Week 10 - Business combinations

Question 1

What are business combinations?
4 examples of motives?

Answer 1

An entity in control of one or more businesses

Motives for acquiring/merging with other companies, eg. Microsoft, Apple
1. Growth reasons
- may be cheaper and simpler to grow externally via acquisition of another co. (your competitor or supplier)
2. Economies of scale
3. Purchasing undervalued assets
4. Reducing competition
etc.

Question 2

3 main effects of accounting for business combinations on the Financial statements

*IFRS 10 (consolidated fin. stt.s) and IFRS 3 (business combinations)

Answer 2

1, Income statement effect
- DIVIDEND INCOME from S is removed, leaving the MINORITY NET INCOME {cannot keep dividend income in P+S or else it is like paying itself and can inflate income}
- Sales & COGS are summed up from P + S in the consolidated I/S

2. Balance sheet effect
   - GOODWILL recognised (and get rid of Investment in S)
   - Assets of subsidiary S are now part of the parent P
3. Ratio effect
   - consolidation has a significant impact on profitability ratios: ROE, ROA, gross margin, net operating margin {can increase or decrease}

Question 3

4 special issues in accounting for business combinations (to account for economic reality) - significant impact on fin. stt.s
1. Measuring non-controlling interest

Answer 3

• NCI (aka minority interest; ownership of Q in S) occurs when a parent does not fully own a subsidiary
• NCI represents the share of assets held by another entity

IFRS 3 allows discretion/leeway of reporting NCI
Alternative 1. At the proportionate share of the acquiree’s identifiable NET ASSETS at fair value
Alternative 2. At the fair value of the share holding of the other entity {subsidiary?}
» shares usually have higher fair value, hence Alt. 2 increases goodwill & increases BS value

-> Choosing which method depends on co’s INCENTIVES (increase BS value or reduce intangibles, etc.)

Question 4

4 special issues in accounting for business combinations (to account for economic reality) - significant impact on fin. stt.s
2. Acquisition of a business in stages (building up an interest over time)

Answer 4

• Remeasurement required of OLD STAKE. Why? New price for stake, so new price (fair value remeasurement)

Note: CONTROL PREMIUM = the amount paid in excess of fair value to gain controlling interest; NOT part of fair value, it is just to facilitate the deal

-> Fair value of original holding - Original cost = Gain in profit or loss {can also be loss}
-> Goodwill & NCI

eg. if prices gone up for the same assets, would want more shares in order to recognise more goodwill

Question 5

4 special issues in accounting for business combinations (to account for economic reality) - significant impact on fin. stt.s
3. Remeasurement of fair values (of assets & liabilities)

Answer 5

• When some of the amounts in the business combination have to be re-measured at a subsequent date b/c not possible to have a definitive price allocation
• Identify the assets/liabilities that would require remeasurement in the consolidated fin. stt.s as of the acq. date
  » PPE might still have the same fair value w/o adjustment needed simply due to DEPRECIATION

-> remeasurements will affect GOODWILL

Question 6

4 special issues in accounting for business combinations (to account for economic reality) - significant impact on fin. stt.s
4. Transactions with non-controlling interest

Answer 6

1. An equity transaction, involving OWNERSHIP
   eg. selling 40% of shares to NCI for £200k if strapped for cash but still want to retain control
2. Consideration received - Share of net assets disposed {including goodwill since recognised as an asset} = Profit on the disposal to be recognised in equity