IFRS 3 Business Combinations

IFRS 3 Business Combinations

 

Background

IFRS 3 Business Combinations establishes principles and requirements on how an acquirer in a business combination recognizes and measures in its financial statements the assets and liabilities acquired and the accounting for related goodwill, if any. Also describe the principles for any interest in the acquiree held by other parties.

 

Objective

The objective of this IFRS is to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects.

To achieve this, this IFRS establishes principles and requirements on how the acquirer:

(a) recognizes and measures the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree;

(b) recognizes and measures the goodwill acquired in the business combination or a gain from an offer purchase; and

(c) determines what information to disclose to enable users of financial statements to assess the nature and financial effects of the business combination

 

Scope

This IFRS applies to a transaction or other event that meets the definition of a business combination. This IFRS does NOT apply to:

(a) the accounting for the formation of a joint arrangement in the financial statements of the joint arrangement itself.

(b) the acquisition of an asset or group asset which will not create a business. In such cases, the acquirer will identify and recognize the identifiable individual assets acquired (including those assets that meet the definition and recognition criteria for intangible assets in IAS 38 Intangible Assets) and assumed liabilities. The cost of the group will be allocated to the each identifiable assets and liabilities on the bases of their relative fair values ​​on the date of purchase. Such a transaction or event does not give rise to goodwill.

(c) a combination of entities or businesses under common control (paragraphs B1-B4 of the Bear Standard provide related application guidance).

 

The requirements of this Standard DO NOT apply to the acquisition by an investment entity, as defined in IFRS 10 Consolidated Financial Statements, of an investment in a subsidiary that must be measured at fair value through profit or loss.

 

Key Definition

business combination

The transaction or any event wherein an acquirer gets control of one or more businesses. Note that transactions like 'true mergers' or 'mergers of equals' are also business combinations as that term is used in IFRS 3

business

Any 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 or generating other income from ordinary activities

acquisition date

When the acquirer gains control of the acquiree

acquirer

The entity that gains control of the acquiree

acquiree

The business or the acquirer obtains control of in a business combination

 

What’s business combination and how to determine that?

An entity will determine whether a transaction or other event is a business combination using the definition given above, which requires that the assets acquired and the liabilities assumed constitute a business. If the acquired assets are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. This guide includes:

• Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing equity instruments (or any combination thereof), or not issuing consideration (ie, by contract only)

• Business combinations can be structured in various ways to satisfy legal, tax or other objectives, including an entity that becomes 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 the following three elements:

·       recognising and measuring the identifiable assets acquired, the liabilities assumed and any non‑controlling interest in the acquiree; and

·       recognising and measuring goodwill or a gain from a bargain purchase.

 

Note- IFRS 3 has also outlined additional guidance for applying the acquisition method to particular types of business combinations.

 

Identifying the acquirer - For each business combination, one of the combined entities will be identified as the acquirer. The guidance in IFRS 10 will be used to identify the acquirer, the entity that

obtains control of another entity, that is, acquires it.

If a business combination has occurred but the application of the guidance in IFRS 10 does not clearly indicate which of the combined entities is the 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 carried out in this way.

·       The acquiring entity is usually, but not always, the entity that issues the equity interests when the transaction is carried out in this way, however, the entity also considers other facts and circumstances that include:

o   relative voting rights in the combined entity after the business combination

o   the existence of a large minority interest if no other owner or group of owners has a significant voting interest

o   the composition of the governing body and senior management of the combined entity

o   the terms in which the equity interests are exchanged

·       The acquirer is usually the entity with the largest relative size (assets, income or earnings)

·       For business combinations involving multiple entities, the entity initiating the combination and the relative sizes of the combined entities are considered.

 

Determining the acquisition date - The acquirer will identify the acquisition date, which is the date on which it obtains control of the acquiree.

The date the acquirer gains control of the acquiree is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquisition, the closing date. However, the acquirer may obtain control earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement states that the acquirer obtains control of the acquisition on a date prior to the closing date. An acquirer will consider the facts and circumstances when identifying the acquisition date.

 

Recognising and measuring the identifiable assets acquired, the liabilities assumed and any non‑controlling interest in the acquire –

Recognition:-

Recognition Principle- Identifiable assets acquired, liabilities assumed, and non-controlling interests in the acquiree, are recognised separately from goodwill.

Following are few ‘’Recognition Conditions’’ given by standard:

1)To qualify for recognition as part of applying the acquisition method, identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in the Framework for preparing and presenting financial statements on the acquisition date.

2)To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and the liabilities assumed must be part of what the acquirer and the acquiree (or their former owners) exchanged in the business combination transaction in place of the result of separate transactions.

3) Application by the acquirer of the recognition principle and conditions may result in the recognition of some assets and liabilities that the acquiree had not previously recognized (result of the identified asset / liability process) as assets and liabilities in its statements. financial. For example, the acquirer measures the identifiable intangible assets acquired, such as a brand, a patent, or a customer relationship, that the acquiree was not measured as an asset in its account books because it was developed internally and charged costs related to expenses .

Classifying or designating identifiable assets acquired and liabilities assumed in a business combination- On the acquisition date, the acquirer will classify or designate the identifiable assets acquired and liabilities assumed as necessary to apply other IFRSs later. The acquirer shall make such classifications or designations on the basis of the contractual terms, the economic conditions, its operating or accounting policies and other related conditions, as they exist on the date of acquisition.

 

Measurement:-

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. IFRS3 outline the guidance for contingent liability (refer subsequent measurement paragraph point b)

·       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 recognised and measured in accordance with IAS 19 Employee Benefits (2011).

·       Indemnification assets - an acquirer recognises 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.

 

Recognising and measuring goodwill ‘’OR” a gain from a bargain purchase

The acquirer shall recognize the capital gain at the acquisition date measured as the excess of (a) over (b) below:

(a) the addition of:

(i) the transferred consideration measured in accordance with the standard, which generally requires the fair value of the acquisition date;

(ii) the amount of any non-controlling interest in the acquisition measured in accordance with the standard; and

(iii) in a business combination achieved in stages, the acquisition date fair value of the previously acquired shareholding by the acquirer in the acquiree.

(b) the net amount on the acquisition date of the identifiable assets acquired and the liabilities assumed measured in accordance with the standard.

This can be written as a simplified equation as follows:

Calculation of Goodwill in following cases;

Exchange only equity interests- In a business combination in which the acquirer and the acquiree exchange only equity interests, the acquisition‑date fair value of the acquiree’s equity interests may be more reliably measurable than the acquisition‑date fair value of the acquirer’s equity interests.

If so, the acquirer shall determine the amount of goodwill by using the acquisition‑date fair value of the acquiree’s equity interests instead of the acquisition‑date fair value of the equity interests transferred.

No Consideration - To determine the amount of goodwill in a business combination in which no consideration is transferred, the acquirer shall use the acquisition‑date fair value of the acquirer’s interest in

the acquiree in place of the acquisition‑date fair value of the consideration transferred.

 

Bargain purchases

If the above difference is negative (rather than Goodwill), the resulting gain is a purchase or sale of profit or loss, which may arise in circumstances as a forced seller acting under obligation. However, before any purchase gain is recognized in the income statement, the acquirer is required to conduct a review to ensure that the identification of assets and liabilities is complete, and that the measurements adequately reflect the consideration of the entire information. available.

 

Transferred consideration

The consideration transferred in a business combination will be measured at fair value. It will be calculated as:

• the sum of the fair values ​​on the acquisition date of the assets transferred by the acquirer

• the liabilities incurred by the acquirer to the former owners of the acquisition and

• the equity interests issued by the acquirer

Contingent consideration: the consideration that the acquirer transfers in exchange for any asset or liability resulting from a contingent consideration agreement. The acquirer will recognize the fair value on the acquisition date of that contingent consideration.

 

Measurement period

The measurement period is the period after the acquisition date during which the acquirer may adjust the recognized provisional amounts for a business combination.

If the initial accounting for a business combination is incomplete at the end of the reporting period in which the combination occurs, the acquirer shall report in its financial statements the provisional amounts of the elements for which the accounting is incomplete. .

During the measurement period, the acquirer will retrospectively adjust the provisional amounts recognized on the acquisition date to reflect the new information obtained on facts and circumstances that existed at the acquisition date and, if known, would have affected the measurement of the recognized amounts. from that date. During the measurement period, the acquirer will also recognize additional assets or liabilities if new information is obtained on facts and circumstances that existed at the acquisition date and, if known, would have resulted in the recognition of those assets and liabilities at that date.

The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed at the acquisition date or learns that no further information can be obtained. However, the measurement period will not exceed one year from the date of acquisition.

 

Pre-existing relationships and reacquired rights- If the acquirer and acquiree were parties to a pre-existing relationship (for example, the acquirer had given the acquiree the right to use their intellectual property), this should be accounted for separately from the business combination. In most cases, this will lead to the recognition of a gain or loss in accordance with IFRS 3 measurement guidance.

However, when the transaction effectively represents a repurchased right, an intangible asset is recognized and measured based on the remaining contractual term of the related contract, excluding renewals. Subsequently, the asset is amortized over the remaining contractual term, again excluding any renewal.

Subsequent measurement and accounting

In general, an acquirer will subsequently measure and account for assets acquired, liabilities assumed or incurred, and equity instruments issued in a business combination in accordance with other applicable IFRSs for those items, depending on their nature. However, this IFRS provides guidance for subsequently measuring and accounting for the following assets acquired, liabilities assumed or incurred and equity instruments issued in a business combination:

(a) reacquired rights;

(b) contingent liabilities recognised at the acquisition date;

(c) indemnification assets; and

(d) contingent consideration.

 

Other IFRSs that provide guidance on subsequent measurement and accounting:-

Examples of other IFRSs that provide guidance on the subsequent measurement and accounting for assets acquired and liabilities assumed or incurred in a business combination include:

(a) IAS 38 prescribes the accounting for identifiable intangible assets acquired in a business combination. The acquirer measures goodwill at the amount recognized on the acquisition date less any accumulated impairment loss. IAS 36 Impairment of Assets prescribes the accounting for impairment losses.

(b) IAS 12 prescribes the subsequent accounting for deferred tax assets (including unrecognized deferred tax assets) and liabilities acquired in a business combination.

(c) IFRS 2 provides guidance on the subsequent measurement and accounting for the portion of replacement share-based payment rewards issued by an acquirer that is attributable to future employee services.

(e) IFRS 10 provides guidance on accounting for changes in the parent's interest in a subsidiary after control is obtained.

 

Re-acquired rights- An acquirer may re-acquire a right that it had previously granted to the acquiree to use one or more of the acquirer's recognized or unrecognized assets. Examples of such rights include the right to use the acquirer's trade name under a franchise agreement.

A reacquired right recognized as an intangible asset will be amortized over the remaining contractual period of the contract in which the right was granted. An acquirer who subsequently sells a right repurchased to a third party will include the carrying amount of the intangible asset to determine the gain or loss on the sale.

 

Contingent liabilities: After initial recognition and until the liability is settled, canceled or expires, the acquirer will measure a recognized contingent liability in a business combination at the higher of:

(a) the amount that would be recognized in accordance with IAS 37; and

(b) the amount initially recognized less (if applicable) the accumulated amount of revenue recognized in accordance with the principles of IFRS 15 Revenue from contracts with customers.

This requirement does not apply to contracts accounted for in accordance with IFRS 9.

 

Compensation assets - at the end of each subsequent reporting period, the acquirer will measure a compensation asset that was recognized on the acquisition date on the same basis as the indemnified liability or asset, subject to any contractual limitation on its amount and, for an indemnity asset that is not subsequently measured at fair value, management's assessment of the collection of the indemnity asset. The acquirer will derecognise the indemnity asset only when it collects the asset, sells it or loses the right to it.

 

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 the contingent consideration changes as a result of a post-acquisition event (such as achieving a profit target), the accounting for the change in consideration depends on whether the additional consideration is classified as an equity instrument or an asset or passive:

• 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 the gains and losses are recognized in profit or loss or in other comprehensive income in accordance with IFRS 9 Financial Instruments.

• If the additional consideration is not within the scope of IFRS 9, it is accounted for in accordance with IAS 37 Provisions, contingent liabilities and contingent assets or other IFRS, as applicable.

When a change in the fair value of the contingent consideration is the result of additional information on facts and circumstances that existed on the acquisition date, these changes are accounted for as adjustments to the measurement period if they arise during the measurement period (see above) .

 

Acquisition cost

The costs of issuing debt or equity instruments are accounted for in accordance with IAS 32 Financial Instruments: Presentation and IFRS 9 Financial Instruments. All other costs associated with an acquisition should be charged, including refunds to the acquiree for bearing some of the acquisition costs.

Examples of costs to be included include search engine fees; advice, legal, accounting, valuation and other professional or consulting fees; and general administrative costs, including the costs of maintaining an internal procurement department.