2010-11-30

Circular 8/2010 of the Bank of Spain, of December 22, amending Circular 4/2004 on public and reserved financial information standards and financial statement models

The Bank of Spain issued Circular 8/2010 to amend Circular 4/2004, aligning Spanish credit institution accounting rules with IAS 27 and IFRS 3 regarding business combinations and consolidated financial statements. The regulation mandates the recognition of goodwill at fair value, prohibits its amortization in favor of periodic impairment testing, and establishes detailed procedures for identifying acquirers and measuring assets and liabilities in business combinations. These modifications apply prospectively to all operations conducted from January 1, 2010, ensuring consistency with evolving international accounting standards.

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Circular 8/2010, of December 22, of the Bank of Spain, to credit institutions, amending Circular 4/2004, of December 22, on standards for public and reserved financial information, and models for financial statements (BOE of December 30)

Please note that according to the transitional provision, the provisions of this Circular shall apply prospectively to all operations carried out from January 1, 2010.

Bank of Spain Circular 4/2004, of December 22, on standards for public and reserved financial information, and models for financial statements (hereinafter, the Accounting Circular), states that «this Circular, by its very nature, connects both with International Financial Reporting Standards and with the Spanish accounting framework, and will be subject to adaptation as that global framework evolves over time».

Regulations (EC) 494/2009 and 495/2009 of the Commission adopted for the European Union the modification of international accounting standard number 27 (IAS 27), on consolidated and separate financial statements, and of international financial reporting standard number 3 (IFRS 3), on business combinations. The combination of both standards represents the completion of the second phase of the review process initiated in 2004 by the International Accounting Standards Board regarding business combination and consolidation standards that had served as the basis for the current text of Circular 4/2004, cited above. In any case, the absence of international pronouncement regarding corporate operations between entities included in the same economic group has advised postponing the inclusion of their treatment in Circular 4/2004, pending their future development.

Consequently, in exercise of the powers granted, the Governing Council of the Bank of Spain, upon proposal of the Executive Committee, has approved this Circular, which contains the following standards:

SINGLE STANDARD

The following modifications are introduced in Circular 4/2004, of December 22, to credit institutions, on standards for public and reserved financial information, and models for financial statements [ 1 ] :

  1. The reference to the «Anonymous Companies Law» in standards first, paragraph 2, and fifty-ninth, paragraph 1, is replaced by «Consolidated Text of the Capital Companies Law».

  2. The reference to «indication fourteen of article 200 of the Consolidated Text of the Anonymous Companies Law» in standards twentieth, paragraph 7.a), and fifty-third, paragraph 1.g), is replaced by «indication thirteen of article 260 of the Consolidated Text of the Capital Companies Law».

  3. New wording is given to the first paragraph of paragraph 6 of standard fourteenth, which reads as follows:

«6. The fair value of assets acquired and liabilities assumed on the date a business combination occurs shall be estimated taking into account the following considerations:»

  1. Letter d) of paragraph 7 of standard twentieth is suppressed, and its letter e) becomes the new d).

  2. New wording is given to the first paragraph of paragraph 4 and to paragraph 7 of standard twenty-eighth, which read as follows:

«4. Intangible assets acquired in a business combination shall be recognized at their fair value on the acquisition date, in accordance with the provisions of standard forty-third.»

«7. Goodwill is an asset that represents future economic benefits, which are not identifiable or recognizable separately or individually, arising from other elements acquired as a consequence of a business combination. Sometimes, goodwill arises from significant synergies and economies of scale expected to be obtained by combining the operations of two or more businesses. When it is appropriate to recognize goodwill, it shall be recognized and measured in accordance with the provisions of standard forty-third. Under no circumstances shall the amount recognized for goodwill be subject to amortization, but, in accordance with standard thirtieth, it shall be periodically subjected to an analysis to assess the possibility of impairment.»

  1. In standard thirtieth, new wording is given to letter b) of paragraph 2 and to paragraphs 9, 10, 12, and 14, which read as follows:

«b). subject the goodwill recognized as a consequence of a business combination to the impairment analysis established in section E) of this standard.»

«9. Goodwill, estimated in accordance with the provisions of standard forty-third, shall be assigned, from the date of its recognition, to one or more cash-generating units expected to benefit from the synergies derived from the business combination, these units possibly being larger than the cash-generating units referenced in the previous paragraphs. Notwithstanding the foregoing, in the case of investments in entities to which the equity method is applied, described in standard forty-ninth, the goodwill included in their book value shall be assigned entirely to the investment as an individual asset.»

«10. Each of the cash-generating units referred to in the previous paragraph shall represent the lowest level from which the entity manages the recognized goodwill, and in no case shall they be higher than a business segment of the entity. For these purposes, a business segment is a component of the entity that engages in business activities from which ordinary revenues can be obtained and expenses incurred, over which differentiated financial information is available and which is regularly evaluated by the Board of Directors, or equivalent body, to decide how to allocate resources and evaluate its performance. Ordinary revenues include, among others, net results from interest and yields and assimilated charges, fees for services rendered, results from the trading portfolio and insurance activity, as well as those derived from investments in equity instruments and from the sale of debt instruments.

When the entity reorganizes its information structure for management, such that the composition of one or more cash-generating units to which a proportion of goodwill had been attributed changes, this shall be redistributed among the affected units using the same criterion indicated in the following paragraph of this standard for the case of the sale or disposal by other means of elements of a cash-generating unit.»

«12. In estimating the impairment of a cash-generating unit to which a part of goodwill has been attributed, the entity shall consider the possible existence of external partners in the controlled business, in which case it shall increase the amount attributed to include a theoretical goodwill attributable to them, except for the part that, due to variations in the participation percentage without loss of control, would already have been attributed, in accordance with the provisions of standard forty-seventh. The book value of the cash-generating unit, once adjusted to include the theoretical and unrecognized goodwill of external partners, shall be compared with its recoverable amount. If the comparison reveals the existence of impairment, only that related to the goodwill assigned to the entity and, if there have been variations in participation without loss of control, that assigned to external partners shall be recognized, distributed in accordance with paragraph 7 of this standard.»

«14. The reversal of an impairment loss on an asset shall not result in an increase in its book value above what it would have been had no impairment losses been recorded in previous years. In any case, impairment losses related to previously recognized goodwill shall never be reversed, except that attributable to investments in entities to which the equity method is applied, described in standard forty-ninth, to the extent that, subsequently, their recoverable amount has increased.»

  1. The expression «or geographic» is suppressed from the last paragraph of paragraph 19 of standard thirty-fourth.

  2. New wording is given to standard forty-third, which reads as follows:

«A). Conceptual Aspects.

  1. A business combination is a transaction, or any other event, by which an entity obtains control of one or more businesses, as this is defined in standard third.

Control of a business can be obtained through the delivery of some type of consideration, such as, for example, the delivery of financial assets or equity instruments, incurring liabilities, or a combination of all of them. Control of a business can also be obtained without delivering any consideration, either on the acquisition date or previously, and without maintaining any participation in the equity of the acquired business, such as, for example, when an entity purchases such a volume of its own equity instruments that a previous investor obtains control; or when two entities agree, by contract, to combine their businesses and operate as a single entity, without any consideration passing between them. Control is also acquired when any of the circumstances provided for in paragraph 3 of standard third occur.

  1. A business is an integrated set of assets and activities capable of being directed and managed with the purpose of providing a return to investors or other owners, members, or participants. The return may be in the form of dividends, cost reduction, or other types of economic benefits. The conclusion as to whether a specific set of assets and activities constitutes a business shall be reached based on whether a third party unrelated to the entity could operate and manage them as a business. The essential elements that define a business are two: a) economic resources, that is, tangible assets, financial assets, workers, etc., and b) processes, that is, systems and procedures for managing economic resources. The result of applying processes to economic resources has the effect of generating returns for investors, participants, or owners. Almost all businesses also have liabilities, but their presence is not necessary to be a business. Unless proven otherwise, a specific group of activities and assets in which there is perceptible evidence of the existence of goodwill shall meet the definition of a business.

  2. Acquirer, in a business combination, is the entity that obtains control of one or more businesses.

  3. Acquired is the business or businesses whose control the acquirer obtains in a business combination.

  4. Non-controlling interests is the part of the equity of an entity not attributable, directly or indirectly, to the entity that has control over it. The amount of non-controlling interests for each of the controlled entities is shown in the consolidated statements in an aggregated manner as «minority interests».

  5. Acquisition method. This expression refers to the accounting treatment that the acquirer will use to record a business combination. The application of this method involves:

a) Identifying the acquirer entity.

b) Establishing the acquisition date.

c) Identifying, if any, the assets and liabilities that require separate accounting treatment from the business combination.

d) Identifying the assets acquired and liabilities assumed that require, on the acquisition date, the adoption of decisions, which must be adequately documented, in order to facilitate the future application of other standards of this Circular, such as the designation of a financial derivative instrument as a hedge, the classification of a financial instrument as a trading portfolio, or the separation of an embedded derivative in a hybrid financial instrument.

e) Recognizing and measuring identifiable assets acquired and liabilities assumed.

f) Recognizing and measuring, when appropriate, the non-controlling interests in the acquired business.

g) Measuring the consideration transferred.

h) Recognizing and measuring goodwill or, in the case of a bargain purchase, the gain obtained.

B). Scope of the standard.

  1. This standard shall apply to all transactions, or other events, that meet the definition of a business combination, except those that involve:

a) The combination of entities that, both before and after the combination, are under the control of:

i. another entity, when the control is not transitory, or

ii. one or more natural persons who, acting jointly under a contractual agreement, have collective power over each of the entities or businesses being combined and this is not transitory.

b) The acquisition of an asset, or group of assets, that does not meet the definition of a business. In this case, the acquirer entity shall recognize only the individual acquired assets that are identifiable and all assumed liabilities, distributing the cost of the acquisition based on the relative fair values of those assets on the date of acquisition.

c) The creation of a joint venture, as this is defined in standard forty-fourth.

  1. In cases of the creation of certain legal instruments that allow obtaining certain advantages related to regulatory capital requirements, such as the creation of an institutional protection scheme, the treatment of the operation as a business combination shall be carried out based on the contractual agreements reached, without prejudice to the provisions of prudential regulation regarding the consideration of participating entities as a consolidatable group of credit institutions.

C). Identification of the acquirer entity.

  1. In every business combination, one of the combining entities must necessarily be identified as the acquirer, based on the presumptions of control described in standard third. When there are doubts or difficulties in identifying which of the entities participating in the combination is the acquirer, the following factors and circumstances shall be taken into consideration, among others:

a) The size of the entities or businesses being combined. In these cases, the acquirer will generally be the entity or business that is significantly larger measured in terms of, for example, average total assets, ordinary revenues (as defined in paragraph 10 of standard thirtieth), regulatory own funds, or profits.

b) The form of settlement. If the combination is settled mainly through the delivery of cash or other assets, or incurring liabilities, the acquirer will normally be the entity that transfers the cash or other assets, or incurs the liabilities.

c) When the combination affects more than two entities, the determination of the acquirer shall include the identification of the entity, among those combining, that initiated the combination, in addition to the relative size of the entities being combined.

d) In business combinations effected mainly through the exchange of equity instruments, the acquirer will normally be the entity that issues new instruments. However, in cases where one of the entities participating in the combination, as a result of the high issuance of equity instruments to be delivered to the owners of another participating entity in exchange for ownership of the latter, causes the effect of coming to be controlled by the previous owners of the acquired business, sometimes referred to as «reverse acquisitions», the acquirer shall be the entity whose previous owners obtain control, unless it does not meet the criteria to be qualified as a business. In any case, when there is an exchange of equity instruments between the combining entities, the following situations and circumstances shall also be considered, among others:

i. The relative voting rights in the combined entity after the business combination. The acquirer shall be the combined entity whose owners as a group retain or receive the largest proportion of voting rights.

ii. The existence of a significant minority group when the combined entity does not have a controlling majority group. The acquirer shall be, among the entities combining, that whose owners, as a group, maintain the largest minority participation.

iii. The resulting Board of Directors, or equivalent body, after the combination. The acquirer shall be the entity, among those combining, whose owners, as a group, have the ability to elect, appoint, or remove the majority of the members of the Board of Directors or equivalent body.

iv. The key management personnel of the combined entity, understood in the sense provided for in letter d) of paragraph 1 of standard sixty-second. The acquirer shall be the entity, among those combining, whose key management personnel, prior to the combination, dominates the key management personnel of the combined entity.

v. The terms of exchange of the equity instruments. The acquirer shall be the entity that pays a premium over the fair values of the equity instruments, prior to the date of the combination, of the other entities being combined.

e) In the event that a new entity, created to effect a business combination between two or more pre-existing entities, delivers cash or other assets in exchange for equity instruments of the pre-existing entities, said new entity may be considered as the acquirer.

D). Acquisition Date.

  1. In a business combination, the acquisition date is that on which the acquirer obtains control of the acquiree.

  2. As a general rule, the acquisition date shall be that on which the acquirer legally transfers, or assumes the commitment to transfer, the consideration necessary to acquire the assets and assume the liabilities of the acquiree. Since control of a business can be acquired in multiple ways, the acquirer shall consider all relevant facts and circumstances to evaluate, based on the economic substance of the transaction when this differs from the legal form, the acquisition of control of a business, particularly when there is no delivery of consideration.

E). Recognition and measurement criteria for identifiable assets acquired, liabilities assumed, and non-controlling interests of the acquiree.

  1. With effect from the acquisition date, the acquirer shall incorporate into its financial statements, or in the consolidated statements, the identifiable assets acquired and liabilities assumed that on that date meet the following two conditions:

i. meet the recognition requirements in accordance with this Circular, even if they were not previously recognized in the financial statements of the acquiree, and

ii. form part of what the acquirer and acquiree exchanged in the transaction that gave rise to the business combination, and are not the result of a separate operation referred to in section G) of this standard.

The classification of said assets and liabilities shall be carried out based on their own contractual conditions and the accounting criteria of the acquirer, as well as by the economic conditions and other relevant information existing on the acquisition date. Likewise, the acquirer shall recognize, on the acquisition date, any non-controlling interests in the acquiree.

  1. Notwithstanding the foregoing, the provisions of standard thirty-seventh regarding contingent liabilities that the acquiree did not have recognized in its balance sheet shall not apply. Consequently, provided that the estimate is reliable, the acquirer shall initially recognize and measure at fair value all contingent liabilities of an acquiree assumed in a business combination that entail present obligations, regardless of the degree of probability of the outflow of economic resources due to the obligation. Subsequently, these liabilities shall be measured at the higher amount between that resulting from applying standard thirty-seventh and the initial amount minus, if applicable, decreases that, respecting standard seventeenth, might have occurred.

  2. On the acquisition date, the acquirer shall measure the identifiable assets acquired and liabilities assumed in a business combination at their fair value, using, among others, the valuation criteria and guidelines collected in standard fourteenth of this Circular. If applicable, non-controlling interests shall be measured by the proportional part they represent in the difference between the identifiable assets acquired and liabilities assumed. However, the following elements shall not be measured at fair value upon initial recognition:

a) The rights to use assets reacquired by the acquirer, which shall be recognized as an intangible asset and initially valued based on the contractual conditions remaining from the contract, without considering possible contractual renewals.

b) Share-based payment arrangements based on equity instruments of the acquiree, when replaced by similar arrangements of the acquirer, unless as a consequence of the combination they may have expired, which at the inception shall be recognized and measured as liabilities or equity instruments in accordance with the criteria established in standard thirty-sixth.

c) Non-current assets, defined in standard thirty-fourth, acquired on the date of the combination, which the acquirer classifies as «non-current assets held for sale», individually or as part of a «disposal group», which shall initially be valued at their fair value less costs to sell in a manner consistent with what is provided for in standard thirty-fourth and, when appropriate, Annex IX.

  1. Notwithstanding the provisions in the previous paragraphs, the following elements shall be recognized and initially measured in accordance with the following criteria:

a) Deferred tax assets and liabilities shall be recognized and measured in accordance with the provisions of standard forty-second.

b) Post-employment benefit arrangements for employees of the acquiree shall be recognized by the acquirer as a liability, or an asset when applicable, and measured in accordance with the provisions of standard thirty-fifth.

c) Rights in favor of the acquirer derived from contractual indemnification agreements as a consequence of potentially adverse effects that might arise after the acquisition date, resulting from contingencies or uncertainties related to the whole, or part, of the identifiable assets acquired or liabilities assumed in a business combination, which shall be recognized as an asset of the acquirer as part of the combination. The valuation of this type of asset shall be estimated using assumptions consistent with those used for the assets or liabilities whose uncertainty they are protecting. For example, the amount of a right to indemnification related to employee benefits of the acquiree