Special Topics Defining a business

Transcription

1 Special Topics Defining a business

2 Content Defining a business Identifying assets of business combination Survey on acquisition price allocation Page 2

3 Definitions g}} ERNST & YOUNG Qu"lity fn E,~ryt"jng We 00

4 Definition of a business A business is: An integrated set of activities and assets Capable of being conducted and managed to provide a return (dividends, lower costs or other economic benefits) Only two essential elements are required: Inputs Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it Processes Any system, standard, protocol, convention or rule that, when applied to an input or inputs, creates or has the ability to create outputs Rebuttable presumption: if goodwill exists in the acquisition, the acquisition is a business. Page 4

5 Definition of a business meaning of capable of Outputs are not required for a set of activities and assets to qualify as a business. Development stage activities without outputs may still be businesses. A business need not include all the inputs or processes that the seller used in operating that business. If a market participant is capable of utilising the acquired set of activities and assets to produce outputs by integrating the acquired set with its own inputs and processes, the acquired set might constitute a business. If the elements that are missing from an acquired set are not present with a market participant but easily replaced/replicated, the acquired set might still be a business. However, in most cases, the acquired set of activities and assets must have at least some inputs and processes in order to be considered a business. Page 5

6 Definition of a business: development stage enterprises When evaluating whether the transferred development stage enterprise is a business, the company needs to determine whether the acquired set of activities and assets in the development stage: Has begun its planned principal activities Has employees, intellectual property and other inputs and processes that could be applied to those inputs Is pursuing a plan to produce outputs Will be able to obtain access to customers that will purchase the outputs The list is not exclusive Page 6

7 Definition of a business: development stage enterprises (cont.) The further an acquired set of assets and activities is in its lifecycle, the more difficult it will be to conclude a market participant is not capable of operating the acquired set as a business. The planned operations of an acquired set of assets and activities have commenced. The acquired activities and assets include employees and intellectual property such that it is capable of producing products. It is likely that the acquired set represents a business. Page 7

8 Definition in practice First, Identify the elements Inputs Processes Outputs If necessary pieces are missing Owner must assess if pieces are minor Owned by competitor Easily replaced or replicated BUT no processes => not a business Highly subjective judgment!! Page 8

9 Examples g}} ERNST & YOUNG Qu"lity fn E,~ryt"jng We 00

10 Development stage enterprises example 1 Biotech A acquires all of the outstanding shares in Biotech B, which is a development stage company with a licence for a product candidate. Due to a loss of funding, Biotech B has no employees and no other assets. Neither clinical trials nor development are currently being performed. When additional funding is obtained, Biotech A plans to commence Phase 1 clinical trials for the product candidate. Input licence to product candidate Processes none Outputs none Should the acquisition be accounted as a business combination or an asset acquisition? Page 10

11 Development stage enterprises example 2 Biotech C acquires all of the outstanding shares in Biotech D, a development stage company that has a license for a product candidate. Phase 1 clinical trials are currently being performed by Biotech D employees (one of whom founded Biotech D and discovered the product candidate). Biotech D s administrative and accounting functions are performed by a contract employee. Inputs license for product candidate and employees Processes operational and management processes associated with the performance and supervision of the clinical trials Outputs none Should the acquisition be accounted as a business combination or an asset acquisition? Page 11

12 Application in extractive industries example 1 E&P Co. A (an oil and gas exploration and production company) acquires a mineral interest from E&P Co. B, on which it intends to perform exploration activities to determine if reserves exist. The mineral interest is an unproven property and there have been no exploration activities performed on the property. Inputs mineral interest Processes none Outputs none Should the acquisition be accounted as a business combination or an asset acquisition? Page 12

13 Application in extractive industries example 2 E&P Co. A acquires a property similar to that in Example 1, except that oil and gas production activities are in place. The target s employees are not part of the transferred set; E&P Co. A will take over the operations by using its own employees. Inputs oil and gas reserves Processes operational processes associated with oil and gas production Outputs revenues from oil and gas production Should the acquisition be accounted as a business combination or an asset acquisition? Page 13

14 Application in real estate industry example 1 Company A acquires land and a vacant building from Company B. No processes, other assets or employees (for example, leases and other contracts, maintenance or security personnel or a leasing office) are acquired in the transaction. Inputs land and vacant building Processes none Outputs none Should the acquisition be accounted as a business combination or an asset acquisition? Page 14

15 Application in real estate industry example 2 Company A acquires an operating hotel, the hotel s employees, the franchise agreement, inventory, reservations system and all back office operations. Inputs non-current assets, franchise agreement and employees Processes operational and resource management processes associated with operating the hotel Outputs revenues from operating the hotel Should the acquisition be accounted as a business combination or an asset acquisition? Page 15

16 Identifying assets in a business combination g}} ERNST & YOUNG Qu"lity fn E,~ryt"jng We 00

17 Identifying assets in a business combination General principle As of the acquisition date, the acquirer shall recognise separately from goodwill, the identifiable assets acquired, the liabilities assumed at their acquisition date fair values Recognition criteria Framework for the preparation and presentation of financial statements Asset Future economic benefits Measurable cost Control over the asset resulting from past transaction or events Liability Present obligation resulting from past transactions or events Settlement involves resources embodying economic benefits Page 17

18 Tangible assets Property, plant and equipment Components Land, building, machinery, ships, aircraft, motor vehicles, furniture and fixtures, office equipment Fair value measurement Market value determined by appraisal Involvement of professionally qualified valuers Page 18

19 Intangible assets Definition and recognition of an intangible asset An identifiable non-monetary asset without physical substance Generally, an intangible asset is recognised if: It is identifiable: Separable, or Arises from contractual or legal rights, whether or not they are separable or transferable The entity is able to control the asset It is probable that future economic benefits attributable to the asset will flow to the entity The cost of the asset can be measured reliably Page 19

20 Intangible assets Under IFRS 3 Business Combinations, the probability and reliability of measurement criterion is deemed to be met Examples of intangible assets that arise in a business combination: Trademarks and trade names Non-competition agreements Internet domain names Customer lists Customer contracts and related customer relationships Lease agreements Databases Page 20

21 Practical difficulties in valuing acquired intangible assets Difficulty in identifying the intangible asset and distinguishing it from goodwill Two elements of identifiability: Existence of contractual or other legal rights Separability Relevance of acquirer s intentions For example, the acquirer does not intend to use the acquired asset (i.e., a competing brand) Difficulty in determining intentions of other market participants Page 21

22 Practical difficulties in valuing acquired intangible assets (cont.) Difficulty in estimating the useful life Consider cash flows used in valuation methodology Indefinite useful lives are allowed Not determined, not infinite Can include renewal periods if evidence for renewal without significant cost Additional impairment testing implications Page 22

23 Approaches to the valuation of intangible assets Market approaches Comparable market transactions Usual market royalty rates Cost approaches Indexed historical cost Replacement cost Income approaches Cash flows Excess earnings Multi-period excess earnings method (MEEM) Royalty rates Relief from royalty The valuation approach selected will depend on the intangible s nature/type. Page 23

24 Multi-period excess earnings method MEEM is the most common approach for the valuation of customer-related assets. Definitions under MEEM: Asset value sum of the discounted future excess earnings attributable to the identified customers over the remaining life of the customer relationships Excess earnings is the difference between: The after-tax operating cash flows attributable to the existing customers at the acquisition date The required cost of invested capital on all the other assets (tangible, intangible and current) used in order to deliver a finished good or maintain the customer relationship Excess earnings should be discounted over the life of the customer relationships Page 24

25 Multi-period excess earnings method (cont.) Appropriateness of the MEEM method A reliable approach as long as all the intangible assets not forming part of the intangible asset ( other assets ) but necessary to its exploitation have been properly identified These other assets have to be valued prior to the subject intangible asset valuation so that the expected cost of invested capital on these assets can be computed and deducted from the cash flows considered MEEM and useful life Page 25

26 Relief from royalty method Used mainly to calculate the value of a trademark or trade name If an entity owns a trademark: It does not have to rent one and is relieved from paying a royalty The amount of that theoretical payment is used as a surrogate for income attributable to the trademark. Key variables include revenue projections, royalty rate and the discount rate The protection costs and the marketing costs are deducted from the revenue streams to obtain the fair value of the trademark Page 26

27 Relief from royalty method (cont.) Steps required to carry out a valuation: 1. Apply a royalty rate to the projected revenue to determine the relief from royalty associated with the brand name 2. Determine the brand protection expense 3. Calculate the annual royalty savings by multiplying each year s projected revenue by the estimated royalty rate and deducting the brand protection expense 4. Apply an effective tax rate to the annual royalty savings 5. Compute the present value of the royalty savings using an appropriate discount rate Page 27

28 Survey on acquisition accounting g}} ERNST & YOUNG Qu"lity fn E,~ryt"jng We 00

29 Survey on acquisition accounting Overall view of total allocation Allocation of the enterprise value (%) ( ~, ~ ~r.~ moy not " "~ up to 100!i ""oio r o ~n~ "'1 re,","u "'J 'f.'i~di~ J ~ O ~~tcrtairm('o: ii,>~l Md " d~"'''''' ot e '<ommun ca t i o ~, Ban',.n9 Jnd (.,pit., m;,i<ct. A"tnmnti',~ FhJrmêICeuticJI _ Gooc,, 11 P~w~ r ~M " tilitie, Siu te, ","u "'J 'f _ 1 ~{; I I ""' :.v r ", t'u i n l.,~ : n '. " '~.< TM'libio', I'Mne;" M~ ol r", ~f'il E <I~ t ~ Oi J,, ~ Q:J~ Page 29 :JJ ERNST & YOUNC Qo<,o';",'" C"'?''"''s ~ 00

30 Survey on acquisition accounting Overall view of intangible assets recognition, > ;,, " 0 ];.~ 0,,,, "'0'-''''.m. ~~ '" '-' "- "' "' ~ ", " " > 0, 0 " q!> " ~ ;.. ;: ~ >; ; ~ i ~ ~ ;; ;: -'!.,. ~ ;.,... ~ "., >!..., ~, ~ fé ~, "!! ~ "l!! I I; ~ ~, -,- - ~.!'$~ "'- = - '" 1; '5 ';ï 2' '~-i5~! ~ '" '", ~!'1!!l:...:;... c 5i.., -;,; ~'5 '-'- -" '" ij " o~ ~ 1'; ;; 5i "i '::"-TI'-!-g o... '" _ ~ ~::o:::;;:,g;as-=3'o: <: 'f0> ~J::~ :; 3.~ " " E 0'. -g -~ '- Ol- ~,~;!"~._~".g tl~ -,, ;- "'q " _lil " :.; ~ ~i~;;3 '~TI"-'~ji - g-i" ""' ~ ". J. " "';:- ~ ~ ~:;; o :b~~ ~ ", 0 Q t A A I ~i ~ Q Q Q ~ Q 'n ~ ~ " HI"'iI!.H [ ~ I'lI " fmiiii!l ' s,. ~, ", "' "',!,, " " " "' "'.., " ", ;:;, ", '.' '".-.,,! l, -" _~c" '.,. ;::, ~ :. i ~ '; '".. '", "- ',' ~ :0- ". ij ',~ " ~ f~~ g : I', ',., " :? ~, ~ ~ q,,,. I.- l -~ ~ ~,,"~.. Z,...,." -=,,, ;\l ;;, 6, )1 ' :0' :E r d ~ ~ Qe '"... g iiil Page 30

31 Survey on acquisition accounting View of intangible assets allocation Minor role for financial services brands Core Deposit Intangibles represent majority of identified intangible assets Page 31

32 Survey on acquisition accounting View of intangible assets allocation Insurance 2% 67% Brands!lradernllrks Cu8lomer contract8/ relmloo8l11pa Technology Non-eompe agreements I Other Intanglble aesels Customer contracts and relationships are the key assets Page 32 :JJ ERNST & YOUNC Qo<,o';",'" C"'?''''''s ~ 00

33 Survey on acquisition accounting View of intangible assets allocation Customer contracts / relationships and brands / trademarks were most commonly Identified intangible assets Goodwill proportions varied significantly between transactions Page 33

34 Survey on acquisition accounting View of intangible assets allocation Highest proportion allocated to brands of all industry groups Lower than average net tangible assets, causing higher than average goodwill Companies also involved in telecommunications, nearly no brands & technology Page 34

35 Survey on acquisition accounting View of intangible assets allocation Typically lower net tangible assets, higher than average goodwill Most significant IAs were customer relationships and brands Page 35

36 Survey on acquisition accounting View of intangible assets allocation Higher percentage of net tangible assets (49 %) Frequent goodwill recognition for access to markets or materials Customer are of high importance (often natural monopoly element) Page 36

37 Survey on acquisition accounting View of intangible assets allocation 44% was captured by tangible assets, remaining split between IAs and goodwill Large importance of customer relationships Allocation varies within industry (ex. brands & technology for car manufacturers) Page 37

38 Survey on acquisition accounting View of intangible assets allocation Pharmaceutical Biotechnology BrlIndtmd.nur\i, Cu.mm.r conlnlck/ r.l.tlo,uhlp. T.chnology.Non-compet.t '11". 000.rl1t1nglli m 61% 22% eu.wltltl'contruw/ Nldon.hlp. T,cllnolOll\' Oil and Gas Technology 6% ClJltom... ni...t., rtllltiono I1Ip. Toc:trIoIog~ NM-00II"IP1t. liil,"mlnl. onmlr1<otoontr8cltsl l1li'''''''''' ClJI!Omlr lioi'trllotll rtii1i01l ' ~~ ' Tlolmlogy Non-oompotl ogrwomlri. Otl'm C<II'i",ot,1 og"om.ri. Page 38 :JJ ERNST & YOUNC Qo<,ol;.,,'" c"'?''''''s ~ 00