uva ifrs 1 consolidation and business combinations bb

Arjan Brouwer

UvA IFRS 1 courseBusiness combinations and consolidation

Agenda

– Consolidation (IAS 27R and SIC12, as of 2013 IFRS 10)

– Investments in Associates (IAS 28)

– Interests in Joint Ventures (IAS 31, as of 2013 IFRS 11)

– Entity accounts

– Business Combinations (IFRS 3R)

Arjan Brouwer

Consolidation

· 4

Introduction - Classification of investments

Purchase of an equity investment

Significantinfluence

(usually 20-50%)

Control

(usually >50%)

None of the two

(usually < 20%)

Could be either:• associated company

• joint venture

Would be a subsidiary and

requires consolidation

Apply relevant policies

for investments using IAS 39

5

When does an entity have control ?

Parent owns > 50% voting power

Parent is able to have more than 50% of the voting power through an agreementParent has the power to govern the financial and operating policies through statute or agreementParent has the power to appoint the majority of the members of the board of directors Parent has the power to cast the majority of votes at board of directors meetings

Situation

Standard presumes that control exists in this situation

· 6

When else does an entity have control ?

Potential voting rights:

• An entity owns instruments that, if exercised or converted, give the entity power over the financial and operating policies of another entity (e.g. share warrants, share call options, debt or equity instruments, etc.)

• IAS 27 requires all potential voting rights that are currently exercisable or convertible are considered.

ALL FACTS AND CIRCUMSTANCES SHOULD BE EXAMINED

· 7


Example:Entity A, B and C own 25%, 35% and 40% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of entity D.

Entities B and C have share warrants exercisable at any time at a fixed price and provide potential voting rights.

Entity A has a call option to purchase these share warrants at any time for a nominal amount. If exercised, it would give entity A the potential to increase its ownership interest in entity D to 51%.

Which entity, if any, has control?

· 8


Answer:

· 9


De facto control:When an entity owns less than 50% of voting shares in another entity but is

deemed to have control.

Example:• Entity A owns 48% of entity B. Entity B is listed. No other shareholder

owns more than 5% of its equity shares• The other shareholders have not formed any group that might vote

collectively for their combined 52% shareholding• Entity A nominates a majority of directors and, due to its presence at

general meetings, these nominations are approved.

Does Entity A have de facto control?

· 10


Answer:

· 11

“It is one thing to have a bank report losses because some of the loans on its balance sheet went bad. That is part of the business of banking. It is something else, however, for a bank to report a multibillion-dollar loss from taking some risk that had never been mentioned in its financial statements”

NYT article – February 29th 2008

Special Purpose Entity (SPE)

· 12


Special Purpose Entity:An ‘entity created to accomplish a narrow and well-defined objective’, for example, to effect a lease, research and development activities or a securitisation of financial assets.

SPEs may take the form of a corporation, trust, partnership or unincorporated entity.

· 13

SIC 12

SPE’s activities

Decision making power over the SPE

Benefits

Risk exposure

The control concept requires in each case assessment of all relevant factors in order to determine if control exists.


· 14

Special Purpose Entity (SPE) - example

• Should Ahold consolidate “SAC”?

Arjan Brouwer

Investments in Associates

· 16

Introduction – scope and definitions

IAS 28 – Scope and definitions

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control over those policies (control defined as in IAS 27)

- The IAS 28's requirements shall be applied in accounting for investments in associates except for such investments held by

- Venture capital organisations - Mutual funds, unit trusts and similar entities including investment-linked

insurance funds

· 17

Definition

Hold 20%+ voting power of the investee

(directly or indirectly through Subsidiaries)

Hold < 20%+ voting power of the investee

• Participation in policy making processes

• Provision of essential technical information.

• Representation on the board of directors or equivalent governing body of the investee

• Material transactions between the investor and the investee

• Interchange of managerialpersonnel

Significant Influence demonstrated by:

Substantial or majority ownership by another party, does not preclude an investor from having significant influence in an entity

· 18

In which of the following examples does an Investor/Associate relationship exist?

A. Company P holds 20% of the voting shares in Company A

B. Company P holds 10% of the voting shares in company A but has representation on the board of directors (2 of the 8 Directors are from Company P).

C. Company P holds 15% of the voting shares in Company A and has 2 members on the Board of Directors (total Directors = 6). The company A Directors never vote in the meetings although they have the right to do so.

Significant influence

· 19

In which of the following examples is there an Investor/Associate relationship?

A. Company P holds 20% of the voting shares in Company A

B. Company P holds 10% of the voting shares in company A but has representation on the board of directors (2 of the 8 Directors are from Company P).

C. Company P holds 15% of the voting shares in Company A and has 2 members on the Board of Directors (total Directors = 6). The company A Directors never vote in the meetings although they have the right to do so.

Significant Influence

· 20

Measurement

• An associate is initially recorded at cost • Subsequently the carrying value of an associate increases (decreases) by

the investors share of the associate’s profit (loss)• The investor's share of the associate's profit or loss is adjusted for the

effect of any fair value differences recognised on acquisition of the associate

• Distributions received reduce carrying amount of the investment

· 21

M

Share of FV adjustments

Dividends

NBV of fair value adjustment

Goodwill Impairment

NAV in consolidated accounts

NBV of goodwill

Cost (fair value of consideration)

Book NAV of investment

Fair value adjustments

Goodwill

Share of profit/ (loss)

Subsequent accounting

Carrying value of an investment

in consolidated a/c

Measurement

· 22

QuestionPoltergeist Ltd, a company with subsidiaries, acquired 25,000 of the 100,000 ordinary shares of Alchemists Co on 1 January 2002 for a total cost of 100,000. In the year to 31 December 2002, Alchemists earns profits after tax of 40,000, from which it declares a dividend of 8,000.

What is the amount shown in Poltergeist’s consolidated income statement and balance sheet for the year ended 31 December 2002 with respect to its investment in Alchemists?

Measurement

· 23

Answer

Measurement

24

Measurement

Elimination of unrealised profits/lossesInvestor

Associate (accountedfor using equity

method)

Up

stream

Dow

nstream

Unrealised profits / losses are eliminated to the extent of investor’s interest in associate

but NOT to the extent that the transaction provides evidence of an impairment of the asset transferred

· 25

QuestionAssume that Poltergeist Ltd owns 40% of Apple Book Co (ABC).

ABC sold books (inventory) to Poltergeist in 2002 for 10,000 above its cost to ABC. 20% of this inventory remains unsold by Poltergeist at the end of 2002.

ABC’s net income for the year, including the profit on the inventory sold to Poltergeist, is 100,000. Assume that ABC’s tax rate is 35%. How much of ABC’s profit should be recognised in Poltergeist’s income statement for the year?

(a) 40,000 (b) 39,200 (c) 39,480

Measurement

· 26

Answer

Measurement

· 27

Measurement

· 28

Impairment of an investment in an associate

Apply IAS 36 ‘Impairment of Assets’The recoverable amount of an investment in an associate is assessed for each associateThe entire carrying amount of the investment in the associate is compared to recoverable amount, which is the higher of value in use or fair value less costs to sell.

Measurement

Arjan Brouwer

Interests in Joint Ventures

· 30


IAS 31 - Scope and definitions

This standard shall be applied in accounting for interests in joint ventures, and thereporting of joint venture assets, liabilities, income and expenses in the

financial statements of venturers and investors

DefinitionsJoint Control – the contractually agreed sharing of control over an

economic activityJoint Venture – a contractual agreement whereby two or more parties

undertake an economic activity that is subject to joint control

· 31


Contractual agreement

• Within IAS 31, activities with no contractual arrangement to establish joint control are not joint ventures

• The contractual agreement– Distinguishes interests with joint control from those

where the investor has a significant influence– Ensures no single venturer is in a position to exert

universal control

32

Accounting for the different forms of Joint VenturesDifferent forms of Joint Ventures

Jointly Controlled Entities

Jointly Controlled Operations

Jointly Controlled Assets

An asset that is shared and jointly

controlled

No legal entity formed

Each venturer bears own costs and takes a share of the proceeds

An entity is created and jointly controlled

Separate legal entity formed

33

Accounting for jointly controlled entities

Benchmark treatmentProportionate Consolidation

Alternative treatmentEquity Method

Combine assets, liabilities, income and expenses on a

line by line basis.

Include separate lines for each of assets, liabilities,

income and expenses

Two methods

34

Transactions between a venturer and a jointly controlled entity Transactions in normal course of operations

Sale for amount in excess of

carrying value

Gain* recognised to the extent of other

venturers equity interest

Sale for amount less than

carrying value

Loss recognised to the extent of other

venturers equity interest

Entire loss recognised immediately

Was the asset impaired prior

to sale?

No

Yes* Gain recognised provided that significant risks and rewards of ownership are transferred

35

Transactions between a venturer and a jointly controlled entity Non-monetary contributions in exchange for an equity interest

Gains and losses to be treated as with

normal transactions.Exception is under SIC 13.

Gain/loss considered unrealised – not recognised in the Income Statement

Risks/rewards are not

transferred to JV, or

If

Reliable measure of gain/loss is not possible,

or

Contributed assets are similar (nature,use, fair

value) then

· 36

Transactions between venturer and Joint VentureQuestion- Snape is a business venture that is jointly controlled by Potter and

Dursley- Potter and Dursley both have a 50% interest in Snape- Both investors apply proportionate consolidation to account for their

investment in Snape- On 1 January 2009 Potter sells a warehouse for 150,000 in cash to

Snape- The warehouse transferred by Potter to Snape had a book value of

80,000 and a remaining useful life of 10 years

What is the gain to be reported by Potter in its consolidated accounts as of 31 December 2009?

· 37

Transactions between venturer and Joint VentureAnswer

· 38

Transactions between venturer and Joint VentureQuestionWhen can the remainder of the gain be recognised?

· 39

Transactions between venturer and Joint VentureAnswer

Arjan Brouwer

IFRS 10 and 11

· 41

Consolidation and Joint ArrangementsThe main elements of the new standards

Revised Control definition: Power and exposure to variable returns

De-facto control: Control present when < 50% shareholding?

Potential voting rights: Substance must be assessed

Two types of joint arrangements: Joint operations and Joint ventures. Distinction based on substance

Proportionate consolidation eliminated for JVs: All joint ventures will be equity accounted

Key changes to joint arrangement accountingTypes of joint arrangements

Joint arrangements don’t require ALL parties to have joint control

42

Type under IAS 31

Jointly controlled assets

Jointly controlled operations

Jointly controlled entities

Type under IFRS 11 Contractual rights and obligations under IFRS 11

Joint operations Rights to assets and obligations for the liabilitiesof the arrangement

Joint ventures Rights to the net assets of the arrangement

Key changes to joint arrangement accountingCommon terms in contractual arrangements

Joint Operation Joint Venture

Terms of the contractual arrangement

The parties have rights to the assets and obligations for the liabilities.

The parties have rights to the net assets relating to the arrangement.

Rights to assets The parties share all interests in the assets in a specified proportion.

The assets belong to the arrangement. No parties to the arrangement have rights, title or ownership in the assets.

Obligations for liabilities

The parties share all obligations for the liabilities in a specified proportion.The parties are liable for claims raised by third parties or by customers of the arrangement.

The joint arrangement is liable for debts and obligations of the arrangement.The parties are liable only to the extent of their investment in the arrangement.Creditors to the arrangement do not have any right of recourse against any party in respect of debts or obligations of the arrangement.

Revenues, expenses, profits or losses

The arrangement establishes allocation based on relative performance of each party (e.g. basis of capacity used by each party) - this could differ from their share in the arrangement.

The arrangement establishes each party’s share in profit or loss of the arrangement.

Guarantees The provision of guarantees, or the commitment to provide them, does not by itself determine the classification of a joint arrangement.

16

Arjan Brouwer

Entity accounts

Entity accounts – Valuation of participations

Consolidated financial statements

IFRS

IFRS

Accounting policies consolidated

financial statementsDutch GAAP

Entity accounts

‘My equity in the entity accounts

will be the same as that of the equity

in my consolidated accounts’

Valuation of participations in separate accounts:

a) At cost or based on IAS 39, when IFRS* separate;b) Net asset value based on IFRS*- valuation principles, when

IFRS* consolidated;c) Net asset value based on ‘Dutch GAAP’, when Title 9, Book 2

Civil Code.

Entity accounts - Valuation of participations

Arjan Brouwer

Business Combinations

Accounting: Overall concept

Purchase Accounting and Purchase Price Allocation:1. How much did you pay?2. Which identifiable assets did you acquire?3. Which identifiable (contingent) liabilities did you assume?4. What is the fair value of the acquired assets and liabilities?5. How much is the deferred tax?6. What is the difference between the price paid and the fair value of

net assets?

Assets, liabilities and contingent liabilities

Excluded elements

Non-controlling interest

Previous interest

Consideration

Goodwill

Within IFRS 3R - “double” column approach


Transaction costs


Previous interest

Consideration

Goodwill



Remuneration for future employee services


Previous interest

Consideration

Goodwill



Settlement of pre-existing relationships


Previous interest

Consideration

Goodwill


Case study “Travel Finance Solutions”

Part 1 – Cost of the acquisitionPart 2 – Pre-existing relationships and reacquired rightsPart 3 – Goodwill calculation: Partial and Full Goodwill MethodPart 4 – Step up and step down: the economic entity concept

• Proposed acquisition by Softpro of Travel Finance Solutions from Pear Plus and management

Travel Finance Solutions

Pear Plus Management

70%

Introduction to case study

10%

Mr. Dos

20%

Travel Finance Solutions – part 1

Cost of the acquisition

What forms part of the consideration?

Principles:• Paid to vendor : Assets transferred, liabilities incurred and

equity issued.• Measured at fair value (FV) at date control passes.• Exclude items not part of consideration.• Contingent consideration: recognised at FV. Subsequent

fair value changes are recognized in the income statement

Arrangement related to a specific asset or liability arising from a past event?

Neither contingent conside-ration nor indemnification

Contingent consideration or Indemnification

Contingent consideration

Obligation or right of acquirer

Indemnification

Obligation of seller

Arrangement related to future events or conditions?

NO YES

NO YES

Indemnification or Contingent Consideration ?

Contingent consideration – Acquisition date accounting

Recognition At acquisition date!

Measurement Fair Value!

Classification Debt/Asset or Equity!

Contingent consideration - Post acquisition accounting

Contingent consideration classified as:

Asset / Liability

Re-measure at FV IAS 39

•Financial liability•Financial asset

(IAS 37)

EquityNo re-measurement

Indemnification

Recognition andMeasurement

Based on indemnified item

Exception to recognition and FV measurement principle!

Points to consider:

Limitation on indemnified amount

Credit worthiness of the seller

Shareholder or employee ?Contingent consideration?

Continuing employment required?

Payments forfeited when employment terminates?

Contingent consideration

Post-acquisition employment expense

Allocate, to consider:• Duration (of employment

vs contingency)• Level of remuneration• Incremental payments• Linkage to valuation/

formula used

NO

YES

YES

NO

Travel Finance Solutions – part 1

Cost of the acquisition

Travel Finance Solutions – Part 2

•Pre-existing relationships and reacquired rights

What are pre-existing relationships and reacquired rights?

Pre-existing relationship– A relationship that existed between the acquirer and acquiree

before the business combination was contemplated– Can be contractual or non-contractual

Reacquired right– A right that the acquirer had previously granted to the acquiree

to use one or more of the acquirer's recognised or unrecognised assets, and which the acquiree still held at acquisition date

– Separately identifiable intangible asset of acquiree

Examples of pre-existing relationships and reacquired rights

Fixed volume, market price purchase contract

Lease for office accommodation

Right to use a patent

Distributorship

Legal case

Fixed price supply contract

Possible interdependency

A B

Settlement of pre-existing relationship

Recognition of reacquired right (if any)

Pre-Business Combination

At date of Business Combination

How are pre-existing relationships and reacquired rights accounted for?

Pre-existing relationship– A separate value must be allocated to the relationship that

existed between the acquirer and acquiree before the business combination was contemplated

– Does not form part of the consideration for the business, but settlement is separately accounted for

Reacquired right– A reacquired tight is a separately identifiable intangible asset of

the acquiree and is therefore separately recognized in the PPA.

Settlement of the relationship

Settlement of relationship

At FV Lower of:

Favourable/ unfavourable element

Settlement provision in contract

Contractual relationship

NO YES


•Pre-existing relationships and reacquired rights


Goodwill calculation: Partial and Full Goodwill Method

Case study – Goodwill determination

“Travel Finance Solutions ” – Acquisition facts– Purchase price of the 80% interest: EUR 750 million– Total transaction costs: EUR 20 million– Fair value of identifiable assets and liabilities: EUR 670 million

Question: calculate the goodwill based on the full goodwill method and the partial goodwill method.

Case study – Goodwill Determination based on partial method

Partial method is in line with past practice

Goodwill calculation IFRS 3R partialTotal purchase consideration 750.000 Net identifiable assets 670.000- Non-controlling interest 134.000 Goodwill 214.000

Case study – Goodwill Determination based on full method

IFRS 3R – The goodwill associated with both the acquirer’s interest and non-controlling interest (i.e. 100% of the goodwill of the acquiree) may be recognized in a business combination

Accounting Impact – Companies that make the choice to recognize the non-controlling interest at fair value (full goodwill method) will recognize more goodwill. Recording goodwill for the non-controlling interest may present new complexities surrounding valuation, allocation, and impairment testing

Goodwill calculation IFRS 3R partial IFRS 3R fullTotal purchase consideration 750.000 750.000 Net identifiable assets 670.000- 670.000- Non-controlling interest 134.000 187.500 Goodwill 214.000 267.500

Travel Finance Solutions – case study

Part 4 – Step up and step down: the economic entity concept

Non controlling interests: the economic entity modelKey features of the economic entity model

• 100% of subsidiary assets/liabilities recognised - including goodwill – with a portion allocated to non-controlling interest

• Non-controlling interest presented within equity/appropriation of profit

• Transactions with minorities are considered transactions with equity holders and treated as contributions and distributions

• Disclosures required to explain impact of transactions with non-controlling interest

Stepping up and down

Impact of economic entity model:• No gains or losses in income statement from transactions with non-

controlling (minority) interest holders.• No (new) PPA or goodwill when non-controlling interest is acquired.

Impact recognized in equity.

But:• Gains or losses are recognized when control is lost (also on the interest

retained) or when control is acquired (on the previously held interest)• See double column approach: all elements at fair value.

Example 1: Stepping upStep-acquisition - pre-existing interest

In 20X1 Softpro acquires 40% stake in Click Limited for EUR 4m

In 20X2 Softpro acquires remaining 60% stake for EUR 12m

20X2: 40% stake carrying value EUR 5.5m.

20X2: FV of 40% was EUR 8m

GAIN on re-measurement of associate EUR 2.5m in income statement

Example 2: Stepping down Principles of losing control

De-recognise assets (inc. goodwill) and liabilities

De-recognise NCI

Recognise consideration received

Recognise at Fair Value any investment retained

Reclassify to income statement any gain or loss previously recognised in other comprehensive income

Difference to income statement

Travel Finance Solutions – case study

Part 4 – Step up and step down: the economic entity concept

Arjan Brouwer

UvA IFRS 1 courseBusiness combinations and consolidation

uva ifrs 1 consolidation and business combinations bb

Documents

travel finance solutions

special purpose entity

economic entity concept

full goodwill method

de facto control

potential voting rights

jointly controlled

significant influence