NIN 91/21 - Accounting for Business Combinations and Corporate Reorganizations [NIN - Rescinded]

I. INTRODUCTION

The Canadian Institute of Chartered Accountants (the CICA") provides guidance on accounting for business combinations as described in section 1580 of the CICA Handbook (the "Handbook"). The alternatives are the purchase method and the pooling of interests method. These are defined in paragraphs 1580.06 to .09 of the Handbook. The fundamental distinction between the two methods lies in the ability to identify an economic (as opposed to a legal) acquirer. The purchase method is used for all business combinations where an acquirer can be identified, and the pooling of interests method where an acquirer cannot be identified.

A lack of consistency has been noted in the manner in which issuers have been accounting for business combinations, particularly in situations where a reverse take-over (a "RTO") has occurred.

Although it describes a RTO, section 1580 of the Handbook does not offer specific guidance on the accounting for this form of business combination. On January 17, 1990 the CICA's Emerging Issues Committee, after reviewing the problems relating to RTO accounting, issued an abstract (the "Abstract") which addressed a number of RTO accounting issues. Issuers and their advisors should refer to the Abstract for further guidance.

On occasion issuers have accounted for a transfer of net assets or exchange of shares between companies under common control as a business combination. As indicated in paragraph 1580.05 of the Handbook, this type of transaction is excluded from the definition of a business combination for the purpose of section 1580. In such cases, the change is largely one of form and not substance.

This Notice has been drafted after consultation with professional accountants and market participants. It is intended to assist issuers in the preparation of financial statements to be filed with the British Columbia Securities Commission (the "Commission") where a business combination has been or will be accomplished by a RTO, to distinguish the accounting treatment of corporate reorganizations from business combinations, to set out the circumstances where an issuer will be required to revise its financial statements, and to address other related issues.

While this Notice does not specifically address business combinations involving one or more unincorporated businesses, the principles set out provide guidance in such situations.

II. RTO ACCOUNTING

Paragraphs 1580.02 and .03 of the Handbook set ut certain types of transactions that are representative of business combinations. Frequently, situations arise where the shareholders of a private business entity will go public by exchanging their shares, or a group of assets that constitute a business, for a controlling interest in the shares of a reporting issuer. This transaction represents a RTO, and is viewed as an alternative to an initial public offering (an "IPO") as a method for a business entity to obtain a listing on a stock exchange.

The Abstract sets out definitive rules on the accounting for RTOs. In essence, the purchase method of accounting is applied, but from the perspective of the legal subsidiary, as this term is defined in the Abstract, being the acquirer.

In a RTO, the fair value (the "F/V") of the shares issued by the legal subsidiary is conceptually the best determinant of the cost of the purchase. In most RTOs, however, this method is neither practical nor reliable since there is no existing market for the legal subsidiary's shares. Accordingly, the cost of the purchase should be determined by reference to the F/V of the shares acquired from the legal parent, as this term is defined in the Abstract, or, failing that, the F/V of the net assets acquired from the legal parent. This approach is recommended on page 10.4 of the Abstract where it states:

"In some cases, the legal parent will be a dormant company or there will be a thin or inactive market for its shares. In these instances, the fair value of the net assets of the legal parent should be used to determine the cost of the purchase if the quoted market price of the shares of the legal parent (as adjusted, where appropriate) is not indicative of the fair value of the shares of the legal parent. CICA 1580.28 provides some guidance on this calculation".

This Notice expands on the Abstract in order to address:

(a) the determination of the cost of acquiring the legal parent when the F/V of the shares of the legal subsidiary cannot be determined and the F/V of the legal parent's shares or net assets cannot be readily determined, and

(b) the accounting for the transaction when the legal parent has a net asset deficiency.

1. Determining the Acquisition Cost - F/V of Legal Parent Not Determinable

In situations where the F/V of the legal parent's shares or net assets cannot be determined in an expeditious and economical manner, the net book value (the "NBV") of the legal parent, after any necessary adjustments (for example, to put the accounting practices previously followed by the legal parent on a common basis with those of the legal subsidiary), will be acceptable as the most appropriate measure of the F/V of the legal parent's net assets acquired.

2. Accounting for a Net Asset Deficiency in Legal Parent - Capital Transaction

There may be situations where the F/V of the legal parent's liabilities exceeds its assets. This deficiency effectively represents the cost of obtaining a listing on a stock exchange. The deficiency has frequently been capitalized in the consolidated financial statements as goodwill. Where an inactive listed company with negative NBV is party to a RTO, it would be misleading to create an asset for accounting purposes. Therefore, any purchase price deficiency associated with a RTO must be recorded as a capital transaction concurrently with the completion of the business combination. See section 3610 of the Handbook for further guidance.

3. Prior Operations - Supplemental Information

Where the financial statements are filed as part of a public offering of securities, supplemental information regarding the legal parent's prior financial operations must be incorporated into the notes of the issuer's financial statements that form part of, or are incorporated by reference into, the offering document. The supplemental information must cover the legal parent's most recently completed financial year and any subsequent period to the date of the RTO.

Where the financial statements are filed pursuant to continuous disclosure requirements, supplemental information regarding the legal parent's prior financial operations must be incorporated into the notes of the issuer's next annual audited consolidated financial statements that are filed with the Commission and delivered to the issuer's security holders. The supplemental information must cover the period from the legal parent's most recently completed financial year end to the date of the RTO.

Whether filed with a public offering of securities or as part of the annual financial statements, the supplemental information must form part of the audited financial statements.

An exchange issuer will also be required to incorporate this supplemental information into the Quarterly Reports (Form 61) filed with the Commission subsequent to the transaction but prior to the issuer's next financial year end. When filed with a Quarterly Report that includes interim financial statements, the supplemental information is not required to be audited.

For exchanger issuers, the supplemental information regarding the legal parent's prior financial operations must include a statement of income or deficit, a schedule of deferred costs, if any, and a statement of changes in financial position. As an alternative, an exchange issuer may file with the Commission a separate set of audited financial statements of the legal parent for the period from the date of the most recent audited financial statements filed with the Commission to the date of the RTO.

III. CORPORATE REORGANIZATION DISTINGUISHED FROM BUSINESS COMBINATION

Issuers should recognize that an exchange of shares or assets between issuers under common control is a form of corporate reorganizations rather than a business combination. Reorganizations are specifically excluded from the Handbook section relating to business combinations. See paragraph 1580.05 of the Handbook.

While the Handbook is silent on how to account for each reorganizations, where a corporate reorganization has occurred principles similar to the pooling of interests method should be applied to the transaction. Specifically, net assets of both entities should be combined at their previously recorded values. No appraisal increases or goodwill are to be recognized as a result of the reorganization.

IV. REVISED FINANCIAL STATEMENTS - CONTINUOUS DISCLOSURE

Part 1 of the Securities Regulation, B.C. Reg. 270/86 (the "Regulation") requires that financial statements be prepared in accordance with generally accepted accounting principles.

Part 10 of the Regulation imposes continuous disclosure requirements on a reporting issuer, including a requirement to file interim and annual financial statements with the Commission and to deliver them to its security holders.

It is essential that financial statements filed with the Commission fairly present an issuer's financial position, results of operations and changes in financial position. Where an issuer's previously issued financial statements have not accounted for a business combination or a corporate reorganization in accordance with the Handbook, the Abstract and this Notice, and the difference is material, the issuer must correct this error in its next interim or annual financial statements filed with the Commission and delivered to its security holders.

Where an error in accounting treatment materially affects its financial position, an issuer should consider whether its previously issued financial statements complied with generally accepted accounting principles at the time the statements were prepared. If they did not, the issuer should consider the need to, and it may be required to, retract them with appropriate amendments. See paragraphs 1506.26 to 30 and 5405.12 to 18 of the Handbook for guidance in situations where there has been a subsequent discovery of an error.

Where corrections to financial statements constitute a material change in the affairs of the issuer, the issuer must file a material change report and issue a news release under section 67 of the Securities Act, S.B.C. 1985, c.83 detailing the corrections, including their financial impact.

V. OTHER RELATED ISSUES

1. Valuing Consideration - Business Combination Other Than RTO

The purchase method is appropriate for all business combinations where an acquirer can be identified. Accordingly, there may be situations, other than a RTO when the purchase method of accounting is applied, and where:

(a) the F/V of the consideration given by the acquirer cannot be determined, for example, because the shares are escrowed shares or thinly traded, and

(b) the F/V of the net assets acquired cannot be determined, for example, where the acquiree is an issuer other than a reporting issuer in the start-up stage of its development.

In these situations, the acquiree's NBV, after any necessary adjustments, will be acceptable as the most appropriate measure of the F/V of the net assets acquired. A cost of the purchase that is greater than the NBV of the net assets acquired will be acceptable only where an acceptable valuation opinion, as defined in Local Policy Statement 3-07, has been prepared.

Issuers should recognize that the deemed price per share permitted by regulators in connection with the approval of a transaction is not necessarily an appropriate measure of F/V for accounting purposes.

2. Changes in Year-End

Where a reporting issuer is party to a business combination or a corporate reorganization, continuous disclosure requirements remain unchanged. Pursuant to section 136(3) of the Regulation, where a change in the ending date of a financial year is anticipated, issuers must provide the Superintendent of Brokers with a notice of the change, and the reasons for the change, on or before the earlier of:

(a) the new date elected for the financial year end, or

(b) 360 days from the end of the latest financial year in respect of which the issuer was required to file annual audited financial statements.

This notice should be addressed to the Deputy Superintendent, Registration and Statutory Filings, and should indicate the date of:

(a) the last year end prior to the change in year end,

(b) the first new year end subsequent to the change of year end, or

(c) the issuer's anticipated interim and annual financial reporting periods, including comparative reporting periods, to be included in filings made in accordance with sections 135 and 136 of the Regulation for the two calendar years subsequent to the change.

3. Note Disclosure

It has been noted, in a number of cases, that the disclosure contained in the notes of financial statements subsequent to a business combination or corporate reorganization is inadequate. In particular, the notes do not contain the disclosure required by paragraphs 1580.79 and 1580.81 of the Handbook.

In addition to complying with the Handbook's disclosure requirements, in financial statements prepared in connection with an IPO or by an exchange issuer the issuer will be required to provide a breakdown of net assets acquired by major category.

VI. EXCEPTIONS

There may be situations where issuers consider the requirements set out in this Notice to be inappropriate. In these case an issuer should discuss the proposed accounting treatment with staff at the Commission prior to the financial statements being finalized.


DATED at Vancouver, British Columbia November 1, 1991.