GRAP Guideline 107 - Mergers

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Accounting Guideline

GRAP 107 Mergers


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Contents

1. INTRODUCTION ......................................................................................................... 3

2. SCOPE ........................................................................................................................ 4

3. THE BIG PICTURE ...................................................................................................... 5

4. IDENTIFICATION ........................................................................................................ 6

4.1 Identifying a combined entity and combining entities ............................................... 6

4.2 Establishing a merger .............................................................................................. 6

4.3 Determining the merger date ................................................................................... 7

5. RECOGNITION AND MEASUREMENT ....................................................................... 9

5.1 Initial recognition and measurement ........................................................................ 9

5.2 Measurement period ............................................................................................. 10

5.3 Subsequent measurement .................................................................................... 10

6. ILLUSTRATIVE EXAMPLES ...................................................................................... 12

7. DISCLOSURE ........................................................................................................... 14

8. TRANSITIONAL PROVISIONS .................................................................................. 16

9. SUMMARY OF KEY PRINCIPLES ............................................................................ 17

9.1 Identification .......................................................................................................... 17

9.2 Recognition and measurement .............................................................................. 17

9.3 Disclosure .............................................................................................................. 17


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1. INTRODUCTION

This document provides guidance on the accounting principles for the combined entity andcombining entities in a merger.

The contents should be read in conjunction with GRAP 107 which forms part of the GRAPReporting Framework (see Directive 5 Determining the GRAP Reporting Framework,issued by the ASB).

For purposes of this guide, entities refer to the following bodies to which the standards ofGRAP relate to, unless specifically stated otherwise:

Public entities

Constitutional institutions

Municipalities and all other entities under their control

Parliament and the provincial legislatures

Trading entities - only effective from 1 April 2013

Explanation of images used in manual:

Definition

Take note

Management process and decision making

Example


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2. SCOPE

GRAP 107 is applicable to all entities on the accrual basis of accounting to account for atransaction or event that meets the definition of a merger.

This standard does not apply to:

transfer of functions between entities under common control; and

transfer of functions between entities not under common control.

(Refer to accounting guideline GRAP 105 and accounting guideline GRAP 106 fordetails)

If an acquirer can be identified in the transaction, GRAP 105 and GRAP 106 ontransfer of functions should be applied.


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3. THE BIG PICTURE

Figure 1


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4. IDENTIFICATION

4.1 Identifying a combined entity and combining entities

Combined entity is a new reporting entity, which was formed from the combination oftwo or more entities.

Combining entities are the entities that were combined for mutual sharing of risks andbenefits in a merger.

4.2 Establishing a merger

A merger is where a new combined entity is established or started and none of theprevious entities obtain control over any other and no acquirer can be identified.

A combined entity and combining entities need to be identified in order for there to be amerger.

There needs to be a binding agreement where the terms and conditions are set out, aswell as, which entities need to be combined as a result of the merger. The binding

agreement should also identify the new reporting entity (combined entity) after themerger.

Example 1: Identifying the combining entity and combined entities

A regulation passed by the Municipal Demarcation Board requires three municipalitiesto transfer all their functions into a new metropolitan municipality.

The combined entity will be the new metropolitan municipality.

The combined entities will be the three municipalities.


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4.3 Determining the merger date

The merger date will be when the newly combined entity obtains controlover the assetsand liabilities of the combining entities and the combining entities lose control of theirassets and liabilities.

The binding arrangement may specify an effective date for the merger. There may, however,be cases where the combined entity obtains control of the assets and liabilities on a datethat is earlier or later than the date on which the assets and liabilities are transferred by the

combining entities, or the date specified in the binding arrangement.

Merger a new combined entity is established and none of the former entities obtainscontrol over any other. With a merger, no acquirer can be identified and it does notresult in an entity having or obtaining control over any of the former entities involved in

the transaction.The following criteria indicate that a transaction or event should be accounted for as amerger:

No acquirer can be identified;

None of the parties acquires control. No party is seen to be dominant and allparties combine their relative risks and benefits in the combined entity andmaintain and preserve their decision making powers;

All the parties to the transaction or event as represented by management,participate in establishing the management structure and in selecting themanagement personnel in the new combined entity; and

The size of the combining entities are not so unequal that one entity can dominatethe combined entity because of its relative size.

Example 2: Identifying a merger

A regulation passed by the Municipal Demarcation Board requires three municipalitiesto transfer all their functions into a new metropolitan municipality.

The above is a merger and not a transfer of functions since no acquirer can beidentified and none of the municipalities acquires control.

Example 3: Identifying the merger date

A regulation passed by the Municipal Demarcation Board on 1 April 2011 requires threemunicipalities to transfer all their functions into a new metropolitan municipality.

A directive is issued that states that the effective date of the transfer is 1 June 2011.

The new metropolitan municipality however only obtains control of the assets andliabilities on 1 July 2011 through a memorandum of understanding.

The merger date (date when the merger should be accounted for) will only be 1 July

2011, since that is the date when the new metropolitan municipality can use or


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otherwise benefit from the combination in pursuit of its objectives, or exclude orotherwise regulate the access of others to those benefits, i.e. obtains control over theassets and liabilities.


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5. RECOGNITION AND MEASUREMENT

5.1 Initial recognition and measurement

The figure below summarises the recognition principles in a merger for the combined entity

and combining entities:

Figure 2

The assets and liabilities that should be recognised should be determined by the terms andconditions as indicated in the binding arrangement.

The assets and liabilities that qualify for recognition under a merger must meet thedefinitions of assets and liabilities in the Framework for the Preparation and Presentation ofFinancial Statements and the recognition criteria in the applicable standards of GRAP at themerger date.

For example, the expected costs, when the newly combined entity in future plans to exit anactivity of the combining entities, terminate employment, or relocate employees, should notbe included as part of the liabilities in a merger if the entity is not obliged to incur such costs.

These costs should be expensed in the period in which the expenditure is incurred (thusafter the merger has occurred).


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All acquisition related costs, such as advisory, legal, accounting, other professional andconsulting fees, etc., should be expensed by the combined entity in the period in which thecosts are incurred and the services are received.

5.2 Measurement period

If the initial accounting of a merger is incomplete at the end of the reporting period, theassets acquired and liabilities assumed for which the accounting is incomplete should berecognised at their provisional amounts.

The combining entity is allowed a two-year measurement periodfrom the merger date inorder to obtain the information necessary to identity and measure the following inaccordance with the requirements of GRAP 107 (which were discussed in detail above):

The assets acquired, and liabilities assumed;

The consideration transferred, if any, for the combining entities; and

The resulting excess of the purchase consideration paid (if any) over the assetsacquired and liabilities assumed.

After the merger date (the measurement period), the provisional amounts should beretrospectively adjusted to reflect the new information obtained about facts andcircumstances that existed at the merger date and, if known, would have affected themeasurement of amounts recognised as of that date.

An increase in the provisional amount recognised for an asset (liability) will result in acorresponding decrease (increase) in the excess of the purchase consideration paid (if any)over the carrying amount of the assets acquired and liabilities assumed previouslyrecognised in accumulated surplus or deficit.

Conversely a decrease in the provisional amount recognised for an asset (liability) will resultin a corresponding increase (decrease) in the excess of the purchase consideration paid (if

any) over the carrying amount of the assets acquired and liabilities assumed previouslyrecognised in accumulated surplus or deficit.

The measurement period ends as soon as the combined entity receives the information itwas seeking about facts and circumstances that existed as of the merger date or learns thatmore information is not obtainable.

5.3 Subsequent measurement

Subsequent to the transfer all assets and liabilities recognised should be measured inaccordance with the applicable standards of GRAP.

If, prior to the merger, a combining entity was not applying the accrual basis ofaccounting, the entity should change its basis of accounting to the accrual basis ofaccounting prior to the merger.


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The assets acquired and liabilities assumed should be classified or designated at the mergerdate as necessary to apply other standards of GRAP subsequent to the merger. Theclassifications or designations should be based on the terms of the binding arrangement,economic conditions, the operating or accounting policies and other relevant conditions asthese exist at the merger date.

An example of a classification or designation to be made on the basis of the relevantconditions, as they exist at the merger date is that of a particular financial asset or liability asa financial asset or liability at fair value or amortised cost in accordance with GRAP 104 -Financial Instruments.

The financial statements of the combined entity should be prepared using uniformaccounting policies for similar transactions and other events or similar circumstances.

There is an exception to the above. The following contracts should be classified ordesignated based on the contractual terms and other factors at the inception ofthe contract (or, if the terms of the contract have been modified in a manner thatwould change its classification, at the date of that modification, which might be themerger date):

Classification of a lease contract as either an operating lease or a finance lease inaccordance with GRAP 13 - Leases; and

Classification of a contract as an insurance contract in accordance with theInternational Financial Reporting Standard (IFRS) 4 - Insurance Contracts.


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6. ILLUSTRATIVE EXAMPLES

Illustrative example A - accounting for a merger

New legislation has determined that a new combining entity (hereafter called Entity AB)

should be established as at 31 March 2012 by combining the assets and liabilities of Entity Aand Entity B. All the assets and liabilities are merged into Entity AB for zero consideration.Neither Entity A nor Entity B will control Entity AB.

The carrying amounts of Entity As assets, liabilities and net assets are as follows as at 31March 2012:

Property, plant and equipment R180,000

Trade receivables R75,000

Cash and cash equivalents R5,000

Trade payables (R250,000)

Net assets (accumulated surplus) (R10,000)

The carrying amounts of Entity Bs assets, liabilities and net assets are as follows as at 31March 2012:

Property, plant and equipment R200,000

Trade receivables R90,000

Cash and cash equivalents R45,000

Trade payables (R270,000)

Net assets (accumulated surplus) (R65,000)

Entity AB incurred acquisition cost amounting to R5,000.

The fair value of Entity As assets and liabilities are R300,000 and R250,000 respectively.

The fair value of Entity Bs assets and liabilities are R350,000 and R270,000 respectively.

Jou rnal entr ies:

The following journal entries will be made for the combined entity and the combining entities:

Combined entity (Entity AB):


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31 March 2012 Debit Credit

R R

Property, plant and equipment (180,000 +R200,000)

380,000

Trade receivables (75,000 + 90,000) 165,000

Cash and cash equivalents (5,000 + 45,000) 50,000

Trade payables (250,000 + 270,000) 520,000

Gain from merger (accumulated surplus or deficit) 75,000

Acquisition cost 5,000

Bank 5,000

Account for merger

Combining entity (Entity A):


R R

Property, plant and equipment 180,000

Trade receivables 75,000

Cash and cash equivalents 5,000

Trade payables 250,000

Loss from merger (accumulated surplus or deficit) 10,000

Account for merger

Combining entity (Entity B):


R R

Property, plant and equipment 200,000

Trade receivables 90,000

Cash and cash equivalents 45,000

Trade payables 270,000

Loss from merger (accumulated surplus or deficit) 65,000

Account for merger


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7. DISCLOSURE

Illustrative example on what should be disclosed, as a minimum, in the annual financialstatements for mergers (refer to the standard for detail):

Accounting policies

1.5 Mergers

Mergers are accounted for by the combined entity by recognising assets acquired andliabilities assumed at their carrying amounts at the date of the merger. Any differencebetween the assets and liabilities recognised and consideration paid, if any, is recognised inaccumulated surplus or deficit.

Mergers are accounted for by the combining entities by derecognising assets and liabilitiesat their carrying amounts at the date of the merger. Any difference between the assets andliabilities derecognised and consideration received, if any, is recognised in accumulated

surplus or deficit.

Extract from the Statement o f Changes in Net Ass ets

Entity

Annual Financial Statements for the period ended ...

Statement of Changes in Net Assets

Notes Accumulatedsurplus

Total netassets

R R

20x0

Balance as at 31 March 20x0 XXX XXX

Surplus/(deficit) for the period XX XX

20x1


Surplus/(deficit) for the period XX XX

Gains from mergers x XX XX



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Other important disclosures to be made in the financial statements of the combinedentity and combining entities include, but are not limited to:

The period during when the merger took place.

The name of the entities involved in the merger and a brief description of the

merger and the reason for undertaking the transaction or event.

The merger date.

For each affected line item in the financial statements, the value of the assetsacquired / derecognised and liabilities assumed / derecognised.

For the combined entity, also disclose:

o Additional contingent liabilities and contingent assets assumed or acquired inthe merger.

The combined entity should disclose the following information for each materialmerger or in the aggregate for individually immaterial mergers that are material

collectively if the initial accounting for a transfer of functions is incomplete forparticular assets, liabilities, or any consideration and the amounts recognised in thefinancial statements for the merger:

The reasons why the initial accounting for the merger is incomplete;

The assets, liabilities, or any consideration for which the initial accounting isincomplete; and

The nature and the amount of any measurement period adjustments recognisedduring the reporting period.

Entities do not have to repeat the disclosure in subsequent periods.


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8. TRANSITIONAL PROVISIONS

Background

Prior to the adoption of GRAP 107, public entities, constitutional institutions, municipalities

and municipal entities did not have any standard to account for mergers.

Application of the transitional provisions for the initial adoption of GRAP 107

The transitional provisions states that the standard should be applied prospectively.

Assets acquired and liabilities assumed in a merger where the merger date preceded theadoption of the standard, should not be adjusted upon the initial adoption of the standard.


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9. SUMMARY OF KEY PRINCIPLES

GRAP 107 sets out the principles on the identification of transactions that should be treatedas a merger.

9.1 IdentificationControl is where an entity can govern or direct the financial and operating policies of theacquiring entity.

Combining entities are the entities that give up assets and liabilities and are combined formutual sharing of risks and benefits in a merger

Combined entity is the newly formed reporting entity and was formed from a combination oftwo or more entities.

Merger is where a new combined entity is started, no acquirer can be identified and thecombining entities dont have any control over the entity.

9.2 Recognition and measurement

With a merger the assets and liabilities should be recognised (by the combined entity) attheir carrying amounts and should be derecognised (by the combining entities) at theircarrying amounts.

The differences between the carrying amounts of assets and liabilities should be recognisedin the accumulated surplus / (deficit).

9.3 Disclosure

Specific disclosures are required when there is a merger.

GRAP Guideline 107 - Mergers

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