Let’s return to the IASB’s discussion paper Business Combinations under Common Control, on which comments are requested by September 1, 2021. As we covered here, 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. We looked here at one of the issues arising in applying a book-value approach. The discussion paper raises another matter that’s sometimes come up in Canada over the years:
- …in some cases when applying a book-value method, companies combine the assets, liabilities, income and expenses of the transferred company retrospectively. In other words, the receiving company’s financial statements are prepared as if the combining companies had always been combined, with pre-combination information restated to include the transferred company’s assets, liabilities, income and expenses from the beginning of the earliest period presented. In other cases, companies combine those items prospectively, that is, from the date of the combination, as is required for business combinations covered by IFRS 3. The prospective approach does not require the receiving company to restate pre-combination information.
In Canada at least, there’s often been a preference for the retrospective method, following the general premise that the notional history of the combined entity is equal to that of the combining entities, and that if that history is relevant in assessing the combined entity’s future prospects, then that’s best represented in a single financial statement. But the discussion paper places more weight on an opposing train of thought:
- many users of financial statements and other stakeholders did not agree with using a retrospective approach in the primary financial statements…although they agreed that pre-combination information for all combining companies could be useful, they expressed a view that such a retrospective approach would provide a picture of a group in a period when that group did not exist. Some stakeholders call such information ‘pro forma’ (or hypothetical) information and consider it inappropriate to include such information in primary financial statements. Some stakeholders also expressed concerns that preparing such information may involve significant judgement and uncertainty. Finally, some stakeholders pointed out that historical information about each of the combining companies would typically be required by capital market regulations if the combination is undertaken in preparation for an initial public offering.
- … the Board has reached the view that the benefits of information provided by a retrospective approach may be limited and may not outweigh the costs of providing that information. Accordingly, the Board has reached the preliminary view that the receiving company should combine the transferred company’s assets, liabilities, income and expenses prospectively from the combination date.
I don’t really agree with this conclusion, based on my own experience. Although the point about “pro forma” or hypothetical information is true enough, it’s a very limited hypothesis, the effects of which can be objectively applied. Given that the exercise is essentially just one of mechanically adding separate entities together and eliminating inter-entity transactions, I doubt that significant judgment and uncertainty would usually be major factors. And while it may be true that regulators would require historical information on each of the combining companies, it’s also true that providing this in the form of separate financial statements is less helpful to investors than on a combined basis, comparable to that of the going-forward entity. And although it’s incrementally true that “the retrospective approach would be more costly to apply than a prospective approach,” that really shouldn’t amount to much. But maybe I’m not placing enough weight on the problems and challenges. For example, instances might arise where entities under common control applied materially different accounting policies and it would be onerous to retrospectively align them…
The discussion paper notes that this conclusion wouldn’t preclude requiring the receiving company to disclose pre-combination information in the notes to its financial statements. It notes that, for example, “the Board could require a complete set of pre-combination information for all the combining companies, such as a full or condensed set of combined financial statements. Alternatively, the Board could require limited pre-combination information, such as the revenue and profit or loss of the combined company for the current reporting period, as if the combination had occurred at the beginning of the reporting period (as required by paragraph B64(q)(ii) of IFRS 3)…In considering whether it should require disclosure of pre-combination information, the Board noted feedback from users of financial statements that such information could be useful, for example, in performing trend analysis.” But ultimately, the preliminary view is that such information shouldn’t be required, for similar reasons to those noted above. Again though, this wouldn’t prevent it being provided voluntarily.
We’ll probably return to the discussion paper again in the future. It’s just that enjoyable!
The opinions expressed are solely those of the author