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461

Chapter 9

Business combinations

1 INTRODUCTION .................................................................................................. 467 1.1  Background................................................................................................... 467 1.2  Development of an international standard ................................................. 468 1.2.1  IAS 22 and related SIC Interpretations .......................................... 468 1.2.2 IASB’s project ................................................................................... 468 1.2.2.A  Phase I .............................................................................. 469 1.2.2.B  Phase II ............................................................................. 469 1.2.3  IFRS 3 (as revised in 2008).............................................................. 470 1.2.3.A  Reasons for revising IFRS 3 ............................................. 470 1.2.3.B Main changes introduced ................................................ 471 1.2.3.C Subsequent amendments to IFRS 3 ............................... 473 1.2.4  Future developments ....................................................................... 473

3 IDENTIFYING A BUSINESS COMBINATION .......................................................... 476 3.1  Identifying a business combination ............................................................ 477 3.2 Definition of a business ............................................................................... 477 3.2.1  Inputs, processes and outputs ......................................................... 478 3.2.2 ‘Capable of’ from the viewpoint of a market participant................ 479 3.2.3 Development stage entities ............................................................. 479 3.2.4 Presence of goodwill ......................................................................... 481 3.2.5 Application of the definition of a business ...................................... 481 4  ACQUISITION METHOD OF ACCOUNTING.......................................................... 483 5

IDENTIFYING THE ACQUIRER ............................................................................. 484

6

DETERMINING THE ACQUISITION DATE ........................................................... 488

Chapter 9

2 EFFECTIVE DATE, OBJECTIVE AND SCOPE OF IFRS 3 ........................................ 474 2.1  Effective date ............................................................................................... 474 2.2 Objective ...................................................................................................... 474 2.3 Scope ............................................................................................................ 475


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Chapter 9 7

RECOGNISING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED, THE LIABILITIES ASSUMED, AND ANY NON-CONTROLLING INTEREST IN THE ACQUIREE..................................................................................................... 490 7.1 General principles ........................................................................................ 490 7.2 Recognition conditions for identifiable assets acquired and liabilities assumed........................................................................................ 490 7.3 Acquisition-date fair values of identifiable assets acquired and liabilities assumed........................................................................................ 491 7.4 Classifying or designating identifiable assets acquired and liabilities assumed ........................................................................................................ 492 7.5 Recognising and measuring particular assets acquired and liabilities assumed ........................................................................................................ 494 7.5.1  Operating leases ............................................................................... 494 7.5.2 Intangible assets ............................................................................... 495 7.5.2.A  What is an identifiable intangible asset?......................... 495 7.5.2.B Examples of identifiable intangible assets ..................... 497 7.5.2.C Customer relationship intangible assets acquired in a business combination ................................................ 502 7.5.2.D Combining an intangible asset with a related contract, identifiable asset or liability ............................. 505 7.5.2.E In-process research or development project expenditure ...................................................................... 506 7.5.2.F Emission rights acquired in a business combination ...................................................................... 508 7.5.2.G Determining the fair values of intangible assets ............ 508 7.5.3  Reacquired rights.............................................................................. 513 7.5.4 Assembled workforce and other items that are not identifiable ........................................................................................ 513 7.5.4.A  Assembled workforce ....................................................... 514 7.5.4.B Items not qualifying as assets .......................................... 515 7.5.5  Assets with uncertain cash flows (valuation allowances) ............... 515 7.5.6 Assets that the acquirer intends not to use or to use in a way that is different from other market participants ............................. 516 7.5.7 Investments in equity-accounted entities ...................................... 517 7.5.8 Deferred revenue.............................................................................. 517 7.6  Exceptions to the recognition and/or measurement principles................. 518 7.6.1  Contingent liabilities ....................................................................... 518 7.6.1.A  Initial recognition and measurement .............................. 519 7.6.1.B Subsequent measurement and accounting ..................... 519 7.6.2  Income taxes ..................................................................................... 520 7.6.3 Employee benefits ............................................................................ 521 7.6.4 Indemnification assets ..................................................................... 522 7.6.4.A  Initial recognition and measurement .............................. 522 7.6.4.B Subsequent measurement and accounting ..................... 523 7.6.5  Reacquired rights.............................................................................. 523


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7.6.5.A Initial recognition and measurement .............................. 523 7.6.5.B Subsequent measurement and accounting ..................... 524 7.6.6  Assets held for sale ........................................................................... 524 7.6.7 Share-based payment transactions .................................................. 524 8  RECOGNISING AND MEASURING GOODWILL OR A GAIN IN A BARGAIN PURCHASE ............................................................................................................ 525 9

CONSIDERATION TRANSFERRED ........................................................................ 528 9.1 Contingent consideration ............................................................................ 530 9.1.1  Initial recognition and measurement .............................................. 532 9.1.2 Classification of a contingent consideration obligation .................. 533 9.1.3 Subsequent measurement and accounting ..................................... 536 9.1.4 Contingent consideration balances arising from business combinations preceding IFRS 3 (as revised in 2008) ..................... 537 9.2  Share-based payment awards exchanged for awards held by the acquiree’s employees ................................................................................... 538 9.3 Acquisition-related costs ............................................................................. 539 9.4 Business combinations achieved without the transfer of consideration ................................................................................................ 539 9.4.1  Business combinations by contract alone ........................................ 540 9.5  Combinations involving mutual entities .................................................... 541

10 RECOGNISING AND MEASURING NON-CONTROLLING INTERESTS IN ACQUIREE............................................................................................................. 542 10.1 Option 1 – Measuring qualifying non-controlling interests at acquisition-date fair value ........................................................................... 544 10.2 Option 2 – Measuring qualifying non-controlling interests at the proportionate share of the value of net identifiable assets acquired ........ 544 10.3 Implications of method chosen for measuring non-controlling interests ........................................................................................................ 545 10.4 Applying the IFRS 3 requirements for measuring different components of non-controlling interests .................................................... 547 10.5 Call and put options over non-controlling interests .................................. 549 11  BUSINESS COMBINATIONS ACHIEVED IN STAGES (‘STEP ACQUISITIONS’) ....... 549 13 ASSESSING WHAT IS PART OF THE EXCHANGE FOR THE ACQUIREE .................. 559 13.1 Effective settlement of pre-existing relationships .................................... 561 13.2 Remuneration for future services of employees or former owners of the acquiree.................................................................................................. 563 13.2.1 Arrangements for contingent payments to employees (or selling shareholders) ......................................................................... 563 13.2.2 Share-based payment awards exchanged for awards held by the acquiree’s employees ................................................................. 568

Chapter 9

12 BARGAIN PURCHASE TRANSACTIONS .................................................................. 556


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Chapter 9 13.3 Reimbursement to the acquiree or its former owners for paying the acquirer’s acquisition-related costs ............................................................. 569 13.4 Restructuring plans...................................................................................... 569 14  MEASUREMENT PERIOD...................................................................................... 571 14.1 Adjustments made during measurement period to provisional amounts ........................................................................................................ 572 14.2 Adjustments made after end of measurement period................................ 574 15  SUBSEQUENT MEASUREMENT AND ACCOUNTING ............................................ 574 16 REVERSE ACQUISITIONS ...................................................................................... 575 16.1 Measuring the consideration transferred.................................................... 576 16.2 Measuring goodwill ...................................................................................... 578 16.3 Preparation and presentation of consolidated financial statements ......... 579 16.4 Non-controlling interest .............................................................................. 581 16.5 Earnings per share........................................................................................ 583 16.6 Cash consideration ....................................................................................... 584 16.7 Share-based payments ................................................................................. 586 16.8 Reverse acquisitions involving a non-trading shell company..................... 586 17  PUSH DOWN ACCOUNTING ................................................................................. 588 18 DISCLOSURES ...................................................................................................... 589 18.1 Nature and financial effect of business combinations ............................... 590 18.1.1 Business combinations during the current reporting period .......... 590 18.1.2 Business combinations effected after the end of the reporting period ................................................................................ 592 18.2 Financial effects of adjustments recognised in the current reporting period relating to business combinations ................................... 592 18.3 Other necessary information ....................................................................... 594 18.4 Illustrative disclosures ................................................................................. 594 19  TRANSITIONAL ARRANGEMENTS........................................................................ 597 19.1 Transitional arrangements under the original IFRS 3 for entities already reporting under IFRS...................................................................... 597 19.2 Transitional arrangements under IFRS 3 (as revised in 2008) for entities already reporting under IFRS ........................................................ 597 19.2.1  Business combinations accounted for under the previous version of IFRS 3 ............................................................................... 597 19.2.2 Entities previously outwith the scope of the previous version of IFRS 3 ........................................................................................... 598 19.2.3 Asset brought forward relating to directly attributable costs of a probable business combination ................................................. 599 19.3 Transitional arrangements relating to May 2010 Annual Improvements amendments for entities already reporting under IFRS ............................................................................................................. 600


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19.3.1 Contingent consideration balances arising from business combinations preceding IFRS 3 (as revised in 2008) ..................... 600

List of examples Example 9.1: Example 9.2:  Example 9.3:  Example 9.4:  Example 9.5:  Example 9.6:  Example 9.7:  Example 9.8:  Example 9.9:  Example 9.10:  Example 9.11:  Example 9.12:  Example 9.13:  Example 9.14:  Example 9.15:  Example 9.16:  Example 9.17: 

Life sciences – definition of a business (1) .............................. 480 Life sciences – definition of a business (2) .............................. 481  Extractive industries – definition of a business (1) ................. 482  Extractive industries – definition of a business (2) ................. 482  Real estate – definition of a business (1) .................................. 483  Real estate – definition of a business (2) .................................. 483  Business combination effected by a Newco for cash consideration (1) ........................................................................ 486  Business combination effected by a Newco for cash consideration (2) ........................................................................ 487  Customer relationship intangible assets acquired in a business combination ................................................................. 502  Emission rights acquired in a business combination under the ‘net liability approach’ .............................................. 508  Acquirer’s intention not to use an intangible asset .................. 516  Deferred revenue of an acquiree ............................................... 518  Contingent consideration – applying the probabilityweighted payout approach to determine fair value .................. 533  Share-settled contingent consideration – financial liability or equity? ....................................................................... 535  Initial measurement of non-controlling interests in a business combination (1) ........................................................... 545  Initial measurement of non-controlling interests in a business combination (2) ........................................................... 546  Measurement of non-controlling interest represented by preference shares and employee share options......................... 548 

Chapter 9

20 FUTURE DEVELOPMENTS ................................................................................... 604 20.1 Formation of joint ventures and business combinations involving entities under common control ................................................................... 604 20.2 Contingencies .............................................................................................. 605 20.3 Fair value measurement .............................................................................. 605 20.4 Improvements to IFRSs .............................................................................. 606 20.4.1 Regrouping and consistency of contingent consideration guidance ............................................................................................ 606 20.5 Other projects .............................................................................................. 606 20.6 Post-implementation review of IFRS 3 (as revised in 2008) and IAS 27 (as amended in 2008) ...................................................................... 607


466

Chapter 9 Example 9.18: Example 9.19:  Example 9.20:  Example 9.21:  Example 9.22:  Example 9.23:  Example 9.24:  Example 9.25:  Example 9.26:  Example 9.27:  Example 9.28:  Example 9.29:  Example 9.30:  Example 9.31:  Example 9.32:  Example 9.33:  Example 9.34:  Example 9.35:  Example 9.36:  Example 9.37:  Example 9.38:  Example 9.39:  Example 9.40: 

Business combination achieved in stages – original investment treated as an available-for-sale investment under IAS 39 ............................................................................... 550 Business combination achieved in stages – original investment treated as an associate under IAS 28 ..................... 553  Business combination achieved in stages – loss arising on step-acquisition .......................................................................... 556  Gain on a bargain purchase (1) .................................................. 558  Gain on a bargain purchase (2) .................................................. 559  Settlement of pre-existing contractual relationship................. 562  Contingent payments to employees.......................................... 567  Recognition or otherwise of a restructuring liability as part of a business combination .................................................. 570  Adjustments made during measurement period to provisional amounts .................................................................... 573  Identification of an asset during measurement period ............ 573  Reverse acquisition – calculating the fair value of the consideration transferred ........................................................... 577  Reverse acquisition – measuring goodwill (1) .......................... 578  Reverse acquisition – measuring goodwill (2) .......................... 578  Reverse acquisition – consolidated balance sheet immediately after the business combination ............................ 580  Reverse acquisition – legal parent’s balance sheet in separate financial statements .................................................... 581  Reverse acquisition – non-controlling interest ......................... 582  Reverse acquisition – earnings per share .................................. 584  Reverse acquisition effected with cash consideration .............. 585  Share-based payments in a reverse acquisition......................... 586  Reverse acquisition of a non-trading shell company ................ 587  Footnote X: Acquisitions ........................................................... 595  Contingent consideration subsequently recognised on a business combination preceding IFRS 3 (as revised in 2008) ....................................................................................... 601  Share-settled contingent consideration recognised on a business combination preceding IFRS 3 (as revised in 2008) ....................................................................................... 603 


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Business combinations

1

INTRODUCTION

1.1

Background

Over the years, business combinations have been defined in different ways. A business combination is now defined by the IASB as a ‘transaction or other event in which an acquirer obtains control of one or more businesses’. [IFRS 3 Appendix A]. Whatever definition is applied, it includes not only when an entity becomes a subsidiary of a parent but also where an entity obtains control of an integrated set of activities and assets that constitute a business.

The two methods of accounting look at business combinations through quite different eyes. An acquisition is seen as the absorption of the target into the clutches of the predator; there is continuity only of the acquiring entity, in the sense that only the post-acquisition results of the target are reported as earnings of the acquiring entity, and the comparative figures remain those of the acquiring entity. In contrast, a uniting of interests or merger is seen as the pooling together of two formerly distinct shareholder groups, and in order to present continuity of both entities there is retrospective restatement to show the enlarged entity as if the two entities had always been together, by combining the results of both entities pre- and post-combination and also by restatement of the comparatives. The difficulty for accountants has been how to translate this difference in philosophy into criteria which permit particular transactions to be categorised as being of one type or the other. However, during the last decade, the pooling of interests method has fallen out of favour with standard setters, including the IASB, as they consider virtually all business combinations as being acquisitions. The purchase method has become the established method of accounting for business combinations. Nevertheless, the pooling of interests method is still sometimes used for business combinations involving entities under common control where the transactions have been scoped out of the relevant standard dealing with business combinations generally (see Chapter 10).

Chapter 9

In accounting terms there have traditionally been two distinctly different forms of reporting the effects of a business combination; the purchase method of accounting (or acquisition method of accounting) and the pooling of interests method (or merger accounting).


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Chapter 9 The other main issues facing accountants have been in relation to accounting for an acquisition. In order to do so, the acquiring entity has generally had to determine the cost of its acquisition and then allocate that cost between the identifiable assets and liabilities of the target. Depending on what items are included within this allocation process and what values are placed on them, this will invariably result in a difference that has to be accounted for. Where the amounts allocated to the assets and liabilities are less than the overall cost, the difference is accounted for as goodwill. Over the years there have been different views on how goodwill should be accounted for, but the general method has been to deal with it as an asset. The question then has been: should it be amortised over its economic life (whatever that may be thought to be) or should it not be amortised at all, but subjected to some form of impairment test? Where the cost has been less than the values allocated to the identifiable assets and liabilities, then this has traditionally been treated as negative goodwill. The issue has then been whether and, if so, when such a credit should be taken to the income statement. Having established the purchase method as the method to use in accounting for business combinations, the IASB and the FASB have published accounting standards dealing with the above issues, but in a recent joint project have looked to see how the method can be improved and give guidance on its application. As a result of that project, revised standards have been issued reflecting an approach whereby the various components of a business combination are measured at their acquisition-date fair values (albeit with a number of exceptions), rather than the previous cost-based approach, whereby the cost of the acquired entity is allocated to the assets acquired and liabilities (and contingent liabilities) assumed. 1.2

Development of an international standard

1.2.1

IAS 22 and related SIC Interpretations

Until a few years ago, the relevant international standard was IAS 22 – Business Combinations. The original standard was issued in November 1983, but had been

revised and amended on a number of occasions since then.1

The SIC issued 3 interpretations relating to IAS 22: SIC-9 – Business Combinations – Classification either as Acquisitions or Unitings of Interests, SIC-22 – Business

Combinations – Subsequent Adjustment of Fair Values and Goodwill Initially Reported – and SIC-28 – Business Combinations – “Date of Exchange” and Fair Value of Equity Instruments. A summary of the requirements of these pronouncements can be found in section 1.2 of Chapter 6 of a previous edition of this book, International GAAP 2005. 1.2.2

IASB’s project

In 2001 the IASB began a project to review IAS 22 as part of its initial agenda, with the objective of improving the quality of, and seeking international convergence on, the accounting for business combinations. The project on business combinations was originally considered to have two phases.


Business combinations 1.2.2.A

469

Phase I

As part of phase I, the IASB published in December 2002 ED 3 – Business Combinations, together with an exposure draft of proposed related amendments to IAS 38 – Intangible Assets – and IAS 36 – Impairment of Assets. [IFRS 3.BC2 (2007)].

The Board’s intention in developing an IFRS as part of the first phase of the project was not to reconsider all of the requirements in IAS 22. Instead, the Board’s primary focus was on: (a) the method of accounting for business combinations; (b) the initial measurement of the identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination; (c) the recognition of liabilities for terminating or reducing the activities of an acquiree; (d) the treatment of any excess of the acquirer’s interest in the fair value of identifiable net assets acquired in a business combination over the cost of the combination; and (e) the accounting for goodwill and intangible assets acquired in a business combination. [IFRS 3.BC3 (2007)]. This phase of the IASB’s project resulted in the Board issuing, simultaneously in March 2004, IFRS 3 – Business Combinations – and revised versions of IAS 36 and IAS 38. The IASB’s reasons for revising IAS 22, together with the main changes introduced by IFRS 3, are set out in the introduction to the original IFRS 3. A discussion of these reasons and changes can be found in section 1.2.3 of Chapter 7 of a previous edition of this book, International GAAP 2008. A detailed discussion of the requirements of IFRS 3, prior to its revision in 2008, can be found in section 2 of Chapter 9 of the previous edition of this book, International GAAP 2010. Phase II

Phase II of the project was considered originally to have three aspects:2 • issues related to the application of the purchase method. This was to be conducted as a joint project with the FASB; • the accounting for business combinations in which separate entities or operations of entities are brought together to form a joint venture, including possible applications for ‘fresh-start’ accounting. ‘Fresh-start’ accounting derives from the view that a new entity emerges as a result of a business combination. Therefore, the assets and liabilities of each of the combining entities, including assets and liabilities not previously recognised, are recorded by the new entity at their fair values; and • the accounting for business combinations excluded from phase I, i.e. • business combination involving entities (or operations of entities) under common control;

Chapter 9

1.2.2.B


470

Chapter 9

• •

business combinations involving two or more mutual entities (such as mutual insurance companies or mutual cooperative entities); and business combinations in which separate entities are brought together to form a reporting entity by contract only without the obtaining of an ownership interest (for example, business combinations in which separate entities are brought together by contract to form a dual listed company).

However, as the project has developed, what was regarded as being phase II is being done as a number of separate phases. Almost immediately after having issued the original version of IFRS 3, in April 2004 the IASB issued an exposure draft of proposed amendments to IFRS 3 to remove the scope exceptions for combinations by contract alone or involving mutual entities. This was only intended to be an interim solution, however, the accounting for such combinations has now been addressed as part of the joint project with the FASB in dealing with issues related to the application of the purchase method. This joint project involved a broad reconsideration of the requirements in IFRSs and US GAAP on applying the purchase method (which is now termed ‘the acquisition method’), and resulted in the IASB publishing simultaneously in June 2005 a draft revised IFRS, which proposed to replace IFRS 3, together with exposure drafts proposing amendments to IAS 27 – Consolidated and Separate Financial Statements – and IAS 37 – Provisions, Contingent Liabilities and Contingent Assets.3 Eventually, in January 2008, the IASB issued revised versions of both IFRS 3 and IAS 27. However, the revised version of IFRS 3 does not deal with all of the aspects originally considered to be in phase II. It still excludes from its scope the formation of a joint venture and a combination of entities or businesses under common control, and the accounting for business combinations in which separate entities or operations of entities are brought together to form a joint venture is not addressed. 1.2.3

IFRS 3 (as revised in 2008)

The requirements of the revised version of IFRS 3 issued in January 2008 are principally dealt with in this Chapter. IFRS 3 made some consequential amendments to other standards, including IAS 36 and IAS 38. The requirements of IAS 36 are covered in Chapter 18, with those relating specifically to the impairment of goodwill dealt with at 5 of that Chapter. The specific requirements of IAS 38 relating to intangible assets acquired as part of a business combination accounted for under IFRS 3 are dealt with as part of the discussion of IFRS 3 in this Chapter; the other requirements of IAS 38 are covered in Chapter 15. The requirements of IAS 27 are dealt with in Chapters 6, 7 and 8. 1.2.3.A

Reasons for revising IFRS 3

The IASB’s reasons for revising IFRS 3 are set out in the introduction to the revised standard. The IASB and the FASB had each decided to address the accounting for business combinations in two phases, but had deliberated the first phase separately. The standards that they issued as a result of their respective first phases were based on


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the conclusion that virtually all business combinations are acquisitions, and required the use of one method of accounting for business combinations – the acquisition method. [IFRS 3.IN1]. The IASB did not reconsider all of the requirements in IAS 22 when issuing the original version of IFRS 3, so there were a number of areas to be addressed in the second phase of the project. The second phase of the project was to address the guidance for applying the acquisition method. The Boards decided that a significant improvement could be made to financial reporting if they had similar standards for accounting for business combinations. Thus, this phase was conducted as a joint effort with the objective of reaching the same conclusions. [IFRS 3.IN2]. Although this was achieved for most of the issues addressed in the project, they reached different conclusions on a few matters. Consequently, although the second phase has been concluded by the Boards issuing similar revised standards, differences remain. The substantive differences between IFRS 3 and its US GAAP equivalent are set out in IFRS 3.4 1.2.3.B

Main changes introduced

The main changes introduced by IFRS 3 (as revised in 2008) are set out by the IASB as follows:5 • The scope was broadened to cover business combinations involving only mutual entities and business combinations achieved by contract alone; • The definitions of a business and a business combination were amended and additional guidance was added for identifying when a group of assets constitutes a business; • For each business combination, the acquirer must measure any non-controlling interest in the acquiree either at fair value or as the non-controlling interest’s proportionate share of the acquiree’s net identifiable assets. Previously, only the latter was permitted;

Chapter 9

The accounting for business combinations under the previous version of IFRS 3 was a cost-based approach, whereby the cost of the acquired entity was allocated to the assets acquired and liabilities (and contingent liabilities) assumed. In contrast, the revised version of IFRS 3 adopts an approach whereby the various components of a business combination are measured at their acquisition-date fair values (albeit with a number of exceptions including that relating to the measurement of non-controlling interests). This represents a change from that originally proposed in the June 2005 exposure draft which was adopting an approach whereby the acquirer should recognise the fair value of the business acquired, regardless of the acquirer’s percentage ownership, with any goodwill then being allocated between the acquirer and any non-controlling interest. The June 2005 exposure draft adopted the working principle that a business combination is an exchange of equal values and that the exchange should be measured based on the fair value of the consideration transferred or the fair value of the business (net assets) acquired, whichever is more reliably measurable.


472

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• • •

The requirements for how the acquirer makes any classifications, designations or assessments for the identifiable assets acquired and liabilities assumed in a business combination were clarified; The period during which changes to deferred tax benefits acquired in a business combination can be adjusted against goodwill has been limited to the measurement period (through a consequential amendment to IAS 12 – Income Taxes); An acquirer is no longer permitted to recognise contingencies acquired in a business combination that do not meet the definition of a liability; Costs the acquirer incurs in connection with the business combination must be accounted for separately from the business combination, which usually means that they are recognised as expenses (rather than included in goodwill); Consideration transferred by the acquirer, including contingent consideration, must be measured and recognised at fair value at the acquisition date. Subsequent changes in the fair value of contingent consideration classified as liabilities are recognised in accordance with IAS 39 – Financial Instruments: Recognition and Measurement, IAS 37 or other IFRSs, as appropriate (rather than by adjusting goodwill). The disclosures required to be made in relation to contingent consideration were enhanced; Application guidance was added in relation to when the acquirer is obliged to replace the acquiree’s share-based payment awards; measuring indemnification assets; rights sold previously that are reacquired in a business combination; operating leases; and valuation allowances related to financial assets such as receivables and loans; For business combinations achieved in stages, having the acquisition date as the single measurement date was extended to include the measurement of goodwill. An acquirer must remeasure any equity interest it holds in the acquiree immediately before achieving control at its acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss.

It can be seen from the above that the revised version of IFRS 3 changes significantly the accounting for business combinations from that under the previous version of the standard. The changes noted by the IASB principally relate to the accounting requirements, but there are a number of changes to the disclosures that are required to be made in relation to business combinations. The main items for which new or specific information is now required by IFRS 3 are listed below: • contingent consideration (as mentioned above) [IFRS 3.B64(g), B67(b)] • acquired receivables [IFRS 3.B64(h)] • transactions recognised separately from the business combination [IFRS 3.B64(l)] • acquisition-related costs [IFRS 3.B64(m)] • non-controlling interests [IFRS 3.B64(o)] • business combinations achieved in stages [IFRS 3.B64(p)]


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473

revenue of the acquiree and of the combined entity [IFRS 3.B64(q)] provisional amounts and measurement period adjustments [IFRS 3.B67(a)]

One item of the previous disclosure requirements that has been deleted is the disclosure of the acquiree’s carrying amounts for each class of assets and liabilities immediately before the combination. [IFRS 3.BC422(n)]. 1.2.3.C

Subsequent amendments to IFRS 3

In its Improvements to IFRSs standard issued in May 2010, the IASB addressed a number of concerns relating to IFRS 3 and has made a number of amendments to the standard. These relate to: (a) measurement of non-controlling interests (see 10 below); (b) unreplaced and voluntarily replaced share-based payment transactions (see 13.2.2 below); and (c) contingent consideration balances arising from business combinations preceding the revised version of IFRS 3 issued in January 2008 (see 19.3.1 below). These amendments are applicable for annual periods beginning on or after 1 July 2010. Some consequential amendments have been made to IFRS 3 as a result of the issue of IFRS 9 – Financial Instruments. These relate to the requirements for: [IFRS 9.C5] (a) classifying or designating identifiable assets acquired and liabilities assumed (see 7.4 below); (b) business combinations achieved in stages (see 11 below); and (c) contingent consideration classified as an asset or liability (see 9.1.3 below). However, these amendments are not mandatory until periods beginning on or after 1 January 2013. 1.2.4

Future developments

Since the publication of the revised versions of IFRS 3 and IAS 27 in January 2008 a number of issues have arisen that have been raised with the Interpretations Committee and the IASB. As a result, the IASB decided to deal with some of the issues within the annual improvements project (subsequently included in the Improvements to IFRSs standard issued in May 2010). However, it also decided that it would address some of the issues in other projects, but defer some of the other topics to the post-implementation review of the revised IFRSs to be conducted two years after their effective date.6 To the extent that these relate to IFRS 3, further discussion is set out at 20.5 and 20.6 below. At its meeting in February 2010, having reviewed an analysis of comment letters received on the Improvements to IFRSs exposure draft published in August 2009,

Chapter 9

IFRS 3 excludes from its scope the formation of a joint venture and a combination of entities or businesses under common control. In addition, proposals in the June 2005 exposure draft relating to contingencies and fair value guidance are not reflected in the final revised standard. Possible future developments on these issues are set out at 20.1 to 20.3 below.


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Chapter 9 the IASB asked the Interpretations Committee to provide a recommendation on how to present the guidance on contingent consideration associated with business combinations within one standard to resolve potential divergence in the application of IFRSs. This is discussed further at 20.4.1 below. In August 2010, the IASB issued its Leases exposure draft which proposes to make some consequential amendments to IFRS 3 (see 20.5 below).

2

EFFECTIVE DATE, OBJECTIVE AND SCOPE OF IFRS 3

2.1

Effective date

IFRS 3 was to be applied prospectively for business combinations where the acquisition date was on or after the beginning of annual periods starting on or after 1 July 2009. Earlier adoption was permitted, although it could only be applied as early as annual periods beginning on or after 30 June 2007. However, if IFRS 3 was adopted early, that fact had to be disclosed, and the revised version of IAS 27 had to be applied at the same time. [IFRS 3.64]. The standard contains a number of transitional provisions for existing IFRS reporters and these are discussed at 19.2 below. The amendments made to IFRS 3 as a result of the Annual Improvements standard issued in May 2010 are applicable for annual periods beginning on or after 1 July 2010. Earlier adoption is permitted, but that fact has to be disclosed. Application of the amendments relating to the measurement of non-controlling interests, and unreplaced and voluntarily replaced share-based payment transactions is prospective from the date when an entity first applied IFRS 3. [IFRS 3.64B, 64C]. Transitional guidance relating to contingent consideration balances arising from business combinations preceding the revised version of IFRS 3 issued in January 2008 is now included within the standard and this is discussed at 19.3 below. The consequential amendments made to IFRS 3 as a result of the issue of IFRS 9 are applicable from when an entity applies IFRS 9. Accordingly, they are not mandatory until periods beginning on or after 1 January 2013. [IFRS 9.8.1.1, C5]. 2.2

Objective

IFRS 3 states that its objective ‘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.’ It goes on to say that to accomplish that, the standard ‘establishes principles and requirements for how the acquirer: (a) recognises and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; (b) recognises and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.’ [IFRS 3.1].


Business combinations 2.3

475

Scope

Entities are required to apply the provisions of IFRS 3 to transactions or other events that meet the definition of a business combination (see 3.2 below). The standard does not apply to: [IFRS 3.2] (a) the formation of a joint venture; (b) the acquisition of an asset or a group of assets that does not constitute a business; (c) a combination of entities or businesses under common control. As far as (a) above is concerned, the Basis for Conclusions notes that in developing the previous version of IFRS 3, the IASB revised the definition of joint control in IAS 31 (see Chapter 12 at 2.2) to clarify that: [IFRS 3.BC60] • Unanimous consent on all financial and operating decisions is not necessary for an arrangement to satisfy the definition of a joint venture – unanimous consent on only strategic decisions is sufficient; • In the absence of a contractual agreement requiring unanimous consent to strategic financial and operating decisions, a transaction in which the owners of multiple businesses agree to combine their businesses into a new entity (sometimes referred to as a roll-up transaction) should be accounted for by the acquisition method. Majority consent on such decisions is not sufficient.

In some situations, there may be difficulties in determining whether or not an acquired asset or a group of assets constitutes a business (see 3.2 below), and judgement will be required to be exercised based on the particular circumstances. The determination of a transaction as a business combination or an asset(s) acquisition can have a considerable impact on an entity’s reported results and the presentation of its financial statements as the accounting for a business combination under IFRS 3 differs from accounting for an asset(s) acquisition in a number of important respects: • goodwill or a gain on bargain purchase only arise on business combinations; • assets acquired and liabilities assumed are generally accounted for at fair value in a business combination, while they are assigned a carrying amount based on their relative fair values in an asset acquisition;

Chapter 9

As far as (b) above is concerned, although it would appear that the requirements of IFRS 3 do not apply, the standard does go on to say that in such cases the acquirer is to identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in IAS 38) and liabilities assumed. The cost of the group is to be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill. [IFRS 3.2]. Thus, existing book values or values in the acquisition agreement may not be appropriate, and no goodwill can be recognised in such an asset deal. Where an entity acquires a controlling interest in an entity that is not a business, but obtains less than 100% of the entity, after it has allocated the cost to the individual assets acquired, it notionally grosses up those assets and recognises the difference as noncontrolling interest (see Chapter 7 at 3.1.1).


476

Chapter 9

• • • •

directly attributable acquisition-related costs are expensed if they relate to a business combination, but are generally capitalised as part of the cost of the asset in an asset acquisition; while deferred tax assets and liabilities must be recognised if the transaction is a business combination, they are not recognised under the current IAS 12 (see Chapter 27) if it is an asset acquisition; where the consideration is in the form of shares, IFRS 2 does not apply in a business combination, but will apply in an asset acquisition; and disclosures are much more onerous for business combinations than for asset acquisitions.

The accounting differences above will not only affect the accounting as of the acquisition date, but will also impact future depreciation, possible impairment and other costs. As far as (c) above is concerned, the Application guidance in Appendix B to IFRS 3 gives some guidance about what constitutes business combinations involving entities or businesses under common control and therefore excluded from the requirements of the standard. [IFRS 3.B1-B4]. Such business combinations are discussed further in Chapter 10. In revising IFRS 3 in January 2008, the IASB broadened the scope of IFRS 3 such that the acquisition method of accounting applies to combinations involving only mutual entities (e.g. mutual insurance companies, credit unions, cooperatives, etc.) and combinations in which separate entities are brought together by contract alone (e.g. dual listed corporations and stapled entity structures). [IFRS 3.BC58]. Despite respondents’ concerns, the Board considers that the attributes of mutual entities are not sufficiently different from those of investor-owned entities to justify a different method of accounting for business combinations between two mutual entities. It also considers that such combinations are economically similar to business combinations involving two investor-owned entities, and should be similarly reported. [IFRS 3.BC71-72]. Similarly, although the Board understands that difficulties may arise in applying the acquisition method to combinations achieved by contract alone, in particular the absence of the payment of any readily measurable consideration, it has concluded that the acquisition method should be applied for such transactions. [IFRS 3.BC79]. However, additional guidance is given in IFRS 3 for applying the acquisition method to such business combinations (see 9.4 and 9.5 below).

3

IDENTIFYING A BUSINESS COMBINATION

IFRS 3 requires an entity to determine whether a transaction or event is a business combination by applying the definition in the standard, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired and liabilities assumed do not constitute a business, the transaction is to be accounted for as an asset acquisition (see 2.3 above). [IFRS 3.3]. Appendix B to IFRS 3 gives the following application guidance on identifying a business combination and the definition of a business.


Business combinations 3.1

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Identifying a business combination

IFRS 3 defines a business combination as a ‘transaction or other event in which an acquirer obtains control of one or more businesses’. [IFRS 3 Appendix A].Under the previous version of IFRS 3, a business combination was defined as ‘the bringing together of separate entities or businesses into one reporting entity’. This definition was considered to be too broad and that it could be read to include circumstances in which there may be no triggering economic event or transaction and thus no change in an economic entity, per se. [IFRS 3.BC8-10]. By emphasising the obtaining of control, IFRS 3 apparently narrows the previous IFRS 3 definition of a business combination, which used the term ‘bringing together’ rather than ‘obtaining control’. Notwithstanding this, the IASB states in the Basis for Conclusions accompanying IFRS 3 that the revised definition includes all transactions and events initially included in the scope of the previous version of IFRS 3. [IFRS 3.BC11].

The standard also indicates that a business combination may be structured in a variety of ways for legal, taxation or other reasons, which include but are not limited to: [IFRS 3.B6] (a) one or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer; (b) one combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners; (c) all of the combining entities transfer their net assets, or the owners of those entities transfer their equity interests, to a newly formed entity (sometimes referred to as a roll-up or put-together transaction); or (d) a group of former owners of one of the combining entities obtains control of the combined entity. Critical to the determination of whether a transaction or event is a ‘business combination’, and therefore required to be accounted for under IFRS 3 is whether the assets acquired and liabilities assumed constitute a ‘business’ (an acquiree). 3.2

Definition of a business

IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of

Chapter 9

IFRS 3 notes that an acquirer might obtain control of an acquiree (i.e. the business or businesses over which the acquirer obtains control) in a variety of ways, for example: [IFRS 3.B5] (a) by transferring cash, cash equivalents or other assets (including net assets that constitute a business); (b) by incurring liabilities; (c) by issuing equity interests; (d) by providing more than one type of consideration; or (e) without transferring consideration – including by contract alone (see 9.4 below).


478

Chapter 9 dividends, lower costs or other economic benefits directly to investors or other owners, members or participants’. [IFRS 3 Appendix A]. The Basis for Conclusions accompanying IFRS 3 notes that the main modification from the previous version being ‘that the integrated set of activities and assets must be capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants. Focusing on the capability to achieve the purposes of the business helps avoid the unduly restrictive interpretations that existed in accordance with the former guidance.’ [IFRS 3.BC18]. While this new version seems to broaden the definition and requires more judgement to be applied, the Basis for Conclusion explains that this was merely an improvement on the IFRS definition to avoiding ‘unduly restrictive interpretations’ particularly relating to start-up entities. As such, we do not believe that this change should result in a significant change to what a business is in other circumstances. However, the determination of whether an acquired set of assets and activities is a business still requires significant judgment. 3.2.1

Inputs, processes and outputs

The Application guidance to IFRS 3 notes that a business consists of inputs and processes applied to those inputs that have the ability to create outputs. It goes on to say that although businesses usually have outputs, they do not need to be present for an integrated set of assets and activities to be a business. The guidance in IFRS 3 provides definitions of each of these elements as follows:

Input Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it. Examples include non-current assets (including intangible assets or rights to use non-current assets), intellectual property, the ability to obtain access to necessary materials or rights and employees.

Process Any system, standard, protocol, convention or rule that when applied to an input or inputs, creates or has the ability to create outputs. Examples include strategic management processes, operational processes and resource management processes. These processes typically are documented, but an organised workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. (Accounting, billing, payroll and other administrative systems typically are not processes used to create outputs.)

Output The result of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.

The guidance in IFRS 3 notes that back-office processes (i.e. accounting, billing, payroll, etc.) typically are not processes used to create outputs. As such, the


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presence or exclusion of such processes generally will not affect the determination of whether an acquired set of activities and assets is considered a business. Furthermore, as noted above, outputs need not be present at the acquisition date for an integrated set of activities and assets to be defined as a business. A business is only required to have the first two of above three elements (i.e. inputs and processes), which together have the ability to create outputs. [IFRS 3.B7]. 3.2.2

‘Capable of’ from the viewpoint of a market participant

As noted above, the revised definition of a business considers only whether the integrated set of assets and activities ‘is capable of being conducted and managed for the purpose of providing a return’ to investors or other owners. IFRS 3 clarifies that an acquired set of activities and assets does not need to include all of the inputs or processes necessary to operate that set of activities and assets as a business (i.e. it does not need to be self-sustaining). If a market participant is capable of utilising the acquired set of activities and assets to produce outputs, for example, by integrating the acquired set with its own inputs and processes (essentially replacing the missing elements), then the acquired set of activities and assets might constitute a business. It is not necessarily relevant whether the seller historically had operated the transferred set as a business, or whether the acquirer intends to operate the acquired set as a business. What is relevant is whether a market participant is capable of operating the acquired set of assets and activities as a business. [IFRS 3.B8, B11]. Moreover, if the elements that are missing from the acquired set are not present with a market participant, but are easily replaced or replicated (i.e. the missing elements are ‘minor’), we believe a market participant would be capable of operating the acquired set in order to generate a return and the acquired set should be considered a business.

Although the revised definition of a business was intended to improve consistency in the application of the definition of a business, the term ‘capable of’ is sufficiently broad that significant judgment will continue to be required in determining whether an acquired set of activities and assets constitute a business. 3.2.3

Development stage entities

The guidance in IFRS 3 also notes that the nature of the elements of a business varies by industry and by the structure of an entity’s operations (activities), including the entity’s stage of development. Established businesses often have many different types of inputs, processes and outputs, whereas new businesses often have few inputs and processes and sometimes only a single output (product). Nearly all businesses also have liabilities, but a business need not have liabilities. [IFRS 3.B9].

Chapter 9

While the expanded definition of a business does not require that the acquired set of activities and assets contain all the inputs and processes necessary, we believe that, in most cases, the acquired set of activities and assets must have at least some inputs and processes in order to be considered a business. That is, if an acquirer obtains control of an input or set of inputs without any processes, in most cases, we do not believe the acquired input(s) would be considered a business, even if a market participant had all the processes necessary to operate the input(s) as a business.


480

Chapter 9 Under IFRS 3, development stage entities may qualify as businesses because outputs are not required to be present at the acquisition date, and certain inputs and processes may not be required if either a market participant has access to the necessary inputs or processes or the missing elements are easily replaced. If so, acquisitions of such entities would be accounted for as business combinations. When evaluating development stage entities, various factors need to be considered to determine whether the transferred set of activities and assets is a business, including, but not limited to, the factors listed within the guidance in IFRS 3 itself. Those factors include whether the acquired set of activities and assets in the development stage: [IFRS 3.B10] (a) has begun its planned principal activities; (b) has employees, intellectual property and other inputs and processes that could be applied to those inputs; (c) is pursuing a plan to produce outputs; and (d) will be able to obtain access to customers that will purchase the outputs. This list of factors should not be considered a checklist; there is no minimum number of criteria that needs to be met when determining if a development stage entity is a business. The primary consideration is whether the inputs and processes acquired, combined with the inputs and processes of a market participant (including those that are easily replaced or replicated, even if not present in a market participant), are capable of being conducted and managed to produce resulting outputs. While the facts and circumstances should be evaluated in each transaction, we believe that the further an acquired set of assets and activities is in its life cycle, the more difficult it will be to conclude a market participant is not capable of operating the acquired set as a business. For example, if the planned operations of an acquired set of assets and activities have commenced, we generally believe that the acquired activities and assets would represent a business. In addition, if the acquired activities and assets include employees and intellectual property such that it is capable of producing products, it is likely that the acquired activities and assets represent a business. We believe that the application of this guidance will be particularly relevant for certain transactions in the life sciences industry since certain companies in that industry could be considered development stage entities. The application of this guidance to two possible transactions in the life sciences industry is illustrated in the following examples. Example 9.1: 

Life sciences – definition of a business (1) 

Biotech A acquires all of the outstanding shares in Biotech B, which is a development stage company with a licence for a product candidate. Due to a loss of funding, Biotech B has no employees and no other assets. Neither clinical trials nor development are currently being performed. When additional funding is obtained, Biotech A plans to commence phase I clinical trials for the product candidate.

Analysis • Input – licence to product candidate • Processes – none • Outputs – none


Business combinations

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Conclusion In this scenario, we do not consider that Biotech A has acquired a business. While Biotech B has an input (licence), it lacks processes to apply to the licence in order to create outputs. Furthermore, Biotech B has no employees and is not pursuing a plan to produce outputs (no research and development is currently being performed).

Example 9.2: 

Life sciences – definition of a business (2) 

Biotech C acquires all of the outstanding shares in Biotech D, a development stage company that has a licence for a product candidate. Phase I clinical trials are currently being performed by Biotech D employees (one of whom founded Biotech D and discovered the product candidate). Biotech D’s administrative and accounting functions are performed by a contract employee. Inputs – licence for product candidate and employees Processes – operational and management processes associated with the performance and supervision of the clinical trials Output – none

Conclusion In this scenario, we generally consider that Biotech C has acquired a business because it has acquired inputs and processes. Furthermore, Biotech D has begun operations (development of the product candidate) and is pursuing a plan to produce outputs (i.e. a commercially developed product to be sold or licensed).

3.2.4

Presence of goodwill

IFRS 3 contains a rebuttable presumption that if goodwill exists in the acquisition (i.e. if the aggregate value of an acquired set of activities and assets is greater than the value of the sum of identifiable tangible and intangible assets acquired), the acquisition is a business. [IFRS 3.B12]. For example, if the total fair value of an acquired set of activities and assets is $15 million and the fair value of the net identifiable assets in that set is only $10 million, the existence of value in excess of the fair value of identifiable assets creates a presumption that the acquired set is a business. However, care should be exercised to ensure that all of the identifiable net assets have been identified and measured appropriately. While the absence of goodwill may be an indicator that the acquired activities and assets do not represent a business, it is not presumptive. [IFRS 3.B12]. An acquisition of a business may involve a ‘bargain purchase’ in which the new bases of the net identifiable assets are actually greater than the fair value of the entity as a whole (see 12 below). Application of the definition of a business

In determining whether acquired assets and activities are a business, we believe the acquirer should first identify the elements acquired; that is, the inputs, processes and outputs. If outputs are not included in the acquired set, an assessment must be made as to whether the acquired activities and assets include inputs and processes that are capable of producing some form of return to its investors, owners, members or participants (the ‘owners’). If some inputs and processes are omitted from the acquired activities and assets such that the acquired set is not capable of providing some form of return to its owners, the acquirer must assess whether the missing inputs and processes would preclude a market participant from operating the acquired activities to earn a return. If a market participant that, in many cases,

Chapter 9

3.2.5


482

Chapter 9 would be a competitor of the acquirer, were to have the missing inputs or processes, or could easily replace or replicate the missing inputs and processes (i.e. the missing elements are minor), the acquired set is likely a business. However, if the acquired set has no processes (e.g. only assets, and no activities, were acquired), the acquired set in most cases would not constitute a business. All of the specific facts and circumstances must be considered in applying this highly subjective judgment. The application of the above guidance to certain transactions in the extractive industries is illustrated in the following examples. Example 9.3: 

Extractive industries – definition of a business (1) 

E&P Co A (an oil and gas exploration and production company) acquires a mineral interest from E&P Co B, on which it intends to perform exploration activities to determine if reserves exist. The mineral interest is an unproven property and there have been no exploration activities performed on the property. Inputs – mineral interest Processes – none Output – none

Conclusion In this scenario, we do not believe E&P Co. A acquired a business. While E&P Co A acquired an input (mineral interest), it did not acquire any processes. Whether or not a market participant has the necessary processes in place to operate the input as a business is not relevant to the determination of whether the acquired set is a business because no processes were acquired from E&P Co B.

Example 9.4: 

Extractive industries – definition of a business (2) 

E&P Co A acquires a property similar to that in Example 9.3 above, except that oil and gas production activities are in place. The target’s employees are not part of the transferred set. E&P Co A will take over the operations by using its own employees. Inputs – oil and gas reserves Processes – operational processes associated with oil and gas production Output – revenues from oil and gas production

Conclusion In this scenario, we generally consider that E&P Co A acquired a business. The acquired set has all three components of a business (inputs, processes and outputs) and is capable of providing a return to its owners. Although the employees are not being transferred to the acquirer, a market participant would generally be able to produce outputs by: (1) supplying the employees necessary to continue production; and (2) integrating the business with its own operations while continuing to produce outputs.

In the real estate industry, IAS 40 – Investment Property – may help in making this assessment. IAS 40 notes that where ancillary processes exist connected to an investment property, and they are insignificant to the overall arrangement, this will not detract from the classification of the asset as investment property, rather than an asset with processes. [IAS 40.9-11]. Therefore, where only some processes are transferred, IAS 40 would lead to an assessment as to how significant the processes are relative to the processes needed for the set of assets and activities to be a real estate business.


Business combinations Example 9.5: 

483

Real estate – definition of a business (1) 

Company A acquires land and a vacant building from Company B. No processes, other assets or employees (for example, leases and other contracts, maintenance or security personnel, or a leasing office) are acquired in the transaction. Inputs – land and vacant building Processes – none Output – none

Conclusion In this scenario, we do not believe Company A has acquired a business. While Company A acquired inputs (land and a vacant building), it did not acquire any processes. Whether or not a market participant has the necessary processes in place to operate the inputs as a business is not relevant to the determination of whether the acquired set is a business, because no processes were acquired from Company B.

Example 9.6: 

Real estate – definition of a business (2) 

Company A acquires an operating hotel, the hotel’s employees, the franchise agreement, inventory, reservations system and all ‘back office’ operations. Inputs – non-current assets, franchise agreement and employees Processes – operational and resource management processes associated with operating the hotel Output – revenues from operating the hotel

Conclusion In this scenario, we generally believe Company A has acquired a business. The acquired set has all three components of a business (inputs, processes and outputs) and is capable of providing a return to its owners.

At its meeting in May 2009, the IASB considered a number of issues brought by the IASB staff, but deferred them to the post-implementation review of the revised versions of IFRS 3 and IAS 27 issued in January 2008, to be conducted two years after their effective date. One of these issues related to the application of the definition of a business in particular situations.7 It is not clear what these particular situations might have been as no details were included in the agenda papers available to the public.

4

ACQUISITION METHOD OF ACCOUNTING

IFRS 3 requires that a business combination is accounted for by applying the acquisition method. [IFRS 3.4]. The change in terminology from the purchase method

Chapter 9

As indicated at 2.3 above, in some situations, there may be difficulties in determining whether or not an acquired group of assets constitutes a business, and judgement will be required to be exercised based on the particular circumstances. The determination of a transaction as a business combination or an asset(s) acquisition can have a considerable impact on an entity’s reported results and the presentation of its financial statements as the accounting for a business combination under IFRS 3 differs from accounting for an asset(s) acquisition in a number of important respects.


484

Chapter 9 (as used in the previous version of IFRS 3) is due to the fact that a business combination can arise in the absence of a purchase transaction. [IFRS 3.BC14]. Applying the acquisition method involves the following steps: [IFRS 3.5] (a) identifying an acquirer; (b) determining the acquisition date; (c) recognising and measuring the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; and (d) recognising and measuring goodwill or a gain in a bargain purchase. The above steps are discussed at 5, 6, 7 and 8 below.

5

IDENTIFYING THE ACQUIRER

The first step in applying the acquisition method is identifying the acquirer. IFRS 3 requires one of the combining entities to be identified as the acquirer. [IFRS 3.6]. For this purpose the guidance in IAS 27 is to be used, i.e. the acquirer is the entity that obtains control of the acquiree; control being defined as ‘the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities’. [IFRS 3.7, Appendix A]. The guidance in IAS 27 for determining whether an entity has control over another is discussed in Chapter 6 at 2.1. If a business combination has occurred, but applying that guidance in IAS 27 does not clearly indicate which of the combining entities is the acquirer, additional guidance in IFRS 3 includes various other factors that are to be considered in making the determination as to which entity is the acquirer. [IFRS 3.7]. Although changes have been made to the wording of the guidance that was included in the previous version of IFRS 3 in order to clarify some of the intentions of the IASB, and to conform with that used in the equivalent US standard, the guidance in IFRS 3 for identifying the acquirer is considered by the IASB to be, in substance, the same as that in the previous version of IFRS 3. [IFRS 3.BC102]. The various other factors in IFRS 3 that are to be considered in making the determination as to which entity is the acquirer are discussed below. These will require significant judgement, particularly when consideration is being given to as to whether the business combination is a ‘reverse acquisition’ or where the combination occurred by contract alone. In a business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities. [IFRS 3.B14]. In a business combination effected primarily by exchanging equity interests, the acquirer is usually the entity that issues its equity interests, but in some business combinations, so-called ‘reverse acquisitions’, the issuing entity is the acquiree. Application guidance on the accounting for reverse acquisitions is provided in Appendix B to IFRS 3 (see 16 below). In identifying the acquirer in a business combination effected by exchanging equity interests, IFRS 3 requires that other pertinent facts and circumstances should also be considered, including: [IFRS 3.B15]


Business combinations

• •

485

the relative voting rights in the combined entity after the business combination. The acquirer is usually the combining entity whose owners as a group retain or receive the largest portion of the voting rights in the combined entity, after taking due account of any unusual or special voting arrangements and options, warrants or convertible securities; the existence of a large minority voting interest in the combined entity if no other owner or organised group of owners has a significant voting interest. The acquirer is usually the combining entity whose single owner or organised group of owners holds the largest minority voting interest in the combined entity; the composition of the governing body of the combined entity. The acquirer is usually the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity; the composition of the senior management of the combined entity. The acquirer is usually the combining entity whose (former) management dominates the management of the combined entity; the terms of the exchange of equity interests. The acquirer is usually the combining entity that pays a premium over the pre-combination fair value of the equity interests of the other combining entity or entities.

The guidance for identifying the acquirer also notes that the acquirer is usually the combining entity whose relative size (measured in, for example, assets, revenues or profit) is significantly greater than that of the other combining entity or entities. [IFRS 3.B16].

The guidance in IFRS 3 emphasises that a new entity formed to effect a business combination is not necessarily the acquirer. If a new entity is formed to issue equity interests to effect a business combination, one of the combining entities that existed before the business combination is to be identified as the acquirer by applying the guidance described above. [IFRS 3.B18]. In such a transaction, the combination between the new entity and the identified acquirer is effectively the same as if a new entity had been inserted above an existing entity. As discussed in Chapter 10 at 4.2, such a transaction should be accounted for as a continuation of the existing entity (under the pooling of interests method). The combination of the new entity with the identified acquirer cannot be accounted for as a ‘reverse acquisition’ because IFRS 3 requires that the accounting acquiree must meet the definition of a business for a transaction to be accounted for as a reverse acquisition. [IFRS 3.B19]. An example of such a business combination is illustrated in the 2005 financial statements of Group 4 Securicor as seen below.

Chapter 9

In a business combination involving more than two entities, determining the acquirer includes a consideration of, among other things, which of the combining entities initiated the combination, as well as the relative size of the combining entities. [IFRS 3.B17].


486

Chapter 9 Extract 9.1: Group 4 Securicor plc (2005)  Notes to the consolidated financial statements [extract] 1 General information [extract] Group 4 Securicor plc is a company incorporated in the United Kingdom under the Companies Act 1985. As a result of a Scheme of Arrangement of Securicor plc, which became effective on 19 July 2004, Group 4 Securicor plc became the ultimate holding company of the Securicor plc group of companies and, on the same date, and as a result of a recommended offer for its shares, acquired Group 4 A/S, the holding company of the former security businesses of Group 4 Falck A/S. On the basis that the transaction was effected by using a new parent, Group 4 A/S was identified as the acquirer. The comparative results for the year to 31 December 2004 are therefore those of the full year of trading of the security businesses of the former Group 4 Falck A/S and the trading of the businesses of Securicor plc for the period from 20 July 2004 to 31 December 2004.

In contrast, the guidance in IFRS 3 notes that a new entity that transfers cash or other assets or incurs liabilities as consideration may be the acquirer. However, it does not specify in what circumstances this may be the case. Nevertheless, it is clear that ‘control’ is the fundamental concept for the purpose of determining an acquirer in a business combination. One situation where we believe this would be appropriate is where the newly formed entity (hereafter referred to as ‘Newco’) is established and used on behalf of a group of investors or another entity to acquire a controlling interest in a ‘target entity’ in an arm’s length transaction. Example 9.7: 

Business combination effected by a Newco for cash consideration (1) 

Entity A intends to acquire the voting shares (and therefore obtain control) of Target Entity. Entity A incorporates Newco and uses this entity to effect the business combination. Entity A provides a loan at commercial interest rates to Newco. The loan funds are used by Newco to acquire 100% of the voting shares of Target Entity in an arm’s length transaction. The group structure post-transaction is as follows: Entity A 100 % Holding Group

Newco 100 % Target Entity

Under its local regulations, Newco is required to prepare IFRS-compliant consolidated financial statements for the Holding Group (the reporting entity). (In most situations like this, Newco would be exempt from preparing consolidated financial statements – see Chapter 6 at 3.1.) As indicated above, under IFRS 3, the acquirer is ‘the entity that obtains control of the acquiree.’ Whenever a new entity is formed to effect a business combination other than through the issue of shares, it is appropriate to consider that Newco as being an extension of one of the transacting parties. Where the Newco is considered to be an extension of the transacting party (or parties) that ultimately gain control of the other combining entities, the Newco would be identified as the acquirer.


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487

In this situation, Entity A has obtained control of Target Entity in an arm’s length transaction, using Newco to effect the acquisition. The transaction has resulted in a change in control of Target Entity and Newco is in effect an extension of Entity A acting at its direction to obtain control for Entity A. Accordingly, Newco would be identified as the acquirer at the Holding Group level.

If, rather than Entity A establishing Newco, a group of investors had established it as the acquiring vehicle through which they obtained control of Target Entity then again it would be appropriate for Newco to be regarded as the acquirer since it is an extension of the group of investors. Another situation where we believe it is appropriate for a Newco to be identified as the acquirer is illustrated in Example 9.8 below. Although Newco has been incorporated by the existing parent of the subsidiaries concerned (and this would generally mean that Newco could not be identified as the acquirer), in this particular situation the critical distinguishing factors are that the acquisition of the subsidiaries was conditional on the IPO proceeding (i.e. there would not have been a combination of Newco with the subsidiaries without the IPO having happened) and there being a substantial change in the ownership of the subsidiaries by virtue of the IPO. Example 9.8: 

Business combination effected by a Newco for cash consideration (2) 

Entity A proposes to spin-off two of its existing businesses (currently housed in two separate entities, Sub1 and Sub2) as part of an initial public offering (IPO). The existing group structure is as follows: Entity A

Other Subs

Sub 1

Sub 2

To facilitate the spin-off, Entity A incorporates a new company (Newco) with nominal equity and appoints independent directors to the Board of Newco. Newco signs an agreement to acquire Sub1 and Sub2 from Entity A conditional on the IPO proceeding. Newco issues a prospectus offering to issue shares for cash to provide Newco with funds to acquire Sub1 and Sub2. The IPO proceeds and Newco acquires Sub1 and Sub2 for cash. Entity A’s nominal equity leaves virtually 100% ownership in Newco with the new investors. Following the IPO, the respective group structures of Entity A and Newco appear as follows:

Other Subs

Chapter 9

Entity A


488

Chapter 9 Newco Investors

Holding Group

Newco

Sub 1

Sub 2

In this case, we believe it is appropriate that Newco should be identified as the acquirer. The Newco investors have obtained control and virtually 100% ownership of Sub1 and Sub2 in an arm’s length transaction, using Newco to effect the acquisition. The transaction has resulted in a change in control of Sub1 and Sub2 (i.e. Entity A losing control and Newco investors, via Newco, obtaining control). Newco is in effect an extension of the Newco investors since: • the acquisition of Sub1 and Sub2 was conditional on the IPO proceeding so that the IPO is an integral part of the transaction as a whole evidencing that Entity A did not have control of the transaction/entities; and • there being a substantial change in the ownership of Sub1 and Sub2 by virtue of the IPO (i.e. Entity A only retains a negligible ownership interest in Newco). Accordingly, Newco should be identified as the acquirer at the Holding Group level.

Whether a Newco formed to facilitate an IPO is capable of being identified as an acquirer depends on the facts and circumstances and ultimately requires judgement. Changes to the fact pattern could result in a different assessment. For example, where Entity A incorporates Newco and arranges for it to acquire Sub1 and Sub2 prior to the IPO proceeding, Newco might be viewed as an extension of Entity A or possibly an extension of Sub1 or Sub2. This is because the IPO and the reorganisation may not be seen as being part of the one integral transaction, and therefore the transaction would be a combination of entities under common control (see Chapter 10 at 3.1). In that situation, Newco would not be the acquirer.

6

DETERMINING THE ACQUISITION DATE

The next step in applying the acquisition method is determining the acquisition date. The acquirer has to identify the acquisition date which is defined in IFRS 3 as ‘the date on which the acquirer obtains control of the acquiree’. [IFRS 3.8, Appendix A]. IFRS 3 indicates that the acquisition date will generally be the ‘closing date’, i.e. the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree. [IFRS 3.9]. Although the standard refers to the ‘closing date’, we do not believe that this necessarily means that the transaction has to be closed or finalised at law before the acquirer obtains control over the acquiree. IFRS 3 acknowledges that the acquirer might obtain control on a date that is either earlier or later than the closing date. The standard notes, for example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. [IFRS 3.9].


Business combinations

489

That is not to say that the acquisition date can be artificially backdated or otherwise altered, for example, by the inclusion of terms in the agreement indicating that the acquisition is to be effective as of an earlier date, with the acquirer being entitled to profits arising after that date, even if the purchase price is based on the net asset position of the acquiree at that date. Although the acquisition date cannot be artificially backdated or otherwise altered, the Basis for Conclusions to IFRS 3 does acknowledge that, for convenience, an entity might wish to designate an acquisition date of the end (or the beginning) of a month, the date on which it closes its books, rather than the actual acquisition date during the month. Unless events between the ‘convenience’ date and the actual acquisition date result in material changes in the amounts recognised, that entity’s practice would comply with the requirements of IFRS 3. [IFRS 3.BC110]. IFRS 3 emphasises that all pertinent facts and circumstances in assessing the acquisition date must be considered. [IFRS 3.8-9]. No further guidance from that outlined above is given in the standard as to how to determine the acquisition date, but it is clearly a matter of fact. The date control is obtained will be dependent on a number of factors, including whether the acquisition arises from a public offer or a private deal, is subject to approval by other parties, or is effected by the issue of shares. For an acquisition by way of a public offer, the date of acquisition could be when the offer has become unconditional as a result of a sufficient number of acceptances being received or at the date that the offer closes. In a private deal, the date would generally be when an unconditional offer has been accepted by the vendors. It can be seen from the above that one of the key factors is that the offer is ‘unconditional’. Thus, where an offer is conditional on the approval of the acquiring entity’s shareholders then until that has been received, it is unlikely that control will have been obtained. Where the offer is conditional upon receiving some form of regulatory approval, then it will depend on the nature of that approval. Where it is a substantive hurdle, such as obtaining the approval of a competition authority, it is unlikely that control could have been obtained prior to that approval. However, where the approval is merely a formality, or ‘rubber-stamping’ exercise, then this would not preclude control having been obtained at an earlier date.

However, as indicated above, whether control has been obtained by a certain date is a matter of fact, and all pertinent facts and circumstances surrounding a business combination need to be considered in assessing when the acquirer has obtained control.

Chapter 9

Where the acquisition is effected by the issue of shares, then the date of control will generally be when the exchange of shares takes place.


490

Chapter 9

7

RECOGNISING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED, THE LIABILITIES ASSUMED, AND ANY NONCONTROLLING INTEREST IN THE ACQUIREE

The next step in applying the acquisition method involves recognising and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. 7.1

General principles

The general principles of IFRS 3 are that the identifiable assets acquired and liabilities assumed of the acquiree are recognised as of the acquisition date and measured at fair value as at that date, with certain limited exceptions. [IFRS 3.10, 14, 18, 20]. Any non-controlling interest in the acquiree is to be recognised at the acquisition date, however, the acquirer can measure components of noncontrolling interests in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation either at fair value at that date or at the non-controlling interest’s proportionate share of the acquiree’s net identifiable assets as measured at the acquisition date. All other components of non-controlling interests are measured at their acquisition-date fair values, unless another measurement basis is required by IFRSs. [IFRS 3.10, 19]. The accounting for any non-controlling interest at the acquisition date is discussed further at 10 below. 7.2

Recognition conditions for identifiable assets acquired and liabilities assumed

To qualify for recognition as part of applying the acquisition method, an item acquired or assumed must be: [IFRS 3.BC112] (a) an asset or liability at the acquisition date; and (b) part of the business acquired (the acquiree) rather than the result of a separate transaction. The first condition requires that the identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in the IASB’s Framework (see Chapter 2 at 2.2.3.A and B) at the acquisition date. This means, for example, costs the acquirer expects but is not obliged to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the acquirer does not recognise those costs as part of applying the acquisition method. Instead, the acquirer recognises those costs in its post-combination financial statements in accordance with other IFRSs. [IFRS 3.11]. Thus, an acquirer recognises liabilities for restructuring or exit activities acquired in a business combination only if they meet the definition of a liability at the acquisition date. [IFRS 3.BC132]. IFRS 3 does not contain the same explicit requirements relating to restructuring plans that were in the previous version of the standard, but the Basis for Conclusions accompanying IFRS 3 clearly indicate that the requirements for recognising


Business combinations

491

liabilities associated with restructuring or exit activities remain the same. [IFRS 3.BC137]. This is discussed further at 13.4 below. This first condition for recognition makes no reference to reliability of measurement or probability as to the inflow or outflow of economic benefits. This is because the IASB considers them to be unnecessary because reliability of measurement is a part of the overall recognition criteria in the Framework and that such recognition criteria includes the concept of ‘probability’ to refer to the degree of uncertainty that the future economic benefits associated with an asset or liability will flow to or from the entity. [IFRS 3.BC125-130]. Thus, identifiable assets and liabilities are recognised regardless of the degree of probability that there will be inflows or outflows of economic benefits. Nevertheless, in recognising a liability in respect of a contingent liability assumed in a business combination, IFRS 3 requires that its fair value can be measured reliably (see 7.6.1.A below). The second condition requires that the identifiable assets acquired and liabilities assumed must be part of the exchange for the acquiree, rather than as a result of separate transactions. [IFRS 3.12]. Explicit guidance is given in the standard for making such an assessment as discussed at 13 below. The objective of this condition and the related guidance is to ensure that each component is accounted for in accordance with its economic substance. [IFRS 3.BC115]. One particular consequence of this condition is that acquisition-related costs are to be expensed, whereas under the previous version of IFRS 3 such costs were included as part of the cost of the business combination and therefore recognised as part of goodwill. The IASB also considers that this meant such costs were being recognised as if they were an asset. [IFRS 3.BC114]. IFRS 3 emphasises that the acquirer’s application of the recognition principle and conditions may result in recognising some assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements. For example, the acquirer recognises the acquired identifiable intangible assets, such as a brand name, a patent or a customer relationship, that the acquiree did not recognise as assets in its financial statements because it developed them internally and charged the related costs to expense. [IFRS 3.13].

7.3

Acquisition-date fair values of identifiable assets acquired and liabilities assumed

The general measurement principle is that the recognised identifiable assets acquired and liabilities assumed are measured at their acquisition-date fair values. For this purpose, ‘fair value’ is defined as ‘the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’. [IFRS 3 Appendix A]. This is the same as the definition in the previous version of IFRS 3 as well in other IFRSs. On the other hand, the equivalent US GAAP definition is ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the

Chapter 9

Guidance is provided on recognising operating leases and intangible assets, as well as specifying types of identifiable assets and liabilities that include items for which IFRS 3 provides limited exceptions to the recognition principle and conditions. [IFRS 3.14]. These are discussed at 7.5 and 7.6 below.


492

Chapter 9 measurement date’. The IASB considered also using the definition of fair value in US GAAP but decided that to do so would prejudge the outcome of its project on fair value measurement (see Chapter 2 at 4.3). [IFRS 3.BC246-247]. The Boards acknowledge that using the different definitions might result in measuring fair values differently but, based on consultations with valuation experts and the Boards’ belief that the underlying concepts are essentially the same, understand that such differences are unlikely to occur often. [IFRS 3.BC248-250]. The Basis for Conclusions accompanying IFRS 3 goes on to identify the following two particular areas where differences may occur as a result of applying the different definitions: (i) if an asset is acquired for its defensive value or (ii) if a liability is measured on the basis of settling it with the creditor rather than transferring it to a third party. [IFRS 3.BC251]. Due to the IASB’s current project on fair value measurement, much of the guidance relating to fair value that was contained in the previous version of IFRS 3 is no longer included in IFRS 3. In addition, the proposed guidance on how to measure fair value contained in Appendix E of the June 2005 exposure draft, including the ‘fair value hierarchy’, is not included in the revised standard. Guidance is provided on measuring the fair value of particular identifiable assets, as well as specifying types of identifiable assets and liabilities that include items for which IFRS 3 provides limited exceptions to the measurement principle. [IFRS 3.20]. These are discussed at 7.5 and 7.6 below. In addition, although the objective of the second phase of the business combinations project was not focused on issues related to the ‘day-two’ accounting for assets acquired and liabilities assumed, IFRS 3 provides guidance on the accounting for certain acquired assets and assumed liabilities subsequent to a business combination. [IFRS 3.54-57]. These are discussed at 15 below. 7.4

Classifying or designating identifiable assets acquired and liabilities assumed

IFRS 3 includes the principle that, at the acquisition date, the acquirer must classify or designate the identifiable assets and liabilities assumed as necessary in order to apply other IFRSs subsequently. Such classifications and designations made by the acquirer are to be based on the contractual terms, economic conditions, the operating and accounting policies of the acquirer, and any other pertinent conditions as they exist at the acquisition date. [IFRS 3.15]. However, the standard provides two exceptions to this principle: • classification of leases in accordance with IAS 17; • classification of a contract as an insurance contract in accordance with IFRS 4. In both these situations, the acquirer classifies the contracts on the basis of the contractual terms and other factors at the inception of the contract or, if the terms of the contract have been modified in a manner that would change its classification, at the date of the modification (which might be the acquisition date). [IFRS 3.17]. Thus, if an acquiree is a lessee under a lease contract that has appropriately been classified as an operating lease under IAS 17, in the absence of any modification to the terms of the contract, the acquirer would continue to account for the lease as an operating


Business combinations

493

lease. It would only be if, prior to or as at the acquisition date, the terms of the lease were modified in such a way that it would be reclassified as a finance lease under IAS 17 (see Chapter 22 at 3.2.3), that the acquirer would recognise the asset and the related finance lease liability. As a result of this principle, examples of classifications or designations that the acquirer has to make on the basis of the pertinent conditions as they exist at the acquisition date include but are not limited to: [IFRS 3.16] (a) classification of particular financial assets and liabilities as a financial asset or liability at fair value through profit or loss, or as a financial asset available for sale or held to maturity, in accordance with IAS 39; (b) designation of a derivative instrument as a hedging instrument in accordance with IAS 39; and (c) assessment of whether an embedded derivative should be separated from the host contract in accordance with IAS 39 (which is a matter of ‘classification’ as IFRS 3 uses that term). Some amendments were made to items (a) and (c) above as a result of the classification requirements of IFRS 9, but these are only applicable when IFRS 9 is applied, so they are not mandatory until periods beginning on or after 1 January 2013. [IFRS 9.8.1.1, C5].

As discussed in Chapter 39 at 5, there are a number of conditions that need to be met for hedge relationships to qualify for hedge accounting, in particular formal designation and documentation, and an ongoing assessment of the designated hedge. If an acquiree has derivative or other financial instruments that have been used as hedging instruments in a hedge relationship, IFRS 3 requires the acquirer to make its own designation about the hedging relationship that satisfy the conditions for hedge accounting, based on the conditions as they exist at the acquisition date If the hedging relationship is being accounted for as a cash flow hedge by the acquiree, the acquirer does not inherit the acquiree’s existing cash flow hedge reserve, as this clearly represents cumulative pre-acquisition gains and losses. This has implications for the assessment of hedge effectiveness and the measurement of ineffectiveness because, so far as the acquirer is concerned, it has started a new hedge relationship with a hedging instrument that is likely to have a non-zero fair value (see Chapter 39

Chapter 9

The requirements for the classification of financial assets and liabilities under IAS 39 are discussed in Chapter 34. Although, as indicated at 6 in that Chapter, IAS 39 has particular requirements that would appear to prohibit the reclassification of items into or out of the fair value through profit or loss category, and permit, and in some situations require, reclassification between held-to-maturity investments and available-for-sale assets as far as the acquiree is concerned, the acquirer has to make its own classification at the acquisition date. If the acquirer has not had to consider the classification of such assets or liabilities before for the purposes of its financial statements, it could choose to continue to adopt the classification applied by the acquiree or adopt a different classification if appropriate. However, if the acquirer already has an accounting policy for like transactions, the classification should be consistent with that existing policy.


494

Chapter 9 at 4.2.4). This may mean that although the acquiree can continue to account for the relationship as a cash flow hedge, the acquirer is unable to account for it as a cash flow hedge in its financial statements. In the situations discussed above, the effect of applying the principle in IFRS 3 only affects the post-business combination accounting for the financial instruments concerned. The financial instruments that are recognised as at the acquisition date, and their measurement at their fair value at that date, do not change. However, the requirement for the acquirer to assess whether an embedded derivative should be separated from the host contract based on pertinent conditions as they exist at the acquisition date could result in additional assets or liabilities being recognised (and measured at their acquisition-date fair value) different from those recognised by the acquiree. Embedded derivatives are discussed in Chapter 32. 7.5

Recognising and measuring particular assets acquired and liabilities assumed

IFRS 3 gives some application guidance on recognising and measuring particular assets acquired and liabilities assumed in a business combination, as discussed at 7.5.1 to 7.5.6 below. 7.5.1

Operating leases

Although existing leases of the acquiree are new leases from the perspective of the acquirer, the classification of the leases between operating and finance is not revisited. If the acquiree is the lessee to an operating lease, the acquirer does not recognise the acquiree’s rights under the operating lease separately from its obligations as part of the purchase price allocation (i.e. the asset and liability arising from the operating lease is not recognised on a gross basis). However, the acquirer is required to recognise operating leases in which the acquiree is the lessee as either intangible assets or liabilities if the terms of the lease are favourable (asset) or unfavourable (liability) relative to market terms and prices. [IFRS 3.B28-29]. IFRS 3 also indicates that an identifiable intangible asset may be associated with an operating lease, even one that is at market terms. This may be evidenced by market participants’ willingness to pay a price for the lease. For example, a lease of gates at an airport or of retail space in a prime shopping centre may provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, for example, as a customer relationship. In that situation, the acquirer recognises the associated identifiable intangible asset(s) (see 7.5.2 below). [IFRS 3.B30]. However, where the acquiree is a lessor in an operating lease, the acquirer does not recognise separately an intangible asset or liability if the terms of the lease are favourable or unfavourable relative to market terms and prices. Instead, off-market terms are reflected in the acquisition-date fair value of the asset (such as a building or a patent) subject to the lease. [IFRS 3.B29, 42]. This is to avoid any inconsistency with the fair value model in IAS 40 – Investment Property – which requires the fair value of investment property to take into account rental income from current leases, and the IASB understands that practice is to measure the fair value of investment property taking into account the contractual terms of the leases and other contracts in place


Business combinations

495

relating to the asset. [IFRS 3.BC146]. Although the reason for not separately recognising the favourable or unfavourable element is due to investment properties accounted for under the fair value model in IAS 40, the requirement to reflect the off-market terms in the fair value of the asset applies to any type of asset. The IASB notes that based on the requirements of IAS 16 and IAS 38, an entity would be required to adjust the depreciation or amortisation method for the leased asset so as to reflect the timing of the cash flows attributable to the underlying leases. [IFRS 3.BC148]. 7.5.2

Intangible assets

The acquirer’s application of the recognition principle and conditions may result in recognising some assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements. One of the main types of assets that an acquirer recognises, separately from goodwill, are identifiable intangible assets. [IFRS 3.B31]. Both IFRS 3 and IAS 38 give guidance on the recognition of intangible assets acquired in a business combination. 7.5.2.A

What is an identifiable intangible asset?

IFRS 3 and IAS 38 both define an ‘intangible asset’ as ‘an identifiable non-monetary asset without physical substance’. [IFRS 3 Appendix A, IAS 38.8]. The definition of an intangible asset requires an intangible asset to be identifiable to distinguish it from goodwill (see 8 below). [IAS 38.11]. IFRS 3 and IAS 38 both regard an asset as identifiable if it either: (a) is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether it intends to do so; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. [IFRS 3 Appendix A, IAS 38.12]. Accordingly, IFRS 3 regards an intangible asset as identifiable if it meets either the separability criterion or the contractual-legal criterion, [IFRS 3.B31], and provides the following Application guidance.

Separability criterion

IFRS 3 notes that the separability criterion means that an acquired intangible asset is capable of being separated or divided from the acquiree and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability. An intangible asset that the acquirer would be able to sell, license or otherwise exchange for something else of value meets the separability criterion even if the acquirer does not intend to sell, license or otherwise exchange it. An acquired intangible asset meets the separability criterion if there is evidence of exchange transactions for that type of asset or an asset of a similar type, even if those transactions are infrequent and regardless of whether the acquirer is involved in them. For example, customer and subscriber lists are frequently licensed and thus meet the separability

Chapter 9


496

Chapter 9 criterion. Even if an acquiree believes its customer lists have characteristics different from other customer lists, the fact that customer lists are frequently licensed generally means that the acquired customer list meets the separability criterion. However, a customer list acquired in a business combination would not meet the separability criterion if the terms of confidentiality or other agreements prohibit an entity from selling, leasing or otherwise exchanging information about its customers. [IFRS 3.B33]. An intangible asset that is not individually separable from the acquiree or combined entity meets the separability criterion if it is separable in combination with a related contract, identifiable asset or liability. For example: [IFRS 3.B34] (a) market participants exchange deposit liabilities and related depositor relationship intangible assets in observable exchange transactions. Therefore, the acquirer should recognise the depositor relationship intangible asset separately from goodwill; (b) an acquiree owns a registered trademark and documented but unpatented technical expertise used to manufacture the trademarked product. To transfer ownership of a trademark, the owner is also required to transfer everything else necessary for the new owner to produce a product or service indistinguishable from that produced by the former owner. Because the unpatented technical expertise must be separated from the acquiree or combined entity and sold if the related trademark is sold, it meets the separability criterion.

•

Contractual-legal criterion

An intangible asset that meets the contractual-legal criterion is identifiable even if the asset is not transferable or separable from the acquiree or from other rights and obligations. For example: [IFRS 3.B32] (a) an acquiree leases a manufacturing facility under an operating lease that has terms that are favourable relative to market terms. The lease terms explicitly prohibit transfer of the lease (through either sale or sublease). The amount by which the lease terms are favourable compared with the terms of current market transactions for the same or similar items is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even though the acquirer cannot sell or otherwise transfer the lease contract; (b) an acquiree owns and operates a nuclear power plant. The licence to operate that power plant is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even if the acquirer cannot sell or transfer it separately from the acquired power plant. However, IFRS 3 goes on to say that an acquirer may recognise the fair value of the operating licence and the fair value of the power plant as a single asset for financial reporting purposes if the useful lives of those assets are similar; (c) an acquiree owns a technology patent. It has licensed that patent to others for their exclusive use outside the domestic market, receiving a specified percentage of future foreign revenue in exchange. Both the technology patent and the related licence agreement meet the contractual-legal criterion for recognition separately from goodwill even if selling or exchanging the patent and the related licence agreement separately from one another would not be practical.


Business combinations

•

497

Removal of reliability of measurement criterion

The previous version of IFRS 3 included an additional criterion that had to be met for an identifiable intangible asset to be recognised separately from goodwill. This was that its fair value had to be measured reliably, although, the IASB within the guidance in IAS 38 made it clear that the IASB believed that there would only be limited circumstances when such a criterion would not have been met. The inclusion in the previous version of IFRS 3 of the reliability of measurement criterion was the result of extensive field tests conducted by the IASB on the proposals in the exposure draft preceding that version of IFRS 3 (ED 3). Those field visits, which included discussions with accountants and valuation professionals, highlighted that there were certain circumstances in which an intangible asset acquired in a business combination might have a value that could not be measured reliably. Despite this, and in the interest of convergence with US GAAP, the Board decided not to include an equivalent statement in IFRS 3, with consequential amendments made to IAS 38 to remove the reliability of measurement criterion for intangible assets acquired in a business combination. [IFRS 3.BC172-174]. Although this was done, the IASB subsequently realised that IAS 38 still indicated that in some situations a group of intangible assets have to be recognised as a single asset separately from goodwill if the individual fair values of the assets within the group are not reliably measurable. The IASB considered that this did not clearly reflect its decisions about accounting for intangible assets acquired in a business, so as part of the annual improvement standard issued in April 2009, the IASB revised the requirements of IAS 38 to clarify what it meant to say in this regard when making the consequential amendments to IAS 38 as a result of IFRS 3. [IAS 38.BC19C]. In doing so, it deleted all references to items not being reliably measurable. Accordingly, under IFRS 3, identifiable intangible assets are recognised separately from goodwill if they are either separable or arise from contractual or other legal rights. [IFRS 3.B31]. It is not necessary that the intangible asset has to be capable of reliable measurement in order for it to be recognised, despite the reasons for including this criterion in the previous version of IFRS 3. Therefore, whenever an intangible asset can be separately identified it has to be recognised and an acquisition-date fair value assigned to it. Examples of identifiable intangible assets

The discussion above refers to a number of different types of identifiable intangible assets that IFRS 3 requires to be separately recognised from goodwill, such as customer and subscriber lists, depositor relationships, registered trademarks, unpatented technical expertise, favourable operating leases, licences and technology patents. IAS 38 also explicitly refers to the fact that the requirement in IFRS 3 means that the acquirer recognises as an asset separately from goodwill an in-process research and development project of the acquiree (if the project meets the definition of an intangible asset). [IAS 38.34]. IFRS 3 itself only refers to this in its Basis for Conclusions, where it is made clear that the acquirer recognises all tangible and intangible research and development assets acquired in a business combination. [IFRS 3.BC149-156]. This is discussed further at 7.5.2.E below.

Chapter 9

7.5.2.B


498

Chapter 9 IFRS 3 gives further guidance in its Illustrative Examples that provides a large list of examples of items acquired in a business combination that are identifiable intangible assets and are therefore to be recognised separately from goodwill, whilst noting that the examples are not intended to be all-inclusive. [IFRS 3.IE16-44]. A non-monetary asset without physical substance acquired in a business combination might meet the identifiability criterion for identification as an intangible asset but not be included in the guidance. The guidance designates the assets listed as being ‘contractual’, i.e. arising from contractual or other legal rights or ‘non-contractual’, i.e. not arising from contractual or other legal rights but are separable, whilst noting that those designated as ‘contractual’ might also be separable. However, it emphasises that separability is not a necessary condition for an asset to meet the contractual-legal criterion. The table below summarises the items included in the Illustrative Examples that the IASB regard as meeting the definition of an intangible asset and are therefore to be recognised separately from goodwill. Reference should be made to the Illustrative Examples for any further explanation about some of these items. Intangible assets arising from contractual or other legal rights (regardless of being separable)

Other intangible assets that are separable

Marketing-related – Trademarks, trade names, service marks, collective marks and certification marks – Trade dress (unique colour, shape or package design) – Newspaper mastheads – Internet domain names – Non-competition agreements Customer-related – Order or production backlog – Customer contracts and the related customer relationships Artistic-related – Plays, operas and ballets – Books, magazines, newspapers and other literary works – Musical works such as compositions, song lyrics and advertising jingles – Pictures and photographs – Video and audiovisual material, including motion pictures or films, music videos and television programmes Contract-based – Licensing, royalty and standstill agreements – Advertising, construction, management, service or supply contracts – Lease agreements – Construction permits – Franchise agreements – Operating and broadcast rights – Servicing contracts such as mortgage servicing contracts – Employment contracts – Use rights such as drilling, water, air, mineral, timber-cutting and route authorities

– Customer lists – Non-contractual customer relationships


Business combinations Technology-based – Patented technology – Computer software and mask works – Trade secrets, such as secret formulas, processes or recipes

499

– Unpatented technology – Databases, including title plants

In some situations, items have been designated as being ‘contractual’ due to legal protection, for example, trademarks and trade secrets. However, the guidance explains that even without that legal protection, they would normally meet the separability criterion so would still be recognised separately from goodwill. It can be seen from the table that customer relationships can potentially fall under either category. Where relationships are established with customers through contracts, those customer relationships arise from contractual rights, regardless of whether a contract exists, or there is any backlog of orders, at the date of acquisition. In such cases, it does not matter that the relationship is separable. It would only be if the relationship did not arise from a contract that the recognition depends on the separability criterion. It is clear from the table above that the IASB envisages a wide range of items meeting the definition of an intangible asset, and therefore potentially being recognised separately from goodwill. One company that has recognised numerous intangible assets as a result of business combinations is ITV as illustrated in the following extract. Extract 9.2: ITV plc (2005)  Notes to the accounts [extract] 28 Acquisitions and disposals of business Acquisition and disposals in 2005

Chapter 9

SDN On 27 April 2005, the Group acquired 50.1% of the shares in SDN Ltd and 100% of the shares in United Media & Information Ltd (which held the remaining shares in SDN Ltd) for a total consideration of £83 million in cash. As part of the acquisition, loan amounts due by these companies, totalling £53 million, were repaid bringing the total cash outflow of the Group to £136 million. SDN holds the licence to operate Multiplex A on digital terrestrial television. In the period to 31 December 2005 SDN contributed £8 million to the consolidated operating profit of the Group (before additional amortisation of £4 million). Had the acquisition occurred on 1 January 2005, the estimated revenue for the Group would have been £7 million higher at £2,184 million and operating profit before amortisation and exceptional items £2 million higher at £462 million (additional amortisation is £2 million) for the year ended 31 December 2005. The acquired net assets of SDN are set out in the table below.


500

Chapter 9

Intangible assets Trade and other receivables Borrowings Trade and other payables Deferred tax liability Net assets and liabilities Goodwill on acquisition Consideration paid Borrowings settled at date of acquisition Total cash outflow

Book value before acquisition £m – 6 (53) (7) – (54)

Fair value adjustments £m 82 – – 3 (25) 60

Fair value to ITV plc £m 82 6 (53) (4) (25) 6 77 83 53 136

The intangible assets recognised at a fair value of £82 million include the Multiplex licence and customer contracts. A deferred tax liability of £25 million has been recognised in respect of these intangible assets. The goodwill recognised represents the wider strategic benefits of the acquisition to ITV plc and the value of those assets not requiring valuation under IFRS 3 (Business combinations). The strategic benefits are principally the enhanced ability to promote Freeview as a platform, business relationships with the channels which are on Multiplex A and the additional capacity available from 2010. These, in combination with existing Group assets including the ITV brand and programming, generate the goodwill on acquisition. Friends Reunited On 6 December 2005, the Group agreed to acquire 100% of the shares in Friends Reunited Holdings Limited for a total initial consideration of £120 million and deferred consideration of up to £55 million payable in 2009 contingent upon the future performance of the acquired business. The initial consideration consisted of £75 million cash, £21 million loan notes and £24 million ITV plc shares. Of the initial consideration £94 million was paid in 2005 with the balance of £26 million paid in 2006 (being the 21 million (£24 million) ITV plc shares and £2 million loan notes). The fair value of the consideration is £145 million. This takes into account the initial consideration, the present value of the expected deferred consideration and other costs associated with the acquisition. Had the acquisition occurred on 1 January 2005, the estimated revenue for the Group would have been £12 million higher at £2,189 million and operating profit before amortisation and exceptional items £6 million higher at £466 million (additional amortisation would have been £4 million) for the year ended 31 December 2005. The acquired net assets of Friends Reunited are set out in the table below. Book value before Fair value Fair value acquisition adjustments to ITV plc £m £m £m Intangible assets 4 34 38 Cash and cash equivalents 3 – 3 Trade and other receivables 1 – 1 Borrowings (2) – (2) Trade and other payables (5) – (5) Current tax (liability)/asset (1) 3 2 Deferred tax asset – 8 8 Net assets and liabilities – 45 45 Goodwill on acquisition 100 Fair value of consideration 145


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The intangible assets recognised at fair value include the brands and customer relationships. A deferred tax liability of £10 million has been recognised in respect of these intangible assets. A current tax asset of £3 million and a deferred tax asset of £18 million has been recognised in respect of the exercise of share options. The goodwill recognised represents the benefits of the acquisition across the Group when combined with existing Group assets and businesses and the value of those assets not requiring valuation under IFRS 3 (Business combinations). Valuation of acquired intangible assets methodology Valuation of acquired intangibles has been performed in accordance with industry standard practice. Methods applied are designed to isolate the value of each intangible asset separately from the other assets of the business. The value of brands are assessed by applying a royalty rate to the expected future revenues over the life of the brand. Licences are valued on a start-up basis. Customer relationships and controls are valued based on expected future cash flows from those existing at the date of acquisition. Contributory charges from other assets are taken as appropriate with post tax cash flows then being discounted back to their present value. Typical discount rates applied in the valuation of intangible assets acquired in the period are 8%-11%. Disposal During the year the Group disposed of Superhire Ltd for gross consideration of £2 million. Acquisition and disposals in 2004 Summary of the effect of the acquisition of new businesses:

Intangible assets Fixed assets Investments Distribution rights Deferred tax Programme rights and other inventory Trade and other receivables Current asset investments Assets held for sale Cash and cash equivalents Trade and other payables, provisions and borrowings Pensions Current tax Share of net assets within equity accounted investments plus minority interest Goodwill on acquisition Revaluation reserve adjustment Fair value of consideration paid Acquisition costs

£m 87 81 96 13 29

Fair value to ITV plc

£m 583 86 122 13 (106)

GMTV/GSkyB Book value before Fair value acquisition to ITV plc

£m – 3 – – –

£m 31 3 – – (9)

Reclassifications*

Total

£m – 7 (36) – 3

£m 614 96 86 13 (112)

106 155 182 – 410

96 149 178 59 410

7 14 – – 19

1 13 – – 19

6 45 – – 59

103 207 178 59 488

(1,204) (129) (62) (236)

(1,245) (129) (62) 154

(29) – – 14

(32) – – 26

(111) (9) – (36)

(1,388) (138) (62) 144

(8) 33 (6) 45 45 – 45

(3) 39 – –

(179) 2,004 (6) 1,963 1,942 21 1,963

(168) 1,932 – 1,918 1,897 21 1,918

*Reclassification of ITV 2, LNN, ITFC, ITV News Channel and ITV Network Limited to subsidiaries on combination of Granada and Carlton. These were previously held within investments in joint ventures and associates.

Chapter 9

Carlton Book value before acquisition


502

Chapter 9 The most material acquisition accounted for during 2004 results from acquisition accounting for the combination with Carlton Communications Plc on 2 February 2004. Consideration comprised 1,308 million ordinary shares and 124 million convertible shares in ITV plc. The fair value of the consideration at the date of merger was £1,897 million. In the period to 31 December 2004 Carlton contributed £82 million to the consolidated operating profit of the Group (before additional amortisation of £101 million). Had the acquisition occurred on 1 January 2004, the estimated revenue for the Group would have been £30 million higher at £2,083 million and operating profit before amortisation and exceptional items £1 million higher at £325 million for the year ended 31 December 2004. The principal fair value adjustments to the book values (under IFRS) of the acquired assets and liabilities are as follows: ● Recognition of acquired intangible assets at fair value. These are principally brands, customer contracts, customer relationships, licences and acquired film libraries. ● Acquired properties stated at market value. ● Revaluation of investments to estimated market value. ● Write down of inventories to estimated selling price less reasonable profit margin. ● Assets held for sale shown at expected net proceeds discounted back to their present value at the date of acquisition. ● Revaluation of financial instruments to market value. ● Deferred tax provided on acquisition accounting adjustments as appropriate. Disposals During 2004 the Group disposed of The Moving Picture Company Holdings Ltd and Carlton Books Ltd (which were classified as held for resale) for respective gross considerations of £59 million and £nil.

7.5.2.C

Customer relationship intangible assets acquired in a business combination

Further guidance on customer relationships acquired in a business combination is provided by IFRS 3 in the Illustrative Examples (which forms the basis of the example below) that demonstrate how an entity should interpret the contractuallegal and separability criteria in the context of acquired customer relationships. [IFRS 3.IE30].

Example 9.9: 

Customer relationship intangible assets acquired in a business  combination 

Supply agreement

Acquirer Company (AC) acquires Target Company (TC) in a business combination on 31 December 2011. TC has a five-year agreement to supply goods to Customer. Both TC and AC believe that Customer will renew the agreement at the end of the current contract. The agreement is not separable. The agreement, whether cancellable or not, meets the contractual-legal criterion. Additionally, because TC establishes its relationship with Customer through a contract, not only the agreement itself but also TC’s customer relationship with Customer meet the contractual-legal criterion. Sporting goods and electronics

AC acquires TC in a business combination on 31 December 2011. TC manufactures goods in two distinct lines of business: sporting goods and electronics. Customer purchases both sporting goods and electronics from TC. TC has a contract with Customer to be its exclusive provider of sporting goods but has no contract for the supply of electronics to Customer. Both TC and AC believe that only one overall customer relationship exists between TC and Customer. The contract to be Customer’s exclusive supplier of sporting goods, whether cancellable or not, meets the contractual-legal criterion. Additionally, because TC establishes its relationship with Customer through a contract, the customer relationship with Customer meets the contractual-legal criterion.


Business combinations

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Because TC has only one customer relationship with Customer, the fair value of that relationship incorporates assumptions about TC’s relationship with Customer related to both sporting goods and electronics. However, if AC determines that the customer relationships with Customer for sporting goods and for electronics are separate from each other, AC would assess whether the customer relationship for electronics meets the separability criterion for identification as an intangible asset. Order backlog and recurring customers

AC acquires TC in a business combination on 31 December 2011. TC does business with its customers solely through purchase and sales orders. At 31 December 2011, TC has a backlog of customer purchase orders from 60 per cent of its customers, all of whom are recurring customers. The other 40 per cent of TC’s customers are also recurring customers. However, as of 31 December 2011, TC has no open purchase orders or other contracts with those customers. Regardless of whether they are cancellable or not, the purchase orders from 60 per cent of TC’s customers meet the contractual-legal criterion. Additionally, because TC has established its relationship with 60 per cent of its customers through contracts, not only the purchase orders but also TC’s customer relationships meet the contractual-legal criterion. Because TC has a practice of establishing contracts with the remaining 40 per cent of its customers, its relationship with those customers also arises through contractual rights and therefore meets the contractual-legal criterion even though TC does not have contracts with those customers at 31 December 2011. Motor insurance contracts

AC acquires TC, an insurer, in a business combination on 31 December 2011. TC has a portfolio of one-year motor insurance contracts that are cancellable by policyholders. Because TC establishes its relationships with policyholders through insurance contracts, the customer relationship with policyholders meets the contractual-legal criterion. IAS 36 and IAS 38 apply to the customer relationship intangible asset.

An example of a company recognising customer contracts and customer relationship intangible assets is ITV as illustrated in Extract 9.2 at 7.5.2.B above. One particular type of customer relationship intangible asset that should be recognised (as indicated by the last scenario in Example 9.9 above) is the value of the future profit of businesses acquired (VOBA) relating to insurance contracts or investment contracts, notwithstanding the fact that it is the customer or policyholder that decides on the continuation of the relationship. One company recognising such intangibles is Sanlam as shown below.

Basis of Presentation and Accounting Policies [extract] Valuation of insurance and investment business acquired The value of insurance and investment management services contracts business acquired (VOBA) in a business combination is recognised as an intangible asset. VOBA, at initial recognition, is equal to the discounted value, using a risk-adjusted discount rate, of the projected stream of future after-tax profit that is expected to flow from the book of businesses acquired, after allowing for the cost of capital supporting the business, as applicable. The valuation is based on the Group’s actuarial and valuation principles as well as assumptions in respect of future premium income, fee income, investment return, policy benefits, costs, taxation, mortality, morbidity and surrenders, as appropriate. VOBA is amortised on a straight-line basis over the expected life of the client relationships underlying the book of business acquired. VOBA is tested for impairment on a bi-annual basis and written down for impairment where this is considered necessary. The gain or loss on disposal of a subsidiary or business includes the carrying amount of VOBA attributable to the entity or business sold. VOBA is derecognised when the related contracts are terminated, settled or disposed of.

Chapter 9

Extract 9.3: Sanlam Limited (2007) 


504

Chapter 9 Even with this guidance in IFRS 3, the Interpretations Committee received a request in 2008 to add to its agenda an item concerning the circumstances in which a non-contractual customer relationship arises in a business combination. In considering this request, the Interpretations Committee acknowledged that IFRS 3 makes a distinction between contractual and non-contractual customer relationships. Contractual customer relationships are always recognised separately from goodwill as they meet the contractual-legal criterion. However, non-contractual customer relationships are recognised only if they meet the separability criterion. Consequently, determining whether a relationship is contractual is critical to identifying and measuring customer relationship intangible assets and different conclusions could result in substantially different accounting outcomes. The staff’s survey of Interpretations Committee members indicated that diversity exists in practice regarding which customer relationships have a contractual basis and which do not. In addition, valuation experts may be taking different views, which could also be contributing to diversity in this area.8 As it drew together the guidance already available, the Interpretations Committee noted that the IFRS Glossary of Terms defines the term ‘contract’9 and that application guidance in IFRS 3 considers the recognition of intangible assets and the different criteria related to whether they are established on the basis of a contract (see 7.5.2.A above). The Interpretations Committee also noted that paragraph IE28 in the Illustrative Examples accompanying IFRS 3 highlights how a customer relationship is deemed to exist if on the one hand the entity has information about the customer and regular contact with it and on the other that the customer can make direct contact with the entity. Regardless of whether any contracts are in place at the acquisition date, the customer relationship meets the contractual-legal criterion for recognition as an intangible asset if an entity has a practice of establishing contracts with its customers. The paragraph also states that a customer relationship ‘may also arise through means other than contracts, such as through regular contact by sales or service representatives.’ [IFRS 3.IE28]. The Interpretations Committee concluded that whilst the manner in which a relationship is established is relevant to confirming the existence of a customer relationship, it should not be the primary basis for determining whether an intangible asset is recognised by the acquirer. What might be more relevant is whether the entity has a practice of establishing contracts with its customers or whether relationships arise through other means, such as through regular contact by sales and service representatives. The existence of contractual relationships and information about a customer’s prior purchases would be important inputs in valuing a customer relationship intangible asset, but should not determine whether it is recognised.10 Having reviewed the explicit guidance in IFRS 3, the Interpretations Committee decided it was not possible to develop an Interpretation reflecting its conclusion. Nevertheless, given widespread confusion in practice on the issue, the Interpretations Committee decided that the matter should be referred to the IASB and the FASB with a recommendation to review and amend IFRS 3 by:11


Business combinations

• •

505

removing the distinction between ‘contractual’ and ‘non-contractual’ customer-related intangible assets recognised in a business combination; and reviewing the indicators that identify the existence of a customer relationship in paragraph IE28 of IFRS 3 and including them in the standard.

At its meeting in December 2008, the IASB tentatively decided to consider a proposed amendment to IFRSs for possible inclusion in the next exposure draft of annual improvements to be published in August 2009.12 At a subsequent meeting in May 2009, the IASB staff recommended that the Board defer the first issue but deal only with the second issue in the exposure draft, together with a proposal to relocate the depositor relationship example in paragraph B34(a) of the application guidance of IFRS 3 from the section that illustrates ‘separable’ intangibles to a more appropriate location in that guidance.13 However, as indicated at 20.6 below, the IASB deferred both of the Interpretations Committee recommendations to the postimplementation review of IFRS 3 and IAS 27, to be conducted two years after their effective date, and it decided tentatively to retain the depositor relationship example in paragraph B34(a) of IFRS 3, noting that this is a separable intangible asset (see 7.5.2.A above).14 7.5.2.D

Combining an intangible asset with a related contract, identifiable asset or liability

The IASB considered that this did not clearly reflect its decisions about accounting for intangible assets acquired in a business, so as part of the annual improvement standard issued in April 2009, the IASB revised the requirements of IAS 38 to clarify what it meant to say in this regard when making the consequential amendments to IAS 38 as a result of IFRS 3. [IAS 38.BC19C]. Accordingly, paragraph 36 of IAS 38 now states that an intangible asset acquired in a business combination might be separable, but only together with a related contract, identifiable asset, or liability. In such cases, the acquirer recognises the intangible assets separately from goodwill, but together with the related item. This paragraph is now consistent with what IFRS 3 says about the ‘separability criterion’ in relation to an intangible asset that is not individually separable, but is separable in combination with a related contract, identifiable asset or liability at 7.5.2.A above, and the examples included therein. Similarly, paragraph 37 of IAS 38 now says that the acquirer may recognise a group of complementary intangible assets as a single asset provided the individual assets have similar useful lives. For example, ‘the terms “brand” and “brand name” are often used as synonyms for trademarks and other marks. However, the former are general

Chapter 9

Although IFRS 3 made consequential amendments to IAS 38 to remove the reliability of measurement criterion for intangible assets acquired in a business combination, the IASB subsequently realised that paragraphs 36 and 37 of IAS 38 still indicated that that an intangible asset acquired in a business combination might be separable, but only together with a related tangible or intangible asset, or that a group of complementary intangible assets had to be recognised as a single asset separately from goodwill, if the individual fair values of the assets within the group are not reliably measurable. [IAS 38.36-37 (2008)].


506

Chapter 9 marketing terms that are typically used to refer to a group of complementary assets such as a trademark (or service mark) and its related trade name, formulas, recipes and technological expertise.’ Again, this is consistent with what IFRS 3 says about brands in its Illustrative Examples, i.e. that an entity can recognise, as a single asset separately from goodwill, a group of complementary intangible assets commonly referred to as a brand if the assets that make up that group has similar lives. [IFRS 3.IE21]. However, what is not clear from these requirements in IAS 38 is whether an intangible asset that is only separable in combination with a tangible asset can be recognised together as a single asset for financial reporting purposes in all circumstances. In its guidance about the ‘contractual-legal criterion’, IFRS 3 gives an example of a licence to operate a nuclear power plant, and says that the fair value of the operating licence and the fair value of the power plant may be recognised as a single asset for financial reporting purposes, if the useful lives of those assets are similar (see 7.5.2.A above), yet the requirements in IAS 38 only refers to similar useful lives in the context of a group of complimentary intangible assets. Guidance on the determination of asset lives of intangible assets is discussed in Chapter 15 at 11.1. 7.5.2.E

In-process research or development project expenditure

IAS 38 explicitly refers to the fact that the requirements in IFRS 3 mean that the acquirer recognises as an asset separately from goodwill an in-process research and development project of the acquiree (if the project meets the definition of an intangible asset). [IAS 38.34]. IFRS 3 itself only refers to in-process research and development in its Basis for Conclusions, where it is made clear that the acquirer recognises all tangible and intangible research and development assets acquired in a business combination. [IFRS 3.BC149-156]. IAS 38 states that ‘an acquiree’s in-process research and development project meets the definition of an intangible asset when it: (a) meets the definition of an asset; and (b) is identifiable, i.e. is separable or arises from contractual or other legal rights.’ [IAS 38.34].

In-process research and development projects, whether or not recognised by the acquiree, are protected by legal rights and are clearly separable as on occasion they are bought and sold by entities without there being a business acquisition. Therefore, they are intangible assets as defined by IAS 38. Moreover, IAS 38 takes the view that the fair value of an intangible asset will reflect expectation about the probability that the expected future economic benefits embodied in the asset will flow to the entity (despite the uncertainty about the timing or the amount of the inflow) and that sufficient information exists to measure reliably the fair value of the asset (even if there is a range of possible outcomes with different probabilities, that uncertainty enters into the measurement of the asset’s fair value). Thus, the probability recognition criterion and the reliable measurement criterion in IAS 38 are


Business combinations

507

always considered to be satisfied for in-process research and development projects acquired in a business combination. [IAS 38.34-35]. Therefore, the recognition of in-process research and development as an asset on acquisition applies different criteria to those that are required for internal projects. The research costs of internal projects may under no circumstances be capitalised. [IAS 38.54]. Before capitalising development expenditure, entities must meet a series of exacting requirements. They must demonstrate the intangible assets’ technical feasibility, their ability to complete the assets and use them or sell them and must be able to measure reliably the attributable expenditure. [IAS 38.57]. The probable future economic benefits must be assessed using the principles in IAS 36 which means that they have to be calculated as the net present value of the cash flows generated by the asset or, if it can only generate cash flows in conjunction with other assets, of the cash-generating unit of which it is a part. [IAS 38.60]. This process is described further in Chapter 18. What this means is that entities will be required to recognise on acquisition some research and development expenditure that they would not have been able to recognise if it had been an internal project. The IASB was aware of this inconsistency when it developed the previous version of IFRS 3, but concluded that this did not provide a basis for subsuming in-process research and development within goodwill. It has considered the alternative (a reconsideration of the conditions for recognition of research and development costs) as being outwith the scope of the business combinations project. [IFRS 3.BC106 (2007), IAS 38.BC82]. Although the amount attributed to the project is accounted for as an asset, IAS 38 goes on to require that any subsequent expenditure incurred after the acquisition of the project is to be accounted for in accordance with paragraphs 54-62 of IAS 38. [IAS 38.42]. These requirements are discussed in Chapter 15 at 8.2.

The inference is that the in-process research and development expenditure recognised as an asset on acquisition that never progresses to the stage of satisfying the recognition criteria for an internal project will ultimately be impaired, although it may be that this impairment will not arise until the entity is satisfied that the project will not continue. However, since it is an intangible asset not yet available for use, such an evaluation cannot be significantly delayed as it will need to be tested for impairment annually by comparing its carrying amount with its recoverable amount. [IAS 36.10].

Chapter 9

In summary, this means that the subsequent expenditure is: (a) recognised as an expense when incurred if it is research expenditure; (b) recognised as an expense when incurred if it is development expenditure that does not satisfy the criteria for recognition as an intangible asset in paragraph 57; and (c) added to the carrying amount of the acquired in-process research or development project if it is development expenditure that satisfies the recognition criteria in paragraph 57. [IAS 38.43].


508

Chapter 9 7.5.2.F

Emission rights acquired in a business combination

If an acquiree has been granted emission rights or allowances under a cap and trade emission rights scheme (see Chapter 15 at 13.3), how should an acquirer recognise these rights and associated liabilities? Emission rights meet the definition of an intangible asset and should therefore be recognised at the acquisition date at their fair value. Likewise, the acquirer is required to recognise a liability at fair value for the actual emissions made at the acquisition date. As discussed in Chapter 15 at 13.3.2 one approach that may be adopted in accounting for such rights is the ‘net liability approach’ whereby the emission rights are recorded at a nominal amount and the entity will only record a liability once the actual emissions exceed the emission rights granted and still held. Where the acquiree has adopted such an approach, it may be that at the date of acquisition it has not recognised an asset or liability. Nevertheless, the acquirer should recognise the emission rights as intangible assets at their fair value and a liability at fair value for the actual emissions made at the acquisition date. As discussed in Chapter 15 at 13.3.2, the net liability approach is not permitted for purchased emission rights and therefore is also not permitted to be applied to emission rights of the acquiree in a business combination. Example 9.10: 

Emission rights acquired in a business combination under the ‘net  liability approach’ 

Entity A acquires all of the shares in Entity B. Entity B had been granted emission rights for free and adopted the net liability approach for recognition of emission rights prior to the acquisition. At acquisition date the emission rights held exceed the actual emissions made and hence no asset or provision is recognised in the financial statements of Entity B in respect of emissions. Entity A also adopts the net liability approach for emission rights granted. In a business combination, the emission rights of the acquiree, regardless of how the acquiree received these rights, are considered to be rights purchased by the Entity A group. Accordingly, they should be treated in the same manner as emission rights purchased directly by the group. At the acquisition date Entity A recognises the emission rights held by Entity B as intangible assets at fair value and recognises a provision for the actual emissions made up to that date at fair value.

One impact of this is that subsequent to the acquisition, the consolidated income statement will show an expense for the actual emissions made thereafter as a provision will have to be recognised on an ongoing basis. As discussed in Chapter 15 at 13.3.2.A, there are different views of the impact that such ‘purchased’ emission rights have on the measurement of the provision. The emission rights held by the acquiree will relate to specific items of property, plant and equipment. Therefore when determining the fair value of these assets, care needs to be taken to ensure that there is no double counting of the rights held. 7.5.2.G

Determining the fair values of intangible assets

Due to the IASB’s current project on fair value measurement, much of the guidance relating to fair value that was contained in the previous version of IFRS 3 is no longer included in IFRS 3. Nevertheless, IAS 38 continues to have guidance relating to determining the acquisition-date fair value of an intangible asset acquired in a


Business combinations

509

business combination. It states that the fair value of an intangible asset will reflect expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. [IAS 38.33]. IAS 38 states that ‘quoted market prices in an active market provide the most reliable estimate of the fair value of an intangible asset’, [IAS 38.39], an active market being as defined in that standard (see Chapter 15 at 1.2). It goes on to say that ‘the appropriate market price is usually the current bid price. If current bid prices are unavailable, the price of the most recent similar transaction may provide a basis from which to estimate fair value, provided that there has not been a significant change in economic circumstances between the transaction date and the date at which the asset’s fair value is estimated.’ [IAS 38.39]. However, IAS 38 also notes that it is uncommon for an active market to exist for intangible assets and that such a market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, [IAS 38.78], i.e. many of the intangible assets that IFRS 3 and IAS 38 require an acquirer to recognise in a business combination. Although IFRS 3 made some consequential amendments to IAS 38, the valuation guidance given in IAS 38, if no active market exists, did not originally change. However, as part of the annual improvement standard issued in April 2009, the IASB revised the guidance in IAS 38 to clarify the description of valuation techniques commonly used by entities when measuring the fair value of intangible assets acquired in a business combination that are not traded in active markets.

The guidance acknowledges that entities that are involved in the purchase and sale of intangible assets may have developed techniques for estimating their fair values indirectly. Accordingly, it allows these techniques to be used for initial measurement of an intangible asset acquired in a business combination if their objective is to estimate fair value and if they reflect current transactions and practices in the industry to which the asset belongs. However, it clarifies that these techniques include, for example: [IAS 38.41] (a) discounting estimated future net cash flows from the asset; or (b) estimating the costs the entity avoids by owning the intangible asset and not needing: (i) to license it from another party in an arm’s length transaction (as in the ‘relief from royalty’ approach, using discounted net cash flows); or (ii) to recreate or replace it (as in the cost approach).

Chapter 9

Accordingly, the guidance in IAS 38 requires that if no active market exists the intangible assets should be valued on a basis that reflects the amounts the acquirer would have paid for the assets in arm’s length transactions between knowledgeable willing parties, based on the best information available. In determining this amount, an entity considers the outcome of recent transactions for similar assets. For example, an entity may apply multiples reflecting current market transactions to factors that drive the profitability of the asset (such as revenue, operating profit or earnings before interest, tax, depreciation and amortisation). [IAS 38.40].


510

Chapter 9 It is generally considered that there are three broad approaches to valuing intangible assets as shown in the diagram below. Observable Market Prices Market Approaches

If not possible

Comparable Market Transactions

Relief from Royalty

Income Approaches

If not possible

Multi-Period Excess Earnings

Incremental Cash Flow

Indexed Historical Cost Cost Approaches Replacement Costs

Under a market-based approach, if no actual market prices are available for the respective asset, the fair value of the intangible is derived by analysing similar intangible assets that have recently been sold or licensed, and then comparing these transactions to the intangible asset that needs to be valued. This approach is regarded as preferable where an active market for the assets exist. However, in practice, the ability to use such an approach is very limited. Intangible assets are generally unique, and there is rarely an active market to examine. A cost-based approach is generally regarded as having limited application and difficult to use in many cases. The premise of the cost approach is that an investor would pay no more for an intangible asset than the cost to recreate it. However, for most intangibles, cost approaches are rarely consistent with the definition of ‘fair value’. Income-based approaches are much more commonly used. These involve identifying the expected economic benefits to be derived from the ownership of the particular intangible asset, and calculating the fair value of an intangible asset at the present value of those benefits. These are discussed further below.


Business combinations

511

For each asset, there are often several methodologies which can be applied. The choice will depend on the circumstances, in particular the nature of the value brought by the asset to the company (i.e. additional revenue, cost savings, replacement time and cost savings, etc.). In some cases, two methods may be used for the same asset – one as the primary approach to valuing the asset and the other as a check for reasonableness. The two main income-based approaches that are used are: • the Multi Period Excess Earnings Method (‘MEEM’) • the Relief from Royalty method. A discounted cash flow method may be used, for example, in determining the value of cost-savings that will be achieved as a result of having a supply contract with advantageous terms in relation to current market rates.

The Relief from Royalty method is used in many cases to calculate the value of a trademark or trade name. This approach is based on the concept that if an entity owns a trademark, it does not have to pay for the use of it and therefore is relieved from paying a royalty. The amount of that theoretical payment is used as a surrogate for income attributable to the trademark. The valuation is arrived at computing the present value of the after-tax royalty savings using an appropriate discount rate. The after-tax royalty savings are calculating by applying an appropriate royalty rate to the projected revenue, deducting the legal protection expenses relating to the trademark, and an allowance for tax at the appropriate rate. Companies will generally use more than one of the above approaches in attributing fair values to intangible assets in a business combination as illustrated in the following extract:

Chapter 9

The MEEM approach will generally be used in valuing the most important intangible asset. This is because it is effectively a residual cash flow approach. The key issue in using this approach is how to determine the income/cash flow that is related to the intangible asset being valued, and the fact that it is not the full cash flow of the business that is used. As its name suggests, the value of an intangible asset determined under the MEEM approach is estimated through the sum of the discounted future excess earnings attributable to the intangible asset. The excess earnings is the difference between the after-tax operating cash flow attributable to the intangible asset and the required cost of invested capital on all other assets used in order to generate those cash flows. These contributory assets include property, plant and equipment, other identifiable intangible assets and net working capital. The allowance made for the cost of such capital is based on the value of such assets and a required rate of return reflecting the risks of the particular assets. As noted at 7.5.4 below, although it cannot be recognised as a separate identifiable asset, an assembled workforce may have to be valued for the purpose of calculating a ‘contributory asset charge’ in determining the fair value of an intangible asset under the MEEM approach.


512

Chapter 9 Extract 9.4: Bayer AG (2005)  Notes to the Consolidated Financial Statements of the Bayer Group [extract] 5. Critical accounting policies Acquisition accounting [extract] We account for the acquired businesses using the purchase method of accounting which requires that the assets acquired and the liabilities assumed be recorded at the date of acquisition at their respective fair values. The application of the purchase method requires certain estimates and assumptions especially concerning the determination of the fair values of acquired intangible assets and property, plant and equipment as well as liabilities assumed at the date of the acquisition. Moreover the useful lives of the acquired intangible assets, property, plant and equipment have to be determined. The judgments made in the context of the purchase price allocation can materially impact our future results of operations. Accordingly, for significant acquisitions, we obtain assistance from third party valuation specialists. The valuations are based on information available at the acquisition date. Significant judgments and assumptions made regarding the purchase price allocation in the course of the acquisition of Schering AG, Berlin, Germany, included the following: For intangible assets associated with products, product related technology, and qualified in-process research and development (IPR&D) we base our valuation on the expected future cash flows using the Multi-Period Excess Earnings approach. This method employs a discounted cash flow analysis using the present value of the estimated after-tax cash flows expected to be generated from the purchased intangible asset using risk adjusted discount rates and revenue forecasts as appropriate. The period of expected cash flows was based on the individual patent protection, taking into account the term of the product’s main patent protection and essential extension of patent protection, as well as market entry of generics, considering sales, volume, potential defense strategies and market development at patent expiry. For the valuation of brands, the relief-from-royalty method was applied which includes estimating the cost savings that result from the company’s ownership of trademarks and licenses on which it does not have to pay royalties to a licensor. The intangible asset is then recognized at the present value of these savings. The brand-specific royalty rates were calculated using a product-specific scoring model. The corporate brands “Schering” and “Medrad” were assumed to have an unlimited life. (Please note that the rights to the name “Schering” in the United States and Canada do not belong to us but to Schering-Plough Corporation, New Jersey. Schering-Plough Corporation and the company acquired by Bayer in June 2006, i.e. Bayer Schering Pharma AG (formerly named Schering AGI, Berlin, Germany, are unaffiliated companies that have been totally independent of each other for many years.) Product brands, however, were assumed to have limited lives depending on the respective products’ life cycles. The expected amortization of these assets is determined on the basis of expected product-specific revenues.

Another example is ITV as shown in Extract 9.2 at 7.5.2.B above. In some situations, it may be that the value of an intangible asset will reflect not only the present value of the future post-tax cash flows as indicated above, but also the value of any tax benefits (sometimes called ‘tax amortisation benefits’) that the owner might have obtained if the asset had been bought separately, i.e. not as part of a business combination. Whether such tax benefits are included will depend on the nature of the intangible asset and the relevant tax jurisdiction. Where such a value is included in the fair value of the intangible asset, an asset that has been purchased as part of a business combination may be one that is wholly or in part not actually taxdeductible by the entity. This therefore raises a potential impairment issue that is discussed in Chapter 18 at 5.4.2. Another issue relating to the valuation of intangible assets is whether the acquirer’s intention in relation to those assets should be taken into account in attributing a fair


Business combinations

513

value, for example, where the acquirer does not intend to use an intangible asset of the acquiree. This is now explicitly addressed in IFRS 3 as discussed at 7.5.6 below. 7.5.3

Reacquired rights

One particular identifiable intangible asset that IFRS 3 requires an acquirer to recognise separately from goodwill is that of a reacquired right, that is a right previously granted to the acquiree to use one or more of the acquirer’s recognised or unrecognised assets. For example, a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement. [IFRS 3.B35]. The Basis for Conclusions accompanying IFRS 3 notes that some commentators suggested recognising a reacquired right as the settlement of a pre-existing relationship; others said that a reacquired right should be recognised as part of goodwill. The IASB rejected the former because reacquisition of, for example, a franchise right does not terminate the right. After a business combination, the right to operate a franchised outlet in a particular region continues to exist. The difference is that the acquirer, rather than the acquiree by itself, now controls the franchise right. The IASB also rejected recognising a reacquired right as part of goodwill. Supporters of that alternative consider that such a right differs from other identifiable intangible assets recognised in a business combination because, from the perspective of the combined entity, a franchising relationship with an outside party no longer exists. As already noted, however, the reacquired right and the related cash flows continue to exist. The IASB concluded that recognising that right separately from goodwill provides users of the financial statements of the combined entity with more decision-useful information than subsuming the right into goodwill. The IASB also observed that a reacquired right meets the contractual-legal and the separability criteria and therefore qualifies as an identifiable intangible asset. [IFRS 3.BC182-184]. Guidance on the valuation of such reacquired rights, and their subsequent accounting, is discussed at 7.6.5 below.

7.5.4

Assembled workforce and other items that are not identifiable

The discussion at 7.5.2 above deals with the requirement in IFRS 3 for an acquirer to recognise, separately from goodwill, the identifiable assets acquired in a business combination. The corollary, therefore, is that the acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of the acquisition date.

Chapter 9

Although the reacquired right itself is not treated as a termination of a pre-existing relationship, to the extent that the terms of the contract giving rise to the reacquired right are favourable or unfavourable relative to the terms of current market transactions for the same or similar items, IFRS 3 regards this as the settlement of a pre-existing relationship and the acquirer has to recognise a settlement gain or loss. [IFRS 3.B36]. Guidance on the measurement of any settlement gain or loss is discussed at 13.1 below.


514

Chapter 9 7.5.4.A

Assembled workforce

A particular example of such an intangible asset is that of an assembled workforce, which IFRS 3 regards as being an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date. [IFRS 3.B37]. Because an assembled workforce is a collection of employees rather than an individual employee, it does not arise from contractual or legal rights. Although individual employees might have employment contracts with the employer, the collection of employees, as a whole, does not have such a contract. In addition, an assembled workforce is not separable, either as individual employees or together with a related contract, identifiable asset or liability. An assembled workforce cannot be sold, transferred, licensed, rented or otherwise exchanged without causing disruption to the acquirer’s business. In contrast, an entity could continue to operate after transferring an identifiable asset. Therefore, an assembled workforce is not an identifiable intangible asset to be recognised separately from goodwill. [IFRS 3.BC178]. IFRS 3 also states that an assembled workforce does not represent the intellectual capital of the skilled workforce – the (often specialised) knowledge and experience that employees of an acquiree bring to their jobs. [IFRS 3.B37]. The IASB observed that the value of intellectual capital is, in effect, recognised because it is part of the fair value of the entity’s other intangible assets, such as proprietary technologies and processes and customer contracts and relationships. In that situation, a process or methodology can be documented and followed to the extent that the business would not be materially affected if a particular employee left the entity. In most jurisdictions, the employer usually ‘owns’ the intellectual capital of an employee. Most employment contracts stipulate that the employer retains the rights to and ownership of any intellectual property created by the employee. For example, a software program created by a particular employee (or group of employees) would be documented and generally would be the property of the entity. The particular programmer who created the program could be replaced by another software programmer with equivalent expertise without significantly affecting the ability of the entity to continue to operate. But the intellectual property created in the form of a software program is part of the fair value of that program and is an identifiable intangible asset if it is separable from the entity. In other words, the prohibition of recognising an assembled workforce as an intangible asset does not apply to intellectual property; it applies only to the value of having a workforce in place on the acquisition date so that the acquirer can continue the acquiree’s operations without having to hire and train a workforce. [IFRS 3.BC180]. As indicated in the Basis for Conclusions accompanying IFRS 3, some commentators said that an assembled workforce may be valued in many situations for the purpose of calculating a ‘contributory asset charge’ in determining the fair value of some intangible assets. [IFRS 3.BC177]. Nevertheless, because the assembled workforce is not an identifiable asset to be recognised separately from goodwill, any value that may be attributed to it by the acquirer is subsumed into goodwill. [IFRS 3.B37].


Business combinations 7.5.4.B

515

Items not qualifying as assets

The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at the acquisition date.

Potential contracts with new customers

IFRS 3 notes, for example, that the acquirer might attribute value to potential contracts the acquiree is negotiating with prospective new customers at the acquisition date. Because those potential contracts are not themselves assets at the acquisition date, the acquirer does not recognise them separately from goodwill. In that case, the acquirer should not subsequently reclassify the value of those contracts from goodwill for events that occur after the acquisition date. However, IFRS 3 goes on to say that the acquirer should assess the facts and circumstances surrounding events occurring shortly after the acquisition to determine whether a separately recognisable intangible asset existed at the acquisition date. [IFRS 3.B38].

Contingent assets

Another example would be where the acquiree has a contingent asset. The IASB clarifies in the Basis for Conclusions accompanying IFRS 3 that these should not be recognised unless they meet the definition of an asset in the IASB’s Framework. This also appears to be the case even if it is virtually certain that they will become unconditional or non-contingent. It would only be if the entity determines that an asset exists at the acquisition date (that is, that it has an unconditional right at the acquisition date) that an asset is to be recognised. [IFRS 3.BC276]. This does appear to be inconsistent with the requirements of IAS 37 which states that, when the realisation of income is virtually certain, then the related asset is no longer regarded as contingent and recognition is appropriate (see Chapter 25 at 3.2.2). [IAS 37.33].

Future contract renewals

One other situation discussed in IFRS 3 is future contract renewals. Although the identifiability criteria determine whether an intangible asset is recognised separately from goodwill, IFRS 3 notes that in measuring the fair value of an intangible asset, the acquirer would take into account assumptions that market participants would consider, such as expectations of future contract renewals, in measuring fair value of that intangible asset. It is not necessary for the renewals themselves to meet the identifiability criteria. [IFRS 3.B40]. In this case any value attributable to the expected future renewal contracts is reflected in the value of, say, the customer relationship, rather than being subsumed within goodwill. As discussed at 7.6.5 below, IFRS 3 establishes an exception to the fair value measurement principle for reacquired rights recognised in a business combination. In that case, any potential contract renewals that market participants would consider in determining the fair value of those rights would be subsumed within goodwill. 7.5.5

Assets with uncertain cash flows (valuation allowances)

An acquiree may have financial assets, such as receivables and loans, against which it may have recognised a provision or valuation allowance for impairment or uncollectible amounts. However, an acquirer cannot ‘carry over’ any such valuation allowances nor create its own separate valuation allowances in respect of those financial assets. Under

Chapter 9


516

Chapter 9 IFRS 3, the acquirer may not recognise a separate provision or valuation allowance as of the acquisition date for assets acquired in a business combination that are initially recognised at fair value. For example, as receivables (including loans) that are acquired in a business combination are to be recognised and measured at fair value at the acquisition date, any uncertainty about collections and future cash flows are included in the fair value measure. Accordingly, the acquiring entity does not recognise a separate provision or valuation allowance for the contractual cash flows that are deemed to be uncollectible at the acquisition date. [IFRS 3.B41]. 7.5.6

Assets that the acquirer intends not to use or to use in a way that is different from other market participants

For competitive or other reasons, the acquirer may intend not to use an acquired asset, for example, a research and development intangible asset, or it may intend to use the asset in a way that is different from the way in which other market participants would use it. Nevertheless, IFRS 3 requires that the acquirer recognises all such identifiable assets, and measures the asset at its fair value determined in accordance with its use by other market participants. [IFRS 3.B43]. This does raise an issue as to whether an immediate impairment loss should be reflected if the acquirer does not intend to use the intangible asset to generate its own cash flows IFRS 3 does not address this particular issue. However, in our view there should be no immediate impairment loss. As discussed at 2.3 of Chapter 18, for the purposes of the impairment test under IAS 36, the recoverable amount of an asset is the higher of its value in use and its fair value less costs to sell. The fair value of the intangible asset will initially not be materially different from the fair value attributed to it, and therefore unlikely to be impaired. However, if the entity is not intending to use the intangible asset to generate cash flows, it is unlikely that it could be regarded as having an indefinite life for the purposes of IAS 38, and therefore it should be amortised over its expected useful life, which is likely to be relatively short. Example 9.11: 

Acquirer’s intention not to use an intangible asset 

Entity A acquires a competitor, Entity B. One of the identifiable intangible assets of Entity B is the trade name of one of Entity B’s branded products. However, since Entity A has a similar product, it does not intend to use that trade name post-acquisition. Entity A will discontinue sales of Entity B’s product, thereby eliminating competition and enhancing the value of its own branded product. The cash flows relating to the acquired trade name are therefore expected to be nil. Given that the cash flows relating to that trade name will be nil, can Entity A attribute a fair value of nil to that trade name? As indicated above, the fair value of the asset has to be determined in accordance with its use by other market participants. Accordingly, Entity A’s future intentions about the asset should only be reflected in determining the fair value if that is what other market participants would do. In most situations, this will not be the case as there are likely to be other market participants that would continue to sell the product and, on that basis, it is likely that the trade name does have a value. In fact, Entity A could probably have sold the trade name post-acquisition, but it has chosen not to do that to protect its own branded product. Accordingly, a fair value is attributed to that trade name. Indeed, even if all other market participants would do the same as Entity A, i.e. not sell the product in order to enhance the value of their own products, the trade name is still likely to have a value.


Business combinations

517

Although the expected cash flows relating to the trade name are nil, there should be no immediate impairment loss. As discussed at 2.3 of Chapter 18, for the purposes of the impairment test under IAS 36, the recoverable amount of an asset is the higher of its value in use and its fair value less costs to sell. The fair value of the trade name will initially not be materially different from the fair value attributed to it, and therefore unlikely to be impaired. However, since Entity A is not intending to use the trade name to generate cash flows, it is unlikely that it could be regarded as having an indefinite life for the purposes of IAS 38, and therefore it should be amortised over its expected useful life. The estimate of the life should reflect the use to which Entity A is putting the trade name, which is as a means of eliminating competition for its own product. This is likely to be a relatively short period as the impact of the absence of that particular trade name in the market will not last for long, and any value that it did have will quickly reduce.

7.5.7

Investments in equity-accounted entities

It may be that one of the identifiable assets of an acquiree is an investment in an associate, which under IAS 28 is accounted for under the equity method (see Chapter 11 at 3). For the purposes of recognising and measuring this identifiable asset, there is no difference between an investment that is an associate or an investment that is a trade investment because the acquirer has acquired the investment not the underlying assets and liabilities of the associate. Accordingly, the fair value of the associate should be determined on the basis of the value of the shares of the associate rather than calculating a fair value based on the appropriate share of the fair values of the various identifiable assets and liabilities of the associate. By doing so, any goodwill relating to the associate is subsumed within the carrying amount for the associate rather than within the goodwill arising on the overall business combination. Nevertheless, although this fair value is effectively the ‘cost’ to the group to which equity accounting is applied, the underlying fair values of the various identifiable assets and liabilities also need to be determined to apply equity accounting (see Chapter 11 at 3.2). If the fair value exercise for the business combination results in a gain on bargain purchase (commonly referred to as ‘negative goodwill’), in accordance with the requirements of IFRS 3 discussed at 12 below, the acquirer should challenge the fair value placed on the associate as it rechallenges the values place on all of the assets and liabilities of the acquiree to ensure that the value has not been overstated. The above would also apply where one of the identifiable assets of an acquiree is an investment is a jointly controlled entity, which under IAS 31 is accounted for under the equity method (see Chapter 12 at 5.4). Deferred revenue

An acquiree may have recorded deferred revenue at the date of acquisition. This could be due to a number of reasons. For example, it could be that it represents upfront payments for services or products that have yet to be delivered, or payments for delivered goods or services sold as a part of a multiple-element arrangement that could not be accounted for separately from undelivered items included in the same arrangement. In accounting for a business combination, an acquirer should recognise a liability for deferred revenue of the acquiree only if it relates to an outstanding performance obligation assumed by the acquirer. Such performance obligations would include obligations to provide goods or services, or the right to use an asset.

Chapter 9

7.5.8


518

Chapter 9 The measurement of the deferred revenue liability should be based on the fair value of the obligation at the date of acquisition, which will not necessarily be the same as the amount of deferred revenue recognised by the acquiree. In general, the fair value of an assumed deferred revenue obligation would be less than the amount recognised by the acquiree, as the amount of revenue that a market participant would expect to receive for meeting that obligation would not include any profit element relating to the selling or other efforts already completed by the acquiree. Example 9.12: 

Deferred revenue of an acquiree 

Target is an electronics company that sells contracts to service all types of electronics equipment for an upfront annual fee of $120,000. Acquirer purchases Target in a business combination. At the acquisition date, Target has one service contract outstanding with 6 months remaining and for which $60,000 of deferred revenue is recorded in Target’s pre-acquisition financial statements. To fulfill the contract over its remaining 6-month term, Acquirer estimates that a market participant would expect to receive $54,000 for fulfilling that obligation. It has estimated that a market participant would incur direct and incremental costs of $45,000, and expect a profit margin for that fulfillment effort of 20%, i.e. $9,000, and would, thus, expect to receive $54,000. Accordingly, Acquirer will recognise a liability of $54,000 in respect of the deferred revenue obligation.

However, where the deferred revenue balance of the acquiree does not relate to an outstanding performance obligation, but relates to goods or services that have already been delivered by the acquiree, no liability should be recognised by the acquirer in a business combination. Where an acquiree has deferred revenue balances as a result of contractual obligations, the acquirer also needs to consider the recognition of customer related intangible assets (see 7.5.2 above). 7.6

Exceptions to the recognition and/or measurement principles

The IASB has made a number of exceptions to the principles in IFRS 3 that all assets acquired and liabilities assumed should be recognised and measured at fair value. For the particular items discussed below, IFRS 3 requires the acquirer to account for those items by applying the requirements in paragraphs 22-31 of the standard, which will result in some items being: [IFRS 3.21] (a) recognised either by applying recognition conditions in addition to those in paragraphs 11 and 12 of IFRS 3 or by applying the requirements of other IFRSs, with results that differ from applying the recognition principle and conditions; and/or (b) measured at an amount other than their acquisition-date fair values. 7.6.1

Contingent liabilities

IAS 37 defines a contingent liability as: [IFRS 3.22, IAS 37.10] (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or


Business combinations (b)

519

a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) the amount of the obligation cannot be measured with sufficient reliability.

7.6.1.A

Initial recognition and measurement

Under IAS 37, contingent liabilities are only disclosed in financial statements, they are not recognised as liabilities. However, IFRS 3 states that ‘the requirements in IAS 37 do not apply in determining which contingent liabilities to recognise as of the acquisition date’. Instead, IFRS 3 requires that for contingent liabilities assumed in a business combination, the acquirer recognises a liability at its fair value if there is a present obligation arising from a past event that can be reliably measured, even if it is not probable that an outflow of resources will be required to settle the obligation. [IFRS 3.23]. However, for a contingent liability that only represents a possible obligation that arises from a past event, whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, no liability is to be recognised under IFRS 3 . [IFRS 3.BC275]. Similarly, no liability is recognised in respect of a contingent liability that represents a present obligation arising from a past event but whose acquisitiondate fair value cannot be measured reliably. As discussed at 7.5.4.B above, the IASB clarifies in the Basis for Conclusions accompanying IFRS 3 that contingent assets should not be recognised unless they meet the definition of an asset in the IASB’s Framework. These requirements of IFRS 3 differ from those proposed in the June 2005 exposure draft which reflected proposed changes to the requirements of IAS 37 contained in another exposure draft issued at the same time, but the project on revising IAS 37 has been delayed (see Chapter 25 at 8.1 for a discussion of those proposals). 7.6.1.B

Subsequent measurement and accounting

IFRS 3 requires that after initial recognition and until the liability is settled, cancelled or expires, the acquirer measures a contingent liability that is recognised in a business combination at the higher of: [IFRS 3.56] (a) the amount that would be recognised in accordance with IAS 37, and (b) the amount initially recognised less, if appropriate, cumulative amortisation recognised in accordance with IAS 18. The implications of part (a) of the requirement are clear. If the acquiree has to recognise a provision in respect of the former contingent liability, and the best estimate of this liability is higher than the original fair value attributed by the acquirer, then the greater liability should now be recognised by the acquirer with the difference taken to the income statement. It would now be a provision to be measured and recognised in accordance with IAS 37. What is less clear is part (b) of

Chapter 9

Where a liability is recognised for a contingent liability, since this is not what would be required under IAS 37, IFRS 3 contains requirements for the subsequent measurement and accounting of such liabilities.


520

Chapter 9 the requirement. The reference to ‘amortisation recognised in accordance with IAS 18’ might relate to the recognition of income in respect of those loan commitments that are contingent liabilities of the acquiree, but have been recognised at fair value at date of acquisition. The implication of the requirement would appear to mean that, unless amortisation under IAS 18 is appropriate, the amount of the liability cannot be reduced below its originally attributed fair value until the liability is settled, cancelled or expires. Despite the fact that the requirement for subsequent measurement discussed above was originally introduced for consistency with IAS 39, [IFRS 3.BC245], IFRS 3 makes it clear that the requirement does not apply to contracts accounted for in accordance with IAS 39. [IFRS 3.56]. However, this would appear to mean that contracts that are excluded from the scope of IAS 39, but are accounted for by applying IAS 37, i.e. loan commitments other than those that are commitments to provide loans at belowmarket interest rates, will fall within the requirements of IFRS 3 outlined above. It was explicitly stated in the previous version of IFRS 3 that such loan commitments were to be regarded as contingent liabilities of the acquiree. [IFRS 3.49 (2007)]. 7.6.2

Income taxes

IFRS 3 requires the acquirer to recognise and measure a deferred tax asset or liability arising from the assets acquired and liabilities assumed in a business combination in accordance with IAS 12. [IFRS 3.24]. The acquirer is also required to account for the potential tax effects of temporary differences and carryforwards of an acquiree that exist at the acquisition date or arise as a result of the acquisition in accordance with IAS 12. [IFRS 3.25]. As most, if not all, of the requirements of IAS 12 are arguably consistent with the recognition principle in IFRS 3, the IASB had considered identifying deferred tax assets and liabilities as an exception to only the measurement principle of using acquisition-date fair values. This is because deferred tax assets or liabilities generally are measured at undiscounted amounts in accordance with IAS 12, and it was decided not to require deferred tax assets or liabilities acquired in a business combination to be measured at fair value. However, the requirements are identified as being exceptions to both the recognition and measurement principles of IFRS 3 to more clearly indicate that the acquirer should apply the recognition and measurement provisions of IAS 12. [IFRS 3.BC279-281]. However, in order to address specific issues pertaining to the acquirer’s income tax accounting in connection with a business combination, and to make the accounting more consistent with the principles in IFRS 3, the requirements of IAS 12 were amended. The first change relates to accounting for deferred tax benefits that do not meet the recognition criteria at the date of acquisition, but are subsequently recognised. IAS 12 now requires that: [IAS 12.68] (a) acquired deferred tax benefits recognised within the measurement period (see 14 below) that result from new information obtained about facts and circumstances existing at the acquisition date are to reduce the goodwill related to that acquisition. If the carrying amount of goodwill is zero, any remaining deferred tax benefits is to be recognised in profit or loss; and


Business combinations (b)

521

all other acquired tax benefits realised are to be recognised in profit or loss.

It will therefore be necessary to carefully assess the reasons for changes in the assessment of deferred tax made during the measurement period to determine whether it relates to facts and circumstances at the acquisition date or if it is a change in facts and circumstances since acquisition date. This differs from the treatment under the previous version of IFRS 3 of deferred tax benefits subsequently recognised, whereby the carrying amount of goodwill was reduced for the subsequent recognition of such deferred tax benefits without any time limit. IAS 12 was also amended so that tax benefits arising from the excess of taxdeductible goodwill over goodwill for financial reporting purposes is accounted for at the acquisition date as a deferred tax asset in the same way as other temporary differences. [IAS 12.32A]. The requirements of IAS 12 relating to the deferred tax consequences of business combinations are discussed further in Chapter 27 at 12. 7.6.3

Employee benefits

IFRS 3 requires the acquirer to recognise and measure a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with IAS 19. [IFRS 3.26].

Accordingly, the acquirer recognises assets and liabilities arising from postemployment benefits that are defined benefit plans at the present value of the defined benefit obligation less the fair value of any plan assets. In computing the present value of the obligation, IAS 19 requires that any items such as actuarial gains and losses (whether or not within the 10% corridor allowed by IAS 19), past service costs and amounts not yet recognised by the acquiree under the transitional provisions of IAS 19 at the date of the acquisition are included. [IAS 19.108]. This means that there are no exemptions for the acquirer from recognising the full defined benefit obligation on acquisition. However, a net asset is recognised only to the extent that it is recoverable, based on the requirements of IAS 19 and IFRIC 14 (see Chapter 29 at 5.3.2). Although IAS 19 only refers to business combinations in the context of defined benefit plans, IFRS 3 requires liabilities (or assets, if any) related to all other types of employee benefit arrangements to be recognised and measured under IAS 19, rather than at their acquisition-date fair values. [IFRS 3.26, BC296-300].

Chapter 9

As with deferred tax assets and liabilities discussed at 7.6.2 above, the IASB considered identifying employee benefits as an exception only to the measurement principle, but in order to make it clear that the acquirer should apply the recognition and measurement requirements of IAS 19 without separately considering the extent to which those requirements are consistent with the principles of IFRS 3, it exempts employee benefit obligations from both the recognition and measurement principles of IFRS 3. [IFRS 3.BC297-299].


522

Chapter 9 7.6.4

Indemnification assets

In certain situations, primarily those related to uncertainties as to the outcome of pre-acquisition contingencies (e.g. uncertain tax positions, environmental liabilities, or legal matters), the seller in a business combination may contractually indemnify the acquirer for the outcome of the contingency or uncertainty related to all or part of the specific asset or liability. The indemnification typically requires the acquiree’s selling shareholders to reimburse the acquirer for some or all of the costs incurred by the acquirer in connection with the assumed pre-acquisition contingency. For example, the seller may indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency, in other words, the seller will guarantee that the acquirer’s liability will not exceed a specified amount. As result, IFRS 3 considers that the acquirer has obtained an indemnification asset. [IFRS 3.27]. Such indemnities were not explicitly addressed in the previous version of IFRS 3 but were either treated as ‘negative’ contingent consideration or as a separate ‘indemnity asset’. 7.6.4.A

Initial recognition and measurement

From the acquirer’s perspective, the indemnification is an acquired asset to be recognised at its acquisition-date fair value. However, in order to avoid ‘recognition or measurement’ anomalies for indemnifications related to items for which liabilities are either not recognised or are not required to be measured at fair value (e.g. uncertain tax positions), IFRS 3 (makes an exception to the general principles of recognising the indemnification asset at its acquisition-date fair values. [IFRS 3.BC302-303].

Accordingly, under IFRS 3 the acquirer recognises an indemnification asset at the same time that it recognises the indemnified item measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. Therefore, if the indemnification relates to an asset or a liability that is recognised at the acquisition date and measured at its acquisition-date fair value, the acquirer recognises the indemnification asset at the acquisition date measured at its acquisition-date fair value. For an indemnification asset measured at fair value, the effects of uncertainty about future cash flows because of collectibility considerations are included in the fair value measure and a separate valuation allowance is not necessary (see 7.5.5 above). [IFRS 3.27]. However, in some circumstances, the indemnification relates to an asset or liability that is an exception to recognition or measurement principles of IFRS 3. For example, an indemnification may relate to a contingent liability that is not recognised at the acquisition date because its fair value is not reliably measurable at that date [IFRS 3.28] or it is only a possible obligation at that date (see 7.6.1 above). Alternatively, an indemnification may relate to an asset or a liability, for example, one that results from an employee benefit, that is measured on a basis other than acquisition-date fair value. [IFRS 3.28]. Another example would be an indemnification pertaining to a tax liability that is measured in accordance with IAS 12, rather than its acquisition-date fair value (see 7.6.2 above). If the indemnified item is recognised as a liability at the acquisition date, but is measured on a basis other than


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acquisition-date fair value, the indemnification asset is recognised and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of collectability of the indemnification asset and any contractual limitations on the indemnified amount. [IFRS 3.27-28]. However, if no liability is recognised for the indemnified item at the date of acquisition, the indemnification asset would also not be recognised. 7.6.4.B

Subsequent measurement and accounting

Subsequent to the business combination, the indemnification asset is measured using the same assumptions used to calculate the indemnified liability or asset, subject to any contractual limitations on its amount and, for an indemnification asset that is not subsequently measured at its fair value, management’s assessment of collectability of the indemnification asset. [IFRS 3.57]. Thus, where the change in the value of the related indemnified liability or asset has to be recognised in profit or loss, this will be offset by any corresponding change in the value recognised for the indemnification asset. The acquirer derecognises the indemnification asset only when it collects the asset, sells it or otherwise loses the right to it. [IFRS 3.57]. At its meeting in May 2009, the IASB considered a number of issues brought by the IASB staff, but deferred them to the post-implementation review of the revised versions of IFRS 3 and IAS 27 issued in January 2008, to be conducted two years after their effective date. One of these related to the treatment of indemnification assets, as part of the business combination transaction or as a separate transaction.15 It is not clear what the particular issue was as no details were included in the agenda papers available to the public. 7.6.5

Reacquired rights

7.6.5.A

Initial recognition and measurement

If the assets of the acquiree include a right previously granted to it allowing use of the acquirer’s assets (a reacquired right), IFRS 3 requires it to be recognised as an identifiable intangible asset. For example, a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement. [IFRS 3.B35]. However, rather than valuing the intangible asset at its acquisition-date fair value, it is to be valued on the basis of the remaining contractual term of the related contract, regardless of whether market participants would consider potential contractual renewals in determining its fair value. The reason for departing from the assumptions that market participants would use in measuring the fair value of the reacquired right is that it would be inconsistent with the requirement for determining the useful life of the reacquired right (as discussed at 7.6.5.B below). The IASB also noted that a contractual right transferred to a third party is not a reacquired right. [IFRS 3.BC309]. To the extent that the terms of the contract giving rise to the reacquired right are favourable or unfavourable relative to the terms of current market transactions for the same or similar items, IFRS 3 regards this as the settlement of a pre-existing

Chapter 9

[IFRS 3.29].


524

Chapter 9 relationship and the acquirer has to recognise a settlement gain or loss. [IFRS 3.B36]. Guidance on the measurement of any settlement gain or loss is discussed at 13.1 below. 7.6.5.B

Subsequent measurement and accounting

After acquisition, the intangible asset is to be amortised over the remaining contractual period of the contract, without including any renewal periods. [IFRS 3.55, BC308]. The reason for excluding any renewal periods is that a reacquired right is no longer a contract with a third party; the acquirer who controls the reacquired right could assume indefinite renewals of its contractual term, effectively making the reacquired right an intangible asset with an indefinite life. The IASB considers that a right reacquired from an acquiree has in substance a finite life; a renewal of the contractual term after the business combination is not part of what was acquired in the business combination. Accordingly, the standard limits the period over which the intangible asset is amortised to the remaining contractual term of the contract from which the reacquired right stems. [IFRS 3.BC308]. If the acquirer subsequently sells a reacquired right to a third party, the carrying amount of the intangible asset is to be included in determining the gain or loss on the sale. [IFRS 3.55, BC308].

7.6.6

Assets held for sale

IFRS 3 requires that non-current assets (or disposal groups) classified as held for sale at the acquisition date in accordance with IFRS 5 are measured at fair value less costs to sell in accordance with paragraphs 15 to 18 of that IFRS (see Chapter 4 at 2.2). [IFRS 3.31]. This exception is to avoid the need to recognise a loss for the selling costs immediately after a business combination (a so-called Day 2 loss), if the assets had initially been measured at their fair value at the acquisition date. Subsequent to the issue of the June 2005 exposure draft, the Board tentatively decided to remove the proposed exception and amend IFRS 5 by replacing the words ‘fair value less costs to sell’ with ‘fair value’. However, this was not done, but the Basis for Conclusions accompanying IFRS 3 indicated that the IASB intended that the eventual amendment to IFRS 5 would be effective at the same time as the revised IFRS 3, [IFRS 3.BC305-307], at which time this temporary exception presumably would be removed. However, at its April 2008 Board meeting, the IASB tentatively decided not to amend IFRS 5 for the measurement of non-current assets held for sale. Accordingly, the exception to the measurement principle of fair value related to non-current assets held for sale in IFRS 3 remains in force.16 7.6.7

Share-based payment transactions

IFRS 3 also provides an exception that, a liability or an equity instrument related to the share-based payment transactions of the acquiree or the replacement of an acquiree’s share-based payment transactions with share-based payment transactions of the acquirer are measured in accordance with IFRS 2 (referred to as the ‘marketbased measure’), rather than at fair value. [IFRS 3.30]. The reason for this exception is that application of measurement methods in IFRS 2 do not result in the amount at which market participants would exchange an award at a particular date (its fair value at that date), and the initial measurement of share-based payment awards at


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525

their acquisition-date fair values would cause difficulties with the subsequent accounting for those awards in accordance with IFRS 2. [IFRS 3.BC311]. Additional guidance given in IFRS 3 for accounting for replacement of share-based payment awards (i.e. vested or unvested share-based payment transactions) in a business combination is discussed at 9.2 and 13.2 below. Any equity-settled sharebased payment transactions of the acquiree that the acquirer does not exchange for its own share-based payment transactions will result in non-controlling interest in the acquiree being recognised and measured at their market-based measure as discussed at 10.4 below.

8

RECOGNISING AND MEASURING GOODWILL OR A GAIN IN A BARGAIN PURCHASE

The final step in applying the acquisition method is recognising and measuring goodwill or a gain in a bargain purchase. IFRS 3 defines ‘goodwill’ in terms of its nature, rather than in terms of its measurement. It is defined as ‘an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.’ [IFRS 3 Appendix A]. It is clear from the above definition that IFRS 3 requires the acquirer to recognise goodwill as an asset. However, having concluded that the direct measurement of goodwill is not possible, the standard requires that goodwill is measured as a residual. [IFRS 3.BC328].

Where (b) exceeds (a), IFRS 3 regards this as giving rise to a gain on a bargain purchase. [IFRS 3.34]. Bargain purchase transactions are discussed further at 12 below. The measurement of (b) has been discussed at 7 above. The items included within (a) are discussed at 9, 10 and 11 below. The computation of goodwill outlined above differs from that in the previous version of IFRS 3, which also measured goodwill as a residual. This is due to the change in focus in IFRS 3 on measuring the various components of the business combination at their acquisition-date fair values (albeit with a number of exceptions including

Chapter 9

Under IFRS 3, the measurement of goodwill at the acquisition date is computed as the excess of (a) over (b) below: [IFRS 3.32] (a) the aggregate of: (i) the consideration transferred (generally measured at acquisition-date fair value); (ii) the amount of any non-controlling interest in the acquiree; and (iii) the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree. (b) the net of the acquisition-date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed.


526

Chapter 9 that relating to the measurement of any non-controlling interest), whereas the previous version of IFRS 3 adopted a cost-based approach. As indicated above, goodwill is to be recognised as an asset. This is because the IASB has concluded that ‘core goodwill’ (see below) meets the definition of an asset in its Framework. [IFRS 3.BC322-323]. The Basis for Conclusions accompanying IFRS 3 contains a discussion of the following six components that, in practice, historically had been included in goodwill: [IFRS 3.BC313] • Component 1 – The excess of the fair values over the book values of the acquiree’s net assets at the date of acquisition; • Component 2 – The fair values of other net assets that the acquiree had not previously recognised. They may not have been recognised because they failed to meet the recognition criteria (perhaps because of measurement difficulties), because of a requirement that prohibited their recognition, or because the acquiree concluded that the costs of recognising them separately were not justified by the benefits; • Component 3 – The fair value of the going concern element of the acquiree’s existing business. The going concern element represents the ability of the established business to earn a higher rate of return on an assembled collection of net assets than would be expected if those net assets had to be acquired separately. That value stems from the synergies of the net assets of the business, as well as from other benefits (such as factors related to market imperfections, including the ability to earn monopoly profits and barriers to market entry – either legal or because of transaction costs – by potential competitors); • Component 4 – The fair value of the expected synergies and other benefits from combining the acquirer’s and acquiree’s net assets and businesses. Those synergies and other benefits are unique to each combination, and different combinations would produce different synergies and, hence, different values; • Component 5 – Overvaluation of the consideration paid by the acquirer stemming from errors in valuing the consideration tendered. Although the purchase price in an all-cash transaction would not be subject to measurement error, the same may not necessarily be said of a transaction involving the acquirer’s equity interests. For example, the number of ordinary shares being traded daily may be small relative to the number of shares issued in the combination. If so, imputing the current market price to all of the shares issued to effect the combination may produce a higher value than those shares would command if they were sold for cash and the cash then used to effect the combination; • Component 6 – Overpayment or underpayment by the acquirer. Overpayment might occur, for example, if the price is driven up in the course of bidding for the acquiree; underpayment may occur in a distress sale (sometimes termed a fire sale). Components 3 and 4 are considered by the IASB to be part of goodwill. Component 3 relates to the acquiree and reflects the excess assembled value of the acquiree’s net assets. It represents the pre-existing goodwill that was either internally generated by the acquiree or acquired by it in prior business combinations.


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Component 4 relates to the acquiree and the acquirer jointly and reflects the excess assembled value that is created by the combination – the synergies that are expected from combining those businesses. It is these components that are described collectively as ‘core goodwill’. [IFRS 3.BC316]. On the other hand, the IASB considers that the other components are conceptually not part of goodwill. Component 1 is not itself an asset; instead, it reflects gains that the acquiree had not recognised on its net assets. As such, that component is part of those assets rather than part of goodwill. Component 2 is also not part of goodwill conceptually; it primarily reflects intangible assets that might be recognised as individual assets. Component 5 is not an asset in and of itself or even part of an asset but, rather, is a measurement error. Component 6 is also not an asset; conceptually it represents a loss (in the case of overpayment) or a gain (in the case of underpayment) to the acquirer. Thus, neither of those components is conceptually part of goodwill. [IFRS 3.BC314-315]. The Basis for Conclusions goes on to say that IFRS 3 tries to avoid subsuming the first, second and fifth components of goodwill into the amount initially recognised as goodwill. Specifically, an acquirer is required to make every effort: [IFRS 3.BC317] (a) to measure the consideration accurately (eliminating or reducing component 5); (b) to recognise the identifiable net assets acquired at their fair values rather than their carrying amounts (eliminating or reducing component 1); and (c) to recognise all acquired intangible assets meeting the criteria in the revised standard (paragraph B31 of IFRS 3) so that they are not subsumed into the amount initially recognised as goodwill (reducing component 2).

The main issue relating to the goodwill acquired in a business combination is how it should be subsequently accounted for. The requirements of IFRS 3 in this respect are straightforward; but that is only because the detailed requirements in relation to the subsequent accounting for goodwill are dealt with in IAS 36. IFRS 3 merely states that the acquirer measures goodwill acquired in a business combination at the amount recognised at the acquisition date less any accumulated impairment losses. [IFRS 3.B63]. Goodwill acquired in a business combination is not to be amortised. Instead, the acquirer has to test it for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with

Chapter 9

Despite these efforts, the amount of goodwill recognised as an asset may still represent more than what the IASB regards as ‘core goodwill’. The fact that exceptions have been made such that certain assets and liabilities are not measured at their acquisition-date fair value, e.g. deferred tax assets and liabilities, will impact on the amount recognised for goodwill. As far as overpayments are concerned, it was concluded that in practice it is not possible to identify and reliably measure an overpayment at the acquisition date, and the accounting for overpayments is best addressed through subsequent impairment testing when evidence of a potential overpayment first arises. [IFRS 3.BC382].


528

Chapter 9 IAS 36. The requirements of IAS 36 relating specifically to the impairment of goodwill are dealt with in Chapter 18 at 5.

9

CONSIDERATION TRANSFERRED

The first item in part (a) of the goodwill computation set out at 8 above is the consideration transferred. IFRS 3 requires that the consideration transferred in a business combination is to be measured at fair value, and comprises the sum of the acquisition-date fair values of assets transferred by the acquirer, liabilities incurred by the acquirer to the former owners of the acquiree, and equity interests issued by the acquirer. The consideration may take many forms, including cash, other assets, a business or subsidiary of the acquirer, and securities of the acquirer (e.g. ordinary shares, preferred shares, options, warrants, and debt instruments). The consideration transferred also includes the fair value of any contingent consideration and may also include some or all of any acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees (these awards are measured using the ‘market-based measure’ under IFRS 2 rather than at fair value). These are discussed further at 9.1 and 9.2 below. [IFRS 3.37]. When the consideration transferred includes assets or liabilities of the acquirer with carrying amounts that differ from the acquisition-date fair values, for example nonmonetary assets or a business of the acquirer, the acquirer remeasures them at their acquisition-date fair values and recognise any resulting gains or losses in profit or loss. However, it may be that the transferred assets or liabilities remain within the combined entity after the acquisition date (for example, they were transferred to the acquiree rather than to its former owners), and therefore the acquirer retains control of them. In that case, they are measured at their existing carrying amounts immediately before the acquisition, and therefore no gain or loss is recognised. [IFRS 3.38]. IFRS 3 defines ‘fair value’ as ‘the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’. [IFRS 3 Appendix A]. This is the same as the definition in the previous version of IFRS 3 as well in other IFRSs. However, as is the case with measuring recognised identifiable assets acquired and liabilities assumed at their acquisitiondate fair values, much of the guidance relating to the fair value of consideration given in the previous version of IFRS 3 is no longer included in the standard. Where the assets given as consideration or the liabilities incurred by the acquirer are financial assets or financial liabilities under IAS 39, then it would seem appropriate that the guidance in determining the fair values of such financial instruments should be followed (see Chapter 37 at 3). Similarly, where equity interests are issued by the acquirer as consideration, it would seem appropriate that the guidance in IAS 39 on determining the fair value of equity instruments (held as investments) should be followed. One aspect about measuring equity interests issued as consideration in a business combination that IFRS 3 does clarify is that they are to be measured at their fair


Business combinations

529

values at the acquisition date, rather than at an earlier agreement date (or on the basis of the market price of the securities for a short period before or after that date). [IFRS 3.BC341]. Some commentators cited one or more of the following as support for their view of using the agreement date: [IFRS 3.BC338-342] (a) An acquirer and a target entity both consider the fair value of a target entity on the agreement date in negotiating the amount of consideration to be paid. Measuring equity securities issued as consideration at fair value on the agreement date reflects the values taken into account in negotiations; (b) Changes in the fair value of the acquirer’s equity securities between the agreement date and the acquisition date may be caused by factors unrelated to the business combination; (c) Changes in the fair value of the acquirer’s equity securities between the agreement date and the acquisition date may result in inappropriate recognition of either a bargain purchase or artificially inflated goodwill if the fair value of those securities is measured at the acquisition date. Although it was considered that a valid conceptual argument could be made for the use of the agreement date, it was observed that the parties to a business combination are likely to take into account expected changes between the agreement date and the acquisition date in the fair value of the acquirer and the market price of the acquirer’s securities issued as consideration. The argument against acquisition date measurement of equity securities noted in (a) above is mitigated if acquirers and targets generally consider their best estimates at the agreement date of the fair values of the amounts to be exchanged on the acquisition dates. In addition, measuring the equity securities on the acquisition date avoids the complexities of dealing with situations in which the number of shares or other consideration transferred can change between the agreement date and the acquisition date. It was also noted that measuring the fair value of equity securities issued on the agreement date (or on the basis of the market price of the securities for a short period before and after that date) did not result in a consistent measure of the consideration transferred. The fair values of all other forms of consideration transferred are measured at the acquisition date. It was decided that all forms of consideration transferred should be valued on the same date, which should also be the same date as when the assets acquired and liabilities assumed are measured. [IFRS 3.BC340].

[IFRS 3.BC342].

In a business combination in which the acquirer and the acquiree (or its former owners) exchange only equity interests, the acquisition-date fair value of the acquiree’s equity interests may be more reliably measurable than that of the acquirer’s equity interests. In that case, IFRS 3 requires that the calculation of goodwill should use the acquisition-date fair value of the acquiree’s equity interests rather than the acquisition-date fair value of the equity interests transferred. [IFRS 3.33]. Where no consideration is transferred by the acquirer, IFRS 3 gives additional guidance for such situations. This is discussed at 9.4 below.

Chapter 9

Thus, it was concluded that equity instruments issued as consideration in a business combination should be measured at their fair values on the acquisition date.


530

Chapter 9 9.1

Contingent consideration

The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. Contingent consideration is defined in IFRS 3 as ‘Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.’ [IFRS 3 Appendix A]. As can be seen from the definition, contingent consideration generally arises where the acquirer agrees to transfer additional consideration to the former owners of the acquired business after the acquisition date if certain specified events occur or conditions are met in the future. When entering into a business combination, the parties to the arrangement may not always agree on the exact value of the business, particularly if there are uncertainties as to the success or worth of particular assets or the outcome of uncertain events. They therefore often agree to an interim value for the purposes of completing the deal, with additional future payments to be made by the acquirer. That is, they share the economic risks relating to the uncertainties about the future of the business. These future payments may be in cash or shares or other assets and may be contingent upon the achievement of specified events, and/or may be linked to future financial performance over a specified period of time. Examples of such additional payments contingent on future events are: • Earnings above an agreed target over an agreed period • Components of earnings (e.g. revenue) above an agreed target over an agreed period • Approval of a patent/licence • Successful completion of specified contract negotiations • Cash flows arising from specified assets over an agreed period • Remaining an employee of the entity for an agreed period of time Alternatively, an arrangement can have a combination of any of the above factors. While these payments may be negotiated as part of gaining control of another entity, the accounting may not necessarily always reflect this – particularly if these payments are made to those who remain as employees of the business after it is acquired. In the latter case, depending on the exact terms of the arrangement, the payment made may be accounted for as remuneration expenses for services provided subsequent to the acquisition, rather than as part of the consideration paid for the business. Such payments are also often referred to as ‘earn-outs’. The approach to accounting for earn-out arrangements is summarised in the diagram below:


Business combinations

531

Approach to accounting for earn-outs Earn-out arrangement

Apply IFRS 3 to classify

Remuneration Settled in or linked to own shares

Apply IFRS 2

Contingent consideration Settled in other way (cash not linked to shares) or other assets

Apply IAS 19

Apply IFRS 3

The guidance in IFRS 3 for determining whether the arrangements involving employees should be accounted for as contingent consideration or remuneration is discussed further at 13.2.1 below. Where it is determined that the earn-out arrangement is to be accounted for as contingent consideration, the requirements discussed below will apply.

Nevertheless, as indicated in the IASB Staff Paper considered by the Board, in most situations it would not matter whether the pre-existing contingent consideration was treated as contingent consideration or as an identifiable liability. This is because most contingent consideration obligations are financial liabilities to be accounted for under IAS 39.18 As discussed further below, they are initially recognised and measured at fair value at the date of acquisition, with any subsequent remeasurements to fair value recognised either in profit or loss or in other comprehensive income in accordance with IAS 39. The treatment of the pre-existing contingent consideration as an identifiable liability also results in the financial liability being measured at fair value at the date of acquisition, with any subsequent remeasurements to fair value recognised either in profit or loss or in other comprehensive income in accordance with IAS 39.

Chapter 9

One issue discussed by the IASB at its meeting in June 2009 was the treatment of contingent consideration arising from a prior business combination of an acquiree that an acquirer assumes in its subsequent acquisition of the acquiree (‘pre-existing contingent consideration’). The IASB clarified that pre-existing contingent consideration does not meet the definition of contingent consideration in the acquirer’s business combination. It is one of the identifiable liabilities assumed in the subsequent acquisition. Therefore, the Board decided tentatively not to add this topic to the annual improvements project.17


532

Chapter 9 9.1.1

Initial recognition and measurement

Under IFRS 3, the acquirer recognises the acquisition-date fair value of any contingent consideration as part of the consideration transferred in exchange for the acquiree. [IFRS 3.39]. This represents a significant change from the practice under the previous version of IFRS 3 of recognising contingent consideration obligations only when the contingency was probable and could be measured reliably. The initial measurement of contingent consideration at the fair value of the obligation is to be based on an assessment of the facts and circumstances that exist at the acquisition date. The Basis for Conclusions accompanying IFRS 3 acknowledges that measuring the fair value of some contingent payments may be difficult, but it was concluded that to delay recognition of, or otherwise ignore, assets or liabilities that are difficult to measure would cause financial reporting to be incomplete and thus diminish its usefulness in making economic decisions. [IFRS 3.BC347]. The Basis for Conclusions goes on to say that a contingent consideration arrangement is inherently part of the economic considerations in the negotiations between the buyer and seller. Such arrangements are commonly used by buyers and sellers to reach an agreement by sharing particular specified economic risks related to uncertainties about future outcomes. Differences in the views of the buyer and seller about those uncertainties are often reconciled by their agreeing to share the risks in such ways that favourable future outcomes generally result in additional payments to the seller and unfavourable outcomes result in no or lower payments. It was observed that information used in those negotiations will often be helpful in estimating the fair value of the contingent obligation assumed by the acquirer. [IFRS 3.BC348]. It was also concluded that the requirements under IFRS 2 for awards of share-based payment subject to performance conditions should not determine the requirements for contingent (or conditional) consideration in a business combination. Again, it was concluded that the negotiations between buyer and seller inherent in a contingent consideration arrangement in a business combination provide better evidence of its fair value than is likely to be available for most sharebased payment arrangements with performance conditions. [IFRS 3.BC350-351]. It was also noted that most contingent consideration obligations are financial instruments, and many are derivative instruments. Reporting entities that use such instruments extensively, auditors and valuation professionals are familiar with the use of valuation techniques for estimating the fair values of financial instruments. It was concluded that acquirers should be able to use valuation techniques to develop estimates of the fair values of contingent consideration obligations that are sufficiently reliable for recognition. It was also observed that an effective estimate of zero for the acquisition-date fair value of contingent consideration, which was often the result under the previous version of IFRS 3, was unreliable. [IFRS 3.BC349]. It would also seem inappropriate to assume an effective estimate of 100% for the acquisition-date fair value of the obligation to make the payments under the contingent consideration arrangement. Given that the arrangement is generally designed to reflect uncertainties about future outcomes, it would seem that the fair


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533

value should take account of all expected outcomes together with the likelihood of each outcome occurring. There are two alternative approaches to estimate the fair value of contingent consideration: • The probability-weighted average of payouts associated with each possible outcome. • The payout associated with the probability-weighted average of outcomes. The method that gives the most reliable result in all circumstances is the probability-weighted payout approach. This method requires taking into account the range of possible outcomes, the payouts associated with each possible outcome and the probability of each outcome arising. The probability-weighted payout is then discounted. This approach is illustrated in the following example. Example 9.13: 

Contingent consideration – applying the probability‐weighted payout  approach to determine fair value 

Entity G acquires Entity H and as part of the arrangement, Entity G agrees to pay an additional amount of consideration to the seller in the future, as follows: • If the 12 month earnings in two years’ time (also referred to as the trailing 12 months) are €1 million or less – nothing will be paid • If the trailing 12 months’ earnings in two years’ time are between €1 million and €2 million – 2 × 12 month earnings will be paid • If the trailing 12 months’ earnings in two years’ time is greater than €2 million – 3 × 12 month earnings will be paid At the date of acquisition, the possible twelve-month earnings of Entity H in two years’ time are determined to be, as follows: • €0.8 million – 40% • €1.5 million – 40% • €2.5 million – 20% The probability-weighted payout is: (40% × €0) + (40% × €1.5 million × 2) + (20% × €2.5 million × 3) = €2.7 million This €2.7 million is then discounted at the date of acquisition to determine its fair value.

IFRS 3 also recognises that, in some situations, the agreement may give the acquirer the right to the return of previously transferred consideration if specified future events occur or conditions are met. Such a right falls within the definition of ‘contingent consideration’, and is to be accounted for as such by recognising an asset at its acquisition-date fair value. [IFRS 3.39-40, Appendix A]. 9.1.2

Classification of a contingent consideration obligation

As indicated above, most contingent consideration obligations are financial instruments, and many are derivative instruments. Some contingent consideration

Chapter 9

Since the liability must be measured at fair value, selecting the discount rate to be applied also requires significant judgment to assess the underlying risks associated with the outcomes, and the risks of payment. More specifically, the entities own credit risk will need to be taken into account in determining the discount rate.


534

Chapter 9 arrangements oblige the acquirer to deliver equity securities if specified future events occur, rather than, say, making additional cash payments. IFRS 3 requires that the classification of a contingent consideration obligation as either a liability or equity is to be based on the definitions of an equity instrument and a financial liability in IAS 32 (see Chapter 33) or other applicable accounting standards. [IFRS 3.40]. These requirements, and the impact of subsequent measurement and accounting (which is discussed further at 9.1.3 below), are summarised in the diagram below.

Classification of contingent consideration Contingent consideration

Initial recognition at fair value

Liability

Financial liability

Equity

Non-financial liability

Subsequent measurement – fair value

No remeasurement

Subsequent measurement – in accordance with IAS 37 or other IFRS

Income

Most contingent consideration obligations will be classified on the basis of IAS 32, and in many cases will meet the definition of a financial liability (including those arrangements where the acquirer is obliged to deliver equity securities). This is because IAS 32 defines a financial liability to include ‘a contract that will or may be settled in the entity’s own equity instruments’ and is: [IAS 32.11]


Business combinations

• •

535

‘a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments’; or ‘a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments’.

Most contingent consideration arrangements that are to be settled by delivering equity shares will involve a variable number of shares; for example, if the arrangement obliges the acquirer to issue between, say, zero and 1 million additional equity shares on a sliding scale based on the acquiree’s post-combination earnings. Such arrangements will be classified as a financial liability. It will only be in situations where the arrangement involves issuing, say, zero or 1 million shares depending on a specified event or target being achieved that the arrangement would be classified as equity. Where the arrangement involves a number of different discrete targets that are independent of one another, which if met will result in additional equity shares being issued as further consideration, we believe that the classification of the obligation to provide such financial instruments in respect of each target is assessed separately in determining whether equity classification is appropriate. However, if the targets are interdependent, the classification of the obligation to provide such additional equity shares should be based on the overall arrangement, and as this is likely to mean that as a variable number of shares may be delivered, the arrangement would be classified as a financial liability. Example 9.14: 

Share‐settled contingent consideration – financial liability or equity? 

Profit target

Additional consideration

Year ended 31 December 2011 – €1m+

100,000 shares

Year ended 31 December 2012 – €1.25m+

150,000 shares

Year ended 31 December 2013 – €1.5m+

200,000 shares

Each target is non-cumulative. If the target for a particular year is met, the additional consideration will be payable, irrespective of whether the targets for the other years are met or not. If a target for a particular year is not met, no shares will be issued in respect of that year. In this scenario, as each of the targets are independent of one another, this arrangement can be regarded as being three distinct contingent consideration arrangements that are assessed separately. As either zero or the requisite number of shares will be issued if each target is met, the obligation in respect of each arrangement is classified as equity. On the other hand, if the targets were dependent on each other, for example, they were based on an average for the 3 year period, were based on a specified percentage increase on the previous year’s profits, or the later targets were forfeited if the earlier targets were not met, the classification would be assessed on the overall arrangement. As this would mean that a variable number of shares may be delivered, the obligation under such an arrangement would have to be classified as a financial liability.

Chapter 9

Entity P acquires a 100% interest in Entity S on 1 January 2011. As part of the consideration arrangements, additional consideration will be payable based on Entity S meeting certain profit targets over the 3 years ended 31 December 2013, as follows:


536

Chapter 9 IFRS 3 does not indicate in what situations other applicable accounting standards would be relevant, but it would presumably relate to arrangements where the consideration was not a financial instrument, but was a non-monetary asset. For those contingent consideration arrangements where the agreement gives the acquirer the right to the return of previously transferred consideration if specified future events occur or conditions are met, IFRS 3 merely requires such a right is classified as an asset. [IFRS 3.40]. At its meeting in May 2009, the IASB indicated that it will address ‘contingent consideration: designation (categories of financial instruments) and classification (as equity or a liability)’ in its projects on financial instruments.19 It is not entirely clear what aspect of the accounting for contingent consideration will be addressed as part of that project as no details were included in the agenda papers available to the public. 9.1.3

Subsequent measurement and accounting

In developing the revised version of IFRS 3, the IASB has concluded that subsequent changes in the fair value of a contingent consideration obligation generally do not affect the acquisition-date fair value of the consideration transferred to the acquiree. Instead, those subsequent changes in value are related to postcombination events and changes in circumstances of the combined entity. Thus, the Board believes that subsequent changes in value for post-combination events and circumstances should not affect the measurement of the consideration transferred or goodwill on the acquisition date. [IFRS 3.BC357]. This differs from the previous version of IFRS 3 which required that subsequent changes in the amount recognised for any contingent consideration would generally be accounted for as adjustments to the consideration transferred in the business combination, resulting in changes to the goodwill until the final outcome was known. Accordingly, IFRS 3 now requires that after initial recognition, changes in the fair value of contingent consideration resulting from events after the acquisition date such as meeting an earnings target, reaching a specified share price, or meeting a milestone on a research and development project are accounted for as follows: [IFRS 3.58]

• •

Contingent consideration classified as equity is not subsequently remeasured (consistent with the accounting for equity instruments generally), and its subsequent settlement is accounted for within equity; Contingent consideration classified as an asset or a liability that: • is a financial instrument and within the scope of IAS 39 is remeasured at fair value, with any resulting gain or loss recognised either in profit or loss or in other comprehensive income in accordance with IAS 39; • is not within the scope of IAS 39 is accounted for in accordance with IAS 37 or other standards as appropriate.

IFRS 3 does not indicate in what situations contingent consideration classified as a liability would not be within the scope of IAS 39, and would therefore be accounted


Business combinations

537

for under IAS 37 or another standard, although as noted at 9.1.2 above it would presumably relate to arrangements where the consideration was not a financial instrument, but was a non-monetary asset. Nevertheless, even where that is the case, any changes in the measurement of the liability would be recognised in profit or loss. The Basis for Conclusions accompanying IFRS 3 notes that many obligations for contingent consideration that qualify for classification as liabilities meet the definition of derivative instruments in IAS 39. To improve transparency in reporting particular instruments, it was concluded that all contracts that would otherwise be within the scope of that standard (if not issued in a business combination) should be subject to its requirements if issued in a business combination. Therefore, it was decided to eliminate the existing provisions (paragraph 2(f) of IAS 39) that excluded contingent consideration in a business combination from the scope of that standard. Accordingly, liabilities for payments of contingent consideration that are subject to the requirements of IAS 39 will be measured at fair value at the end of each reporting period, with changes in fair value recognised in accordance with IAS 39. [IFRS 3.BC354]. The equivalent scope exemptions in IAS 32 and IFRS 7 – Financial Instruments: Disclosures – have also been deleted. In considering the subsequent accounting for contingent payments that are liabilities but are not derivatives, it was also concluded that, in concept, all liabilities for contingent payments should be accounted for similarly. Therefore, financial liabilities for contingent payments that are not derivative instruments should also be remeasured at fair value after the acquisition date. [IFRS 3.BC355]. As indicated at 9.1.2 above, most contingent consideration obligations will be classified on the basis of IAS 32, and in many cases will meet the definition of a financial liability (including those arrangements where the acquirer is obliged to deliver a variable number of equity securities).

At its meeting in February 2010, having reviewed an analysis of comment letters received on the Improvements to IFRSs exposure draft published in August 2009, the IASB asked the Interpretations Committee to provide a recommendation on how to present the guidance on contingent consideration associated with business combinations within one standard to resolve potential divergence in the application of IFRSs. This is discussed further at 20.4.1 below. 9.1.4

Contingent consideration balances arising from business combinations preceding IFRS 3 (as revised in 2008)

The accounting described above does not apply to contingent consideration arrangements relating to business combinations that were initially accounted for under the previous version of IFRS 3. Due to the deletion of the scope exemptions in the financial instrument standards (IFRS 7, IAS 32 and IAS 39), a perceived

Chapter 9

IFRS 3 includes one exception to the above requirement for accounting for changes in the fair value of contingent consideration, and that is where the changes are the result of additional information about the facts and circumstances that existed at the acquisition date that the acquirer obtained after that date. [IFRS 3.58]. Such changes are measurement period adjustments and are to be accounted for as discussed at 14 below.


538

Chapter 9 conflict arose as to whether this was to be the case or IAS 39 should apply instead. This concern has been addressed by the IASB in its Improvements to IFRSs standard issued in May 2010, and IFRS 3 now contains explicit transitional guidance that reproduces the requirements of the previous version of IFRS 3 for such contingent consideration arrangements. This is discussed further at 19.3.1 below. 9.2

Share-based payment awards exchanged for awards held by the acquiree’s employees

Acquirers often exchange share-based payment awards (i.e. replacement awards) for awards held by employees of the acquiree. These exchanges frequently occur because the acquirer wants to avoid the effect of having non-controlling interests in the acquiree represented by the shares that are ultimately held by employees, the acquirer’s shares are often more liquid than the shares of the acquired business after the acquisition, and/or to motivate former employees of the acquiree toward the overall performance of the combined, post-acquisition business. If the acquirer replaces any acquiree awards, as indicated at 9 above, the consideration transferred will include some or all of any acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees. In addition, as discussed at 13 below, IFRS 3 requires that the acquirer recognises as part of applying the acquisition method only the consideration transferred for the acquiree and the assets and liabilities assumed in the exchange for the acquiree; separate transactions are accounted for in accordance with the relevant IFRSs. An example of a transaction that is not to be included in applying the acquisition method is one that remunerates employees or former owners for paying for future services. IFRS 3 includes Application Guidance dealing with the situation where an acquirer exchanges its share-based payment awards (replacement awards) for awards held by employees of the acquiree. [IFRS 3.B56-62]. Such exchanges are modifications of sharebased payment awards in accordance with IFRS 2. Discussion of this guidance, including illustrative examples that reflect the substance of the Illustrative Examples that accompany IFRS 3, [IFRS 3.IE61-71], is dealt with in Chapter 28 at 11.2. When the revised version of IFRS 3 was originally issued in January 2008, it was only if the acquirer was obliged to replace any acquiree awards that the consideration transferred would include some or all of any acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees. However, concerns were soon raised about the accounting for unreplaced share-based payment transactions of the acquiree and voluntary replacements of share-based payment transactions. Consequently, the IASB dealt with these issues within its Improvements to IFRSs standard issued in May 2010. The Application Guidance in paragraphs B56 – B62 of IFRS 3 therefore now requires the acquirer to apply the guidance and include some or all replacement awards (i.e. vested or unvested share-based payment transactions) as part of the consideration transferred, irrespective of whether it is obliged to do so or does so voluntarily. It would only be if acquiree awards would expire as a consequence of the business combination and the acquiree replaces those when it was not obliged to do so, that none of the market-based measure of the awards would be included in the consideration transferred. In that case, all of the market-


Business combinations

539

based measure of the awards is recognised as remuneration cost in the postcombination financial statements. [IFRS 3.B56]. In addition, IFRS 3 was amended such that any equity-settled share-based payment transactions of the acquiree that the acquirer does not exchange for its own sharebased payment transactions will result in non-controlling interest in the acquiree being recognised and measured at their market-based measure as discussed at 10.4 below. [IFRS 3.B62A, B62B]. 9.3

Acquisition-related costs

An acquirer generally incurs various acquisition-related costs in connection with a business combination, including: • direct costs of the transaction, such as (i) costs for the services of lawyers, investment bankers, accountants, and other third parties and (ii) costs to issue debt or equity instruments used to effect the business combination (i.e. issuance costs); and • indirect costs of the transaction, such as recurring internal costs (e.g. the cost of maintaining an acquisition department).

In addition, in order to mitigate concerns about potential abuse, e.g. where a buyer might ask a seller to make payments to third parties on its behalf, but the consideration to be paid for the business is sufficient to reimburse the seller for making such payments, IFRS 3 requires that a transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs is not to be included in applying the acquisition method (see 13.3 below). [IFRS 3.51-53, BC370].

9.4

Business combinations achieved without the transfer of consideration

An acquirer sometimes obtains control of an acquiree without transferring consideration. IFRS 3 indicates that such circumstances include: [IFRS 3.43]

Chapter 9

In developing the revised version of IFRS 3 issued in January 2008, the IASB concluded that acquisition-related costs, whether for services performed by external parties or internal staff of the acquirer, are not part of the fair value exchange between the buyer and seller for the acquired business. Accordingly, they are not part of the consideration transferred for the acquiree. Rather, they are separate transactions in which the buyer makes payments in exchange for the services received. Consequently, under IFRS 3, the acquirer accounts for acquisition-related costs separately from the business combination. The Board noted that acquisitionrelated costs generally do not represent assets of the acquirer at the acquisition date as they are consumed as the services are received. [IFRS 3.53, BC365-367]. Thus, with the exception of the costs of registering and issuing debt and securities that are recognised in accordance with IAS 32 and IAS 39, i.e. as a reduction of the proceeds of the debt or securities issued, IFRS 3 requires that acquisition-related costs are to be accounted for as expenses in the periods in which the costs are incurred and the related services are received. [IFRS 3.53].


540

Chapter 9 (a) (b) (c)

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; and the acquirer and the acquiree agree to combine their businesses by contract alone. In that case, the acquirer transfers no consideration in exchange for control of an acquiree and holds no equity interests in the acquiree, either on the acquisition date or previously. Examples of business combinations achieved by contract alone include bringing two businesses together in a stapling arrangement or forming a dual listed corporation.

The standard emphasises that the acquisition method applies to a business combination achieved without the transfer of consideration. [IFRS 3.43]. However, in computing the amount of goodwill in such a business combination, IFRS 3 requires the acquirer to use the acquisition-date fair value of the acquirer’s interest in the acquiree as the first item in part (a) of the goodwill computation set out at 8 above, instead of the acquisition-date fair value of the consideration transferred (which is nil). [IFRS 3.33]. The acquisition-date fair value of the acquirer’s interest in the acquiree is to be determined using one or more valuation techniques that are appropriate in the circumstances and for which sufficient data is available. If more than one valuation technique is used, the acquirer should evaluate the results of the techniques, considering the relevance and reliability of the inputs used and the extent of the available data. [IFRS 3.B46]. In the first two circumstances described in (a) and (b) above, the acquirer has a previously-held equity interest in the acquiree. The computation of goodwill set out at 8 above would appear to suggest that the acquisition-date fair value of that previously-held interest would also be included as the third item in part (a) of the computation, but that would be clearly double-counting the value of the acquirer’s interest in the acquiree. The acquisition-date fair value of the acquirer’s interest in the acquiree should only be included once in the computation of goodwill. Nevertheless, it would appear that these two circumstances would also be examples of business combinations achieved in stages (see 11 below). 9.4.1

Business combinations by contract alone

In the third circumstance described above, that of a business combination achieved by contract alone, since the acquirer does not have an interest in the equity in the acquiree, it would appear that no amount is included for the first item in part (a) of the calculation of goodwill. However, in such a business combination, IFRS 3 requires that the acquirer attributes to the owners of the acquiree the amount of the acquiree’s net assets recognised under the standard (see 7 above). In other words, the equity interests in the acquiree held by parties other than the acquirer are a non-controlling interest in the acquirer’s consolidated financial statements, even if it results in all of the equity interests in the acquiree being attributed to the non-controlling interest. [IFRS 3.44]. This might suggest that no goodwill is to be recognised in a business combination achieved by contract alone as the second item in part (a) will be equal to part (b) of the goodwill computation set out at 8 above. However, we believe that this


Business combinations

541

requirement to attribute the equity interests in the acquiree to the non-controlling interest is emphasising the presentation within equity in the consolidated financial statements. Thus, where the option discussed at 10 below in measuring noncontrolling interests in an acquiree at its acquisition-date fair value is chosen, goodwill would be recognised. If the option of measuring the non-controlling interest at its proportionate share of the value of net identifiable assets acquired is chosen, no goodwill would be recognised (except to the extent any is recognised as a result of there being other equity instruments that are required to be measured at their acquisition-date fair value or other measurement basis required by IFRSs). 9.5

Combinations involving mutual entities

Combinations involving mutual entities are within the scope of IFRS 3 and the standard provides some guidance in applying its requirements when two mutual entities combine. A mutual entity is defined by IFRS 3 as ‘an entity, other than an investor-owned entity, that provides dividends, lower costs or other economic benefits directly to its owners, members or participants. For example, a mutual insurance company, a credit union and a co-operative entity are all mutual entities.’ [IFRS 3 Appendix A].

The standard notes that the fair value of the equity or member interests in the acquiree (or the fair value of the acquiree) may be more reliably measurable than the fair value of the member interests transferred by the acquirer. In that situation, the acquirer should determine the amount of goodwill by using the acquisition-date fair value of the acquiree’s equity interests as the first item of part (a) of the goodwill computation set out at 8 above, instead of the acquirer’s equity interests transferred as consideration. [IFRS 3.B47]. Some representatives of mutual entities suggested that the revised standard should permit an acquisition of a mutual entity to be reported as an increase in the retained earnings of the acquirer (combined entity) as had been previous practice. However, the IASB rejected this idea, concluding that business combinations of two investorowned entities are economically similar to those of two mutual entities in which the acquirer issues members interests for all the member interests of the acquiree and should be similarly reported. [IFRS 3.BC72]. Accordingly, IFRS 3 clarifies that the acquirer in a combination of mutual entities recognises the acquiree’s net assets as a direct addition to capital or equity, not as an addition to retained earnings, which is consistent with the way other types of entity apply the acquisition method. IFRS 3 recognises that mutual entities, although similar in many ways to other businesses, have distinct characteristics that arise primarily because their members are both customers and owners. Members of mutual entities generally expect to receive benefits for their membership, often in the form of reduced fees charged for goods and services or patronage dividends. The portion of such patronage dividends allocated to each member is often based on the amount of business the member did with the mutual entity during the year. [IFRS 3.B48]. The standard goes on to say that a fair value measurement of a mutual entity should include the assumptions that market participants would make about future member

Chapter 9

[IFRS 3.B47].


542

Chapter 9 benefits as well as any other relevant assumptions market participants would make about the mutual entity. For example, where an estimated cash flow model is used to determine the fair value of the mutual entity, the cash flows used as inputs to the model should be based on the expected cash flows of the mutual entity, which are likely to reflect reductions for member benefits, such as reduced fees charged for goods and services. [IFRS 3.B49].

10

RECOGNISING AND MEASURING NON-CONTROLLING INTERESTS IN ACQUIREE

The second item in part (a) of the goodwill computation set out at 8 above is the amount of any non-controlling interests in the acquiree. IFRS 3 requires any non-controlling interest in an acquiree to be recognised, [IFRS 3.10], but provides a choice of two methods in measuring the acquisition date components of any non-controlling interests arising in a business combination that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of a liquidation (hereafter referred to as ‘qualifying non-controlling interests’): • Option 1, to measure such components of non-controlling interests at acquisition-date fair value (consistent with the measurement principle for other components of the business combination) • Option 2, to measure such components of non-controlling interests at their proportionate share of the value of net identifiable assets acquired (see 7 above). Such a choice is not available for all other components of non-controlling interests. These are required to be measured at their acquisition-date fair values, unless another measurement basis is required by IFRSs. [IFRS 3.19]. IFRS 3 defines non-controlling interest as ‘the equity in a subsidiary not attributable, directly or indirectly, to a parent’. [IFRS 3 Appendix A]. This is the same as that in IAS 27. As discussed in Chapter 7 at 4.1, this definition includes not only equity shares in the subsidiary held by other parties, but also other elements of ‘equity’ in the subsidiary that relates to, say, other equity instruments such as options or warrants, the equity element of convertible debt instruments, and the ‘equity’ related to sharebased payment awards held by parties other than the parent. When the revised version of IFRS 3 was originally issued in January 2008, it did not refer to particular types of non-controlling interests. Thus, where an acquiree had such other equity instruments, if the acquirer chose to measure non-controlling interest under Option 2 above, the acquirer might have measured some of these equity instruments at nil. The IASB considered that this would result in not recognising economic interests that other parties have in the acquiree, consequently, the IASB dealt with this within its Improvements to IFRSs standard issued in May 2010, and amended IFRS 3 to limit the scope of the measurement choice. [IFRS 3.BC221A]. The application of the above requirements in IFRS 3 (following the May 2010 amendment) for particular instruments are set out in the table below.


Business combinations Instruments issued by the acquiree

Measurement required by IFRS 3

Ordinary shares

Proportionate share of net assets OR fair value

Preference shares entitled to a pro rata share of net assets upon liquidation

Proportionate share of net assets OR fair value

Preference shares not entitled to a pro rata share of net assets upon liquidation*

Fair value

Equity component of convertible debt and other compound financial instruments◊

Fair value

Share warrants◊

Fair value

Options over own shares◊

Fair value

Options under share-based payment transactions◊

IFRS 2 ‘market-based measure’

543

* As these instruments are not entitled to a share of net assets as of the acquisition date, their proportionate share of net assets is nil. Accordingly, prior to the May 2010 amendment, they could have been measured at nil rather than at fair value (determined at the acquisition date) as now required by IFRS 3. ◊ In practice, because these instruments are generally not entitled to a share of net assets as of the acquisition date, their proportionate share of net assets is nil. Accordingly, prior to the May 2010 amendment, they could have been measured at nil rather than at fair value (determined at the acquisition date) as now required by IFRS 3. As a result, these instruments would only have been recognised when exercised.

An illustration of the consequences of applying these requirements is given at 10.4 below. For the components of any qualifying non-controlling interests, the choice of method is to be made for each business combination on a transaction-by-transaction basis, rather than being a policy choice. This will require management to carefully consider their future intentions about acquiring such non-controlling interests, as each option, combined with the accounting for changes in ownership interest of a subsidiary in IAS 27 (see Chapter 7 at 3.3) will potentially have a significant effect on the amount recognised for goodwill.

Under the June 2005 exposure draft, the IASB proposed that in a business combination in which the acquirer holds less than 100% of the equity interests in the acquiree at the acquisition date, the acquirer would recognise the acquiree, as a whole, and the assets acquired and liabilities assumed at the full amount of their fair values as of that date, regardless of the percentage ownership in the acquiree. The excess of the fair value of the business acquired over the net amount of the recognised identifiable assets acquired and liabilities assumed would be measured and recognised as goodwill. Thus, all of the goodwill of the acquired business, not only the acquirer’s share, would be recognised under this ‘full-goodwill’ approach.

Chapter 9

Under the previous version of IFRS 3, where the acquirer obtained less than a 100% interest in the acquiree, a minority interest (the former term for non-controlling interest) in the acquiree was recognised reflecting the minority’s proportion of the net identifiable assets, liabilities and contingent liabilities of the acquiree at their attributed fair values at the date of acquisition; no amount was included for any goodwill relating to the minority interest.


544

Chapter 9 The amount of goodwill would then be allocated to the controlling and noncontrolling interests.20 In redeliberating the exposure draft, the Board observed that it had specified the mechanics of determining the reported amount of a non-controlling interest, but had not identified its measurement attribute. The result of those mechanics would have been that the non-controlling interest was effectively measured as the ‘final residual’ in a business combination. As goodwill is also measured as a residual, the Board concluded that it is undesirable to have two residual amounts in accounting for a business combination. Accordingly, it was concluded that, in principle, the noncontrolling interest, like other components of the business combination, should be measured at fair value. [IFRS 3.BC206-207]. However, the IASB was unable to agree on a single measurement basis for non-controlling interests because neither of the alternatives (fair value or proportionate share of the acquiree’s net identifiable assets) received sufficient Board support to enable a revised business combinations standard to be issued. [IFRS 3.BC210]. 10.1

Option 1 – Measuring qualifying non-controlling interests at acquisitiondate fair value

Where this option is applied to those components of qualifying non-controlling interests, IFRS 3 states that an acquirer will sometimes be able to measure the acquisition-date fair value of a non-controlling interest on the basis of active market prices for equity shares not held by the acquirer. However, in other situations an active market price may not be available, so the acquirer will need to measure the fair value of the non-controlling interest by using other valuation techniques. [IFRS 3.B44]. The standard goes on to say that the fair value of the acquirer’s interest in the acquiree and the non-controlling interest on a per-share basis might differ. This is likely to be because the consideration transferred by the acquirer will generally include a control premium, or conversely, the inclusion of a discount for lack of control (also referred to as a minority discount) in the per-share value of the noncontrolling interest. [IFRS 3.B45]. Therefore, it may not be appropriate to extrapolate the fair value of an acquirer’s interest (i.e. the amount that the acquirer paid per share) to determine the fair value of the non-controlling interests. 10.2

Option 2 – Measuring qualifying non-controlling interests at the proportionate share of the value of net identifiable assets acquired

Under this option for those components of qualifying non-controlling interests, the non-controlling interest is measured at the share of the value of the net assets acquired and liabilities assumed of the acquiree (see 7 above), consistent with the requirements of the previous version of IFRS 3. The result is that the amount recognised for goodwill is the equivalent of only the acquirer’s share, as was the case under the previous version of IFRS 3. However, where the outstanding noncontrolling interest is subsequently acquired, no additional goodwill is recorded since under IAS 27 this is an equity transaction (see Chapter 7 at 3.3).


Business combinations 10.3

545

Implications of method chosen for measuring non-controlling interests

The following example illustrates the impact of these options on measuring those components of qualifying non-controlling interests. Example 9.15: 

Initial measurement of non‐controlling interests in a business  combination (1) 

Entity B has 40% of its shares publicly traded on an exchange. Entity A purchases the 60% nonpublicly traded shares in one transaction, paying €630. Based on the trading price of the shares of Entity B at the date of gaining control a value of €400 is assigned to the 40% non-controlling interest, indicating that Entity A has paid a control premium of €30. The fair value of Entity B’s identifiable net assets is €700. For the purposes of illustration, Entity B has no other instruments that would be regarded as non-controlling interests.

Option 1 Entity A accounts for the acquisition as follows: € Fair value of identifiable net assets acquired Goodwill Cash Non-controlling interest in entity B

700 330

630 400

Option 2 Entity A accounts for the acquisition as follows: € Fair value of identifiable net assets acquired Goodwill Cash Non-controlling interest in entity B (€700 × 40%)

700 210

630 280

The IASB has noted that there are likely to be three main differences arising from measuring the non-controlling interest at its proportionate share of the acquiree’s net identifiable assets, rather than at fair value. First, the amounts recognised in a business combination for the non-controlling interest and goodwill are likely to be lower (as illustrated in the above example).

The third difference noted by the IASB is that which arises if the acquirer subsequently purchases some or all of the shares held by the non-controlling shareholders. Under IAS 27, such a transaction is to be accounted for as an equity transaction (see Chapter 7 at 3.3). By acquiring the non-controlling interest, presumably at fair value, the equity of the group is reduced by the non-controlling interest’s share of any unrecognised changes in fair value of the net assets of the business, including goodwill. By measuring the non-controlling interest initially as a proportionate share of the acquiree’s net identifiable assets, rather than at fair value,

Chapter 9

Second, if a cash generating unit to which the goodwill has been allocated is subsequently impaired, any resulting impairment of goodwill recognised through income is likely to be lower than it would have been if the non-controlling interest had been measured at fair value. The IASB states that it will not affect the impairment loss attributable to the controlling interest. [IFRS 3.BC217].


546

Chapter 9 the reduction in the reported equity attributable to the acquirer is likely to be larger. [IFRS 3.BC218]. If in Example 9.15 above, Entity A were to subsequently acquire all of the non-controlling interest for, say, €500, then assuming that there had been no changes in the carrying amounts for the net identifiable assets and the goodwill, the equity attributable to the parent, Entity A, would be reduced by €220 (€500 – €280) if option 2 had been adopted, whereas the reduction would only be €100 (€500 – €400) if option 1 had been adopted. In Example 9.15 above, for the purposes of illustration, the acquiree had no other instruments that would be regarded as non-controlling interests. This will not always be the case. Where the acquiree has such other instruments, the impact of the measurement of such non-controlling interests in a business combination on goodwill is illustrated in Example 9.16 below. Example 9.16: 

Initial measurement of non‐controlling interests in a business  combination (2) 

Parent acquires 80% of the ordinary shares of Target for €950 in cash. The total fair value of the equity instruments issued by Target is €1,165 and the fair value of its identifiable net assets is €850. The market value of the 20% of the ordinary shares owned by non-controlling shareholders is €190. In addition, the subsidiary has also written gross settled call options over its own shares with a market value of €25, which are considered equity instruments under IAS 32.

Option 1 – Non-controlling interest at fair value The non-controlling interests are measured as follows: € Fair value of identifiable net assets Goodwill (€1,165 – €850) Cash Non-controlling interest (€190 + €25)

850 315

950 215

Under this method, goodwill represents the difference between the fair value of Target and the fair value of its identifiable net assets. The non-controlling interests are measured as the fair value of all equity instruments issued by Target that are not owned by the parent (i.e. ordinary shares and gross settled call options).

Option 2 – Certain non-controlling interests are measured at proportionate share of identifiable net assets The non-controlling interests are measured as follows: € Fair value of identifiable net assets Goodwill (€950 – 80% × €850+ €25) Cash Non-controlling interest (20% × €850 + €25)

850 295

950 195

Under this method, goodwill represents the difference between the purchase consideration paid and the parent’s share of the identifiable net assets. The non-controlling interests that are present ownership interests and entitle their holders to a proportionate share of the Target’s net assets in the event of liquidation (i.e. the ordinary shares) are measured at the non-controlling interest’s proportionate share of the identifiable net assets of Target. The non-controlling interests that are not present ownership interests or do not entitle their holders to a proportionate share of the Target’s net assets in the event of liquidation (i.e. the gross settled call options) are measured at their fair value.


Business combinations

547

Reconciliation of goodwill Goodwill as determined under the two methods can be reconciled as follows: € Option 2: Goodwill (€950 – 80% × €850+ €25) Goodwill related to the non-controlling interest in ordinary shares (€190 – 20% × €850) Option 1: Goodwill (€1,165 – €850)

295 20 315

The above reconciliation makes clear that Option 2 effectively ignores the goodwill related to ordinary shares that are held by non-controlling shareholders.

In Example 9.16 above, under Option 2, the computation of the non-controlling interests represented by the ordinary shares was based solely on the fair value of the identifiable net assets; i.e. no deduction was made in respect of the other component of non-controlling interest. IFRS 3 does not explicitly state whether this should be the case or not. An alternative view would be that such other components of non-controlling interests should be deducted from the value of the net identifiable net assets acquired based on their acquisition-date fair value (or marketbased measure) or based on their liquidation rights. 10.4

Applying the IFRS 3 requirements for measuring different components of non-controlling interests

It can be seen that most components of non-controlling interests that are not eligible for the choice of measurement are to be measured at their acquisition-date fair values. The exception to this relates to where the acquiree may have outstanding share-based payment transactions that the acquirer does not exchange for its share-based payment transactions. If vested, those acquiree share-based payment transactions are part of the non-controlling interest in the acquiree and are measured at their market-based measure. If unvested, they are measured at their market-based measure as if the acquisition date were the grant date in accordance with paragraphs 19 and 30. [IFRS 3.B62A]. The market-based measure of unvested share-based payment transactions is allocated to the non-controlling interest on the basis of the ratio of the portion of the vesting period completed to the greater of the total vesting period or the original vesting period of the share-based payment transaction. The balance is allocated to post-combination service. [IFRS 3.62B]. The above requirements for equity-settled share-based payment transactions of the acquiree are discussed further in Chapter 28 at 11.2.

Chapter 9

As discussed above, the choice of these options in measuring the acquisition-date fair values of non-controlling interests only applies to components of any noncontrolling interests arising in a business combination that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of a liquidation. Such a choice is not available for all other components of non-controlling interests. These are required to be measured at their acquisitiondate fair values, unless another measurement basis is required by IFRSs. [IFRS 3.19].


548

Chapter 9 The following example, which is based on that included in the illustrative examples accompanying IFRS 3, [IFRS 3.IE44B-IE44J], illustrates the application of the requirements in paragraph 19 of IFRS 3 for measuring different components of noncontrolling interest at the acquisition date in a business combination. Example 9.17: 

Measurement of non‐controlling interest represented by preference  shares and employee share options 

TC has issued 100 preference shares, which are classified as equity. The preference shares have a nominal value of CU1 each. The preference shares give their holders a right to a preferential dividend in priority to the payment of any dividend to the holders of ordinary shares. Upon liquidation of TC, the holders of the preference shares are entitled to receive out of the assets available for distribution the amount of CU1 per share in priority to the holders of ordinary shares. The holders of the preference shares do not have any further rights on liquidation. AC acquires all ordinary shares of TC. The acquisition gives AC control of TC. The acquisition-date fair value of the preference shares is CU120. Paragraph 19 of IFRS 3 states that for each business combination, the acquirer shall measure at the acquisition date components of non-controlling interest in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation at either fair value or the present ownership instruments’ proportionate share in the acquiree’s recognised amounts of the identifiable net assets. All other components of noncontrolling interest must be measured at their acquisition-date fair value, unless another measurement basis is required by IFRSs. The non-controlling interests that relate to TC’s preference shares do not qualify for the measurement choice in paragraph 19 of IFRS 3 because they do not entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation. The acquirer measures the preference shares at their acquisition-date fair value of CU120.

First variation Suppose that upon liquidation of TC, the preference shares entitle their holders to receive a proportionate share of the assets available for distribution. The holders of the preference shares have equal right and ranking to the holders of ordinary shares in the event of liquidation. Assume that the acquisition-date fair value of the preference shares is now CU160 and that the proportionate share of TC’s recognised amounts of the identifiable net assets that is attributable to the preference shares is CU140. The preference shares qualify for the measurement choice in paragraph 19 of IFRS 3. AC can choose to measure the preference shares either at their acquisition-date fair value of CU160 or at their proportionate share in the acquiree’s recognised amounts of the identifiable net assets of CU140.

Second variation Suppose also that TC has issued share options as remuneration to its employees. The share options are classified as equity and are vested at the acquisition date. They do not represent present ownership interest and do not entitle their holders to a proportionate share of TC’s net assets in the event of liquidation. The market-based measure of the share options in accordance with IFRS 2 at the acquisition date is CU200. The share options do not expire on the acquisition date and AC does not replace them. Paragraph 19 of IFRS 3 requires such share options to be measured at their acquisition-date fair value, unless another measurement basis is required by IFRSs. Paragraph 30 of IFRS 3 states that the acquirer shall measure an equity instrument related to share-based payment transactions of the acquiree in accordance with the method in IFRS 2. The acquirer measures the non-controlling interests that are related to the share options at their market-based measure of CU200.


Business combinations 10.5

549

Call and put options over non-controlling interests

In some business combinations where less than 100% of the equity shares are acquired, it may be that the transaction also involves options over some or all of the outstanding shares held by the non-controlling shareholders. It may that the acquirer has a call option, i.e. a right to acquire the outstanding shares at a future date for cash at a particular price. Alternatively, it may be that the acquirer has granted a put option to the other shareholders whereby they have the right to sell their shares to the acquirer at a future date for cash at a particular price. Indeed in some cases, there may be a combination of such call and put options, the terms of which may be equivalent or may be different. IFRS 3 gives no guidance as to how such options should impact on the accounting for a business combination. This issue is discussed in Chapter 7 at 5. Similarly, IFRS 3 does not address the accounting for a sequence of transactions that begin with an acquirer gaining control over another entity, followed by acquiring additional ownership interests shortly thereafter. Therefore, in these situations, an entity must apply judgement, based on facts and circumstances to determining the appropriate accounting. An assessment must be made of whether the transactions are treated as a single transaction in which control is gained (a single business combination), or are treated as discrete transactions (a business combination, followed by an acquisition of non-controlling interests). A common example of when multiple transactions are determined to be a single arrangement is when there is a regulatory requirement for an acquirer to make an offer to all other shareholders of the acquiree, which results in a put option being granted by the acquirer. This issue is discussed in Chapter 7 at 5.2.2.

11

BUSINESS COMBINATIONS ACHIEVED IN STAGES (‘STEP ACQUISITIONS’)

An acquirer sometimes obtains control of an acquiree in which it held an equity interest immediately before the acquisition date. For example, on 31 December 2010, Entity A holds a 35 per cent non-controlling equity interest in Entity B. On that date, Entity A purchases an additional 40 per cent interest in Entity B, which gives it control of Entity B. IFRS 3 refers to such a transaction as a business combination achieved in stages, sometimes also referred to as a ‘step acquisition’. [IFRS 3.41]. Under the previous version of IFRS 3, an acquirer was required to treat each exchange transaction separately for the purpose of measuring goodwill. This resulted in a step-by-step comparison of the cost of the individual investments with the acquirer’s interest in the net fair value of the acquiree’s identifiable assets and liabilities at each step. IFRS 3 takes a completely different approach in accounting for step acquisitions. It requires that, if the acquirer holds a non-controlling equity investment in the

Chapter 9

The third item in part (a) of the goodwill computation set out at 8 above is the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.


550

Chapter 9 acquiree immediately before obtaining control, the acquirer remeasures that previously held equity investment at its acquisition-date fair value and recognises any resulting gain or loss in profit or loss. [IFRS 3.42]. The Board has concluded that a change from holding a non-controlling equity investment in an entity to obtaining control of that entity is a significant change in the nature of and economic circumstances surrounding that investment. That change warrants a change in the investment’s classification and measurement. Once it obtains control, the acquirer is no longer the owner of a non-controlling investment asset in the acquiree. In effect, the acquirer exchanges its status as an owner of an investment asset in an entity for a controlling financial interest in all of the underlying assets and liabilities of that entity (acquiree) and the right to direct how the acquiree and its management use those assets in its operations. [IFRS 3.BC384]. In addition to recognising the above gain or loss, IFRS 3 requires that if the acquirer had recognised changes in the value of its equity interest in the acquiree in other comprehensive income (i.e. the investment was classified as available-for-sale in accordance with IAS 39), the amount so recognised is to be recognised on the same basis that would be required if the acquirer had directly disposed of the previously held equity investment, i.e. the amount at the acquisition date is reclassified into profit or loss. [IFRS 3.42]. Some consequential amendments were made to the above requirements in paragraph 42 of IFRS 3 as a result of IFRS 9. For entities applying IFRS 9, any resulting gain or loss is to be recognised in profit or loss or other comprehensive income, as appropriate. The acquirer’s non-controlling equity investment in the acquiree prior to obtaining control, after remeasurement to its acquisition-date fair value, would then be included as the third item of part (a) of the goodwill computation set out at 8 above. These requirements are illustrated in the following examples. Example 9.18: 

Business combination achieved in stages – original investment treated  as an available‐for‐sale investment under IAS 39 

Investor acquires a 20 per cent ownership interest in Investee (a service company) on 1 January 2010 for £3,500,000 cash. At that date, the fair value of Investee’s identifiable assets is £10,000,000, and the carrying amount of those assets is £8,000,000. Investee has no liabilities or contingent liabilities at that date. The following shows Investee’s balance sheet at 1 January 2010 together with the fair values of the identifiable assets: Investee’s balance sheet at 1 January 2010

Carrying amounts £’000

Fair values £’000

Cash and receivables Land

2,000 6,000 8,000

2,000 8,000 10,000

Issued equity: 1,000,000 ordinary shares Retained earnings

5,000 3,000 8,000


Business combinations

551

During the year ended 31 December 2010, Investee reports a profit of £6,000,000 but does not pay any dividends. In addition, the fair value of Investee’s land increases by £3,000,000 to £11,000,000. However, the amount recognised by Investee in respect of the land remains unchanged at £6,000,000. The following shows Investee’s balance sheet at 31 December 2010 together with the fair values of the identifiable assets: Investee’s balance sheet at 31 December 2010

Carrying amounts £’000

Fair values £’000

Cash and receivables Land

8,000 6,000 14,000

8,000 11,000 19,000

Issued equity: 1,000,000 ordinary shares Retained earnings

5,000 9,000 14,000

On 1 January 2011, Investor acquires a further 60 per cent ownership interest in Investee for £22,000,000 cash, thereby obtaining control. Before obtaining control, Investor does not have significant influence over Investee, and accounts for its initial 20 per cent investment at fair value with changes in value recognised as a component of other comprehensive income. Investee’s ordinary shares have a quoted market price at 31 December 2010 of £30 per share. Throughout the period 1 January 2010 to 1 January 2011, Investor’s issued equity was £30,000,000. Investor’s only asset apart from its investment in Investee is cash. Accounting for the initial investment before obtaining control Investor’s initial 20 per cent investment in Investee is measured at its cost of £3,500,000. However, Investee’s 1,000,000 ordinary shares have a quoted market price at 31 December 2010 of £30 per share. Therefore, the carrying amount of Investor’s initial 20 per cent investment is remeasured in Investor’s financial statements to £6,000,000 at 31 December 2010, with the £2,500,000 increase recognised as a component of other comprehensive income. Therefore, Investor’s balance sheet at 31 December 2010, before the acquisition of the additional 60 per cent ownership interest, is as follows: £’000

Cash Investment in Investee

26,500 6,000 32,500

Issued equity Gain on available-for-sale investment

30,000 2,500 32,500

Accounting for the business combination Assuming Investor adopts option 2 for measuring the non-controlling interest in Investee, i.e. at the proportionate share of the value of the net identifiable assets acquired, it recognises the following amount for goodwill in its consolidated financial statements based on the computation set out at 8 above:

Chapter 9

Investor’s balance sheet at 31 December 2010


552

Chapter 9 £’000 Consideration transferred for 60% interest acquired on 1 January 2011 Non-controlling interest – share of fair values at that date (20% × £19,000,000) Acquisition-date fair value of initial 20% interest

22,000 3,800 6,000 31,800 19,000 12,800

Acquisition-date fair values of identifiable assets acquired Goodwill

The existing gain on available-for-sale investment of £2,500,000 is reclassified into profit or loss at the date of obtaining control on 1 January 2011. The following shows Investor’s consolidation worksheet immediately after the acquisition of the additional 60 per cent ownership interest in Investee, together with consolidation adjustments and associated explanations: Investor Investee Consolidation adjustments Consolidated Dr Cr £’000 £’000 £’000 £’000 £’000 Cash and receivables Investment in investee

4,500

8,000

28,000

Land

6,000

Goodwill Issued equity

32,500

14,000

30,000

5,000

Asset revaluation surplus Gain on available-forsale investment

12,500 28,000 (3) 5,000 (1)

11,000 (a)

12,800 (3)

12,800 (b) 36,300

4,000 (3) 1,000 (4)

30,000 (c)

4,000 (3) 1,000 (4) 2,500

Retained earnings

9,000

Profit for 2011 Non-controlling interest 32,500

5,000 (1)

– (d)

2,500 (2)

– (f)

7,200 (3) 1,800 (4)

– (e) (f) 2,500 (2)

2,500 (f)

3,800 (4)

3,800 (a) 36,300

14,000

Consolidation Adjustments (1)

(2)

£’000

£’000

Land 5,000 Asset revaluation surplus To recognise Investee’s identifiable assets at fair values at the acquisition date

5,000

£’000

£’000

Gain on available-for-sale investment 2,500 Profit for year 2,500 To reclassify to profit for year the existing gain in other comprehensive income relating to the previously held 20% interest in Investee.


Business combinations £’000 (3)

Issued equity [80% × 5,000,000] Asset revaluation surplus [80% × 5,000,000] Retained earnings [80% × 9,000,000] Goodwill Investment in investee To recognise goodwill on obtaining control over Investee and record Investor’s investment against associated equity balances Issued equity [20% × 5,000,000] Asset revaluation surplus [20% × 5,000,000] Retained earnings [20% × 9,000,000] Non-controlling interest (in issued equity) Non-controlling interest (in asset revaluation surplus) Non-controlling interest (in retained earnings) To recognise the non-controlling interest in the Investee

£’000

4,000 4,000 7,200 12,800

28,000 the elimination of £’000

(4)

553

1,000 1,000 1,800

£’000

1,000 1,000 1,800

Notes The above consolidation adjustments result in: (a) Investee’s identifiable net assets being stated at their full fair values at the date Investor obtains control of Investee, i.e. £19,000,000. This means that the 20 per cent non-controlling interest in Investee also is stated at the non-controlling interest’s 20 per cent share of the fair values of Investee’s identifiable net assets. (b) goodwill being recognised from the acquisition date based on the computation set out at 8 above. (c) issued equity of £30,000,000 comprising the issued equity of Investor of£30,000,000. (d) an asset revaluation surplus of £nil as Investor’s share of the increase in the fair value of Investee’s identifiable net assets at the acquisition date represents pre-acquisition profits. (e) a retained earnings balance of £nil as Investor’s share thereof represents pre-acquisition profits. (f) profit of £2,500 being the amount reclassified from other comprehensive income relating to the previously held investment in Acquiree on the step acquisition. As a result, total retained earnings in the balance sheet are £2,500.

If the investor in the above example had accounted for its original investment of 20% as an associate using the equity method under IAS 28, then the accounting would have been as follows: Business combination achieved in stages – original investment treated  as an associate under IAS 28 

This example uses the same facts as in Example 9.18 above, except that Investor does have significant influence over Investee following its initial 20 per cent investment. Accounting for the initial investment before obtaining control Investor’s initial 20 per cent investment in Investee is included in Investor’s consolidated financial statements under the equity method (see Chapter 11 at 3). Accordingly, it is initially recognised at its cost of £3,500,000 and adjusted thereafter for its share of the profits of Investee after the date of acquisition of £1,200,000 (being 20% × £6,000,000). Investor’s policy for property, plant and equipment is to use the cost model under IAS 16 (see Chapter 16 at 6), therefore in applying the equity method it does not include its share of the increased value of the land held by Investee.

Chapter 9

Example 9.19: 


554

Chapter 9 IAS 28 requires that on the acquisition of an associate, any difference between the cost of the acquisition and its share of the fair values of the associate’s identifiable assets and liabilities is accounted for as goodwill, but is included within the carrying amount of the investment in the associate. Accordingly, Investor has included goodwill of £1,500,000 arising on its original investment of 20%, being £3,500,000 less £2,000,000 (20% × £10,000,000). Therefore, Investor’s consolidated balance sheet at 31 December 2010, before the acquisition of the additional 60 per cent ownership interest, is as follows: Investor’s consolidated balance sheet at 31 December 2010

£’000

Cash Investment in associate

26,500 4,700 31,200

Issued equity Retained earnings

30,000 1,200 31,200

In its separate financial statements, Investor includes its investment in the associate at its cost of £3,500,000. Accounting for the business combination Although Investor has previously equity accounted for its previously held 20% interest in Investee (and calculated goodwill on that acquisition), the computation of goodwill in its consolidated financial statements as a result of obtaining control over Investee is the same as that in Example 9.18 above: £’000 Consideration transferred for 60% interest acquired on 1 January 2011 Non-controlling interest – share of fair values at that date (20% × £19,000,000) Acquisition-date fair value of initial 20% interest Acquisition-date fair values of identifiable assets acquired Goodwill

22,000 3,800 6,000 31,800 19,000 12,800

Investor recognises a gain of £1,300,000 in profit or loss as a result of remeasuring its existing interest from its equity-accounted amount of £4,700,000 at the date of obtaining control to its acquisition-date fair value of £6,000,000. The following shows Investor’s consolidation worksheet immediately after the acquisition of the additional 60 per cent ownership interest in Investee, together with consolidation adjustments and associated explanations.


Business combinations

Cash and receivables Investment in investee

Investor

Investee

£’000

£’000

4,500

8,000

25,500

1,200 (2) 1,300 (2)

6,000

5,000 (1)

11,000 (a)

12,800 (4)

12,800 (b) 36,300

4,000 (3) 1,000 (4)

30,000 (c)

Land Goodwill Issued equity

30,000

14,000

30,000

5,000

Asset revaluation surplus

Consolidation adjustments Dr Cr £’000 £’000

Consolidated £’000 12,500

28,000 (3)

4,000 (3) 1,000 (4)

5,000 (1)

7,200 (3) 1,800 (4)

1,200 (2)

1,200

(f)

Profit for 2011

1,300 (2)

1,300

(f)

Non-controlling interest

3,800 (4)

3,800 (a)

Retained earnings

9,000

30,000

14,000

555

– (d)

36,300

The consolidation adjustments are exactly the same as in Example 9.18 above, except for adjustment (2) where 2 journals are required, being: £’000 £’000 Investment in investee 1,200 Retained earnings 1,200 To reflect the retained earnings balance that has already been reflected in the consolidated balance sheet of Investor at 31 December 2010 as a result of equity accounting for Investee while it was an associate. Investment in investee 1,300 Profit for year 1,300 To remeasure the investment in the associate from its equity-accounted amount of £4,700,000 to its acquisition-date fair value of £6,000,000 and recognising the resulting gain in profit for year.

The notes in Example 9.18 also apply to this example. The only difference is that the cumulative amount of retained earnings balance is made up of the 2 amounts in adjustment (2) above, rather than the reclassified amount of £2,500,000.

Although the Examples above illustrate the requirements of IFRS 3 when the previously held investment has been accounted for as an available-for-sale investment or as an associate, the requirements in IFRS 3 for step acquisitions apply to all previously held non-controlling equity investments in the acquiree, including those that were accounted for as jointly controlled entities under IAS 31. [IAS 31.45]. As a result of obtaining control over a former associate or jointly controlled entity, the acquirer accounts for the business combination by applying the other requirements under IFRS 3 as it would any other business combination. Thus, it

Chapter 9

(2)


556

Chapter 9 needs to recognise the net of the acquisition-date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed relating to the former associate or jointly controlled entity (see 7 above), i.e. perform a new purchase price allocation. This will include reassessing the classification and designation of assets and liabilities (including the classification of financial instruments, embedded derivatives and hedge accounting), based on the circumstances that exist at the acquisition date (see 7.4 above). For a former jointly controlled entity, this applies regardless of whether the entity previously accounted for the jointly controlled entity using proportionate consolidation or the equity method. It should also be noted that the obtaining of control over a former associate or jointly controlled entity means that the investor ‘loses’ significant influence over the former associate/ ‘loses’ joint control over the jointly controlled entity. Therefore, any amounts recognised in other comprehensive income relating to the associate or jointly controlled entity should be recognised by the investor on the same basis that would be required of the associate or jointly controlled entity had directly disposed of the related assets or liabilities. For associates, this is discussed further in Chapter 11 at 3.12.2 and for jointly controlled entities in Chapter 12 at 5.8.2. In Example 9.19 above, a gain was recognised as a result of the step-acquisition of the former associate. However, it could be that a loss has to be recognised as a result of the step-acquisition. Example 9.20: 

Business combination achieved in stages – loss arising on step‐ acquisition 

An investor has an equity-accounted interest in a listed associate comprising 1,000 shares with a carrying value of €1,000. The quoted price of the associate’s shares is €0.90 per share, i.e. €900 in total. As there is an impairment indicator, the investment is tested for impairment in accordance with IAS 36. However, the investor determines that the investment’s value in use exceeds €1,000. Therefore, there is no impairment loss recognised. In the following period, the investor acquires all of the other outstanding shares in the associate following a takeover offer. Up to the date of obtaining control, the investor has recognised a further share of profits of the associate, such that the equity-accounted interest in the associate is now €1,050. At the date of obtaining control, the fair value of the shares has increased to €0.93. As a result of the requirements of IFRS 3, at the date of obtaining control, the existing shares are remeasured to fair value at that date and a loss of €120 (€1,050 less €930) is recognised in profit or loss.

12

BARGAIN PURCHASE TRANSACTIONS

The IASB considers bargain purchases anomalous transactions – business entities and their owners generally do not knowingly and willingly sell assets or businesses at prices below their fair values. [IFRS 3.BC371]. Nevertheless, occasionally, an acquirer will make a bargain purchase. IFRS 3 regards a bargain purchase as being a business combination in which the amount specified in paragraph 32(b) exceeds the aggregate of the amounts specified in paragraph 32(a) of the standard, i.e.


Business combinations

• •

557

the net of the acquisition-date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed, exceeds the aggregate of: • the consideration transferred (generally measured at acquisition-date fair value); • the amount of any non-controlling interest in the acquiree; and • the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree. [IFRS 3.34].

A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion. [IFRS 3.35]. Circumstances in which they occur include a forced liquidation or distress sale (e.g. after the death of a founder or key manager) in which owners need to sell a business quickly. The IASB observed that an economic gain is inherent in a bargain purchase and concluded that, in concept, the acquirer should recognise that gain at the acquisition date. However, the Board acknowledged that sometimes there may not be clear evidence that a bargain purchase has taken place, and shared constituents’ concerns about the potential for inappropriate gain recognition resulting from measurement bias or undetected measurement errors. [IFRS 3.BC372-375]. Accordingly, IFRS 3 requires that before recognising a gain on a bargain purchase, the acquirer should reassess all components of the computation. It should reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and is to recognise any additional assets or liabilities that are identified in that review. The acquirer is then to review the procedures used to measure the amounts the standard requires to be recognised at the acquisition date for all of the following: (a) the identifiable assets acquired and liabilities assumed; (b) the non-controlling interest in the acquiree, if any; (c) for a business combination achieved in stages, the acquirer’s previously held equity interest in the acquiree; and (d) the consideration transferred.

Having undertaken that review (and made any necessary revisions), if an excess remains, a gain is to be recognised in profit or loss on the acquisition date. All of the gain is attributed to the acquirer. [IFRS 3.34]. The IASB has acknowledged that the required review might be insufficient to eliminate concerns about unintentional measurement bias, but considers that by limiting the measurement of the gain in the way that it is calculated will mitigate the potential for inappropriate gain recognition. The computation means that a gain on a bargain purchase and goodwill cannot both be recognised for the same business combination. [IFRS 3.BC376-377].

Chapter 9

The objective of the review is to ensure that the measurements appropriately reflect consideration of all available information as of the acquisition date. [IFRS 3.36].


558

Chapter 9 IFRS 3 acknowledges that the recognition and measurement exceptions for particular items (see 7.6 above), principally the requirements to measure particular assets acquired or liabilities assumed in accordance with other IFRSs, rather than their acquisition-date fair value, may result in recognising a gain (or change the amount of a recognised gain) on a bargain purchase this is not really a bargain purchase but a so-called negative goodwill result. However, it considers that in most situations this is a remote possibility. [IFRS 3.35, BC379]. The computation of a gain on a bargain purchase is illustrated in the following example, which is based on one included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE45-49]. Example 9.21: 

Gain on a bargain purchase (1) 

On 1 January 2011 Entity A acquires 80% of the equity interests of Entity B, a private entity, in exchange for cash of €150m. Because the former owners of Entity B needed to dispose of their investments in Entity B by a specified date, they did not have sufficient time to market Entity B to multiple potential buyers. The management of Entity A initially measures the separately recognisable identifiable assets acquired and the liabilities assumed as of the acquisition date in accordance with the requirements of IFRS 3. The identifiable assets are measured at €250m and the liabilities assumed are measured at €50m. Entity A engages an independent consultant, who determines that the fair value of the 20% non-controlling interest in Entity B is €42m. The amount of Entity B’s identifiable net assets of €200m (being €250m – €50m) exceeds the fair value of the consideration transferred plus the fair value of the non-controlling interest in Entity B. Therefore, Entity A reviews the procedures it used to identify and measure the assets acquired and liabilities assumed and to measure the fair value of both the non-controlling interest in Entity B and the consideration transferred. After that review, Entity A decides that the procedures and resulting measures were appropriate. Entity A measures the gain on its purchase of the 80% interest as follows: €m Amount of the identifiable net assets acquired (€250m – €50m) Less: Fair value of the consideration transferred for Entity A’s 80% interest Fair value of non-controlling interest in Entity B

€m 200

150 42 192 8

Gain on bargain purchase of 80% interest in Entity B

Entity A would record its acquisition of Entity B in its consolidated financial statements as follows: €m Identifiable assets acquired Cash Liabilities assumed Gain on bargain purchase Equity – non-controlling interest in Entity B

250

€m 150 50 8 42

If Entity A chose to measure the non-controlling interest in Entity B on the basis of its proportionate interest in the identifiable net assets of the acquiree, the gain on the purchase of the 80% interest would have been as follows:


Business combinations €m Amount of the identifiable net assets acquired (€250m – €50m) Less: Fair value of the consideration transferred for Entity A’s 80% interest Non-controlling interest in Entity B (20% × €200m)

559

€m 200

150 40 190 10

Gain on bargain purchase of 80% interest in Entity B

On that basis, Entity A would record its acquisition of Entity B in its consolidated financial statements as follows: €m €m Identifiable assets acquired Cash Liabilities assumed Gain on bargain purchase Equity – non-controlling interest in Entity B

250

150 50 10 40

It can be seen from the above example that the amount of the gain recognised is affected by the way in which the non-controlling interest is measured. Indeed, it might be that if the non-controlling interest is measured at its acquisition-date fair value, goodwill is recognised rather than a gain as shown below. Example 9.22: 

Gain on a bargain purchase (2) 

This example uses the same facts as in Example 9.21 above, except that the independent consultant, determines that the fair value of the 20% non-controlling interest in Entity B is €52m. In this situation, the fair value of the consideration transferred plus the fair value of the noncontrolling interest in Entity B exceeds the amount of the identifiable net assets acquired, giving rise to goodwill on the acquisition as follows: €m

Less: Amount of the identifiable net assets acquired (€250m – €50m) Goodwill on acquisition of 80% interest in Entity B

150 52 202 200 2

So, although Entity A in the above example might have made a ‘bargain purchase’, the requirements of IFRS 3 lead to no gain being recognised. If Entity A wished to record a gain on the bargain purchase, it would need to choose the option to measure the non-controlling interest at its proportionate interest in the identifiable net assets of the acquiree, i.e. €40m, as shown in Example 9.21 above.

13

ASSESSING WHAT IS PART OF THE EXCHANGE FOR THE ACQUIREE

To be included in the accounting for the business combination, the identifiable assets acquired and liabilities assumed must be part of the exchange for the acquiree, rather than as a result of separate transactions. [IFRS 3.12].

Chapter 9

Fair value of the consideration transferred for Entity A’s 80% interest Fair value of non-controlling interest in Entity B


560

Chapter 9 IFRS 3 recognises that the acquirer and the acquiree may have a pre-existing relationship or other arrangement before the negotiations for the business combination, or they may enter into an arrangement during the negotiations that is separate from the business combination. In either situation, the acquirer is required to identify any amounts that are separate from the business combination and thus are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, that is, amounts that are not part of the exchange for the acquiree. Accordingly, the acquirer has to assess if any assets acquired, liabilities assumed, or portions of the consideration transferred for the acquiree are not part of the exchange for the acquiree to be included in applying the acquisition method, but should instead be accounted for as separate transactions in accordance with relevant IFRSs. [IFRS 3.51]. This requires the acquirer to evaluate the substance of transactions entered into by the parties to determine whether they were entered into by or on behalf of the acquirer or designed primarily for the economic benefit of the acquirer or the combined entity, rather than primarily for the economic benefit of the acquiree (or its former owners) before the transaction. The former are not part of the business combination transaction, and are likely to be accounted for as separate transactions. [IFRS 3.52]. The standard requires that the acquirer should consider the following factors, which are neither mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for the acquiree or whether the transaction is separate from the business combination: [IFRS 3.B50, 51]

•

The reasons for the transaction Understanding the reasons why the parties to the combination (the acquirer and the acquiree and their owners, directors and managers – and their agents) entered into a particular transaction or arrangement may provide insight into whether it is part of the consideration transferred and the assets acquired or liabilities assumed. For example, if a transaction is arranged primarily for the benefit of the acquirer or the combined entity rather than primarily for the benefit of the acquiree or its former owners before the combination, that portion of the transaction price paid (and any related assets or liabilities) is less likely to be part of the exchange for the acquiree. Accordingly, the acquirer would account for that portion separately from the business combination;

•

Who initiated the transaction Understanding who initiated the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction or other event that is initiated by the acquirer may be entered into for the purpose of providing future economic benefits to the acquirer or combined entity with little or no benefit received by the acquiree or its former owners before the combination. On the other hand, a transaction or arrangement initiated by the acquiree or its former owners is less likely to be for the benefit of the acquirer or the combined entity and more likely to be part of the business combination transaction;


Business combinations

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The timing of the transaction The timing of the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction between the acquirer and the acquiree that takes place during the negotiations of the terms of a business combination may have been entered into in contemplation of the business combination to provide future economic benefits to the acquirer or the combined entity. If so, the acquiree or its former owners before the business combination are likely to receive little or no benefit from the transaction except for benefits they receive as part of the combined entity.

Examples of transactions that IFRS 3 regards as substantively separate that should not be considered part of the exchange for the acquiree are as follows: [IFRS 3.52] • A transaction that effectively settles pre-existing relationships between the acquirer and acquiree. For example, a lawsuit, supply contract, franchising or licensing arrangement; • A transaction that remunerates employees or former owners of the acquiree for future services; • A transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs. Application guidance provided in IFRS 3 in respect of these transactions is discussed at 13.1 to 13.3 below. As indicated above, the acquirer and the acquiree may enter into an arrangement during the negotiations that is separate from the business combination, and which should be accounted for as a separate transaction in accordance with the relevant IFRS, rather than as part of the business combination transaction. One particular area that may be negotiated could be a restructuring plan relating to the activities of the acquiree. This is discussed at 13.4 below. 13.1

Effective settlement of pre-existing relationships

The Basis for Conclusions accompanying IFRS 3 explains that this first example is directed at ensuring that a transaction that in effect settles a pre-existing relationship between the acquirer and the acquiree is excluded from the accounting for the business combination. Assume, for example, that a potential acquiree has an asset (receivable) for an unresolved claim against the potential acquirer. The acquirer and the acquiree’s owners agree to settle that claim as part of an agreement to sell the acquiree to the acquirer. It was concluded that if the acquirer makes a lump sum payment to the seller-owner, part of that payment is to settle the claim and is not part of the consideration transferred to acquire the business. Thus, the portion of the payment that relates to the claim settlement should be excluded from the accounting for the business combination and accounted for separately. In effect,

Chapter 9

The first example is where the acquirer and acquiree may have a relationship that existed before they contemplated the business combination, referred to as a ‘preexisting relationship’. Such a relationship between the acquirer and acquiree may be contractual (for example, vendor and customer or licensor and licensee) or noncontractual (for example, plaintiff and defendant). [IFRS 3.B51].


562

Chapter 9 the acquiree relinquished its claim (receivable) against the acquirer by transferring it (as a dividend) to the acquiree’s owner. Thus, at the acquisition date the acquiree has no receivable (asset) to be acquired as part of the combination, and the acquirer would account for its settlement payment separately. [IFRS 3.BC122]. IFRS 3 requires that if the business combination results in the effective settlement of a pre-existing relationship, the acquirer is to recognise a gain or a loss, measured on the following bases. For a pre-existing non-contractual relationship, such as a lawsuit, the gain or loss is measured at its fair value. For a pre-existing contractual relationship, such as a supply contract, the gain or loss is measured as the lesser of: (a) the amount by which the contract is favourable or unfavourable from the perspective of the acquirer when compared with terms for current market transactions for the same or similar terms. (It is emphasised that an unfavourable contract is a contract that is unfavourable in terms of current market terms. It is not necessarily an onerous contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.); and (b) the amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavourable. If (b) is less than (a), the difference is included as part of the business combination accounting. The Application guidance notes, however, that the amount of gain or loss recognised may depend in part on whether the acquirer had previously recognised a related asset or liability, and the reported gain or loss therefore may differ from the amount calculated by applying the above requirements. [IFRS 3.B52]. The requirements for contractual relationships are illustrated in the following example. [IFRS 3.IE54-57]. Example 9.23: 

Settlement of pre‐existing contractual relationship 

Entity A purchases electronic components from Entity B under a five-year supply contract at fixed rates. Currently, the fixed rates are higher than the rates at which Entity A could purchase similar electronic components from another supplier. The supply contract allows Entity A to terminate the contract before the end of the initial five-year term but only by paying a €6m penalty. With three years remaining under the supply contract, Entity A pays €50m to acquire Entity B, which is the fair value of Entity B based on what other market participants would be willing to pay. Included in the total fair value of Entity B is €8m related to the fair value of the supply contract with Entity A. The €8m represents a €3m component that is ‘at market’ because the pricing is comparable to pricing for current market transactions for the same or similar items (selling effort, customer relationships and so on) and a €5 million component for pricing that is unfavourable to Entity A because it exceeds the price of current market transactions for similar items. Entity B has no other identifiable assets or liabilities related to the supply contract, and Entity A has not recognised any assets or liabilities related to the supply contract before the business combination. In this example, Entity A calculates a loss of €5m (the lesser of the €6m stated settlement amount and the amount by which the contract is unfavourable to the acquirer) separately from the business combination. The €3m ‘at-market’ component of the contract is part of goodwill.


Business combinations

563

Whether Entity A had recognised previously an amount in its financial statements related to a preexisting relationship will affect the amount recognised as a gain or loss for the effective settlement of the relationship. Suppose that IFRSs had required Entity A to recognise a €6m liability for the supply contract before the business combination. In that situation, Entity A recognises a €1m settlement gain on the contract in profit or loss at the acquisition date (the €5m measured loss on the contract less the €6m loss previously recognised). In other words, Entity A has in effect settled a recognised liability of €6m for €5m, resulting in a gain of €1m.

A pre-existing relationship may be a contract that the acquirer recognises as a reacquired right. As indicated at 7.6.5 above, if the contract includes terms that are favourable or unfavourable when compared with pricing for current market transactions for the same or similar items, the acquirer recognises, separately from the business combination, a gain or loss for the effective settlement of the contract, measured in accordance with requirements described above. [IFRS 3.B53]. 13.2

Remuneration for future services of employees or former owners of the acquiree

The second example is where a transaction remunerates employees or former owners of the acquiree for future services. The Basis for Conclusions accompanying IFRS 3 explains that this example is directed at ensuring that payments that are not part of the consideration transferred for the acquiree are excluded from the business combination accounting. Instead, the payments should be accounted for separately. [IFRS 3.BC123]. Additional application guidance is given that deal with this aspect of the requirement in the standard. 13.2.1 Arrangements for contingent payments to employees (or selling shareholders) The first area that is dealt with is arrangements for contingent payments to employees (or selling shareholders). Whether arrangement for contingent payments to employees (or selling shareholders) are contingent consideration to be included in the measure of the consideration transferred (see 9.1 above) or are separate transactions to be accounted for as remuneration will depend on the nature of the arrangements.

Chapter 9

Such payments are also often referred to as ‘earn-outs’. The approach to accounting for earn-out arrangements is summarised in the diagram below:


564

Chapter 9

Approach to accounting for earn-outs Earn-out arrangement

Apply IFRS 3 to classify

Remuneration Settled in or linked to own shares

Apply IFRS 2

Contingent consideration Settled in other way (cash not linked to shares) or other assets

Apply IAS 19

Apply IFRS 3

The guidance in IFRS 3 for determining whether the arrangements involving employees should be accounted for as contingent consideration or remuneration is discussed below. In general, conditions that tie the payment to continuing employment result in the additional payment being considered remuneration for services rather than additional consideration for the business. Understanding the reasons why the acquisition agreement includes a provision for contingent payments, who initiated the arrangement and when the parties entered into the arrangement may be helpful in assessing the nature of the arrangement. [IFRS 3.B54]. If it is not clear whether the arrangement for payments to employees (or selling shareholders) is part of the exchange for the acquiree or is a transaction separate from the business combination, IFRS 3 includes a number of indicators that should be considered by the acquirer in determining whether the arrangements involving employees should be accounted for as contingent consideration or remuneration. [IFRS 3.B55]. These are summarised in the table below:


Business combinations

565

Indicators to consider when classifying payments as remuneration or contingent consideration Lead to conclusion as remuneration

Indicators to consider when negotiating terms of additional payments to selling shareholders that remain employers

Lead to conclusion as contingent consideration

Payments forfeit on termination

Continuing employment

Payments are not affected by termination

Coincides with or exceeds payment period

Duration of required employment

Shorter than the payment period

Not reasonable compared to other key employees of the group

Level of other elements of remuneration

Reasonable compared to the other key employees of the group

Other non-employee selling shareholders receive lower additional payments (on a per share basis)

Incremental payments to other nonemployee selling shareholders

Other non-employee selling shareholders receive similar additional payments (on a per share basis)

Selling shareholders remaining as employees owned substantially all shares (in substance profit-sharing)

Number of shares owned when all selling shareholders receive same level of additional consideration (on a per share basis)

Selling shareholders remaining as employees owned only a small portion of shares

Formula for additional payment consistent with other profit-sharing arrangements rather than the valuation approach

Linkage of payments to valuation of business

Initial consideration at lower end of range of business valuation, and formula for additional payment linked to the valuation approach

Formula is based on performance, such as percentage of earnings

Formula for additional payments

Formula is based on a valuation formula, such as multiple earnings, indicating it is connected to a business valuation

The guidance in IFRS 3 relating to these various indicators, as well as a final one to consider other agreements and issues is set out below: [IFRS 3.B55]

•

Continuing employment The terms of continuing employment by the selling shareholders who become key employees may be an indicator of the substance of a contingent consideration arrangement. The relevant terms of continuing employment may be included in an employment agreement, acquisition agreement or some other document. A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is remuneration for postcombination services. Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than remuneration;

Duration of continuing employment If the period of required employment coincides with or is longer than the contingent payment period, that fact may indicate that the contingent payments are, in substance, remuneration;

•

Level of remuneration Situations in which employee remuneration other than the contingent payments is at a reasonable level in comparison with that of other key employees in the combined entity may indicate that the contingent payments are additional consideration rather than remuneration;

Chapter 9

•


566

Chapter 9

Incremental payments to employees If selling shareholders who do not become employees receive lower contingent payments on a per-share basis than the selling shareholders who become employees of the combined entity, that fact may indicate that the incremental amount of contingent payments to the selling shareholders who become employees is remuneration;

Number of shares owned The relative number of shares owned by the selling shareholders who remain as key employees may be an indicator of the substance of the contingent consideration arrangement. For example, if the selling shareholders who owned substantially all of the shares in the acquiree continue as key employees, that fact may indicate that the arrangement is, in substance, a profit-sharing arrangement intended to provide remuneration for postcombination services. Alternatively, if selling shareholders who continue as key employees owned only a small number of shares of the acquiree and all selling shareholders receive the same amount of contingent consideration on a pershare basis, that fact may indicate that the contingent payments are additional consideration. The pre-acquisition ownership interests held by parties related to selling shareholders who continue as key employees, such as family members, should also be considered;

Linkage to the valuation If the initial consideration transferred at the acquisition date is based on the low end of a range established in the valuation of the acquiree and the contingent formula relates to that valuation approach, that fact may suggest that the contingent payments are additional consideration. Alternatively, if the contingent payment formula is consistent with prior profit-sharing arrangements, that fact may suggest that the substance of the arrangement is to provide remuneration;

Formula for determining consideration The formula used to determine the contingent payment may be helpful in assessing the substance of the arrangement. For example, if a contingent payment is determined on the basis of a multiple of earnings, that might suggest that the obligation is contingent consideration in the business combination and that the formula is intended to establish or verify the fair value of the acquiree. In contrast, a contingent payment that is a specified percentage of earnings might suggest that the obligation to employees is a profit-sharing arrangement to remunerate employees for services rendered;

Other agreements and issues The terms of other arrangements with selling shareholders (such as agreements not to compete, executory contracts, consulting contracts and property lease agreements) and the income tax treatment of contingent payments may indicate that contingent payments are attributable to something other than consideration for the acquiree. For example, in connection with the acquisition, the acquirer might enter into a property lease


Business combinations

567

arrangement with a significant selling shareholder. If the lease payments specified in the lease contract are significantly below market, some or all of the contingent payments to the lessor (the selling shareholder) required by a separate arrangement for contingent payments might be, in substance, payments for the use of the leased property that the acquirer should recognise separately in its post-combination financial statements. In contrast, if the lease contract specifies lease payments that are consistent with market terms for the leased property, the arrangement for contingent payments to the selling shareholder may be contingent consideration in the business combination. Although the guidance says that the acquirer should consider the above factors in determining whether the arrangement is part of the business combination or not, in the first bullet point dealing with ‘continuing employment’ it is categorically stated that ‘a contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is remuneration for postcombination services’. However, apart from that, no other single indicator is likely to be enough to be conclusive on the accounting treatment. Therefore, judgement will be required in making this assessment. Where it is determined that some or all of the arrangement is to be accounted for as contingent consideration, the requirements in IFRS 3 discussed at 9.1 should be applied. Where some or all of the arrangement is to be accounted for as postcombination remuneration, if it represents a share-based payment transaction it will be accounted for under IFRS 2 (see Chapter 28) or if not a share-based payment transaction under IAS 19 (see Chapter 29). The requirements for contingent payments to employees are illustrated in the following example. [IFRS 3.IE58-60]. Contingent payments to employees 

Entity B appointed a candidate as its new CEO under a ten-year contract. The contract required Entity B to pay the candidate $5m if Entity B is acquired before the contract expires. Entity A acquires Entity B eight years later. The CEO was still employed at the acquisition date and will receive the additional payment under the existing contract. In this example, Entity B entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of CEO. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Entity A or the combined entity. Therefore, the liability to pay $5m is included in the application of the acquisition method. In other circumstances, Entity B might enter into a similar agreement with CEO at the suggestion of Entity A during the negotiations for the business combination. If so, the primary purpose of the agreement might be to provide severance pay to CEO, and the agreement may primarily benefit Entity A or the combined entity rather than Entity B or its former owners. In that situation, Entity A accounts for the liability to pay CEO in its post-combination financial statements separately from application of the acquisition method.

Chapter 9

Example 9.24: 


568

Chapter 9 13.2.2 Share-based payment awards exchanged for awards held by the acquiree’s employees The second area that is dealt with is arrangements whereby the acquirer exchanges share-based payment awards (i.e. replacement awards) for awards held by employees of the acquiree. Acquirers often exchange share-based payment awards (i.e. replacement awards) for awards held by employees of the acquiree. These exchanges frequently occur because the acquirer wants to avoid the effect of having non-controlling interests in the acquiree represented by the shares that are ultimately held by employees, the acquirer’s shares are often more liquid than the shares of the acquired business after the acquisition, and/or to motivate former employees of the acquiree toward the overall performance of the combined, post-acquisition business. If the acquirer replaces any acquiree awards, as indicated at 9.2 above, the consideration transferred will include some or all of any acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees. To the extent that the market-based measure of those replacement awards is not included in the consideration transferred, it is treated as a post-combination remuneration expense. IFRS 3 includes Application Guidance dealing with the situation where an acquirer exchanges its share-based payment awards (replacement awards) for awards held by employees of the acquiree. [IFRS 3.B56-62]. Such exchanges are modifications of sharebased payment awards in accordance with IFRS 2. Discussion of this guidance, including illustrative examples that reflect the substance of the Illustrative Examples that accompany IFRS 3, [IFRS 3.IE61-71], is dealt with in Chapter 28 at 11.2. When the revised version of IFRS 3 was originally issued in January 2008, it was only if the acquirer was obliged to replace any acquiree awards that the consideration transferred would include some or all of any acquirer’s share-based payment awards exchanged for awards held by the acquiree’s employees. However, concerns were soon raised about the accounting for unreplaced share-based payment transactions of the acquiree and voluntary replacements of share-based payment transactions. Consequently, the IASB dealt with these issues within its Improvements to IFRSs standard issued in May 2010. The Application Guidance in paragraphs B56 – B62 of IFRS 3 therefore now requires the acquirer to apply the guidance and include some or all replacement awards (i.e. vested or unvested share-based payment transactions) as part of the consideration transferred, irrespective of whether is obliged to so or does it voluntarily. It would only be if acquiree awards would expire as a consequence of the business combination and the acquiree replaces those when it was not obliged to do so, that none of the market-based measure of the awards would be included in the consideration transferred. In that case, all of the marketbased measure of the awards is recognised as remuneration cost in the postcombination financial statements. [IFRS 3.B56]. In addition, IFRS 3 was amended such that any equity-settled share-based payment transactions of the acquiree that the acquirer does not exchange for its own sharebased payment transactions will result in non-controlling interest in the acquiree


Business combinations

569

being recognised and measured at their market-based measure as discussed at 10.4 above. [IFRS 3.B62A, B62B]. 13.3

Reimbursement to the acquiree or its former owners for paying the acquirer’s acquisition-related costs

The third example is where a transaction reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs (see 9.3 above). The Basis for Conclusions accompanying IFRS 3 explains that this example is directed at ensuring that payments that are not part of the consideration transferred for the acquiree are excluded from the business combination accounting. Instead, the payments should be accounted for separately. [IFRS 3.BC123]. IFRS 3 requires that the acquirer expenses its acquisition-related costs – they are not included as part of the consideration transferred for the acquiree (and therefore included as part of the computation of goodwill as was the case under the previous version of IFRS 3). This third example is included in order to mitigate concerns about potential abuse with respect to the treatment of acquisition-related costs in IFRS 3. If acquirers can no longer capitalise acquisition-related costs as part of the cost of the business acquired, they might modify transactions to avoid recognising those costs as expenses. For example, a buyer might ask a seller to make payments to third parties on its behalf. To facilitate the negotiations and sale of the business, the seller might agree to make those payments if the total amount to be paid to it upon closing of the business combination is sufficient to reimburse the seller for payments it made on the buyer’s behalf. If the disguised reimbursements were treated as part of the consideration transferred for the business, the acquirer might not recognise those expenses. [IFRS 3.BC370]. The same would also apply if the acquirer asks the acquiree to pay some or all of the acquisition-related costs on its behalf and the acquiree has paid those costs before the acquisition date, such that at the acquisition date the acquiree shows no liability for those costs. [IFRS 3.BC120]. This transaction has been entered into on behalf of the acquirer, or primarily for the benefit of the acquirer. 13.4

Restructuring plans

In our view, a restructuring plan that is implemented by or at the request of the acquirer is not a liability of the acquiree as at the date of acquisition and cannot be part of the accounting for the business combination under the acquisition method, regardless of whether or not the combination is contingent on the plan being implemented. A restructuring plan that is decided upon or put in place between the date the negotiations for the business combination started and the date the business combination is consummated is only likely to be accounted for as a pre-combination transaction of the acquiree if there is no evidence that the acquirer initiated the

Chapter 9

As indicated at 13 above, one particular area that may be negotiated between the acquirer and the acquiree (or its former owners) could be a restructuring plan relating to the activities of the acquiree.


570

Chapter 9 restructuring and the plan makes commercial sense even if the business combination does not proceed. If a plan initiated by the acquirer is implemented without an explicit link to the combination this may indicate that control has already passed to the acquirer at this earlier date. This is discussed further in the following example. Example 9.25: 

Recognition or otherwise of a restructuring liability as part of a  business combination 

The acquirer and the acquiree (or the vendors of the acquiree) enter into an arrangement (before the acquisition) that requires the acquiree to restructure its workforce or activities (i.e. to develop the main features of a plan that involve terminating or reducing its activities and to announce the plan's main features to those affected by it so as to raise a valid expectation that the plan will be implemented). The combination is contingent on the plan being implemented. Does such a restructuring plan that the acquiree puts in place simultaneously with the business combination (i.e. the plan is effective upon the change in control) but was implemented by or at the request of the acquirer qualify for inclusion as part of the liabilities assumed in accounting for the business combination? Applying the guidance in paragraph B50 of IFRS 3 set out at 13 above to the fact pattern: (a) the reason: a restructuring plan implemented at the request of the acquirer is presumably arranged primarily for the benefit of the acquirer or the combined entity because of the possible redundancy expected to arise from the combination of activities of the acquirer with activities of the acquiree (e.g. capacity redundancy that requires to close acquiree’s facilities); (b) who initiated: if such a plan is the result of a request of the acquirer, it means that the acquirer is expecting future economic benefits from the arrangement and the decision to restructure; (c) the timing; the restructuring plan is usually discussed during the negotiations; therefore, it is contemplated in the perspective of the future combined entity. Furthermore, as discussed at 7.2 above, an acquirer recognises liabilities for restructuring or exit activities acquired in a business combination only if they meet the definition of a liability at the acquisition date. [IFRS 3.BC132]. IFRS 3 does not contain the same explicit requirements relating to restructuring plans that were in the previous version of IFRS 3, but the Basis for Conclusions accompanying IFRS 3 clearly indicate that the requirements for recognising liabilities associated with restructuring or exit activities remain the same. [IFRS 3.BC137]. Accordingly, such a restructuring plan that is implemented as a result of an arrangement between the acquirer and the acquiree is not a liability of the acquiree as at the date of acquisition and cannot be part of the accounting for the business combination under the acquisition method. Does the answer differ if the combination is not contingent on the plan being implemented? The answer applies regardless of whether the combination is contingent on the plan being implemented. A plan initiated by the acquirer will most likely not make commercial sense from the acquiree’s perspective absent the business combination. For example, because there are retrenchments of staff whose position will only truly become redundant once the entities are combined. In that case, the guidance from paragraph B50 of to IFRS 3 still indicates that this is an arrangement to be accounted for separately rather than as part of the business combination exchange. A restructuring plan that is decided upon or put in place between the date the negotiations for the business combination started and the date the business combination is consummated is only likely to be accounted for as a pre-combination transaction of the acquiree if there is no evidence that the acquirer initiated the restructuring and the plan makes commercial sense even if the business combination does not proceed.


Business combinations

571

If a plan initiated by the acquirer is implemented without an explicit link to the combination this may indicate that control has already passed to the acquirer at this earlier date. Even if it does not, the conclusion remains the same when the combination is not contingent upon the plan being implemented. If the acquirer initiates the restructuring, then the restructuring will likely make no commercial sense from the acquiree’s perspective absent the combination.

14

MEASUREMENT PERIOD

IFRS 3 contains provisions in respect of a ‘measurement period’, which although quite similar to those in the previous version of IFRS 3 are not identical. [IFRS 3.BC394]. The measurement period is to provide the acquirer with a reasonable time to obtain the information necessary to identify and measure all of the various components of the business combination as of the acquisition date in accordance with the standard, i.e. [IFRS 3.46] (a) the identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree; (b) the consideration transferred for the acquiree (or the other amount used in measuring goodwill); (c) in a business combination achieved in stages, the equity interest in the acquiree previously held by the acquirer; and (d) the resulting goodwill or gain on a bargain purchase.

The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable. However, the measurement period is not to exceed one year from the acquisition date. [IFRS 3.45]. The Basis for Conclusions accompanying IFRS 3 notes that in placing this constraint it was ‘concluded that allowing a measurement period longer than one year would not be especially helpful; obtaining reliable information about circumstances and conditions that existed more than a year ago is likely to become more difficult as time passes. Of course, the outcome of some contingencies and similar matters may not be known within a year. But the objective of the measurement period is to provide time to obtain the information necessary to measure the fair value of the item as of the acquisition date. Determining the ultimate settlement amount of a contingency or other item is not necessary. Uncertainties about the timing and amount of future cash flows are part of the measure of the fair value of an asset or liability.’ [IFRS 3.BC392]. Under IFRS 3, if the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the acquirer reports in its financial statements provisional amounts for the items for which the

Chapter 9

For most business combinations, the main area where information will need to be obtained is in relation to the acquiree, i.e. the identifiable assets acquired and the liabilities assumed, particularly as these may include items that the acquiree had not previously recognised as assets and liabilities in its financial statements and, in most cases, need to be measured at their acquisition-date fair value (see 7 above). Information may also need to be obtained in determining the fair value of any contingent consideration arrangements (see 9.1 above).


572

Chapter 9 accounting is incomplete. [IFRS 3.45]. It was concluded that acquirers should provide relevant information about the status of items that have been measured only provisionally, so IFRS 3 specifies particular disclosures about those items (see 18.2 below). [IFRS 3.BC392]. Although the wording of paragraph 45 refers to the initial accounting being ‘incomplete by the end of the reporting period’ and the acquirer reporting ‘provisional amounts for the items for which the accounting is incomplete’, it is clear from the Illustrative Examples accompanying IFRS 3 that this means being incomplete at the date of authorising for issue the financial statements for that period (see Example 9.26 below). Thus, any items that are finalised up to that date should be reflected in the initial accounting. 14.1

Adjustments made during measurement period to provisional amounts

During the measurement period, the acquirer retrospectively adjusts the provisional amounts recognised at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date and, if known, would have affected the measurement of the amounts recognised as of that date. Also, during the measurement period, the acquirer recognises additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date and, if known, would have resulted in the recognition of those assets and liabilities as of that date. [IFRS 3.45]. IFRS 3 requires the acquirer to consider all pertinent factors in determining whether information obtained after the acquisition date should result in an adjustment to the provisional amounts recognised or whether the information results from events that occurred after the acquisition date. Pertinent factors include the date when additional information is obtained and whether the acquirer can identify a reason for a change to provisional amounts. The standard states that information obtained shortly after the acquisition date is more likely to reflect circumstances that existed at the acquisition date than information obtained several months later. For example, the sale of an asset to a third party shortly after the acquisition date for an amount that differs significantly from its provisional fair value determined at that date is likely to indicate an ‘error’ in the provisional amount unless an intervening event that changes its fair value can be identified. [IFRS 3.47]. Adjustments to provisional amounts that are made during the measurement period are recognised as if the accounting for the business combination had been completed at the acquisition date. Thus, the acquirer revises comparative information for prior periods presented in financial statements as needed, including making any change in depreciation, amortisation or other income effects recognised in completing the acquisition accounting. [IFRS 3.49]. These requirements are illustrated in the following example, which is based on one included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE50-53]. The deferred tax implications are ignored.


Business combinations Example 9.26: 

573

Adjustments made during measurement period to provisional amounts 

Entity A acquired Entity B on 30 September 2010. Entity A sought an independent valuation for an item of property, plant and equipment acquired in the combination. However, the valuation was not complete by the time Entity A authorised for issue its financial statements for the year ended 31 December 2010. In its 2010 annual financial statements, Entity A recognised a provisional fair value for the asset of €30,000. At the acquisition date, the item of property, plant and equipment had a remaining useful life of five years. Five months after the acquisition date, Entity A received the independent valuation, which estimated the asset’s acquisition-date fair value at €40,000. In its financial statements for the year ended 31 December 2011 financial statements, Entity A retrospectively adjusts the 2010 prior year information as follows: (a) The carrying amount of property, plant and equipment as of 31 December 2010 is increased by €9,500. That adjustment is measured as the fair value adjustment at the acquisition date of €10,000 less the additional depreciation that would have been recognised if the asset’s fair value at the acquisition date had been recognised from that date (€500 for three months’ depreciation). (b) The carrying amount of goodwill as of 31 December 2010 is decreased by €10,000. (c) Depreciation expense for 2010 is increased by €500. Entity A disclosed in its 2010 financial statements that the initial accounting for the business combination has not been completed because the valuation of property, plant and equipment has not yet been received. In its 2011 financial statements, Entity A will disclose the amounts and explanations of the adjustments to the provisional values recognised during the current reporting period. Therefore, Entity A will disclose that the 2010 comparative information is adjusted retrospectively to increase the fair value of the item of property, plant and equipment at the acquisition date by €10,000, resulting in an increase to property, plant and equipment of €9,500, offset by a decrease to goodwill of €10,000 and an increase in depreciation expense of €500.

The above example illustrates a situation where a provisional value of an asset was finalised at a different amount as a result of receiving information during the measurement period about the asset’s fair value as of the acquisition date. The example below illustrates that adjustments during the measurement period are also made where information is received about the existence of an asset as of the acquisition date: Identification of an asset during measurement period 

Entity C acquired Entity D on 30 November 2010. Entity C engaged an independent appraiser to assist with the identification and determination of fair values to be assigned to the acquiree’s assets and liabilities. However, the appraisal was not finalised by the time Entity C authorised for issue its financial statements for the year ended 31 December 2010, and therefore the amounts recognised in its 2010 annual financial statements were on a provisional basis. Six months after the acquisition date, Entity C received the independent appraiser’s final report, in which it was identified by the independent appraiser that the acquiree had an intangible asset (meeting all of the IAS 38 recognition and identification criteria) with a fair value at the date of acquisition of €20,000. However, this had not been identified at the time when Entity C was preparing its 2010 annual financial statements. Thus, no value had been included for this intangible asset. In its financial statements for the year ended 31 December 2011 financial statements, Entity C retrospectively adjusts the 2010 prior year information to reflect the recognition of this intangible asset. Although in this case, no value had been recognised, and indeed, the intangible asset had not even been identified at the time of preparing its 2010 financial statements, IFRS 3 requires that an acquirer recognises additional assets (or liabilities) if new information is obtained about facts and circumstances that existed as of the acquisition date and, if known, would have resulted in the recognition of those assets and liabilities as of that date.

Chapter 9

Example 9.27: 


574

Chapter 9 Although an increase/(decrease) in the provisional amount recognised for an identifiable asset will usually mean a corresponding decrease/(increase) in goodwill, IFRS 3 notes that the new information obtained may result in an adjustment to another identifiable asset or liability. For example, the acquirer might have assumed a liability to pay damages related to an accident in one of the acquiree’s facilities, part or all of which are covered by the acquiree’s liability insurance policy. If the acquirer obtains new information during the measurement period about the acquisition-date fair value of that liability, the adjustment to goodwill would be offset (in whole or in part) by a corresponding adjustment to goodwill resulting from a change to the provisional amount recognised for the claim receivable from the insurer. [IFRS 3.48]. Similarly, if there is a non-controlling interest in the acquiree, and this is measured based on the proportionate share of the net identifiable assets of the acquiree (see 10 above), any adjustments to those assets that had initially been determined on a provisional basis will be offset by the proportionate share attributable to the non-controlling interest. 14.2

Adjustments made after end of measurement period

Under IFRS 3, after the measurement period ends, the acquirer can only revise the accounting for a business combination to correct an error in accordance with IAS 8. [IFRS 3.50]. This would probably be the case only if the original accounting was based on a misinterpretation of the facts which were available at the time; it would not apply simply because new information had come to light which changed the acquiring management’s view of the value of the item in question. Adjustments to the accounting for a business combination after the end of the measurement period are therefore not made for the effect of changes in estimates. In accordance with IAS 8, the effect of a change in estimates is recognised in the current and future periods (see Chapter 3 at 4.5).

15

SUBSEQUENT MEASUREMENT AND ACCOUNTING

In general, an acquirer subsequently measures and accounts 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, IFRS 3 provides guidance on subsequently measuring and accounting for the following assets acquired, liabilities assumed or incurred and equity instruments issued in a business combination: [IFRS 3.54] (a) reacquired rights (see 7.6.5.B above); (b) contingent liabilities recognised as of the acquisition date (see 7.6.1.B above); (c) indemnification assets (see 7.6.4.B above); and (d) contingent consideration (see 9.1.3 above). The Application guidance in IFRS 3 includes the following examples of other IFRSs that provide guidance on subsequently measuring and accounting for assets acquired and liabilities assumed or incurred in a business combination: [IFRS 3.B63]


Business combinations (a)

(b) (c) (d) (e)

16

575

IAS 38 prescribes the accounting for identifiable intangible assets acquired in a business combination (see Chapter 15), although as noted elsewhere in the Application guidance ‘as described in paragraph 3 of IAS 38, the accounting for some acquired intangible assets after initial recognition is prescribed by other IFRSs’ [IFRS 3.B39] (see Chapter 15 at 2). The acquirer measures goodwill at the amount recognised at the acquisition date less any accumulated impairment losses. IAS 36 prescribes the accounting for impairment losses (see Chapter 18 at 5); IFRS 4 provides guidance on the subsequent accounting for an insurance contract acquired in a business combination (see Chapter 49); IAS 12 prescribes the subsequent accounting for deferred tax assets (including unrecognised deferred tax assets) and liabilities acquired in a business combination (see Chapter 27); IFRS 2 provides guidance on subsequent measurement and accounting for the portion of replacement share-based payment awards issued by an acquirer that is attributable to employees’ future services (see Chapter 28); IAS 27 provides guidance on accounting for changes in a parent’s ownership interest in a subsidiary after control is obtained (see Chapter 7).

REVERSE ACQUISITIONS

Under IFRS 3, a reverse acquisition is stated to occur when the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes on the basis of the guidance in paragraphs B13-B18 of the standard discussed at 5 above. Or more accurately, the entity whose equity interests are acquired (the legal acquiree) must be identified as the acquirer for accounting purposes, based on that guidance, for the transaction to be considered a reverse acquisition. For example, reverse acquisitions sometimes occur when a private operating entity wants to become a public entity but does not want to register its equity shares. To accomplish that, the private entity will arrange for a public entity to acquire its equity interests in exchange for the equity interests of the public entity. In this example, the public entity is the legal acquirer because it issued its equity interests, and the private entity is the legal acquiree because its equity interests were acquired. However, application of the guidance results in identifying: (a) the public entity as the acquiree for accounting purposes (the accounting acquiree); and (b) the private entity as the acquirer for accounting purposes (the accounting acquirer). [IFRS 3.B19]. If the private entity is identified as the acquirer as a result of applying that guidance, the transaction should be accounted for as a reverse acquisition, i.e. as an acquisition

Chapter 9

As discussed at 5 above, in a business combination effected primarily by exchanging equity interests, the standard takes the view that the acquirer is usually the entity that issues its equity interests, but recognises that in some business combinations, so-called ‘reverse acquisitions’, the issuing entity is the acquiree.


576

Chapter 9 by the private entity of the public entity, in which case, all of the recognition and measurement principles in IFRS 3, including the requirement to recognise goodwill, apply. The standard also notes that the accounting acquiree (legal acquirer) must meet the definition of a business (see 3.2 above) for the transaction to be accounted for as a reverse acquisition, [IFRS 3.B19], but does not say how the transaction should be accounted for where the accounting acquiree is not a business. It clearly cannot be accounted for as an acquisition of the legal acquiree by the legal acquirer under the standard either, if the legal acquirer has not been identified as the accounting acquirer based on the guidance in the standard. This is discussed further at 16.8 below. As indicated above, where a transaction is to be accounted for as a reverse acquisition, all of the recognition and measurement principles in IFRS 3, including the requirement to recognise goodwill, apply, but treating the legal acquiree/subsidiary as the accounting acquirer and the legal acquirer/parent as the accounting acquiree. This means that the measurement of goodwill will not be as discussed at 8 above, but the amount of goodwill that is recognised in a reverse acquisition is generally measured as the excess of (a) over (b) below: [IFRS 3.IE6] (a) the consideration transferred (generally measured at acquisition-date fair value) by the accounting acquirer, i.e. the legal acquiree/subsidiary; (b) the net of the acquisition-date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed of the accounting acquiree, i.e. the legal acquirer/parent. There is no non-controlling interest in the accounting acquiree, i.e. the legal acquirer/parent, to be taken into account in the computation of goodwill, but there may be a non-controlling interest in the accounting acquirer, i.e. the legal acquiree/subsidiary, to be recognised in the consolidated financial statements (see 16.4 below). IFRS 3 gives the following guidance in the accounting for a reverse acquisition. 16.1

Measuring the consideration transferred

As indicated above, the first item to be included in the computation of goodwill in a reverse acquisition is the consideration transferred (generally measured at acquisition-date fair value) by the accounting acquirer, i.e. the legal acquiree/subsidiary. However, in a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead, the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly, the acquisitiondate fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition. The fair value of the number of equity interests calculated in that way can be used as the fair value of consideration transferred in exchange for the acquiree. [IFRS 3.B20].


Business combinations

577

These requirements are illustrated in the following example, which is based on one included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE1-5]. Example 9.28: 

Reverse acquisition – calculating the fair value of the consideration  transferred 

Entity A, the entity issuing equity instruments and therefore the legal parent, is acquired in a reverse acquisition by Entity B, the legal subsidiary, on 30 September 2011. The accounting for any income tax effects is ignored. Balance sheets (Statements of financial position) of Entity A and Entity B immediately before the business combination are: Entity A Entity B € €

Current liabilities Non-current liabilities Total liabilities Owner’s equity Issued equity 100 ordinary shares 60 Ordinary shares Retained earnings Total shareholders’ equity

500 1,300 1,800

700 3,000 3,700

300 400 700

600 1,100 1,700

300 800 1,100

600 1,400 2,000

Other information (a) On 30 September 2011, Entity A issues 2.5 shares in exchange for each ordinary share of Entity B. All of Entity B’s shareholders exchange their shares in Entity B. Therefore, Entity A issues 150 ordinary shares in exchange for all 60 ordinary shares of Entity B. (b) The fair value of each ordinary share of Entity B at 30 September 2011 is €40. The quoted market price of Entity A’s ordinary shares at that date is €16. (c) The fair values of Entity A’s identifiable assets and liabilities at 30 September 2011 are the same as their carrying amounts, except that the fair value of Entity A’s non-current assets at 30 September 2011 is €1,500. Calculating the fair value of the consideration transferred As a result of Entity A (legal parent, accounting acquiree) issuing 150 ordinary shares, Entity B’s shareholders own 60 per cent of the issued shares of the combined entity (i.e. 150 of 250 issued shares). The remaining 40 per cent are owned by Entity A’s shareholders. If the business combination had taken the form of Entity B issuing additional ordinary shares to Entity A’s shareholders in exchange for their ordinary shares in Entity A, Entity B would have had to issue 40 shares for the ratio of ownership interest in the combined entity to be the same. Entity B’s shareholders would then own 60 out of the 100 issued shares of Entity B – 60 per cent of the combined entity. As a result, the fair value of the consideration effectively transferred by Entity B and the group’s interest in Entity A is €1,600 (i.e. 40 shares each with a fair value of €40). The fair value of the consideration effectively transferred should be based on the most reliable measure. In this example, the quoted market price of Entity A’s shares provides a more reliable basis for measuring the consideration effectively transferred than the estimated fair value of the shares in Entity B, and the consideration is measured using the market price of Entity A’s shares – 100 shares with a fair value per share of €16, i.e. €1,600.

Chapter 9

Current assets Non-current assets Total assets


578

Chapter 9 The final paragraph in the above example reflects that in the Illustrative Example accompanying IFRS 3. [IFRS 3.IE5]. This would appear to based on the requirements of paragraph 33 of the standard, i.e. ‘in a business combination in which the acquirer and the acquiree (or its former owners) 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.’ In the above example, this did not make any difference as the value of the consideration measured under both approaches was the same. However, it does suggest that as the quoted market price of Entity A’s shares is a more reliable basis than the fair value of Entity B’s shares, if the quoted market price of Entity A’s shares had been, say, €14 per share, the fair value of the consideration effectively transferred would have been measured at €1,400. 16.2

Measuring goodwill

As there is no non-controlling interest in the accounting acquiree, and assuming that the accounting acquirer had no previously held equity interest in the accounting acquiree, goodwill is measured as the excess of (a) over (b) below: (a) the consideration effectively transferred (generally measured at acquisitiondate fair value) by the accounting acquirer, i.e. the legal acquiree/subsidiary; (b) the net of the acquisition-date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed of the accounting acquiree, i.e. the legal acquirer/parent. Example 9.29: 

Reverse acquisition – measuring goodwill (1) [IFRS 3.IE6] 

Using the facts in Example 9.28 above, this results in goodwill of €300, measured as follows: € Consideration effectively transferred by Entity B Net recognised values of Entity A’s identifiable assets and liabilities: Current assets Non-current assets Current liabilities Non-current liabilities

1,600 500 1,500 (300) (400) 1,300 300

Goodwill

Example 9.30: 

Reverse acquisition – measuring goodwill (2) 

If Example 9.29 had been based on the same facts as Example 9.28, except that the quoted market price of Entity A’s shares had been €14 per share, and this was considered to be a more reliable measure of the consideration transferred, this would have meant that the fair value of the consideration effectively transferred was €1,400, resulting in goodwill of €100. Indeed, if the quoted market price of Entity A’s shares had been €12 per share, such that the fair value of the consideration effectively transferred was €1,200, no goodwill would have arisen and, assuming no adjustments were required as a result of the re-assessment of the components of the computation (see 12 above), a gain on a bargain purchase of €100 would be recognised immediately in profit or loss.


Business combinations 16.3

579

Preparation and presentation of consolidated financial statements

Because such consolidated financial statements represent a continuation of the financial statements of the legal subsidiary (accounting acquirer) except for its capital structure, the consolidated financial statements reflect: (a) the assets and liabilities of the legal subsidiary (accounting acquirer) recognised and measured at their pre-combination carrying amounts, i.e. not at their acquisition-date fair values; (b) the assets and liabilities of the legal parent (accounting acquiree) recognised and measured in accordance with IFRS 3, i.e. generally at their acquisitiondate fair values; (c) the retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination, i.e. not those of the legal parent (accounting acquiree); (d) the amount recognised as issued equity instruments in the consolidated financial statements determined by adding the issued equity of the legal subsidiary (accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with IFRS 3. However, the equity structure (i.e. the number and type of equity instruments issued) reflects the equity structure of the legal parent (accounting acquiree), including the equity instruments issued by the legal parent to effect the combination. Accordingly, the equity structure of the legal subsidiary (accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition; (e) the non-controlling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) pre-combination carrying amounts of retained earnings and other equity interests (as discussed in 16.4 below); [IFRS 3.B22] (f) the income statement for the current period reflects that of the legal subsidiary (accounting acquirer) for the full period together with the postacquisition results of the legal parent (accounting acquiree) (based on the attributed fair values).

Chapter 9

Although the accounting for the reverse acquisition reflects the legal subsidiary as being the accounting acquirer, the consolidated financial statements prepared following a reverse acquisition are issued under the name of the legal parent (accounting acquiree). Consequently they have to be described in the notes as a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment, which is to adjust retroactively the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. Comparative information presented in those consolidated financial statements is therefore that of the legal subsidiary (accounting acquirer), not that originally presented in the previous financial statements of the legal parent (accounting acquiree), and also is retroactively adjusted to reflect the legal capital of the legal parent (accounting acquiree). [IFRS 3.B21].


580

Chapter 9 It is unclear why the Application guidance in (d) above refers to using ‘the fair value of the legal parent (accounting acquiree) determined in accordance with’ IFRS 3, when, as discussed previously at 16.1 above, the guidance for determining ‘the fair value of the consideration effectively transferred’ uses a different method of arriving at the value of the consideration given. We believe that the amount recognised as issued equity should reflect whichever value has been determined for the consideration effectively transferred. Continuing with Example 9.28 above, the consolidated balance sheet immediately after the business combination will be as follows: Example 9.31: 

Reverse acquisition – consolidated balance sheet immediately after the  business combination [IFRS 3.IE7, 8] 

Using the facts in Example 9.28 above, the consolidated balance sheet immediately after the date of the business combination is as follows (the intermediate columns for Entity B (legal subsidiary, accounting acquirer) and Entity A (legal parent, accounting acquiree) are included to show the workings): Entity B Book values €

Entity A Fair values €

Consolidated

700 3,000

1,200 4,500 300 6,000

Current assets Non-current assets Goodwill Total assets

3,700

500 1,500 300 2,300

Current liabilities Non-current liabilities Total liabilities

600 1,100 1,700

300 400 700

900 1,500 2,400

Owner’s equity Issued equity 250 ordinary shares Retained earnings Total shareholders’ equity

600 1,400 2,000

1,600 – 1,600

2,200 1,400 3,600

The amount recognised as issued equity interests in the consolidated financial statements (€2,200) is determined by adding the issued equity of the legal subsidiary immediately before the business combination (€600) and the fair value of the consideration effectively transferred (€1,600). However, the equity structure appearing in the consolidated financial statements (i.e. the number and type of equity interests issued) must reflect the equity structure of the legal parent, including the equity interests issued by the legal parent to effect the combination.

Interestingly, the final paragraph in the above example, which reflects that in the Illustrative Example accompanying IFRS 3, [IFRS 3.IE8], refers to the amount for issued equity instruments being determined by adding ‘the fair value of the consideration effectively transferred’ (see 16.1 above), rather than using ‘the fair value of the legal parent (accounting acquiree) determined in accordance with’ IFRS 3 as discussed above. As noted above, we believe that the amount recognised as issued equity should reflect whichever value has been determined for the consideration effectively transferred.


Business combinations

581

The Application guidance in IFRS 3 only deals with the reverse acquisition accounting in the consolidated financial statements; no mention is made as to what should happen in the separate financial statements of the legal parent (accounting acquiree), if any. However, the previous version of IFRS 3 indicated that reverse acquisition accounting applies only in the consolidated financial statements, and that in the legal parent’s separate financial statements, the investment in the legal subsidiary is accounted for in accordance with the requirements in IAS 27 on accounting for investments in an investor’s separate financial statements. [IFRS 3.B8 (2007)].

Example 9.32: 

Reverse acquisition – legal parent’s balance sheet in separate financial  statements 

Using the facts in Example 9.28 above, the balance sheet of Entity A, the legal parent, in its separate financial statements immediately following the business combination will be as follows: Entity A € Current assets Non-current assets Investment in subsidiary (Entity B) Total assets Current liabilities Non-current liabilities Total liabilities Owner’s equity Issued equity 250 ordinary shares Retained earnings

500 1,300 2,400 4,200 300 400 700

2,700 800 3,500

The investment in the subsidiary is included at its cost of €2,400, being the fair value of the shares issued by Entity A (150 × €16). It can be seen that the issued equity is different from that in the consolidated financial statements and its non-current assets remain at their carrying amounts before the business combination.

Non-controlling interest

In a reverse acquisition, some of the owners of the legal subsidiary (accounting acquirer) might not exchange their equity instruments for equity instruments of the legal parent (accounting acquiree). Although reverse acquisition accounting regards the entity in which those owners hold equity instruments (the legal subsidiary) as having acquired the other entity (the legal parent), those owners are required to be treated as a non-controlling interest in the consolidated financial statements after the reverse acquisition. This is because the owners of the legal subsidiary that do not exchange their equity instruments for equity instruments of the legal parent have an interest only in the results and net assets of the legal subsidiary, and not in the results and net assets of the combined entity. Conversely, even though the legal parent is the acquiree for accounting purposes, the owners of the legal parent have an interest in the results and net assets of the combined entity. [IFRS 3.B23].

Chapter 9

16.4


582

Chapter 9 As indicated at 16.3 above, the assets and liabilities of the legal subsidiary (accounting acquirer) are recognised and measured in the consolidated financial statements at their pre-combination carrying amounts. Therefore, in a reverse acquisition the non-controlling interest reflects the non-controlling shareholders’ proportionate interest in the pre-combination carrying amounts of the legal subsidiary’s net assets even if the non-controlling interests in other acquisitions are measured at fair value at the acquisition date. [IFRS 3.B24]. These requirements are illustrated in the following example, which is based on one included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE11-15]. Example 9.33: 

Reverse acquisition – non‐controlling interest 

This example uses the same facts in Example 9.28 above, except that only 56 of Entity B’s 60 ordinary shares are exchanged. Because Entity A issues 2.5 shares in exchange for each ordinary share of Entity B, Entity A issues only 140 (rather than 150) shares. As a result, Entity B’s shareholders own 58.3 per cent of the issued shares of the combined entity (i.e. 140 shares out of 240 issued shares). As in Example 9.28 above, the fair value of the consideration transferred for Entity A, the accounting acquiree) is calculated by assuming that the combination had had been effected by Entity B issuing additional ordinary shares to the shareholders of Entity A in exchange for their ordinary shares in Entity A. That is because Entity B is the accounting acquirer, and IFRS 3 requires the acquirer to measure the consideration exchanged for the accounting acquiree (see 16.1 above). In calculating the number of shares that Entity B would have had to issue, the non-controlling interest is excluded from the calculation. The majority shareholders own 56 shares of Entity B. For that to represent a 58.3 per cent ownership interest, Entity B would have had to issue an additional 40 shares. The majority shareholders would then own 56 out of the 96 issued shares of Entity B and therefore 58.3 per cent of the combined entity. As a result, the fair value of the consideration transferred for Entity A, the accounting acquiree, is €1,600 (i.e. 40 shares, each with a fair value of €40). That is the same amount as when all 60 of Entity B’s shareholders tender all 60 of its ordinary shares for exchange (see Example 9.28 above). The recognised amount of the group’s interest in Entity A, the accounting acquiree, does not change if some of Entity B’s shareholders do not participate in the exchange. The non-controlling interest is represented by the 4 shares of the total 60 shares of Entity B that are not exchanged for shares of Entity A. Therefore, the non-controlling interest is 6.7 per cent. The non-controlling interest reflects the proportionate interest of the non-controlling shareholders in the pre-combination carrying amounts of the net assets of Entity B, the legal subsidiary. Therefore, the consolidated balance sheet is adjusted to show a non-controlling interest of 6.7 per cent of the precombination carrying amounts of Entity B’s net assets (i.e. €134 or 6.7 per cent of €2,000). The consolidated balance sheet at 30 September 2011 (the date of the business combination) reflecting the non-controlling interest is as follows (the intermediate columns for Entity B (legal subsidiary, accounting acquirer), non-controlling interest and Entity A (legal parent, accounting acquiree) are included to show the workings): NonEntity B controlling Entity A Consolidated Book values interest Fair values € € € € Current assets Non-current assets Goodwill Total assets

700 3,000 3,700

500 1,500 300 2,300

1,200 4,500 300 6,000


Business combinations Current liabilities Non-current liabilities Owner’s equity Issued equity 240 ordinary shares Retained earnings Non-controlling interest

600 1,100 1,700

600 1,400 – 2,000

(40) (94) 134 –

300 400 700

900 1,500 2,400

1,600 – – 1,600

2,160 1,306 134 3,600

583

The non-controlling interest of €134 has two components. The first component is the reclassification of the non-controlling interest’s share of the accounting acquirer’s retained earnings immediately before the acquisition (€1,400 × 6.7 per cent or €93.80). The second component represents the reclassification of the non-controlling interest’s share of the accounting acquirer’s issued equity (€600 × 6.7 per cent or €40.20).

16.5

Earnings per share

As indicated at 16.3 above, the equity structure (i.e. the number and type of equity instruments issued) appearing in the consolidated financial statements following a reverse acquisition reflects the equity structure of the legal parent (accounting acquiree), including the equity instruments issued by the legal parent to effect the business combination. [IFRS 3.B25].

The basic earnings per share disclosed for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse acquisition is calculated by dividing: (a) the profit or loss of the legal subsidiary (accounting acquirer) attributable to ordinary shareholders in each of those periods by (b) the legal subsidiary’s historical weighted average number of ordinary shares outstanding multiplied by the exchange ratio established in the acquisition agreement. [IFRS 3.B27]. These requirements are illustrated in the following example, which is based on one included within the Illustrative Examples accompanying IFRS 3. [IFRS 3.IE9, 10].

Chapter 9

Where the legal parent is required by IAS 33 to disclose earnings per share information (see Chapter 42), then for the purpose of calculating the weighted average number of ordinary shares outstanding (the denominator of the earnings per share calculation) during the period in which the reverse acquisition occurs: (a) the number of ordinary shares outstanding from the beginning of that period to the acquisition date is computed on the basis of the weighted average number of ordinary shares of the legal subsidiary (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the acquisition agreement; and (b) the number of ordinary shares outstanding from the acquisition date to the end of that period is the actual number of ordinary shares of the legal parent (accounting acquiree) outstanding during that period. [IFRS 3.B26].


584

Chapter 9 Example 9.34: 

Reverse acquisition – earnings per share 

This example uses the same facts in Example 9.28 above. Assume that Entity B’s earnings for the annual period ended 31 December 2010 were €600, and that the consolidated earnings for the annual period ending 31 December 2011 were €800. Assume also that there was no change in the number of ordinary shares issued by Entity B (legal subsidiary, accounting acquirer) during the annual period ended 31 December 2010 and during the period from 1 January 2011 to the date of the reverse acquisition (30 September 2011), nor by Entity A (legal parent, accounting acquiree) after that date. Earnings per share for the annual period ended 31 December 2011 is calculated as follows: Number of shares deemed to be outstanding for the period from 1 January 2011 to the acquisition date (i.e. the number of ordinary shares issued by Entity A (legal parent, accounting acquiree) in the reverse acquisition, or more accurately, the weighted average number of ordinary shares of Entity B (legal subsidiary, accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the acquisition agreement, i.e. 60 × 2.5)

150

Number of shares of Entity A (legal parent, accounting acquiree) outstanding from the acquisition date to 31 December 2011

250

Weighted average number of shares outstanding (150 × 9/12) + (250 × 3/12) Earnings per share €800/175

175 €4.57

The restated earnings per share for the annual period ending 31 December 2010 is €4.00 (being €600/150, i.e. the earnings of Entity B (legal subsidiary, accounting acquirer) for that period divided by the number of ordinary shares Entity A issued in the reverse acquisition (or more accurately, by the weighted average number of ordinary shares of Entity B (legal subsidiary, accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the acquisition agreement, i.e. 60 × 2.5). Any earnings per share information for that period previously disclosed by either Entity A or Entity B is irrelevant.

16.6

Cash consideration

Typically, a reverse acquisition occurs where the legal acquirer (Entity A) issues new shares to ‘acquire’ shares in the legal acquiree (Entity B), but on the basis of the guidance in paragraphs B13-B18 of the standard discussed at 5 above, Entity B is determined to be the accounting acquirer. However, in some circumstances the combination may be effected whereby some of the consideration given by Entity A to acquire the shares in Entity B is cash. In such circumstances, can the combination be accounted for as a reverse acquisition of Entity A by Entity B despite some of the consideration being in the form of cash? Normally, the entity issuing cash consideration would be considered to be the acquirer. [IFRS 3.B14]. However, despite the form of the consideration, the key determinant in identifying an acquirer is whether it has control over the other (see 5 above). Therefore, where having considered the guidance referred to above, including all the facts and circumstances relating to the business combination, there is evidence


Business combinations

585

demonstrating that the legal acquiree, Entity B, has obtained the power to govern the financial and operating policies of Entity A so as to obtain benefits from its activities, this will overcome the presumption that Entity A is the acquirer and the combination should be accounted for as a reverse acquisition. In that case, how should any cash paid be accounted for? One approach might be to treat the payment as a pre-acquisition transaction with a resulting reduction in the consideration and in net assets acquired (with no net impact on goodwill). However, we do not believe this to be appropriate. Any consideration, whether cash or shares, transferred by Entity A cannot form part of the consideration transferred by the acquirer as Entity A is the accounting acquiree. As discussed at 16.3 above, although the consolidated financial statements following a reverse acquisition are issued under the name of the legal parent (Entity A), they are to be described in the notes as a continuation of the financial statements of the legal subsidiary (Entity B). Therefore, since the consolidated financial statements are a continuation of Entity B’s financial statements, in our view the cash consideration paid from Entity A (the accounting acquiree) should be accounted for as a distribution from the consolidated group to the accounting acquirer’s (Entity B’s) shareholders as at the combination date. However, where a cash payment is made to effect the combination, the requirements of the Application guidance in Appendix B to IFRS 3 need to be applied with care as illustrated in the following example. Reverse acquisition effected with cash consideration 

Entity A has 100,000 ordinary shares in issue, with a market price of £2.00 per share, giving a market capitalisation of £200,000. It acquires all of the shares in Entity B for a consideration of £500,000 satisfied by the issue of 200,000 shares (with a value of £400,000) and a cash payment of £100,000 to Entity B’s shareholders. Entity B has 200,000 shares in issue, with an estimated fair value of £2.50 per share. After the combination Entity B’s shareholders control the voting of Entity A and, as a result, have been able to appoint Entity B’s directors and key executives to replace their Entity A counterparts. Accordingly, as Entity B has the power to govern the financial and operating policies of Entity A so as to obtain benefits from its activities, Entity B is identified as the accounting acquirer. The combination must be accounted for as a reverse acquisition, i.e. an acquisition of Entity A (legal parent, accounting acquiree) by Entity B (legal subsidiary, accounting acquirer). How should the consideration transferred by the accounting acquirer (Entity B) for its interest in the accounting acquiree (Entity A) be determined? Applying the requirements of paragraph B20 of IFRS 3 (discussed at 16.1 above) to the transaction might lead to the following conclusion. Entity A has had to issue 200,000 shares to Entity B’s shareholders, resulting in Entity B’s shareholders having 66.67% (200,000/300,000) of the equity and Entity A’s shareholders 33.33% (100,000/300,000). If Entity B’s share price is used to determine the fair value of the consideration transferred, then under paragraph B20, Entity B would have had to issue 100,000 shares to Entity A’s shareholders to result in the same % shareholdings (200,000/300,000 = 66.67%). This would apparently give a value of the consideration transferred of 100,000 @ £2.50 = £250,000. This does not seem correct. If there had been no cash consideration at all, Entity A would have issued 250,000 shares to Entity B’s shareholders, resulting in Entity B’s shareholders having 71.43% (250,000/350,000) of the equity and Entity A’s shareholders 28.57% (100,000/350,000). If Entity B’s share price is used to determine the value of the consideration transferred, then under paragraph B20, Entity B would have had to issue 80,000 shares to Entity A’s shareholders to result in the same % shareholdings

Chapter 9

Example 9.35: 


586

Chapter 9 (200,000/280,000 = 71.43%). This would give a value for the consideration transferred of 80,000 @ £2.50 = £200,000. If it was thought that the fair value of Entity A’s shares was more reliably measurable, paragraph 33 of IFRS 3 would require the consideration to be measured using the market price of Entity A’s shares. As Entity B has effectively acquired 100% of Entity A, the value of the consideration transferred would be £200,000 (the same as under the revised paragraph B20 calculation above). In our view, the proper analysis of the paragraph B20 calculation in this case is that of the 100,000 shares that Entity B is deemed to have issued, only 80,000 of them are to acquire Entity A’s shares, resulting in a cost of £200,000. The extra 20,000 shares are to compensate Entity A’s shareholders for the fact that Entity B’s shareholders have received a cash distribution of £100,000, and is effectively a stock distribution to Entity A’s shareholders of £50,000 (20,000 @ £2.50), being their share (33.33%) of a total distribution of £150,000. However, since the equity structure (i.e. the number and type of shares) appearing in the consolidated financial statements reflects that of the legal parent, Entity A, this ‘stock distribution’ will not actually be apparent. The only distribution that will be shown as a movement in equity is the £100,000 cash paid to Entity B’s shareholders.

16.7

Share-based payments

It may that in a reverse acquisition the legal acquirer (Entity A) has an existing share-based payment plan at the date of acquisition. In such a situation, how does the entity account for awards held by the employees of the accounting acquiree? Example 9.36: 

Share‐based payments in a reverse acquisition 

Entity A legally acquires Entity B, but Entity B (the legal subsidiary) is the accounting acquirer under IFRS 3. Entity A has an existing share-based payment plan at the date of acquisition. The terms of awards held by employees of Entity A are not changed. How are these share-based payment awards accounted for in the consolidated financial statements? Under IFRS 3, accounting for a reverse acquisition takes place from the perspective of the accounting acquirer, not the legal acquirer. Therefore, the accounting for the share-based payment plan of Entity A is based on what would have happened if Entity B rather than Entity A had issued such equity instruments. As indicated at 16.1 above, in a reverse acquisition, the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition. The fair value of the number of equity interests calculated in that way can be used as the fair value of consideration transferred in exchange for the acquiree. Therefore, although the legal form of awards made by the accounting acquiree (Entity A) does not change, from an accounting perspective, it is as if these awards have been exchanged for a sharebased payment award of the accounting acquirer (Entity B). As a result, absent any legal modification to the share-based payment awards in Entity A, the acquisition-date fair value of the legal parent’s (accounting acquiree’s, Entity A) share-based payments awards are included as part of the consideration transferred by the accounting acquirer (Entity B), based on the same principles as those described in paragraphs B56 to B62 of IFRS 3 – see 9.2 above and Chapter 28 at 11.2. That is, the portion of the fair value attributed to the vesting period prior to the reverse acquisition is recognised as part of the consideration paid for the business combination and the portion that vests after the reverse acquisition is treated as postcombination expense.

16.8

Reverse acquisitions involving a non-trading shell company

The requirements for reverse acquisitions in IFRS 3, and the guidance provided by the standard, discussed above are based on the premise that the legal parent (accounting acquiree) has a business which has been acquired by the legal subsidiary


Business combinations

587

(accounting acquirer). In some situations, this may not be the case, for example where a private entity arranges to have itself ‘acquired’ by a non-trading public entity as a means of obtaining a stock exchange listing. As indicated at 16 above, the standard notes that the accounting acquiree (legal acquirer) must meet the definition of a business (see 3.2 above) for the transaction to be accounted for as a reverse acquisition, [IFRS 3.B19], but does not say how the transaction should be accounted for where the accounting acquiree is not a business. It clearly cannot be accounted for as an acquisition of the legal acquiree by the legal acquirer under the standard either, if the legal acquirer has not been identified as the accounting acquirer based on the guidance in the standard. In our view, such a transaction should be accounted for in the consolidated financial statements of the legal parent as a continuation of the financial statements of the private entity (the legal subsidiary), together with a deemed issue of shares, equivalent to the shares held by the former shareholders of the legal parent, and a re-capitalisation of the equity of the private entity. This deemed issue of shares is, in effect, an equity-settled share based payment transaction whereby the private entity has received the net assets of the legal parent, generally cash, together with the listing status of the legal parent. Reverse acquisition of a non‐trading shell company 

Entity A is a non-trading public company with 10,000 ordinary shares in issue. On 31 December 2011, Entity A issues 190,000 ordinary shares in exchange for all of the ordinary share capital of Entity B, a private trading company, with 9,500 ordinary shares in issue. At the date of the transaction, Entity A has $85,000 of cash and the quoted market price of Entity A’s ordinary shares is $12. The fair value of Entity B has been determined by an independent professional valuer as being $2,185,000, giving a value per share of $230. Following the transaction, apart from one non-executive director, all of the directors of Entity A resign and four new directors from Entity B are appointed to the Board of Entity A. As a result of Entity A issuing 190,000 ordinary shares, Entity B’s shareholders own 95 per cent of the issued share capital of the combined entity (i.e. 190,000 of the 200,000 issued shares), with the remaining 5 per cent held by Entity A’s existing shareholders. How should this transaction be accounted for in the consolidated financial statements of Entity A? As the shareholders of Entity A only retain a 5 per cent interest in the combined entity after the transaction, and the Board is dominated by appointees from Entity B, this cannot be accounted for as an acquisition of Entity B by Entity A. Also, as a result of Entity A being a non-trading cash shell company, and therefore not comprising a business (see 3.2 above), it cannot be accounted for as a reverse acquisition of Entity A by Entity B either. The consolidated financial statements should reflect the substance of the transaction which is that Entity B is the continuing entity, therefore the principles and guidance on the preparation and presentation of the consolidated financial statements in a reverse acquisition set out in IFRS 3 should be applied in this transaction by analogy. However, as the transaction is not a business combination under IFRS 3, the transaction effectively involves a share-based payment transaction under IFRS 2 (see Chapter 28) whereby Entity B is deemed to have issued shares in exchange for the $85,000 cash held by Entity A together with the listing status of Entity A. However, the listing status does not qualify for recognition as an intangible asset, and therefore needs to be expensed in profit or loss. Under IFRS 2. for equitysettled share-based payments transactions, an entity measures the goods or services received, and

Chapter 9

Example 9.37: 


588

Chapter 9 the corresponding increase in equity, directly at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods and services received, the entity measures the amounts, indirectly, by reference to the fair value of the equity instruments issued. [IFRS 2.10]. For transactions with non-employees, IFRS 2 presumes that the fair value of the goods and services received is more readily determinable. [IFRS 2.13]. This would suggest that the increase in equity should be based on the fair value of the cash and the fair value of the listing status. However, it is unlikely that a fair value of the listing status can be reliably estimated, therefore the increase in equity should be measured by reference to the fair value of the shares that are deemed to have been issued. Indeed, even if a fair value could be attributed to the listing status, if the total identifiable consideration received is less than the fair value of the equity given as consideration, the transaction should be measured based on the fair value of the shares that are deemed to be issued. [IFRS 2.13A]. Given that the existing shareholders of Entity A have a 5 per cent interest in the combined entity, Entity B would have had to issue 500 shares for the ratio of ownership interest in the combined entity to be the same. Based on the fair value of an Entity B share of $230, the accounting for the deemed share-based payment transaction is: $ $ Cash received Listing expense (income statement) Issued equity (500 × $230)

85,000 30,000

115,000

As Entity B is a private entity, it may be that a more reliable basis for determining the fair value of the deemed shares issued would have been to use the quoted market price of Entity A’s shares at the date of the transaction. On this basis, the issued equity would have been $120,000 (10,000 × $12), giving rise to a listing expense of $35,000. In summary, the accounting for this transaction is similar in many respects to that which would have been the case if the transaction had been accounted for as a reverse acquisition; the main difference being that no goodwill arises on the transaction, and that any amount that would have been so recognised is accounted for as a listing expense. Indeed, if the transaction had been accounted for as a reverse acquisition, the overall effect may have been the same if an impairment loss on the ‘goodwill’ had been recognised.

17

PUSH DOWN ACCOUNTING

The term ‘push down accounting’ relates to the practice adopted in some jurisdictions of incorporating, or ‘pushing down’, the fair value adjustments which have been made by the acquirer into the financial statements of the acquiree, including the goodwill arising on the acquisition. It is argued that the acquisition, being an independently bargained transaction, provides better evidence of the values of the assets and liabilities of the acquiree than those previously contained within its financial statements, and therefore represents an improved basis of accounting. There are, however, contrary views, which hold that the transaction in question was one to which the reporting entity was not a party, and there is no reason why it should intrude into the entity’s own accounting records. Whatever the theoretical arguments, it is certainly true that push down accounting could be an expedient practice, because it obviates the need to make extensive consolidation adjustments in each subsequent year, based on parallel accounting records. Nevertheless, if the acquiree is preparing its financial statements under


Business combinations

589

IFRS, in our view it cannot apply push down accounting and reflect the fair value adjustments made by the acquirer and the goodwill that arose on its acquisition. All of the requirements of IFRS must be applied when an entity prepares its financial statements. IFRS requires assets and liabilities to be recognised initially at cost or fair value, depending on the nature of the assets and liabilities. The acquisition of an entity is not a transaction undertaken by that entity itself, hence it cannot be a transaction to determine cost. Application of push down accounting would result in the recognition and measurement of assets and liabilities that are prohibited by some standards (such as internally generated intangibles and goodwill) and the recognition and measurement of assets and liabilities at amounts that are not permitted under IFRS. While some IFRS standards include an option or requirement to revalue particular assets, this is undertaken as part of a process of determining accounting policies rather than as one-off revaluations. For example: • IAS 2 requires that inventories are measured at the lower of cost and net realisable value (see Chapter 20 at 3); • IAS 16 requires that items of property, plant and equipment are initially measured at cost. Subsequently, property, plant and equipment can be measured at cost or at revalued amount. However, revaluations must be applied consistently and must be performed on a regular basis. Therefore a one-off revaluation is not permitted (see Chapter 16 at 7); • IAS 38 requires that intangible assets are initially measured at cost. Subsequently, they can be revalued only in rare circumstances where there is an active market. In addition, IAS 38 specifically prohibits the recognition of internally generated goodwill. Therefore a one-off revaluation is not permitted (see Chapter 15 at 8.1 and 10.2).

18

DISCLOSURES

Many of the specific disclosures required by the previous version of IFRS 3 are included within IFRS 3, although some of them have been modified to reflect the acquisition-date fair value approach of IFRS 3 rather than the cost-based approach of the previous version of IFRS 3. Some additional disclosures are now required (principally as a result of new explicit guidance for particular issues). [IFRS 3.BC419-422]. The disclosure requirements of IFRS 3 are dealt with below.

Chapter 9

IFRS 3 identifies two disclosure objectives relating to business combinations and specifies particular disclosures that should be made to meet those objectives. These objectives are similar to those in the previous version of IFRS 3, but IFRS 3 now incorporates the previously separate objective dealing with goodwill within the objective to provide information that enables users to evaluate the financial effects of adjustments recognised in the current period that relate to business combinations that occurred in the current or previous reporting periods.


590

Chapter 9 18.1

Nature and financial effect of business combinations

The first disclosure objective is that the acquirer discloses information that enables users of its financial statements to evaluate the nature and financial effect of a business combination that occurs either: [IFRS 3.59] (a) during the current reporting period; or (b) after the end of the reporting period but before the financial statements are authorised for issue. Information that is required to be disclosed by the acquirer to meet the above objective is specified in the Application guidance of the standard. [IFRS 3.60]. 18.1.1 Business combinations during the current reporting period To meet the above objective, the acquirer is required to disclose the following information for each business combination that occurs during the reporting period: [IFRS 3.B64]

(a) (b) (c) (d) (e)

(f)

(g)

the name and a description of the acquiree; the acquisition date; the percentage of voting equity interests acquired; the primary reasons for the business combination and a description of how the acquirer obtained control of the acquiree; a qualitative description of the factors that make up the goodwill recognised, such as expected synergies from combining operations of the acquiree and the acquirer, intangible assets that do not qualify for separate recognition or other factors; the acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of each major class of consideration, such as: (i) cash; (ii) other tangible or intangible assets, including a business or subsidiary of the acquirer; (iii) liabilities incurred, for example, a liability for contingent consideration; and (iv) equity interests of the acquirer, including the number of instruments or interests issued or issuable and the method of determining the fair value of those instruments or interests; for contingent consideration arrangements and indemnification assets: (i) the amount recognised as of the acquisition date; (ii) a description of the arrangement and the basis for determining the amount of the payment; and (iii) an estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, that fact and the reasons why a range cannot be estimated. If the maximum amount of the payment is unlimited, the acquirer discloses that fact;


Business combinations

591

for acquired receivables: (i) the fair value of the receivables; (ii) the gross contractual amounts receivable; and (iii) the best estimate at the acquisition date of the contractual cash flows not expected to be collected. The disclosures are to be provided by major class of receivable, such as loans, direct finance leases and any other class of receivables; (i) the amounts recognised as of the acquisition date for each major class of assets acquired and liabilities assumed; (j) for each contingent liability recognised in accordance with paragraph 23 of the standard (see 7.6.1 above), the information required in paragraph 85 of IAS 37 (see Chapter 25 at 6.1). If a contingent liability is not recognised because its fair value cannot be measured reliably, the acquirer discloses: (i) the information required by paragraph 86 of IAS 37 (see Chapter 25 at 6.2); and (ii) the reasons why the liability cannot be measured reliably; (k) the total amount of goodwill that is expected to be deductible for tax purposes; (l) for transactions that are recognised separately from the acquisition of assets and assumption of liabilities in the business combination in accordance with paragraph 51 of the standard (see 13 above): (i) a description of each transaction; (ii) how the acquirer accounted for each transaction; (iii) the amounts recognised for each transaction and the line item in the financial statements in which each amount is recognised; and (iv) if the transaction is the effective settlement of a pre-existing relationship, the method used to determine the settlement amount; (m) the disclosure of separately recognised transactions required by (l) includes the amount of acquisition-related costs and, separately, the amount of those costs recognised as an expense and the line item or items in the statement of comprehensive income in which those expenses are recognised. The amount of any issue costs not recognised as an expense and how they were recognised are also to be disclosed; (n) in a bargain purchase (see 12 above): (i) the amount of any gain recognised and the line item in the statement of comprehensive income in which the gain is recognised; and (ii) a description of the reasons why the transaction resulted in a gain; (o) for each business combination in which the acquirer holds less than 100 per cent of the equity interests in the acquiree at the acquisition date (see 10 above):

Chapter 9

(h)


592

Chapter 9 (i)

(p)

(q)

the amount of the non-controlling interest in the acquiree recognised at the acquisition date and the measurement basis for that amount; and (ii) for each non-controlling interest in an acquiree measured at fair value, the valuation techniques and key model inputs used for determining that value; in a business combination achieved in stages (see 11 above): (i) the acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately before the acquisition date; and (ii) the amount of any gain or loss recognised as a result of remeasuring to fair value the equity interest in the acquiree held by the acquirer before the business combination and the line item in the statement of comprehensive income in which that gain or loss is recognised; the following information: (i) the amounts of revenue and profit or loss of the acquiree since the acquisition date included in the consolidated statement of comprehensive income for the reporting period; and (ii) the revenue and profit or loss of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If disclosure of any of the information required by this subparagraph is impracticable, the acquirer shall disclose that fact and explain why the disclosure is impracticable. IFRS 3 uses the term ‘impracticable’ with the same meaning as in IAS 8 (see Chapter 3 at 4.7).

Although it is not explicitly stated in paragraph B64 of the standard, it is evident that the above information is required to be given for each material business combination. This is due to the fact that the standard states that for individually immaterial business combinations occurring during the reporting period that are material collectively, the acquirer has to disclose, in aggregate, the information required by items (e) to (q) above. [IFRS 3.B65]. 18.1.2 Business combinations effected after the end of the reporting period If the acquisition date of a business combination is after the end of the reporting period but before the financial statements are authorised for issue, the acquirer is required to disclose the information set out in 18.1.1 above for that business combination, unless the initial accounting for the business combination is incomplete at the time the financial statements are authorised for issue. In that situation, the acquirer describes which disclosures could not be made and the reasons why they cannot be made. [IFRS 3.B66]. 18.2

Financial effects of adjustments recognised in the current reporting period relating to business combinations

The second objective is that the acquirer discloses information that enables users of its financial statements to evaluate the financial effects of adjustments recognised in


Business combinations

593

the current reporting period that relate to business combinations that occurred in the period or previous reporting periods. [IFRS 3.61].

To meet the above objective, the acquirer is required to disclose the following information for each material business combination or in the aggregate for individually immaterial business combinations that are material collectively: [IFRS 3.B67] (a) if the initial accounting for a business combination is incomplete (see 14 above) for particular assets, liabilities, non-controlling interests or items of consideration and the amounts recognised in the financial statements for the business combination thus have been determined only provisionally: (i) the reasons why the initial accounting for the business combination is incomplete; (ii) the assets, liabilities, equity interests or items of consideration for which the initial accounting is incomplete; and (iii) the nature and amount of any measurement period adjustments recognised during the reporting period in accordance with paragraph 49 of the standard (see 14.1 above); (b) for each reporting period after the acquisition date until the entity collects, sells or otherwise loses the right to a contingent consideration asset, or until the entity settles a contingent consideration liability or the liability is cancelled or expires (see 9.1 above): (i) any changes in the recognised amounts, including any differences arising upon settlement; (ii) any changes in the range of outcomes (undiscounted) and the reasons for those changes; and (iii) the valuation techniques and key model inputs used to measure contingent consideration; (c) for contingent liabilities recognised in a business combination, the acquirer shall disclose the information required by paragraphs 84 and 85 of IAS 37 for each class of provision (see Chapter 25 at 6.1); (d) a reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period showing separately: (i) the gross amount and accumulated impairment losses at the beginning of the reporting period; (ii) additional goodwill recognised during the reporting period (except goodwill included in a disposal group that, on acquisition, meets the criteria to be classified as held for sale in accordance with IFRS 5 – see Chapter 4 at 2.1); (iii) adjustments resulting from the subsequent recognition of deferred tax assets during the reporting period in accordance with paragraph 67 of the standard (see 19.2.1 below);

Chapter 9

Information that is required to be disclosed by the acquirer to meet the above objective is specified in the Application guidance of the standard. [IFRS 3.62].


594

Chapter 9

(e)

18.3

(iv) goodwill included in a disposal group classified as held for sale in accordance with IFRS 5 and goodwill derecognised during the reporting period without having previously been included in a disposal group classified as held for sale; (v) impairment losses recognised during the reporting period in accordance with IAS 36. (IAS 36 requires disclosure of information about the recoverable amount and impairment of goodwill in addition to this requirement – see Chapter 18 at 7.2); (vi) net exchange rate differences arising during the reporting period in accordance with IAS 21 (see Chapter 13 at 6.5); (vii) any other changes in the carrying amount during the reporting period; and (viii) the gross amount and accumulated impairment losses at the end of the reporting period. the amount and an explanation of any gain or loss recognised in the current reporting period that both: (i) relates to the identifiable assets acquired or liabilities assumed in a business combination that was effected in the current or previous reporting period; and (ii) is of such a size, nature or incidence that disclosure is relevant to understanding the combined entity’s financial statements. Other necessary information

IFRS 3 includes a catch-all disclosure requirement, that if in any situation the information required to be disclosed set out above, or by other IFRSs, does not satisfy the objectives of IFRS 3, the acquirer discloses whatever additional information is necessary to meet those objectives. [IFRS 3.63]. In addition to the disclosures required by IFRS 3 discussed above, IAS 7 requires disclosures in respect of obtaining control of subsidiaries and other businesses (see Chapter 45 at 2.4.2). [IAS 7.39-42]. 18.4

Illustrative disclosures

An illustration of some of the disclosure requirements of IFRS 3 is given by way of an example in the Illustrative Examples accompanying the standard. The example, which is reproduced below, assumes that the acquirer, AC, is a listed entity and that the acquiree, TC, is an unlisted entity. The illustration presents the disclosures in a tabular format that refers to the specific disclosure requirements illustrated. (The references to paragraph B64 correspond to the equivalent item at 18.1.1 above and those to paragraph B67 correspond to the equivalent item at 18.2 above.) It is also emphasised that an actual footnote might present many of the disclosures illustrated in a simple narrative format. [IFRS 3.IE72].


Business combinations Example 9.38: 

595

Footnote X: Acquisitions 

Paragraph reference B64(a-d)

On 30 June 20X0 AC acquired 15 per cent of the outstanding ordinary shares of TC. On 30 June 20X2 AC acquired 60 per cent of the outstanding ordinary shares of TC and obtained control of TC. TC is a provider of data networking products and services in Canada and Mexico. As a result of the acquisition, AC is expected to be the leading provider of data networking products and services in those markets. It also expects to reduce costs through economies of scale.

B64(e)

The goodwill of CU2,500 arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of AC and TC.

B64(k)

None of the goodwill recognised is expected to be deductible for income tax purposes. The following table summarises the consideration paid for TC and the amounts of the assets acquired and liabilities assumed recognised at the acquisition date, as well as the fair value at the acquisition date of the non-controlling interest in TC. At 30 June 20X2 Consideration Cash

CU 5,000

B64(f)(iv) B64(f)(iii); B64(g)(i)

Equity instruments (100,000 ordinary shares of AC)

4,000

Contingent consideration arrangement

1,000

B64(f)

Total consideration transferred

B64(p)(i)

Fair value of AC’s equity interest in TC held before the business combination

B64(m)

Acquisition-related costs (included in selling, general and administrative expenses in AC’s statement of comprehensive income for the year ended 31 December 20X2)

B64(i)

Recognised amounts of identifiable assets acquired and liabilities assumed

B64(o)(i)

B64(f)(iv)

10,000 2,000 12,000 1,250

Financial assets Inventory Property, plant and equipment Identifiable intangible assets Financial liabilities Contingent liability Total identifiable net assets

3,500 1,000 10,000 3,300 –4,000 –1,000 12,800

Non-controlling interest in TC

–3,300

Goodwill

2,500 12,000

The fair value of the 100,000 ordinary shares issued as part of the consideration paid for TC (CU4,000) was determined on the basis of the closing market price of AC’s ordinary shares on the acquisition date.

Chapter 9

B64(f)(i)


596

Chapter 9 B64(f)(iii) B64(g) B67(b)

The contingent consideration arrangement requires AC to pay the former owners of TC 5 per cent of the revenues of XC, an unconsolidated equity investment owned by TC, in excess of CU7,500 for 20X3, up to a maximum amount of CU2,500 (undiscounted). The potential undiscounted amount of all future payments that AC could be required to make under the contingent consideration arrangement is between CU0 and CU2,500. The fair value of the contingent consideration arrangement of CU1,000 was estimated by applying the income approach. The fair value estimates are based on an assumed discount rate range of 20-25 per cent and assumed probability-adjusted revenues in XC of CU10,000-20,000. As of 31 December 20X2, neither the amount recognised for the contingent consideration arrangement, nor the range of outcomes or the assumptions used to develop the estimates had changed.

B64(h)

The fair value of the financial assets acquired includes receivables under finance leases of data networking equipment with a fair value of CU2,375. The gross amount due under the contracts is CU3,100, of which CU450 is expected to be uncollectible.

B67(a)

The fair value of the acquired identifiable intangible assets of CU3,300 is provisional pending receipt of the final valuations for those assets.

B64(j) B67(c) IAS 37.84, 85

A contingent liability of CU1,000 has been recognised for expected warranty claims on products sold by TC during the last three years. We expect that the majority of this expenditure will be incurred in 20X3 and that all will be incurred by the end of 20X4. The potential undiscounted amount of all future payments that AC could be required to make under the warranty arrangements is estimated to be between CU500 and CU1,500. As of 31 December 20X2, there has been no change since 30 June 20X2 in the amount recognised for the liability or any change in the range of outcomes or assumptions used to develop the estimates.

B64(o)

The fair value of the non-controlling interest in TC, an unlisted company, was estimated by applying a market approach and an income approach. The fair value estimates are based on: (a) an assumed discount rate range of 20-25 per cent; (b) an assumed terminal value based on a range of terminal EBITDA multiples between 3 and 5 times (or, if appropriate, based on long term sustainable growth rates ranging from 3 to 6 per cent); (c) assumed financial multiples of companies deemed to be similar to TC; and (d) assumed adjustments because of the lack of control or lack of marketability that market participants would consider when estimating the fair value of the non-controlling interest in TC.

B64(p)(ii)

AC recognised a gain of CU500 as a result of measuring at fair value its 15 per cent equity interest in TC held before the business combination. The gain is included in other income in AC’s statement of comprehensive income for the year ending 31 December 20X2.

B64(q)(i)

The revenue included in the consolidated statement of comprehensive income since 30 June 20X2 contributed by TC was CU4,090. TC also contributed profit of CU1,710 over the same period.

B64(q)(ii)

Had TC been consolidated from 1 January 20X2 the consolidated statement of comprehensive income would have included revenue of CU27,670 and profit of CU12,870.


Business combinations

19

TRANSITIONAL ARRANGEMENTS

19.1

Transitional arrangements under the original IFRS 3 for entities already reporting under IFRS

597

These transitional arrangements for existing IFRS adopters are no longer relevant. A discussion of the arrangements can be found in section 4.1 of Chapter 7 of a previous edition of this book, International GAAP 2007. 19.2

Transitional arrangements under IFRS 3 (as revised in 2008) for entities already reporting under IFRS

IFRS 3 (as revised in 2008) was to be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the annual period in which the standard is adopted, [IFRS 3.64], and contained a number of transitional provisions. 19.2.1 Business combinations accounted for under the previous version of IFRS 3

As discussed at 7.6.2 above, a consequential amendment to IAS 12 was made as a result of IFRS 3 (as revised in 2008) so as to change the accounting for deferred tax benefits that do not meet the recognition criteria at the date of acquisition, but are subsequently recognised. The amended IAS 12 was to be applied prospectively. Therefore, for business combinations effected before the adoption date of IFRS 3 (as revised in 2008), goodwill was not to be adjusted for the subsequent recognition of deferred tax benefits that failed to satisfy the criteria for separate recognition as of the acquisition date, [IFRS 3.67], unless the benefits subsequently recognised were within twelve months of the acquisition date and result from new information obtained about facts and circumstances existing at the acquisition date, in which case goodwill was to be adjusted until it was zero. [IAS 12.68]. Where goodwill was adjusted due to the subsequent recognition of deferred tax assets, this needed to be disclosed as a separate reconciling item in the reconciliation of goodwill (see item (d) (iii) at 18.2 above).

Chapter 9

Assets and liabilities that arose from business combinations whose acquisition dates preceded the adoption of IFRS 3 (as revised in 2008) were not to be adjusted upon application of the standard. [IFRS 3.65]. As a result, with one exception relating to changes in deferred tax of the acquiree, the previous version of IFRS 3 continues to apply to business combinations effected before the adoption date of IFRS 3 (as revised in 2008). In particular, the requirements relating to contingent consideration under the previous version of the standard effectively continue to apply to those earlier business combinations, rather than those discussed at 9.1 above that apply to business combinations accounted for under IFRS 3 (as revised in 2008). This particular aspect has been clarified by the IASB by introducing explicit transitional guidance into IFRS 3 as part of the Annual Improvements standard issued in May 2010 (see 19.3.1 below).


598

Chapter 9 19.2.2 Entities previously outwith the scope of the previous version of IFRS 3 Business combinations involving only mutual entities and combinations in which separate entities are brought together by contract alone are now within the scope of IFRS 3 (as revised in 2008). As such business combinations were outwith the scope of the previous version of IFRS 3, an entity, such as a mutual entity, that had not applied the previous version of IFRS 3 and had one or more business combinations that were accounted for using the purchase method was to apply the following transitional provisions included in the Application guidance in IFRS 3 (as revised in 2008): [IFRS 3.66, BC68-69]

Classification The entity continued to classify the prior business combination in accordance with the entity’s previous accounting policies for such combinations;

Previously recognised goodwill At the beginning of the first annual period in which IFRS 3 (as revised in 2008) was applied, the carrying amount of goodwill arising from the prior business combination was its carrying amount at that date in accordance with the entity’s previous accounting policies. In determining that amount, the entity eliminated the carrying amount of any accumulated amortisation of that goodwill and the corresponding decrease in goodwill. No other adjustments were to be made to the carrying amount of goodwill;

Goodwill previously recognised as a deduction from equity The entity’s previous accounting policies may have resulted in goodwill arising from the prior business combination being recognised as a deduction from equity. In that situation the entity was not to recognise that goodwill as an asset at the beginning of the first annual period in which IFRS 3 (as revised in 2008) was applied. Furthermore, the entity was not to recognise in profit or loss any part of that goodwill when it disposes of all or part of the business to which that goodwill relates or when a cash-generating unit to which the goodwill relates becomes impaired;

Subsequent accounting for goodwill From the beginning of the first annual period in which IFRS 3 (as revised in 2008) was applied, the entity discontinues amortising goodwill arising from the prior business combination and tests goodwill for impairment in accordance with IAS 36;

Previously recognised negative goodwill An entity that accounted for the prior business combination by applying the purchase method may have recognised a deferred credit for an excess of its interest in the net fair value of the acquiree’s identifiable assets and liabilities over the cost of that interest (sometimes called negative goodwill). If so, the entity was to derecognise the carrying amount of that deferred credit at the beginning of the first annual period in which IFRS 3 (as revised in 2008) was applied with a corresponding adjustment to the opening balance of retained earnings at that date.


Business combinations

599

19.2.3 Asset brought forward relating to directly attributable costs of a probable business combination

The treatment for such costs was considered by the Interpretations Committee. At its meeting in May 2009, and subsequently confirmed at its meeting in July 2009, the Interpretations Committee noted that more than one interpretation of how the requirements of the two IFRSs interact is possible. Accordingly, the Interpretations Committee concluded that an entity should disclose its accounting policy for such costs and the amount recognised in the financial statements. Because this was a transitional issue, the Interpretations Committee decided not to add the issue to its agenda.21 Each of the above treatments were included within the Staff Paper considered by the Interpretations Committee at its meeting in May 2009,22 so in the light of the Interpretations Committee decision, an entity in that situation should have disclosed which treatment it adopted and the amount of the expenses recognised in the financial statements.

Chapter 9

At the end of the financial period prior to adopting IFRS 3 (as revised in 2008) an entity may have carried forward an asset in respect of the directly attributable costs relating to a probable business combination. If that business combination was subsequently completed, it had to be accounted for under IFRS 3 (as revised in 2008). The transitional arrangements in IFRS 3 (as revised in 2008) did not explicitly deal with this issue. Accordingly, in our view, the entity had a number of options available and could choose to recognise the carried forward costs as either: • an expense in profit or loss for the current period As IFRS 3 (as revised in 2008) was to be applied prospectively to the business combination, any further acquisition-related costs had to be expensed in profit or loss for the period (see 9.3 above), so the carried forward costs should be expensed likewise; • an immediate charge to retained earnings Again, IFRS 3 (as revised in 2008) was to be applied prospectively to the business combination. However, although any further acquisition-related costs had to be expensed in profit or loss for the period, the carried forward costs were not incurred in the current period and did not relate to services received in the period. Thus, they should be taken as an immediate charge to retained earnings; • an expense in profit or loss of the prior period Although IFRS 3 (as revised in 2008) was to be applied prospectively to the business combination, the costs were incurred in the previous period and related to services received in that period. The transitional provisions in IFRS 3 (as revised in 2008) only dealt with business combinations whose acquisition dates preceded the application of the revised standard. As there was no transitional provision within IFRS 3 (as revised in 2008) dealing specifically with this issue, under IAS 8 the entity’s change in accounting policy for the treatment of acquisition-related costs should be applied retrospectively (see Chapter 3 at 4.4).


600

Chapter 9 19.3

Transitional arrangements relating to May 2010 Annual Improvements amendments for entities already reporting under IFRS

The amendments made to IFRS 3 as a result of the Annual Improvements standard issued in May 2010 are applicable for annual periods beginning on or after 1 July 2010. Earlier adoption is permitted, but that fact has to be disclosed. Application of the amendments relating to the measurement of non-controlling interests, and unreplaced and voluntarily replaced share-based payment transactions is prospective from the date when an entity first applied IFRS 3. [IFRS 3.64B, 64C]. There are no transitional arrangements in respect of these amendments. However, transitional guidance relating to contingent consideration balances arising from business combinations preceding the revised version of IFRS 3 issued in January 2008 is now explicitly included within the standard. 19.3.1 Contingent consideration balances arising from business combinations preceding IFRS 3 (as revised in 2008) IFRS 3 now explicitly states that contingent consideration balances arising from business combinations whose acquisition dates preceded the date when an entity first applied this IFRS as issued in 2008 are not to be adjusted upon first application of this IFRS. The newly introduced paragraphs 65B-65E are to be applied in the subsequent accounting for those balances. It is emphasised in the standard that those paragraphs do not apply to the accounting for contingent consideration balances arising from business combinations with acquisition dates on or after the date when the entity first applied this IFRS as issued in 2008. (These are accounted for under the requirements of IFRS 3 discussed at 9.1 above.) In paragraphs 65B-65E business combination refers exclusively to business combinations whose acquisition date preceded the application of this IFRS as issued in 2008. [IFRS 3.65A]. These paragraphs are effectively a reproduction of the requirements set out in paragraphs 32-35 of the previous version of IFRS 3. [IFRS 3.BC434C].

Although there were a number of issues that arose in respect of these requirements (see section 2.4.5 of Chapter 9 of the previous edition of this book, International GAAP 2010, most of them related to whether or not particular arrangements were contingent consideration or not. As such determination will have already been made, these are no longer of any particular relevance, other than to the extent that where the arrangement was determined to be ‘contingent consideration’, the transitional guidance in IFRS 3 about the subsequent accounting for such contingent consideration applies to those arrangements. For such business combinations whose acquisition dates preceded the application of IFRS 3 (as revised in 2008), the standard recognises that the terms of a business combination agreement may provide for an adjustment to the cost of the combination contingent on future events, such as a specified level of profit being maintained or achieved in future periods, or on the market price of the instruments issued being maintained. [IFRS 3.65C].


Business combinations

601

When a business combination agreement provides for an adjustment to the cost of the business combination contingent on future events, IFRS 3 requires the acquirer to include the amount of the adjustment in the cost of the combination at the acquisition date if the adjustment is probable and can be measured reliably. [IFRS 3.65B]. If the future events do not occur or the estimate needs to be revised, the cost of the business combination is to be adjusted accordingly, [IFRS 3.65C]. (unless the payment to the seller is compensation for a reduction in value of consideration received as discussed below). The standard states that ‘it is usually possible to estimate the amount of any such adjustment at the time of initially accounting for the combination without impairing the reliability of the information, even though some uncertainty exists’. [IFRS 3.65C]. This is more likely to be the case in those situations where the contingent consideration is based on the acquiree maintaining a level of profits which it is currently earning (either for a particular period or as an average over a set period) or achieving profits which it is currently budgeting. However, when a business combination agreement provides for such an adjustment, that adjustment is not included in the cost of the combination at the time of initially accounting for the combination if it either is not probable or cannot be measured reliably. If that adjustment subsequently becomes probable and can be measured reliably, the additional consideration shall be treated as an adjustment to the cost of the combination. [IFRS 3.65D]. Any subsequent adjustments in respect of such contingent consideration will consequently be reflected in the carrying amount of goodwill. However, if an impairment loss has already been recognised in respect of the goodwill (see Chapter 18 at 5), this is likely to require a further impairment loss to be recognised.

In our view, the adjustment is due to a change in probability which is generally considered to be a change in estimate. As discussed in Chapter 3 at 4.5, changes in estimates are recognised prospectively from the date of change. Therefore at the date that the contingent event becomes probable it should be recognised as a change in estimate and measured at that date, taking into account the period in which the expected payment will be made. It is, therefore, discounted at the rate determined at the date that the contingent consideration is recognised to reflect the fair value of the consideration expected to be given. The adjustment should not be calculated retrospectively, as if it had occurred as at the date of acquisition. Example 9.39: 

Contingent consideration subsequently recognised on a business  combination preceding IFRS 3 (as revised in 2008) 

Entity A acquires Entity B on 31 December 2009 where consideration of $8 million is contingent on meeting a profit target by 31 December 2013. At the date of acquisition and at 31 December 2010 it was not considered probable that the acquiree would meet the profit target. Accordingly, no amount was recognised as part of the cost of the

Chapter 9

Where contingent consideration for a business combination does become probable after the date of acquisition, what amount should be recognised as the adjustment to the cost of acquisition and how should the adjustment be reflected in the financial statements?


602

Chapter 9 acquisition in the financial statements for 31 December 2009 and 31 December 2010. However, at 31 December 2011 it is considered probable that Entity B will meet the profit target. Assuming a discount rate of 8% as at the date of acquisition (31 December 2009) and a discount rate of 7% as at the date of probability of meeting conditions (31 December 2011) the relevant present values are as follows: PV at 8% PV at 7% $ $ 31 December 2009 5,880,239 6,103,162 427,221 Interest for 2010 470,419 31 December 2010 6,350,658 6,530,383 457,127 Interest for 2011 508,053 31 December 2011 6,858,711 6,987,510 489,126 Interest for 2012 548,696 31 December 2012 7,407,407 7,476,636 523,364 Interest for 2013 592,593 31 December 2013 8,000,000 8,000,000 What amount should be recognised as the adjustment to the cost of the combination at 31 December 2011 and how should it be reflected in the financial statements? One view is that the adjustment should be calculated retrospectively, as if it had occurred as at the date of acquisition. Accordingly, the cost of the investment and goodwill would be adjusted by $5,880,239 (being the present value at the date of acquisition), with interest charged since the date of acquisition of $978,472 ($470,419 + $508,053). However, we do not consider this view appropriate. In our view, the adjustment is due to a change in probability which is generally considered to be a change in estimate. As discussed in Chapter 3 at 4.5, changes in estimates are recognised prospectively from the date of change. Therefore at the date that the contingent event becomes probable it should be recognised as a change in estimate and measured at that date, taking into account the period in which the expected payment will be made. It is, therefore, discounted at the rate determined at the date that the contingent consideration is recognised to reflect the fair value of the consideration expected to be given. Accordingly, an adjustment of $6,987,510 to the purchase price and therefore goodwill is recognised at 31 December 2011. The unwinding of the discount will be reflected in the income statement in 2012 and 2013. However, the resulting liability should continue to be reassessed at the end of each reporting period thereafter for changes in estimated cash flows, including changes in discount rates, and any necessary adjustment made to the cost of the combination (and therefore goodwill).

The above requirements would apply to contingent consideration arrangements that are to be settled by equity instruments that had been determined should be classified as a liability in accounting for the business combination under the previous version of IFRS 3. However, for contingent consideration arrangements that are to be settled by equity instruments that had been determined should be classified as equity in accounting for the business combination, the requirements should be applied slightly differently. In such situations, although the acquirer should reassess the contingent consideration based on the probability of the number of equity instruments that will be issued, we believe that no adjustment for any subsequent change in value of those equity instruments should be made.


Business combinations Example 9.40: 

603

Share‐settled contingent consideration recognised on a business  combination preceding IFRS 3 (as revised in 2008) 

Entity P acquires a 100% interest in Entity S on 31 December 2009. As part of the consideration arrangements, additional consideration will be payable on 1 January 2014, based on Entity S meeting certain profit targets over the 4 years ended 31 December 2013, as follows:

Profit target (average profits over 4 year period)

Additional consideration

€1m but less than €1.25m

100,000 shares

€1.25m but less than €1.5m

150,000 shares

€1.5m+

200,000 shares

IFRS 3 also recognises that in some circumstances, the acquirer may be required to make a subsequent payment to the seller as compensation for a reduction in the value of the assets given, equity instruments issued or liabilities incurred or assumed by the acquirer in exchange for control of the acquiree. For example, the acquirer may guarantee the market price of equity or debt instruments issued as part of the cost of the business combination and is required to issue additional equity or debt instruments to restore the originally determined cost. In such cases, no increase in the cost of the business combination is recognised. In the case of equity instruments, the fair value of the additional payment is offset by an equal reduction in the value attributed to the instruments initially issued. [IFRS 3.65E]. Thus, it would appear that any increase

Chapter 9

In accounting for the business combination under the previous version of IFRS 3 for its financial statements for the year ended 31 December 2009, Entity P determined that any additional consideration should be reflected as equity. In determining the contingent consideration to be recorded under that version of IFRS 3, Entity P estimated what level of profit it anticipated Entity S would achieve and the relevant number of shares to be issued as a result. Entity P determined that it was probable that Entity S would meet the first target level, and as a result Entity P would issue 100,000 shares on 1 January 2014. Entity P recognised consideration of €150,000 in respect of these 100,000 shares, i.e. at €1.50 per share. This was based on the requirements of that version of IFRS 3 in respect of equity instruments issued as consideration i.e. at the fair value at the date of exchange (31 December 2009), taking into account an allowance for any estimated dividends on the shares that would not be payable during the period until they are issued on 1 January 2014. One issue that arises in this situation is whether adjustments should be made to the consideration, and thus goodwill, to reflect subsequent changes in the fair value of the shares such that the consideration is ultimately measured at Entity P’s share price at the date the shares are finally issued. Although the requirements for contingent consideration would generally require subsequent changes in the estimate of the consideration that will ultimately be given to be recognised, we do not believe that this should reflect such changes in fair value. Since the consideration is regarded as equity, then consistent with the requirements of paragraph 22 of IAS 32, ‘changes in the fair value of an equity instrument are not recognised in the financial statements’. If at 31 December 2011, Entity P considers that is it is probable that Entity S will now meet the second target, the financial statements at that date need to reflect that Entity P now expects to issue 150,000 shares. As discussed above, we do not believe that any change should be made to reflect changes in the value of Entity P’s shares since the date of exchange (31 December 2009), and so the additional consideration of 50,000 shares should be valued using the same value per share as the original estimated consideration of 100,000 shares, i.e. at €1.50 per share. An adjustment of €75,000 to the cost of the business combination, and therefore goodwill, would be made.


604

Chapter 9 reflected in equity for the extra equity instruments issued is offset by a corresponding debit to equity. In the case of debt instruments, the additional payment is regarded as a reduction in the premium or an increase in the discount on the initial issue. [IFRS 3.35 (2007)]. The extra payment will be taken to the income statement as part of an increased interest expense over the period of the debt instrument.

20

FUTURE DEVELOPMENTS

IFRS 3 continues to exclude from its scope the formation of a joint venture and a combination of entities or businesses under common control. In addition, proposals in the June 2005 exposure draft relating to contingencies and fair value guidance were not reflected in the final revised standard. Possible future developments on these issues are discussed at 20.1 to 20.3 below. Since the publication of the revised versions of IFRS 3 and IAS 27 in January 2008 a number of issues have arisen that have been raised with the Interpretations Committee and the IASB. As a result, the IASB decided to deal with some of the issues within the annual improvements project (subsequently included in the Improvements to IFRSs standard issued in May 2010). However, it also decided that it would address some of the issues in other projects, but defer some of the other topics to the post-implementation review of the revised IFRSs to be conducted two years after their effective date.23 To the extent that these relate to IFRS 3, further discussion is set out at 20.4 and 20.6 below. At its meeting in February 2010, having reviewed an analysis of comment letters received on the Improvements to IFRSs exposure draft published in August 2009, the IASB asked the Interpretations Committee to provide a recommendation on how to present the guidance on contingent consideration associated with business combinations within one standard to resolve potential divergence in the application of IFRSs. This is discussed further at 20.4.1 below. In August 2010, the IASB issued its Leases exposure draft which proposes to make some consequential amendments to IFRS 3 (see 20.5 below). 20.1

Formation of joint ventures and business combinations involving entities under common control

In the June 2005 exposure draft that preceded IFRS 3 (as revised in 2008), the IASB indicated that it would consider the following issues as part of future phases of its project on business combinations: 24 (a) the accounting for business combinations in which separate entities or businesses are brought together to form a joint venture, including possible applications of ‘’ accounting; (b) the accounting for business combinations involving entities under common control. When IFRS 3 (as revised in 2008) was issued, it indicated that neither the FASB nor the IASB had on its agenda a project to consider the ‘’ method of accounting, although they might at some future date undertake a joint project to consider the


Business combinations

605

issues. [IFRS 3.BC57]. At the time of writing, the IASB’s latest work plan no longer includes a project on business combinations on its agenda.25 In December 2007, the IASB decided to add to its active agenda a project on common control transactions,26 although at the time of writing this chapter, it is now reported that in the light of other priorities, the Board paused the project and has directed the staff to consider at a later date whether it should resume its work on common control transactions. The date for making that decision about continuation of the project is yet to be confirmed.27 This is discussed further in Chapter 10 at 1.4. 20.2

Contingencies

The IASB had also issued an exposure draft proposing amendments to IAS 37 at the same as the June 2005 exposure draft that preceded IFRS 3 (as revised in 2008). At that time, the IASB expected that the effective date of the revised IAS 37 would be the same as the effective date of the revised IFRS 3. However, the IASB did not issue a revised IAS 37. Consequently, the IASB did not reflect in IFRS 3 (as revised in 2008) its original proposals for dealing with contingencies, but indicated that it expected to reconsider the requirements within IFRS 3 when it eventually issues the revised IAS 37. [IFRS 3.BC272, 273]. As part of its deliberations on a revised IAS 37, in September 2009 the IASB discussed amendments to the IFRS 3 requirements for contingent liabilities (see 7.6.1 above) and made a number of tentative decision regarding recognition, subsequent measurement and disclosures.28 However, since then the IASB has continued its deliberations and also issued a further limited exposure draft, but seems no nearer issuing a final IFRS. The IASB’s latest work plan indicates that the estimated publication date of an IFRS on Liabilities (amendments to IAS 37) is some time during 2011.29 The IASB proposals for revising IAS 37 are discussed in Chapter 25 at 8.1. Fair value measurement

For the purpose of determining acquisition-date fair values, ‘fair value’ is defined by IFRS 3 (as revised in 2008) as ‘the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’. [IFRS 3 Appendix A]. This is the same as the definition in the previous version of IFRS 3 as well in other IFRSs. On the other hand, the equivalent US GAAP definition is ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’. The IASB considered also using the definition of fair value in US GAAP but decided that to do so would prejudge the outcome of its project on fair value measurement. [IFRS 3.BC246-247]. Consequently, much of the guidance relating to fair value that was contained in the previous version of IFRS 3 is longer included in IFRS 3. In addition, the proposed guidance on how to measure fair value contained in Appendix E of the June 2005 exposure draft, including the ‘fair value hierarchy’, is not included in the revised standard.

Chapter 9

20.3


606

Chapter 9 In May 2009, the IASB published an exposure draft – Fair Value Measurement. This proposes to clarify the definition of fair value, establish a framework for measuring fair value (including a fair value hierarchy) and enhance the disclosures where fair value is used (although it is unclear whether the disclosures would apply to fair values that are only attributed to assets and liabilities when initially recognised in a business combination). The guidance contained in other IFRSs will be removed. As a result, some consequential amendments to IFRS 3 (as revised in 2008) are to be made.30 The exposure draft proposes to define fair value as ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’,31 i.e. the same as in US GAAP. Fair value is therefore to be an exit price, rather than an entry price. Key aspects of the definition proposed in the exposure draft relate to the characteristics of the asset/liability, orderly transactions, most advantageous market, market participants, highest and best use, and the transfer of a liability. In August 2010, a staff draft of the IFRS was made available on the IASB’s website. and the key aspects of this project are discussed further in Chapter 2 at 4.3. The IASB’s latest work plan estimates that an IFRS on fair value measurement guidance is published in the first quarter of 2011.32 20.4

Improvements to IFRSs

20.4.1 Regrouping and consistency of contingent consideration guidance At its meeting in February 2010, having reviewed an analysis of comment letters received on the Improvements to IFRSs exposure draft published in August 2009, the IASB asked the Interpretations Committee to provide a recommendation on how to present the guidance on contingent consideration associated with business combinations within one standard to resolve potential divergence in the application of IFRSs. In July 2010, the Interpretations Committee discussed the current guidance relating to contingent consideration and noted the existence of inconsistencies relating to the contingent consideration guidance within IFRSs. Consequently the Interpretations Committee recommended that the IASB remove inconsistencies in classification, measurement and disclosures relating to contingent consideration associated with business combinations by deleting references to other IFRSs in paragraphs 40 and 58 of IFRS 3 as part of the Annual Improvements exposure draft expected to be published in October 2010. The Interpretations Committee also recommended that the IASB make consequential amendments to IAS 39, IFRS 7 and IAS 37.33 20.5

Other projects

Rather than dealing with some of the issues that have arisen since the publication of the revised versions of IFRS 3 and IAS 27 as part of its Improvements to IFRSs process, the IASB has decided to address some of the issues in other projects. At its meeting in May 2009, the IASB indicated that it will address ‘contingent consideration: designation (categories of financial instruments) and classification (as equity or a liability)’ in its projects on financial instruments.34


Business combinations

607

The accounting for contingent consideration under IFRS 3 is discussed at 9.1 above. It is not entirely clear what aspect of the accounting for such contingent consideration will be addressed as part of that project as no details were included in the agenda papers available to the public. Indeed, it may be that this is overtaken by events since, as noted at 20.4.1 above, the Interpretations Committee has recommended that the IASB considers the regrouping and consistency of contingent consideration by deleting all references to other IFRSs from the relevant paragraphs in IFRS 3 dealing with contingent consideration.

20.6

Post-implementation review of IFRS 3 (as revised in 2008) and IAS 27 (as amended in 2008)

Also at its meeting in May 2009, the IASB deferred the following issues relating to IFRS 3 to the post-implementation review of IFRS 3 (as revised in 2008) and IAS 27 (as amended in 2008), to be conducted two years after their effective date:36

Chapter 9

In August 2010, the IASB issued its Leases exposure draft which proposes to make some consequential amendments to IFRS 3. These amendments would amend or delete those paragraphs that refer to operating leases since the exposure draft proposes to remove the distinction between operating and finance leases. It is proposed to amend the model relating to leases acquired in a business combination as follows:35 (a) If the acquiree is a lessee, the acquirer recognises a liability to make lease payments and a right-of-use asset for all leases in accordance with IFRS X [the proposed leasing standard]. The liability to make lease payments and the rightof-use asset are to be measured at the present value of remaining lease payments, discounted using the acquirer’s discount rate. Where there is a difference between the rate charged in the lease and market rates, the acquirer adjusts the right-of-use asset to reflect the off-market rate of the lease. (b) If the acquiree is a lessor, the acquirer: • recognises a right to receive lease payments and a lease liability for all leases to which the acquirer applies the performance obligation approach. The acquirer measures the right to receive rentals and the lease liability at the present value of the remaining lease payments discounted using the acquirer’s discount rate. • recognise a right to receive lease payments and derecognise the portion of the carrying amount of the underlying asset that represents the cost of the lessee’s right to use the underlying asset during the term of the lease for all leases to which the acquirer applies the derecognition approach. The acquirer measures the right to receive rentals at the present value of the remaining lease payments discounted using the acquirer’s discount rate and measures the residual asset at fair value. (c) After initial measurement, the acquirer shall apply the requirements of IFR.S X to the lease assets and lease liabilities.


608

Chapter 9

• •

The application of the definition of a business in particular situations (see 3.2 above); Interpretations Committee recommendations on (a) removing the distinction between ‘contractual’ and ‘non-contractual’ customer-related intangible assets in a business combination and (b) including in the standard the indicators that identify the existence of a customer relationship. The Board decided tentatively to retain the depositor relationship example in paragraph B34(a) of IFRS 3, noting that this is a separable intangible asset (see 7.5.2 above); and the treatment of indemnification assets, as part of the business combination transaction or as a separate transaction (see 7.6.4 above).

References 1 See the introductory pages of IAS 22, Business Combinations, IASC, September 1998 (superseded March 2004), for a summary of the changes. 2 Project Summary, Business Combinations

(Phase II) – Application of the Purchase Method, IASB, 26 January 2004, pp. 1 and 2. 3 Exposure Draft of Proposed Amendments to IFRS 3 Business Combinations (‘IFRS 3

ED’), IASB, June 2005, BC7. 4 IFRS 3, Comparison of IFRS 3 (as revised

in 2008) and SFAS 141(R) [now codified in FASB ASC 805]. IFRS 3, Table of Concordance. IASB Update, May 2009, p. 5. IASB Update, May 2009, p. 5. IFRIC Update, September 2008, p. 2.

5 6 7 8 9 The Glossary of Terms defines a contract as ‘An agreement between two or more parties that has clear economic consequences that the parties have little, if any, discretion to avoid, usually because the agreement is enforceable in law. Contracts may take a variety of forms and need not be in writing.’ 10 IFRIC Update, March 2009, pages 2-3. 11 IFRIC Update, March 2009, p. 3. 12 IASB Update, December 2008, p. 4. 13 Staff Paper, IASB meeting, May 2009, Agenda reference 13E, Annual Improvement

Project, Amendments to IFRS 3 – Customerrelated intangible assets, pp. 2 and 3. IASB Update, May 2009, p. 5. IASB Update, May 2009, p. 5. IASB Update, April 2008, p.3. IASB Update, June 2009, p. 6.

14 15 16 17 18 Staff Paper, IASB meeting, June 2009, Agenda reference 13C, Annual Improvements Process,

Contingent consideration of an Acquiree (“pre-existing contingent consideration”), p. 3. 19 IASB Update, May 2009, p. 5. 20 IFRS 3 ED.49, 58. 21 IFRIC Update, July 2009, p. 2. 22 Staff Paper, Interpretations Committee meeting, May 2009, Agenda reference 6A,

Amendments to IFRS 3 and IAS 27 – Acquisition-related costs in a business combination, pp. 2 and 3. 23 IASB Update, May 2009, p. 5.

24 IFRS 3 ED BC9. 25 IASB Work Plan – projected timetable as at 1 July 2010, IASB. 26 IASB Update, December 2007, p. 1. 27 Project page, Common Control Transactions, IASB website, 16 August 2010. 28 IASB Update, September 2009, Liabilities. 29 IASB Work Plan – projected timetable as at 1 July 2010. 30 Exposure Draft (ED 2009/05), Fair Value Measurement, IASB, D6-D9. 31 ED 2009/05.1. 32 IASB Work Plan – projected timetable as at 1 July 2010, IASB. 33 IFRIC Update, July 2010, Issues recommended for inclusion in the 2009-2011 cycle for Annual Improvements; IFRS 3 Business Combinations – Regrouping and consistency of contingent consideration guidance. 34 IASB Update, May 2009, p. 5. 35 Exposure Draft (ED 2010/9), Leases, IASB, Appendix C, IFRS 3 Business Combinations. 36 IASB Update, May 2009, p. 5.




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International GAAP 2011 Sample Chapter  

International GAAP 2011 Sample Chapter

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