IFRS 3

Business
Combinations

1
Objective of the Lecture

 Discuss the key principles of IFRS 3

• Definition of a business
• Acquisition method

2
Business Combination Identification

Does the transaction

meet the definition of
a business
combination in terms
of IFRS 3?

YES NO

Account for the Treat the acquisition as

transaction in terms of a normal asset
IFRS 3 acquisition

3
Business
Combinatio
n  Appendix A important definitions:
Identificatio • Business combination
n • Business
• Acquirer
• Acquiree

4
Business Combination Defined

A ‘business
A transaction or other combination’ is the
event in which an acquirer term given by
obtains control of one or International Financial
more businesses by the Reporting Standards to
transfer of cash, incurrence transactions and other
of liabilities, issue of equity events wherein one
interests or by contract entity obtains control
alone. over another entity.
Business Defined

• An integrated set of activities and

assets (inputs) that is
• capable of being conducted and
managed (process) for the
• purpose of providing a return
(output) in the form of dividends,
lower costs or other economic
benefits directly to investors or
other owners, members or
participants.
 Exclusions

IFRS 3 does not apply

to business
combinations which:
Involve the
Involve entities acquisition of
Result in the or businesses an asset or
forming of a under group of assets
joint venture. common that does not
control. constitute a
business.
7
Business combination Identification
Three main elements in a business

INPUT PROCESS OUTPUT

A business generally consists of inputs and processes applied to

those inputs that have the ability to create outputs (ability to
provide a return to investors), although outputs are not required
for an integrated set of activities and assets to qualify as a
business.
 In the absence of outputs (during
development stage of a business), other
factors indicating that the set of activities is a
business include whether the set:
• has begun planned principal activities,
• has employees, intellectual property and other inputs
and processes that could be transferred to those inputs,
• is pursuing a plan to produce outputs, and
• will be able to obtain access to customers that will
purchase the benefits.

See - CLASS EXAMPLE 1

9
Illustrative example 1- Acquisition of a group of assets not
constituting a business

On 1 April 2018, A Limited acquired a group of assets and related

liabilities from B Limited for a total of N$2 million. The group of
assets and liabilities acquired do not constitute a ‘business’ as
envisaged by IFRS 3 Business Combinations.

 
Required:
Discuss the accounting treatment of the acquisition of the group
of assets and related liabilities by A Limited on 1 April 2018.

10
Solution:
A Limited must identify and recognise the individual assets
acquired appropriately as property, plant and equipment,
intangible assets, or inventories, etc as the case may be in
terms of their definitions and recognition criteria and
specific IFRSs. The liabilities so assumed must likewise be
identified and recognised in terms of the definition of
liabilities and its recognition criteria.
 
The total cost of N$2 million for the grouping of assets and
liabilities acquired must then be allocated to the individual
assets and liabilities on the basis of their relative fair values
at the date they were purchased. No goodwill will be
recognised in this transaction.

11
Assets & Liabilities Acquisition

• Journal for the acquisition of assets & liabilities in separate AFS of

acquirer

Dr: Individual assets bought xxx

Dr: Goodwill (or cr – gain) xxx
Cr: Individual liabilities taken over xxx
Cr: Consideration transferred xxx
 

12
Business Combination Identification
Is it a
business?

YES NO
Did you gain Asset
control? Acquisition

YES NO IAS 16
Asset
IFRS 3 IAS 2
Acquisition
IAS 38

No
consolidation No Goodwill
IAS 32/IFRS 9
13
Business Combination
Identification

IFRS 3

Assets and
Shares
Liabilities

IFRS 9 Apply IFRS 3

IFRS 3 Group
Separate Separate
AFS
AFS AFS

14
A business combination may be structured
in a variety of ways, some of which are:
• one or more businesses become subsidiaries of the
acquirer;
• the net assets of one or more businesses are legally
merged into the acquirer;
• one combining entity transfers its net assets to
another combining entity;
• all of the combining entities transfer their net assets
to a newly formed entity (a roll-up or put-together
transaction); and
• the owners of combining entities transfer their
equity interests to a newly formed entity.
15
Business Combination Identification

IFRS 3

Assets and
Shares
Liabilities

IFRS 9 IFRS 3 Group Apply IFRS 3

Separate AFS AFS Separate AFS

16
 • Journal for the acquisition of shares in the
separate AFS of acquirer

• Dr: Investment in subsidiary xxx

Acquisitio xxx
Cr: Consideration transferred

n of shares (Share capital)

(Asset)
(Loan/Payable)
(Bank)
 

17
 The acquisition method

Identify the acquirer

Determine the acquisition date

Measure the identifiable assets, liabilities and non-

controlling interest in the acquiree

Recognise and measure goodwill or a gain from bargain

purchase
 One of the entities must
always be identified as the
acquirer:
• Additional guidance IFRS 3.B13–B18
Identifyin
g the Use guidance of IFRS 10 to
determine if control exists:
acquirer
Class example 2

19
 Acquisition date

• Date on which control of the acquiree is obtained

• Generally, the closing date
• Unless contract states differently

Acquisitio Look out for BC subject to the satisfaction

of certain suspensive legal conditions

n Date E.g., successful completion of a due

diligence review, competition commission
ruling

Class example 3

20
Illustrative example : Acquisition date
 

On 31 December 2018, Hampton Limited completed the

acquisition of 75% of Staines Limited for the sum of N$5 million.
The two companies had previously signed a contractual
agreement whereby Hampton Limited would take control of the
operations of Staines Limited with effect from 1 November
2018.

 
Required:
At what date did Hampton Limited acquire Staines Limited?

21
Solution:

Although the closing date is 31 December 2018. the acquisition date

would appear to be 1 November 2018 when Hampton Limited
effectively take control of Staines Limited.

22
Goodwill/ Gain on Bargain Purchase

• IFRS 3.32
• Recognise goodwill as (a) The aggregate of:
the excess of (a) over (b) Consideration transferred
Non-Controlling interest

(b) Net of the identified assets and

liabilities assumed in BC
E=A-L

23
Recognising & measuring assets
acquired, liabilities assumed & NCI

General recognition principle in IFRS 3:

• A & L obtained must comply with the definition of assets & liabilities per
the Framework
• May result in additional A & L not previously recognised
• A & L obtained must be part of what the acquirer and acquiree exchanged
in the business combination transaction rather than the result of separate
transactions.

General measurement principle in IFRS 3:

• Measure identifiable A & L at their acquisition-date fair values

24
RECOGNISING
AND Recognition principle
MEASURING • At acquisition date, the acquirer must recognise
THE separately from goodwill, the identifiable assets
IDENTIFIABLE acquired, liabilities assumed and any non-controlling
interest in the acquiree.
ASSETS
ACQUIRED • IFRS 3.11 specifies the following two recognition
AND conditions in pursuance of the abovementioned
recognition principle:
LIABILITIES
ASSUMED • the identifiable assets acquired and liabilities assumed
must meet the definitions of assets and liabilities in the
‘Framework for the Preparation and Presentation of
Financial Statements’ at the acquisition date to qualify
for recognition in terms of the acquisition method.

25
RECOGNISING
AND • Recognition principle
MEASURING • So for example, future restructuring costs in the
THE acquiree that the acquirer expects to incur or
employee termination benefits that the acquirer
IDENTIFIABLE expects to pay to the acquiree’s employees that
ASSETS do not meet the definition of a liability at
acquisition date are not part of ‘liabilities
ACQUIRED assumed’ on acquisition;
AND
LIABILITIES • the identifiable assets acquired and liabilities
assumed must be part of what was exchanged
ASSUMED between the acquirer and the acquiree (or its
former owners) in the business combination
transaction (i.e. amounts that are not part of the
exchange for the acquiree but rather the result
of a separate transaction must be accounted for
in terms of their nature and relevant IFRSs).

26
Recognising & measuring assets acquired,
liabilities assumed & NCI

At acquisition date acquirer must recognise

(separately from goodwill) identifiable assets
acquired, liabilities assumed and any NCI in acquiree

Classification & designation of A & L obtained:

• General rule: acquirer classifies/designates based on
conditions at acquisition date
• Exceptions:
• Classification of lease contract – acquiree is the lessor classifies
as either operating or finance lease based on conditions at
inception of lease contract (or modification date)
• Insurance Contract

27
Recognising & measuring assets acquired,
liabilities assumed & NCI

Example – application of general rule (classification/ designation)

• Co A purchases a controlling interest in Co B
• Co B owns an investment property that it has
rented out to Co A (and will continue to do so after
the acquisition)

At acquisition date Co A should classify the

building as:
• PPE
• IP?

28
Illustrative example : Future Restructuring Costs
On 30 June 2020, A Limited acquired 80% of B Limited for the
sum of N$8.2 million. A Limited immediately announced a
restructuring plan at a cost of N$1.4 million involving the
closure of duplicate facilities and other cost saving
efficiencies.
 
Required:
Can A Limited recognise the cost of the restructuring plan as a
liability in accounting for the business combination at the date
of acquisition?
 

29
 
Solution:

The cost of restructuring does not meet the definition of a liability in accordance with
the Framework as at the date of acquisition. Liabilities are defined as ‘a present
obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow of economic benefits. A Limited do not have any
obligation in respect of the restructuring as at 30 June 2020.
 
Furthermore, IFRS3.11 explicitly requires that the liabilities assumed at acquisition (and
consequently impacting on the measurement of goodwill) must meet the definition of a
liability in terms of the Framework.
 
Therefore, the costs must be recognised as a post-acquisition expense by A Limited.

30
 Recognition Measurement Recognition and
measurement

Contingent Reacquired rights Income taxes

Exceptions liabilities

to
recognition
Share-based payment Employee benefits
and/ or awards
measuremen
t principles Leases in which the
acquiree is the
lessee

Assets held for sale Indemnification

assets

31
Contingent Liability

Contingent Liability

No present obligation Present obligation

exists. Definition of exists but one or
Liability NOT met more recognition
(Possible Obligation) criteria NOT met
32
Contingent Liability

• Contingent liability assumed in a business combination

shall be recognised by the acquirer at the acquisition date
if:
• It is a present obligation that arises from past events;
and
• It has a fair value that can be reliably measured.
• The contingent liability is therefore recognised by the
acquirer, even if it is not probable that an outflow of
economic benefits will be required to settle the obligation.

• CLASS EXAMPLE 4A
33
Illustrative example : Contingent liabilities of acquiree at acquisition date

On 1 January 2018 A Limited acquired 80% of the ordinary shares of B Limited. You have
been asked by the directors of the parent to give advice on the following matter in
determining the goodwill arising on the acquisition of B Limited:
 
B Limited, the acquiree, had three items of contingent liabilities which were disclosed but
not recognised B Limited at acquisition date:
 
 A possible obligation in connection with disputed penalties payable on a cancelled
order with a supplier of N$1 million but which had a fair value of N$300 000 at date of
acquisition. By 31 December 2018, no change had occurred in the status of this
obligation or its fair value.
 
 A present obligation in connection with a claim by a customer relating to injuries
allegedly sustained on the acquiree’s premises of N$2 million but which had a fair value
of N$600 000 at date of acquisition. Due to a legal technicality, it was not probable
than an outflow of benefits will be required to settle the obligation. By 31 December
2018, no change had occurred in the status of this obligation and its fair value was now
N$400 000.
 

34
• A present obligation of N$3 million arising from a claim by a competitor in
connection with the alleged infringement of its trademark. The fair value of
this present obligation was determined at N$1,2 million at date of
acquisition as the claim was subject to court appeal by B Limited and the
related outflow of economic benefits was not considered probable. During
August 2018 however, B Limited settled this matter out of court for a total
amount of N$700 000.

Required:

1. Briefly discuss how A Limited would account for each of the contingent
liabilities of the acquiree in its consolidated financial statements for the year
ended 31 December 2018. Ignore taxation and discounting.

 
1. Draft the pro-forma journal entry necessary to record the consolidation
adjustment relating to the settlement of the claim for trademark
infringement by the competitor for the year ended 31 December 2018.
 

35
Solution:
Part 1
The contingent liability relating to the disputed penalties payable on a cancelled order with a supplier is a
possible obligation and will therefore not be recognised as a liability by the acquirer in the business
combination and in the determination of goodwill, i.e. it does not meet the definition of a liability in terms of
the conceptual framework.
 
The second contingent liability relating to the claim for injuries sustained by the customer is a present
obligation and as such is recognised at acquisition date as a liability by the acquirer in the business
combination and in the determination of goodwill, at its fair value of N$600 000.
 
On 31 December 2018, the second contingent liability is still recognised at N$600 000 being the higher:
 of the amount that would be recognised in terms of IAS 37, which is nil, as it is still a contingent liability
for which it is not probable than an outflow of economic benefits will be required to settle the obligation;
and
 the amount initially recognised, i.e. N$600 000.

 
The third contingent liability relating to the claim by the competitor for trademark infringement is a present
obligation and as such is recognised at acquisition date as a liability by the acquirer in the business
combination and in the determination of goodwill, at its fair value of N$1,2 million. The fact that it was settled
during the year for N$700 000 (the amount of which is in fact irrelevant) will require the derecognition of the
liability of N$1,2 million by the group and a credit to consolidated profit or loss of N$1,2 million during 2018.

Part 2
Dr Contingent Liability (SOFP) 1 200 000    
Cr Settlement of contingent liability (P/L)   1 200 000  
Pro-forma journal to derecognise contingent liability on      
settlement
36
  
In a business combination, acquired non-
current assets, or disposal groups, that
are classified as held for sale in terms of
IFRS 5 Non-current Assets Held for Sale
and Discontinued Operations shall be
measured
Assets held for sale
‘’by the acquirer at acquisition date in
accordance with IFRS 5 at fair value less
costs to sell”

(rather than simply at “fair value” which

is the general rule in a business
combination) at acquisition date.

37
Assets held • Acquirer to measure acquired
for sale NCAHFS at fair value less cost to sell
o Not lower of CA and FVLCTS

• Class example 4B

38
 • Acquirer to measure deferred tax
Deferred assets/ liabilities in accordance with
IAS 12
tax • Remember
o The initial recognition exemption
in IAS 12 does not apply to assets
acquired/ liabilities assumed in a
business combination

39
 • Acquirer to measure employee
Employee benefit liabilities (or assets) in
benefits accordance with IAS 19

40
 • Acquirer shall recognise the right of
Leases in use assets and lease liabilities in
which the terms of IFRS 16

ACQUIRE • The acquirer shall not recognise right

E is the of use assets and lease liabilities for
the following:
lessee • Leases for which the lease term
ends within 12 months of the
acquisition date or
• Leases for which the underlying
asset is of low value

41
 • An operating lease may be considered
Operating as favourable or unfavourable
depending on whether the contractual
leases in lease payments are lower or higher
than market lease rentals.
which the • In terms of IFRS 3, where the
acquiree is acquiree is the lessee in an operating
lease agreement, the acquirer
the lessee recognises an asset on acquisition if
the terms of the lease agreement are
favourable or a liability if the terms of
the lease agreement are unfavourable
relative to market terms.

42
 A further identifiable intangible asset may
arise in relation to the acquiree’s operating
lease, even if the lease is at market terms.
Operating
leases in This may arise where market participants
are willing to pay a price for the market-
which the related lease to obtain future economic
acquiree is benefits, for example a lease of retail space
in a prime shopping area may qualify as
the lessee identifiable intangible assets (as a customer
relationship).

43
On 1 January 2018, A Limited acquired 80% of B Limited for N$1,6 million. At
acquisition date, B Limited was a lessee under an operating lease agreement
in terms of which it was required to pay an annual rental of N$150 000 on 31
December each year for the remaining five years of the lease agreement.
The market rentals for a similar property was N$180 000 per annum. An
appropriate discount rate is 10%.

 
Required:
Briefly discuss how A Limited would account for the operating lease
agreement in its consolidated financial statements for the year ended 31
December 2018. Ignore taxation.
 

44
Solution:
In terms of IFRS 3.B29, the acquirer recognises an intangible asset at
acquisition date if the terms of an operating lease agreement to which the
acquiree is a lessee are favourable relative to market terms. This lease is
favourable as B Limited is required to pay N$30 000 less than market rentals
for the next five years. From a group point of view, A Limited therefore
recognises at acquisition, an operating lease intangible asset of N$113 725
(PMT = 30 000; n = 5; i = 10; COMP PV).
 
During the year ended 31 December 2018, an amount of N$22 745 (113
725 /5) will be amortised to consolidated profit or loss while an intangible
asset of N$90 980 (113 725 – 22 745) will be reported in the consolidated
statement of financial position at 31 December 2018.

45
 Definition (IAS 38):
An intangible asset is a non-monetary asset
without physical substance and must be
identifiable.
• To be identifiable, the intangible asset must
Guidance be:
• Separable (capable of being
on separated/divided from the entity and
sold, transferred, rented, exchanged),
intangible or
assets • Arise out of a contractual or other
legal right

 Intangible assets will be recognised if they meet

the above definition, and the fair value can be
measured reliably.

46
 • Measure intangibles at their at-acquisition
date fair values
• The fair value reflects market expectations
about the probability that future economic
benefits will flow to the entity
Guidance • Thus, probability criteria always assumed
to be met in a BC!
on • If the intangible asset has a finite useful life
intangible • Rebuttable presumption that fair value can
be measured reliably.
assets • Recognise irrespective of whether acquiree
recognised the intangible before (e.g.,
internally generated goodwill).
• You need a thorough knowledge of IAS 38 in
IFRS 3!

CLASS EXAMPLE 4C

47
 • Marketing-related intangible assets: e.g.
trademarks and trade names; trade dress (unique
colour, package design); newspaper mastheads;
internet domain names, non-competition
IFRS 3 IE, agreements.
provides the  Customer-related intangible assets: e.g.
customer lists; order or production backlog;
following customer contracts and related customer
examples of relationships; non-contractual customer
relationships.
identifiable  Artistic-related intangible assets: e.g. plays,
intangible operas and ballets; books, magazines and other
literary works; musical works; pictures and
assets that may photographs; video and audio-visual material.
be acquired in  Contract-based intangible assets: servicing
a business contracts; employment contracts (may be
favourable relative to market terms); use rights
combination: (for drilling, water, bus routes, etc).
 Technology-based intangible assets: e.g.
patented technology (contractual); unpatented
technology; computer software; databases;
trade secrets (formulas and recipes), etc.

48
 • Acquirer may intend to use
certain assets acquired in a
Assets that different manner to acquiree,
or not at all
acquirer oE.g. acquire a patent that it
intends to plans to discontinue
use • None-the-less the acquirer
differently shall measure the asset at FV
as a market participant would
value it

49
 • The consideration transferred in a
business combination shall be measured
at fair value, i.e., the sum of the
acquisition-date fair values of:
o the assets transferred by the acquirer;
Consideratio o the liabilities incurred by the acquirer
n transferred to former owners of the acquiree; and
o equity interests issued by the
acquirer.

Class example 6

50
Contingent consideration
Obligation of the acquirer to A & L that arise from a
transfer additional assets/ contingent consideration
equity instruments if agreement are included in
specified future events occur the consideration transferred

The obligation to pay the

The contingent consideration
contingent consideration is
shall be measured at its
classified by the acquirer in
acquisition-date fair value
terms of IAS 32

An asset may also be

recognised by the acquirer for
the right it has to the return
of previously transferred
consideration if certain
specified conditions are met. 51
 NCI can be
measured at either:
• NCI’s proportionate share
of the acquiree’s
Measurin identifiable net assets;
g the NCI or
• At fair value

Class example 5

52
Goodwill/ gain from bargain purchase

FV of identifiable assets and liabilities

Goodwill /
Gain from
bargain
purchase

Consideration transferred + NCI

53
Goodwill/ gain from bargain
purchase
• Occasionally a gain on bargain purchase will arise.
• Before such a gain is recognised, the acquirer shall:
o Reassess whether it has correctly identified all Assets
acquired & Liabilities assumed
o Recognise additional assets or liabilities identified;
o Review procedures used to measure amounts that IFRS 3
requires to be recognised @ acquisition date for all of the
following:
1. Identifiable assets acquired and liabilities assumed;
2. Non-controlling interest;
3. For a BC achieved in stages
o Acquirer’s previously held equity interest in the acquiree;
and
4. Consideration transferred.

61
Measurement period
• If initial accounting is incomplete at end of the
reporting period in which BC occurs
oAcquirer to use provisional amounts in AFS
oAFS to state that the amounts are provisional
• During measurement period all provisional amounts
will be adjusted retrospectively to reflect new
information obtained
• Measurement period ends as soon as acquirer obtains
info needed.
• Measurement period may not exceed one year from
acquisition date

Class example 7
62
 Acquirer to recognise only the
consideration transferred/ liabilities
assumed to gain control of acquiree
• Pre-existing relationships/ transactions should
be ‘kept out of’ the acquisition method
Determinin Separate transactions shall be
g what is accounted for separately in terms of
the relevant IFRSs
part of BC
transaction Look at intentions of both parties!

• Acquiree to benefit from transaction

• Likely to be part of BC
• Acquirer to benefit from transaction
• Likely to be a separate transaction

63
 Examples of acquisition related costs
• Professional or consulting fees;
• Administrative costs,
• Registering and issuing debt and equity

Acquisitio
securities

These are not part of consideration

n related transferred
• Therefore, expensed in the period in which

costs they are incurred

• Exception:
• Cost to issue debt or equity securities
recognised in accordance with IAS 32 & IFRS
9

CLASS EXAMPLE 8

64
Subsequent measurement

• General rule:
oMeasure in accordance with relevant IFRS/ IAS
Standard

• Guidance provided in IFRS 3 wrt subsequent

measurement of:
oReacquired rights ;
oContingent liabilities;
oIndemnification assets; and
oContingent consideration
65
 The seller in a business combination may
contractually indemnify the acquirer, in the
form of a reimbursement agreement, for the
outcome of a contingency related to a specific
asset or liability (for example, the seller
indemnifies the acquirer against losses above a
certain amount for a liability or provides a
guarantee for the acquiree’s tax liability
exposure in a tax investigation by SARS etc).
Indemnificatio
n assets
In these situations, the acquirer in effect
receives an indemnification asset which must
be recognised in the business combination, and
which will have an effect on the amount of
goodwill recognised.

66
 The acquirer recognises the indemnification
asset at the same time as it recognises the
related indemnified item. The
indemnification asset is measured on the
same basis as the indemnified item, which is
normally at the acquisition-date fair value.

Indemnificatio
n assets However, an indemnified item may not have
been measured at the acquisition-date fair
value because it is an exception to the
recognition and measurement principle. In
this latter case, the indemnification asset is
measured using the same basis and
assumptions as the indemnified asset,
subject to valuation allowances for
uncollectible amounts and contractual
limitations on the indemnified amount.

67
Indemnification assets

In terms of IFRS 3.57, the

Such indemnification
indemnification asset is
assets are derecognised
measured at the end of
when it collects the related
each subsequent reporting
asset, sells it or loses the
period on the same basis
right to it.
as the indemnified item.

68
Illustrative example : Indemnification Assets
 
On 1 January 2018 A Limited acquired 60% of the ordinary shares of B Limited for N$3 million. At
acquisition date, B Limited had a contingent liability in terms of a legal action instituted against it.
Although the legal claim was considered to be a present obligation, it was not considered probable
that an outflow of economic benefits will be required to settle this obligation. The fair value of this
contingent liability was estimated to be N$100 000.
 
In terms of the acquisition agreement, the sellers agreed to indemnify the cost of any settlement up
to a maximum amount of N$70 000. During December 2018, B Limited lost the case and paid the
other party an amount of N$90 000 as damages.
 
Also during December 2018, A Limited was reimbursed the amount of N$70 000 in terms of the
acquisition agreement.
 
Required:
1. Briefly discuss how A Limited would account for this arrangement in its consolidated financial
statements for the year ended 31 December 2018. Ignore taxation.
 
2. How would your answer to 1 above change if the fair value of the contingent liability at acquisition
date was N$40 000?
 
3. How would your answer to 1 above change if the fair value of the contingent liability at acquisition
date was N$ Nil?

69
Solution:
Part 1
At acquisition date, the A Limited Group recognises a contingent liability (the indemnified item) at
its fair value of N$100 000 and an indemnification asset (measured on the same basis as the
indemnified item) of N$70 000. These items together result in goodwill recognised at acquisition
to be N$30 000 higher (incremental liability of 100 000 less incremental asset of 70 000) than
would otherwise have been the case. On consolidation for the 2018 year, both the contingent
liability and the indemnification asset will be eliminated by way of a pro-forma journal entry as
follows:
       

Dr Contingent liability 100 000   

Cr Indemnification asset   70 000  
Cr Gain on indemnification asset (P/L)   30 000  
Pro-forma journal entry to eliminate contingent     
liability and related indemnification asset
 
Part 2

70
Solution:
Part 2
At acquisition date, the A Limited Group recognises a contingent liability (the indemnified
item) at its fair value of N$40 000 and an indemnification asset (measured on the same basis
as the indemnified item) of N$40 000. These items together have no effect on goodwill
recognised at acquisition (incremental liability of N$40 000 less incremental asset of N$40
000). On consolidation for the 2018 year, both the contingent liability and the indemnification
asset will be eliminated by way of a pro-forma journal entry as follows:

       

Dr Contingent liability 40 000    

Cr Indemnification asset   40 000  

Pro-forma journal entry to eliminate contingent      

liability and related indemnification asset

71
Solution:

Part 3
Neither the contingent liability nor the indemnification asset will be
recognised at acquisition date. So the pro-forma journal entries on
consolidation will not be required. (Note that the related net loss for the
group of N$20 000 (N$90 000 paid – N$70 000 reimbursed) would already
have been recognised by B Limited (N$90 000 paid) and A Limited (N$70 000
reimbursed).

72
Subsequent measurement:
Contingent liabilities

•After initial recognition, measure at

higher of:
oAmount recognised i.t.o. IAS 37, and
oAmount initially recognised less (if
appropriate) cumulative amortisation

73
 Subsequent measurement:
Contingent consideration
• Changes in FV may be due to additional info obtained
o These are measurement period changes (see par .45 - .49)
• Other changes (reaching specific share price, milestone on project,
meeting earnings target) are not measurement period changes
• Accounted for as follows:
o Contingent consideration classified as equity:
 not remeasured, settlement accounted for in equity
o Contingent consideration classified as asset/liability:
• If inside scope of IFRS 9
Measure at fair value (P/L to Other Comprehensive Income)
If not inside scope of IFRS 9
Measure in accordance with IAS 37.

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Reacquired rights
•The acquirer may have, prior to the business combination,
granted certain rights to the acquiree to use one or more of
the acquirer’s recognised or unrecognised assets.

•This may occur where for example the acquirer could have
granted the acquiree a right to use its trade name under a
franchise agreement, or a right to use the acquirer’s
intellectual property under a licensing agreement.

•In a business combination therefore, the acquirer has in effect

‘reacquired’ the right previously granted to the acquiree. Such
a reacquired right qualifies as an identifiable intangible asset
that must be recognised separately from goodwill.

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Reacquired rights
The reacquired right is measured at acquisition date on
the basis of the remaining contractual term of the
contract in which the original right was granted.

The fact that market participants would consider

potential contractual renewals in measuring the fair value
of the contract must be ignored (i.e. the ‘true’ fair value is
not taken into account in arriving at the value of the
reacquired right).

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 Reacquired rights
• The reacquired right so recognised (as an intangible asset) and
measured as above should be amortised over the remaining
contractual period of the original contract in which the right
was granted.

• If the right is sold by the acquirer to a third party, the gain or

loss is calculated by including the value of the intangible asset.

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Illustrative example : Reacquired rights
On 1 January 2016, A Limited, a fast-food franchisor, granted a franchise right to B
Limited for a total of N$1,2 million to operate two franchise outlets for a period of
10 years with an option to renew the franchise agreement for a further 5 years. On
1 January 2018 A Limited acquired 80% of the issued equity shares of B Limited for
N$5 million. At that date, the franchise right was measured as follows:
 Without taking into account the contractual renewal period, N$700 000;
 After taking into account the contractual renewal period, N$990 000.

 
Required:
Discuss how the reacquired right should be accounted for at acquisition date and
in the consolidated financial statements thereafter.

78
Solution:
The franchise right previously granted to B Limited qualifies as a
‘reacquired right’ as envisaged by IFRS 3. The reacquired right
must be recognised by the acquirer at acquisition date as an
identifiable intangible asset.
The recognition thereof at acquisition date therefore affects
goodwill. At acquisition, the reacquired right is measured at
N$700 000, without taking into account potential contract
renewals. The intangible asset is amortised over the remaining
period of the original contract (i.e. over 8 years).
 

79
Share-based payment awards

•The acquirer shall measure a liability or an equity instrument related to the

replacement of an acquiree’s share-based payment awards with awards

issued by the acquirer in accordance with IFRS 2 Share-based Payment.

80
Illustrative example : Comprehensive example of fair value calculation
 
Milan Limited acquired all of the assets comprising a ‘business’, of Venice Limited for N$7 400
million. The purchase price is to be settled in cash on 1 January 2015 (the date upon which the
purchase agreement was finalised).
 
On 1 January 2015, Venice Limited had the following assets (presented in millions of rand):
  Fair value Carrying
amount
 Emission rights (rights are actively traded) 2 500 2 000
 Internally generated customer list (confidentiality agreements
prohibit the sale/exchange of information contained in the list)
1 000 -
 Registered unique packaging design (trade dress) 700 -
 Plant (carried at its depreciated historic cost) 2 000 1 000
 Goodwill (arose from the acquisition of net assets of a competitor) ? 500
     

     

Required:
 Determine the cost at which Milan Limited shall initially record the assets acquired in the
business combination; and
 Indicate how Milan Limited is likely to have arrived at the fair value of each of the intangible
assets recognised in the business combination.
Ignore taxation.
81
 
Solution:
  Reason for not recognising the intangible asset/ N$m
Probable method of determining fair value:
 Emission rights FV = bid price in that jurisdiction’s active market 2 500
     
 Internally generated Recognition is prohibited as it is not a contractual or
customer list legal right and it is not separable due to confidentiality
clauses (i.e. it fails the identifiability criterion). -
     
 Trade dress (unique FV determined with reference to the amount that
packaging design) would have been paid in an arms length transaction or
with reference to various valuation techniques. 700
     
 Plant FV determined with reference to a recent arms length
transaction involving a similar plant, failing which
various valuation techniques 2 000

82
      
 Goodwill – recorded by Venice Not recognised as it falls into goodwill
Limited arising from this business
combination -
     
 Goodwill arising from the
acquisition of the net assets of
Venice Limited Balancing figure 2 200
     
Paid in cash Given 7 400

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THE MEASUREMENT
PERIOD
If the initial accounting for a business
combination is incomplete by the end of the
reporting period in which it occurs, the acquiree
shall report provisional amounts for items for
which the accounting is incomplete.

During the measurement period, the acquirer

shall retrospectively adjust the provisional
amounts to reflect new information obtained
about the facts and circumstances that existed at
the acquisition date.

Additional assets and liabilities may also be

recognised retrospectively if new information
comes to light in the measurement period.

84
Illustrative example : Errors at acquisition
 
On 30 June 2013, A Limited acquired all of the equity of B Limited for N$1 000 000,
when the fair value of the identifiable net assets of B Limited was N$900 000 and the
difference of N$100 000 was correctly attributed to goodwill.
 
As a result of a random environmental inspection conducted during July 2015 B
Limited became liable to restore the land from which it operates. The environmental
contamination occurred at least ten years before and is expected to cost N$50 000 to
rectify (ignore the effects of discounting). The environmental legislation was in
existence at the date of acquisition.

 
Required:
Briefly outline how A Limited should account for the discovery of the environmental
liability in its 31 December 2015 consolidated annual financial statements.
 

85
Solution:
•As the contamination occurred at least ten years ago the liability for the
environmental restoration clearly was in existence at the date of acquisition of B
Limited. The accounting treatment will depend upon whether an error occurred
in the initial accounting for the business combination.

•If the acquirer could reasonably be expected to have known of the

environmental liability then an error in the initial accounting for the business
combination has occurred and the error should be corrected retrospectively. The
correcting journal entry would be: Dr Goodwill: Cr Provision: N$50 000.

•If the acquirer could not reasonably be expected to have known of the
environmental liability then the discovery of the liability is accounted for
prospectively as a change in accounting estimate in accordance with IAS 8 with
no effect on the business combination and consequently no effect on goodwill.
The correcting journal entry would be: Dr Profit from operations; Cr Provision:
N$50 000.
86
Illustrative example : Calculation of goodwill
 
On 1 January 20.8, H Ltd acquired 800 of S Ltd.'s 1 000 issued ordinary shares for R7 600.
The carrying amount and fair value of S Ltd.'s net assets at that date amounted to R5
000 and R7 000 respectively. S Ltd.'s shares were trading at R9,20 each on 1 January
20.8.
 
Required
1. Calculate the non-controlling interest (NCI) and goodwill at acquisition date
assuming that H Ltd measures NCI at their proportionate share of the identifiable fair
net assets.

 
2. Calculate the non-controlling interest (NCI) and goodwill at acquisition date assuming
that H Ltd measures NCI at fair value.
 
3. Recalculate part 1 above assuming that H Ltd paid R5 100 for its 80% interest in S Ltd.
 
4. Recalculate part 2 above assuming that H Ltd paid R5 100 for its 80% interest in S Ltd.
 
5. Draft the pro-forma journal entry to consolidate S Ltd at acquisition for parts 2 and 4.
87
Solution:
Part 1 Part 2
Non-controlling interest (NCI) at acquisition date: 20% x R7 000
200 shares x R9.20
= R1 400 = R1 840
Goodwill calculation:
Consideration transferred 7 600 7 600
NCI 1 400 1 840
9 000 9 440
Fair value of identifiable net assets (7 000) (7 000)
Goodwill 2 000 2 440

Part 3 Part 4
Non-controlling interest (NCI) at acquisition date:
20% x R7 000 200 shares x R9.20
= R1 400 = R1 840
Goodwill calculation:
Consideration transferred 5 100 5 100
NCI 1 400 1 840
6 500 6 940
Fair value of identifiable net assets (7 000) (7 000)
Gain on bargain purchase 500 60
88
Solution: continued
 
Part 5 – Pro-forma Journal entries
For part 2 For part 4
Equity of S Ltd 5 000 5 000
Net assets (subject to fair value adjustment) 2 000 2 000
Non-controlling interest (1 840) (1 840)
Investment in S Ltd (7 600) (5 100)
Goodwill 2 440 -
Gain from bargain purchase (P or L) - (60)
To eliminate the equity of S Ltd at acquisition against the Investment in S account.

89
BUSINESS COMBINATION IN
STAGES

An acquirer sometimes obtains control of an acquiree in which it

previously held an equity interest (for example a 10% holding)
immediately before the acquisition date.

Similarly, it also happens that the acquirer acquires small ‘pockets of

shares’ in the prospective acquiree on a piecemeal basis such that it
eventually acquires control over the acquiree after say three or four
purchases of small ‘pockets of shares’.

This is sometimes referred to as a ‘piecemeal’ or ‘step’ acquisition or,

as IFRS 3 refers to it, as a business combination achieved in stages.

90
 Road Map
• Read through the paragraphs in the standard (45
minutes)
• Work through Chapter and Chapter 9 of the group
statements textbook (60 minutes)
• Work through your slides, class examples and accounting
standard question (60 minutes)
• Engage with the topic, develop an understanding of key
concepts and prepare your standard for assessments (60
minutes)
• Attempt questions– past tests and examinations on E-
learning (150 minutes)