IFRS 3: Business combinations

IFRS 3 pertains to business combinations, that is, mergers and amalgamations

or similar acquisitions of control over a business. IFRS 3 overrides IAS 22. The
traditional approach in accounting for business combinations was to allow
entities two options, referred to as the “purchase method” and the “pooling of
interest” method. The former method was said to be appropriate in cases where
one entity acquired the other; the latter method where two entities, almost like
equals, merged to form a third entity. The key difference between the “pooling
of interest” approach and the purchase approach was that in the former, the
assets/liabilities of the transferor entity came in the books of the transferee entity
at cost, the purchase method was treated as a purchase of the assets/liabilities of
the transferor by the transferee, and hence, assets and liabilities would come into
the books of the transferee at their fair values on the date of the acquisition.

While this was the traditional IAS approach, the US approach was to treat all
business combinations as purchase or acquisition.

IFRS 3 falls in line with the US method, and therefore, treats all business
combinations as acquisitions. Hence, it has one method for all business
combinations – purchase or acquisition method. Hence, the core feature is that
all identifiable assets/liabilities of the transferor entity are recognized in the
books of the transferee at their fair values on the date of the acquisition.

The scope of IFRS 3 extends to:

 All amalgamations and mergers where control is being acquired. As a

corollary, merger of entities already under common control is not a
business combination.
 All takeovers, where control over a business is being acquired. Acquisition
of assets or group of assets of a business is not a business combination.

As to whether the assets being acquired constitute a business or not, para B5 to

B12 provide guidance. A business is an integrated set of processes applied on
inputs, which give rise to an output. Commercial considerations are to be applied
whether what is acquired is simply piecemeal assets or a business. In real life
circumstances, disclosures made by the acquirer in shareholder communications
or press releases will also be relevant. There is a presumption that where goodwill
is present in an acquisition, a business is being acquired.
All business combinations are treated using the acquisition method. There are 4
key elements of applying the acquisition method:

 Identifying the acquirer

 Identifying the acquisition date
 Identifying the assets being acquired and the liabilities being taken over,
and putting the same at fair values
 Finding out the goodwill or gain pertinent to the acquisition

Vonod Kothari Consultant

Identification of the acquirer:

Identification of the acquirer is important because assets of the acquired entity
are stated at fair values in the books of the acquirer – that is, there is no change
in the assets/liabilities of the acquirer. Though it is not usually difficult to find
who is the acquirer in a business combination, difficulties may arise in case of
merger of equals, or reverse mergers. Paras B14 to B18 provide guidance.
Primarily, the entity that either pays, or the one that issues equity shares for
acquiring net assets is the acquirer. Other than these, there are several indicators
mentioned in Para B15.

Identification of the acquisition date:

Identification of the acquisition date as that is the date on which the
assets/liabilities of the acquired entity are fair-valued. Prima facie, the date of
payment of the consideration and the legal transfer of the assets/liabilities is the
date of acquisition. However, many acquisitions state the date from which the
acquisition will be operative. For instance, in India, it is common practice for
courts to order a merger to take effect from a retrospective date.

Identification of assets/liabilities and their initial recognition:

On the question of what assets/liabilities will be recognized on a business
combination, the answer is, whatever assets have been acquired and liabilities
taken over as a result of the business combination, and not arising out of separate
transactions. There might be assets that the acquirer may recognize, but which
the acquiree had not recognized – for example, patents or intangible assets that
were self-developed by the acquiree. The IFRS permits acquisition of such
assets.

The valuation of the assets/liabilities is to be done on their acquisition-date fair

values. The determination of fair values is done based on established fair
valuation techniques relevant to the asset/liability in question. Likewise, fair
value of the non-controlling interest, also known as minority interest, is
computed by applying the proportion of non-controlling interests to the net
assets of the acquiree entity.

While most assets/liabilities are fair valued on acquisition, certain items like
contingent liabilities, income-tax assets/liabilities, employee benefits,
indemnification assets, share based payment awards, etc., are not subject to the
usual fair valuation rules and are measured/valued as per specific rules applicable
to each such item.

Valuation of gain/goodwill:
If the aggregate of the consideration transferred, plus fair value of non-
controlling interests, exceeds the net asset value of the assets/liabilities are fair-
valued in accordance with the Standard, there is a goodwill on acquisition. Other
way round, there is a gain on acquisition. It is notable that the consideration
provided on acquisition also requires valuation. Acquisitions may involve, for
example, shares for assets, shares for shares, assets for assets, etc. In every case
where the consideration is other than cash, the question of fair valuation of the
consideration shall arise.

In case where the fair value of net assets is more than the fair value of the
consideration, the Standard treats the transaction as a bargain purchase, and the
gain on such bargain purchase is taken to profit and loss account. Paras 34-36
pertain to recognition of such gain.

An acquisition may also happen in stages. Paras 41-42 deal with acquisition in
stages. Likewise, an acquisition may not involve payment of consideration – this
special situation is covered by paras 43-44.

Subsequent measurement of assets/liabilities

The subsequent-to-acquisition-date valuation of assets/liabilities will be done as
per applicable IFRSs pertaining to the relevant asset/liability. However, the
Standard contains provisions about the following:

 reacquired rights: that is, intangible asset re-acquired on acquisition will

be amortised over the remaining period of the contract.
 contingent liabilities recognised as of the acquisition date: will be re-
assessed, and recognized at higher of the amount recognized as per IAS 37,
and initial recognition less cumulative amortization.
 indemnification assets: to be de-recognised when the indemnification asset
is realized, or ceases to be realizable.

contingent consideration: certain changes as mentioned in para 58 may be made

on the valuation of contingent consideration paid.