Getting it right: accounting solutions

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Step acquisitions

An acquirer sometimes obtains control of an acquiree in which it held an equity interest immediately before the acquisition date. IFRS 3 Business Combinations refers to such a transaction as a ‘business combination achieved in stages’, also referred to as a ‘step acquisition’.

Example – Financial asset under IAS 39 becomes a subsidiary

Entity A acquired a 75% controlling interest in Entity B in two stages, as follows:

  • In 20X1, it acquired a 15% equity interest for cash consideration of €10,000. Entity A classified the interest as available for sale under IAS 39. From 20X1 to the end of 20X5, Entity A reported fair value increases of €2,000 in other comprehensive income.
  • In 20X6, it acquired a further 60% equity interest for cash consideration of €60,000. Entity A identified net assets of Entity B with a fair value of €80,000. Entity A elected to measure non-controlling interests at their proportionate share of net assets. On the acquisition date, the previously held 15% interest had a fair value of €12,500.

In 20X6, Entity A recognises €2,500 in profit or loss, calculated as follows:

Gain on ‘disposal’ of 15% investment (€12,500 – €12,000) 500
Gain previously reported in other comprehensive income (€12,000 – €10,000) 2,000
Total 2,500

In 20X6, Entity A measures goodwill as follows:

Fair value of consideration given for controlling interest 60,000
Non-controlling interest (25% * €80,000) 20,000
Fair value of previously held interest 12,500
Sub-total 92,500
Less: fair value of net assets of acquire (80,000)
Goodwill 12,500

The principles to be applied for such transactions are as follows:

  • SCOPE – the guidance on step acquisitions is applied only in respect of transactions that result in the acquirer obtaining control of an entity;
  • IDENTIFIABLE NET ASSETS ACQUIRED – the acquiree’s identifiable net assets are remeasured to their fair value on the acquisition date in accordance with IFRS 3;
  • NON-CONTROLLING INTERESTS – non-controlling interests are measured on the date of acquisition;
  • PREVIOUSLY HELD INTEREST – the previously held equity interest in the acquiree is remeasured at its acquisition-date fair value, with any resulting gain or loss being recognised in profit or loss. The previously held equity interest is treated as if it were disposed of and reacquired at fair value on the acquisition date:
    • For an available-for-sale financial asset, any amount that has previously been recognised in other comprehensive income is reclassified from equity to profit or loss;
    • Any amount that has previously been recognised in other comprehensive income in connection with an associate or a joint venture, and that would be reclassified to profit or loss following a disposal, is similarly reclassified from equity to profit or loss;
  • GOODWILL – goodwill (or a gain from a bargain purchase) is measured as follows:
    • Consideration transferred to obtain control plus
    • Amount of non-controlling interest plus
    • Fair value of previously held equity interest less
    • Fair value of the identifiable net assets of the acquiree (100%)

Allocation of goodwill to cash-generating units (‘CGUs’)

A CGU to which goodwill has been allocated shall be tested for impairment annually, and whenever there is an indication that the unit may be impaired. If the carrying amount of the unit (including the goodwill) exceeds its recoverable amount, the entity shall recognise an impairment loss in accordance with IAS 36 Impairment of Assets.

Goodwill does not generate cash flows independently of other assets or groups of assets and, therefore, it will always be tested for impairment as part of a CGU or a group of CGUs. A CGU is defined as the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

For the purpose of impairment testing, goodwill acquired in a business combination is, from the acquisition date, allocated to each of the acquirer’s CGUs (or groups of CGUs) that is expected to benefit from the synergies of the combination. Each CGU or group of CGUs to which goodwill is allocated shall:

  • Represent the lowest level within the entity at which goodwill is monitored for internal management purposes; and
  • Not be larger than an operating segment, as defined by paragraph 5 of IFRS 8 Operating Segments, before aggregation.

In certain instances, the goodwill acquired in a business combination enhances the value of all of the acquirer’s pre-existing CGUs. Some might argue that, in such circumstances, goodwill should be tested for impairment at the entity level. The International Accounting Standards Board has rejected this argument and determined that the highest level at which goodwill should be tested for impairment is the operating segment level, before aggregation.

Example – Allocation of goodwill by unlisted entities

Company A is an unlisted entity. It is therefore not within the scope of IFRS 8; nor does it choose to apply that Standard voluntarily. Company A acquired a subsidiary some years ago, which resulted in the recognition of goodwill. Management generally monitors Company A’s activities on a country-by-country basis. If Company A were to apply IFRS 8, each country would represent an operating segment under that Standard.

Should Company A test goodwill for impairment at the reporting entity (group) level, or should it test for impairment at a lower level?

The objective of the guidance in IAS 36 on allocating goodwill is to ensure that goodwill is tested for impairment “at a level that reflects the way an entity manages its operations and with which the goodwill would naturally be associated”. In specifying the level at which goodwill should be allocated, IAS 36 requires that the unit or group of units to which goodwill is allocated “not be larger than an operating segment as defined by paragraph 5 of IFRS 8, before aggregation”. Note that this requirement does not refer to the level of reported operating segments. Therefore, irrespective of whether an entity reports segment information in terms of IFRS 8, it should assess its goodwill at the operating segment level in accordance with IAS 36.

In the circumstances described, the internal management reporting system on an individual country basis appears to represent an appropriate operating segment level for Company A. Therefore, goodwill should be tested for impairment at the country level.

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