[PN 54] Practice Note 54 Accounting for the acquisition of net assets in financial statements or a prospectus

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1 ASIC PRACTICE NOTES [PN 54.3] [PN 54] Practice Note 54 Accounting for the acquisition of net assets in financial statements or a prospectus Chapter 3 Internal administration (Part 3.6) Issued 1/9/1994 Headnotes Section 191; Accounting Standard AASB 1015 Accounting for the Acquisition of Assets; Accounting Standard AASB 1013 Accounting for Goodwill; s1022; fair value; purchase consideration; accounting for, and disclosure in prospectuses of, information relating to acquisitions of assets. Purpose [PN 54.1] This Practice Note sets out the views of the ASC on the application of Accounting Standard AASB 1015 in relation to s191 of the Corporations Law (Law). In particular this Practice Note sets out the ASC s views on valuing consideration given in exchange for the acquisition of assets (net, where applicable) and the recognition of goodwill. In addition, it discusses the ASC s view on the applicability of AASB 1015 when a merger, business combination, restructure or reconstruction has taken place. The Practice Note is intended to guide ASC staff involved in the surveillance of financial statements and for the guidance of directors, preparers and auditors of financial statements. The views expressed in it will also assist people preparing financial reports for prospectuses and ASC staff who register prospectuses. [PN 54.2] While the Australian Accounting Standards Board is responsible for developing and promulgating accounting standards, it is for the ASC to regulate compliance with them. It is in the interests of both the market and the ASC that the ASC indicates in advance what it will accept as compliance. Background [PN 54.3] This Practice Note about the acquisition of assets is needed because some companies have failed to comply with the requirements of s191 of the Law and AASB It is also required because some 1

2 [PN 54.3] ASIC PRACTICE NOTES companies hold the erroneous belief that s191 and AASB 1015 are not applicable in their circumstances. In particular, the ASC has identified cases where companies which have acquired assets: (a) have failed to determine the fair value of those assets (including goodwill); and (b) have failed to make an assessment of the fair value of shares issued as consideration. Application of AASB 1015 [PN 54.4] AASB 1015 specifies the accounting treatment for all acquisitions of assets. Paragraph (iii) of the commentary to AASB 1015 elaborates on this by stating that the Standard applies not only where one or more assets are obtained in exchange for a cost of acquisition, but also to an exchange of assets under a merger or business combination. [PN 54.5] The ASC notes that the corresponding Australian Accounting Standard AAS 21 (applicable to non-corporate entities) provides an exemption for intra-group company reconstructions in which a new holding company completely replaces an existing holding company. Because there is no similar exemption in AASB 1015 from the coverage of the Standard, AASB 1015 applies if assets are acquired in a restructuring or reconstruction. Requirements of AASB 1015 [PN 54.6] Clause.10 of AASB 1015 states, in part, that: In accounting for all acquisitions of assets, the assets acquired shall be recorded at the cost of acquisition, being the purchase consideration determined as at the date of the acquisition plus costs incidental to the acquisition. [PN 54.7] AASB 1015 defines purchase consideration as the fair value of assets given or share capital issued, liabilities undertaken, and other securities given by the purchaser, in exchange for assets (net, where applicable) or shares of another entity. [PN 54.8] Paragraph (viii) of the commentary to AASB 1015 states that:... where the purchase consideration comprises, either partially or totally, non-monetary assets, the fair value will need to be ascertained by reference to existing markets for such assets. Paragraph (ix) of the commentary to AASB 1013 goes on to explain that: Where the purchase consideration comprises shares or other securities of the purchaser and these securities are listed publicly on an Australian Stock Exchange, the price at which they could be placed in the market will usually be an indication of their fair value. Where the 2

3 ASIC PRACTICE NOTES [PN 54.14] securities issued are those of an unlisted company it may be necessary to make a valuation of those securities. It should not be assumed that the par value reflects their fair value, as this rarely is the case. [PN 54.9] The ASC agrees that the market price of shares issued to vendors as consideration for the acquisition of assets may provide a benchmark against which to measure the fair value of those shares. However, other factors which may influence the fair value of such shares include, but are not limited to: (a) the price effect of escrow restrictions; (b) whether a premium for control attaches to those shares because of the size of the parcel; and (c) the effects of illiquidity in respect of shares issued by an unlisted company. [PN 54.10] In accounting for an acquisition, the ASC expects all assets, including intangible assets, which are capable of being individually identified and separately brought to account, to be recognised in determining the fair value of net assets acquired. Intangible assets include, for example, patents, trademarks, brand names, licences, mining tenements and management rights. The fair value of liabilities, including income tax, also needs to be assessed. [PN 54.11] The assessment of the fair value of the assets and liabilities acquired and the assessment of the purchase consideration should be adequately documented in accordance with the requirement to keep proper books and records (s289(1)). [PN 54.12] Directors should give consideration as to whether an independent valuation of the assets and liabilities acquired is needed. Goodwill [PN 54.13] Where the cost of acquisition exceeds the fair value of the identifiable net assets acquired, AASB 1013 provides that the difference between these two amounts represents goodwill. In other words, goodwill is the residual. Paragraph 34 of AASB 1013 requires purchased goodwill to be brought to account as a non-current asset at acquisition. However, where the difference between the cost of acquisition and the fair value of the identifiable net assets acquired does not constitute goodwill, because future benefits will probably not eventuate, para 33 of AASB 1013 requires the amount of any such difference to be written off to the profit and loss account immediately. [PN 54.14] Goodwill should be accounted for in financial statements in accordance with AASB

4 [PN 54.15] ASIC PRACTICE NOTES Section 191 and shares as consideration [PN 54.15] Subsection 191(1) of the Law provides that: Where a company issues shares for which it receives a premium, whether in cash or in the form of other valuable consideration, a sum equal to the aggregate amount of value of the premiums on those shares shall be transferred to an account called the share premium account, and the provisions of this Law relating to the reduction of the share capital of a company, other than subsection 195(6) apply, subject to this section, as if the share premium account were paid up share capital of the company. In complying with s191, the ASC believes that directors must assess the fair value of all assets (and liabilities) which the company is acquiring. Where the company is acquiring a business this will involve determining the fair value of the business acquired. The share premium must then be calculated as the difference between the fair value of the net assets acquired and the par value of the shares issued. [PN 54.16] If the fair value of the net assets acquired differs from the fair value of the shares issued to acquire them, s191 requires the fair value of the net assets acquired to be used to ascertain the share premium. This is because under s286a of the Law, s191 prevails over AASB [PN 54.17] It is the ASC s view that s191 requires goodwill to be included in the calculation of the fair value of total assets acquired. Therefore, when determining the fair value of assets acquired, the total of identifiable and unidentifiable net assets (ie the value of the business) must be used to calculate the amount (if any) which must be credited to the share premium account. [PN 54.18] AASB 1013 requires that goodwill be determined as the difference between the purchase consideration and the fair value of identifiable assets and liabilities. The ASC expects that in most cases the amount of goodwill calculated for the purpose of complying with s191 will be approximately the same as the amount calculated in accordance with AASB 1015 and This is because an acquirer is unlikely to pay more for assets than what it perceives is the fair value of the assets. Conversely, it is unlikely that an entity will be able to purchase assets at a price less than their fair value at that particular time. [PN 54.19] If assets initially appear to have been purchased for more than the preliminary assessment of the fair value of net assets acquired, there should be a reconsideration of the fair value of net assets acquired. 4

5 ASIC PRACTICE NOTES [PN 54.22] Treatment of acquisitions in prospectuses [PN 54.20] A prospectus must include all such information as investors and their professional advisers would reasonably require and reasonably expect to find in the prospectus, for the purpose of making an informed assessment of the assets and liabilities, financial position, profits and losses and the prospects of the corporation (s1022). [PN 54.21] Consider a corporation which has recently acquired assets or shares of another entity and issued its own shares to the vendors in consideration for that acquisition. It then wants to issue a prospectus. The ASC believes that, to avoid misleading users the financial reporting of those transactions in the prospectus should be consistent with the accounting requirements of s191 of the Law, AASB 1015 and AASB It follows that, where goodwill is required to be recognised in the financial statements and that goodwill is material in amount, or the amortisation of that goodwill is likely to have a material effect on distributable profits in the future, this information should also be disclosed in the prospectus. [PN 54.22] If directors have an interest in the promotion of a company or in assets to be acquired by the company, then the nature and extent of their interests must be stated in a prospectus (s1021(6)). The ASC believes that a prospectus cannot satisfy s1021(6) unless it includes details of the nature of the consideration received by the vendor, including its quantified value, in addition to any other disclosures the promoters believe necessary. The fair value of the assets received by the company in exchange for that consideration should also be disclosed. 5