an appropriate carrying value for the part disposed of, and a gain or loss on disposal. See
Chapter 17 at 9.5 and Chapter 18 at 7.3.
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8 ACQUISITIONS
8.1
Business combinations versus asset acquisitions
When an entity acquires an asset or a group of assets, careful analysis is required to
identify whether what is acquired constitutes a business or represents only an asset or
group of assets. Accounting for business combinations is discussed in detail in Chapter 9.
8.1.1
Differences between asset purchase transactions and business
combinations
The reason it is important to distinguish between an asset acquisition and a business
combination is because the accounting consequences are significantly different. The
main differences between accounting for an asset acquisition and a business
combination can be summarised as follows:
• goodwill or a bargain purchase (also sometimes referred to as negative goodwill)
only arise in business combinations;
• assets and liabilities are accounted for at fair value in a business combination, while they
are assigned a carrying amount based on their relative fair values in an asset acquisition;
• transaction costs should be recognised as an expense under IFRS 3, but can be
capitalised on an asset acquisition; and
• in an asset acquisition no deferred tax will arise in relation to acquired assets and
assumed liabilities as the initial recognition exception for deferred tax under IAS 12
– Income Taxes – applies.
8.1.2
Definition of a business
A business is defined in IFRS 3 as ‘an integrated set of activities and assets that is capable
of being conducted and managed for the purpose of providing a return in the form of
dividends, lower costs or other economic benefits directly to investors or other owners,
members or participants’. [IFRS 3 Appendix A]. Specifically IFRS 3: [IFRS 3.BC18]
• requires the integrated set of activities and assets to be ‘capable’ of being
conducted and managed for the purpose of providing a return in the form of
dividends, lower costs or other economic benefits directly to investors or other
owners, members or participants. The focus on the capability to achieve the
purposes of the business helps avoid the unduly restrictive interpretations that
existed under the former guidance;
• clarifies the meaning of the terms ‘inputs’, ‘processes’ and ‘outputs’, which helps
eliminate the need for extensive detailed guidance and the misinterpretations that
sometimes stem from such guidance;
• clarifies that inputs and processes applied to those inputs are essential and that
although the resulting outputs are normally present, they need not be present; and
• clarifies that a business need not include all of the inputs or processes that the seller
used in operating that business if a market participant is capable of continuing to
produce outputs, which helps avoid the need for extensive detailed guidance and
assessments about whether a missing input or process is minor.
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As discussed in Chapter 9 at 3.2.1, we believe that, in most cases, the acquired set of
activities and assets must have at least some inputs and processes in order to be
considered a business. If an acquirer obtains control of an input or set of inputs without
any processes, we think it is unlikely that the acquired input(s) would be considered a
business, even if a market participant had all the processes necessary to operate the
input(s) as a business. The definition of a business under IFRS 3 is discussed in more
detail in Chapter 9 at 3.2.
Determining whether a particular set of integrated activities and assets is a business will
often require a significant amount of judgement, particularly for oil and gas companies
and mining companies as illustrated in Example 39.6 below.
Example 39.6: Definition of a business under IFRS 3
Oil and gas company C acquires a single oil exploration area where there are active exploration activities
underway, oil has been found and the company is close to declaring reserves but implementation of the
development plan has not yet commenced.
This may be a business under IFRS 3 as assets and processes have been acquired and a market participant is
capable of producing outputs by integrating these with its own inputs and processes.
Mining company D acquires a development stage mine, including all inputs (i.e. employees, mineral reserve
and property, plant and equipment) and processes (i.e. exploration and evaluation processes e.g. active drilling
programmes etc.) that are required to generate output.
This meets the definition of a business under IFRS 3 because it includes inputs and processes even though
there are currently no outputs.
Oil and gas company E acquires a group of pipelines (or a fleet of oil or gas tankers) used for transporting
gas on behalf of customers and the employees responsible for operational, maintenance and administrative
tasks transfer to the buyer.
This meets the definition of a business under IFRS 3 because it includes inputs, processes and outputs.
Mining company F acquires a mine that was abandoned 10 years ago. There are no activities currently
occurring at the mine. The company plans to perform new geological and geophysical survey to determine
whether sufficient economic reserves are present.
The abandoned mine does not meet the definition of a business because there are no processes acquired in
addition to the assets purchased.
Oil and gas company G acquires a producing oil field, but the seller’s on-site staff will not transfer to the
buyer. Instead, oil and gas company G will enter into maintenance and oil field services contracts with
different contractors.
A business need not include all of the inputs or processes that the seller used in operating that business if
market participants are capable of continuing to produce outputs. If market participants can easily outsource
processes to contractors then the oil field would be a business under IFRS 3.
In June 2016, in response to stakeholder concerns raised during the post implementation
review of IFRS 3, the IASB proposed amendments that clarify how to apply the
definition of a business in IFRS 3. The proposed amendments aim to provide additional
guidance to help distinguish between the acquisition of a business and the acquisition
of a group of assets. The FASB also issued a proposal in response to similar feedback in
its PIR regarding difficulties in applying the definition of a business. The FASB and the
IASB jointly discussed the clarifications to the definition of a business in IFRS 3 and the
FASB’s Accounting Standards Codification (ASC) 805. In January 2017, the FASB
concluded its project and issued ASU 2017-01, Business Combinations (Topic 805):
Clarifying the Definition of a Business. At the time of writing, the IASB had not yet
finalised its amendments to IFRS 3 on the definition of a business, but at its meeting in
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October 2017, the IASB concluded that the due-process steps required to issue a
narrow-scop
e amendment have been completed and tentatively decided not to re-
expose the amendments to IFRS 3.103 The IASB expects to issue its amendments in the
second half of 2018.104 The IASB’s proposed amendments are discussed in Chapter 9
at 1.1.2 and 3.2.6.
8.2 Business
combinations
8.2.1
Goodwill in business combinations
Prior to the adoption of IFRS, many mining companies and oil and gas companies
assumed that the entire consideration paid for upstream assets should be allocated to
the identifiable net assets acquired, i.e. any excess of the consideration transferred
over the fair value of the identifiable net assets (excluding mineral reserves and
resources) acquired would then have been included within mineral reserves and
resources acquired and goodwill would not generally be recognised. However,
goodwill could arise as a result of synergies, overpayment by the acquirer, or when
IFRS requires that acquired assets and/or liabilities are measured at an amount that is
not fair value (e.g. deferred taxation). Therefore, it is unlikely to be appropriate for
mining companies or oil and gas companies to simply assume that goodwill would
never arise in a business combination and that any differential automatically goes to
mineral reserves and resources. Mineral reserves and resources and any exploration
potential (if relevant) acquired should be valued separately and any excess of the
consideration transferred over and above the supportable fair value of the identifiable
net assets (which include mineral reserves, resources and acquired exploration
potential), should be allocated to goodwill.
By virtue of the way IFRS 3 operates, if an entity were simply to take any excess of the
consideration transferred over the fair value of the identifiable net assets acquired to
mineral reserves and resources, they may end up having to allocate significantly larger
values to minerals reserves and resources than expected. This is because, under IFRS 3,
an entity is required to provide for deferred taxation on the temporary differences
relating to all identifiable net assets acquired (including mineral reserves and resources),
but not on temporary differences related to goodwill. Therefore, if any excess was
simply allocated to mineral reserves and resources, to the extent that this created a
difference between the carrying amount and the tax base of the mineral reserves and
resources, IAS 12 would give rise to a deferred tax liability on the temporary difference,
which would create a further excess. This would then result in an iterative calculation
in which the deferred tax liability recognised would increase the amount attributed to
mineral reserves and resources, which would in turn give rise to an increase in the
deferred tax liability (see Chapter 29 at 7.2.2). Given the very high marginal tax rates to
which extractive activities are often subject (i.e. tax rates of 60 to 80% are not
uncommon) the mineral reserves and resources might end up being grossed up by a
factor of 2.5 to 5 (i.e. 1/(1 – 60%) = 2.5). Such an approach would only be acceptable if
the final amount allocated to mineral reserves and resources remained in the range of
fair values determined for those mineral reserves and resources. If not, such an
approach would lead to excessive amounts being allocated to mineral reserves and
resources which could not be supported by appropriate valuations.
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The extract below from Glencore financial statements illustrates a typical accounting policy
for business combinations in which excess consideration transferred is treated as goodwill.
Extract 39.13: Glencore plc (2017)
Notes to the financial statements [extract]
1. Accounting policies[extract]
Business combinations and goodwill [extract]
Acquisitions of subsidiaries and businesses are accounted for using the acquisition method of accounting. The cost
of the acquisition is measured at fair value, which is calculated as the sum of the acquisition date fair values of the
assets transferred, liabilities incurred to the former owners of the acquiree and the equity interests issued in exchange for control of the acquiree. The identifiable assets, liabilities and contingent liabilities (“identifiable net assets”) are recognised at their fair value at the date of acquisition. Acquisition related costs are recognised in the consolidated
statement of income as incurred.
Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non-controlling
interests in the acquiree, and the fair value of the acquirer’s previously held equity interest in the acquiree (if any)
over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.
8.2.2
Impairment of assets and goodwill recognised on acquisition
There are a number of circumstances in which the carrying amount of assets and
goodwill acquired as part of a business combination and as recorded in the consolidated
accounts, may be measured at a higher amount through recognition of notional tax
benefits, also known as tax amortisation benefits (i.e. the value has been grossed up on
the assumption that its carrying value is deductible for tax) or deferred tax (which can
increase goodwill as described above). Application of IAS 36 to goodwill which arises
upon recognition of deferred tax liabilities in a business combination is discussed in
Chapter 20 at 8.3.1.
8.2.3
Value beyond proven and probable reserves (VBPP)
In the mining sector specifically, the ‘value beyond proven and probable reserves’
(VBPP) is defined as the economic value of the estimated cash flows of a mining asset
beyond that asset’s proven and probable reserves.
While this term is specifically relevant to the mining sector by virtue of specific
guidance in US GAAP, the concept may be equally relevant to the oil and gas sector,
i.e. the economic value of an oil and gas licence/area beyond the proven and
probable reserves.
For mining companies, there are various situations in which mineralisation and mineral
resources might not be classified as proven or probable:
• prior to the quantification of a resource, a mining company may identify
mineralisation following exploration activities. However, it may be too early to
assess if the geology and grade is sufficiently expansive to meet the definition
of a resource;
• Acquired Exploration Potential (AEP) represents the legal right to explore for
minerals in a particular property, occurring in the same geological area of interest;
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• carrying out the required assessments and studies to obtain classification of mineral
reserves can be very costly. Consequently, these activities are often deferred until
they become necessary for the planning of future operations. Significant mineral
resources are often awaiting the initiation of this process; and
• if an entity acquires a mining company at a time when commodity prices are
particularly low, the mineral resources owned by the acquiree may not meet the
definition of proven or probable reserves because extraction might not be
commercially viable.
While t
he above types of mineralisation and mineral resources cannot be classified as
proven or probable, they will often be valuable because of the future potential that they
represent (i.e. reserves may be proven in the future and commodity price increases may
make extraction commercially feasible).
IFRS 3 requires that an acquirer recognises the identifiable assets acquired and liabilities
assumed that meet the definitions of assets and liabilities at the acquisition date.
[IFRS 3.11].
While the legal or contractual rights that allow an entity to extract minerals are not
themselves tangible assets, the mineral reserves concerned clearly are. The legal or
contractual rights – that allow an entity to extract mineral reserves and resources –
acquired in business combinations should be recognised, without exception, at fair value.
An entity that acquires mineral reserves and resources that cannot be classified as
proven or probable, should account for the VBPP as part of the value allocated to mining
assets, to the extent that a market participant would include VBPP in determining the
fair value of the asset, rather than as goodwill.105 In practice, the majority of mining
companies treat mining assets, the related mineral reserves and resources and licences
as tangible assets on the basis that they relate to minerals in the ground, which are
themselves tangible assets. However, some entities present the value associated with
E&E assets as intangible assets.
AEP would often be indistinguishable from the value of the mineral licence to which it
relates. Therefore, the classification of AEP may vary depending on how an entity
presents its mining assets and licences. If an entity presents them as tangible assets, they
may be likely to treat AEP (or its equivalent), where applicable, as forming part of
mineral properties, and hence AEP would be classified as a tangible asset. For an entity
that classifies some of its mineral assets as intangible assets, e.g. E&E assets, then they
may classify AEP as an intangible also.
Determining the fair value of VBPP requires a considerable amount of expertise. An
entity should not only take account of commodity spot prices but also consider the
effects of anticipated fluctuations in the future price of minerals, in a manner that is
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