ASEM IFRS SEMINAR
Shanghai, 25-26 March 2006
Consolidation and Business Combinations
Changes to IFRS 3, IAS 27, IAS 37
Reinhard Biebel, EFRAG Deputy Technical Director
www.efrag.org
Consolidation - Combination
Acquisition
Merger
Common Control
Hostile take-over
De facto Control
Joint Venture
Need for consolidated information
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Racing ahead …
1993
1996
-1999
IAS 22(revised 1993)
minor changes
SIC 9, 22 & 28
2004
31 March  IFRS 3
2005
30 June  ED IFRS 3
????
©EFRAG 2006
minor changes 2004-2005
?  common control
fresh-start (true mergers)
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3 – Phase II
 Issued 30 June 2005
 Joint project with US standard setter FASB
 Objective = improvement and convergence IASB/FASB
 Consequential amendments to IAS 27, 37 and 19
 Completely new method of treating:
 Business combinations
 Minority interests (now: non-controlling interests)
 Contingent assets and liabilities
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Changes to terminology
Minority-interests
Non-controlling interest (NCI)
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Changes to definitions
Business combination [IFRS 3]
The bringing together of separate entities or businesses
into one reporting entity
Business combination [ED IFRS 3]
A business combination is a transaction or other event
in which an acquirer obtains control of one or more
businesses
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Control under IAS 27
IASB Statement, IASB Update October 2005:
“IAS 27 contemplates that there are circumstances in
which one entity can control another entity without
owning more than half the voting power.”
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Acquisition method
 Amendment:
Purchase Method 
Acquisition Method
1. Identify acquirer
2. Determine the acquisition date
3. Measure the fair value of the acquiree
4. Recognise and measure identifiable assets
acquired and liabilities assumed at fair value

1+2  similar to current IFRS 3

3+4  amended to reflect the transition to full fair value
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Significant changes
IFRS 3
ED IFRS 3
Business combination recognised
and measured at the acquiror’s
accumulated cost at the
acquisition date (aggregate of the
fair values of assets given, liabilities
assumed, and equity instruments
issued)
Business combination recognised
and measured at fair value of the
acquiree at the acquisition date
Direct costs of acquisition
recognised in the cost of the
business combination
Direct costs of acquisition
recognised separately, i.e. typically
in profit or loss
©EFRAG 2006
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Even if achieved in stages or if less
than 100% of the equity interests
are owned
AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Significant changes
IFRS 3
ED IFRS 3
Contingent consideration only
recognised in the cost of acquisition at
the acquisition date, if payment is
probable and can be measured
reliably
Contingent consideration measured at
fair value at the date of acquisition
Subsequent changes in contingent
consideration affect goodwill (+/÷)
Subsequent changes in contingent
consideration classified as liabilities are
recognised in accordance with IAS 39,
IAS 37 or other relevant IFRS and
typically affect profit or loss
Large number of
disclosures required
More new disclosure
requirements
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Significant changes goodwill gross up
 Acquired business measured at fair value as a
whole
 100% goodwill recognised
 Consistent with treatment of other assets
 Goodwill allocated between acquirer and noncontrolling interest (was minority interest)
 Allocation of goodwill to acquirer based on:
 Fair value of acquirer’s equity interest LESS
 Fair value of share of net assets acquired
 Balance to NCI
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Goodwill example
 P acquires 75% (750 000 shares) of S for CU7.5m
 Shares in S trading about A$8 per share
 Expectation of synergies
 Independent valuation  value of S = CU9.7m
 Fair value of net assets acquired = CU8m
Current requirements IFRS 3
Consideration
Share of identifiable A+L
(75% 8m)
Goodwill as per IFRS 3
©EFRAG 2006
Current requirements IFRS 3
7,5
(6,0)
1,5
12
Goodwill
1,5
Net assets
8,0
Minority interest
2,0
AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Goodwill example
ED IFRS 3
Fair value of S
Fair value of net assets
Current requirements IFRS 3
Goodwill
1,5
Net assets
8,0
Minority interest (MI)
2,0
Goodwill
Share of identifiable A+L
(75% 8m)
ED IFRS 3
1,7
Net assets
8,0
Non-controlling interest (NCI)
©EFRAG 2006
2,2
(8,0)
1,7
ED IFRS 3 - allocate to P
Consideration
Goodwill
9,7
13
7,5
(6,0)
GW allocated to P
1,5
=> Balance to NCI
0,2
AISAM SEMINAR 25-26 March 2006
Step acquisitions
 Change in accounting for step acquisitions
 A owns an investment in B
 B = associated comp to A (i.e. A doesn’t control B)
 If A increase its stake & gains control over B it must
 Determine fair value of associate
 Recognise profit/loss in income statement
 Follow the provisions of IFRS 3
• Cost would include fair value of B
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Step acquisition – illustration
 A owns 35% stake in B at 31 Dec 2007
 Book value at 31 Dec 2007 = CU2,500
 Buying additional 40% on 31 Dec 2007 at CU4,000
 Fair value (FV) of total B = CU10,000
31 Dec 2007
 A recognise gain of CU1,000 [(35%*CU10,000)- CU2,500]
 A accounts for 40% purchase under ED IFRS 3
 FV of all of B = CU10,000 and FV of 75% of B = CU7,500
 Subsequent purchases = equity transaction
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IFRS 3: Acquisition costs
•Recognised in profit
or loss
•Impact on
goodwill
•Represent
payment for
services (e.g.
legal costs.
auditor, bank)
Direct
acquisition
costs
•Do not represent
assets of acquirer
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Contingent consideration
 Fair value of consideration paid includes fair value
of contingent consideration at acquisition date
 Classify as debt or equity per IAS 32
 Examples
 Financial or non-financial hurdles
 Share-based payment
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Contingent consideration
 Measurement period* adjustments
 12 months from date of acquisition (no change)
 New information about facts existing at acquisition date
 Post measurement period
 Equity  not remeasured
 Otherwise  re-measure
•  No impact on business combination
* Measurement period = reasonable time to obtain
information about facts and circumstances existing
at acquisition date. Limited to on year.
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Contingent consideration - example
 Contingent consideration of CU6m payable if
certain profit targets met
 Fair value on acquisition date is CU4m
 Subsequent changes reported in I/S
 As likelihood of meeting target increases, so does liability
 When target met, liability is recorded at CU6m
 CU2m will have been recorded in I/S
 No impact to accounting for business combination
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Other changes
Date of acquisition
Recognition of intangibles – probability and
reliability criterion!
Treatment of negative goodwill
…
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Board members view on ED IFRS 3
 Proposed effective date 1 January 2007
 Quite a few IASB Board Members have
dissenting opinions (alternative views)
 Recognise goodwill at 100%
5 dissenters
 Increase/decrease in stake after control
3 dissenters
 Definition of ‘business combination’
2 dissenters
 Widening of scope
1 dissenter
 Direct cost to be recognised in I/S
2 dissenters
 Removal of ’reliable measurement’
-criteria re. intangible assets
in Business Combinations
1 dissenter
 Important joint project with FASB
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
EFRAG position on ED IFRS 3
Reasons for not supporting the EDs:
 introduction of radical new and untested concepts,
 the reasons for issuing the proposals and the assumed benefits,
 the increased use of fair value without a conceptual debate,
 the accounting for business combinations at fair value,
 the application of an economic entity view,
 the proposed full goodwill method,
 the proposed treatment of acquisitions in steps,
 the extended scope without providing a solution for true mergers.
This does not pre-empt an assessment regarding endorsement
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Business Combinations II:
Changes to other standards
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Other standards affected
 IAS 27 Consolidated and Separate Financial
Statements
 IAS 37 Provisions, Contingent Liabilities and
Contingent Assets
 IAS 19 Employee Benefits
 Purpose of proposed changes:
 to align ongoing accounting with that required on a
business combination (e.g. re contingencies)
 to align IFRS with US GAAP in certain areas (e.g.
restructuring)
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IAS 27: “non-controlling interest”
(NCI)
 ‘Minority interest’
‘non-controlling interest’
 Non-controlling interest classified as equity
 Transactions with NCI = equity transactions
 Gains/losses recorded in P&L only on loss of control
 Losses applicable to NCI are allocated to NCI - any
guarantees/support arrangements accounted for
separately
 currently, losses not allocated to minority unless binding
obligation on them to make good losses incurred which
they are able to meet
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IAS 27: Increased stake in sub




 Increase from 80% to 100%
 Transaction with EQ holders =>



No change to goodwill
(already at 100%)
No gain/loss recorded
Consideration paid/payable
debited to EQ
ED IAS 27
 Current position – no detailed
guidance

A owns 80% of B
Consolidated equity of B = 100
A’s share = 80, NCI = 20
A buys remaining 20% for 30
Typically recognise additional
goodwill
D
NCI (share of
consolidated equity)
20
Equity*
10
C
Cash/creditors
 Different views internationally


how to measure additional GW
what to do about fair value
changes re assets / liabilities
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 Debit of 10 = excess price parent
paid to acquire NCI
*The draft doesn’t explain where these
debits/credits should be recognised
AISAM SEMINAR 25-26 March 2006
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ED IAS 27: Decreased stake in sub





 Decrease from 80% to 60%
 Transaction with EQ holders =>



No change to goodwill
(already at 100%)
No gain/loss recorded
Consideration received /
receivable credited to EQ
 Current position – no detailed
guidance:

Typically recognise gain or loss
on “part disposal”
 No real consensus on reduction to
goodwill?
A owns 80% of B
Consolidated equity of B = 120
A’s share = 96, NCI = 24
A sells 20% for 40
A retains control over B
ED IAS 27
D
Cash/debtors
40
C
NCI (share of
consolidated equity)
24
Equity
16
 Credit of 16 = gain from sale of NCI
 Currently gain/loss goes to P/L. Not
possible under the ED.
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IAS 27: disposal of subsidiary
 Disposal  when loss of control
 Need not involve change in stake
 On disposal, any continuing EQ
interest to be remeasured to FV
 currently, typically roll forward
appropriate proportion of carrying
amount





A owns 100% af B
Consolidated equity of B = 800
A sells 60% and loses control
Proceeds on sale of 60% = 500
FV of remaining 40% = 400
ED IAS 27
Cash/receivables
 Gain/loss to income statement on + FV, remaining investment
disposal determined as
 FV of Proceeds + FV of any
retained investment MINUS
 Aggregate of parent’s interest in
carrying amount of net assets prior
to disposal
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Total
- Consolidated NA of B
Gain on disposal
FV of remaining 40% (400)
applied as cost of initial
investment under IAS 28
AISAM SEMINAR 25-26 March 2006
500
400
900
(800)
100
ED IAS 37: change to terminology
 ‘Contingent liabilities’ & ‘contingent assets’ cease to
exist
 If obligation exists = ‘non-financial liability’
 If rights exist = asset
 If obligation/rights don’t yet exist because conditional =
‘contingency’
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
ED IAS 37: New Recognition Criteria
100%
IAS
37
ED


50%
0%
÷
©EFRAG 2006

Probability criterion omitted from ED
Probability
Example
 A has obligation to B
 20% chance A will have to pay
CU1m
 80% chance A will pay nothing

Currently: no provision

Proposed: recognise CU0,2m
liability (CU1m x 20%)
 Similar applies to assets: if rights
exist, recognise asset (IAS 38/IAS 37)
Result = more asset & liabilities on balance sheet
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AISAM SEMINAR 25-26 March 2006
ED IAS 37: Measurement
Measurement
principle
Move away from concept of ‘best
estimate’ to more fair value based ’exit
value’
Single obligation
‘Most likely outcome’ not necessarily
consistent with the ED’s measurement
objective
Future events
Take into consideration if sufficiently
objective evidence exits
Reimbursements
Move away from ’virtually certain’.
Recognise if unconditional right to
receive.
Restructurings
Recognise only when definition of
liability is satisfied. Specific guidance
deleted.
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
Conclusion
New proposals for accounting for Business Combinations
are seen critical because of:
 Increased use of fair value
 New an untested concepts
 Practicability concerns
 Usefulness of information
 Scope
IASB indicated to re-deliberate most of new concepts
Final standard in 2007
Will IASB and FASB come up with a practical solution?
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006
“xiè xie”
©EFRAG 2006
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AISAM SEMINAR 25-26 March 2006