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not required to be measured at fair value (e.g. uncertain tax positions).
[IFRS 3.BC302-BC303]. Accordingly, under IFRS 3 the acquirer measures an indemnification
asset on the same basis as the indemnified item, subject to the need for a valuation
allowance for uncollectible amounts.
• If the indemnification relates to an asset or a liability that is measured at fair value,
the acquirer will recognise the indemnification asset at its fair value. The effects
of uncertainty about future cash flows (i.e. the collectability of the asset) are
included in the fair value measure and a separate valuation allowance is not
necessary (see 5.5.5 above). [IFRS 3.27].
• The indemnification may relate to an asset or liability that is not measured at fair
value. A common example is an indemnification pertaining to a tax liability that is
measured in accordance with IAS 12, rather than at its fair value (see 5.6.2 above).
If the indemnified item is recognised as a liability but is measured on a basis other
than fair value, the indemnification asset is recognised and measured using
consistent assumptions, subject to management’s assessment of collectability and
any contractual limitations on the indemnified amount. [IFRS 3.27-28].
• If the indemnified item is not recognised as a liability at the date of acquisition, the
indemnification asset is not recognised. An indemnification could relate to a contingent
liability that is not recognised at the acquisition date because its fair value is not reliably
measurable, [IFRS 3.28], or it is only a possible obligation at that date (see 5.6.1 above).
Thereafter, the indemnification asset continues to be measured using the same
assumptions as the indemnified liability or 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].
5.6.5 Reacquired
rights
If the assets of the acquiree include a right previously granted to it allowing use of the
acquirer’s assets, IFRS 3 requires it to be recognised as an identifiable intangible asset.
Reacquired rights include rights to use the acquirer’s trade name under a franchise
agreement or the acquirer’s technology under a technology licensing agreement. [IFRS 3.B35].
Reacquired rights are valued on the basis of the remaining contractual term of the
related contract, regardless of whether market participants would consider potential
contractual renewals when measuring their fair value. [IFRS 3.29].
If the terms of the contract giving rise to the reacquired right are favourable or unfavourable
relative to current market transactions for the same or similar items, this is accounted for 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 11.1 below. An example of accounting for the settlement gain or loss on the
acquisition of a reacquired rights is illustrated in Example 9.26 below.
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]. As the
reacquired right is no longer a contract with a third party it might be thought that the
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acquirer could assume indefinite renewals of its contractual term, effectively making
the reacquired right an intangible asset with an indefinite life. However, the IASB
considers that a right reacquired from an acquiree has, in substance, a finite life.
[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, BC310].
5.6.6
Assets held for sale
Non-current assets or disposal groups classified as held for sale at the acquisition date
in accordance with IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations – are measured at fair value less costs to sell (see Chapter 4 at 2.2). [IFRS 3.31].
This avoids the need to recognise a loss for the selling costs immediately after a business
combination (a so-called Day 2 loss).
5.6.7
Share-based payment transactions
Liabilities or equity instruments related to the acquiree’s share-based payments are
measured in accordance with IFRS 2 (referred to as the ‘market-based measure’), rather
than at fair value, as are replacement schemes where the acquirer replaces the
acquiree’s share-based payments with its own. [IFRS 3.30, IFRS 13.6]. The measurement
rules of IFRS 2 are not based on the fair value of the award at a particular date;
measuring share-based payment awards at their acquisition-date fair values would
cause difficulties with the subsequent accounting in accordance with IFRS 2.
[IFRS 3.BC311].
Additional guidance given in IFRS 3 for accounting for the replacement of share-based
payment awards (i.e. vested or unvested share-based payment transactions) in a
business combination is discussed at 7.2 and 11.2 below. Any equity-settled share-based
payment transactions of the acquiree that the acquirer does not exchange for its own
share-based payment transactions will result in a non-controlling interest in the
acquiree being recognised, as discussed at 8.4 below.
5.6.8
Leases in which the acquiree is the lessee (IFRS 16)
As a result of issue of IFRS 16, consequential amendments have been made to the
recognition and measurement principles of IFRS 3. 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).
Paragraph 28B of IFRS 3 added as a result of consequential amendments of IFRS 16
requires the acquirer to measure the acquired lease liability as if the lease contract were
a new lease at the acquisition date. That is, the acquirer applies IFRS 16’s initial
measurement provisions, using the present value of the remaining lease payments at the
acquisition date. The acquirer follows the requirements for determining the lease term,
lease payments and discount rate as discussed in Chapter 24 at 4.
The added paragraph 28B in IFRS 3 also requires the acquirer to measure the right-of-
use asset at an amount equal to the recognised liability, adjusted to reflect the
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favourable or unfavourable terms of the lease, relative to market terms. Because the
off-market nature of the lease is captured in the right-of-use asset, the acquirer does
not separately recognise an intangible asset or liability for favourable or unfavourable
lease terms relative to market terms. Accounting for th
e favourable or unfavourable
terms of the acquiree’s operating lease under IAS 17 is discussed at 5.5.1 above.
In accordance with paragraph 28A of IFRS 3, the acquirer is not required to recognise
right-of-use assets and lease liabilities for leases with lease terms which end
within 12 months of the acquisition date and leases for low-value assets. As indicated in
paragraph BC298 of the Basis for Conclusions of IFRS 16, the IASB considered whether
to require an acquirer to recognise assets and liabilities relating to off-market terms for
short-term leases and leases of low-value assets. However, the Board observed that the
effect of off-market terms would rarely be material for short-term leases and leases of
low-value assets and so decided not to require this.
5.6.9
Insurance contracts within the scope of IFRS 17
IFRS 17 replaces IFRS 4 and is effective for reporting periods beginning on or after
1 January 2021, with early application permitted. IFRS 17 introduced a new exception
to measurement principles in IFRS 3. Under IFRS 3, as amended by IFRS 17, the
acquirer in a business combination shall measure a group of contracts within the scope
of IFRS 17 as a liability or asset in accordance with paragraphs 39 and B93-B95 of
IFRS 17, at the acquisition date.38
6
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].
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].
Goodwill at the acquisition date is computed as the excess of (a) over (b) below:
(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. [IFRS 3.32].
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Having concluded that goodwill should be measured as a residual, the IASB, in deliberating
IFRS 3, considered the following two components to comprise ‘core goodwill’:
• The fair value of the going concern element of the acquiree’s existing business. This
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. The 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 (by potential competitors, whether through legal restrictions or costs of entry);
• The fair value of the expected synergies and other benefits from combining the
acquirer’s and acquiree’s net assets and businesses. These are unique to each
combination, and different combinations would produce different synergies and,
hence, different values. [IFRS 3.BC313, BC316].
However, in practice the amount of goodwill recognised in a business combination will
probably not be limited to ‘core goodwill’. Items that do not qualify for separate
recognition (see 5.5.4 above) and items that are not measured at fair value, e.g. deferred
tax assets and liabilities, will also affect the amount of goodwill recognised.
Even though goodwill is measured as a residual, after identifying and measuring all the
items in (a) and (b), the acquirer should have an understanding of the factors that make
up the goodwill recognised. IFRS 3 requires the disclosure of qualitative description of
those factors (see 16.1.1 below).
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 10 below.
The measurement of (b) has been discussed at 5 above. The items included within (a)
are discussed at 7, 8 and 9 below.
6.1
Subsequent accounting for goodwill
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; 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 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 IAS 36. The requirements of IAS 36 relating
specifically to the impairment of goodwill are dealt with in Chapter 20 at 8.
7 CONSIDERATION
TRANSFERRED
The consideration transferred in a business combination 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
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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 measured in accordance with IFRS 2 rather
than at fair value. These are discussed further at 7.1 and 7.2 below. [IFRS 3.37].
The consideration transferred could include assets or liabilities whose carrying amounts
differ from their fair values. These are remeasured to fair value at the acquisition date
and any resulting gains or losses are recognised in profit or loss. If the transferred assets
or liabilities remain within the combined entity after the acquisition date because they
were transferred to the acquiree rather than to its former owners, the acquirer retains
control of them. They are retained at their existing carrying amounts and no gain or loss
is recognised. [IFRS 3.38].
Where the assets given as consideration or the liabilities incurred by the acquirer are
financial assets or financial liabilities as defined by IAS 32 – Financial Instruments:
Presentation (see Chapter 43), the guidance in IFRS 13 on determining the fair values of
such financial instruments should be followed (see Chapter 14 at 2).
These assets and liabilities might be denominated in a foreign currency, in which case the
entity may have hedged the foreign exchange risk. IFRS 9 (or IAS 39, if an entity when it
first applied IFRS 9 chose as its accounting policy to continue to apply the hedge
requirements in IAS 39 instead of the hedge requirements in IFRS 9) allows an entity to
apply hedge accounting when hedging the movements in foreign currency exchange rates
for a firm commitment to acquire a business in a business combination. [IFRS 9.B6.3.1,
IAS 39.AG98]). In January 2011, the Interpretations Committee considered the treatment of
gains or losses arising from hedging this risk under IAS 39 and in particular whether they
would result in an adjustment to the amount that is recognised for goodwill. When a basis
adjustment is made to a hedged item, it is after other applicable IFRSs have been applied.
Accordingly, the Interpretations Committee noted that ‘such a basis adjustment is made
to goodwill (or the gain from a bargain purchase) after the application of the guidance in
IFRS 3’.39 That conclusion applies under IFRS 9 as well. Where equity interests are issued
by the acquirer as consideration, the guidance in IFRS 13 on determining the fair value of
an entity’s own equity should be followed (see Chapter 14 at 11). [IFRS 13.34]. IFRS 3 clarifies
that they are to be measured at their fair 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.BC337-342].
Although 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.
While an acquirer and a target entity both consider the fair value of the target on the
agreement date in negotiating the amount of consideration to be paid, the distorting
effects are mitigated if acquirers and targets generally consider their best estimates of
the fair values on the acquisition dates. In addition, measuring the equity securities on
the acquisition date avoids the complexities of dealing with situations in which the