Accounting for Business Combinations (IFRS 3) - IFRScommunity.com (2024)

Last updated: 29 May 2023

Under IFRS 3, business combinations should be accounted for using the acquisition method consisting of the following steps (IFRS 3.4-5):

1. Identifying the acquirer.
2. Determining the acquisition date.
3. Recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree.
4. Recognising and measuring goodwill or a gain from a bargain purchase.

Pooling of interest method, fresh start method, or other methods are not allowed by IFRS 3. However, they may be used in accounting for business combinations under common control (which are on the IASB’s agenda).

Recognition of acquired assets and assumed liabilities

As of the acquisition date, the acquirer recognises, separately from goodwill, the identifiable assets acquired and the liabilities assumed in a business combination. Assets and liabilities are identifiable if they (IFRS 3.10-12):

• satisfy the definitions of assets and liabilities in the Conceptual Framework for Financial Reporting at the acquisition date (with limited exceptions), and
• are part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination transaction rather than the result of separate transactions (see Determining what is part of the business combination transaction for further discussion).

The Framework defines an asset as a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits (CF 4.3-4).

A liability is a present obligation of the entity to transfer an economic resource as a result of past events. For a liability to exist, three criteria must all be satisfied:

1. the entity has an obligation,
2. the obligation is to transfer an economic resource, and
3. the obligation is a present obligation that exists as a result of past events (CF 4.26-4.27).

Consequently, entities cannot recognise liabilities for future expenditures for which there is no present obligation as at the acquisition date. Specifically, a restructuring that the acquirer plans to carry out is not recognised at the acquisition date. See provisions and contingent liabilities for more discussion.

Note that the criteria above do not include the ‘expected flow’. Consequently, it does not need to be certain, or even likely, that economic benefits will flow to, or outflow from, an entity for an item to satisfy the Framework’s definition of an asset or a liability.

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).

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Acquired identifiable assets

Identifiable intangible assets

Typical examples of assets that are recognised on business combination, but were not recognised before by the acquiree, are internally generated intangible assets such as brands, patents or customer relationships. An intangible asset must be identifiable in order to be recognised by the acquirer. An intangible asset is identifiable is it meets one of the two criteria (IAS 38.12, IFRS 3.B31):

1. Separability criterion; or
2. Contractual-legal criterion.

Separability criterion

An intangible asset is separable if it can be 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. This criterion is to be assessed irrespective of what the acquirer plans to do with the asset. There needs to be evidence of exchange transactions for that type of asset or an asset of a similar type, even if those transactions are infrequent (IFRS 3.B33-B34).

Examples of assets that can be recognised under separability criterion are:

• Customer lists and non-contractual customer relationships. Customer lists may include data such as name, age, geographical location or history of orders. Customer list is recognised as an intangible asset if the terms of confidentiality or other agreements or simply the law do not prohibit the entity from selling, leasing or otherwise exchanging the list. (IFRS 3.IE24, IE31).
• Technology-based intangible assets (IFRS 3.IE39-IE44).

Contractual-legal criterion

An intangible asset meets the contractual-legal criterion if it 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.B32). Examples of such assets are:

• Licences to operate in a specific sector, geographical area etc. even if not separable from the related assets or legal entity.
• Legally protected trademarks (IFRS 3.IE18-IE21).
• Internet domains (IFRS 3.IE 22).
• Customer contracts and orders, together with related customer relationships (IFRS 3.IE25-IE30). Contracts and placed orders (even if cancellable) arise from contractual rights and therefore need not meet the separability criterion in order to be recognised. In other words, they are recognised even if the terms of confidentiality or other agreements or simply the law prohibit the acquirer/acquiree from selling, leasing or otherwise exchanging these contracts. Customer relationships meet the contractual-legal criterion if an entity has a practice of establishing contracts with its customers, regardless of whether a contract exists at the acquisition date (IFRS 3.IE30c).
• Copyright materials such as films, books etc. (IFRS 3. IE32-IE33).
• Contract-based intangible assets. Lots of examples of contract-based intangible assets are given in IFRS 3.IE34-IE38.
• Technology-based intangible assets (IFRS 3.IE39-IE44).

Items that are not identifiable

Intangible assets that do not meet separability criterion or contractual-legal criterion cannot be recognised separately. They are included in the value of goodwill (IFRS 3.B37-B40). Examples of such assets are:

• assembled workforce,
• potential contracts,
• synergy benefits,
• contingent assets, and
• expected renewals of reacquired rights.

In-process research and development project

IAS 38.34 specifically requires separate recognition of acquired in-process research and development project. Paragraphs IAS 38.42-43 cover subsequent expenditure on an acquired in-process research and development project. If such a project is never completed, it must be impaired.

Assets that the acquirer does not intend to use

All assets and liabilities acquired should be recognised irrespective of whether the acquirer intends to use or settle them. Assets that the acquirer does not intend to use, or intends to use in a ‘suboptimal’ way, should still be measured at fair value assuming their highest and best use. They also cannot be written-off immediately after the acquisition, as the impairment loss under IAS 36 can be recognised only when both value in use and fair value less costs of disposal are below the carrying value of the asset (IFRS 3.B43). Such assets will be removed from the accounts through amortisation over their useful life. It may be challenging to determine the useful life of such asset, especially if the acquirer does not intend to use it at all, but some estimate needs to be made. See examples below.

Example: Acquired brand that will not be used after the business combination

Acquiring Company (AC) acquired a competitor, the Target Company (TC), which had a TC brand with a fair value of $10 million. AC intends to withdraw the brand of TC from the market within a year, which will increase the market share of its original AC brand. AC intends to keep legal rights to brand TC forever in order to prevent other companies from using it.

AC recognises TC brand at its fair value of $10 million despite intent to withdraw the brand from the market. The economic benefits for AC to be obtained from TC brand is that competitors cannot use it, which in turn increases profits of AC. The useful life should therefore be longer than 1 year during which AC intends to withdraw the TC brand from the market. The useful life can be estimated as the period over which a significant competitor will fill the void after TC was withdrawn from the market, which will depend on many variables, such as the significance of entry barriers.

Example: Acquired software that will not be used after the business combination

Acquiring Company (AC) acquired a competitor, the Target Company (TC), which had a customised client relationship management software (CRM) with a fair value of $2 million (determined with the assumption of continuous use). AC has its own CRM software and therefore intends to migrate all TC customers within 6 months. As a result, CRM software of TC will be useless after 6 months, it was so customised that AC will not be able to sell it to third parties.

AC recognises TC’s CRM software at fair value of $2 million even though it will use it only for 6 months. This software will be amortised over those 6 months as this is the period during which AC will obtain benefits from it.

Classification of acquired assets

At the acquisition date, the acquirer should classify or designate acquired assets and assumed liabilities as required by other relevant IFRS (e.g. IFRS 9). This should be done based on terms and conditions existing at the date of business combination (IFRS 3.15). An exception to this rule relates to classification of lease contracts where the acquiree is the lessor (IFRS 3.17).

Measurement of acquired assets and liabilities

The acquirer measures the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values (IFRS 3.18-19), with certain exceptions as specified below. IFRS 3 does not say how to measure fair value, as this is covered in IFRS 13.

Assets acquired in a business combination should be accounted for in a ‘fresh start’ mode, e.g. allowance for credit losses or accumulated depreciation of fixed assets should not be continued in financial statements of the acquirer (IFRS 3.B41).

Exceptions to recognition or measurement principles

There are exceptions to the recognition and measurement principles of IFRS 3 applicable to certain specified assets and liabilities. These are set out in paragraphs IFRS 3.21A-31A,54-57 and include items discussed below.

Provisions and contingent liabilities

For a provision or a contingent liability that would be within the scope of IAS 37 or IFRIC 21 if incurred separately, the acquirer applies IAS 37 or IFRIC 21, respectively, to determine whether a present obligation exists at the acquisition date. Consequently, for this particular class of liabilities, the acquirer does not apply the Framework when assessing recognition conditions (IFRS 3:21A-21C).

The acquirer should recognise assumed contingent liabilities for which a present obligation exists at fair value, even if the probability of outflow of resources is lower than 50% (IFRS 3.23). This approach is different from ‘regular’ requirements of IAS 37 where a liability is recognised only when the probability of outflow of resources exceeds 50%. Conversely, a contingent liability isn’t recognised if it is a possible obligation only whose existence will be confirmed by the occurrence or non-occurrence of uncertain future events not wholly within the control of the entity.

After the initial recognition, the contingent liability is measured at the higher of the following amounts:

1. the amount that would be recognised in accordance with IAS 37;
2. the amount initially recognised less, if applicable, the cumulative amount of revenue recognised in accordance with IFRS 15.

The method of subsequent measurement specified above forbids to derecognise a liability assumed in a business combination until it is settled or expires.

Contingent assets

The acquirer should not recognise contingent assets unless the acquiree has an unconditional right at the acquisition date (IFRS 3.23A). If there is an unconditional right, an asset is no longer considered contingent and should be recognised at fair value and subsequently measured in accordance with appropriate IFRS, e.g. IFRS 9 (IFRS 3.BC276). It is often difficult to assess whether a right is unconditional, especially for non-contractual assets. In practice, if there is any doubt, a separate asset is not recognised until all uncertainties are resolved.

Income tax

Deferred tax resulting from temporary differences and unused tax losses is accounted for according to IAS 12, i.e. not at fair value (IFRS 3.24-25). Deferred tax is recognised for assets and liabilities recognised at business combination as well as for fair value adjustments (IAS 12.19).

More discussion on business combinations and income tax accounting can be found in IAS 12.

Employee benefits

Employee benefits are recognised and measured in accordance with IAS 19, i.e. not at fair value (IFRS 3.26).

Indemnification assets

It is common occurrence that the acquirer protects himself from uncertain and/or unknown outcomes of pending or potential matters relating to acquiree. The most common examples are claims and litigation (C&L) where the seller promises to reimburse the acquirer if the amounts to be paid as a result of C&L relating to pre-acquisition events exceed a certain amount. In such cases, the acquirer has an indemnification asset. Such an asset should be measured (both on initial recognition and subsequent measurement) on the same basis as the indemnified item (C&L liability in our example) with consideration given to credit risk (IFRS 3.27-28). In practice, such assets are valued at the same amount as related liability, after taking into account any contractual limits for indemnification.

Leases in which the acquiree is the lessee

Right-of-use assets and lease liabilities for leases where the acquiree is the lessee are recognised at the present value of the remaining lease payments as if the acquired lease were a new lease at the acquisition date. The acquirer measures the right-of-use asset at the same amount as the lease liability, adjusted to reflect favourable or unfavourable terms of the lease when compared with market terms (IFRS 3.28A). More on leases in IFRS 16.

Leases in which the acquiree is the lessor

Operating leases in which the acquiree is the lessor are not recognised separately if the terms of an operating lease are either favourable or unfavourable when compared with market terms. Instead, terms of the lease are taken into account when measuring the fair value of the asset subject to a lease (IFRS 3.B42).

Reacquired rights

It may happen that one of the assets acquired a as part of business combination is a right previously granted by the acquirer to the acquiree. It most often concerns a right to use an asset (recognised or unrecognised by the acquirer) by the acquiree (such as brand). Such a right is recognised as an asset on a business combination, but the fair value measurement should be based only on the remaining contractual term, i.e. without taking into account possible contract renewals (IFRS 3.29,B35). A reacquired right should be amortised over the remaining contractual period.

The extract below illustrates recognition of EUR 7.8 billion (sic!) of reacquired rights by BMW as part of obtaining control over its Chinese joint venture (BMW Brilliance) in 2022:

If the terms of reacquired right were favourable or unfavourable relatively to market terms, a settlement gain or loss on pre-existing relationship should be recognised (IFRS 3.B36).

See a separate section on share-based payment arrangements in the context of business combinations in IFRS 2.

Assets held for sale

Acquired assets held for sale should be initially measured at fair value less costs to sell in accordance with IFRS 5 (IFRS 3.31).

Insurance contracts

Group of contracts within the scope of IFRS 17, and any assets for insurance acquisition cash flows as defined in IFRS 17, should be measured in accordance with IFRS 17.39 and IFRS 17.B93–B95F (IFRS 3:31A).

Recognising and measuring goodwill

Goodwill represents the future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognised. The core components of goodwill are the going concern element of the acquiree’s existing business, including assembled workforce, and expected synergies and other benefits from combining the acquirer’s and acquiree’s net assets and businesses (see BC313+ for more discussion). IFRS 3.B64e requires a qualitative description of the factors that make up the goodwill recognised.

Goodwill is measured as a residual as the difference between (IFRS 3.32):

• consideration transferred,
• non-controlling interest in the acquiree,
• fair value of the acquirer’s previously held equity interest in the acquiree, and
• net identifiable assets acquired and liabilities assumed.

Goodwill is not amortised, but is subject to impairment testing at least annually as per IAS 36 requirements. If goodwill relates to an acquisition of a foreign subsidiary, it is expressed in functional currency of this subsidiary and then subsequently translated as per IAS 21 requirements.

Example: illustration of calculation of goodwill

Acquirer Company (AC) acquires 80% shareholding of Target Company (TC) for $100m. TC has the following assets and liabilities as at the acquisition date:

AC assesses that the fair value of assets and liabilities of TC equals their net book value as presented in the statement of financial position of TC. Additionally, AC considers that the brand of entity TC is an identifiable asset to be recognised on acquisition. It is an internally generated brand, so it hasn’t been recognised by TC. Fair value of ‘TC’ brand is estimated at $20m. Impact of this acquisition on consolidated financial statements of AC is as follows ($m):

The formula for goodwill calculation may yield a negative number. If this is the case, a gain on a bargain purchase may need to be recognised.

Consideration transferred and contingent consideration

Consideration transferred is the sum of fair values of (IFRS 3.37):

• assets transferred by the acquirer,
• liabilities to former owners incurred by the acquirer, and
• equity interests issued by the acquirer.

Usually, consideration is paid in cash. If acquirer transfers other assets, they should be remeasured to fair value at the acquisition date. Any difference between fair value and net book value is recognised immediately in P/L. This rule does not apply to assets transferred to the acquiree, because the acquirer controls them also after the acquisition (IFRS 3.38).

Sometimes the amount (level) of consideration depends on future events. Such consideration is referred to as contingent consideration and it should also be recognised at fair value as a part of business combination. General criteria of IFRS 13 for determination of fair value of liabilities apply also to contingent consideration. Note that the part of contingent consideration that depends on continuous employment of the selling shareholder (so-called ‘earn-outs’) needs to be excluded from acquisition accounting and treated as an expense in future periods (see IFRS 3.B55(a) and January 2013 IFRIC update).

If all contingent consideration is paid in full, but the acquirer has a right to partial return, such a right is recognised as an asset at fair value and it decreases the total consideration (IFRS 3.39-40).

Changes in fair value of contingent consideration resulting from events after the acquisition date (e.g. meeting post-acquisition performance targets) are recognised in P/L. Classification in P/L is not covered in IFRS, usually it is presented as a part of operating income and changes resulting from unwinding of discount are presented in finance costs.

Contingent consideration classified as equity as per IAS 32 is not subsequently remeasured and its settlement is accounted for within equity (IFRS 3.58). See IAS 32 for equity/liability distinction.

The acquirer sometimes has a right to withhold part of the consideration for a specific period in case of e.g. violation of the share purchase agreement by the seller (e.g. non-disclosure of a claim against the acquiree). This is often referred to as deferred consideration. Changes or adjustments to deferred consideration will most likely result from additional information about facts and circ*mstances that existed at the acquisition date and are treated as measurement period adjustments.

Similarly, the level of consideration often depends on the level of working capital of the acquiree as at the acquisition date, but this is determined sometime after the acquisition. Any changes to consideration resulting from working capital balances of the acquiree as at the acquisition date are treated as measurement period adjustments.

It is possible that the acquirer obtains control without transferring consideration. It can happen e.g. when the acquiree repurchases its own shares or some rights held by previous controlling interests lapse. All IFRS 3 requirements apply also to this kind of business combinations (IFRS 3.43-44).

Measurement of non-controlling interest

IFRS 3 allows two measurement bases for non-controlling interest (NCI):

1. fair value or
2. the present ownership instruments’ proportionate share of acquiree’s identifiable net assets (IFRS 3.19).

Note that variant 2. is available only for ‘ordinary’ NCI, i.e. equity instruments that are present ownership instruments and entitle their holders to a proportionate share of the acquiree’s net assets in the event of liquidation. So e.g. preference shares that entitle their holders to disproportionately higher or lower share of the acquiree ’s net assets in the event of liquidation must be measured at fair value. Same with share warrants or equity components of compound financial instruments.

Fair value of NCI need to be determined using valuation techniques under IFRS 13. If shares of the acquiree are quoted, their fair value will be determined as ‘price x quantity’. However, it will hardly ever be the case, and it is important to keep in mind that the fair value of NCI will be usually lower than implied by simple reference to controlling interest of the acquirer (i.e. 30% NCI is worth less than half the value of 60% of controlling stake). It is so because the acquirer paid so-called control premium (IFRS 3.B44-B45).

The decision about the measurement basis can be made on a transaction-by-transaction basis (i.e. this is not a ‘fixed’ accounting policy). There are three major implications of such a decision (IFRS 3:BC217-BC218):

1. Non-controlling interest measured at fair value will usually be higher than when measured at proportionate share of identifiable net assets – the corresponding impact affects goodwill, making it also higher (see the illustrative example below).
2. When an impairment loss is charged against goodwill, its amount will be higher when non-controlling interest is measured at fair value (see point 1. above). The ‘additional’ impairment loss will be allocated to non-controlling interest. See also the section on Goodwill and non-controlling interests within IAS 36.
3. When the non-controlling interest is subsequently reduced through purchase of additional shares by the parent company, such a transaction is accounted for as an equity transaction under IFRS 10. The higher the non-controlling interest is valued before such a transaction, the lower the reduction in consolidated equity after the transaction.

Example: two methods of measurement of non-controlling interest

Acquirer Company (AC) acquires 70% shareholding in Target Company (TC) for $50m. Fair value of net identifiable assets of TC as at the acquisition is $40m. Fair value of the remaining 30% stake in TC is $17m.

The impact of this acquisition on consolidated financial statements of AC is as follows ($m):

Method 1: Non-controlling interest measured at fair value:

* Measured at fair value under IFRS 13, not the same as 30% x $40m.

Method 2: Non-controlling interest measured at present ownership interest:

* 30% x $40m

Previously held equity interest in the acquiree

An acquirer may obtain control over acquiree in which it held some equity interest at the time of obtaining control. For example: Acquirer Company (AC) has 30% interest in Target Company (TC), and then it acquires additional 40% which in aggregate gives AC a 70% interest and control over TC. This is often referred to as ‘step acquisition’ or ‘piecemeal acquisition’. In such a case, the 30% interest should be remeasured to fair value at the acquisition date and any difference between fair value at the date of obtaining control and carrying value should be recognised as gain/loss in P/L or OCI as if it was sold (including recycling OCI to P/L if applicable) (IFRS 3.41-42).

The extract below illustrates recognition of EUR 7.6 billion of gain recognised by BMW on remeasurement of previously held 50% interest in its Chinese joint venture:

The fair value of previously held equity interest in the acquiree is then derecognised and included in calculation of goodwill (as if it was a part of consideration transferred).

If, prior to business combination, the acquirer recognised changes in the value of its equity interest in the acquiree in OCI (e.g. as share in OCI of associates), that amounts should be recognised on the same basis as would be required if the acquirer had disposed directly of the previously held equity interest. This means that they may or may not need to be recycled to P/L.

Gain on bargain purchase

The equation used for calculating goodwill may give a negative number. Is such cases, a one-off gain on bargain purchase is recognised in P/L. But before that, IFRS 3 requires reassessment and re-examination of all the steps performed in the business acquisition accounting (IFRS 3.34-36). Furthermore, IFRS 3.B64n(ii) requires a disclosure of the reasons why the transaction resulted in a gain (e.g. the seller was under pressure due to liquidity issues).

Gains on bargain purchases are rare in real life. If initial calculations reveal such a gain, fair valuation of assets may need to be decreased (alternatively – fair valuation of liabilities increased). This way of reassessing the initial gain is also more convenient for the management of the acquirer. This is because one-off gains are usually excluded from KPIs used by management and investors anyway. Whereas lower value of assets recognised on a business combination results in lower depreciation and amortisation charges in post-acquisition P/L, or higher gains on their subsequent disposal.

Overpayments

IFRS 3 does not cover overpayments. It is so because the IASB believes such instances are rare are nearly impossible to detect. Anyway, an acquirer cannot recognise any loss on acquisition due to overpayment, so any overpayment will increase the value of goodwill. In theory, overpayment will trigger an impairment loss during nearest impairment test (IFRS 3.BC382).

Acquisition-related costs, such as professional fees, should be expensed in the periods in which the costs are incurred and the services are received. The costs to issue debt or equity securities should be recognised in accordance with IAS 32 and IFRS 9 (IFRS 3.53).

Acquirer’s acquisition-related costs that were paid by the acquiree or selling shareholders should also be recognised as an expense by the acquirer (IFRS 3.52(c)).

Measurement period

The complexity of business combinations combined with often limited access to financial data of the acquiree before the acquisition can make the acquisition accounting impossible to conclude before reporting date. IFRS 3 takes such limitations into account and introduces the concept of measurement period. It is a period during which the acquirer can make retrospective adjustments to acquisition accounting if it obtains new information about facts and circ*mstances that existed at the acquisition date. Such adjustments should be applied retrospectively together with changes in comparative data, e.g. adjustment to depreciation charges.

The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circ*mstances that existed as of the acquisition date or learns that more information is not obtainable. However, the measurement period cannot exceed one year from the acquisition date (IFRS 3.45-50).

There is no relief with respect to timing of an impairment test for goodwill during the measurement period. As a result, CGUs to which newly recognised goodwill has been allocated should be tested for impairment before the end of the first annual period during which the business combination took place (IAS 36.96).

Determining what is part of the business combination transaction

Paragraphs IFRS 3.51-52; B50-B62 cover pre-existing relationships and transactions entered into during business combinations which are de facto separate transactions. Transactions that are entered into 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, are likely to be separate transactions and should be accounted for separately from the business combination. Examples of such transactions given in IFRS 3.52 are:

• settlements of pre-existing relationships between acquirer and acquiree,
• remuneration of employees or former owners of the acquiree for future services (see also IFRS 3.B55(a) and January 2013 IFRIC update).

IFRS 3.B50 lists factors to consider when assessing whether a transaction should be accounted for separately from a business combination. These include reasons for the transaction, who initiated the transaction and timing of the transaction. Additionally, paragraphs IFRS 3.B54-B55 provide detailed guidance on contingent payments to employees or former owners of the acquiree that help to determine whether such payments are remuneration for future service or a contingent consideration for the acquiree.

The accounting for share-based payment arrangements in the context of business combinations is covered in IFRS 2.

If the business combination settles a pre-existing relationship, the acquirer recognises a gain or loss, measured as follows (IFRS 3.B52):

1. for a pre-existing non-contractual relationship (such as a lawsuit), fair value.
2. for a pre-existing contractual relationship, the lesser of (i) and (ii):

1. 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 items,
2. the amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavourable (see an example in IFRS 3.IE54-IE57).

The share purchase contract may determine that the acquirer repays the debt of the acquiree at the acquisition date, or the acquirer may do it voluntarily. However, if the debt was not owed to selling shareholders, its settlement should be excluded from the business combination accounting. Instead, acquirer should recognise these liabilities as part of the net identifiable assets acquired at the acquisition date and recognise the repayment as a post-acquisition event.

Note that cash flows that are associated with the business combination but are not part of the exchange for control over the acquiree should be excluded from investing cash flows if they do not give rise to an asset.

Example: Settlement of pre-existing lawsuit

Acquirer Company (AC) acquired Target Company (TC) for $100m. Before the acquisition, TC filed a lawsuit against AC for breaches of contractual terms. TC demanded a payment of $10m from AC. AC did not recognise any provision as it believed that the probability of cash outflow relating to this case is only 20%. Fair value of the liability is estimated at $2m.

This claim becomes an intragroup claim after the business combination, so it should be considered effectively settled in the consolidated financial statements of AC and AC should account for this settlement separately from business combination. $2m should be expensed as a cost of settlement, and the remaining $98m should be accounted for as a consideration for acquisition of TC.

Example: Settlement of pre-existing contract

Acquirer Company (AC) acquired Target Company (TC) for $100m. Before the acquisition, TC was a supplier of AC. At the acquisition date, they had a valid supply contract for product Y at fixed prices and the remaining contractual term was 3 years. As prices of the product Y dropped on the market since the conclusion of the contract, it was unfavourable to AC at the acquisition date. AC was contractually committed to order a minimum of 1,000 pieces of Y each year until the expiration of the contract. AC could terminate the contract, but then it would need to pay a penalty of $5m to TC.

The fair value of the contract from the supplier’s (TC) perspective is determined at $7m, of which $3m relates to above-market fixed pricing, and the remaining $4m relates to at-market prices. In other words, $3m is the fair value of the contract attributable to the fact that it is unfavourable to AC.

As a part of the acquisition accounting, the $3m of consideration paid is recognised by AC as an expense relating to settlement of pre-existing contract. The remaining $4m corresponding to at-market prices forms a part of goodwill (IFRS 3.IE56).

Acquisition of individual assets

In case of an acquisition of assets that do not constitute a business, the acquirer recognises individual identifiable assets (and liabilities) by allocating the cost of acquisition on the basis of their relative fair values at the date of purchase. Goodwill is not recognised (IFRS 3.2(b)).

Identifying the acquirer

General requirements for identifying the acquirer

Entities are required to identify the acquirer for each business combination (IFRS 3.6-7). The acquirer is an entity that obtains control over the acquiree. ‘Control‘ is used here in the meaning introduced by IFRS 10.

It is usually straightforward to determine which entity is the acquirer – it is the entity that transfers cash and/or incurs liabilities and is clearly larger (in terms of assets, revenue etc.) than other parties involved in the transaction. Paragraphs IFRS 3.B14-B18 provide more guidance on identifying the acquirer.

Reverse acquisitions

Paragraphs IFRS 3.B19-B27 provide guidance on a particular kind of business combination called reverse acquisitions, or reverse takeovers, or reverse IPO (initial public offering). Reverse acquisition occurs when a (usually) publicly traded company is taken over by a private company. First, owners of the private company obtain control over the public company by buying adequate number of shares on the market. Second, the public company ‘acquires’ the private company by issuing its shares to owners of the private company. Finally, both entities are merged into one entity or operations of the private company are transferred to the public company. In the end, the benefit for the owners of a private company is that they can take their business public without going through costly and lengthy IPO process.

The public company is usually a legal acquirer as it issues shares to owners of the private company in exchange for shares in the private company. Despite the legal classification, if the guidance in IFRS 3.B14-B18 indicates that the private company is de facto the acquirer, the business combination should be accounted for with the private company as the acquirer.

Determining the acquisition date

Acquisition date is the date when the acquirer obtains control over the acquiree. It is usually straightforward to determine the acquisition date, which is usually the so-called ‘closing date’. Closing date is the date when the consideration is transferred to the seller. However, IFRS 3 takes into account instances when the control is obtained before or after the closing date (IFRS 3.8-9).

Example: Determining the acquisition date

Acquirer Company (AC) acquired Target Company (TC). The following milestones relate to the transaction:

1. The agreement was signed on 9 February. The agreement stated that the effective date of the transaction was 31 March. In particular:
   • TC’s selling shareholders weren’t entitled to dividends or other equity distributions after 31 March,
   • the price for TC’s shares was linked to TC’s working capital balances at 31 March, and
   • TC’s management had to seek AC’s written consent for any strategic business decisions after 31 March.
2. The acquisition of TC was subject to shareholder approval at AC’s AGM on 17 May.
3. After AGM’s approval was obtained, the price for TC’s shares was paid on 24 May and TC’s new board of directors was appointed day by AC shortly after the payment.
4. Change in ownership became legally binding on 27 June when the transaction was recorded in a public company register.

As said before, the key in determining the acquisition date is the notion of control. In the example above, the control was most likely obtained on 24 May, i.e. when the payment was made. Despite the stated effective date of the transaction, AC did not obtain power over TC on 31 March. In particular, AC did not have existing rights that would give it the current ability to direct the relevant activities of TC at that date. The requirement of TC’s management to seek AC’s approval for strategic business decisions was a protective right only.

If there are any legal procedures to be fulfilled after the acquisition, they are usually virtually certain to be successfully processed and the control over TC is usually passed by TC’s former owners to AC before that date. However, if the procedures to be fulfilled are substantive, e.g. consent of competition authorities, the acquisition date can be determined only after the consent is received.

In practice, the acquisition date for accounting purposes is often set at the month closing date, as it is easier to determine the value of assets and liabilities acquired. This approach is specifically allowed by IFRS 3.BC110 provided that there are no material events between the month closing date and actual acquisition date.

Pushdown accounting

Some GAAP allow to use acquirer’s basis of accounting in acquiree’s separate financial statements. For example, fair value adjustments recognised in consolidated financial statements are ‘pushed down’ to separate financial statements of the acquiree. However, pushdown accounting is not allowed under IFRS. More information about pushdown accounting can be found in Deloitte’s roadmap series.

More about IFRS 3

See other pages relating to IFRS 3:

Scope of IFRS 3
Accounting for Business Combinations
Disclosure Requirements for Business Combinations