International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  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. 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 acquisition date conditions could

  result in additional assets or liabilities being recognised (and measured at their

  acquisition-date fair value) that differ from those recognised by the acquiree.

  Embedded derivatives are discussed in Chapter 42.

  5.5

  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, discussed below.

  5.5.1 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 in accordance

  with IAS 17 is not revisited (see 5.4 above). If the acquiree is the lessee to an operating

  lease and the terms of the lease are favourable (asset) or unfavourable (liability) relative

  to market terms and prices, the acquirer is required to recognise either an intangible

  asset or a liability. [IFRS 3.B28-B29].

  An operating lease at market terms may be associated with an identifiable intangible

  asset if market participants are willing to pay a price for the lease. 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 (see 5.5.2 below). [IFRS 3.B30].

  For entities applying IFRS 16, as a result of consequential amendments to IFRS 3, the

  above guidance in paragraphs B28-B29 of IFRS 3 has been removed and a new

  exception in paragraphs 28A-28B has been introduced to the recognition and

  measurement principles of IFRS 3 for leases in which the acquiree is the lessee

  (see 5.6.8 below). IFRS 16 and its consequential amendments are mandatory for annual

  periods beginning on or after 1 January 2019, although early adoption is permitted,

  provided IFRS 15 has been applied, or is applied at the same date as IFRS 16 (for further

  guidance on IFRS 16, see Chapter 24).

  If the acquiree is a lessor in an operating lease, i.e. it has an item of property, plant

  and equipment that is leased to another party, there is no requirement for the

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  acquirer to recognise intangible assets or liabilities 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.B42]. The IASB sought to avoid any

  inconsistency with the fair value model in IAS 40, which requires the fair value of

  investment property to take into account rental income from current leases.

  [IFRS 3.BC146].

  The requirement to reflect the off-market terms in the fair value of the asset subject

  to an operating lease in which the acquiree is the lessor applies to any type of asset,

  to the extent market participants would take them into consideration when pricing

  the asset, and is not restricted to investment properties accounted for under the fair

  value model in IAS 40. 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].

  For entities applying IFRS 16, this guidance in paragraph B42 of IFRS 3 for leases where

  the acquiree is a lessor effectively remains unchanged, since for lessors the new

  standard introduces little change to the existing accounting in IAS 17.

  5.5.2 Intangible

  assets

  Identifiable intangible assets may have to be recognised by an acquirer although they

  have not previously been recognised by the acquiree. [IFRS 3.B31]. IFRS 3 and IAS 38 give

  guidance on the recognition of intangible assets acquired in a business combination.

  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 requires an

  intangible asset to be ‘identifiable’ to distinguish it from goodwill. [IAS 38.11]. Both

  standards regard an asset as identifiable if it:

  (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 the entity

  intends to do so (the ‘separability’ criterion); 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 (the

  ‘contractual-legal’ criterion). [IFRS 3 Appendix A, IAS 38.12].

  IFRS 3 provides the following application guidance.

  • Separability

  An intangible asset is separable even if the acquirer has no intention of selling,

  licensing or otherwise exchanging it. An acquired intangible asset is separable 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 separable. Even if an acquiree believes its customer

  lists have characteristics that distinguish them from others, this would not generally

  prevent the acquired customer list being considered separable. However, if

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  combinations

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  confidentiality terms or other agreements prohibit an entity from selling, leasing or

  otherwise exchanging information about its customers, then the customer list would

  not be separable. [IFRS 3.B33].

  An intangible asset may be separable from goodwill in combination with a related

  contract, identifiable asset or liability. Two examples are given by IFRS 3:

  (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 m
anufacture the trademarked product. When it sells

  the trademark, the owner must also 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. [IFRS 3.B34].

  • Contractual-legal

  An intangible asset that meets the contractual-legal criterion is identifiable, and hence

  accounted for separately from goodwill, even if the asset is not transferable or separable

  from the acquiree or from other rights and obligations. For example:

  (a) an acquiree leases a manufacturing facility under an operating lease; its terms are

  favourable relative to market. The lease terms explicitly prohibit transfer, whether

  by sale or sublease. The amount by which the lease terms are favourable compared

  to market transactions is an intangible asset that meets the contractual-legal

  criterion for recognition separately, even though the lease contract cannot be sold

  or transferred by the acquirer;

  (b) an acquiree owns and operates a nuclear power plant. The licence to operate the

  power plant is a separate intangible asset, even if the acquirer cannot sell or

  transfer it separately from the power plant itself. IFRS 3 goes on to say that an

  acquirer may recognise the operating licence and the power plant as a single asset

  for financial reporting purposes if their useful lives are similar;

  (c) an acquiree owns a technology patent that it has licensed to others for their

  exclusive use outside the domestic market, for which it has received a specified

  percentage of future foreign revenue. Both the technology patent and the related

  licence agreement meet the contractual-legal criterion for separate recognition

  even if it would not be practical to sell or exchange them separately from one

  another. [IFRS 3.B32].

  Accordingly, under IFRS 3, intangible assets are recognised separately from goodwill if

  they are identifiable, i.e. they either are separable or arise from contractual or other

  legal rights. [IFRS 3.B31]. They must be assigned an acquisition-date fair value.

  For entities applying IFRS 16, as a result of consequential amendments, the above

  example (a) has been removed from paragraph B32 of IFRS 3. This is because IFRS 16

  requires the off-market nature of the lease to be captured in the right-of-use asset,

  rather than recognised separately as an intangible asset or liability (see 5.6.8 below).

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  IFRS 16 and its consequential amendments are mandatory for annual periods beginning

  on or after 1 January 2019, although early adoption is permitted, provided IFRS 15 has

  been applied, or is applied at the same date as IFRS 16 (for further guidance on IFRS 16,

  see Chapter 24).

  5.5.2.A

  Examples of identifiable intangible assets

  We have considered above a number of different types of identifiable intangible assets

  that are recognised separately from goodwill, such as customer and subscriber lists,

  depositor relationships, registered trademarks, unpatented technical expertise,

  favourable operating leases under IAS 17, licences and technology patents.

  IAS 38 also explicitly requires an acquirer to recognise as a separate intangible asset

  in-process research and development of the acquiree, in accordance with IFRS 3, 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. [IFRS 3.BC149-BC156]. This is discussed

  at 5.5.2.D below.

  IFRS 3’s Illustrative Examples list items acquired in a business combination that are

  identifiable intangible assets, noting that the examples are not intended to be all-

  inclusive. [IFRS 3.IE16-IE44]. The assets listed are designated as being ‘contractual’, or ‘non-

  contractual’, in which case they do not arise from contractual or other legal rights but

  are separable. It emphasises that assets do not have to be separable to meet the

  contractual-legal criterion.

  The table below summarises the items included in the Illustrative Examples. See the

  Illustrative Examples for further explanations.

  Intangible assets arising from contractual or

  Other intangible assets

  other legal rights (regardless of being separable)

  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 lists

  – Customer contracts and the related customer relationships

  – Non-contractual 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

  Business

  combinations

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  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

  Technology-based

  – Patented

  technology

  – Unpatented

  technology

  – Computer software and mask works

  – Databases, including title plants

  – Trade secrets, such as secret formulas, processes or recipes

  Some items have been designated as being ‘contractual’ due to legal protection, for

  example, trademarks and trade secrets. The guidance explains that even without that

  legal protection, they would still normally meet the separability criterion.

  Customer relationships established through contracts are deemed identifiable as they

  meet the contractual-legal criterion. However, there need not be a current contract or

  any outstanding orders at the date of acquisition for customer relationships to meet the

  identifiability criteria. Customer relationships can also be recognised as intangible

  assets if they arise outside a contract but in this case they must be separable to be

  recognised. This is discussed further in 5.5.2.B below.

  IFRS 3’s Illustrative Examples clarify that for contracts with terms that are favourable

  or unfavourable relative to the market terms, the acquirer recognises either a liability

  assumed or an asset acquired in a
business combination. For example, if the terms of a

  customer contract are unfavourable in comparison to market terms, the acquirer should

  recognise a corresponding liability. [IFRS 3.IE34]. Conversely, for supply contracts

  acquired in a business combination that are beneficial from the perspective of the

  acquiree because the pricing of those contracts is favourable in comparison to market

  terms, the acquirer recognises a contract-based intangible asset.

  5.5.2.B Customer

  relationship intangible assets

  Further guidance on customer relationships acquired in a business combination is

  provided in IFRS 3’s Illustrative Examples, which form the basis of the example below.

  These demonstrate how an entity should interpret the contractual-legal and

  separability criteria in the context of acquired customer relationships. [IFRS 3.IE30].

  Example 9.10: Customer relationship intangible assets

  (i) Supply

  agreement

  Acquirer Company (AC) acquires Target Company (TC) in a business combination on 31 December 2019.

  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.

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  The agreement, whether cancellable or not, meets the contractual-legal criterion. Because TC establishes its

  relationship with Customer through a contract, both the agreement itself and also TC’s customer relationship

  with Customer meet the contractual-legal criterion.

  (ii)

  Sporting goods and electronics

  AC acquires TC in a business combination on 31 December 2019. TC manufactures goods in two distinct

  lines of business: sporting goods and electronics. Customer purchases both sporting goods and electronics