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«Business combinations and changes in ownership interests A guide to the revised IFRS 3 and IAS 27 Audit.Tax.Consulting.Financial Advisory. Contacts ...»

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Business combinations

and changes in

ownership interests

A guide to the revised

IFRS 3 and IAS 27

Audit.Tax.Consulting.Financial Advisory.


Global IFRS leadership team

IFRS global office

Global IFRS leader

Ken Wild


IFRS centres of excellence


Robert Uhl


Asia Pacific

Hong Kong Melbourne

Stephen Taylor Bruce Porter

iasplus@deloitte.com.hk iasplus@deloitte.com.au Europe-Africa Copenhagen Johannesburg London Paris Jan Peter Larsen Graeme Berry Veronica Poole Laurence Rivat dk_iasplus@deloitte.dk iasplus@deloitte.co.za iasplus@deloitte.co.uk iasplus@deloitte.fr Deloitte’s www.iasplus.com website provides comprehensive information about international

financial reporting in general and IASB activities in particular. Unique features include:

• daily news about financial reporting globally.

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• many IFRS-related publications available for download.

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• an electronic library of several hundred IFRS resources.

• all Deloitte Touche Tohmatsu comment letters to the IASB.

• links to several hundred international accounting websites.

• e-learning modules for each IAS and IFRS – at no charge.

• complete history of adoption of IFRSs in Europe and information about adoptions of IFRSs elsewhere around the world.

• updates on developments in national accounting standards.


1. Introduction 1

1.1 Summary of major changes 1

1.2 Convergence of IFRSs and US GAAP 3

2. Principles underlying the revised Standards 5

2.1 Entity concept 5

2.2 Crossing an accounting boundary involves a disposal 6

3. Acquisition method of accounting 9

4. Scope 12

4.1 Definition of a business combination 12

4.2 Transactions outside the scope of IFRS 3(2008) 12 4.2.1 Formation of a joint venture 13 4.2.2 Common control transactions 13 4.2.3 Combinations involving mutual entities 14

5. Identifying a business combination 16

5.1 Acquirer obtains control as a result of a transaction or an event 1

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FASB Financial Accounting Standards Board (US) GAAP Generally Accepted Accounting Principles IASB International Accounting Standards Board (the Board) IE Illustrative Examples (accompanying IFRS 3(2008)) IFRIC International Financial Reporting Interpretations Committee of the IASB and interpretations issued by that committee IFRS(s) International Financial Reporting Standard(s) IG Implementation guidance (accompanying IAS 27(2008)) NCI Non-controlling interest(s)

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SFAS Statement of Financial Accounting Standards (US standards) SIC Standing Interpretations Committee of the IASC (predecessor body to the IASB) and interpretations issued by that committee

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1. Introduction In January 2008, the International Accounting Standards Board (the IASB) issued a revised IFRS 3 Business Combinations and a revised IAS 27 Consolidated and Separate Financial Statements, referred to in this guide as IFRS 3(2008) and IAS 27(2008) respectively. In doing so, the Board completed phase II of its business combinations project, and achieved substantial convergence between International Financial Reporting Standards (IFRSs) and US Generally Accepted Accounting Principles (US GAAP) on these topics.

This guide deals mainly with accounting for business combinations under IFRS 3(2008).

Where appropriate, it deals with related requirements of IAS 27(2008) – particularly as regards the definition of control, accounting for non-controlling interests, and changes in ownership interests.

Other aspects of IAS 27 (such as the requirements to prepare consolidated financial statements and detailed procedures for consolidation) are not addressed.

1.1 Summary of major changes Five headline changes brought about by the 2008 Standards are set out in the following table, and explained below.

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• Acquisition costs All acquisition-related costs (e.g. finder’s fees, advisory, legal, accounting, valuation and other professional or consulting fees) are to be recognised as period expenses and generally written-off rather than added to goodwill (as previously). Costs incurred to issue debt or equity securities will continue to be recognised in accordance with the Standards on financial instruments. This change reflects the Board’s move to focus on what is given to the vendor as consideration, rather than on what is spent to achieve the acquisition. The change is explained further in section 9.4.

• Contingent consideration Consideration for an acquisition, including any contingent consideration arrangements, is recognised and measured at fair value at the acquisition date Subsequent changes in those fair values can only affect the measurement of goodwill where they occur during the ‘measurement period’ and are as a result of additional information becoming available about facts and circumstances that existed at the acquisition date. All other changes (e.g. due to the acquiree meeting an earnings target, reaching a specific share price, or meeting a milestone on a research and development project) are dealt with in accordance with relevant IFRSs. This will usually mean that changes in the fair value of consideration are recognised in profit or loss (e.g. where the contingent consideration is classified as debt under IAS 32 Financial Instruments: Presentation). This change is a further application of the Board’s move to focus on what is given to the vendor as consideration in the business combination.

The consequence is separation of, and separate accounting for, aspects of the transaction that are not part of the business combination. Contingent consideration is discussed in detail in section 9.2.

• Partial acquisitions A partial acquisition refers to the acquisition of a controlling interest, but with a proportion of acquiree equity interests held by other investors referred to as ‘noncontrolling interests’ (formerly ‘minority interests’). A choice is available, on an acquisition-byacquisition basis, to measure such non-controlling interests either at their proportionate interest in the net identifiable assets of the acquiree (which is the previous IFRS 3 requirement) or at fair value (which is a new option and is mandatory under US GAAP). The choice of method has a consequential effect on the balancing amount recognised as goodwill. The principle behind the treatment of non-controlling interests is explained more fully in section 2.1 below, and accounting guidance given in section 8.3.

• Step acquisitions A step acquisition refers to obtaining a controlling interest through two or more separate transactions. The Board has developed the principle that a change in control is a significant economic event. Accordingly, changes to IFRS 3 and IAS 27 work together with the effect that a business combination occurs, and acquisition accounting is applied, only at the date that control is achieved. Consequently, goodwill is identified and net assets remeasured to fair value only in respect of the transaction that achieved control, and not in respect of any earlier or subsequent acquisitions of equity interests. In measuring goodwill, any previouslyheld interests in the acquiree are first remeasured to fair value, with any gain recognised in profit or loss (including the reclassification to profit or loss of any gains previously recognised in other comprehensive income if this would be required on disposal). Similarly, on disposal of a controlling interest, any residual interest is remeasured to fair value and reflected in any profit or loss on disposal. The principle behind this treatment is discussed more fully in section 2.2 below, and step acquisitions explained more fully in chapter 12.


• Transactions with non-controlling interests Once control has been achieved and acquisition accounting applied, any subsequent transactions in subsidiary equity interests between the parent and non-controlling interests (both acquisitions and disposals that do not result in a loss of control) are accounted for as equity transactions. Consequently, additional goodwill does not arise on any increase in parent interest, there is no remeasurement of net assets to fair value, and no gain or loss is recognised on any decrease in parent interest.

Transactions with non-controlling interests are explained more fully in chapter 12.

A detailed list of the changes from the earlier Standards to the 2008 Standards is set out in Appendix 1.

1.2 Convergence of IFRSs and US GAAP Phase II of the business combinations project has resulted in more changes to US GAAP than to IFRSs. The table overleaf identifies the changes to IFRSs, changes to US GAAP, and changes common to both.


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Changes to both IFRSs and US GAAP

• Single goodwill recognition and measurement date.

• Acquisition costs expensed.

• Adjustments to contingent consideration generally recognised in profit or loss.

• Previously-held interests remeasured to fair value.

• Non-controlling interests at fair value (IFRS option).

• Transactions with non-controlling interests in equity.

Continuing differences between IFRSs and US GAAP are summarised in Appendix 2.

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2. Principles underlying the revised Standards Underlying the 2008 versions of IAS 27 and IFRS 3 is the development of two important principles.

2.1 Entity concept Although the Standards do not use the term ‘entity concept’, and the Board has noted that it ‘did not consider comprehensively the entity and proprietary approaches as part of the amendments to IAS 27 in 2008’, nevertheless, throughout the various phases of the business combinations project, Standards have changed conceptually both in respect of classification and measurement.

In respect of classification, the Standards have changed from the position where non-controlling interests were recognised separately from both shareholders’ equity and liabilities in a consolidated statement of financial position, and as a deduction in arriving at the ‘bottom line’ of a statement of comprehensive income, (which is usually described as a ‘parent concept’ or ‘proprietary concept’) to a position where non-controlling interests are part of equity (which is a feature of the ‘entity concept’). This change has occurred in two stages.

• Firstly, as part of the 2003 revision of IAS 27, the Board required minority interests (as they were then called) to be presented in the consolidated statement of financial position within equity, but separately from the equity of the shareholders of the parent. In the statement of comprehensive income, the minority’s share of net income was presented as an allocation rather than as a deduction within the statement. This reflected the Board’s view that a minority interest is not a liability of a group.

• Secondly, the 2008 amendments to IAS 27 implemented further changes as a consequence of their view that non-controlling interests (as they are now called) are part of equity. The effect is that transactions between non-controlling interests and parent shareholders which do not affect control are now reported as movements within equity such that goodwill is not recognised when parent interests are increased, and no profit or loss is recognised when parent interests are decreased (see section 12.3).

In respect of measurement, the Board did not fully implement the proposal in the 2005 Exposure Draft to focus on the fair value of the business combination and thereby require goodwill to be based on both parent and non-controlling interests measured at fair value (sometimes referred to as the ‘gross-up’ of goodwill, or the ‘full goodwill’ method). Rather, the Board has provided an option on an acquisition-by-acquisition basis which allows non-controlling interests to be measured initially at fair value or at a proportionate share of identifiable net assets (see section 8.3). The policy adopted to measure non-controlling interests impacts the initial measurement of goodwill, which is a residual number.

Underlying principles

The position in the 2008 versions of IFRS 3 and IAS 27 could therefore be described as a ‘partial entity concept’. As part of its Conceptual Framework project, the IASB has decided to issue an invitation to comment requesting comment on the ‘entity view’ of financial reporting. The IASB believes the ‘entity view’ is the only appropriate view and that the ‘proprietary/parent entity’ view is not appropriate.

Transactions that are reported wholly within equity

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2.2 Crossing an accounting boundary involves a disposal ‘Crossing an accounting boundary’ describes a change in the method of accounting (e.g.

measurement at fair value, equity accounting, proportionate consolidation or full consolidation) as a result of increasing or deceasing an equity interest in another entity. Prior to the 2008 revisions, a controlling interest achieved in stages was dealt with as a series of separate acquisition transactions with goodwill recognised as the sum of the goodwill arising on the separate transactions. On disposal, various approaches were used to measure residual interests, but commonly these were measured by reference to the residual proportion of previous carrying amounts (e.g. the residual share of net assets and goodwill).

Under the 2008 revisions, a business combination accounted for under IFRS 3 occurs only at the time that one entity obtains control over another, and does not apply to previous or subsequent transactions not involving a change in control. Any change in equity interests which crosses an accounting boundary causing a change in the method of accounting is regarded as a significant economic event.

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