The on-going global financial crisis originating from the North American market which slowly resonates to the rest of the world can be viewed by some market players as only another chapter in the natural cycle of the financial market. The capital market, after having been through several crises in the past, is all too familiar with the periods of nervousness; and recognize that economies do periodically slow down. To some of these players the issue is not an absence of opportunities or a shortage of capital. It’s simply a question of adjusting the strategy to suit the circumstances.
In the aftermath of the 1997 financial crisis for example, the Philippine market witnessed a series of major business mergers and acquisitions. Indeed, to investors with long-term perspective, some of the best-value transactions can be closed when asset prices are under intense pressure. As we already read in the papers and heard from business news, these types of investors are already on the look-out for companies which are ripe for the picking, thereby triggering a new wave of acquisitions and merger proposals.
With the prospects of business acquisitions and mergers, it is probably best to take a closer look at the Revised International Financial Reporting Standard (IFRS) 3 Business Combinations (2008) and the amendments to International Accounting Standard (IAS) 27 Consolidated and Separate Financial Statements (2008) published by the International Accounting Standards Board (IASB) on Jan. 10, 2008.
Background
IFRS 3 (2008) is the outcome of the second phase of the IASB’s and the US Financial Accounting Standards Board’s (FASB) business combinations project, which was conducted as a joint project of the Boards. The first phase of the project resulted in the issuance of IFRS 3 (2004) and the US standard SFAS 141 Business Combinations (2001). The second phase of the project reconsidered the application of acquisition accounting for business combinations. The amendments to IAS 27 (2008) reflect changes to the accounting for non-controlling (minority) interest and deal primarily with the accounting for changes in ownership interests in subsidiaries after control is obtained, the accounting for the loss of control of subsidiaries, and the allocation of profit or loss to controlling and non-controlling interests in a subsidiary.
Note that the revised international standards require less change for IFRS users than for entities reporting under United States generally accepted accounting principles (US GAAP),. This is partly due to the option that is available under IFRS 3 (2008) and IAS 27 (2008), but not under US GAAP, to limit the recognition of goodwill to the controlling interest acquired by the parent entity.
The revised standards will supersede the existing versions of IFRS 3 and IAS 27, respectively, effective for annual periods beginning on or after July 1, 2009 with early adoption permitted. On the local front, the Philippine Financial Reporting Standards Council (FRSC) has already approved the adoption of these revised standards.
Main changes
On business combinations, perhaps, the most significant change is a move from a purchase price allocation approach to a fair value measurement approach. Several other changes mean that business combinations are likely to have an immediate impact on reported profits. Examples of these changes are as follows:
• Any pre-existing interests in the acquired company will be remeasured to fair value at the acquisition date, with any gain or loss recognized in profit or loss rather than directly in equity.
• Many transaction costs that currently are capitalized will be required instead to be recognized as an expense.
• Contingent consideration will be measured at fair value at acquisition date. Generally, subsequent changes will be recognized in profit or loss if the contingent consideration is classified as a liability.
In particular, IAS 27 (2008) requires purchases and sales of non-controlling shareholdings when control is retained, to be accounted for fully as equity transactions. Consequently, this will reduce the current diversity in accounting for such transactions. When control is lost, a gain or loss is recognized in profit or loss, comprising a realized gain or loss on the interest disposed of, and an unrealized gain or loss from remeasurement to fair value of any retained non-controlling equity investment in the former subsidiary. Losses applicable to the non-controlling interest in a subsidiary are allocated to the non-controlling interest even if this causes the non-controlling interest to be in a deficit position.
Conclusion
Business combinations play a significant role in the capital markets. According to the Financial Reporting Standards Council, over the past decade, the average annual value of corporate acquisitions worldwide has been the equivalent of eight to 10 percent of the total market capitalization of listed securities. And given that the impact of accounting for business combinations plays a vital role in the business environment, companies applying IFRS would be well advised to carefully look at the new requirements of the revised standards to anticipate the impact of a planned business combination on the acquirer’s financial position and results of operations.
The technical matters discussed here are based primarily on our KPMG publication, First Impressions: IFRS 3 and FAS 141R Business Combinations which has been produced jointly by the KPMG International Financial Reporting Group and the Department of Professional Practice of KPMG LLP in the US.
(Jose C. Catequista is a Partner for Audit Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or jcatequista@kpmg.com).