IFRS 3 - Business combinations

1
IFRS 3 - Business combinations
2
Executive summary

• There is a fair amount of conformity between IFRS
  and US GAAP in the area of business combinations.
  Both standards use the acquisition method of
  accounting. Both standards similarly identify
  the acquirer and determine the acquisition date.
  In addition, both standards similarly measure the
  price paid by the acquirer.
• Both IFRS and GAAP measure the assets and
  liabilities of the acquired company at fair
  value.
• Under IFRS, preacquisition contingent liabilities
  are recognized if there is a present obligation
  that arises from past events and the fair value
  of the obligation can be measured reliably. 
  Contingent assets are never recognized.  Under US
  GAAP, preacquisition contingent assets and
  liabilities are recognized at the acquisition
  date at fair value, if fair value can be
  determined during the measurement period.
  However, if fair value cannot be determined,
  contingent assets and liabilities are recognized
  if information prior to the end of the
  measurement period indicates that it is probable
  that an asset existed or a liability had been
  incurred at the acquisition date, and the amount
  of the asset or liability can be reasonably
  estimated.

3
Executive summary

• Under both IFRS and US GAAP, any excess of the
  amount paid at the acquisition date and the fair
  value of the net assets acquired is recognized as
  goodwill. In the rare circumstance when the fair
  value of the net assets is greater than the
  acquisition price, the difference is recognized
  in earnings immediately (after the measurements
  utilized in the acquisition accounting are
  reassessed).
• The accounting treatment for contingent
  consideration is similar between IFRS and US
  GAAP. Under both US GAAP and IFRS, contingent
  consideration is recognized initially at fair
  value as part of the price paid for the acquired
  company, and subsequent adjustments to contingent
  consideration are recognized in income. Under
  both standards, contingent consideration that is
  classified as equity is never adjusted through
  income, but rather the ultimate settlement should
  be accounted for within equity. Differences do
  exist in determining whether contingent
  consideration is classified as equity versus a
  liability.
• Push-down accounting is not allowed under IFRS
  but is required in certain circumstances by the
  SEC.

4
Progress on convergence

• With the issuance of IFRS 13 in May 2011and the
  issuance of ASU No. 2011-04 the definition of
  fair value has converged. Fair value is now
  defined as the price that would be received to
  sell an asset or paid to transfer a liability in
  an orderly transaction between market
  participants.
• No further convergence is planned at this time.

5
General
IFRS
US GAAP
Business combinations (with limited exceptions)
are accounted for using the acquisition
method. Under the acquisition method, upon
obtaining control of another entity, the
underlying transaction should be measured at fair
value, and this should be the basis on which the
assets and liabilities and non-controlling
interests of the acquired entity are measured.
Similar
6
Initial steps in the acquisition
modelIdentification of the acquirer
IFRS
US GAAP
Identification of the acquirer is required.
Similar
Factors such as relative sizes of the companies,
relative voting rights, composition of the
entitys governing body and management team are
considered in determining which company is the
acquirer.
Similar
7
Initial steps in the acquisition
modelDetermination of the acquisition date
IFRS
US GAAP
The date of acquisition is the date that control
is transferred to the acquirer.
Similar
8
Initial steps in the acquisition modelMeasuring
fair value of the acquiree
IFRS
US GAAP
The fair value of the acquiree is generally
considered to be the price paid by the acquirer.
The price paid is the sum of the fair values of
the assets transferred, liabilities incurred,
equity interests issued and any contingent
consideration. Acquisition-related costs (and
any costs associated with equity issuance) are
not included in the fair value of the acquired
company.
Similar
The fair value of the acquired company is
determined on the acquisition date.
Similar
9
Valuing and recording the acquirees assets and
liabilities
IFRS
US GAAP
With certain exceptions (e.g., income taxes), the
acquirer is required to measure the identifiable
assets acquired and the liabilities assumed at
their acquisition-date fair values.
Similar
A separate intangible asset is recognized if it
is identifiable. Both systems define
identifiable as the asset meeting either the
separability or contractual legal criteria.
Similar
10
Valuing and recording the acquirees assets and
liabilities
IFRS
US GAAP
Any excess of the amount paid at the acquisition
date and the fair value of the net assets
acquired is recognized as goodwill. In the rare
circumstance when the fair value of the net
assets is greater than the acquisition price, the
difference is recognized in net income
immediately (after the measurements utilized in
the acquisition accounting are reassessed).
Similar
11
Valuing and recording the acquirees assets and
liabilities
IFRS
US GAAP
Adjustments can be made to amounts recorded in
the business combination during the measurement
period, which cannot exceed 12 months past the
acquisition date. Adjustments made during the
measurement period are applied retrospectively.
Adjustments after the measurement period are
made only to correct an error. These adjustments
are accounted for like any other error correction.
Similar
12
Valuing and recording the acquirees assets and
liabilitiesDefinition of fair value before the
issuance of IFRS 13 and ASU No. 2011-04

• IFRS
• Fair value is defined as the amount for which an
  asset could be exchanged, or a liability settled,
  between knowledgeable, willing parties in an
  arms-length transaction.
• No detailed guidance on the determination of fair
  values.

• US GAAP
• Fair value is defined as the price that would be
  received to sell an asset or paid to transfer a
  liability in an orderly transaction between
  market participants.
• Extensive guidance on the determination of fair
  value is contained in ASC 820-10-35.

Due to the different definitions of fair value,
it is possible that differences may arise in
determining the acquisition-date fair values of
certain assets acquired and liabilities assumed
in a business combination.
13
Differences in fair value example

• Example 1
• On January 1, 201X, Doodlebugs Clothing and
  Accessories (Doodlebug) purchased a 100 interest
  in Halles Fashion Accessories (HFA). Doodlebug
  issued 50,000 shares of common stock (1 par
  value) that were trading at 30 on January 1 (the
  acquisition date).
• The book value of HFAs net assets was 750,000
  on January 1. The fair value of net assets,
  exclusive of PPE, was 1.0 million. HFAs PPE
  is particularly hard to value as there is no
  active market. Consequently, the assessment of
  the fair value of this PPE under IFRS is
  150,000, whereas the assessment of fair value
  under US GAAP is 200,000.

• Provide the acquisition journal entry under both
  US GAAP and IFRS.

14
Differences in fair value example

• Example 1 solution
• US GAAP
• Net assets (excluding PPE) 1,000,000
• PPE 200,000
• Goodwill 300,000
• Common stock 50,000
• Additional paid-in capital 1,450,000
• IFRS
• Net assets (excluding PPE) 1,000,000
• PPE 150,000
• Goodwill 350,000
• Common stock 50,000
• Additional paid-in capital 1,450,000

15
Convergence update

• With the issuance of IFRS 13 in May 2011, the
  definition of fair value has converged with the
  US GAAP definition. Fair value is defined as the
  price that would be received to sell an asset or
  paid to transfer a liability in an orderly
  transaction between market participants.
• IFRS 13 is effective for annual periods beginning
  on or after January 1, 2013. Earlier application
  is permitted.
• ASU No. 2011-04 is effective for public companies
  for interim and annual periods beginning after
  December 15, 2011. Earlier application is not
  permitted.
• ASU No. 2011-04 is effective for nonpublic
  companies for annual periods beginning after
  December 15, 2011. Earlier application is
  permitted.

16
Valuing and recording the acquirees assets and
liabilitiesMeasurement of non-controlling
interests

• IFRS
• A choice is allowed whereby non-controlling
  interests can be measured either at the fair
  value (including goodwill) or the proportionate
  interest in the values assigned to the assets
  acquired (excluding goodwill) and the liabilities
  assumed.

• US GAAP
• Non-controlling interests are measured at the
  acquisition date at fair value (including
  goodwill).

17
Non-controlling interests example

• Example 2
• Peter Pipers Peppers, Inc. (PPPI) acquired a 60
  interest in Peter Ns Tomatoes, Inc. (PNTI) on
  January 1, 201X. PPPI paid 600 in cash for
  their interest in PNTI. The fair value of PNTIs
  assets is 1,300, and the fair value of its
  liabilities is 500.

• Provide the journal entry for the acquisition
  using US GAAP.
• Provide the journal entry for the acquisition
  using IFRS, assuming that PPPI does not wish to
  report the non-controlling interest at fair value.

18
Non-controlling interests example

• Example 2 solution
• US GAAP
• Acquired assets 1,300
• Goodwill 200(1)
• Cash 600
• Acquired liabilities 500
• Non-controlling interests 400(2)
• (1) 600 (1,300 500 400)
• (2) (600/60) x 40

19
Non-controlling interests example

• Example 2 solution (continued)
• IFRS
• Acquired assets 1,300
• Goodwill 120(1)
• Cash 600
• Acquired liabilities 500
• Non-controlling interests 320(2)
• (1) 600 (1,300 500 320)
• (2) 40 x (1,300 500)

20
Valuing and recording the acquirees assets and
liabilitiesInitial recognition of preacquisition
contingent assets and liabilities

• IFRS
• Under IFRS, liabilities subject to contingencies
  are recognized as of the acquisition date if
  there is a present obligation (even if it is not
  probable that an outflow of resources embodying
  economic benefits will be required to settle the
  obligation) and the fair value of the obligation
  can be measured reliably. Thus, if the fair value
  of the obligation cannot be measured reliably, no
  liability is recognized. Contingent assets are
  not recognized in a business combination.

• US GAAP
• Under ASC 805, preacquisition contingent assets
  and liabilities are recognized at the acquisition
  date at fair value if fair value can be
  determined during the measurement period.
  However, if fair value cannot be determined at
  the acquisition date or during the measurement
  period, contingent assets and liabilities are
  recognized if information prior to the end of the
  measurement period indicates that it is probable
  that an asset existed or a liability had been
  incurred at the acquisition date (it is implicit
  in this condition that it must be probable that
  one or more future events will occur confirming
  the existences of the asset, liability or
  impairment) and the amount of the asset or
  liability can be reasonably estimated. The
  guidance in ASC 450 should be used for purposes
  of determining whether these conditions have been
  met.

21
Valuing and recording the acquirees assets and
liabilitiesSubsequent recognition of
preacquisition contingent assets and liabilities

• IFRS
• Under IFRS, liabilities subject to contingencies
  should be subsequently measured at the higher of
  (1) the amount that would be recognized in
  accordance with IAS 37, Provisions, Contingent
  Liabilities and Contingent Assets or (2) the
  amount initially recognized less, when
  appropriate, cumulative amortization recognized
  in accordance with IAS 18, Revenue.

• US GAAP
• Subsequent measurement of these assets and
  liabilities is done on a systematic and rational
  basis.

For contingent liabilities that are initially
recognized and measured at fair value under IFRS
3(R) but at an amount other than fair value under
ASC 805 (using the probable and reasonably
estimable criteria in ASC 450), such
contingent liabilities may be derecognized
earlier under US GAAP than IFRS. This is because
under US GAAP, contingent liabilities may be
derecognized once it becomes remote that a
liability exists. In contrast, under IFRS 3(R),
because contingent liabilities are subsequently
accounted for at the higher of (1) the amount
that would be recognized in accordance with IAS
37 or (2) the amount recognized less any
amortization, such liabilities may not be
derecognized if it becomes remote that a
liability exists.
22
Contingent liability example

• Example 4
• XYZ Company acquired ABC Company on January 1,
  201X. ABC is a defendant in a lawsuit as of
  January 1, 201X. The contingency is considered to
  be a present obligation and the fair value of the
  obligation can be reliably measured as 23,000.
  As of the acquisition date it is not believed
  that an out flow of cash or other assets will be
  required to settle this matter.

• What amount should be initially recorded under
  both US GAAP and IFRS for this contingent
  liability?

23
Contingent liability example

• Example 4 solution
• US GAAP Preacquisition contingent liabilities
  are recognized at the acquisition date at fair
  value, so a liability of 23,000 would be
  recorded.
• IFRS Preacquisition liabilities subject to
  contingencies are recognized as of the
  acquisition date if there is a present obligation
  (even if it is not probable that an outflow of
  resources embodying economic benefits will be
  required to settle the obligation) and the fair
  value of the obligation can be measured reliably,
  so a liability of 23,000 would be recorded.

24
Accounting for contingent consideration
IFRS
US GAAP
Contingent consideration is recognized initially
at fair value as part of the price paid for the
acquired company and is classified as an asset,
liability or equity. (Contingent consideration
would be classified as an asset when the acquirer
has the right of return of previously transferred
consideration when certain conditions are met.)
Similar
Subsequent adjustments to contingent
consideration that is due to additional
information about circumstances that existed at
the acquisition date that the acquirer obtains
during the measurement period are adjusted, with
the offset going to goodwill.
Similar
25
Accounting for contingent consideration
IFRS
US GAAP
Subsequent adjustments that are related to events
that occur after the acquisition date (e.g.,
meeting an earnings target) are generally
recognized in income if the consideration was
originally classified as an asset or liability.
Similar
Under both standards, contingent consideration
that is classified as equity is not adjusted
through income, but rather the ultimate
settlement should be accounted for within equity.
Similar
26
Accounting for contingent consideration

• IFRS
• The distinction is generally based on IAS 37
  or IAS 39.

• US GAAP
• Whether contingent consideration is classified as
  equity versus a liability is generally based on
  ASC 480-10.

27
Push-down accounting

• IFRS
• Push-down accounting is not allowed.

• US GAAP
• Push-down accounting (whereby the acquiree
  recognizes the fair value adjustments, including
  goodwill, in their financial statements) is
  required by the SEC when the subsidiary becomes
  substantially wholly owned.
• The SEC does not permit push-down accounting when
  a subsidiary is less than 80 owned.
• When ownership is greater than 80 but less than
  95, push-down accounting is permitted but not
  required.
• When ownership is greater than or equal to 95,
  push-down accounting is generally required.

28
Push-down accounting example

• Example 5 On January 1, 201X, Doodlebugs
  Clothing and Accessories (Doodlebug) purchased a
  100 interest in Halles Fashion Accessories
  (HFA). Doodlebug issued 50,000 shares of common
  stock (1 par value) that were trading at 30 on
  January 1 (the acquisition date).
• The book value of HFAs net assets (including
  PPE) was 750,000 on January 1. The balance in
  the PPE account was 78,000. The balance in
  HFAs retained earnings account was 55,000. The
  fair value of net assets, exclusive of PPE, was
  1.0 million. HFAs PPE is particularly hard to
  value as there is no active market.
  Consequently, the assessment of the fair value of
  this PPE under IFRS is 150,000, whereas the
  assessment of fair value under US GAAP is
  200,000.

• Provide the necessary journal entries under both
  US GAAP and IFRS to record push-down accounting.

29
Push-down accounting example

• Example 5 solution
• US GAAP
• Net assets (excluding PPE) 328,000
• PPE 122,000
• Goodwill 300,000
• Retained earnings 55,000
• Additional paid-in capital 805,000
• IFRS
• No journal entry is required since IFRS does not
  allow push-down accounting.

30
Disclosures
IFRS
US GAAP
Similar. The requirements are found in IFRS
3(R), paragraphs 59 through 63 and B64 through
B67. Most of the disclosure requirements have
identical wording. Since these disclosure
requirements are extensive, they are not
reproduced here.
The disclosure requirements for US GAAP are found
in ASC 805-10-50, 805-20-50 and 805-30-50.
31
Disclosures

• IFRS
• The disclosure of contingent liabilities
  recognized in a business combination may differ
  as IFRS 3(R) refers back to IAS 37.
• The disclosure by reportable segment is not
  required.

• US GAAP
• Differences between US GAAP and IFRS in
  disclosures of contingent liabilities are
  included in the module on contingent liabilities.
  
• The acquirer must disclose, for each business
  combination that occurs during the period or in
  the aggregate for individually immaterial
  business combinations that are material
  collectively and that occur during the period,
  the amount of goodwill by reportable segment if
  the combined entity is required to disclose
  segment information in accordance with ASC
  280-10, Segment Reporting, unless such disclosure
  is impracticable.

32
Disclosures

• IFRS
• No similar requirement.

• US GAAP
• If comparative financial statements are presented
  and the entity is a public business enterprise
  (as described in ASC 280-10-20), ASC 805-10-50-2
  requires disclosure of revenue and earnings of
  the combined entity for the comparable prior
  reporting period as though the acquisition date
  for all business combinations that occurred
  during the current year had occurred as of the
  beginning of the comparable prior annual
  reporting period (supplemental pro forma
  information).

33
Disclosures

• IFRS
• Requires the acquirer to disclose the amount and
  an explanation of any gain or loss recognized in
  the current period that (a) relates to the
  identifiable assets acquired or liabilities
  assumed in a business combination that was
  effected in the current or previous reporting
  period and (b) is of such a size, nature or
  incidence that disclosure is relevant to
  understanding the combined entitys financial
  statements.

• US GAAP
• No similar requirement.