Mergers and acquisitions and other complex transactions
Action: Entities need to consider accounting implications as part of their planning and implementation process for material transactions.
We’re seeing increasing transaction activity in the marketplace, with acquisitions, mergers, IPOs and capital management initiatives occurring.
When considering or undertaking such transactions, entities need to consider the accounting aspects early in the process, ensuring optimal accounting outcomes and clear and transparent disclosures. This is particularly relevant when unusual or infrequent transactions occur to ensure there are ‘no surprises’ in outcomes.
Accounting Standards generally adopt a substance over form approach. It is particularly important that legal agreements and other documents surrounding a transaction are fully understood so that their commercial substance is clear.
We’ve set out below a number of common challenges that arise in complex transactions and common points to consider. These examples are not designed to be comprehensive but seek to illustrate some of the types of issues that can arise in these transactions.
Asset acquisitions vs business combinations
Where groups of assets and liabilities are acquired, misclassifying the transaction can have a broad impact, including:
- Recognition and measurement of assets and liabilities. In a business combination, the initial recognition of identified assets and liabilities is at fair value, while an asset acquisition is accounted for by allocating the total cost of the transaction to the assets and liabilities acquired
- Recognition of deferred taxes. In a business combination, deferred taxes are recognised, while in an asset acquisition there is a recognition exemption and deferred taxes should not be recognised
- Transaction costs. In a business combination transaction costs are expensed, while in an asset acquisition they form part of the total transaction price allocated to assets and liabilities acquired
- Provisional accounting. Provisional accounting for the transaction is only permitted (within the measurement period) for business combinations, with no guidance for asset acquisitions.
Recent standard amendments provide additional guidance on making the distinction between acquisitions of a business and asset acquisitions. For more information, see IFRS in Focus IASB amends the definition of a business in IFRS 3.
Accounting for business combinations
The accounting requirements for business combinations can be complex and require attention to detail, understanding all of the aspects of the transaction. Common areas that may result in unexpected outcomes include:
- Embedded employee remuneration arrangements. Transaction components must be treated as employee remuneration rather than part of the transaction price in some cases, particularly contingent payments (including earn out arrangements)involving employees or selling shareholders that are directly or indirectly linked to continued employment (even if the linkage is in a document other than the acquisition agreement)
- Identification of the acquirer. The acquirer is the entity that obtains control of the acquiree. Determination of the acquirer is often straightforward but can be complex and involve substantial judgement when numerous entities are involved, in transactions involving entities under common control, or where a ‘reverse acquisition’ occurs. Incorrect identification of the acquirer can result in material errors in accounting for the combination
- Determining the acquisition date. Determination of the acquisition date will require careful assessment of a number of factors, particularly where there are conditions precedent (including shareholder approvals). The acquisition date drives the measurement of equity consideration (and the fair value of assets and liabilities acquired), which can have a material impact on resultant goodwill, particularly where the acquirer’s share price moves significantly between transaction announcement and the acquisition date
- Contracts and arrangements between acquirer and acquiree. Arrangements such as franchise agreements, licensing arrangements, leases, legal cases, supply arrangements and other contracts between the parties need to be assessed. Settlement of non‑contractual arrangements such as legal cases will have a profit or loss impact, and any ‘off-market’ component of contractual arrangements needs to be separately recognised (e.g. long-term contracts where market prices have changed since the contract was entered into)
- Put and call options. Put and call options over a non‑controlling interest arising from a partial acquisition can result in unexpected outcomes. Providing a minority shareholder with an option to sell their interest will usually result in a ‘gross liability’ being recognised for the amount that would be paid on exercise of the option. This liability is remeasured, to fair value and changes are reflected in profit or loss, resulting in volatility.
Complex financing arrangements
Some financing transactions such as raising capital, supplier finance arrangements and borrowing facilities may involve features that change the accounting treatment of the transaction (e.g. debt vs equity).
The following are some examples of arrangements to look out for:
- Debt or equity. Arrangements may involve features that appear to be equity but are in fact liabilities. For example, share options that may be settled in cash in certain circumstances. Incorrect classification may result in material errors. Transactions involving share capital are not automatically classified as equity. For example, “piggyback options” attached to a rights issue can result in derivative classification, resulting in profit or loss volatility. For more information, see iGAAP Chapter B3 Section 6.1.6*
- Sale and leaseback transactions. Transactions where an asset is legally sold to another party and immediately leased back by the seller can result in unexpected accounting outcomes. In some cases, the transaction will be considered purely a financing arrangement (i.e. not a sale), whilst in others only a proportion of the overall gain will be recognised (see iGAAP Chapter A17 Section 13*)
- Unusual features. Financing facilities that contain linkages to non‑standard variables may result in embedded derivatives or compound financial instrument accounting, e.g. conversion features, equity‑linked features (see iGAAP Chapter B3 Section 2*).
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