Document Sample
					IFRS 3
Business Combinations

 Mumbai, December 20, 2005
 P.R. RAMESH - Deloitte

   Scope
   Application of the Purchase Method
   Revised IAS 38
   Revised IAS 36
   Valuation Considerations
   Transition
   Questions and Answers

   Business Combination
     – Transaction where two or more entities or
       businesses are brought together to form a single
       reporting entity
   Business
         Integrated set of activities and assets conducted

          and managed for the purposes of providing
           – A return to investors; or
           – Lower costs or other economic benefits
             directly and proportionately to shareholders.

   Scope Exemptions
    – Business combinations in which separate entities or
      businesses form a joint venture
    – Business Combinations involving entities or
      businesses under common control
    – Business Combinations involving two or more
      mutual entities
    – Business Combinations in which separate entities or
      businesses are brought together by contract alone
      without the obtaining of an ownership interest
Purchase Method

  Identify an Acquirer

  Determine the cost of
      the business

   Allocate the cost of
       the business
           Identify an Acquirer

   Consider
     – Respective sizes of entities prior to the combination
     – Power to govern financial and operating policies of
       combined entity
     – Voting rights in combined entity
   Acquirer for accounting may be different than legal
    acquirer (a ‘reverse acquisition’)
   Where a new entity is formed one of the pre-existing
    entities must be identified as the acquirer
             Cost of Business
   Equity instruments issued as purchase consideration
    measured at market price
   Include
     – Cash consideration
     – Equity instruments issues to effect the transaction
     – Expenses incurred by the acquirer solely for
       purpose of business combination (e.g. legal fees)
     – Contingent payments to the extent they are
       probable and can be reliably measured
   Costs of arranging finance for the acquisition and
    costs of issuing equity instruments are not recognised
    as an asset – they are accounted for in accordance
    with IAS 39 (i.e. initial cost to treated as either liability
    or offering costs)
               Allocate Cost of
               Business Combination
   Assets are recognized at fair value if it can be measured
    reliably and it is probable that the economic benefit will
    flow to the acquirer

   Liabilities, other than contingent liabilities are recognized at
    fair value only if it can be measures reliably and it is
    probable that there would be an outflow of economic
    benefit to settle obligation

   Only allocate to those assets, liabilities and contingent
    liabilities of the acquiree that exist at the date of acquisition
    (i.e. restructuring)

   Measure contingent liabilities if reliably measurable – base
    on the amount a third party would charge to assume the
                  Fair Values of Net
                  Assets and Contingent
   Traded financial instruments (eg. investments) at market values
   Unquoted financial instruments based on estimated values such as price-earning
    ratio, dividend yield, growth rates of similar traded instruments
   Long-term receivables and other long-term assets at present values determined at
    appropriate current interest rates less allowances for doubtful receivables and
    collection costs
   Inventories- Finished goods at selling price less sum of cost of disposal and profit
                  allowance for acquirer’s effort

                  Work-in-progress at selling price of finished goods less sum of cost to
                  complete, cost of disposal and profit allowance for acquirer’s effort

                  Raw materials at replacement cost

   Land and building at market values
   Plant and equipment at market values determined by an appraiser. In absence of
    market value depreciated replacement cost
   Net employee defined benefit asset or liability at present value less fair value of plan
   Long-term liability at present values at appropriate interest rates

                   Fair Value of
Cost of
                  assets,
Business      -    liabilities and   >0           Goodwill
Combination        contingent

Recognise   as an asset at date of transaction
Do not amortise
Test for impairment at least annually
          Negative Goodwill’

                  Fair Value of
Cost of
                 assets,
Business      -   liabilities and   <0         Negative
Combination       contingent                   Goodwill

  Reassess the fair values originally determined
  Any remaining excess is recognised in profit and
   loss immediately
             IAS 38

   Identification and recognition of certain
    intangible assets
   Finite useful life – amortise
   Indefinite useful life – Assess annually for
   Reassess the useful life of intangible assets at
    least annually
              IAS 36 – Cash-
              generating units

   Cash-generating units (CGUs)
     – The smallest identifiable group of assets that
        generate cash inflows that are largely independent
        of the cash inflows from other groups of assets
   Allocate acquired goodwill amongst CGUs expected to
    benefit from the synergies of the combination
   CGUs (or groups of CGUs) to which goodwill is
    allocated for impairment testing must be
     – Lowest level at which management monitor goodwill
     – No larger than a segment (in accordance with IAS
          IAS 36 – Calculation

   Determine carrying amount of the CGU
    (including allocated goodwill)
   Determine fair value less costs to sell and/or
    value in use
   Compare higher of the two with carrying
   Any shortfall must be recognised as a
    recoverable amount write-down
           IAS 36 – Write-

   All write-downs are recognised immediately
   Where a write-down is required in relation to a
    CGU with allocated goodwill, the goodwill is
    first written down
   Any remaining write down is taken
    proportionately against the non-monetary
   Write-downs of goodwill may not be reversed
    in future reporting periods
          IAS 36 – Practical

   A CGU must be assessed at the same time
    each year
   Where an indicator of impairment exists, the
    asset concerned must be tested for impairment
    before testing the CGU
   Detailed calculations may be carried forward
    from prior reporting periods providing certain
    conditions are met

   Overview
    – Cash Generating Unit Valuations
    – Identifiable Intangible Asset Valuations
    – Documentation Guidelines
               Cash Generating Unit
               Valuations (1)
   Assessing the Recoverable Amount of a CGU
     – IAS 36 (18) defines recoverable amount as the HIGHER of:
          Fair value less costs to sell; and

          Value in Use

     – Best evidence of an asset’s FAIR VALUE (less costs to sell) is a price
       in a binding sale in an arm’s length transaction, adjusted incremental
       costs that would be directly attributable to the disposal of the asset.
          Binding sales agreement; or

          Comparable companies and Transactions involving similar
            companies (MARKET APPROACH)
     – The expected present value of the future cash flows derived from the
       asset (DCF APPROACH) should be used in assessing the VALUE IN
         Cash Generating Unit
         Valuations (2)

   MARKET APPROACH – Key Elements and
     – Typical methodologies
         Comparable public companies

         Comparable transactions

     – Valuation multiples
         Market value of “Invested Capital” to revenue,

          EBITDA, or EBIT
         Market value of “Equity” to net income, or BV of

          tangible net equity
                 Intangible Asset
                 Valuations (1)
   Recognition as part of a business combination
     – Recognised separately if it meets the following criteria:
         Separately identifiable (i.e. capable of being separated or
             divided from the entity and sold, transferred, licensed,
             rented, or exchanged – either individually or together with
             a related contract, asset or liability)
            Controlled by the entity (arises from contractual or other
             legal rights, regardless of whether those rights are
             transferable or separable from the entity or from other
             rights and obligations)
          A source of future economic benefits
          Fair value can be measured reliably

     – Useful list of “Illustrative Examples” of types intangibles is
       provided with IFRS 3 – similar to SFAS 141
     – Determination will ultimately be based on the facts and
       circumstances of each individual business combination
           Intangible Asset
           Valuations (2)

   Intangible Asset Valuations
     – Market Approach
         Comparable transaction

     – Income Approach
         Relief-from-royalty

         Discounted cash flow

         Cost-savings

     – Cost Approach
         Replacement cost

   Key Elements of Valuation Documentation
     – Description of the CGU
         Nature of operations

         Consider value drivers

     – Financial analysis with respect to the CGU
         Financial condition

         Profitability and earnings capacity

         Available documentation regarding

   Key Elements of Valuation Documentation
    – Supporting calculations consistent with generally
      accepted valuation procedures for each valuation
      method adopted
    – Sufficient documentation of key assumptions and
      sources of data
    – Rationale for conclusion and rationalisation of
      various indications of value – global sense check
          Closing Observations

   Appropriate valuation methodologies should be
    carefully selected and consistently applied over
   Whether a particular fair value measurement is
    prepared internally or with the assistance of a
    third-party specialist, the level of
    documentation to support the conclusions of
    the entity is expected to be similar
   It’s a subjective and difficult area – so please
    consult with the appropriate specialists
          Tax Effect of Business

   Fair value of assets and liabilities may result in
    deferred tax asset or liability

   If asset or liability is not recognized which
    subsequently is incurred or realized then:
    recognize benefit \ expense in P&L
    adjust carrying value of goodwill through P&L
              Transition – Current
              IFRS User
   Applies to transactions for which agreement date is on or after 31
    March 2004
   In the first reporting period beginning on or after 31 March 2004
     – Discontinue amortisation of goodwill in first reporting period
     – Eliminate carrying amount of goodwill amortisation against
     – Test carrying amount of goodwill for impairment
     – Reclassify intangibles recognised in previous business
        combinations that do not meet the recognition criteria to
   Early adoption can only be achieved in conjunction with early
    adoption of revised IAS 36 and IAS 38
   Transitional requirements should be applied in respect of goodwill
    arising from joint ventures and associates
             Transition – First-
             Time Adopter
   Not required to restate prior business combinations
    accounted for under a standard different from the IFRS
    applicable at the date of reporting.
   Still need to eliminate assets and liabilities that do not
    meet the recognition criteria under IFRS outside of a
    business combination (adjustment to goodwill).
   If subsidiary has not been consolidated under previous
    GAAP, restate assets and liabilities in accordance with
   Test goodwill in opening IFRS balance sheet for
   Must account for all business combinations after date
    of transition in accordance with IFRS 3

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