BUSINESS COMBINATIONS

IFRS 3-BUSINESS COMBINATIONS

 Overview
IFRS 3 Business Combinations outlines the accounting when an
acquirer obtains control of a business (e.g. an acquisition or
merger). Such business combinations are accounted for using
the 'acquisition method', which generally requires assets
acquired and liabilities assumed to be measured at their fair
values at the acquisition date.
A revised version of IFRS 3 was issued in January 2008 and
applies to business combinations occurring in an entity's first
annual period beginning on or after 1 July 2009.
 Background
IFRS 3 (2008) seeks to enhance the relevance, reliability and
comparability of information provided about business
combinations (e.g. acquisitions and mergers) and their effects. It
sets out the principles on the recognition and measurement of
acquired assets and liabilities, the determination of goodwill and
the necessary disclosures.
IFRS 3 (2008) resulted from a joint project with the US Financial
Accounting Standards Board (FASB) and replaced IFRS 3 (2004).
FASB issued a similar standard in December 2007 (SFAS 141(R)).
The revisions result in a high degree of convergence between
IFRSs and US GAAP in the accounting for business combinations,
although some potentially significant differences remain.
 Key definitions
 Business combination:
A transaction or other event in which an acquirer obtains control
of one or more businesses. Transactions sometimes referred to as
'true mergers' or 'mergers of equals' are also business
combinations as that term is used in [IFRS 3].
 Business:
An integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing a return in
the form of dividends, lower costs or other economic benefits
directly to investors or other owners, members or participants
 Key definitions
 Acquisition Date:
The date on which the acquirer obtains control of the
acquiree.
 Acquirer:
The entity that obtains control of the acquiree.
 Acquiree:
The business or businesses that the acquirer obtains control
of in a business combination.
 Scope
IFRS 3 must be applied when accounting for business combinations, but does not apply
to:
 The formation of a joint venture*.
 The acquisition of an asset or group of assets that is not a business, although general
guidance is provided on how such transactions should be accounted for.
 Combinations of entities or businesses under common control (the IASB has a separate
agenda project on common control transactions).
 Acquisitions by an investment entity of a subsidiary that is required to be measured at
fair value through profit or loss under IFRS 10 Consolidated Financial Statements.
* Annual Improvements to IFRSs 2011–2013 Cycle, effective for annual periods beginning on
or after 1 July 2014, amends this scope exclusion to clarify that is applies to the
accounting for the formation of a joint arrangement in the financial statements of the
joint arrangement itself.
 Determining whether a transaction is a business
combination.
 IFRS 3 provides additional guidance on determining whether a transaction meets the
definition of a business combination, and so accounted for in accordance with its
requirements.This guidance includes:
 Business combinations can occur in various ways, such as by transferring cash, incurring
liabilities, issuing equity instruments (or any combination thereof), or by not issuing
consideration at all (i.e. by contract alone).
 Business combinations can be structured in various ways to satisfy legal, taxation or other
objectives, including one entity becoming a subsidiary of another, the transfer of net assets
from one entity to another or to a new entity.
 The business combination must involve the acquisition of a business, which generally has three
elements:
 Inputs – an economic resource (e.g. non-current assets, intellectual property) that creates outputs when one
or more processes are applied to it
 Process – a system, standard, protocol, convention or rule that when applied to an input or inputs, creates
outputs (e.g. strategic management, operational processes, resource management)
 Output – the result of inputs and processes applied to those inputs.
 Method of accounting for business
combinations
Acquisition method:
The acquisition method (called the 'purchase method' in the 2004
version of IFRS 3) is used for all business combinations.
Steps in applying the acquisition method are:
 Identification of the 'acquirer‘.
 Determination of the 'acquisition date‘.
 Recognition and measurement of the identifiable assets acquired, the
liabilities assumed and any non-controlling interest (NCI, formerly
called minority interest) in the acquiree.
 Recognition and measurement of goodwill or a gain from a bargain
purchase.
 Identifying an acquirer
The guidance in IFRS 10 Consolidated Financial Statements is used to identify an
acquirer in a business combination, i.e. the entity that obtains 'control' of the
acquiree.
If the guidance in IFRS 10 does not clearly indicate which of the combining
entities is an acquirer, IFRS 3 provides additional guidance which is then
considered:
 The acquirer is usually the entity that transfers cash or other assets where the business combination is effected
in this manner.
 The acquirer is usually, but not always, the entity issuing equity interests where the transaction is effected in
this manner, however the entity also considers other pertinent facts and circumstances including:
 relative voting rights in the combined entity after the business combination
 the existence of any large minority interest if no other owner or group of owners has a significant
voting interest
 the composition of the governing body and senior management of the combined entity
 the terms on which equity interests are exchanged
 The acquirer is usually the entity with the largest relative size (assets, revenues or profit)
 For business combinations involving multiple entities, consideration is given to the entity initiating the
combination, and the relative sizes of the combining entities.
 Acquisition date
An acquirer considers all pertinent facts and circumstances when
determining the acquisition date, i.e. the date on which it obtains
control of the acquiree. The acquisition date may be a date that is earlier
or later than the closing date.
IFRS 3 does not provide detailed guidance on the determination of the
acquisition date and the date identified should reflect all relevant facts
and circumstances. Considerations might include, among others, the
date a public offer becomes unconditional (with a controlling interest
acquired), when the acquirer can effect change in the board of directors
of the acquiree, the date of acceptance of an unconditional offer, when
the acquirer starts directing the acquiree's operating and financing
policies, or the date competition or other authorities provide necessarily
clearances.
 Acquired assets and liabilities
IFRS 3 establishes the following principles in relation to the
recognition and measurement of items arising in a business
combination:
 Recognition principle. Identifiable assets acquired,
liabilities assumed, and non-controlling interests in the
acquiree, are recognized separately from goodwill.
 Measurement principle. All assets acquired and liabilities
assumed in a business combination are measured at
acquisition-date fair value.
 Exceptions to the recognition and
measurement principles
The following exceptions to the above principles apply:
 Contingent liabilities – the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent
Assets do not apply to the recognition of contingent liabilities arising in a business combination.
 Income taxes – the recognition and measurement of income taxes is in accordance with IAS 12
Income Taxes.
 Employee benefits – assets and liabilities arising from an acquiree's employee benefits
arrangements are recognized and measured in accordance with IAS 19 Employee Benefits (2011).
 Indemnification assets - an acquirer recognizes indemnification assets at the same time and on
the same basis as the indemnified item.
 Reacquired rights – the measurement of reacquired rights is by reference to the remaining
contractual term without renewals.
 Share-based payment transactions - these are measured by reference to the method in IFRS 2
Share-based Payment
 Assets held for sale – IFRS 5 Non-current Assets Held for Sale and Discontinued Operations is applied
in measuring acquired non-current assets and disposal groups classified as held for sale at the
acquisition date.
 Goodwill
Goodwill is measured as the difference between:
 the aggregate of (i) the value of the consideration transferred (generally at fair value), (ii) the
amount of any non-controlling interest (NCI, see below), and (iii) in a business combination
achieved in stages (see below), the acquisition-date fair value of the acquirer's previously-held
equity interest in the acquiree, and
 the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed
(measured in accordance with IFRS 3).
This can be written in simplified equation form as follows:
Goodwill=Consideration transferred + Amount of non-controlling interests + Fair value of
previous equity interests - Net assets recognized
If the difference above is negative, the resulting gain is a bargain purchase in profit or loss, which
may arise in circumstances such as a forced seller acting under compulsion. However, before any
bargain purchase gain is recognized in profit or loss, the acquirer is required to undertake a review
to ensure the identification of assets and liabilities is complete, and that measurements appropriately
reflect consideration of all available information.
 Choice in the measurement of non-controlling
interests (NCI)
IFRS 3 allows an accounting policy choice, available on a transaction by
transaction basis, to measure non-controlling interests (NCI) either at:
 fair value (sometimes called the full goodwill method), or
 the NCI's proportionate share of net assets of the acquiree.
The choice in accounting policy applies only to present ownership
interests in the acquiree that entitle holders to a proportionate share of
the entity's net assets in the event of a liquidation (e.g. outside holdings
of an acquiree's ordinary shares). Other components of non-controlling
interests at must be measured at acquisition date fair values or in
accordance with other applicable IFRSs (e.g. share-based payment
transactions accounted for under IFRS 2 Share-based Payment).
 Example
P pays 800 to acquire an 80% interest in the ordinary shares
of S. The aggregated fair value of 100% of S's identifiable
assets and liabilities (determined in accordance with the
requirements of IFRS 3) is 600, and the fair value of the non-
controlling interest (the remaining 20% holding of ordinary
shares) is 185.
The measurement of the non-controlling interest, and its
resultant impacts on the determination of goodwill, under
each option is illustrated below:
 NCI Based on Fair Value NCI Based on Net Assets

Consideration transferred 800 800

Non-controlling interest 185 (1) 120 (2)

985 920

Net assets (600) (600)

Goodwill 385 320

(1) The fair value of the 20% non-controlling interest in S will not necessarily be proportionate to the price paid by P
for its 80% interest, primarily due to any control premium or discount.

(2) Calculated as 20% of the fair value of the net assets of 600.
 Business combination achieved in stages (step
acquisitions)
Prior to control being obtained, an acquirer accounts for its investment in the equity
interests of an acquiree in accordance with the nature of the investment by applying the
relevant standard, e.g. IAS 28 Investments in Associates and Joint Ventures (2011), IFRS 11
Joint Arrangements, IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9
Financial Instruments. As part of accounting for the business combination, the acquirer
remeasures any previously held interest at fair value and takes this amount into account
in the determination of goodwill as noted above. Any resultant gain or loss is recognized
in profit or loss or other comprehensive income as appropriate.
The accounting treatment of an entity's pre-combination interest in an acquiree is
consistent with the view that the obtaining of control is a significant economic event that
triggers a remeasurement. Consistent with this view, all of the assets and liabilities of the
acquiree are fully remeasured in accordance with the requirements of IFRS 3 (generally
at fair value). Accordingly, the determination of goodwill occurs only at the acquisition
date.This is different to the accounting for step acquisitions under IFRS 3(2004).
 Measurement period
If the initial accounting for a business combination can be
determined only provisionally by the end of the first reporting
period, the business combination is accounted for using
provisional amounts. Adjustments to provisional amounts, and the
recognition of newly identified asset and liabilities, must be made
within the 'measurement period' where they reflect new
information obtained about facts and circumstances that were in
existence at the acquisition date. The measurement period cannot
exceed one year from the acquisition date and no adjustments are
permitted after one year except to correct an error in accordance
with IAS 8.
 Related transactions and subsequent accounting
General principles
In general:
 transactions that are not part of what the acquirer and acquiree (or its
former owners) exchanged in the business combination are identified and
accounted for separately from business combination
 the recognition and measurement of assets and liabilities arising in a business
combination after the initial accounting for the business combination is dealt
with under other relevant standards, e.g. acquired inventory is subsequently
accounted under IAS 2 Inventories.
When determining whether a particular item is part of the exchange for
the acquiree or whether it is separate from the business combination, an
acquirer considers the reason for the transaction, who initiated the
transaction and the timing of the transaction.
 Contingent consideration
Contingent consideration must be measured at fair value at the time of the business combination
and is taken into account in the determination of goodwill. If the amount of contingent
consideration changes as a result of a post-acquisition event (such as meeting an earnings target),
accounting for the change in consideration depends on whether the additional consideration is
classified as an equity instrument or an asset or liability:
 If the contingent consideration is classified as an equity instrument, the original amount is not
remeasured
 If the additional consideration is classified as an asset or liability that is a financial instrument, the
contingent consideration is measured at fair value and gains and losses are recognized in either
profit or loss or other comprehensive income in accordance with IFRS 9 Financial Instruments or IAS
39 Financial Instruments: Recognition and Measurement
 If the additional consideration is not within the scope of IFRS 9 (or IAS 39), it is accounted for in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets or other IFRSs as
appropriate.
Where a change in the fair value of contingent consideration is the result of additional information
about facts and circumstances that existed at the acquisition date, these changes are accounted for as
measurement period adjustments if they arise during the measurement period.
 Acquisition costs
Costs of issuing debt or equity instruments are accounted for
under IAS 32 Financial Instruments: Presentation and IAS 39 Financial
Instruments: Recognition and Measurement/IFRS 9 Financial
Instruments. All other costs associated with an acquisition must be
expensed, including reimbursements to the acquiree for bearing
some of the acquisition costs. Examples of costs to be expensed
include finder's fees; advisory, legal, accounting, valuation and
other professional or consulting fees; and general administrative
costs, including the costs of maintaining an internal acquisitions
department.
 Pre-existing relationships and reacquired rights
If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the
acquirer had granted the acquiree a right to use its intellectual property), this must be
accounted for separately from the business combination. In most cases, this will lead to
the recognition of a gain or loss for the amount of the consideration transferred to the
vendor which effectively represents a 'settlement' of the pre-existing relationship. The
amount of the gain or loss is measured as follows:
 for pre-existing non-contractual relationships (for example, a lawsuit): by reference to
fair value
 for pre-existing contractual relationships: at the lesser of (a) the favourable/unfavourable
contract position and (b) any stated settlement provisions in the contract available to the
counterparty to whom the contract is unfavourable.
However, where the transaction effectively represents a reacquired right, an intangible
asset is recognised and measured on the basis of the remaining contractual term of the
related contract excluding any renewals. The asset is then subsequently amortized over
the remaining contractual term, again excluding any renewals.
 Contingent liabilities
Until a contingent liability is settled, cancelled or expired, a
contingent liability that was recognized in the initial
accounting for a business combination is measured at the
higher of the amount the liability would be recognized under
IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and
the amount less accumulated amortization under IAS 18
Revenue.
Contingent payments to employees and shareholders
As part of a business combination, an acquirer may enter into
arrangements with selling shareholders or employees. In determining
whether such arrangements are part of the business combination or
accounted for separately, the acquirer considers a number of factors,
including whether the arrangement requires continuing employment
(and if so, its term), the level or remuneration compared to other
employees, whether payments to shareholder employees are incremental
to non-employee shareholders, the relative number of shares owns,
linkages to valuation of the acquiree, how the consideration is calculated,
and other agreements and issues.
Where share-based payment arrangements of the acquiree exist and are
replaced, the value of such awards must be apportioned between pre-
combination and post-combination service and accounted for
accordingly.
 Indemnification assets
Indemnification assets recognised at the acquisition date
(under the exceptions to the general recognition and
measurement principles noted above) are subsequently
measured on the same basis of the indemnified liability or
asset, subject to contractual impacts and collectability.
Indemnification assets are only derecognised when collected,
sold or when rights to it are lost.
 Disclosure
Disclosure of information about current business
combinations
An acquirer is required to disclose information that enables
users of its financial statements to evaluate the nature and
financial effect of a business combination that occurs either
during the current reporting period or after the end of the
period but before the financial statements are authorized for
issue.
 Among the disclosures required to meet the foregoing objective are the following:
 name and a description of the acquiree
 acquisition date
 percentage of voting equity interests acquired
 primary reasons for the business combination and a description of how the acquirer obtained
control of the acquiree
 description of the factors that make up the goodwill recognised
 qualitative description of the factors that make up the goodwill recognised, such as expected
synergies from combining operations, intangible assets that do not qualify for separate recognition
 acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of
each major class of consideration
 details of contingent consideration arrangements and indemnification assets
 details of acquired receivables
 the amounts recognised as of the acquisition date for each major class of assets acquired and
liabilities assumed
 details of contingent liabilities recognised
 total amount of goodwill that is expected to be deductible for tax
purposes
 details about any transactions that are recognised separately from the
acquisition of assets and assumption of liabilities in the business
combination
 information about a bargain purchase
 information about the measurement of non-controlling interests
 details about a business combination achieved in stages
 information about the acquiree's revenue and profit or loss
 information about a business combination whose acquisition date is after
the end of the reporting period but before the financial statements are
authorised for issue
 Disclosure of information about adjustments of past business
combinations
An acquirer is required to disclose information that enables users of its financial statements to evaluate the
financial effects of adjustments recognised in the current reporting period that relate to business
combinations that occurred in the period or previous reporting periods.
Among the disclosures required to meet the foregoing objective are the following:
 details when the initial accounting for a business combination is incomplete for particular assets, liabilities,
non-controlling interests or items of consideration (and the amounts recognised in the financial statements
for the business combination thus have been determined only provisionally)
 follow-up information on contingent consideration
 follow-up information about contingent liabilities recognised in a business combination
 a reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period, with
various details shown separately
 the amount and an explanation of any gain or loss recognised in the current reporting period that both:
 relates to the identifiable assets acquired or liabilities assumed in a business combination that was effected in the
current or previous reporting period, and
 is of such a size, nature or incidence that disclosure is relevant to understanding the combined entity's financial
statements.