Ind AS 103 | Business Combination and Corporate Restructuring
- Blog|Account & Audit|
- 20 Min Read
- By Taxmann
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- Last Updated on 29 August, 2023
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Table of Content
1. FAQs on Scope (Asset Acquisition) [Based on Para No. 2]
3. FAQs on Determine the Acquisition Date (Based on Para Nos. 8 and 9)
4. FAQs on Computation of Consideration Transferred (Based on Para Nos. 37 to 40 and 53)
5. FAQs on Contingent Consideration (Based on Para Nos. 39, 40 and 58)
6. FAQs on Contingent Liability+ Indemnification Assets (Based on Para Nos. 22, 23, 27 and 28)
7. FAQs on Measurement After Acquisition Accounting – Adjustments to Provisional Amounts
1. FAQs on Scope (Asset Acquisition) [based On Para No. 2]
FAQ 1. What are the key differences in accounting of an asset acquisition and a business combination?
The following are the key differences in accounting of an asset acquisition and a business combination:
|
Topic |
Business combination |
Acquisition of group of assets under Ind AS |
| Intangible assets, including goodwill | Intangible assets are recognized at fair value, if they are separately identifiable. Goodwill is recognized as a separate asset. | Intangible assets acquired as part of a group of assets would be recognized and measured based on an allocation of the overall cost of the transaction with reference to their relative fair values. No goodwill would be recognized. |
| Transaction costs | In a business combination, acquisition-related costs (including stamp duty) are expensed in the period in which such costs are incurred and are not included as part of the consideration transferred. | Transaction costs are capitalized as a component of the cost of the assets acquired. |
| Deferred tax accounting | Deferred taxes are recorded on temporary differences of assets acquired (other than goodwill) and liabilities assumed in a business combination. | Ind AS prohibits recognition of deferred taxes for temporary differences that arise upon initial recognition of an asset or liability in a transaction that (i) is not a business combination and (ii) at the time of the transaction, affects neither accounting nor taxable income. Accordingly, no deferred taxes are recognized for temporary differences on asset acquisitions (on initial recognition). |
| Situations where the fair value of the assets acquired and liabilities assumed exceeds the fair value of consideration transferred (referred to as bargain purchases) | If the fair value of the assets acquired and liabilities assumed exceeds the fair value of the consideration transferred (plus the amount of non-controlling interest and the fair value of the acquirer’s previously held equity interests in the acquiree), a gain is recognized by the acquirer in other comprehensive income and accumulated in capital reserve. | The assets acquired and liabilities assumed are measured using an allocation of the fair value of consideration transferred based upon relative fair values. As a result, no gain is recognized for a bargain purchase. |
Dive Deeper:
[FAQs] on Accounting Aspects of Corporate Restructuring
Corporate Restructuring: Types and Importance
2. FAQs on Identification of a Business Combination (Based on Para No. 3 and Para Nos. B5 to B12 of Appendix B)
FAQ 2. Which of the following scenario represents a Business Combination?
(a) Case A: On 1st January, 2012, A Ltd. owns a majority share of its investee’s voting equity interests. The other investors in the investee hold contractual rights (for example, board membership rights accompanied by veto rights on operating matters, or other substantive participation rights) which preclude A Ltd. from exercising control over the investor. The contractual rights of other investors were for 5 years which lapsed on 31st December, 2016 as per the terms of the contract.
(b) Case B: P Ltd. owns an equity investment in an investee that gives it significant influence but not control. During the year, the investee repurchased its own shares from other parties and the same were extinguished which resulted in an increase in the P Ltd.’s proportional interest in the investee (to 60% of the voting rights), which results in P Ltd. acquiring control of the investee.
(a) In Case A, on 1st January 2017, it represents a change in the rights of other shareholders (elimination or expiration of the contractual rights precluding control) which result in A Ltd. obtaining control of the investee and qualifying as a business combination.
(b) In Case B, the repurchase by investee of its own shares from other parties results in P Ltd. obtaining control of the investee (presuming no other indicator impacting control). This transaction qualifies as a business combination and the acquisition method would be applied by P Ltd.
3. FAQs on Determine the Acquisition Date (Based on Para Nos. 8 and 9)
FAQ 3. Company A Ltd. acquired all the shares of Company X Ltd. The negotiations had commenced on 1st January, 2016 and the agreement was finalized on 1 March, 2016. While A Ltd. obtains the power to control X’s operations on 1 March, 2016, the agreement states that the acquisition is effective from 1 January, 2016 and that A Ltd. is entitled to all profits after that date. In addition, the purchase price is based on X’s net asset position as at 1 January 2016. What is the date of acquisition?
The answer is based on Paragraphs 6, 7, 8 and 9 of Ind AS 103.
Therefore, in this case, notwithstanding that the price is based on the net assets at 1 January, 2016 and that X’s shareholders do not receive any dividends after that date, the date of acquisition for accounting purposes will be 1 March 2016. It is only on 1 March, 2016 and not 1 January, 2016, that A has the power to direct the relevant activities of X Ltd. so as to affect its returns from its involvement with X Ltd. Accordingly, the date of acquisition is 1 March, 2016.
FAQ 4. Company A Ltd. and Company X Ltd. are manufacturers of rubber components for a particular type of equipment. A Ltd. makes a bid for X Ltd.’s business and the Competition Commission of India (CCI) announces that the proposed transaction is to be scrutinized to ensure that competition laws are not breached. Even though the contracts are made subject to the approval of the CCI, A Ltd. and X Ltd. mutually agree the terms of the acquisition and the purchase price before competition authority clearance is obtained. Can the acquisition date in this situation be the date on which A Ltd. and X Ltd. agree the terms even though the approval of CCI is awaited (Assume that the approval of CCI is substantive)?
The answer is based on Paragraphs 8 and 9 of Ind AS 103.
Since CCI approval is a substantive approval for A Ltd. to acquire control of X Ltd.’s operations, the date of acquisition cannot be earlier than the date on which approval is obtained from CCI. This is pertinent given that the approval from CCI is considered to be a substantive process and accordingly, the acquisition is considered to be completed only on receipt of such approval.
FAQ 5. X Ltd. makes an offer (subject to the satisfactory completion of due diligence) to buy all of the shares in Y Ltd. which is wholly owned by Z Ltd. Pending transfer of shares to X, the parties agree that X Ltd. should be consulted on any major business decisions. Whether offer date can be considered to be the date of acquisition?
The answer is based on paragraphs 8 and 9 of Ind AS 103.
In the given case, X Ltd. cannot be considered to have the power to direct the relevant activities of Y Ltd. only due to the fact that it will be consulted on major decisions. X Ltd. does not have the power to impose its decisions on Y Ltd. Accordingly, based on the above, the offer date cannot be considered to be the date of acquisition.
4. FAQs on Computation of Consideration Transferred (Based on Para Nos. 37 to 40 and 53)
FAQ 6. A Ltd. acquired the entire equity share capital of P Ltd. for INR 8 crores. A Ltd. paid INR 2 crores in cash and the balance INR 6 crores has been agreed to be paid to the seller in 5 years as a deferred consideration. How should the deferred consideration be valued for determining the consideration transferred in relation to computation of goodwill?
The answer is based on Paragraph 37 of Ind AS 103.
The deferred consideration issued is required to be measured at its fair value. The deferred consideration will be valued at its net present value determined with reference to an appropriate discount rate (e.g. the rate at which entity A Ltd. could issue the same amount of debt in a separate market transaction with the appropriate adjustment for credit rating) for the purpose of computation of the consideration transferred.
Subsequent unwinding of the discounting discussed above is required to be recognized as finance cost in the respective years’ statement of profit and loss.
FAQ 7. Should stamp duty paid on acquisition of land pursuant to a business combination be capitalized to the cost of the asset or should it be treated as an acquisition related cost and accordingly be expensed off?
The transfer of land and the related stamp duty is required to be accounted as part of the business combination transaction as per requirements of Ind AS 103 and not as a separate transaction under Ind AS. Accordingly, stamp duty incurred in relation to land acquired as part of a business combination transaction are required to be recognized as an expense in the period in which the acquisition is completed and given effect to in the financial statements of the acquirer.
FAQ 8. On 1st April, 2016, Company P Ltd. acquired 30% of the voting ordinary shares of Company X Ltd. for INR 8,000 crores. P Ltd. accounts its investment in X Ltd. using equity method as prescribed under Ind AS 28, Investments in Associates and Joint Ventures. At 31 March, 2017, P Ltd. recognized its share of the net asset changes of X Ltd. using equity accounting as follows:
(Amounts in INR-crores)
Share of profit or loss |
700 |
Share of exchange difference in OCI |
100 |
Share of revaluation reserve of PPE in OCI |
50 |
The carrying amount of the investment in the associate on 31 March, 2017 was therefore 8,850 (8,000 + 700 + 100 + 50).
On 1 April, 2017, P Ltd. acquired the remaining 70% of X Ltd. for cash of INR 25,000 crores. The following additional information is relevant at that date
Fair value of the 30% interest already owned |
9,000 |
Fair value of X’s identifiable net assets |
30,000 |
How should such business combination be accounted for?
P Ltd. records the following entry in its consolidated financial statements:
(Amounts in INR-crores)
| Debit | Credit | |
| Identifiable net assets of X Ltd. | 30,000 | |
| Goodwill | 4,000 | |
| Foreign currency translation reserve | 100 | |
| PPE revaluation reserve | 50 | |
| Cash | 25,000 | |
| Investment in associate -X Ltd. | 8,850 | |
| Retained earnings (See Note 2) | 50 |
Gain on previously held interest in X recognized in Profit or loss P 250
[To recognize acquisition of X Ltd.]
Notes:
1. Goodwill calculated as follows:
| Cash consideration | 25,000 |
| Fair value of previously held equity interest in X Ltd. | 9,000 |
| Total consideration | 34,000 |
| Fair value of identifiable net assets acquired | (30,000) |
| Goodwill | 4,000 |
2. The credit to retained earnings represents the reversal of the unrealized gain of INR 50 crores in Other Comprehensive Income related to the revaluation of property, plant and equipment. In accordance with Ind AS 16, this amount is not reclassified to profit or loss.
3. The gain on the previously held equity interest in X Ltd. is calculated as follows: INR
| Fair Value of 30% interest in XYZ Ltd. at 1st April, 2017 | 9,000 |
| Carrying amount of interest in XYZ Ltd. at 1st April, 2017 | (8,850) |
| 150 | |
| Unrealized gain previously recognized in OCI | 100 |
| Gain on previously held interest in X Ltd. recognized in profit or loss | 250 |
FAQ 9. Deepak Ltd., an automobile group acquires 25% of the voting ordinary shares of Shaun Ltd., another automobile business, by paying ` 4,320 crore on 01.04.2017. Deepak Ltd. accounts its investment in Shaun Ltd. using equity method as prescribed under Ind AS 28. At 31.03.2018, Deepak Ltd. recognised its share of the net asset changes of Shaun Ltd. using equity accounting as follows:
|
|
(` in crore) |
| Share of Profit or Loss | 378 |
| Share of Exchange difference in OCI | 54 |
| Share of Revaluation Reserve of PPE in OCI | 27 |
The carrying amount of the investment in the associate on 31.03.2018 was therefore ` 4,779 crore (4,320+378+54+27).
On 01.04.2018, Deepak Ltd. acquired remaining 75% of Shaun Ltd. for cash ` 13,500 crore. Fair value of the 25% interest already owned was ` 4,860 crore and fair value of Shaun Ltd.’s identifiable net assets was ` 16,200 crore as on 01.04.2018.
How should such business combination be accounted for in accordance with the applicable Ind AS ?
Deepak Ltd. records the following entry in its consolidated financial statements:
| (` in crore) | |||
| Debit | Credit | ||
| Identifiable net assets of Shaun Ltd. | Dr. | 16,200 | |
| Goodwill (W.N.1) | Dr. | 2,160 | |
| Foreign currency translation reserve | Dr. | 54 | |
| PPE revaluation reserve | Dr. | 27 | |
| To Cash | 13,500 | ||
| To Investment in associate – Shaun Ltd. | 4,320 | ||
| To Retained earnings (W.N.2) | 27 | ||
| To Gain on previously held interest in Shaun Ltd. recognized in Profit or loss (W.N.3) | 594 | ||
| (To recognize acquisition of Shaun Ltd.) | |||
Working Notes:
- Calculation of Goodwill
| ` in crore | |
| Cash consideration | 13,500 |
| Add: Fair value of previously held equity interest in Shaun Ltd. | 4,860 |
| Total consideration | 18,360 |
| Less: Fair value of identifiable net assets acquired | (16,200) |
| Goodwill | 2,160 |
- The credit to retained earnings represents the reversal of the unrealized gain of ` 27 crore in Other Comprehensive Income related to the revaluation of property, plant and equipment. In accordance with Ind AS 16, this amount is not reclassified to profit or loss.
- The gain on the previously held equity interest in Shaun Ltd. is calculated as follows:
| ` in crore | |
| Fair Value of 30% interest in Shaun Ltd. at 1st April, 2017 | 4,860 |
| Carrying amount of interest in Shaun Ltd. at 1st April, 2017 | (4,320) |
| 540 | |
| Unrealised gain previously recognised in OCI | 54 |
| Gain on previously held interest in Shaun Ltd. recognised in profit or loss | 594 |
5. FAQs on Contingent Consideration (Based on Para Nos. 39, 40 And 58)
FAQ 10. How should contingent consideration payable in relation to a business combination be accounted for on initial recognition and at the subsequent measurement in the following cases:
(a) On 1 April, 2016, A Ltd. acquires 100% interest in B Ltd. As per the terms of agreement the purchase consideration is payable in the following 2 tranches:
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-
-
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an immediate issuance of 10 lakhs shares of A Ltd. having face value of INR 10 per share;
-
a further issuance of 2 lakhs shares after one year if the profit before interest and tax of B Ltd. for the first year following acquisition exceeds INR 1 crore.
-
-
-
The fair value of the shares of A Ltd. on the date of acquisition is INR 20 per share. Further, the management has estimated that on the date of acquisition, the fair value of contingent consideration is INR 25 lakhs.
During the year ended 31 March, 2017, the profit before interest and tax of B Ltd. exceeded INR 1 crore. As on 31 March, 2017, the fair value of shares of A Ltd. is INR 25 per share.
(b) Continuing with the fact pattern in (a) above except for:
-
-
-
-
The number of shares to be issued after one year is not fixed.
-
Rather, A Ltd. agreed to issue variable number of shares having a fair value equal to INR 40 lakhs after one year, if the profit before interest and tax for the first year following acquisition exceeds INR 1 crore.
-
-
-
The answer is based on Paragraphs 37 and 39 of Ind AS 103.
(a) The amount of purchase consideration to be recognized on initial recognition shall as follows:
|
Fair value shares issued (10,00,000 × INR 20) |
INR 2,00,00,000 |
|
Fair value of contingent consideration |
INR 25,00,000 |
| Total purchase consideration |
INR 2,25,00,000 |
Subsequent measurement of contingent consideration payable for business combination
In general, an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Ind AS 32 describes an equity instrument as one that meets both of the following conditions:
-
- There is no contractual obligation to deliver cash or another financial asset to another party, or to exchange financial assets or financial liabilities with another party under potentially unfavourable conditions (for the issuer of the instrument).
- If the instrument will or may be settled in the issuer’s own equity instruments, then it is:
— a non-derivative that comprises an obligation for the issuer to deliver a fixed number of its own equity instruments; or
— a derivative that will be settled only by the issuer exchanging a fixed amount of cash or other financial assets for a fixed number of its own equity instruments.
In the given case, given that the acquirer has an obligation to issue fixed number of shares on fulfilment of the contingency, the contingent consideration will be classified as equity as per the requirements of Ind AS 32.
As per paragraph 58 of Ind AS 103, contingent consideration classified as equity should not be re-measured and its subsequent settlement should be accounted for within equity.
In the given case, the obligation to pay contingent consideration amounting to INR 25,00,000 is recognized as a part of equity and therefore not re-measured subsequently or on issuance of shares.
(b) The amount of purchase consideration to be recognized on initial recognition is as follows-:
|
Fair value shares issued (10,00,000 × INR 20) |
INR 2,00,00,000 |
|
Fair value of contingent consideration |
INR 25,00,000 |
|
Total purchase consideration |
INR 2,25,00,000 |
Subsequent measurement of contingent consideration payable for business combination
In the given case, the contingent consideration will be classified as liability as per Ind AS 32.
As per paragraph 58 of Ind AS 103, contingent consideration not classified as equity should be measured at fair value at each reporting date and changes in fair value should be recognized in profit or loss.
As at 31 March, 2017 (being the date of settlement of contingent consideration), the liability would be measured at its fair value and the resulting loss of INR 15,00,000 (INR 40,00,000 – INR 25,00,000) should be recognized in the profit or loss for the period. A Ltd. would recognize issuance of 1,60,000 (INR 40,00,000/25) shares at a premium of INR 15 per share.
FAQ 11. A Ltd. acquires P Ltd. in September 2016 for cash. Additionally, A Ltd. agrees to pay the selling shareholder an amount equivalent to 10% of profits in excess of INR 10 crores generated over the next two years in cash in lump sum at the end of the three years. A Ltd. determines the fair value of the contingent consideration liability to be INR 1 crores at the date of acquisition.
A year after the acquisition, P Ltd. has performed better than initially projected by A Ltd. and a higher payment is now expected to be made at the end of year two. The fair value of this financial liability is INR 2.5 crores at the end of the first year.
Whether there should be any adjustment in the acquisition accounting? If yes, by what amount?
The answer is based on Paragraph 58 of Ind AS 103.
Where contingent consideration is not classified as equity, the changes in its fair value that are not measurement period adjustment should be remeasured to fair value at each reporting date until the contingency is settled. Such changes in fair value are required to recognized in profit or loss (in accordance with Ind AS 109 where such contingent consideration is within the scope of the standard).
Thus, A Ltd. should re-measure contingent consideration at the end of the year i.e. 31 March 2017 as follows:
| Profit and loss A/c | Dr. | 1,50,00,000 |
| Liability for contingent consideration | Cr. | 1,50,00,000 |
Similarly, the adjustment to the financial liability to reflect the final settlement amount (final fair value) is required to be recognized in profit or loss if the amount differs from the fair value estimate at the end of the first year.
FAQ 12. Entity A Ltd. acquired entity P Ltd. for INR 5 crores. To protect A for false representations and warranties (if any) asserted by the sellers of entity P Ltd. the acquisition agreement provides that A Ltd. will pay INR 4.5 crores at the acquisition date and place the balance INR 50 Lakhs in an escrow account (being a protective clause). If no violation of the representations and warranties is reported or noticed within one year of the acquisition date, the amount of INR 50 Lakhs in the escrow account will be released to the sellers. Should INR 50 Lakhs lying in escrow be accounted for as contingent consideration by entity A Ltd.?
In the given case, the funds lying in escrow are released to the sellers based on the validity of conditions that existed at the acquisition date and are not dependent on the future performance of entity P Ltd. Further, as the escrow arrangement is only protective in nature. Therefore, INR 50 Lakhs will not be considered as a contingent consideration. It is instead required to be treated as part of the consideration for the business combination on the date of acquisition and consequently should be considered for computation of goodwill in relation to the acquisition.
Subsequently, based on paragraph 45 of Ind AS 103, adjustments, if any, to the amount in escrow would be accounted, for as a measurement period adjustment that impacts goodwill given that they result from new information that is obtained after the acquisition date about facts and circumstances that existed as of the acquisition date.
FAQ 13. A Ltd. agrees to acquire P Ltd. for INR 60 crores as per an agreement dated 15 March, 2017. The acquisition is however subject to the successful completion of the closing conditions. As per the agreement between A Ltd. and P Ltd., to the extent the working capital (that is, inventory, receivables and payables) at the acquisition date (on successful completion of closing conditions) exceeds a specified minimum level of 10 crores, A Ltd. will pay additional consideration to the seller. For instance, if P’s working capital is INR 11 crores, A will pay an additional INR 1 crores. Should A Ltd. account for the working capital adjustment as contingent consideration?
The answer is based on Paragraph 45 of Ind AS 103.
The working capital adjustment in relation to A Ltd.’s acquisition of P Ltd. is a mechanism to determine the working capital as of the acquisition date. While the working capital computation may be completed post the acquisition date, the computation does not consider the impact of any future event, conditions, contingencies etc.
Accordingly, given that the working capital adjustment reflects the consideration to be paid as of the acquisition date, the same may not be treated as contingent consideration.
FAQ 14. P Ltd., a manufacturing company, prepares consolidated financial statements to 31st March each year. During the year ended 31st March, 2018, the following events affected the tax position of the group:
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Q Ltd., a wholly owned subsidiary of P Ltd., incurred a loss adjusted for tax purposes of ` 30,00,000. Q Ltd. is unable to utilise this loss against previous tax liabilities. Income-tax Act does not allow Q Ltd. to transfer the tax loss to other group companies. However, it allows Q Ltd. to carry the loss forward and utilise it against company’s future taxable profits. The directors of P Ltd. do not consider that Q Ltd. will make taxable profits in the foreseeable future.
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During the year ended 31st March, 2018, P Ltd. capitalised development costs which satisfied the criteria as per Ind AS 38 ‘Intangible Assets’.
The total amount capitalised was ` 16,00,000. The development project began to generate economic benefits for PQR Ltd. from 1st January, 2018. The directors of P Ltd. estimated that the project would generate economic benefits for five years from that date. The development expenditure was fully deductible against taxable profits for the year ended 31st March, 2018.
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On 1st April, 2017, P Ltd. borrowed ` 1,00,00,000. The cost to P Ltd. of arranging the borrowing was ` 2,00,000 and this cost qualified for a tax deduction on 1st April 2017. The loan was for a three-year period. No interest was payable on the loan but the amount repayable on 31st March 2020 will be ` 1,30,43,800. This equates to an effective annual interest rate of 10%. As per the Income-tax Act, a further tax deduction of ` 30,43,800 will be claimable when the loan is repaid on 31st March, 2020.
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Explain and show how each of these events would affect the deferred tax assets/liabilities in the consolidated balance sheet of P Ltd. group at 31st March, 2018 as per Ind AS. The rate of corporate income tax is 30%.
Impact on consolidated balance sheet of PQR Ltd. group at 31st March, 2018
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- The tax loss creates a potential deferred tax asset for the P Ltd. group since its carrying value is nil and its tax base is ` 30,00,000. However, no deferred tax asset can be recognised because there is no prospect of being able to reduce tax liabilities in the foreseeable future as no taxable profits are anticipated.
- The development costs have a carrying value of ` 15,20,000 [` 16,00,000 – (` 16,00,000 × 1/5 × 3/12)]. The tax base of the development costs is nil since the relevant tax deduction has already been claimed. The deferred tax liability will be ` 4,56,000 (` 15,20,000 × 30%). All deferred tax liabilities are shown as non-current.
- The carrying value of the loan at 31st March, 2018 is ` 1,07,80,000 [` 1,00,00,000 – ` 200,000 + (` 98,00,000 x 10%)]. The tax base of the loan is 1,00,00,000. This creates a deductible temporary difference of ` 7,80,000 and a potential deferred tax asset of ` 2,34,000 (` 7,80,000 x 30%).
6. FAQs on Contingent Liability+ Indemnification Assets (Based on Para Nos. 22, 23, 27 And 28)
FAQ 15. (a) A Ltd. acquired a beverage company P Ltd. from X Ltd. At the time of the acquisition, P Ltd. is the defendant in a court case whereby certain customers of P Ltd. have alleged that its products contain pesticides in excess of the permissible levels that have caused them health damage.
P Ltd. is being sued for damages of INR 2 crores. X Ltd. has indemnified A Ltd. for the losses, if any, due to the case for amount up to INR 1 crore. The fair value of the contingent liability for the court case is INR 70 lakhs.
How should A Ltd. account for the contingent liability and the indemnification asset?
(b) A Ltd. acquires P Ltd. in July 2017. P Ltd. is in dispute with local tax authorities over its tax return for 2015. A Ltd. receives an indemnity from the selling shareholder(s) of P Ltd. to cover the outcome of the tax dispute. A Ltd. ascertains that an outflow in relation to the tax case is probable and estimates the amount expected to be paid as INR 25 lakhs i.e., the full amount being claimed by the tax authorities. The fair value of the liability is INR 17.4 lakhs.
Paragraph 24 of Ind AS 103 requires the acquirer to recognize and measure a deferred tax asset or liability arising from the assets acquired and liabilities assumed in a business combination in accordance with Ind AS 12, Income Taxes. Thus, A Ltd. recognized a liability of INR 25 lakhs. If the tax authorities require this amount to be paid, the seller of P Ltd. will pay A Ltd. the full INR 25 lakhs. A Ltd. considers the creditworthiness of selling shareholders of P Ltd. to be such that the indemnification asset is fully collectible. How should indemnification asset be accounted for?
(c) A Ltd. pays INR 50 crores to acquire P Ltd. from X Ltd. P Ltd. manufactured products containing fiber glass and has been named in 10 class actions concerning the effects of these fiber glass. X Ltd. agrees to indemnify A Ltd. for the adverse results of any court cases up to an amount of INR 10 crores. The class actions have not specified amounts of damages and past experience suggests that claims may be up to INR 1 crore each, but that they are often settled for small amounts.
A Ltd. makes an assessment of the court cases and decides that due to the potential variance in outcomes, the contingent liability cannot be measured reliably and accordingly no amount is recognized in respect of the court cases. How should indemnification asset be accounted for?
(a) In the current scenario, A Ltd. measures the identifiable liability of entity P Ltd. at INR 70 lakhs and also recognizes a corresponding asset of INR 70 lakhs on its consolidated balance sheet. The net impact on goodwill from the recognition of the contingent liability and associated indemnification asset is nil. However, in the case where the liability’s fair value is more than INR 1 crore (for example INR 1.2 crores), the asset will be limited to INR 1 crore.
(b) A Ltd. recognizes an indemnification asset of INR 25 lakhs which is measured on the same basis as the indemnified liability as no adjustment has been required for collectability or contractual limitations on the indemnified amount.
(c) Since no liability is recognized in the given case, A Ltd. will also not recognize an indemnification asset as part of the business combination accounting.
Further, A Ltd. is required to make the necessary disclosures for contingent consideration arrangements and indemnification assets as required by paragraph B64 (g) of Ind AS 103.
7. FAQs on Measurement After Acquisition Accounting – Adjustments to Provisional Amounts
FAQ 16. As part of its business expansion strategy, K Ltd. is in process of setting up a pharma intermediates business which is at very initial stage. For this purpose, K Ltd. has acquired on 1st April, 2018, 100% shares of A Ltd. that manufactures pharma intermediates. The purchase consideration for the same was by way of a share exchange valued at ` 35 crores. The fair value of A Ltd.’s net assets was ` 15 crores, but does not include:
(i) A patent owned by A Ltd. for an established successful intermediate drug that has a remaining life of 8 years. A consultant has estimated the value of this patent to be ` 10 crores. However, the outcome of clinical trials for the same are awaited. If the trials are successful, the value of the drug would fetch the estimated ` 15 crores.
(ii) A Ltd. has developed and patented a new drug which has been approved for clinical use. The cost of developing the drug was ` 12 crores. Based on early assessment of its sales success, the valuer has estimated its market value at ` 20 crores.
(iii) A Ltd.’s manufacturing facilities have received a favourable inspection by a Government department. As a result of this, the Company has been granted an exclusive five-year license to manufacture and distribute a new vaccine. Although the license has no direct cost to the Company, its directors believe that obtaining the license is a valuable asset which assures guaranteed sales and the value for the same is estimated at ` 10 crores.
K Ltd. has requested you to suggest the accounting treatment of the above transaction under applicable Ind AS.
The company can recognise following Intangible assets while determining Goodwill/Bargain Purchase for the transaction:
(i) Patent owned by A Ltd.: The patent owned will be recognised at fair value by K Ltd. even though it was not recognised by A Ltd. in its financial statements. The patent will be amortised over the remaining useful life of the asset i.e. 8 years. Since the company is awaiting the outcome of the trials, the value of the patent cannot be estimated at ` 15 crore and the extra ` 5 crore should only be disclosed as a Contingent Asset and not recognised.
(ii) Patent internally developed by A Ltd.: Further as per para 75 of Ind AS 38 ‘Intangible Assets’, after initial recognition, an intangible asset shall be carried at revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be determined by reference to an active market.
From the information given in the question, it appears that there is no active market for patents since the fair value is based on early assessment of its sale success. Hence it is suggested to use the cost model and recognise the patent at the actual development cost of ` 12 crore.
(iii) Grant of Licence to A Ltd. by the Government: As regards to the five-year license, para 44 of Ind AS 38 requires to recognize grant asset at fair value. K Ltd. can recognize both the asset (license) and the grant at ` 10 crore to be amortised over 5 years.
Hence the revised working would be as follows:
| Fair value of net assets of A Ltd. | ` 15 crore |
| Add: Patent (10 + 12) | ` 22 crore |
| Add: License | ` 10 crore |
| Less: Grant for License | (` 10 crore) |
| ` 37 crores | |
| Purchase Consideration | ` 35 crores |
| Bargain purchase | ` 2 crore |
8. FAQs on Reacquired Rights (Based on Para No. 29 + Para Nos. B35 And B36 of Appendix B + Para Nos. B51 to B53 of Appendix B)
FAQ 17. Entity A has acquired entity P, because it sees high potential in the European market and wishes to exploit it. Entity A calculates that under current economic conditions and at current prices it could grant a six-year franchise for a price of INR 4,50,000.
How is the license accounted for as part of the business combination?
The answer is based on Paragraphs B51 and B52 of Ind AS 103.
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