Here’s an issue discussed a while ago by Canada’s IFRS Discussion Group:
- “Entity A acquires 80 per cent of the issued shares of Entity B. Consideration is in the form of cash. Entity B has just one asset, the rights to a mineral property in the exploration and evaluation stage.
- As a result of the transaction, Entity A obtains control of Entity B as defined by IFRS 10. Consolidated Financial Statements. The remaining 20 per cent of the issued shares of Entity B are retained by the entity from which Entity A acquired its shares (the seller). This fact pattern assumes Entity B would not be considered an investment entity as defined by IFRS 10.”
The question under discussion was how Entity A should account for the 20% interest it didn’t acquire, given that: “IFRS 3 does not apply to the acquisition of an asset or a group of assets that does not constitute a business, and states that in such cases, the acquirer shall identify and recognize the individual identifiable assets acquired and liabilities assumed.”
It might impress you that the group identified no less than four possible answers to this question. For example, one might argue it’s not necessary to recognize anything at all for the 20%, because: “the substance of the transaction is no different than if Entity A had acquired a direct 80 per cent interest in the mineral property asset. IFRS 3 is clear that when there is an acquisition of an asset or a group of assets that does not constitute a business, the acquirer shall recognize the individual assets acquired. It is considered that Entity A will only receive a future economic benefit from its interest and not the 20 per cent residual interest held by the seller.” The group rejected this approach though, assessing it as a “a ‘look-through’ approach that in general is not supported within the principles of IFRSs.”
Others might argue that “the cost of the non-controlling interest would be determined based on the carrying amount of the interest in the subsidiary retained by the seller.” I’m not sure why you’d really take that view though, unless out of nostalgia for old standards. The group saw a couple of problems with it: “it would be difficult to support recognizing non-controlling interest at cost because there is a control premium that should be considered. It was further noted that if the acquiree’s carrying amount was used as a measurement basis, a pro-rata approach to record the non-controlling interest at cost could result in the acquirer recording the subsidiary in excess of its fair value, which does not seem reasonable.”
You might take the view that it’s simply an area where a policy choice exists, but the group thought there’s enough guidance in the standards to reject that view. Which brings us to the apparent winner, of simply following the concepts that usually apply to business combinations, and recognizing the non-controlling interest at its fair value:
- “IFRS 10 requires that consolidation procedures consist of combining assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries. Entity B holds 100 per cent interest in the mineral property. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors requires that in the absence of an IFRS, management shall first refer to the requirements in IFRSs dealing with similar and related issues. A business combination could be viewed as a similar and related issue and, thus, IFRS 3 could be referred to for guidance.
- IFRS 6 Exploration for and Evaluation of Mineral Resources requires that exploration and evaluation assets shall be measured at cost. While IFRS 6 does not provide specific guidance on the measurement of cost, IAS 16 Property, Plant and Equipment indicates that cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire the asset.
- Under this view, the non-controlling interest recognized would be a reflection of the fair value of the interest in Entity B that is not acquired by Entity A. For example, if Entity A paid $80 for 80 per cent of Entity B, the non-controlling interest recognized would be $20, and the asset recorded would be at $100.”
Maybe that seems largely obvious, except that there must have been sufficient uncertainty in practice to bring it to the agenda. Maybe this uncertainty arises from regarding business combinations and asset acquisitions as being more different than they really are, in particular because incremental transaction costs are expensed for the former, and treated as part of the allocated purchase consideration for the latter. Although the difference can be justified in theory, it arguably suggests too great a distinction between the economic investment that’s being made in the two cases. So it’s helpful to have some confirmation that in other key respects, like whether and how to recognize that all your assets aren’t actually entirely your assets, the two things are more the same than different.
The opinions expressed are solely those of the author