The Philippine economy is moving at full speed ahead. It is a strong performer compared with the economies of its neighbors. Even with the recent decline in value of the Philippine peso, forecasts disclose that this economic growth is likely to remain strong and even accelerate in the coming months.
With such positive outlook, the Philippine market continues to be very dynamic. Businesses become more aggressive in exploring growth opportunities by entering into deals for investment or divestment for funding. As businesses continue to enter into strategic collaborations, company executives would usually put more attention on managing stabilization of operations, which would involve process transition, people and business integration, and investor relations. Businesses often forget the financial reporting element of the transaction, including the impact of the new accounting rules to the financial figures and disclosures. Considering the strict implementation of the accounting rules by regulators, companies and their executives should give financial reporting the needed importance.
The accounting rules have significantly evolved over the years. Gone are the days when you just have to record the asset that you acquired based on the amount paid and deduct the same amount from your cash balance. With this, it is essential to know some important points that businesses need to consider in its financial reporting while strategizing a deal.
Share-deal: Subsidiary or other investments
A share-deal is an acquisition of shares of a company. The type of investment acquired would drive accounting, as well as impact on required regulatory filings. Following share acquisition, when a buyer obtains ‘control’ over the seller’s company, the buyer has an investment in a subsidiary in its stand-alone financial statements and is required to prepare consolidated financial statements. Identification of control was previously tied-up with the percentage ownership or voting rights of an investor—having more than 50 percent ownership means control over a subsidiary. Philippine Financial Reporting Standards (PFRS) 10, the new consolidation standard, provides that assessment of control should not be limited to an investor’s percentage ownership interest. The new standard explains that an investor may have control over the company in which he has invested and have a subsidiary even with less than 51 percent ownership interest. It clarifies that if the investor has significant exposure to the earnings/losses of the company he has invested in and if the investor has the ability to participate or influence decisions over operational and financial matters of that company, the investor has control and should recognize an investment in a subsidiary in its financial statements and generally prepare consolidated financial statements.
If the investor does not have control over a company, its investment would either be an investment in an associate or a regular financial investment. These types of investments would not require the investor to consolidate and would generally impact the investor’s financials for its annual share in profits/losses, dividends and possible impairment.
Asset deal: Asset or business
An asset-deal is an acquisition of an asset or group of assets of a company. In the past, accounting for an asset-deal was very straightforward. However, when PFRS 3 on business combination was issued, the expanded application guidance of the standard introduced changes that led to more transactions being recognized as business combinations. At present, once an asset or group of assets are acquired, the buyer has to assess if such acquisition is a simple asset acquisition or would qualify as a business acquisition that should be accounted for at fair value under PFRS 3.
For example, an investor acquired a building with tenants and has agreed to take on the related lease contracts of the existing tenants. Such transaction may qualify as a business acquisition because the investor acquired an integrated set of assets that is capable of being managed for the purpose of providing a return. Identifying whether the transaction is an asset or business acquisition is important because the type of transaction would drive its accounting recognition and the extent of financial statement disclosure requirements.
Valuation, intangibles and negative goodwill
Accounting for a share-deal transaction resulting to an investment in a subsidiary is simple in the investor’s stand-alone financials. The investment would just be recorded at purchase price. However, accounting for the subsidiary acquisition in its consolidated financial statements would be tricky, because similar to accounting for business acquisition in an asset-deal, the investor should follow the fair value recognition of all assets acquired and liabilities assumed.
While an investor may have a fair value estimation of the acquired company’s assets and liabilities, it is essential to involve valuation experts in the process because there may be intangibles that would only be captured in a purchase price allocation (PPA) report. These intangibles may not necessarily be present in the seller’s financials, but may appear in a PPA report prepared by valuation experts. Once identified in a PPA report, these intangibles (e.g. goodwill, franchise rights, customer relationships), should be taken-up in the investor’s financial statements. Like any asset, investors should look out for possible impairment indicators to be able to assess any impairment loss of intangibles at a given period. However, in the case of goodwill, an impairment assessment is required to be performed on an annual basis.
Negative goodwill or the excess of the seller’s net assets at fair value over consideration paid by the buyer is no longer allowed to be recognized in the balance sheets. Negative goodwill is immediately recognized as gain in the investor’s income statement.
Related party considerations
An important matter to consider when assessing deal transactions is the buyer-seller relationship on deal date. If the buyer and seller are related parties, the investor has an option to account for the business acquisition at cost or based on the book value per seller’s financial statements.
For most related parties entering into these types of transaction, the objective is just reorganization. So, the preference is to apply the transaction retrospectively to show comparative results in the financial statements, which is acceptable locally.
While the existing PFRS does not have explicit rules for business acquisition or combination amongst related parties, the Philippine Interpretations Committee (PIC) has issued PIC Q&As 2011-02 and 2012-01 to clarify accounting options for these related party transactions. However, once an accounting option has been selected or applied, a company should follow the same policy for all similar transactions in the future.
Disposal of a business segment
A strategic business decision does not only involve expansion through acquisition. Some businesses would refer to a sale of a business segment as a strategic business move. In cases of divestment, management should be aware that disposal of a business segment or division would require more financial statement disclosures compared to a simple sale of assets.
Assets and liabilities of a disposed segment may not significantly affect the balance sheet presentation, but details of the disposal (e.g. amount of cash or property received in exchange) are required to be disclosed in the notes to financial statements. The income statement on the other hand would need to present comparative profit or loss from continuing operations separately from discontinued operations. Further, net cash flows from operating, investing and financing activities of the disposed segment should also be presented in the statement of cash flows or in the notes to financial statements.
In that case, while a divestment may happen only in the current year, comparative information would be affected for purposes of financial reporting. Companies should be ready for all the required disclosure information in cases of segment disposal.
A number of the new and revised accounting rules would require judgment, and an option taken by management now may not only affect the current financials of companies but may also affect the future financial results. Be aware of the changing rules and ensure readiness by involving the right people who would help you maximize value in moments of change and adjustment.
Again, as management think of how they will turn around businesses, they should always consider the accounting and reporting implication of the same. Make sure that financial reporting is correct to avoid unexpected costs from litigations or from regulatory penalties.
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Ma. Lois G. Abad is a partner from Assurance, Accounting Consulting Services and Human Capital of Isla Lipana & Co./PwC Philippines. Email your comments and questions to email@example.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
MA. LOIS G. ABAD