Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Financial Reporting Standards (PFRS) 3, Business Combinations, highlighting aspects that are more difficult to interpret and revisiting the most relevant features that could impact reporting entities.

Overview

Acquisitions of businesses can take many forms and can have a fundamental impact on the acquirer’s operations, resources, and strategies. These acquisitions are sometimes referred to as mergers or business combinations, and the accounting and disclosure requirements are set out in PFRS 3.

What is reverse acquisition

A reverse acquisition occurs when an entity that issues securities (the legal parent or the legal acquirer) is identified as the accounting acquiree, and accordingly, the legal subsidiary (or the legal acquiree) is identified as the accounting acquirer.  One situation in which reverse acquisitions often arise is when a private operating entity wants a fast-track to a public listing.  To accomplish this, the private entity arranges for its equity interests to be acquired by a smaller, publicly listed entity.  The listed entity carries out the acquisition by issuing shares to the shareholders of the private operating entity.

Identifying the acquirer

When a transaction between entities is carried out primarily by exchanging shares, the entity that obtains the control over the other entity is the accounting acquirer. Although PFRS 3 indicates to use the guidance in PFRS 10, Consolidated Financial Statements, to identify such acquirer, in practice, the factors listed in PFRS 3 with regards to the transactions effected by an exchange of equity interests should also be analyzed.  The following facts and circumstances are likely to indicate the legal subsidiary is the accounting acquirer:

• the former shareholders of the legal subsidiary, as a group, retain or receive the largest portion of the voting rights in the new combined entity (which include potential voting rights that could be exercised);
• the relative size (measured in, for example, assets, revenues or profit) of the legal subsidiary is significantly greater than that of the legal parent; and,
• the former owners or managers of the legal subsidiary dominate the composition of the governing body or senior management of the combined entity.

What is a business

A business is defined as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.' PFRS 3 acknowledges that despite most businesses having outputs, outputs are not necessary for an integrated set of assets and activities to qualify as a business. In order to meet the definition of a business, the acquired set of activities and assets must have as a minimum an input and a substantive process that can collectively significantly contribute to the creation of outputs.

How to account for a reverse acquisition

If the accounting acquiree is defined as a business, the reverse acquisition should be accounted for under PFRS 3, otherwise, it shall be accounted for as a reverse acquisition along with a share-based payment outside the scope of PFRS 3.  The Accounting Alert provides a flowchart on how to account for a reverse acquisition

See attached Accounting Alert for further details and illustrative examples.