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IFRS-3: Business Combinations

A business combination is the bringing together of separate entities or businesses into one reporting entity. A business combination may be structured in a variety of ways for tax, legal or other reasons. In all business combinations, an acquirer has to be identified for accounting purposes. The acquirer will be the entity that has obtained control of one or more other entities or businesses (the acquiree). Control is defined as the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities. A number of factors may influence which entity has control. These include equity shareholding, control of the board and control agreements. If an entity owns more than 50 per cent of the equity shareholding in another entity, there is a presumption of control.

The acquirer measures the cost of the combination at the acquisition date (the date on which it obtains control over the net assets of the acquiree). The cost of the combination includes cash and cash equivalents and the fair value of any non-cash consideration given, plus any costs directly attributable to the acquisition. Any shares issued as part of the consideration are fair valued. The market value of shares is used as evidence of the fair value. If any of the consideration is deferred, it is discounted to reflect its present value at the acquisition date.

A portion of the consideration may be contingent on the outcome of future events or the acquired entity’s performance (‘contingent consideration’). Contingent consideration that can be reliably estimated and where payment is probable is recorded in full at the date of the business combination.

Contingent consideration is adjusted to reflect the actual outcome. Once the cost of consideration is established, it is compared to the fair value of the acquiree’s identifiable assets (including intangible assets not previously recognised), liabilities and contingent liabilities. The acquiree’s assets and liabilities are fair valued (that is, their value is determined by reference to an arm’s length transaction – the intention of the acquirer is not relevant). If the acquisition is for less than 100 per cent of the acquiree, there is a minority interest (also called ‘non-controlling interest’). The minority interest represents the portion of the fair value of the net identifiable assets of an entity not owned by the entity that controls it.

The difference between the cost of acquisition and the fair value of the identifiable assets and liabilities represents goodwill. After recognizing all intangibles, the goodwill balance represents synergies and certain unrecognized intangibles such as the entity’s workforce.

Goodwill is recognized as an intangible asset and tested annually for impairment. If the fair value of the assets and liabilities acquired exceeds the cost of acquisition, this difference is taken to the income statement. This would be expected to occur only in rare circumstances – for example, where there has been a bargain purchase.

The above summarizes the current requirements. A new standard – IFRS 3 (revised) – has been published and comes into effect from July 2009.

You may want to read the other chapters as well:

IFRS-1: First Time Adoption of IFRS
IFRS-2: Share-based Payment
IFRS-3: Business Combination
IFRS-4: Insurance Contract
IFRS-5: Disposal of Subsidiaries, Business and Non-current Asset
IFRS-6: Extractive Industries
IFRS-7, IAS 32 & 39: Financial Instruments
IFRS-8: Segment Reporting

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