International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 146
combination (and there is no change in control arising). Accordingly, one of the pre-existing entities (Entity C or D)
will need to be identified as the acquirer (see Chapter 9 at 4.1). If, for example, Entity C is identified as the acquirer, the consolidated financial statements of Newco are effectively a continuation of Entity C, and will reflect pre-combination carrying amounts for sub-group C and acquisition-date fair values of the assets acquired and liabilities
assumed, together with any resulting goodwill, for sub-group D. The financial information presented in those
financial statements for periods prior to the acquisition date is that of Entity C. Newco cannot be accounted for as
acquiree in a reverse acquisition, because it is not a business as defined. The application of the acquisition method is
discussed generally in Chapter 9 and for business combinations under common control specifically at 3.2 above.
In Example 10.13 above, the reorganisation was effected by Newco issuing shares. If
Newco gave cash or other consideration as part of the transaction, then in most
situations this will not affect the analysis above and the further consequences would be
exactly the same as those described at 4.2.2 above.
Only in limited circumstances would it be possible to identify Newco as the acquirer
under IFRS 3, as discussed at 4.1 above. This accounting may be appropriate when, for
example, the transaction was contingent on completion of an IPO that resulted in a
change of control over Newco. In that case, the application of the acquisition method
would result in fair values being attributed to the assets acquired and liabilities assumed
of both sub-groups C and D, and the recognition of goodwill or a gain on a bargain
purchase relating to those businesses.
4.4
Transferring businesses outside an existing group using a
Newco
Example 10.14 below illustrates a scenario where a business is transferred outside an
existing group to a Newco owned by the same shareholders.
Example 10.14: Newco created to take over a business of an existing group (spin-off)
Entity C, a subsidiary of Parent A, transfers the shares held in its subsidiary, Entity E, to a newly formed
entity, Newco. In return, Newco issues shares to the existing shareholders of Parent A. Entity E is a business
as defined in IFRS 3. The group structure before and after this transaction is as follows:
Before
[A Shareholder group]
A
B
C
D
E
Business combinations under common control 737
After
[A Shareholder group]
[A Shareholder group]
A
Newco
B
C
D
E
How should this reorganisation be accounted for in Newco’s consolidated financial statements?
In many situations, this type of transaction will not be ‘under common control’ since there will be no
contractual arrangement between the shareholders (see 2.1.1 above). However, whether there is common
ownership or common control by one individual, or a sub-group of the shareholders, over the combining
parties is irrelevant in this specific scenario.
The transaction does not meet the definition of a business combination under IFRS 3, because neither Newco
nor Entity E can be identified as the acquirer. Newco cannot be identified as the acquirer as it issues shares
to effect the combination. Entity E cannot be identified as the acquirer (in a reverse acquisition) as Newco is
not a business as defined. On that basis, the transaction is outside the scope of IFRS 3.
Applying the IAS 8 hierarchy, Newco cannot elect to apply the acquisition method as set out in IFRS 3 since
the transaction does not result in any change of economic substance for Newco and Entity E (e.g. in terms of
any real alteration to the composition or ownership of Entity E). Accordingly, the consolidated financial
statements of Newco reflect that the arrangement is in substance a continuation of Entity E. Any difference
in share capital is reflected as an adjustment to equity.
Apart from any necessary change in share capital, the accounting treatment set out in
Example 10.14 above is the same as would have been applied if the business was
transferred by distributing the shares in Entity E directly to Parent A’s shareholders,
without the use of a Newco. In that case, there would be no question that there had
been a business combination at all. Entity E would not reflect any changes in its financial
statements. The only impact for Entity E would be that, rather than only having one
shareholder (Entity C), it now has a number of shareholders.
In Example 10.14 above, the reorganisation was effected by Newco issuing shares. If
Newco gave cash or other consideration as part of the transaction, then in most
situations this will not affect the analysis above. The only difference is that any
consideration transferred to the shareholders is effectively a distribution and should be
accounted for as such (see 4.2.2 above).
Only in limited circumstances would it be possible to identify Newco as the acquirer
under IFRS 3, as discussed at 4.1 above. This accounting may be appropriate when, for
example, the transaction was contingent on completion of an IPO that resulted in a
change of control over Newco. In that case, the application of the acquisition method
would result in fair values being attributed to the assets acquired and liabilities assumed
of Entity E, and the recognition of goodwill or a gain on a bargain purchase relating to
that business.
For Entity A, this transaction is a spin-off (or demerger) of Entity E, and therefore the
discussion in Chapter 7 at 3.7 and in Chapter 8 at 2.4.2 would be relevant.
738 Chapter
10
5
ACCOUNTING FOR TRANSFERS OF ASSOCIATES OR
JOINT VENTURES UNDER COMMON CONTROL
Although this chapter principally addresses common control transactions in which
the receiving entity obtains control over a business, a reorganisation may also
involve the transfer of an associate or joint venture between entities under common
control (e.g. within an existing group). Investments in associates and joint ventures
are generally accounted for using the equity method as set out in IAS 28 –
Investments in Associates and Joint Ventures (see Chapter 11). That standard states
that ‘the concepts underlying the procedures used in accounting for the acquisition
of a subsidiary are also adopted in accounting for the acquisition of an investment
in an associate or a joint venture’. [IAS 28.26]. Consequently, the question arises
whether the scope exclusion for business combinations under common control in
IFRS 3 can be extended to the acquisition of an investment in an associate or joint
venture from an entity under common control (i.e. where significant influence or
joint control is obtained, rather than control).
This question is relevant when the investment in an associate or joint venture is
acquired in a separate common control transaction, rather than as part of a larger
business combination under common control. That is, if an associate or joint venture is
being transferred as part of a business combination under common control (i.e. where
the investment is one of the identifi
able assets of the acquired business), the entire
transaction is excluded from the scope of IFRS 3 and the receiving entity would need
to develop an accounting policy as discussed at 3.1 above.
In October 2012, the Interpretations Committee was asked whether it is appropriate
to apply the scope exclusion for business combinations under common control in
IFRS 3 by analogy to the acquisition of an interest in an associate or joint venture
from an entity under common control. On the one hand, it was noted that
paragraph 32 of IAS 28 has guidance on such acquisitions and does not distinguish
between acquisitions under common control and acquisitions not under common
control. Paragraph 10 of IAS 8 requires management to use its judgement in
developing and applying an accounting policy only in the absence of an IFRS that
specifically applies to a transaction. On the other hand, it was noted that
paragraph 26 of IAS 28 refers to adopting ‘the concepts underlying the procedures
used in accounting for the acquisition of a subsidiary’ and that paragraph 2(c) of
IFRS 3 excludes business combinations under common control from its scope. The
Interpretations Committee ‘observed that some might read these paragraphs as
contradicting the guidance in paragraph 32 of IAS 28, and so potentially leading to
a lack of clarity’. Ultimately, the Interpretations Committee noted that accounting
for the acquisition of an interest in an associate or joint venture under common
control would be better considered within the context of broader projects on
accounting for business combinations under common control and the equity
method. Consequently, it decided in May 2013 not to take the issue onto its agenda.8
Business combinations under common control 739
In June 2017, the Interpretations Committee reconsidered this topic and tentatively
decided that the requirements in IFRSs provide an adequate basis to account for the
acquisition of an interest in an associate or joint venture from an entity under common
control. The Interpretations Committee observed that IAS 28 does not include a scope
exception for acquisitions under common control and, accordingly, applies to the
transaction. Paragraph 26 of IAS 28 should not be used as a basis to apply the scope
exclusion for business combinations under common control in paragraph 2(c) of IFRS 3
by analogy. The Interpretations Committee also observed that in accounting for the
acquisition of the interest, an entity would assess whether the transaction includes a
transaction with owners in their capacity as owners – if so, the entity determines the cost
of the investment taking into account that transaction with owners.9 However, the
tentative agenda decision was eventually not finalised, as that might have been premature
pending developments in the IASB’s research project on business combinations under
common control (see 6 below). Although the acquisition of an interest in an associate or
joint venture under common control is itself outside the scope of the project, the IASB
acknowledged that there is an interaction with transactions within the scope. This
interaction will be considered as the project progresses.10
Based on the discussions of the Interpretations Committee described above, we believe
there are two possible approaches to account for the acquisition of an investment in an
associate or joint venture from an entity under common control, when applying the
equity method. As IAS 28 is not clear, in our view, the receiving entity has an accounting
policy choice between:
• Approach 1 – acquisition accounting
The requirements in IAS 28 are applied as there is no scope exclusion for the
acquisition of an interest in an associate or joint venture from an entity under
common control. The receiving entity/investor compares the cost of the investment
against its share of the net fair value of the investee’s assets and liabilities on the date
of acquisition, to identify any goodwill or gain on a bargain purchase. Goodwill is
included in the carrying amount of the investment. Any gain on a bargain purchase is
recognised in profit or loss. [IAS 28.32]. If the common control transaction is not at arm’s
length, we believe that the receiving entity has an accounting policy choice to impute
an equity contribution or distribution when it determines the cost of the investment.
• Approach 2 – pooling of interests
The scope exclusion for business combinations under common control in IFRS 3
is applied by analogy to the acquisition of an interest in an associate or joint
venture from an entity under common control. This is on the basis that IAS 28
indicates that the concepts applied to accounting for acquisitions of investments
in associates or joint ventures are similar to those applied to acquisitions of
subsidiaries. As such, the receiving entity/investor may recognise the investment
in the associate or joint venture at its predecessor equity-accounted carrying
amount on the date of acquisition. Any difference between this amount and the
consideration given is accounted for as an equity contribution or distribution.
740 Chapter
10
An entity must consistently apply the chosen accounting policy. The two approaches
are illustrated in Example 10.15 below.
Example 10.15: Transfer of an associate within an existing group
Entity B and Entity C are under common control of Entity A. Entity C holds an investment in Associate D,
which it sells to Entity B for cash. The transaction can be illustrated as follows:
Before
A
100%
100%
B
C
20%
D
After
A
100%
100%
B
C
20%
D
In Entity C’s financial statements, the equity-accounted carrying amount of its 20% interest in Associate D
is £100. The net fair value of the identifiable assets and liabilities of Associate D is £800 (based on 100%).
Entity B gives consideration of £190 to Entity C for the 20% interest in Associate D, which is the fair value
of the 20% interest.
The consolidated financial statements of Entity A will not be impacted, because from the group’s perspective
there has been no change. How should Entity B account for this transaction in its own financial statements
when applying the equity method to investments in associates?
In our view, there are two approaches that Entity B can apply in accounting for this common control
transaction, but whichever approach is adopted it should be applied consistently.
Approach 1 – acquisition accounting
Under this approach, IAS 28 applies as it does to any other acquisition of an investment in an associate
(see Chapter 11 at 7). Accordingly, the receiving entity calculates its share of the net fair value of the
investee’s identifiable assets and liabilities applying paragraph 32 of IAS 28.
Entity B recognises an investment in an associate with a cost of £190 (fair value of consideration given). This
amount comprises Entity B’s share of the net fair value of Associate D’s identifiable assets and liabilities of
£160 (20% × £800) and goodwill of £30 (£190 less £160).
&nbs
p; Business combinations under common control 741
Approach 2 – pooling of interests
Under this approach, the scope exclusion in paragraph 2(c) of IFRS 3 is applied by analogy to the
acquisition of interest in an associate from an entity under common control. This is because
paragraph 26 of IAS 28 indicates that the concepts underlying the procedures used in accounting for
the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an
associate. Similarly, the receiving entity may elect to account for such transactions on a carry-over
basis as its accounting policy.
Entity B recognises an investment in an associate based on the equity-accounted carrying amount in
Entity C’s financial statements as at the acquisition date, which is £100. Entity B does not reassess the fair
values of Associate D’s identifiable assets and liabilities. Rather, Entity B continues to recognise any
adjustments that Entity C recognised in accordance with paragraph 32 of IAS 28 due to differences in fair
values at the date Entity C acquired its interest in Associate D.
Entity B recognises the excess of the consideration paid (£190) over the carrying amount (£100) of £90 as a
distribution from equity.
Although Example 10.15 above discusses the acquisition of an investment in an associate
from an entity under common control, the same accounting policy choice would also
apply to transfers of joint ventures between entities under common control.
6 FUTURE
DEVELOPMENTS
Historically, the IASB noted that the absence of specific requirements for business
combinations under common control has led to diversity in practice. Following views
received in response to the Agenda Consultation 2011, the IASB identified ‘business
combinations under common control’ (BCUCC) as one of its priority research projects.11
In June 2014, when setting the scope of the project, the IASB tentatively decided that
the project should consider:
• business combinations under common control that are currently excluded from
the scope of IFRS 3;
• group restructurings; and
• the need to clarify the description of business combinations under common
control, including the meaning of ‘common control’.
The IASB also tentatively decided that the project should give priority to considering