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4 IFRS 3 (revised) and IFRS 13: Fair values

4 IFRS 3 (revised) and IFRS 13: Fair values

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Solution

The highest and best use of the land would be determined by comparing both of the following:

(a)



The value of the land as currently developed for industrial use (ie the land would be used in

combination with other assets, such as the factory, or with other assets and liabilities).



(b)



The value of the land as a vacant site for residential use, taking into account the costs of

demolishing the factory and other costs (including the uncertainty about whether the entity would

be able to convert the asset to the alternative use) necessary to convert the land to a vacant site

(ie the land is to be used by market participants on a stand-alone basis).



The highest and best use of the land would be determined on the basis of the higher of those values.



Example: Research and development project

Searcher has a research and development (R & D) project in a business combination. Searcher does not

intend to complete the project. If completed, the project would compete with one of its own projects (to

provide the next generation of the entity's commercialised technology). Instead, the entity intends to hold

(ie lock up) the project to prevent its competitors from obtaining access to the technology. In doing this

the project is expected to provide defensive value, principally by improving the prospects for the entity's

own competing technology.

If it could purchase the R & D project, Developer Co would continue to develop the project and that use

would maximise the value of the group of assets or of assets and liabilities in which the project would be

used (ie the asset would be used in combination with other assets or with other assets and liabilities).

Developer Co does not have similar technology.

How would the fair value of the project be measured?



Solution

The fair value of the project would be measured on the basis of the price that would be received in a

current transaction to sell the project, assuming that the R & D would be used with its complementary

assets and the associated liabilities and that those assets and liabilities would be available to Developer

Co.



Example: Decommissioning liability

Deacon assumes a decommissioning liability in a business combination. It is legally required to dismantle

a power station at the end of its useful life, which is estimated to be twenty years.

How would the decommissioning liability be measured?



Solution

Because this is a business combination, Deacon must measure the liability at fair value in accordance with

IFRS 13, rather than using the best estimate measurement required by IAS 37 Provisions, contingent

liabilities and contingent assets.

Deacon will use the expected present value technique to measure the fair value of the decommissioning

liability. If Deacon were contractually committed to transfer its decommissioning liability to a market

participant, it would conclude that a market participant would use all of the following inputs, probability

weighted as appropriate, when estimating the price it would expect to receive.

(a)



Labour costs



(b)



Allocated overhead costs



(c)



The compensation that a market participant would generally receive for undertaking the activity,

including profit on labour and overhead costs and the risk that the actual cash outflows might differ

from those expected



(d)



The effect of inflation



(e)



The time value of money (risk-free rate)



(f)



Non-performance risk, including Deacon’s own credit risk



Part C Group financial statements  12: Revision of basic groups



371



As an example of how the probability adjustment might work, Deacon values labour costs on the basis of

current marketplace wages adjusted for expected future wage increases. It determines that there is a 20%

probability that the wage bill will be $15 million, a 30% probability that it will be $25 million and a 50%

probability that it will be $20 million. Expected cash flows will then be (20% × $15m) + (30% × $25m) +

(50% × $20m) = $20.5m. The probability assessments will be developed on the basis of Deacon’s

knowledge of the market and experience of fulfilling obligations of this type.



3.4.2 Restructuring and future losses

An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a

result of the business combination.

IFRS 3 (revised) explains that a plan to restructure a subsidiary following an acquisition is not a present

obligation of the acquiree at the acquisition date. Neither does it meet the definition of a contingent

liability. Therefore, an acquirer should not recognise a liability for such a restructuring plan as part of

allocating the cost of the combination unless the subsidiary was already committed to the plan before the

acquisition.

This prevents creative accounting. An acquirer cannot set up a provision for restructuring or future

losses of a subsidiary and then release this to profit or loss in subsequent periods in order to reduce

losses or smooth profits.



3.4.3 Intangible assets

The acquiree may have intangible assets, such as development expenditure. These can be recognised

separately from goodwill only if they are identifiable. An intangible asset is identifiable only if it:

(a)



Is separable, ie capable of being separated or divided from the entity and sold, transferred, or

exchanged, either individually or together with a related contract, asset or liability, or



(b)



Arises from contractual or other legal rights.



3.4.4 Contingent liabilities

Contingent liabilities of the acquiree are recognised if their fair value can be measured reliably. A

contingent liability must be recognised even if the outflow is not probable, provided there is a present

obligation.

This is a departure from the normal rules in IAS 37; contingent liabilities are not normally recognised, but

only disclosed.

After their initial recognition, the acquirer should measure contingent liabilities that are recognised

separately at the higher of:

(a)



The amount that would be recognised in accordance with IAS 37



(b)



The amount initially recognised



3.4.5 Other exceptions to the recognition or measurement principles



372



(a)



Deferred tax: use IAS 12 values.



(b)



Employee benefits: use IAS 19 values.



(c)



Indemnification assets: measurement should be consistent with the measurement of the

indemnified item, for example an employee benefit or a contingent liability.



(d)



Reacquired rights: value on the basis of the remaining contractual term of the related contract

regardless of whether market participants would consider potential contractual renewals in

determining its fair value.



(e)



Share-based payment: use IFRS 2 values.



(f)



Assets held for sale: use IFRS 5 values.



12: Revision of basic groups  Part C Group financial statements



Question



Fair values



Tyzo Co prepares accounts to 31 December. On 1 September 20X7 Tyzo Co acquired six million $1 shares

in Kono Co at $2.00 per share. At that date Kono Co produced the following interim financial statements.

Non-current assets

Property, plant and

equipment (Note 1)

Current assets

Inventories (Note 2)

Receivables

Cash and cash equivalents

Total assets

Equity and liabilities

Equity

Share capital ($1 shares)

Reserves

Non-current liabilities

Long-term loans

Current liabilities

Trade payables

Provision for taxation

Bank overdraft

Total equity and liabilities



$'000

16.0

4.0

2.9

1.2

8.1

24.1



8.0

4.4

12.4

4.0



3.2

0.6

3.9

(7.7)

24.1



Notes

(a)



The following information relates to the property, plant and equipment of Kono Co at 1 September

20X7.

$m

Gross replacement cost

28.4

Net replacement cost

16.6

Economic value

18.0

Net realisable value

8.0

The property, plant and equipment of Kono Co at 1 September 20X7 had a total purchase cost to

Kono Co of $27.0 million. They were all being depreciated at 25 per cent per annum pro rata on

that cost. This policy is also appropriate for the consolidated financial statements of Tyzo Co. No

non-current assets of Kono Co which were included in the interim financial statements drawn up as

at 1 September 20X7 were disposed of by Kono Co prior to 31 December 20X7. No non-current

asset was fully depreciated by 31 December 20X7.



(b)



The inventories of Kono Co which were shown in the interim financial statements are raw materials

at cost to Kono Co of $4 million. They would have cost $4.2 million to replace at 1 September

20X7. Of the inventory of Kono Co in hand at 1 September 20X7, goods costing Kono Co

$3.0 million were sold for $3.6 million between 1 September 20X7 and 31 December 20X7.



(c)



On 1 September 20X7 Tyzo Co took a decision to rationalise the group so as to integrate Kono Co.

The costs of the rationalisation were estimated to total $3.0 million and the process was due to

start on 1 March 20X8. No provision for these costs has been made in any of the financial

statements given above.



Part C Group financial statements  12: Revision of basic groups



373



(d)



It is the group’s policy to value the non-controlling interests at its proportionate share of the fair

value of the subsidiary’s net assets.



Required

Compute the goodwill on consolidation of Kono Co that will be included in the consolidated financial

statements of the Tyzo Co group for the year ended 31 December 20X7, explaining your treatment of the

items mentioned above. You should refer to the provisions of relevant accounting standards.



Answer

Goodwill on consolidation of Kono Co



$m



Consideration ($2.00  6m)

Non-controlling interest (13.2m × 25%)

Group share of fair value of net assets acquired

Share capital

Pre-acquisition reserves

Fair value adjustments

Property, plant and equipment (16.6 – 16.0)

Inventories (4.2 – 4.0)



8.0

4.4

$m



$m

12.0

3.3

15.3



$m



0.6

0.2



Goodwill



(13.2)

2.1



Notes on treatment

(a)



Share capital and pre-acquisition profits represent the book value of the net assets of Kono Co at

the date of acquisition. Adjustments are then required to this book value in order to give the fair

value of the net assets at the date of acquisition. For short-term monetary items, fair value is their

carrying value on acquisition.



(b)



IFRS 3 (revised) states that the fair value of property, plant and equipment should be measured by

market value or, if information on a market price is not available (as is the case here), then by

reference to depreciated replacement cost, reflecting normal business practice. The net

replacement cost (ie $16.6m) represents the gross replacement cost less depreciation based on

that amount, and so further adjustment for extra depreciation is unnecessary.



(c)



IFRS 3 (revised) also states that raw materials should be valued at replacement cost. In this case

that amount is $4.2m.



(d)



The rationalisation costs cannot be reported in pre-acquisition results under IFRS 3 (revised) as

they are not a liability of Kono Co at the acquisition date.



3.5 Goodwill arising on acquisition

Goodwill should be carried in the statement of financial position at cost less any accumulated

impairment losses. The treatment of goodwill is covered in detail in Chapter 3.



3.6 Adjustments after the initial accounting is complete

Sometimes the fair values of the acquiree's identifiable assets, liabilities or contingent liabilities or the cost

of the combination can only be measured provisionally by the end of the period in which the

combination takes place. In this situation, the acquirer should account for the combination using those

provisional values. The acquirer should recognise any adjustments to those provisional values as a

result of completing the initial accounting:



374



12: Revision of basic groups  Part C Group financial statements



(a)

(b)



Within twelve months of the acquisition date, and

From the acquisition date (ie, retrospectively)



This means that:

(a)



The carrying amount of an item that is recognised or adjusted as a result of completing the initial

accounting shall be calculated as if its fair value at the acquisition date had been recognised from

that date.



(b)



Goodwill should be adjusted from the acquisition date by an amount equal to the adjustment to

the fair value of the item being recognised or adjusted.



Any further adjustments after the initial accounting is complete should be recognised only to correct an

error in accordance with IAS 8 Accounting policies, changes in accounting estimates and errors. Any

subsequent changes in estimates are dealt with in accordance with IAS 8 (ie, the effect is recognised in the

current and future periods). IAS 8 requires an entity to account for an error correction retrospectively, and

to present financial statements as if the error had never occurred by restating the comparative information

for the prior period(s) in which the error occurred.



3.6.1 Reverse acquisitions

IFRS 3 (revised) also addresses a certain type of acquisition, known as a reverse acquisition or takeover.

This is where Company A acquires ownership of Company B through a share exchange. (For example, a

private entity may arrange to have itself 'acquired' by a smaller public entity as a means of obtaining a

stock exchange listing.) The number of shares issued by Company A as consideration to the shareholders

of Company B is so great that control of the combined entity after the transaction is with the shareholders

of Company B.

In legal terms Company A may be regarded as the parent or continuing entity, but IFRS 3 (revised) states

that, as it is the Company B shareholders who control the combined entity, Company B should be treated

as the acquirer. Company B should apply the acquisition (or purchase) method to the assets and liabilities

of Company A.



3.7 ED Measuring quoted investments in subsidiaries, joint ventures and

associates at fair value

This exposure draft was published in September 2014, and contains proposals concerning the

measurement of investments in subsidiaries, joint ventures and associates at fair value when those

investments are quoted in an active market.

The proposed amendments are to IFRS 10 Consolidated financial statements, IFRS 12 Disclosure of

interests in other entities, IAS 27 Separate financial statements, IAS 28 Investments in associates and joint

ventures, IAS 36 Impairment of assets and IFRS 13 Fair value measurement.

Level 1 inputs in IFRS 13 should be prioritised even when those inputs do not correspond to the unit of

account of the asset measured (the investment as a whole). The proposed amendments clarify that an

entity should measure the fair value of quoted investments and quoted cash-generating units as the

product of the quoted price for the individual financial instruments that make up the investments held

by the entity and the quantity of financial instruments.



3.7.1 Specific amendments

The following IFRS/IAS would be amended.

(a)



IFRS 10 Consolidated financial statements. When an investment entity has an investment in a

subsidiary that is quoted in an active market, its fair value must be the product of the quoted price

multiplied by the quantity of the financial instruments that make up the investment without

adjustment.



(b)



IAS 27 Separate financial statements. When an entity accounts for its investments in

subsidiaries, joint ventures and associates at fair value and those investments are quoted in an



Part C Group financial statements  12: Revision of basic groups



375



active market, their fair value must be the product of the quoted price multiplied by the quantity of

the financial instruments that make up the investments without adjustment.

(c)



IAS 28 Investments in associates and joint ventures. As (a), above, when an entity measures its

investments in associates or joint ventures at fair value and those investments are quoted in an

active market.



(d)



IFRS 12 Disclosure of interests in other entities. As (a), above.



(f)



IAS 36 Impairment of assets. This proposed amendment is relevant to cash-generating units.

When the cash-generating unit is an investment in a subsidiary, joint venture or associate that is

quoted in an active market its fair value must be the product of the quoted price multiplied by the

quantity of the financial instruments that make up the investment without adjustment.



(e)



IAS 13 Fair value measurement. An illustrative example would be added showing the application

of the exception in paragraph IFRS 13.48 to a group of financial assets and financial liabilities

whose market risks are substantially the same and whose fair value measurement is categorised

within Level 1 of the fair value hierarchy.



4 IAS 28 Investments in associates and joint ventures

12/14

FAST FORWARD



IAS 28 deals with accounting for associates and joint ventures. The definitions are important as they

govern the accounting treatment, particularly 'significant influence' and 'joint control'.

IFRS 11 (see Chapter 13) and IAS 28 require joint ventures to be accounted for using the equity method.

We looked at investments in associates briefly in Section 1. IAS 28 Investments in associates and joint

ventures covers this type of investment. IAS 28 does not apply to investments in associates or joint

ventures held by venture capital organisations, mutual funds, unit trusts, and similar entities. Those

investments may be measured at fair value through profit or loss in accordance with IFRS 9.

In this section we will focus on associates. The criteria that exist to identify a joint venture will be covered in

Chapter 13, although the method for accounting for a joint venture is identical to that used for associates.

Some of the important definitions in Section 1 are repeated here, with some additional important terms.



Key terms



Associate. An entity, including an unincorporated entity such as a partnership, over which an investor has

significant influence and which is neither a subsidiary nor a joint venture of the investor.

Significant influence is the power to participate in the financial and operating policy decisions of an

economic activity but is not control or joint control over those policies.

Joint control is the contractually agreed sharing of control over an economic activity.

Equity method. A method of accounting whereby the investment is initially recorded at cost and adjusted

thereafter for the post acquisition change in the investor's share of net assets of the investee. The profit or

loss of the investor includes the investor's share of the profit or loss of the investee and the investor’s

other comprehensive income includes its share of the investee's other comprehensive income.

We have already looked at how the status of an investment in an associate should be determined. Go back

to Section 2 to revise it. (Note that, as for an investment in a subsidiary, any potential voting rights

should be taken into account in assessing whether the investor has significant influence over the

investee.)

IAS 28 requires all investments in associates and joint ventures to be accounted for using the equity

method, unless the investment is classified as 'held for sale' in accordance with IFRS 5 in which case it

should be accounted for under IFRS 5 (see Chapter 15).



376



12: Revision of basic groups  Part C Group financial statements



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4 IFRS 3 (revised) and IFRS 13: Fair values

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