Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Financial Reporting Standards (PFRS) 3, Business Combination highlighting the aspects that are challenging to interpret and apply in practice. This includes the present guidance on PFRS' requirements for recognizing and measuring non-controlling interests (NCI), determining and measuring the amount of consideration transferred, and determining what is part of a business combination in cases where there are other transactions and arrangements between parties.

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, Business Combinations, contains the requirements for these transactions, which can be challenging in practice. The Standard itself has now been in place for more than ten years and has undergone a comprehensive post implementation review by the International Accounting Standards Board (IASB).

This article contains the present guidance on PFRS' requirements for the following:

• Recognizing and measuring NCI
• Determining and measuring the amount of consideration transferred
• Determining what is part of a business combination in cases where there are other transactions and arrangements between parties

Recognizing and measuring NCI

PFRS 3 defines NCI as 'the equity in a subsidiary not attributable, directly or indirectly, to a parent. The simplest and most common form of NCI is shares in the acquiree held by non-selling shareholders. However, all instruments issued by the acquiree that meet the definition of equity set out in PAS 32, Financial Instruments: Presentation - such as share options, preferred shares, equity component of convertible bonds are also NCI if they are not owned or acquired by the acquirer.

Depending on the nature and the rights those equity instruments entitle their holders, NCI can be grouped into two broad categories, which in turn determine the available measurement options at initial recognition.

1. Present ownership interests - Measured at far value or proportionate share of recognized amount of assets and liabilities of the acquiree. The choice between the two measurement options is to be made for each business combination on a transaction-by-transaction basis.
2. All other equity instruments not held directly or indirectly by the acquirer - Measured at fair value unless another measurement basis is required by PFRS, e.g. share-based payment awards classified as equity and held by parties other than the acquirer are measured in accordance with PFRS 2, Share Based Payment.

Determining and measuring the amount of consideration transferred

Consideration transferred is the sum of the acquisition date-fair values of:

• the assets transferred by the acquirer
• the liabilities incurred by the acquirer to former owners of the acquiree
• the equity interests issued by the acquirer in exchange of the acquiree

Consideration transferred could differ from the contractual purchase price for different reasons. One of the reasons could be if the overall transaction or arrangement includes elements that are not part of the business combination. It could also be because the fair value of the consideration transferred at the date of acquisition is not the same as the amount stated in the contractual arrangement to determine the purchase price. Consideration transferred may include the following:

Deferred consideration is an obligation to pay a certain amount at a specified date after the date of acquisition. This is measured at fair value at the acquisition date (considering the time value of money). The unwinding of the discount is recognized in profit or loss.​

Contingent consideration is the obligation of the acquirer to transfer additional assets or equity interests to the acquiree’s former owners if specified future events occur or conditions are met.

Specific considerations also apply to:

Share-for-share exchanges and combinations of mutual entities -  Under PFRS 3, consideration transferred is determined based on the fair value of the shares issued by the acquirer. However, PFRS 3 provides a mandatory alternative if the shares acquired are more reliably measurable. The consideration transferred is measured using the acquisition-date fair value of the acquiree’s equity interests received if this fair value is more reliably measurable than the acquisition-date fair value of the acquirer’s equity interests transferred. For business combinations of mutual entities, the same principle also apply.

Business combinations with no consideration transferred - Even if no consideration is transferred in certain situations, the acquisition method shall still be applied. To determine the amount of goodwill when no consideration is transferred, the acquirer must substitute the fair value of any consideration transferred with the acquisition-date fair value of the acquirer's interest in the acquiree (determined using an appropriate valuation technique). 

Business combination achieved by contract alone - The acquirer can hold no equity interest in the acquiree before or after the acquisition date. In such situations, the acquirer must attribute all of the equity interest held by parties other the acquirer as non-controlling interest (NCI), even if this results in 100% NCI.

Determining what is part of a business combination transaction

In effecting a business combination, the acquirer may also enter into transactions and arrangements with the vendor and/or acquiree. Under PFRS 3, the acquirer should determine whether such a transaction is part of the exchange for the acquiree. If not, the transaction must be accounted for separately.

PFRS 3 provides a list of indicators to be considered when determining whether a transaction is part of the exchange for the acquiree or a separate transaction. The indicators are neither mutually exclusive nor individually conclusive.

• A transaction arranged primarily for the benefit of the acquirer or the combined entity (i.e., acquirer and acquiree) is less likely to be part of the exchange for the acquiree.
• A transaction or other event initiated by the acquirer with the objective of providing future economic benefits to the acquirer or the combined entity is less likely to be part of the exchange for the acquiree.
• A transaction entered into between the acquirer and the acquiree during the negotiations of the terms of the business combination, with the objective of providing future economic benefits to the acquirer or the combined entity is less likely to be part of the exchange for the acquiree.

PFRS 3 provides three examples of transactions that should be accounted for separately from the business combination and provides guidance on how these transactions affect the calculation of the consideration transferred, if any:

• In effect settles pre-existing relationships between the parties
• Remunerates employees or former owners of the acquiree for future services
• Reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs.

See attached files for further details and illustrative examples.