Business Combinations Flashcards
Company A owns 61% of the voting shares of Company B and 58% of the voting shares of Company C. Company B owns 28% of the voting shares of company D; Company C owns 26% of the voting shares of Company D. Which company(s) does company A likely control?
Company A would likely be able to control Company B, Company C and Company D.As long as A can control B and C (which would likely be the case, based on the fact that A owns the majority of the voting shares of B and C), it has control over how both B and C vote <u>all</u> of their shares of D. Accordingly it can indirectly control D. This situation is treated in the same manner as if A directly owned the 28% of the shares of D owned by B as well as the 26% of the shares of D owned by C, which in total amounts to ownership of 54% of the shares of D.
Company A, a public company, owns 40% of the 1 million voting shares of Company B outstanding. It also holds all $1,000,000 of Company B?s convertible debt. Each $100 of debt is convertible into 25 voting shares of Company B. The conversion option can be exercised at any time. The shares are currently trading at $5.00. As at year end, none of the debt has been converted into voting shares. Under IFRS should Company A consolidate Company B?
Company A currently owns 400,000 voting shares of B. It has potential voting rights which are substantive (i.e. in the money). If company A was to convert its debt into shares, it would acquire an additional 250,000 shares and would own in total, 650,000 shares of the 1,250,000 shares outstanding, (i.e. over 50% of the voting shares of B). The fact that Company A has not yet converted, is not relevant, as the mere fact that A can convert if it wishes to at any time and by doing so acquire a majority interest in B, is sufficient for control to exist even before the debt has been converted.
On July 1, 2017, Johnson Inc. (JI), purchased 75% of the voting shares of Pablon Inc. (PI) for $4,000,000. As at the date of the acquisition, the book value of PI?s net assets, amounted to $3,000,000. The fair value of the net assets, corresponded to the book value, with the exception of a customer list which has a fair value of $200,000 and a book value of zero. Management?s best estimate of the customer list?s useful life is 5 years. What is the amount of goodwill that would be recorded at the time of the acquisition, assuming that the non-controlling interest is measured based on the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets?
Goodwill is calculated as follows:\n\nFV of Consideration: $4,000,000\n\nPlus non controlling interest: 800,000\n\nLess book value of assets acquired: (3,000,000)\n\nLess FV increment on customer list: (<u>200,000)</u>\n\n$1,600,000\n\n* The fair value of the non-controlling interest is based on a net book value for the sub of $3,000,000 plus a fair value increment customer list of $ $200,000. The non-controlling interest based on 25% of the net identifiable assets of $3.2 million is $800,000.
Price Co. has gradually been acquiring shares in Berry Co., a private company, and now owns 37% of the outstanding voting common shares. The remaining 63% of the shares are held by members of the family of the company founder. To date, the family has elected all members of the board of directors, and Price Co. has not been able to obtain a seat on the board. Price Co. is hoping eventually to buy a block of shares from an elderly family member and thus one day own 60%. Can Price account for its investment in Berry using the equity method?
Given that the remaining shares are held by one family who has elected all of the Board (and prevented Price Co. from electing any members), Price Co does not have significant influence and therefore can not use the equity method.
ABC purchases 60% of DEF. At the date of acquisition the carrying value of the land owned by ABC and DEF is $200,000 and $110,000 respectively and the fair value is $300,000 and $180,000 respectively. What is the amount of the land reflected in consolidated financial statements?
For consolidation purposes one would addtogether thecarrying value of the parent?s assets and liabilities and the sub?s assets and liabilities and then addthe fair value increments.\n\nCalculation: $200,000 + $110,000 + ($180,000 - $110,000) = $380,000.\n\nIt should be noted that although ABC only purchased 60% of DEF we still add together 100% of the land in each of the 2 companies. We would take into account the fact that ABC only owns 60% of DEF in the non-controlling interest portion of the balance sheet.
ABC Inc. purchases DEF Inc. by paying cash of $10,000,000 and also agrees to pay an additional $1 million if DEF’s sales reach $3 million in the year following the acquisition. There is about a 30% to 40% probability that sales will reach $3 million. For consolidation purposes, would ABC include the portion of the consideration which is contingent on sales reaching $3 million in the cost of the acquisition?
The $3 million is contingent consideration.Contingent consideration should be recorded at fair value and considered as part of the cost of the purchase. The fair value will be less than $3 million as there is only a 30% to 40% probability that the contingent consideration will be paid.
ABC Inc. consolidates its only subsidiary DEF Inc. for the purpose of its statutory financial statements. ABC however does not wish to consolidate in the additional set of financial statements it will be producing for taxation purposes. Under IFRS would ABC Inc. be allowed to not consolidate DEF Inc. in the financial statements prepared for taxation purposes?
The additional financial statements prepared for taxation purposes are referred to as “separate” financial statements.\n\nIn the separate financial statements, the entity would account for investments in subsidiaries, either:\n\n(a) at cost, or\n\n(b) as a financial instrument (in accordance with IAS 39)\n\n(c) using equity method\n\n<em><strong>Note that under ASPE there is no discussion of ?Separate Financial Statements?</strong></em>
Under ASPE, does an investor’s involvement in managing the day to day operations of an investee impact whether the investor investee controls the investee?
No - Control is defined as: ?The continuing power to determine the acquiree?s strategic, operating, investing and financing policies without the co-operation of others?.
How does one account for a business combination?
One uses consolidation.
Does a business combination always involve one company acquiring (or merging) with another company?
No - A business combination is a transaction or other event in which an acquirer obtains control of one or more <strong>businesses. </strong>A business does not necessarily mean a <strong>company </strong>(i.e. a legal entity). Business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business (e.g. start up company may not have outputs yet).
How is control defined under IFRS?
Control is defined as follows:\n\nAn investor controls an investee if and only if the investor has all of the following:\n\n(a) power over the investee\n\n(b) exposure, or rights, to variable returns from its involvement with the investee\n\n(c) the ability to use its power over the investee to affect the amount of the investor’s returns
One aspect of control under IFRS, is power over the investee. What constitutes power over the investee?
An investor has power over an investee when the investor has existing rights that give it the current ability to direct the <em><u>relevant activities</u></em> - i.e. the activities that significantly affect the investee’s returns.\n\nExamples of relevant activities include, but are not limited to:\n\n(a) selling and purchasing of goods or services;\n\n(b) managing financial assets during their life (including upon default);\n\n(c) selecting, acquiring or disposing of assets;\n\n(d) researching and developing new products or processes; and\n\n(e) determining a funding structure or obtaining funding.
If one company owns more than 50% of the voting shares of the other company would they necessarily have control over that company?
No - however with over 50% of the voting shares, control would be presumed to exist unless there is evidence to the contrary.
If one company owns less than 50% of the voting shares of the other company would they always not have control over that company?
No - it is possible to have control without majority ownership of voting shares. An investor can have power even if it holds less than a majority of the voting rights of an investee, say for example through a contractual arrangements or in light of the other shares being widely dispersed (e.g. investor owns 47% of the shares outstanding and the other shares are owned by 10,000 investors with no investor owning more than5 shares).
Do potential voting rights impact control?
Yes - they do as long as they are substantive. Potential voting rights would include rights to obtain additional voting rights of an investee, for example through convertible instruments like convertible debt or preferred shares or options, warrants, forward contracts etc. In order for the voting rights to be substantive, (a) there can <strong>not</strong> be any barriers (economic or otherwise) that prevent the holder (or holders) from exercising the rights (e.g. there is a financial penalty for exercising the right) and (b) the holder of the rights would be able to benefit from exercising the rights (e.g. the instrument is in the money or the company holding the rightswould benefit from exercising the rights due to some synergy between the company holding the rights (the investor) and the investee).
DEF currently owns 30% of the shares of ABC. They also own stock options that would allow them to purchase a sufficient number of shares so that following the exercise of the stock options it will own 55% of the shares. DEF has not yet exercised its stock options. The exercise price of the stock option is $10 per share and the shares are currently trading for $8 per share. Would DEF be presumed to have control over ABC?
They may or may not havecontrol. It all depends on whether the stock options are substantive and that depends on whether DEF would benefit from exercising the options. The stock options are out of the money (i.e. the exercise price exceeds the price of the shares) and therefore DEF would not make money by exercising. However if there is some other economic benefit that DEF could enjoy by exercising the options (e.g. a synergy between DEF and ABC) then the rights are substantive and we would take them into account and consider DEF to have control over ABC (even beforeDEF exercises the options).
A owns 40% of the shares of B and also owns enough options to purchase another 20% of the shares of B; however based on the terms of the option contract, it is required to wait 2 years to exercise the options. Would A be presumed to have control over B?
No - the options are not substantive given that they can not be exercised for 2 years. Therefore we would ignore them in determining control.
How is control defined under ASPE?
Control is defined as: ?The continuing power to determine the acquiree?s strategic, operating, investing and financing policies without the co-operation of others?.\n\n<strong><em></em></strong>
In the case of a business combination, how is the acquisition date determined?
The acquisition date, is the date on which the acquirer obtains control of the acquire, generally the legal closing date. However, it is possible to obtain control on a date that is either earlier or later than the closing date (e.g. through legal agreement).
Why is the acquisition date relevant for the purpose of consolidation?
Acquisition date is critical as parent would only include results of operation from the acquisition date.
