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Sunday, May 16, 2010
IFRS 3 Business Combinations
as issued at 1 January 2009
The objective of the IFRS is to enhance the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. It does that by establishing principles and requirements for how an acquirer:
- recognises and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree;
- recognises and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and
- determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
Core principle
An acquirer of a business recognises the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enables users to evaluate the nature and financial effects of the acquisition.
Applying the acquisition method
A business combination must be accounted for by applying the acquisition method, unless it is a combination involving entities or businesses under common control. One of the parties to a business combination can always be identified as the acquirer, being the entity that obtains control of the other business (the acquiree). Formations of a joint venture or the acquisition of an asset or a group of assets that does not constitute a business are not business combinations.
The IFRS establishes principles for recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. Any classifications or designations made in recognising these items must be made in accordance with the contractual terms, economic conditions, acquirer’s operating or accounting policies and other factors that exist at the acquisition date.
Each identifiable asset and liability is measured at its acquisition-date fair value. Any non-controlling interest in an acquiree is measured at fair value or as the non-controlling interest’s proportionate share of the acquiree’s net identifiable assets.
The IFRS provides limited exceptions to these recognition and measurement principles:
- Leases and insurance contracts are required to be classified on the basis of the contractual terms and other factors at the inception of the contract (or when the terms have changed) rather than on the basis of the factors that exist at the acquisition date.
- Only those contingent liabilities assumed in a business combination that are a present obligation and can be measured reliably are recognised.
- Some assets and liabilities are required to be recognised or measured in accordance with other IFRSs, rather than at fair value. The assets and liabilities affected are those falling within the scope of IAS 12 Income Taxes, IAS 19 Employee Benefits, IFRS 2 Share-based Payment and IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
- There are special requirements for measuring a reacquired right.
- Indemnification assets are recognised and measured on a basis that is consistent with the item that is subject to the indemnification, even if that measure is not fair value.
The IFRS requires the acquirer, having recognised the identifiable assets, the liabilities and any non-controlling interests, to identify any difference between:
- the aggregate of the consideration transferred, any non-controlling interest in the acquiree and, in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree; and
- the net identifiable assets acquired.
The difference will, generally, be recognised as goodwill. If the acquirer has made a gain from a bargain purchase that gain is recognised in profit or loss.
The consideration transferred in a business combination (including any contingent consideration) is measured at fair value.
In general, an acquirer measures and accounts for assets acquired and liabilities assumed or incurred in a business combination after the business combination has been completed in accordance with other applicable IFRSs. However, the IFRS provides accounting requirements for reacquired rights, contingent liabilities, contingent consideration and indemnification assets.
Disclosure
The IFRS requires the acquirer to disclose information that enables users of its financial statements to evaluate the nature and financial effect of business combinations that occurred during the current reporting period or after the reporting date but before the financial statements are authorised for issue. After a business combination, the acquirer must disclose any adjustments recognised in the current reporting period that relate to business combinations that occurred in the current or previous reporting periods.
Wednesday, May 5, 2010
IFRS 2 Share-based Payment
The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees.
The IFRS requires an entity to recognise share-based payment transactions in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the entity. There are no exceptions to the IFRS, other than for transactions to which other Standards apply.
This also applies to transfers of equity instruments of the entity’s parent, or equity instruments of another entity in the same group as the entity, to parties that have supplied goods or services to the entity.
The IFRS sets out measurement principles and specific requirements for three types of share-based payment transactions:
- equity-settled share-based payment transactions, in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options);
- cash-settled share-based payment transactions, in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity; and
- transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments.
For equity-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity is required to measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted.
Furthermore:
- for transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received. The fair value of the equity instruments granted is measured at grant date.
- for transactions with parties other than employees (and those providing similar services), there is a rebuttable presumption that the fair value of the goods or services received can be estimated reliably. That fair value is measured at the date the entity obtains the goods or the counterparty renders service. In rare cases, if the presumption is rebutted, the transaction is measured by reference to the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders service.
- for goods or services measured by reference to the fair value of the equity instruments granted, the IFRS specifies that vesting conditions, other than market conditions, are not taken into account when estimating the fair value of the shares or options at the relevant measurement date (as specified above). Instead, vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest. Hence, on a cumulative basis, no amount is recognised for goods or services received if the equity instruments granted do not vest because of failure to satisfy a vesting condition (other than a market condition).
- the IFRS requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated, using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm’s length transaction between knowledgeable, willing parties.
- the IFRS also sets out requirements if the terms and conditions of an option or share grant are modified (eg an option is repriced) or if a grant is cancelled, repurchased or replaced with another grant of equity instruments. For example, irrespective of any modification, cancellation or settlement of a grant of equity instruments to employees, the IFRS generally requires the entity to recognise, as a minimum, the services received measured at the grant date fair value of the equity instruments granted.
For cash-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity is required to remeasure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in profit or loss for the period.
For share-based payment transactions in which the terms of the arrangement provide either the entity or the supplier of goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments, the entity is required to account for that transaction, or the components of that transaction, as a cash-settled share-based payment transaction if, and to the extent that, the entity has incurred a liability to settle in cash (or other assets), or as an equity-settled share-based payment transaction if, and to the extent that, no such liability has been incurred.
The IFRS prescribes various disclosure requirements to enable users of financial statements to understand:
- the nature and extent of share-based payment arrangements that existed during the period;
- how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period was determined; and
- the effect of share-based payment transactions on the entity’s profit or loss for the period and on its financial position.
IFRS 1 First-time Adoption of International Financial Reporting Standards
The objective of this IFRS is to ensure that an entity’s first IFRS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that:
(a) is transparent for users and comparable over all periods presented;
(b) provides a suitable starting point for accounting under International Financial Reporting Standards (IFRSs); and
(c) can be generated at a cost that does not exceed the benefits to users.
An entity’s first IFRS financial statements are the first annual financial statements in which the entity adopts IFRSs, by an explicit and unreserved statement in those financial statements of compliance with IFRSs.
An entity shall prepare an opening IFRS statement of financial position at the date of transition to IFRSs. This is the starting point for its accounting under IFRSs. An entity need not present its opening IFRS balance sheet in its first IFRS financial statements.
In general, the IFRS requires an entity to comply with each IFRS effective at the reporting date for its first IFRS financial statements. In particular, the IFRS requires an entity to do the following in the opening IFRS balance sheet that it prepares as a starting point for its accounting under IFRSs:
(a) recognise all assets and liabilities whose recognition is required by IFRSs;
(b) not recognise items as assets or liabilities if IFRSs do not permit such recognition;
(c) reclassify items that it recognised under previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity under IFRSs; and
(d) apply IFRSs in measuring all recognised assets and liabilities.
The IFRS grants limited exemptions from these requirements in specified areas where the cost of complying with them would be likely to exceed the benefits to users of financial statements. The IFRS also prohibits retrospective application of IFRSs in some areas, particularly where retrospective application would require judgements by management about past conditions after the outcome of a particular transaction is already known.
The IFRS requires disclosures that explain how the transition from previous GAAP to IFRSs affected the entity’s reported financial position, financial performance and cash flows.
Sunday, May 2, 2010
IAS 28 investments in associates – significant influence
X owns 60% of the voting rights of Y, Z owns 19% of the voting rights of Y, and the remainder are dispersed among the public. Z also is the sole supplier of raw materials to Y and has a contract to supply certain expertise regarding the maintenance of Y’s equipment.
Required
What is the relationship between Z and Y?
Solution
Z may be able to exercise significant influence over Y, and therefore it may have to be treated as an associate. Although Z owns only 19% of the voting rights, it is the sole supplier of raw materials to Y and provides expertise in the form of maintenance of Y’s equipment.
IAS 28 – carrying value of investments in associates
A acquires 25% of the voting shares of B on January 1, 20X5. The purchase consideration was $10 million, and A has significant influence over B. The retained earnings of B were $15 million at the date of acquisition, and the A group has several other subsidiaries. The retained earnings of B at December 31, 20X5, were $21 million.
Required
Calculate the carrying value of the investment in B in the group financial statements at December 31, 20X5.
Solution
| $m | |
| Cost of investment | 10.0 |
| Share of postacquisition reserves 25% of ($21 – 15)m | 1.5 |
| 11.5 |
The share of the post-acquisition reserves will be credited to the retained earnings of the group. Goodwill in an associate is not separately recognized. The entire carrying amount is tested for impairment.
In the consolidated income statement [consolidated statement of comprehensive income], income from associates for the year is reported after profit from operations, just before profit before tax.
IAS 28 investments in associates – intercompany profits
Company A sells inventory to its 30% owned associate, B. The inventory had cost A $200,000 and was sold for $300,000. B also has sold inventory to A. The cost of this inventory to B was $100,000, and it was sold for $120,000.
Required
How would the intercompany profit on these transactions be dealt with in the financial statements if none of the inventory had been sold at year-end?
Solution
Company A to Company B
| $000 | |
| The intergroup profit is $(300 – 200) | 100 |
| Profit reported would be 100 × 70/100 = | 70 |
The remaining profit would be deferred until the sale of the inventory.
Company B to Company A
The profit made by B would be $(120 – 100) = 20
An amount of 20 × 30/100 would be eliminated from the carrying value of the investment, that is, $6,000.
The alternative is to eliminate the whole of the profit from B’s profit for the period and then calculate the profit attributable to the associate.
IAS 28 investments in associates – significant influence
Company X owns 22% of Company Y and is entitled to appoint two directors to the board, which consists of eight members. The remaining 78% of the voting rights are held by two other companies, each of which is entitled to appoint three directors. The board makes decisions on the basis of a simple majority. Because board meetings are often held at very short notice, Company X does not always have representation on the board. Often the suggestions of the representative of Company X are ignored, and the decisions of the board seem to take little notice of any representations made by the director from Company X.
Required
What is the relationship between Company X and Company Y?
Solution
Company X is unable to exercise significant influence as its directors seem to be ignored at board meetings. Therefore, the equity method should not be used.
If the investor ceases to have significant influence over an associate, then the equity method should not be used and the investment should be accounted for using IAS 39.
IAS 28 investments in associates – impairment losses
A acquired 30% of the issued capital of B for $1 million on December 31, 20X5. The accumulated profits at that date were $2 million. A appointed three directors to the board of B, and A intends to hold the investment for a significant period of time. The companies prepare their financial statements to December 31 each year. The abbreviated balance sheet [financial position] of B on December 31, 20X7 is
| Sundry net assets | $6 million |
| Issued share capital of $1 | $1 million |
| Share premium | $2 million |
| Retained earnings | $3 million |
B had made no new issues of shares since the acquisition of the investment by A. The recoverable amount of net assets of B is deemed to be $7 million. The fair value of the net assets at the date of acquisition was $5 million.
Required
What amount should be shown in A’s consolidated balance sheet [consolidated statement of financial position] at December 31, 20X7, for the investment in B?
Solution
Investment in associate (30% × $6 million) = $1.8 million
Alternative Calculation:
| $ million | |
| Cost | 1.0 |
| Post-acquisition profits 30% (3 – 2) | 0.3 |
| Negative goodwill (30% of $5 million) – $1 million | 0.5 |
| 1.8 |
The negative goodwill [gain from a bargain purchase] will be credited to income.
An impairment test would prove that the carrying amount of the investment is not impaired.
| $million | |
| Recoverable amount $7 million × 30% | 2.1 |
| Carrying value of investment | 1.8 |
(Goodwill should not be impairment tested separately but included in the carrying value of the investment.)
Saturday, May 1, 2010
Accounting policies
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.
Source: IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
Accounting profit
Accounting profit is profit or loss for a period before deducting tax expense.
Source: IAS 12 Income Taxes.
Accrual basis of accounting
The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
Source: Framework for the Preparation and Presentation of Financial Statements
Accumulating compensated absences
Accumulating compensated absences are compensated absences that are carried forward and can be used in future periods if the current period’s entitlement is not used in full.
Source: IAS 19 Employee Benefits.
Acquiree
Acquiree is the business or businesses that the acquirer obtains control of in a business combination.
Source: IFRS 3 Business Combinations.
Acquirer
Acquirer is the entity that obtains control of the acquiree.
Source: IFRS 3 Business Combinations.
Acquisition date
Acquisition date is the date on which the acquirer obtains control of theacquiree.
Source: IFRS 3 Business Combinations.
Active market
A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis. (IAS 39)
An active market also defined as a market in which all the following conditions exist:
(a) the items traded within the market are homogeneous;
(b) willing buyers and sellers can normally be found at any time; and
(c) prices are available to the public.
Sources:
- IAS 36 Impairment of Assets
- IAS 38 Intangible Assets
- IAS 39 Financial Instruments: Recognition and Measurement
- IAS 41 Agriculture.
Actuarial assumptions
Actuarial assumptions are an entity’s unbiased and mutually compatible best estimates of the demographic and financial variables that will determine the ultimate cost of providing post-employment benefits.
Source: IAS 19 Employee Benefits.
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