Reporting Standards
IFRS 3 Business Combination
ISSUED OR LAST REVISED March 2004
EFFECTIVE DATE
Business combinations where the agreement date is on or after March 31, 2004.
PROBLEM AND PURPOSE
Entities may seek growth through acquisitions or organic means. Users should be able to conclude from financial statements which strategy has been followed and the way that acquisitions have contributed toward growth. The comparison of financial statements is adversely affected where entities are able to use either the pooling of interest methods or the purchase method to account for business combinations. There is also the danger that each method can give different results and that, therefore, entities may structure a business combination to achieve a particular accounting result. IFRS 3 aims both to improve the accounting treatment for business combinations and to con- tribute toward international convergence on the issue. The prohibition of the pooling method in Australia, Canada, and the United States was an impetus for the issue of IFRS 3.
EXCLUSIONS
• Joint venture
• Mutual entities such as mutual insurance companies
• The reorganization of a number of entities that are already under com- mon control
• The combination of separated entities by agreement to form a reporting entity by contract but without obtaining ownership interest
MAIN REQUIREMENTS
A business combination is the bringing together of separate entities or busi- nesses into one reporting entity and must be accounted for using the purchase method. The pooling of interests method is prohibited. The standard views the business combination from the perspective of the acquirer, and an ac- quirer must be identified.
One entity is deemed to have control if it acquires more than 50% of the voting rights, but this may be rebutted. Even without 50% of the voting rights, control may be regarded as being achieved by gaining power as fol- lows:
• Obtaining over 50% of the voting rights by means of an agreement with another investor
• To govern the controlled entity’s financial and operating policies by means of statute or agreement
IFRS 3 • 167
• To appoint or remove the majority of the board of directors
• To cast the majority of votes
From the acquirer’s perspective, the costs of the business combination are the sum of:
• The fair values, at the date of exchange, of assets given, liabilities in- curred or assumed, and equity instruments issued by the acquirer in ex- change for control of the acquiree; plus
• Any costs directly attributable to the combination.
If equity instruments are issued as consideration for the acquisition, the market price of those equity instruments at the date of exchange is the best evidence of fair value. If a market price does not exist, or is not considered re- liable, other valuation techniques are used to measure fair value.
The acquirer recognizes separately the acquiree’s identifiable assets, liabili- ties, and contingent liabilities at their fair value at the date of acquisition, ex- cept for non-current assets that are classified as held for sale in accordance with IFRS 5. Such assets held for sale are recognized at fair value less costs to sell. The acquirer has to satisfy the following recognition criteria at that date, irrespective of whether they had been previously recognized in the acquiree’s financial statements:
• Intangible assets of the acquiree at the acquisition date can only be rec- ognized if they meet the definition requirements and can be measured re- liably.
• Goodwill is the residual acquisition cost. It is recognized by the acquirer as an asset from the acquisition date and is initially measured as the ex- cess of the cost of the business combination over the acquirer’s share of the net fair values of the acquiree’s identifiable assets, liabilities, and contingent liabilities. Goodwill must not be amortized but must be tested for impairment at least annually.
• “Negative” goodwill arises where the cost of an acquisition is less than the share of identifiable net assets acquired. The standard considers such an amount as a result of an error either in the measurement of the ac- quiree’s net assets or in the cost of the combination. The cost of these two elements should be reassessed by the acquirer. If “negative” good- will still exists it should be regarded as a discount arising from a bargain purchase and the amount of discount should be recognized in the in- come statement.
IFRS 3 specifies the accounting treatment:
• For business combinations that are achieved in stages
• Where fair values can only be determined provisionally in the period of acquisition
• Where deferred tax assets are recognized after the accounting for the ac- quisition is complete
• For previously recognized goodwill, negative goodwill and intangible as- sets
MAIN DISCLOSURES
• Names and descriptions of combining entities
• Acquisition date
• Percentage of voting instruments acquired
• Cost of the combination
• Amounts recognized for assets, liabilities, and contingent liabilities
• Amount of negative goodwill recognized
• Profit or loss of acquiree since acquisition date that is included in the ac- quirer’s profit or loss
• The revenue and profit or loss for the combined entity should be shown as if the acquisition date for all business combinations had been the be- ginning of the period, where possible
EXAMPLES OF RELATED NATIONAL STANDARDS Canada: CICA Handbook 1581
Malaysia: MASB 21 New Zealand: FRS 36
IFRS 3 • 169