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Practical aspects of accounting for business combinations in the fuel and energy sector

A contribution is any economic resource that creates or can create returns as a result of applying one or more processes.A process is any system, standard, protocol, agreement or rule that, when applied to a deposit or deposits, creates or can produce returns.

Return – the result of contributions and processes applied to such deposits that provide or are able to provide income in the form of dividends, cost savings or other economic benefits directly to investors or other owners, members or participants.

Given the fact that the acquisition of a business and a group of individual assets is reflected in the statements differently, it is important to understand how the first differs from the second. Such an analysis is based on the three components of a business in terms of IFRS 3 Business Combinations, which is why if a company is able to demonstrate contributions, processes and returns, then, as a rule, there is a business as such.

Note that it is not always necessary to qualify a set of assets as a business that requires return: its absence at the stage of formation does not exclude the occurrence of returns in the future. In such cases, it is necessary to apply a specific analysis of factors that can directly or indirectly indicate the appearance of returns later and, therefore, that the integrated population is a business. Among them are such factors as the beginning of the main planned activity, following the plan for the production of returns, the presence of customers who want to acquire returns generated by the integrated aggregate in the future, and so on.

The specifics of the fuel and energy sector introduces particular difficulties in identifying a business as such, but in general it can reasonably be assumed that the exploration phase will more often be a separate asset or a group of individual assets due to the lack of certainty regarding the return element, despite the presence of contributions and processes, while the production phase is likely to meet the criteria of the business, as there are contributions, processes and returns.

Example 1

The Dobycha company acquired the well at an early stage in exploration. The company does not have information about the proven amount of minerals. Check the operation for the acquisition of assets for compliance with the definition of an asset:

there is no contribution in this case, since the asset is at the exploration stage, which implies a lack of information about the availability of a resource that creates returns as a result of the application of the process or processes;

due to the lack of production plans and other programs for transforming the contribution to the return, we conclude that the conditions for the existence of the process are not fulfilled, despite the ongoing exploration;

there is no production plan; there is no plan for obtaining returns on the asset.

According to the analysis, the investment will most likely be recognized as an asset, since the necessary conditions for recognizing a resource as a business have not been met.

Example 2

The company acquired the field at the development stage. There are proven reserves and resources. We test the acquisition for compliance with the definition of a business:

there is a contribution in the form of proven mineral reserves that may create future returns as a result of the application of a process or processes;

the company incurs operating costs for the extraction of reserves in the field, which, in essence, is a process aimed at obtaining a return on assets;

the company plans to receive or receives returns on the use of the asset in the form of revenue from sales of minerals to customers.

Thus, the conditions for having a business, rather than an individual asset, are fulfilled, and the acquired field must be recognized as a business and reflect the merger transaction in accordance with the specific requirements prescribed by IFRS 3.

The main differences in accounting for the acquisition of individual assets or business combinations can be summarized in the following table.

Acquisition of an individual asset
Business combination

Capitalization of transaction costs

Deferred tax in accordance with IAS 12 “Income taxes”

First, a business combination is the only operation in which it is permitted to recognize goodwill (issues of determining goodwill will be discussed in more detail below).

Secondly, when it comes to recognition of an asset, the company, as a rule, includes transaction costs in the value of the asset. When a business is combined, this does not happen, the assessment is made using the acquisition method, which will also be discussed below.

The next significant difference is the specifics of deferred tax accounting. Clauses 15 and 24 of IAS 12 “Income Taxes” exempt companies from recognizing a deferred tax asset or liability arising from the initial recognition of an asset or liability as a result of a transaction that is not a business combination and does not affect accounting profit, nor taxable profit (tax loss).

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