IAS22:CHANGES IN GROUP STRUCTURES

CHANGES IN GROUP STRUCTURES

STEP ACQUISITIONS AND DISPOSALS

STEP ACQUISITIONS

What is a step acquisition?

A ‗step acquisitions‘ is a business combination achieved in stages, where the acquirer (parent company) gains control of an acquiree (subsidiary) in stages over a period of time.

When control is achieved

  • Any previously held equity shareholding should be treated as if it had been disposal of and then reacquired at fair value at the acquisition date.
  • Any gain or loss on remeasurement to fair value should be recognised in profit or loss in the period.

Goodwill is calculated as:

$

Fair value of consideration paid to acquire control                                                                               X

Non-controlling interest (valued using either fair value or the proportion of net assets method)                                                                                                                                                           X

Fair value of previously held equity interest at acquisition date                                                        X

X

Fair value of net assets of acquiree                                                                                                        (X)

Goodwill                                                                                                                                                          X

 

Increasing or reducing a shareholding whilst retaining control

After a parent company has acquired a subsidiary, it might increase or reduce its shareholding, whilst still retaining control.

IAS 27 (revised) states that when an entity changes the percentage size of its ownership in a subsidiary without losing control, the transaction should be accounted for as an equity transaction.

  • A group of companies is viewed as a single economic entity, and the equity ownership of this entity consists of equity shareholders in the parent and non-controlling interests in subsidiaries.
  • The sale of shares between the parent company and non-controlling interests is therefore a transaction between equity owners of the group.
  • Since the sale of the shares is a transaction between equity owners in their capacity as owners of the group, no profit or loss arises on the transaction, and there is no gain or loss to report either as ‘other comprehensive income’.
  • The transaction should simply result in an adjustment to equity. The carrying amounts of the parent’s interests and the non-controlling interests in the equity of the group are adjusted to record the change in their ownership interests.

The rules summarised

When shares in a subsidiary are bought from or sold to non-controlling interests, but the parent entity retains control over the subsidiary, the transaction should be recorded directly in equity for the purpose of preparing consolidated accounts.

When shares are purchased from NCI, the difference between the price paid for the shares and the carrying value of the NCI shares purchased should be recorded as a debit or credit to the parent entity’s equity interest in the group.

If the price paid for the shares exceeds their carrying value, there will be a reduction in the parent entity’s equity interest in the group, and so the excess price paid should be debited to the parent entity’s interest. Similarly when shares in a subsidiary are sold to NCI but the parent retains control over the subsidiary the difference between the price paid for the shares and the carrying value of the NCI shares purchased should be recorded as a debit or credit to the parent entity’s equity interest in the group.

A ‘gain’ on the sale will be recorded as a credit to the parent entity’s equity interest in the group.

It follows that no additional goodwill or reduction in goodwill occurs as a result of these transactions.

There is also no recognition of any gain or loss on the transaction in the consolidated statement of comprehensive income (either profit or loss, or other comprehensive, income).

The calculation is as follows:

$

Fair value of consideration paid                                                                                                             (X)

Decrease in NCI in net assets at date of transaction                                                                         X Decrease in NCI in goodwill at date of transaction                                                                     X

Adjustment to parent’s equity                                                                                                                (X)

Full and partial disposals of shares in a subsidiary

Four possible situations following a disposal

  • Disposals of shares in subsidiaries without loss of control
  • Disposals of shares in subsidiaries and loss of control: the general accounting rules
  • Full disposal of shares in a subsidiary
  • Partial disposal of shares: subsidiary becomes an associate after the disposal
  • Partial disposal of shares: the remaining shares become an ordinary investment

Full and partial disposals of shares in a subsidiary

Whenever you cross the 50% boundary, you revalue, and a gain or loss is reported in profit or loss for the year. If you do not cross the 50% boundary, no gain or loss is reported: instead there is an adjustment to the parent‘s equity.

Disposal of Shares in Subsidiaries without Loss of Control

The previous section explained the accounting rules for an increase or reduction in the shareholding of a parent entity in a subsidiary, without any change in control. The transaction is accounted for within equity, as a transaction between owners of equity in the group.

The same rules apply to the disposal of some shares without losing control as to the purchase of additional shares when control already exists.

Disposals where control is lost: accounting treatment

For a full disposal, apply the following treatment.

  • Statement of profit or loss and other comprehensive income (i) Consolidate results and non-controlling interest to the date of disposal.

(ii)       Show the group profit or loss on disposal.

 

  • Statement of financial position

There will be no non-controlling interest and no consolidation as there is no subsidiary at the date the statement of financial position is being prepared.

Disposal of a whole subsidiary or associate – revision

Parent company’s accounts

In the parent’s Individual financial statements the profit or loss on disposal of a subsidiary or associate holding will be calculated as:

 

Sales proceeds

  $

X

Less: Carrying amount (cost in P’s own statement of financial position)   (X)
Profit (loss) on disposal

Group accounts — disposal of subsidiary

Gain or loss on disposal

In the group financial statements the profit or loss on disposal will be calculated as:

  X/(X)
  $ $
Proceeds   X
Less: Amounts recognised prior to disposal:    
                Net assets of subsidiary X  
                Goodwill X  
                Non-controlling interest (X) (X)
Profit / loss   X/(X)

 

Remember:

  • If the disposal is midyear:
    • A working will be required to calculate both net assets and the non-controlling interest at the disposal date.
    • Any dividends declared or paid in the year of disposal and prior to the disposal date must be deducted from the net assets of the subsidiary if they have not already been accounted for.
  • Goodwill recognised prior to disposal is original goodwill arising less any impairments to date.

For partial disposals, use the following treatments.

  • Subsidiary to associate
    • Statement of profit or loss and other comprehensive income
      • Treat the undertaking as a subsidiary up to the date of disposal, i.e. consolidate for the correct number of months and show the non-controlling interest in that amount.
      • Show the profit or loss on disposal.
      • Treat as an associate thereafter.
    • Statement of financial position
      • The investment remaining is at its fair value at the date of disposal (to calculate the gain)
      • Equity account (as an associate) thereafter, using the fair value as the new ‘cost’. (Post ‘acquisition’ retained earnings are added to this cost in future years to arrive at the carrying value of the investment in the associate in the statement of financial position.)

GAIN OR LOSS ON DISPOSAL

In this case there is a loss of control, and so a gain or loss on disposal is calculated as:

 

Proceeds

Fair value of interest retained

  $ $

X

X

 

Less: net assets of subsidiary recognised prior to disposal:

Net assets

Goodwill

Non-controlling interest

   

 

X

X

X

X

 

 

 

 

      X
Profit / loss     X/(X)
  • Subsidiary to trade investment/IEI
    • Statement of profit or loss and other comprehensive income
      • Treat the undertaking as a subsidiary up to the date of disposal, i.e. consolidate.
      • Show profit or loss on disposal.
      • Show dividend income only thereafter.

 

  • Statement of financial position
    • The investment remaining is at its fair value at the date of disposal (to calculate the gain).
    • Thereafter, treat as an investment in equity instruments under IFRS 9.

 

 

GROUP REORGANISATIONS AND RESTRUCTURING

Changes in direct ownership (i.e. internal group reorganisations) can take many forms. Apart from divisionalisation, all other internal reorganisations will not affect the consolidated financial statements, but they will affect the accounts of individual companies within the group.

Groups will reorganise on occasions for a variety of reasons.

  • A group may want to float a business to reduce the gearing of the group. The holding company will initially transfer the business into a separate company.
  • Companies may be transferred to another business during a divisionalisation
  • The group may ‘reverse’ into another company to obtain a stock exchange quotation. (d) Internal reorganisations may create efficiencies of group structure for tax purposes.

GROUP REORGANISATIONS AND RESTRUCTURING

Methods of reorganising/restructuring

Groups may sometimes be restructured or reorganised. There are various reasons why a restructuring might be considered necessary or desirable. These are explained later. Examples of reorganisations or restructuring include the following:

  • Creating a new holding company for the group
  • A change in ownership between companies in the group
  • Divisionalisation  A demerger

Creating a new holding company

A new holding company may be created for the group. The reason for this may be to improve the structure of the group, possibly with a view to making more changes later, such as adding new subsidiaries.

The effect of creating a new holding company is typically as follows:

To create the new holding company, the former shareholders of Company X may exchange their shares in Company X for shares in the new holding company H. They become the owners of H, and H is the 100% owner of Company X. In these arrangements, there is usually just a share-for-share exchange, with shares in X exchanged for shares in H, and no cash transactions are involved.

A change in ownership of companies within a group

When companies in a group are 100%-owned, it may be decided to reorganise the group and transfer ownership of subsidiaries from one group company to another.

For example, a holding company H may own two subsidiaries, Entity A and Entity B. It may be proposed that Entity A should buy the shares in Entity B from H, for cash. As a result of this reorganisation, Entity B would become a subsidiary of Entity A and a sub-subsidiary of H. There would also be a transfer of cash from Entity A to H, in exchange for the shares in Entity B.

 

Current structure   Proposed structure
 

 

 

 

 

Shareholders

 

Company A buys the equity capital of B from H for cash.

 

All companies continue to operate.

In the proposed structure, there is a change in the ownership of Entity B, as it has been transferred so that it is directly owned by Entity A, not H.

The accounting implications are as follows:

  • The reorganisation has not changed the assets of the group and so will not affect the group financial statements.

 

  • In the individual accounts of H, there is a gain or loss in disposal of the shares in Entity B. In H’s own financial statements, the cost of the investment in Entity B is removed and replaced with the cash received, together with the resulting gain or loss (in H’s reserves).

ALTERNATIVE CHANGE IN OWNERSHIP

An alternative situation is where a subsidiary becomes directly owned by the parent, as can be seen in the diagram below.

This type of group reorganisation is often done when the parent company wishes to sell Company B, but to retain company C. This reorganisation will have no effect on the consolidated accounts because the group remains the same. It is the individual companies whose accounts will change.

This transaction cannot normally be effected by a share-for-share exchange, because the law in some countries does not allow a subsidiary to hold shares in a parent company. Instead, Company B pays a special dividend called a ‘dividend in specie’ to the parent, which is effectively the cost of investment in Company C. Company B must have sufficient distributable profits to do this.

Alternatively, Company A can pay cash to Company B in return for the investment in Company C.

  • There is no effect on the group financial statements as the assets of the group are unchanged.
  • There has not been a disposal of shares in Entity B by H, so the investment must remain in the accounts of H.
  • The investment in Entity B in the individual H’s accounts will certainly have suffered impairment, given that the trade of Entity B has been transferred to Entity A.
  • If any goodwill arose when H acquired B, this will also be impaired, because the business to which the goodwill relates has now been transferred.
  • Entity A has not bought the shares of Entity B. It has bought the net assets of B in exchange for cash. Entity A will therefore include all of B’s net assets into its own statement of financial position, as B’s business operations have now been merged with A’s own.

DIVISIONALISATION WITHIN A GROUP

Within a group, there may be operating divisions, and each division may be established as a subsidiary company within the group. Each division may own several sub-subsidiaries, each responsible for a different aspect of the division’s overall operations.

When there is divisionalisation of operations within the group, it may be decided from time to time to switch assets from one division to another. For example, it may be decided to close down one division and transfer its operations to another division.

 

Accounting for a Divisional Reorganisation

This is a divisionalisation restructuring or reorganisation. It does not affect the ownership of Entity B. Entity B is still owned by H and the investment remains in the statement of financial position of H. Entity B has simply transferred its assets, liabilities and all business operations to Entity A, in exchange for cash. As a result, Entity B is now a ‘shell’ company, containing just share capital and the cash from the sale.

SUBSIDIARY ACQUIRED EXCLUSIVELY WITH A VIEW TO SUBSEQUENT DISPOSAL

Subsidiaries acquired exclusively with a view to resell are classified as Discontinued Operations under IFRS 5.

n entity that is committed to a sale involving loss of control of a subsidiary that qualifies for held-for-sale classification under IFRS 5 classifies all of the assets and liabilities of that subsidiary as held for sale, even if the entity will retain a non-controlling interest in its former subsidiary after the sale.

 

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