Combinations Of Businesses Under Common Control . - IFRS
June 2020In briefCombinations of businesses undercommon control—one size does not fit allProject updateAccounting requirements for business combinations between unrelatedparties—sometimes called mergers and acquisitions—are set out inIFRS 3 Business Combinations. However, IFRS 3 does not specify how toaccount for combinations of businesses under common control.The International Accounting Standards Board (Board) is carryingout a research project to consider filling this gap in IFRS Standardsto improve the comparability and transparency of reportingthese combinations.In this update, Gary Kabureck, a member of the Board, discusses theBoard’s preliminary views.What are these business combinations?Combinations of businesses under common controlinvolve companies or businesses that are ultimatelycontrolled by the same party before and after thecombination. Diagram 1 shows a simple example ofa combination of businesses under common control.In this example, control of Company C(the transferred company) is transferred fromCompany A to Company B (the receiving company).The combining companies are ultimately controlledby Company P (the controlling party) before andafter the transaction. The controlling party could bea company, an individual or a group of individuals.For that party, the group as a whole is unchanged.Diagram 1—A combination of businesses under common controlBefore the combinationAfter the combinationPPACBABCIn brief: Combinations of businesses under common control June 2020 1
Why is the Board doing the project?What is the focus of the project?IFRS Standards specify reporting requirements forthe controlling party (Company P), the transferringcompany (Company A) and the transferredcompany (Company C). However, IFRS Standardsdo not specify how the receiving company(Company B) should report its combination withthe transferred company. A receiving companythat prepares financial statements in accordancewith IFRS Standards must therefore develop its ownaccounting policy for reporting such transactions.Financial statements prepared in accordance withIFRS Standards are intended to meet commoninformation needs of the company’s existing andpotential shareholders, lenders and other creditorswho must rely on those financial statements formuch of their information needs because theycannot require the company to provide informationtailored to their information needs directly to them.In developing IFRS Standards, the Board views thoseshareholders, lenders and other creditors as theprimary users of the company’s financial statements.2The lack of specific requirements has resultedin diversity in practice. For example, in somecases, companies report these combinations usingthe acquisition method set out in IFRS 3, whichmeasures assets and liabilities received in thecombination at fair value. In other cases, companiesuse a book-value method, which measures assetsand liabilities at their book values. In addition,a variety of book-value methods are currentlyused.1 Such diversity makes it difficult for usersof financial statements to understand how acombination of businesses under common controlaffected the receiving company and to comparecompanies that undertake similar transactions butapply different accounting policies.This project considers reporting by thereceiving company (Company B) and focuseson the information needs of that company’sexisting non‑controlling shareholders, potentialshareholders and existing and potential lenders andother creditors, as shown in Diagram 2. The projectdoes not seek to meet the information needs of thecontrolling party. The controlling party controlsthe receiving company and therefore does not needto rely on that company’s financial statementsfor meeting its information needs. Furthermore,the project will not affect information receivedby existing and potential shareholders, lendersand other creditors of the controlling party. Thatinformation is provided in the financial statementsof that party, not of the receiving company.Diagram 2—Primary users of informationPInformation needsABnon-controlling shareholderspotential shareholderslenders and other creditorsCC1 Various labels are used for book-value methods, including predecessor method, pooling (or uniting) of interests method and merger accounting. This articleuses ‘book-value method’ as a collective term for all these methods.2 Paragraph 1.5 of the Conceptual Framework for Financial Reporting.In brief: Combinations of businesses under common control June 2020 2
What has the Board heard?Why not a single method in all cases?Stakeholders have expressed diverse views onwhich measurement method should be applied tocombinations of businesses under common controland why.The Board explored whether combinations ofbusinesses under common control are similar tocombinations covered by IFRS 3, what informationwould be useful to the primary users of thereceiving company’s financial statements and therelated costs of providing that information. It hasreached the preliminary view that one size does notfit all—the acquisition method should be used forsome combinations of businesses under commoncontrol and a book-value method should be used forall other such combinations.Some stakeholders consider that all combinationsof businesses under common control differ frombusiness combinations covered by IFRS 3 becausea combination under common control does notchange ultimate control of the transferred companyby the controlling party. These stakeholdersconsider that the controlling party simply movesits economic resources within the group from one‘location’ to another. Thus, they consider that theacquisition method should not be used for suchcombinations. Instead, a book-value method shouldbe used for all such combinations.The Board has reached the preliminaryview that one size does not fit all—theacquisition method should be used for somecombinations of businesses under commoncontrol and a book-value method should beused for all other such combinations.Some stakeholders consider that most, if not all,combinations of businesses under common controlare similar to business combinations covered byIFRS 3. These stakeholders note that from theperspective of the receiving company (but not theperspective of the controlling party), a combinationunder common control transfers control of thetransferred company to the receiving company,just as occurs in a business combination coveredby IFRS 3. Thus, they consider that the acquisitionmethod should be used, except when the benefits ofinformation produced by that method do not justifythe costs of applying it.Some stakeholders consider that some combinationsof businesses under common control are similar tobusiness combinations covered by IFRS 3 and othersmay not be similar. Thus, they consider that theacquisition method should be used in some cases anda book-value method should be used in other cases.Specifically, the Board has reached the preliminaryview that some combinations of businesses undercommon control are similar to combinationscovered by IFRS 3, and the acquisition methodshould apply to these transactions. However, othersuch combinations may not be similar, indicatingthat the acquisition method may not be appropriate.In addition, cost-benefit considerations may suggestthat the acquisition method is not appropriate forsome such combinations.The Board has taken the view that it should notprovide companies with a set of indicators to usein selecting the appropriate accounting method.Instead, the Board focused on an objective criterionsupported by many stakeholders during the project:whether the combination affects non‑controllingshareholders of the receiving company.When would the acquisition methodbe applied?The Board has reached the preliminary view that, inprinciple, the acquisition method should apply tocombinations of businesses under common controlthat affect non-controlling shareholders of thereceiving company.Such combinations are not simply reallocationsof economic resources within the group. Rather,from the point of view of the primary users of thereceiving company’s financial statements, theyresult in a substantive change in ownership interestsin the transferred company, just as happens in abusiness combination covered by IFRS 3. This isbecause in such combinations under commonIn brief: Combinations of businesses under common control June 2020 3
control, non-controlling shareholders of thereceiving company indirectly obtain an ownershipinterest in the transferred company.That similarity is illustrated in Diagrams 3 and 4.In both scenarios, non-controlling shareholdersof the receiving company (Company B), obtainan ownership interest in the transferredcompany (Company C), regardless of whetherultimate control of the transferred companychanges. Both combinations result in a substantivechange in the ownership interest in thetransferred company.Furthermore, when a combination under commoncontrol affects non-controlling shareholders of thereceiving company, the primary users who relyon the receiving company’s financial statementsfor meeting their information needs are thosenon-controlling shareholders, as well as potentialshareholders and lenders and other creditors ofthe receiving company. In the Board’s preliminaryview, the acquisition method would best meet theircommon information needs, because those types ofprimary users are the same as the types of primaryusers of information in a combination covered byIFRS 3.Diagram 3—Non-controlling shareholders: Business combinations covered by IFRS 3Before the combinationP1P2ABAfter the ontrollingshareholdersCDiagram 4—Non-controlling shareholders: Common controlBefore the combinationNon-controllingshareholdersPACAfter the combinationBNon-controllingshareholdersPABCIn brief: Combinations of businesses under common control June 2020 4
How would the acquisition method be applied?In the Board’s preliminary view, the acquisition method should apply as set out in IFRS 3. However, toaddress a feature that is not present in business combinations between unrelated parties, companiesshould be required to recognise any excess fair value of the acquired assets and liabilities over theconsideration paid as a capital contribution and not in the statement of profit or loss as a gain on abargain purchase.The Board also considered whether companies should be required to report any capital distribution if theconsideration paid exceeds the consideration that would have been negotiated between unrelated parties.However, any such distribution could be difficult to identify and measure, and is unlikely to occur in acombination that affects non-controlling shareholders. Therefore, the Board has reached the view thatthe receiving company should not be required to identify and measure any such distribution.When would a book-value methodbe applied?The Board has reached the preliminary view that abook-value method should apply to combinationsof businesses under common control that do notaffect non-controlling shareholders of the receivingcompany (such as in a combination involvingwholly-owned companies). In all such combinations,there is no substantive change in ownershipinterests in the combining companies. In suchcircumstances, questions may arise about thesubstance of the combination and the suitability ofthe acquisition method.Stakeholder feedback indicates that companies mayhave a variety of business reasons for undertakinginternal reorganisations that do not result in asubstantive change in ownership interests in thecombining entities. The Board has reached thepreliminary view that a book-value method shouldapply to all such combinations.Diagram 5 shows an example of a controlling party(Company P) that wishes to sell its wholly-ownedsubsidiaries (Companies A and B) in an initial publicoffering. In preparation, Company P would need torestructure its subsidiaries. Company P could do soin various ways, as illustrated in Diagram 5.Diagram 5—A combination under common control between wholly-owned companiesBefore thecombinationPABAfter the combinationScenario 1Scenario 2Scenario 3PPPNewCoABBACompany B istransferred toCompany ACompany Ais transferred toCompany BABCompanies A and Bare transferred to anew intermediateparent (NewCo)In brief: Combinations of businesses under common control June 2020 5
Regardless of how the controlling party chooses tostructure the combination, potential shareholdersare invited to invest in the same economic resourcesin all scenarios, as illustrated by the shaded areasin Diagram 5. Thus, similar information shouldbe provided about those economic resources inall scenarios. A book-value method achieves thatoutcome—all assets and liabilities of the combiningcompanies would continue to be measured at theirbook values.In contrast, if the acquisition method is applied tothe scenarios in Diagram 5, the nature and extent ofthe information provided to potential shareholderscould vary greatly, depending on which company isidentified as the ‘acquirer’—Company A, Company Bor NewCo.3 The assets and liabilities of the companyidentified as the acquirer would be measured attheir existing book values, whereas the assets andliabilities of the other combining companies wouldbe measured at fair value. For combinations thatinvolve no substantive change in ownership interestin the combining companies, it might be difficult toidentify the acquirer in a way that provides usefulinformation to potential shareholders.Combinations that involve no substantive changein ownership interests in the combining companiesmay affect lenders and other creditors of thereceiving company. However, the Board receivedfeedback that lenders and other creditors primarilyneed information about the receiving company’scash flows and debt commitments, so that they canassess the company’s ability to service its existingdebt and to raise new debt. The informationthey need is largely unaffected by whether theacquisition method or a book-value method is usedto report the combination.The Board has reached the preliminary viewthat a book-value method should apply tocombinations of businesses under commoncontrol that do not affect non‑controllingshareholders of the receiving company(such as in a combination involvingwholly‑owned companies).How would a book-value method be applied?A variety of book-value methods are currentlyused. To reduce that diversity and improvecomparability, the Board is of the view thatit should specify how to apply a book-valuemethod to combinations of businesses undercommon control. For example, in the Board’spreliminary view:(a) the receiving company should measurethe assets and liabilities received using thebook values in the financial statementsof the transferred company, not thebook values in the consolidated financialstatements of the controlling party; and(b) the results, assets and liabilities of thetransferred company should be combinedwith those of the receiving company fromthe combination date, without restatingpre-combination information.What about costs to companies?Some stakeholders have suggested that the benefitsto the primary users of the receiving company’sfinancial statements from using the acquisitionmethod may not always outweigh the costs tothe company of using that method. For example,the costs could outweigh the benefits when theownership interest of non-controlling shareholdersin the receiving company is small or when thoseshareholders are the company’s related partieswho do not need to rely on the company’s financialstatements for their information needs. Somestakeholders have also expressed concerns thatopportunities for accounting arbitrage could arise ifthe acquisition method were required in such cases.The Board has reached the preliminary view thatfor companies whose shares are traded in a publicmarket the benefits of using the acquisition methodwould always outweigh the costs of using thatmethod. This is because capital markets regulationstypically prevent listing of instruments if publiclytraded ownership interest in the company is small.3 Paragraph B18 of IFRS 3 limits the circumstances when a new company can be identified as the acquirer. Applying IFRS 3, if NewCo cannot be identified asthe acquirer, either Company A or Company B must be identified as the acquirer.In brief: Combinations of businesses under common control June 2020 6
Furthermore, a criterion that shares are traded in apublic market is objective, easy to apply and wouldnot create opportunities for accounting arbitrage.4However, the Board has concluded that forprivately‑held companies (ie those whose sharesare not traded in a public market) the benefits ofusing the acquisition method might not alwaysoutweigh the costs of doing so. Thus, the Boardhas reached the preliminary view that it shouldallow such companies to opt out of the acquisitionmethod and to apply a book-value method instead,provided that non‑controlling shareholders do notobject. This condition is based on one already usedin IFRS Standards for exempting privately‑heldcompanies from some requirements when, inthe Board’s view, the costs of applying thoserequirements may outweigh the benefits of doing so.5The Board has also reached the preliminary viewthat a privately-held company should be required touse a book-value method if all of its non-controllingshareholders are the company’s related parties asdefined in IAS 24 Related Party Disclosures. In suchcases, the benefits of using the acquisition methodmay not be enough to justify the costs. Requiring abook-value method in these cases would also preventopportunities to structure a combination to achievea favourable accounting outcome.In addition, the Board considered whether it shouldallow publicly-traded companies to opt-out of theacquisition method and whether it should requirethem to use a book-value method if all non‑controllingshareholders are the company’s related parties.In the Board’s preliminary view, it should not extendthat option and that requirement to publicly-tradedcompanies. However, the Board will seek stakeholderfeedback on that preliminary view.Diagram 6—A summary of the Board’s preliminary views on when each method should be appliedNoDoes the transaction affect non‑controllingshareholders of the receiving company?YesAre the receiving company’s sharestraded in a public market?YesNoYesAre all non-controlling shareholders relatedparties of the receiving company?NoYesBook‑valuemethodHas the receiving company chosen touse a book-value method, and have itsnon‑controlling shareholders not objected?NoAcquisitionmethod4 IFRS Standards describe public market as a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets.5 See paragraph 4 of IFRS 10 Consolidated Financial Statements and paragraph 17 of IAS 28 Investments in Associates and Joint Ventures.In brief: Combinations of businesses under common control June 2020 7
How would financial reportingimprove?If the Board’s preliminary views are confirmed andimplemented, diversity in practice would reduce andcomparability in reporting business combinationswould improve because:(a) the acquisition method would be applied bothto business combinations covered by IFRS 3 andto similar combinations of businesses undercommon control;(b) IFRS Standards would specify which methodshould be applied in which circumstances,so that companies undertaking similartransactions would apply the sameaccounting policies; and(c) IFRS Standards would specify a single book-valuemethod, thus eliminating the diversity causedby the variety of book-value methods used.In summary, in a given set of circumstances, oneaccounting method would apply, thus reducingdiversity and improving comparability.What about disclosures?The Board has reached the preliminary viewthat disclosure requirements in IFRS 3 shouldalso apply
Accounting requirements for business combinations between unrelated parties—sometimes called mergers and acquisitions—are set out in IFRS 3 Business Combinations. However, IFRS 3 does not specify how to account for combinations of businesses under common control. The International Accounting Standards Board (Board) is carrying
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