IFRS 3, Business combinations – A survival guide to the essentials of takeovers, Part II

Athens, February 2018
Chris Ragkavas, BA, MA, FCCA, CGMA
IFRS technical expert, financial consultant.

Assuming A would value NCI in B at its proportionate value of B’s NAV on the date of acquisition. Goodwill calculation would change to:

Consideration and NCI        $
Share exchange: 75,000 / 5 x 2 = 30,000 x $50 = 1,500,000
Fleet of cars delivered =    320,000
Deferred cash consideration: $ 275,625 / 1,05^2 =    250,000
NCI: 25% x $2,378,000    594,500
Total 2,664,500
Unadjusted NAV acquired 1,870,000
Property adjustment =    100,000
Brand valuation =    378,000
Inventories adjustment =     30,000
Total (2,378,000)

Goodwill arising on acquisition                                    286,500

Attention points, common misconceptions resolved:

  1. NCI is in this case measured at its proportionate share of the NAV on acquisition. However, as NAV itself reflects the fair values of the assets acquired less the fair value of the liabilities assumed, in an indirect way, still, NCI is measured at some sort of “fair value”. However this “fair value” should not be confused with the standard’s version of fair value, which as explained in Part I, is simply the result of multiplying the number of shares held by NCI with the fair value per share of B. Neither will the two values be identical, nor are the two goodwill calculations supposed to be reconciled in any way.

  2. Any post acquisition losses / profits / dividends, are attributed between CI and NCI, based on their respective shareholdings.

  3. Goodwill impairments are likewise shared based on the related shareholdings, only if NCI is fair valued on the date of acquisition. If NCI is measured at its proportionate share the allocation of impairment losses is more complex and beyond the scope of these articles.

  4. Elements as NCI, goodwill, are recognized only in the consolidated financial statements of A (investor), and its subsidiaries.

Other goodwill issues

  1. IFRS 3 compels acquirers to recognize almost all identifiable assets and liabilities acquired, at their acquisition date fair values.

  2. A limited number of assets and liabilities are not fair valued on acquisition, and are subject to other standards, e.g. IAS 19 Employee Benefits, IAS 12 Income Taxes.

  3. The acquirer subsumes into goodwill the value of any acquired asset that is not identifiable at the acquisition date. In very simple terms, goodwill is “air” paid for, in order to convince the previous owners to surrender their shareholding.

  4. Goodwill can also be negative, i.e. a bargain purchase may have been secured. Irrespective of how NCI has been measured on the date of acquisition, negative goodwill is always recognized immediately, in full, through the consolidated statement of profit or loss, and is fully attributed to the CI.

Valuation bonanza
Let’s compare the following two values:

  1. The market value of B shares acquired by A, 75,000 x $ 25 = $ 1,875,000;

  2. The fair value of all forms of A’s consideration agreed to be transferred to previous owners of these shares, $ 2,070,000.

One might ask: why is there such a big gap between the two values? There is a multifold answer to this question:

  1. When obtaining control of an entity, a premium is normally expected to be paid. A does not simply purchase B’s shares. They become B’s new owners. Thus, A’s consideration for B is much higher than if they were simply purchasing shares, without a control premium.

  2. B’s previous owners may have been tough negotiators. They were aware not only of their hidden assets as reflected in the fair value adjustments (property, brand, inventory). They have identified themselves through proper reverse due diligence, synergies to be achieved and economies to be enjoyed by A, thanks to the acquisition of B. B negotiated a higher value for their shareholding, based on these perceived future benefits not reflected in B’s “stand alone” fair value measurement.

  3. B’s previous owners were aware of the fact that the fleet of cars were surplus assets to A, and have managed to squeeze them into the negotiation as part of the consideration. I’d like to remind you that these cars, as all other forms of consideration, will be owned post acquisition by the previous owners of the 75% of B’s share capital purchased by A, and not by subsidiary B.

Queries, comments, are welcome at [email protected]

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