International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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Example 9.37:
Reverse acquisition – earnings per share ....................................... 690
Example 9.38:
Reverse acquisition effected with cash consideration ................. 692
Example 9.39:
Reverse acquisition of a non-trading shell company ................... 694
Example 9.40:
Footnote X: Acquisitions ................................................................... 702
593
Chapter 9
Business combinations
1 INTRODUCTION
A business combination is defined by the IASB (‘the Board’) as a ‘transaction or other
event in which an acquirer obtains control of one or more businesses’. [IFRS 3 Appendix A].
Over the years, business combinations have been defined in different ways. Whatever
definition has been applied, it includes circumstances in which an entity obtains control
of an integrated set of activities and assets that constitute a business.
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).
The two methods of accounting look at business combinations through quite different eyes.
An acquisition was seen as the absorption of the target by the acquirer; 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 pooling of interests or merger is seen as the pooling
together of two formerly distinct shareholder groups; 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. However, 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 (see Chapter 10).
The other main issues facing accountants have been in relation to accounting for an
acquisition. Broadly speaking, the acquiring entity has had to determine the fair values
of 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
result in a difference to the consideration given that has to be accounted for. Where the
amounts allocated to the assets and liabilities are less than the overall consideration
given, the difference is accounted for as goodwill. Goodwill is an asset that is not
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amortised, but subjected to some form of impairment test, although some national
standards still require amortisation. Where the consideration given is less than the
values allocated to the identifiable assets and liabilities, the issue has then been whether
and, if so, when, such a credit should be taken to the income statement.
1.1
IFRS 3 (as revised in 2008) and subsequent amendments
This chapter discusses IFRS 3 – Business Combinations – as revised in 2008 and
amended subsequently and its associated Basis for Conclusions and Illustrative Examples.
The specific requirements of IAS 38 – Intangible Assets – 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 17. Impairment of goodwill is addressed in Chapter 20 at 8.
In May 2011, the IASB issued a series of IFRSs that deal broadly with consolidated
financial statements. IFRS 10 – Consolidated Financial Statements – is a single standard
addressing consolidation. The requirements of IFRS 10 are discussed in Chapters 6
and 7 which address, respectively, its consolidation requirements and consolidation
procedures. Some consequential amendments were made to IFRS 3, principally to
reflect that the guidance on ‘control’ within IFRS 10 is to be used to identify the acquirer
in a business combination.
IFRS 13 – Fair Value Measurement – changed the definition of ‘fair value’ to an explicit
exit value, but it did not change when fair value is required or permitted under IFRS.
Its impact on IFRS 3 is considered at 5.3 below and reference should be made to
Chapter 14 for a full discussion. Unless otherwise indicated, references to fair value in
this chapter are to fair value as defined by IFRS 13.
In October 2012, the IASB amended IFRS 10 to provide an exception to the
consolidation requirement for entities that meet the definition of an investment entity.
As a result of this amendment the scope of IFRS 3 was also amended. The investment
entities exception is discussed in Chapter 6 at 10.
In December 2013, the IASB issued two cycles of Annual Improvements –
Cycles 2010-2012 and 2011-2013 – that had the following impact on IFRS 3.
• Contingent consideration in a business combination that is not classified as equity
is subsequently measured at fair value through profit or loss whether or not it falls
within the scope of IFRS 9 – Financial Instruments (see 7.1.2 and 7.1.3 below).
• The formation of joint arrangements, both joint operations and joint ventures, is
outside the scope of IFRS 3. The amendment has also clarified that the scope
exception applies only to the accounting in the financial statements of the joint
arrangement itself (see 2.2.1 below).
• A clarification that the guidance on ancillary services in IAS 40 – Investment
Property, [IAS 40.11-14], is intended to distinguish an investment property from an
owner-occupied property, not whether a transaction is a business combination or
an asset acquisition (see 3.2.3 below).
As a result of the issue of IFRS 15 – Revenue from Contracts with Customers – in
May 2014, a consequential amendment has been made to the requirements for the
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combinations
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subsequent measurement of a contingent liability recognised in a business combination
(see 5.6.1.B below). IFRS 15 is effective for annual periods beginning on or after
1 January 2018. See Chapter 28 for a detailed discussion of IFRS 15.
Some consequential amendments have been made to IFRS 3 as a result of the issue of
IFRS 9. These relate principally to the requirements for:
• classifying or designating identifiable assets acquired and liabilities assumed
(see 5.4 below);
• business combinations achieved in stages (see 9 below); and
• contingent consideration classified as an asset or liability (see 7.1 below).
The requirements of IFRS 9 are mandatory for annual periods
beginning on or after
1 January 2018.
In January 2016, the IASB issued IFRS 16 – Leases – which requires lessees to recognise
assets and liabilities for most leases under a single accounting model (i.e. no
classification of a lease contract as either operating or finance lease for lessees). For
lessors there is little change to the existing accounting in IAS 17 – Leases. A number of
consequential amendments have been made to IFRS 3 in respect of leases accounted
for under IFRS 16. These relate to the requirements for:
• classifying or designating identifiable assets acquired and liabilities assumed
(see 5.4 below);
• recognising and measuring particular assets acquired and liabilities assumed
(see 5.5.1 below); and
• exceptions to the recognition and/or measurement principles (see 5.6.8 below).
IFRS 16 becomes effective for annual periods beginning on or after 1 January 2019. Early
adoption is permitted, provided IFRS 15 has been applied, or is applied at the same date
as IFRS 16. See Chapter 24 for a detailed discussion of IFRS 16.
1.1.1 Post-implementation
review
In June 2015, the IASB completed the post-implementation review (PIR) of IFRS 3. The
PIR was conducted in two phases. The first phase which consisted of an initial
assessment of all of the issues that arose on the implementation of IFRS 3 and a
consultation with interested parties about those issues identified the main questions to
be addressed in the PIR of IFRS 3. In the second phase the IASB considered the
comments received from a Request for Information – Post-Implementation Review:
IFRS 3 Business Combinations, along with the information gathered through other
consultative activities and a review of relevant academic studies.
In June 2015, the IASB issued its Report and Feedback Statement – Post-implementation
Review of IFRS 3 Business Combinations (RFS), which summarised the PIR process, the
feedback received and conclusions reached by the IASB. The review of academic
literature provided evidence that generally supported the current requirement on
business combinations accounting, particularly in relation to the usefulness of reported
goodwill, other intangible assets and goodwill impairment. However, investors expressed
mixed views on certain aspects of the current accounting, including subsequent
accounting for goodwill, separate recognition of intangible assets, measurement of non-
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controlling interests and subsequent accounting for contingent consideration. Also, many
investors do not support the current requirements on step acquisitions and loss of control,
and are asking for additional information about the subsequent performance of an
acquired business. Many preparers, auditors and regulators identified implementation
challenges in the requirements. In particular, applying the definition of a business,
measuring the fair value of contingent consideration, contingent liabilities and intangible
assets, testing goodwill for impairment on an annual basis and accounting for contingent
payments to selling shareholders who become employees.1
Taking into account all of the evidence collected, the IASB decided to add to its
research agenda the following areas of focus, assessed as being of high significance:
• effectiveness and complexity of testing goodwill for impairment;
• subsequent accounting for goodwill (i.e. impairment-only approach compared
with an amortisation and impairment approach);
• challenges in applying the definition of a business;
• identification and fair value measurement of intangible assets such as customer
relationships and brand names.2
In June 2016, the IASB proposed amendments to IFRS 3 to address the challenges in
applying the definition of a business.3 These are discussed in detail in 3.2.6 below.
The other three areas of high significance listed above are being considered by the IASB
within its Goodwill and Impairment research project. The IASB has tentatively decided to
consider ways of ensuring that impairment of goodwill is recognised in a timely fashion and
improving the application of the impairment testing requirements by making some changes
to the value in use calculation, but not to consider reintroducing amortisation of goodwill
and allowing some identifiable intangible assets acquired in a business combination to be
included within goodwill. In May 2018, the IASB also tentatively decided not to develop a
document that would seek feedback solely about using the unrecognised headroom of a
cash-generating unit (or group of units) as an additional input in the impairment testing of
goodwill. Instead, the IASB decided to pursue including in the value in use calculation the
expected cash flows from future restructuring and future performance enhancements that
management is more likely than not to undertake. The IASB is exploring the form and
content of the consultation document that should be issued as the next step in the research
project. However, at the time of writing, the IASB’s work plan does not indicate when a
Discussion Paper or Exposure Draft is expected to be issued.4
1.1.2
Proposed amendments to IFRS 3
In June 2016, the IASB issued an exposure draft Definition of a Business and Accounting
for Previously Held Interests (Proposed amendments to IFRS 3 and IFRS 11) (‘the ED’).
The proposed amendments aimed among other things to clarify the application of the
definition of a business (see 3.2.6 below).5
The ED proposes that an entity would be required to apply the proposed amendments
to IFRS 3 to any business combination for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after the effective date of
the amendments.6 In October 2017, the Board tentatively decided that the amendments
to IFRS 3 should apply for business combinations for which the acquisition date is on
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or after the beginning of the first annual reporting period beginning or after
1 January 2020, with earlier application permitted.7 The IASB’s work plan indicates that
amendment to IFRS 3 on definition of a business is expected in September 2018.8
2
SCOPE OF IFRS 3
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). [IFRS 3.2].
2.1 Mutual
entities
The acquisition method of accounting applies to combinations involving only mutual
entities (e.g. mutual insurance companies, credit unions and cooperatives) and
combinations in which separate entities are brought together by contract alone (e.g.
dual listed corporations and stapled entity structures). [IFRS 3.BC58]. 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-BC72]. S
imilarly, the Board has concluded that the
acquisition method should be applied for combinations achieved by contract alone.
[IFRS 3.BC79]. Additional guidance is given in IFRS 3 for applying the acquisition method
to such business combinations (see 7.4 and 7.5 below).
2.2
Arrangements out of scope of IFRS 3
The standard does not apply to:
(a) the accounting for the formation of a joint arrangement in the financial statements
of the joint arrangement itself;
(b) the acquisition of an asset or a group of assets that does not constitute a business;
(c) a combination of entities or businesses under common control; or
(d) the acquisition by an investment entity, as defined in IFRS 10 (see Chapter 6
at 10.1), of an investment in subsidiary that is required to be measured at fair value
through profit or loss. [IFRS 3.2, 2A].
2.2.1
Formation of a joint arrangement
The scope exception of IFRS 3 for the formation of a joint arrangement relates only to
the accounting in the financial statements of the joint arrangement, i.e. the joint venture
or joint operation, and not to the accounting for the joint venturer’s or joint operator’s
interest in the joint arrangement. [IFRS 3.BC61B-BC61D].
By contrast, a particular type of arrangement in which the owners of multiple businesses
agree to combine their businesses into a new entity (sometimes referred to as a roll-up
transaction) does not include a contractual agreement requiring unanimous consent to
decisions about the relevant activities. Majority consent on such decisions is not
sufficient to create a joint arrangement. Therefore, such arrangements should be
accounted for by the acquisition method. [IFRS 3.BC60].
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2.2.2
Acquisition of an asset or a group of assets that does not constitute a
business
Although the acquisition of an asset or a group of assets is not within the scope of
IFRS 3, in such cases the acquirer has to identify and recognise the individual
identifiable assets acquired (including intangible assets) and liabilities assumed. The cost
of the group is allocated to the individual identifiable assets and liabilities on the basis
of their relative fair values at the date of purchase. These transactions or events do not