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ACQUISITION METHOD OF ACCOUNTING
IFRS 3 requires a business combination to be accounted for by applying the acquisition
method. [IFRS 3.4]. Applying the acquisition method involves the following steps:
(a) identifying an acquirer (4.1 below);
(b) determining the acquisition date (4.2 below);
(c) recognising and measuring the identifiable assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree (5 below); and
(d) recognising and measuring goodwill or a gain in a bargain purchase (6 below). [IFRS 3.5].
4.1
Identifying the acquirer
The first step in applying the acquisition method is identifying the acquirer. IFRS 3
requires one of the combining entities to be identified as the acquirer. [IFRS 3.6]. For this
purpose the guidance in IFRS 10 is to be used, i.e. the acquirer is the entity that obtains
control of the acquiree. [IFRS 3.7, B13]. An investor controls an investee when it is
exposed, or has rights, to variable returns from its involvement with the investee and
has the ability to affect those returns through its power over the investee. [IFRS 10.6]. This
is discussed further in Chapter 6 at 3.
If IFRS 10 does not clearly indicate which of the combining entities is the acquirer, additional
guidance in IFRS 3 includes various other factors to take into account. [IFRS 3.7, B13].
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The various other factors require significant judgement, particularly where the business
combination may be a ‘reverse acquisition’ or where the combination occurred by
contract alone.
In a business combination effected primarily by transferring cash or other assets or by
incurring liabilities, the acquirer is usually the entity that transfers the cash or other
assets or incurs the liabilities. [IFRS 3.B14].
In a business combination effected primarily by exchanging equity interests, the
acquirer is usually the entity that issues its equity interests, but in some business
combinations, so-called ‘reverse acquisitions’, the issuing entity is the acquiree.
Application guidance on the accounting for reverse acquisitions is provided in
Appendix B to IFRS 3 (see 14 below). In identifying the acquirer, IFRS 3 requires that
other facts and circumstances should also be considered, including:
• the relative voting rights in the combined entity after the business combination.
The acquirer is usually the combining entity whose owners as a group retain or
receive the largest portion of the voting rights in the combined entity, after taking
due account of any unusual or special voting arrangements and options, warrants
or convertible securities;
• the existence of a large minority voting interest in the combined entity if no other
owner or organised group of owners has a significant voting interest. The acquirer
is usually the combining entity whose single owner or organised group of owners
holds the largest minority voting interest in the combined entity;
• the composition of the governing body of the combined entity. The acquirer is
usually the combining entity whose owners have the ability to elect or appoint or to
remove a majority of the members of the governing body of the combined entity;
• the composition of the senior management of the combined entity. The acquirer
is usually the combining entity whose (former) management dominates the
management of the combined entity; and
• the terms of the exchange of equity interests. The acquirer is usually the combining
entity that pays a premium over the pre-combination fair value of the equity
interests of the other combining entity or entities. [IFRS 3.B15].
The acquirer is usually the combining entity whose relative size is significantly greater
than that of the other combining entity or entities, whether this be measured by, for
example, assets, revenues or profit. [IFRS 3.B16].
If the business combination involves more than two entities, determining the acquirer
includes considering, among other things, which of the combining entities initiated the
combination, as well as the relative size of the combining entities. [IFRS 3.B17].
4.1.1
New entity formed to effect a business combination
A new entity formed to effect a business combination is not necessarily the acquirer.
This will depend among others on whether it has issued equity interests or paid cash. If
it has issued equity interests, one of the combining entities is to be identified as the
acquirer by applying the guidance described above. [IFRS 3.B18].
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If a new entity transfers cash or other assets or incurs liabilities as consideration, it may be
the acquirer. IFRS 3 does not specify in what circumstances this may be the case but it is
clear that ‘control’ is the fundamental concept when identifying an acquirer. Generally, a
new entity that was formed to effect a business combination other than through the issue
of shares will be identified as an acquirer if this new entity is an extension of the party (or
parties) that ultimately gains control of the combining entities. The determination of
whether such a new entity is an extension of the selling party (or parties) or the party (or
parties) that ultimately gains control over the combining entities, requires a thorough
analysis of all the facts and circumstances. This analysis requires an assessment of the
purpose and design of the transaction. Sometimes, even if the transaction results in a change
of control, the underlying substance of the transaction may be for a purpose other than a
party or parties to gain control of an entity. In such a situation, even if a new entity transfers
cash or other assets and/or incurs liabilities as consideration, it may be appropriate to
conclude that this new entity is not an extension of the party (or parties) ultimately gaining
control and, therefore cannot be identified as an acquirer (see Example 9.9 below).
However, when the purpose and design of the transaction indicate that its underlying
substance is to gain control over the business by the new ultimate controlling party (or
parties), then this new entity is an extension of such party (or parties) and, therefore, would
likely be identified as an acquirer. An example of the latter is a situation where the newly
formed entity (‘Newco’) is used by a group of investors or another entity to acquire a
controlling interest in a target entity in an arm’s length transaction.
Example 9.7:
Business combination effected by a Newco for cash consideration
(1)
Entity A intends to acquire the voting shares (and therefore obtain control) of Target Entity. Entity A
incorporates Newco and uses this entity to effect the business combination. Entity A provides a loan at
commercial interest rates to Newco. The loan funds are used by Newco to acquire 100% of the voting shares
of Target Entity in an arm’s length transaction.
The group structure post-transaction is as follows:
Entity A
100 %
Holding
Group
Newco
100 %
Target Entity
Under its local regulations, Newco is required to prepare IFRS-c
ompliant consolidated financial statements
for the Holding Group (the reporting entity). (In most situations like this, Newco would be exempt from
preparing consolidated financial statements – see Chapter 6 at 2.2.1.)
The acquirer is the entity that obtains control of the acquiree. Whenever a new entity is formed to effect a
business combination other than through the issue of shares, it is appropriate to consider whether Newco is
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an extension of one of the transacting parties. If it is an extension of the transacting party (or parties) that
ultimately gain control of the other combining entities, Newco is the acquirer.
In this situation, Entity A has obtained control of Target Entity in an arm’s length transaction, using Newco
to effect the acquisition. The transaction has resulted in a change in control of Target Entity and Newco is in
effect an extension of Entity A acting at its direction to obtain control for Entity A. Accordingly, Newco
would be identified as the acquirer at the Holding Group level.
If, rather than Entity A establishing Newco, a group of investors had established it as the acquiring vehicle
through which they obtained control of Target Entity then, we believe, Newco would also be regarded as the
acquirer since it is an extension of the group of investors.
Another specific situation in which a Newco might be identified as the acquirer is
illustrated in Example 9.8 below, where a parent uses a Newco to facilitate a public
flotation of shares in a group of subsidiary companies. Although a Newco
incorporated by the existing parent of the subsidiaries concerned would not
generally be identified as the acquirer, in this particular situation the critical
distinguishing factor is that the acquisition of the subsidiaries was conditional on an
Initial Public Offering (‘IPO’) of Newco. This means that there has been a substantial
change in the ownership of the subsidiaries by virtue of the IPO and indicates that
the purpose and design of the transaction is to achieve a change in control over the
transferred business. The Interpretations Committee discussed similar fact
patterns29 but has subsequently observed that accounting for arrangements
involving the creation of a newly formed entity is too broad to be addressed through
an interpretation or an annual improvement. The Interpretations Committee
concluded that it would be better considered within the context of a broader project
on accounting for common control transactions.30 In December 2017, the IASB
tentatively decided that the scope of its project on business combinations under
common control would include transfers of businesses under common control that
are conditional on a future IPO.31 At the time of writing, the project is on the IASB’s
active agenda with the next step likely to be a discussion paper in the second half
of 2019 (see Chapter 10 at 1.3).32
Example 9.8:
Business combination effected by a Newco for cash
consideration: spin-off transaction (2)
Entity A proposes to spin off two of its existing businesses (currently housed in two separate entities, Sub 1
and Sub 2) as part of an initial public offering (IPO). The existing group structure is as follows:
Entity A
Other Subs
Sub 1
Sub 2
To facilitate the spin off, Entity A incorporates a new company (Newco) with nominal equity and appoints
independent directors to the Board of Newco.
Newco signs an agreement to acquire Sub 1 and Sub 2 from Entity A conditional on the IPO proceeding.
Newco issues a prospectus offering to issue shares for cash to provide Newco with funds to acquire Sub 1
and Sub 2. The IPO proceeds and Newco acquires Sub 1 and Sub 2 for cash. Entity A’s nominal equity leaves
virtually 100% ownership in Newco with the new investors.
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Following the IPO, the respective group structures of Entity A and Newco appear as follows:
Entity A
Newco Investors
0.01%
99.99%
Holding Group
Newco
Other Subs
Sub 1
Sub 2
In this case, we believe it would likely be appropriate to identify Newco as the acquirer. The Newco investors
have obtained control and virtually 100% ownership of Sub 1 and Sub 2 in an arm’s length transaction, using
Newco to effect the acquisition. The transaction has resulted in a change in control of Sub 1 and Sub 2 (i.e.
Entity A losing control and Newco investors, via Newco, obtaining control). Newco could in effect be
considered as an extension of the Newco investors since:
• the acquisition of Sub 1 and Sub 2 was conditional on the IPO proceeding so that the IPO is an integral
part of the transaction as a whole evidencing that Newco is an extension of new investors to acquire
control of Sub 1 and Sub 2; and
• there is a substantial change in the ownership of Sub1 and Sub 2 by virtue of the IPO (i.e. Entity A only
retains a negligible ownership interest in Newco).
Accordingly, Newco might be identified as the acquirer at the Holding Group level.
Whether a Newco formed to facilitate an IPO is capable of being identified as an
acquirer depends on the facts and circumstances and ultimately requires judgement. If,
for example, Entity A incorporates Newco and arranges for it to acquire Sub 1 and Sub 2
prior to the IPO proceeding, Newco might be viewed as an extension of Entity A or
possibly an extension of Sub 1 or Sub 2. This is because the IPO and the reorganisation
may not be seen as being part of one integral transaction, and therefore the transaction
would be a combination of entities under common control (see Chapter 10 at 2.1). In
that situation, Newco would not be the acquirer.
Example 9.9 below illustrates a situation where, despite the fact that the transaction results
in a change of control, the purpose and design indicate that the substance of the transaction
was to achieve something other than gaining control. Assessing the purpose and design of a
transaction is a judgement that requires careful consideration of all facts and circumstances.
Example 9.9:
Newco formed to facilitate a debt-to-equity swap transaction
Entity A was wholly owned by a single shareholder Mr X, and had issued bonds whose ownership is widely
dispersed. Five years before the maturity of the bonds, Entity A initiated and negotiated with bondholders to
swap their bonds for an equity interest in Entity A, in order to facilitate Entity A’s future market expansion
strategy. Mainly due to tax reasons, the transaction was structured as follows: Mr. X formed Newco with de
minimis share capital, appointed to its Board of Directors the same individuals that comprise the Board of
Directors of Entity A, and contributed its interest in Entity A for nil consideration. The bondholders then
swapped their bonds for new shares issued by Newco. As result of the transaction, Mr. X owns indirectly
through Newco 30% of Entity A’s shares, and the former bondholders hold 70%. Neither Mr. X, nor any
individual former bondholder, nor any organised sub-group of former bondholders, controls Newco. No
changes were made or are expected to be made to the Board of Directors of Entity A or Newco, on which the
former bondholders
are not represented. While under the local legislation, Newco is required to present its
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IFRS financial statements to the regulator, the shareholders of Newco (i.e. Mr. X and former bondholders)
will continue to use Entity A’s financial statements to evaluate its performance and financial position. The
shareholding and debt structures before after the transaction are as follows:
Before transaction:
Mr X
100 %
Entity A
Bondholders (debt capital)
After transaction:
Former bondholders
Mr X
70 %
30 %
Holding
Group
Newco
Intercompany
100 %
debt (bonds)
Entity A
In this transaction, Mr. X loses control over Entity A and the former bondholders as a group obtain the
majority of shares in Newco and indirectly in Entity A. In order to assess whether the purpose and design of
the transaction is to obtain ultimate control over Entity A by the former bondholders as a group, and hence
whether it is appropriate to consider Newco as an extension of the former bondholders, the following facts
and circumstances are identified:
• the debt-to-equity swap was initiated by Entity A to facilitate its future market expansion strategy;
• the Newco was formed mainly for tax reasons;
• there was no concerted effort by the bondholders to form Newco to acquire control over Entity A;
• there was no new cash involved in this transaction;
• there is no existing or planned Board representation of the former bondholders at Newco or Entity A
level. This suggests that the intention of the bondholders was not to change control over Entity A
through Newco;
• financial statements of Entity A will continue to be used to provide the shareholders of Newco (Mr. X and
former bondholders) with information about the financial performance and financial position of Entity A; and
• neither Mr. X, nor any individual bondholder, or any organised sub-group of bondholders, controls
Newco after the transaction.
When assessing all these facts and circumstances, the purpose and design of this transaction appears to reflect
a facilitation of a debt-to-equity swap rather than an intended change in control over Entity A, even though
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