Business combinations under common control

IFRS 3 Business Combinations applies only to transactions which take place between unrelated parties. Therefore, the requirements of IFRS 3 do not apply in accounting for business combinations that include entities which are under common control.

Common control

A business combination of entities under common control is such where all of the combining entities are ultimately controlled by the same party before and after the transaction, and where control is not transitory. The party holding control could be the ultimate parent entity, an individual or group of individuals. In determining whether entities are under common control, the existence of non-controlling interest and whether the combining entity has been consolidated before, are not relevant, as the subsidiary is nevertheless under the control of the parent.

Where group of individuals are regarded as having control, this should be evidenced by a contractual arrangement, either in the form of a written or unwritten agreement.

Illustrative example – Business combination under common control

Company A has two 100% subsidiaries – Company X and Company Y. Company A sells its subsidiary – Company X to another of its subsidiary – Company Y. Company A ultimately controls both Company X and Company Y before and after the business combination.

Structure of the group before and after the transaction is as follows:

Before

After

Accounting for business combinations under common control

Under IFRS, there are two acceptable approaches for accounting for business combination taking place under common control. These are:

• The acquisition method as per IFRS 3, and
• The pooling of interests method (book-value method under the US GAAP)

Acquisition method

Although the company has an option to select the acquisition method as an accounting policy to account for the business combinations under common control, it could only be selected if the transaction has substance for the combining entities.

Careful consideration should be given when assessing whether the business combination under common control has substance. Factors to be evaluated involve, but are not limited to the below:

• The purpose of the business combination under common control
• The involvement of third parties in the business combination, e.g. non-controlling interests or others
• Is the transaction conducted at fair value
• The current activities of the entities involved in the business combination under common control
• Whether the entities are brought together into a reporting entity that did not exist before

Therefore, accounting policy choice is actually only available if the business combination has substance.

The acquisition method as ruled by IFRS 3, is considered applicable where the business combination takes place on arm’s length basis. i.e. the consideration transferred is generally measured at acquisition date fair value of net assets and the fair value of the consideration reflects the value of acquired entity. Business combinations effected under common control, however, might not be conducted on arm’s length basis and the fair value of consideration transferred might not represent the value of the entity obtained. If the business combination under common control does not take place at arm’s length, but assuming it has substance, then the receiving entity has an accounting policy choice to either:

• Recognise the business combination under common control at the consideration transferred as it is agreed between the buyer and seller (measured at the acquisition–date fair value in accordance with IFRS 3), or
• Recognise the business combination under common control at the fair value of the acquired business
  • the difference arising between the fair value of the consideration transferred and the fair value of the acquired business is then recognised as a contribution to or distribution from equity

Illustrative example – Application of acquisition method

If the business combination does not have substance, then the only acceptable method for accounting for the business combination under common control is the pooling of interests method.

Pooling of interests method

The pooling of interests method is generally considered to involve the following:

• The assets and liabilities of the combining entities are reflected at their carrying amounts.
  • No adjustments are made to reflect fair values, or recognise any new assets or liabilities, at the date of the business combination under common control, which would be done under the acquisition method. The only adjustments necessary are to align accounting policies.
• No “new” goodwill is recognised as a result of the business combination under common control.
  • The only goodwill that is recognised is any existing goodwill which relates to either of the combining entities. The difference between the consideration transferred and the net assets acquired is reflected within equity.
• The income statement reflects the results of the combining entities.

In applying the pooling of interest method, few practical issues arise.

Which carrying amounts to use?

The carrying amounts of the assets acquired and liabilities assumed could be derived from at least two sources:

• Amounts recognised in the individual financial statements of the entity transferred
• Amounts recognised by the controlling entity in the consolidated financial statements.

The above two sets of carrying amounts could differ from one another, for example, due to different accounting policies applied in the individual financial statements and by the group. Also, differences in carrying amounts could result from the fair value adjustments and goodwill arising from the past acquisition of the transferred entity by that controlling party.

Generally, the receiving entity, when applying the pooling of interests method, would use the carrying amounts of the transferred entity as were recognised by the controlling entity, however using the amounts recognised by the acquiree could be acceptable in certain circumstances.

In considering which set of carrying amounts to use, the receiving entity should consider the following factors:

• The timing of the business combination under common control – close to the initial acquisition by the controlling party vs acquisition that took place a long time ago
• Whether the transaction is carried out in the preparation for external sale – similar to previous point
• The identity and nature of the users of the financial statements – existence of significant non-controlling interests and/or creditors
• Whether consistent accounting policies have been used for similar and related transactions.

The carrying amounts of the receiving entity’s assets and liabilities remain the same as those in its existing financial statements prior to the business combination under common control.

Should the financial information of periods prior to business combination under common control be restated?

The receiving entity has an accounting policy choice either to:

• Restate the financial information in the consolidated financial statements for periods prior to the business combination under common control, to reflect that the transaction had occurred from the beginning of the earliest period presented, ignoring the actual transaction date but limited to the prior periods of only those where the combining entities were under the same controlling party, or
• Account for the business combination under common control prospectively from the date on which it occurred, and thus the financial information of prior periods is not restated in the consolidated financial statements.

What to do with equity reserves and the history of assets and liabilities of the transferred entity?

If the receiving entity in a business combination under common control elects to restate the prior period information, pooling is applied in full and the history of the combining entities (since they were under common control of the same controlling party) is continued.

If the receiving entity in a business combination under common control elects not to restate the prior period information, it has further choice to:

• Retain the equity reserves and history of assets and liabilities - the financial information for periods prior to the business combination is not restated, but the pre–combination equity reserves and history of assets and liabilities of the entity transferred are carried over as at the date of transaction and are reflected in the post–combination financial statements of the receiving entity.
• Reset of equity balances and history of assets and liabilities - the financial information for prior periods is not restated, the transaction results in an initial recognition of the assets and liabilities of the entity transferred at their predecessor carrying amounts and the equity balances of the entity transferred are not carried over but adjusted to another component of equity (e.g., retained earnings). Thus, the post–combination financial statements of the receiving entity do not reflect any pre–combination history of the entity transferred.

Net assets position of the above choices at the date of business combination under common control is the same, whereas the composition of equity would differ.

How to recognise the acquisition of non–controlling interest as part of a business combination under common control?

Where the reorganisation of the group takes place so that a non–controlling interest in the entity transferred is acquired simultaneously with a business combination under common control, there are two separate transactions to be accounted for:

• The reorganisation of entities under common control
• The acquisition of the non-controlling interest

It is not appropriate to reflect the acquisition of non–controlling interest as if it occurred prior to the acquisition even if the acquisition occurs simultaneously with a common control transaction. Thus, the receiving entity accounts for the acquisition of non–controlling interest at the actual date of acquisition, regardless of whether or not the receiving entity elects to restate prior periods. Therefore, the change in ownership interest resulting from the acquisition of non-controlling interest will be accounted for as an equity transaction at that acquisition date. If the receiving entity restates its consolidated financial statements to reflect the comparative information of the entity transferred for the period before the business combination under common control, it will include the non–controlling interest in transferred entity within equity until the actual date of the transaction.

Illustrative example – Application of pooling of interests method

Company A has two 100% subsidiaries – Company X and Company Y. On 1 January 2022 Company A sells Company X to Company Y for 4500 KEUR.
No intra-group transactions have taken place between Companies X and Y.
In the consolidated financial statements of Company A the following balances are related to Company X as at 31.12.2021:

• Goodwill from the acquisition of Company X is carried at 500 KEUR
• PPE fair value adjustment at cost of 1000 EUR is carried at 600 KEUR and amortised over 5 years

Group structures before and after the reorganisation are as follows:

Before

After

Statements of financial position of Company X and Company Y before and after the business combination under common control:

Company Y
SOFP	31.12.2021	31.12.2022
Current assets	4 000	5 700
Non-current assets	3 500	6 600
incl Investment in subsidiary	0	4 500
Total Assets	7 500	12 300
Current liabilities	1 000	1 300
Non-current liabilities	2 500	4 500
Total Liabilities	3 500	5 800
Share capital	1 000	1 000
Reserves	100	100
Retained earnings	2 900	5 400
Total Equity	4 000	6 500
Total Liabilities and Equity	7 500	12 300
SOCI	2021	2022
Revenue	25 000	30 000
Operating expenses	-22 000	-26 000
Operating profit	3 000	4 000
Finance income/-expenses	-1 000	-1 500
Profit for the year	2 000	2 500

Company X
SOFP	31.12.2021	31.12.2022
Current assets	4 000	5 000
Non-current assets	1 200	2 000
Total Assets	5 200	7 000
Current liabilities	1 200	1 400
Non-current liabilities	1 000	1 100
Total Liabilities	2 200	2 500
Share capital	1 000	1 000
Reserves	100	100
Retained earnings	1 900	3 400
Total Equity	3 000	4 500
Total Liabilities and Equity	5 200	7 000
SOCI	2021	2022
Revenue	20 000	21 000
Operating expenses	-18 000	-18 500
Operating profit	2 000	2 500
Finance income/-expenses	-900	-1 000
Profit for the year	1 100	1 500

Company Y has made the following accounting policy choices:

• Carrying amounts of assets and liabilities as reported in the consolidated financial statements of Company A are used
• Periods prior to the business combination under common control are not restated
• Equity balances of Company X are not carried over

Consolidated SOFP at the date of business combination is as follows:

	Company Y	Company X	Adjustments	Consolidated 01.01.2022
Current assets	4 000	4 000		8 000
Non-current assets	3 500	1 200	600	5 300
incl: Investment in subsidiary	4 500		-4 500	0
Goodwill			500	500
Total Assets	7 500	5 200	-3 400	9 300
Current liabilities	1 000	1 200		2 200
Non-current liabilities	2 500	1 000		3 500
Total Liabilities	3 500	2 200	0	5 700
Share capital	1 000	1 000	-1 000	1 000
Reserves	100	100	-100	100
Retained earnings	2 900	1 900	-2 300	2 500
Total Equity	4 000	3 000	-3 400	3 600
Total Liabilities and Equity	7 500	5 200	-3 400	9 300

Calculation of the effect of the business combination under common control:

Consideration transferred	4 500
Company X net assets at date of acquisition	3 000
Previously accounted:
Goodwill related to Company X	500
PPE fair value adjustment related to Company X	600
Difference between the consideration transferred and net assets acquired	400	Decrease in equity
Accounting entries:
CR Cash	4 500
DR Net assets, incl goodwill	4 100
DR Retained earnings	400

Adjustments reflected in equity in SOFP as at acquisition date equal to the elimination of net assets of Company X and decrease from the difference between the consideration transferred and the net assets acquired (-3000 – 400 = -3400).

Consolidated SOFP and SOCE as at 31.12.2022 and SOCI for the year then ended are as follows:

Consolidated SOFP as at 31.12.2022
	Company Y	Company X	Adjustments	Consolidated 31.12.2022
Current assets	5 700	5 000		10 700
Non-current assets	6 600	2 000	400	9 000
incl: Investment in subsidiary	4 500		-4 500	0
Goodwill			500	500
Total Assets	12 300	7 000	-3 600	15 700
Current liabilities	1 300	1 400		2 700
Non-current liabilities	4 500	1 100		5 600
Total Liabilities	5 800	2 500	0	8 300
Share capital	1 000	1 000	-1 000	1 000
Reserves	100	100	-100	100
Retained earnings	5 400	3 400	-2 500	6 300
Total Equity	6 500	4 500	-3 600	7 400
Total Liabilities and Equity	12 300	7 000	-3 600	15 700

Adjustments in equity contain amounts carried forward from the date of acquisition and additional annual depreciation of PPE = -3400 – 200 = -3600.

Consolidated SOCI for the year ended 31.12.2022
	Company Y	Company X	Adjustments	Consolidated 2022
Revenue	30 000	21 000		51 000
Operating expenses	-26 000	-18 500	-200	-44 700
Operating profit	4 000	2 500	-200	6 300
Finance income/-expenses	-1 500	-1 000		-2 500
Profit for the year	2 500	1 500	-200	3 800

Consolidated SOCE as at 31.12.2022
	Share capital	Reserves	Retained earnings	Total
As at 31.12.2021	1 000	100	2 900	4 000
Business combinations under common control	0	0	-400	-400
Profit for the year	0	0	3 800	3 800
As at 31.12.2022	1 000	100	6 300	7 400

Considerations under the US GAAP

Under the US GAAP the accounting and reporting requirements for transactions between entities under common control is addressed in the subsections of ASC 805-50.

The main differences with IFRS are:

• Only the book-value method (pooling of interest method under IFRS) is acceptable in accounting for the business combinations under common control
• The assets and liabilities transferred shall be measured by the receiving entity at the carrying amounts recognised by the controlling entity in the consolidated financial statements
• Financial information of prior periods shall be restated in the consolidated financial statements of the receiving entity.