GRAP Guideline 106 - Transfer of Functions Between Entities Not Under Common Control

Accounting Guideline

GRAP 106

Transfer of Functions Between Entities Not Under Common Control

GRAP 106 – Transfer of Functions Between Entities Not Under Common Control

January 2014

Contents

1. INTRODUCTION ......................................................................................................... 3

2. SCOPE ........................................................................................................................ 4

3. THE BIG PICTURE ...................................................................................................... 6

4. IDENTIFICATION ........................................................................................................ 7

4.1 Identifying the acquirer and acquiree ....................................................................... 7

4.2 Establishing common control ................................................................................... 8

4.3 Establish what is a function ................................................................................... 10

4.4 Residual interest.................................................................................................... 11

4.5 Determining the acquisition date ........................................................................... 11

5. RECOGNITION AND MEASUREMENT ..................................................................... 13

5.1 Recognition and measurement principles .............................................................. 13

5.2 Measurement period ............................................................................................. 28

6. ILLUSTRATIVE EXAMPLES ...................................................................................... 29

7. DISCLOSURE ........................................................................................................... 33

8. TRANSITIONAL PROVISIONS .................................................................................. 37

9. SUMMARY OF KEY PRINCIPLES ............................................................................ 39

9.1 Identification .......................................................................................................... 39

9.2 Recognition and measurement .............................................................................. 39

9.3 Disclosure ............................................................................................................. 39


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1. INTRODUCTION

This document provides guidance on the accounting principles to be applied by the acquirer in accounting for a transfer of functions between entities not under common control.

The contents should be read in conjunction with GRAP 106, which form part of the GRAP Reporting Framework (see Directive 5 – Determining the GRAP Reporting Framework, issued by the ASB).

For purposes of this guide, “entities” refer to the following bodies to which the standards of GRAP relate to, unless specifically stated otherwise:

Public entities

Constitutional institutions

Municipalities and all other entities under their control

Parliament and the provincial legislatures

Trading entities - only effective from 1 April 2013

Explanation of images used in manual:

Definition

Take note

Management process and decision making

Example


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2. SCOPE

GRAP 106 is applicable to all entities on the accrual basis of accounting for an acquirer and acquiree to account for a transaction or event that meets the definition of a transfer of functions.

This standard does not apply to:

transfers of individual or groups of assets and/or liabilities that do not meet the definition of a transfer of functions (for example SANRAL may be requested to take over provincial roads from various provincial departments from time to time - this will be treated as an acquisition of assets by SANRAL in terms of GRAP 17 - Property, Plant and Equipment rather than a transfer of functions) (refer to accounting guideline GRAP 17 for details);

transfer of functions between entities under common control (refer to accounting guideline GRAP 105 for details); and

a merger (refer to accounting guideline GRAP 107 for details).

If no acquirer can be identified in the transaction, GRAP 107 on mergers should be applied.

F.A.Q

One of the most frequently asked questions are:

When should a transfer of functions be accounted for in accordance with GRAP 105 and when should GRAP 106 be applied?

Answer:

GRAP 105 Transfer of Functions Between Entities Under Common Control establishes accounting principles for an acquirer and transferor in a transfer of functions between entities under common control whereas GRAP 106 Transfer of Functions Between Entities Not Under Common Control provides guidance to an acquirer where a transfer of functions is undertaken between entities not under common control.

In determining whether GRAP 105 or GRAP 106 should be applied in accounting for the transaction or event, entities should consider whether the transaction or event was undertaken between entities in the same sphere of government; and/or between entities that are part of the same economic entity.

The Government of the Republic of South Africa is divided into three distinct spheres, i.e. national, provincial and local and each is independent from the decision-making of another sphere. Even if the transaction or event occurred between entities within the same sphere of government, entities should ultimately be controlled by the same party (economic entity) before and after the transfer of functions for it to be within the same economic entity (i.e. a group of entities as described in GRAP 6). Where transactions or events occurred between entities within different spheres of government, the relationship between the entities need to be assessed to determine whether the entities are ultimately controlled by the same economic entity before and after the transfer of functions in order for it to be under common control.

If two departments within the same province enters into a transaction or event


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where it is concluded that such a transaction or event is a transfer of functions, the entity should consider applying the principles in GRAP 105, because (a) the transaction or event occurred between two departments that are within the same sphere of government (i.e. the same province), and (b) the departments are ultimately controlled by the same economic entity before and after the transfer of functions.

Even though all municipalities are within the same sphere of government, each municipality is independent from every other municipality and each municipality is responsible for the establishment and election of its own municipal council. If a transaction or event occurs between two municipalities, the transaction or event will not be a transfer of functions between entities under common control because the transaction or event did not occur between entities that are controlled by the same party before and after the transaction or event. Thus, even though municipalities are within the same sphere of government, the entities are not part of the same economic entity (i.e. the same municipal council) before and after the transaction or event. Municipalities should also consider whether GRAP 106 Transfer of Functions between entities Not under Common Control or GRAP 107 Mergers is more applicable in accounting for the transaction or event, depending on whether one municipality gained control over another municipality.

F.A.Q One of the most frequently asked questions relating to GRAP 106 is:

What accounting should a transferor apply in a transfer of function between entities not under common control?

Answer:

GRAP 106 Transfer of Functions Between Entities Not Under Common Control does not prescribe an accounting treatment for the transferor in the arrangement. As a result, the transferor should apply the existing Standards of GRAP.

- Where the transferor disposes of assets, or groups of assets and liabilities, in accordance with the requirements of GRAP 100 Non-Current Assets Held for Sale and Discontinued Operations, it applies the requirements in that Standard in accounting for assets or disposal groups held for sale. Note: An entity might not meet the requirements to treat the assets or disposal groups as held for sale, but it still needs to assess whether the disclosures should be made because the assets or disposal groups held for sale are a discontinued operation.

- Where an entity does not dispose of assets or groups of assets and liabilities in accordance with GRAP 100 and the assets or disposal group is not a discontinued operation, the entity formulates an appropriate accounting policy and appropriate disclosures using other Standards of GRAP. For example, where GRAP 100 does not apply, an entity would apply the requirements of GRAP 17 Property, Plant and Equipment and the impairment Standards (GRAP 21 and/or GRAP 26) in accounting for the assets until they are transferred.


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3. THE BIG PICTURE

Figure 1


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4. IDENTIFICATION

4.1 Identifying the acquirer and acquiree

The acquirer is the entity which obtains control / takes possession of the acquiree.

The acquiree is the entity and / or the functions that the acquirer obtains.

The terms and conditions are set out in a binding agreement between the parties (this can be a formal written agreement, legislation, council resolution, etc.).

This agreement will usually set out the parties, indicating the acquiree and the acquirer. When the acquiree and the acquirer are not clearly indicated in the agreement, the behaviour or the actions of the entities may indicate which entity is the acquiree and which entity is the acquirer.

For example, where a transfer of functions is effected by transferring cash, other assets or incurring liabilities, the entity transferring the cash or other assets or who incurs the liabilities is usually the acquirer.

Where a transfer is brought about through the exchange of residual interests, the acquirer will be the entity that does not experience a change in control.

If no acquirer can be identified, the transaction or event should be accounted for in terms of GRAP 107 - Mergers (refer to accounting guideline GRAP 107 for details).

Example 1: Identity the acquiree and acquirer

Department A is currently running a specific programme in accordance with its mandate. New legislation mandated Department A to transfer this programme to Department B. The agreement did not specify which entity is the acquiree and which entity is the acquirer. After the transfer Department A will receive no more grants in respect of this project.

There is thus a clear indication by evaluating the transaction that the acquiree will be Department A and the acquirer will be Department B.

Additional evidence that Department A is the acquiree is that Department A will no longer receive funding to carry out the specific programme.


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4.2 Establishing common control

Where functions are transferred to a newly established entity which did not exist prior to the acquisition date, this will be regarded as a transfer of functions between entities not under common control, if this newly established entity is identified as the acquirer and the acquiree does not form part of the same economic entity subsequent to the transfer.

Control is where an entity has power to govern or direct the financial and operating policies of another entity, so that the entity will receive benefits from its activities.

Common control can only occur between entities in the same sphere of government or between entities that are part of the same economic entity (where entities are finally controlled by the same entity before and after the transfer of functions, the transfer would be within the same economic entity). Each sphere of government is responsible for executing its assigned functions which should be in line with the overall policies and objectives set by national government.

Although the national government provides funding to the other spheres of government and the national government benefits from the activities of the other spheres of government (as they assist in achieving its overall policies and objectives), this does not imply control for financial reporting purposes. Entities within one sphere of government are thus independent of other spheres of government.

When a transfer of functions take place, the level of non-controlling interest is irrelevant in determining if the transaction involves entities under common control.

Common control is not transitory / temporary.


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The following figure illustrates the entities in the South African government context (note that entities within the different spheres of government are not under common control):

Figure 2

Example 2: Entities under common control within the relevant spheres of government

National sphere:

For example: Telkom, the Post Office, Transnet, the National Departments of Public Works and Trade and Industry, the Competition Commission and the Market Theatre will all be under common control, as they fall within the national sphere of government.

Provincial sphere:

For example: The Gauteng Department of Health, Gauteng Economic Development Agency, Gauteng Gambling Board and the Gauteng Tourism Authority will all be under common control , as they fall within the same province. Note that these entities will not be under common control in relation to any departments or public entities from another province.

Local sphere:

For example: The City of Johannesburg and its municipal entities are under common control. The City of Tshwane and the City of Johannesburg are not under common control.


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4.3 Establish what is a function

Function is an integrated set of activities that is capable of being conducted and managed for purposes of achieving an entity’s objectives, by either providing economic benefits (increased sales, cash flow, net income) or service potential (anticipated future benefits to be obtained from an asset).

Achieving the entity‟s objectives can be either by providing economic benefits or service potential.

A function should be based on the definition of a business.

A transfer of functions results in a wide range of outcomes, and as a result may be undertaken for a variety of reasons, including:

To provide a return to owners of the entity, either in the form of economic benefits or service potential. For example, entities may acquire entities or parts of entities in the private sector for the potential return to be yielded by the entity;

To generate revenue. Trading entities and public entities may be established by government in order to maximise the revenue potential of certain activities, for example, the establishment of a property management company to maximise rental revenue generated from government owned land and buildings;

To reduce costs or improve the way in which resources are used. Entities may be rationalised in order to save on costs, maximise efficiencies, or as a means of improving service delivery. For example, the transfer of certain functions from the national and various provincial departments of social development to a newly formed agency in a bid to improve service delivery; and

Example 3: Identifying a transfer of functions

Department A is currently running a specific programme in accordance with its mandate. New legislation mandated Department A to transfer this programme to Department B.

Acquirer: Department B.

Sphere: National and Provincial.

Function: Specific programme

The two departments are not within the same economic entity as they are not within the same sphere of government.

The transfer of function will thus fall within the scope of GRAP 106 - Transfer of Functions Between Entities Not Under Common Control.

If however, the function was transferred from a National Department to another National Department, then the transfer of function will fall within the scope of GRAP 105 – Transfer of Functions Between Entities Under Common Control. This is because the departments do fall within the same sphere of government or within the same economic entity.


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To deliver goods and services (whether for full or only part compensation). An example of this is the establishment of municipal entities by municipalities to provide essential services such as electricity, water supply, and rubbish removal in return for fees charged to users.

A function consists of three elements, i.e. input, process and output as shown in the figure below:

Figure 3

4.4 Residual interest

4.5 Determining the acquisition date

The acquisition date will be the date on which the acquirer obtains control and the acquiree loses control over this function.

Residual interest is where a contract gives evidence of an interest in the net assets of another entity.

Residual interest will entitle the holder of the interest to a part of the net assets of the other entity. Any payments made to the holder of the interest are discretionary (for example dividends).

Critical for outputs


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This date is sometimes determined in a binding arrangement. However, it is important to note that the acquirer may obtain control on a date that is either earlier or later than the date specified in the binding arrangement. The acquirer has to consider all the relevant facts and circumstances in determining the acquisition date.

The acquirer will account for the assets acquired and liabilities assumed in its financial statements from the acquisition date.

The acquiree will derecognise the assets transferred and liabilities relinquished in its financial statements from that date.

Example 4: Determining the acquisition date

Legislation passed in Parliament on 1 April 2011 requires Department A to take over the functions of Department B. The departments are not within the same sphere of government (thus not under common control). A directive is issued stating that the effective date of the transfer is 1 June 2011 however; Department A only obtains control over the assets and liabilities of Department B on 1 July 2011 in terms of a memorandum of understanding between the departments.

As Department A can only use or otherwise benefit from the transfer of functions from 1 July 2011, this is the date from which the transfer should be accounted for.


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5. RECOGNITION AND MEASUREMENT

5.1 Recognition and measurement principles

The figure below summarises the recognition principles in a transfer of functions between entities not under common control for the acquirer and acquiree:

Figure 4

For transfer of functions between entities not under common control, all identifiable assets acquired and liabilities assumed by the acquirer should be measured at acquisition-date fair values.

The assets acquired or transferred and the liabilities assumed or relinquished must be part of what had been agreed in terms of the binding arrangement, rather than the result of separate transactions. The acquirer and acquiree should determine which assets are acquired or transferred and which liabilities are assumed or relinquished as part of a transfer of functions and which, if any, are the result of separate transactions to be accounted for in accordance with their nature and the applicable standard of GRAP.

From this point forward, up to the illustrative examples, the guide only deals with the accounting of a transfer of functions from the acquirer’s perspective.


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The acquirer should identify any amounts that are not part of what the acquirer and acquiree exchanged in a transfer of functions in the following situations:

The acquirer and acquiree had a pre-existing relationship before or when negotiations for a transfer of functions began; or

The acquirer and acquiree enter into a binding arrangement during the negotiations that is separate from a transfer of functions.

The following are examples of separate transactions that are not to be included in applying the acquisition method:

A transaction that in effect settles pre-existing relationships between the acquirer and the acquiree (this is discussed in more detail below);

A transaction that reimburses the acquiree or its former owners for paying the acquirer„s acquisition-related costs; and

Contributions received from third parties as compensation for future services as a result of undertaking the transfer of functions.

A pre-existing relationship between the acquirer and acquiree may be contractual (for example, vendor and customer or supplier) or non-contractual (for example, plaintiff and defendant). A gain or loss should be recognised by the acquirer if a transfer of functions in effect settles a pre-existing relationship, the measurement would be different depending on whether the pre-existing relationship was contractual or non-contractual.

For a pre-existing non-contractual relationship, the gain or loss should be measured at fair value.

For a pre-existing contractual relationship, the gain or loss should be measured at the lesser of:

The amount by which the binding arrangement is favourable or unfavourable from the perspective of the acquirer when compared with terms for current market transactions for the same or similar items.

The amount of any stated settlement provisions in the binding arrangement available to the counterparty to which the contract is unfavourable.

If the latter is less than the former, the difference should be included as part of the transfer of functions accounting.

Example 5: Pre-existing non-contractual relationship

Department A, the acquirer, is a defendant in a lawsuit brought about by acquiree. At the date of transfer, the fair value of the settlement of the lawsuit is R2 million. This is the amount at which the loss should be measured at.

If the acquirer already recognised a provision for the settlement of the lawsuit for R1.5 million, then the loss recognised would be measured at R500,000 (the difference between R2m and R1.5m already recognised.

This has to be recognised as a separate transaction to the transfer of functions.


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All acquisition related costs, such as advisory, legal, accounting, valuation, other professional and consulting fees, etc., should be expensed by the acquirer in the period in which the costs are incurred and the services are received. However, if the acquirer incurs costs to issue debt or equity securities, those costs should be recognised in accordance with GRAP 104 - Financial Instruments, i.e. capitalised or taken to net assets.

Subsequent to the transfer, all assets and liabilities recognised should be measured in accordance with the applicable standards of GRAP.

The acquisition method requires that:

1. The acquirer should be identified.

2. The acquisition date should be determined.

3. The identifiable assets acquired, the liabilities assumed and non-controlling interest in the acquiree should be recognised and measured at their acquisition-date fair values (there are however exceptions).

4. The difference between the identifiable assets acquired, the liabilities assumed and non-controlling interest in the acquiree and the consideration transferred to the acquiree should be recognised in surplus and deficit.

Steps 1 to 4 are discussed below.

1. Identify the acquirer

The terms and conditions are set out in a binding arrangement which may encompass a formal written agreement between the entities, legislation passed in parliament or a

Example 6: Pre-existing contractual relationship

Entity A, the acquirer, leases an office building from Entity B, the acquiree.

If the contract terms are unfavourable by R2 million, then a R2 million loss should be recognised at the transfer date.

However, if the contract includes is a provision for the acquirer to settle the contract by making a payment of R1.2 million, then the loss will be recognised at this reduced amount.

The difference between the two amounts (R800,000) is included as part of the transfer of functions accounting.

The settlement of a pre-existing relationship between the acquirer and the acquiree is not part of the transfer of functions as these transactions were entered into by, or on behalf of the acquirer or primarily for the benefit of the acquirer rather than primarily for the benefit of the acquiree before a transfer of functions. Consequently, these transactions should be accounted for in terms of the applicable Standards of GRAP.

As these transactions were entered into in at arm’s length, the acquirer should measure the gain or loss when settling the pre-existing relationship, at its fair value.


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provincial legislature, cabinet decision, ministerial order, a decision made by a municipal council, regulation or a notice or other official means.

Where a transfer of functions is effected by transferring cash, other assets or incurring liabilities, the entity transferring the cash or other assets or who incurs the liabilities is usually the acquirer.

Where a transfer is brought about through the exchange of residual interests, the acquirer will be the entity that does not experience a change in control.

If no acquirer can be identified, the transaction or event should be accounted for in terms of GRAP 107 - Mergers (refer to accounting guideline GRAP 107 for details).

2. Determining the acquisition date

The acquisition date is the date where the acquirer obtains control over the acquiree.

The binding arrangement may specify an effective date for the transfer of functions. There may however be cases where the acquirer obtains control over the acquiree on a date that is earlier or later than the date on which the assets and liabilities are transferred by the acquiree, or specified in the binding arrangement.

3. Recognition and measurement of identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree

The following should happen:

The identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in the Framework for the Preparation and Presentation of Financial Statements and the recognition criteria in the applicable standards of GRAP at the acquisition date;

For example, the expected costs, when the acquirer in future plans to exit an activity of the transferor, terminate employment, or relocate employees, should not be included as part of the liabilities in a transfer of functions, but should be expensed in the period in which the expenditure is incurred (thus after the transfer of functions has occurred).

Example 7: Identifying the acquisition date

Legislation passed on 1 April 2012 requires Provincial Department A (acquirer) to take over the functions of Department B (acquiree). The departments are not within the same sphere of government.

A directive is issued that states that the effective date of the transfer is 1 June 2012.

Department A however only obtains control of the assets and liabilities on 1 July 2012 through a memorandum of understanding.

The transaction date (date when the transfer of functions should be accounted for) will only be 1 July 2012, since that is the date when the acquirer can use or otherwise benefit from the transfer of functions in pursuit of its objectives, or exclude or otherwise regulate the access of others to those benefits, i.e. obtains control over the assets and liabilities.


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The identifiable assets acquired and liabilities assumed must be part of what was agreed by in the binding arrangement between the acquirer and the acquiree; and

Under the binding arrangement, the acquirer should have an enforceable claim over the acquiree either, to relinquish control of the entity, or over the assets and liabilities of the function to be transferred.

There are some specific recognition and measurement principles and exceptions to the recognition and measurement principles outlined above. These are discussed below.

Operating leases

An acquirer should not recognise any assets or liabilities related to an operating lease in which the acquiree is the lessee. There are, however, certain exceptions which are summarised in the figure below:

Figure 5

Example 8: Determining the whether the terms of an operating lease are favourable or unfavourable

The acquiree is the lessee in an operating lease. At 1 April 2011, the acquisition date, the lease has a remaining term of four years and the lease rentals are fixed at R120,000 per annum over the remaining term.

A market rate for a similar lease is R140,000 per annum. The lease rentals are therefore favourable relative to market terms.

The acquirer should therefore record an intangible asset for the favourable lease and amortise it over the remaining lease term.

The asset to be recognised should be measured as follows (assuming a market-


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Intangible assets

Identifiable intangible assets acquired in a transfer of functions should be separately recognised. That is if the intangible asset meets either:

The separability criterion, i.e. capable of being separated or divided from the acquiree and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability (the asset is separable even if the acquirer does not intend to sell, license or otherwise exchange it); or

The contractual-legal right criterion (the asset is identifiable even if the asset is not transferable or separable from the acquiree or from other rights and obligations).

related interest rate of :

PMT = R20,000 (R140,000 – R120,000)

i = 8% (assumed market-related interest rate)

n = 4

PV = R66,243

The journals are as follows in the accounting records of the acquirer:

1. 1 April 2011 Debit Credit

R R

Intangible asset – operating lease 66,243

Gain from transfer of functions (surplus or deficit)

66,243

Account for favourable operating lease acquired through a transfer of functions

Subsequently, the intangible asset should be amortised over the remaining lease period. The journal for the first year will be as follows (the entries in respect of subsequent years will be similar):

2. 1 April 2011 Debit Credit

R R

Amortisation of operating lease (66,243 / 4) 16,560.75

Intangible asset – operating lease 16,560.75

Account for amortisation of intangible asset recognised in respect of favourable operating lease acquired through a transfer of functions

Example 9: Assets that meet the separability and contractual-legal right criteria

Separability criterion

An acquired intangible asset will meet the separability criterion if there is evidence of exchange transactions for that type of asset or an asset of a similar type, even if those


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Classifying identifiable assets acquired and liabilities assumed

Identifiable assets acquired and liabilities assumed should be classified or designated at the acquisition date as necessary, to apply other standards of GRAP subsequent to the acquisition date, based on the terms of the binding agreement, economic conditions, the operating or accounting policies and other relevant conditions as these exist at the acquisition date.

An example of a classification or designation to be made on the basis of the relevant conditions as they exist at the acquisition date is that of a particular financial asset or liability as a financial asset or liability at fair value or amortised cost in accordance with GRAP 104 - Financial Instruments.

Non-controlling interest in an acquiree

At acquisition date measure components of non-controlling interests in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity„s net assets in the event of liquidation at either:

Fair value (either based on the active market prices for the equity shares not held by the acquirer or by using other valuation techniques where there is no active market prices); or

transactions are infrequent and regardless of whether the acquirer is involved in them.

If terms of confidentiality or other agreements prohibit an entity from selling, leasing or otherwise exchanging the intangible asset, it will not meet the separability criterion.

Contractual-legal right criterion

The acquiree leases a facility under an operating lease that has terms that are favourable relative to market terms; it may however not sell or sublease the lease. An intangible asset that meets the contractual-legal right criterion for separate recognition will be recognised for the amount by which the lease terms are favourable compared with the terms of current market transactions for the same or similar items, even if the acquirer cannot sell or otherwise transfer the lease contract (refer to Example 8 above for details and journal entry).

The acquiree owns and operates a power plant under license. An intangible asset that meets the contractual-legal right criterion for separate recognition will be recognised for the license to operate that power plant, even if the acquirer cannot sell or otherwise transfer it separately from the acquired power plant.

There is an exception to above. The following contracts should be classified or designated based on the contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification, which might be the acquisition date):

Classification of a lease contract as either an operating lease or a finance lease in accordance with GRAP 13 - Leases; and

Classification of a contract as an insurance contract in accordance with the International Financial Reporting Standard (IFRS) 4 - Insurance Contracts.


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The present ownership instruments‟ proportionate share in the recognised amounts of the acquiree's identifiable net assets.

Assets with uncertain cash flows (valuation allowances)

No separate valuation allowance should be recognised, as the effects of uncertainty about future cash flows are already included in the fair value measurement. For example, a separate valuation allowance for the contractual cash flows for acquired receivables (including loans) that are deemed uncollectible should not be recognised at acquisition date, since the receivables are measured at their acquisition-date fair values.

Assets subject to operating leases in which the acquiree is the lessor

In measuring the acquisition-date fair value of an asset (e.g. building) that is subject to an operating lease as lessor, the terms of the lease should be taken into account. Therefore, a separate asset or liability should not be recognised where an operating lease is either favourable or unfavourable when compared with market terms for leases in which the acquiree is the lessor.

There are some exceptions to the recognition and measurement principles. These are discussed below.

Contingent liabilities

GRAP 19 - Provisions, Contingent Liabilities and Contingent Assets defines a contingent liability as:

Possible obligation arising from past events and whose existence will only be confirmed with the occurrence or non-occurrence of the uncertain future events not wholly within the control of the entity, or

Example 10: Measurement of non-controlling interest in an acquiree

On 31 March 2012 Entity A acquires an 80% interest in Entity B for a cash consideration.

Details are as follows as at 31 March 2011:

80% interest at cost (consideration paid) R1,070,000

Fair value of identifiable net assets R1,200,000

Fair value of non-controlling interest (20%) R280,000

GRAP 106 provides a choice on the measurement of non-controlling interest (NCI) at either:

1. fair value; or

2. the acquirer’s proportionate share of the acquiree’s identifiable net assets.

Therefore the value of the non-controlling interest will be R280,000 under option 1 and R240,000 (R1,200,000 x 20%) under option 2.


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A present obligation arising from a past event, but is not recognised as it is not probable that an outflow of resources will be required to settle the obligation or the amount of the obligation cannot be measured reliably.

For the purposes of GRAP 106, a contingent liability assumed in a transfer of functions should be recognised at acquisition date if there is a present obligation arising from past events and its fair value can be measured reliably.

Subsequently, up to when the liability is settled, cancelled or expires, a contingent liability should be measured at the higher of:

The amount that will be recognised in accordance with GRAP 19 - Provisions, Contingent Liabilities and Contingent Assets; and

The initial amount recognised less cumulative amortisation in accordance with GRAP 9 - Revenue from Exchange Transactions.

Employee benefits

The acquirer should recognise and measure a liability (or asset) related to the acquiree‟s employee benefit arrangements in accordance with GRAP 25 - Employee Benefits.

Indemnification assets

The seller may contractually indemnify the acquirer for the outcome of a contingency or uncertainty related to all or part of a specific asset or liability.

For example, the seller may indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency. In other words, the seller guarantees that the acquirer‟s liability will not exceed a specified amount. The acquirer therefore obtains an indemnification asset.

The acquirer should recognise the indemnification asset at the same time that it recognises the indemnified item and measure the indemnification asset on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts if it is not measured at fair value.

Subsequently, the acquirer should measure the indemnification asset on the same basis as the indemnified liability or asset, subject to any limitations as set in the binding arrangement on its amount. If the indemnification asset is not subsequently measured at fair value, a valuation allowance for uncollectible amounts should be included.

The acquirer should derecognise the indemnification asset only when it collects the asset, sells it, or otherwise loses the right to it.

Reacquired rights

A reacquired right is an intangible asset that the acquirer recognises separately from the difference between the identifiable assets acquired and liabilities assumed and the consideration transferred.

The value of a reacquired right recognised as an intangible asset should be measured on the basis of the remaining contractual term of the related contract or binding agreement.


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Where the terms of the binding arrangement are favourable or unfavourable relative to the terms of current market transactions for the same or similar items, a settlement gain or loss should be recognised separately from the transfer of functions.

A pre-existing relationship may be a contract that the acquirer recognises as a reacquired right. A gain or loss should be recognised by the acquirer, the measurement of the gain or loss will be different depending on whether the pre-existing relationship was contractual (for example, vendor and customer or supplier) or non-contractual (for example, plaintiff and defendant).

For a pre-existing non-contractual relationship, the gain or loss should be measured at fair value.

For a pre-existing contractual relationship, the gain or loss should be measured at the lesser of:

The amount by which the binding arrangement is favourable or unfavourable from the perspective of the acquirer when compared with terms for current market transactions for the same or similar items.

The amount of any stated settlement provisions in the binding arrangement available to the counterparty to which the contract is unfavourable.

If the latter is less than the former, the difference should be included as part of the transfer of functions accounting.

Subsequently, reacquired rights should be amortised over the remaining contractual period of the contract in which the right was granted. If the acquirer subsequently sells the reacquired right to a third party, the carrying amount of the intangible asset should be taken into account in determining the gain or loss on sale.

Assets held for sale

Acquired non-current assets held for sale (or disposal group) - which is classified as held for sale at acquisition date - should be measured in accordance with GRAP 100 - Non-current assets Held for Sale and Discontinued Operations at fair value less costs to sell (refer to accounting guideline GRAP 100 for details).

4. Recognising and measuring the difference between the assets acquired, liabilities assumed and the non-controlling interest and the consideration transferred (if any)

The difference is measured as the excess of 1 over 2 below:

1. The aggregate of:

(i) the consideration transferred (if any) measured in accordance with GRAP 106, which generally requires acquisition-date fair value (see consideration transferred further below);

(ii) the amount of any non-controlling interest in the acquiree measured in accordance with GRAP 106 (see non-controlling interest in an acquiree above); and


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(iii) in a transfer of functions achieved in stages (see transfer of functions achieved in stages further below), the acquisition-date fair value of the acquirer‟s previously held equity interest in the acquiree.

2. The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with GRAP 106.

Consideration transferred

The consideration transferred should be measured at fair value, which is the sum of the fair value of assets transferred, the liabilities incurred, and residual interest issued by the acquirer.

If the carrying amounts of assets transferred or liabilities incurred by the acquirer differ from their fair values, the acquirer should re-measure the assets or liabilities to their fair values at acquisition date and recognise any difference in surplus or deficit.

A transfer of functions achieved in stages

A transfer achieved in stages can be where an acquirer obtains control of an acquiree in which it held a residual interest prior to the acquisition date.

The acquirer should re-measure its previously held residual interest in the acquiree at its acquisition-date fair value. Any resulting gain or loss should be recognised in surplus or deficit.

There may be situations where some of the transferred assets or liabilities remain within the combined entity after the transfer of functions and the acquirer therefore retains control of them. These assets and liabilities should not be re-measured to their fair values, but rather measured at their carrying amounts immediately before the acquisition date. No gain or loss will be recognised in surplus or deficit on assets or liabilities that the acquirer controls both before and after the transfer of functions.

Example 11: Transfer of functions achieved in stages

In 2006 Entity A acquired a 30% interest in Entity B for a cash consideration of R320,000.

On 1 April 2012 Entity A acquired a further 50% interest in Entity B for a cash consideration of R750,000 which gives Entity A control over Entity B.

This is known as a transfer of functions achieved in stages.

The fair value of Entity A’s original interest (30%) as at 1 April 2012 is R400,000.

GRAP 106 requires the acquirer to re-measure its previously held residual interest in the acquiree at its acquisition-date fair value.

The journal entry will be as follows:

3. 31 March 2012 Debit Credit


January 2014

R R

Investment in Entity B

(R400,000 – R320,000)

80,000

Gain on re-measurement of previously held residual interest (surplus or deficit)

80,000

Re-measure previously held residual interest at acquisition-date fair value

Example 12: Measurement of the difference between the assets acquired, liabilities assumed and the non-controlling interest and the consideration transferred

In 2006 Entity A acquired a 30% interest in Entity B for a cash consideration of R320,000 when the fair value of Entity B’s identifiable net assets was R1,000,000.

On 1 April 2012 Entity A acquired a further 50% interest in Entity B for a cash consideration.

Details are as follows as at 1 April 2012:

50% interest at cost (consideration paid) R750,000

Fair value of identifiable net assets R1,200,000

Fair value of Entity A’s original interest (30%) R400,000

Fair value of non-controlling interest (20%) R280,000

GRAP 106 requires that for a transfer of functions achieved in stages, the acquirer has to re-measure its previously held residual interest in the acquiree at its acquisition-date fair value (refer to Example 11 above for details and journal entry).

GRAP 106 furthermore provides a choice on the measurement of non-controlling interest (NCI) at either:

fair value; or

the acquirer’s proportionate share of the acquiree’s identifiable net assets.

The difference in the calculation of the excess in the two options allowed is illustrated below.

NCI @ fair value NCI @ share of net assets

Fair value of consideration R750,000 R750,000

Non-controlling interest R280,000 R240,000 (R1,200,000 x 20%)

Previously held interest R400,000 R400,000


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Contingent consideration

Any asset or liability resulting from a contingent consideration arrangement should form part of the consideration that the acquirer transfers in exchange for the acquiree (see consideration transferred above).

The contingent consideration should be measured at its acquisition-date fair value.

An obligation to pay contingent consideration should be classified as a liability or as net assets depending on whether it meets the definition of a financial liability or a residual interest in GRAP 104 - Financial Instruments.

R1,430,000 R1,390,000

Fair value of identifiable net assets

R1,200,000 R1,200,000

Loss from transfer of functions (surplus or deficit)

R230,000 R190,000

The consolidation journal entry will be as follows where the non-controlling interest is measured at fair value:


R R

Net assets of Entity B 1,200,000

Investment in Entity B (R750,000 + R400,000) 1,150,000

Non-controlling interest 280,000


230,000

Account for transfer of functions

The consolidation journal entry will be as follows where the non-controlling interest is measured at the proportionate share of the acquiree’s identifiable net assets:


R R

Net assets of Entity B 1,200,000

Investment in Entity B (R750,000 + R400,000) 1,150,000

Non-controlling interest 240,000


190,000



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A right to a return of previously transferred consideration if specified conditions are met should be classified as an asset.

In subsequent reporting periods additional information obtained (thus after the acquisition date) may result in changes in the fair value of a contingent consideration.

However, changes resulting from events after the acquisition date, such as meeting a performance target, or reaching a milestone on a research and development project, are not measurement period adjustments. The acquirer should account for changes in the fair value of contingent consideration that are not measurement period adjustments as follows:

Contingent considerations classified as net assets should not be remeasured. Subsequent settlement should be accounted for within net assets.

Contingent consideration classified as an asset or a liability that:

o Is a financial instrument according to GRAP 104 - Financial Instruments, should be measured at fair value with gains and losses recognised in surplus or deficit.

o Is not a financial instrument according to GRAP 104 - Financial Instruments, should be treated according to GRAP 19 - Provisions, Contingent Liabilities and Contingent Assets) or other standards of GRAP as appropriate (such as GRAP 102 - Intangibles Assets, GRAP 6 - Consolidated and Separate Financial Statements and IFRS 4 - Insurance Contracts).

Example 13: Contingent consideration

Scenario 1:

Entity A acquires a 80% interest in Entity B for R210,000 (settled in cash) on 1 April 2012. In terms of the binding arrangement 10% of this purchase price will have to be repaid (to Entity A) if Entity B’s revenue is below R800,000 for the 12 months following the acquisition date. At that date, Entity B’s identifiable net assets have a fair value of R150,000.

It is regarded highly improbable that the revenue of Entity B will be above R800,000 for the year. It is therefore likely that the contingent consideration will be repayable to Entity A at the end of the 12 month period.

At the date of acquisition the contingent component of the consideration is assessed as having a fair value of R15,000.

The journal entry will be as follows in the separate financial statements:


R R


(R210,000 – R15,000)

195,000

Receivable 15,000

Bank 210,000


The journal entry will be as follows in the consolidated financial statements:


January 2014


R R

Net assets of Entity B

150,000

Investment in Entity B 195,000

Non-controlling interest (R150,000 x 20%) 30,000

Loss from transfer of functions 75,000


Scenario 2:

Entity A acquires a 80% interest in Entity B for R210,000 (settled in cash) on 1 April 2012. In terms of the binding arrangement an additional R5,000 will be paid if Entity B’s revenue exceeds R1,000,000 for the 12 months following the acquisition date. At that date, Entity B’s identifiable net assets have a fair value of R150,000.

During the 5 year period preceding the acquisition, the revenue of Entity B never dropped below R1,000,000 per annum. It is therefore regarded highly improbable that the revenue of Entity B will drop below R1,000,000 per year.

At the date of acquisition the contingent component of the consideration is assessed as having a fair value of R2,000.

The journal entry will be as follows in the separate financial statements:


R R


(R210,000 + R2,000)

212,000

Payable 2,000

Bank 210,000


The journal entry will be as follows in the consolidated financial statements:


R R

Net assets of Entity B

150,000

Investment in Entity B 212,000

Non-controlling interest (R150,000 x 20%) 30,000

Loss from transfer of functions 92,000



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5.2 Measurement period

If the initial accounting of a transfer of functions is incomplete at the end of the reporting period, the identifiable assets acquired and liabilities assumed, for which the accounting is incomplete, should be recognised at their provisional amounts.

The acquirer is allowed a two-year measurement period from the date of acquisition to obtain the information necessary to identity and measure the following in accordance with the requirements of GRAP 106 (which were discussed in detail above):

The identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree;

The consideration transferred, if any, for the acquiree;

In a transfer of functions achieved in stages, the interest in the acquiree previously held by the acquirer; and

The resulting excess of the purchase consideration paid (if any) over the fair value of the assets acquired and liabilities assumed.

After the acquisition date (the measurement period), the provisional amounts should be retrospectively adjusted to reflect the new information obtained about facts and circumstances that existed at the acquisition date and, if known, would have affected the measurement of amounts recognised as of that date.

An increase in the provisional amount recognised for an identifiable asset (liability) will result in a corresponding decrease (increase) in the excess of the purchase consideration paid (if any) over the fair value of the assets acquired and liabilities assumed previously recognised in surplus or deficit.

Conversely a decrease in the provisional amount recognised for an identifiable asset (liability) will result in a corresponding increase (decrease) in the excess of the purchase consideration paid (if any) over the fair value of the assets acquired and liabilities assumed previously recognised in surplus or deficit.

During the measurement period, the acquirer should also recognise additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date and, if known, would have resulted in the recognition of those assets and liabilities as of that date.

The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable.


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6. ILLUSTRATIVE EXAMPLES

Illustrative example A - accounting for a transfer of functions between entities not under common control

New legislation has determined that Entity B should be integrated in Entity A as at 31 March 2012. All the assets and liabilities are transferred to Entity A for zero consideration. The two entities are not within the same sphere of government.

The carrying amounts of Entity B‟s assets, liabilities and net assets are as follows as at 31 March 2012:

Property, plant and equipment R200,000

Trade receivables R75,000

Cash and cash equivalents R45,000

Trade payables (R250,000)

Net assets (accumulated surplus) (R70,000)

Entity A incurred acquisition cost amounting to R5,000.

The acquisition-date fair values of Entity B‟s assets and the liabilities are as follows as at 31 March 2012:

Property, plant and equipment R300,000

Trade receivables R125,000

Cash and cash equivalents R45,000

Trade payables (R250,000)

Journal entries:

The following journal entries will be made for both entities:

Acquirer (Entity A):


January 2014


R R

Property, plant and equipment 300,000

Trade receivables 125,000

Cash and cash equivalents 45,000

Trade payables 250,000

Gain from transfer of functions (surplus or deficit) 220,000

Acquisition cost 5,000

Bank 5,000

Account for transfer of functions between entities not under common control


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Acquiree (Entity B):


R R





Loss from transfer of functions (surplus or deficit) 70,000


If Entity A would have paid a consideration for the net assets by means of cash to the value of R150,000 and by means of equipment with a carrying value of R75,000 and a fair value of R90,000, the journal entries will be as follows:

Acquirer (Entity A):


R R





Bank 150,000

Equipment 90,000

Loss from transfer of functions (surplus or deficit) 20,000

Acquisition cost 5,000

Bank 5,000



January 2014

Acquiree (Entity B):


R R





Bank 150,000

Equipment 90,000

Gain from transfer of functions (surplus or deficit) 170,000



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7. DISCLOSURE

Illustrative example on what should be disclosed, as a minimum, in the annual financial statements for transfer of functions between entities not under common control (refer to the standard for detail):

Accounting policies

1.5 Transfer of functions between entities not under common control

Transfers of functions between entities not under common control are accounted for by the acquirer by recognising assets acquired and liabilities assumed at their fair value at the date of transfer. Any difference between the assets and liabilities recognised and consideration paid, if any, is recognised in surplus or deficit.

Transfers of functions between entities not under common control are accounted for by the acquiree by derecognising assets and liabilities at their carrying amounts at the date of transfer. Any difference between the assets and liabilities derecognised and consideration received, if any, is recognised in surplus or deficit.

Extract from the Statement of Financial Performance

Entity

Annual Financial Statements for the period ended ...

Statement of Financial Performance

Notes 20x1 20x0

R R

Revenue

… x XX XX

Gain attributable to transfer of functions between entities not under common control

x XX XX

Total revenue XXX XXX

Expenditure

… x XX XX

Total expenses XXX XXX

Surplus/(deficit) for the period XXX XXX


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Other important disclosures to be made in the financial statements of the acquirer include, but are not limited to:

The period during when the transfer of functions took place.

The name and description of acquiree.

The acquisition date.

The percentage of voting rights acquired through a residual interest.

The primary reasons for the transfer of functions and a description of how the acquirer obtained control of the acquiree.

The acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of each major class of consideration, such as:

o Cash;

o Other tangible or intangible assets, including a function or controlled entity of the acquirer;

o Liabilities incurred, for example, a liability for contingent consideration; and

o Residual interests of the acquirer, including the number of instruments or interests issued or issuable and the method of determining the fair value of those instruments or interests.

For contingent consideration arrangements and indemnification assets:

o The amount recognised as of the acquisition date;

o A description of the arrangement and the basis for determining the amount of the payment; and

o An estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, that fact and the reasons why a range cannot be estimated. If the maximum amount of the payment is unlimited, the acquirer shall disclose that fact.

For acquired receivables (by each major class):

o The fair value of the receivables;

o The gross contractual amounts receivable; and

o The best estimate at the acquisition date of the contractual cash flows not expected to be collected.

The amounts recognised as of the acquisition date for each major class of assets acquired and liabilities assumed.

Additional contingent liabilities and contingent assets assumed or acquired in the transfer of functions.

For transactions that are recognised separately from the acquisition of assets and assumption of liabilities in the transfer of functions:

o A description of each transaction;

o How the acquirer accounted for each transaction;

o The amounts recognised for each transaction and the line item in the financial statements in which each amount is recognised; and


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o If the transaction is the effective settlement of a pre-existing relationship, the method used to determine the settlement amount.

For each transfer of function in which the acquirer holds less than 100 percent of the equity interests in the acquiree at the acquisition date:

o The amount of the non-controlling interest in the acquiree recognised at the acquisition date and the measurement basis for that amount; and

o For each non-controlling interest in an acquiree measured at fair value, the valuation techniques, and key model inputs used for determining that value.

In a transfer of functions achieved in stages:

o The acquisition-date fair value of the residual interest in the acquiree held by the acquirer immediately before the acquisition date; and

o The amount of any gain or loss recognised as a result of remeasuring to fair value the residual interest in the acquiree held by the acquirer before the transfer of functions (see paragraph .71) and the line item in the consolidated statement of financial performance in which that gain or loss is recognised.

The following:

o The amounts of revenue and surplus or deficit of the acquiree since the acquisition date; and

o The revenue and surplus or deficit of the combined entity for the current reporting period as though the acquisition date for all transfer of functions that occurred during the year had been as of the beginning of the annual reporting period.

The acquirer shall disclose the following information for each material transfer of functions or in the aggregate for individually immaterial transfer of functions that are material collectively:

If the initial accounting for a transfer of functions is incomplete (see paragraph .72) for particular assets, liabilities, non-controlling interests or any consideration and the amounts recognised in the financial statements for the transfer of functions thus have been determined:

o The reasons why the initial accounting for the transfer of functions is incomplete;

o The assets, liabilities, residual interest or any consideration for which the initial accounting is incomplete; and

o The nature and the amount of any measurement period adjustments recognised during the reporting period.

For each reporting period after the acquisition date until the entity collects, sells or otherwise loses the right to a contingent consideration asset, or until the entity settles a contingent consideration liability or the liability is cancelled or expires:

o Any changes in the recognised amounts, including any differences arising upon settlement;

o Any changes in the range of outcomes (undiscounted) and the reasons for those changes; and

o The valuation techniques and key model inputs used to measure contingent consideration.


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For contingent liabilities recognised in a transfer of functions, the acquirer shall disclose the information required by paragraphs .107 and .108 of the Standard of GRAP 19 on Provisions, Contingent Liabilities and Contingent Assets for each class of provision.


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8. TRANSITIONAL PROVISIONS

Background

Prior to the adoption of GRAP 106, public entities, constitutional institutions, municipalities and municipal entities would have applied IFRS 3 - Business Combinations as part of the GRAP reporting framework. The principles in using GRAP 106 and IFRS 3 are consistent, but there are some differences.

The main differences between the recognition and measurement of a transfer of functions between entities not under common in GRAP 106 and IFRS 3 relate to the following:

Area of concern GRAP 106 IFRS 3 Impact

Scope Deals with transfer of functions occurring in both exchange and non-exchange transactions

Only deals with exchange transactions

No impact

Common control Guidance is provided

Not included in the standard

If common control exists, need to apply GRAP 105

Residual interest Additional guidance is provided


No impact

Application guidance

Application guidance, where appropriate, is included as part of the standard

Included as an Appendix to the standard

No impact

Identifying the acquiree and determining the acquisition date

Additional guidance is provided


No impact

Exceptions to recognition principles

Certain exceptions to recognition and / or principles were excluded

Requires that all identifiable assets and liabilities that meet the definition in the Framework and recognition criteria should be recognised

No material impact, since only exceptions relating to income taxes and share-based payment transactions were excluded in GRAP 106

Measurement period

Allows a two year measurement period

Only allows a one year measurement period

Additional year given in order to recognise and measure where accounting is incomplete on the acquisition date

Excess of Recognised in Recognised as Under GRAP 106


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consideration paid over fair value of assets and liabilities

surplus or deficit goodwill will not recognise goodwill

Illustrative examples

Not included Included as an Appendix to the standard

No impact

Transitional provisions

Requires prospective application

Requires retrospective application

Easier to adopt the standard

Application of the transitional provisions for the initial adoption of GRAP 106

The transitional provisions state that the standard should be applied prospectively.

Assets acquired and liabilities assumed in a transfer of functions where the acquisition date preceded the adoption of the standard, should not be adjusted upon initial adoption of the standard.

The following are however required on initial adoption:

The opening balance of any recognised goodwill, that arose from a transfer of functions where the acquisition date preceded the adoption of the standard, should be recognised against accumulated surplus or deficit for the earliest period presented.


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9. SUMMARY OF KEY PRINCIPLES

GRAP 106 sets out the principles on the identification of entities that should be treated as a transfer of functions and where there is not common control and how the transfer should be treated.

9.1 Identification

Common control is where an entity can govern or direct the financial and operating policies of the acquiring entity.

A transfer of functions between entities not under common control is a reorganisation and/or reallocation of functions between entities that are not ultimately controlled by the same entity before and after a transfer of functions.

Common control is between entities within the same sphere of government.

A function is an integrated set of activities that is conducted and managed in order to achieve the entity‟s objectives.

A function can be seen as a “business”.

9.2 Recognition and measurement

In the event of a transfer of functions between entities not under common control, the assets and liabilities should be recognised (by the acquirer) at acquisition-date fair values and should be derecognised (by the acquiree) at their carrying amounts.

The difference between amount of consideration paid or received, if any, and the fair value of assets acquired and liabilities assumed or carrying amounts of assets transferred and liabilities relinquished should be recognised in the surplus / (deficit).

For transfer of functions between entities not under common control there are some specific recognition and measurement principles and exceptions to the recognition and measurement principles.

9.3 Disclosure

Specific disclosures are required when there is a transfer of functions between entities not under common control.

GRAP Guideline 106 - Transfer of Functions Between Entities Not Under Common Control

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