Allocation of shared group-items and elimination of inter-company transactions

In addition to the three segments that are now properly allocated above, the financial statements are also divided into the segment “Other and elimination”. An allocation of this

cross-segment to the carve-out entity, NewCo, will be discussed below. Other and elimination is a result of shared activities that are not defined or allocated directly by the three operating segments, such as headquarter cost or shared assets. The cross-segment is also a result of inter-company

transactions between the operating segments, such as elimination of unrealized gains and losses (Yara, 2019). According to IAS 24, attention should be directed towards whether profit or loss are affected by these transactions of related parties (IFRS, n.d.a).

Related party transactions are eliminated in the consolidated financial statement, but may be recognized in the cave-out financial statement based on different measure approaches (KPMG, 2017; EY, 2018a). Since Yara’s inter-company transactions are based on an arm-length basis as they were sold to third parties, the reported values are assumed directly attributed and transferred to NewCo’s carve-out financial statement (KPMG, 2017). Further, Yara does not divide the cross-segment eliminations and other shared items, but rather collects the items combined in Other and elimination. This creates challenges as although elimination is created to even out the Production’s profit, NewCo still needs to allocate some of the other shared items. The net effect of Other and eliminations is allocated to NewCo on a “cause-and-effect” relationship in both the income statement and balance sheet and will be discussed below.

In addition to allocate Other and elimination, the carve-out financial statement of NewCo on a stand-alone basis is made by allocating Industrial’s respective group-items. All the remaining group-items from Production and Crop Nutrition, as well as the rest of the allocation of Other and elimination is transferred to RemainCo. This results in an income statement and balance sheet for both RemainCo and NewCo presented in Appendix 16, where the treatment of other shared items and eliminations are highlighted in green. A common-size analyses and trend analysis of each company is conducted for further examination and shown in Appendix 17. Further, a comparison on operational ratios, i.e. profitability margins, are conducted as a sanity-check of the size of NewCo’s activities as a stand-alone company compared with its peers. This is shown in Appendix 18.

Stand-alone revenue

As mentioned above, an important assumption involves that the reported profits are directly transferable for both NewCo and RemainCo due to the arm-length basis, i.e. that the transactions could have been towards another party. This leads to both companies expecting to produce the same volume as prior to the carve-out, and therefore the external revenue of each company has been allocated. The external revenue of which is shared, is allocated based on the “cause-and-effect” relation from the percentage share of Industrial’s total revenue. Furthermore, as NewCo will be separated from RemainCo, the stand-alone company will not undertake any internal

transactions as it currently does. The internal revenue will therefore not be distributed to NewCo.

However, as RemainCo will keep the production segment within its company, RemainCo will still undertake the internal transactions.

Stand-alone expenses

When evaluating a carve-out, costs could be considered in three broad categories, including costs directly attributed to each segment, shared corporate costs, and costs not related to the carve-out entity. The shared costs, such as accounting, legal and headquarter costs, are often not distributed to each segment and should be allocated based on different methodologies depending on the nature of the costs (EY, 2018a; PwC, 2018). As mentioned, the total operating expenses are not divided into sub-items. Although it is expected that the distribution within the item is different for each segment, and hence different methods could have been applied, the expenses must be treated as one single item. In order to eliminate the internal profit, i.e. even out the eliminations, the difference between the item from internal revenue and operating expenses is calculated. This net effect represents the total shared costs. NewCo’s share is calculated using the Industrial’s

percentage share of total revenue. The “cause-and-effect” argument is a good indication, as costs arguably reflect the revenue activity.

Other items

Share of equity-accounted investees is reported in each segment and does not include Other and elimination and is therefore considered completely allocated. Further, there might be more ideal drivers for allocating the item Other and elimination of Depreciation, amortization and impairment loss (DAI), interest income/expense and foreign currency gain/loss. However, the revenue share is considered a reasonable method, due to limited information. This is justified, as these costs are considered to reflect the operational activity, giving a reasonable indication of the cause-effect relationship (Horngren, 2018).

Balance sheet

Judgements are required when considering whether the carve-out entity will recognize the entire asset or liability (EY, 2018a). As mentioned, it is generally not appropriate to divide assets and liabilities, such as a property or machine (PWC, 2018). An alternative distribution of these assets could be based on the relative use of each square meter as they are frequently used by multiple entities (EY, 2018a). Yet, due to limited information, assumptions need to be taken when allocation these shared assets and liabilities. The net effect of Other and elimination can therefore arguably be allocated based on a proportional method by Industrial's percentage share of total revenue (Horngren, 2018).

Overall discussion

It is worth mentioning that the Industrial segment seems to have an abnormal low share of non-current assets. This has led to a lower allocation of debt, which as mentioned is still in line with the only reported debt figures in 2012 and 2013. There might be several reasons for this, such as the high investment level of Yara has mainly originated from the fertilizer business compared with the Industrial segment. This might be due to a long-term preparation of the carve-out. Another

explanation could be the companies’ different business areas. The revenue of Industrial has experienced growth over the years, resulting in an increased turnover rate on invested capital for NewCo, as shown in Appendix 19. The rate is significantly high in recent years, especially

compared with RemainCo’s. RemainCo produces more of its own products relative to NewCo which purchases a much larger volume for its production. This is in line with theory, as production companies tend to have higher profitability and lower turnover rate of invested capital as opposed to retail companies (Sørensen, 2012). Based on these arguments, the assumptions argued for in this section could have adjusted for this issue by allocating a larger share of non-current assets to

industrial from the other segments. However, as this is the share reported in the balance sheet, this case study chose to continue using this proportion.