common control transactions or business combinations under common control

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Common Control Transactions or Business

Combinations under Common Control

Note:

I have used this writing as a personal learning process and present this primarily based on my

readings on the documents published by, IASB, IFRIC, IASB Board Meeting, IASB Staff Paper

and presentation slides, as follows:

Presentation Slides of Business Combinations under Common Control. Gary Kabureck

(IASB Member) and Yulia Feygina (IASB Senior Technical Manager). IFRS Conference

at Paris (Perancis) on 29 and 30 June 2015.

IASB Staff Paper (Agenda Paper 5C). SAC Meeting: June 2007, London. Project: IASB

Work Programme Common Control Transactions.

IASB Board Meeting: 12 December 2007. Project : Common Control Transactions.

Agenda Paper 5C.

IASB Staff Paper (IASB Agenda Ref 14). September 2013. Project: Business

Combinations under Common Control.

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IASB Staff Paper (ASAF Agenda ref 2A). June 2014. Project: Business Combinations

under Common Control.

IFRIC Update (September 2011). One of the agenda topics: IFRS 3 Business

Combinations—Business Combinations Involving Newly Formed Entities: Business

Combinations under Common Control.

IFRS 3 Business Combinations, which was amended in May 2010 by Improvements to

IFRSs, and other IFRSs have made minor consequential amendments to IFRS 3 since

2010.

IFRIC Update (March 2006). “Transitory” Common Control.

Exposure Draft ED/2015/3 (May 2015). Conceptual Framework for Financial Reporting.

For those readers that are interested to do further research on this topic, could gather materials

such as the ones published by big accounting firms (such as PWC, KPMG, E&Y and Deloitte),

EFRAG (European Financial Reporting Advisory Group), KASB (Korean Accounting Standards

Board), and even US GAAP (though the guidance is still limited).

In certain parts of this writing, I have just copied and pasted from original documents, and make

necessary changes and give comment here and there as per my understanding.

I have no general or specific preference for any method to be used to account for common

control transactions over another method.

Scope of Discussions

The common control transactions are limited to the accounting for combinations between

entities or businesses under common control in the acquirer’s consolidated financial

statements.

Not in the scope of discussions:

The acquirer’s separate financial statements.

The acquiree’s consolidated and separate financial statements.


PART I: Introduction

During IFRS Conference at Paris on 29-30 June 2015, one of the break-out sessions being

presented is Business Combinations under Common Control by International Accounting

Standards Board (IASB) members. This topic is always interesting to me since I know that IASB

has included an agenda to review the definition of “transactions among enterprises under

common control” as part of the first phase of the Business Combinations project.

Agenda Paper 5C of IASB Staff Paper in June 2007 had added to its agenda a project on

business combinations between entities or businesses under common control, and common

control transactions more generally. In 2009, the global financial crisis has changed IASB’s

priorities in a significant way that made the project on business combinations under common

control was put on hold. It is not until September 2013, we see another IASB Staff Paper came

up under IASB Agenda Ref 14 with the same subject.

Though IFRS 3 Business Combinations have got revised a couple of times since it was first

published in March 2004, yet, presently, business combinations under common control are [still]

excluded from the scope of the IFRS 3. It means that both IAS and IFRS do not give any

guidance about the accounting for a [business] combination between entities or businesses

under common control.

Though IASB Staff Paper keeps using “Business Combinations under Common Control” as the

title of its project, yet under Staff Paper ASAF Agenda ref 2A (June 2014), IASB differentiates

two types :

a) Common control transactions that are not business combinations; or a group

restructuring that do not involve a business combination.

b) Common control transactions that are business combinations, or the other way around,

business combinations under common control.

Those transactions arise often in the context of group restructurings or reorganizations. The

party having common control might want to restructure its group for legal, tax or economic or

commercial reasons. For example, a group restructuring might be undertaken to achieve a

change in the tax base of a subsidiary, to enable the distribution of dividends, because of

regulatory requirements or in preparation for a sale.

Why then common control transactions is different from those non-common control

transactions? It could be arguably said that:


1) they might be directed transactions rather than arm’s-length exchanges and therefore

the transaction price might not be representative of the fair value of the transferred

business (or as assessed by the financial community or market participants); and

2) The economical or business purpose of such transactions could be different from the

purpose of business combinations that are not under common control.

Therefore, it is important to understand the underlying economic reasons, including the review

of the business relationships of all related or affiliated entities that are part of the group

[business] restructurings before and after the restructuring, in order to be able to understand

whether and why a group restructurings make sense economically (such as from expected profit

potential, exploiting business opportunities, shared risks, corporate strategy, or aimed at Initial

Public Offering (IPO) in near future) for a group of entities.

However, later in the IFRS Staff Paper with the project on Business Combinations under

Common Control, the term “common control transactions” is introduced in a broad sense, since

it could cover as follows:

(a) transactions under common control that are not business combinations; and

(b) business combinations under common control

Or could we say that:

all related party transactions are under common control transactions? Or the other way

round, that all common control transactions are related party transactions? In

accordance with paragraph 9 of IAS 24 Related Party Disclosures, the parent, the

acquirer and the acquire in a combination between entities or businesses under common

control are related parties, and a related party transaction is meant to be “a transfer of

resources, services or obligations between a reporting entity and a related party,

regardless of whether a price is charged.”

How about transactions between related party that are not part of the same group? Are

they common control transactions?


How about transactions between entities that have different shareholders, but share the

same key management personnel1? Are they common control transactions?

Or even broader, there is a transfer pricing issue behind common control transactions?

In general, all transfers either between related parties or not, could be done at:

At historical cost (or predecessor-carrying value)

At fair value

At transaction value (exchange value, actual consideration paid or transferred between

entities) that is not the same with the fair value?

We could say transactions under common control that are business combinations are a change-

in-control-in-business event, following the way the business combinations are defined in IFRS 3.

Yet, not all common control transactions are involving the change-in-control-in-business event.

Before we see further about those TWO types of common control transactions above, I would

like to see first what IFRS 3 Business Combinations meant with a “Business Combinations

between (Entities or) Businesses under Common Control”?

Appendix B, Application Guidance of IFRS 3 gives two criteria about WHEN a business

combination is considered as common control transaction or event.

[paragraph B1] ……A business combination involving entities or businesses under common

control is

(1) a business combination in which ALL OF the combining entities or businesses are

ULTIMATELY CONTROLLED by the SAME PARTY OR PARTIES both BEFORE and

AFTER the business combination, AND

(2) that control is NOT TRANSITORY.

The following pictorial representations of the business combination transaction or event that is

not under common control (Illustrative 1) and the one under common control (Illustrative 2):

1 Paragraph 9 of IAS 24 Related Party Disclosures defines key management personnel as “those persons

having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity”.


Illustrative 1:

Illustrative 2:

So IFRS 3 gave us guidance on determining WHEN (entities or businesses) combinations are

considered to be under common control. Upon reading quickly the above, the key word is that

control remains within the original group before and after the business combinations within the

group. This key word is re-emphasized in paragraph B4 of Appendix B, Application Guidance of

IFRS 3, that the extent of non-controlling interest and one of the combining entities is a

subsidiary that has been excluded from the consolidated financial statements are not relevant

points at all to consider. The latter point is that, whether the combining entities coming from the

same group are not relevant to consider, as long as, those combining entities have the same

ultimate controlling entity or even individual. For example, entities would be under common


control if they were wholly owned by an individual shareholder who was not required to prepare

financial statements.

[paragraph B4] (i) The extent of non-controlling interests in each of the combining entities before

and after the business combinations is not relevant to determining whether the combination

involves entities under common control. (ii) Similarly, the fact that one of the combining entities

is a subsidiary that has been excluded from the consolidated financial statements is not relevant

to determining whether a combination involves entities under common control.

There are a couple of stuffs to be clarified:

First question: What is meant with a “Business Combination” event or transaction?

Second question: What is meant with “…ultimately controlled by the SAME PARTY OR

PARTIES… both BEFORE and AFTER the business combination”?

Third question: What is meant with “…that control is not transitory”?

The answer to the first question could be found at paragraphs of B5 to B6 of Appendix A,

Application Guide of IFRS 3, which under the subject of “Identifying a Business Combination”.

[paragraph B5]

The IFRS defines a business combination as a transaction or other event in which an acquirer

obtains control of one or more businesses. An acquirer might obtain control of an acquire in a

variety of ways, for example:

(a) by transferring cash, cash equivalents or other assets (including net assets that

constitute a business);

(b) by incurring liabilities;

(c) by issuing equity interests;

(d) by providing more than one type of consideration; or

(e) without transferring consideration, including by contract alone (see paragraph 43 [of

IFRS 3]).

[paragraph B6]

A business combination may be structured in a variety of ways for legal, taxation or other

reasons, which include but are not limited to:

(a) one or more businesses become subsidiaries of an acquirer or the net assets of one or

more businesses are legally merged into the acquirer;


(b) one combining entity transfers its net assets, or its owners transfer their equity interests,

to another combining entity or its owners;

(c) all of the combining entities transfer their net assets, or the owners of those entities

transfer their equity interests, to a newly formed entity (sometimes referred to as a roll-

up or put-together transaction); or

(d) a group of former owners of one of the combining entities obtains control of the

combined entity.

From the above description of the business combinations, it is obvious that to be considered as

a business combination transaction or event, the transaction or event should involve at least:

“a business” or “businesses” of the acquire; and

there should be “an acquirer”, that is the entity that obtains control of the acquire;

and it is the “control” of the business or businesses that is the main subject of the

changes in this business combination.

IFRS 3 gave further sufficient guidance to clear up about what it is meant with:

“a business” (see paragraphs B7 to B12 of IFRS 3) and

“identifying an acquirer” (see paragraphs B13 to B18 of IFRS 3), and

control is discussed at length at IFRS 10 Consolidated Financial Statements (Note:

Even though the definition of common control is linked directly to “control”, I do not think

that we could presume that “common control” as mentioned in IFRS 3 having the same

underlying notion as “control” is defined under IFRS 10. When “control” notion is

developed under IFRS 10, “common control” might not be there yet to be considered to

be part of “control”).

However, I noted that there is an inconsistency of the way “business combination” definition as

expressed in the Appendix A, Defined Terms of IFRS 3, that is:

Business combination: a transaction or other event in which an acquirer obtains control of one

or more businesses. Transactions sometimes referred to as “true mergers” or “mergers of

equals” are also business combinations as that term is used in this IFRS.

If we observe above, then there is no mention at all about “entity” or “entities”, so business

combinations are purely about combining “business or businesses” as defined in the Appendix

A, Defined Terms of IFRS 3, and business is explicitly defined as:


Business: An integrated set of activities and assets that is capable of being conducted and

managed for the purpose of providing a return in the form of dividends, lower costs or other

economic benefits directly to investors or other owners, members or participants.

So it is apparent that IFRS 3 prescribes the accounting for a business combination only and

only for combination involving “business” or “businesses” and NOT “entity” or “entities”, unless if

that “entity” or “entities” is or are a “house” for “business” or “businesses”. In other words, the

activities of that entity/entities are indeed meet the definition of business in accordance with

IFRS 3 (see paragraph of B7 to B12 of IFRS 3, Appendix B). So this is to make sure that that

entity/entities is more than just a collection of assets or a combination of assets or liabilities. We

could see here that the accounting for a business combination under IFRS 3 is different from the

accounting for an acquisition of a group of assets (and liabilities), or indeed for a single asset

under the applicable IFRSs (see paragraph 2(b) of IFRS 3).

I would like to emphasize 2 (two) things before we move on:

First, what IFRS 3 said for a business combination to exist, there should be an acquisition of

“control” over the business or businesses of the acquire.

So what is acquired in this business combination? It is the “control”, and not just “an interest in

another entity”, the latter of which could include “control”, “joint control” and “significant

influence” and any other involvement either contractually or non-contractually with another

entity.

Appendix A, Defined Terms of IFRS 10 Consolidated Financial Statements, said that:

Control of an investee: 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.

While, Appendix A, Defined Terms of IFRS 12 Disclosure of Interests in Other Entities, defined:

Interest in Another Entity: For the purpose of this IFRS, an interest in another entity refers to

contractual and non-contractual involvement that exposes an entity to variability of returns from

the performance of the other entity. An interest in another entity can be evidenced by, but is not

limited to, the holding of equity or debt instruments as well as other forms of involvement such

as the provision of funding, liquidity support, credit enhancement and guarantees. It includes the

means by which an entity has control or joint control of, or significant influence over, another


entity. An entity does not necessarily have an interest in another entity solely because of a

typical customer supplier relationship.

Yet, it is worthwhile to note down that up to now, there is no definition about “entity” found in

current IASs or IFRSs

The answer to the second and third question above, that is the one related to that words

“before” and “after”, is not easy as well, since the words ‘before and after’ do not give any

indication of how long that time period would be and the meaning of ‘transitory’ is not explained,

resulting in confusion as to whether common control only has to exist immediately before and

after the transaction or if it must exist for a longer period of time.

Looking at all definitions about business combination as per IFRS 3, we could say that, unlike

the limitation imposed on the business combinations not under common control transaction or

event that the combining transaction or event should be between “business” or “businesses”,

then business combinations under common control, could involve:

combining “business” or “businesses”; or

combining “entity” or “entities”, regardless whether that “entity” or “entities” meets or not

the business definition, or just a group of assets and/or liabilities.

I agree with the way that common control transactions or events do not necessarily involve the

strict requirement for the presence of “business”, because determining whether the transferred

group of assets constitutes a business is generally difficult. There could be unidentifiable

elements in the transferred group, in general, we could say, by including “entities” and not just

“businesses” probably the better approach to deal with common control transactions.

Second, business combinations under common control as excluded from the scope of IFRS 3,

requires that ALL OF the combining entities or businesses are ULTIMATELY CONTROLLED by

the SAME PARTY OR PARTIES both BEFORE and AFTER the business combination, and that

control is not transitory.

The emphasis of “Before” and “After” the business combination and its interaction with that

control is not transitory, is not always quite clear or easy to put into the practice, especially in

the case involving a newly formed entity in the business reorganization.


PART II: Accounting Issues for Business Combinations under Common Control

In the IFRS Staff Paper under Agenda Paper 5C (June 2007), there is a discussion over the

accounting issues related to business combinations under common control.

As a prelude, IASB answered the question about “what is meant a combination between entities

under common control?” which we found the same point as expressed in IFRS 3.

A combination is between entities or businesses under common control when the controlling

party before and after a business combination is the same. A common example is the case of a

group restructuring. These restructurings might be carried out for a number of reasons, for

example tax efficiencies, regulatory requirements, release of distributable reserves from

‘dividend traps’ or in preparation of a spin-off.

[Note: it seems to me that IFRS Staff Paper mixed up between “business combinations” and

“group restructuring, which might or might not be business combinations”. Again, this is about

whether that group restructuring involves the “business” in that combining entities.]

For example, assume that entity A owns 100% of the voting interest of entities B and C. Entity C

owns 100% of the voting interest in entity D. Entity B acquires all voting interests in entity D from

entity C. All entities meet the definition of a business.

This transaction is a common control transaction because entities B, C and D are under the

control of entity A before and after the transaction. This type of restructuring might be used in

preparation, for example, for the sale by initial public offering of entity B and its subsidiaries

(including entity D), commonly referred to as a spin-off transaction.

The above transaction is not difficult to understand as part of a common control transaction –

but not necessarily as part of business combination, if that Entity B, Entity C and Entity D are


not housing “business” in their activities - as we could see straightforward that Entity A remains

in control BEFORE AND AFTER the acquisition of Entity D by Entity B from Entity C, and its

100% equity ownership in the group structure.

The issue is WHAT THAT DOES NOT CHANGE BEFORE AND AFTER THE TRANSACTION?

We could have more than one interpretation, which one is correct?

Entity A’s financial position remains unchanged before and after the transaction. If Entity

A prepares consolidated financial statements, they should not be affected by a

combination between entities or businesses under common control.

The relative [substantive] rights of the ultimate shareholders that do not alter before and

after the combination between entities or businesses under common control. However,

how about if there is a change in the relative [substantive, and not just protective] rights

of non-controlling interests in the group, before and after the transaction?

Can we say, that should the existence of non-controlling interest affect the accounting

for common control transactions? Where there is a significant non-controlling interest or

other investors, accounting for the transactions between entities under common control

at fair value would be an appropriate accounting choice?

Or, a common control transaction is indeed the acquisition of all or a part of the non-

controlling equity interest, for example, in a subsidiary?

This type of restructuring might be used in preparation, for example, for the sale by initial public

offering of Entity B and its subsidiaries (including entity D), commonly referred to as a spin-off

transaction. We could see this is done to increase the [net] assets size of Entity B and its

subsidiaries. Yet, upon looking at the group overall, we could see that this might be just

“transferring from left pocket to right pocket”. There might be no consideration involved at all,

and the [only] consequence to the group’s cash flows, might be that the group might pay the tax

incurred on asset transfer.

The above transaction under common control might be followed by the subsequent legal merger

between entities B and D (that is, in order to simplify entity A’s group structure or to achieve a

change in the tax base of entity D’s assets and liabilities).


If we focus on Entity A’s [consolidated] financial statements, yes….we could say, there is

nothing changed there. With its 100% equity ownership in the structure, Entity A could be said

just moving the money from “left pocket” to “right pocket”.

Yet, the example above necessitates us to identify “who is the ultimate controlling party or

parties?” (single or many). IFRS 3 explicitly stated that controlling is as “party” or “parties” and

not “entity” or “entities”, brings us to a note that the party having common control is not

necessarily a legal [affiliated in some other manner] entity or even prepares its own set of

consolidated financial statements. If an individual restructures his/her corporate investments,

the guidance on combinations between entities or businesses under common control would

apply. Thus, if, in the illustration above, Entity A could be changed with an “individual, person”

(let’s name it the same, Person A), the acquisition of Entity D by Entity B or the subsequent

legal merger between Entities B and D would also be a combination between entities under

common control.

If there are more than one individual or entity involved, then according to paragraphs B2 and B3

of Appendix B, Application Guidance of IFRS 3, all those individuals (or family members or

immediate family members or close members of a person as defined under paragraph 9 of IAS

24 Related Party Disclosures2) or entities are bound by a contractual arrangement that they

must act together to direct the activities (of the business) that significantly affect the returns of

the arrangement (that is the relevant activities of that business). This is not quite different from

sharing “joint control” among all those individuals or entities, as per IFRS 11 Joint

Arrangements.

[paragraph B2] A group of individuals shall be regarded as controlling an entity when, as a result

of contractual arrangements, they collectively have the power to govern its financial and

operating policies so as to obtain benefits from its activities. Therefore, a business combination

is outside the scope of this IFRS when the same group of individuals has, as a result of

contractual arrangements, ultimate collective power to govern the financial and operating

policies of each of the combining entities so as to obtain benefits from their activities, and that

ultimate collective power is not transitory.

2 According to paragraph 9 of IAS 24 Related Party Disclosures, close members of the family of a person

are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity and include:

(a) that person’s children and spouse or domestic partner; (b) children of that person’s spouse or domestic partner; and (c) dependents of that person or that person’s spouse or domestic partner.


[paragraph B3] An entity may be controlled by an individual or by a group of individuals acting

together under a contractual arrangement, and that individual or group of individuals may not be

subject to the financial reporting requirements of IFRSs. Therefore, it is not necessary for

combining entities to be included as part of the same consolidated financial statements for a

business combination to be regarded as one involving entities under common control.

In other words, a group of individuals (for example, family members) would only be regarded as

having common control over Entities B, C and D when, as a result of [enforceable] contractual

arrangements, the group of individuals has collectively the power to govern the financial and

operating policies of those entities so as to obtain benefits from their activities. So, it is the

existence of the contractual arrangement that establishes “[shared, joint] common control” over

the group. Yet, in practice, this is not always easy, for example, in the family members, the head

of the family members might have more power than the rest (usually the younger ones, or

younger generation), or the contractual arrangement could only be an unwritten or informal (not

in a separate written form) arrangement among family members. Just they act collectively or in

concert in certain circumstances for making decisions, we cannot draw a firm conclusion, that

will always be that way in other circumstances, or should we presume that immediate family

members will vote their shares in concert absent evidence to the contrary?

The “contractual arrangements” term is also used in IFRS 11 Joint Arrangements, and

according to IFRS 11, Appendix B paragraph B2, the contractual arrangement or agreement

between two or more parties within the arrangements does not have to be in writing. Can we

include then the minutes of meetings and documentation of discussions also is evidence of an

[enforceable] contractual arrangement? How about articles of associations, charters or by-laws?

In practice, probably, most of those documents contain only general terms and conditions of the

arrangement without specifically touching how is control to be exercised over the group, or who

is going to take the decision on major issues over the group restructuring, capital restructuring,

group reorganization, group reconstruction, etc.

The way that the business combination under common control is defined in IFRS 3 that the

focus on the “same ultimate controlling party or parties”, this adds the complexity on the way we

see the appropriate method to use to account for the common control transactions. Now we

have (3) three levels of focus:

First: from the perspective of the party (or parties) that ultimately exercises control the

business combinations under common control. If yes, how do we know that the ultimate


controlling party involves itself into “directing” the transactions within the group? In most

of the cases, that involvement might not be evident in the written documents that could

be read and confirmed. Can we just simply conclude that all common control

transactions, all transactions (group restructuring, group reconstruction, capital

restructuring, group reorganization, transfers within the group, borrowing consolidation,

etc.) are ALL UNDER THE DIRECTION and GUIDANCE (note: approval?) of that

ultimate controlling party or parties? Just because all transactions take place within the

same group and the aim of the transactions are not against the ultimate controlling

party’s or parties’ best interests, it does not automatically lead to the conclusion that

such transactions will require a different accounting method other than the Acquisition

Method for business combination between entities NOT under common control.

Second: Or we just focus it from the perspective of the acquirer, instead of ultimate

controlling party or parties in the group? This case could be simple when the party that

has common control is also the acquirer in the combination between entities under

common control.

Third: Or some kind of mix between from the perspective of the acquirer and the acquire

at the same time, meaning that the business combinations under common control

creates the whole assessment of the assets and liabilities of the acquirer and the

acquire, that is now to be reported under the same consolidated financial statements.

Which level of focus from the aforementioned three might depend on which entity or entities (the

acquirer or the entire group) as the reporting entity. The ability to include entities within a set of

IFRS financial statements depends on the interpretation of “Reporting Entity” in the context of

common control.

It seems that paragraphs 3.11 to 3.15 of the Exposure Draft ED/2015/3 Conceptual Framework

for Financial Reporting” seem that they do not give much guidance to decide with reporting

entity that should be used in the circumstances of business combinations under common control

or common control transactions in general.

[paragraph 3.11] A reporting entity is an entity that chooses, or is required, to prepare general

purpose financial statements.

[paragraph 3.12] A reporting entity is not necessarily a legal entity. It can comprise a portion of

an entity, or two or more entities.


[paragraph 3.13] Financial statements provide information about the assets, liabilities, equity,

income and expenses generated by the set of economic activities that lie within the boundary of

the reporting entity.

[paragraph 3.14] When one entity (the parent) has control over another entity (the subsidiary), it

would be possible to determine the boundary of the reporting entity using either:

(a) direct control only (see paragraphs 3.19–3.20); or

(b) both direct and indirect control (see paragraphs 3.21–3.25).

[paragraph 3.15] In this [draft]Conceptual Framework:

(a) financial statements of a reporting entity whose boundary is based on direct control

only are called unconsolidated financial statements; and

(b) financial statements of a reporting entity whose boundary is based on both direct and

indirect control are called consolidated financial statements

However, in reality, defining “controlling party” is not that easy.

If that one singles ultimate parent entity, or a holding entity, probably the conclusion could be

drawn, yet how about control is exercised by group of individuals or family members? How to

say that there is a contractual arrangement among all those individuals? That individuals might

act together in certain decision-makings but not all the time. Yet, I guess, the key is that all

those individuals, in most of the time, act together in [protecting, and not against] the best

interests of them. [Immediate, or close] Family members might be said to have such inclination.


PART III: De-Merging (instead of Merger) Transactions under Common Control or Not

IASB Staff Paper (ASAF Agenda ref 2A) in June 2014 gave 3 (three) examples that involve

“demerging” a controlled business into a newly formed separate legal entity, however,

depending on who controls that newly formed entity.

Example 1 represents a transaction under common control but is NOT a business combination

under common control. This because there are NO combining entities (housing the business) or

businesses. Instead, the immediate parent continues to control the demerged business.

There are at least 2 (two) questions that we could raise about accounting for the “demerger” of

Entity S to Entity S and Entity S1:

In Example 1, in which a business (division) of Entity S is demerged to be separate from

Entity S, let’s say Entity S1, yet both Entity S and Entity S remains under control of the

same Immediate Parent, that is Entity IP. Is it then appropriate to adjust the carrying

values of assets and liabilities comprising the demerged business, which is (now) Entity

S1, to their current values at the demerger date, in the Entity IP’s consolidated financial

statements?

Let’s say, the demerger above in Example 1, was done at the “transaction” price, rather

than at the “fair value” (note : transaction price is not always the same with the fair value

as per IFRS 13 Fair Value Measurement), and this includes the transfer of assets

transferred from Entity S, to now Entity S1. IFRS 3 through the acquisition method


requires the acquirer to measure the identifiable assets acquired and the liabilities

assumed at their acquisition-date fair value. If so, then how should that difference

between the acquisition-date fair value and the transaction price is accounted for?

Will the difference be treated similar to non-recognition of goodwill or gain from a bargain

purchase, a practice generally found for accounting for business combinations or group

restructuring under common control, in which the difference between the consideration

and the net assets will be recognized in equity?

For example, one could raise a question over whether all transactions under common

control—or even all transactions between related parties—should be accounted for at

the predecessor value rather than the transaction price, if it is different.

Example 2 represents a business combination under common control where the combining

entities (housing the business), or businesses, are Entity S1 and Entity A, which are both

controlled by Entity P before and after the transaction. If Entity S1 were not a business but

rather a group of assets, that transaction would fall into the same category as Example 1 rather

than Example 2—that is transactions under common control that are not business combinations.


Within this scope, there is one issue raised to IFRIC regarding the accounting for group

restructurings contingent on a successful IPO in which the original parent loses control

(September 2011 IFRIC Update)3

Here is the challenge, that we have the acquirer, Entity A, and the acquire, the business

demerged from Entity S, which now is housed under [legal] Entity S1.

From the acquiring entity or acquirer’s perspective: how to account for this

acquisition, which ultimately controlled by Entity P, or from the perspective of the overall

group, there is no much change? Should (i) the Acquisition Method, (ii) the Predecessor

Method or (iii) a different accounting method should be applied to some or all of those

transactions.

From the acquired entity or acquiree’s perspective: whether the carrying values of

that entity’s assets and liabilities should be adjusted to their current values in the

acquired entity’s financial statements as a result of the transaction (i.e. the application of

the so called “push-down accounting” in a business combination under common control).

IFRS 3 only addresses the application of the Acquisition Method of accounting for business

combinations (NOT under common control) from the acquiring entity’s perspective. Current

IFRSs do not permit or require adjusting the carrying values of the acquired entity’s assets and

liabilities in the acquired entity or acquiree’s financial statements as a result of a business

combination.

The application of the Acquisition Method for this type of common control transaction could raise

an opportunity to “inflate” the assets for the group, regardless there is a commercial or no

commercial reason to do so. Just by moving or transferring the business division from one entity

and house it into newly formed legal entity, yet under the same group, in Example 2, assets and

liabilities of Entity S1 would be reflected in the financial statements of Entity A at their current

values or acquisition-date fair value (as you could guess, it could be higher in most of cases,

meaning at inflated value). This could be interesting since if the group subsequently disposes of

3 The Interpretations Committee received a request for guidance on accounting for common control

transactions. More specifically, the submission describes a fact pattern that illustrates a type of common control transaction in which the parent company (Entity A), which is wholly owned by Shareholder A, transfers a business (Business A) to a new entity (referred to as ‘Newco’) also wholly owned by Shareholder A. The submission requests clarification on (a) the accounting at the time of the transfer of the business to Newco; and (b) whether an initial public offering (IPO) of Newco, which might occur after the transfer of Business A to Newco, is considered to be relevant in analyzing the transaction under IFRS 3.


the combined entity (A+S1), for example in an IPO, the new shareholders would get a higher

net assets base. It is common that a company in contemplation of IPO will tend to “inflate” the

net assets base, since the market likes bigger net assets size, if that company is to be sold at a

higher price to the public.

If instead, Entity S1 is directly disposed of to public shareholders—there is no basis in the

current IFRSs to adjust the carrying values of S1 as a result of such a transaction, to its

transaction-date value.

If we think that now that the Predecessor[-Value] Method should be able to prevent the group to

“inflate” its assets value just by moving from “left pocket” to “right pocket”, this might be true, yet

this does not always give a fair presentation (or more representationally faithful) of the

transaction that might economically be similar. In this case, in Example 2, the assets and

liabilities of Entity S1 would be reflected in the financial statements of Entity A at their

predecessor carrying values. In that case, if the group subsequently disposes of the combined

entity (A+S1), for example in an IPO, the new shareholders would get the same set of values for

Entity S1 as they would in Example 3 (see below).

However, that set of values would be different compared to a scenario in which the business

disposed of—whether it is a combined entity A+S1 as in Example 2 followed by an IPO or entity

S1 as in Example 3—is acquired by a controlling party which in its turn is owned by public

shareholders, as illustrated below.

In this case, the public shareholders would get the fair values of the disposed-of-business

because the new parent will be required to apply the Acquisition Method under IFRS 3.


We could see this in the IFRIC Update (March 2006) regarding the “Transitory” Common

Control, in which IFRIC considered whether a reorganization involving a formation of a new

entity to facilitate the sale of part of an organization is a business combination within the scope

of IFRS 3. IFRS 3 does not apply to business combinations in which all the combining entities or

businesses are under common control both before and after the combination, unless the control

is transitory. It was suggested to the IFRIC that, because control of the new entity is

transitory, a combination involving the newly formed entity would be within the scope of

IFRS 3. IFRS 3 paragraph 22 (now paragraph B18) states that when an entity is formed to issue

equity instruments to effect a business combination, one of the combining entities existed before

the combination must be identified as the acquirer on the basis of the evidence available (now

must be identified as the acquirer by applying the guidance in paragraphs B13-B17 of Appendix

B of IFRS 3). However, the IFRIC noted that, to be consistent, the question of whether the

entities or businesses are under common control applies to the combining entities that existed

BEFORE the combination, excluding the newly formed entity. However, based on the wording of

the rejection statement, we could read that a group restructuring immediately preceding an

initial public offering is outside the scope of IFRS 3 because common control is not transitory.

Example 3 represents a transaction NOT under common control, since the demerged business

is not controlled by the same immediate parent (Entity IP) or ultimate party (Entity P) before and

after the transaction.


In the Staff Paper September 2013 under “IASB Agenda ref 14” with a project on “Business

Combinations under Common Control”, it seems that common control transactions are akin to

“restructuring” and the Staff Paper identified the most common types of internal restructurings or

reorganizations driven by many reasons either for business purposes or non-business

purposes, involving entities under common control, as follows:

(a) Creation of a New Company (NewCo) and transfer of business to the NewCo (also

referred to as spin-offs) in anticipation of a listing of securities or sale of business or debt

raising or taking benefit of a tax advantageous territory etc. There are several forms in

which these transactions are structured.

(b) Group reorganization involving moving of assets or entities within the group mainly

driven by tax or financial considerations or for simplification of group structure. Similar to

spin-offs, these could take several forms as these reorganizations are driven by varied

necessities. Mergers and amalgamations of group entities are the most common forms

of reorganizations.

IASB 's common control project referred to above will also consider the accounting for

demergers, such as the spin-off of a subsidiary or business.


PART IV: Financial Statements of the Entity

We could raise the questions about:

How about the financial statements of Entity B, the acquirer? After the acquisition of

Entity D, then now, Entity B is required to prepare the consolidated financial statements.

Entity B surely has to book the acquisition transaction of Entity D, but at what value?

How about the financial statements of Entity D, the acquire?

In general, the following accounting methods are commonly advocated in practice in the

consolidated financial statements of Entity B, the acquirer or acquiring entity’s perspective4:

(a) Acquisition Method: The common control transaction would be accounted for as if it

were a business combination between unrelated parties. In the example, Entity B (the

acquirer) would recognize entity D (the acquire)’s assets and liabilities at their acquisition

date fair values.

Under this method, only the identifiable assets and liabilities of the acquired entity, that is

Entity D, which should be measured at fair value at the acquisition date. No

measurement to fair value for identifiable assets and liabilities of the acquirer, that is

Entity B, should be done.

This might not be much different with the Acquisition Method introduced in IFRS 3. So

here, whether the combining transaction or event happens between entities or

4 IFRS 3 only addresses the application of the Acquisition Method of accounting for business

combinations from the acquiring entity’s perspective. Current IFRSs do not permit or require adjusting the carrying values of the acquired entity’s assets and liabilities in the acquired entity’s financial statements as a result of a business combination (i.e. the application of the so called “Push-Down Accounting”).

If the acquired entity prepares separate financial statements, a question arises as to whether (i) the historical basis of the acquired entity or (ii) the “stepped-up basis” of the acquirer should be reflected in those separate financial statements (since this is because an acquirer of a business initially recognizes most of the acquired assets and liabilities at fair value). Pushdown accounting refers to the latter, which means establishing a new basis for the assets and liabilities of the acquired company based on a “push down” of the acquirer’s stepped-up basis.

Push-Down Accounting typically results in higher net assets for the acquired company on the acquisition date because the assets and liabilities are “stepped-up” to fair value and goodwill is recognized.

On November 18, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2014-17, Business Combinations (Topic 805), Push-Down Accounting, which provides guidance on when and how an acquired entity can apply push-down accounting in its separate financial statements. Push-down accounting would be OPTIONAL for an entity when control over the entity has been obtained by an acquirer.


businesses under common control or not, the accounting treatment will not be different.

However, the difference might be that business combinations not under common control

should require the existence of “business”, yet for those under common control, it is not

required, as long as ultimately, the controlling party (or parties) remains the same.

It is interesting to note down why IFRS 3 in favor of adopting the Acquisition Method, as

elaborated under Basis for Conclusions (BC) on IFRS 3.

[paragraph BC24] Both boards (IASB and FASB) concluded that the acquisition method

is appropriate method of accounting for all business combinations in which one

entity obtains control of one or more other businesses because that method is

consistent with how the accounting model generally accounts for transactions in

which assets are acquired and liabilities are assumed or incurred. Therefore, it

produces information that is comparable with other accounting information.

[paragraph BC25] The Acquisition Method views a combination from the perspective of

the acquirer [Note: the acquisition is primarily aimed to acquire, so it is natural to think

that from the acquirer’s eyes…how about common control transactions, from the eyes of

the ultimate controlling party or parties or group’s owners?] – the entity that obtains

control of the other combining businesses. The acquirer purchases or otherwise obtains

control over net assets and recognizes in its financial statements the assets acquired

and liabilities assumed, including those not previously recognized by the acquire.

Consequently, users of financial statements are better able to assess the initial

investments made and the subsequent performance of those investments and compare

them with the performance of other entities. In addition, by initially recognizing almost all

of the assets acquired and liabilities assumed at their fair values, the acquisition method

includes in the financial statement more information about the market’s expectation of

the value of the future cash flows associated with those assets and liabilities, which

enhances the relevance of that information.

[paragraph BC27] The boards concluded that most business combinations, both two-

party transactions and those involving three or more entities (multi-party

combinations), are acquisitions. The boards acknowledged that some multi-party

combinations (in particular, those that are commonly referred to as roll-up or put-


together transactions) might not be acquisitions; however, they noted that the

acquisition method has generally been used to account for them. The boards

decided not to change that practice at this time. Consequently, the revised standards

require the acquisition method to be used to account for all business combinations,

including those that some might not consider acquisitions. [Note: In practice, regardless

the entities or parties being involved in the business combinations, acquisition method is

noted to be used to record the transaction).

[paragraph B28] Both boards considered assertions that exceptions to the acquisition

method should be provided for circumstances in which identifying the acquirer is difficult.

Respondents taking that view generally said that the pooling method would provide

better information in those circumstances. Although acknowledging that identifying the

acquirer sometimes may be difficult, the boards concluded that it would be practicable

to identify an acquirer in all business combinations. Moreover, in some

jurisdictions an acquirer must be identified for tax purposes, regardless how

difficult it may be to do so. Both boards also concluded that in no circumstances does

the pooling method provide better information than the acquisition method. [Note: It is

common to see that upon looking at a business combination transaction or event, the

analyst will try to identify, which party or company is the buyer, and which company is

bought by another company).

Paragraphs BC29 to BC35 of IFRS 3 explains away that the boards (IASB and FASB)

view mergers and acquisitions are economically similar, and thus rejecting the

pooling[ of interests] method to account for merger transactions, including “true mergers”

or “mergers of equals” in which represent combinations of entities of approximately

equal size or those in which it is difficult to identify an acquirer.

Mergers, in general, said to be business combinations in which the predominant form of

consideration is equity interests, are different from acquisitions and should be accounted

for differently. They said that the pooling [of interests] method is appropriate for a merger

because:

(i) ownership interests are continued (either completely or substantially),

(ii) no new capital is invested and


(iii) no assets are distributed,

(iv) post-combination ownership interests are proportional to those before the

combination, and

(v) the intention is to unite commercial strategies. Those respondents to the

Exposure Draft (ED) 3 and to the 1999 ED, said that a merger should be

accounted for in terms of the carrying amounts of the assets and liabilities of the

combining entities because, unlike acquisitions in which only the acquirer

survives the combination, all of the combining entities effectively survive a

merger.

[Note: some ideas that we could see from above paragraph is that merger sometimes is

incorrectly seen to be that all entities or parties involved in the business combinations

will survive intact after the transaction, the only change is on their legal equity structure,

an understanding that I do not think, is correct.]

However, paragraph BC32 of IFRS 3 said that many respondents agreed with the

boards (IASB and FASB) that although ownership interests are continued in a

combination effected by an exchange of equity instruments, those interests CHANGE

as a result of the combination. The former owners of each entity no longer have

an exclusive interest in the net assets of the pre-combination entities. Rather,

after the business combination, the owners of the combining entities have a

residual interest in the net assets of the combined entity. The information provided

by the pooling method fails to reflect that and is therefore not a faithful representation.

[Note: The change in the ownership interest between pre-combination and post-

combination justifies the use of the acquisition method, but how about if that change is

as directed by the ultimate controlling party or parties?]

Paragraph BC34 of IFRS 3 makes it clear that economically, mergers are virtually

identical to acquisitions, making them in-substance acquisitions. Some noted that shares

could have been issued for cash and that cash then used to effect the combination, with

the result being economically the same as if shares had been used to effect the

combination.


Even, IFRS 3 is applicable if the transaction or event is business combinations…..how

about demergers, such as a spin-off of a subsidiary or business?

(b) Fresh-Start Method: All parties involved in the common control transaction are

controlled by the same party or parties who can structure the transaction according to

their wishes. As a consequence, identifying one entity as the acquirer and another entity

as the acquire might not always be representationally faithful. Under the fresh start

method all assets and liabilities of the newly formed group would be measured at their

fair values. In the example, both, Entity B’s and Entity D’s assets and liabilities would be

measured at their acquisition date fair values.

So unlike Acquisition Method, under Fresh-Start Method, both the identifiable assets and

liabilities of the acquirer and acquire should be assessed to its fair value at the

acquisition date.

Can subsidiaries (including NewCos) use the Fresh-Start accounting (using the fair

value adjustments pushed down by the parent) for their individual/ separate financial

statements?

Under paragraph BC55 of Basis for Conclusions on IFRS 3:

In the Fresh-Start Method, none of the combining entities is viewed as having survived

the combination as an independent reporting entity. Rather, the combination is viewed

as the transfer of the net assets of the combining entities to a new entity that assumes

control over them. This history of that new entity, by definition, begins with the

combination.

Paragraphs BC56 and BC57 expressed that IASB and FASB have ever considered the

use of the Fresh-Start Method to account for:

the relatively rare business combination that does not clearly qualify as an

acquisition. Such a combination might be defined either as one in which an

acquirer cannot be identified or as one in which the acquirer is substantially

modified by the transaction.

The joint venture formations and some formations of new entities in multi-party

business combinations.


As a note, both under the Acquisition Method and the Fresh-Start Method, Entity D (the

acquire)’s identifiable assets and liabilities would be measured at their acquisition-date

fair values, except that under the Fresh-Start Method, this acquisition-date fair value is

extended to remeasure the acquirer (Entity B)’s identifiable assets and liabilities as well

as both Entity B and Entity D is now reported under the same consolidated financial

statements, or considered as one single economic entity to outside parties.

(c) Uniting-of-Interests Method (or Pooling-of-Interests Method, or Predecessor-

Carrying-Value Method: According to this view, the assets and liabilities of the involved

parties should not be remeasured and rather the acquiree’s book values are carried over

in the acquirer’s financial statements. However, it is not clear which book values should

be carried over into the acquirer’s financial statements. In the example, entity B could

recognize entity D’s assets and liabilities at their carrying values in:

i. Entity A (the ultimate controlling entity)’s consolidated financial statements;

ii. Entity C(the transferring party)’s consolidated financial statements5; or

iii. Entity D (the acquire)’s individual financial statements.

Under Uniting-of-Interests Method (or also known as Pooling-of-Interests Method or

carry-over basis), can we say that implicitly the underlying assumption is that if Entity B

acquires Entity D in an exchange of equal value, Entity A’s investments in Entities B and

C should not be affected by the combination between entities under common control?

The implementation of an exchange of equal value cannot always be sustained in view

of there are so many types of common control transactions, for example, entities under

common control might share the same intellectual capital, exchange employees or sell

goods and services to each other. It is highly possible that some type of exchange could

be benchmarked to market, but others might not be that easy, especially if the goods or

services are not traded in the market, for example, industrial trade secret. Some

transactions might be made not at arm’s length for certain purposes, which could be

read as indeed, a capital contribution by one party to another party within the same

group, though it is not formalized in the agreement of exchange.

5 Paragraph D9 (Appendix D) of US Statement on Financial Accounting Standard No. 141(Revised)

Business Combinations requires that the acquirer in a combination between entities or businesses under common control recognizes the assets acquired and liabilities assumed in the transaction at their carrying amounts in the accounts of the transferring entity at the date of the transfer.


So, in a common control transaction, it cannot always be presumed that equal values

are exchanged.

In addition, the way the exchange of value is expressed also creates another problem.

Under this Uniting-of-Interests or Pooling-of-Interests Method, we have 3 (three) options

to define the “book value or carrying value” of [identifiable] assets and liabilities of the

acquire, that is Entity D, that should be recorded in the books of the acquirer, that is

Entity B.

The key issue, which information of measurement is the most useful for the users or readers of

the financial statements?

The Acquisition Method and the Fresh-Start Method measure some or all of the assets and

liabilities at their acquisition-date fair values. Application of those methods is likely to result in

the recognition of previously unrecognized goodwill and other intangible assets or to recognize

formerly unrecognized assets and liabilities.

In contrast, the Uniting-of-Interests Method carries over the book values of the acquiree’s assets

and liabilities into the consolidated financial statements. Thus, the acquisition method is likely to

result in the presentation of higher assets, liabilities and equity amounts than the pooling-of-

interests method. After the business combination, the acquisition method is likely to cause

higher depreciation and amortization expenses.

The question is there are at least three levels of the readers or users of the financial statements:

There are readers or users of Entity B and Entity D’s only.

There are readers or users of Entity A group.

There are readers or users of the separate financial statements of Entity B.

So we see that the support for using the Acquisition Method to account for the business

combination transaction or event could be said are driven by the fact that business combination

- that is transaction between the combining entities, and NOT between the owners of the

combining entities – is an economic transaction or event, meaning that is driven by economic

(and not accounting) considerations, economically sound to be done. The entities, not their

owners, engage in the negotiations necessary to carry out the combination, although the owners

must eventually participate in and approve the transaction.


The problem with common control transactions, they might be driven not merely by economic

considerations6?

What motivates the common control transactions? Why it is just “moving money or net assets

from left pocket to right pocket”?

I guess it is very critical to identify first whether a particular transaction would meet the definition

of a combination between entities or businesses under common control.

6 For example, a distribution of all shares in the entity’s subsidiary to the entity’s owners (would be within

the scope of IFRIC 17 Distributions of Non-Cash Assets to Owners, if no party or parties control the transferring entity. However, such a distribution would be outside of the scope of IFRIC 17 if the transferring entity is under the control of another party or parties—that is, if it is a distribution under common control. IFRIC 17 Distributions of non-cash Assets to Owners. IFRIC 17 addressed the accounting for non-reciprocal transfers of non-cash assets by an entity to its owners from the transferring entity’s perspective. The IFRIC noted that such distributions are often conducted for the purpose of group restructuring.


PART V: Pictorial Representation of the Various Scenarios of Restructurings

To close off this writing, the following are several pictorial representation of the various forms of

restructurings, which were being presented during IFRS conference at Paris on 29-30 June

2015.

Scenario 1: The existence of non-controlling interests in the group restructurings

Scenario 2: With group restructuring in preparation for an Initial Public Offering (IPO)


The above two scenarios, especially in case 1.2 and 2.2, raise the questions about how should

the acquisition of Entity B be accounted for?

A. At fair value in accordance with IFRS 3

B. At the predecessor carrying value

C. At fair value or the predecessor carrying value depending on facts and circumstances

Scenario 3: Applying the Predecessor Method on a Prospective Basis


In Scenario 3, how should the Predecessor Method is applied by Entity A?

A. From the date of acquisition without restating comparatives (prospective application)

B. As if the combining entities have always been together with restating comparatives

(retrospective application)

C. Accounting policy choice between A and B


Scenario 4: Where is to Record the Difference in Applying the Predecessor Method?

There are 3 (three) options to account for the difference between the fair value of the

consideration transferred by Entity A and the carrying value of the acquired net assets of Entity

B:


Option 1: As a consolidation adjustment to retained earnings

Option 2: As a consolidation merger reserve

Option 3: . As a consolidation adjustment to share capital


Scenario 5 : Applying the Predecessor Method, which Carrying Value of the Acquire to be

Used?


In Scenario 5, which carrying values of Entity B should be used in the Predecessor Method?

A. As per separate financial statements of Entity B

B. As per consolidated financial statements of P1

~~~~~~ ####### ~~~~~~

Jakarta, July 2015


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