New Accounting for Business Combinations and Non-controlling Interests

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1 IFRS ADVISORY SERVICES New Accounting for Business Combinations and Non-controlling Interests August 2008 KPMG LLP The proposed new accounting standards for business combinations and non-controlling interests represent significant change from current Canadian standards. The proposed standards also move Canada much closer to the comparable IFRSs. The Canadian Accounting Standards Board (AcSB) proposes to withdraw CICA Handbook Section 1581, Business Combinations, in 2008 and replace it with a new standard Section 1582, and replace Section 1600, Consolidated Financial Statements, with new Sections 1602, Non-controlling Interests, 1 and 1601, Consolidated Financial Statements. This new business combinations standard has been developed in conjunction with new converged standards issued by the US Financial Accounting Standards Board (FASB) as new Statements 141R and 160, and the International Accounting Standards Board (IASB) as revised IFRS 3 and IAS Although the proposals have not yet been finalized, if approved, they will significantly change the accounting for business combinations and noncontrolling interests. Sections 1582 and 1602 will require Contents Effective Date 2 Scope 2 Fundamental Principles 2 The Acquisition Method 3 Special Considerations 10 Differences in Accounting Standards 13 How Can KPMG Help? 15 Appendix 1 16 Significant Changes in Accounting for Business Combinations Appendix 2 18 Comparison of New IFRS Standard with Proposed New Canadian Standards most identifiable net assets, non-controlling interests, and goodwill acquired in a business combination to be recorded at full fair value non-controlling interests (minority interests) to be reported as a component of equity, thus changing the accounting for transactions with non-controlling interest holders. Some transactions now accounted for as asset acquisitions will come within the scope of business-combination accounting under an expanded definition of a business. All other existing aspects of accounting for investments in subsidiaries and the preparation of consolidated financial statements in current Canadian GAAP are carried forward unchanged in new Section Exposure Draft Non-controlling interests, April FASB Statements No. 141 (revised October 2007), Business Combinations, October 2007, and No. 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, October 2007, are both available at In January 2008, the IASB revised IFRS 3, Business Combinations, and revised IAS 27, Consolidated and Separate Financial Statements.

2 2 New Accounting for Business Combinations and Non-controlling Interests Effective Date The AcSB decided that Sections 1582, 1601, and 1602 should be made mandatory for fiscal years beginning on or after January 1, 2011, with earlier adoption permitted. The three new sections are to be implemented concurrently. Non-controlling interests and transactions with non-controlling interests relating to business combinations completed prior to the implementation date are presented in accordance with Section 1602, but are not to be remeasured. The AcSB hopes to issue final standards before the end of Scope Section 1582 applies to all business combinations; Section 1602 applies to the accounting for non-controlling interests and transactions with noncontrolling interest holders in consolidated financial statements. The new standard defines a business combination as a transaction in which an entity (the acquirer) obtains control of one or more businesses (the acquiree or acquirees), even if control is not obtained by purchasing equity interests or net assets, as in the case of control obtained by contract alone. This situation can occur, for example, when certain minority shareholders rights expire. The expanded definition of a business now includes a set of activities and assets that is a development stage entity. The definition of a business will be amended such that Section 1582 defines a business as an integrated set of activities and assets that are capable of being managed to provide a return to investors or economic benefits to owners, members, or participants. Thus, a set of activities and assets may be considered a business even if it cannot currently access customers or is an early-stage development stage entity. The new standard also applies to combinations among mutual entities 3, but, like the replaced standard, it does not apply to formations of joint ventures, combinations among entities under common control, and combinations between not-for-profit organizations or the acquisition of a for-profit business by a not-for-profit organization. Fundamental Principles Section 1582 is based on the following fundamental principles: The acquirer obtains control of the acquiree at the acquisition date and, therefore, becomes responsible and accountable for all of the acquiree s assets, liabilities, and activities, regardless of the percentage of its ownership in the acquiree. The acquirer accounts for the acquisition at the fair value of the acquiree as a whole. 3 A mutual entity is defined as an entity other than an investor-owned entity that provides dividends, lower costs, or other economic benefits directly and proportionately to its owners, members, or participants.

3 August The identifiable assets acquired and liabilities assumed in a business combination are measured at their fair values on the date control is obtained. Any other aspects of the transaction not directly related to acquiring the assets and assuming the liabilities of the acquiree are not accounted for as part of the business combinations; rather, they are accounted for in accordance with other applicable GAAP. The Acquisition Method All business combinations will be accounted for by applying the acquisition method (previously referred to as the purchase method). Companies applying this method will have to identify the acquirer; determine the acquisition date and purchase price; recognize the identifiable assets acquired and liabilities assumed of the acquiree at their fair values; and recognize goodwill or, in the case of a bargain purchase, a gain. Identifying the acquirer The first step in identifying the acquirer of a voting interest entity is to consult the current guidance in Subsidiaries, Section If this section does not provide a sufficient basis for identifying the acquirer, the indicators in Section 1582, which are similar to those contained in Section 1581, should be considered. The acquirer in a business combination in which a variable interest entity is acquired is always the primary beneficiary of the variable interest entity determined in accordance with AcG-15. Acquisition date In the new standards, the only relevant date for measurement, including the measurement of consideration paid, is the acquisition date. The acquisition date is the date the acquirer obtains control of the acquiree, the only relevant date for recognition and measurement. This date is used to measure the fair value of not only the consideration paid but also the assets acquired and liabilities assumed. When the acquirer issues equity instruments as full or partial payment for the acquiree, the fair value of the acquirer s equity instruments will be measured at the acquisition date. This approach differs from the current standard where equity instruments are measured at fair value on the date the terms of the business combination are agreed and announced. Purchase price The acquirer must determine the acquisition-date fair value of the consideration paid for its interest in the acquiree. The consideration paid can include cash and other assets, equity interests, and contingent consideration, all measured at fair value at the acquisition date. In a change from today s accounting requirements, contingent consideration is measured at fair value at the acquisition date and included when determining the fair value of the consideration paid. The contingent

4 4 New Accounting for Business Combinations and Non-controlling Interests consideration is classified as equity or a liability in accordance with current GAAP. If the contingent consideration is classified as a liability, it will be remeasured to fair value until resolution and subsequent changes in the fair value will be recognized in earnings. Contingent consideration that is equityclassified is not subsequently remeasured. This provision contrasts with the current accounting requirements, under which contingent consideration is generally not recognized until the contingency is resolved and the consideration is paid or payable. Acquisition costs In the new standards, the direct costs of a business combination are expensed as incurred. Acquisition costs associated with a business combination, such as legal costs, are not part of the consideration exchanged for the business acquired. Acquisition costs are therefore excluded from the acquisition accounting. Instead, they are accounted for under other GAAP, meaning the costs (e.g., due diligence costs) are expensed as incurred, unless they qualify to be treated as debt issue costs, or as a cost of issuing equity securities. Recognizing and measuring assets, liabilities, and non-controlling interests Under the acquisition method, the acquirer recognizes most identifiable assets acquired and liabilities assumed of the acquiree at their full fair value on the acquisition date. Section 1582 provides the following exceptions from fair-value measurement (the section in which the relevant guidance is found is indicated after each item): future income taxes and future income tax liabilities (Section 3465) employee future benefits (Section 3461) leases (Section 3065) assets held for sale (Section 3475) intangible assets that do not meet the criteria for separate recognition (Section 1582) indemnification assets reacquired rights share-based payment awards. All other elements, including contingent liabilities that meet the recognition threshold, are measured at full fair value whether the acquirer acquires 100% or a lesser amount (i.e., a partial acquisition). The acquiree will have the option of accounting for non-controlling interest at full fair value, or at the non-controlling interest s proportionate interest in the fair value of the acquiree s net assets.

5 August The requirements for fair-value measurement and the changes in recognition principles will change accounting practices for acquired contingencies, restructuring costs, long-lived assets, share-based payment awards, indemnification assets, and tax benefits. In the new standards, assets or liabilities arising from contractual contingencies are recognized and measured at fair value on the date of acquisition. Contingencies The acquirer recognizes, separately from goodwill, the acquisition-date fair value of assets and liabilities arising from contractual contingencies that were acquired or assumed as part of the business combination. The acquirer therefore recognizes, as of the acquisition date, an asset or a liability for a contractual contingency acquired in a business combination if it meets the definition of an asset or a liability in Financial Statement Concepts, Section 1000, even if that contingency does not meet the recognition criteria in Contingencies, Section At this time, it is unclear what accounting treatment the AcSB will require for non-contractual contingencies, such as litigation. The AcSB may take the same approach that the FASB took in revised FAS 141 and require such non-contractual contingencies to be recognized only if it is more likely than not (i.e., greater than 50% likely) that a liability exists at the acquisition date. Under FAS 141R, after initial recognition, contingencies that are recognized as liabilities at the acquisition date would be subsequently measured at the greater of the acquisition-date fair value or the amount in accordance with HB Under the FASB s approach, non-contractual contingencies that do not qualify for recognition at the acquisition date would be accounted for in accordance with Section All other contingencies are accounted for in accordance with the respective GAAP for that contingency. For example, a contingency that is a financial instrument is accounted for in accordance with applicable financial instrument guidance. Alternatively, the AcSB may require the accounting treatment for noncontractual contingencies that the IASB approved in the revised IFRS 3 (2008). Under this approach, all contingencies, including non-contractual contingencies, would be recognized on the acquisition date and measured at fair value. Under this approach, all contingencies would be measured in subsequent periods at the greater of their then current amount in accordance with HB 3290, and the amount recognized originally on the acquisition date, less amortization if applicable, with gains and losses recognized in profit or loss until settlement.

6 6 New Accounting for Business Combinations and Non-controlling Interests In many cases, restructuring costs will be expensed as post-acquisition costs. Under the new standards, fair value for long-lived assets reflects the market participants' perspective rather than the acquirer's specific planned use or non-use of the asset. Restructuring costs Section 1582 nullifies EIC 114 and requires costs associated with restructuring or exit activities that do not meet the recognition criteria in EIC 134 or EIC 135 as of the acquisition date in the acquiree to be subsequently recognized as post-combination costs when those criteria are met. 4 Therefore, if the costs are not liabilities of the acquired business on the acquisition date, costs expected to be incurred to terminate or restructure certain activities are expensed in the period the criteria under EIC 134 or EIC 135 are met. Long-lived assets Long-lived assets that meet the criteria for recognition, apart from goodwill, are recognized at fair value. Section 1582 will indicate that fair value should reflect the market participants perspective rather than the acquirer s specific planned use or non-use of the asset. All other guidance on measuring fair value in existing 1581 will likely not be carried forward into Statement 1582 refers to the guidance in Section 3475 that assets meeting the held-for-sale criteria as of the acquisition date are measured at fair value less costs to sell. 5 Leases In accordance with Leases, Section 3065, a lease of the acquiree (regardless of whether the acquiree is the lessee or lessor) retains the lease classification determined by the acquiree at the lease inception, unless the provisions of a lease are modified as a result of the business combination in a way that would require the acquirer to consider the revised agreement a new lease agreement in accordance with Section Consistent with the current requirement of Section 1581, the fair value of the net assets acquired would include recognition of assets and liabilities in respect of existing favourable and unfavourable lease terms. Consistent with existing standards, certain accounting elections, such as hedges, will need to be redesignated, and financial assets and liabilities designated as held-for-trading. Contractual arrangements will also need to be re-evaluated to determine whether they contain a lease or embedded derivatives that require separation. Share-based payment awards As is currently required, share-based payment awards are segregated into acquisition consideration and postcombination compensation based on the proportion of the requisite service period (including service required post-combination) that is complete as of the acquisition date. However, unlike current practice, the portion of the share-based payment that is part of the acquisition consideration is a temporary difference between the tax basis and the reported amount, and a deferred tax asset is therefore recognized as part of the acquisition accounting. 4 EIC 134, Accounting for Severance and Termination Benefits, March 2003; EIC 135, Accounting for Costs Associated with Exit and Disposal Activities (Including Costs Incurred in a Restructuring); EIC 114, Liability Recognition for Costs Incurred in Purchase Business Combinations. 5 Section 3475, Disposal of Long-Lived Assets and Discontinued Operations.

7 August Indemnification assets If an acquirer receives an indemnity for the outcome of an uncertainty in connection with a business combination (e.g., for tax uncertainties), the acquirer will recognize an indemnification asset amount equal to the recognized amount for the related contingency. However, consideration will need to be given to whether any valuation allowance against the indemnification asset is required due to uncertainties associated with collectibility. In the new standards, the acquirer's unrecognized tax benefits that are recognizable as a result of the acquisition are recognized as a reduction of income tax expense. Tax benefits The acquirer s unrecognized tax benefits (e.g., tax loss carryforwards) that are recognizable as a result of the acquisition are not included in the acquisition accounting as is currently required. Instead, the amounts are recognized as a tax benefit in consolidated income. Adjustments for recognized tax benefits related to the acquiree (e.g., in response to an effectively settled tax uncertainty) that are recognized subsequent to the acquisition date will generally be recognized in consolidated income, not as an adjustment to the acquisition accounting as is currently required. Section 3465 will be amended to reflect this change. Partial acquisitions A company that obtains control, but acquires less than 100% of an acquiree, records 100% of the fair value at the acquisition date of the acquiree s assets, liabilities, and non-controlling interests, excluding the exceptions to fair-value measurement previously described. Under current requirements, an acquiring company that obtains less than 100% of an acquiree adjusts the assets and liabilities only for its proportionate ownership interest, and recognizes only its portion of the goodwill of the acquiree. Non-controlling interests are currently recorded at the acquiree s book value. Under Section 1582, the acquirer has the option to record or not record the goodwill attributable to the non-controlling interest. Goodwill Goodwill is recognized as the excess of the acquisition-date fair value of the purchase price over the recognized amounts of assets, liabilities, and noncontrolling interests. If an acquirer obtains less than 100% of the acquiree at the acquisition date, goodwill is allocated to the controlling interest, and may be allocated to the non-controlling interests. The amount of goodwill allocated to the controlling interest is the difference between the fair value of the controlling interest and the controlling interest s share in the fair value of the identifiable net assets acquired. If the acquirer elects, any remaining goodwill may be allocated to the non-controlling interests. This situation is illustrated in the boxed example on the following page.

8 8 New Accounting for Business Combinations and Non-controlling Interests Example: Allocating Goodwill to Controlling and Non-controlling Interests Assume Company A acquires 80% of Company B s outstanding common stock for $160 million in cash. The non-controlling interests remain publicly traded and have a fair value of $35 million (i.e., the $160 million paid for the 80% interest includes a control premium). As of the acquisition date, the book value and fair value of the separately recognizable and identifiable net assets acquired are $100 million and $150 million, respectively. Under three options the current purchase method, the new acquisition method, and the optional method under which the non-controlling interests share of goodwill is not recorded the amounts allocated to identifiable net assets, goodwill, non-controlling interests, and controlling interest in Company B are: Millions Purchase Acquisition Optional Method Method Method Identifiable net assets $140 a $150 b $150 b Goodwill $ 40 c $ 45 d $ 40 c Non-controlling interests $ 20 e $ 35 f $ 30 g Controlling interest $160 $160 $160 a b c d Book value of identifiable net assets plus Company A s share of the difference between fair value and book value of identifiable net assets ($100 + (($150 $100) 80%)) Fair value of identifiable net assets Purchase price paid by Company A less Company A s share of fair value of identifiable net assets ($160 ($150 80%)) Consideration paid by Company A plus fair value of non-controlling interests less fair value of identifiable net assets [($160 + $35) $150)]. Goodwill includes only the control premium paid by the acquirer in respect of its 80% interest, and such control premium is not taken into consideration in determining the fair value of the non-controlling interests. e Non-controlling interests share of the book value of identifiable net assets ($100 20%) f Fair value of non-controlling interests g Non-controlling interest in fair value of identifiable assets ($150 20%) Goodwill is allocated to controlling and non-controlling interests as follows: Fair value of Company A s 80% interest $160 Less: fair value of Company A s share of identifiable net assets ($150 80%) (120) Company A s share of goodwill $40 Total goodwill $45 d Company A s share of goodwill 40 Non-controlling interests share of goodwill $ 5

9 August Bargain purchase Negative goodwill arising in a bargain purchase is recognized in profit or loss. In a bargain purchase, the fair value of the recognized identifiable net assets acquired exceeds the fair value of the acquirer s interest in the acquiree plus the recognized amount of any non-controlling interests in the acquiree. In such cases, the acquirer should re-evaluate the measurements of the recognized assets and liabilities at the acquisition date. If no adjustments are necessary, or if an excess remains after the adjustments, the acquirer should recognize the excess as a gain at the acquisition date. Under current accounting for negative goodwill, the reported amounts of specified identifiable long-lived assets are reduced to zero before any remaining amount is recognized as an extraordinary gain. Measurement period Section 1582 defines the measurement period as the period after the acquisition date during which the acquirer may make adjustments to the provisional amounts recognized at the acquisition date. As is the case under Section 1581, the measurement period ends as soon as the acquirer receives the necessary information about facts and circumstances that existed at the acquisition date, or concludes that the information cannot be obtained. Consistent with Section 1581, the measurement period may not exceed one year from the acquisition date. However, unlike today s accounting requirements, any adjustments to the provisional amounts during the measurement period are reflected by retrospectively adjusting the provisional amounts and recasting the prior-period information. Section 1582 also requires that changes in acquired tax benefits (e.g., by eliminating a valuation allowance) and in acquired tax uncertainties during the measurement period, resulting from new information about facts and circumstances that existed as of the acquisition date, are to be applied first to reduce goodwill and then to reduce income tax expense. All other adjustments are made as a direct adjustment to income tax expense rather than an adjustment of goodwill.

10 10 New Accounting for Business Combinations and Non-controlling Interests Special Considerations Non-controlling interests The new standards require non-controlling interest to be presented as a separate component of shareholders' equity. Section 1602 specifies that non-controlling interests are to be treated as a separate component of equity, not as a liability or other item outside equity. Because non-controlling interests are treated as an element of equity, increases and decreases in the parent s ownership interest that leave control intact are accounted for as capital transactions (i.e., as increases or decreases in ownership), rather than as step acquisitions or dilution gains or losses. The carrying amount of the non-controlling interests is adjusted to reflect the change in ownership interests, and any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognized directly in equity attributable to the controlling interest (i.e., increase or reduction in contributed surplus or retained earnings in accordance with Section 3251, Equity). Step acquisitions Under current requirements for step acquisitions, each investment tranche is reflected in the financial statements at its basis, either through the application of the equity method or in consolidation once control is obtained. Under Section 1582, when a business combination is achieved in stages, the acquirer s interest in the acquiree includes the acquisition-date fair value of the equity interest the acquirer held in the acquiree before the business combination. Therefore, the carrying amounts of the previously acquired tranches are adjusted to fair value as of the date control was obtained (the acquisition date), and the acquirer recognizes the differences as a gain or loss in income at the acquisition date. Amounts the acquirer previously recognized in accumulated other comprehensive income (e.g., cumulative translation adjustments recognized during the period the equity method was used to account for the investment tranches) would be included in the gain or loss recognized in income at the date control is obtained. Loss of control Section 1602 requires that a transaction that ends control is also a remeasurement event. Therefore, a retained interest after a sale of interests that ends control would be remeasured to fair value. The gain or loss recognized in income includes the realized gain or loss related to the portion of the ownership interest sold (including all amounts recognized in other comprehensive income in relation to that subsidiary), and the gain or loss on the remeasurement to fair value of any interest retained. The following examples illustrate the accounting for transactions with noncontrolling interests: the first with control retained, and the second with loss of control.

11 August Example: Control retained Assume that Company A on January 1, 20X8, acquires 60% of Company B s common stock for $700 million, which is the fair value of a 60% interest in Company B. The fair value of the noncontrolling interests is $400 million. After the acquisition, the consolidated financial statements would report the following amounts related to Company B: Millions Net assets (including goodwill) $1,100 Non-controlling interests $ 400 Controlling interest $ 700 Total equity (excluding contributed surplus) $1,100 Company B s net income and comprehensive income for 20X8 are zero. On January 1, 20X9, Company A acquires an additional 20% of Company B s common stock for $250 million. Since Company A had control both before and after the transaction, it is treated as a capital transaction. Non-controlling interests are reduced by the carrying amount of the proportionate interest relinquished ($400 million 20% / 40%). The difference between the carrying amount of non-controlling interests acquired ($200 million) and the amount paid ($250 million) is reported as an adjustment to additional paid-in capital. After the transaction, the consolidated financial statements would report the following amounts related to Company B: Millions Net assets (including goodwill) $1,100 Non-controlling interests $ 200 Controlling interest $ 900 Total equity (excluding contributed surplus) $1,100 Company B s net income and comprehensive income for 20X9 again are zero. On January 1, 20Y0, Company A sells 10% of Company B s common stock for $100 million. Since Company A retains control of Company B after the transaction, the sale is recorded as a capital transaction. Noncontrolling interests are increased by the carrying amount of the interest sold by Company A ($900 million 10% / 80%). The difference between the increase to non-controlling interests ($113 million) and the selling price is reported as an adjustment to additional paid-in capital. After the transaction, the consolidated financial statements would report the following amounts related to Company B: Millions Net assets (including goodwill) $1,100 Non-controlling interests $ 313 Controlling interest $ 787 Total equity (excluding contributed surplus) $1,100

12 12 New Accounting for Business Combinations and Non-controlling Interests Example: Loss of control Company B s net income and comprehensive income for 20Y0 again are zero. On January 1, 20Y1, Company A sells 30% of Company B s common stock for $400 million. The fair value of the 40% retained interest in Company B is determined to be $525 million. Company A would recognize a gain on the date of the sale, computed as follows: Millions Sales proceeds on 30% sold interest $ 400 Fair value of 40% retained interest $ 525 Carrying amount of non-controlling interest $ 313 $1,238 Less: carrying amount of Company B's ($1,100) net assets Gain recognized on January 1, 20Y1 $138 Series of transactions Section 1602 contains guidance designed to prevent manipulation of income through a series of planned transactions designed to take advantage of the fact that obtaining or surrendering control over an investee is a remeasurement event through income. The section identifies the following four conditions, one or more of which may indicate that multiple arrangements should be accounted for as a single transaction: The arrangements are entered into at the same time or are entered into in contemplation of one another. They form a single transaction designed to achieve an overall commercial effect. The occurrence of one arrangement depends on the occurrence of at least one other arrangement. One arrangement considered on its own is not economically justified, but the arrangements are economically justified when considered together. Allocation of income and other comprehensive income Under Section 1602, non-controlling interest in income is not deducted in arriving at consolidated net income or other comprehensive income. Rather, net income and each component of other comprehensive income are allocated to the controlling and non-controlling interests based on relative ownership interests, unless a contractual arrangement between the controlling and non-controlling interests requires a different attribution. Losses applicable to the non-controlling interests are attributed and

13 August recorded as adjustments to the non-controlling interests even if the losses would cause non-controlling interests to be negative whether or not the non-controlling interests have an obligation to fund those losses. Presentation and disclosure Certain new requirements change not only the presentation of operating results but also earnings per share and equity. The new requirements for non-controlling interests, results of operations, and comprehensive income of subsidiaries change not only the presentation of operating results but also earnings per share and equity. Section 1602 requires net income and comprehensive income to be displayed for both the controlling and the non-controlling interests. Additional required disclosures and reconciliations include a separate schedule that shows the effects of any transactions with the non-controlling interests on the equity attributable to the controlling interest. Differences in Accounting Standards Differences from existing Canadian GAAP requirements The new Canadian standards for business combinations and non-controlling interests differ in some significant ways from existing Canadian GAAP. Appendix 1 provides a comparison of the new requirements and the existing standards, and summarizes the significant changes. New US GAAP differences that will arise The existing Canadian business combinations accounting standard is aligned with Statement 141. However, certain US GAAP differences will arise when the new Canadian business combinations standard is effective. These differences arise because, in certain areas, the new Canadian standard was aligned with the equivalent IFRS standard, given Canada s planned adoption of IFRS in The principal difference relates to the measurement of non-controlling interest. Under the proposed Canadian standard, the acquirer can elect to measure non-controlling interest at the acquisition-date fair value, or its proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree at the acquisition date. However, under the new US standard, the acquirer is required to measure non-controlling interest at the acquisition-date fair value. In addition, differences may arise due to differences in the effective dates of the new Canadian and US standards. Section 1582 is expected to be effective for business combinations entered into on or after January 1, 2011.

14 14 New Accounting for Business Combinations and Non-controlling Interests Section 1602 is expected to be effective for fiscal periods beginning on or after January 1, Both standards, which are expected to be finalized before the end of 2008, will permit early adoption, so as to permit the entity to largely eliminate differences between Canadian GAAP and/or US GAAP and/or IFRS. However, the comparable US Statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. Statement 141R will be applied to business combinations occurring after the effective date. Statement 160 will be applied prospectively to all non-controlling interests, including any that arose before the effective date. Differences from IFRS and their impact on Canadian companies The new Canadian standards for business combinations and non-controlling interests have been developed in conjunction with the new converged standards issued by the International Accounting Standards Board (IASB) as a revised IFRS 3, Business Combinations, and amended IAS 27, Consolidated and Separate Financial Statements. The IASB s revised standards are effective for fiscal years beginning on or after July 1, The new Canadian and IFRS standards are, however, not identical, and IFRS differences will remain. Appendix 2 compares the new IFRS and Canadian standards, highlighting the differences that will remain until Canadian publicly accountable companies fully adopt IFRS in Consider IFRS 1, First-time Adoption of IFRS, when considering how the remaining IFRS differences will affect Canadian companies. In considering how these remaining IFRS differences will affect Canadian companies adoption of IFRS, companies should be aware that IFRS 1, Firsttime Adoption of IFRS, provides certain elective exemptions from the retroactive application of IFRS, when it is adopted as a financial reporting framework for the first time. IFRS 1 also contains certain elective exceptions for business combinations that occurred prior to the entity s IFRS transition date. All business combinations that occur after the transition date (January 1, 2010, for most Canadian publicly accountable entities) must be accounted for in accordance with revised IFRS 3. The descriptive and summary statements in this publication are not intended to be a substitute for the text of CICA Section 1582 and Section 1602, or for the text of any other potential or cited requirements. Reporting entities complying with applicable requirements or complying with SEC filing requirements should consult the texts of the requirements, the particular circumstances to which the requirements are to be applied, and their accounting and legal advisers.

15 August How Can KPMG Help? KPMG has helped many organizations to assess the impact and implementation of new accounting standards, as well as the adoption of IFRS. We have developed tools to be used for a quick assessment of the potential impact of the new accounting standards. We can help you to interpret these new standards, and we can conduct technical accounting training for your organization. For broader IFRS conversion projects, KPMG has an established conversion methodology that incorporates the different disciplines critical to a successful implementation. Our IFRS conversion services teams are multidisciplinary teams of professionals knowledgeable in IFRS and Canadian GAAP, and skilled in financial reporting processes and financial integration. Our teams are supported by internationally trained professionals with global experience in both converting to IFRS and applying IFRS. To learn more about our IFRS resources and our conversion services, visit

16 16 New Accounting for Business Combinations and Non-controlling Interests Appendix 1 Significant Changes in Accounting for Business Combinations Topic Definition of a business Measuring equity instruments issued Acquisition-related costs Contingent consideration Recognizing and measuring assets acquired, liabilities assumed, and non-controlling interests Existing Standards CICA 1581 and 1600 A business is defined as a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors. For a transferred set of activities and assets to be a business, it must contain all of the inputs and processes necessary for it to continue to conduct normal operations after the transferred set is separated from the transferor, which includes the ability to sustain a revenue stream by providing its outputs to customers. Equity instruments issued by the acquirer as consideration are measured at fair value a few days before and after the measurement date (i.e., date when the terms and conditions have been agreed and the acquisition announced). The purchase price includes direct costs of a business combination. Contingent consideration based on earnings is generally recognized as an adjustment to the purchase price when the contingency is resolved and consideration is issued or issuable. Contingent consideration based on the acquirer s security price is recognized as an adjustment to paid-in capital when the contingency is resolved and the consideration is issued or issuable. The assets acquired and liabilities assumed are adjusted only for the acquirer s share of the fair value. Non-controlling interests and their share of the acquiree s assets and liabilities are measured based on the carrying amount of the recognized assets and liabilities in the acquiree s financial statements. Proposed New Standards CICA 1582 and 1602 The definition of a business is expanded such that the integrated set of activities only must be capable of being conducted and managed to provide a return or lower costs. As a consequence, a business or group of assets no longer must be self-sustaining to be a business and the previous presumption that an early-stage development stage entity is not a business has been removed. Equity instruments issued by the acquirer as consideration are measured at fair value on the acquisition date. Direct costs of a business combination are not part of the acquisition accounting. Instead, such costs are accounted for under other GAAP and will be expensed, unless they constitute the costs associated with issuing debt or equity securities. Contingent consideration is recognized and measured at fair value on the date of acquisition. Subsequent changes in fair value of liabilityclassified contingent consideration are recognized in earnings and not as an adjustment to the purchase price. Equity-classified contingent consideration is not remeasured after the acquisition date. Whether the acquirer acquires all or a partial interest in the acquiree, the full fair value of the assets acquired and liabilities assumed is recognized. The carrying amount of previously acquired tranches is adjusted to fair value at the date when control is obtained, and the acquirer recognizes the differences as a gain or loss in income at the acquisition date. Non-controlling interest is recorded at either fair value or the non-controlling interest in the fair value of the acquiree s net assets.

17 August Topic Contingencies Restructuring costs Tax benefits Increases in ownership interest Decreases in ownership interest Non-controlling interest Existing Standards CICA 1581 and 1600 If the fair value of a contingent liability is not readily determinable at the acquisition date, a contingent liability is recognized at the date of acquisition only if it is probable and reasonably estimable. It is measured at the best estimate of the settlement amount rather than its fair value. Restructuring costs for plans to be implemented subsequent to the acquisition are recognized as a liability in purchase accounting, if criteria established in EIC-114 are met within a short period of time after the acquisition date. The acquirer s unrecognized tax benefits that are recognizable as a result of an acquisition are in purchase accounting at the acquisition date. A post-acquisition recognition of the acquiree s tax benefits is generally an adjustment to the purchase accounting. Each investment tranche is reflected in the financial statements with a separate purchase adjustment and goodwill amount related to each tranche. Decreases in ownership interest result in a dilution gain or loss. Non-controlling interest is presented outside consolidated shareholders equity. The noncontrolling interest in the net income of a subsidiary is shown as a deduction to arrive at consolidated net income. Proposed New Standards CICA 1582 and 1602 A liability is recognized at fair value on the date of acquisition for contractual contingencies. At this time, the AcSB has not indicated whether it will require that a liability be recognized at fair value on the acquisition date for non-contractual contingencies if it is more likely than not that the liability exists. The AcSB may require the IFRS treatment under which all contingencies, including non-contractual contingencies, are to be recognized at fair value on the date of acquisition. Restructuring costs are not recognized as a liability in acquisition accounting unless the criteria in EIC 134 or EIC 135 are met in the acquiree at the acquisition date. The acquirer s unrecognized tax benefits that are recognizable as a result of an acquisition are recognized as a reduction of income tax expense. Unrecognized tax benefits related to the acquiree that are recognized subsequent to the acquisition date are generally recognized in income rather than as an adjustment to the acquisition accounting. Increases in the parent s share of ownership after control is obtained are accounted for as a capital transaction. Decreases in the parent s share of ownership while retaining control are accounted for as capital transactions. A transaction that results in the loss of control produces a gain or loss that comprises a realized portion related to the portion sold and an unrealized portion on any retained non-controlling investment that is remeasured to fair value. Non-controlling interest is presented in consolidated shareholder s equity. Consolidated net income and other comprehensive income are shown gross and then are allocated proportionately between the controlling and non-controlling interests.

18 18 New Accounting for Business Combinations and Non-controlling Interests Appendix 2 Comparison of New IFRS Standard with Proposed New Canadian Standards Issue IFRS 3 (2008) and IAS 27 (2008) CICA 1582 and 1602 Scope Identifying the acquirer definition of control Measurement principle definition of fair value Transactions among entities under common control are outside the scope of IFRS 3 (2007). IFRS currently provides very limited guidance on the accounting for such common-control transactions. Control is used with the same meaning as IAS 27 (2007), i.e., the power to govern the financial and operating policies of an entity. IFRSs do not include the concept of variable interest entities. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s-length transaction. Like IFRSs, transactions among entities under common control are outside the scope of CICA Section Such transactions are governed by CICA Section 3840, Related Party Transactions. Control carries the same meaning, as defined in CICA Section 1590, Subsidiaries the continuing power to determine its strategic, operating, investing, and financing policies without the co-operation of others. Control carries the meaning of primary beneficiary for variable interest entities. Fair value is currently defined in 1582 as the amount of the consideration that would be agreed upon in an arm's-length transaction between knowledgeable, willing parties who are under no compulsion to act. However, the AcSB may harmonize this definition with the FASB and IASB definition under a new Fair Value Measurement standard. Contingent liabilities (assets and liabilities subject to contingencies) Contingent liabilities are recognized on the acquisition date and measured at fair value if they relate to a present obligation of the acquiree that arises from past transactions and fair value can be measured reliably, i.e., a contingency is recognized even if it is not probable. Like IFRSs, all contractual contingencies are recognized on the acquisition date at fair value. Such contractual contingencies are recognized if they meet the definition of an asset or liability under CICA Standard 1000, Financial Statement Concepts, even if they do not meet the definition under CICA Standard 3290, Contingencies. At this time, it is unclear whether the accounting treatment the AcSB will require for non-contractual contingencies will be consistent with IFRS 3 or whether it will adopt the approach taken by the FASB in its revised business combinations standard. Under the FASB s approach, only non-contractual contingencies that are more likely than not to exist at the acquisition date would be recognized.

19 August Issue IFRS 3 (2008) and IAS 27 (2008) CICA 1582 and 1602 Remeasurement of retained non-controlling equity investment on a loss of control or significant influence When control, significant influence, or joint control is lost, a gain or loss is recognized in the profit or loss comprising both: a realized gain or loss on the disposed interest, and an unrealized gain or loss from remeasurement to fair value of any retained non-controlling equity investment in the former subsidiary, equity method investment, or joint venture. Like IFRSs, when control is lost, a gain or loss is recognized in the profit or loss comprising both: a realized gain or loss on the disposed interest, and an unrealized gain or loss from remeasurement to fair value of any retained non-controlling equity investment in the former subsidiary. Unlike IFRSs, the loss of significant influence is not an event resulting in remeasurement. Other recognition and measurement exceptions referenced to existing IFRSs and US GAAP Effective date and transition The following items are recognized and measured in accordance with other relevant IFRSs: deferred income taxes employee benefit arrangements share-based payment awards and related tax impact acquisition-related costs classification of contingent consideration as a liability and equity. IFRS 3 (2008) is effective for annual periods beginning on or after July 1, 2009, but early adoption is permitted. If an entity adopts the standard early, then it must also apply the amendments to IAS 27 and disclose that fact. Early adoption is prohibited prior to annual periods on or after June 30, IFRS 3 (2008) requires prospective application. The amendments to IAS 27 (2008) are effective July 1, 2009, but early adoption is permitted. The amendments apply retrospectively, except in specific limited circumstances. IFRS 3 (2008) provides no special transitional rules for business combinations between mutual entities or by contract alone, but states that these must be accounted for prospectively. Like IFRSs, the following items are recognized and measured in accordance with other relevant IFRSs: future income taxes employee future benefits stock-based compensation and other stockbased payments acquisition-related costs classification of contingent consideration as a liability and equity. However, those requirements differ in certain respects from IFRSs. The proposals indicate that CICA 1582 would be mandatory for fiscal years beginning on or after January 1, 2011, with earlier adoption permitted. If an entity early adopts the standard, then it must also apply the amendments to HB 1602 and disclose that fact. The AcSB expects to issue a final pronouncement before the end of Like IFRSs, CICA 1582 requires prospective adoption. CICA 1602 will have the same transition provisions as IAS 27R, but a later effective date (January 1, 2011). Like IFRSs, CICA 1582 provides no special transitional rules for combinations between mutual entities.

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