1. Chapter 11 Business Combinations

2. Financial Information Analysis2 Copyright 2006 John Wiley & Sons Ltd Business Combinations (Groups) Most large UK plc’s are Groups i.e., companies combined together in various ways and forms Anglo-American governance culture favours this means of ‘growth’ Usually achieved by: Acquisition, or Merger IAS 27; IFRS 3

3. Financial Information Analysis3 Copyright 2006 John Wiley & Sons Ltd Acquisition Company buys shares in another directly or indirectly This gives in “an interest” If it acquires a controlling interest then this creates parent/subsidiary relationship A company is a parent of another if it: holds a majority of voting rights, or has right to appoint majority of board, or governs its financial and reporting policies, or can cast majority of votes at board meeting

4. Financial Information Analysis4 Copyright 2006 John Wiley & Sons Ltd Company Relationships

5. Financial Information Analysis5 Copyright 2006 John Wiley & Sons Ltd Purchase method IAS 27 / IFRS 3 only permit ‘Purchase’ method for Group (Consolidated) Accounts applies to both acquisitions and mergers ‘merger’ method no longer permitted Purchase method results of acquired company incorporated into group accounts from date of acquisition assets and liabilities acquired (including identifiable intangibles) included at fair value excess of consideration over fair value of separable net assets = Goodwill Goodwill subject to impairment tests (IAS 36)

6. Financial Information Analysis6 Copyright 2006 John Wiley & Sons Ltd Purchase method ctd. 2 basic principles 1. Amalgamate e.g., where P and S have Fixed Assets of £150k and £100k, Group a/cs will show £250k 2. Cancel out corresponding items e.g., where P shows ‘Investment in S’ of £200k and S shows Share Capital of £200k they cancel each other

7. Financial Information Analysis7 Copyright 2006 John Wiley & Sons Ltd Purchase Method ctd. Group Balance Sheet: amalgamate those of parent and subsidiaries partly-owned subsidiary: un-cancelled Share Capital in subsidiary = Minority Interest Revenue Reserves in subsidiary at date of acquisition cannot be distributed Goodwill = excess of consideration over fair values of separable net assets

8. Financial Information Analysis8 Copyright 2006 John Wiley & Sons Ltd Purchase method ctd. Group Income Statement: amalgamate those of parent and subsidiaries Minority Interest’s share of profits must be indicated inter-company dividends will cancel unrealised profits on inter-company trading must be eliminated

9. Financial Information Analysis9 Copyright 2006 John Wiley & Sons Ltd Associates Relationships other than parent/subsidiary e.g., where interest in another is not sufficient to result in parent/subsidiary IAS 9, defines Associate as ‘an entity over which investor has significant influence’ normally a 20% interest is sufficient ‘Equity accounting’ method applies

10. Financial Information Analysis10 Copyright 2006 John Wiley & Sons Ltd Equity Accounting method Investor must reflect relationship with Associate in own accounts Equity accounting method: investment shown as non-current asset goodwill identified and grouped with other goodwill carrying amount adjusted annually for gains, losses share of associate’s profits included in IS CFS shows flows between investor and investee

11. Financial Information Analysis11 Copyright 2006 John Wiley & Sons Ltd Joint Ventures Companies often join together to carry out projects, contracts, etc. IAS 31: ‘contractual arrangement whereby entities undertake economic activity subject to joint control’ e.g.: collaborative manufacture of aircraft IAS 31 allows Equity Accounting or Proportionate Consolidation methods Favours latter because results in line for line incorporation into group accounts

12. Financial Information Analysis12 Copyright 2006 John Wiley & Sons Ltd Related-Party Transactions Not all transactions at ‘arms- length’ e.g., company granting loan to a director Such ‘related party’ transactions require disclosure

13. Financial Information Analysis13 Copyright 2006 John Wiley & Sons Ltd IAS 24: disclosure of related-party transactions required where: one party has direct or indirect control of other two parties subject to same source of control one party has influence over policies of other Significant disclosure requirements imposed Related-Party Transactions

14. Financial Information Analysis14 Copyright 2006 John Wiley & Sons Ltd Summary Various forms of business combination exist Relationship usually depends on nature of investment parent/wholly-owned subsidiary parent/partly-owned subsidiary investor/associate joint venture Accounting method used depends on nature of relationship