11.2.1 Arrangements
for
contingent payments to employees or selling
shareholders
Whether arrangements for contingent payments to employees (or selling shareholders)
are contingent consideration to be included in the measure of the consideration
transferred (see 7.1 above) or are separate transactions to be accounted for as
remuneration will depend on the nature of the arrangements.
Such payments are also often referred to as ‘earn-outs’. The approach to accounting for
earn-out arrangements is summarised in the diagram below:
Approach to accounting for earn-outs
Earn-out arrangement
Apply IFRS 3 to classify
Remuneration
Contingent consideration
Settled in or
Settled in other
linked to own
way (cash not
shares
linked to shares)
or other assets
Apply IFRS 2
Apply IAS 19
Apply IFRS 3
In general, conditions that tie the payment to continuing employment result in the
additional payment being considered remuneration for services rather than additional
consideration for the business.
Understanding the reasons why the acquisition agreement includes a provision for
contingent payments, who initiated the arrangement and when the parties entered into
the arrangement may be helpful in assessing the nature of the arrangement. [IFRS 3.B54].
If it is not clear whether the arrangement for payments to employees or selling
shareholders is part of the exchange for the acquiree or is a transaction separate from
the business combination, there are a number of indicators in IFRS 3. [IFRS 3.B55]. These
are summarised in the table below:
676 Chapter
9
Indicators to consider when classifying payments as remuneration or contingent consideration
Indicators to consider when
assessing terms of
Lead to conclusion as
Lead to conclusion as
additional payments to
remuneration
contingent consideration
selling shareholders that
remain employees
Payments are not affected by
Payments forfeited on termination
Continuing employment
termination
Coincides with or exceeds payment
Duration of required
Shorter than the payment period
period
employment
Not reasonable compared to other
Level of other elements of
Reasonable compared to the other
key employees of the group
remuneration
key employees of the group
Other non-employee selling
Other non-employee selling
Incremental payments to
shareholders receive similar
shareholders receive lower additional other non-employee selling
additional payments (on a per share
payments (on a per share basis)
shareholders
basis)
Number of shares owned when
Selling shareholders remaining as
all selling shareholders receive
Selling shareholders remaining as
employees owned substantially all
same level of additional
employees owned only a small
shares (in substance profit-sharing)
consideration (on a per share
portion of shares
basis)
Formula for additional payment
Initial consideration at lower end of
consistent with other profit-sharing
Linkage of payments to
range of business valuation, and
arrangements rather than the
valuation of business
formula for additional payment linked
valuation approach
to the valuation approach
Formula is based on a valuation
Formula is based on performance,
Formula for additional
formula, such as multiple of earnings,
such as percentage of earnings
payments
indicating it is connected to a
business valuation
Although these points are supposed to be indicators, continuing employment is an
exception. It is categorically stated that ‘a contingent consideration arrangement in which
the payments are automatically forfeited if employment terminates is remuneration for
post-combination services’. [IFRS 3.B55(a)]. With this exception, no other single indicator is
likely to be enough to be conclusive as to the accounting treatment.
The Interpretations Committee has considered whether payments that are forfeited on
termination of employment should automatically be classified as remuneration for post-
combination services. The Interpretations Committee observed that an arrangement in
which contingent payments are automatically forfeited if employment terminates leads to a
conclusion that the arrangement is compensation for post-combination services rather than
additional consideration for an acquisition, unless the service condition is not substantive.
The Interpretations Committee reached this conclusion on the basis of the conclusive
language used in paragraph B55(a) of IFRS 3. The Interpretations Committee decided not to
Business
combinations
677
add this issue to its agenda. The IASB indicated in its Report and Feedback Statement – Post-
implementation Review of IFRS 3 Business Combinations (June 2015) that many participants
asked the Board to revisit the guidance in paragraph B55(a) of IFRS 3 for contingent
payments to selling shareholders in circumstances in which those selling shareholders
become, or continue as, employees. However, the IASB considered the issue as being of low
significance and, having considered the feedback received from the 2015 Agenda
Consultation, the Board decided not to include it in its work plan and research pipeline.44
The guidance in IFRS 3 expands the points in the table above, but also notes that:
(i)
The relevant terms of continuing employment may be included in an employment
agreement, acquisition agreement or some other document. [IFRS 3.B55(a)].
(ii) Other pre-acquisition ownership interests may be relevant, e.g. those held by
parties related to selling shareholders such as family members, who continue as
key employees. [IFRS 3.B55(e)].
Where it is determined that some or all of the arrangement is to be accounted for as
contingent consideration, the requirements in IFRS 3 discussed at 7.1 above should be
applied. If some or all of the arrangement is post-combination remuneration, it will be
accounted for under IFRS 2 if it represents a share-based payment transaction
(see Chapter 30) or otherwise under IAS 19 (see Chapter 31).
The requirements for contingent payments to employees are illustrated in the following
example. [IFRS 3.IE58-IE60].
Example 9.27: Contingent payments to employees
Entity B appointed a candidate as its new CEO under a ten-year contract. The contract required Entity B to pay the
candidate $5m if Entity B is acquired before the contract expires. Entity A acquires Entity B eight years later. The
CEO was still employed at the
acquisition date and will receive the additional payment under the existing contract.
In this example, Entity B entered into the employment agreement before the negotiations of the combination
began, and the purpose of the agreement was to obtain the services of CEO. Thus, there is no evidence that
the agreement was arranged primarily to provide benefits to Entity A or the combined entity. Therefore, the
liability to pay $5m is accounted for as part of the acquisition of Entity B.
In other circumstances, Entity B might enter into a similar agreement with CEO at the suggestion of Entity A
during the negotiations for the business combination. If so, the primary purpose of the agreement might be
to provide severance pay to CEO, and the agreement may primarily benefit Entity A or the combined entity
rather than Entity B or its former owners. In that situation, Entity A accounts for the liability to pay CEO in
its post-combination financial statements separately from the acquisition of Entity B.
Not all arrangements relate to judgements about whether an arrangement is remuneration
or contingent consideration and other agreements and relationships with selling
shareholders may have to be considered. The terms of other arrangements and the
income tax treatment of contingent payments may indicate that contingent payments are
attributable to something other than consideration for the acquiree. These can include
agreements not to compete, executory contracts, consulting contracts and property lease
agreements. For example, the acquirer might enter into a property lease arrangement
with a significant selling shareholder. If the lease payments specified in the lease contract
are significantly below market, some or all of the contingent payments to the lessor (the
selling shareholder) required by a separate arrangement for contingent payments might
be, in substance, payments for the use of the leased property that the acquirer should
recognise separately in its post-combination financial statements. In contrast, if the lease
678 Chapter
9
contract specifies lease payments that are consistent with market terms for the leased
property, the arrangement for contingent payments to the selling shareholder may be
contingent consideration in the business combination.
11.2.2
Share-based payment awards exchanged for awards held by the
acquiree’s employees
The acquirer may exchange share-based payment awards (i.e. replacement awards) for
awards held by employees of the acquiree.
If the acquirer replaces any acquiree awards, the consideration transferred will include
some or all of any replacement awards. Any amount not included in the consideration
transferred is treated as a post-combination remuneration expense.
IFRS 3 includes application guidance dealing with replacement awards. [IFRS 3.B56-B62].
Replacement awards are modifications of share-based payment awards in accordance
with IFRS 2. Discussion of this guidance, including illustrative examples that reflect the
substance of the Illustrative Examples that accompany IFRS 3, [IFRS 3.IE61-IE71], is dealt
with in Chapter 30 at 11.2.
11.3 Reimbursement
for
paying the acquirer’s acquisition-related costs
The third example of a separate transaction is included to mitigate concerns about
potential abuse. IFRS 3 requires the acquirer to expense its acquisition-related costs –
they are not included as part of the consideration transferred for the acquiree. This means
that they are not reflected in the computation of goodwill. As a result, acquirers might
modify transactions to avoid recognising those costs as expenses. They might disguise
reimbursements, e.g. a buyer might ask a seller to make payments to third parties on its
behalf; the seller might agree to make those payments if the total amount to be paid to it
is sufficient to reimburse it for payments made on the buyer’s behalf. [IFRS 3.BC370].
The same would apply if the acquirer asks the acquiree to pay some or all of the
acquisition-related costs on its behalf and the acquiree has paid those costs before the
acquisition date, so that at the acquisition date the acquiree does not record a liability
for them. [IFRS 3.BC120]. This transaction has been entered into on behalf of the acquirer,
or primarily for the benefit of the acquirer.
11.4 Restructuring
plans
One particular area that could be negotiated between the acquirer and the acquiree or
its former owners is a restructuring plan relating to the acquiree’s activities.
In our view, a restructuring plan that is implemented by or at the request of the acquirer is
not a liability of the acquiree as at the date of acquisition and cannot be part of the
accounting for the business combination under the acquisition method, regardless of
whether the combination is contingent on the plan being implemented. IFRS 3 does not
contain the same explicit requirements relating to restructuring plans that were in the
previous version of IFRS 3, but the Basis for Conclusions accompanying IFRS 3 clearly
indicate that the requirements for recognising liabilities associated with restructuring or exit
activities remain the same. [IFRS 3.BC137]. Furthermore, as discussed at 5.2 above, an acquirer
Business
combinations
679
recognises liabilities for restructuring or exit activities acquired in a business combination
only if they meet the definition of a liability at the acquisition date. [IFRS 3.BC132].
A restructuring plan that is decided upon or put in place between the date the negotiations
for the business combination started and the date the business combination is
consummated is only likely to be accounted for as a pre-combination transaction of the
acquiree if there is no evidence that the acquirer initiated the restructuring and the plan
makes commercial sense even if the business combination does not proceed.
If a plan initiated by the acquirer is implemented without an explicit link to the combination
this may indicate that control has already passed to the acquirer at this earlier date.
This is discussed further in the following example.
Example 9.28: Recognition or otherwise of a restructuring liability as part of a
business combination
The acquirer and the acquiree (or the vendors of the acquiree) enter into an arrangement before the acquisition
that requires the acquiree to restructure its workforce or activities. They intend to develop the main features
of a plan that involve terminating or reducing its activities and to announce the plan’s main features to those
affected by it so as to raise a valid expectation that the plan will be implemented. The combination is
contingent on the plan being implemented.
Does such a restructuring plan that the acquiree puts in place simultaneously with the business combination,
i.e. the plan is effective upon the change in control, but was implemented by or at the request of the acquirer
qualify for inclusion as part of the liabilities assumed in accounting for the business combination?
If these facts are analysed:
(a) the reason: a restructuring plan implemented at the request of the acquirer is presumably arranged
primarily for the benefit of the acquirer or the combined entity because of the possible redundancy
> expected to arise from the combination of activities of the acquirer with activities of the acquiree, e.g.
capacity redundancy leading to closure of the acquiree’s facilities;
(b) who initiated: if such a plan is the result of a request of the acquirer, it means that the acquirer is
expecting future economic benefits from the arrangement and the decision to restructure;
(c) the timing: the restructuring plan is usually discussed during the negotiations; therefore, it is
contemplated in the perspective of the future combined entity.
Accordingly, a restructuring plan that is implemented as a result of an arrangement between the acquirer and
the acquiree is not a liability of the acquiree as at the date of acquisition and cannot be part of the accounting
for the business combination under the acquisition method.
Does the answer differ if the combination is not contingent on the plan being implemented?
The answer applies regardless of whether the combination is contingent on the plan being implemented. A
plan initiated by the acquirer will most likely not make commercial sense from the acquiree’s perspective
absent the business combination. For example, there are retrenchments of staff whose position will only truly
become redundant once the entities are combined. In that case, this is an arrangement to be accounted for
separately rather than as part of the business combination exchange. This arrangement may also indicate that
control of acquiree has already passed to the acquirer as otherwise there would be little reason for the acquiree
to enter into an arrangement that makes little or no commercial sense to it.
12 MEASUREMENT
PERIOD
IFRS 3 contains provisions in respect of a ‘measurement period’ which provides the
acquirer with a reasonable period of time to obtain the information necessary to
680 Chapter
9
identify and measure all of the various components of the business combination as of
the acquisition date in accordance with the standard, i.e.:
(a) the identifiable assets acquired, liabilities assumed and any non-controlling
interest in the acquiree;
(b) the consideration transferred for the acquiree (or the other amount used in
measuring goodwill);
(c) in a business combination achieved in stages, the equity interest in the acquiree
previously held by the acquirer; and
(d) the resulting goodwill or gain on a bargain purchase. [IFRS 3.46].
For most business combinations, the main area where information will need to be obtained
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 134
