52
202
Less: Amount of the identifiable net assets acquired (€250m – €50m)
200
Goodwill on acquisition of 80% interest in Entity B
2
So, although Entity A in the above example might have made a ‘bargain purchase’, the
requirements of IFRS 3 lead to no gain being recognised.
11
ASSESSING WHAT IS PART OF THE EXCHANGE FOR THE
ACQUIREE
To be included in the accounting for the business combination, the identifiable assets
acquired and liabilities assumed must be part of the exchange for the acquiree, rather
than a result of separate transactions. [IFRS 3.12].
IFRS 3 recognises that the acquirer and the acquiree may have a pre-existing
relationship or other arrangement before the negotiations for the business combination,
or they may enter into an arrangement during the negotiations that is separate from the
business combination. In either situation, the acquirer is required to identify any
amounts that are separate from the business combination and thus are not part of the
exchange for the acquiree. [IFRS 3.51]. This requires the acquirer to evaluate the
substance of transactions between the parties.
There are three types of transactions that IFRS 3 regards as separate transactions that
should not be considered part of the exchange for the acquiree:
• a transaction that effectively settles pre-existing relationships between the
acquirer and acquiree, e.g. a lawsuit, supply contract, franchising or licensing
arrangement (see 11.1 below);
• a transaction that remunerates employees or former owners of the acquiree for
future services (see 11.2 below); or
• a transaction that reimburses the acquiree or its former owners for paying the
acquirer’s acquisition-related costs (see 11.3 below). [IFRS 3.52].
The acquirer should consider the following factors to determine whether a transaction
is part of the exchange for the acquiree or whether it is separate. The standard stresses
that these factors are neither mutually exclusive nor individually conclusive. [IFRS 3.B50].
• The reasons for the transaction
Understanding the reasons why the parties to the combination, the acquirer and
the acquiree and their owners, directors and managers – and their agents –
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entered into a particular transaction or arrangement may provide insight into
whether it is part of the consideration transferred and the assets acquired or
liabilities assumed. If a transaction is arranged primarily for the benefit of the
acquirer or the combined entity rather than for the benefit of the acquiree or its
former owners before the combination, that portion of the transaction price paid
(and any related assets or liabilities) is less likely to be part of the exchange for the
acquiree. The acquirer would account for that portion separately from the
business combination.
• Who initiated the transaction
A transaction or other event that is initiated by the acquirer may be entered into
for the purpose of providing future economic benefits to the acquirer or combined
entity with little or no benefit received by the acquiree or its former owners before
the combination. A transaction or arrangement initiated by the acquiree or its
former owners is less likely to be for the benefit of the acquirer or the combined
entity and more likely to be part of the business combination transaction.
• The timing of the transaction
A transaction between the acquirer and the acquiree during the negotiations of the
terms of a business combination may have been entered into in contemplation of
the business combination to provide future economic benefits to the acquirer or
the combined entity. If so, the acquiree or its former owners before the business
combination are likely to receive little or no benefit from the transaction except
for benefits they receive as part of the combined entity.
One particular area that may be negotiated between acquirer and acquiree could be a
restructuring plan relating to the activities of the acquiree. This is discussed at 11.4 below.
11.1 Effective settlement of pre-existing relationships
The acquirer and acquiree may have a relationship that existed before they
contemplated the business combination, referred to as a ‘pre-existing relationship’. This
may be contractual, e.g. vendor and customer or licensor and licensee, or non-
contractual, e.g. plaintiff and defendant. [IFRS 3.B51].
The purpose of this guidance is to ensure that a transaction that in effect settles a pre-
existing relationship between the acquirer and the acquiree is excluded from the
accounting for the business combination. If a potential acquiree has an asset, a
receivable for an unresolved claim against the potential acquirer, the acquiree’s owners
could agree to settle that claim as part of an agreement to sell the acquiree to the
acquirer. If the acquirer makes a lump sum payment to the seller-owner for the
business, part of that payment is to settle the claim. In effect, the acquiree relinquished
its claim against the acquirer by transferring its receivable as a dividend to the acquiree’s
owner. Thus, at the acquisition date the acquiree has no receivable to be acquired as
part of the combination, and the acquirer should account separately for its settlement
payment. [IFRS 3.BC122].
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The acquirer is to recognise a gain or a loss on effective settlement of a pre-existing
relationship, measured on the following bases:
• for a pre-existing non-contractual relationship, such as a lawsuit, the gain or loss
is measured at its fair value;
• for a pre-existing contractual relationship, such as a supply contract, the gain or
loss is measured as the lesser of:
(a) 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 terms. (A contract that is unfavourable in
terms of current market terms is not necessarily an onerous contract in which
the unavoidable costs of meeting the obligations under the contract exceed
the economic benefits expected to be received under it); and
(b) the amount of any settlement provisions in the contract available to the
counterparty to whom the contract is unfavourable.
If (b) is less than (a), the difference is included as part of the business combination
accounting.
The amount of gain or loss will depend in part on whether the acquirer had previously
recognised a related asset or liability, and the reported gain or loss therefore may differ
from the amount calculated by applying the above requirements. [IFRS 3.B52].
If there is an ‘at market’ component to the settlement (i.e. part of the payment reflects
the price any market participant would pay to settle the relationship), this is to be
accounted for as part of goodwill and may not be treated as a separate intangible asset.43
The requirements for non-contractual relationships are illustrated in the following example.
Example 9.23: Settlement of pre-existing non-con
tractual relationship
On 1 January 2019 Entity A acquires a 100% interest in Entity B for €250m in cash.
At the beginning of 2017 a dispute arose over the interpretation of a contract for the development and
implementation by Entity A of an e-business platform for Entity C, which at the end of 2016 was merged
with Entity B. The contract, signed in 2012 and for which work was completed in December 2015, provided
for payment of part of the contract price by allocating to Entity A 5% of the profit from the platform for five
years from the system’s installation, i.e. from January 2016 to January 2021. At the end of 2016 the merged
Entity ceased to use the platform developed by Entity A as Entity B had its own platform. Entity A, however,
believes that 5% of certain profits should be payable by Entity B for the period January 2017 to January 2021
regardless of the system used by Entity B. Several legal hearings took place in 2017 and 2018. However, at
the date of acquisition the dispute is still unresolved. Entity B recognised a provision amounting to €12m
reflecting the best estimate of the expenditure required to settle the present obligation at 1 January 2019. No
assets are recognised by Entity A with respect to the dispute prior to the date of acquisition.
The acquisition by Entity A of Entity B includes the effective settlement of the dispute between Entity A and
Entity B which is accounted for as a separate transaction from the business combination. On 1 January 2019
Entity A recognises a gain on effective settlement of the dispute at its fair value, which is not necessarily
equal to the amount of the provision reported by Entity B. The amount of consideration transferred for the
acquisition of Entity B is increased accordingly. Assuming the fair value of the dispute at 1 January 2019 is
assessed to be €15m, Entity A will recognise a gain on effective settlement of €15m, and the consideration
transferred for the purposes of determining goodwill will total €265m (€250m + €15m).
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The requirements for contractual relationships are illustrated in the following example
relating to a supply contract. [IFRS 3.IE54-IE57].
Example 9.24: Settlement of pre-existing contractual relationship – Supply
contract
Entity A purchases electronic components from Entity B under a five-year supply contract at fixed rates.
Currently, the fixed rates are higher than the rates at which Entity A could purchase similar electronic
components from another supplier. The supply contract allows Entity A to terminate the contract before the
end of the initial five-year term but only by paying a €6m penalty. With three years remaining under the
supply contract, Entity A pays €50m to acquire Entity B, which is the fair value of Entity B based on what
other market participants would be willing to pay.
Included in the total fair value of Entity B is €8m related to the fair value of the supply contract with Entity A.
The €8m represents a €3m component that is ‘at market’ because the pricing is comparable to pricing for
current market transactions for the same or similar items (selling effort, customer relationships and so on)
and a €5 million component for pricing that is unfavourable to Entity A because it exceeds the price of current
market transactions for similar items. Entity B has no other identifiable assets or liabilities related to the
supply contract, and Entity A has not recognised any assets or liabilities related to the supply contract before
the business combination.
In this example, Entity A calculates a loss of €5m (the lesser of the €6m stated settlement amount and the
amount by which the contract is unfavourable to the acquirer) separately from the business combination. The
€3m ‘at-market’ component of the contract is part of goodwill.
Whether Entity A had recognised previously an amount in its financial statements
related to a pre-existing relationship will affect the amount recognised as a gain or loss
for the effective settlement of the relationship. Suppose that Entity A had recognised a
€6m liability for the supply contract before the business combination. In that situation,
Entity A recognises a €1m settlement gain on the contract in profit or loss at the
acquisition date (the €5m measured loss on the contract less the €6m loss previously
recognised). In other words, Entity A has in effect settled a recognised liability of €6m
for €5m, resulting in a gain of €1m. [IFRS 3.IE57].
Another example of settlement of a pre-existing contractual relationship, which should
be recognised separately from the business combination, is where the acquirer has a
loan payable to or receivable from the acquiree.
Example 9.25: Settlement of pre-existing contractual relationship – Loan
agreement
Entity A acquires a 100% interest in Entity B for €500m in cash.
Before the acquisition, Entity B granted a fixed interest rate loan to Entity A and as at the date of acquisition
Entity A has recognised a financial liability in respect of the loan amounting to €50m. Fair value of that
financial liability is assessed to be €45m. The fair value of the net identifiable assets and liabilities of Entity B
as at the date of acquisition is €460m, including €45m in respect of the fixed rate loan to Entity A.
The amount of consideration transferred for the acquisition of Entity B is decreased by the fair value of the
financial liability and the financial liability is derecognised. As such, the consideration transferred for
purposes of determining goodwill is €455m (€500m – €45m). The amount by which the loan agreement is
favourable to the acquirer is recognised as a gain in the consolidated profit or loss. The net identifiable assets
and liabilities of Entity B exclude the receivable due from Entity A.
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Entity A accounts for the acquisition of Entity B and settlement of the financial liability as follows:
€m €m
Net identifiable assets and liabilities acquired (€460m – €45m)
415
Loan due to Entity B
50
Goodwill (€455m – €415m)
40
Gain on derecognition of loan due to Entity B (€50m – €45m)
5
Cash – consideration for business combination (€500m – €45m)
455
Cash – effective settlement of loan due to Entity B
45
A pre-existing relationship may be a contract that the acquirer recognises as a
reacquired right. As indicated at 5.6.5 above, if the contract includes terms that
are favourable or unfavourable when compared with pricing for current market
transactions for the same or similar items, the acquirer recognises, separately from
the business combination, a gain or loss for the effective settlement of the
contract, measured in accordance with the requirements described above.
[IFRS 3.B53].
Example 9.26: Settlement of pre-existing contractual relationship – Reacquired
technology licensing agreement
Entity A acquires a 100% interest in Entity B for €350m in cash.
Before the acquisition, Entity A sold to Entity B an exclusive right to use Entity A’s technology in a specified
territory. Entity B also pays a revenue-based royalty on a monthly basis. The terms of the technology
licensing
agreement state that if Entity A terminates the arrangement without cause, Entity A would be
required to pay a penalty of €30m. Neither Entity A nor Entity B has recognised any assets or liabilities
related to the licence agreement.
The fair value of the licence agreement is assessed to be €120m, which includes a value of €20m for
the future royalties which are below current market rates. Therefore, the licence agreement is
unfavourable to Entity A and favourable to Entity B. The fair value of the net identifiable assets and
liabilities of Entity B as at the date of the business combination is €320m, including the fair value of
the licence agreement of €120m.
The reacquired licence right is recognised at €100m, being the licence’s fair value at current market rates
(€120m – €20m). Entity A recognises a loss on settlement of the agreement at the lower of:
• €20m, which is the amount by which the royalty is unfavourable to Entity A compared to market terms;
• €30m, which is the amount that Entity A would have to pay to terminate the right at the date of acquisition.
A loss is therefore recognised of €20m. The amount of consideration transferred for the acquisition of
Entity B is decreased accordingly to €330m (€350m – €20m).
Entity A accounts for the acquisition of Entity B and the reacquired technology licensing agreement as follows:
€m €m
Net identifiable assets and liabilities acquired (€320m – €20m)
300
Goodwill (€330m – €300m)
30
Loss on settlement of technology licensing agreement
20
Cash – consideration for business combination (€350m – €20m)
330
Cash – effective settlement of technology licensing agreement
20
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11.2 Remuneration for future services of employees or former
owners of the acquiree
A transaction that remunerates employees or former owners of the acquiree for future
services is excluded from the business combination accounting and accounted for
separately. [IFRS 3.52].
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 133
