As seen in the above picture, I would like to compare Business Combinations to the all familiar game that we all played as kids known as Pacman. Often businesses with more capital and in need to expand in the most cost-effective way will ‘eat’smaller entities’ assets and absorb their liabilities in order to gain a controlling interest through the acquisition of shares so that they can affect the returns that they get from these entities for their own benefits. The acquirers act as Pacman, eating and using the acquiree’s equity.
Chapter 1-3 of Consolidations is covered in FRK100, therefore, the following work is assumed knowledge and my reflection on what I have learned is a revision of 2017.
Basic concepts and definitions I have learned:
Minority passive investments
- Share investments that are purchased only for the purpose of generating future economic benefits – dividend income or capital gains. Due to the small ownership percentage and/or very limited contractual rights, the investor can not influence the economic activities of the entity in order to affect returns.
- If these investments are less than 12 months they are disclosed as current assets, but more than 12 months, then they are disclosed as non-currents assets.
Minority active investments
- Share investments and/or other limited contractual rights to exert significant influence, but not control, over the activities of the entity in order to affect returns earned by the investor.
- These investments are disclosed as non-current assets.
Majority active investments
- Share investments and/or other limited contractual rights to direct the economic activities of the investee to influence the level of returns earned by the investor.
- Influences in the economic activities of the investee can be on the policy-making level and on the day-to-day operational level.
- The element of control is present, not only influence.
- This is presumed to be a business combination by IFRS.
Business Combination (according to IFRS 3, Business Combinations, Appendix A)
- “a transaction or other event in which an acquirer obtains control of one or more businesses”
Control (IFRS 10, Appendix A and IFRS 3, Appendix A)
- A situation in which “an investor 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”
- Refers to the rights held by the investor, which are either
– voting rights through ownership of shares; or
– contractual rights
A Business (according to IFRS 3, Business Combinations, Appendix A)
- “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors and other owners, members and participants”
- Refers to a company whose entire share capital is held by a single controlling company (the parent).
- The date at which the acquirer(parent) acquires a controlling interest in the acquiree (subsidiary).
- The assets and liabilities of the subsidiary at acquisition are eliminated against the investment of the parent (and of the non-controlling interest if not wholly owned).
- Goodwill or a gain on bargain purchase is the purpose of this elimination in the at-acquisition journal.
Gain on bargain purchase
- This gain is created when the acquirer pays an amount less than the fair value on the acquisition date of the identifiable assets and liabilities of the subsidiary.
- This discount is recognised as an income in the parent’s Statement of Profit and Loss and Other Comprehensive Income.
- This is created when the acquirer pays an amount more than the fair value on the acquisition date of the identifiable assets and liabilities of the subsidiary.
- The goodwill amount is recognised in the parent’s Statement of Financial Position under Non-Current Assets.
Non-Controlling Interest (IFRS 10, Consolidated Financial Statements, Appendix A)
- “the equity in the subsidiary not directly or indirectly attributable to the parent”
- Amount of controlling interest of the Non-Controlling Interest is shown as a percentage in relation to the subsidiary (just as in the parent’s case too).
- The Non-Controlling Interest can be measured at either fair value of proportionate of share at the at-acquisition date.
It is important to remember that the parent and subsidiary are separate legal entities but one reporting entity.
I personally enjoy using the Analysis of Equity method to determine specific amounts needed when compiling the consolidated financial statements of a group.
The following is the basic format of the Analysis of Equity:
|Analysis of Equity of Subsidiary||Total||At-acquisition||Since-acquisition||Non-Controlling Interest|
|Total equity (net assets)||-|
|Goodwill/ Gain on bargain purchase||A||–|
|From the date of acquisition until the beginning of the current period|
|Retained earnings (@-TB)||–||H||C|
|Profit for the year||–||F||D|
When compiling the Consolidated Financial Statements of a group, the following principle is extremely important to apply, thereafter the above amounts marked with the letters A-J will be used to adjust the amounts accordingly so that the correct amounts are disclosed in the Consolidated Financial Statements :
100%P + 100%S