IFRS Business Comb Consolid Fin Stments March09

8/2/2019 IFRS Business Comb Consolid Fin Stments March09

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Business combinations

and consolidatedfnancial statements

How the changes will impactyour business



Business combinations and consolidated fnancial statements

Contents

Executive summary 1

1. Introduction 3

2. Changes in application of the acquisition method of accounting 4

3. Consolidated financial statements 11

4. Effective date and transition 14

5. Differences between IFRS and US GAAP 15



1Business combinations and consolidated fnancial statements

Executive summary

In this publication, we discuss the key

changes introduced by IFRS 3R and IAS27R and what these will mean for your

business — in particular, how they may

change the way acquisitions are structured

and negotiated. The most signicant

changes introduced and their potential

impact can be seen in Table 1 below.

Sections 2 and 3 discuss IFRS 3R and IAS

27R in more detail. Applying the new

requirements will mean, in many cases,

that either goodwill will be lower or that the

reported results of the group will decrease

or become more volatile — both in the year

of acquisition and subsequently. And all

of this could have an impact on debt

covenants and management remuneration

structures tied to the performance of the

group, which will require management

to re-examine these. Every acquisition

will be affected by the requirement to

expense transaction costs.

The changes will also require more

extensive disclosures, particularly

of the determination of fair value

for contingent liabilities acquired.

Going forward, management will

need to ensure that disclosures meet

the requirement of the standard,

without being detrimental to future

negotiations or its competitive position.

IFRS 3R and IAS 27R are not applicable

until annual periods beginning on or after1 July 2009, although early application is

permitted for annual periods beginning on

or after 30 June 2007. 1 July 2009 may

seem a long way off, but management

should consider the effect of changes when

planning or negotiating future transactions,

particularly where a less than 100% interest

is being acquired. Generally, there is no

need to restate acquisitions that take place

prior to the effective date. The exception

to this and the specic requirements for

transitioning to the new standard are

discussed further in Section 4.

While the project was conducted jointly

with the US Financial Accounting Standards

Board (FASB) as part of the convergence

programme with the IASB, and is based on

the same underlying principles, a number

of differences between the IASB and

FASB standards exist due to different

‘exemptions’ within the revised standards,

and the interaction of the business

combinations standards with other IASB

and FASB standards that differ from each

other. A summary of the key differences

is contained in Section 5.

In January 2008, the International Accounting Standards Board (IASB or Board) issued revised standards,

IFRS 3 Business Combinations (IFRS 3R) and IAS 27 Consolidated and Separate Financial Statements (IAS

27R), that signicantly change the accounting for business combinations and transactions with non-controlling

interests (minority interests).



Table 1: Summary of key changes in accounting and their impact on goodwill and reported results

Impact on

Summary of change Goodwill

Time/cost to

implement

Reported results

Volatility Earnings

Option to measure non-controlling interest at its fair value (a) — —

Accounting for changes in ownership interests of a subsidiary

(that do not result in loss of control) as an equity transaction

(a) — — (a)

Contingent consideration recognised at fair value at the date

of acquisition, with subsequent changes generally reected in

prot or loss

Future

Expensing acquisition costs as incurred — —

Current

Reassess the classication of all assets and liabilities of

the acquiree—

Separately account for re-acquired rights of the acquirer and

pre-existing relationships between the acquirer and acquireeor —

Contingent liabilities only reect those that are present

obligations arising from past events

— —

Recognise gains or losses from measuring initial equity holdings

in step acquisitions at fair value—

Current

Separately account for indemnities related to liabilities of

the acquiree— —

2 Business combinations and consolidated fnancial statements

•

•

•

•

•

•

•

•

• •

•

•

•

• •

•

•

•

•

• •

Note (a): The impact on goodwill and reported results is dependent on both the choice of accounting policy applied in the past when acquiring the non-controlling interest and the option chosen to measure

non-controlling interest when applying the revised standard. The different permutations and the effect on goodwill are discussed further in Section 3.2.




1. Introduction

A business combination occurs when an

entity ‘obtains control of one or more

businesses’ by acquiring its net assets

or its equity interests. While the focus on

‘obtaining control’ appears to be narrower

than ‘bringing together’ a business,

as currently exists in IFRS 3, we do not

believe that in practice this will give rise

to any signicant changes. However,

IFRS 3R has redened a business as:

“… an integrated set of activities and assets

that is capable of being conducted and

managed for the purpose of providing a

return in the form of dividends, lower costs,

or other economic benets directly to

investors or other owners, members,

or participants.”

While a business consists of inputs,

processes applied to those inputs, and

outputs, IFRS 3R states that it is not

necessary for outputs to be present for

the acquired set of assets to qualify as a

business. It is only necessary that inputs

and processes are, or will be, used to create

outputs. It is not necessary for the acquired

set of assets to include all of the inputs or

processes used by the seller to operate

that business. If other market participants

are able to produce outputs from the set

of assets, for example, by integrating

them with their own inputs and processes,

then this is ‘capable of’ being conducted

in a manner that constitutes a business

according to IFRS 3. It is not relevant

whether the seller had historically operated

the transferred set of assets as a business

or whether the acquirer intends to operate

the transferred set as a business. The broad

scope of the term ‘capable of’ requires

judgment in assessing whether an acquired

set of activities and assets constitutes a

business, to which the acquisition method

is to be applied.

As outputs are not required to exist at the

acquisition date, some development-stage

enterprises may now qualify as businesses.

In these situations, various factors will need

to be assessed to determine whether the

transferred set of assets and activities is

a business, including whether the set has

begun its planned principal activities,

has employees and other inputs and

processes that can be applied to those

inputs, is pursuing a plan to produce

outputs, and has the ability to obtain

access to customers that will purchasethose outputs.

We expect that there will be an increase

in the number of acquisition transactions

that will be accounted for as a business

combination under IFRS 3R compared with

current practice. It is likely that difculties

will arise — and careful judgment will be

required, particularly for acquisitions of

single-asset entities, and assets such as

non-operating oil elds.

At the time IFRS 3 was issued in 2004,

the IASB excluded from its scope

mutual entities (e.g., credit unions and

cooperatives) and combinations between

entities brought together by contract alone,

without obtaining an ownership interest.

The Boards concluded that these events

are economically similar to combinations

between other entities and, therefore,

extended the scope of IFRS 3R to include

such transactions — thereby requiring theacquisition method to be applied. Due to

the way such transactions are structured,

there is additional guidance to explain how

this method is to be applied in such cases.

As the ‘pooling of interests’ method was

often applied to such transactions in the

past, considerably more time and effort

will be required by such entities to apply

the acquisition method in the future.

Business combinations between entities

under common control and those in which

businesses are brought together to form

a joint venture remain outside of the scope

of IFRS 3R.

The current practice of accounting for business combinations is a cost-based approach, whereby the cost of

the acquired entity is allocated to the assets acquired and liabilities (and contingent liabilities) assumed. In

contrast, the revised standards are based on the principle that, upon obtaining control of another entity, the

underlying exchange transaction should be measured at fair value, and this should be the basis on which the

assets, liabilities and equity (other than that purchased by the controller) of the acquired entity are measured.

However, a number of exceptions to this principle have been included in the standard, as explained in the

following sections.




2. Changes in the applicationof the acquisition methodof accounting

2.1 Recognising and

measuring goodwill

or a gain from a

bargain purchase

As noted above, the underlying principle

in IFRS 3R is for all components of thebusiness acquired to be recognised at

their fair value. This effectively means

that the consideration paid and the assets

and liabilities of the acquiree and equity

attributable to non-controlling interests are

measured at fair value. In acknowledging

the strong disagreement of many

of its constituents with recognising

non-controlling interests at fair value,

the IASB introduced an option as to how

non-controlling interest (formerly minority

interest) is measured.

As a result, the way in which goodwill or

a gain on a bargain purchase is calculated

has changed, being the difference between:

1. The acquisition-date fair value of the

consideration transferred plus the

amount of any non-controlling interest

in the acquiree plus the acquisition-date

fair value of the acquirer’s previously

held equity interest in the acquiree;

and

2. The acquisition-date fair values (or

other amounts recognised in accordance

with the requirements of IFRS 3R,

as discussed below) of the identiable

assets acquired and liabilities assumed.

Goodwill arises when 1 exceeds 2. A

bargain purchase arises when 2 exceeds 1.

2.1.1 Recognising and measuring

non-controlling interests

IFRS 3R provides a choice of two

methods for management to measure

non-controlling interests arising in a

business combination: Option 1 — to

measure the non-controlling interest at

fair value (effectively recognising the

acquired business at fair value); Option 2

— to measure the non-controlling interest

at the share of the value of net assets

acquired, as calculated in accordance withIFRS 3R. The choice is made for each

business combination (rather than being

an accounting policy choice), and will

require management to carefully consider

their future intentions regarding the

acquisition of the non-controlling interest,

as the two methods, combined with the

revisions to accounting for changes in

ownership interest of a subsidiary (see 3.2

below) will potentially result in signicantly

different amounts of goodwill.

Option 1 — Measuring non-controlling

interest at fair value

Non-controlling interest is measured at

its fair value, determined on the basis of

market prices for equity shares not held by

the acquirer or, if these are not available,

by using a valuation technique. The result

is that recognised goodwill represents all

of the goodwill of the acquired business,not just the acquirer’s share as currently

recognised under IFRS 3.

The amount of consideration transferred by

an acquirer is not usually indicative of the

fair value of the non-controlling interest,

because consideration transferred by the

acquirer will generally include a control

premium. Therefore, it is often not

appropriate to determine the fair value

of the acquired business as a whole or

that of the non-controlling interest by

extrapolating the fair value of the acquirer’sinterest. Hence, adopting this option also

means that additional time and expertise

may be needed to determine the fair value

of the non-controlling interest (see the

example in box 1).



Entity B has 40% of its shares publicly traded on an exchange. Entity A purchases the 60% non-publicly traded shares in one

transaction, paying €630. Based on the trading price of the shares of entity B at the date of gaining control a value of €400 is

assigned to the 40% non-controlling interest, indicating that entity A has paid a control premium of €30. The fair value of entity

B’s identiable net assets is €700.

Option 1: Non-controlling interest at fair value

Acquirer accounts for the acquisition as follows:

Fair value of identiable net assets acquired € 700

Goodwill 330

Cash 630

Non-controlling interest 400

The amount of goodwill associated with the controlling interest is €210, which is equal to the consideration transferred (€630)

for the controlling interest less the controlling interest’s share in the fair value of the identiable net assets acquired of €420

(€700 x 60%). The remaining €120 of goodwill (€330 total less €210 associated with the controlling interest) is associated

with the non-controlling interest.

Option 2: Non-controlling interest at proportion of net assets

Acquirer accounts for the acquisition as follows:

Fair value of identiable net assets acquired € 700

Goodwill 210

Cash 630

Non-controlling interest 280

The goodwill of € 210 represents only that associated with the parent, being the difference between the consideration transferred(€630) and the share of the fair value of the identiable net assets acquired of €420 (€700 x 60%).


Option 2 — Measuring non-controlling

interest at the value of the assets and

liabilities of the acquiree, calculated in

accordance with IFRS 3R

Non-controlling interest is measured as

the share of the value of the assets and

liabilities of the acquiree, consistent with

the current requirements of IFRS 3

(see the example in box 1). The result isthat recognised goodwill represents only

the acquirer’s share, as it does today.

However, contrary to the practice

commonly applied today, the subsequent

acquisition of the outstanding non-

controlling interest does not give rise to

additional goodwill being recorded, as the

transaction is regarded as one between

shareholders (see 3.2 below).

Which option?

Management must elect, for each

acquisition, the option to measure the

non-controlling interest. This will be largely

dependent on the future intentions to

acquire non-controlling interest, due to

the potential impact on equity when the

outstanding interest is acquired.

2.1.2 Bargain purchases

When a bargain purchase (as dened

above) occurs, a gain on acquisition is

recognised in the prot or loss. While this is

consistent with the current requirements of

IFRS 3, the amount recognised may differ,

due to the other changes in the standard.

Consistent with the current requirements

of IFRS 3, before the gain can be

recognised, the acquirer reassesses the

procedures used to identify and measure

acquisition-date fair values of: 1) the

identiable assets acquired and liabilities

assumed; 2) the non-controlling interest

in the acquiree (if any); 3) for business

combinations achieved in stages (as

discussed below), the acquirer’s previouslyheld interest in the acquiree; and 4) the

consideration transferred. Any excess that

remains is recognised as a gain, which is

attributed only to the acquirer.

Box 1 Example:



2.1.3 Consideration transferred

The consideration transferred is comprised

of the acquisition date fair values of assets

transferred by the acquirer, liabilities to

former owners that are incurred by the

acquirer — including the fair value of

contingent consideration — and equity

interests issued by the acquirer.

When the consideration transferred

includes assets or liabilities with carrying

amounts that differ from the acquisition-

date fair values, the acquirer should

remeasure the transferred assets or

liabilities at their acquisition-date fair

values and recognise the resulting gain

or loss in prot or loss. However, if the

transferred assets or liabilities remain in

the combined entity after the acquisition

date, the gain or loss is eliminated in

the consolidated nancial statementsand the respective transferred assets or

liabilities are restored to their historical

carrying amount.

When the combination is by contract alone,

there is unlikely to be any consideration,

and IFRS 3R acknowledges this by

indicating that there will be a 100%

non-controlling interest in the net fair

value of the acquiree’s assets and liabilities.

Depending on the option chosen to

measure non-controlling interest, this could

result in recognising goodwill relating onlyto the non-controlling interest or

recognising no goodwill at all.

Contingent consideration

An acquirer may commit to deliver

(or receive) cash, additional equity

interests, or other assets to (or from)

former owners of an acquired business

after the acquisition date, if certain

specied events occur or conditions

are met in the future. Buyers and sellers

commonly use these arrangements when

there are differences in view as to the fair

value of the acquired business. Contingent

consideration arrangements are recognised

as of the acquisition date (as part of the

consideration transferred in exchange for

the acquired business) at fair value —

giving rise to either an asset or a liability.

This approach represents a signicant

change from the practice under IFRS 3

of recognising contingent consideration

only when the contingency is probableand can be reliably measured. The initial

measurement of contingent consideration

at the fair value of the obligation is based

on an assessment of the circumstances and

expectations that exist as of the acquisition

date. Classication of contingent

consideration obligations as either liabilities

or equity is based on other applicable

accounting standards.

Another signicant change from current

practice under IFRS 3 is that subsequent

changes in the value of contingentconsideration no longer result in changes

to goodwill. Instead, subsequent changes

in value that relate to post-combination

events and changes in circumstances of the

combined entity (as opposed to changes

arising from additional information about

circumstances at the acquisition date)

are accounted for, as follows:

• Contingent consideration classied

as equity is not remeasured,

and settlement is accounted for

within equity.

• Contingent consideration that takes the

form of nancial instruments within the

scope of IAS 39 Financial Instruments:

Recognition and Measurement is

measured at fair value, with changes in

value recognised either in prot or loss

or in equity as required by IAS 39.

• Contingent consideration that does not

take the form of a nancial instrument

within the scope of IAS 39 is accounted

for in accordance with IAS 37 or otherapplicable standards, with changes in

value recognised in the prot or loss.

In a number of cases, the terms of the

arrangement will result in a derivative

being recognised, (as contingent

consideration is no longer scoped out of

IAS 39) thereby leading to an increase in

the volatility of reported results. The IASB

is currently discussing proposals to revise

the denition of a derivative as it relates

to payments linked to prots, and thismay result in even more contingent

consideration arrangements being

classied as derivatives.

As goodwill is no longer adjusted for the

actual outcome of contingencies, it is

important to have a reliable estimate

of fair value at the date of acquisition.

As re-measurement will affect subsequent

results, the potential impact on debt

covenants and management remuneration

structures should also be evaluated at

acquisition date.

Transaction costs

An acquirer often incurs acquisition-related

costs such as costs for the services of

lawyers, investment bankers, accountants,

valuation experts, and other third parties.

As such costs are not part of the fair value

exchange between the buyer and the

seller for the acquired business, they are

accounted for as a separate transaction

in which payments are made in exchange

for services received, and will generallybe expensed in the period in which the

services are received. This is a signicant

difference from current practice in which

such costs are included in the cost of the

combination, and are therefore included

in the calculation of goodwill. Results

reported for the period of any acquisition

will now be affected. It must also be

remembered that this must be included

as part of operating cost.




Share-based payment awards

exchanged for awards held by the

acquiree’s employees

Acquirers often exchange share-based

payment awards (i.e., replacement

awards) for awards held by employees of

the acquired business. These exchanges

frequently occur because the acquirer

wants to avoid having non-controllinginterests in the acquiree, and/or to motivate

former employees of the acquiree to

contribute to the overall results of the

combined, post-acquisition business.

Such exchanges are accounted for as

a modication of a plan in accordance

with IFRS 2 Share-based Payments.

If the acquirer is obligated to issue

replacement awards in exchange for

acquiree share-based payment awards

held by employees of the acquiree,

then all or a portion of the market-basedmeasure of the acquirer’s replacement

awards should be treated as part of the

consideration transferred by the acquirer.

The effect will be to increase goodwill

and record a corresponding amount in

equity. The acquirer is considered to

have an obligation if the employees or

the acquiree can enforce replacement.

Such an obligation may arise from the

terms of the acquisition agreement,

the terms of the acquiree’s award scheme

or legislation. If the acquirer is notobligated to issue replacement awards but

elects to do so, none of the replacement

awards are treated as part of the

consideration transferred, therefore

having no impact on goodwill and equity.

Rather, the replacement awards are a

post-combination modication, giving rise

to employee compensation expenses.

Therefore, where management is

considering replacement of the acquiree’s

share-based payment schemes, careful

consideration should be given at the

time of negotiating the arrangement

to ensure management’s intention is

correctly reected.

The portion of the replacement award

that is treated as consideration transferred

is the amount attributable to past service

that the employee has provided to the

acquiree, based on the market-based

measure of the awards issued by the

acquiree (not the market-based measure

of the replacement awards issued by

the acquirer). When additional service

conditions are imposed by the acquirer,

this affects the total vesting period and,

therefore, the portion of the awards that

is considered pre-combination service.

As a result, the portion of replacement

award treated as part of the considerationtransferred (i.e., the portion related to

past services) is determined as follows:

Market-based

measure at the

acquisition date

of the replaced

(i.e., acquiree)

award

Complete vesting

period

Greater of total

vesting period

and original

vesting period

x

The excess of the market-based measure

at the acquisition date of the replacement

(i.e., acquirer) award over the amount

treated as consideration transferred is

recognised as compensation cost over the

period from the acquisition date until the

end of the vesting period. Effectively, this

means the excess of the market-based

measure of the replacement awards

over the market-based measure of the

acquiree award, if any, is recognised

as compensation cost in the acquirer’s

post-combination nancial statements.

Therefore, management must carefully

consider the terms of replacement

awards to avoid surprises.

2.1.4 A business combination

achieved in stages

An acquirer may obtain control of an

acquiree in stages, by successive purchasesof shares (commonly referred to as a

‘step acquisition’). If the acquirer holds

a non-controlling equity investment in the

acquiree immediately before obtaining

control, that investment is remeasured to

fair value as at the date of gaining control,

with any gain or loss on remeasurement

recognised in prot or loss.1 A change from

holding a non-controlling equity investment

in an entity to obtaining control of that

entity is regarded as a signicant change in

the nature of, and economic circumstances

surrounding, that investment, which results

in a change in the classication and

measurement of the investment.

This is a signicant change from the cost

accumulation model that applies under

current IFRS 3, whereby goodwill was

calculated for each separate purchase.

Under IFRS 3R, the previously held balance

is remeasured to fair value at the date of

obtaining control, with the result that if fair

value has increased since each purchase

date, goodwill will be higher than that

recognised today. Any increase in fair value

that has arisen is reected in prot or loss

at the date of gaining control. Conversely,

if there has been a decrease in fair value,

this may have already been recognised as

an impairment loss in earlier periods. If not,

it will give rise to an additional charge at

the date of gaining control.


1 If the acquirer recognised changes in the value of the investment directly in equity (i.e., the investment was classied as available-for-sale in accordance with IAS 39), the amount recognised directly in

equity as of the acquisition date should be reclassied at the acquisition date on the same basis as if the asset was disposed (i.e., recognised in prot or loss).



2.2 Recognising and

measuring assets acquired

and liabilities assumed

Identiable assets acquired and liabilities

assumed are recognised and measured

at fair value as of the acquisition date,

(with certain limited exceptions).Guidance is provided in IFRS 3R on

recognising and measuring particular

assets and liabilities. However, much of

the general guidance relating to fair value

in the existing IFRS 3 is no longer included

in anticipation of a separate standard on

fair value measurement being issued. But

IFRS 3R does clarify that, if an acquired

asset is not intended to be used by the

acquirer, or is to be used in a manner

different from the way in which other

market participants would use it, then thisfactor is ignored. That is, the asset should

be valued in accordance with how it would

be used by other market participants.

Although IFRS 3 was silent on this issue,

the practice that developed was consistent

with this principle. A number of these

requirements differ from current practice,

and/or existing IFRS 3, and each will

result in a different amount of goodwill

being reported.

While the objective of the second phase

of the business combinations project wasnot focused on how to account for assets

acquired and liabilities assumed after the

date of acquisition, IFRS 3R does provide

accounting guidance for certain acquired

assets and assumed liabilities after

the business combination. We discuss

these below.

2.2.1 Classifying and

designating assets acquired

and liabilities assumed

The classication and designation of all

assets acquired and liabilities assumed are

reassessed by the acquirer at the date of

acquisition, based on the contractual

terms, economic conditions, accountingpolicies of the acquirer and any other

relevant factors as at that date, with the

exception of:

• Classication of leases in accordance

with IAS 17 Leases — classication is

determined based on the contractual

terms and factors at inception of the

contract, unless the contract terms are

modied at the date of acquisition.

• Classication of a contract as an

insurance contract in accordance

with IFRS 4 Insurance Contracts —

classication is determined based on

the contractual terms and factors at

inception of the contract, unless the

contract terms are modied at the date

of acquisition.

IFRS 3 was silent on this point and

differing practices developed. Therefore,

all nancial instruments of the acquiree

must be carefully reviewed to determine

how they should be classied and

designated and subsequently accounted

for. For example, the classication of

nancial assets as ‘held-for-sale’ or

‘held at fair value through the prot and

loss’ will need to be assessed in addition

to a re-designation (if effectiveness is

achievable) of hedging relationships.

This also extends to a reassessment of

whether any embedded derivatives

exist in any contracts that relate to the

assets acquired and liabilities assumed.

It is not appropriate for an acquirer to

simply assume the same classications

and designations of nancial instruments

that the acquirer previously adopted.

Such reassessments can be time-

consuming and may result in additional

assets or liabilities having to beremeasured to fair value.

2.2.2 Operating leases

IFRS 3R contains specic guidance relating

to operating leases, which reects practice

that has developed in applying IFRS 3.

Lessees recognise operating leases as

either intangible assets or liabilities to

the extent that the terms of the lease

are favourable (asset) or unfavourable

(liability) relative to current market

terms and prices.

A lessor, however, will not separately

recognise an intangible asset or liability

where the terms of the lease are favourable

or unfavourable relative to market terms

and prices. The extent of any off-market

terms will instead be reected in the

carrying value of the asset subject to lease.

2.2.3 Intangible assets

Identiable intangible assets are recognised

separately from goodwill if it is eithercontractual or separable. IFRS 3 currently

also requires that an asset’s fair value can

be reliably measured, but this requirement

has not been carried forward in IFRS 3R.

Therefore, whenever an intangible asset

can be separately identied, it must now be

recognised and measured. This may

increase the accounting complexity for




some business combinations, and therefore

add time and cost, and will result in higher

post-combination amortisation charges

being recognised.

2.2.4 Valuation allowances

As assets acquired are to be measured

at their fair value (which will reect any

uncertainty about future cash ows),

at the date of acquisition, it is not

appropriate to present separately a

valuation allowance relating to such assets.

This may be a change from current practice

for some entities, particularly those in the

nancial services industry. The need to

maintain appropriate records for the period

subsequent to acquisition may require

enhancements to information systems.

2.2.5 Exceptions to the recognition

and/or measurement principle

Contingent liabilities

IFRS 3R retains the same accounting

requirements for contingent liabilities

as the current IFRS 3, except that the

contingency must meet the denition of

a liability. That is, there must be a present

obligation arising from a past event that

can be reliably measured. Such a liability is

recognised at fair value. The determination

of whether a past event has occurred is

a matter of judgment, particularly incases of litigation claims, and it is likely to

require greater time and effort to identify.

Additionally, fewer claims may meet this

criteria and fewer contingent liabilities are

likely to be recognised.

Reacquired rights

In some cases the assets of the acquiree

include a right previously granted to it by

the acquirer to use one of the acquirer’s

assets, such as the licence of a brand,

trade name or technology. No account is

taken of any renewal rights (either explicit

or implicit) in determining the asset’s

fair value. The acquisition results inthe acquirer reacquiring that right.

That reacquired right is recognised

as an identiable intangible asset.

After acquisition, the asset is amortised

over the remaining contractual period

of the contract, and will not include any

renewal periods.

If the terms of the right are favourable

or unfavourable compared with market

terms and prices at the date of acquisition,

a settlement gain or loss will be recognised

in prot or loss.

As IFRS 3 was silent in this area, different

practices have arisen. Consequently for

some entities, this may result in a

signicantly different outcome for

future acquisitions — in relation to both the

assets recognised and the reported results

in the period of an acquisition, and the

amortisation recognised post-combination.

Deferred tax assets and liabilities

Consistent with IFRS 3, deferred income

tax assets and liabilities are recognised

and measured in accordance with IAS 12

Income Taxes, rather than at their

acquisition-date fair values. However, IAS

12 has also been amended to change the

accounting for deferred tax benets that

do not meet the recognition criteria at thedate of acquisition, but are subsequently

recognised, as follows:

• A change arising from new information

obtained within the measurement

period (i.e., within one year after the

acquisition date) about facts and

circumstances existing at the acquisition

date, results in a reduction of goodwill.

• All other changes are recognised in

prot or loss.

Management must therefore carefullyassess the reasons for changes in deferred

tax assets during the measurement period

to determine whether they relate to facts

and circumstances at the acquisition date,

or whether they arise from changes in

facts and circumstances after the

acquisition date.

IAS 12 has also been amended to require

any tax benets arising from the excess

of tax-deductible goodwill over goodwill

for nancial reporting purposes to be

accounted for at the acquisition dateas a deferred tax asset similar to other

temporary differences.




Indemnifcation assets

In certain situations, particularly when

there are uncertainties surrounding the

outcome of pre-acquisition contingencies

(e.g., uncertain tax positions,

environmental liabilities, or legal matters),

the seller may indemnify the acquirer

against an adverse outcome. From the

acquirer’s perspective, the indemnity is anacquired asset. However, the recognition

and measurement of the indemnity asset

is linked to the related indemnied item.

When the indemnied item is measured

at fair value at the date of acquisition,

the indemnity asset is also measured at fair

value (and reects uncertainty relating to

the collectability of the asset). When the

indemnied item is one that is not

measured at fair value (as the item is an

exception to the general principle), or it

is not recognised (as it cannot be reliablymeasured), the indemnity asset is

recognised and measured using the same

assumptions (subject to the assessment of

collectability). Consequently, if the related

liability is not recognised at the date of

acquisition, an indemnication asset is also

not recognised. This effectively results in

eliminating a mismatch that arises today

when applying IFRS 3. Subsequent to the

business combination, the indemnication

asset is measured using the same

assumptions as are used to calculate the

liability, (subject to the assessment of

collectability and contractual limitations

on its amount). Any changes in the

measurement of the asset are recognised

in prot or loss, where changes in the

measurement of the related liability are

also recognised.

Employee benefts

Consistent with current practice, assets and

liabilities relating to employee benet plans

are measured in accordance with IAS 19

Employee Benets. Therefore, anyamendments to a plan that are made in

connection with, or at the same time as,

the business combination, are considered

to be a post-combination event.

Other exceptions

Consistent with the current IFRS 3,

non-current assets (or disposal groups)

classied as ‘held for sale’ at acquisition

date are accounted for in accordance with

IFRS 5. That is, they are valued at fair valueless costs to sell. The Board intends to

amend IFRS 5 to change its measurement

principle to fair value in order that this

exception is eliminated from IFRS 3R.

Non-current assets held for sale and

discontinued operations

Currently, IFRS 3 does not discuss how

to account for the acquiree’s share-based

payment transactions in an acquisition,

which has led to differing practices

evolving. However IFRS 3R requires theliability arising from a share-based payment

award or an equity instrument issued to

be measured in accordance with IFRS 2,

rather than at fair value. Management

may therefore need to change its approach

to how such items are considered in

future acquisitions.

2.3 Assessing what is

part of the exchange for

the acquireeAn acquirer must assess whether any

assets acquired, liabilities assumed,

or portions of the transaction price do not

form part of the exchange for the acquiree.

This means the acquirer should evaluate

the substance of arrangements entered

into by the parties before, or at the time of,

the combination. Factors such as the

reasons for the other aspects of the

transaction, the party initiating the

transaction or event, the nature and

extent of pre-existing relationships between

the acquirer and the acquiree or its former

owners, and the timing of the overall

transaction should be considered in

completing the assessment.

Examples of payments or other

arrangements that would not be considered

part of the exchange for the acquiree

include the following:

• Payments that effectively settlepre-existing relationships between the

acquirer and acquiree, for example,

a lawsuit or supply contract. An element

of the consideration is allocated to the

settlement of the relationship which can

give rise to a gain or loss recognised in

prot or loss.

• Payments to compensate former owners

or employees of the acquiree for future

services. In a number of businesses,

success is dependent on relationships

held by the former owners or employees(e.g., advisory service businesses,

brokers, recruitment businesses).

In other businesses, the skills of the

former owners or employees may be

critical. The acquirer often locks these

people into the business going forward

to ensure this is not lost and that it is

transferred to others. Invariably, this is

achieved through substantial additional

payments linked to continued

employment. To date, practice has

varied as to the extent to which such

payments were considered part of the

consideration paid for the business.

Considerable application guidance has

been included which indicates that,

when there is a payment of ‘earn-out’

or other amounts conditional on

continued employment by the acquirer,

the payments are treated as

compensation for future services rather

than as consideration. Consequently,

it will be critical that the accounting is

considered before terms of acquisition

agreements are nalised or there will be

nasty surprises for many businesses.





3. Consolidatedfnancial statements

The basic principle underlying the changes

has been the use of the economic entity

concept model — whereby all residualeconomic interest holders in any part of the

consolidated entity are regarded as having

an equity interest in the consolidated entity,

regardless of their decision-making ability

and where in the group the interest is held.

By contrast, existing IFRS has adopted a

mixed model, applying some elements of

an economic entity concept model (e.g.,

when a minority interest is classied as a

component of equity) and other elements

of a parent entity model (e.g., where losses

attributable to a minority interest, that

result in the minority interest becoming

negative, are allocated to the parent unless

there is a binding obligation).

3.1 Allocation of losses to

non-controlling interests

When a partially-owned subsidiary incurs

losses, these are to be allocated to both

controlling and non-controlling interests,

even if those losses exceed the non-

controlling interest in the equity of the

subsidiary. This is signicantly differentfrom the practice today whereby IAS 27

only permits these losses to be allocated

to the non-controlling interest if minority

interests entered into a binding obligation

to cover the funding. The controlling

interest in such situations will now be

higher than it was under IAS 27.

3.2 Changes in ownership interest

— without loss of control

Changes in a parent’s controlling ownership

interest that do not result in a loss of

control of the subsidiary are accounted for

as equity transactions — with the owners

acting in their capacity as owners — and

therefore do not give rise to gains or losses.

A parent may increase its ownership

interest in a subsidiary by purchasing

additional shares, by having the subsidiary

re-acquire a portion of outstanding shares

from non-controlling interests, or by having

the subsidiary issue new shares to the

parent. Similarly, a parent may reduce its

ownership interest by selling shares in the

subsidiary, by having the subsidiary issue

new shares to non-controlling interests or

by having the subsidiary buy-back shares

from the parent. When such events occur,

the carrying amounts of controlling and

non-controlling interest are adjusted to

reect the change in respective ownership

interests. To the extent that the

consideration payable/receivable for the

increase/decrease in interest exceeds

the carrying value of the relevant non-controlling interest, it is recognised

directly in equity attributable to the

controlling interest.

This method of accounting applies,

regardless of the option chosen to measure

non-controlling interest when control was

initially obtained — that is at its fair value,

or at the proportionate share of the net

assets as discussed in section 2.1.1.

This differs signicantly from practice

today, whereby entities effectively have a

choice of three accounting policies, in theabsence of any guiding principle in IFRS,

as follows:

1. Any difference between the carrying

amount of the relevant non-controlling

interest and the consideration payable

is regarded as the purchase or disposal

of goodwill. This has been by far the

most common practice applied. In the

example above, this would have resulted

in an increase in goodwill of €100.

2. Accounting for a change in the

non-controlling interest as an equitytransaction between owners acting in

their capacity as owners. Any difference

between the carrying amount of the

relevant non-controlling interest and

the consideration payable is regarded

as an increase or decrease in equity,

consistent with IAS 27R.

3. Accounting for the acquisition of a

non-controlling interest as a partial

acquisition or disposal of goodwill and

partially an equity transaction.

As a result of the changes to accounting for business combinations, the Board reconsidered related aspects

of IAS 27, primarily those relating to non-controlling interests: accounting for increases and decreases of

ownership after control has been obtained, and accounting for the loss of control of a subsidiary.



Example:

A parent owns an 80% interest in a

subsidiary which has net assets of

€4,000. The carrying amount of the

non-controlling interest share is €800.

The parent acquires an additional 10%

interest from the non-controllinginterest for €500. The parent accounts

for this directly in consolidated equity

as follows:

Equity — non-controlling

interest € 400

Equity — controlling

interest 100

Cash € 500


IAS 27R effectively removes options 1

and 3 above. This, together with the

option introduced to initially measure

non-controlling interest, means that

goodwill could be impacted in a number

of ways. Table 2 indicates how these

combinations affect goodwill compared

with that recognised today (ignoring the

impact of other changes in IFRS 3R) oncea 100% interest is held (i.e., the non-

controlling interest has been acquired).

As common practice has been to account

for changes in ownership interest similar

to an acquisition or disposal of goodwill,

management will need to adopt the new

method to measure non-controlling

interests when they anticipate acquiring

the outstanding interests, in order to avoid

a future reduction in equity (representing

goodwill attributable to the non-controlling

interest being acquired).

Another area of signicantly different

practice has been accounting for put

options offered by parent entities to

non-controlling interests, due to conicts

between IFRS 3 and IAS 32. The revised

standards do not address this area. It

remains unclear how current practices will

be impacted, and management should

monitor developments in this area.

3.3 Loss of control

of a subsidiary

Control of a subsidiary may be lost as

the result of a parent’s decision to sell its

controlling interest in the subsidiary to

another party or as a result of a subsidiary

issuing its shares to others. Control may

also be lost, with or without a change in

absolute or relative ownership levels,

as a result of a contractual arrangement

or if the subsidiary becomes subject to

the control of a government, court,

administrator, or regulator (e.g., through

legal reorganisation or bankruptcy).

Table 2: Effect on goodwill after the change in accounting for acquisitions of non-controlling interest

Current practice New practice — effect on goodwill

compared with current practice

Goodwill relating to the

NCI* acquired

NCI — share of net assets NCI — fair value

of business

Aquire goodwill

(Option 1 above)

Goodwill recognised as difference

between proceeds and carrying value

Lower (a)

Equity transaction

(Option 2 above)

No goodwill recognised Same Higher

Combination of above

(Option 3 above)

Goodwill recognised as difference

between proceeds and fair value

Lower (a)

* NCI = non-controlling interest

Note (a): Generally, due to the difference in measurement, we would expect that goodwil l may be sl ightly lower. However, the new practice may result in signicantly more or less goodwill if the acquisition of

non-controlling interest takes place after a signicant period of time from the acquisition of the original controlling interest.



Example:

Entity A has a 90% controlling interest in Entity B. On December 31, 2006,

the carrying value of Entity B’s net assets in Entity A’s consolidated nancial

statements is €100 and the carrying amount attributable to the non-controlling

interests in Entity B (including the non-controlling interest’s share of accumulated

other comprehensive income) is €10. On January 1, 2007, Entity A sells 80% of

the share in Entity B to a third party for cash proceeds of €120. As a result of the sale,

Entity A loses control of Entity B but retains a 10% non-controlling interest in Entity B.

The fair value of the retained interest on that date is €12.

The gain on sale of the 80% interest in Entity B is calculated follows:

Cash proceeds € 120

Fair value of retained non-controlling equity investment 12

€ 132

Less:

Carrying value of Company B’s net assets € 100

Less Carrying value of the non-controlling interest 10 90Gain on sale €42


Consistent with the approach taken for

step acquisitions, when control of a

subsidiary is lost, and an interest is

retained, that interest is measured at

fair value, and this is factored into the

calculation of the gain or loss on disposal.

The gain or loss on disposal is therefore

calculated as follows:Fair value of the proceeds (if any)

from the transaction that resulted in

the loss of control

+ Fair value of any retained non-

controlling equity investment in the

former subsidiary, at the date control

is lost

+ Carrying value of the non-controlling

interest in the former subsidiary

(including accumulated other

comprehensive income attributable

to it) at the date control is lost

— Carrying value of the former

subsidiary’s net assets at the date

control is lost

+/— Any amounts included in other

components of equity that relate to

the subsidiary, that would be required

to be reclassied to prot or loss or

another component of equity if the

parent had disposed of the related

assets and liabilities.

This change applies also to situationsin which an entity loses joint control of,

or signicant inuence over, another entity.

3.3.1 Multiple arrangements

that result in loss of control of

a subsidiary

To prevent different accounting for

transactions that are structured differently,

but have essentially the same economic

consequences, the Board concluded that

an entity that expects to sell ownership

interests or otherwise lose control of asubsidiary through multiple arrangements

should consider whether or not the multiple

arrangements should be accounted for as a

single transaction. Although not intended

to be an all-inclusive list, IFRS 3R

indicates that one or more of the

following factors may indicate multiple

arrangements that should be accounted

for as a single transaction:

• The arrangements are entered into

at the same time.

• The arrangements are entered intoin contemplation of one another.

• The arrangements form a single

transaction designed to achieve an

overall commercial effect.

• The occurrence of one arrangement

is dependent on the occurrence of at

least one other arrangement.

• One arrangement considered on its own

is not economically justied, but when

considered with one or more other

arrangements, it is economically justied, for example, when one disposal

is priced below market value, that is

compensated for by a subsequent

disposal priced above market value.



4. Effective date and transition

IFRS 3R is to be applied prospectively

to business combinations for which the

acquisition date is on or after the beginningof the annual period in which the standard

is adopted. No adjustment is permitted for

business combinations taking place before

that date, with one exception noted below.

Therefore, transactions occurring before

IFRS 3R is effective continue to apply

current IFRS 3, for example post-

acquisition adjustments to contingent

consideration will continue to result in

changes to the cost of the acquisition and,

consequently, to goodwill on those

acquisitions. The one exception relates

to changes in deferred tax assets of the

acquiree: any change in a deferred tax

benet acquired in a business combination

before the application of IFRS 3R, that

occurs after IFRS 3R is adopted, does not

adjust goodwill, but is recognised in prot

or loss for the period (or if permitted by

IAS 12, directly in equity).

By contrast, the changes in IAS 27R

are applied retrospectively, except in

the following scenarios:• Attribution of losses to non-controlling

interests.

• Changes in ownership interest of a

subsidiary that was acquired prior to

the standard being adopted.

• Loss of control of a subsidiary occurring

prior to the standard being adopted.

Restatement will therefore only be required

in those circumstances where multiple

arrangements should, in substance,

be accounted for as a single transactionand an element of the transaction has

not yet been completed or was completed

in the comparative period. As a result,

management will need to assess all disposal

transactions occurring during the period

IFRS 3R is adopted and the comparative

period to assess if a change to the

accounting is required.

IFRS 3R and IAS 27R come into effect for the rst annual reporting period beginning on or after 1 July 2009.

Earlier adoption is permitted, although they may not be applied to periods beginning prior to 30 June 2007.

If early adoption is elected, both IFRS 3R and IAS 27R must be applied at the same time.





5. Differences between IFRS 3Rand IAS 27R and US FAS 141Rand FAS 160

Description IFRS US GAAP Impact

Non-controlling

interest in

an acquiree

The acquirer has a choice to

measure the non-controlling interest

at its proportionate share of the

acquiree’s net identiable assets

or at its fair value.

A non-controlling interest in an

acquiree is measured at fair value.

Goodwill impacted, as discussed

in 2.1.1.

Contingent assets

and liabilities

The acquirer recognises a

contingent liability assumed ina business combination if it is a

present obligation that arises from

past events and its fair value can

be measured reliably.

Contingent liabilities are measured

subsequently at the higher of the

amount that would be recognised

in accordance with IAS 37 or the

amount initially recognised less

cumulative amortisation recognised

in accordance with IAS 18 Revenue.

Contingent assets are

not recognised.

The acquirer recognises assets

acquired and liabilities assumed thatarise from contractual contingencies

at the acquisition date.

The acquirer recognises any other

contingency (non-contractual

contingencies) as an asset or

liability at the acquisition date if

it is more likely than not that it

gives rise to an asset or a liability

at the acquisition date.

When new information about

the possible outcomes of the

contingency is obtained:

• Contingent liabilities are

subsequently measured at the

higher of the acquisition date

fair value and the amount that

would be recognised by applying

Statement 5.

• Contingent assets are

subsequently measured at the

lower of the acquisition date fair

value and the best estimate of

the future settlement.

Goodwill will be greater under

IFRS where contingent assets arerecognized under US GAAP.

Goodwill may be impacted by

differences in the recognition

and measurement of contingent

liabilities.

Subsequent measurement will

impact reported results subsequent

to the acquisition.

Denition of

control

Control is dened in IAS 27R as

“the power to govern the nancial

and operating policies of an entity

so as to obtain benets from

its activities”.

The acquirer is the entity that

obtains control of the acquiree,

applying this denition.

Control means majority voting

interest as explained in paragraph 2

of Accounting Research Bulletin No.

51, Consolidated Financial

Statements or primary beneciary

in accordance with FASB

Interpretation no. 46(R),

Consolidation of Variable

Interest Entities.

The acquirer is the entity that

obtains control of the acquiree,

applying this denition.

Potentially different entities would

be identied as the acquirer in a

business combination.




Description IFRS US GAAP Impact

Denition of

fair value

Fair value is the amount for

which an asset could be exchanged,

or a liability settled, between

knowledgeable, willing parties in

an arm’s length transaction.

Fair value is dened in FASB

Statement No. 157, Fair Value

Measurements, as the price that

would be received to sell an asset

or paid to transfer a liability in

an orderly transaction between

market participants at themeasurement date.

Potentially different values assigned

to assets and liabilities at the

acquisition date, affecting the

amount of goodwill recognised

and subsequent reported results.

References to other standards

Exceptions to

the recognition

and measurement

principles

Deferred tax:

Accounted for in accordance

with IAS 12.

Employee benets:


with IAS 19.

Share based payments:


with IFRS 2.

Deferred tax:


with FASB Statement No. 109

Accounting for Income Taxes.

Employee benets:

Accounted for in accordance with a

number of US standards including,

APB 12, and FASB statements

numbered: 43, 87, 88, 106, 112,

146 and 158.

Share based payments:


with FAS 123(R) Share-based

Payments.

Differences in recognition and

measurement of the assets and

liabilities affect the goodwill

recognized and subsequent

reported results.

Classication

of contingent

consideration

Contingent consideration classied

as a liability is either within the

scope of IAS 39 or is accounted for

in accordance with IAS 37.

Contingent consideration classied

as a liability and is measured

subsequently at fair value.

Subsequent measurement of the

liability may differ, affecting the

reported results.

Lessor — assets

with operating

leases

Fair value of the asset subject to

the lease is based on the terms of

the lease.

Fair value of the asset subject to the

lease is measured based on market

conditions, independent of any leaseterms. A separate asset or liability is

recognised for the lease, if the terms

differ from market terms.

Classication difference in the

balance sheet and may also result

in differences in the subsequentreported results.

Effective date Business combinations for which

the acquisition date is on or after

nancial years beginning on or

after 1 July 2009. Early application

is permitted.

Business combinations for which

the acquisition date is on or after

the beginning of the rst annual

reporting period beginning on

or after 15 December 2008.

Early application is prohibited.

Early IFRS 3R adopters will report

signicantly different results






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IFRS Business Comb Consolid Fin Stments March09