SIC-28 Business Combinations – ‘Date of Exchange’ and Fair Value of Equity Instruments is a standard issued by the International Accounting Standards Committee (IASC) that provides guidance on how to determine the fair value of equity instruments issued as consideration in a business combination. It also addresses the determination of the ‘date of exchange’ for measuring the fair value of equity instruments.
Definition and Explanation:
Under SIC-28, a business combination refers to the acquisition of one entity (the acquirer) by another entity (the acquiree) or the formation of a new entity through a combination of two or more entities. Equity instruments, such as common shares or stock options, may be issued as consideration for the acquisition of the acquiree. The fair value of these equity instruments is a key component in determining the total consideration exchanged in the business combination.
The ‘date of exchange’ is the date at which the equity instruments are issued by the acquirer to the acquiree as part of the business combination. The fair value of the equity instruments is measured at the date of exchange, which may be different from the acquisition date, and is used in determining the total consideration transferred in the business combination.
SIC-28 requires that the fair value of equity instruments issued as consideration in a business combination be measured at the date of exchange, which is the date the equity instruments are issued, rather than at the acquisition date or any other date. This is because the fair value of the equity instruments may change between the acquisition date and the date of exchange, and measuring at the date of exchange provides more relevant and reliable information about the consideration transferred.
Examples and Cases Studies:
Let’s take an example to illustrate the concepts of ‘date of exchange’ and fair value of equity instruments in a business combination:
Example 1:
Company A acquires 100% of the outstanding shares of Company B on January 1, 2023. As part of the acquisition, Company A issues 1,000,000 common shares to the shareholders of Company B as consideration. The acquisition date fair value of the common shares is $10 per share. However, due to regulatory requirements, the shares cannot be issued until March 31, 2023.
Under SIC-28, the ‘date of exchange’ is March 31, 2023, when the common shares are actually issued by Company A to the shareholders of Company B. The fair value of the common shares should be measured at the date of exchange, which is March 31, 2023, rather than the acquisition date of January 1, 2023. If the fair value of the common shares on March 31, 2023, is determined to be $12 per share, then the total consideration transferred in the business combination would be $12,000,000 (1,000,000 shares x $12 per share), rather than $10,000,000 (1,000,000 shares x $10 per share).
Example 2:
Company X acquires 80% of the outstanding shares of Company Y on April 1, 2023. As part of the acquisition, Company X issues 500,000 stock options to the employees of Company Y as consideration. The stock options have an exercise price of $20 per share and a fair value of $25 per share on the acquisition date.
Under SIC-28, the ‘date of exchange’ is April 1, 2023, when the stock options are granted by Company X to the employees of Company Y. The fair value of the stock options should be measured at the date of exchange, which is April 1, 2023, rather than the acquisition date of April 1, 2023. If the fair value of the stock options on April 1, 2023, is determined to be $30 per share, then the total consideration transferred in the business combination would include the fair value of the stock options, which is $15,000,000 (500,000 options x $30 per option), rather than $12,500,000 (500,000 options x $25 per option).
SIC-28 also provides additional guidance on how to determine the fair value of equity instruments issued as consideration in a business combination. It requires that the fair value be based on the best available evidence at the date of exchange, and may consider factors such as market prices, recent transactions in the same or similar instruments, valuation techniques, and other relevant information.
Case Studies:
Case Study 1:
Company C acquires 100% of the outstanding shares of Company D on July 1, 2022. The acquisition is structured as a share swap, where Company C issues 2,000,000 of its common shares to the shareholders of Company D as consideration. The acquisition date fair value of Company C’s common shares is $8 per share. However, due to regulatory approvals, the shares cannot be issued until September 30, 2022.
In accordance with SIC-28, the ‘date of exchange’ is September 30, 2022, when the common shares are actually issued by Company C to the shareholders of Company D. The fair value of the common shares should be measured at the date of exchange, which is September 30, 2022, rather than the acquisition date of July 1, 2022. If the fair value of the common shares on September 30, 2022, is determined to be $10 per share, then the total consideration transferred in the business combination would be $20,000,000 (2,000,000 shares x $10 per share), rather than $16,000,000 (2,000,000 shares x $8 per share).
Case Study 2:
Company M acquires 75% of the outstanding shares of Company N on February 1, 2023. As part of the acquisition, Company M issues 1,500,000 stock options to the employees of Company N as consideration. The stock options have an exercise price of $15 per share and a fair value of $18 per share on the acquisition date.
Under SIC-28, the ‘date of exchange’ is February 1, 2023, when the stock options are granted by Company M to the employees of Company N. The fair value of the stock options should be measured at the date of exchange, which is February 1, 2023, rather than the acquisition date of February 1, 2023. If the fair value of the stock options on February 1, 2023, is determined to be $20 per share, then the total consideration transferred in the business combination would include the fair value of the stock options, which is $30,000,000 (1,500,000 options x $20 per option), rather than $27,000,000 (1,500,000 options x $18 per option).
Conclusion:
In conclusion, SIC-28 Business Combinations – ‘Date of Exchange’ and Fair Value of Equity Instruments provides guidance on how to determine the fair value of equity instruments issued as consideration in a business combination. It emphasizes that the fair value should be measured at the ‘date of exchange’, which is the date when the equity instruments are actually issued, rather than the acquisition date or any other date. The standard requires that the fair value be based on the best available evidence at the date of exchange and provides examples and case studies to illustrate its application. Compliance with SIC-28 helps ensure that the business combination is accounted for accurately and in accordance with the relevant accounting standards, such as IFRS 3.
Companies should carefully consider the requirements of SIC-28 when determining the fair value of equity instruments issued as consideration in a business combination. It is important to use the best available evidence at the date of exchange, such as market prices, recent transactions, and valuation techniques, to ensure that the fair value is accurately determined. Failure to comply with the requirements of SIC-28 could result in misstatement of the financial statements and potential misinterpretation by investors and other stakeholders.
It is also crucial to document and disclose the fair value determination process and related assumptions in the financial statements to provide transparency and facilitate understanding by users of the financial statements. Companies should seek professional accounting advice if they encounter complex or unique situations that require judgment in applying the guidance of SIC-28.
In summary, SIC-28 provides important guidance on how to determine the fair value of equity instruments issued as consideration in a business combination. Companies need to carefully assess the fair value at the ‘date of exchange’ and use the best available evidence to ensure accurate financial reporting. Compliance with SIC-28 helps ensure that the financial statements reflect the economic substance of the business combination and provide relevant information to users for decision-making purposes.