Accounting for Business Combination - Essay Example

?Accounting For Business Combination Table of Contents Introduction 3 Business Combinations 3 Advantages and Disadvantages of Business Combination 4 Issues Related To Accounting for Business Combination 7 Conclusion 10 References 11 Introduction A business combination can be acknowledged as a transaction or an event where the acquirer gains control over one or in excess of one business. The acquirer gains command over the assets and the associated liabilities. It is worthy of stating that when interchange in business takes place, it can be termed as business combination. It is significant for all the business combinations to be accounted for utilising the purchase process of accounting. Control can be gained by purchasing the assets themselves or by means of purchasing control over the corporation possessing the assets (Grant Thornton, 2011). The main objective of the paper is to discuss about accounting for business combination, to identify the current issues and thus to critically analyse them. The paper will endeavour to discuss numerous standards that can be applicable in resolving the issues related to accounting for business combination. Business Combinations One of the main goals of the business organisation is to attain growth. It is often stated by the top managements that growth or expansion is the major goal of the business organisation. A company may develop steadily by mounting its range of products. A number of the companies have attained their objective of growth by way of business combinations. The accounting for business combinations is primarily controlled with the help to four principles such as IFRS3, IAS 27, IAS 36 as well as IAS 38.The factor worth considering is that a business combination may be either friendly or might as well be unfriendly. When friendly combination takes place, it is the duty of the boards of directors of both the combining companies to bargain upon communally satisfying terms related to planned combinations. After that the stockholders of the combining companies need to approve the proposal. On the other hand, an unfriendly combination takes place when the board of directors of the company oppose the combination. In such cases, mostly by way of tender offer the acquiring company is capable of interacting with the individual shareholders (Qfinance, 2012). Advantages and Disadvantages of Business Combination There are numerous ways through which the companies may expand. A few of the companies might want to expand internally while others may choose to expand externally. An organisation may choose to expand internally by involving themselves in research and development. In case of external expansion, the companies attempt to expand through acquiring one or more companies. Along with quick expansion, there are numerous benefits of external expansion or business combination method in comparison to internal expansion (Deloitte, 2012). When the combination is vertical or horizontal, such combination with an existing company tends to present the management of the acquiring company with a business unit which is established possessing experienced personnel, productive facilities, regular suppliers as well as distribution channels. Furthermore, such business combinations assist companies to compete in an effective way in the international market. Most of the times, it is apparent that the companies go for business combinations in order to take benefit of the income tax laws. By means of filing a consolidated tax return, the profitable corporations’ tax liability might be minimised because of the losses of unbeneficial affiliates. Diversification occurring from such combinations provides the combining companies with numerous benefits such as greater flexibility, an internal capital market, rise in the debt capacity of the company, greater shield from the rivals over proprietary information, and at times capability to make better use of the organisational resources (PwC, 2012). In spite of its innumerable benefits, business combination might not always be considered as the best method to be adopted by the companies for their purpose of expansion. When companies tend to focus too much upon rapid growth then it may lead to pyramiding of one company over the other without adequate control of the management over such conglomerate. Quite often, in such circumstances, it is noted that management is incapable of maintaining a proper financial base to continue the company. It is because of the mismatched business combinations, which lead to potential divestitures. Business combinations at times might demolish instead of creating value (PwC, 2012). IFRS 3 defines the business combination as an incident or dealings where the acquirer attains control of one of more businesses. It is significant for the acquirer to be recognised for all business combinations under IFRS 3. IFRS 3 is applicable to grouping of communal firms as well as combination without deliberation. However, it needs to be remembered that IFRS 3 is not appropriate for the creation of the joint ventures, grouping of firms or businesses under general control. The acquisition method is implemented for all business combinations. Under such business combinations, both the assets as well as liabilities are evaluated at their acquisition date fair value. IFRS 3 further demands an acquirer to identify separately, at the date of attainment, the personal assets, liabilities as well as dependent liabilities of the acquiree fulfilling the various recognition parameters at the time when that transaction took place, irrespective of whether they had been formerly recorded in the financial statements of the acquiree. The first recognition parameter is that in case of an asset excluding intangible assets, it is quite possible that any interrelated potential economic gains will flow to the purchaser and thus its fair value can be evaluated consistently. The other recognition criteria is that in case of liability excluding a contingent liability, it is likely that there will be requirement of outflow of resources exemplifying economic gains in order to settle the responsibilities and its fair value can be evaluated consistently. Last but not the least, the third recognition criteria is that both the intangible assets’ as well as contingent liabilities’ fair value can be evaluated reliably. Business combinations may consist of innumerable exchange transactions, for example, when they take place in phases by consecutive share purchases. If this is the case then each exchange transaction needs to be treated differently by the purchaser by making use of cost of transaction along with fair value information when such transactions take place for the purpose of identifying the amount of goodwill linked with the transaction. This leads to step-by-step assessment of the cost related to individual investments with the interest of the acquirer in the fair values related to acquiree’s personal assets and contingent liabilities. If it is possible to determine the initial accounting for a business combination at the end of the period in which the combination took place, the acquirer will be responsible for the combination using provisional values. Conversely, the purchaser will record any adjustment to such temporary values as a consequence of accomplishing the initial accounting within the period of one year of acquisition date (IASB Foundation Education, n.d.). Issues Related To Accounting for Business Combination IFRS 3 offers assistance on certain specific components of business combinations comprising business combination attained without shifting the deliberation, reverse acquisitions, recognition of the intangible assets that have been gained and the re-examination of the acquiree’s contractual activities at the date of such acquisitions (PwC, 2012).. When the business combination is impacted by open-market acquisition of stock, no general problem tends to take place in connection with identification of the price or related to procedure of payment. Price is generally identified by how stock market functions and the payments are generally made in terms of cash. The acquiring company might require raising part of cash or entire amount by way of debt or equity issues. Carrying out a combination may lead to certain issues if the number of willing sellers is quite low at open-market price for allowing the acquiring company to purchase most of the outstanding shares of the company that is being acquired. In such circumstances, it becomes significant for the acquiring company to either bargain over the price directly with the individuals possessing huge number of shares or might as well revert to an open tender offer. On the other hand, when a business transaction tends to be impacted because of the stock swap, the problems related to price as well as method of payments may arise. It is significant for the accountants to comprehend the fact that each element of the combination can make two forms of combinations to the new entity. One is net assets and the other is future earnings (PwC, 2012). It is to be remembered that if the business combination is observed to be beyond the capacity of IFRS 3 then in such circumstances it is significant for the management to create an accounting policy that will support in offering pertinent as well as unfailing information. Certain companies think of applying IFRS 3 by equivalence which is generally regarded as acceptable. Actually, nonetheless, companies make use of the accounting policies which can be described as predecessor value methods. Such methods comprise grouping of interests’ methods and merger accounting. The most significant feature of this method is that the balance sheet of the two joining companies are brought together by making use of IFRS-based book values of the entities i.e. assets and liabilities without taking into consideration a fair value exercise. It is worthy of stating the fact that predecessor value methods as well as the acquisition method are dependent upon distinct principles and create different accounting results (PwC, 2009). Reverse acquisition tends to take place in business combinations where the accounting acquirer is considered to be legal acquiree. One context giving rise to the reverse acquisitions is in situations when a company operating on a private basis wants a fast track to a public listing. In order to attain these, arrangements are made by the private companies for its equity interests to be purchased by smaller, publicly-listed company. Reverse acquisitions are within the capacity of IFRS 3 if the accounting acquiree is a business. In cases when the acquiree is considered to be a business then in such circumstances the recording as well as evaluation principles in IFRS 3 is applicable and there is need to recognise goodwill as well (Heuer & Travers, n.d.). It is significant to determine intangible assets separately since in numerous cases, their lives will be limited and thus amortisation under IAS 38 will be required. There is a major impact upon the post-combination earnings if they are to be recorded separately. It is because of this reason IFRS 3 approach places greater emphasis upon separate record rather than including intangibles within goodwill (Deloitte, 2012). In most of the business combinations, the acquiree is a part of operating lease agreement either as lessee or as lessor. However, its own financial statements will be devoid of lease-related intangible assets as well as liabilities. The acquisition method might demand the acquirer to identify additional items in case the acquiree is the lessee (PwC, 2012). In business combinations, the acquirer may regain a right that has been offered to the acquiree previously in order to use the assets of the acquirer. The re-acquired right is considered to be particular asset which is recorded separately, no matter if the fundamental asset was capitalised previously in the financial statement of the acquirer or not. For illustration, it might so have been the case that the acquirer offered the acquiree the right to make use of its trade name. In such circumstances, the business combination occurs in the acquirer reacquiring this right, even in cases it continues in legal continuation and will be utilised in the acquiree’s business in the near future (Bond & Pecaro, 2001). IFRS 3 states the fact that the acquirer needs to divulge information permitting the users of its financial statements to gauge the financial impacts of regulations needed in the current reporting period that is related to business combination taking place in the period or at preceding reporting period (European Commission, 2008). Conclusion A business combination takes place when the acquirer achieves control over one or more than one businesses. The accounting for business combinations is monitored by four main principles namely IFRS3, IAS 27, IAS 36 and IAS 38. When recording the business transaction of the combined business, it is significant to make use of the acquisition accounting method. There are numerous issues that may take place in relation to the accounting for business transactions which need to be resolved adequately in order to avoid any kind of misrepresentation of the accounting transactions and to attain utmost accuracy. References Bond & Pecaro, 2001. Accounting for Business Combinations: The FASB Acts. Business Combinations. [Online] Available at: http://www.bondpecaro.com/images/FASB_act_01.pdf [Accessed April 23, 2012]. Deloitte, 2012. Business Combinations and Changes in Ownership Interests — A Guide to The Revised IFRS 3 And IAS 27. Standards. [Online] Available at: http://www.iasplus.com/en/publications/guides/pub2690 [Accessed April 23, 2012]. Deloitte, 2012. IFRS 3 — Business Combinations. Standards. [Online] Available at: http://www.iasplus.com/en/standards/standard43 [Accessed April 23, 2012]. European Commission, 2008. Endorsement Of Revised IFRS 3 Business Combinations And Amended IAS 27 Consolidated And Separate Financial Statements. Introduction, Background And Conclusions. [Online] Available at: http://ec.europa.eu/internal_market/accounting/docs/ias27_business_combinations_en.pdf [Accessed April 23, 2012]. Grant Thornton, 2011. Navigating The Accounting For Business Combinations. Introduction. [Online] Available at: http://www.grantthornton.cz/uploads/media_items/navigating_business_combinations.original.pdf [Accessed April 23, 2012]. Heuer, C. & Travers, M. A. K., No Date. FASB Issues New Accounting Standards for Business Combinations. Templates. [Online] Available at: http://www.hfma.org/Templates/Print.aspx?id=21158 [Accessed April 23, 2012]. IASB Foundation Education, No Date. Technical Summary. IFRS 3 Business Combinations. [Online] Available at: http://www.iasb.org/NR/rdonlyres/73E562FE-F581-4DD4-8365-B17E228955C9/0/IFRS3.pdf [Accessed April 23, 2012]. PwC, 2012. Change The Way You Think About Tomorrow's Deals. Issues. [Online] Available at: http://www.pwc.com/us/en/issues/business-combinations/fas-141r-fas-160-standards.jhtml [Accessed April 23, 2012]. PwC, 2009. Mergers & Acquisitions —A snapshot. What is Defensive Assets. [Online] Available at: http://www.pwc.com/en_US/us/issues/business-combinations/assets/ma_snapshot_1109.pdf [Accessed April 23, 2012]. Qfinance, 2012. Accounting for Business Combinations in Accordance with International Financial Reporting Standards (IFRS) Requirements. Introduction. [Online] Available at: http://www.qfinance.com/mergers-and-acquisitions-best-practice/accounting-for-business-combinations-in-accordance-with-international-financial-reporting-standards-ifrs-requirements?page=1 [Accessed April 23, 2012]. Read More