for Accounting Professionals

IFRS 3 - BUSINESS COMBINATIONS

 Business Combinations

12. DISCLOSURE .....................................................................21

13. PROPOSED AMENDMENTS TO IFRS 3............................23

14. MULTICHOICE QUESTIONS...............................................23

15. ANSWERS TO MULTIPLE CHOICE QUESTIONS.............27

CONTENTS 1.

2. BUSINESS COMBINATIONS - INTRODUCTION....................3

2. DEFINITIONS...........................................................................4

3. IDENTIFYING A BUSINESS COMBINATION ........................5

5. ALLOCATING THE COST OF A COMBINATION ................13

6. INTANGIBLE ASSETS...........................................................13

7. GOODWILL ...........................................................................14

8. PROVISIONAL ACCOUNTING .............................................16

9. REVERSE ACQUISITIONS ...................................................17

10. PRACTICAL ISSUES...........................................................20

11. COMBINATIONS INVOLVING UNDERTAKINGS UNDER

COMMON CONTROL OUTSIDE THE SCOPE OF IFRS 3........21
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 Business Combinations

Goodwill
2. Business Combinations - Introduction IFRS 3 requires goodwill to be measured after initial recognition at cost, less
any accumulated impairment losses.
OVERVIEW Goodwill is not amortised but must be tested for impairment annually, or more
frequently.
AIM
The aim of this workbook is to assist the individual in understanding the Negative goodwill
IFRS 3 treatment of Business Combinations.
IFRS 3 requires that negative goodwill must be credited by the acquirer
IFRS 3 supersedes IAS 22. immediately to the income statement.

ACCOUNTING The acquirer records the acquiree’s identifiable assets, liabilities and
Business combinations within the scope of IFRS 3 are accounted for using the contingent liabilities at their fair values at the acquisition date and also records
‘purchase method’. goodwill, which is subsequently tested for impairment.

The acquirer records the acquiree’s identifiable assets, liabilities and SCOPE
contingent liabilities at their fair values at the acquisition date and also records IFRS 3 does not apply to:
goodwill, which is subsequently tested for impairment. (i) joint ventures (see IAS 31).
(ii) businesses under common control.
Assets acquired and assumed (iii) combinations involving two or more mutual undertakings.
(i) Recognition

If there is an existing restructuring liability per IAS37 it is included in the

goodwill calculation.

If fair values can be measured reliably, the acquirer must record separately the
acquiree’s contingent liabilities at the acquisition date, as part of allocating the
cost of a business combination. If the contingent liabilities cannot be
measured, they are not included in the allocation of cost.

(ii) Measurement

IFRS 3 requires the acquiree’s identifiable assets, liabilities and contingent

liabilities to be measured initially at their fair values, at the acquisition date.

Any minority interest in the acquiree is the minority’s proportion of the net fair
values.

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2. DEFINITIONS
acquisition date The date on which the acquirer effectively obtains
control of the acquiree.
agreement date The date that an agreement between the combining
parties is reached.
In the case of publicly listed undertakings, the date
that is announced to the public.
In the case of a hostile takeover, the earliest date
that an agreement between the combining parties
is reached. This is the date that a sufficient
number of the acquiree’s owners have accepted
the acquirer’s offer, for the acquirer to obtain
control of the acquiree.
business An integrated set of activities and assets,
conducted and managed, for the purpose of
providing:
i a return to investors; or
ii lower costs or other benefits directly and
proportionately to participants. This relates to
mutual undertakings.
A business generally consists of inputs, processes
and resulting outputs that are used to generate
revenues. If goodwill is present, an organisation
is presumed to be a business.
business combination The bringing together of separate businesses into
one reporting undertaking.
business combination A business combination in which all of the
involving businesses combining businesses ultimately are controlled by
under common control the same party or parties, both before and after
the combination and that control is not transitory.
Business Combinations
contingent liability Contingent liability has the meaning given to it in
IAS 37 Provisions:
a possible obligation that arises from past
events and whose existence will be confirmed
only by the occurrence or non-occurrence
(1) of one or more uncertain future events, not
wholly within the control of the undertaking;
or
(2) a present obligation that arises from past
events, but is not recorded because:
i it is not probable that payment will be required to
settle the obligation; or
ii the amount of the obligation cannot be measured
with sufficient reliability.
control The power to govern the financial and operating
policies of a business.
date of exchange When a business combination is achieved in a
single exchange transaction, the date of
exchange is the acquisition date. When a
business combination involves more than one
exchange transaction for example when it is
achieved in stages by successive share
purchases, the date of exchange is the date that
each individual investment is recorded in the
financial statements of the acquirer.
fair value The amount for which an asset could be
exchanged, or a liability settled, between
knowledgeable, independent parties.
goodwill Benefits arising from assets that are not capable of
being individually identified and separately
recorded.
intangible asset Intangible asset has the meaning given to it in IAS
38: an identifiable non-monetary asset without
physical substance.
joint venture Joint venture has the meaning given to it in IAS 31:
a contractual arrangement, whereby parties
undertake an activity, that is subject to joint
control.
minority interest That portion of the income statement and net
assets of a subsidiary attributable to shares that
are not owned directly or indirectly by the parent.
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mutual undertaking An undertaking other than an investor-owned
undertaking, such as a mutual insurance
company, or a mutual cooperative undertaking,
that provides lower costs, or other economic
benefits, directly and proportionately to its
participants.
parent An undertaking that has one or more subsidiaries.
probable More likely than not.
reporting undertaking An undertaking for which there are users who rely
on the undertaking’s financial statements for
information, which will be useful to them for
making decisions about the allocation of
resources. A reporting undertaking can be a
single undertaking, or a group.
subsidiary An undertaking including an unincorporated
undertaking such as a partnership, which is
controlled by the parent.
(ii) purchase of all the net assets of another undertaking,
(iii) assumption of the liabilities of another undertaking, or
(iv) purchase of some of the net assets of another undertaking, that
together form one or more businesses.
It may be effected by the issue of shares, the transfer of cash, cash
equivalents or other assets, or a combination thereof.
In the following examples, I/B refers to Income Statement and Balance Sheet.
EXAMPLE-Buying a business using cash and shares
You buy 100% of a business for $10m. You pay $4m in cash and issue $6m of
equity to finance the purchase.
I/B DR CR
Investment in subsidiary B $10m
Cash B $4m
Share capital B $6m
Purchase of business

3. Identifying a business combination
A combination is the bringing together of separate undertakings into one
reporting undertaking.
The result of nearly all combinations is that the ‘acquirer’ obtains control of
one, or more, other businesses, the ‘acquiree’.
When an undertaking acquires a group of assets that does not constitute a
business, it must allocate the cost between the individual identifiable assets
and liabilities in the group, based on their relative fair values at the date of
acquisition.
The transaction may be between the shareholders of the combining
undertakings, or between one undertaking and the shareholders of another
undertaking.
It may involve the establishment of a new undertaking to control the combining
undertakings or net assets transferred, or the restructuring of one or more of
the combining undertakings.
EXAMPLES-Methods of purchase
1. Your shareholders and the shareholders of another company merge
your companies by issuing shares in a new company that will
encompass both companies.
2. Your company pays cash to the shareholders of another company to buy
their business.

EXAMPLE-Buying assets A business combination may result in a parent-subsidiary relationship in which

You buy some assets, including lists of clients, from a firm that is being
liquidated. This is not a combination and should be treated as a purchase of
assets. The cost will be allocated to the assets purchased, based on their
fair values.
A combination may be structured in a variety of ways for legal, taxation, or
other reasons. It may involve
(i) purchase of the equity of another undertaking,
the acquirer is the parent and the acquiree its subsidiary. In such
circumstances, the acquirer applies IFRS 3 in its consolidated financial
statements.
EXAMPLE-Buying a business - parent-subsidiary relationship
Your company the acquirer buys 100% of another company the acquiree.
Your company is the parent. The acquiree is the subsidiary.
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As the purchase method views a combination from the acquirer’s perspective,

It includes its interest in the acquiree, in any separate financial statements, as
an investment in a subsidiary see IAS 27.
A combination may involve the purchase of the net assets, including any
goodwill, rather than the purchase of the equity. Such a combination does not
result in a parent-subsidiary relationship.
it assumes that one of the parties can be identified as the acquirer.
Control
Control is the power to govern the financial and operating policies of an
undertaking.
An undertaking is presumed to have obtained control of another undertaking
when it acquires more than one-half of that other undertaking’s voting rights,
unless it can be demonstrated that such ownership does not constitute control.

EXAMPLE-Buying assets, including goodwill EXAMPLES- Control

You pay $5m to buy assets worth $3m from a firm that is being liquidated. 1.You buy 60% of a company. This entitles you to 60% of the votes at
The additional $2m premium is called goodwill. This is not a combination and shareholders meetings. You have control, even though the other 40% of the
should be treated as a purchase of assets. The cost will be allocated to the votes are in the hands of others.
assets purchased, based on their fair values. 2. You own 100% of a firm in the defence industry. The government appoints
I/B DR CR the directors of this firm. You do not have control, as the government-
Assets various B $3m appointed directors may not follow your policies.
Cash B $5m
Goodwill B $2m Even without one-half of the voting rights control may be obtained in other
Purchase of assets ways.
i power over more than one-half of the voting rights of the other undertaking,
4. METHOD OF ACCOUNTING by virtue of an agreement with other investors; or

All combinations must be accounted for by applying the purchase method. The
purchase method views a combination from the perspective of the acquirer.
This means that the accounting will always reflect one undertaking buying
another, even if the combination is regarded as a merger of equals.
The acquirer purchases net assets and records the assets, liabilities and
contingent liabilities.
APPLICATION OF THE PURCHASE METHOD
Applying the purchase method involves the following steps:
(i) identifying an acquirer;
(ii) measuring the cost of the combination; and
(iii) at the acquisition date, allocating, the cost of the combination to
the assets, liabilities and contingent liabilities acquired .
EXAMPLE- Control by agreement
You buy 40% of the voting shares in a foreign company. Other investors,
representing 35% of the company wish you to manage their investment and
sign an agreement that gives you their votes in all matters relating to the
company. You have control of the company
ii power to govern the financial and operating policies of the other undertaking
under a statute, or an agreement; or
EXAMPLE- Control by statute
Your firm is providing electricity. The government controls all sales tariffs and
your purchase prices. The government has control of your financial policies,
so has control of the firm.
iii power to appoint or remove the majority of the members of the
board of directors or equivalent of the other undertaking; or

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EXAMPLE- Control of board appointments
You own 100% of a firm in the defence industry. The government appoints
the directors of this firm. You do not have control, as the government-
appointed directors may not follow your policies.
iv power to cast the majority of votes at meetings of the board of
directors or equivalent of the other undertaking.
iii if the combination results in the management of one of the
undertakings being able to run the combined undertaking, the dominant
management is likely to be the acquirer.
EXAMPLE- Acquirer – management control
Your firm has a market value of $100m. You merge with another firm with a
market value of $120m. Your directors and management will run the
combination. As your firm has management control, your firm will be the
acquirer.

In a combination effected through an exchange of shares, the undertaking that

EXAMPLE- Control of votes
You buy 20% of the shares of a company. The capital structure of the
company entitles you to 60% of the votes at shareholders meetings. You
have control, even though the other 80% of the shares are in the hands of
others.
Identifying the Acquirer
Although sometimes it may be difficult to identify an acquirer, there are usually
indications that one exists. For example:
i if the fair value of one of the undertakings is greater than that of the other,
the greater is likely to be the acquirer;
EXAMPLE- Acquirer – the larger undertaking
Your firm has a market value of $100m. You merge with another firm with a
market value of $5m. As your firm is larger, it will be the acquirer.
issues the shares is normally the acquirer.
In ‘reverse acquisitions’, the acquirer ‘s shares are acquired.
EXAMPLE- Reverse acquisition
A private undertaking arranges to have itself ‘acquired’ by a smaller public
undertaking, as a means of obtaining a stock exchange listing.
‘Small’, a listed company, buys ‘Big’ a private company, in a reverse
acquisition. Big wants to become a quoted group, and this method is used.
The shareholders of Big buy the shares of Small. Big’s directors take control
of Small. Small then buys Big, in exchange for shares.
Small is the legal parent, but Big is the acquirer as it dictates the financial
and operating policies of Small.

ii if the combination is effected through an exchange of voting ordinary shares The allocation of the cost of the combination and the calculation of goodwill,
for cash or other assets, the undertaking giving up cash or other assets is is based on the net assets of Small.
likely to be the acquirer; and
Big’s assets are not revalued to fair value but Small’s are to establish the
cost of combination and goodwill.
EXAMPLE- Acquirer –Issuing shares
Your firm merges with another. Your firm pays $50m for the shares of the other
firm. Your firm is the acquirer.
I/B DR CR The power to govern the financial and operating policies defines the acquirer.
Investment in subsidiary B $50m
When a new undertaking is formed to issue shares to effect a combination,
Share capital B $50m
one of the undertakings that existed before the combination must be identified
Purchase of business- Issuing shares
as the acquirer, on the basis of the evidence available.

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EXAMPLE – New company formed for combination

Natasha and Alexandra companies merge. Their net assets are transferred
into a new company, Gemini and the original companies liquidated. Either
Natasha or Alexandra will be identified as the acquirer, based on the tests
described above. Even though the two companies have been liquidated, one
must be identified as the acquirer for accounting purposes.
Similarly, when a combination involves more than two undertakings, one that
existed before the combination must be identified as the acquirer on the basis
of the evidence available.
Determining the acquirer in such cases must include consideration of which of
the undertakings initiated the combination and whether the assets or revenues
of one of the undertakings exceed those of the others.
EXAMPLE- Initiator
Your company makes a bid for another listed company. The merger is
agreed.
Following tax advice, the other company buys the shares of your company
and becomes the legal parent. Nonetheless, your company is the acquirer,
as you initiated the combination.
When this is achieved through a single exchange transaction, the date of
exchange coincides with the acquisition date.
A combination may involve stages of successive share purchase. When this
occurs:
i the cost of the combination is the aggregate cost of the individual
transactions; and
ii the date of exchange is the date of each exchange transaction
This is that each individual transaction is recorded in the financial
statements of the acquirer.
EXAMPLE-combination in stages of successive share purchases
On 1st January, you agree to buy a company. You will buy 20% of the shares
on January 1st, another 50% on March 1st and the final 30% on June 1st.
You will pay a total of $200m for all the shares. This is the cost of the
combination.
The dates of exchange are January 1st, March 1st and June 1st.
The acquisition date is March 1st, as that is when you acquired voting control
of the company.

Cost of a combination Assets and liabilities in exchange for control of the acquiree must be measured
at their fair values at the date of exchange.
The acquirer must measure the cost of a combination as the aggregate of: If settlement of any part of the cost of a combination is deferred, the fair value
i the fair values at the date of exchange of net assets given in exchange for of the part is determined by discounting the costs to their present value.
control of the acquiree; plus This is at the date of exchange including any premium or discount, incurred in
ii any costs directly attributable to the combination. settlement.
EXAMPLE-Cost of a combination The published price at the date of exchange of a quoted equity instrument
You buy a company for $100m. You have incurred legal costs of $2m. provides the best evidence of the instrument’s fair value and must be used.
Your total cost is $102m
I/B DR CR EXAMPLE – Fair value- share price on the date of exchange
Investment in subsidiary B $102m You offer 1million of your shares for a company. You offer is accepted.
Cash B $100m At the date of exchange, your shares are quoted at $33 per share.
Legal costs I $2m Their par value is $10, so $23 (33-10) is treated as share premium.
Purchase of business - Cost of a
combination I/B DR CR
Investment in subsidiary B $33m
The acquisition date is the date on which the acquirer effectively obtains Share capital B $10m
control of the acquiree. Share premium B $23m
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Purchase of business- share price on the

date of exchange The costs of arranging and issuing financial liabilities eg a debt issue, are part
of the issue costs, even when the liabilities are issued to effect a combination.
The cost of a combination includes liabilities incurred or assumed by the They are not costs of the combination. Such costs reduce the proceeds from
acquirer, in exchange for control of the acquiree. the equity issue. (See IAS 39)

The cost includes any costs directly attributable to the combination, such as Adjustments to the cost of a combination contingent on future events
professional fees paid to accountants, legal advisers, valuers and other
consultants to effect the combination. When a combination agreement provides for an adjustment to the cost
contingent on future events, the acquirer must include the amount of that
General administrative costs, including the costs of maintaining an acquisitions adjustment in the cost of the combination at the acquisition date, if the
department, are not included in the cost of the combination but are expensed adjustment is probable and can be measured reliably.
when incurred.
EXAMPLE- Adjustments to the cost, contingent on future events
EXAMPLE – Costs included in a combination You buy a company for $60m. You will pay an additional $10m, if the profit
The company costs $60m. Accounting costs are $5m, legal costs are $6m. for the coming year is more than last year’s profit. This will be an adjustment
These are included in the cost of the combination. to the cost, which is contingent on future events. If it is probable that the
General overheads, relating to the acquisition team of $2m are expensed. target will be achieved, you will include the amount of that adjustment in the
I/B DR CR cost of the combination, at the acquisition date.
Investment in subsidiary B $71m
Cash B $60m It is usually possible to estimate the amount of any such adjustment but if
Accounting costs I $5m events do not occur or the estimate needs to be revised, the cost of the
Legal costs I $6m combination must be adjusted accordingly.
Purchase of business-cost aggregation
An adjustment is not included in the cost if it either is not probable, or cannot
Future losses or other costs expected to be incurred as a result of a be measured reliably. An adjustment that then becomes probable must be
combination, are not liabilities incurred for control of the acquiree and are not adjusted on the cost.
included as part of the cost of the combination.
In some circumstances, the acquirer may be required to make a subsequent
EXAMPLE-Future losses payment to the seller.
You buy a company for $30m. You plan to make staff cuts costing $4m to make
the company profitable. These are future losses and will not be included as EXAMPLE- Compensation for a reduction in shares issued
part of the cost of the combination. You buy a firm for $50m. Your seller wants cash. You prefer to issue shares.
I/B DR CR You agree to issue 50m shares priced at $1 per share. If the price falls within
Investment in subsidiary B $30m the first 3 months, you will issue more shares as compensation.
Cash B $30m The shares fall to $0,80. You provide an extra 12,5m shares in
Purchase of business compensation.

Contingent liabilities are not future losses. They are liabilities from the past, In such cases, no increase in the cost of the combination is recorded.
which have been estimated, or there is uncertainty as to whether they will be In the case of shares, the fair value of the additional payment is offset by an
paid. equal reduction in the value, attributed to the shares initially issued.

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The exceptions are non-current assets or disposal groups that are classified as
‘held for sale’ in accordance with IFRS 5, which must be recorded at ‘fair
value, less costs to sell’.

EXAMPLE- cost allocation

EXAMPLE-additional payment offset by a reduction in initial shares. You buy a group of companies for $45m. You are going to sell one division and
You buy a firm for $50m. Your seller wants cash. You prefer to issue shares. no selling cost will be incurred. Its ‘fair value, less costs to sell’ is $8m.
You agree to issue 50m shares priced at $1 per share. (The par value of each The remaining business assets are worth $50m, liabilities are worth $11 and
share is $0,10.) If the price falls within the first 3 months, you will issue more contingent liabilities are worth $2m. For cost allocation purposes, the following
shares as compensation. analysis is made:
The shares fall to $0,80. You provide an extra 12,5m shares in compensation.
I/B DR CR I/B DR CR
Net Assets-various B $50m Assets-various B $50m
Shares B $5m Cash B $45m
Share premium B $45m Liabilities-various B $11m
First issue of shares Contingent liabilities B $2m
Share premium B $10m Assets ‘held for sale’ B $8m
Shares (12,5m * $0,80) B $1m Purchase of business-cost allocation
Share premium B $9m
Second issue of shares The acquirer must record separately the acquiree’s identifiable assets,
liabilities and contingent liabilities at the acquisition date only if they satisfy the
In the case of debt instruments, the additional payment is regarded as a following criteria, at that date if:
reduction in the premium or an increase in the discount on the initial issue. i assets other than an intangible assets – it is probable that any
associated benefits will flow to the acquirer and its fair value can be
EXAMPLE-additional payment offset by a reduction in debt instruments. measured reliably;
You buy a firm for $100m. Your seller wants cash. You prefer to issue bonds. ii liability other than a contingent liability - it is probable that payment will
You agree to issue 100m shares priced at $1 each. If the price falls within the be required to settle the obligation and its fair value can be measured
first 3 months, you will issue more bonds as compensation. reliably;
The bonds fall to $0,80. You provide an extra 25m bonds in compensation. iii intangible assets or a contingent liabilities - its fair value can be
I/B DR CR measured reliably.
Net Assets-various B $100m
Bonds B $100m The consolidated accounts must reflect the values at acquisition.
First issue of bonds For example an asset in the acquiree’s book at $5m may have, at acquisition,
Discount on bonds B $20m a value of $7m. In the consolidated accounts the depreciation charge made in
Bonds (25m * $0,80) B $20m the subsidiary income statement will be based on $7m.
Second issue of bonds

Allocating the cost to the assets acquired.

At the acquisition date, the acquirer must allocate the cost of a combination
according to the fair values of identifiable assets and liabilities acquired.
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EXAMPLE-income statement, based on the costs to the acquirer EXAMPLE- minority’s proportion of the net fair value
You buy a foreign company. It has a building that cost $80m, 10 years before You have bought 80% of a company for $400m. Its assets are valued at $700m
the merger. It is being depreciated over 20 years, at $4million per year. It now and its liabilities are valued at $500m.
has a carrying value of $40m (80m-10years*4m). You are told that you cannot It will be consolidated at the date of purchase as follows:
revalue the property in the local accounts. I/B DR CR
The building will continue to be depreciated at $4million per year, in the local Assets-various B $700m
accounts. Liabilities-various B $500m
In your consolidated accounts, the fair value is now $100m. You will depreciate Minority interests 20% * $500m B $40m
it over the remaining 10 years of its life, at $10m per year. Goodwill $240m
Your consolidation adjustments will be: Investment in subsidiary B $400m
I/B DR CR Consolidation adjustment at acquisition
Property –cost B $80m
Property-accumulated depreciation B $40m Acquiree’s identifiable assets and liabilities
Property –revalued B $100m
Revaluation reserve B $60m (i) As part of allocating the cost of the combination, the acquirer must
Consolidation adjustment at acquisition record existing liabilities for restructuring or for reducing the activities
Property –depreciation I $6m of the acquiree.
Property-accumulated depreciation B $6m
Year 1 additional charge in consolidated EXAMPLES- liability for restructuring
accounts 1. You buy a group of companies. A month before the purchase, the
Revaluation reserve B $6m previous management had announced plans to close a division and
Retained earnings B $6m made a provision for restructuring. This provision can be used by you as
Reserve movement see IAS16 workbook part of allocating the cost of the combination.
2. You buy a company for $80m. You plan to make staff cuts costing $5m
Application of the purchase method starts from the acquisition date, which is to make the company profitable. These are future losses and will not be
the date on which the acquirer effectively obtains control of the acquiree. included as part of the cost of the combination. The acquiree did not
have an existing liability for restructuring at the balance sheet date.
It is not necessary for a transaction to be finalised before the acquirer obtains
control. All pertinent facts surrounding a combination must be considered, in (ii) the acquirer, when allocating the cost of the combination, must not
assessing when the acquirer has obtained control. record liabilities for future losses or other costs expected to be
incurred, as a result of the combination.
EXAMPLE – Control, but transaction to be finalised
You buy a company. You have paid, have a binding agreement, but some A payment that an undertaking is contractually required to make is regarded as
registrations have yet to be completed before you become the legal owner. a contingent liability, until it becomes probable that a combination will take
Nonetheless, you have control, for accounting purposes. place.

As the acquirer records the acquiree’s identifiable assets, liabilities and
contingent liabilities at their fair values at the acquisition date, any minority
interest in the acquiree is stated at the minority’s proportion of the net fair
value of those items.
EXAMPLE-Golden parachutes
Your board members will each be paid $1m if the company is sold
‘golden parachutes’. This is a contingent liability, until it is likely that the
company will be sold. It is then reclassified as a liability and recorded by the
acquirer, as part of allocating the cost of the combination.

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The contractual obligation is recorded when a combination becomes probable
and the liability can be measured reliably.
When the combination is effected, such a liability of the acquiree is recorded
by the acquirer, as part of allocating the cost of the combination.
An acquiree’s restructuring plan conditional upon being acquired is neither a
present obligation nor a contingent liability before the combination.
Therefore, an acquirer must not record a liability for such restructuring plans,
as part of allocating the cost of the combination.
EXAMPLE- conditional restructuring plans
You are going buy a group of companies. A condition is that the acquiree
records provisions for restructuring, that will occur if the merger occurs.
These provisions cannot be used as part of allocating the cost of the
combination.
The identifiable assets and liabilities include all of the acquiree’s financial
assets and financial liabilities.
They might also include assets and liabilities not previously recorded in the
acquiree’s financial statements, eg because they did not qualify for recognition
before the acquisition.
EXAMPLE- assets not previously recorded in the acquiree’s financial
statements
You buy a business that has been generating tax losses for many years. The
tax credits have not been recorded, as there was no likelihood of them being
used. You will bring in contracts that will make the business profitable. The
tax authorities have confirmed that you will be able to use the brought-
forward losses. These tax losses can be valued as an asset as part of
allocating the cost of the combination.
Combination achieved in stages
A combination may involve more than one exchange transaction, for example
when it occurs in stages by successive share purchases.
If so, each exchange transaction must be treated separately by the acquirer.
Business Combinations
The cost of the transaction and fair value information at the date of each
exchange transaction is used to determine the amount of any goodwill
associated with that transaction.
This results in a step-by-step comparison of the cost and fair values at each
step.
The fair values of the acquiree’s net assets may be different at the date of
each exchange transaction.
As:
i the acquiree’s net assets are notionally restated to their fair values at
the date of each exchange transaction to determine the amount of any
goodwill associated with each transaction; and
ii the acquiree’s net assets must then be recorded by the acquirer at
their fair values at the acquisition date,
any adjustment to those fair values, relating to previously held interests of the
acquirer and must be accounted for as a revaluation.
EXAMPLE - Property, Plant and Equipment acquired
You buy a company whose fixed assets are in the acquiree’s books at $12m.
Their fair value is $14m, which you record in your consolidated statements.
I/B DR CR
Property, Plant and Equipment B $2m
Revaluation reserve B $2m
Property, Plant and Equipment revaluation
For the classifications of IAS 16 Property, Plant and Equipment, the fair value
of the assets when acquired is their cost to the group, not a revaluation.
EXAMPLE - Property, Plant and Equipment acquired
You buy a company whose fixed assets are in the acquiree’s books at $12m.
Their fair value is $14m, which you record in your consolidated statements.
These are classified as ‘Property, Plant and Equipment stated at cost’ in the
notes not as ‘Property, Plant and Equipment at valuation’.
Before qualifying as a combination, a transaction may qualify as an investment
in an associate and be accounted for in accordance with IAS 28, using the
equity method.
In applying the equity method to the investment., the fair values of the
investee’s identifiable net assets at the date of each earlier exchange
transaction will have been determined previously,
12

EXAMPLE - Combination achieved in stages
You agree to buy a company. You will buy 20% of the shares on January 1st,
another 50% on March 1st and the final 30% on June 1st.
On January 1st the company will be an associate. On March 1st it will become
a subsidiary.
5. Allocating the cost of a combination
IFRS 3 requires an acquirer to record the acquiree’s net assets, at their fair
values, at the acquisition date. For the purpose of allocating the cost of a
combination, the acquirer must treat the following measures as fair values:
1 for financial instruments, traded in an active market, the acquirer must
use current market values.
2 for financial instruments not traded in an active market, the acquirer
must use estimated values that take into consideration features such
as price-earnings ratios, dividend yields and expected growth rates of
comparable instruments of undertakings with similar characteristics.
3 for receivables, beneficial contracts and other identifiable assets, the
acquirer must use the present values of the amounts to be received,
determined at appropriate current interest rates, less allowances for
doubtful debts and collection costs.
Discounting is not required for short-term receivables, beneficial contracts and
other identifiable assets, unless the impact is material.
(4) for inventories of:
i finished goods and merchandise, use selling prices less the sum of the
costs of disposal and a reasonable profit allowance.
Profit is based on the selling effort, and profit for similar finished goods and
merchandise;
ii work in progress, use selling prices of finished goods less the sum of:
(1) costs to complete, costs of disposal and a reasonable profit allowance for
the completing and selling effort based on profit for similar finished goods;
iii raw materials, use current replacement costs.
5 for land and buildings, use market values.
6 for plant and equipment, use market values, normally determined by
appraisal.
If there is no market-based evidence of fair value, because of the specialised
nature of the item of plant and equipment and the item is rarely sold, except as
part of a continuing business, estimate fair value, using an income, or a
depreciated replacement cost, approach.
Business Combinations
7 for intangible assets, the acquirer must determine fair value:
i by reference to an active market, as defined in IAS 38; or
ii if no active market exists, on a basis that reflects the amounts the
acquirer would have paid for the assets, in transactions between
independent willing parties, based on the best information available
see IAS 38.
8 for net employee benefit assets or liabilities for defined benefit plans,
the acquirer must use the present value of the defined benefit
obligation, less the fair value of any plan assets.
9 for tax assets and liabilities, the acquirer must use the amount of the
tax benefit arising from tax losses or the taxes payable in accordance
with IAS 12 Income Taxes, assessed from the perspective of the
combined undertaking.
The tax asset or liability is determined, after allowing for the tax effect of
restating net assets to their fair values and is not discounted.
10 for accounts and notes payable, long-term debt, liabilities, accruals
and other claims payable, use the present values of amounts to be
paid in settling the liabilities, determined at appropriate current interest
rates.
Discounting is not required for short-term liabilities, unless the impact
is material.
11 for onerous contracts and other identifiable liabilities of the acquiree,
the acquirer must use the present values of payments in settling the
obligations, determined at appropriate current interest rates.
12 for contingent liabilities of the acquiree, the acquirer must use the
amounts that a third party would charge to assume those contingent
liabilities. Such an amount must reflect all expectations about possible
cash flows and not the single most likely nor the expected maximum,
or minimum, cash flow.
Present value techniques may always be used in estimating the fair values.
6. Intangible assets
The acquirer records an intangible asset at the acquisition date, only if it meets
the definition of an intangible asset in IAS 38.
13
 Business Combinations

EXAMPLE – acquiree intangible assets ii the acquirer must disclose the information about that contingent
The acquirer records as an asset separately from goodwill an in-process liability see IAS 37.
research and development project of the acquiree, as it meets the definition of
an intangible asset and its fair value can be measured reliably. After their initial recognition, the acquirer must measure contingent liabilities at
the higher of:
Identifiability criteria i the amount that would be recorded under IAS 37 and
ii the amount initially recorded.
Is the intangible asset:
i is separable, capable of being separated or divided from the undertaking The acquirer must disclose for those contingent liabilities, the information
and sold, transferred, licensed, rented or exchanged, either individually or required by IAS 37, for each class of provision.
together with a related contract, asset or liability; or
ii arises from contractual or legal rights, regardless of whether those rights
are transferable or separable from the undertaking, or from other rights 7. Goodwill
and obligations.
The acquirer must, at the acquisition date:
Previously recorded intangible assets i record goodwill acquired in a combination as an asset; and
ii initially measure that goodwill at its cost.
The carrying amount of an item classified as an intangible asset that either: This is the net fair value of the identifiable assets, liabilities and
i was acquired in a combination before 31 March 2004 or contingent liabilities less the cost.
ii arises from an interest in a jointly-controlled undertaking obtained
before 31 March 2004 and accounted for by applying proportionate EXAMPLE- Goodwill calculation
consolidation You buy a group for $55m. You are going to sell one division no selling cost will
must be reclassified as goodwill at the beginning of the first annual period be incurred. Its ‘fair value, less costs to sell’ is $8m. For the remaining
beginning on or after 31 March 2004, if that intangible asset does not at that business, assets are worth $50m, liabilities are worth $11 and contingent
date meet the identifiability criterion in IAS 38. liabilities are worth $2m.
The premium that you have paid for the group is $10m, as you have net assets
EXAMPLE- Previously recorded intangible assets of only $45m for the $55m you have paid:
You have $36m of assets that were classified as intangibles, prior to 31 March I/B DR CR
2004. They no longer meet the IAS 38 criteria. They will be written off, by Goodwill B $10m
reclassifying them as goodwill. Assets-various B $50m
I/B DR CR Cash B $55m
Goodwill B $36m Liabilities-various B $11m
Intangible assets- net B $36m Contingent liabilities B $2m
Intangible assets reclassified as goodwill Assets ‘held for sale’ B $8m
Purchase of business-cost allocation
Acquiree’s contingent liabilities
Goodwill represents a payment made by the acquirer, in anticipation of
The acquirer records separately a contingent liability as part of allocating the benefits from assets, that are not capable of being individually identified and
cost of a combination, only if its fair value can be measured reliably. separately recorded.
If fair value cannot be measured reliably:
i there is a resulting effect on the amount recorded as goodwill; and
14
 Business Combinations

After initial recognition, the acquirer must test goodwill acquired for impairment EXAMPLE-Goodwill Impairment
annually or more frequently and measure at cost, less any accumulated You purchase a group and pay $40m for the goodwill.
impairment losses. You do not amortise it.
You test it for impairment each year. At the end of the third year, you find that it
EXAMPLE-Goodwill Impairment is worth only $34m. You record an impairment loss of $6m.
You purchase a group and pay $20m for the goodwill. You do not amortise it. I/B DR CR
You test it for impairment each year. At the end of the third year, you find that it Goodwill B $6m
is worth only $14m. You record an impairment loss of $6m. Impairment loss - goodwill I $6m
I/B DR CR Year 3 Impairment loss
Goodwill B $6m
Impairment loss - goodwill I $6m If goodwill was previously recorded as a deduction from equity, it must not be
Year 3 Impairment loss recorded in the income statement:
(ii) on disposal of all or part of the business, to which that goodwill relates
Previously-recorded goodwill (iii) on impairment of a cash-generating unit to which the goodwill relates

For any goodwill that has been amortised, an undertaking must: Negative goodwill
i from the beginning of the first annual period beginning on or after 31
March 2004, discontinue amortising such goodwill; If the net assets acquired are worth more than the price paid, the surplus
ii at the beginning of the first annual period beginning on or after 31 negative goodwill is recorded immediately in the income statement.
March 2004, eliminate the carrying amount of the related accumulated
amortisation, with a corresponding decrease in goodwill; and Before doing so, all assets, liabilities and contingent liabilities should be
reviewed to ensure that they have been properly accounted for.
EXAMPLE - Revised accounting for goodwill
You bought a group for $800m. When the initial accounting for a combination EXAMPLE-Negative goodwill
was complete, you value net assets at $720m so goodwill is $80m (800m- You buy a group for $150m. The fair value of the net assets is $155m.
720m). At 31 March 2004, accumulated amortisation of the goodwill was $12m. The $5m is credited to the income statement.
You eliminate the accumulated amortisation, with a corresponding decrease in I/B DR CR
goodwill. Net assets-various B $155m
I/B DR CR Cash B $150m
Goodwill – Accumulated amortisation B $12m Negative goodwill I $5m
Goodwill B $12m Negative goodwill taken to the income
Elimination of accumulated amortisation of statement
goodwill
Previously-recorded negative goodwill
iii from the beginning of the first annual period beginning on or after 31
March 2004, test the goodwill for impairment in accordance with IAS The carrying amount of negative goodwill at the beginning of the first annual
36. period beginning on or after 31 March 2004 that arose from either
i a combination, for which the agreement date was before 31 March
2004 or
ii an interest in a jointly-controlled undertaking obtained before 31 March
2004 and accounted for by applying proportionate consolidation

15

must be derecognised at the beginning of that period, with a corresponding
adjustment to the opening balance of retained earnings.
EXAMPLE – Negative goodwill derecognition
At 31 March 2004, you are carrying negative goodwill of $55m, relating to an
earlier acquisition. You credit it to the opening balance of retained earnings.
I/B DR CR
Opening retained earnings B $55m
Negative goodwill B $55m
Negative goodwill derecognition
8. Provisional Accounting
If the initial accounting for a combination can be determined only provisionally
by the end of the period in which the combination is effected, the acquirer must
account for the combination using those provisional values.
EXAMPLE provisional values
You buy a group in November. At your year-end in December, some foreign
assets have yet to be fair valued. Provisional values can be used.
The acquirer must record any adjustments to those provisional values:
1 within twelve months of the acquisition date; and
2 use the correct values as of the acquisition date.
Any depreciation will be applied from the acquisition date (not the
adjustment date,
EXAMPLE – Date relating to the valuation
You buy a group in November. At your year-end in December, some foreign
assets have yet to be fair valued. When they are finally valued, the valuation
relates to the purchase date in November, not the date of the actual
valuation.
3. Goodwill must be adjusted from the acquisition date, to balance any
adjustment to the provisional values.
Business Combinations
EXAMPLE-Provisional valuation and the impact on goodwill
You buy a group in November for $700m. At your year-end in December, some
foreign assets have yet to be fair valued. Your provisional figures plus the
actual valuations of other assets value net assets at $680m. This yields a
goodwill figure of $20m 700m-680m.
When all the valuations are finalised, the value of all the net assets falls to
$650m. You increase goodwill to $50m 700m-650m.
I/B DR CR
Goodwill B $30m
Net assets-various B $30m
Revision of provisional valuation
4. comparative information is adjusted for revisions to the provisional
figures.
Adjustments after the initial accounting is complete
After the initial accounting is complete, adjustments must be recorded only to
correct an error in accordance with IAS 8.
EXAMPLE – Valuation errors
You buy a group. After you have completed the initial accounting for a
combination, you find that $7m of consignment inventory never existed.
This must be recorded as an error. See IAS 8
Adjustments to the initial accounting for a combination, after that accounting is
complete, must not be recorded for the effect of changes in estimates.
IAS 8 requires an undertaking to account for an error correction retrospectively
and to present financial statements as if the error had never occurred, by
restating the comparative information for the prior periods in which the error
occurred.
The carrying amount requiring correction must be calculated as if its fair value
had been recorded from the acquisition date.
Goodwill must be adjusted retrospectively by an equal amount.
16
 Business Combinations

EXAMPLE - Revised accounting for a combination and goodwill EXAMPLE - deferred tax less than goodwill
You buy a group for $700m. When the initial accounting for a combination is You bought a group for $800m and you value net assets at $725m so goodwill
complete, you value net assets at $680m so goodwill is $20m (700m-680m). is $75m (800m-725m).
When an error is found, the value of all the net assets falls to $650m. You In this example the goodwill is less than the deferred tax asset:
increase goodwill to $50m 700m-650m. A deferred tax asset of $90m has since been realised. It had not been
I/B DR CR recognised within the $725. Goodwill is eliminated, but no negative goodwill is
Goodwill B $30m created.
Net assets-various B $30m The deferred tax asset is shown as income and the goodwill reduction is
Revision of valuation expensed.
I/B DR CR
Recognition of deferred tax assets after the initial accounting is complete Goodwill – write off I $75m
Goodwill B $75m
If the potential benefit of the acquiree’s income tax loss carry-forwards or other Deferred tax asset B $90m
deferred tax assets did not initially satisfy the criteria for separate recognition, Tax I $90m
but is subsequently realised, the acquirer must record that benefit as income in Deferred tax asset recognition
accordance with IAS 12 Income Taxes.
Limited retrospective application
In addition, the acquirer must reduce the carrying amount of goodwill and
expense the amount of the reduction. The creation or increase in negative
An undertaking is permitted to apply the requirements of IFRS 3 to goodwill
goodwill must not result.
existing at any date before 31 March 2004, provided the undertaking also
applies IAS 36 and IAS 38 prospectively. All valuations and other information
EXAMPLE - Revised accounting for deferred tax and goodwill
must be obtained at the time of initial accounting for the combinations.
You bought a group for $800m. The initial value net of assets was $725m so
goodwill was $75m (800m-725m).
A deferred tax asset of $15m has since been realised. It had not been
recognised within the $725. Goodwill is decreased to $60m 800m-740m. 9. Reverse acquisitions
The deferred tax asset is shown as income and the goodwill reduction is
expensed.
In reverse acquisitions, the acquirer’s shares are acquired and the issuer is the
I/B DR CR
acquiree.
Goodwill – write off I $15m
Goodwill B $15m For example, a private undertaking arranges to have itself ‘acquired’ by a
Deferred tax asset B $15m smaller listed company to obtain a stock exchange listing.
Tax I $15m
Deferred tax asset recognition Legally the issuer is regarded as the parent and the acquiree is regarded as
the subsidiary. In control terms subsidiary may have the power to control the
financial and operating policies of the legal parent.

17

EXAMPLE-Reverse acquisition-parent and acquirer
‘Small’ buys ‘Big’ in a reverse acquisition.
Small is the legal parent, but Big is the acquirer as it dictates the financial
and operating policies of Small.
The allocation of the cost of the combination and the calculation of goodwill,
is based on the net assets of Small.
Big’s assets are not revalued to fair value but Small’s are to establish the
cost of combination and goodwill.
Reverse acquisition accounting determines the allocation of the cost of the
combination as at the acquisition date and does not apply to transactions after
the combination.
Cost of the combination
The cost of the combination includes the fair value of shares are issued as part
of the cost of the combination.
If there is no published price, the fair value of the shares can be estimated, by
reference to the fair value of the acquirer, or the fair value of the acquiree,
whichever is clearer.
In a reverse acquisition, the cost of the combination is deemed to have been
incurred by the legal subsidiary (legal acquirer).
EXAMPLE- Reverse acquisition-cost of combination
‘Small’ buys ‘Big’ in a reverse acquisition. The cost of the combination is
deemed to have been incurred by Big, in the form of shares issued by Big to
Small.
Preparation and presentation of consolidated financial statements
Consolidated financial statements, prepared following a reverse acquisition,
must be issued under the name of the legal parent, but described in the notes
as a continuation of the financial statements of the legal subsidiary ie the
acquirer for accounting purposes.
Business Combinations
EXAMPLE- Reverse acquisition-cost of combination
‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements
will be issued in the name of Small, but described as a continuation of those
of Big.
As such consolidated financial statements represent a continuation of the
financial statements of the legal subsidiary:
(i) the assets and liabilities of the legal subsidiary must be recorded in
those consolidated financial statements, at their pre-combination
carrying amounts.
EXAMPLE- Reverse acquisition-no asset revaluation to fair value
‘Small’ buys ‘Big’ in a reverse acquisition. Big’s assets are not revalued to
fair value, but remain at their carrying amounts from before the combination.
Small’s assets would be revalued, to establish the cost of combination and
goodwill.
Small’s net assets were $15m, revalued to $20m. Big’s net assets were
$100m, and have not been revalued.
(ii) the retained earnings and other equity balances must be the retained
earnings and other equity balances of the legal subsidiary,
immediately before the combination.
EXAMPLE- Reverse acquisition-retained earnings
‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements
will use Big’s retained earnings and other equity balances, rather than those
of small.
(iii) the amount recorded as issued shares must be determined by adding
the cost of the combination, to the issued equity of the legal subsidiary,
immediately before the combination.
EXAMPLE- Reverse acquisition-shares
‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements
show the amount of Big’s issued shares from before the merger, plus the
amount of additional shares issued by Small. This provides the total value.
The description of the number and type of shares will relate to the legal
capital of Small.
However, the equity the number and type of shares issued must reflect the
equity structure of the legal parent, including the shares issued by the legal
parent, to effect the combination.
iv comparative information must be that of the legal subsidiary.
18

EXAMPLE- Reverse acquisition- comparative information
‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements
show the comparative figures of Big for previous periods.
Reverse acquisition accounting applies only in the consolidated financial
statements.
In the legal parent’s separate financial statements, the investment in the legal
subsidiary is accounted for in accordance with the requirements in IAS 27.
EXAMPLE- Reverse acquisition- parent’s separate financial statements
‘Small’ buys ‘Big’ in a reverse acquisition. Small’s parent company balance
sheet shows Big as an investment in subsidiary.
Consolidated financial statements, prepared following a reverse acquisition,
must reflect the fair values of the net assets and contingent liabilities of the
legal parent the acquiree for accounting purposes.
EXAMPLE- Reverse acquisition- minority interests 2
‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders
choose not to sell to Small. They will be interested only in the results of Big,
as they have no stake in Small.
The cost of the combination must be allocated by measuring the identifiable
assets, liabilities and contingent liabilities of the legal parent, at their fair values
at the acquisition date.
Any excess of the cost of the combination, over the net fair value of those
items, must be accounted for as goodwill. The reverse is negative goodwill.
Minority interest
Some of the owners of the legal subsidiary may not exchange their shares for
those of the legal parent and they must be treated as a minority interest in the
consolidated financial statements, prepared after the reverse acquisition.
Business Combinations
EXAMPLE- Reverse acquisition- minority interests 1
‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders
choose not to sell to Small. They will be minority interests in the consolidated
financial statements.
The owners of the legal subsidiary that do not exchange their shares for
shares of the legal parent have an interest only in the results and net assets of
the legal subsidiary and not in the results and net assets of the combined
undertaking.
EXAMPLE- Reverse acquisition- minority interests 2
‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders
choose not to sell to Small. They will be interested only in the results of Big,
as they have no stake in Small.
Conversely, all of the owners of the legal parent, notwithstanding that the legal
parent is regarded as the acquiree, have an interest in the results and net
assets of the combined undertaking.
EXAMPLE- Reverse acquisition- minority interests 3
‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders
choose not to sell to Small. All Small’s shareholders have an interest in both
Small and Big..
As the assets and liabilities of the legal subsidiary are recorded in the
consolidated financial statements, at their pre-combination carrying amounts,
the minority interest must reflect the minority shareholders’ proportionate
interest in the pre-combination carrying amounts of the legal subsidiary’s net
assets.
EXAMPLE- Reverse acquisition- minority interests 4
‘Small’ buys ‘Big’ in a reverse acquisition. 25% of Big’s shareholders choose
not to sell to Small. As Big’s net assets have not been revalued to fair values
and remain at their $100m carrying value, from just prior to the merger. The
minority interests’ share remains at $25m, based on Big’s pre-combination
carrying amounts .
Earnings per share
19
 Business Combinations

The equity structure appearing in the consolidated financial statements, The calculation of earnings per share must be adjusted, to take into account a
following a reverse acquisition, reflects the equity structure of the legal parent, change in the number of the legal subsidiary’s issued ordinary shares, during
including the shares issued by the legal parent to effect the combination. those periods. See IAS 33.

EXAMPLE- Reverse acquisition- EPS 1

‘Small’ buys ‘Big’ in a reverse acquisition. The shares of Small are used for
the consolidated financial statements.
10. PRACTICAL ISSUES
For the purpose of calculating the weighted-average number of ordinary FAIR VALUE EXERCISE
shares outstanding the denominator, during the period in which the reverse
acquisition occurs: In-progress research and development is regarded as an intangible asset
(i) the number of ordinary shares, outstanding from the beginning of that when purchased.
period to the acquisition date, must be deemed to be the number of
ordinary shares issued by the legal parent to the owners of the legal Intangible assets do not need to be individually separable and should be
subsidiary; and recorded, even if negative goodwill arises.
(ii) the number of ordinary shares, outstanding from the acquisition date
to the end of that period, must be the actual number of ordinary shares Measurable contingent liabilities are now required to be recorded when
of the legal parent outstanding during that period. purchased.

ALLOCATING GOODWILL TO CASH-GENERATING UNITS CGU’s

EXAMPLE- Reverse acquisition- EPS 2
‘Small’ buys ‘Big’ in a reverse acquisition. Small had 100 shares issued prior
Allocation of goodwill needs objective support for each decision. The
to the merger. It then issued 2.000 shares to Big’s owners.
anticipated synergies of the merger should be identified, as the CGU’s (Cash
For calculating the EPS, 2.000 not 100 is the number of shares for the
Generating Units) will have to support the recoverable amount of goodwill or
period prior to the merger. 2.100 is the number following the merger.
suffer an impairment charge.
The disclosure requirements are exhaustive.
The earnings per share for each comparative period before the acquisition
date, must be calculated by dividing the income of the subsidiary by the They include information about goodwill and the CGU’s to which it is allocated.
number of shares issued by the parent to the owners of the subsidiary in the
reverse acquisition. Allocation should be made before the end of the accounting period following
the acquisition. Failure to do so has to be explained and may suggest that the
EXAMPLE- Reverse acquisition- EPS 3 acquisition was made without a clear strategic view.
‘Small’ buys ‘Big’ in a reverse acquisition. Small had 100 shares issued prior
to the merger. It then issued 2.000 shares to Big’s owners. Comparative EPS IMPAIRMENT TESTS
figures for previous figures should use Big’s earnings for the period and
divide them by 2.000 shares. Impairment tests must now be carried out annually for all CGU’s with goodwill,
or indefinite-lived intangible assets. Impairment tests have become a core
This assumes that there were no changes, in the number of the legal element in the day-to-day internal financial reporting process. The consistency
subsidiary’s issued ordinary shares during the comparative periods and during and robustness of management’s assertions over time is crucial.
the period, from the beginning of the period in which the reverse acquisition
occurred, to the acquisition date.

20

Goodwill amortisation has disappeared, but the transition rules do not require
restatement of past transactions, so there may be an immediate positive
impact on earnings.
More intangible assets will result in more amortisation.
The new treatments of limiting restructuring provisions and liquidating negative
will impact earnings.
The acquisition process will become more rigorous, from planning to
execution.
More thorough evaluation of targets and structuring of deals will be required, in
order to withstand greater market scrutiny.
TRANSITION PROVISIONS
First-time adopters.
Having a reporting date of 31 March 2004, or later, they must use IFRS 3, IAS
36 and IAS 38 for all periods covered by the first set of financial statements. All
comparative information for prior periods, must also apply these standards.
If the reporting date is 30 June 2004 and 2 years of comparatives are
presented, the firm must apply the rules from 1 July 2001.
Current preparer – no retrospective application
Calendar-year preparers will continue to amortise goodwill during 2004.
Amortisation will cease at 1 January 2005 and impairment tests will be carried
out during 2005, on historical goodwill.
Current preparer –retrospective application but no covered transactions
IFRS 3 may be retrospectively applied. This is easiest when there have been
no combinations in the prior periods. An early adopter does not amortise
goodwill in 2004, but must carry out an impairment test during 2004.
Current preparer –retrospective application transactions in the period
All relevant fair value information for purchase price allocation, for historic
mergers, must be available. It should have been collected when the
transactions occurred; it cannot be re-created after the fact.
A preparer will have the majority of the required information if it has reconciled
its financial statements to USGAAP, during the relevant periods, as the
procedures are similar.
Business Combinations
11. Combinations involving undertakings
under common control outside the scope of
IFRS 3
A combination involving undertakings under common control is a combination
in which all of the combining undertakings are ultimately controlled by the
same party or parties, both before and after the combination and that control is
not transitory.
A group of individuals must be regarded as controlling an undertaking when as
a result of contractual arrangements they collectively have the power to govern
its financial and operating policies.
A combination is outside the scope of IFRS 3 when the same group of
individuals has ultimate collective power to govern the financial and operating
policies of each of the combining undertakings and that power is not transitory.
An undertaking can be controlled by an individual or by a group, acting
together under a contractual arrangement and that individual or group may not
be subject to the financial reporting requirements of IFRSs.
The extent of minority interests in each of the combining undertakings before
and after, the combination is not relevant to determining whether the
combination involves undertakings under common control.
12. DISCLOSURE
An acquirer must disclose information that enables users to evaluate the
nature and financial effect, of combinations that were effected:
i during the period.
ii after the balance sheet date, but before the financial statements are
approved for issue.
The acquirer must disclose, for each combination that was effected during the
period:
i names and descriptions of the combining undertakings.
21

ii acquisition date.
iii percentage of voting shares acquired.
iv cost of the combination and the components of that cost, including any
costs directly attributable to the combination.
When shares are issued or issuable as part of the cost, the following must also
be disclosed:
i number of shares issued or issuable; and
ii fair value of those shares and the basis for determining that fair value.
If a published price does not exist for the shares at the date of exchange, the
assumptions used to determine fair value must be disclosed.
If a published price exists at the date of exchange, but was not used as the
basis for determining the cost of the combination, that fact must be disclosed
together with:
- reasons the published price was not used;
- method and assumptions used to attribute a value to the shares; and
- aggregate amount of the difference between the value attributed to
and the published price of, the shares.
iii details of any operations the undertaking has decided to dispose of, as a
result of the combination.
iv amounts recorded at the acquisition date for each class of the acquiree’s
assets, liabilities and contingent liabilities and unless disclosure would be
impracticable the carrying amounts of each of those classes, determined
in accordance with IFRSs, immediately before the combination.
If such disclosure would be impracticable, that fact must be disclosed, together
with an explanation of why.
v amount recorded in the income statement in as negative goodwill and
the line item in the income statement in which it is recorded.
vi description of the factors that contributed to a cost that results in the
recognition of goodwill—a description of each intangible asset that
was not recorded separately from goodwill and an explanation of why
the intangible asset’s fair value could not be measured reliably—or a
description of the nature of any negative goodwill.
vii amount of the acquiree’s profit since the acquisition date included in
the acquirer’s the income statement for the period, unless disclosure
would be impracticable. If impracticable, that fact must be disclosed,
together with an explanation of why this is the case.
The information must be disclosed in aggregate, for combinations effected
during the reporting period, that are individually immaterial.
Business Combinations
If the initial accounting for a combination that was effected during the period
was determined only provisionally, that fact must also be disclosed, together
with an explanation of why this is the case.
The acquirer must disclose the following information, unless impracticable:
i the revenue of the combined undertaking for the period, as though the
acquisition date for all combinations effected during the period had
been the beginning of that period.
ii the profit of the combined undertaking for the period, as though the
acquisition date for all combinations effected during the period had
been the beginning of the period.
If impracticable, that fact must be disclosed, together with an explanation of
why this is the case.
The acquirer must disclose the information for each combination effected after
the balance sheet date, but before the financial statements are approved for
issue, unless impracticable.
If impracticable, that fact must be disclosed, together with an explanation of
why this is the case.
An acquirer must disclose information that enables users to evaluate the
financial effects of gains, losses, error corrections and other adjustments,
recorded in the current period, that relate to combinations that were effected in
the current or in previous periods.
The acquirer must disclose the following information:
1 the amount and an explanation, of any gain or loss recorded in the
current period that:
i relates to the identifiable assets acquired or liabilities, or contingent
liabilities assumed in a combination, that was effected in the current,
or a previous, period; and
ii is of such size, nature or incidence, that disclosure is relevant to an
understanding of the combined undertaking’s financial performance.
2 if the initial accounting for a combination, that was effected in the
immediately preceding period, was determined only provisionally at
the end of that period, the amounts and explanations of the
adjustments to the provisional values, recorded during the current
period.
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 Business Combinations

3 the information about error corrections, required to be disclosed by -fair value of the acquiree’s net assets
IAS 8, for any of the acquiree’s identifiable assets, liabilities or -purchase price paid by the acquirer.
contingent liabilities, or changes in the values assigned to those items.
Costs directly attributable to the merger, such as professional and legal fees,
An undertaking must disclose information, which enables users to evaluate will be expensed and not included in the cost.
changes in the carrying amount of goodwill, during the period.
When the combination is created by contract alone, the cost will be the fair
The undertaking must disclose a reconciliation of the carrying amount of value of the acquiree’s net assets. Costs directly attributable to the merger,
goodwill, at the beginning and end of the period, showing separately: such as professional and legal fees, will be expensed and not included in the
i the gross amount and accumulated impairment losses at the cost.
beginning of the period;
ii additional goodwill recorded during the period, except goodwill
included in a disposal group that, on acquisition, meets the criteria to
14. MULTICHOICE QUESTIONS
be classified as held for sale, in accordance with IFRS 5;
iii adjustments resulting from the subsequent recognition of deferred tax 1. IFRS 3:
assets, during the period; 1. Allows either the unitings of interest method, or the purchase
iv goodwill, included in a disposal group classified as held for sale, in method.
accordance with IFRS 5 and goodwill derecognised during the period, 2. Allows only the unitings of interest method.
without having previously been included in a disposal group classified 3. Allows only the purchase method.
as held for sale;
v impairment losses recorded during the period, in accordance with IAS 2. Under IFRS 3, acquired contingent liabilities are:
36; 1. Always included in the cost of combination.
vi net exchange differences arising during the period, in accordance with 2. Included in the cost of combination, only if they can be reliably
IAS 21; measured.
vii any other changes in the carrying amount during the period; and 3. Included in goodwill.
viii the gross amount and accumulated impairment losses, at the end of
the period. 3. Goodwill should be:
1.Tested annually for impairment.
The undertaking discloses information about the recoverable amount and 2. Held at cost.
impairment of goodwill. 3. Amortised.

4. Negative goodwill should be:

1. Matched to future losses.
13. PROPOSED AMENDMENTS TO IFRS 3 2. Allocated to non-current assets.
3. Recorded in the income statement.
Business combinations of mutual entities and undertakings brought together
5. The result of nearly all combinations is that the:
by contract alone were excluded from IFRS3, when it first appeared.
1. ‘Acquirer’ obtains control of the ‘acquiree’.
The IASB proposes to amend this to include both types of merger within IFRS
2. ‘Acquiree’ obtains control of the ‘acquirer’.
3. Such mergers would differ in measuring the cost of combination.
3. ‘Acquirer’ is a partner of the ‘acquiree’.
When both parties are mutual entities, the cost will be the aggregate of the
following:
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 Business Combinations

6. A combination may involve: iii If the combination results in the management of one of the
(i) The purchase of the equity of another undertaking. undertakings being able to run the combined undertaking, the
(ii) The purchase of all the net assets of another undertaking whose management is able to dominate is likely to be the
undertaking. acquirer.
(iii) The assumption of the liabilities of another iv In a combination effected through an exchange of shares, the
undertaking. undertaking that issues the shares is normally the acquirer.
(iv) The purchase of some of the net assets of another
undertaking, that together form one or more v In a combination effected through an exchange of shares, the older
businesses. undertaking is normally the acquirer.
(v) The purchase of assets from a firm in liquidation.
1. i – ii
1. i – ii 2. i – iii
2. i – iii 3. ii – iii
3. ii – iii 4. i – iv
4. i – iv 5. i–v
5. i–v
10. When a new undertaking is formed to effect a combination:
7. Applying the purchase method involves the following steps: 1. There will be no acquirer.
i Identifying an acquirer. 2. 0ne of the undertakings that existed before the combination
ii Measuring the cost of the combination. must be identified as the acquirer.
iii Allocating, at the acquisition date, the cost of the combination to the 3. The new undertaking will be the acquirer.
assets acquired and liabilities and contingent liabilities assumed.
iv Amortising the goodwill. 11. The cost of a combination includes:
(i) Liabilities incurred or assumed by the acquirer.
1. i – ii (ii) Professional fees paid to accountants.
2. i – iii (iii) Legal advisers’ fees.
3. ii – iii (iv) Valuers’ fees.
4. i – iv (v) General administrative costs

8. Control is the power: 1. i – ii

1. To govern the financial and operating policies of an 2. i – iii
undertaking. 3. ii – iii
2. To control more than 40% of the ordinary shares. 4. i – iv
3. Appoint board members in proportion to your shareholding. 5. i–v

9. To identify an acquirer, indications that one exists are:. 12. Future losses are:
i If the fair value of one of the undertakings is greater than that of the 1. Liabilities incurred for control of the acquiree.
other, the greater is likely to be the acquirer. 2. Included as part of the cost of the combination.
ii If the combination is effected through an exchange of voting ordinary 3. Neither 1 nor 2.
equity instruments for cash or other assets, the undertaking giving up
cash or other assets is likely to be the acquirer.

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 Business Combinations

13. For an adjustment to the cost of the combination contingent on future
events, the acquirer must include the amount of that adjustment in the
cost of the combination at the acquisition date, if the adjustment is:
1. Probable and can be measured reliably.
2. Certain and exactly measurable.
3. Payable within one year.
14. The acquirer may be required to make a subsequent payment to the
seller, as compensation for a reduction in the value of the shares issued
for control of the acquiree.
In such cases:
1. An increase in the cost of the combination is recorded.
2. The fair value of the additional payment is offset by an equal reduction
in the value, attributed to the shares initially issued.
3. An increase in goodwill is recorded.
15. The acquirer must allocate the cost of a combination, by recording
the acquiree’s identifiable:
17. You buy a company. You have paid, have a binding agreement, but
some registrations have yet to be completed before you become the
legal owner.
1. You have control, for accounting purposes.
2. You do not have control, for accounting purposes.
3. You have partial control, for accounting purposes.
18. Minority interest in the acquiree is stated:
1. Zero.
2. The minority’s proportion of the fair value the net assets.
3. The minority’s proportion of the fair value the assets.
19. An acquiree’s restructuring plan, whose execution is conditional
upon its being acquired in a combination is:
1. Not a present obligation of the acquiree.
2. A contingent liability.
3. A liability.

(i) Assets. 20. A tax benefit arising from the acquiree’s tax losses that was not
(ii) Liabilities recorded by the acquiree:
(iii) Contingent liabilities. 1.Qualifies for recognition as an identifiable, if it is probable that
(iv) Non-current assets that are as ‘held for sale’. the acquirer will have future taxable profits, against which the
(v) Non-current liabilities that are as ‘held for sale’. unrecorded tax benefit can be applied.
2. Will be included in goodwill.
1. i – ii 3. Will not be recognised.
2. i – iii
3. ii – iii 21. The acquirer records an in-process research and development
4. i – iv project of the acquiree, if the project meets the definition of an intangible
5. i – v asset and its fair value can be measured reliably:
1. As goodwill.
16. A building has a cost in the books of the acquiree of $200m. It is 2. As an asset separately from goodwill.
being depreciated over 20 years, the length of the lease. After 15 years, 3. Research as an expense, development as an intangible asset.
you buy the company and fair value the property at $400m. In the
consolidated books of account, annual depreciation will be recorded as: 22. The carrying amount of an item classified as an intangible asset that
1. $10m. was acquired in a combination, if that intangible asset does not at that
2. $20m date meet the identifiability criterion in IAS 38, for which the agreement
3. $27m date was before 31 March 2004, is recorded:
4. $80m 1. As goodwill.
2. As an asset separately from goodwill.
3. Research as an expense, development as an intangible asset.

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 Business Combinations

1. Directly to the income statement.

2. As an error in accordance with IAS 8.
23. After their initial recognition, the acquirer must measure contingent 3. As an impairment.
liabilities at:
(1) The amount that would be recorded under IAS 37. 30. A reverse acquisition is:
(2) The amount initially recorded. 1. A sale of a business.
(3) The lower of 1 and 2. 2. When a larger firm is bought by a smaller firm.
(4) The higher of 1 and 2. 3. When a private firm buys a listed firm.

24. Goodwill acquired in a combination must be: 31. In a reverse acquisition, consolidated accounts are prepared in the
1. Amortised. name of:
2. Tested for impairment annually. 1.The parent.
3. Tested for impairment annually, or more frequently, if required. 2.The subsidiary.
3. Either 1 or 2.
25. To eliminate amortisation on previously-recorded goodwill:
1. Credit to the income statement. 32. In a reverse acquisition, the opening retained earnings are those of:
2. Eliminate the carrying amount, with a corresponding decrease in 1.The parent.
goodwill. 2.The subsidiary.
3. Eliminate the carrying amount, with a corresponding increase in 3. Either 1 or 2.
opening retained earnings.
33. In a reverse acquisition, the comparative figures are those of:
26. To eliminate previously-recognised negative goodwill: 1.The parent.
1. Credit to the income statement. 2.The subsidiary.
2. Eliminate the carrying amount, with a corresponding decrease in 3. Either 1 or 2.
goodwill.
3. Eliminate the carrying amount, with a corresponding increase in 34. In a reverse acquisition, the minority interests have shares in:
opening retained earnings. 1.The parent.
2.The subsidiary.
27. When provisional values of net assets need to be amended, the 3. Either 1 or 2.
difference goes to:
1. The income statement. 35. In a reverse acquisition, the company whose assets are revalued are
2. Goodwill. those of:
3. Opening retained earnings. 1.The parent.
2.The subsidiary.
28. When provisional values of net assets need to be amended, the 3. Either 1 or 2.
differences will be applied:
1. From the date of acquisition. 36. ‘Small’ buys ‘Big’ in a reverse acquisition. Small had 500 shares
2. From the date of amendment. issued prior to the merger. It then issued 10.000 shares to Big’s owners.
3. Over the following 3 years. For calculating the EPS, the number of shares for the period prior to the
merger is:
29. Adjustments to the initial accounting for a combination, after that 1. 500.
initial accounting is complete, must be recorded: 2. 10.000
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 Business Combinations

3. 10.500 19. 1
20. 1
37. ‘Small’ buys ‘Big’ in a reverse acquisition. Small had 500 shares 21. 2
issued prior to the merger. It then issued 10.000 shares to Big’s owners. 22. 1
Comparative EPS figures for previous figures should use Big’s earnings 23. 4
for the period and divide them by: 24. 3
1. 500 shares. 25. 2
2. 10.000 shares. 26. 3
3. 10.500 shares. 27. 2
28. 1
38. The proposed amendment includes mutual undertakings under the
29. 2
scope of IFRS 3.
30. 2
The main difference would be:
31. 1
1. Costs directly attributable to the merger, such as professional and
legal fees, will be expensed and not included in the cost. 32. 2
2. Goodwill would not be subject to impairment tests. 33. 2
3. Fair values would not be used. 34. 2
35. 1
36. 2
37 2
15. Answers to multiple choice questions 38 1

Question Answer
1. 3
2. 2
3. 1
4. 3
5. 1
6. 4
7. 2
8. 1
9. 4
10. 2
11. 4
12. 3
13. 1
14. 2
15. 2
16. 4
17. 1
18. 2
27