GAAP: Consolidated financial statements and business combinations, current GAAP v FRS 102
How to address business combinations under FSR 102.
Current accounting treatment FRS 2 requires a parent undertaking to prepare consolidated financial statements unless it is exempted from doing so under the provisions of Companies Act 2006.
Under FRS 6 acquisition accounting should be used for business combinations not accounted for by merger accounting.
FRS 6 requires a business combination to be accounted for by using merger accounting if the combination meets the specific criteria to qualify as a merger and also meets the conditions for the use of merger accounting in company legislation.
A group reconstruction may be accounted for by using merger accounting even if the definition of merger in FRS 6 is not met.
Accounting treatment under FRS102 FRS 102 mirrors FRS 2 as a parent is required to prepare consolidated financial statements unless it is exempt under the provisions of Companies Act 2006. The impact of the changes in small company limits for accounting which - if the directors of the company so decide - could apply from 1 January 2015, will impact on consolidation.
Under FRS 102 all business combinations should be accounted for by applying the purchase method except for some involving public benefit entities.
Group reconstructions may be accounted for by using the merger accounting method.
Transition A first-time adopter of FRS 102 may elect not to apply the business combinations provisions to combinations effected before the date of transition. In such a case the entity shall recognise, reclassify and measure, as at the date of transition, all its assets and liabilities acquired or assumed in a past business combination in accordance with the various relevant provisions in FRS 102, apart from a few exceptions including:
intangible assets other than goodwill, as intangible assets subsumed within goodwill shall not be separately recognised
goodwill, as no adjustment shall be made to the carrying value of goodwill
accounting estimates, such as amortisation, depreciation and provisions
financial assets and liabilities derecognised under previous accounting standards.
If a first-time adopter restates any business combination to comply with FRS 102, it shall restate all later business combinations.
Reporting and commercial impact of the changes The requirements for the preparation of consolidated accounts are unchanged under FRS 102 compared with current UK GAAP. In particular exemptions from preparing group accounts are based on the provisions of Companies Act 2006. FRS 102 also maintains that a parent is not required to prepare group accounts if all its subsidiaries are excluded from consolidation.
In particular a subsidiary has to be excluded from consolidation where severe long-term restrictions over its management or assets exist or if the interest in it is held exclusively with a view to subsequent resale. Additionally a subsidiary may be excluded if its inclusion is not material, individually or collectively for more than a subsidiary, for the purposes of giving a true and fair view in the context of the group.
Business combinations are defined in FRS 102 as the bringing together of separate entities or businesses into one reporting entity, ie the acquisition of the equity of another entity or the purchase of all or some of the net assets of another entity that together form a business. Under FRS 102 all business combinations should be accounted for by using the purchase method (acquisition accounting), except for group reconstructions meeting certain conditions which may be accounted for by merger accounting.
Under current UK GAAP, ie FRS 6 Acquisitions and Mergers, if a business combination meets the specific criteria to be classified as a merger then it should be accounted for using merger accounting, unless prohibited by companies legislation; while merger accounting is allowed for group reconstructions in certain circumstances. In contrast FRS 102 does not allow or require the use of merger accounting even for ‘genuine’ mergers and therefore the main impact of such a change is that an acquirer will always need to be identified for accounting purposes.
However, FRS 102 maintains the use of merger accounting for group reconstructions, including for example the addition of a new parent to a group or the transfer of the shares in a subsidiary from a group entity to another, when the use of merger accounting is not prohibited by company law, the ultimate equity holders remain the same with the same rights in respect of each other and no non-controlling interest (minority interest) is altered by the transfer.
In commercial terms the fact that an acquirer will always need to be identified for financial reporting purposes, even in the circumstances of a genuine merger, may create problems, as the parties involved and purported to be acquirers or acquisition targets may not accept a financial reporting representation of the business combination that does not reflect its commercial reality.
The potential impact of the required accounting treatment for mergers will need to be carefully assessed in respect of the various stakeholders of the entities involved, such as shareholders, finance providers, employees and suppliers, to verify whether it would be acceptable to the parties involved or whether it would imply renegotiations/adjustments of financing/shareholders agreements or employees/suppliers contracts. It may be possible to see that the successful completion of a merger may depend on the fact that the acquisition of one entity by another, as depicted in the financial statements, is acceptable to the stakeholders involved.
Taxation impact of the changes No taxation implications.