IFRS 3 Business Combinations
IFRS 3 Business Combinations provide guidance on how acquirers must value net identifiable assets, non-controlling interest, and goodwill in a business combination. IFRS 3 does not apply to joint arrangements, acquisition of group of assets which are not a ‘business’, a combination of entities or businesses under common control, or an acquisition of an investment entity as defined in IFRS 10.
Definition of business
The standard defines business as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.’ The standard contains detailed guidance on when an acquired set of activities and assets can be considered a business.
IFRS 3 allows an optional concentration test which requires entities not to consider a set of activities/assets as a business if the fair value of gross assets (except cash, goodwill and deferred tax assets) is concerned in a single asset or a group of assets.
For an integrated set of activities and assets to be considered a business, it must (at minimum) have inputs and a substantive process. The standard contains detailed guidance on when a process is substantive.
The acquisition method
IFRS 3 requires business to apply the acquisition methods to all their business combinations. The acquisition method involves:
- Identifying the acquirer: This is done with reference first to the criteria given in IFRS 10 and then in additional guidance given in IFRS 3.
- Determining the acquisition date: This is often the closing date of the deal when consideration is transferred.
- Identifying and measuring the identifiable assets transferred, liabilities assumed and the non-controlling interests; and
- Recognizing and measuring goodwill or gain from bargain purchase.
Recognizing and measuring identifiable assets, liabilities and NCI
An acquirer recognizes items exchanged in a business combination if they meet the relevant recognition definition in the Framework and they are transferred in the business combination and not through separate transactions.
At the acquisition data, the acquirer classifies or designates assets and liabilities according to different IFRSs for post-acquisition date accounting keeping in view the contractual terms, economic conditions, etc. For example, an acquirer chooses whether a financial asset is classified at amortized cost or at fair value through profit and loss, etc. However, any leases in which the acquiree is a lessor are classified into finance or operating leases based on their inception date designations.
At the acquisition date, the acquirer measures assets and liabilities at their acquisition date fair values.
However, the standard allows the following exceptions from the general recognition and measurement principles:
- Contingent liabilities are required to be recognize even if the acquirer considers that an outflow of resources embodying economic benefits are not probable.
- Deferred tax assets and liabilities and employee benefits are recognized in accordance with relevant IFRSs, i.e. IAS 12 and IAS 19.
- Any indemnification assets (an asset arising from acquiree’s commitment to make good any adverse contingent outcome) are to be recognized on the same basis as the associated indemnified asset or liability.
- The acquirer is not required to recognize short-term leases and leases of low-value items. Any lease liabilities are to be recognized at the acquisition date present value of remaining lease payments. Right of use assets are recognized by adjusting lease liability for difference in the market terms and the terms of the leases in question.
There are some further exceptions from the general measurement principle related to reacquired assets, share-based payment transactions, assets held for sale, and insurance contracts.
Recognizing and measuring goodwill and gain from a bargain purchase
An acquirer measures goodwill arising on acquisition based on the following equation:
Goodwill = C + NCI + P – NIA
Where C is the consideration transferred by the acquirer measured at fair value, NCI is the amount of the non-controlling interest, P is the acquisition-date fair value of the acquirer’s stake (relevant only in case of step acquisitions), and NIA is the fair value of net identifiable assets.
If there is an exchange of equity interests between the acquirer and the acquiree, the consideration is valued based on the acquiree’s equity interest.
If NIA exceeds the sum of C, NCI and P above, the transaction is called a bargain purchase. An acquirer must reassess its recognition process to make sure it has correctly identified all the items. If NIA still exceeds the sum of C, NCI and P, the difference is recognized by the acquirer in profit or loss.
Measurement of consideration transferred
The consideration transferred shall be measured at the acquisition date fair value. It includes any assets transferred, any liabilities assumed, any contingent consideration, etc. If the consideration is transferred to the previous owners of the acquiree, the acquirer recognizes any profit or loss arising from acquisition-date remeasurement but if the consideration is transferred to the acquiree, no such gains or losses are recognized.
In case of a business combination achieved in stages (also called step acquisition), the acquirer remeasures the equity interest previously held and recognizes any gain or loss in profit or loss or other comprehensive income. IFRS 3 also applies to business combinations in which no transfer of consideration takes place, for example where the acquiree repurchases its own shares so as to the acquirer control. If a business combination occurs by contract, the acquirer shall attribute the net assets of the acquiree to the owners of the acquiree.
An acquirer shall include provisional amounts in recognizing a business combination if the accounting is not complete by the end of the reporting period in which the acquisition date occurs. It shall subsequently adjust these amounts when new information becomes available. Such adjustment shall affect goodwill and also any comparative information. In any case, the measurement period (the date between complete accounting for business combination date and the acquisition date) shall not exceed one year.
Non-acquisition transactions and acquisition-related costs
An acquirer shall account for transactions which arise from its prior-relationship with the acquiree and which are not part of the consideration for the acquisition separately in accordance with the applicable standards. An acquirer shall expense out any acquisition-related costs in the period in which the acquisition is being finalized. However, any costs related to financial instruments issued as part of acquisition are accounted for in accordance with IAS 32 and IFRS 9.
Subsequent accounting for assets/liabilities assumed in a business combination
Subsequent to completion of a business combination, any assets and liabilities assumed as part of the combination shall be accounted for under the relevant IFRSs except for the following which are accounted for under IFRS 3:
- Reacquired rights: These are are amortized over remaining life,
- Contingent liabilities: These are measured at the higher of IAS 37 value or value recognition at acquisition minus adjustments,
- Indemnification assets: Measured on the same basis as the indemnified assets, and
- Contingent consideration: Contingent consideration classified as equity shall be remeasured with any adjustments reflected in equity and other contingent consideration are reflected in accordance with IFRS 9 or if not within the scope of IFRS 9, in profit or loss.
The standard requires extensive disclosure requirements regarding business combinations which are concluded either during current reporting period or after the balance sheet date but before authorization for issuance of financial statements.