Background
Appendix C, Business
Combinations of Entities under Common Control of Ind AS 103, Business
Combinations, deals with accounting of common control business
combinations. The assets and liabilities of the combining entities in a common
control business transaction are reflected at their carrying amounts. This is
commonly known as “The pooling of interest method”. Paragraph 9 of Appendix C is reproduced
below.
“9 The pooling of interest method is considered to involve
the following:
(i) The assets and liabilities of the combining entities
are reflected at their carrying amounts.
(ii) No adjustments are made to reflect fair values, or
recognise any new assets or liabilities. The only adjustments that are made are
to harmonise accounting policies.
(iii) ………… “
Issue
An interesting question arises on
the application of the pooling of interest method. The question is whether
the carrying amount of assets and liabilities of the combining entities should
be reflected as per the books of the entities transferred/merged or the
ultimate parent. The standard requires reflecting the business combination
under common control at carrying value of the combining entities. However the
standard is silent about whether the carrying amounts should be those as
reflected in the standalone financial statements of the combining entities or
those as reflected in the consolidated financial statements (CFS) of the parent
or the ultimate parent.
Consider a basic fact pattern. A Ltd. is the parent company
of two subsidiaries, viz., B Ltd. & C Ltd. Consider the following two
Scenarios.
Scenario 1: B Ltd. merges with C Ltd.
Scenario 2: B Ltd. merges with A Ltd.
The question is raised from the perspective of how C Ltd. in
Scenario 1 and A Ltd in Scenario 2 will prepare their post combination
standalone financial statements.
It
may be noted that as far as A Ltd / parent’s CFS is concerned; the merger will
have absolutely no effect. This is because all intra-group transactions should
be eliminated in preparing CFS in accordance with Ind AS 110. The legal merger
of a subsidiary with the parent or legal merger of fellow subsidiaries is an
intra-group transaction and accordingly, will have to be eliminated in the CFS
of the parent or the ultimate parent.
Response
A similar question was raised to
the Ind AS Transition Facilitation Group (ITFG). In responding to the query,
the ITFG made a distinction between Scenario 1 and Scenario 2. The ITFG’s view
is given below.
Scenario 1
Assets and liabilities of
the combining entities are reflected at their carrying amounts. Accordingly, in
the separate financial statements of C Ltd., the carrying values of the assets
and liabilities as appearing in the standalone financial statements of the
entities being combined i.e B Ltd. & C Ltd. shall be recognised.
Scenario 2
In this case, since B Ltd. is merging with A Ltd.
(i.e. parent) nothing has changed and the transaction only means that the
assets, liabilities and reserves of B Ltd. which were appearing in the CFS of
Group A immediately before the merger would now be a part of the separate
financial statements of A Ltd. Accordingly, it would be appropriate to
recognise the carrying value of the assets, liabilities and reserves pertaining
to B Ltd. as appearing in the CFS of A Ltd. Separate financial statements to
the extent of this common control transaction shall be considered as a
continuation of the consolidated group.
Author’s View
The
ITFG has made a distinction between Scenario 1 and Scenario 2. In Scenario 1,
since the parent is not a party to the combination, the standalone financial
statements of C will combine carrying value of assets and liabilities of B and
C as appearing in their standalone financial statements. In Scenario 2, since
the parent is a party to the combination, A Ltd./ the parent’s post combination
financial statements will combine carrying values of A and carrying value of B
as appearing in A’s CFS. In other words, in Scenario 2, the accounting for the
combination is accounted as if, A had acquired B, and merged it with itself
from the very inception.
The logic of two different
approaches for accounting common control business combination based on whether
the parent is a party to the business combination is not absolutely clear.
Further, the logic does not emanate from a reading of the standard. In both
Scenario’s, business under common control are merging. Since the standard is
not clear on which carrying values to be used, the author believes that in both
Scenarios, there should be a clear accounting policy choice of either using
standalone carrying values or those that are reflected in the CFS of the parent
or ultimate parent.
The continuation of the
consolidation group approach should be an accounting policy choice and should
not be made conditional to the parent being a party to the business
combination. Globally under IFRS too,
either methods are acceptable, irrespective of whether a parent is party to the
business combination. Giving up the shares for the underlying assets is
essentially a change in perspective of the parent of its investment, from a
‘direct equity interest’ to ‘the reported results and net assets.’ Hence, the
values recognised in the CFS becomes the cost of these assets for the parent.
If the author’s approach is
considered, other relevant questions as detailed below, and not addressed by
ITFG, may not need any further clarification:
– In Scenario 2, B Ltd does not merge with A
Ltd, but A Ltd. merges with B Ltd.
– In Scenario 2, it is not absolutely clear
whether it is mandatory to use the carrying values of B Ltd as appearing in the
CFS of A or there is a choice to use the carrying values of B Ltd. as appearing
in the standalone financial statements of B Ltd.
The ITFG may provide appropriate clarification.
