P R Ramesh Business Combinations


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  • OPENING COMMENTS The following are applicable only if presented as a stand-alone module: Welcome participants Introduce yourself with special emphasis on practical experience If necessary - use introduction as an ice-breaker Introduce content map and objectives (details on next 2 slides) Set learning environment guidelines (questions any time) Emphasise peer learning opportunities (working in pairs, sharing problems) Introduce Module Learning Objectives Understanding the rationale and conceptual logic of the revised Standard. The principal issues in accounting for property, plant and equipment are the timing of recognition of the assets, the determination of their carrying amounts and the depreciation charges to be recognised in relation to them. Module opening comments This is a revised Standard, effective for annual financial statements beginning on or after 1 July 1999. Earlier application is encouraged. If the Standard is adopted for a financial period beginning prior to this date, the enterprise should disclose that fact and adopt IAS 22 (revised 1998), Business Combinations, IAS 36 Impairment of Assets, and IAS 37 Provisions, Contingent Assets and Contingent Liabilities at the same time. There are no transitional provisions in the revised Standard, as the basic accounting treatments do not differ from those prescribed by the 1993 Standard. The main purpose of the latest revision was to make the Standard consistent with IAS 22 (revised 1998), Business Combinations, IAS 36, Impairment of Assets, and IAS 37, Provisions, Contingent Liabilities and Contingent Assets. There are no significant changes to the basic principles of the Standard as revised in 1993. Date of review of module and approval by technical specialist: Date: 07/99
  • Slide level: 1 and 2 The principal issues listed on the slide will be addressed in the sections of this module dealing with the recognition and measurement of property, plant and equipment. Timing of recognition addresses the question of when an item of property, plant and equipment should be recognised in the balance sheet, and when should it be de-recognised, ie eliminated from the balance sheet. Determination of carrying amount addresses the question of the amount at which the asset is reflected in the balance sheet: when it is initially acquired; when subsequent expenditure is made after the acquisition (e.g. improvements); and how its value is adjusted for external factors (such as changes in market price, obsolescence as a result of new technology, etc.) during the course of its useful life. Depreciation addresses the issue of how to allocate the carrying amount of the asset to the income statement over its useful life, in order to achieve matching between the cost of the asset and the economic benefit derived therefrom (e.g. the income derived from the sale of the goods manufactured with a piece of machinery).
  • P R Ramesh Business Combinations

    1. 1. IFRS 3 Business Combinations Mumbai, December 20, 2005 P.R. RAMESH - Deloitte
    2. 2. Agenda <ul><li>Scope </li></ul><ul><li>Application of the Purchase Method </li></ul><ul><li>Revised IAS 38 </li></ul><ul><li>Revised IAS 36 </li></ul><ul><li>Valuation Considerations </li></ul><ul><li>Transition </li></ul><ul><li>Questions and Answers </li></ul>
    3. 3. Scope <ul><li>Business Combination </li></ul><ul><ul><li>Transaction where two or more entities or businesses are brought together to form a single reporting entity </li></ul></ul><ul><li>Business </li></ul><ul><ul><ul><li>Integrated set of activities and assets conducted and managed for the purposes of providing </li></ul></ul></ul><ul><ul><ul><ul><li>A return to investors; or </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Lower costs or other economic benefits directly and proportionately to shareholders. </li></ul></ul></ul></ul>
    4. 4. Scope <ul><li>Scope Exemptions </li></ul><ul><ul><li>Business combinations in which separate entities or businesses form a joint venture </li></ul></ul><ul><ul><li>Business Combinations involving entities or businesses under common control </li></ul></ul><ul><ul><li>Business Combinations involving two or more mutual entities </li></ul></ul><ul><ul><li>Business Combinations in which separate entities or businesses are brought together by contract alone without the obtaining of an ownership interest </li></ul></ul>
    5. 5. Purchase Method Identify an Acquirer Determine the cost of the business combination Allocate the cost of the business combination
    6. 6. Identify an Acquirer <ul><li>Consider </li></ul><ul><ul><li>Respective sizes of entities prior to the combination </li></ul></ul><ul><ul><li>Power to govern financial and operating policies of combined entity </li></ul></ul><ul><ul><li>Voting rights in combined entity </li></ul></ul><ul><li>Acquirer for accounting may be different than legal acquirer (a ‘reverse acquisition’) </li></ul><ul><li>Where a new entity is formed one of the pre-existing entities must be identified as the acquirer </li></ul>
    7. 7. Cost of Business Combination <ul><li>Equity instruments issued as purchase consideration measured at market price </li></ul><ul><li>Include </li></ul><ul><ul><li>Cash consideration </li></ul></ul><ul><ul><li>Equity instruments issues to effect the transaction </li></ul></ul><ul><ul><li>Expenses incurred by the acquirer solely for purpose of business combination (e.g. legal fees) </li></ul></ul><ul><ul><li>Contingent payments to the extent they are probable and can be reliably measured </li></ul></ul><ul><li>Costs of arranging finance for the acquisition and costs of issuing equity instruments are not recognised as an asset – they are accounted for in accordance with IAS 39 (i.e. initial cost to treated as either liability or offering costs) </li></ul>
    8. 8. Allocate Cost of Business Combination <ul><li>Assets are recognized at fair value if it can be measured reliably and it is probable that the economic benefit will flow to the acquirer </li></ul><ul><li>Liabilities, other than contingent liabilities are recognized at fair value only if it can be measures reliably and it is probable that there would be an outflow of economic benefit to settle obligation </li></ul><ul><li>Only allocate to those assets, liabilities and contingent liabilities of the acquiree that exist at the date of acquisition (i.e. restructuring) </li></ul><ul><li>Measure contingent liabilities if reliably measurable – base on the amount a third party would charge to assume the liability </li></ul>
    9. 9. Fair Values of Net Assets and Contingent Liabilities <ul><li>Traded financial instruments (eg. investments) at market values </li></ul><ul><li>Unquoted financial instruments based on estimated values such as price-earning ratio, dividend yield, growth rates of similar traded instruments </li></ul><ul><li>Long-term receivables and other long-term assets at present values determined at appropriate current interest rates less allowances for doubtful receivables and collection costs </li></ul><ul><li>Inventories- Finished goods at selling price less sum of cost of disposal and profit allowance for acquirer’s effort </li></ul><ul><li> </li></ul><ul><li> Work-in-progress at selling price of finished goods less sum of cost to complete, cost of disposal and profit allowance for acquirer’s effort </li></ul><ul><li> Raw materials at replacement cost </li></ul><ul><li>Land and building at market values </li></ul><ul><li>Plant and equipment at market values determined by an appraiser. In absence of market value depreciated replacement cost </li></ul><ul><li>Net employee defined benefit asset or liability at present value less fair value of plan assets </li></ul><ul><li>Long-term liability at present values at appropriate interest rates </li></ul>
    10. 10. Goodwill Cost of Business Combination - Fair Value of assets, liabilities and contingent liabilities assumed > 0 Goodwill <ul><li>Recognise as an asset at date of transaction </li></ul><ul><li>Do not amortise </li></ul><ul><li>Test for impairment at least annually </li></ul>
    11. 11. Negative Goodwill’ Cost of Business Combination - Fair Value of assets, liabilities and contingent liabilities assumed < 0 Negative Goodwill <ul><li>Reassess the fair values originally determined </li></ul><ul><li>Any remaining excess is recognised in profit and </li></ul><ul><li>loss immediately </li></ul>
    12. 12. IAS 38 <ul><li>Identification and recognition of certain intangible assets </li></ul><ul><li>Finite useful life – amortise </li></ul><ul><li>Indefinite useful life – Assess annually for impairment </li></ul><ul><li>Reassess the useful life of intangible assets at least annually </li></ul>
    13. 13. IAS 36 – Cash-generating units <ul><li>Cash-generating units (CGUs) </li></ul><ul><ul><li>The smallest identifiable group of assets that generate cash inflows that are largely independent of the cash inflows from other groups of assets </li></ul></ul><ul><li>Allocate acquired goodwill amongst CGUs expected to benefit from the synergies of the combination </li></ul><ul><li>CGUs (or groups of CGUs) to which goodwill is allocated for impairment testing must be </li></ul><ul><ul><li>Lowest level at which management monitor goodwill </li></ul></ul><ul><ul><li>No larger than a segment (in accordance with IAS 14) </li></ul></ul>
    14. 14. IAS 36 – Calculation <ul><li>Determine carrying amount of the CGU (including allocated goodwill) </li></ul><ul><li>Determine fair value less costs to sell and/or value in use </li></ul><ul><li>Compare higher of the two with carrying amount </li></ul><ul><li>Any shortfall must be recognised as a recoverable amount write-down </li></ul>
    15. 15. IAS 36 – Write-downs <ul><li>All write-downs are recognised immediately </li></ul><ul><li>Where a write-down is required in relation to a CGU with allocated goodwill, the goodwill is first written down </li></ul><ul><li>Any remaining write down is taken proportionately against the non-monetary assets </li></ul><ul><li>Write-downs of goodwill may not be reversed in future reporting periods </li></ul>
    16. 16. IAS 36 – Practical Considerations <ul><li>A CGU must be assessed at the same time each year </li></ul><ul><li>Where an indicator of impairment exists, the asset concerned must be tested for impairment before testing the CGU </li></ul><ul><li>Detailed calculations may be carried forward from prior reporting periods providing certain conditions are met </li></ul>
    17. 17. Valuation Considerations <ul><li>Overview </li></ul><ul><ul><li>Cash Generating Unit Valuations </li></ul></ul><ul><ul><li>Identifiable Intangible Asset Valuations </li></ul></ul><ul><ul><li>Documentation Guidelines </li></ul></ul>
    18. 18. Cash Generating Unit Valuations (1) <ul><li>Assessing the Recoverable Amount of a CGU </li></ul><ul><ul><li>IAS 36 (18) defines recoverable amount as the HIGHER of: </li></ul></ul><ul><ul><ul><li>Fair value less costs to sell; and </li></ul></ul></ul><ul><ul><ul><li>Value in Use </li></ul></ul></ul><ul><ul><li>Best evidence of an asset’s FAIR VALUE (less costs to sell) is a price in a binding sale in an arm’s length transaction, adjusted incremental costs that would be directly attributable to the disposal of the asset. Consider: </li></ul></ul><ul><ul><ul><li>Binding sales agreement; or </li></ul></ul></ul><ul><ul><ul><li>Comparable companies and Transactions involving similar companies (MARKET APPROACH) </li></ul></ul></ul><ul><ul><li>The expected present value of the future cash flows derived from the asset (DCF APPROACH) should be used in assessing the VALUE IN USE </li></ul></ul>
    19. 19. Cash Generating Unit Valuations (2) <ul><li>MARKET APPROACH – Key Elements and Considerations </li></ul><ul><ul><li>Typical methodologies </li></ul></ul><ul><ul><ul><li>Comparable public companies </li></ul></ul></ul><ul><ul><ul><li>Comparable transactions </li></ul></ul></ul><ul><ul><li>Valuation multiples </li></ul></ul><ul><ul><ul><li>Market value of “Invested Capital” to revenue, EBITDA, or EBIT </li></ul></ul></ul><ul><ul><ul><li>Market value of “Equity” to net income, or BV of tangible net equity </li></ul></ul></ul>
    20. 20. Intangible Asset Valuations (1) <ul><li>Recognition as part of a business combination </li></ul><ul><ul><li>Recognised separately if it meets the following criteria: </li></ul></ul><ul><ul><ul><li>Separately identifiable (i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged – either individually or together with a related contract, asset or liability) </li></ul></ul></ul><ul><ul><ul><li>Controlled by the entity (arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations) </li></ul></ul></ul><ul><ul><ul><li>A source of future economic benefits </li></ul></ul></ul><ul><ul><ul><li>Fair value can be measured reliably </li></ul></ul></ul><ul><ul><li>Useful list of “Illustrative Examples” of types intangibles is provided with IFRS 3 – similar to SFAS 141 </li></ul></ul><ul><ul><li>Determination will ultimately be based on the facts and circumstances of each individual business combination </li></ul></ul>
    21. 21. Intangible Asset Valuations (2) <ul><li>Intangible Asset Valuations </li></ul><ul><ul><li>Market Approach </li></ul></ul><ul><ul><ul><li>Comparable transaction </li></ul></ul></ul><ul><ul><li>Income Approach </li></ul></ul><ul><ul><ul><li>Relief-from-royalty </li></ul></ul></ul><ul><ul><ul><li>Discounted cash flow </li></ul></ul></ul><ul><ul><ul><li>Cost-savings </li></ul></ul></ul><ul><ul><li>Cost Approach </li></ul></ul><ul><ul><ul><li>Replacement cost </li></ul></ul></ul>
    22. 22. Documentation Guidelines <ul><li>Key Elements of Valuation Documentation </li></ul><ul><ul><li>Description of the CGU </li></ul></ul><ul><ul><ul><li>Nature of operations </li></ul></ul></ul><ul><ul><ul><li>Consider value drivers </li></ul></ul></ul><ul><ul><li>Financial analysis with respect to the CGU </li></ul></ul><ul><ul><ul><li>Financial condition </li></ul></ul></ul><ul><ul><ul><li>Profitability and earnings capacity </li></ul></ul></ul><ul><ul><ul><li>Available documentation regarding forecasts </li></ul></ul></ul>
    23. 23. Documentation Guidelines <ul><li>Key Elements of Valuation Documentation (cont.) </li></ul><ul><ul><li>Supporting calculations consistent with generally accepted valuation procedures for each valuation method adopted </li></ul></ul><ul><ul><li>Sufficient documentation of key assumptions and sources of data </li></ul></ul><ul><ul><li>Rationale for conclusion and rationalisation of various indications of value – global sense check </li></ul></ul>
    24. 24. Closing Observations <ul><li>Appropriate valuation methodologies should be carefully selected and consistently applied over time </li></ul><ul><li>Whether a particular fair value measurement is prepared internally or with the assistance of a third-party specialist, the level of documentation to support the conclusions of the entity is expected to be similar </li></ul><ul><li>It’s a subjective and difficult area – so please consult with the appropriate specialists </li></ul>
    25. 25. Tax Effect of Business Combination <ul><li>Fair value of assets and liabilities may result in deferred tax asset or liability </li></ul><ul><li>If asset or liability is not recognized which subsequently is incurred or realized then: </li></ul><ul><li>recognize benefit expense in P&L </li></ul><ul><li>adjust carrying value of goodwill through P&L </li></ul>
    26. 26. Transition – Current IFRS User <ul><li>Applies to transactions for which agreement date is on or after 31 March 2004 </li></ul><ul><li>In the first reporting period beginning on or after 31 March 2004 </li></ul><ul><ul><li>Discontinue amortisation of goodwill in first reporting period after </li></ul></ul><ul><ul><li>Eliminate carrying amount of goodwill amortisation against goodwill </li></ul></ul><ul><ul><li>Test carrying amount of goodwill for impairment </li></ul></ul><ul><ul><li>Reclassify intangibles recognised in previous business combinations that do not meet the recognition criteria to goodwill </li></ul></ul><ul><li>Early adoption can only be achieved in conjunction with early adoption of revised IAS 36 and IAS 38 </li></ul><ul><li>Transitional requirements should be applied in respect of goodwill arising from joint ventures and associates </li></ul>
    27. 27. Transition – First-Time Adopter <ul><li>Not required to restate prior business combinations accounted for under a standard different from the IFRS applicable at the date of reporting. </li></ul><ul><li>Still need to eliminate assets and liabilities that do not meet the recognition criteria under IFRS outside of a business combination (adjustment to goodwill). </li></ul><ul><li>If subsidiary has not been consolidated under previous GAAP, restate assets and liabilities in accordance with IFRS </li></ul><ul><li>Test goodwill in opening IFRS balance sheet for impairment. </li></ul><ul><li>Must account for all business combinations after date of transition in accordance with IFRS 3 </li></ul>
    28. 28. <ul><li>THANK YOU </li></ul>