Accounting Standards
In some business combinations, commonly referred to as
reverse acquisitions, the acquirer is the entity whose equity interests have
been acquired and the issuing entity is the acquiree. This might be the case
when, for example, a private entity arranges to have itself ‘acquired’ by a
smaller public entity as a means of obtaining a stock exchange listing. Although
legally the issuing public entity is regarded as the parent and the private
entity is regarded as the subsidiary, the legal subsidiary is the acquirer if it
has the power to govern the financial and operating policies of the legal parent
so as to obtain benefits from its activities. Commonly the acquirer is the
larger entity.
Example :
A Ltd. a big private company wants to become a public entity,
but does not want to register its equity shares. In order to accomplish that, A
Ltd. gets itself acquired by B Ltd., a smaller public entity.
|
A
Ltd.
|
B
Ltd.
|
Private company Legal
subsidiary Accounting acquirer |
Public company Legal
holding Accounting acquiree |
Under International Financial Reporting Standard-3, in a
reverse acquisition, the cost of the business combination is deemed to have been
incurred by the legal subsidiary (i.e., the acquirer for accounting
purposes) in the form of equity instruments issued to the owners of the legal
parent (i.e., the acquiree for accounting purposes). If the published
price of the equity instruments of the legal subsidiary is used to determine the
cost of the combination, a calculation shall be made to determine the number of
equity instruments the legal subsidiary would have had to issue to provide the
same percentage ownership interest of the combined entity to the owners of the
legal parent as they have in the combined entity as a result of the reverse
acquisition. The fair value of the number of equity instruments so calculated
shall be used as the cost of the combination.
Example
Balance sheet before business combination
| |
C (CU) |
D (CU) |
Net
Assets |
1,100 |
2,000 |
Total |
1,100
|
2,000 |
Equity |
100 shares
|
300 |
| |
60 Shares
|
600 |
Retained Earning |
800 |
1,400 |
Total |
1,100
|
2,000 |
C issues 2.5 shares in exchange for each ordinary share of D.
Therefore C issues 150 shares in exchange of all 60 shares of D. Therefore,
legally C is the acquirer. However, C is in substance an accounting acquiree
(assume). Fair value of one equity share of D at date of acquisition is Currency
Units (CU) 50. Fair value of C’s identifiable net assets as at date of
acquisition is CU1,300.
Response :
- In the exchange, D’s shareholders own 60% of the combined entity (150/250).
- If the business combination would have taken place in the form of D issuing equity to shareholders of C, in the same exchange ratio, it would have issued 40 shares (i.e., 100/2.5).
- Thus, cost of business combination would be CU2000 (40 X CU50).
- Goodwill = CU2000 — CU1300, i.e., CU700.
- Consolidated Balance sheet of C Limited & Group after the acquisition:
Consolidated financial statements prepared following a reverse acquisition shall be issued under the name of the legal parent, but described in the notes as a continuation of the financial statements of the legal subsidiary (i.e., the acquirer for accounting purposes). Because such consolidated financial statements represent a continuation of the financial statements of the legal subsidiary:
(a) the assets and liabilities of the legal subsidiary shall be recognised and measured in those consolidated financial statements at their pre-combination carrying amounts.
(b) the retained earnings and other equity balances recognised in those consolidated financial statements shall be the retained earnings and other equity balances of the legal subsidiary immediately before the business combination.
(c) the amount recognised as issued equity instruments in those consolidated financial statements shall be determined by adding to the issued equity of the legal subsidiary immediately before the business combination the cost of the combination. However, the equity structure appearing in those consolidated financial statements (i.e., the number and type of equity instruments issued) shall reflect the equity structure of the legal parent, including the equity instruments issued by the legal parent to effect the combination.
(d) comparative information presented in those consolidated financial statements shall be that of the legal subsidiary.
As can be seen from the above, the accounting for reverse acquisition under IFRS is based on identifying the true acquirer. Goodwill is determined on the basis that the accounting acquiree is fair valued, considering the accounting acquirer has paid the consideration. Indian GAAP does not recognise the concept of reverse acquisition at all, and hence it is high time that Indian GAAP adopts IFRS-3 standard on business combination.
