Advanced Accounting

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Question:
Why is the allocation of the income tax expense figure between the members of a business combination important? By what methods can this allocation be made?

Answer:

Business Combination according to IFRS3(2008) (Appendix A) is defined as an event or transaction where the control of one or more businesses is obtained by the acquirer (Silvia). This is not applicable to any form of acquisitions of assets or a group assets; joint ventures and common control combination between businesses or entities (Deloitte 2008). Unless there is no acquisition made it cannot be termed as a business combination.This acquisition will include purchaser gaining control over the net assets that have constituted the business (Pearson).

Allocation of income tax among the members of business combination is very essential for determining the tax value before acquisition and after acquisition and preparation of consolidation statement.Additionally, business combination often initiates additional financial and tax reporting (Lord, 2018). As all transactions associated with business combination are closely examined by investors and regulators and other financial users such that the entity should be able to support their business judgements and conclusions made for accounting performance.Allocation of income tax is important for a business combination because it also helps the reporting entities to be able to answer questions associated with its treatment. The most common methods used for allocation under business combination are purchase price method and acquisition method.Every business combination brings together separate entities or businesses into one reporting entity and in the process purchase method is required for accounting (Thomson Reuters, 2017).

According to the norms of IFRS3 business combinations financial reporting should be made as per the purchase method of accounting. This method requires more effort than the pooling of interest method and results in negative goodwill or goodwill recognition on acquisition.The basic idea behind this allocation method for financial or tax purposes is that the consideration value given to the transactions should be given to assets and liabilities that are being acquired. Even though the value consideration problem is complex, once it is determined it is allocated among all the tangible and intangible assets and liabilities. The residual value determined is allocated to goodwill. As it impacts the balance sheet, income statements and ultimately profits that impact tax. Thus, a poorly performed purchase price method will have negative impact on the business (Lord 2018).

Acquisition method is used only when an acquisition is qualified as business combination. This method uses the same control concept that is described under the consolidation guidance. Acquisition method of accounting helps the business combination in accounting transactions. However, not all business combination transactions are included in the scope of acquisition method such as: transaction involving creation of joint venture, not-for-profit entities acquisition that has occurred before December 15, 2009 and NFPs mergers among others. In a business combination an acquirer accounts their transaction through acquisition method which involves the following steps(Thomson Reuters, 2017):

Acquirer identification is the first step under this method, followed by determining the date of acquisition which helps in measuring business combination. The third step involves recognition of all assets, liabilities and noncontrolling interest in the financial statements by the acquirer. The final step of acquisition method includes calculating and recognizing gain from purchase bargain or any form of goodwill(Thomson Reuters, 2017).

Thus, from the above discussion we understand that every transaction under business combination should be calculated as it impacts the users of financial statements. Further, it is essential to use from method for allocation of income tax.

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