International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 137
Entity B
controlling
Entity A
Consolidated
Book
values
interest
Fair values
€
€
€
€
Current assets
700
–
500
1,200
Non-current assets
3,000
–
1,500
4,500
Goodwill
–
–
300
300
Total assets
3,700
–
2,300
6,000
Current liabilities
600
–
300
900
Non-current liabilities
1,100
–
400
1,500
1,700
–
700
2,400
Owner’s equity
Issued equity
240 ordinary shares
600
(40)
1,600
2,160
Retained earnings
1,400
(94)
–
1,306
Non-controlling interest
–
134
–
134
2,000
–
1,600
3,600
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The non-controlling interest of €134 has two components. The first component is the reclassification
of the non-controlling interest’s share of the accounting acquirer’s retained earnings immediately
before the acquisition (€1,400 × 6.7 per cent or €93.80). The second component represents the
reclassification of the non-controlling interest’s share of the accounting acquirer’s issued equity
(€600 × 6.7 per cent or €40.20).
14.5 Earnings per share
The equity structure, i.e. the number and type of equity instruments issued, in the
consolidated financial statements following a reverse acquisition reflects the equity
structure of the legal parent/accounting acquiree, including the equity instruments
issued by the legal parent to effect the business combination. [IFRS 3.B25].
Where the legal parent is required by IAS 33 – Earnings per Share – to disclose earnings
per share information (see Chapter 33), then for the purpose of calculating the weighted
average number of ordinary shares outstanding (the denominator of the earnings per
share calculation) during the period in which the reverse acquisition occurs:
(a) the number of ordinary shares outstanding from the beginning of that period to the
acquisition date is computed on the basis of the weighted average number of
ordinary shares of the legal subsidiary/accounting acquirer outstanding during the
period multiplied by the exchange ratio established in the acquisition agreement;
and
(b) the number of ordinary shares outstanding from the acquisition date to the end of
that period is the actual number of ordinary shares of the legal parent/accounting
acquiree outstanding during that period. [IFRS 3.B26].
The basic earnings per share disclosed for each comparative period before the
acquisition date is calculated by dividing:
(a) the profit or loss of the legal subsidiary/accounting acquirer attributable to
ordinary shareholders in each of those periods; by
(b) the legal subsidiary’s historical weighted average number of ordinary shares
outstanding multiplied by the exchange ratio established in the acquisition
agreement. [IFRS 3.B27].
These requirements are illustrated in the following example, which is based on one
included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE9, 10].
Example 9.37: Reverse acquisition – earnings per share
This example uses the same facts as in Example 9.31 above. Assume that Entity B’s earnings for the annual
period ended 31 December 2018 were €600, and that the consolidated earnings for the annual period ending
31 December 2019 were €800. Assume also that there was no change in the number of ordinary shares issued
by Entity B (legal subsidiary, accounting acquirer) during the annual period ended 31 December 2018 and
during the period from 1 January 2019 to the date of the reverse acquisition (30 September 2019), nor by
Entity A (legal parent, accounting acquiree) after that date.
Earnings per share for the annual period ended 31 December 2019 is calculated as follows:
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Number of shares deemed to be outstanding for the period from
1 January 2019 to the acquisition date (i.e. the number of ordinary
shares issued by Entity A (legal parent, accounting acquiree) in the
reverse acquisition, or more accurately, the weighted average
number of ordinary shares of Entity B (legal subsidiary, accounting
acquirer) outstanding during the period multiplied by the exchange
ratio established in the acquisition agreement, i.e. 60 × 2.5)
150
Number of shares of Entity A (legal parent, accounting acquiree)
outstanding from the acquisition date to 31 December 2019
250
Weighted average number of shares outstanding
(150 × 9/12) + (250 × 3/12)
175
Earnings per share (€800 ÷ 175)
€4.57
The restated earnings per share for the annual period ending 31 December 2018 is €4.00 (being €600 ÷ 150,
i.e. the earnings of Entity B (legal subsidiary, accounting acquirer) for that period divided by the number of
ordinary shares Entity A issued in the reverse acquisition (or more accurately, by the weighted average
number of ordinary shares of Entity B (legal subsidiary, accounting acquirer) outstanding during the period
multiplied by the exchange ratio established in the acquisition agreement, i.e. 60 × 2.5). Any earnings per
share information for that period previously disclosed by either Entity A or Entity B is irrelevant.
14.6 Cash
consideration
In some circumstances the combination may be effected whereby some of the
consideration given by the legal acquirer (Entity A) to acquire the shares in the legal
acquiree (Entity B) is cash.
Normally, the entity transferring cash consideration would be considered to be the
acquirer. [IFRS 3.B14]. However, despite the form of the consideration, the key determinant
in identifying an acquirer is whether it has control over the other (see 4.1 above).
Therefore, if there is evidence demonstrating that the legal acquiree, Entity B, has
obtained control over Entity A by being exposed, or having rights, to variable returns
from its involvement with Entity A and having the ability to affect those returns through
its power over Entity A, Entity B is then the acquirer and the combination should be
accounted for as a reverse acquisition.
In that case, how should any cash paid be accounted for?
One approach might be to treat the payment as a pre-acquisition transaction with a
resulting reduction in the consideration and in net assets acquired (with no net impact
on goodwill). However, we do not believe this is appropriate. Any consideration,
whether cash or
shares, transferred by Entity A cannot form part of the consideration
transferred by the acquirer as Entity A is the accounting acquiree. As discussed at 14.3
above, although the consolidated financial statements following a reverse acquisition
are issued under the name of the legal parent (Entity A), they are to be described in the
notes as a continuation of the financial statements of the legal subsidiary (Entity B).
Therefore, since the consolidated financial statements are a continuation of Entity B’s
financial statements, in our view the cash consideration paid from Entity A (the
accounting acquiree) should be accounted for as a distribution from the consolidated
group to the accounting acquirer’s (Entity B’s) shareholders as at the combination date.
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Where a cash payment is made to effect the combination, the requirements of IFRS 3
need to be applied with care as illustrated in the following example.
Example 9.38: Reverse acquisition effected with cash consideration
Entity A has 100,000 ordinary shares in issue, with a market price of £2.00 per share, giving a market
capitalisation of £200,000. It acquires all of the shares in Entity B for a consideration of £500,000 satisfied
by the issue of 200,000 shares (with a value of £400,000) and a cash payment of £100,000 to Entity B’s
shareholders. Entity B has 200,000 shares in issue, with an estimated fair value of £2.50 per share. After the
combination Entity B’s shareholders control the voting of Entity A and, as a result, have been able to appoint
Entity B’s directors and key executives to replace their Entity A counterparts. Accordingly, Entity B is
considered to have obtained control over Entity A. Therefore, Entity B is identified as the accounting
acquirer. The combination must be accounted for as a reverse acquisition, i.e. an acquisition of Entity A
(legal parent/ accounting acquiree) by Entity B (legal subsidiary/ accounting acquirer).
How should the consideration transferred by the accounting acquirer (Entity B) for its interest in the
accounting acquiree (Entity A) be determined?
Applying the requirements of paragraph B20 of IFRS 3 (discussed at 14.1 above) to the transaction
might erroneously lead to the following conclusion. Entity A has had to issue 200,000 shares to
Entity B’s shareholders, resulting in Entity B’s shareholders having 66.67% (200,000 ÷ 300,000) of the
equity and Entity A’s shareholders 33.33% (100,000 ÷ 300,000). If Entity B’s share price is used to
determine the fair value of the consideration transferred, then under paragraph B20, Entity B would
have had to issue 100,000 shares to Entity A’s shareholders to result in the same % shareholdings
(200,000 ÷ 300,000 = 66.67%). This would apparently give a value of the consideration transferred of
100,000 @ £2.50 = £250,000. This does not seem correct, for the reasons discussed below.
If there had been no cash consideration at all, Entity A would have issued 250,000 shares to Entity B’s
shareholders, resulting in Entity B’s shareholders having 71.43% (250,000 ÷ 350,000) of the equity and
Entity A’s shareholders 28.57% (100,000 ÷ 350,000). If Entity B’s share price is used to determine the value
of the consideration transferred, then under paragraph B20, Entity B would have had to issue 80,000 shares
to Entity A’s shareholders to result in the same % shareholdings (200,000 ÷ 280,000 = 71.43%). This would
give a value for the consideration transferred of 80,000 @ £2.50 = £200,000. If it was thought that the fair
value of Entity A’s shares was more reliably measurable, paragraph 33 of IFRS 3 would require the
consideration to be measured using the market price of Entity A’s shares. As Entity B has effectively acquired
100% of Entity A, the value of the consideration transferred would be £200,000 (the same as under the
revised paragraph B20 calculation above).
In our view, the proper analysis of the paragraph B20 calculation in this case is that of the 100,000 shares
that Entity B is deemed to have issued, only 80,000 of them are to acquire Entity A’s shares, resulting in
consideration transferred of £200,000. The extra 20,000 shares are to compensate Entity A’s shareholders for
the fact that Entity B’s shareholders have received a cash distribution of £100,000, and is effectively a stock
distribution to Entity A’s shareholders of £50,000 (20,000 @ £2.50), being their share (33.33%) of a total
distribution of £150,000. However, since the equity structure (i.e. the number and type of shares) appearing
in the consolidated financial statements reflects that of the legal parent, Entity A, this ‘stock distribution’ will
not actually be apparent. The only distribution that will be shown as a movement in equity is the £100,000
cash paid to Entity B’s shareholders.
14.7 Share-based
payments
In a reverse acquisition, the legal acquirer (Entity A) may have an existing share-based
payment plan at the date of acquisition. How does the entity account for awards held
by the employees of the accounting acquiree?
Under IFRS 3, accounting for a reverse acquisition takes place from the perspective of
the accounting acquirer, not the legal acquirer. Therefore, the accounting for the share-
based payment plan of Entity A is based on what would have happened if Entity B rather
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combinations
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than Entity A had issued such equity instruments. As indicated at 14.1 above, in a reverse
acquisition, the acquisition-date fair value of the consideration transferred by the
accounting acquirer for its interest in the accounting acquiree is based on the number of
equity interests the legal subsidiary would have had to issue to give the owners of the legal
parent the same percentage equity interest in the combined entity that results from the
reverse acquisition. The fair value of the number of equity interests calculated in that way
can be used as the fair value of consideration transferred in exchange for the acquiree.
Therefore, although the legal form of awards made by the accounting acquiree (Entity A)
does not change, from an accounting perspective, it is as if these awards have been
exchanged for a share-based payment award of the accounting acquirer (Entity B).
As a result, absent any legal modification to the share-based payment awards in Entity A,
the acquisition-date fair value of the legal parent/accounting acquiree’s (Entity A’s) share-
based payments awards are included as part of the consideration transferred by the
accounting acquirer (Entity B), based on the same principles as those described in
paragraphs B56 to B62 of IFRS 3 – see 7.2 above and Chapter 30 at 11.2. [IFRS 3.B56-B62]. That
is, the portion of the fair value attributed to the vesting period prior to the reverse
acquisition is recognised as part of the consideration paid for the business combination and
the portion that vests after the reverse acquisition is treated as post-combination expense.
14.8 Reverse acquisitions involving a non-trading shell company
The requirements for reverse acquisitions in IFRS 3, and the guidance provided by the
standard, discussed above are based on the premise that the legal parent/accounting
acquiree has a business which has been acquired by the legal subsidiary/accounting
acquirer. In some situations, this may not be the case, for example w
here a private entity
arranges to have itself ‘acquired’ by a non-trading public entity as a means of obtaining
a stock exchange listing. As indicated at 14 above, the standard notes that the legal
parent/accounting acquiree must meet the definition of a business (see 3.2 above) for
the transaction to be accounted for as a reverse acquisition, [IFRS 3.B19], but does not say
how the transaction should be accounted for where the accounting acquiree is not a
business. It clearly cannot be accounted for as an acquisition of the legal acquiree by
the legal acquirer under the standard either, if the legal acquirer has not been identified
as the accounting acquirer based on the guidance in the standard.
In our view, such a transaction should be accounted for in the consolidated financial
statements of the legal parent as a continuation of the financial statements of the private
entity (the legal subsidiary), together with a deemed issue of shares, equivalent to the
shares held by the former shareholders of the legal parent, and a re-capitalisation of the
equity of the private entity. This deemed issue of shares is, in effect, an equity-settled
share-based payment transaction whereby the private entity has received the net assets
of the legal parent, generally cash, together with the listing status of the legal parent.
Under IFRS 2, for equity-settled share-based payments, an entity measures the goods or
services received, and the corresponding increase in equity, directly at the fair value of the
goods or services received. If the entity cannot estimate reliably the fair value of the goods
and services received, the entity measures the amounts, indirectly, by reference to the fair
value of the equity instruments issued. [IFRS 2.10]. For transactions with non-employees,
IFRS 2 presumes that the fair value of the goods and services received is more readily
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determinable. [IFRS 2.13]. This would suggest that the increase in equity should be based on
the fair value of the cash and the fair value of the listing status. As it is unlikely that a fair