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January 2015

Ind -AS Carve Out – Recognition of bargain purchase gain and common control transactions

By Dolphy D’Souza Chartered Accountant
Reading Time 7 mins
Recognition of bargain purchase gain
3 requires bargain purchase gain arising on business combination to be
recognised in profit or loss. However, a careful analysis is required to
determine whether a gain truly exists. Ind-AS 103 (draft) requires the
same to be recognised in other comprehensive income (OCI) and
accumulated in equity as capital reserve. However, if there is no clear
evidence for the underlying reason for classification of the business
combination as a bargain purchase, then the gain should be recognised
directly in the equity as capital reserve. Ind-AS’s are still in draft
stage and a final version may be available even before this article is

Technical perspective
Arguments against this carve out are as follows:

An economic gain is inherent in a bargain purchase. At the acquisition
date, the acquirer is better off by the amount by which the fair value
of the acquired business exceeds the fair value of the consideration
paid. In concept, the acquirer should recognise this gain in its profit
or loss.

(b) We appreciate that appearance of a bargain
purchase, particularly, without any evidence of the underlying reasons,
will raise concerns about the existence of measurement errors. IFRS 3
have addressed these concerns by requiring the acquirer to review
procedures used to measure the amounts to be recognised at the
acquisition date. Moreover, concerns regarding measurement
errors/potential abuse may not be sufficient reason to reject
technically correct accounting treatment.

(c) The application of
Ind-AS carve-out implies that whilst an entity recognises bargain
purchase gain directly in OCI, it will recognise depreciation,
amortisation or impairment of assets acquired in profit or loss for the
subsequent periods based on the fair valuation of the assets taken over.
This creates a mismatch between items recognised in profit or loss and
those recognized in OCI. Also, it may adversely impact divided paying
capacity of companies.

To avoid such mismatches and to protect
their future profit or loss/distributable reserves, certain entities may
attempt to notionally reduce the fair value of the assets acquired and
avoid bargain purchase gain scenario. The ICAI has made this carve-out
to avoid potential abuse; however, it may actually end up doing the

(d) Concerns about abuse resulting from gain
recognition may be exaggerated. Our experience and interactions with
financial analysts and other users suggest that they give little weight,
if any, to one-time or unusual gains, such as those resulting from a
bargain purchase transaction. In addition, we believe that entities
would have a disincentive to overstate assets acquired or understate
liabilities assumed in a business combination because that generally
results in higher post-combination expenses, i.e., when the assets are
used or become impaired or liabilities are re-measured or settled.

believe that Ind-AS 103 should require bargain purchase gain arising on
business combination to be recognised in profit or loss both for
acquisition of subsidiaries and associates. In any case, we do not
believe that this is a major issue, and making a carve-out for this
matter seems unwarranted.

Accounting for common control transactions
3 excludes from its scope business combinations of entities under
common control and provides no further guidance on how common control
transactions are accounted for. Based on prevailing practices, an entity
may account for such combination by applying either the acquisition
method (in accordance with IFRS 3) or the pooling of interests method.
The selected accounting policy is applied consistently. However, where
an entity selects the acquisition method of accounting, the transaction
must have substance from the perspective of the reporting entity.

103 requires business combinations under common control to be
mandatorily accounted using the pooling method. The application of this
method requires the following:

(i) The assets and liabilities of the combining entities are reflected at their carrying amounts.
No adjustments are made to reflect fair values, or recognise any new
assets or liabilities. The only adjustments that are made are to
harmonize the accounting policies.
(iii) The financial information
in the financial statements in respect of prior periods have to be
restated as if the combination had occurred from the beginning of the
earliest period presented in the financial statements, irrespective of
the actual date of the combination.
(iv) Ind-AS 103 originally
hosted on the MCA website required that excess of the amount recorded as
share capital issued plus any additional consideration in form of cash
or other assets given by the transferee entity over the amount of share
capital of the transferor company is recognised as goodwill.

an exposure draft of amendment to Ind-AS 103 proposes that any
difference between the consideration paid and share capital of the
transferor should be transferred to separate component of equity, viz.,
“Common Control Transaction Capital Reserve.” Ind-AS’s are still in
draft stage and a final version may be available even before this
article is published.

Though there is no IFRS standard that
deals with common control transactions, global practice is to account
them using the pooling method; and in case where the common control
transaction has substance acquisition accounting is permitted.

Technical perspective
does not deal with the pooling method. However, it was dealt with in
the erstwhile IAS 22 Business Combinations. Both US and UK GAAP also
provide guidance on the pooling method. Interestingly, neither of these
standards nor AS 14 Accounting for Amalgamations under Indian GAAP allow
any new goodwill to be recognized in the pooling method. Any excess
consideration paid to the erstwhile shareholders of the transferee is a
transaction between the shareholders and reflected directly in the
equity. Thus, goodwill accounting required by original Ind- AS 103 was
contrary to the basic principle of the pooling method. Hence, we agree
that the change proposed in the ED reflects better application of the
pooling method. Despite the proposed correction, we have the following
concerns on accounting for common control business combination
prescribed in Ind-AS 103.

(a) I n our view, it is not
appropriate to mandate the pooling method for all common control
business combinations. In practice, many groups enter into these
transactions as part of their IPO plans. Post IPO, there will be
significant non-controlling interest in the combined entity. In such
cases, companies typically prefer applying the acquisition method to the
common control business combination. However, it may not be possible
under Ind-AS 103.

(b) T he pooling method as discussed in Ind-AS
103 is applicable only to accounting for common control business
combinations. It is not applicable to accounting for transfer between
common control entities of assets/ liabilities not constituting

(c) Whilst Ind-AS 103 requires common control business
combinations to be accounted for using the pooling method, it is not
clear whether the same principles also apply to acquisition of an
associate/ joint venture from an entity under common control.

Our preferred view is that at this juncture, the ICAI should not address common control business combination accounting     in     Ind-AS    103.    Rather,     there     is     sufficient    global precedence to rely upon. however, this approach is not suitable for the long term.  it may be noted that the IASB is developing a separate  IFRS for common control transactions. the ICAI should work with the IASB on the     proposed     IFRS     to     address     India     specific     concerns.      Alternatively, the  ICAI should develop a temporary  
standard, but ensure that the same is in line with current global practice.

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