As we discussed previously, the main proposal is that fair-value information should be provided when a business combination under common control affects shareholders outside the group. In all other cases, the Board is suggesting that book-value information should be provided using a single approach to be specified in IFRS Standards. The discussion paper proposes an optional exemption from the acquisition method, permitting the receiving company to use a book-value method rather than the acquisition method, if it has informed all of its non-controlling shareholders that it proposes to use a book-value method and they have not objected; and a mandatory exemption by which the receiving company should be required to use a book-value method rather than the acquisition method if all of its non-controlling shareholders are related parties of the company, as defined in IAS 24.
You’ll recall that applying the acquisition method, an acquirer recognizes the identifiable assets and liabilities acquired in the business combination and measures them at fair value; the acquirer also recognizes goodwill and measures it as a residual amount: the excess of the fair value of the consideration paid over the fair value of the identifiable acquired assets and liabilities. As a result, goodwill is measured at an amount that is expected to reflect the fair value of the pre-existing goodwill in the acquired business and the price paid for any synergies expected from the combination.
The discussion paper makes some interesting observations on how this concept applies in a common-control situation:
- … in a business combination under common control, the receiving company and the transferring company might not have been involved in deciding how much consideration is paid. Instead, the controlling party might have determined the amount of consideration. Any difference between that amount and the amount that would have been paid to an unrelated party in an arm’s length transaction indicates that the combination includes an additional component—a transaction with the owners acting in their capacity as owners. Specifically…(a) if the consideration paid is higher, that excess constitutes a distribution from equity by the receiving company to the transferring company, and ultimately to the controlling party; and (b) if the consideration paid is lower, that difference constitutes a contribution to equity of the receiving company from the transferring company, and ultimately from the controlling party.
On the first scenario, the Board concluded, consistent with the view taken at the time of developing IFRS 3, that “in practice, an overpayment is unlikely to be detectable or known at the acquisition date and that the overpayment would be difficult, if not impossible, to quantify. Accordingly, if an overpayment occurs, it is initially included in goodwill recognized in a business combination and is addressed through subsequent testing of goodwill for impairment.” For this and other reasons, they decided not to propose any new requirements for common control situations. (As an appendix to the distribution paper sets out, if the Board were to introduce requirements for recognizing distributions from equity in such situations, it would trigger various resulting measurement questions, revolving around how to determine what portion of any “excess” consideration constitutes an overpayment, rather than a reasonable reflection of unrecognized goodwill).
However, in the second scenario, the Board “reached the preliminary view that it should develop a requirement for the receiving company in a business combination under common control to recognize any excess of the fair value of the identifiable acquired assets and liabilities over the consideration paid as a contribution to equity.” This has some parallel with the requirement in IFRS 3 to recognize a bargain purchase gain (such as might arise for example from a forced sale), with the difference that because in this case the difference arises from a transaction with the owners acting in their capacity as owners, it’s recognized as a contribution to equity.
Canadian readers with a relatively long memory might recall that old Canadian GAAP had a measurement model for non-ordinary-course-of-business related party transactions built along similar lines, recognizing amounts in equity for differences arising between the previous carrying amount and the amount exchanged, unless the exchange entailed a substantive change in ownership (usually regarded as around 20%). IFRS has never set out distinct measurement requirements for such transactions, although I’ve occasionally seen companies identity and recognize such amounts in equity, reasoning from basic principles. But given the absence of specific requirements, and practical challenges such as (for instance) the difficulty of identifying when owners are acting solely as owners, it’s usually hard to take issue with seemingly inflated related-party gains or losses that appear in income. Maybe the discussion paper will lead in time to a broader reconsideration of this issue.
More on the discussion paper another time…
The opinions expressed are solely those of the author