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

Mergers and acquisitions (business combinations) can have a fundamental impact on the acquirer’s operations, resources, and strategies. For most entities such transactions are infrequent, and each is unique. PFRS 3 contains the requirements for these transactions, which are challenging in practice. The Standard itself has been in place for more than ten years now and has undergone a post implementation review by the IASB. It is one of the most referred to Standards currently issued.

The acquisition method

PFRS 3 establishes the accounting and reporting requirements (known as ‘the acquisition method’) for the acquirer in a business combination. The key steps in applying the acquisition method are summarized below:

• Step 1: Identifying a business combination
• Step 2: Identifying the acquirer
• Step 3: Determining the acquisition date
• Step 4: Recognizing and measuring identifiable assets acquired and liabilities assumed
• Step 5: Recognizing and measuring any non-controlling interest (NCI)
• Step 6: Determining the consideration transferred
• Step 7: Recognizing and measuring goodwill or a gain from a bargain purchase

Effect of deal terms on the accounting for business combinations

The terms and structures of sales and purchase agreements vary extensively, and they will determine how a business combination should be accounted for. It is important that management is aware of the financial reporting consequences of putting in place certain terms and conditions into sale and purchase agreements. The following are some common deal terms and their related effects on the financial reporting for business combinations.

• Structure of the purchase price: The purchase price may include contingent consideration arrangements or contingent payment arrangements with selling employee-shareholders who remain employees of the acquired business. The parties may also agree to transfer some of the acquirer's assets.
• Arrangements for the payment of acquisition costs: The parties may arrange that transaction costs are paid by the vendor which may or may not be reimbursed by the acquirer.
• Replacement or continuation of an acquiree’s share-based payment awards: The acquirer may replace the acquiree’s share-based payment awards or alternatively continue the acquiree’s share based payment awards without changes.
• Contracts to acquire shares from non-selling shareholders at a later date: These contracts may be negotiated at or around the same time as the business combination.

Reporting business combinations and avoiding surprises

Reporting a business combination is a significant exercise. A considerable amount of time and effort usually needs to be put into gathering, assembling and evaluating all the information required to be reported in the financial statements under PFRS 3. Presented below are some planning considerations:

• During the deal negotiation: 
• understand the accounting effects of the terms set out in the sale and purchase agreement
• identify related transactions or other elements that may require separate accounting
• identify transactions/agreements or other arrangements that have negotiated at or near the same time to assess whether they should form part of the business combination.
• Applying the acquisition method:
• identifying intangible assets - these assets are more challenging to identify as they are often not recognized in the acquiree’s financial statements.
• identifying contingent liabilities - the acquirer should recognize at the acquisition date a contingent liability assumed in a business combination if it is a present obligation and its fair value can be measured reliably.
• valuation process - fair values of certain items may not be readily available and may require complex estimates.
• determining consideration transferred - need to consider the effects of transactions that are not part of the business combination under PFRS 3
• making an accounting policy choice in certain areas, for example, in measurement of NCI and classification and designation of assets acquired and liabilities assumed.
• Determining the need for outside experts:
• some entities enter into frequent business combination transactions but for others, these are one-time events. The entity may then not have the adequate resources to apply PFRS 3’s requirements.
• Timely completion of the accounting for the business combination:
• the accounting for a business combination, including all the required disclosures, should be completed within the measurement period (which should not exceed 12 months after the acquisition date). Depending on the complexity of the business combination, this time frame may be challenging.
  
  

See attached Accounting Alert for further details.