The accounting treatment of a reverse acquisition by a listed company can be complicated. John Black outlines the key considerations for operating companies obtaining a listing this way.
A reverse acquisition is said to have occurred when the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes. The entity whose equity interests are acquired (the legal acquiree) must also be the acquirer for accounting purposes.
Reverse acquisitions can occur when a private operating company is seeking a listing to a stock exchange but does not want to register its equity shares from scratch. Instead, it is looking for a fast- track listing by arranging for a listed shell company to acquire them in a share for share transaction.
Understanding ‘business combination’
How do you know if a ‘business combination’ has taken place? First, it’s important to assess who the accounting acquirer is; and secondly, whether the assets being acquired and liabilities assumed constitute a business.
You should use the guidance in IFRS 10 to identify the accounting acquirer – this means the entity that obtains control of another entity (the acquiree). More often than not in these transactions the shareholders in the operating company will obtain a controlling interest, and this usually indicates that the operating company is the accounting acquirer.
Defining a ‘business’
Does the shell company (accounting acquiree) constitute a business as defined in IFRS 3? Typically a cash shell fails to meet this definition of a business because its activities are usually limited to managing the cash and complying with its regulatory obligations.
IFRS 3’s definition of a business: “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.”
This definition was amended in October 2018 for accounting periods beginning on or after 1 January 2020. The changes are not expected to alter the position for acquisitions by listed shell companies but are likely to affect more complex transactions.
So an operating company that obtains control over a listed company which does not constitute a business is not a ‘business combination’ and therefore is outside the scope of IFRS 3.
What to put in financial statements?
So what is the accounting treatment when the transaction is not a ‘business combination’? Despite being outside the scope of IFRS 3, the cash shell has become a legal parent and therefore must prepare consolidated financial statements. It’s widely accepted
that these should follow the reverse acquisition methodology from IFRS 3, but without recognising goodwill.
Consolidated financial statements prepared following a reverse acquisition are issued under the name of the legal parent (accounting acquirer). But
they are described in the notes as a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one difference. This is to adjust retroactively the accounting acquirer’s legal capital to reflect that of the accounting acquiree. Comparative information presented in these consolidated financial statements is also retroactively adjusted to reflect the legal capital of the legal parent.
Rather than recognising goodwill, any excess of the deemed acquisition cost over the fair value of the assets and liabilities of the listed shell company is considered to represent the cost of the operating company obtaining a listing. This is accounted for as a share-based payment within the scope of IFRS 2.
The appeal to mining companies
Fast-track listings are appealing to mining companies, especially those in the exploration phase, because they are often in need of cash quickly in order to progress their projects. By obtaining a listing, a company can greatly improve its accessibility to investors and their cash.
Getting fast-track help
What should you do if you are an operating company seeking a fast to track listing? We recommend you appoint professional advisors from the beginning of your journey. PKF Littlejohn’s experienced and dedicated Capital Markets team can advise you throughout the process and guide you through the accounting complexities of the transaction. For more information please contact. Written by John Black in our London office.