Business combinations under common control (BCUCC) are common in Hong Kong. In the absence of a specifically applicable International Financial Reporting Standard (IFRS) for such combinations, companies applying IFRS account for them in different ways. Based on the Institute’s research findings and stakeholders’ feedback, a majority of Hong Kong-listed companies and companies preparing for listing accounted for BCUCC using a book-value method; other BCUCC are reported using the acquisition method as set out in IFRS 3 Business Combinations.

In August, the Institute’s Standard Setting Department responded to the International Accounting Standards Board’s (IASB) discussion paper (DP) which sought feedback from stakeholders on its proposed new accounting model for BCUCC. Our A Plus April 2021 issue article provided an overview of the IASB’s proposals. This article summarizes specific areas and highlights points of our response to the DP. The full response is available on our website.

Selecting the measurement method

We consider that not all BCUCC have the same nature or economic substance. Some are similar to business combinations covered by IFRS 3 while others are not. Therefore, we agree with the IASB’s preliminary views that neither the acquisition method nor a book-value method should be applied to all BCUCC, and welcome the IASB in drawing a clear line for when each measurement method should be applied.

We note that although our respondents expressed mixed views on the IASB’s preliminary views on determining when to use which measurement method, they generally agreed with the overall conclusions that:

• The acquisition method should be applied for BCUCC that affect non-controlling shareholders (NCS) of the receiving company whose shares are publicly traded, because these BCUCC are more akin to business combinations under IFRS 3.
• A book-value method could be applied to BCUCC for companies whose shares are privately held as this takes into account cost-benefit considerations, and internal group restructurings in initial public offering (IPO) cases because these transactions do not have real commercial substance.

We agree with the overall accounting outcomes resulting from the IASB’s proposals on selecting the measurement method, and have the following recommendations:

• The IASB should further explore whether, and if so, how the information needs of holders of equity-like financial instruments that are not classified as equity under International Accounting Standard 32 Financial Instruments: Presentation should be captured in this project given the prevalence of these instruments in private or pre-IPO companies in Hong Kong.
• Similar to NCS, not all related parties can always access the internal information of the receiving company, and so the information needs of related parties could be the same as the NCS of the receiving company. Accordingly, we recommend that the IASB remove the related party exception so the optional exemption can also apply to related parties.

Applying a book-value method

(a) Pre-combination information

We have significant concerns about the IASB’s preliminary view of prohibiting a receiving company from restating pre-combination information when applying a book-value method, for reasons including the following:

• Applying the IASB’s preliminary view, the presentation of pre-combination information would solely depend on how the BCUCC is legally structured, i.e. which entity is the receiving company. This would result in different pre-combination information being presented for economically similar transactions, which would impair comparability.
• BCUCC undertaken for the purpose of an IPO are often internal group restructurings. Restating pre-combination information in such cases would meet the information needs of potential investors because it provides evidence of management’s track record of the listing group as a whole, which helps potential investors assess the prospects for future cash flows to the listing group.
• For many years, Hong Kong listing applicants have been applying a book-value method to IPO cases and restating the pre-combination information in their financial statements. Such presentation is considered to be useful and effective by investors for making informed investment decisions and by regulators for assessing the eligibility of applicants for listing. The IASB’s preliminary views, if implemented, would inevitably create a significant negative impact to the investor community and the Hong Kong capital market.

Given the above, we strongly recommend that the IASB provide an accounting policy option for companies to choose whether to restate pre-combination information to cater for the information needs of potential investors and regulators.

(b) Measuring assets and liabilities received

We acknowledge that the IASB’s preliminary views on requiring the receiving company to use the transferred company’s book values to measure assets and liabilities received are in line with the overall thinking of the DP that focuses on the receiving company’s perspective.  However, we consider that there are situations where using the controlling party’s book values would better reflect the economic substance of the transaction and mitigate structuring opportunities. This could be the case when the BCUCC is undertaken solely to hide goodwill and intangible assets related to the transferred company, and any associated impairment losses, arising from a past business combination. Accordingly, we recommend that the IASB provide an accounting policy option for companies to use the controlling party’s book values when such an approach would provide useful information, and require companies to disclose which book values they have used.

This article was contributed by Carmen Ho and Eky Liu CPA, Associate Directors of the Institute’s Standard Setting Department.