IFRS 3 Common Errors: Getting the Acquirer Wrong

Identifying the acquirer under IFRS 3 sounds simple until reverse acquisition scenarios prove otherwise. One of the most common errors in IFRS 3 is getting the acquirer wrong, and when that happens, the entire set of financial statements can be materially misstated.

In this episode, we unpack how reverse acquisition issues arise, why legal form often misleads, and how to correctly identify the acquirer under IFRS 3. We walk through real-world indicators of control, common “Blind Freddy” mistakes, and the consequences of applying reverse acquisition accounting incorrectly.

If you think the entity issuing shares is always the acquirer, this episode will challenge that assumption.

Financial Reporting Conversations is brought to you by Basford Consulting helping professionals go beyond compliance and get financial reporting right.

For technical insights, training, and resources that make the unknowns in financial reporting known, visit basfordconsulting.com

🔗 Connect with us:
LinkedIn: Wayne Basford & Judith Leung
YouTube: @BasfordConsulting
Website: basfordconsulting.com

Transcript

SPEAKER_01 0:00

Welcome to Financial Reporting Conversations brought to you by Bass for Consulting.

SPEAKER_00 0:04

We're here to make the unknowns and known accounting, auditing and climate standards known so you can avoid the blindfredding mistakes and do financial reporting better.

SPEAKER_01 0:13

Each episode will unpack what the standards really say, what they mean in practice.

SPEAKER_00 0:18

Whether you're a preparer, auditor, director, or litigator, our aim is to help you get it right. Hello and welcome to Financial Reporting Conversations. If you have tuned into our previous episodes, you would have heard that Wayne and I have been working on an iFres 3 course that is turning out to be one of our longest courses. Mainly because there are so many areas in applying iFres 3 where material misstatements can and do occur. In that episode, we first talked about the key question of whether the transaction should even be accounted for and under iForest 3 was just simply an asset acquisition. In that episode, we also talked about top hats, and that is where a new entity is inserted in between an existing business or a business group and its shareholders. And there is no change in the ultimate control ownership of that group. Now, in this episode, Wayne and I are going to talk about another area where errors can frequently occur, and that is identifying the acquirer. This is usually the entity that transfers cash or shares, and the entity that will ultimately become the parent of the group. So, Wayne, isn't this step relatively straightforward? We identify the entity that pays cash or transfer the shares, which usually is the purchase purchaser in the share sales agreement contract, isn't it?

SPEAKER_01 1:39

I would agree with the proposition that usually the person that issues the shares is the acquirer, the person that pays the cash is the acquirer. But it is a complicated world. When you're in the world of backdoor listings, reverse acquisitions, putting restructuring together to go IPOs. So you know, classically, I Lisco issue shares to operating co, I'm the acquirer, I am the legal acquirer. But I've only got a thousand shares on issue, and I go and issue two thousand shares to the owners of Operating Co. And after the transaction, the owners of Operating Co. own two thousand of the three thousand Lisco shares. Well, it's a reverse acquisition. Operating Co. has acquired Lisco. It's complicated. And remember, in a lot of cases, in all of these reverse acquisitions, no cash flows to the vendor, it's only shares. And this is where again we flip into that world of top hats. And is it just a reorganization of an existing business with a purpose of going IPO?

SPEAKER_00 3:00

So IFRS3 defines the acquirer as the entity that obtains control of another entity. And IFRS3 tells us control is defined under IFRS 10. What are the indicators that preparers and auditors should look at to determining which entity actually has control when you know the situation that you you've described where transactions affected by issuing shares?

SPEAKER_01 3:25

For all auditors, you need to understand the transaction. Why was the transaction entered into and who are the dominant parties in it? Which shareholders or which board members of the pre-existing companies will end up on the board of the enlarged group. In a number of cases, when you've got these LISCO situations, the existing board approves the acquirer of operating co. Operating co has got their own board, and as soon as the transaction happens, all of the Lisco board resigns and the operating co board becomes the directors. They've got the majority of the shares. Again, it's a reverse acquisition. So look at where the shareholdings flow and where the board composition flows.

SPEAKER_00 4:24

If you're finding this discussion useful, please take a moment to click like, subscribe, and share. And so I think you've sort of explained how I forest like a reverse acquisition works. What sort of common mistakes do you see in financial reporting in terms of reverse acquisitions?

SPEAKER_01 4:50

There's two. And that confusion happens in typically two ways. That a lot of times the reverse acquisition, in order to get a listing, actually is alongside a capital raise. The existing shareholders of Lisco only end up with 5% of the shares, but the new money that came in actually ends up with a bounce, ends up with 55%. And then people wrongly conclude ah, because they only ended up with 40% of the shares, they it's not a reverse acquisition, it's flawed. And the other way to miss things is a lot of these organ these transactions, they also they can be mixed as all almost a merger that you have operating co a merges and acquires operating co B, and that in large group reverses into Lisco, and again people look at it and say, ah, operating Co A only ended up with 40% of the shares, and they're missing the fact there were a number of entities involved, and the ultimate acquirer is operating CoA. And then the second one that people get wrong a lot is they say that is a backdoor listing, therefore it is a reverse acquisition, and the entity they've backdoored into is a shell. It has no business, it has no processes, it has no assets, it has no employees, it fails the definition of a business, and therefore it's not a business combination, it is not subject to reverse acquisition accounting, it's actually a share-based payment under IFRS2.

SPEAKER_00 7:11

So we need to go back to what we talked about last episode in terms of whether that acquiry still we still need to go back and look at whether that is an asset.

SPEAKER_01 7:22

But putting your mind into this reverse, so we've convinced ourselves the company being acquired legally is a business. It's got a mine, it's got operating, it's a real business. But you need also to put your mind to ah, we're doing a reverse acquisition. Is the entity for an accounting purpose is being acquired? Is that a business? And in so many cases, it's just a shell. And therefore, again, you're not in reverse acquisition accounting, you do not get goodwill, you have a listing expense under IFRS2.

SPEAKER_00 7:58

Thanks, mate. So going back, if we miss, you said one of the common mistakes is people miss the um a reverse acquisition and wrongly identify the right acquirer. So the accounting acquiry, they've wrongly treated that as the acquirer. How does that impact on the financial statements like goodwill, comparatives, EPS?

SPEAKER_01 8:22

Everything's wrong. So if you get the wrong acquirer, you've gone and fair valued the assets of the wrong entity. So if you've believed it's not a reverse acquisition, really Lisco acquired operating co, you've then gone and done your purchase price allocation, you've fair valued all of operating co's assets, and you shouldn't have. You've recognised a weird amount of goodwill that relates really to the goodwill in operating co where it should relate to the goodwill in Lisco. Your comparatives are the wrong companies, your EPS is completely wrong. So if you manage to get the wrong acquirer, you really have misstated your accounts.

SPEAKER_00 9:10

So that's when you had you treated Lisco as the parent and the operating co as the subsidiary.

SPEAKER_01 9:16

Yeah. We did not end up with more than 50% of the shares, missing the fact it was also a capital raise, or it was a close call, and oh look, a month after the transaction, all of Lisco board uh resigned, and suddenly all of Operating Co.'s board are Lisco's board.

SPEAKER_00 9:38

So what should it look like?

SPEAKER_01 9:39

It's the reverse. So it should be you do the purchase price allocation of the assets and liabilities of Lisco. If you end up with Goodwill, it is the difference that Operating Co. paid for the fair value of the net assets of Lisco. And comparatives, it's a continuation of Operating Co.

SPEAKER_00 10:05

Okay, thanks Wayne. So well, this is a short episode, but this is a very uh important area where people can get it wrong and where getting it wrong makes everything quite looks completely wrong.

SPEAKER_01 10:20

I think the phrase it is materially misstated, completely materially misstated, and extraordinarily embarrassing for again the audit committee, the directors, the financial controller, and really brings into question how the auditor signed an unmodified audit opinion. You know, this is when you're doing the transaction, not when you're doing the audit in the last week in September, when the transaction has been announced, the auditors need an accounting paper, ticking off why who the acquirer is, and be satisfied right at the start of the transaction, almost before the transactions happened, to get the accounting right.

SPEAKER_00 11:08

So, like many aspects of IF3, it's one of those areas where a transaction that could look simple but can actually become quite complex.

SPEAKER_01 11:15

People in this mindset, I acquired 100% of the shares of that entity. It must be a business combination, or I am the acquirer. That mindset is a very dangerous mindset.

SPEAKER_00 11:28

Yeah, thanks. So if you'd like to explore these issues further, Wayne and I cover them in much more detail in our IFS3 business combinations icepring course, and where we'll walk through the practical examples, some of the common mistakes we see in practice, and so feel free to contact us for more details if you're interested. And thanks for joining us for this short episode of Financial Reporting Conversations. We'll see you in our next episode.

SPEAKER_01 11:53

Thanks for listening to Financial Reporting Conversations. For guidance on applying accounting and auditing standards, or to access our online training programs, please visit buzzfordconsulting.com.

SPEAKER_00 12:04

Don't forget to like, subscribe, and share this episode with your colleagues and contacts. We'll see you next time where we make the unknowns in financial reporting known.