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| International Accounting Rules for Groups |
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By
Christy Kearney
Mar 8, 2011 |
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This article outlines the current international accounting rules for Group accounting, which are set out in the revised IFRS 3.
(Christy Kearney is delivering a CPD course on the Financial Reporting issues in relation to Group Accounting. For further details on this CPD Course please view our Group Accounting Trouble-Shooter CPD Brochure. This course also explores Taxation & Auditing issues for Groups.)
IFRS 3(revised) is a further step in the process of converging International and US standards. The revision results in significant changes in accounting for groups. It applies to accounting periods beginning on or after 1 July 2009. Importantly retrospective application to earlier business combinations is not permitted. Accordingly, the changes first effected acquisitions in reporting periods in 2010.
The principal changes are in relation to:
- Goodwill; For less than 100% subsidiaries, two methods are permitted for valuing Goodwill & Non Controlling Interest
- The treatment of Bargain purchases (Negative Goodwill)
- Purchase Consideration;There are a number of changes in the way components of the purchase consideration are valued.
- The process of identifying and valuing Subsidiary assets & liabilities acquired at the acquisition date.
- Changes in the Group structure.
Goodwill & Non Controlling Interest (NCI)
The standard permits two options for measuring Goodwill where there is a Non Controlling Interest (NCI) in the subsidiary.
The first option is to measure the Goodwill that is solely attributable to the Parent interest. This is the traditional approach known as the Partial Method. Goodwill is measured as the difference between the Consideration paid and the acquirer’s share of the Fair Value of the Net Assets.
The NCI is measured at “Their proportionate share of the Fair Value of the Net Assets excluding Goodwill” .
The second and new option is to measure the Goodwill that is attributable to the full entity. This is known as the Full Method. The difference here is that the NCI is valued at their share of the business including Goodwill. Combining this with the Consideration paid by the purchaser gives the Fair Value of the entity as a whole. The excess of the Fair Value of the entity over the fair value of the individual assets and liabilities acquired is Goodwill. The Full Method results in a larger Goodwill on the Balance Sheet and it makes Goodwill Impairment testing easier. The measurement of the NCI at Fair Value may prove a difficult exercise where the acquiree is a private company.
Gain on a bargain Purchase (Negative Goodwill)
The standard requires that gains on an acquisition shall be recognized immediately in the Income Statement at the date of acquisition. The Gain is fully attributable to the Parent company.
Purchase Consideration
Some of the most significant changes are in relation to the Purchase Consideration, which now includes the fair value of all interests that the acquirer may have held previously in the acquired business, i.e. Associate Company, Joint Venture or Trade Investment. Any prior shareholding held in the acquiree is deemed to be sold and then reacquired as part of the new subsidiary. A Gain or loss is recognized in the Income statement (not the OCI) at the date of the business combination
The requirement for the recognition of Contingent Consideration (earn out payments) has been amended. Contingent consideration is measured at Fair Value at the date of the acquisition, even if payment is not deemed to be probable at the date of the acquisition. Contingent Consideration may take the form of equity (fixed number of shares) or a liability (cash or loan note). Contingent Consideration that is equity shall not be re-measured. Contingent Consideration that is a liability will be re-measured at each reporting period until it crystallizes, and the resulting adjustment shall be recognized in the Income Statement.
Transaction Costs are no longer part of the Purchase Consideration. They are expensed in the Income Statement at the date of acquisition. Transaction costs relating to acquisitions that are expensed should be disclosed in the Financial Statements.
Fair Valuing Assets and Liabilities
The revision of IFRS 3 has introduced certain changes in the assets or liabilities recognized in the accounts.
The existing requirement to measure assets and liabilities at fair value is retained with exceptions for deferred tax and pension liabilities. The standard requires that many more intangible assets are recognized at the acquisition date. Acquirers are required to recognize brands, licenses and customer relationships and any other intangible assets that meet IAS 38 requirements.
There is little change to the treatment of contingent assets and liabilities. Contingent assets are not recognized. Contingent liabilities are recognized at fair value. After the date of the acquisition, contingent liabilities are measured at the higher of the original amount and the amount under the relevant standard.
The acquirer has a maximum period of twelve months from the date of acquisition to finalize the acquisition accounting. The adjustment period ends when the acquirer receives all the necessary information, subject to a twelve month maximum. There is no exemption from the twelve month rule for deferred tax assets or contingent consideration. The revised standard permits adjustments against goodwill within this period. Subsequent changes are recognized in the Income Statement.
Changes in the Group structure
The revised standard moves International Standards toward the use of the economic entity approach. The economic entity approach treats all providers of equity capital as shareholders of the entity, even when they are not shareholders of the parent company. The traditional parent company approach sees the financial statements from the perspective of the parent company shareholders.
For example, where the parent disposes of shares in the subsidiary but retains control. This does not result in a change in the group, nor in a gain or loss in the Income Statement. Any gain or loss made by the parent is recognized within equity.
On the other hand, a partial disposal leading to a loss in control is recognized as a full disposal of the subsidiary. The subsidiary is derecognized and a gain or loss is calculated as if the parent had sold its entire shareholding.
Conclusion
The foregoing is a brief summary of the changes in IFRS 3. The upcoming OmniPro presentation on Group Accounting will provide detailed case studies clearly outlining the practical and quantitive effects of all the changes in the IFRS.
Christy Kearney
Kearney Christy@eircom.net
Download the Group Accounting Trouble-Shooter CPD Brochure
This 8 hour CPD seminar aims to give delegates the opportunity to recap on the basics of group accounting, refreshing their knowledge of consolidation for the balance sheet, income statement (or profit and loss account) and the cash flow statement.
The seminar will then examine more complex group situations. Some previous experience of group accounting is assumed.
To Register for this CPD Course Click Here
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