Chapter 12
Business Combinations
Prepared by
Mark Vallely
Learning objectives
1. Discuss the nature of a business combination and its various forms (p. 568)
2. Explain the basic steps in the acquisition method of accounting for business
combinations (p. 570)
3. Account for a business combination in the records of the acquirer (p. 574)
4. Recognise and measure the assets acquired and liabilities assumed in the
business combination (p. 574)
5. Discuss the nature of and the accounting for goodwill and gain from bargain
purchase (p. 580)
6. Account for shares acquired in the acquiree (p. 594)
7. Prepare the accounting records of the acquiree (p. 597)
8. Account for subsequent adjustments to the initial accounting for a business
combination (p. 601)
9. Apply the disclosures required under AASB 3 (p. 604).
The nature of a business combination
• AASB 3 defines a business combination as:
–
‘a transaction or other event in which an acquirer obtains control of one
or more businesses’
• Control has the same meaning as defined in AASB 10
Consolidated Financial Statements (refer to CH 18)
• Control exists when
–
An investor is exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect those
returns through its power over the investee
• A ‘business’ is not just a group of assets
–
–
–
An integrated set of activities and assets
Capable of being conducted / managed to provide a return
in the form of dividends, lower costs or other economic benefits
The nature of a business combination
Assuming the existence of two companies – A Ltd and B Ltd
Four general forms of business combination are as follows :
1. A Ltd acquires all assets and liabilities of B Ltd
B Ltd continues as a company, holding shares in A Ltd
2. A Ltd acquires all assets and liabilities of B Ltd
B Ltd liquidates
3. C Ltd is formed to acquire all assets and liabilities of A Ltd and
B Ltd
A Ltd and B Ltd liquidate
4. A Ltd acquires a group of net assets of B Ltd
Refer to figure 12.2 of text for key steps
(that constitutes a business)
involved under each of the above
B Ltd continues to operate
scenarios
Accounting for business combinations:
Basic principles
AASB 3 prescribes the acquisition method in
accounting for a business combination. The
key steps in this method are:
1.
2.
3.
4.
Identify an acquirer
Determine the acquisition date
Recognise and measure the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest* in the acquiree; and
Recognise and measure goodwill or a gain from
bargain purchase.
* Non-controlling interest – you do not have to purchase all the shares in B
Ltd to obtain control. E.g. A Ltd acquires 60% of shares in B Ltd; the other
40% B Ltd shares are held by the NCI
Accounting for business combinations:
Step 1 – Identifying the acquirer
•
•
•
The business combination is viewed from the perspective of
the acquirer
The acquirer is the entity that obtains control of the acquiree
In most cases this step is straight forward. In other cases
judgement may be required.
–
–
–
•
E.g. where two existing entities (A&B) combine and a new entity (C) is
formed to acquire all the shares of the existing entities
Who is the acquirer?
A or B – it cannot be C
Indicative factors contained within Appendix B of AASB 3 assist
in identifying the acquirer
Accounting for business combinations:
Step 2 – Determining the acquisition date
• Acquisition date is ‘…the date on which the acquirer obtains
control of the acquiree’
(AASB 3 Appendix A)
• Determining the correct acquisition date is important as the
following are affected by the choice of acquisition date:
– The fair values of net assets acquired
– Consideration given, where the consideration takes a non-cash form
– Measurement of the non-controlling interest
• Discussed in chapter 21
– Measurement of the FV of any equity holding acquired prior to gaining
control (e.g. an initial 20% holding)
Accounting in the records of the
acquirer
• In a business combination the acquirer has to consider:
– The recognition and measurement of the identifiable assets
acquired and the liabilities assumed (Step 3 of the
acquisition method)
– The recognition and measurement of goodwill or a gain
from a bargain purchase (Step 4 of the acquisition method)
• In this chapter
– We do not consider business combinations in which the
acquirer purchases shares in the acquiree
• Parent – Subsidiary relationships are considered in detail in Chapters
18 to 22.
• How to account for the acquirer’s investment in section 12.6
Accounting in the records of the acquirer:
Step 3 – Recognition/measurement of
assets acquired and liabilities assumed
Recognition
• Fair value allocation occurs at acquisition date and requires the
recognition of:
–
–
–
–
–
In accordance with Framework definition
Identifiable assets acquired
(AASB 3 – para. 11)
Liabilities assumed
Contingent liabilities
Any non-controlling interest in the acquiree
Goodwill
• FVINA = fair value of identifiable net assets (incl. contingent
liabilities)
– Recognise all identifiable assets acquired and liabilities assumed
regardless of the probability of inflows and outflows
– Therefore, certain contingent liabilities are included in FVINA
– Probability is dealt with in the measurement of FV
Accounting in the records of the acquirer:
Step 3 – Recognition/measurement of
assets acquired and liabilities assumed
Recognition – Contingent Liabilities
•
AASB 3 requires that contingent liabilities which can be
measured reliably are recognised by the acquirer
–
–
–
Therefore contingent liabilities where a present obligation exists
But that do not qualify for recognition in the acquiree's books under
AASB 137
May be recognised by the acquirer as part of a business combination
Possible obligations are not recognised in a business combination
•
What is the fair value of a contingent liability?
–
–
–
It is the amount that a third party would charge to assume those
contingent liabilities.
Such an amount reflects the expectations about possible cash flows.
It is not simply the expected maximum/minimum cash flow
Accounting in the records of the acquirer:
Step 3 – Recognition/measurement of
assets acquired and liabilities assumed
Recognition – Intangible assets
• The AASB 3 recognition requirements, based on Framework
definitions, can result in the recognition of intangible assets
excluded by AASB 138
–
–
Where the asset can be measured reliably
Refer to Figure 12.3 for a list of possible intangibles assets recognised
when accounting for a business combination
Examples include trademarks, customer lists, royalty agreements, patented
technology etc.
• FV of an intangible reflects market expectations about the
probability of future economic benefits flowing to the entity
–
E.g. if the expected benefits are $1,000 and the probability of receiving
the benefits is 90%, the fair value will be $900
Accounting in the records of the acquirer:
Step 3 – Recognition/measurement of
assets acquired and liabilities assumed
Measurement
• AASB 3 requires that assets acquired and liabilities and
contingent liabilities assumed are measured at FV
–
–
–
–
Fair value is basically a market based measure (exit value)
Determined using judgement and estimation (three techniques)
Based on data using a three-level ‘fair value hierarchy’
AASB 13 requirements are discussed in detail in chapter 5.
• The determination of FV for all assets and liabilities takes time
–
–
–
–
Acquirer has 12 months from acquisition date to determine fair values
At first balance date after acquisition the fair values may only be
provisionally determined – a best estimate
Finalisation of fair values will result in adjustments to goodwill
Refer to Figure 12.5 – the Wesfarmers acquisition of Coles
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Consideration transferred
• Consideration transferred is measured at fair value
at the date of acquisition, calculated as the sum of:
• Assets transferred by the acquirer
• Liabilities incurred by the acquirer to the former owners
(e.g. settlement via a series of cash payments)
• Equity instruments issued by the acquirer
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Consideration transferred
Consideration paid by the acquirer may consist of one or
a number of the following forms of consideration:
•
•
•
•
•
•
Cash
Non-monetary assets
Equity instruments
Liabilities undertaken
Cost of issuing debt/equity instruments
Contingent consideration
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Consideration – Cash
• Where the settlement is deferred, the cash must be discounted
to present value as at the date of acquisition
• The discount rate used is the entity’s incremental borrowing
rate; interest expense is recognised on payment
Consideration – Equity instruments
• Where an acquirer issues their own shares as consideration
they need to determine the fair value of the shares as at the
date of exchange
• If listed, the fair value is the quoted market price of the shares
(with a few limited exceptions)
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Costs of issuing debt and equity instruments
• Transaction costs such as stamp duties, underwriting fees and
brokers fees may be incurred in issuing equity instruments
• Such costs are considered to be an integral part of the equity
transaction and should be recognised directly in equity
• Journal entry required would be:
Dr Share Capital xx
Cr
Cash
xx
• Costs associated with the issue of debt instruments are
included in the measurement of the liability
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Contingent consideration
• In some cases the agreement will provide for additional (or
repayment of) consideration , contingent on a future event
• Example
–
Where an acquirer issues shares as part of their consideration, the
agreement may require an additional payment IF the value of the
shares falls below a certain amount within a specified period of time
• If the adjustment is probable and can be measured reliably,
then the amount should be included in the calculation of the
cost of acquisition
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Acquisition related costs
• Acquisition related costs that are directly attributable to a
business combination
–
Do not form part of the consideration transferred (expense as incurred)
* Compare this to the requirements of AASB 116 PPE and AASB 138 IA,
where such costs are capitalised into the cost of acquisition
• Examples include:
–
–
–
Finder’s fees
Advisory, legal accounting, valuation and other professional or
consulting fees
General administrative costs, including the costs of maintaining an
internal acquisitions department.
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Example
On 1 January 2016 A Ltd acquired all the assets and liabilities of B
Ltd. Details of the consideration transferred are as follows:
•
Cash of $400,000, half to be paid on 1 January 2016, with the balance due on
1 January 2017. The incremental borrowing rate for A Ltd is 10%
•
100,000 shares in A Ltd were issued. The share price on 1 January 2016 was $1.50
per share. This price represented a six-month high. Costs of issuing the shares was
$1,000.
•
Due to doubts as to whether the share price would remain at or above the $1.50
level, A Ltd agreed to supply cash to the value of any decrease in the share price
below $1.50. This guarantee was valid for a period of 3 months (to 31 March 2016).
A Ltd believed that there was a 75% chance that the share price would remain at or
above $1.50 until 31 March 2016 (and a 25% chance that it would fall to $1.40)
•
Supply of a patent to B Ltd. The fair value of the patent is $60,000. As the patent
was internally generated it has not been recognised in A Ltd’s books.
•
Legal fees and associated costs with the acquisition totalled $5,000.
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Example: Required – Calculate the consideration transferred
Cash
Discounted to PV at rate of 10%
Shares
Based on quoted
market price
Guarantee
Payable now
200,000
Deferred ($200,000 x 0.909091)
181,818
100,000 x $1.50
150,000
100,000 x ($1.50-$1.40) x 25%
2,500
Based on probability of share price falling below $1.50
Patent
FV of patent
Total cost of acquisition
Share issue costs, legal fees and stamp duty are excluded from the calculation
60,000
594,318
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Goodwill
• Provides future economic benefits from assets that could not
be individually identified or separately recognised in the
combination
What would happen to
• AASB 3 requires that the goodwill is:
reported Goodwill if
– Recognised as an asset
– Measured at its cost at the date of acquisition
Brand Names and
other intangible assets
were not included in
the FVINA?
• Goodwill = Consideration transferred
Less
Acquirer’s interest in the FVINA
• Goodwill is considered to be a residual, and as such is affected
–
–
By the way consideration is measured
By what is recognised in FVINA and how it is measured
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Goodwill Example
Details of B Ltd’s assets and liabilities
acquired by A Ltd are as follows:
CA
FV
Plant & equipment
360,000
367,000
Land
260,000
257,000
Inventory
24,000
30,000
Accounts receivable
18,000
16,000
Accounts payable
(35,000)
(35,000)
Bank overdraft
(55,000)
(55,000)
Net assets
572,000
580,000
B Ltd is currently being sued by a previous customer. The expected damages is
$50,000. Lawyers estimate that there is a 20% chance of losing the case.
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Goodwill Example – Required:
a) Calculate the FVINA acquired and determine the goodwill on acquisition.
b) Prepare the journal entry in the books of A Ltd to account for the
acquisition
Fair value of recorded net assets
580,000
Carrying amounts in B’s books are irrelevant to A
Less: Contingent liability re damages ($50,000 x 20%)
(10,000)
Based on probability of losing the case
FVINA
Cost of acquisition
Goodwill on acquisition
570,000
Per Slide 20
“Residual” interest
594,318
24,318
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Journal entries in the books of A Ltd to account for the acquisition
Plant & equipment
367,000
Land
257,000
Inventory
30,000
A/C Receivable (net)
16,000
Goodwill
24,318
Residual interest
FV
A/C Payable
35,000
Bank o/draft
55,000
Provision for damages
10,000
Contingent liability
Cash
Deferred consideration payable
Share capital
Provision for loss in value of shares
Gain on sale of patent
200,000
Components of
cost of acq’n
181,818
150,000
2,500
60,000
FV
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Journal entries in the books of A Ltd to account for the
acquisition (cont.)
Legal fee expenses
5,000
Share capital
1,000
Cash
6,000
Accounting in the records of the acquirer:
Step 4 – Goodwill / gain on bargain purchase
Gain on bargain purchase
Refer to example 10.3 of text
• A gain on bargain purchase rises
–
When the acquirer’s interest in the FVINA exceeds the consideration
transferred
• The existence of a gain on bargain purchase is an anomalous
transaction – it should be a rare event
–
A fire sale? Excellent bargaining skills?
• In the event of a gain on bargain purchase the acquirer is
required to reassess if it has correctly
–
–
–
Identified all the assets acquired and liabilities assumed
Measured at fair value all the assets acquired and liabilities assumed
Measured the consideration transferred
• If a bargain purchase remains, it is recognised immediately as a
gain in the profit & loss
Accounting by the acquirer:
shares acquired in an acquiree
• Often the acquirer invests in shares of the acquiree (rather than
acquiring the net assets
• Accounting depends on the acquirer – acquiree relationship
–
AASB 9 Financial Instruments applies, unless the acquiree is a Subsidiary,
Associate, Joint Venture or Joint Arrangement
• AASB 9 requires the investment to be accounted
for at FV of the consideration
• The accounting treatment in the acquirer’s
books at acquisition is:
Dr Investment in A
XX
Cr Cash
XX
• Refer to Example 12.4
Accounting by the acquirer:
shares acquired in an acquiree
• At initial recognition , AASB 9 requires the acquirer to make an
irrevocable choice regarding where to record subsequent
movements in fair value:
– In profit and loss; or
– Other comprehensive income (OCI)
• Transaction costs incurred on the acquisition (such as stamp
duty) are accounted for as follows
– If subsequent movements in FV are accounted for through profit or loss
> transaction costs are expensed
– If subsequent movements in FV are accounted for OCI > transaction
costs are included in the measurement of the cost of investments
Accounting in the records of the acquiree
Acquiree does not liquidate
Refer to Figure 12.19
• Where the acquiree sells a business to the acquirer and
continues its other businesses
– AASB 116 applies - It recognises a “Gain /Loss on sale of operation” and
de-recognises the assets sold and liabilities transferred
Acquiree liquidates
•
Refer to Figure 12.20
A “Liquidation account” and a “Shareholders’ distribution
account” are used to effect the liquidation
Acquirer buys only shares in the acquiree
•
No entries are required in the books of the acquiree
–
Change in share ownership is reflected in the share register only
Subsequent adjustments to the initial
accounting for business combinations
• Adjustments may be made subsequent to acquisition
date in relation to:
– Goodwill
– Contingent liabilities
– Contingent consideration
Goodwill
• Cannot be revalued
• Cannot be amortised
• Is subject to annual impairment testing
– Refer chapter 13
Subsequent adjustments to the initial
accounting for business combinations
Contingent liabilities
• Contingent liabilities are initially recognised at FV
• Subsequent to acquisition date the liability is measured as the
higher of:
(a) the best estimate of the expenditure required to settle the present
E.g. where a liability was recognised in
obligation; and
relation to a court case
(b) the amount initially recognised less cumulative amortisation
recognised in accordance with AASB 118 Revenue.
E.g. where a liability was recognised in relation to a
guarantee
• Subsequent adjustments do not affect the goodwill calculated
at acquisition date.
Subsequent adjustments to the initial
accounting for business combinations
Contingent consideration
• At acquisition date, the contingent consideration is measured at
fair value, and is classified either:
• As equity
• For example
– The requirement for
the acquirer to issue
more shares subject
to subsequent events
• As a liability
• For example
– The requirement to
provide more cash
subject to subsequent
events.
Subsequent adjustments to the initial
accounting for business combinations
Contingent consideration
• Subsequent accounting treatment is a follows:
• Classified as equity
– No re-measurement is
required
– Subsequent settlement is
accounted for within equity.
– This means that extra equity
instruments issued are
effectively issued for no
consideration and there is no
change to share capital
• Classified as a liability
–
–
–
Accounted for under AASB 9
or AASB 137
Where the contingent
consideration is a financial
liability, AASB 9 requires
changes in FV via the P&L
If not a financial liability,
AASB 137 applies
Disclosures
• AASB 3 contains extensive disclosure requirements in
relation to business combinations
• Apply Appendix B, which is an integral part of AASB 3
• Figure 12.23 provides a sample of the disclosures
• Figure 12.24 provides an example – Boral Ltd 2012
annual report