Despite the release of some significant new accounting standards in recent years, a few areas are still not covered adequately (or, indeed, at all in some cases) by IFRS Standards. This column in particular has questioned the suitability in the current digital climate of IAS 38, Intangible Assets, a standard that was written before the iPod was even invented.
One such remaining issue relates to business combinations under common control (BCUCC), an area that is effectively not covered under the current standards. A BCUCC is a combination in which all the combining companies are ultimately controlled by the same party, both before and after the combination.
In the above illustration, companies A, B and C all fall under the immediate or ultimate control of P. If company C is sold by company A to company B, then the financial impact on P (the ultimate controlling party) and company A (the transferring party) is covered by IFRS 10, Consolidated Financial Statements. Company C needs to disclose information about its new immediate parent under IAS 24, Related Party Disclosures.
Current IFRS Standards do not address how company B should record the transaction. Unsurprisingly, this has led to diversity in practice. The major issue in this project has been the measurement method to be applied to BCUCC transactions. In practice there are two distinct approaches:
- the acquisition method, which measures the net assets at fair value – the principles of IFRS 3, Business Combinations, are broadly applied, and an element of goodwill is included if consideration exceeds the net assets
- the book-value method, which transfers the net assets over at their carrying amounts.
IASB research results
The International Accounting Standards Board (IASB), which sets IFRS Standards, has issued a discussion paper as it aims to close this gap in the standards. Unsurprisingly, the IASB’s research found a number of contrasting viewpoints.
Some respondents believe that all BCUCC transactions are similar to business combinations under IFRS 3, while others argue that the acquisition method should be used only if there is a change in ultimate control of the business. Meanwhile, a third group of respondents believe that some BCUCC transactions are similar to business combinations under IFRS 3 and others are not, and to prescribe one set of rules would be mistaken.
This may be an issue that doesn’t affect many entities, but it is hoped that this will reduce diversity in practice
Despite these opposing views, the IASB research did find some common ground among the respondents. Most commentators favour a book-value approach if there are no non-controlling interests in the receiving company. The IASB also found that more respondents favour the acquisition method when there are substantial non-controlling interests in the receiving company.
The preliminary view of the IASB is that either method can be applied, with companies following a set of guidelines in determining which to use.
The acquisition method
The acquisition method should be used if either of the following conditions apply:
- the combination affects non-controlling interests and the receiving company’s shares are traded on a public market
- the receiving company’s shares are not publicly traded, but the combination affects non-controlling shareholders who object to the use of the book-value method.
The IASB’s reasoning here is that such transactions are not simply a reallocation of economic resources within the group but have a substantive impact on the receiving company and its shareholders.
Applying the acquisition method will result in the use of fair values and the calculation of goodwill in the receiving entity’s financial statements. If the transaction results in a gain on bargain purchase (negative goodwill), the IASB proposes this be recognised as a contribution in equity rather than a gain in the statement of profit or loss.
The book-value method
The IASB proposes the book-value method be used in all cases other than those mentioned above in relation to the acquisition method. The thinking behind this is that such transactions do not result in a change in ultimate control of the entity and are much more likely to relate to a reallocation of economic resources within the group.
There has been discussion over whether these are the book values in the individual transferred company or in the consolidated financial statements. The IASB’s preliminary view is that these should be the carrying amounts in the individual transferred company records.
The IASB is attempting to close a gap that exists in the consolidation standards. This may be an issue that doesn’t affect many entities, but it is hoped that this will reduce diversity in practice and result in better information for the users.
Comments on the discussion paper must be submitted by 1 September 2021.
