Chapter 11 Business Combinations Business combinations Groups z

Chapter 11 Business Combinations

Business combinations (Groups) z Most large UK plcs are Groups yi. e. , companies combined together z Anglo-American governance culture favours this means of “growth” z Usually achieved by: yacquisition, or ymerger z Group means Group (consolidated) accounts y. IFRS 3, IFRS 10 Chapter 11 © Philip O’Regan 2016 2

Acquisition z Entity buys shares in others directly or indirectly y. This gives it “an interest” z IFRS 10: a “controlling interest” creates parent/subsidiary relationship = Group z IFRS 10: control exists where one entity has: ypower over investee yexposure or rights to variable returns yability to affect its returns z Typically control = 50%+ of voting rights Chapter 11 © Philip O’Regan 2016 3

Group structures (p. 386) Chapter 11 A B C P plc 100% 51% 25% S 1 plc S 2 plc S 3 plc 51% 80% SS 1 plc SS 2 plc SS 3 plc © Philip O’Regan 2016 4

Group relationships Chapter 11 © Philip O’Regan 2016 5

Acquisition method z IFRS: “Acquisition” method for Group Accounts y. Applies to both acquisitions and mergers y“Merger” method no longer permitted z Acquisition method y. Results of acquired company incorporated into group accounts only from date of acquisition y. Assets and liabilities acquired (including identifiable intangibles) included at fair value y. Excess of consideration over fair value of separable net assets = Goodwill y. Goodwill subject to impairment tests (IAS 36) Chapter 11 © Philip O’Regan 2016 6

Acquisition method ctd. z 2 basic principles: y 1. Amalgamate xe. g. , where P and S have Fixed Assets of £ 150 k and £ 100 k, Group a/cs will show £ 250 k y 2. Cancel out corresponding items xe. g. , where P shows “Investment in S” of £ 200 k and S shows Share Capital of £ 200 k they cancel each other Chapter 11 Financial Information Analysis 7

Acquisition method ctd. z Group Balance Sheet: y. Amalgamate those of parent and subsidiaries y. Partly-owned subsidiary: un-cancelled Share Capital in subsidiary = Non-Controlling Interest y. Revenue Reserves in subsidiary at date of acquisition cannot be distributed y. Goodwill = excess of consideration over fair values of separable net assets Chapter 11 © Philip O’Regan 2016 8

Worked example (p. 391) P plc statement of financial position as at December 31, 20 X 0 S plc statement of financial position as at December 31, 20 X 0 Tangible assets 200, 000 Tangible assets Investment in S plc 100, 000 Net current assets 150, 000 Net current assets 450, 000 100, 000 Share capital 450, 000 Share capital 100, 000 Chapter 11 © Philip O’Regan 2016 50, 000 9

Worked example (p. 391) Chapter 11 © Philip O’Regan 2016 10

Acquisition method ctd. z Consolidated Income Statement: y. Amalgamates those of parent and subsidiaries y. Non-controlling interest’s share of profits must be indicated y. Inter-company dividends will cancel y. Unrealized profits on inter-company trading must be eliminated Chapter 11 © Philip O’Regan 2016 11

Worked example (p. 399) P plc S plc Revenue 600, 000 500, 000 Cost of goods sold 300, 000 320, 000 Profit on activities before tax 300, 000 180, 000 Taxation 100, 000 60, 000 Profit after tax 200, 000 120, 000 Chapter 11 © Philip O’Regan 2016 12

Worked example (p. 399) P plc Revenue (600 + 500 – 80) 1, 020, 000 Cost of goods sold (300 + 320 – 80) 540, 000 Profit on activities before tax 480, 000 Taxation 160, 000 Profit after tax 320, 000 Chapter 11 © Philip O’Regan 2016 13

Associates z Relationships other than parent/subsidiary ye. g. , where interest in another is not sufficient to result in parent/subsidiary z IAS 28 defines Associate as “an entity over which the investor has significant influence” ynormally a 20% interest is sufficient z “Equity accounting” method applies Chapter 11 © Philip O’Regan 2016 14

Equity accounting method z Investor must reflect relationship with Associate in own accounts z Equity accounting method: y. Investment shown as non-current asset y. Goodwill identified and grouped with other goodwill y. Carrying amount adjusted annually for gains, losses y. Share of associate’s profits included in investor’s IS y. Cash-flow statement shows flows between investor and investee Chapter 11 © Philip O’Regan 2016 15

Related party transactions z Not all transactions at “arm’s-length” ye. g. , company granting loan to a director z Such “related party” transactions require disclosure z IAS 24: disclosure of related-party transactions required where, among others: yone party has direct or indirect control of other ytwo parties subject to same source of control yone party has influence over policies of other z Significant disclosure requirements imposed Chapter 11 © Philip O’Regan 2016 16

Summary z Various forms of business combination exist z Relationships possibilities include: yparent/wholly-owned subsidiary yparent/partly-owned subsidiary yinvestor/associate yjoint venture z Accounting method depends on nature of relationship Chapter 11 © Philip O’Regan 2016 17