Navigating the IFRS Seas: Questions Audit Committees should ask around acquisitions

JOHANNESBURG — In part two of a series on what questions Audit Committees should be askingGlynnis Carthy highlights the points that members should consider when it comes to acquisitions. There are key questions to ask during this process and Carthy highlights them. – Gareth van Zyl

By Glynnis Carthy*

An audit committee member is not an executive director and does not have all the facts. Asking the right questions can go a long way to making sure you understand what is happening in the business. Having said that, how can you know which questions to ask if the topic is unfamiliar?

Glynis Carthy

The Audit Committee Snippets is a series of articles that aim to simplify accounting issues and highlight some of the questions that you, as an audit committee member, could ask. This is the second article that deals with the accounting issues that arise when a company buys another business because the accounting can be extremely complex.

Buying a business – part 2

In part 1, I discussed the definition of a business and a business combination in IFRS 3 – Business Combinations. This article assumes that that a business is being acquired and considers the accounting when the legal terms differ from what IFRS 3 requires. Remember that accounting often focuses on the substance of a transaction (instead of the legal form).

Part 2 is based on the purchase of a business on the following terms:  

On 5 January 2018, listed company A announced the acquisition of 100% of a competitor, company B (an unlisted company). The purchase price was $15 million to be settled in 15 million shares. On 5 January 2018 the share price of company A was $1 per share.

Company A announced that the acquisition would be effective from 31 January 2018 (in line with the share purchase agreement). The share purchase agreement listed three conditions precedent:

Condition Date met
Approval at a shareholder meeting of company A 15 February 2018
Approval at a shareholder meeting of company B 30 January 2018
Approval by the Competition Authorities 15 March 2018

The market reacted well to the announcement which resulted in a rally in the share price. At the date of approval by the Competition Authorities, the share price was $1.30.

In terms of IFRS 3, company A is required to:

  1. Identify the acquisition date, which is the date on which it obtains control of company B.  
    • At first glance, it appears that the acquisition date is the 31 January 2018 because this is what is stipulated in the written agreements.  
    • However, in assessing when control is obtained, the principles in IFRS 10 – Consolidated Financial Statements, should be applied.  
    • IFRS 10 is a subject for another day, however, the date of control is unlikely to be a date before the conditions precedent have been met.  
  1. Calculate the purchase price (called consideration).  
    • The purchase price is determined at the date that company A obtains control of company B (15 March 2018) and not in terms of what is stipulated in the agreement.
    • Therefore, the purchase price will not necessarily be calculated in terms of the legal agreements.  It will be determined on 15 March 2018 by applying IFRS 3.

The table below illustrates how the date of acquiring company B changes from 31 January 2018 to 15 March 2018 and how the purchase price changes from $15 million to $19.5 million.

As you can see from the table above, from an accounting perspective, the date and share price specified in the agreement are largely irrelevant. Ask management whether there are any conditions precedent in the acquisition agreement, what they are and the reason for each condition. Thereafter, you need to know when each condition was met to assess whether IFRS 3 has been correctly applied.  

  • Glynnis Carthy is a chartered accountant who is based in England. She is an independent financial reporting advisor and is employed by BhalaGood Limited.  
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