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Give a detailed explanation of what is AASB 3 standard.

Importance of identifying the acquirer

The AASB 3 business combination was adopted by Australian Accounting Standards Board that is said to be solely responsible for the maintenance and development of all financial reporting standards that are relevant to both private and public entities of the economy of Australia (He, Evans and He, 2016) . The purpose of this report is to give a detailed explanation of what is AASB 3 standard. It includes the proper definition and functionalities of the AASB 3 business combination. The report is drafted to give users the meaning of business combination that uses AASB 3. It further demonstrates the importance of identifying the acquirer, in a business combination. Relevant examples in the report throw limelight on the assets and liabilities that have not been recognized by the acquiree but are identifiable by the acquirer. Supporting instances have been attached to allow the user to avail a better understanding of AASB 3 business standards.

Background

The main agenda behind going ahead for AASB3 was to present the financial reporting that is submitted by any particular entity whenever it applies or shoulders a business combination (Dickinson, Wangerin and Wild, 2016). It gives detailed analyses of all the business combination reports that are accounted while tackling the purchase procedure or method. An excerpt of this standard was earlier published in 2014 in Commonwealth of Australia Gazette. AASB3 acts as an aid in helping the acquirer to identify the acquiree’s assets.

This further includes the identification of the liabilities of an acquiree at their actual fair values. This standard is considered, not to be valid and applicable to the annual reporting periods which have begun before the time span of 1 January 2005. Therefore, this standard is implemented to create the financial reports that are pertaining to part 2M.3 of the Corporation Act which is called as a reporting entity. The standard of AASB3 shall be applicable to all those annual reporting time duration that occur after 1 January 2005. Bugeja and Loyeung, (2015) asserted that the standard is finally applicable to all the accounting financial reports that are in real time, considered to be general purpose financial and accounting reports. All the content of information which is material in relation to AASB 1031 Materiality, in the financial reports is known to be the general requirements in this standard (Dickinson, Wangerin and Wild, 2016).

It specifies the requirement analysis for the standard of AASB3. The standard of AASB3 is said to supersede AASB1015, AAS21, AAS 18, and AASB1013. Since it is said to be superseding the above-mentioned standards, they all remain in the applicable active state until they are superseded. It is considered ideal to apply this standard to only those entities that are accounting for a business combination. The application and implementation of the standard of AASB3 are said to be irrelevant to the business entities which are joint together to create a shared venture. Any two business entities that desire to develop a joint venture are not considered to be eligible for applying this standard (AASB 3, Business Combinations, 2018). Furthermore, the business combination that constitutes two or more mutual entities is said to be ineligible to use the AASB3 standard in financial accounting.

Assets and liabilities that have not been recognized by the acquiree

In order to successfully apply AASB3 accounting standards in the field of a business combination, it is imperative first to identify and analyze which is a business combination. Since this standard cannot be considered appropriate to use without a business combination; it is required to recognize a business combination correctly. As per the norms generalized by Australian Accounting Standards Board, it is inappropriate to consider an entity as business combination if that particular entity has although gained the control of more than one entity, they are not business entities in reality. In such cases, we cannot use the application of AASB3. According to AASB3, the application would be considered relevant, if and only if it is in context of the business combination. In this scenario, a single entity, called the acquirer, should be able to gain the control of the equities that are developed by one or more entities which are known as acquiree (Jin, Shan and Taylor, 2015.).

Also, it further states that any entity that owns a group of assets which do not comprise a business, in that case, it should allocate the price of the entire group among the individual identifiable assets and liabilities. Such tasks are performed by evaluating the criteria in that particular group relying on their fair costs at the date on which they were acquired. However, an actual business combination is said to be organized in several different ways for the purpose of taxation and other legal issues. It, therefore, includes the purchase and assumptions of liabilities of one and another entity that is referred to combine and constitute one entity in a business combination environment. This involves the transactions between shareholders that own the joint entities (AASB, 2015).

The business combinations in AASB3 lead to a parent-subsidiary relationship as an output. To be precise, the acquirer enacts the role of a parent whereas; the acquiree plays the role of the subsidiary. The standard of AASB3 is implemented in all the consolidated financial statements, especially in these situations. A parent-subsidiary relationship is not said to be developed when a business combination constitutes the purchase of net assets that involves goodwill at the same time, instead of the purchase of equity of that particular entity (Bodle, Cybinski and Monem, 2016). Clause remains firm in AASB3 that the date of acquiring the control shall never collide with the date of acquiring the ownership of interest.

The method used for accounting in AASB3 stays strictly abiding by the application of purchase method. As per this standard, entire business combinations must be accounted by implementing the purchase method. The purchase method in this standard tends first to recognize the acquirer. Since all the methodologies in the AASB3 standard revolve around the activities of acquirer and acquiree, its first and foremost duty remains at identifying who the acquirer is (Ferrer and Tang, 2016). The post is recognizing the acquirer; it determines the exact cost of the business combination. Once, it calculates the entire cost of a business combination, the purchase method in AASB3, allocates the net cost to all the liabilities and assets at the date of acquisition. As the prime task of purchase method remains at identifying the acquirer, he should be responsible for calculating the exact cost of a business combination as the sum of fair values and costs.

Applicability and requirements of AASB3 standards

AASB3 requires that all the assets and liabilities that are identified and acquired must be displayed at a fair cost. Loyeung and et al. (2016), asserted that it is inclined towards this because a fair value helps in providing fairly correct information to all the users. The main agenda behind this standard is to provide genuinely improved information which is pertaining to reliability and comparability of the reporting entity. This standard is said to be relevant to any transaction or an entity which meets the defined norms of a pure business combination. It has been proven successful in identifying and calculating the financial statements for an acquirer and the assumed liabilities in acquiree (Dunbar and Laing, 2017). It has also been able to help in determining which type of information is eligible to be disclosed to the users in order to let them have proper analyses of the financial statement for effects of finance and nature in the context of the business combination. Moreover, the standard uses the acquisition method to providing the facilities of accounting to entities in a business combination.

Role of acquirer

Identifying the acquirer is one of the most important tasks in AASB3. The role of the acquirer is to stay in a combining state for one or more entities and gain the control or access for other combining entities in a business combination. Dickinson, Wangerin, and Wild, (2016) assessed that the methodology of purchase method tends to centralize the acquirer in the field of the business combination. It views the same from the perspective of the acquirer and begins to assume that either one of the organizations in the mode of the transaction may be recognized as an acquirer.

An acquirer is said to be one of the most imperative and powerful in the business combination. It is important to correctly identify an acquirer since he has the sole authority of control over one or more entities in a business combination. An acquirer in AASB3 takes control of the operation and financial policies and governs them in an entity. In order to obtain benefits in a productive manner, an acquirer is required in business combination. In the field of a business combination, the governing entity shall be acquiring more than one-half of the voting rights of another entity. Since the governing entity is the combining entity, it must have the voting rights until and unless, it can be evidently interpreted that such ownership does not necessarily involve any kind of control (Tran and Zhu, 2017). However, as a result of a combining entity, one of the entities is liable to take over control of another entity even if it does not acquire one-half of the voting rights of another entity. In such circumstances, it is the negotiation of agreements that come into action. In order to settle for acquiring the assets and liabilities of other entity, they allow settling through generalized agreements.

Assessment of acquirer

It is important to know the correct and eligible acquirer in an entity since it is purely related to the acquisition of other assets and liabilities which in turn helps in obtaining maximum benefits. A sort of virtue of agreement is signed with different investors to gain control on more than one half voting rights of entities (Russell, 2017). In situations wherein the combining entity fails to obtain more than one-half of the voting rights of the other entity, it tries to sort through agreements. It further gains control to appoint or even remove, the position holders sitting in the other entity. However, it is stated in AASB3 that while recognizing the acquirer in a business combination, the guidance provided in AASB10 shall be used for reference. Either one of the combining entities is identified as an acquirer. But, in cases where a new entity is formed, it becomes difficult to identify the correct acquirer. An incorrect and ineligible acquirer might not be beneficial for gaining control and obtaining assets from the other entity in a business combination.

The purchase method in AASB3

This is why, the entities that existed earlier are examined, and on the basis of evidence, the acquirer is chosen. While identifying the acquirer, several other factors are kept in mind in a business combination when using the AASB3 standards. It is checked if the revenue generated in the governance of acquirer is comparatively better than other revenues of the rest of the entities. Also, the acquirer is said to be responsible for measuring the cost of a business combination. If the cost calculated by the acquirer is somewhat incorrect or meets any discrepancies that will further create a problem in the accounting of financial reports. The acquirer must be fairly capable of identifying the absolute correct acquisition date since that is effective in calculating the fair value of all the assets and liabilities that are currently in the acquisition of the acquirer. Sometimes, the cost of a business combination is given in exchange for obtaining the control of the acquiree. Therefore, while identifying the acquirer, this becomes important to examine whether the acquirer will be able to determine the correct fair value or it. It is because; this would further reflect the position of a business organization. An acquirer enacts the role of the entity which is responsible for issuing the equity interests (Ferrer and Tang, 2016). A business combination is said to be highly affected by the exchange values issued by equity interests.

Scenarios to be considered while identifying the acquirer

It is important to consider all the current circumstances and pertinent fact while assigning the role of an acquirer to an entity in order to obtain maximum benefit from the activities that are performed in a business organization. Although, in situations of the reverse acquisition, the role of the acquirer is reversed. Here, the issuing entity becomes the acquiree, and the acquirer is the one whose equities are acquired. Therefore, it is vital to examine the situation while recognizing the acquirer correctly. Any different situation might lead to several varied outputs. In that case, an incorrect assignment to an acquirer also worsens the situation. Generally, an acquirer is believed to be a much larger entity but, sometimes all the liabilities and assets determine that a smaller entity tends to acquire large assets. The acquirer further enacts the role of a parent in the parent-subsidiary relationship (Carey, Potter and Tanewski, 2014). The parent is responsible for yielding high product and assigning duties to the subsidiary. It is also helpful in interpreting which all assets are acquired. Hence, this is imperative, to correctly recognize and identify an acquirer in order to allow a business combination to generate the maximum product.  

Assets and liabilities are recognized in order to ascertain the appropriate value of the business in case of business combination or acquisition of any business. Thus, significant consideration is to be provided in accordance with the importance of asset for the acquirer or acquiree. In words of Steenkamp and Steenkamp (2016) ,the asset or liabilities which will be of no value for the acquiree will be those on which it has no more control. It will comprise those liabilities too for which the same is not concerned in a significant manner. Three instances of such assets along with justification have been specified below:

Intangible Assets

Intangible assets can be defined as that asset which does not have any substance form. Though they don’t comprise physical existence, they add worth to business (Norman, 2017). They are long-term assets which mean that company can utilize it more than one year. For Instance, goodwill, trademark, patents, brand identification, copyrights, trade names and customer lists. There are two types of intangible assets that are intellectual property and goodwill. According to the paragraph 37 of AASB 138 acquirer identifies value of the intangible asset individually on the purchase date only in case it complies with the definition and its valuation can be done on a reliable basis. It can be analyzed from above discussion that evaluation and measurement of the intangible asset are more important for acquirer as the amount to be paid for acquisition is to ascertained after giving effect to same. Acquirer identifies assets apart from goodwill as it is intangible and value of it will be calculated only when someone purchases it (Bond, Govendir and Wells, 2016.). AASB 138 supplies assistance on decisive whether the fair value of an intangible asset permutation can be considered consistently. In reality, intangible assets are very vital for the company as it increases the value of the firm and can be essential to its long-term victory of life.

Contingent Liabilities

In accordance with provision specified in Para 86 of AASB 3, a liability is reported as a contingent liability only in case the outflow of resource remote. In case the organization is jointly and severally liable for the payment, the part is only to be treated as a contingent liability. It is necessary for an acquirer to ascertain whether the liabilities recorded as contingent liabilities continue to be of same nature as not. It is because the acquirer will be responsible for all the future liabilities of acquired organization.  It is important for an acquirer to identify contingent liability of the acquiree as part of allotting cost of business amalgamation only in case if its value can be estimated (AASB, 2014). In case it is not possible to value liability on reliable basis than the below specification is to be provided:

  • There will be a resultant cause of the amount classified as goodwill or amount as per Para 56 of AASB 3. (Zhuang, 2016).
  • The acquirer must reveal all the details related to that contingent liability needed to be presented in accordance with AASB 137.

Goodwill

Goodwill refers to an intangible asset; it is essential for the company in order to carry on the functions of the business. Moreover, people frequently depict goodwill as the capital infrastructure of the business. Hence, it is very significant to emphasize that it is not included in assets for business purchases which are exclusively connected to the purchase of plants, equipment, and stock. Ji and Lu (2014) , asserted that acquirer should identify goodwill at the purchase date into a business permutation like an asset. Goodwill obtains in a business amalgamation symbolizes a payment made through the acquirer into an expectation of future financial profits from assets that are not able of being recognized individually. Goodwill is estimated as the leftover expense of the business after identifying acquiree’s particular assets, liabilities and contingent liabilities (Leung and et al. 2014). In accordance to IFRS 3 “goodwill can be defined as the difference between the quantities of deliberation transferred from acquirer to acquiree and net individual assets obtained.” The same is ascertained through reducing net asset recognized from the sum of three variants, i.e., consideration transferred, amount of non-controlling interest and fair value of previous equity interest.

Conclusion

The above discussion depicts that AASB 3 deals with the provision relating to business combinations. The same is require to complied by each entity which is required to prepare financial reports in accordance with Corporations Act. Further, the standard appropriately provides explanation relating all the variants considered regarding a business combination. Goodwill of an organization is to be evaluated on a continuing basis, but the consideration of same is essential for acquirer than acquiree in case of a business combination. The reason behind same is that it becomes more important for an acquirer to ascertain whether the valuation presented by acquiree is appropriate or not. It is analyzed not only in case of goodwill but for all other asset and liabilities too.

References 

AASB 3. Business Combinations. (2017). (Online). Available through < https://www.legislation.gov.au/Details/F2009C01053>. [Accessed on 23rd May 2018]

AASB, C.A.S., 2014. Business Combinations. Disclosure, 66, p.77.

AASB, C.A.S., 2015. Investments in Associates and Joint Ventures.

Bodle, K.A., Cybinski, P.J. and Monem, R., 2016. Effect of IFRS adoption on financial reporting quality: Evidence from bankruptcy prediction. Accounting Research Journal, 29(3), pp.292-312.

Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairment decisions by Australian firms and whether this was impacted by AASB 136.

Bugeja, M. and Loyeung, A., 2015. What drives the allocation of the purchase price to goodwill?. Journal of Contemporary Accounting & Economics, 11(3), pp.245-261.

Carey, P., Potter, B. and Tanewski, G., 2014. AASB Research Report No.

Dickinson, V., Wangerin, D.D. and Wild, J.J., 2016. Accounting Rules and Post-Acquisition Profitability in Business Combinations. Accounting Horizons, 30(4), pp.427-447.

Dunbar, K. and Laing, G.K., 2017. Deconstructing the Accounting Standard AASB 13 Fair Value: Exit vs Entry Price for Assets. The Journal of New Business Ideas & Trends, 15(2), pp.12-19.

Ferrer, R.C. and Tang, A., 2016. An empirical investigation of the impact of financial ratios and business combination on stock price among the service firms in the Philippines. Academy of Accounting and Financial Studies Journal, 20(2), p.104.

Ferrer, R.C. and Tang, A., 2016. An empirical investigation of the impact of financial ratios and business combination on stock price among the service firms in the Philippines. Academy of Accounting and Financial Studies Journal, 20(2), p.104.

He, L., Evans, E. and He, R., 2016. The Impact of AASB 8 Operating Segments on Analysts’ Earnings Forecasts: Australian Evidence. Australian Accounting Review, 26(4), pp.330-340.

Ji, X.D. and Lu, W., 2014. The value relevance and reliability of intangible assets: Evidence from Australia before and after adopting IFRS. Asian Review of Accounting, 22(3), pp.182-216.

Jin, K., Shan, Y. and Taylor, S., 2015. Matching between revenues and expenses and the adoption of International Financial Reporting Standards. Pacific-Basin Finance Journal, 35, pp.90-107.

Leung, P., Coram, P., Cooper, B.J. and Richardson, P., 2014. Modern Auditing and Assurance Services 6e. Wiley.

Loyeung, A., Matolcsy, Z., Weber, J. and Wells, P., 2016. The cost of implementing new accounting standards: The case of IFRS adoption in Australia. Australian Journal of Management, 41(4), pp.611-632.

Norman, D., 2017. Returns on Equity, Cost of Equity and the Implications for Banks. The Recent Economic Performance of the States 1 Insights into Low Wage Growth in Australia 13 Housing Market Turnover 21 Inflation Expectations in Advanced Economies 31 Developments in Banks’ Funding Costs and Lending Rates 45, p.51.

Russell, M., 2017. Management incentives to recognise intangible assets. Accounting & Finance, 57(S1), pp.211-234.

Steenkamp, N. and Steenkamp, S., 2016. AASB 138: catalyst for managerial decisions reducing R&D spending?. Journal of Financial Reporting and Accounting, 14(1), pp.116-130.

Tran, A. and Zhu, Y.H., 2017. The impact of adopting IFRS on corporate ETR and book-tax income gap. In Australian Tax Forum (Vol. 32, No. 4, p. 757). Tax Institute.

Zhuang, Z., 2016. Discussion of ‘An evaluation of asset impairments by Australian firms and whether they were impacted by AASB 136’. Accounting & Finance, 56(1), pp.289-294.

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