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Chapter 4: Acquisitions and disposals of subsidiaries and other businesses
The aggregate cash flows relating to consideration for the acquisition or disposal of a subsidiary or business unit are reported separately, under investing activities, in the cash flow statement. The amounts of cash and cash equivalents paid or received in respect of the consideration should be shown under investing activities net of any cash and cash equivalent balances transferred as part of the purchase or sale.
Separate disclosure of cash flows related to acquisitions and disposals Question: Is separate disclosure of cash flows relating to a major acquisition or disposal required on the face of the cash flow statement?
Answer: There is no specific requirement to present the cash flows from a major acquisition or disposal separately on the face of the cash flow statement. However, such presentation would be in line with the spirit of IAS 7, because major classes of gross cash receipts and gross cash payments are to be reported separately.
Working capital acquired in an acquisition Question: How is working capital acquired or disposed of in an acquisition or disposal of a subsidiary accounted for in the cash flow statement?
Answer: Any fixed assets, working capital (excluding cash and cash equivalents) and borrowings of the subsidiary at the acquisition date or disposal date are eliminated from cash flow headings.
The cash flow statement only reflects actual cash flows from the date of acquisition or up to the date of disposal; this is because the cash flows for the acquisition or disposal are separately reported.
For example, inventory, debtors and creditors acquired or disposed of would need to be eliminated from the total balance sheet changes in inventory, debtors and creditors in the reconciliation of profit to operating cash flows where the indirect method is used.
Non-cash consideration paid for an acquisition Question: What is the impact on the cash flow statement of an acquisition paid for partly by the issue of shares?
Answer: The cash flow statement would show only the cash element of consideration paid for the acquisition if the consideration has been discharged partly in cash and partly by the issue of shares. This would be presented as a single item under investing activities (net of any cash and cash equivalents of the subsidiary acquired). The shares that are issued as part of the consideration in exchange for net assets acquired do not give rise to any cash flows. Consequently, they should not be shown in the cash flow statement. Instead, they are disclosed as non-cash transactions.
For example, a parent entity acquired subsidiary B for C1,000 in March 20X6. The purchase consideration included cash of C250, the assumption of liabilities of C400, and the issue of equity securities of C350.
The cash payment of C250 is classified in the parent’s cash flow statement within investing activities. The non-cash elements of the transaction (that is, the liabilities and the equity securities) are disclosed in the notes to the financial statements.
Suitable disclosure might be:
Non-cash transactions
On 1 March 20X6 the group acquired subsidiary B (Note X) for C1,000. In addition to a cash payment of C250, the following non-cash transactions were used to settle the purchase consideration:
· Issue of ordinary shares: C350.
· Assumption of liabilities: C400.
Presentation of cash acquired and cash paid Question: What is the cash flow statement presentation where cash acquired exceeds cash paid for the acquisition of a subsidiary?
Answer: Consider a parent entity that pays C20,000 in cash and issues C80,000 in shares to acquire a subsidiary, which has cash balances of C30,000 and other net assets, including goodwill, of C70,000. The cash flow statement would show a net cash inflow of C10,000 under investing activities. The issue of the ordinary shares would be disclosed as a non-cash transaction.
Dividends paid to former shareholders Question: Are dividends paid to former shareholders on acquisition included as a cash flow in the cash flow statement?
Answer: Any payment by the acquired entity to former shareholders that is, in substance, part of the former shareholders’ proceeds and the purchaser’s cost of acquisition should be accounted for as part of the fair value of the consideration paid for the acquisition. So, the payment of the dividend would be shown as part of the cash flows relating to acquisitions under investing activities.
For example, an entity acquires a subsidiary and, as part of the acquisition agreement, the subsidiary’s shareholders authorized a dividend, pre-acquisition, that is payable to the former shareholders. The purchase consideration payable for the acquisition was reduced, to take account of this. This dividend was paid to the former shareholders after the acquisition date. The dividend is classified as an investing activity.
However, where the dividend was not part of the acquisition arrangement (For example, a normal dividend authorized prior to the acquired entity’s acquisition), it would not form part of the consideration. When the dividend was paid, it would be included in the post-acquisition consolidated cash flow statement as part of cash flows from operating activities; this is because it would represent the settlement of a normal creditor (brought in on acquisition).
Repayment of acquirer’s debt on change in control Question: What is the impact on the cash flow statement of the repayment of the acquirer’s debt on a change in control?
Answer: Business combinations are often accompanied by a change in the acquirer’s financing. There can be differing reasons for the repayment of the acquirer’s bank debt, including the following circumstances:
· The acquirer’s bank debt might include a change of control clause, triggering repayment in the event of a business combination.
· The acquirer might wish to buy the acquire debt-free, resulting in the repayment of debt being written into the sale and purchase agreement.
· The acquirer might wish to change the acquirer’s lenders, in order to bring its new subsidiary into line with the group’s banking arrangements.
· The acquirer might pass cash to the acquire, to repay third party debt on the business combination, or the acquirer might pay the bank directly. This could be viewed commercially by the acquirer as part of the consideration for the business combination.
However, the consideration in a business combination is generally taken to include only amounts transferred between the acquirer and the previous owners, so it is accounted for as a separate transaction, from an IFRS 3 perspective, in accounting for the acquisition, and the resulting cash flow is classified as a cash flow from financing activities. This is the case, For example, where the acquirer decides to repay the debt voluntarily.
Where the acquirer does not have discretion as to whether the acquirer’s debt is repaid, the repayment of debt still cannot be treated as part of the consideration transferred to the seller in exchange for control of the acquire under IFRS 3. However, the resulting cash outflow is, in substance, triggered by the business combination, and so it is also acceptable to classify it as an investing activity in the cash flow statement.
For example, where the cash outflow is triggered by a pre-existing change of control clause so that, as part of the acquisition agreement, the acquiring group immediately repays the loans, the cash outflow resulting from the repayment could be shown as part of ‘Acquisitions of subsidiaries and other businesses’ under investing activities in the cash flow statement.
The debt acquired in connection with the business combination should be clearly disclosed as a non-cash transaction.
Deferred or contingent consideration Question: How should payments to settle a liability for deferred or contingent consideration in a business combination be presented in the cash flow statement?
Answer: Assume that the fair value of the deferred or contingent consideration payable by the acquirer to the acquirer’s former owners at the acquisition date is C10 million, and it is settled in a later period at C12 million. Deferred or contingent consideration (For example, earn-out payments) is initially measured at fair value and included in the business combination accounting at the acquisition date. The liability is subsequently remeasured, with changes in fair value that are not measurement period adjustments recognized in profit or loss.
Cash flow treatment for the C10 million initially recognized in the business combination accounting
The subsequent payment of any deferred or contingent consideration recognized at the acquisition date (and any adjustments that are IFRS 3 measurement period adjustments) should, in most circumstances, be classified as an investing activity, because these cash flows result from assets being recognized in the balance sheet. This is consistent with the requirement for aggregate cash flows arising from a business combination to be presented separately and classified as investing activities. However, where there is clear evidence that the arrangement is, in substance, a financing transaction (For example, a long-term loan note), the settlement of the initial recognized amount could be classified as a financing outflow.
Cash flow treatment for the C2 million subsequently recognized on re-measurement of the liability to fair value
IAS 7 requires that investing cash flows arise only when an asset is recognized. Because re-measurements are recognized in profit or loss, there is no recognized asset. Therefore, payments for additional contingent consideration that arises outside of the measurement period would normally be classified as operating cash flows (or financing cash flows, if this reflects the substance). The payments are often linked to the business’ ongoing performance (For example, earn-out payments) and are, in effect, an operating cash flow of the business. The classification in the cash flow statement of contingent consideration should be clearly disclosed, if material.
For deferred consideration (of a fixed amount), the cash paid in excess of the initial fair value represents a finance cost, and it could be classified consistently with interest paid.
If subsequent re-measurement of the liability reduces the total cash payable below the acquired assets recognized (For example, if the final payout was C8 million and not C12 million), this effectively caps the amount shown as investing cash flows. The reduced cash payment of C8 million is shown as the investing cash outflow, and not as an investing cash outflow of C10 million offset by a C2 million operating cash inflow.
The standard allows the aggregation of cash flows from acquisitions or from disposals. However, the cash flow from disposals should be presented separately from the cash flow from acquisitions.
Cash flows arising from changes in ownership interests in a subsidiary that do not result in a loss of control are classified as cash flows from financing activities.
Transactions with non-controlling interests that do not result in a change of control Question: Does the requirement to present, as financing transactions, transactions with non-controlling interests that do not result in a change of control extend to separate financial statements?
Answer: It is not clear whether the requirements of paragraphs 42A and 42B of IAS 7 apply only in respect of consolidated financial statements, or if they apply also to separate financial statements. The reference in paragraph 42B to accounting for equity transactions under IFRS 10 implies that this requirement is only in respect of consolidated financial statements. In our view, cash paid and/or received for the change in ownership of a subsidiary is classified as an investing activity in the cash flow statement in separate financial statements.
Transaction costs relating to equity transactions with non-controlling shareholders Question: How are transaction costs incurred on the purchase (or sale) of equity instruments from (or to) non-controlling interests classified in the cash flow statement?
Answer: The payment of incremental, directly attributable transaction costs for the purchase or sale of a non-controlling interest in a subsidiary, where control is maintained, is classified as a financing activity in the consolidated cash flow statement. This is consistent with the recognition of incremental, directly attributable transaction costs as a deduction from equity in accordance with IAS 32.
IAS 7 requires disclosures in respect of the cash flow effect of acquisitions or disposals of subsidiaries or other businesses during the financial year. However, certain requirements (specifically, the amount of cash and cash equivalents and major categories of other assets and liabilities held in the subsidiary or other business units acquired or disposed of) do not apply to investment entities that carry their subsidiaries at fair value through profit or loss.
Discontinued operations Question: What are the cash flow statement implications for a disposal that results in discontinued operations being presented in the income statement?
Answer: IFRS 5 requires entities to disclose the net cash flows attributable to the operating, investing and financing activities of discontinued operations (except for newly acquired subsidiaries classified as held for sale on acquisition. These disclosures could be presented either in the notes or on the face of the cash flow statement.
There are various ways in which entities might comply with these disclosure requirements:
· No presentation of cash flows from discontinued operations on the face of the cash flow statement (that is, gross cash flows are presented), with a breakdown between the three categories presented in the notes.
· Cash flows from discontinued operations are split between the three relevant categories on the face of the cash flow statement, with one line for each category including the relevant results from the discontinued operation. A total is presented for each category.
· Information is presented separately for continuing and discontinued operations, on a line-by-line basis, on the face of the cash flow statement. A total is presented for each category.
Separate financial statements Question: Do the requirements to disclose the amount of cash and cash equivalents, in a subsidiary or other business units acquired or disposed of, apply for the acquisition or disposal of a subsidiary where the reporting entity is preparing separate financial statements?
Answer: IAS 7 is not clear on whether these requirements apply for the acquisition or disposal of a subsidiary where the reporting entity is not preparing consolidated financial statements and is not an investment entity. The cash flow statement’s purpose is to report the cash flows of the reporting entity, and so the parent’s separate financial statements (as defined in IAS 27) will not incorporate the subsidiary’s cash flows. Reporting any cash consideration net of the cash transferred to or from the subsidiary would therefore not accurately reflect the parent entity’s cash flows. We consider that it would be acceptable to present these disclosures for the acquisition and disposal of subsidiaries only in the consolidated financial statements.
However, these disclosures are required in an entity’s separate financial statements where they are in relation to the purchase or sale of a business unit.