Question

how to recognize and measure identifiable assets acquired and liabilities assumed in business combination ? Explain in around 1500 words

Answer 1

IFRS 3 Business Combinations outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition or merger). Such business combinations are accounted for using the 'acquisition method', which generally requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date.

IFRS 3 (2008) seeks to enhance the relevance, reliability and comparability of information provided about business combinations (e.g. acquisitions and mergers) and their effects. It sets out the principles on the recognition and measurement of acquired assets and liabilities, the determination of goodwill and the necessary disclosures.

Key definitions

Business Combinations

A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as 'true mergers' or 'mergers of equals' are also business combinations as that term is used in [IFRS 3]

Business

An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities*

Acquisition Date

The date on which the acquirer obtains control of the acquiree

Acquirer

The entity that obtains control of the acquiree

Acquiree

The business or businesses that the acquirer obtains control of in a business combination

Determining whether a transaction is a business combination

IFRS 3 provides additional guidance on determining whether a transaction meets the definition of a business combination, and so accounted for in accordance with its requirements. This guidance includes:

• Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing equity instruments (or any combination thereof), or by not issuing consideration at all (i.e. by contract alone) [IFRS 3.B5]
• Business combinations can be structured in various ways to satisfy legal, taxation or other objectives, including one entity becoming a subsidiary of another, the transfer of net assets from one entity to another or to a new entity [IFRS 3.B6]
• The business combination must involve the acquisition of a business, which generally has three elements: [IFRS 3.B7]
  • Inputs – an economic resource (e.g. non-current assets, intellectual property) that creates outputs when one or more processes are applied to it
  • Process – a system, standard, protocol, convention or rule that when applied to an input or inputs, creates outputs (e.g. strategic management, operational processes, resource management)
  • Output – the result of inputs and processes applied to those inputs.

Identifying an acquirer

The guidance in IFRS 10 Consolidated Financial Statements is used to identify an acquirer in a business combination, i.e. the entity that obtains 'control' of the acquiree. [IFRS 3.7]

If the guidance in IFRS 10 does not clearly indicate which of the combining entities is an acquirer, IFRS 3 provides additional guidance which is then considered:

• The acquirer is usually the entity that transfers cash or other assets where the business combination is effected in this manner [IFRS 3.B14]
• The acquirer is usually, but not always, the entity issuing equity interests where the transaction is effected in this manner, however the entity also considers other pertinent facts and circumstances including: [IFRS 3.B15]
  • relative voting rights in the combined entity after the business combination
  • the existence of any large minority interest if no other owner or group of owners has a significant voting interest
  • the composition of the governing body and senior management of the combined entity
  • the terms on which equity interests are exchanged

Acquisition date

An acquirer considers all pertinent facts and circumstances when determining the acquisition date, i.e. the date on which it obtains control of the acquiree.

Acquired assets and liabilities

IFRS 3 establishes the following principles in relation to the recognition and measurement of items arising in a business combination:

• Recognition principle. Identifiable assets acquired, liabilities assumed, and non-controlling interests in the acquiree, are recognised separately from goodwill [IFRS 3.10]
• Measurement principle. All assets acquired and liabilities assumed in a business combination are measured at acquisition-date fair value. [IFRS 3.18]

Exceptions to the recognition and measurement principles

The following exceptions to the above principles apply:

• Contingent liabilities – the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets do not apply to the recognition of contingent liabilities arising in a business combination [IFRS 3.22-23]
• Income taxes – the recognition and measurement of income taxes is in accordance with IAS 12 Income Taxes [IFRS 3.24-25]
• Employee benefits – assets and liabilities arising from an acquiree's employee benefits arrangements are recognised and measured in accordance with IAS 19 Employee Benefits (2011) [IFRS 2.26]
• Indemnification assets - an acquirer recognises indemnification assets at the same time and on the same basis as the indemnified item [IFRS 3.27-28]
• Reacquired rights – the measurement of reacquired rights is by reference to the remaining contractual term without renewals [IFRS 3.29]
• Share-based payment transactions - these are measured by reference to the method in IFRS 2 Share-based Payment
• Assets held for sale – IFRS 5 Non-current Assets Held for Sale and Discontinued Operations is applied in measuring acquired non-current assets and disposal groups classified as held for sale at the acquisition date.

Goodwill

Goodwill is measured as the difference between:

Goodwill

=

Consideration transferred

+

Amount of non-controlling interests

+

Fair value of previous equity interests

-

Net assets recognised

Choice in the measurement of non-controlling interests (NCI)

IFRS 3 allows an accounting policy choice, available on a transaction by transaction basis, to measure non-controlling interests (NCI) either at: [IFRS 3.19]

• fair value (sometimes called the full goodwill method), or
• the NCI's proportionate share of net assets of the acquiree.

The choice in accounting policy applies only to present ownership interests in the acquiree that entitle holders to a proportionate share of the entity's net assets in the event of a liquidation.