Financial Reporting FR

SIC-22 Business Combinations – Subsequent Adjustment of Fair Values and Goodwill Initially Reported

SIC-22 Business Combinations – Subsequent Adjustment of Fair Values and Goodwill Initially Reported
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SIC-22, also known as “Business Combinations – Subsequent Adjustment of Fair Values and Goodwill Initially Reported,” is a guidance issued by the International Financial Reporting Interpretations Committee (IFRIC) that provides clarification and guidance on how to account for subsequent adjustments to fair values and goodwill in business combinations.

 

Definitions:

Business Combination: A transaction or event in which an acquirer obtains control over one or more businesses. Control is the power to govern the financial and operating policies of an entity to obtain benefits from its activities.

Goodwill: The excess of the cost of an acquired entity over the fair value of its identifiable net assets at the acquisition date.

Fair Value: The amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction.

 

Explanations:

SIC-22 provides guidance on how to account for subsequent adjustments to fair values and goodwill that were initially reported in a business combination. It clarifies that the accounting treatment for such adjustments depends on the nature of the adjustment and whether it relates to assets or liabilities recognized in the business combination.

 

Adjustments to Fair Values of Assets and Liabilities:

If a subsequent adjustment to the fair value of an asset or a liability recognized in a business combination is identifiable and can be directly attributed to events occurring after the acquisition date, the adjustment should be recognized in the acquirer’s financial statements as follows:

If the adjustment results in an increase in the fair value of an asset or a decrease in the fair value of a liability, it should be recognized as an income or gain in the acquirer’s profit or loss.

If the adjustment results in a decrease in the fair value of an asset or an increase in the fair value of a liability, it should be recognized as an expense or loss in the acquirer’s profit or loss.

 

Adjustments to Goodwill:

If a subsequent adjustment to the fair value of a recognized net asset or liability of the acquiree is identifiable and can be directly attributed to events occurring after the acquisition date, the acquirer should determine whether the adjustment would have met the criteria for recognition as part of the acquisition cost if it had occurred at the acquisition date. If the adjustment meets the criteria, it should be treated as an adjustment to the cost of the acquisition, and the carrying amount of goodwill should be adjusted accordingly. If the adjustment does not meet the criteria, it should be recognized in the acquirer’s profit or loss.

 

Examples:

Let’s consider an example to illustrate the application of SIC-22. ABC Corp acquires XYZ Ltd on January 1, 2023, for a total consideration of $1,000,000. At the acquisition date, the fair value of XYZ Ltd’s identifiable net assets is $800,000, and goodwill is recognized for the difference between the consideration paid and the fair value of the identifiable net assets, which is $200,000.

Subsequently, on March 31, 2023, XYZ Ltd’s plant, which was recognized at fair value of $300,000 at the acquisition date, suffers damage due to a fire. The insurance claim is settled for $250,000 on April 30, 2023. As a result, XYZ Ltd incurs repair costs of $100,000 to restore the plant to its original condition.

 

In this case:

Adjustment to Fair Value of Asset:

The adjustment to the fair value of the plant is identifiable and can be directly attributed to events occurring after the acquisition date. As the fair value of the plant decreases by $50,000 ($300,000 at acquisition date – $250,000 after the insurance claim), ABC Corp should recognize this as an expense in its profit or loss for the period ended April 30, 2023.

 

Adjustment to Goodwill:

The repair costs incurred by XYZ Ltd to restore the plant are not considered part of the acquisition cost, as they are costs incurred after the acquisition date. Therefore, these costs do not meet the criteria for recognition as part of the acquisition cost. As a result, ABC Corp should recognize the repair costs of $100,000 as an expense in its profit or loss for the period ended April 30, 2023.

 

 

Case Studies:

Let’s consider another case study to further understand the application of SIC-22. Company A acquires Company B on January 1, 2023, for a total consideration of $10 million. At the acquisition date, the fair value of Company B’s identifiable net assets is $8 million, and goodwill of $2 million is recognized.

 

Subsequently, on February 28, 2023, Company B’s intangible asset, which was recognized at fair value of $1 million at the acquisition date, is impaired due to changes in market conditions. The recoverable amount of the intangible asset is determined to be $600,000.

 

In this case:

Adjustment to Fair Value of Asset:

The impairment of the intangible asset is identifiable and can be directly attributed to events occurring after the acquisition date. As the fair value of the intangible asset decreases by $400,000 ($1 million at acquisition date – $600,000 recoverable amount), Company A should recognize this as an expense in its profit or loss for the period ended February 28, 2023.

 

Adjustment to Goodwill:

The impairment of the intangible asset is not considered part of the acquisition cost, as it is a subsequent event that occurred after the acquisition date. Therefore, this impairment loss does not meet the criteria for recognition as part of the acquisition cost. As a result, Company A should recognize the impairment loss of $400,000 as an expense in its profit or loss for the period ended February 28, 2023, and adjust the carrying amount of goodwill accordingly.

 

Conclusion:

In conclusion, SIC-22 provides guidance on how to account for subsequent adjustments to fair values and goodwill initially reported in business combinations. It clarifies that adjustments to fair values of assets and liabilities should be recognized in the acquirer’s profit or loss, while adjustments to goodwill should be treated as adjustments to the cost of the acquisition or recognized in the profit or loss, depending on whether they meet the criteria for recognition as part of the acquisition cost. Examples and case studies are helpful in understanding the application of SIC-22 in practical scenarios. It is important for companies to carefully consider and apply the guidance of SIC-22 when accounting for subsequent adjustments in business combinations to ensure compliance with the relevant accounting standards and principles.