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International Financial Reporting Standards

Accounting for
business combinations
and consolidated
financial statements
Joint World Bank and IFRS Foundation train the
trainers workshop hosted by the ECCB,
30 April to 4 May 2012

The views expressed in this presentation are those of the


presenter, not necessarily those of the IASB or IFRS Foundation.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


International Financial Reporting Standards

Control
IFRS 10 Consolidated Financial Statements

[[[
The views expressed in this presentation are those of the
presenter,
not necessarily those of the IASB or IFRS Foundation
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Objective 3

Information about
resources under the control of the group (assets)
and
claims against those resources
assists users to better assess the prospects for future
net cash inflows to the group which is useful in making
decisions about providing resources to the group.
The global financial crisis highlighted the importance of
enhancing disclosure requirements, in particular for
special purpose or structured entities.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Definition of control 4

An investor controls an investee when the investor is exposed, or


has rights, to variable returns from its involvement with the
investee and has the ability to affect those returns through its
power over the investee.
Single consolidation model for all entities, including structured entities
Consolidation based on control power so as to benefit model
Investor must have some exposure to risks and rewards
Exposure is an indicator of control but not control of itself
Power arises from rightsvoting rights, potential voting rights,
other contractual arrangements, or a combination thereof.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Assessing control of an investee 5

Consider the purpose and design


Identify the activities of the investee that significantly
affect the returns of the investee (relevant activities)
Identify how decisions about relevant activities are
made
Determine whether the rights of the investor give it the
ability to direct the relevant activities (see next slide)
Determine whether the investor is exposed, or has
rights, to the variability associated with the returns of
the investee
Determine whether the investor has the ability to use its
power over the investee to affect its own returns
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Example:
Control 6

In the absence of evidence to the contrary, in each


scenario below, does A control Z?
i. A owns 100% of Z.
ii. A owns 51% of Z.
iii. A owns 50% of Z.
iv. A owns 50% of Z and holds currently exercisable in
the money options to acquire another 100 shares in
Z.
v. Same as (iv) except B owns the options.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Structured entity 7

A pharmaceutical manufacturer (entity A) established a


viral research centre (RC) at a university.
A determined sole & unalterable purpose of RC =
research & develop immunisation & cures for viruses
that cause human suffering.
RC is owned and staffed by the university.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Structured entity continued 8

All costs of establishing & running RC are paid by the


university from the proceeds of a grant from A.
the budget for the research centre is approved by A
yearly in advance.
A benefits from the research centre:
by association with the university; and
through exclusive right to patent any immunisations
and cures developed.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


De facto control 9

Entity can control with less than 50% of voting rights.


Factors to consider include:
size of the holding relative to the size and
dispersion of other vote holders
potential voting rights
other contractual rights
If the above not conclusive consider additional facts and
circumstances that provide evidence of power (eg
voting patterns at previous board meeting, etc)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
de facto control 10

Entity A owns 45 per cent of the ordinary shares of


Entity B to which voting rights are attached.
Entity A is the largest shareholder of Entity B.
It also has the right to appoint the majority of the
members of the Board of Directors (the management
board) of Entity B in accordance with special rights
given to Entity A in the founding document of the entity.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Assessing power 11

Entity A and B each have 50%


ownership interest in the trust.
Entity A appointed as manager
Entity A Entity B of trust.
Manager: manages the assets
of the trust, identifies
development opportunities,
Trust
manages development activity
and manages leasing activity.
Cannot be removed without
cause.
Relevant activities?
Who directs?
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Example:
Delegated rights 12

Responsible Other Responsible entity:


entity investors
Broad decision making
powers
Removal by simple majority
Investment
trust Remunerated via market-
based fee - 1% of assets
under management and
Investment 20% of profits over a hurdle
portfolio Equity interest of 20%

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Potential voting rights 13

Substantive potential voting rights (PVR) can give the


holder power
Consider the terms and conditions, including:
Whether there are any barriers that prevent the
holder from exercising
Whether exercise of the rights would be beneficial
to the holder
Whether the rights are exercisable when decisions
need to be made

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Agency relationships 14

Consider all of the following factors:


scope of the decision-making authority
rights held by other parties (ie kick-out rights)
remuneration of the decision-maker
other interests that the decision maker holds in the
investee

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Judgements and estimates 15

Determining whether an investor controls an investee


involves assessing whether the investor:
has power over the investee
exposure, or rights, to variable returns from its
involvement with the investee
the ability to use its power over the investee to
affect the amount of the investors returns.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Judgements and estimates continued 16

Factors to consider when assessing whether control


exists include, for example:
assessing the purpose and design of the investee
(eg are voting rights or contractual arrangements
the dominant factor?)
identifying relevant activities and how decisions
about those activities are made
assessing current ability to direct (practical ability to
direct the relevant activities unilaterally?)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


International Financial Reporting Standards

IFRS 3
Business
Combinations

[[[
The views expressed in this presentation are those of the
presenter,
not necessarily those of the IASB or IFRS Foundation
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Introduction 18

A business combination is a transaction or other event


in which a reporting entity (the acquirer) obtains control
of one or more businesses (the acquiree).
IFRS 3 does not apply to the following:
the formation of a joint venture
the acquisition of an asset or group of assets that is
not a business as defined
a combination of entities or businesses under
common control

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


The acquisition method 19

Business combinations are accounted for using the


acquisition method, ie
identifying the acquirer;
determining the acquisition date;
recognise and measure the identifiable assets
acquired and the liabilities assumed and any non-
controlling interest; and
recognise and measure any goodwill or bargain
purchase.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Identifying the acquirer 20

The acquirer is the entity that obtains control of another


entity

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Who is the acquirer? 21

On 31/12/20X0 A has 100 shares in issue.


On 1/1/20X1 A issued 200 new A shares to the owners
of B in exchange for all of Bs shares.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Determining the acquisition date 22

The acquisition date is the date on which the acquirer


obtains control
often the date the consideration is transferred,
assets are acquired and liabilities assumed
closing date
may be other dates (earlier or later than the closing
date) at which control is assumed

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Recognition and measurement 23

Recognition principle (IFRS 3.1017):


separate recognition of identifiable assets acquired,
liabilities and contingent liabilities assumed (think
Conceptual Framework)
Measurement principle (IFRS 3.1820):
assets and liabilities that qualify for recognition are
measured at their acquisition-date fair values
measurement at fair value provides relevant
information that is more comparable and
understandable (IFRS 3.BC198)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Exceptions to the measurement 24

Reacquired rights
measured at fair value based on remaining
contractual term ignoring the fair value effect of
renewal
Share-based payment transactions
replacement awards: measured in accordance with
IFRS 2
Assets held for sale
measured in accordance with IFRS 5 (ie fair value
less costs to sell)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Exceptions to both the recognition
and measurement principles 25

Income taxes
deferred tax assets or liabilities arising from acquired
assets or liabilities accounted for using IAS 12
Employee benefits
accounted for using IAS 19
Indemnification assets
may not be recognised at fair value if it relates to an
item not recognised or measured in accordance with
IFRS 3

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Consideration transferred 26

The consideration transferred is measured at the fair


value of the sum of assets transferred and liabilities
assumed
acquisition-related costs are excluded
contingent consideration is included at its fair value
at acquisition date (subsequent changes in fair
value are not included in the consideration
transferred at acquisition-date)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
What is the cost of the Bus Com? 27

Entity A acquires 75% of entity B in exchange for


CU85,000 cash and 1,000 entity A shares (fair value =
CU10,000) issued for the transfer.
Entity A incurred CU5,000 advisory and legal costs
directly attributable to the business combination and
CU1,000 share issue expenses.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Goodwill 28

Goodwill (an asset) is measured initially indirectly as the


difference between the consideration transferred (see IFRS
3.3740) excluding transaction costs in exchange for the
acquirees identifiable assets, liabilities and contingent
liabilities (measured as set out above)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Goodwill continued 29

If the value of acquired identifiable assets and liabilities


exceeds the consideration transferred, the acquirer
immediately recognises a gain (bargain purchase)
Goodwill is not amortised, but is subject to an impairment
test.
If less than 100% of the equity interests of another entity is
acquired in a business combination, non-controlling
interest is recognised.
Choice in each business combination to measure non-
controlling interest either at fair value or at the non-
controlling interests proportionate share of the acquirees
identifiable net assets.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Disclosure 30

Comprehensive disclosure requirements designed to


enable users to evaluate the nature and financial
effects of business combinations (and any
adjustments made to prior period business
combinations).
Refer to IFRS 3.B64B67.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Comparison to the IFRS for SMEs 31

The main differences between IFRS 3 and Section 19


Business Combinations and Goodwill of the IFRS for
SMEs include:
the costs associated with acquisition are included in
the consideration transferred rather than being
expensed
changes in the recognised amount of contingent
consideration affect goodwill
goodwill is amortised over its estimated useful life (or
10 years if a reliable estimate cannot be made)
non-controlling interest must be measured using the
proportionate share method

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Judgements and estimates 32

Determining whether a particular set of assets and


activities is a business requires assessing their
capabilities of being conducted and managed for the
purpose of providing economic benefits.
Identifying the acquirer in some business
combinations that combine two or more entities can
require judgement.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Judgements and estimates continued 33

Accounting for business combinations requires broad


use of fair value estimates. Level 3 fair value
measurement can require significant judgements and
estimates (see IFRS 13).
The acquirees identifiable intangible assets at the
acquisition date are recognised separately and might
include assets that have not been recognised by the
acquiree.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


International Financial Reporting Standards

IFRS 10
Consolidated Financial
Statements

[[[
The views expressed in this presentation are those of the
presenter,
not necessarily those of the IASB or IFRS Foundation
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Effective Date 35

Aligned effective date for IFRS 10 and IFRS 12


Annual periods beginning on or after 1 January
2013
Earlier application permitted if applied as a
package

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Introduction 36

IFRS 10 establishes principles for the presentation and


preparation of consolidated financial statements when
an entity controls one or more other entities.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Who presents consolidated
financial statements? 37

An entity that has one or more subsidiaries (a parent)


must present consolidated financial statements.
Two exceptions:
a parent if:
its owners have been informed and do not object,
its securities are not publicly traded or in the process of
becoming publicly traded, and
its parent publishes IFRS-compliant financial statements
that are available to the public.
Post-employment plans or other long-term employee
benefit plans to which IAS 19 applies

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Principle 38

Consolidated financial statements present the parent


and all its subsidiaries as financial statements of a
single economic entity
uniform accounting policies
same reporting periods
eliminate intragroup transactions and balances
non-controlling interest (the equity in a subsidiary that is
not attributable, directly or indirectly, to the parent) is
presented within equity, separately from the parent
shareholders equity.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Consolidation procedures 39

On 1/1/20X1 entity A acquires 100% of entity B for


CU1,000 when Bs share capital & reserves = CU700 (net
FV of Bs assets & liabilities = CU800).
B has no contingent liabilities. The CU100 difference
between CA & FV is i.r.o. a machine with 5 yrs remaining
useful life and nil residual value.
Bs profit for the year ended 31/12/20X1 = CU400.
In 20X1 A sold inventory which cost it 100 to B for 150. At
31/12/20X1 Bs inventory included CU60 inventory bought
from A.
Ignore taxation effects.
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Example:
Consolidation procedures continued 40

The proforma journal entry at acquisition to eliminate


As investment in B; recognise goodwill; & eliminate Bs
share capital & reserves accumulated before it became
part of the group.
Property, plant & equipment 100
Bs at-acquisition share capital &
700
reserves
Goodwill (asset) 200
As investment in B 1,000

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Consolidation procedures continued 41

Proforma journal entry to increase depreciation to


group values (remaining estimated useful life = 5
years):

Profit or loss 20
Property, plant & equipment 20

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
Consolidation procedures continued 42

Proforma journal entry to eliminate intragroup sale of


inventory and the unrealise profit in inventories
(ignoring tax effects):
Profit or loss (revenue) 150
Profit or loss (COS) 150
Profit or loss (COS) 20
Inventory (asset) 20

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Non-controlling interest (NCI) 43

Non-controlling interest (NCI) in net assets consists of:


the amount of the NCI recognised in accounting for
Bus Com at date of acquisition; plus
the NCIs share of recognised changes in equity (ie
recognised changes in Subs net assets) since the
date of the combination.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
NCI 44

On 1/1/20X1 entity A acquires 75% of entity B for


CU1,000 when Bs share capital & reserves = CU700
(net FV of Bs assets & liabilities = CU800).
B has no contingent liabilities. The CU100 difference
between CA & FV is i.r.o. a machine with 5 yrs
remaining useful life and nil residual value.
Ignore taxation effects. Bs profit for the year ended
31/12/20X1 = CU400.
In 20X1 A sold inventory which cost it 100 to B for 150.
At 31/12/20X1 Bs inventory included CU60 inventory
bought from A.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
NCI continued 45

Eliminate Investment
Proforma journal entry at acquisition is:

Property, plant & equip. 100


Bs at-acquisition share capital & 700
reserves

Goodwill 400
Non-controlling interest 200
As investment in B 1,000

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
NCI continued 46

Adjust consolidated depreciation


Proforma journal entry to increase depreciation to
group values (remaining estimated useful life = 5
years):

Profit or loss 20
Property, plant & equipment 20

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
NCI continued 47

Allocate profit
Proforma journal entry allocating the NCI their share of
Bs profit for the year:

NCI profit allocation 95


NCI (equity) 95

Calculation:
Profit 400
Depreciation adjust (20)
380
25% attributable to NCI 95
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Example:
NCI continued 48

Proforma journal entry to eliminate downstream


intragroup sale of inventory and the unrealised profit in
inventories (ignoring tax effects):

Profit or loss (revenue) 150


Profit or loss (COS) 150
Profit or loss (COS) 20
Inventory (asset) 20

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Example:
NCI upstream sale 49

Same as previous example except upstream sale of


inventory (ie from B to A)
Same proforma journal entries as in previous example
and an additional journal entry (below) to eliminate
from NCI their share of the unrealised profit:
NCI (equity) 5
NCI profit allocation 5

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Loss of control 50

If a parent no longer controls a subsidiary, the parent:


Derecognises the assets and liabilities of the
former subsidiary.
Recognises any retained investment at fair value
when control is lost. This investment is
subsequently accounted for as a financial
instrument or, if appropriate as an associate or joint
venture.
Recognises a gain or loss associated with loss of
control.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Comparison with the IFRS for
SMEs 51

Section 19 Business Combinations and Goodwill of


the IFRS for SMEs differs from full IFRSsin Section
19:
goodwill is amortised over its estimated useful life
(or 10 years if a reliable estimate cannot be
made)
non-controlling interest must be measured using
the proportionate share method
there is no specified maximum allowable
difference between the reporting periods of the
parent and the subsidiary.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


International Financial Reporting Standards

IFRS 12
Disclosure of Interests in
Other Entities

[[[
The views expressed in this presentation are those of the
presenter,
not necessarily those of the IASB or IFRS Foundation
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Introduction 53

IFRS 12 applies to entities that have an interest in a


subsidiary, a joint arrangement, an associate or an
unconsolidated structured entity.
It does not apply to (paragraph 6):
Post-employment plans to which IAS 19 applies.
Entities separate financial statements to which IAS 27
applies.
A joint arrangement where joint control does not exist
(unless significant influence exists).
An interest in another entity accounted for in terms of
IFRS 9 (with exceptions).

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Reasons for issuing IFRS 12 54

Users have consistently requested improvements to the


disclosure of a reporting entitys interests in other
entities.
The global financial crisis also highlighted a lack of
transparency about the risks to which a reporting entity
was exposed from its involvement with structured
entities.
In response to input received from users and others, the
IASB decided to address in IFRS 12 the need for
improved disclosure of a reporting entitys interests in
other entities.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Objective 55

IFRS 12 requires an entity to disclose information that


enables users of financial statements to evaluate:
the nature of, and risks associated with, its interests
in other entities; and
the effects of those interests on its financial
position, financial performance and cash flows.
That evaluation assists users in making decisions about
providing resources to the entity.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Disclosures 56

significant judgements and assumptions made


information about interests in:
subsidiaries
joint arrangements and associates
unconsolidated structured entities
any additional information that is necessary to meet the
disclosure objective

Strike a balance between overburdening financial


statements with excessive detail and obscuring information
as a result of too much aggregation

56
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Subsidiaries 57

The composition of the group (including any


changes)
Involvement of NCI in the groups activities (including
profit and loss allocation and summarised financial
information for subsidiaries with large NCI)
The effect of significant or unusual restrictions on
assets and liabilities
The nature of, and changes in, the risks associated
with structured entities

57
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Unconsolidated structured entities 58

Nature and extent of interests in unconsolidated structured


entities
eg nature, purpose, size, activities and financing
For sponsors not providing other risk disclosures
Type of income earned
The carrying amount of all assets transferred
Nature of, and changes in, the risks associated with an
entitys interests
Carrying amount of the assets and liabilities recognised
Maximum exposure to loss and comparison to carrying
amounts
Non-contractual support provided

58
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Judgements and estimates 59

An entity must disclose information about significant


judgements and assumptions it has made in
determining:
control of another entity (see IFRS 10)
Joint control (see IFRS 11) of an arrangement or
significant influence (see IAS 28) over an entity
type of joint arrangement when the arrangement has
been structured through a separate vehicle

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Judgements and estimates continued 60

For unconsolidated structured entities, a summary of


the amount that best represents the entitys maximum
exposure to loss for its interest must be provided.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


Questions or comments? 61

Expressions of individual views


by members of the IASB and its
staff are encouraged.

The views expressed in this


presentation are those of the
presenter.

Official positions of the IASB on


accounting matters are
determined only after extensive
due process and deliberation.

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


62

The requirements are set out in International Financial


Reporting Standards (IFRSs), as issued by the IASB at
1 January 2012 with an effective date after 1 January
2012 but not the IFRSs they will replace.
The IFRS Foundation, the authors, the presenters and
the publishers do not accept responsibility for loss
caused to any person who acts or refrains from acting
in reliance on the material in this PowerPoint
presentation, whether such loss is caused by
negligence or otherwise.

2011
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IFRS Foundation Street
| 30 | London
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Street 6XH | UK.
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