6.3 Identification of a business
Acquisition date is ‘the date on which the acquirer obtains control of the acquiree’. Although the acquisition date is generally the date that the transaction closes (i.e., the date on which the acquirer transfers consideration and acquires the assets and liabilities of the acquiree), in some cases the acquirer may actually obtain control on a different date. Careful consideration of all facts and circumstances is required as to when the acquirer obtained control.
6.4.2 Consideration transferred The consideration transferred may consist of:
• cash or cash equivalents paid;
• the fair value of assets given, liabilities incurred or assumed and equity instruments issued by the acquirer in exchange for control;
• the fair value of any contingent consideration arrangement as of the acquisition date; and
• a business or a subsidiary of the acquirer.
Transaction costs are expensed and not included as part of the consideration transferred. These transaction costs include investment banking fees and professional fees, such as legal and accounting fees. The direct costs of issuing shares or arranging finance are accounted for as part of the equity proceeds or financial liability rather than as a cost of the acquisition.
Some business combinations result in gains in the income statement. In a step acquisition, any previously owned equity interest is seen as being ‘given up’ to acquire the business and a gain or loss is recorded on its disposal. The existing stake is remeasured to fair value at the date of acquisition, taking any gains to the income statement. A loss on acquisition is theoretically possible but this usually indicates an unrecognised impairment and is seldom seen.
The acquirer must identify any transactions that are not part of what the acquirer and the acquiree exchange in the business combination and separate this from the consideration transferred for the business. Examples include: the amount paid or received for the settlement of pre-existing relationships; and remuneration paid to employees or former owners for future services.
6.4.3 Contingent consideration
The purchase consideration may vary depending on future events. The acquirer may want to make further payments only if the business is successful. The vendor, on the other hand, wants to receive the full value of the business. Contingent consideration in the mining industry often takes the form of:
• royalties payable to the vendor as a percentage of future revenue;
• payments based on the achievement of specific production levels;
• payments based on specific market prices of the commodity; and
• payments on achievement of milestones (e.g.
completion of a feasibility study, start of commercial production).
An arrangement containing a royalty payable to the vendor is different from a royalty payable to the tax authorities of a country. A royalty payable to the vendor in a business combination is often contingent consideration; essentially a type of earn-out. It may also be a retained working interest; this is an area of significant judgement.
The acquirer should record at fair value all of the consideration at the date of acquisition including the contingent consideration (earn-out). Since fair value takes account of the probabilities of different outcomes, there is no requirement for payments to be probable.
Therefore, contingent consideration is recognised whether it is probable that a payment will be made or not.
This may well be a change for many mining companies that under the previous version of IFRS 3 treated vendor type royalties as period costs. Any subsequent payment or transfer of shares to the vendor should be scrutinised to determine if these are contingent consideration.
Contingent consideration can take the form of a liability or equity. If the earn-out is a liability (cash or shares to the value of a specific amount), any subsequent re-measurement of the liability is recognised in income statement. If the earn-out is classified as equity it is not remeasured and any subsequent settlement is accounted for within equity.
6.4.4 Allocation of the cost of the combination to assets and liabilities acquired
IFRS 3 requires all identifiable assets and liabilities (including contingent liabilities) acquired or assumed to be recorded at their fair value. These include assets and liabilities that may not have been previously recorded by the entity acquired (e.g., acquired reserves and resources).
IFRS 3 also requires recognition separately of intangible assets if they arise from contractual or legal rights, or are separable from the business. The standard includes a list of items that are presumed to satisfy the recognition criteria. The items that should satisfy the recognition criteria include trademarks, trade names, service and certification marks, customer lists, customer and supplier contracts, use rights (such as drilling, water, etc.), patented/unpatented technology, etc.
Some of the common identifiable assets and liabilities specific to the mining industry that might be recognised in a business combination, in addition to inventory or property, plant and equipment, include the following:
• Exploration, development and production licences;
• Mineral properties;
• Purchase and sales contracts; and
• Closure and rehabilitation provisions.
6.4.5 Undeveloped properties
Undeveloped properties or exploration potential can present challenges when ascribing fair value to individual assets, particularly those properties still in the exploration phase for which proved or probable reserves have not yet been determined. A significant portion of the consideration transferred may relate to the value of these undeveloped properties.
Management should consider similar recent transactions in the market and use market participant assumptions to develop fair values. The specific characteristics of the properties also need to be taken into account, including the type and volume of exploration and evaluation work on resource estimates previously carried out, the location of the deposits and expected future commodity prices. The challenges associated within this are discussed further in 6.7.
6.4.6 Tax amortisation benefit
In many business combinations, especially related to mining acquisitions, the fair value of assets acquired uses an after-tax discounted cash flow approach. Inherent in this approach is an amount for the present value of the income tax benefits of deducting the purchase price through higher future depreciation charges. This is often referred to as the tax amortisation benefit (“TAB”).
An asset’s fair value in a business combination should reflect the price which would be paid for the individual asset if it were to be acquired separately. Accordingly, any TAB that would be available if the asset were acquired separately should be reflected in the fair value of the asset.
The TAB will increase the value of intangible and tangible assets and reduce goodwill. Assets that are valued via a market observable price rather than the use of discounted cash flows (“DCF”) should already reflect the general tax benefit associated with the asset. Where the fair value has been determined using a DCF model the TAB should normally be incorporated into the model.
6.4.7 Key questions
There are key questions for management to consider in a business combination as they can affect the values assigned to assets and liabilities, with a resulting effect on goodwill. These questions include:
• Have all intangible assets, such as geological &
geotechnical information, mineral property, exploration potential, been separately identified? There may be tax implications in allocating value to certain assets and each will need to be assessed in terms of their useful lives and impact on post acquisition earnings.
• Have closure and rehabilitation liabilities been fully captured? The value the acquirer would need to pay a third party to assume the obligation may be significantly different to the value calculated by the target.
• Does the acquiree have contracts that are at a price favourable or unfavourable to the market? Such contracts would have to be fair valued as at the date of acquisition.
• Do the terms of purchase provide for an ongoing royalty, other payments or transfer of equity instruments?
These arrangements could be contingent consideration that needs to be fair valued as at the date of acquisition.
• Does the acquiree use derivative instruments to hedge exposures? Post combination hedge accounting for pre-combination hedging instruments can be complex. The acquirer will need to designate these and prepare new contemporaneous documentation for each hedging relationship.
• Have all embedded derivatives been identified? New ownership of the acquired entity may mean that there are changes in the original conclusions reached when contracts were first entered into.
The above questions provide a flavour of the issues that management should consider in accounting for business combinations, and highlight the complexity of this area.