In terms of Regulation 37(c) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process For Corporate Persons) Regulations, 2016, a resolution plan shall provide for the measures, as may be necessary, for insolvency resolution of the corporate debtor for maximization of value of its assets, including but not limited to the substantial acquisition of shares of the corporate debtor, or the merger or consolidation of the corporate debtor with one or more persons.
The above will give rise accounting issues for the successful resolution applicant who would be acquiring substantial shares of the corporate debtor. The present article makes an attempt to discuss the core accounting issues that may arise under Ind AS 103 on Business Combination from the point of view of the legal acquirer (i.e. successful resolution applicant).
1. Business combination
Ind AS 103 provides that a business combination is a transaction or other event in which an acquirer obtains control of one or more businesses. An acquirer might obtain control of an acquiree in a variety of ways, for example:
(a) by transferring cash, cash equivalents or other assets (including net assets that constitute a business);
(b) by incurring liabilities;
(c) by issuing equity interests;
(d) by providing more than one type of consideration; or
(e) without transferring consideration, including by contract alone.
Further, a business combination may be structured in a variety of ways for legal, taxation or other reasons, which include but are not limited to:
(a) one or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer;
(b) one combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners;
(c) all of the combining entities transfer their net assets, or the owners of those entities transfer their equity interests, to a newly formed entity (sometimes referred to as a roll-up or put-together transaction); or
(d) a group of former owners of one of the combining entities obtains control of the combined entity.
Appendix C of Ind AS 103 deals with accounting for combination of entities or businesses under common control which is not discussed in the present article as the subject matter has been kept confined to only those business combinations which are not under common control even post such combination.
2. Acquisition method
An entity shall account for each business combination by applying the acquisition method. Applying the acquisition method requires:
(a) identifying the acquirer – The guidance in Ind AS 110 shall be used to identify the acquirer—the entity that obtains control of another entity, i.e. the acquiree;
(b) determining the acquisition date – The date on which the acquirer obtains control of the acquiree is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree—the closing date. However, the acquirer might obtain control on a date that is either earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. An acquirer shall consider all pertinent facts and circumstances in identifying the acquisition date;
(c) recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree – As of the acquisition date, the acquirer shall recognise, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. Further, the acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.
(d) recognising and measuring goodwill or a gain from a bargain purchase – Para 32 provides that the acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:
(a) the aggregate of:
(i) the consideration transferred measured in accordance with this Ind AS, which generally requires acquisition-date fair value;
(ii) the amount of any non-controlling interest in the acquiree measured in accordance with this Ind AS; and
(iii) in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.
(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Ind AS.
In extremely rare circumstances, an acquirer will make a bargain purchase in a business combination in which the amount in paragraph 32(b) exceeds the aggregate of the amounts specified in paragraph 32(a). Before recognising a gain on a bargain purchase, the acquirer shall determine whether there exists clear evidence of the underlying reasons for classifying the business combination as a bargain purchase. If such evidence exists, the acquirer shall reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and shall recognise any additional assets or liabilities that are identified in that review. If that excess remains even after applying the aforesaid requirements, the acquirer shall recognise the resulting gain in other comprehensive income on the acquisition date and accumulate the same in equity as capital reserve. The gain shall be attributed to the acquirer. A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion.
3. Fair value when the acquiree is acquired under CIRP – whether a rule of thumb
A moot question that may arise is that what shall be the fair values for the purpose of measurement principle as given in Ind AS 103 when the acquiree is acquired under Corporate Insolvency Resolution Process (CIRP). This is important because Ind AS 103 states that under acquisition method, as of the acquisition date, the acquirer shall recognise, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree and the acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.
Ind AS 103 is not that much explicit in this regard and hence the possible resolution for this question can be derived from Ind AS 113 on Fair Value Measurement as deliberate in the following paragraphs.
3.1. Fair value under Ind AS 113: This Ind AS defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
3.2. What is orderly transaction: A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (e.g. a forced liquidation or distress sale).
3.3. Who is market participant: Buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics:
(a) They are independent of each other;
(b) They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction;
(c) They are able to enter into a transaction for the asset or liability;
(d) They are willing to enter into a transaction for the asset or liability, i.e. they are motivated but not forced or otherwise compelled to do so.
Para 31 of Ind AS 103 also states that the acquirer shall measure an acquired non-current asset (or disposal group) that is classified as held for sale at the acquisition date in accordance with Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations, at fair value less costs to sell in accordance with paragraphs 15 of that Ind AS (i.e. an entity shall measure a non-current asset (or disposal group) classified as held for sale at the lower of its carrying amount and fair value less costs to sell). Primarily, just before the acquisition date the acquiree would have been classifying the assets (disposal group) as held for sale. This will result in their automatic fair valuation in terms of Ind AS 113 as on the acquisition date.
Even otherwise if it is argued that the acquiree would not have classified the assets (disposal group) as held for sale then also Ind AS 113 will lead a fair valuation but in such circumstances the fair valuation so adopted is a value under distress sale and not under an orderly transaction in between the market participants (the feature of being a market participant being absent on the acquiree side since his willingness for such a transaction is non-existent). So on acquisition date, the values that could be adopted would need to seen from the point of view of the acquirer that might have been negotiated under the approved resolution plan.
So the fair value measurement principle under Ind AS 103 is not a rule of thumb and such a principle read with Ind AS 113 provides sufficient flexibility in terms of such valuation specially when there are no orderly transactions and market participants.