Table of Contents
Business combinations achieved in stages
A business combination is accounted for from the date of acquisition, i.e. when the parent obtains control of the subsidiary. However, an investor could already hold an interest in an investee prior to the latter becoming the subsidiary. Such investments could be a small ownership of equity interest, accounted for as financial instruments, or an investor could have a significant influence over the investee (but not control), making the latter an associate or joint arrangement.
For example, on 31 December 2022, Company P has a 25% non–controlling equity interest in Company S. Company P considers this investment as an investment in an associate, which is accounted for using the equity method. On 1 January 2023, Company P purchases an additional 45% interest in Company S, which gives it control of Company S. From 1 January 2023 onwards, Company P accounts for the investment in Company S as an investment in subsidiary and thus consolidates Company S.
If an investor obtains control of such an entity where it already has non-controlling interest, it has performed a step acquisition, i.e. a business combination achieved in stages. A business combination achieved in stages is accounted for using the acquisition method at the acquisition date. The investment previously held by the investor, is remeasured to fair value at the date of acquisition and any gain or loss resulting from the remeasurement is recognised in profit or loss or other comprehensive income, as appropriate. In essence, it means that an investor disposes of any previously held interest in return, together with the consideration transferred, for the controlling interest gained in the subsidiary.
At acquisition, goodwill is calculated as the difference between:
- The aggregate of:
- The consideration transferred (generally measured at acquisition–date fair value)
- The amount of any non–controlling interest in the acquiree, and
- The acquisition–date fair value of the acquirer’s previously held equity interest in the acquiree
- The net of the acquisition–date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed
Therefore, the fair value of the interest held previously is one of the components in the calculation of goodwill. Goodwill is calculated only once, i.e. at the date when the parent obtains control of the subsidiary.
Upon obtaining control, any equity reserves relating to the previously held interest (e.g. cumulative translation differences, cash flow hedging reserves) would be recycled through profit or loss. In contrary, any revaluation reserve arising from the revaluation of intangible assets or property, plant and equipment, should be transferred directly to retained earnings and not through profit or loss.
Illustrative example – Business combination achieved in stages
Company P has a 20% ownership interest in Company S. This equity interest has been accounted for as an investment in an associate and its carrying value as at 31 December 2022 is 10 MEUR. On 1 January 2023, Company P purchases the remaining 80% interest in Company S for 400 MEUR, consideration transferred in cash.
- The fair value of the previously held 20% equity interest is 100 MEUR.
- The net amount of acquisition-date fair values of identifiable assets and liabilities is 230 MEUR.
- No tax effects are assumed in this example.
Business combination is accounted for by Company P as follows:
|Fair value of consideration transferred||400|
|Fair value of previously held equity interest||100|
|Less: fair value of net assets||(230)|
|Net gain from remeasurement of previously held 20% equity interest:||MEUR|
|Fair value of the 20% equity interest||100|
|Carrying value of the 20% equity interest||(10)|
|Gain from remeasurement||90|
|Accounting for business combination:||MEUR||MEUR|
|DR Identifiable net assets||230|
|CR Investment in associate||10|
|CR Gain on equity interest (recognised in profit or loss)||90|
Acquirers are given a reasonable period of time (measurement period) to gather information necessary to account for the business combination, e.g. identifiable assets and liabilities assumed together with their fair values, determine consideration transferred including any contingent consideration, fair value of any previously held interest and consequently the goodwill arising from the transaction.
Measurement period lasts until the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that it cannot obtain more information, whereas the measurement period cannot be any longer than one year from the date of acquisition. If by the end of the reporting period the parent has not fully completed accounting for the business combination, then provisional amounts shall be used for the incomplete items.
Any adjustments subsequently made to the provisional amounts to reflect the new information obtained about facts and circumstances at the acquisition date that, if known, would have affected the measurement of the amounts recognised, are accounted for retrospectively. Similarly, the acquirer recognises additional assets or liabilities if new information is obtained about facts and circumstances at the acquisition date and, if known, would have resulted in the recognition of those assets and liabilities as of that date. If the acquisition accounting is completed after the reporting date, then any adjustments to provisional amounts are thus recognised in the comparative figures, which in turn could result in changes in depreciation, amortisation and other income effects.
Illustrative example – Adjustments made to provisional amounts during the measurement period
Company P acquired Company S on 30 September 2021. Company P hired an independent valuer for valuing an item of property, plant and equipment acquired in the business combination. As the valuation was not yet complete by the time Company P authorised its financial statements for issue for the year ended 31 December 2021, it recognised a provisional fair value for the asset of 24 000 MEUR in its 2021 financial statements. The remaining useful life of the asset at the acquisition date is estimated to be two years.
Four months after the acquisition date (and after the date if issue of 2021 financial statements), Company P received the final valuation, based on which the acquisition–date fair value of the item of PPE was 32 000 MEUR.
In its financial statements for the year ended 31 December 2022, Company P retrospectively adjusts the 2021 prior year information as follows:
- The carrying amount of PPE as of 31 December 2021 is increased by 7 000 MEUR. That adjustment is measured as:
- the fair value adjustment at the acquisition date of 8 000 MEUR
- less the additional depreciation of 1 000 MEUR that would have been recognised if the asset’s fair value at the date of acquisition had been recognised from that date (for three months’ depreciation).
- The carrying amount of goodwill as of 31 December 2021 is decreased by 8 000 MEUR.
- Depreciation expense for 2021 is increased by 1 000 MEUR.
Company P disclosed in its 2021 financial statements that the initial accounting for the business combination had not been completed because the valuation for the item of PPE had not yet been received.
In its 2022 financial statements, Company P will disclose the amounts and explanations of the adjustments to the provisional values recognised during the current reporting period. Thus, Company P will disclose that the 2021 comparative information is adjusted retrospectively to increase the fair value of the item of PPE at the acquisition date by 8 000 MEUR, resulting in an increase to PPE of 7 000 MEUR, which is offset by a decrease in goodwill of 8 000 MEUR and an increase in depreciation expense of 1 000 MEUR.
Recognition of business combinations in Statement of cash Flows
Cash flows that arise from the changes in ownership interests in a subsidiary that do not result in a loss of control are reported in the statement of cash flows under financing activities.
Cash flows that arise from the changes in ownership interests where control is obtained or lost are classified as investing cash flows. The aggregate amount of cash paid or received as consideration is reported in the statement of cash flows net of cash and cash equivalents acquired or disposed of.
Illustrative example – Acquisition of subsidiary
Company P acquired 90% ownership interest in Company S for 1 000 MEUR. Cash balance of Company S at date of acquisition amounted to 30 MEUR.
In the statement of cash flows Company P reports the acquisition of Company S as follows:
|Acquisition of a subsidiary, net of assets acquired (1000 MEUR - 30 MEUR)||(970)|
Illustrative example – Disposal of subsidiary
Company P had a subsidiary Company S. Company P sold its ownership interest in Company S for 1 000 MEUR. Cash balance of Company S at date of acquisition amounted to 40 MEUR.
In the statement of cash flows Company P reports the disposal of Company S as follows:
|Proceeds from sale of discontinued operations, net of cash disposed (1000 MEUR - 40 MEUR)||960|
At the acquisition or disposal, any fixed assets, working capital (except for cash and cash equivalents) and borrowings of the subsidiary are eliminated from the respective cash flow movements. For example, if using indirect method for the preparation of statement of cash flows, inventory, debtors and creditors acquired or disposed of shall be eliminated from the total balance sheet changes in these lines when reconciling profit to operating cash flows. This means that the statement of cash flows only reflects the actual cash flows from the date of acquisition or up to the date of disposal. Cash flows arising from acquisition or disposal are thus reported on a separate line item.
Furthermore, the cash flow effects of losing control and obtaining control are disclosed separately in the statement of cash flows, i.e. all disposals are reported separately from all acquisitions, and they are not netted.
Illustrative example – Statement of cash flows after the acquisition of subsidiary
Company P acquired 100% of ownership interest in Company S on 31 December 2022 for 500 MEUR.
The following information is available about Company P and Company S:
|Statement of financial position||Company P||Company P||Company S||Elim.||Group||Change|
|Cash and cash equivalents||800||200||200||400||(400)|
|Investment in subsidiary||0||500||0||(500)||0||0|
Preparation of statement of cash flows:
|Statement of cash flows for the year ended 31.12.2022|
|Profit before tax||0||0|
|Decrease/(increase) in trade receivables||(150)||100 1|
|Decrease in trade payables||(50)||(200) 2|
|Cash flows from investing activities||(200)||(300) 3|
|Net cash outflows in cash and cash equivalents||(400)||(400)|
|Cash and cash equivalents at 1 January||800||800|
|Cash and cash equivalents at 31 December||400||400|
Rephop helps you record all the information required for business combination and automatically uses this information in the consolidation process, whether you are adhering to IFRS or US GAAP. We also help you handle entities that may be exempt from consolidation and report investments if control does not exist. With our software, you can ensure that your consolidated financial statements are accurate and comply with both IFRS and US GAAP reporting requirements, all while saving time and reducing manual effort.
Change in trade receivables is calculated as opening balance less closing balance (adjusted for the balance of subsidiary obtained at acquisition): 200 – (350 – 250) = 100. ↩
Change in trade payables is calculated as closing balance (adjusted for the balance of subsidiary obtained at acquisition) less opening balance: (550 – 150) – 600 = (200). ↩
Cash outflows from investing activities is calculated as the net of consideration transferred at acquisition of a subsidiary and cash balance of the subsidiary at acquisition ↩