Common control business combination and Measurement of Consideration
Facts of the case:
S1 and S2 are wholly owned subsidiaries of Holdco. One division of S1 is getting demerged into S2. For this purpose, Holdco will be issued shares of S2. The entire combination is that of common control. In this connection, we reproduce some research:
“The shareholder (being a company covered under Ind-AS) of amalgamating company/ demerged company receiving shares of the unrelated amalgamated company/ resulting company should record investments in the amalgamated company/ resulting company at their respective fair value. As per Ind-AS 109 Financial Instruments, the difference between the fair value and cost recorded in books of accounts of the shareholders will be credited to the profit and loss account and not routed through the Other Comprehensive Income.”
Issue/Query:
Whether prior period needs to be restated for S1 and S2 which is as per Ind AS 103 Business Combination that says to restate the earliest reported period in the financials
Whether the value of investment in S1 (in Holdco books) would change
What would be the value at which new investments in S2 will be recognised in the Holdco books and where will be the second impact be given.
Response:
The financial information in the financial statements of S2 in respect of prior periods must be restated as if the business combination had occurred from the beginning of the preceding period. The financial information in the financial statements of S1 in respect of prior periods are not to be restated as if the transfer occurred in the preceding period.
The value of investment in S1 in Holdco Books will change depending on the accounting policy of Holdco with respect to measurement of investment in subsidiary.
The value at which new investments in S2 will be recognised in the Holdco Books and its second impact depends on the accounting policy of Holdco with respect to measurement of investment in subsidiary.
Basis for Response:
The querist has not specified what is the consideration flowing to S1 for transfer of its division to S2. The consideration is flowing to Holdco, the parent.
The following assumptions are made in absence of details:
The division being demerged from S1 is a business as defined in Ind AS 103 Business combinations.
There is neither any change to share capital of S1 nor any cash or other asset is flowing to S1 from either S2 or Holdco.
Ind AS 103 Business Combinations applies to the acquirer in case of business combination not under common control. In case of common control business combinations, Appendix C of Ind AS 103 applies to the transferee. In the given case, S1 is the transferor and S2 is the transferee. Paragraph 1 of Appendix C Business Combinations of entities under Common Control states that the appendix deals with accounting for business combinations of entities or businesses under common control.
Paragraph 2 of Appendix C Business Combinations of entities under Common Control defines ‘Common control business combination’ as follows:
“Common control business combination means a business combination involving entities or businesses in which all the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory.”
Basis the limited information submitted by the querist, the given case is of a common control business combination as S1 and S2 are ultimately controlled by Holdco both before and after the business combination transaction. Therefore, S2 shall account for the business combination in accordance with Appendix C of Ind AS 103.
Paragraph 9(iii) of Appendix C of Ind AS 103 requires that the financial information in the financial statements in respect of prior periods should be restated as if the business combination had occurred from the beginning of the preceding period in the financial statements, irrespective of the actual date of the combination. Therefore, S2 shall restate the prior period in the financials.
Holdco will recognise the shares issued by S2 as an addition to investment in subsidiary S2. Paragraph 2.1(a) of Ind AS 109 Financial Instruments scopes out interests in subsidiaries that are accounted for in accordance with Ind AS 27 Separate Financial Statements. Paragraph 10 of Ind AS 27 provides a measurement choice for investments in subsidiaries either:
At cost; or
In accordance with Ind AS 109
Ind AS 27 does not define cost or explain the composition of cost. Cost of investment may be taken as
Historical cost being the consideration paid to acquire the investment originally; or
Fair Value as deemed cost being the fair value of the investment in subsidiaries on acquisition. Further fair valuation is done on any transaction on the investment in subsidiary.
The measurement of investments in S1 and new investment in S2 depends on the accounting policy of Holdco:
Accounting policy to measure investment in subsidiary at historical cost:
Holdco is receiving new shares of subsidiary S2 for no cost. The carrying amount of the investment in subsidiary S1 and subsidiary S2 remain the same.
Accounting policy to measure investment in subsidiary at fair value as deemed cost:
Carrying amount of investment in subsidiary S1 is measured at fair value on the date of transfer. The revised fair value is the deemed cost of investment in subsidiary S1 on that date.
Any increase or decrease in the carrying amount of investment in S1 is recognised in profit or loss.
Holdco will recognise the investment in subsidiary S2 along with the shares issued at fair value of S2 shares on the date of issue and recognise it as gain or loss in profit or loss.
Accounting policy to measure investment in subsidiary in accordance with Ind AS 109 at fair value through profit or loss:
The accounting will be same as explained for accounting policy to measure investment in subsidiary at fair value as deemed cost except that the gain / loss recognised in profit or loss will differ as the carrying amount of the investment will already be at the fair value determined at the end of the immediately preceding reporting period.
Accounting policy to measure investment in subsidiary in accordance with Ind AS 109 at fair value through other comprehensive income:
In this case, the difference between the carrying amount of investment and the fair value of the investments in subsidiary S1 and S2 will be recognised in other comprehensive income.
Holdco could also have a policy of measuring investment in subsidiary S1 at fair through profit or loss and investment in subsidiary S2 at fair value through other comprehensive income or vice versa provided the company has identified both the investment in subsidiaries under different categories. In that case, the effect of the investment that is through profit or loss shall be recognised in profit or loss and the effect of the investment through other comprehensive income shall be recognised in other comprehensive income.
Attention of the readers is drawn to the following requirements of paragraph 117B of Ind AS 1, Presentation of Financial Statements:
“Accounting policy information is expected to be material if users of an entity�s financial statements would need it to understand other material information in the financial statements. For example, an entity is likely to consider accounting policy information material to its financial statements if that information relates to material transactions, other events or conditions and:
(a) the entity changed its accounting policy during the reporting period and this change resulted in a material change to the information in the financial statements;
(b)the entity chose the accounting policy from one or more options permitted by Ind ASs;
(c) the accounting policy was developed in accordance with Ind AS 8 in the absence of an Ind AS that specifically applies;
(d) the accounting policy relates to an area for which an entity is required to make significant judgements or assumptions in applying an accounting policy, and the entity discloses those judgements or assumptions in accordance with paragraphs 122 and 125; or
(e) the accounting required for them is complex and users of the entity's financial statements would otherwise not understand those material transactions, other events or conditions-such a situation could arise if an entity applies more than one Ind AS to a class of material transactions.”
Holdco would be choosing an accounting policy from the above stated options permitted by Ind AS 27. Therefore, the company shall disclose the policy for measurement of investment in subsidiaries in its material accounting policy information specifying in clear terms the chosen policy with recognition, measurement and presentation of any gain or loss on investment in subsidiary in its separate financial statements.