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

and costs of registering and issuing debt and equity securities. Under IFRS 3(2008), the acquirer is required to recognise acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities are recognised in accordance with IAS 32 (for equity) and IAS 39 (for debt). [IFRS 3(2008).53] This requirement is a change from IFRS 3(2004) where direct costs were included in the acquisition cost, but indirect costs were excluded. In explaining this change, the Basis for Conclusions notes: ‘The boards concluded that acquisition-related costs are not part of the fair value exchange between the buyer and seller for the business. Rather, they are separate transactions in which the buyer pays for the fair value of services received. The boards also observed that those costs, whether for services performed by external parties or internal staff of the acquirer, do not generally represent assets of the acquirer at the acquisition date because the benefits obtained are consumed as the services are received.’ [IFRS 3(2008).BC366] The Board rejected arguments that certain costs are unavoidable, or are taken into account by the buyer in deciding what it is willing to pay for the acquiree. The Board noted that the amount that a seller is willing to accept as consideration for its business does not vary with the costs incurred by different potential buyers. Also, the recoverability of costs is considered to be a matter that is separate from ‘the fair value measurement objective in the revised standards’.

[IFRS 3(2008).BC368] It has been pointed out that this change results in the treatment of acquisition-related costs in a business combination transaction being inconsistent with the treatment of direct incremental costs incurred in acquiring, for example, property, plant and equipment (capitalised in accordance with IAS 16 Property, Plant and Equipment), or inventory (capitalised in accordance with IAS 2 Inventories) The Board notes, in the ‘Feedback Statement’ issued with the new Standards, that it does not see this as a reason to delay change in the treatment of business combination costs.

It is suggested that, since the Board has introduced the requirement to expense acquisition costs within IFRS 3(2008), it only applies to financial statements in which a business combination is accounted for under IFRS 3(2008). It follows that this requirement does not extend to the individual financial statements of the investing or parent entity.

The Board has also identified a potential for abuse, whereby the acquirer might arrange for the seller to pay certain acquisition-related costs on its behalf in return for increased purchase consideration for the business combination. This is considered in section 9.3.5 above.

Goodwill/bargain purchase gain

10. Recognising and measuring goodwill or a gain from a bargain purchase 10.1 Measuring goodwill or a gain from a bargain purchase

Goodwill arising from a business combination is determined as:

[IFRS 3(2008).32]

Under IFRS 3(2004) the calculation of goodwill compared just two numbers, being the excess of the cost of the business combination over the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities. In a business combination achieved in stages, goodwill was determined as the sum of goodwill arising at each stage (or ‘step’) of the acquisition.

The revised treatment has expanded the calculation to involve potentially four numbers.

• As noted in section 8.3, under IFRS 3(2008), non-controlling interests can be measured on two bases – by reference to their share of the identifiable net assets of the acquiree or the fair value of the non-controlling interests. The latter measure results in the recognition of the non-controlling interest’s share of goodwill. Because non-controlling interests can be measured by alternative methods, it is necessary to include the non-controlling interests within the calculation of goodwill, and also to deduct the entire identifiable acquiree net assets (rather than only the acquirer’s share of those net assets). Example 10.1 below provides an illustration.

• As discussed in detail in section 2.2 of this guide, under IFRS 3(2008) a business combination occurs only at the date when an acquirer obtains control of an acquiree.

Accounting for a business combination therefore reflects the fair value of any previouslyheld equity interests in the acquiree. Under IFRS 3(2004), goodwill was calculated separately for each stage of a step acquisition. Business combinations achieved in stages are discussed in further detail in chapter 12.

Example 10.1 Calculation of goodwill

The implications of the choice between the alternatives for measuring non-controlling interests are discussed in section 8.3.2.

Goodwill/bargain purchase gain 10.2 Special situations 10.2.1 Share-for-share exchanges In a business combination in which the acquirer and the acquiree (or its former owners) exchange only equity interests, the fair value of the acquiree’s equity interests may be more reliably measurable than the fair value of the acquirer’s equity interests. If so, the acquirer should determine the amount of goodwill by using the fair value of the acquiree’s equity interests rather than the fair value of the equity interests transferred. [IFRS 3(2008).33] Use of the fair value of the acquiree’s equity interests in this situation, as an alternative to measuring the fair value of consideration transferred by the acquirer, is on grounds of reliable measurement only.

Consideration measured using acquiree’s equity An unlisted private equity entity acquires a listed entity through an exchange of equity instruments. The published price of the quoted equity instruments of the acquiree at the date of exchange is likely to provide a more reliable indicator of fair value than the valuation methods used to measure the fair value of the private acquirer’s equity instruments.

10.2.2 Business combinations with no consideration

Paragraph 33 of IFRS 3(2008) also deals with the situation of a business combination in which no consideration is transferred. This could occur where the acquiree repurchases equity interests from other investors such that the acquirer’s unchanged equity interest becomes a controlling interest, or a business combination achieved by contract alone.

In a business combination achieved without the transfer of consideration, goodwill is determined by using the acquisition-date fair value of the acquirer’s interest in the acquiree (measured using a valuation technique) rather than the acquisition-date fair value of the consideration transferred.

[IFRS 3(2008).33] The acquirer measures the fair value of its interest in the acquiree using one or more valuation techniques that are appropriate in the circumstances and for which sufficient data is available.

If more than one valuation technique is used, the acquirer should evaluate the results of the techniques, considering the relevance and reliability of the inputs used and the extent of the available data. [IFRS 3(2008).B46] Business combinations with no transfer of consideration are considered in more detail in chapter 13.

10.2.3 Mutual entities Earlier sections of this guide dealt with the change to include combinations involving mutual entities within the scope of IFRS 3(2008) (section 4.2.3), and the identification of the acquirer in such circumstances (section 6.3.2). This section deals with measurement issues.

When two mutual entities combine, the entity identified as the acquirer gives member interests in itself in exchange for the member interests in the acquiree. Thus consideration is paid, but its fair value is not readily determinable by reference to a market. IFRS 3(2008) recognises that it may be easier to fair value the entire member interest of the acquiree, rather than the incremental member interests given by the acquirer.

10.2.3.1 Consideration given

Accordingly, IFRS 3(2008) provides that where the fair value of the equity or member interests in the acquiree (or the fair value of the acquiree) is more reliably measurable than the fair value of the member interests transferred by the acquirer, the acquirer should determine the amount of goodwill by using the acquisition-date fair value of the acquiree’s equity interests instead of the acquisitiondate fair value of the acquirer’s equity interests transferred as consideration. [IFRS 3(2008).B47] This is an example of IFRS 3(2008) using the fair value of the acquiree to measure consideration as it is more reliably measurable than consideration given by the acquirer.

10.2.3.2 Basis of valuation Although they are similar in many ways to other businesses, mutual entities have distinct characteristics that arise primarily because their members are both customers and owners. Members of mutual entities generally expect to receive benefits for their membership, often in the form of reduced fees charged for goods and services or patronage dividends. The portion of patronage dividends allocated to each member is often based on the amount of business the member did with the mutual entity during the year. [IFRS 3(2008).B48] A fair value measurement of a mutual entity should include the assumptions that market participants would make about future member benefits as well as any other relevant assumptions market participants would make about the mutual entity. For example, an estimated cash flow model may be used to determine the fair value of a mutual entity. The cash flows used as inputs to the model should be based on the expected cash flows of the mutual entity, which are likely to reflect reductions for member benefits, such as reduced fees charged for goods and services.

[IFRS 3(2008).B49]

10.2.3.3 Identifiable net assets acquired

The acquirer in a combination of mutual entities recognises the acquiree’s net assets as a direct addition to capital or equity in its statement of financial position, not as an addition to retained earnings, which is consistent with the way in which other types of entities apply the acquisition method. [IFRS 3(2008).B47]

Goodwill/bargain purchase gain

Member interests given by the acquirer will be recognised directly in equity. IFRSs do not usually prescribe where within equity such items are classified. In this case, however, IFRS 3(2008) is specific that the amount recognised (equal to the acquiree’s identifiable net assets) should not be added to retained earnings.

Example 10.2.3.3 Combination of mutual entities X and Y are co-operative institutions owned by their customers who receive dividends in proportion to the amount of goods purchased. They combine, with X identified as the acquirer.

Members of Y become members of X.

A valuation of Y as an entity indicates a fair value of CU500,000. The fair value of Y’s identifiable net assets is CU400,000.

X records its acquisition of Y in its consolidated financial statements as follows:

The classification of member interests as either equity or a financial liability is determined by applying IAS 32.

10.3 Bargain purchases A bargain purchase is a business combination in which the net fair value of the identifiable assets acquired and liabilities assumed exceeds the aggregate of the consideration transferred, the noncontrolling interests and the fair value of any previously-held equity interest in the acquiree.

A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion. However, the recognition and measurement exceptions for particular items, as discussed in chapter 8, might also lead to the recognition of a gain (or a change in the amount of a recognised gain) on a bargain purchase. [IFRS 3(2008).35] 10.3.1 Accounting for a bargain purchase gain If, after applying the requirements in section 10.3.2 below, it is determined that the acquisition is a bargain purchase, the acquirer recognises the resulting gain in profit or loss on the acquisition date.

The gain is attributed to the acquirer. [IFRS 3(2008).34]

10.3.2 Reassessment required prior to recognising a bargain purchase gain An acquirer’s initial calculations under IFRS 3(2008).32 (see section 10.1) may indicate that the acquisition has resulted in a bargain purchase. Before recognising any gain, the Standard requires that the acquirer should reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed. The acquirer should recognise any additional assets or liabilities that are identified in that review. [IFRS 3(2008).36] The acquirer is then required to review the procedures used to measure the amounts that IFRS 3(2008) requires to be recognised at the acquisition date for all of the following:

[IFRS 3(2008).36] (a) the identifiable assets acquired and liabilities assumed;

(b) the non-controlling interest in the acquiree, if any;

(c) for a business combination achieved in stages, the acquirer’s previously-held equity interest in the acquiree; and (d) the consideration transferred.

The objective of the review is to ensure that the measurements appropriately reflect consideration of all available information as of the acquisition date. [IFRS 3(2008).36]

[IFRS 3(2008).IE46-IE49] On 1 January 20X5 AC acquires 80 per cent of the equity interests of TC, a private entity, in exchange for cash of CU150. Because the former owners of TC needed to dispose of their investments in TC by a specified date, they did not have sufficient time to market TC to multiple potential buyers. The management of AC initially measures the separately recognisable identifiable assets acquired and the liabilities assumed as of the acquisition date in accordance with the requirements of IFRS 3. The identifiable assets are measured at CU250 and the liabilities assumed are measured at CU50. AC engages an independent consultant, who determines that the fair value of the 20 per cent non-controlling interest in TC is CU42.