acct4011_lecture 3_business combinations iii (revised) (class)

SCHOOL OF ACCOUNTANCY ACCT 4011 FINANCIAL ACCOUNTING STUDIES LECTURE 3 – BUSINESS COMBINATIONS III: SPECIAL TOPICS

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TOPIC III BUSINESS COMBINATION ACHIEVED IN STAGES (OR STEP ACQUISITION)

Acquirer may achieve control in acquiree only after acquiring additional block(s) of shares to

complement its existing holdings

Financial assets – Investment in equity instruments (HKFRS 9)

Measured at fair value

(i) through profit or loss (default; the only choice for shares held for trading and derivatives)

(ii) through other comprehensive income (irrevocable initial designation)

Measurement procedures:

Previously held equity interest in the acquiree must be REMEASURED to fair value at

acquisition date when control is achieved

RECOGNISE GAIN/LOSS arising from remeasurement to fair value of previously held equity

interest in profit or loss or other comprehensive income, as appropriate

If the acquirer has, in prior periods, recognised changes in value of its equity interest in the

acquiree directly in equity, the cumulative amount that was recognised directly in equity will be

accounted for in a manner as if the acquirer had disposed of the previously held equity interests

No recycling to profit or loss

Can choose to transfer balance in other comprehensive income to retained earnings (within

equity)

Recognise goodwill upon obtaining control and starts consolidation subsidiary since then:

(Note: This formula is a revision to the formula in the notes of Lecture 2. This applies to business

combination achieved in stages in which the acquirer subsequently acquires 100% of equity interests of the

acquiree. If the step acquisition results in a partially-owned subsidiary, i.e. involving non-controlling

interest calculation, the formula below requires further revision. We will discuss that in Lecture 6.)

Illustration: On 1 November 2010, Entity A acquired 5% of the 30,000 outstanding common shares of Entity

B at consideration $10 per share. On Entity A’s 31 December 2010 statement of financial position, it

designated its investment in Entity B to be measured at fair value through other comprehensive income.

On 31 December 2010, the fair value of Entity B’s share spurred to $16 per share. On 31 March 2011,

Entity A acquired the remaining equity shares at market price $20 per share in Entity B so that Entity B

becomes a wholly-owned subsidiary of Entity A. On 31 March 2011, the fair value of identifiable net

assets of Entity B was valued at $590,000.

＋ Goodwill

Fair value of consideration transferred

Fair value of acquirer’s previously held equity interest in acquiree

= Acquirer’s interest in the

net fair value of the acquiree’s identifiable assets and liabilities

－


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TOPIC IV REVERSE ACQUISITION

An entity (legal parent: issue equity interests) obtains ownership of the equity of another entity (legal

subsidiary: equity interests being acquired)

As part of the exchange transaction, legal parent issues enough voting equity as consideration for

control of the combined entity to pass to the owners of the legal subsidiary

Referring to the definition of acquirer in HKFRS 3 (Revised),

Legal parent becomes the ‘accounting acquiree’

Legal subsidiary becomes the ‘accounting acquirer’ who obtains control of the combined entity


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Accounting implications:

Consolidated financial statement still issued under the name of the legal parent

Consideration transferred (*) = fair value of notional number of equity instruments which

would have been issued by the legal subsidiary to the legal parent to provide the resulting

percentage ownership in the combined entity

Identifiable net assets acquired = those assets of legal parent

Assets of legal parent restated to fair value

Goodwill = Consideration transferred (*) – fair value of identifiable net assets of legal parent

Illustration (adapted from Tan, Lim & Lee, Appendix 3A, pages 103 – 107):

On 1 July 2011, Entity P, a private entity, arranged to have all its shares acquired by Entity L, a publicly

listed entity. The arrangement required Entity L to issue 20,000,000 shares to Entity P’s shareholders in

exchange for the existing 6,000,000 shares of Entity P. The following information relates to Entities L and

P at the date of exchange:

100%

20% (100% à 20%)

80% (control) 100% 100%

LS’s shareholders LP’s shareholders

Legal Subsidiary/Acquiree (Accounting Acquirer)

Legal Parent/Acquirer (Accounting Acquiree)

LS’s shareholders LP’s shareholders

Legal Parent/Acquirer (Accounting Acquiree)

Legal Subsidiary/Acquiree (Accounting Acquirer)

Before reverse acquisition After reverse acquisition


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After the issue of an additional 20,000,000 shares by Entity L, the shareholding structure of the combined

entity should be:

In substance, Entity P becomes the effective parent obtaining control of the combined entity. Reversing

(or reinterpreting) the ownership structure, it is required to work out the number of shares that Entity P

would have issued (now, Entity L is the entity issuing the shares to Entity P) to Entity L’s shareholders for

Entity P’s shareholders to own the same percentage in the combined entity (i.e. 80%). In effect, Entity P

would have to issue 1,500,000* of its own shares to Entity L’s shareholders for Entity P’s shareholders to

own 80% in the combined entity. Consequentially, under such re-interpretation, Entity P would own

100% of Entity L and Entity L’s shareholders would own 20% of Entity P as follows:

* Calculation of the number of shares Entity P would have to issue to own 80% in the combined entity:

6,000,000 (original issued shares of Entity P) / (6,000,000 + hypothetical newly issued shares) = 80%

30,000,000 = 4x + 24,000,000

4x = 6,000,000

Solving for x yields 1,500,000

If Entity P had been the acquirer, the consideration transferred would be:

1,500,000 (hypothetical newly issued shares by Entity P) x $10 (share price of Entity P) = $15,000,000

The goodwill arising from the business combination would be:

Consideration – Fair value of identifiable net assets acquired = $15,000,000 - $12,000,000 (Entity L’s fair value) =

$3,000,000

100%

100à 20% 0 à 80%

P’s shareholders L’s shareholders

Entity L

Entity P

100%

20% 80%

P’s shareholders L’s shareholders

Entity P

Entity L

acct4011_lecture 3_business combinations iii (revised) (class)

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