IFRS 3: Business Combinations

The objective of this IFRS is to deal with the information that an entity provides within their financial statements about a business combination and the effect of this combination on the financial statements. IFRS 3 deals with how an acquirer:
  • recognises and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree;
  • recognises and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and
  • determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
The Acquisition Method of Accounting
When a business acquires another business, the business combination must be accounted for by applying the ‘acquisition method’ of accounting. One party in the transaction is the ‘acquirer’ and the entity that is being acquired is the ‘acquiree’. 
All identifiable assets and liabilities are measured at their acquisition-date fair value. Any non-controlling interest in an acquiree is measured at fair value or as the non-controlling interest’s proportionate share of the acquiree’s net identifiable assets.
The IFRS requires an acquirer to identify any difference between:
  • the aggregate of the consideration transferred, any non-controlling interest in the acquiree and (in the case of step acquisitions) the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree; and
  • the net identifiable assets acquired.
The difference between the two will generally be recognised as goodwill. In the situation where there is a bargain purchase, the gain will instead be recognised in the statement of comprehensive income. Any consideration (including contingent consideration) is measured at fair value.
Disclosure Requirements
IFRS 3 requires the acquirer to disclose information within the financial statements that enables the user of the financial statements to evaluate the nature and financial effect of the business combination(s) that occurred during the reporting period, or a period after the reporting date but before the financial statements are authorised for issue. After a business combination, the acquirer must also disclose any adjustments recognised in the current reporting period that relate to business combinations that occurred in the current or previous reporting periods.
Recent Amendments to IFRS 3
There have been some major amendments to IFRS 3 which occurred in January 2008. The main reason for the changes in IFRS 3 was so that the standard itself was more fully converged with US GAAP and to place greater emphasis on control. A summary of the major changes are as follows:
Goodwill can be recognised in full even where control is less than 100%.   Before the revisions to IFRS 3, the IFRS stated that on acquisition, goodwill should only be recognised with respect to the part of the subsidiary undertaking that is attributable to the interest held by the parent. This is still an option in IFRS 3 but now goodwill can be recognised in full which now means that the non-controlling interest (previously known as ‘minority interest’) will be measured at fair value and be included within goodwill.
Acquisition-Related Costs
Previously transaction costs associated with a business combination (for example legal fees and accountancy fees for due diligence work) were capitalised along with the cost of the acquisition thus forming part of the goodwill calculation. The IASB have concluded that these types of cost must now be expensed as these costs are not part of the fair value exchange between the buyer and seller of the business. This means, therefore, that in the year of acquisition, the acquirer’s income statement will show substantially higher legal and professional fees. However, this reduction in profits should be outweighed in future years because the annual impairment test on the goodwill will be based on a reduced initial balance.
Step Acquisitions
Prior to the revisions of IFRS 3, it was a requirement to measure the assets and liabilities at fair value at every step of the transaction to calculate a ‘portion’ of goodwill. This requirement was removed during the revision process. Instead you should measure goodwill as the difference, at the acquisition date, between the fair value of any interest in the business held before the acquisition, the consideration transferred and the net assets acquired.
Partial Acquisitions
Non-controlling interests are measured as their proportionate interest in the net identifiable assets (as was the case before IFRS 3 was revised). Non-controlling interests can also be measured at fair value. 
Recognition of Assets and Liabilities Subject to Contingencies
There are a few (limited) changes to the assets and liabilities recognition under IFRS 3. There is a new requirement to recognise assets and liabilities that are subject to contingencies at fair value at the acquisition date. Any subsequent changes in fair value will be accounted for in accordance with other IFRS’s (which will usually be in profit or loss) rather than as an adjustment to goodwill.
Partial Disposal of a Subsidiary Whilst Control is Retained
Where a partial disposal of an investment in a subsidiary is disposed of whilst control is retained, this is accounted for as an equity transaction with owners and a gain or loss is not recognised.
A partial disposal of an interest in a subsidiary where the parent loses control, but retains an interest and thus becomes (for example) an associate, will trigger recognition of a gain or loss on the entire interest. A realised gain or loss is recognised on the portion that has been disposed of; a holding gain is recognised on the interest retained, calculated as the difference between the fair value and book value of the retained interest.
Acquisition of Shares after Control has been Obtained

Where the parent acquires some, or all of, the non-controlling interest in a subsidiary, this should be treated as a treasury share-type transaction and therefore should be accounted for as an equity transaction. There is an interpretation summary, IFRIC 11 ‘IFRS 2: Group and Treasury Share Transactions’ which gives guidance in this area.

About the author:

Steve Collings FMAAT ACCA DipIFRS is Audit Manager at Leavitt Walmsley Associates www.lwaltd.com. Read all of Collings's analyses of the International Financial Reporting Standards.

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