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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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Employment contracts Employment contracts that are beneficial contracts from the perspective of the employer because the pricing of those contracts is favourable relative to market terms are one type of contract-based intangible asset.

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Use rights include rights for drilling, water, air, timber cutting and route authorities. Some use rights are contract-based intangible assets to be accounted for separately from goodwill.

Other use rights may have characteristics of tangible assets rather than of intangible assets.

An acquirer should account for use rights on the basis of their nature.

Example 8.4.

2.3E Technology-based intangible assets [IFRS 3(2008).IE39-IE44]

Examples of technology-based intangible assets are:

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Computer software and mask works Computer software and program formats acquired in a business combination that are protected legally, such as by patent or copyright, meet the contractual-legal criterion for identification as intangible assets.

Mask works are software permanently stored on a read-only memory chip as a series of stencils or integrated circuitry. Mask works may have legal protection. Mask works with legal protection that are acquired in a business combination meet the contractual-legal criterion for identification as intangible assets.

Databases, including title plants

Databases are collections of information, often stored in electronic form (such as on computer disks or files). A database that includes original works of authorship may be entitled to copyright protection. A database acquired in a business combination and protected by copyright meets the contractual-legal criterion. However, a database typically includes information created as a consequence of an entity’s normal operations, such as customer lists, or specialised information, such as scientific data or credit information. Databases that are not protected by copyright can be, and often are, exchanged, licensed or leased to others in their entirety or in part. Therefore, even if the future economic benefits from a database do not arise from legal rights, a database acquired in a business combination meets the separability criterion.

Title plants constitute a historical record of all matters affecting title to parcels of land in a particular geographical area. Title plant assets are bought and sold, either in whole or in part, in exchange transactions or are licensed. Therefore, title plant assets acquired in a business combination meet the separability criterion.

Trade secrets, such as secret formulas, processes and recipes

A trade secret is ‘information, including a formula, pattern, recipe, compilation, program, device, method, technique, or process that (a) derives independent economic value, actual or potential, from not being generally known and (b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.’ If the future economic benefits from a trade secret acquired in a business combination are legally protected, that asset meets the contractual-legal criterion. Otherwise, trade secrets acquired in a business combination are identifiable only if the separability criterion is met, which is likely to be the case.

Assets, liabilities and non-controlling interests 8.4.2.4 Assembled workforce and other items that are not identifiable The acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of the acquisition date. [IFRS 3(2008).B37] Example 8.4.

2.4A Assembled workforce [IFRS 3(2008).B37] An acquirer may attribute value to the existence of an assembled workforce, which is an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date. An assembled workforce does not represent the intellectual capital of the skilled workforce – the (often specialised) knowledge and experience that employees of an acquiree bring to their jobs, which would be included in the fair value of an entity’s other intangible assets, such as proprietary technologies and processes and customer contracts and relationships. Because the assembled workforce is not an identifiable asset to be recognised separately from goodwill, and any value attributed to it is subsumed into goodwill.

Example 8.4.

2.4B Agreements with independent contractors Although an entity’s arrangements with its independent contractors are similar in many ways to its arrangements with its at-will employees making up an assembled workforce, the existence of contractual arrangements with independent contractors can represent an intangible asset in some cases. Although individual employees might have employment contracts that are similar to arrangements with independent contractors, it is the collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date and this collection is not an identifiable asset.





Independent contractors are often engaged to perform specific tasks and are not employees of the organisation. There are often negotiated rights for the contractor to retain intellectual property generated during a contract phase. They usually provide services to a number of different entities. Accordingly, the nature of the relationship with independent contractors is often quite different to that with employees and, where that relationship leads to the existence of an intangible asset, it should be recognised and measured in accordance with IFRS 3(2008).

The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at the acquisition date. [IFRS 3(2008).B38]

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Example 8.4.

2.4C Potential contracts [IFRS 3(2008).B38] The acquirer might attribute value to potential contracts the acquiree is negotiating with prospective new customers at the acquisition date. The acquirer does not recognise those potential contracts separately from goodwill, because they are not themselves assets at the acquisition date. The acquirer should not subsequently reclassify the value of those contracts from goodwill for events that occur after the acquisition date. However, the acquirer should assess the facts and circumstances surrounding events occurring shortly after the acquisition to determine whether a separately recognisable intangible asset existed at the acquisition date.

Example 8.4.

2.4D Expansion of business In negotiating the purchase consideration, an acquirer may place significant value on the ‘critical mass’ or ‘base’ that an entity’s existing customers, sales channels and other systems may provide to allow a significant expansion of the business after the combination. Sometimes, the acquiree’s resources and systems are planned to be used in conjunction with the acquirer’s own.

In such an acquisition, the customer base of the acquiree at the acquisition date will usually be a separately identifiable intangible asset. However, where the acquirer attributes value to the future customers that the acquiree might obtain, this will not represent a separately identifiable asset and this amount should be subsumed within goodwill.

Example 8.4.

2.4E Future growth in monopoly businesses An acquiree may operate its business under a monopoly created by legislation. This might occur in telecommunications, utilities and similar industry sectors where individual entities are given rights to be the exclusive supplier of a utility or telecommunication service in a particular geographical region. Because of these monopoly rights, any future customers in that region will be required to use the acquiree to provide its service.

In these cases, the acquirer will usually ascribe significant value to the monopoly licence asset rather than customer-related intangible assets. In addition, future growth expected in the geographical region would be factored into the value of the monopoly licence rather than being subsumed within goodwill.

Assets, liabilities and non-controlling interests

The identifiability criteria determine whether an intangible asset is recognised separately from goodwill. However, the criteria neither provide guidance for measuring the fair value of an intangible asset nor restrict the assumptions used in estimating the fair value of an intangible asset.

[IFRS 3(2008).B40] Example 8.4.

2.4F Contract renewal [IFRS 3(2008).B40] The acquirer would take into account assumptions that market participants would consider, such as expectations of future contract renewals, in measuring fair value. It is not necessary for the renewals themselves to meet the identifiability criteria.

However there is an exception to this measurement principle for reacquired rights recognised in a business combination [see section 8.5.2].

Paragraphs 36 and 37 of IAS 38 provide guidance for determining whether intangible assets should be combined into a single unit of account with other intangible or tangible assets.

8.5 Exceptions to the recognition and measurement principles IFRS 3(2008) sets out limited exceptions to its general recognition and measurement principles.

This results in particular items being:

[IFRS 3(2008).21].

(a) recognised either by applying recognition conditions in addition to those set out at section 8.1 above, or by applying the requirements of other IFRSs, with results that differ from applying the recognition principle and conditions; or (b) measured at an amount other than their acquisition-date fair values.

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8.5.1 Contingent liabilities 8.5.1.1 Background IFRS 3(2004) required the contingent liabilities of the acquiree to be recognised and measured in a business combination at acquisition-date fair value. IFRS 3(2008) effectively reapplies the requirement of IFRS 3(2004) to measure at acquisition-date fair value regardless of probability, but retains a filter based on whether fair value can be measured reliably.

This may result in the recognition of contingent liabilities that would not qualify for recognition under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Consequently, IFRS 3(2008) also includes guidance on the subsequent measurement of contingent liabilities recognised in a business combination.

8.5.1.2 Requirements

IAS 37 defines a contingent liability as:

[IAS 37.10] (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control or the entity; or Assets, liabilities and non-controlling interests (b) a present obligation that arises from past events but is not recognised because:

(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) the amount of the obligation cannot be measured with sufficient reliability.

In a business combination, the requirements of IAS 37 are not applied in determining which contingent liabilities should be recognised as of the acquisition date. Instead, IFRS 3(2008) requires that the acquirer should recognise a contingent liability assumed in a business combination as of the

acquisition date if:

[IFRS 3(2008).23] • it is a present obligation that arises from past events; and • its fair value can be measured reliably.

Therefore, contrary to IAS 37, the acquirer recognises a contingent liability assumed in a business combination at the acquisition date even if it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation. [IFRS 3(2008).23]

8.5.1.3 Implications

In practice, the application of IAS 37 to past events focuses on the future outcome of those events. Where the occurrence or non-occurrence of an uncertain future event will determine whether an obligation will arise, it is classified as ‘possible’ under IAS 37, included within contingent liabilities, and therefore not recognised as a liability in the statement of financial position, but disclosed by way of note.

Under the fair value principle of IFRS 3(2008), the fact that there is a past event giving rise to ongoing uncertainty and, therefore, a present obligation, means that the risk has a fair value since the entity would rationally pay to have the risk removed. This is true regardless of the probability of outcomes. In practice, it will be necessary to determine whether a present obligation exists (recognised if reliably measurable), or whether there is just a possible obligation (not recognised).

The Board’s original intention was to revise IAS 37 as part of phase II of the business combinations project. At present, the Board is continuing its deliberations on this related topic.

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