This series of blogs describes how SAP Financial Consolidation, Starter Kit for IFRS has been configured to meet International Financial Reporting Standards (IFRS).
In our previous blogs, we have covered the following topics:
- Brief overview of SAP Financial Consolidation starter kit for IFRS (blog #1)
- Presentation of consolidated financial statements according to IAS 1 and IAS 7
- Translation of a foreign entity’s financial statements as set out in IAS 21
- Consolidation, part 1: current consolidation process
We will now focus on the first consolidation of an entity as a result from a business combination.
IFRS 3 requires that each business combination – defined as a transaction in which an acquirer obtains control of one or more businesses – should be accounted for using the acquisition method. IFRS 3 lists four steps in applying the acquisition method:
- Identify the acquirer
- Determine the acquisition date
- Recognize and measure the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree
- Recognize and measure goodwill or a gain from a bargain purchase.
The first two steps are not handled in the consolidation software and are not therefore addressed in this document.
Measuring assets and liabilities
The acquirer should recognize, separately from goodwill, the identifiable assets acquired and the liabilities assumed and measure them at their acquisition-date fair values. It may result in recognizing some assets and liabilities that the acquiree had not previously recognized in its financial statements (for
example, intangible assets such as brand name or customer relationship). These acquisition-date fair values become the initial carrying values of the acquired assets and liabilities in the consolidated financial statements.
In the starter kit, adjustments resulting from the remeasurement of identifiable assets and liabilities (including recognition of assets and liabilities that do not exist in the subsidiary’s separate statements) are booked manually using a dedicated audit-ID (FVA11). Impacts on deferred tax assets and liabilities are
also booked manually using the same audit-ID.
Two specific cases need further analysis:
- Accumulated other comprehensive income (other than foreign currency translation reserve)
As at the acquisition date, accumulated other comprehensive income can exist in the acquiree’s separate financial statements. These reserves (revaluation surplus, hedging reserve and fair value reserve) represent the difference between the fair value of the underlying assets (intangible and tangible assets for which revaluation method is applied, hedging instruments used in a cash flow hedge and available-for-sale financial assets) and their original value.
Since these assets are already measured at their fair value, no manual adjustment is generally necessary at the acquisition date. However, in our opinion, the difference between fair value and original value should be part of the acquired equity which means that the accounts mentioned above should be reclassified in ordinary reserves (retained earnings). This reclassification is done automatically by rules in the starter kit.
- Foreign currency translation reserve
The starter kit for IFRS does not allow data collection at a sub consolidated level, except for entities accounted for using the equity method (specific data entry schedules).
For those entities, the foreign currency translation reserve existing as at theacquisition date should be reclassified to retained earnings in the consolidated statements, given that every asset and liability has to be measured at the acquisition-date fair value and translated into group currency using the acquisition-date exchange rate. This reclassification is done automatically by rules in the starter kit.
Measuring non-controlling interests (NCI)
For each business combination, the acquirer should measure any non-controlling interest in the acquiree either at fair value (which is mandatory under revised US GAAP) or at their proportionate share of the acquiree’s identifiable net assets. This choice is available for each business combination, so an entity can use fair value for one business combination and the proportionate share of the acquiree’s identifiable net assets for another.
For the purpose of measuring NCI at fair value, it may be possible to determine the acquisition-date fair value on the basis of active market prices for the equity shares not held by the acquirer. When a market price is not available because the shares are not publicly traded, the acquirer should measure the fair value of NCI using other valuation techniques.
When non-controlling interest are measured at fair value, the difference between this amount and their proportionate share of the identifiable net assets is recognized as goodwill (see below).
Goodwill or gain from a bargain purchase
According to IFRS 3, goodwill or gain from a bargain purchase is calculated as follows:
These calculation principles can also be presented as follows to better illustrate the impact of the choice regarding the measurement of non-controlling interests (example given for a goodwill but principles remain the same for a bargain purchase):
The starter kit offers an automatic calculation and booking of goodwill for incoming entities. However, this calculation only applies to the parent’s share. If non-controlling interests are measured at fair value, a manual journal entry should be booked to declare the amount of goodwill attributable to non-controlling interests. This declaration will then be used to automatically book the corresponding entry in the consolidated balance sheet.
To be more precise, the configuration regarding goodwill relies on dedicated off-balance (technical) accounts (XA1310 for goodwill, XA1300 for bargain purchase). These accounts are populated (automatically or manually) with a breakdown per share used to identify the owner company or the non-controlling interests when need be.
The automatic calculation of goodwill is optional. It can be easily disabled by removing the subset 11-GWC from the set of rules used for consolidation.
In case of a bargain purchase, the related gain is booked on a dedicated account in profit or loss (P1640 Gain on a bargain purchase).
In our next blog, we will focus on associates and joint ventures.