Business combinations pt. 2

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.

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:
  1. The consideration transferred (generally measured at acquisition–date fair value)
  2. The amount of any non–controlling interest in the acquiree, and
  3. 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

Measurement period

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

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

Illustrative example – Disposal of subsidiary

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