Business combination analysis

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The UK is particularly important for global financial reporting because it has been a major power in the world economy since the mid 19th century (Flower and Ebbers, 2002). Since then, environmental and cultural influences such as global warming, economic downturns and corporate meltdowns overseas (Enron) have meant an increased interest in social reporting as well as transparency which have fomented the development of regulatory financial reporting practices, methods and procedures (Elliott and Elliott, 2006). Since companies' activities extend beyond national frontiers, it is necessary to generate a flow of reliable homogeneous financial information about them and therefore utilise national as well as international accounting standards (Alexander et al., 2003).

The evolution and harmonization of the UK's accounting standard have been greatly influenced by the International Accounting Standards Committee (IASC). Based on the IASC, International Accounting Standards (IAS) have been developed through an international process, involving world-wide accounting professionals, preparers and users of financial statements and as well as national standard setting bodies (Alexander et al., 2003; Harisson et al., 2004). Many UK companies, especially large multinational companies and international financial institutions, prepare their financial reports in accordance with International Accounting Standards (Nobes and Parker, 2000). Recently, the European Union (EU) adopted a regulation requiring listed companies governed by the law of a member state to prepare their consolidated accounts in accordance with international accounting standards after 1st January 2005 (Harisson et al., 2004). Following changes in EU regulations, UK companies listed on a stock exchange in the UK will be required to adopt International Financial Reporting Standards (IFRS) (Nobes and Parker, 2000). The development of IFRS takes place during International Accounting Standards Board (IASB) meetings and such standards are increasingly adopted by UK companies in place of financial reporting standards issued by the Accounting Standards Board (ASB) (Flower and Ebbers, 2002); Elliott and Elliott, 2006). The Institute of Chartered Accountants in England and Wales (ICAEW) adds that, "Other UK companies within the UK have a choice of reporting under UK GAAP or IFRS" (ICAEW website).

We have chosen to analyse the annual reports (henceforth ARs) of BP PLC & Royal Dutch Shell PLC. Both are major players in global energy production and are recognized as being two sixths of the group commonly known as 'super majors', describing the six largest energy companies within the private sector. Both are truly global companies with operations in over 100 countries, employing over 90,000 staff.

The purpose of comparing similar companies is to allow a more in-depth analysis of financial reporting practices and examine whether companies with such similar operations implemented diverging accounting financial reporting policies or disclosure practices and the implications of these.

Both BP and Shell's consolidated financial statements "have been prepared in accordance with the provisions of the Companies Act 1985, Article 4 of the International Accounting Standards (IAS) Regulation and with International Financial Reporting Standards (IFRS) as adopted by the European Union ... [and] in accordance with IFRS as issued by the IASB" (SAR, 2009: 118; for BP see BPAR, 2009: 108). Although, while Shell's parent company financial statements have been prepared in accordance with the same IFRS (SAR, 2009: 177), BP's have been prepared "in accordance with ... United Kingdom generally accepted accounting practice [UK GAAP]" (BPAR, 2009: 191). However, this has no material impact on our analyses as we only deal with consolidated financial statements and their "related notes" (BPAR, 2009: 103; SAR, 2009: 111).

Before looking in depth at BP and Shell's ARs, it is important to recognise that BP and Shell's registered auditors (Ernst & Young LLP and PriceWaterhouseCooper LLP respectively) state that their "consolidated financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union" (BPAR, 2009: 103; SAR, 2009: 111).

Consolidation and Business Combination Reporting

Before looking into the accounting policies related to business combination and consolidation, the terms 'group' and 'control' must be defined.

IAS 27 Consolidated and Separate Financial Statement states that when one enterprise exercises control over another, directly or indirectly, a group is said to exist; the controlling enterprise is called the parent and the other, its subsidiary. (Elliot and Elliot,2006: 525)

IAS 27 defines control "as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities" (Bonham et al., 2009: 402). Owning more than half of the voting rights in another entity, directly or through a subsidiary, is considered the threshold for control (Elliot and Elliot,2006: 527). Even if less than half of the voting rights are acquired, it is still possible to identify the acquirer (Elliot and Elliot,2006: 527-528).

Accounting for a business combination and consolidation is done by using IAS27, IFRS3, IAS 3(Joint Ventures (JVs)) and IAS 28 (Associates).

According to IAS 27, the parent has to prepare consolidated financial statements for all subsidiaries. This avoids the creation of misleading accounts by the parent. It also determines the full earnings of the parent's investment and measures the performance of the company's directors (Elliot and Elliot, 2006: 525-526). The exemptions are when the parent company is itself a wholly owned or partially owned subsidiary of another enterprise and its owners don't have an objection with the parent not presenting consolidated accounts (Elliot and Elliot ,2006: 525-526)

Under UK GAAP there are a few differences. FRS 2 governs the Consolidation of Subsidiaries. Under IAS 27 a subsidiary should be excluded from consolidation when the control is intended to be temporary (Elliot and Elliot, 2006: 527). However, FRS 2 places a limit of "approximately one year from date of acquisition" (Wilson et al.,2001: 314). IAS' longer term holdings could therefore distort the consolidated reports of IFRS reporting for a longer period than UK GAAP. Contrary to UK GAAP, IAS 27 does not permit the exclusion from consolidation of an entity it continues to control simply because that entity is operating under severe long-term restrictions (Elliot and Elliot, 2006:527). Under IAS 27 exclusion "on the grounds that a subsidiary's activities are dissimilar from those of the others within a group cannot be justified" (Elliot and Elliot, 2006: 527) However, FRS 2 "requires non-consolidation where the subsidiary's activities are so different from those of the rest of the group that its inclusion would be incompatible with the obligation to give a true fair view"; although this is only in exceptional circumstances (Wilson et al.,2001:315).

The method used for accounting a business combination is called acquisition method (Purchase method, IFRS 2004). The steps involved are:

There are 3 kinds of business combination: wholly owned subsidiaries, associates and JVs.

Subsidiaries are owned and controlled by parent company from the acquisition date (Alfredson, et al, 2005: 668.). BP states that in note 1, page108.

An associate, according to IAS 28, "is an entity, including an unincorporated entity such as a partnership, over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture." (Alfredson, et al, 2005: 937) Accounting for associates is done by using the equity method. (Appendix A)

JV, as defined by IAS31, "is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control" (Alfredson, et al, 2005: 986). As shown below, JV is widely used by both BP and Shell.

What is evident in the consolidated financial statement are (I) revenues from associates and JVs, (II) investments in associates, (III) JV and (IV) the value of minority interests (MIs).

The difference in UK GAAP here is that the proportionate consolidation method is recommended for jointly-controlled entities, while the equity method is permitted. The proportionate consolidation method leads to a different disclosure amounts in financial statement, such as the venture has to put share of assets, liabilities, income and expenses line- by-line with similar items in the financial statement (Gee, 2007: 450). The equity method, however, only shows the profit and loss from the investment, which is more crucial for investors.

Beside the income directly generated from the combination, MI is another revenue source. In a combination, shareholders other than the parent company are collectively referred as MI (Elliot and Elliot, 2006: 530). According to IAS 27, "Minority interests ... shall be presented in the consolidated balance sheet within equity, separately from the parent shareholders' equity. Minority interests in the profit or loss of the group shall be separately presented". (Alfredson et al, 2005: 775). IASB states that MI should be calculated by the entity concept ( Appendix A), in which MI is counted as the equity holder of the group (Alfredson et al, 2005: 655).

Intangible assets are also influenced by business combination, especially goodwill, which is important to MNCs. During business combination, the assets acquired and liabilities assumed are recognized at their fair value at the date of acquisition, but the cost of the purchase is not always equal with the fair value, so the difference between cost of purchase and fair value is counted as goodwill (Appendix A) (Alfredson, et al, 2005: 396).

For instance, Shell's acquisition of Duvernay Oil Corp., where goodwill was valued at $330m, almost 1/15th of the total consideration of their equity ($5,013m) (SAR 2008, NOTE 11).

Shell and BP present their goodwill in different ways. Shell opts to group all intangible assets into one table, whereas BP chooses to treat goodwill separately. Perhaps this is to soften the blow from both their losses in goodwill. BP's note 25 (intangible assets) is spared the $1,128m fall in goodwill (since 2007) and Shell can lump its goodwill loss together ($181m) along with its 'other' intangible assets. However, this should not be difficult for discerning investors to identify:

Interestingly, BP uses note 12 to separate the impairment of goodwill from its goodwill and intangible asset tables. Shell, however, compounds goodwill impairment into its intangible asset table (see note 10 above) under 'Charges for the year' ($311m in 2008). They both use the discounted cash flow model(Appendix A) for impairment of goodwill. However, BP used a discount rate (Appendix A) of 11% and Shell a rate of 6%. Because of the differences in informational disclosure, BP appears to have greater transparency than Shell, a very important concept for potential investors.

Both BP and Shell experienced a golden three years, starting in 2006 due to increasing oil prices (see Figure 1.). BP and Shell increased the investments in Business Combination. BP, however, experienced a decline in disposal during 2006-2008. Shell lost $1.1 billion on provision for decommissioning and restoration on disposal in UK and USA, (SAR, 2009: 142) but this didn't have a strong influence on the cash flow of the group (SAR, 2009: 154) Besides, Shell had gained $1,395 million from the disposal of certain operations in Germany (SAR, 2009: 132). Strong cash inflows and fewer losses on disposals are always encouraging for investors.

Environmental and Social Reporting

Social and environmental reporting exists because "there is a philosophical view that holds that a company possess a role in society" and cannot act "without regard for the range of consequences for its actions" (Elliot and Elliot, 2007:796). However, there appears to be no unifying paradigm or framework for adequate disclosure (Zéghal and Ahmed, 1990: 1) and this is evident in Shell and BP's ARs. Firstly we will examine the external environmental standards both companies adhere to comparing them to UK GAAP. Then we consider the involuntary and voluntary information disclosed.

IAS 37 is applicable under IFRS and covers regulations on 'Provisions, Contingent Liabilities and Contingent Assets' (IASB, 2009:1877) as well as IAS 16 which covers 'Property, Plant and Equipment' "acquired for safety or environmental reasons ... [and] to comply with environmental requirements" (Bonham et al., 2009:1511; IASB, 2009:1150). According to IFRS provisions are "liabilities of uncertain timing or amount" (IASB, 2009:1888). For there to be a liability, there must be an obligation at the balance sheet date that is present or probable (Nobes and Parker, 2008:141; IASB, 2009:1888-90). As Bonham et al. describe, "[w]hether an 'obligating event' or not there is a 'constructive obligation to clean up the land'" (2009:1504). BP's policy honours this: "Liabilities for environmental costs are recognized when a clean-up is probable and the associated costs can be reliably estimated" (BPAR, 2009:113). This is in line with IAS 37's outlines of "unlawful environmental damage" (IASB, 2009:1889). Therefore Shell is obligated to disclose its $1.0 billion "environmental capital spending" (SAR, 2009:65), its "total liabilities ... carried for environmental clean-up" of $1.2 billion (SAR, 2009:65) and its "obligations being carried for spending on decommissioning and restoration including oil and gas platforms" of $10.5 billion (SAR, 2009:65). Though BP is not as forthcoming in their "Environment" section, their note 37, 'Provisions', provides their relevant figures: $9,501 million in decommissioning liabilities, $2,107 million in environmental ones and $3,487 million in litigation and other costs (BPAR, 2009:158). The fact that IFRS only require figures pertaining to liabilities, decommissioning, plant, property and equipment, highlights the lack of environmental requirements in annual reports.

These accounting standards were developed through collaboration between the ASB and the IASC and apply both internationally through IAS 37 and in the UK through UK GAAP's FRS 12. As a result the wording and implications of the standards are virtually identical (Wilson et al 2001: 1952). Since then, the similarities have been furthered by Financial Reporting Exposure Draft 14's (FRED 14) proposals on environmental provisions which mirror those of IAS 37. This posses few problems for comparative analysis (Wilson et al 2001: 1987).

Since 1997 and the removal of the British Standard Institute's BS7750 there are two remaining environmental reporting standards, "the European Union's Eco-Management and Audit Scheme (EMAS) and the International Organization for Standardization's ISO 14000 series" (Gray and Bebbington, 2001:105 & 106). EMAS' regulatory strictness makes it a less attractive policy choice for companies (Gray and Bebbington, 2001:107). Gray and Bebbington suggest that "ISO 14000 is now the standard for environmental management and audit" (2001:108). However, "the ISO's guidance on environmental management and audit is explicitly voluntary ... and ... contains no requirement for either disclosure or vigorous verification" (2001:108). This may be a fundamental reason for ISO 14000's wide-scale adoption.

Shell claims, in their "Environment and Society", it is "having major facilities certified to international environmental standards, such as ISO 14001" (SAR, 2009:64). BP states: "the operations at our major operating sites are covered by certification to the ISO 14001" (BPAR, 2009:43-4). This, however, ignores 39% of BP's fixed assets as their environmental and social reporting covers only their operations in the EU and the U.S (BPAR, 2009:43). Furthermore, they mention their own, "Operating Management System (OMS), including ISO 14001" (BPAR, 2009:44). While BP has its system in place which applies its "Environmental Group Defined Practice (GDP)" (BPAR, 2009:44), Shell claims that it behaves "in line with the Shell General Business Principles ... and Code of Conduct" (SAR, 2009:64). ISO 14001's flexible and voluntary nature provides scope for companies to adopt internal standards in their environmental reporting (Gray et al., 1995).

Both Shell and BP voluntarily provide information regarding greenhouse gas emissions (Fig. 1 Shell, Fig. 2 BP), injuries (Fig. 3 Shell, Fig 4. BP) and oil spills (Fig. 5 Shell, Fig 6. BP) in their ARs:

One example of variation is how Shell and BP use the consulting firm Solomon Associates (SAR, 2009:67; BPAR, 2009:7). Both employ Solomon Associates' Energy Intensity Index (EIIÔ;) measuring the efficiency of their refineries. However, interestingly, Shell uses it as an environmental reporting tool and BP as a productivity and performance measure, highlighting the companies' diverging focus.

Despite the similarities shown above a number of differences still exist. Shell, unlike BP, discloses the nature of its spills. This is perhaps to justify its total 1.5 thousand ton rise in volume spilt since 2007, blamed on "one sabotage incident in Nigeria" (SAR, 2009: 68). Also, Shell's data goes back five years to 1999 and BP's only to 2006. One glaring social responsibility discrepancy is that only BP reports on its employee's satisfaction. This emphasises the arbitrary nature of social reporting.


Having examined both consolidation and environmental and social reporting in detail, it appears that the differences between the two companies' disclosure in the ARs are minimal but not undetectable.

Shell and BP's Consolidated Financial Statements disclose information in various ways, spreading their figures among different notes or tables or by presenting information differently, as we saw with 'Goodwill'. Even a superficial examination of their Group (BP) and Consolidated (Shell) Balance Sheets clearly show that, although the same essential information is presented, they both go into different levels of detail (evident in their equity disclosures). However, these differences are superficial and should not pose a problem for the trained eyes of an investor or analyst familiar with accounting practices.

With regards to environmental and social reporting, comparative analysis is problematic because the annual reports sporadically mix voluntary reporting with data required by financial reporting standards. Though the differences in reporting under IFRS are negligible, those between voluntarily disclosed information are great and inconsistent. Despite this it is in their best interests to report as fully as possible because, "If not done voluntarily it will become mandatory" (Gray and Bebbington, 2001:242).

Shell appears more forthcoming in its environmental reporting than BP. Potential explanations for this could be due to Western stakeholder pressure as there will be an "unwillingness to report on ethical issues in lesser developed countries until public pressure intensifie[s]" (Adams, 2002:235). It is also possible that BP is targeting their Western investors.

There are, however, problems with making assumptions; companies go to great lengths to communicate their environmental activities through a range of media, not solely the AR (Zéghal and Sadrudin, 1990:38). BP and Shell make use of separate 'Sustainability Reports' to release relevant data on their environmental and social reporting and on other related external regulations (see Appendix B).

When comparing BP & Shell's IFRS to those of UK GAAP our analysis of Business Combination and Social reporting has revealed some key areas of discussion. In Business Combination, investors will need to be aware of the aforementioned differences between IFRS and UK GAAP, such as those pertaining to the profit and loss arising from business combination. However, these differences appear to be highly circumstantial and only apply under specific scenarios, the effects of which are therefore unlikely to affect an investment decision.

As for Environmental and Social reporting, investors and analysts should not face many problems when comparing the numerical disclosure of the two companies although they are likely to when examining the disparate environmental elements contained herein. This is because while IFRS and UK GAAP hardly differ, voluntary environmental reporting varies greatly. Ethically-inclined investors will therefore find it difficult to discern between the environmental policies of the two companies. Financial analysts will also face similar problems when attempting to evaluate the two companies' environmental impact. However, people who take ethical and environmental issues into consideration when making investments are unlikely to consider Shell and BP due to the nature of their business; other companies which operate in other industries will be more affected by this type of reporting.

There were always going to be a large numbers of similarities in the annual reports of two of the major players within the oil and gas industry. However, we have proved that, though subtle and sometimes voluntary, there are disclosure discrepancies to take into account when drawing comparisons that are worthy of further investigation.


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