Accounting for common control business combinations use of acquisition method? (1)
Entity A currently has two businesses operated through two wholly-owned subsidiaries, Entity B and Entity C. The group structure (ignoring other entities within the group) is as follows:
Entity A proposes to combine the two businesses (currently operated by Entity B and Entity C) into the one entity in anticipation of spinning-off the combined entity as part of an initial public offering (IPO). The purpose of the restructuring was to combine the complementary businesses of Entity C and Entity B into a reporting entity to facilitate common management. Both of the businesses have been owned by Entity A for several years. The internal reconstruction will be structured such that Entity C will acquire the shares of the much smaller Entity B from Entity A for cash at its fair value of £1,000. The carrying value of the net assets of Entity B is £200. This also represents the carrying amount of Entity B “s net assets in the consolidated financial statements of Entity A. The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed of Entity B measured in accordance with IFRS 3 (generally fair values) are £600.
Assuming that the policy is to apply the acquisition method of accounting to such transactions, how should this business combination be accounted for in the consolidated financial statements of both Entity C and Entity A?
As far as Entity C is concerned, there is substance to this transaction from its perspective. There is a business purpose to the transaction; it has been conducted at fair value; both Entity B and Entity C have existing activities; and they have been brought together to create a reporting entity that did not exist before. Accordingly, Entity C can apply the acquisition method of accounting to this transaction in its consolidated financial statements.
Whether Entity C or Entity B is the acquirer depends on an assessment of the facts and circumstances as to which entity has obtained control of the other. If Entity C now controls Entity B, in summary, this will mean that the net of acquisition-date amounts of the identifiable assets acquired and the liabilities assumed of Entity B will be initially reflected at £600, together with goodwill of £400 ( £1,000 less £600), in the consolidated balance sheet. Only the post-acquisition results of Entity B will be reflected in the consolidated income statement.
As far as Entity A is concerned, from the perspective of the Entity A group, there has been no change in the reporting entity all that has happened is that Entity B, rather than being directly held and controlled by Entity A, is now indirectly held and controlled through Entity C. Accordingly, there is no business combination that can be accounted for under the acquisition method. The transaction therefore has no impact on the consolidated financial statements of Entity A. Thus, the carrying amounts for Entity B “s net assets included in those consolidated financial statements do not change.