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Classification of contingent consideration
Contingent consideration
Initial recognition at fair value
Other contingent
Equity
consideration
Within the scope of
Not within the scope of
No remeasurement
IFRS 9
IFRS 9
Subsequently measured at
Subsequently measured at
fair value through profit
fair value through profit
or loss in accordance with
or loss
IFRS 9
Contingent consideration will often meet the definition of a financial liability. This
includes those arrangements where the acquirer is obliged to deliver equity securities
because IAS 32 defines a financial liability to include ‘a contract that will or may be
settled in the entity’s own equity instruments’ and is:
• ‘a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments’; or
• ‘a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s own
equity instruments’. [IAS 32.11].
Most contingent consideration arrangements that are to be settled by delivering equity
shares will involve a variable number of shares; e.g. an arrangement obliges the acquirer to
issue between zero and 1 million additional equity shares on a sliding scale based on the
acquiree’s post-combination earnings. This arrangement will be classified as a financial
liability. Only in situations where the arrangement involves issuing, say, zero or 1 million
shares depending on a specified event or target being achieved would the arrangement be
classified as equity. Where the arrangement involves a number of different discrete targets
that are independent of one another, which if met will result in additional equity shares being
issued as further consideration, we believe that the classification of the obligation to provide
such financial instruments in respect of each target is assessed separately in determining
whether equity classification is appropriate. However, if the targets are interdependent, the
classification of the obligation to provide such additional equity shares should be based on
the overall arrangement, and as this is likely to mean that as a variable number of shares may
be delivered, the arrangement would be classified as a financial liability.
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Example 9.14: Share-settled contingent consideration – financial liability or
equity?
Entity P acquires a 100% interest in Entity S on 1 January 2019. As part of the consideration arrangements,
additional consideration will be payable based on Entity S meeting certain profit targets over the 3 years
ended 31 December 2021, as follows:
Profit target
Additional consideration
Year ended 31 December 2019 – €1m+
100,000 shares
Year ended 31 December 2020 – €1.25m+
150,000 shares
Year ended 31 December 2021 – €1.5m+
200,000 shares
Each target is non-cumulative. If the target for a particular year is met, the additional consideration will be
payable, irrespective of whether the targets for the other years are met or not. If a target for a particular year
is not met, no shares will be issued in respect of that year.
In this scenario, as each of the targets are independent of one another, this arrangement can be regarded as
being three distinct contingent consideration arrangements that are assessed separately. As either zero or the
requisite number of shares will be issued if each target is met, the obligation in respect of each arrangement
is classified as equity.
If the targets were dependent on each other, for example, if they were based on an average for the 3 year
period, a specified percentage increase on the previous year’s profits, or the later targets were forfeited if the
earlier targets were not met, the classification would be assessed on the overall arrangement. As this would
mean that a variable number of shares may be delivered, the obligation under such an arrangement would
have to be classified as a financial liability.
For those contingent consideration arrangements where the agreement gives the
acquirer the right to the return of previously transferred consideration if specified
future events occur or conditions are met, IFRS 3 merely requires that such a right is
classified as an asset. [IFRS 3.40].
7.1.3
Subsequent measurement and accounting
The IASB has concluded that subsequent changes in the fair value of a contingent
consideration obligation generally do not affect the fair value of the consideration
transferred to the acquiree. Subsequent changes in value relate to post-combination
events and changes in circumstances of the combined entity and should not affect the
measurement of the consideration transferred or goodwill. [IFRS 3.BC357].
Accordingly, IFRS 3 requires that changes in the fair value of contingent consideration
resulting from events after the acquisition date such as meeting an earnings target,
reaching a specified share price, or meeting a milestone on a research and development
project are accounted for as follows:
• contingent consideration classified as equity is not subsequently remeasured
(consistent with the accounting for equity instruments generally), and its
subsequent settlement is accounted for within equity;
• other contingent consideration that:
• is within the scope of IFRS 9 is remeasured at fair value at each reporting date and
changes in fair value are recognised in profit or loss in accordance with IFRS 9; or
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651
• is not within the scope of IFRS 9 (e.g. the consideration is a non-monetary
asset) is remeasured at fair value at each reporting date and changes in fair
value are recognised in profit or loss. [IFRS 3.58].
If the changes are the result of additional information about the facts and circumstances
that existed at the acquisition date, they are measurement period adjustments and are
to be accounted for as discussed at 12 below. [IFRS 3.58].
7.2
Replacement share-based payment awards
Acquirers often exchange share-based payment awards (i.e. replacement awards) for
awards held by employees of the acquiree. These exchanges frequently occur because
the acquirer wants to avoid the effect of having non-controlling interests in the
acquiree, the acquirer’s shares are often more liquid than the shares of the acquired
business after the acquisition, and/or to motivate former employees of the acquiree
toward the overall performance of the combined, post-acquisition business.
If the acquirer replaces any acquiree awards, the consideration transferred will include
some or all of any replacement share-based payment awards. However, arrangements
that remunerate employees or former owners for future services are excluded from
consideration transferred (see 11.2 below).
Replacement awards are modifications of share-based payment awards in accordance
with IFRS 2. [IFRS 3.B56-
B62]. Discussion of this guidance, including illustrative examples
is dealt with in Chapter 30 at 11.2.
The acquirer is required to include some or all replacement awards (i.e. vested or
unvested share-based payment transactions) as part of the consideration
transferred, irrespective of whether it is obliged to do so or does so voluntarily.
There is only one situation in which none of the market-based measure of the
awards is included in the consideration transferred: if acquiree awards would expire
as a consequence of the business combination and the acquirer replaces those when
it was not obliged to do so. In that case, all of the market-based measure of the
awards is recognised as remuneration cost in the post-combination financial
statements. [IFRS 3.B56].
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 non-
controlling interest in the acquiree being recognised and measured at their market-
based measure as discussed at 8.4 below. [IFRS 3.B62A, B62B].
7.3 Acquisition-related
costs
IFRS 3 requires acquisition-related costs to be accounted for as expenses in the
periods in which the costs are incurred and the related services are received with
the exception of the costs of registering and issuing debt and equity securities that
are recognised in accordance with IAS 32 and IFRS 9, i.e. as a reduction of the
proceeds of the debt or equity securities issued. [IFRS 3.53]. In addition, IFRS 3
requires that a transaction that reimburses the acquiree or its former owners for
paying the acquirer’s acquisition-related costs is not to be included in applying the
acquisition method (see 11.3 below). This is in order to mitigate concerns about
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potential abuse, e.g. a buyer might ask a seller to make payments to third parties on
its behalf, but the consideration to be paid for the business is sufficient to reimburse
the seller for making such payments. [IFRS 3.51-53, BC370].
An acquirer’s costs incurred in connection with a business combination include:
• direct costs of the transaction, such as costs for the services of lawyers, investment
bankers, accountants, and other third parties and issuance costs of debt or equity
instruments used to effect the business combination; and
• indirect costs of the transaction, such as recurring internal costs, e.g. the cost of
maintaining an acquisition department.
Acquisition-related costs, whether for services performed by external parties or
internal staff of the acquirer, are not part of the fair value exchange between the buyer
and seller for the acquired business. Accordingly, they are not part of the consideration
transferred for the acquiree. Rather, they are separate transactions in which the buyer
makes payments in exchange for the services received, to be accounted for separately.
7.4
Business combinations achieved without the transfer of
consideration
An acquirer sometimes obtains control of an acquiree without transferring
consideration. The standard emphasises that the acquisition method applies to a
business combination achieved without the transfer of consideration. [IFRS 3.43]. IFRS 3
indicates that such circumstances include:
(a) the acquiree repurchases a sufficient number of its own shares for an existing
investor (the acquirer) to obtain control;
(b) minority veto rights lapse that previously kept the acquirer from controlling an
acquiree in which the acquirer held the majority voting rights; and
(c) the acquirer and the acquiree agree to combine their businesses by contract alone.
In that case, the acquirer transfers no consideration in exchange for control of an
acquiree and holds no equity interests in the acquiree, either on the acquisition
date or previously. Examples of business combinations achieved by contract alone
include bringing two businesses together in a stapling arrangement or forming a
dual listed corporation. [IFRS 3.43].
In computing the amount of goodwill in a business combination, IFRS 3 normally
requires the acquirer to aggregate:
• the consideration transferred;
• the amount of any non-controlling interest in the acquiree; and
• the acquisition-date fair value of the acquirer’s previously held equity interest in
the acquiree. [IFRS 3.32].
However, where the consideration transferred is nil, IFRS 3 requires the entity to use the
acquisition-date fair value of the acquirer’s interest in the acquiree instead. [IFRS 3.33, B46].
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653
In the first two circumstances described in (a) and (b) above, the acquirer has a
previously-held equity interest in the acquiree. To include also the acquisition-date fair
value of the previously-held interest would result in double-counting the value of the
acquirer’s interest in the acquiree. The acquisition-date fair value of the acquirer’s
interest in the acquiree should only be included once in the computation of goodwill.
These two circumstances would also be examples of business combinations achieved
in stages (see 9 below).
The fair value of the acquirer’s interest in the acquiree is to be measured in accordance
with IFRS 13.
7.4.1
Business combinations by contract alone
In a business combination achieved by contract alone ((c) above), IFRS 3 requires
that the acquirer attributes to the owners of the acquiree the amount of the
acquiree’s net assets recognised under the standard (see 2.1 above). In other words,
the equity interests in the acquiree held by parties other than the acquirer are a
non-controlling interest in the acquirer’s consolidated financial statements, even if
it results in all of the equity interests in the acquiree being attributed to the non-
controlling interest. [IFRS 3.44].
This might suggest that no goodwill is to be recognised in a business combination
achieved by contract alone as the second item in part (a) will be equal to part (b) of
the goodwill computation set out at 6 above. However, we believe that this
requirement to attribute the equity interests in the acquiree to the non-controlling
interest is emphasising the presentation within equity in the consolidated financial
statements. Thus, where the option of measuring non-controlling interests in an
acquiree at its acquisition-date fair value is chosen, goodwill would be recognised.
If the option of measuring the non-controlling interest at its proportionate share of
the value of net identifiable assets acquired is chosen, no goodwill would be
recognised (except to the extent any is recognised as a result of there being other
equity instruments that are required to be measured at their acquisition-date fair
value or other measurement basis required by IFRSs). These options are discussed
at 8 below.
7.5 Combinations
involving mutual entities
Combinations involving mutual entities are within the scope of IFRS 3. A mutual entity
is defined by IFRS 3 as ‘an entity, other than an investor-owned entity, that provides
dividends, lower co
sts or other economic benefits directly to its owners, members or
participants. For example, a mutual insurance company, a credit union and a co-
operative entity are all mutual entities.’ [IFRS 3 Appendix A].
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The standard notes that the fair value of the equity or member interests in the acquiree
(or the fair value of the acquiree) may be more reliably measurable than the fair value
of the member interests transferred by the acquirer. In that situation, the acquirer
should determine the amount of goodwill by using the acquisition-date fair value of the
acquiree’s equity interests as the equivalent to the consideration transferred in the
goodwill computation set out at 7.4 above, instead of the acquirer’s equity interests
transferred as consideration. [IFRS 3.B47].
IFRS 3 clarifies that the acquirer in a combination of mutual entities recognises the
acquiree’s net assets as a direct addition to capital or equity, not as an addition to
retained earnings, which is consistent with the way other types of entity apply the
acquisition method. [IFRS 3.B47].
IFRS 3 recognises that mutual entities, although similar in many ways to other
businesses, have distinct characteristics that arise primarily because their members
are both customers and owners. Members of mutual entities generally expect to
receive benefits for their membership, often in the form of reduced fees charged for
goods and services or patronage dividends. Patronage dividends are distributions paid
to members (or investors) in mutual entities and the portion allocated to each member
is often based on the amount of business the member did with the mutual entity during
the year. [IFRS 3.B48]. The fair value of a mutual entity should include the assumptions
that market participants would make about future member benefits. If, for example, a
present value technique is used to measure the fair value of the mutual entity, the
cash flow inputs should be based on the expected cash flows of the mutual entity,
which are likely to reflect reductions for member benefits, such as reduced fees
charged for goods and services. [IFRS 3.B49].
8
RECOGNISING AND MEASURING NON-CONTROLLING
INTERESTS
IFRS 3 requires any non-controlling interest in an acquiree to be recognised, [IFRS 3.10],
but provides a choice of two measurement methods. This choice only applies to those
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 129
