High level overview IFRS 3 Business Combinations

Scope

IFRS 3 does not apply to:

• The accounting for the formation of a joint arrangement in the financial statements of the joint arrangement itself.
• Acquisition of an asset or group of assets that is not a business.
• A combination of entities or businesses under common control.

Definition

A business combination is: A transaction or event in which acquirer obtains control over a business (e.g. acquisition of shares or net assets, legal mergers, reverse acquisitions).

Definition of a “Business”

A business is:

• Integrated set of activities and assets
• Capable of being conducted and managed to provide return
• Returns include dividends and cost savings.

The Acquisition Method

A business combination must be accounted for by applying the 4- step acquisition method.

Step 1 – Identify the acquirer

– Why?

In the past it has occurred that two parties consolidated an acquired business into their consolidated accounts.

IFRS 10 Consolidated Financial Statements is used to identify the acquirer – the entity that obtains control of the acquiree.

Definition of “control of an investee”

(IFRS 10)

An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

Power: when existing rights give an investor the current ability to direct the relevant activities of an investee (ie the activities that significantly affect the investee’s returns)

Rights to variable returns: an investor is exposed or has rights to returns that vary as a result of the investee’s performance

Link between power and returns: control exists when an investor has power over an investee and exposure or rights to the investee’s variable returns, and has the ability to use its power to affect the investee’s returns.

Principal or agent: an investor with power over an investee determines whether it is a principal or an agent. An investor that is an agent does not control an investee when it exercises delegated rights.

Step 2 – Determine the acquisition date

– Why?

In the past the sale of a business by one party and acquisition by the other party were not synchronized >> late derecognition and early recognition resulted in double counts of profits/performance

The date which the acquirer obtains control of the acquiree.

Step 3 – Recognise and measure the identifiable assets acquired, the liabilities assumed and any non-controlling interest

– Why?

Define a generic approach to accounting for an acquisition of a business (not the acquisition of assets and liabilities) to uniform the IFRS accounting practice.

As of the acquisition date, the acquirer recognises, separately from goodwill:

• – The identifiable assets acquired
• – The liabilities assumed
• – Any NCI in the acquiree

The acquired assets and liabilities are required to be measured at their acquisition-date fair values

There are certain exceptions to the recognition and/or measurement principles which cover contingent liabilities, income taxes, employee benefits, indemnification assets, reacquired rights, share-based payments and assets held for sale.

NCI that represent ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation (e.g. shares) are measured at acquisition-date fair value or at the NCI’s proportionate share in net assets

All other components of NCI (e.g. from IFRS 2 Share-based payments or calls) are required to be measured at their acquisition-date fair values.

Step 4 Recognising and measuring goodwill or a gain from a bargain purchase

– Why?

Define a uniform approach to recognise the two possible outcomes of an acquisition: acquire a profitable or otherwise valuable business or acquire a loss-making or otherwise undervalued business.

Goodwill is recognised as the excess between:

• The aggregate of the consideration transferred, any non-controlling interest in the acquiree and, in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree
• The identifiable net assets acquired (including any deferred tax balances)

Goodwill can be grossed up to include the amounts attributable to NCI, which is the case when NCI is measured at their acquisition date fair value.

A gain from a bargain purchase is immediately recognised in profit or loss

The consideration transferred in a business combination (including any contingent consideration) is measured at fair value

Contingent consideration is either classified as a liability or an equity instrument on the basis of IAS 32 Financial Instruments

Contingent consideration that is within the scope of IFRS 9 (classified as a financial liability) needs to be remeasured at fair value at each reporting date with changes reported in profit or loss.

Specific topics part of the acquisition method

Measurement period

Applies when initial accounting is incomplete at the end of the reporting period in which the business combination occurs Measurement period ends when acquirer receives information seeking about facts and circumstances at acquisition date, not to exceed one year from acquisition date.

Determining what is part of the business combination

The acquirer should consider if the consideration includes amounts attributable to other transactions within the contract (pre-existing relationship, arrangements that remunerate employees etc.).

Acquisition and other costs:

• Cannot be capitalised, must instead be expensed in the period they are incurred
• Costs to issue debt or equity are recognised in accordance with IAS 32 and IFRS 9.

Subsequent measurement and accounting

In general, after the date of a business combination an acquirer measures and accounts for assets acquired and liabilities assumed or incurred in accordance with other applicable IFRSs.

However, IFRS 3 includes accounting requirements for reacquired rights, contingent liabilities, contingent consideration and indemnification assets.

Specific types of business combinations

Business combinations achieved in stages

An acquirer sometimes obtains control of an acquiree in which it held an equity interest immediately before the acquisition date.

This is known as a business combination achieved in stages or as a step acquisition High level overview IFRS 3 Business Combinations

Obtaining control triggers re-measurement of previous investments (equity interests)

The acquirer remeasures its previously held equity interest in the acquiree at its acquisition-date fair value. Any resulting gain/loss is recognised in profit or loss.

Business combinations achieved without transfer of consideration

The acquisition method of accounting for a business combination also applies if no consideration is transferred.

Such circumstances include:

• The acquiree repurchases a sufficient number of its own shares for an existing investor (the acquirer) to obtain control
• Minority veto rights lapse that previously kept the acquirer from controlling an acquiree in which the acquirer held the majority voting rights
• The acquirer and the acquiree agree to combine their businesses by contract alone.