rise to a taxable temporary difference and vice versa. FV > Book value of identifiable assets Deferred tax liabilities FV < Book value of identifiable assets __| Deferred tax assets FV < Book value of identifiable liabilities | Deferred tax liabilities FV > Book value of identifiable liabilities | Deferred tax assets + No deferred tax liability is recognized on goodwill as goodwill is a residual= Non-controlling interests (NCI) arises when acquirer obtains control of a subsidiary but does not have full ownership of voting rights. a In a business combination, NCI are recognized by the acquirer as equity based on the following equation Rationale: To represent outside interests’ share in the net assets of the acquiree Assets - Liabilities = Equity Carrying ‘amount of Carrying ‘acquirer's ‘amount of ee acquirer's Acquirer’s ‘Acq date FV liabilities + ‘equity + NCI esas ‘Acq date FY share of equity identifiable of acquiree's of acquires ossets + identifiable Goodwill liabilitiesoA premium that an acquirer pays to achieve synergies from business combination Must be recognized separately as an asset Determined as a residual OIFRS 3 allows 2 ways of determining goodwill: alGoodwill Depends on reliable measurement of consideration transferred, NCI, previously held equity interests and identifiable net assets Integral to the entity as a whole, not individually identifiable or severable as a standalone asset ‘An expectation of future economic benefits arising from acquisitionP pays 800 to acquire an 80% interest in the ordinary shares of S. The aggregated fair value of 100% of S's identifiable assets and liabilities (determined in accordance with the requirements of IFRS 3) is 600, and the fair value of the non-controlling interest (the remaining 20% holding of ordinary shares) is 185. NCI based on NCI based on Ge 800 Consideration transferred= P pays 800 to acquire an 80% interest in the ordinary shares of S. The aggregated fair value of 100% of S's identifiable assets and liabilities (determined in accordance with the requirements of IFRS 3) is 600, and the fair value of the non-controlling interest (the remaining 20% holding of ordinary shares) is 185. Consideration transferred 800 800 Non-controlling interest 185 120= P pays 800 to acquire an 80% interest in the ordinary shares of S. The aggregated fair value of 100% of S's identifiable assets and liabilities (determined in accordance with the requirements of IFRS 3) is 600, and the fair value of the non-controlling interest (the remaining 20% holding of ordinary shares) is 185. Consideration transferred 800 800 Non-controlling interest 185 120 985 920 Net assets 600) 600)= P pays 800 to acquire an 80% interest in the ordinary shares of S. The aggregated fair value of 100% of S's identifiable assets and liabilities (determined in accordance with the requirements of IFRS 3) is 600, and the fair value of the non-controlling interest (the remaining 20% holding of ordinary shares) is 185. Consideration transferred 800 800 Non-controlling interest 185 120 985 920 Net assets (600) (600) Goodwill 385 320- Again from bargain purchase arises when: < [=| - In essence, a windfall gain to acquirer » The acquirer must re-assess the fair value of identifiable net assets, consideration transferred and non-controlling interests. If there is no measurement error: The gain will be recognized immediately in the income statementOn 1 July 20x1, P purchased 1.5 million shares from S Co's existing owners. Total number of shares issued by S$ Co was 2 million. A reliable FV of S Co's share was $10/share. P Co was obligated to pay an additional $1 million to vendors of $ Co if S Co maintained existing profitability over the subsequent two years from 1 July 20x1. It was highly likely that $ Co would achieve this expectation and the fair value of the contingent consideration was assessed at $1 million. FV of NCI as at 1 July 20x1 was $5 million. Assume a tax rate of 20% Additional information of S Co. 13 Book value of net assets: $3,650,000 2 FV of net assets : $14,350,000 5 FV less book value (net assets): $10,700,000 © Share capital: $2,000,000 © Retained earnings: $1,650,000Determine the acquirer's interest in the acquiree: 1,500,000 (75%) 2,000,000 Consideration transferred: = ($1,500,000 x $10) + $1,000,000 [FV of contingent consideration] = $16,000,000 Determine goodwill: Consideration transferred + FV of NCI — FV of Percentage ownership = identifiable net assets at acqui n date Determine deferred tax liability of (20% x $10,700,000) = $2,140,000 Determine FV of identifiable net assets = $14,350,000 - $2,140,000 = $12,210,000 Goodwill = $16,000,000 + $5,000,000 - $12,210,000 = $8,790,000On 1 July 20x1, P purchased 3 million shares from $ Co’s existing owners. Total number of shares issued by S Co was 3.75 million. A reliable FV of S Co’s share was $5/share. P Co was obligated to pay an additional $0.3 million to vendors of S Co if $ Co maintained existing profitability over the subsequent two years from 1 July 20x1. It was highly likely that $ Co would achieve this expectation and the fair value of the contingent consideration was assessed at $0.25 million. FY of NCI as at 1 July 20x1 was $3.75 million. Assume a tax rate of 20% Additional information of S Co. © Book value of net assets: $8,650,000 2 FV of net assets : $12,650,000cet us assume that the S Co. to be acquired by P Co., has the following balance sheet on the October 1, 2021, acquisition date: SCo. Statement of Financial Position October 1, 2021 BV FV Difference Cash Br.40,000 | 40,000 0 Marketable investments 60,000 | 66,000 6,000 Inventory 100,000 110,000 10,000 Land 30,000 |__ 72,000 42,000 Buildings (net) 150,000 288,000 138,000 Equipment (net) 80,000 | 145,000 65,000 Customer list 125,000 | __ 125,000 Total assets Br460,000 | 846,000 386,000 Current liabilities Br.25,000 | 25,000 0 8%, 5-year bond payable 100,000 [104,000 4,000 Warranty liability 12,000 12,000 Total liabilities Br.125,000 [141,000 16,000 ‘Common stock (Br par) Br.10,000 Paid-in capital in excess of par 140,000 Retained earnings 185,000 Total equi Br.335,000 Liabilities plus equity 460,000Total price paid (consideration given), 40,000 shares x Br.20 market value Br. 800,000 Total fair value of net assets acquired from $ Co....... : (705,000) Goodwill (excess of total cost over fair value of net assets) .............. Br. 95,000 To record purchase of net assets: Cash, 40,000 Marketable Investments. 66,000 Inventory 2.2.6... ee0e aes ee 110,000 Land. 72,000 Buildings 288,000 Equipment..... : : - 145,000 Customer List 125,000 Goodwill sigs . 95,000 Current Liabilities 25,000 Bonds Payable. 104,000 Warranty Liability .... 2 12,000 Share capital- Ordinary (Br.1 pat, 40,000 shares issued) . 40,000 Premium-Shares (Br.20-1 per share 40,000) 760,000 Acquisition Expense .....00.eecccecseeeeeereeeaes 35,000 Cash 35,000Total price paid (consideration given), 25,000 shares x Br.20 market value Br. 500,000 Total fair value of net assets acquired from S Co, (705,000) Gain on purchase of business (excess of fair value of net assets over total cost) [Br. 95,000 To record purchase of net assets: Cash..... a sxemmasaman ane 40,000 Marketable Investments, 66,000 Inventory TORR ET PROTEC TD 110,000 Land... F : ss 72,000 Buildings 288,000 Equipment 145,000 Customer List 125,000 Current Liabilities . - : : 25,000 Bonds Payable....... , s 3 104,000 Warranty Liability 12,000 Share capital- Ordinary (Br.1 par, 25,000 shares issued) 25,000 Premium-Shares (Br.20-1 per share 25,000) 475,000 Gain on Acquisition of Business ...... 205,000 Acquisition Expense 35,000 Cash .. 35,000Case 3: P Co,, issues 25,000 shares of its Br.1 par value common stock with a Pom CO Mote ee Meters UU me ORS Te illustrated above. P Co., pays related acquisition costs of Br.35,000. To record purchase of equity: Equity Investments: S Co.......cccees 500,000 Share capital- Ordinary (Br.1 pat, 25,000 shares issued) .. ‘Premium-Shares (Br.20-1 per share 25,000) sesrosebieasCase 4: Let us return to the earlier example of the acquisition of S Co. in exchange for stock with a total value of Br.800,000. Assume now that the values assigned to the buildings, customer list, and warranty liability are provisional. Better estimates Ora Ura ee ted ee ere Cee UE Buildings Br.320,000 Cero macs 150,000 Warranty Liability 18,000 he recorded values are adjusted during 2022 as follows: Buildings (Br.320,000 new estimate - Br.288,000 provisional value). 32,000 Customer List (Br.150,000 new estimate ~ Br.125,000 provisional value)... 25,000 ‘Warranty Liability (Br.18,000 new estimate ~ Br.12,000 provisional valtie) 6,000 Goodwill (sum of above adjustments) + 51,000Total price paid: Stock issued, 40,000 shares © Br.20 market value. =. Br.800,000 Estimated value of contingent payment 40,000 Br. 840,000 Total faic value of net assets acquired from $ Co... 705,000) Goodwill Br. 135,000 Cash z eer ae 40,000 Marketable Investments, a sees 66,000 Inventory 120,000 Land... : : : 72,000 Buildings... oe — 288,000 Equipment...... wre ve 145,000 Customer List ...... : = 125,000 Goodwill. . cee cee : 135,000 Current Liabilities : : s+. 25,000 Bonds Payable. conan meres oes 104,000 Warranty Liability 12,000 Estimated Liability for Contingent Consideration. seeesees 40,000 Share capital- Ordinary (Br-1 pas, 40,000 shares issued) .......... 40,000 Premium-Shares (Br.20-1 per share 40,000)... 760,000Re et meno oe ust MU Meo sit mest e toy was revalued based on improved information, the estimated liability and the goodwill (or gain in a bargain acquisition) would be adjusted. For example, assume that within the measurement period fair value of (eo e@C oele Con cath OsCase 7: If the estimate is again revised after the measurement period, the PREC R RO CCR MUO mT ei Coms vo ett Ae cere cry) oe assume that after the measurement period fair value of Contingent est cnn ek UII Expense, Increase in Estimated Contingent Consideration Payment. Estimated Liability for Contingent Consideration.The goodwill recorded by the acquirer is not tied to the gain (or loss) recorded by Peete pire rer ener tie ma terri ra temo mt tts eon cee a etn ake eae Tn au eece ng Perce ne eo ee ecu tareme moan ta toy eri cts of Br.335,000 (Br.460,000 assets - Br.125,000 liabilities) is recorded as a gain on the POOR Tenet MC era CACM Lea emt eee ny emcee roles Equity Investment-P Co,, Stock Current Liabilities. .. 8% 5-Year Bonds Payable CashExample 4.4:Pat Company acqired Set Company On December 31, 2019 with the following balance sheet items. ‘Set Company Balance Sheet December 31,2019 Liabilities and Equity: 60,000 | Current Liabilities . 420,000 | Long-term debt .. 400,000 | Capital Stock (Br 10 Par). 240,000 | PICin Excess of Par.. 320,000 280,000 | Retained Eamings. 450,000 1.400.000] TotalliabiltiesandEquity..... 1.400.000 BOD established the following Current Fair Value for assets and 180,000 250,000 200,000 ng: a Accordingly on December 31, 2019 Pat issued 100,000 shares of its Br 10 Par (Current Fair Value of Br.13) Common Stock for all the net asset of Set on an acquisition type of business combinationand paid an additional Br 50,000 cash. Also on December 31, 2019 Pat paid the following out-of-pocket costs in connection with the combination: > Finder's Fees and Legal Fees. 180,000 > Costs associated with issuance of shares..... 120,000 Required: Prepared General Joumal Entries for Pat Company on December 31, 2019- All business combinations are characterized by three conditions: Existence of acquirer Acquirer has control over an acquiree Acquiree is a business - Many modes of business combinations: Acquirers acquires net assets of the business (Consequence: Assets and liabilities acquired recognized in the acquirer's legal entity financial statements) Acquirer acquires control over the equity of the acquiree (Consequence: acquirer and acquiree retain separate legal identities but economically, these entities belong to same group) Regardless of form, economic substance of combination is the same and acquisition method should be appliedAcquisition method Identify acquirer with reference to the control criteria of IFRS 10 Recognize and measure identifiable net assets at fair value at acquisition date Goodwill is a residual figure and is determined on a “top-down” approach = May include recognition and measurement errors and identifiable elements Measurement period Acquirers are allowed a 12 month measurement period to correct and revise the following on a retrospectively basis: 1. Provisional amounts of goodwill 2. Fair value of identifiable net assets, Non-controlling interests and previously held interestsEnd of Chapter