CBIZ & MHM Executive Education Series™ IFRS: Business Combinations

Presented by: Marco Pulido, Shareholder

September 4, 2014

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Before We Get Started…

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CPE Credit

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The information in this Executive Education Series course is a brief summary and may not include all

the details relevant to your situation.

Please contact your service provider to further discuss the impact on your business.

Disclaimer

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Today’s Presenters

Marco Pulido, CPA Shareholder 310.268.2746 | mpulido@cbiz.com Marco has 15 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards in the U.S., Europe and in Latin America with Big 4 accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution & Manufacturing - Technology - Utilities - Consumer Services - Construction/Real Estate - Health Sciences - Agriculture.

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Today’s Agenda

Identify Transactions within Scope of IFRS 3

Definition of a Business

Valuation of Assets, Liabilities and NCI

Calculation of Goodwill

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2

3

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5

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Other Issues

IFRS vs. US GAAP Differences

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IFRS 3 requires a business combination be accounted for using the acquisition method. This is the required method when an entity obtains control of one or

more businesses. IFRS 3 does not apply to: a combination between entities or businesses under common control formation of a joint venture acquisition of an asset or group of assets that does not constitute a

“business.” <IFRS 3.2>

Scope

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Acquisition Method

Under the acquisition method: An acquirer must be identified, i.e., who obtains control Each asset and liability that is acquired is valued at fair value (FV)

at the date of purchase. The NCI (Non-Controlling Interest) is valued at: FV, or The proportionate share in the recognized amounts of the acquiree’s

identifiable net assets. Goodwill is generally recognized as the difference between: The sum of consideration transferred (+ or - FV of contingent

consideration), amount of any NCI and fair value of any previously held equity, less

The identifiable net assets acquired. The consideration transferred is valued at fair value. <IFRS 3, INT 6, 7,8 10 and 11>

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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What Constitutes a “Business?”

+ PROCESSES (systems,

standards, etc)

OUTPUTS (returns)

• Employees • Materials • Rights of use • Non-current assets

• Excludes accounting, billing, payroll and other administrative systems

INPUTS (economic resources)

• Dividends • Lower costs • Economic benefits to stakeholders

Must be present for a business to exist Doesn’t need to be all the inputs and processes required

Must be capable of being managed as a business If goodwill present, presumed to be a business

Outputs are not necessary.

Development stage entities can be a

business.

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Background: Dollar Car Wash and Super Clean Cars are two companies who own and

operate car wash stations throughout the country. Dollar Car Wash purchases 20 stations from Super Clean Cars for $36 million.

The Super Clean Cars employees and managers will work at the same stations.

Dollar Car Wash will change the name of the acquired stations to its own name.

Dollar Car Wash will use its own accounting, payroll and human resources departments.

The fair value of the land acquired is $20 million, equipment acquired $6 million and intangibles of $4 million.

Question: Is the transaction a business combination?

Example – Acquisition of a Business?

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Response: ‒ Yes. The essential elements of inputs and processes are being

acquired. Accounting, payroll and other administrative functions are normally not considered required processes for the purpose of generating outputs.

‒ Dollar Car Wash is paying an amount that is greater than the value of the net assets acquired. Goodwill is being acquired, therefore presumed that a business is being acquired.

Example – Acquisition of a Business?

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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Identify the Acquirer

One of the entities must be identified as the acquirer. The acquirer is the entity that obtains control over the other

entity. Control is defined at IFRS 10 Consolidated Financial Statements

<IFRS 3.7>

If control is not clear, the following factors are considered: Who paid cash or assumed liabilities? Was stock issued? Who issued the stock? Which of the two parties is considered larger?

<IFRS 3.B13 and B18>

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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The acquirer must identify the acquisition date which is generally the date in which it obtains control:

Generally the date in which consideration is paid, assets are legally acquired, and the liabilities are assumed.

However, there are cases where control is obtained on a different date, e.g. a contractually determined date.

Why is acquisition date important?

It is the date that is used for the purpose of valuing the assets that are acquired and liabilities that are assumed.

The date in which the acquired business activities are consolidated.

Determine the Acquisition Date

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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Recognition and Measurement

Recognize at date of purchase: Acquired identifiable assets Assumed identifiable liabilities NCI (Non-Controlling Interest) NCI measurement choice:

• Net assets (excluding goodwill) • Fair value (including goodwill)

<IFRS 3.10, 18 and 19>

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Recognition Measurement

Principle Must meet the definition of assets and liabilities in the

Framework

Measure assets and liabilities at acquisition date fair values

Exceptions (note: no exception for intangible assets)

Contingent liabilities (measure at fair value)

Reacquired rights Share-based payment awards Assets held for sale (IFRS 5)

Income taxes (IAS 12), indemnification assets (IFRS 3.27-28), employee benefits (IAS 19)

Specific Guidance

Assets not intended to be used valued at highest and best use

by other market participants

Operating leases

Recognition and Measurement

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Intangible Assets in Business Combinations

Possible intangible asset

Recognize an intangible asset (assumption that ‘probable’ recognition criteria always met and can always be

reliably measured)

Is it separable? (can be separated/divided from the

entity and sold, transferred, licensed, rented or exchanged)

Does it arise from contractual or other legal rights?

(regardless of whether transferable or separable, e.g. favorable term leases)

Value subsumed within goodwill (e.g., assembled workforce)

No

No

Yes

Yes

Measure at fair value (uncertainties taken into account in

measurement)

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Background: USA Trucking purchases Big Trucking. Big Trucking provides transportation

services to customers. Big Trucking has the contractual right and obligation to provide specified transportation services to these customers under contracts for varying years.

Question: Should an intangible be recognized for the customer list at the date of purchase?

Example – Recognition

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Background: USA Trucking purchases Big Trucking. Big Trucking provides transportation

services to customers. Big Trucking has the contractual right and obligation to provide specified transportation services to these customers under contracts for varying years.

Question: Should an intangible be recognized for the customer list at the date of purchase? Response: Yes. Although the customer list may not be separable, e.g. by sale to a third party, there is a contractual right, over a specified time period, to provide future services to the customers, therefore, an identifiable asset exists which should be separately valued in the opening balance sheet for the acquired entity.

Example – Recognition

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Possible obligations

Subsequent treatment At acquisition date

Follow IAS 37 Not recognised

Present obligations that are not probable

Higher of IAS 37 and IAS 18

Recognised if reliably measurable

Contingent assets Not recognised (even if virtually certain) Follow IAS 37

Contingencies in Business Combinations

Contingent liabilities

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Acquisition Method Steps

Determine if the transaction is a business combination Scope

Identify the acquirer Acquiree

Recognize and value assets, liabilities and NCI Recognition and Valuation

Determine the acquisition date Date

Calculate goodwill Goodwill

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Fair value of consideration transferred

less Amount of any NCI

Fair value of any previously held interest

Fair value of identifiable assets and liabilities acquired

GOODWILL or BARGAIN

PURCHASE arising from the

combination

equals

Measurement choice: • Net assets

(excluding goodwill) • Fair value

(including goodwill)

Gain or loss recognized in the

profit or loss

Goodwill /gain only measured at the acquisition date

Determining Goodwill

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Question Which of the following statements are correct in relation to the choice in measurement of non-controlling interests in a business combination?

A – The choice of using fair value can only be used if the acquiree is a listed entity.

B – The choice must be consistently applied as an accounting policy choice. C – The choice must be applied consistently within each accounting period. D – The choice can be determined separately for each business combination.

Example — Measurement of NCI

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Question Which of the following statements are correct in relation to the choice in measurement of non-controlling interests in a business combination?

A – The choice of using fair value can only be used if the acquiree is a listed entity.

B – The choice must be consistently applied as an accounting policy choice. C – The choice must be applied consistently within each accounting period. D – The choice can be determined separately for each business combination.

Answer D – IFRS 3.19 states that the choice is available “for each business

combination.” This is also reinforced in IFRS 3.BC216 which states that the choice is available “on a transaction by transaction basis.”

Example — Measurement of NCI

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Acquiree Balance Sheet A “new” balance sheet with assets/liabilities at fair value, plus goodwill, will

be used by the acquirer to consolidate the acquiree Referred to as the Purchase Price Allocation (PPA) Deferred tax assets and liabilities will be recognized for temporary differences

between book basis vs. tax basis for asset and liabilities, with corresponding adjustment to goodwill

Companies have 12 months from the date of purchase to finalize the PPA. Any changes to the PPA shall be made based on the facts and circumstances that existed

as of the purchase date.

Acquirer will use the values on the “new” balance sheet The values on the acquiree’s previous balance sheet will not be used

Push-down accounting - the requirement for the acquiree to use the new basis for the assets and liabilities on its individual financial statements

Currently being addressed by the IASB due to lack of guidance (SEC has specific guidance for push-down accounting)

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Changes in Equity Participation

Increases in equity participation and accounting to be followed.

Applicable standards: ‒ IAS 28 (equity

method) ‒ IFRS 9 (financial

Instruments)

0% 100%

Business Combination: ‒ Existing investment valued at FV with

gain or loss recognized ‒ Net assets acquired at FV ‒ Calculate Goodwill

Equity changes: ‒ No change to

Goodwill ‒ No gain or loss

recognized

50%

Control is obtained (IFRS 10) Initial Investment Purchase of NCI

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Common Control Transactions

A transaction between entities under common control will generally be accounted for using the predecessor values for assets and liabilities, unless the transaction has “commercial substance.”

Before the transaction: After the transaction:

Subsidiary 2

Shareholders

Company 1

Subsidiary 1 Subsidiary 2

Shareholders

Company 1

Subsidiary 1

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IFRS vs. U.S. GAAP – Key Differences

U.S. GAAP IFRS

• NCI Measurement- FV (including GW)

• Acquiree’s operating leases- An intangible or liability will be recognized for unfavorable terms vs. current market rates

• Combination of entities under common control- Receiving entity records net assets at carrying amounts (historical cost) of predecessor.

• NCI Measurement- Measurement choice: (a) Net assets (excluding GW) or (b) FV (including GW)

• Acquiree’s operating leases- An intangible or liability is recognized only if the acquiree is the lessee. If lessor, terms are considered for FV of assets subject to lease.

• Combination of entities under common control- Outside the scope of IFRS 3. Follow US GAAP or apply the acquisition method if there is “commercial substance” (policy election).

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IFRS vs. U.S. GAAP – Key Differences

U.S. GAAP IFRS

Assets and liabilities arising from contingencies

Initial Recognition - Assets and liabilities arising from contingencies are recognized at FV. If FV can’t be determined, measure using contingencies guidance at ASC 450.

Subsequent Measurement - Develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies. If using ASC 450, the subsequent accounting and measurement should be based on the same guidance.

Assets and liabilities arising from contingencies (Initial recognition)

Initial Recognition - Liabilities are recognized if there is a present obligation that arises from past events and its FV can be measured reliably. Contingent assets are not recognized.

Subsequent Measurement - Liabilities subject to contingencies are subsequently measured at the higher of (i) the amount that would be recognized in accordance with IAS 37 Liabilities, or (ii) the amount initially recognized less, if appropriate, cumulative amortization recognized in accordance with IAS 18 Revenue.

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Questions?

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Join us for these upcoming IFRS courses: October 23: Consolidated Financial Statements Using

IFRS November 20: The Impact of IFRS on Income Taxes

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