From the IFRS Institute – August 27, 2021
Current IFRS Standards do not address business combinations under common control. Significant diversity has emerged: some companies account for them like other business combinations (using the acquisition method) while others use a book-value method. The International Accounting Standards Board (the Board) is suggesting (subject to feedback) to reduce this diversity by mandating when and how each method would apply. Currently dual reporters can generally elect to align their accounting under IFRS Standards with the US GAAP requirements; in that case, the proposals would introduce significant differences from US GAAP.
What is a business combination under common control?
A business combination under common control is a combination in which all of the combining companies or businesses are ultimately controlled by the same party(ies), both before and after the combination.
Example of a business combination under control
Control of S3 is transferred from S1 to S2 (the receiving company). S2 and S3 (the combining business) are ultimately controlled by P before and after the transaction.
Using the example in the diagram, current IFRS Standards do not address the accounting by the receiving company (S2). However, they do provide guidance on how the other companies involved in the combination should account for the transaction.
- The controlling party (P) follows the guidance in IFRS 10, Consolidated Financial Statements. Assuming S1, S2 and S3 are wholly owned by P, the transaction has no effect on the consolidated financial statements of P;
- The transferring company (S1) accounts for its loss of control of the transferred company (S3) under IFRS 10, and may recognize a gain or loss; and
- The transferred company (S3) provides disclosures of its new parent company under IAS 24, Related Party Disclosures.
Acquisition method vs book-value method: what are the consequences for the receiving company?
Business combinations under common control are outside the scope of IFRS 3, Business Combinations. However, in the absence of specific guidance, receiving companies often use the acquisition method in IFRS 3 by analogy. Others use a book-value method.
These two methods lead to vastly different financial statements outcomes, as summarized below:
|Acquisition method (IFRS 3)||Book-value method|
|How does S2 measure the assets and liabilities of S3 received in the combination?||Fair value, with limited exceptions||Book value, with various book values used in practice|
|Does S2 recognize all the identifiable assets and liabilities of S3 received in the combination?||Yes, with limited exceptions||No – only assets and liabilities already recognized before the combination|
|Does S2 potentially recognize goodwill as a result of the combination?||Yes, unless the combination results in a gain (bargain purchase)||No|
|From what date does S2 include in its financial statements the assets, liabilities, income and expenses of S3?||Date of the combination||— Date of the combination; or
— Beginning of the earliest period presented
Suggestions to reduce diversity in practice
The Board’s discussion paper includes its preliminary views on a possible framework under which the receiving company (S2) would determine its accounting for business combinations under common control. The Board’s aim is to reduce diversity in practice, and improve the comparability and transparency of information provided to users of financial statements to help them evaluate these transactions.
The proposals are especially focused on the information needs of the receiving company’s existing non-controlling shareholders and other users of its financial statements (e.g. potential shareholders, existing and potential lenders/creditors). Unlike the controlling party, these users may not have access to information about the combination and therefore rely on the receiving company’s general purpose financial statements to meet their information needs.
The Board is exploring two possible measurement methods in the financial statements of the receiving company:
- the acquisition method (i.e. applying IFRS 3); and
- a specific book-value method.
The method the company applies would depend on the type of transaction.
The acquisition method would generally be required for transactions that affect non-controlling shareholders of a receiving company. Those transactions are similar to business combinations in the scope of IFRS 3 because the non-controlling shareholders are acquiring an ownership interest in the business transferred to the receiving company. In such cases, the Board believes the financial statement users would benefit from the accounting and disclosures of IFRS 3.
The Board’s proposal is summarized in the following flowchart.
Which book values would be used?
For companies that currently account for business combinations under common control using book values, IFRS Standards do not specify how the book-value method applies. A diverse range of book values are used in practice, including the transferred company’s book values (S3) and the controlling party’s book values (P). These book values often differ – e.g. if the transferred company was initially acquired from a third party, the controlling party would have recorded acquisition accounting adjustments.
The book-value method proposed by the Board would require the receiving company measure the assets and liabilities received using the book values of the transferred company, not the controlling party’s book values.
Would pre-combination information be restated?
No. The Board is proposing to prohibit the restatement of pre-combination information. This means that the financial information of the transferred company would be included in the financial statements of the receiving company prospectively – i.e. from the date of the transaction.
This would represent a change from current practice for some companies and could create potential issues in regulatory filings.
Comparison to US GAAP
The proposals would result in significant differences from current US GAAP1 in terms of measurement and presentation.
Under US GAAP, the receiving company always uses the book-value method when accounting for business combinations under common control. Unlike US GAAP, the Board’s proposals would require the acquisition method under certain circumstances.
Under US GAAP, the assets and liabilities transferred are measured at their historical carrying amounts in the financial statements of the ultimate parent of the transferred and receiving companies (P). Unlike US GAAP, the Board’s proposals would require using the book values of the transferred company (S3).
US GAAP requires the financial statements of the receiving company to report the results of operations for the period in which the transfer occurred as though it had occurred at the beginning of the period. The results of operations for that period therefore comprise those of the previously separate companies combined from the beginning of the period to the date the transfer is completed, and those of the combined operations from that date to the end of the period. Financial information presented for prior periods is retrospectively adjusted to furnish comparative information. As noted above, the Board’s proposals would prohibit the restatement of pre-combination information and the results of the combined operations would be presented prospectively.
The preliminary views of the Board outlined in the discussion paper would address an existing gap in accounting guidance in IFRS Standards and reduce the diversity in practice that currently exists.
However, the proposed approach is very different from US GAAP, especially for companies with non-controlling shareholders. This may create practical accounting challenges for dual preparers engaging in group restructurings; this is because currently dual reporters can generally elect to align their accounting under IFRS Standards with the US GAAP requirements.
The deadline for comments in response to the proposals outlined in the discussion paper is September 1, 2021.
- ASC 805-50, Business Combinations.