Business Combinations

Guide to accounting for business combinations

1. INTRODUCTION
This guide looks at business
combinations.
Understanding
how to account for business
combinations is an essential first
step in preparing consolidated
financial statements.
IFRS 3 Business Combinations
contains
principles
to
be
followed
when
an
entity
acquires control of another
entity.

A business combination is a transaction or other event in which an acquirer obtains

control of one or more businesses.
An acquirer is an entity that obtains control of an acquiree.
An acquiree is a business that the acquirer obtains control of in a business
combination.
Fair value is the amount for which an asset could be exchanged, or a liability
settled between knowledgeable, willing parties in an arms length transaction.
Examples of business combinations include:
One business buying another business by acquiring its equity (shares)

One business buying another business by acquiring its net assets

The merger of two unrelated companies

The creation of a new entity to control the combining entities.

IFRS 3 does not apply to transactions involving the creation of a joint venture or
entities under the control of a common parent.

> ACQUISITION METHOD BASICS

The acquisition method of accounting for a business combination must be used. This
views the business combination from the acquirers perspective. In essence:

Acquired entitys assets, liabilities and contingent liabilities are recognised

by the acquirer at fair value at acquisition date;

Goodwill is recognised as an asset and subsequently tested annually for

impairment (not amortised).

Changes to net assets acquired, after control has passed, are reported as part
of the acquirers post-acquisition financial performance.

Acquirers own assets are not affected.

STEP 1 Identify the acquirer

STEP 2 Determine the acquisition date

STEP 3 Recognise and measure the identifiable assets acquired, liabilities
assumed and any non-controlling interest in the acquiree.

STEP 4 Recognise and measure goodwill or gain from bargain purchase

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STEP 1. IDENTIFY THE ACQUIRER

The acquirer is the entity that obtains control of the other entity
Acquirer must be identified for each Business Combination

> CONTROL

Acquiring 50% or more of the voting rights leads to the presumption of control,
unless there is evidence to the contrary.
An investor controls an investee if the investor has all of the following
o Power over the investee
o Exposure or rights to variable returns from the investee
o Ability to use its power over the investee to affect returns

> ACQUIRER INDICATORS

Entity that transfers cash or incurs liabilities

Entity issuing equity instruments
Entity whose relative size (assets, revenue or profit) is significantly greater
Entity with majority of voting rights post-combination
Entity with management influence of new entity

> ESTABLISHMENT OF A N EW ENTITY

Equity issued to acquire businesses
Requirement for one of the combining entities to be identified as the acquirer.

Need to determine which entity has control (use acquirer indicators)

Cash issued to acquire businesses

A new entity which transfers cash/other assets or incurs liabilities as

consideration may be the acquirer.

> REVERSE ACQUISITIONS

Consider:
Which of the combining entities initiated the combination

Whether the revenues and expenses of one of the combining entities

significantly exceed those of the others.

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STEP 2. DETERMINE THE ACQUISITION D ATE

The acquirer must identify the acquisition date, which is the date on which it obtains
control of the acquiree.
In most cases this will be the date of settlement (i.e. the closing date) of the
acquisition, when the acquirer obtains ownership of the assets and assumes the
liabilities of the acquiree. However, the date of acquisition may be different to the
contract date, and consideration should be given to relevant facts and circumstances.

> ACQUISITION DATE INDICATORS

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Date control of business obtained

Date legal ownership of assets transfers
Settlement date per contract of sale

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STEP 3. M EASURE AND ALLOCATE COST T O THE NET IDENTIFIABLE ASSETS

> NOTE

> M EASURE THE COST

Examples of fair value of

purchase consideration
Cash
Amount receivable (discount to
PV if applicable)

The purchase consideration (cost) is measured as the fair value of:

assets given

liabilities incurred or assumed

equity instruments issued, and

contingent consideration (even if not probable of payment)

at the date of acquisition, in exchange for control

Other assets
Estimated realisable value,
market prices, valuations.

Cost of business combination

Note

Liabilities assumed
Amount payable (discount to PV
if applicable)

Cash

X.

Deferred payment (discount if > 12 months)

X.

Shares

X.

Shares (equity)
Current market value (published
share price)

Contingent consideration

X.

> NOTE
Dividends paid by the acquirer
and amounts payable under
earn out clauses (contingent
consideration) can form part of
purchase consideration

Total

Notes:
1. .
2. .
Deferred consideration:
Discount to present value at acquisition date

o Use incremental borrowing rate

Discount rate considerations

o Prevailing commercial rates applicable to the entity

o Existing financial arrangements of the entity
o Alternative sources of finance available to the entity at acquisition date
o Other relevant factors
Contingent consideration:
Aka. Earn-out clauses

e.g. payable upon reaching performance targets

Include as part of purchase consideration at fair value

Dividends paid by acquirer after the acquisition date

May be treated as part of purchase consideration, if

o Acquirer issued shares to vendor as part of acquisition

o Shares ranked for dividends during period prior to acquisition, but no
dividends paid
o Dividends paid shortly after control passes
Purchase consideration excludes:
Future costs (e.g. restructuring) that the acquirer is not obliged to incur

Costs of acquisition (charged to SOCI)

Future losses

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STEP 3. M EASURE AND ALLOCATE COST T O THE NET IDENTIFIABLE ASSETS ( CONT.)
> NOTE
Examples of fair value of assets
Receivables
PV of recoverable amount
Non-current assets
Market value
Intangible assets
Estimated value (if separately
identifiable)
Marketable securities
Current market value

The acquirer is required to allocate the cost of the acquisition by recognising the fair
value of the acquirees:
Identifiable assets (tangible and intangible);

o Intangible assets
Must meet the definition of an intangible asset in accordance

with IAS 38
Fair value must be capable of being reliably measured;

Must be identifiable:

Separable or capable of being separated, or

Arises from contractual or other legal rights

o If the assets are not identifiable, they form part of goodwill.

Liabilities, and

o Only liabilities that exist at acquisition date and satisfy the recognition
criteria are separately recognised.
o Restructuring liabilities are only recognised if recognised at the time of
the acquisition and unconditional.
Contingent liabilities.

o Recognise only if fair value can be measured reliably.

o Fair value is the amount a third party would charge to assume the
contingent liability.
o If fair value can be determined, it must be recognised regardless of
probability.

Fair value of net identifiable assets

Note

Carrying amount of net assets

Fair value adjustments:

Increase in value of asset X

X.

Decrease in value of asset Y

X.

(X)

X/(X)

Total

> ASSETS H ELD FOR SALE

An acquired non-current asset (or disposal group) that is classified as held for sale in
accordance with IFRS 5 Non-current Assets held for Sale and Discontinued Operations,
is measured at fair value less costs to sell in accordance with IFRS 5.

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STEP 4. RECOGNISE AND M EASURE G OODWILL/BARGAIN PURCHASE

> NOTE

> NON-CONTROLLING I NTEREST

Acquirers decide, on a
transaction-by-transaction basis,
which way to measure NCI in the
acquiree. The calculation of
goodwill will depend on the
method chosen.

When an acquirer doesnt own all the shares in an acquiree, the equity in the
subsidiary not held by the acquiree is called the non-controlling interest (NCI)
NCI resulting from a business combination is measured at:
The NCIs proportionate share of the acquirees identifiable net assets

(partial goodwill method), or

Fair value (full goodwill method)

> PARTIAL G OODWILL METHOD

XX
(XX)
XX
(XX)
XX/(XX)

Identifiable net assets (fair value)

NCI (Identifiable net assets x %)
Net assets acquired
Purchase consideration
Bargain Purchase/(Goodwill)

NCI will not include its proportion of goodwill. Any future goodwill impairment will be
deducted entirely from the groups reserves.

> NOTE
Goodwill
Capitalise and test for impairment
annually. Do not amortise. May
have to apportion between
owners of parent and NCI.
Bargain purchase
Negative goodwill. Recognise
immediately in SOCI (P&L)

> FULL GOODWILL METHOD

XX
(XX)
XX
(XX)
XX/(XX)

Identifiable net assets (fair value)

NCI (valuation)
Net assets acquired
Purchase consideration
Bargain Purchase/(Goodwill)

NCI balance will include its proportion of goodwill. Any future goodwill impairment will
be from group reserves and NCI.

> BARGAIN PURCHASE/NEGATIVE G OODWILL

First, recalculate and reassess measurement basis of consideration transferred, net
assets acquired, NCI, and previously held equity.
Any gain (bargain purchase) must be recognised immediately in profit or loss.

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