Annualised figures

Guidance on preparation of the pro forma information

IFRS 3 includes a requirement to disclose what are effectively pro forma figures. It requires disclosure of the following information for each business combination (or in aggregate, for business combinations that are individually immaterial), unless such disclosure would be impracticable:

• The combined entity’s revenue for the period, as though the acquisition date for all business combinations effected during the period had been the beginning of that period.
• The combined entity’s profit or loss for the period, as though the acquisition date for all business combinations effected during the period had been the beginning of the period.

The standard contains no guidance on how the pro forma information is calculated. In practice, there could be a number of approaches, ranging from a simple aggregation of results through to more complicated (but, arguably, more meaningful) aggregations, with adjustments for accounting policy alignments, the revised debt structure and other similar factors.

In our view, where adjustments are made in pro forma information disclosed under IFRS 3, the adjustments should be:

• Clearly shown and explained.
• Directly attributable to the transaction concerned, and not relating to future events or decisions.
• Factually supportable.

Clearly showing and explaining adjustments could include the need to set out:

The assumptions on which the adjustments are based. The range of outcomes where there is significant uncertainty. The sources of the amounts concerned. How the adjustments have been aggregated or allocated to financial statement captions, where relevant.

The summary below lists a number of common adjustments that might be made to pro forma information. It also indicates which of these are generally acceptable for the purpose of the disclosure in paragraph B64(q)(ii) of IFRS 3. Local market practice and guidance from the local regulator might impact on the acceptability or otherwise of the adjustments.

Common adjustments

Alignment of accounting policies: the acquiree’s results for the pre-combination period are adjusted to reflect accounting policy differences between the group’s policies and the acquiree’s own accounting policies. This is consistent with the adjustments made to the acquiree’s results in the post-combination period.

Eliminating intra-group trading before the acquisition date: sales between the group and the acquiree during the pre-combination period (including any profit) are eliminated, unless the goods have subsequently been sold outside the group. This is consistent with the adjustments made to the acquiree’s results in the post-combination period.

Fair value adjustments: these adjustments are made if they are factually supportable – which should be the case, given that the fair value adjustments will have been established after acquisition. The underlying principle is that, where acquisition accounting results in fair value adjustments to assets and liabilities on acquisition and a residual for goodwill, these will have an impact on the combined group’s post-combination earnings. The adjustments reflect the impact of the fair value adjustments as if they had occurred at the beginning of the reporting period − for example, an increased depreciation charge for the full year due to a fair value increase of an item of property, plant and equipment on acquisition.

Acquisition-related costs: transaction costs should be reflected as if they occurred at the beginning of the annual reporting period.

Borrowings incurred to finance the acquisition − these would have been incurred at the beginning of the year if the acquisition had taken place at the beginning of the year. An additional finance charge could, therefore, be included for the pre-combination period in order to reflect what the effect of the business combination would have been if the acquisition had occurred at the start of the year.

Tax effects of the above adjustments (that is, the tax effects of adjustments attributable to the acquisition) are reflected. The tax adjustment is not simply applying the issuer’s effective tax rate, but it involves looking at the incremental effect of the acquisition. Adjustments that are generally not considered acceptable

Synergy benefits: synergy benefits are normally dependent on future, post-transaction actions, and so they are not the subject of adjustments in deriving the pro forma financial information. It will normally not be possible to factually support what the synergy benefits would have been if backdated to the start of the financial year, so the reported results are not adjusted. Assumptions make this clear.

Cost eliminations: it might be possible to eliminate certain costs (for example, the acquired entity’s directors’ fees). It might be reasonable to assume that these costs will be eliminated, but there will often be other increases in costs as a result of the transaction that themselves cannot be factually supported. Therefore, in our view, the cost eliminations are a form of synergies and should not be treated as pro forma adjustments.

Backdating of hedging strategies put in place after acquisition: IFRS 9 prohibits the backdating of hedging documentation. The pro forma financial information should not be adjusted to reflect hedging strategies that management might have put in place if the combination had taken place at the beginning of the year.

Tax losses brought forward: these could have been utilised more quickly if synergy benefits had been available from the start of the period, but there is no equivalent adjustment in the post-combination period. The pro forma information does not represent actual results for the year. It must be clearly labelled as pro forma, and the assumptions made should be clearly disclosed and factually supportable.

Cash flow statement presentation and disclosure

Cash flow presentation and disclosure

The following specific disclosures are required by IAS 7 in relation to the cash flow effect of the acquisition of a business: The total purchase consideration, together with how much of the consideration comprised cash and cash equivalents. The amount of the cash and cash equivalents in the acquired business. The assets and liabilities (other than cash and cash equivalents) of the acquired business, by each major category. The requirement of the first bullet point aligns with the requirement in IFRS 3 to disclose elements of the consideration payable.

Similarly, the requirements in the second and third bullet points are aligned to IFRS 3’s requirements. Entities will, therefore, be able to comply with IFRS 3 and IAS 7 disclosure requirements by providing one combined disclosure.

Income statement presentation and disclosure

Disclosure is required of the amount of each different type of gain or loss recognised and an indication of the line item in which such amount is recognised in the statement of comprehensive income. Gains and losses for business combinations could also be aggregated and recorded in a separate line item (for example, ‘gains and losses relating to business combinations’).

The line item needs to be properly described, with appropriate supplemental description provided in the footnotes and subject to the IAS 1 overall requirements for fair presentation. There should be transparent disclosure of which gains and losses are included in the single line presentation. It is also acceptable to aggregate gains, losses and expenses from more than one business combination in a single line, if it is accompanied by an appropriate description and adequate note disclosure.

An entity that elects to present gains and losses arising from business combinations in a single line item might also include acquisition-related costs in the single line item. However, an entity is not obliged to segregate all acquisition-related costs in a single line item, and it might choose not to do so, particularly if it uses the ‘by nature’ presentation.

IFRS 3 defines acquisition-related costs to include, amongst other items, “… general administrative costs, including the costs of maintaining an internal acquisitions department …” . Such internal costs might include a separate department that considers potential acquisition targets, bonuses paid on successful transactions, and an allocation of the costs of senior executives involved in negotiations.

Entities should develop an accounting policy that considers which of the internal costs relate to a particular transaction, to determine the extent to which these costs are included in the single line item. An example of a reasonable policy is to include only incremental expenses arising from business combinations, or incremental costs together with an allocation of ongoing cost based on time spent. Including 100% of internal costs in the single line item would result in entities presenting ’gains, losses and expenses from business combinations’ in periods when there have been no business combinations.

Therefore, while not prohibited under the standards, this might not provide meaningful information. There might be circumstances where individual gains and losses are presented separately (and not aggregated within other line items). An example of this might be a gain on a bargain purchase.

The nature and significance of the bargain purchase gain might warrant separate presentation to comply with the IAS 1 principle of disclosing material items of income and expense. There should be transparent disclosure of which gains and losses are included in the single line item and which are not, including where the other gains and losses are reflected in the statement of comprehensive income.

IAS 1 does not require presentation of ‘operating income’, although many entities do present it. If a single line item for gains and losses related to a business combination is presented, classification as operating or nonoperating should be consistent with the presentation of other items of income and expense.

Management should consider where such amounts would have been presented without a business combination.

For example, if an operating profit line item is presented on the statement of comprehensive income, and acquisition-related costs are included in the single line item, this would suggest that the single line item should be included in operating profit, because such costs would have been reflected in operating profit without a business combination.

The use of a single line item presentation is more consistent with a ‘by function’ income statement presentation. However, it is also acceptable to use this presentation for a ‘by nature’ income statement, provided that: the line item for employee costs is clearly labelled (on the face of the statement of comprehensive income) as exclusive of employee costs related to business combinations; total employee costs, including the amount allocated to gains and losses related to a business combination, are disclosed in the financial statements in accordance with IAS 1; and the accounting policy regarding which internal costs relate to a particular transaction and are included in the single line item is disclosed.

A statement of comprehensive income presented either by nature or by function is generally preferable to a mixed presentation. However, mixed presentation is acceptable if transparent disclosure is provided. Adjustments for changes in the value of indemnification assets and the indemnified item can generally be offset in the statement of comprehensive income, except for income tax indemnities.

An indemnification asset will change in response to changes in the indemnified item (typically, a liability within the scope of IAS 12, IAS 19 or IAS 37), although it might be in relation to an asset such as receivables or inventory. IAS 37 includes guidance about reimbursements for provisions recognised, and it indicates that the income and expense for a provision and a reimbursement can be presented net in the statement of comprehensive income. Movements in the indemnified liability can be offset by the movements in the indemnification asset where the liability is measured under IAS 37.

There is similar guidance in IAS 19, relating specifically to reimbursements of defined benefit plan expenses; so, by analogy, it is acceptable to offset movements in an indemnification asset related to an IAS 19 liability in the statement of comprehensive income. [IAS 19 para 104A]. Separate indemnification assets and liabilities would seldom, if ever, meet the IAS 1 criteria for offsetting within the balance sheet, and they should be presented gross. A common form of indemnity is for income tax liabilities. Tax expense is a defined term in IAS 12, and it is referenced as a required line item in IAS 1.

The movement in a tax indemnification asset is not included on the income tax line item, because it does not meet the definition of tax expense in IAS 12. If an entity elects to present a single line item for gains and losses related to a business combination, the changes to a tax indemnification asset arising from a business combination are reflected in such single line item, accompanied by appropriate note disclosure.

Disclosure of comparative information

IFRS 3 does not make reference as to whether comparative information in respect of business combinations should be given, because the standard does not specifically deal with the disclosure of comparative information. In our view, the IFRS 3 disclosure is required for business combinations that occur during the period. This means that, in the period following the combination, IFRS 3’s disclosures do not have to be repeated. This applies, for instance, to the disclosures in paragraph B64 of IFRS 3, including the fair values of assets and liabilities and the disclosure of post-combination results. Certain disclosures in respect of prior business combinations will, however, need to be given in the current period. This includes disclosure of any measurement period adjustments related to past business combinations.

Gains and losses in the period of acquisition and subsequent periods

Disclosure of post-combination gains and losses

The results of acquired businesses disclosed for the first period after acquisition might not be entirely indicative of the ongoing performance of such businesses. This is because, for example, they might be affected by changes introduced by the acquirer soon after the acquisition.

IFRS 3 requires an acquirer to disclose the amount and an explanation of any gain or loss recognised in the current period that: relates to the identifiable assets acquired or liabilities assumed in a business combination that was effected in the current or a previous period; and is of such size, nature or incidence that disclosure is relevant to an understanding of the combined entity’s financial performance.

This disclosure applies to each material business combination, or in aggregate for business combinations that are individually immaterial but collectively material. The above disclosure requirement is consistent with the requirement in IAS 1 to disclose separately the nature and amount of material items of income and expense. Either the size or the nature of an item, or a combination of both, could determine whether an item is material.

IFRS 3 does not give examples of circumstances where such disclosures might be necessary. The following situations might warrant disclosure: Abnormal trading margins resulting from the revaluation of inventories to fair values on acquisition. Material gains resulting from the acquirer turning a loss-making longterm contract into a profitable contract. Material gains or losses resulting from contingent assets or liabilities crystallising at amounts that are different from their attributed fair values.

Gains on the disposal of non-current assets acquired in the business combination but not retained by the continuing group. There is no specific requirement in IFRS 3 to disclose the post-combination costs incurred in reorganising, restructuring and integrating the acquisition. Such costs might fall to be disclosed under the requirements of IAS 19 or IAS 37.

If not captured by specific standards, such costs, if material, are required to be disclosed separately under IAS 1. Paragraph 98 of IAS 1 includes the restructuring of an entity’s activities as a situation giving rise to separate disclosure.

Asset acquisitions

Determining the cost of an asset acquisition

IFRS 3 contains no specific guidance on how the cost of the acquisition of a group of assets should be determined. Generally, the cost of the transaction is measured at the fair value of the consideration transferred. This will include cash payments made to the seller, and the fair value of any financial liabilities incurred. Standards such as IAS 2, IAS 16, IAS 38 and IAS 40 include transaction costs as part of the overall cost. Transaction costs that deal with the accounting for assets are generally included within the cost of the transaction where a group of assets is purchased. To the extent that equities are issued, the measurement principles of IFRS 9 and IFRS 2 might apply. Non-monetary assets might be exchanged as part of the consideration for the transaction. The cost of an item acquired in exchange for a non-monetary asset or assets is generally measured at fair value, unless certain exceptions apply.

Measurement of an asset acquisition

An entity acquires a custom, special-purpose machine and a patent in exchange for C1,000 cash and a warehouse facility. The fair value of the warehouse facility is C600 and its carrying value is C100. The fair values of the special-purpose machine and patent are estimated to be C750 and C1,250 respectively. The special-purpose machine and patent relate to a product that has recently been commercialised. The market for this product is developing and uncertain.

Assume that the entity incurred no transaction costs. For the purpose of this example, the tax consequences on the gain have been ignored.

How is the transaction accounted for?

The cost of the asset acquisition is determined based on the fair value of the assets given, unless the fair value of the assets received is more reliably determinable. The entity concludes that the fair value measurement of the warehouse facility is more reliable than the fair value estimate of the special-purpose machine and patent. The fair value of this consideration given is attributed to the individual assets, based on their relative estimated fair values. Therefore, the entity records the acquisition of the special-purpose machine and patent as C1,600 (that is, the total fair value of the consideration transferred).

The entity records a C500 gain, for the difference between the fair value and the carrying value of the warehouse facility. The special-purpose machine and patent are recorded at their relative fair values. The entry to record the transaction would be:

Dr Machine 600

Dr Patent 1,000

Cr Cash 1,000

Cr Warehouse facility 100

Cr Gain on acquisition 500

The machine is recorded at its relative fair value ((C750 ÷ C2,000) × C1,600 = C600). The patent is recorded at its relative fair value ((C1,250 ÷ C2,000) × C1,600 = C1,000).

Differences in accounting for business combinations and asset acquisitions

Reference to standard:

The following chart describes the more common areas where differences in accounting arise between a business combination and an asset acquisition:

Business combination Acquisition of group of assets

Deferred tax accounting

Deferred taxes are recorded on most temporary book/tax differences of assets acquired and liabilities assumed in a business combination. IFRS prohibits recognition of deferred taxes for temporary differences that arise on recording an asset or liability in a transaction that (i) is not a business combination, and (ii) affects neither accounting nor taxable income. [IAS 12 para 15]. Accordingly, no deferred taxes are recognised for book/tax differences on asset acquisitions.

Assembled workforce

An assembled workforce does not qualify as an identifiable intangible asset to be recognised separately from goodwill.

Under IFRS, an entity usually has insufficient control over the expected future economic benefits arising from its workforce to meet the definition of an intangible asset. amount of income recognised in accordance with the principles of IFRS 15. an intangible asset.

A workforce generally does not qualify as an identifiable intangible asset. Additionally, if a workforce is present, it is likely that the group of acquired assets will qualify as a business. Accounting for the classification of a lease Classification of a lease contract as an operating or a finance lease (only for the lessor under IFRS 16) is based on the contractual terms at the inception of the contract, or at the date of modification if the terms have been changed in a manner that would change classification.

Classification of leases should be reassessed, based on facts and circumstances, because no specific guidance is provided under IFRS. Situations where the fair value of the assets acquired and liabilities assumed exceeds the fair value of consideration transferred (referred to as ‘bargain purchases’) If the fair value of the assets acquired and liabilities assumed exceeds the fair value of the consideration transferred (plus the amount of non-controlling interest and the fair value of the acquirer’s previously held equity interests in the acquiree), a gain is recognised by the acquirer. [IFRS 3 para 34]. The assets acquired and liabilities assumed are measured using an allocation of the fair value of consideration transferred, based on relative fair values. As a result, no gain is recognised for a bargain purchase.

Contingent consideration

Contingent consideration is recorded at fair value on the date of acquisition. Subsequent changes in the fair value of contingent consideration not classified as equity are recorded in profit or loss until settled. Contingent consideration is generally recorded at fair value on the date of purchase. An accounting policy election could be made, to record the subsequent changes in fair value against the asset’s cost (IAS 16) or in profit or loss (IFRS 9). Indemnifications Indemnification assets are recognised and measured based on the related indemnified item. Indemnifications provided outside a business combination are generally measured at fair value.

Measurement of non-controlling interest

Non-controlling interest is measured at either fair value or the non-controlling interest’s proportionate share in the recognised amounts of the acquiree’s identifiable net assets.

There is no guidance outside a business combination on the measurement of non-controlling interest.

Remeasurement of a previously held noncontrolling interest

On the acquisition date, the change in the previously held equity interest in the acquiree is remeasured at fair value. The acquirer recognises an unrealised gain or loss in profit or loss based on the remeasurement of the There is no guidance outside a business combination requiring the remeasurement of a previously held interest. based on the remeasurement of the previously held interest.

Settlement of pre-existing relationships

A pre-existing relationship can be contractual or non-contractual. There is no guidance outside a business combination on the settlement of a pre-existing relationship. Settlement gains and losses are generally recognised through profit and loss. The settlement of a contractual relationship is measured as the lesser of the amount the contract terms are favourable/unfavourable and the amount of any stated settlement provisions in the contract.

Effective date and transition

Contingent consideration in business combinations before 2009

Under IFRS 3 (superseded), any subsequent changes in contingent consideration will continue to be treated as an adjustment to the combination’s cost, and thus goodwill, until the amount of consideration is finally determined. [IFRS 3 (superseded) para 34]. Although the scope exception in  for contingent consideration has been removed from , as part of its 2010 improvements to IFRSs, the IASB has amended IFRS 3 to clarify that the guidance in  and IFRS 9, IAS 32 and IFRS 7 will not apply to contingent consideration arising from business combinations with an effective date before the application of the revised version of IFRS 3.

Deferred tax originated in business combinations before 2009

Deferred tax assets relating to business combinations that took place under IFRS 3 (superseded), that are recognised after IFRS 3 applies, should be recognised in accordance with paragraph 68 of IAS 12, as amended by IFRS 3. Recognition of deferred tax assets from past business combinations does not adjust goodwill. Instead, any changes in such assets should be recognised in profit or loss or other comprehensive income. [IFRS 3 para 67]. [IAS 12 The settlement of a non-contractual relationship is measured at fair value on the acquisition date. Any gain or loss on settlement is recognised in the income statement.