Enquiry:

Common Control

Percentage of Shareholding in ‘z’
A = 3.19%
B = 11.18%
C = 18.44%

Percentage of Shareholding of ‘A’ in B = 50.01 %
Percentage of Shareholding of ‘A’ in C = 60.25 %

Total Direct & Indirect Shareholding of A’ in ‘z’= 19.14%

The question arises whether this constitutes Business Combinations under Common Control (BCUCC)?

The issues related to BCUCC are still at the discussion stage at IASB (refer to IFRS – Staff Paper of September 2013). IFRS – Staff Paper also refers to the discussion paper of European Financial Reporting Advisory Group – EFRAG.

IFRS – Staff Paper suggests that the scope of ‘common control’ could possibly be restricted to transactions within a group controlled by a single ultimate parent entity.

There also suggestions that control is only possible if the subsidiaries are wholly owned subsidiaries.

ACCOUNTING PRACTICES

Both the above referred discussion papers acknowledge prevalent diverse accounting treatments. These include Acquisition Method, Predecessor Accounting (Purchase Method & Pooling of Interests) and Fresh Start Accounting.

It was also suggested by many respondents to the discussion paper of EFRAG that diversity in accounting treatment was not necessarily undesirable.

In the bifurcation and subsequent merger under consideration all requirements of the Purchase Method were applied which also conforms with the acquisition method with the exception of creation of Capital Reserve.

APPLICATION OF IAS-8

lAS 8 Para 10, 11 & 12 ‘Applying Changes in Accounting Policies’ stipulates:

Para-10: In absence of an IFRS that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy that results in information that is.
a) Relevant to the economic decision making needs of the users, and
b) Reliable, in that financial statements.’

i.  Represent faithfully the financial position, financial performance and cash flow of the entity,
ii. Reflect the economic substance of transactions, other events and conditions and not merely the legal form,
iii. Are neutral i.e. free from bias,
iv. Are prudent, and
v.  Are complete in all material respects.

Para-11: In making the judgement described in paragraph 10 management shall refer to and consider the applicability of the following sources in descending order:

a) The requirements in IFRSs dealing with similar or related issues, and
b) The definition, recognition criteria measurement concepts for assets and liabilities, income and expenses in the ‘Framework’.

Para-12: In making the judgment described in paragraph 10 management MAY also consider the most recent pronouncements of other standard-setting bodies that use a SIMILAR CONCEPTUAL FRAMEWORK to develop accounting standards, other accounting literature and accepted industry practice, to the extent that these do not conflict with the sources in paragraph 11 .

If you examine the Economic Substance particularly in the case of Company ‘B’ & ‘C’, assets and liabilities were transferred to them in lieu of investments already in ‘Z’. As such the excess of net assets transferred to ‘B’ & ‘C’, has to be recognized as gain on disposal of investments.

Some practicing firms advocate the application of US GAAP in accordance with Para 12 of IAS-8. My objection to the same is that till US GAAP is totally converged there are a lot of differences between US GAAP & IFRSs. US GAAP doesn’t even recognize the Revaluation Model, the very essence of Business Combinations.

As such there is no justification to equate US GAAP as Similar Conceptual Framework and the same should not be applied.

We shall we grateful to provide technical opinion on the above referred matters. We also seek the opinion of the Technical Committee on application of US GAAP.

Opinion:

The Committee considered both of your enquiries and concurs with your views that that in the absence of IFRS that specifically applies to any transaction, it is necessary for an accounting policy to be developed in accordance with the guidance given in para 8 to 10 of IAS 8.

For transactions which have economic substance, because IFRS does not specify the accounting approach to be followed, an entity should select one of the following two approaches as an accounting policy choice to be applied consistently to all business combinations involving entities under common control:

• The acquisition method (as set out in IFRS 3), or
• Book value accounting (often referred to as the ‘pooling of interests’ method).

The acquisition method is only available if a business combination involving entities under common control has economic substance. If a transaction does not have economic substance, then acquisition accounting is not appropriate and book value accounting is followed instead. Careful consideration needs to be given to whether a common control transaction has economic substance, from the perspectives of all entities involved. This is because it is possible for a business combination under common control to be undertaken at the direction of a parent entity, and not because there is a substantive transaction with an unrelated third party. Factors to consider include:

• The purpose of the transaction
• Whether the transaction price is at fair value (when the transaction is not effected through the issue of equity shares)
• The activities of the entities involved in the transaction.

For substantive transactions, the rationale for applying IFRS 3 would be that, although it is part of a group of entities under common control, the acquirer is still a separate entity in its own right. The rationale for book value accounting would be that the business has simply been moved from one part of a group of entities under common control to another. Because business combinations involving entities under common control typically arise from businesses being moved around a group as part of a restructuring, to effect a tax planning arrangement, or in preparation for the sale or listing of part of an existing group, it is likely that the appropriate approach will be to use book value accounting.

Based on information provided to us, the Committee is of the view that there is no economic substance in this transaction. Further, in either case the gain arising on such business combination would go to equity and will not be recognized in P&L.

With regard to your query regarding application of US GAAP, the Committee believes that it is matter of judgment of the management of the Company to decide which similar conceptual framework or other accepted industry practices to be used which is best appropriate with the scenario, to the extent that it is not in conflict with paragraph 11 of IAS 8.

(June 27, 2014)