Background
This standard aims to enhance the relevance, reliability and comparability of the information that an entity provides in its financial statements about a business combination and its effects. It establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. The standard also recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
An acquirer of a business recognizes the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enables users to evaluate the nature and financial effects of the acquisition.
Business combinations
A business combination is a transaction or event in which an acquirer obtains control of one or more businesses. A business is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return directly to investors or other owners, members or participants.
Scope
IFRS 3 applies to all business combinations except combinations of entities under common control, and formations of joint ventures. Also, IFRS 3 does not apply to the acquisition of an asset or a group of assets that do not constitute a business. Such a transaction does not give rise to goodwill.
Method of accounting for business combinations
Acquisition method
All business combinations within the scope of IFRS 3 must be accounted for using the purchase method.
Steps in applying the acquisition method are:
- Identification of the acquirer which is the combining entity that obtains control of the acquiree.
- determination of the acquisition date which is the date on which the acquirer obtains control of the acquiree.
- Recognition and measurement of the identifiable assets acquired the liabilities assumed and any minority interest in the acquiree.
- Recognition and measurement of goodwill or a gain from a bargain purchase.
Identification of an acquirer
Under revised IFRS 3, an acquirer must be identified for all business combinations.
The acquirer is the combining entity that obtains control of the other combining entities or businesses. IFRS 3 provides considerable guidance for identifying the acquirer.
Control is presumed when the parent acquires more than half of the voting rights of the enterprise. Even when more than one half of the voting rights is not acquired, control may be evidenced by power:
- Over more than one half of the voting rights by virtue of an agreement with other investors; or
- To govern the financial and operating policies of the other enterprise under a statute or an agreement; or
- To appoint or remove the majority of the members of the board of directors; or to cost the majority of votes at a meeting of the board of directors.
Cost of a business combination
Measurement
Consideration for the acquisition includes the acquisition-date fair value of contingent consideration. Changes to contingent consideration resulting from events after the acquisition date must be recognized in profit or loss.
Acquisition costs
Costs of issuing debt or equity instruments are accounted for under IAS 32 and IAS 39. All other costs associated with the 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, accunting, valuation and other professional or consulting fees; and general administrative costs, including the costs of maintaining an internal acquisitions department.
Contingent consideration
Contingent consideration is required to be recognizes at fair value even if it is not deemed to be probable of payment at the date of the acquisition. All subsequent changes in debt contingent consideration are recognized in the income statement, rather than against goodwill as it is deemed to be a liability recognized under under IAS 32 ans IAS 39. An increase in the liability for good performance by the subsidiary results in an expense in the income statement and under-performance against targets will result in the reduction in the expected and will be recorded as a gain in the income statement. These changes were previously recorded against goodwill.
The nature of the contingent consideration is important as it may may meet the definition of a liability or equity. If it meets the definition of the latter there will be no re-measurement as per IAS 32 and IAS 39. The new requirement that contingent consideration is fair valued at acquisition and, unless it is equity, is subsequently re-measured through earnings rather than the historic practice of re-measuring through goodwill, is likely to increase the focus and attention on the opening fair value calculation and subsequent re-measurements. The standard also requires any gain on a "bargain purchase" (negative goodwill) to be recorded in the income statement as in the previous standard.
Further acquisition
Purchase consideration includes the fair value of all interests that the acquirer may have held previously in the acquired business. This includes any interest in an associate or joint venture or other equity interests of the acquired business. Any previous stake is seen as being "given up" to acquire the entity and a gain or loss is recorded on its disposal.
In the acquirer already held an interest in the acquired entity before acquisition, the standard requires the existing stake to be re-measured to fair value at the date of acquisition, taking any movement to the income statement together with any gains previously recorded in equity that relate to the existing holding.
If the value of the stake has increased, there will be a gain recognized in the statement of comprehensive income (income statement) of the acquirer at the date of the business combination. A loss would only occur if the existing interest has a book value in excess of the proportion of the fair value of the business obtained and no impairment had been recorded previously. This loss situation is expected to occur infrequently.
Transaction cost
Transaction costs no longer form a part of the acquisition price; they are expensed as incurred. Transaction costs are deemed not to be part of what is paid to the seller of a business. They are also not deemed to be assets of the purchased business that should be recognized on acquisition. The standard requires entities to disclose the amount of transaction costs that have been incurred.
Employee share based payments
The standard clarifies accounting for employee share-based payments by providing additional guidence on valuation, as well as how to decide whether share awards are part of the consideration for the business combination or compensation for future services.
Recognition and measurement of identifiable acquired assets and liabilities
Recognition of acquired assets and liabilities
The acquirer recognizes separately, at the acquisition date, the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the following recognition criteria at that date, regardless of what they had been previously recognizes in the acquiree's financial statements.
The revised standard has introduced some changes to the assets and liabilities recognizes in the acquisition balance sheet. The existing requirement to recognize all of the identifiable assets and liabilities of the acuiree is retained. Most assets are recognize at fair value, with exceptions for certain items such as deferred tax and pension obligations. The standard has provided additional clarify that may well result in more intangible assets being recognizes. Acquirers are required to recognize brands, licences and customer relationships, and other intangible assets.
There is very little change to current standard as regards contingencies. Contingent assets are not recognized, and contingent liabilities are measured at fair value. After the date of the business combination, contingent liabilities are re-measured at the higher of the original amount and the amount under the relevant standard.
Reorganization provision
The acquirer can seldom recognize a reorganization provision at the date of the business combination. There is no change from the previous guidance in the new standard: the ability of an acquirer to recognize a liability for terminating or reducing the activities of the acquiree is severely restricted. A restructuring or reducing the activities of the acquiree is severely restricted. A restructuring provision can be recognized in a business combination only when the acquiree has, at the acquisition date, an existing liability, for which there are detailed conditions are unlikely yo exist at the acquisition date in most business combinations.
Measurement of non-controlling interest (NCI)
IFRS 3 allows an accounting policy choice, available on a transaction by transaction basis, to measure NCI either at:
- Fir value (sometimes called the full goodwill method), or
- The NCI's proportionate share of net assets of the acquiree (option is available on a transaction by transaction basis)
Goodwill
Goodwill is measured as the difference between:
- The aggregate of (i) the acquisition date fair value of the consideration transferred, (ii) the amount of any NCI, and (iii) in a business combination achieved in stages, 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.
If the difference above is negative, the resulting gain is recognized as a bargain purchase in profit or loss.
Business combination achieved in stages (step acquisitions)
Prior to control being obtained, the investment is accounted for under IAS 28, IAS 31 or IAS 39, as appropriate. On the date that control is obtained, the fair value of the acquired entity's assets and liabilities, including goodwill, are measured (with the option to measure full goodwill or only the acquirer's percentage of goodwill) Any resulting adjustments to previously recognized assets and liabilities are recognized in profit or loss. Thus, attaining control triggers re-measurement.
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 itellectual 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-contractual relationships: at the lesser of (a) the favourable / unfavourable contract available to the counterparty to whom the contract is unfavourable.
However, where the transaction effectively represents a reacquired right, an intangible asset is recognized and measured on the basis of the remaining contralectual term of the related contract excluding any renewals. The asset is then subsequently amortised over the remaining contractual term, again excluding any renewals.
Provisional accounting
If the initial accounting for a business combination can be determined only provisional by the end of the first reporting period, account for the combination using provisional values. The adjustment period ends when the acquirer has gathered all the necessary information, subject to the one year maximum.
An acquirer has a maximum period of 12 months to finalize the acquisition accounting. There is no exemption from the 12 month rule for deferred tax assets or changes in the amount of contingent consideration. The revised standard will only allow adjustments against goodwill within this one-year period. No adjustments after one year except to correct an error in accordance with IAS 8.
Disclosure
Disclosure of information about current business combinations
The acquire disclose information that 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 makeup the goodwill recognized.
- Qualitative description of the factors that make up the goodwill recognized, such as expected synergies from combining operations, intangible assets that do not qualify for separate recognition
- Acquisition date fair vale 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 recognized as of the acquisition date for each major class of assets acquired and liabilities assumed
- Details of contingent liabilities recognized
- Total amount of goodwill that is expected to be deductible for tax purposes
- Details of any transactions that are recognized separately from the acquisition of assets and assumption of liabilities in the business combination
- Information about a bargain purchase (negative goodwill)
- For each business combination in which the acquirer holds less than 100 per cent of the equity interest in the acquiree at the acquisition date, various disclosures are required
- 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 authorized for issue
Disclosure of information about adjustments of past business combinations
The acquirer shall disclose information that enables users of its financial statements to evaluate the financial effects of adjustments recognized 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 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 recognized 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 recognized 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 recognized in the current reporting period the 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
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