Our 'IFRS Viewpoint' series provides insights from our global IFRS team on applying IFRSs in challenging situations. Each issue will focus on an area where the Standards have proved difficult to apply or lack guidance. This issue considers how to account for a common control business combination.
What's the issue?
How should an entity account for a business combination involving entities under common control? This is an important issue because common control combinations occur frequently but are excluded from the scope of IFRS 3 - the IASB's standard on business combination accounting.
This IFRS Viewpoint gives you our views on how to account for common control combinations.
Most business combinations are governed by IFRS 3. However, those involving entities under common control are outside the scope of this Standard. There is no other specific guidance on this topic elsewhere in IFRS. Management therefore needs to use judgement to develop an accounting policy that provides relevant and reliable information in accordance with IAS 8.
In our view, the most suitable accounting policies are to apply:
- a predecessor value method; or
- the acquisition method in accordance with IFRS 3.
Whichever accounting policy is chosen, it should be applied consistently to similar transactions. The accounting policy should also be disclosed if material.
A predecessor value method
A predecessor value method involves accounting for the assets and liabilities of the acquired business using existing carrying values. The detailed application sometimes differs but the general features of this approach are that:
- the acquired assets and liabilities are recorded at their existing carrying values rather than at fair value
- no goodwill is recorded
- comparative periods are sometimes restated as if the combination had taken place at the beginning of the earliest comparative period presented. Note, alternative methods are seen in practice – see 'more analysis' section in the attached pdf.
Terms such as the 'pooling of interests', 'merger accounting' and 'carryover basis' are used in some jurisdictions to describe specific applications of a predecessor value method. When such methods are prescribed in local GAAP they might be referred to in accordance with IAS 8's principles for developing accounting policies.
Acquisition method in accordance with IFRS 3
Although common control combinations are outside the scope of IFRS 3, in our view IFRS 3's principles can be applied by analogy. In that case we believe that IFRS 3's principles should be applied in full. This includes identifying the correct 'accounting acquirer', which is not always the legal acquirer. As a general indication, if one of the pre-combination entities has significantly greater net assets or revenues than the other, the larger entity is probably the accounting acquirer. This is discussed in more detail under the 'Who is the acquirer?' section within the attached pdf.
When the accounting acquirer is not the legal acquirer, the principles of reverse acquisition accounting should be applied. IFRS 3 provides guidance on accounting for reverse acquisitions (IFRS 3.B19-B27). When the legal acquirer is a new (or 'shell') entity or a near-dormant entity, and the other combining entity is the accounting acquirer, the effect of reverse acquisition accounting is very similar to a predecessor value method.
Review the attached pdf for more analysis and some application examples.