UNIT 2:IFRS 3 BUAINESS

COMBINATIONS
FINANCIAL ACCOUNTING 3A: AFE3871
2024
SCHOOL OF ACCOUNTING
GROUP STATEMENTS
Study:
1. Group Statements Volume 1, Chapter 2
2. Group Statements Volume 2, Chapter 9, specifically only:
• 9.5  consideration transferred and
• 9.7  measurement period (only high level)
WHERE ARE WE?

. Study unit 01: IAS 12 Income tax (GAAP Handbook)

Study unit 02: Business combinations (GS Vol 1 Chapter1)
Study unit 03: Revision, tax, adjustments and sundry aspects GS Chapter 6
Study unit 03: Pref. shares GS Vol 1 Chapter 6.17-6.23
Study unit 04: Interim acquisition (GS Chapter 8)
Study unit 05: IFRS 16 Leases (GAAP Handbook Chapter 10)
Study unit 06: Associates and Joint Ventures (GS Vol 2 Chapter 11)
Study unit 07: Complex groups (GS Vol 1 Chapter 7)
Study unit 08: Joint Arrangements (GS Vol 2 Chapter 12)
Study unit 09: Change in ownership (GS Vol 2 Chapter 13-14)
Study unit 10: Employee Benefits (GAAP Handbook Chapter 12)
Study unit 11: Cash Flows (Self study)
 STUDY OUTCOMES

• Explain and apply the purchase method;

• Recognise and measure the identifiable assets acquired, liabilities assumed
and non-controlling interest in the acquiree, including more advanced
types of assets and liabilities;
• Recognise and measure the consideration (cost of acquisition);
• Account for contingent consideration in a business combination;
• Account for the resulting goodwill or gain on bargain purchase;
• Discuss and apply the effect of the measurement period.
2 WAYS TO ACQUIRE A BUSINESS
COMBINATION (GS 2.2- 2.3)
BUYING EQUITY PURCHASE OF ASSETS
INTEREST AND LIABILITIES

The purchase of a The purchase/take-over of

controlling equity interest the assets and liabilities of
in another entity (i.e. another entity (i.e. not group
purchase >50% ordinary statements).
shares). H's books:
H's books: Dr Assets
Dr Investment S Not group
Cr Liabilities
Cr Bank Group Cr Bank statements
statements
Dr Goodwill (but use
(IFRS 3 principles
& IAS 27) of IFRS 3)
CONSEQUENCES
BUYING EQUITY PURCHASE OF ASSETS
. INTEREST AND LIABILITIES

Consequence? Consequence?
 Company becomes subsidiary  Net Assets belong to acquirer
 Goodwill/gain recognised in  Goodwill/gain recognised in
Consol AFS by means of pro- acquirer
forma journals  NO CONSOLIDATED AFS
 CONSOLIDATED AFS TO PREPARED
BE DRAWN FOR GROUP
(IFRS 10 consolidated AFS,
IFRS 12 Disclosure in other
IFRS 11 iro Joint Arrangements
entities)
ACQUIRING SHARES IN A BUSINESS
COMBINATION
SELF STUDY
Purchase the SHARES in another entity
In the separate AFS of Acquirer
a) Recognize consideration paid (No goodwill/bargain purchase arises on
acquisition date = No underlying A/L have been recognised in separate AFS,
thus Cost price of investment = Fair Value of consideration)
b) Measure investment in shares ito IFRS 9 (through P/L or OCI)
In the consolidated AFS of Acquirer
c) Ensure acquirer gained CONTROL over entity that represents a BUSINESS
. d) Recognize all identifiable assets and liabilities (Remember assets not
recognised in SoFP of acquiree, but recognisable in BC e.g. intangible assets or
contingent liabilities. Don’t recognise A/L that do not form part of BC)
e) Measure all identifiable assets and liabilities @ acquisition date @ Fair Value.
Assets and liabilities that cannot be measured reliably @ acquisition must be
measured at prelim fair values.
f) Measure the NCI – make choice between proportionate or FV method
(CONT)
SELF STUDY
Purchase the SHARES in another entity (continued)
In the separate AFS of Acquirer
e) Eliminate cost price of investment (FV of consideration) against FV of
equity of acquiree (Scap, RE and Reserves). Recognize NCI
f) Recognize goodwill (if cost price of inv + NCI > equity) or gain from
bargain purchase (if cost price of inv + NCI < equity) .
g) Assets and liabilities that could not be measured reliably @ acquisition
must be re-measured and adjusted during the measurement period.
(adjusted against A/L and other leg against goodwill or gain
h) All pro-forma journals passed @ acquisition could have post acquisition
impact (e.g. revaluation of depreciable asset revalued to @ acquisition
fair value)
i) Adjustments made to consideration during measurement period = also
against goodwill or the gain
ACQUIRING NET ASSETS IN A BUSINESS
COMBINATION
SELF STUDY
Purchase the NET ASSETS of another entity (In the separate AFS of the Acquirer)
a) The assets and liabilities acquired MUST constitute a BUSINESS
b) Recognize all identifiable assets and liabilities in separate AFS of acquirer.
(Remember assets not recognised in SoFP of acquiree, but recognisable in BC
e.g. intangible assets or contingent liabilities)
c) Measure all identifiable assets and liabilities @ acquisition date @ Fair Value in
separate AFS of acquirer
d) Recognize consideration
e) Recognize goodwill (if consideration > net assets) or gain from bargain
purchase (if consideration < net assets) in separate AFS of acquirer.
f) Assets and liabilities that could not be measured reliably @ acquisition must be
re-measured and adjusted during the measurement period in separate AFS of
acquirer. (adjusted against A/L and other leg against goodwill or gain)
g) Adjustments made to consideration during measurement period = also
against goodwill or the gain
EXAMPLE A - BUSINESS COMBINATION BY
ACQUIRING NET ASSETS
The net assets of S now belong to the acquirer, but no shares of S have been
purchased by the acquirer.
Goodwill/Gain on bargain purchase only may arise on purchase date
if there is a difference between the consideration transferred and the
value of net assets.
No Group Statements (Consolidated AFS) are prepared

In OWN Financial Statements:

Dr Assets xxx
Cr Liabilities xxx
Cr Bank, etc. (consideration) xxx
Dr/Cr Goodwill/Gain on bargain purchase (balancing) xxx
 EXAMPLE B - BUSINESS COMBINATION BY
ACQUIRING SHARES IN S
S now becomes a subsidiary of the acquirer
Goodwill/Gain on bargain purchase only arises on consolidation date.
Group Statements (Consolidated AFS) must be drawn up
In separate AFS of acquirer: Dr Investment in Subsidiary xxx
In consolidated AFS: Cr Bank xxx
 As part of consolidation process:

Dr Assets Acquired xxx Revalue assets and

Cr Liabilities Assumed xxx liabilities to IFRS 3
Dr/Cr Revaluation Surplus/Retained Earnings and D/Tax values (fair values)

Dr Equity at acquisition (Scap, RE and Reserves) xxx

Cr Investment in subsidiary (consideration) xxx
Cr Non-controlling interest (choice) xxx NCI if not 100%
shareholding
Dr/Cr Goodwill/Gain on bargain purchase (balancing) xxx
WHEN DO WE USE IFRS 3?
IFRS 3  applicable to all business combination transactions where control
is obtained
Regardless of whether shares were acquired or net assets
BUT have to acquire business
DEFINITION OF CONTROL & OF A BUSINESS
IFRS 10: Control is where an investor:
a. has power over the investee
b. Is exposure or rights to variable returns from its involvement
c. Has the ability to use power over the investee to influence the returns
DEFINITION OF A BUSINESS

Old Definition New Definition

An integrated set of activities An integrated set of activities

and assets that is capable of and assets that is capable of
being conducted and being conducted and
managed for the purpose of managed for the purpose of
providing a return in the form providing goods or services to
of dividends, lower costs or customers, generating
other economic benefits investment income (such as
directly to investors or other dividends or interest) or
owners, members or generating other income from
participants. ordinary activities.

• (inputs → processes → outputs).

CLARIFICATIONS BY THE NEW
DEFINITIONS
The amendments :
a) Clarify that to be considered a business, an acquired set of activities and assets must
include, @ a minimum, an input and substantive process that significantly contribute
to the ability to create outputs.
b) Remove the assessments of whether market participants are capable of replacing any
missing inputs of processes and continuing to produce outputs.
c) Add guidance and illustrative examples to help entities decide whether a substantive
process has been acquired.
d) Narrow the definitions of a business and of output by focusing on goods and services
provided to customers and by removing the reference to an ability to reduce cost; and
e) Add an optional concentration test that permits a simplified assessment of whether
an acquired set of activities and assets is not a business.
DIFFERENCES BETWEEN THE OLD & THE
NEW
Old guidance Why change?

Business Definition too broad

Defined in IFRS 3 Amendment clarifies

Focused on returns in the Definition How to

definition
form of dividends ,lower of What is apply
cost or other economic a business definition
benefits to investors and
others. in
CONCENTRATION TEST

Does the entity want to apply the concentration Consider general

test? (choice can be made for each
( )
No guidance
transaction)
Yes
Is substantially all of the fair Is substantially all of the fair
Test failed
value of the gross asset value of the gross assets (
(consider
acquired concentrated in a No
acquired concentrated in a the general
single identifiable asset? group of similar identifiable No
guidance
Yes assets? Yes

Test passed (Not a Test passed (Not a

)
business) business)
MINIMUM REQUIREMENTS TO MEET THE
DEFINITION OF A BUSINESS
minimum requirements to meet the definition of a business?
3 elements of a Explanation Examples
business
Inputs An economic resource that creates outputs or • tangible fixed assets
can contribute to the creation of outputs when • right-of-use assets
processes are applied to it. • intangible assets
• intellectual property
Processes A system, standard, protocol, convention or rule • strategic management
that when applied to an input, creates outputs processes
or can contribute to the creation of outputs. • operational processes
• resource management
processes
Outputs The result of inputs and processes applied to • revenue

those inputs that provide goods or services to

customers, generate investment income (such as
dividends or interest) or generate other income
from ordinary activities.
IS THE ACQUIRED PROCESS SUBSTANTIVE?
Does the acquired set of activities and assets have
outputs at the acquisition date?
yes Yes
No No

The acquired process is considered substantive if: The acquired process is considered
It is critical to the ability to continue producing substantive only if:
outputs, and the inputs acquired include an organised It is critical to the ability to
workforce with the necessary skills, knowledge, or develop or convert an acquired
experience to perform that process input or inputs into outputs
OR AND
It significantly contributes to the ability to continue The inputs acquired include BOTH
producing outputs and is considered unique or scarce an organised workforce that has the
or cannot be replaced without significant cost, effort, necessary skills, knowledge, or
or delay in the ability to continue producing outputs. experience to perform that process
(or group of processes) AND other
inputs that the organised workforce
could develop or convert into
outputs.
ILLUSTRATIVE EXAMPLE

Acquisition of a radio station An entity (Entity S) sells its radio

broadcasting assets to another entity (Entity R). The acquired set of
activities and assets sold comprise the broadcasting licence, the
broadcasting equipment and a broadcasting studio. At the acquisition
date, the fair value for each of the assets sold is considered similar. No
processes needed to broadcast the radio shows are sold, and there are
no employees or other assets, activities or processes included. Entity S
has stopped using the acquired set of activities and assets before the
date they are sold to Entity R.
Required: Discuss whether a business exists or not. (15 Marks)
SOLUTION

Analysis Entity R decides to apply the optional concentration test and determines that:
• the broadcasting equipment and the studio are not a single identifiable asset because the
equipment is not attached to the studio and can be separated without being costly or
causing a loss of use or fair value of either asset.
• the licence is an intangible asset, and the broadcasting equipment and studio are both
tangible assets belonging in different classes. As a result, the assets are not considered
similar to each other.
• there is a similar fair value for each of the single identifiable assets. Thus, the fair value of
the gross assets acquired is not substantially all concentrated in a single identifiable asset or
group of similar identifiable assets.
Therefore, the concentration test is failed. Entity R therefore assesses whether the acquired
set of activities and assets meets the minimum requirements to be considered a business.
The acquired set of activities and assets does not have outputs, because Entity S has
stopped broadcasting. Thus, Entity R applies the relevant criteria in IFRS 3 to determine
whether the process is substantive. As the set does not include an organised workforce, the
relevant criteria have not been met. Therefore, Entity R concludes that the acquired set of
activities and assets is not a business.
IFRS 3 IN A NUTSHELL

IFRS 3 determines mainly how goodwill is calculated by addressing the

following questions:
• How is the consideration for a business combination (e.g. the investment in
a subsidiary) determined?
• How is the acquirer’s interest in the fair value of the net assets of the
acquired entity (the “acquiree”) determined on the date of acquisition?
The difference between the above two issues is equal to goodwill
 TRANSACTION COSTS REVISION

IAS 27 Investment in H's books

UNDER IAS 27 AT IFRS 9

AT COST FAIR VALUE

movement profit/loss election via OCI

capitalise transaction exclude transaction capitalise transaction
costs costs costs
IFRS 3: CONSIDERATION PAID
Investment in H’s books = FV of assets given, liabilities incurred, and
equity issued (adjustment to CA  Gain/Loss in P/L)
• Discount (present value) if extended/deferred payment terms
• If debt/equity issued as part of consideration paid - transaction costs set
off/deduct according to IAS 32 & IFRS 9 – do not form part of business
combination
• Include FV of contingent consideration
• Exclude acquisition related transaction costs (Expense at group level – in
separate AFS treat differently.)
 E.g. – Advisory, Legal, accounting, valuation, admin etc.
 TRANSACTION COSTS SOLUTION
IAS 27 Investment in H's books

UNDER IAS 27 AT IFRS 9

AT COST FAIR VALUE

movement profit/loss election via OCI

exclude transaction capitalise transaction
capitalise transaction costs costs costs
DT Retained Earnings DT Retained Earnings
(transaction costs) 4,000 DO NOTHING IFRS 3 is the (transaction costs) 4,000
same - expense transaction
CT Goodwill (4,000) costs CT Goodwill (4,000)

Alternatively you can Dr Transactions cost (RE) and CR Investment before doing the at acquisition
journal
PURCHASE METHOD
All business combinations are accounted for according to the
acquisition/purchase method.
1. Identification of the acquirer.
2. Determining the acquisition date.
3. Recognition and measurement of the
o assets acquired,
o liabilities assumed and any
o non-controlling interest.
4. Recognition and measurement of goodwill or a gain from a bargain
purchase (including the determination of the consideration for the business
combination).
IDENTIFICATION OF THE ACQUIRER AND
2. ACQUISITION DATE
ENTITY that obtains control of the acquiree
ACQUIRER • usually transfers the cash or other assets, incurs the
liabilities or issues its equity instruments.
• Also refer to IFRS 3 par. B15 (a-e).

Date on which the acquired OBTAINS control

• (IFRS 3.9 – normally when consideration is
ACQUISITION transferred & Fair Value of A/L is
DATE determined – NB substance over form is
NOT considered  e.g. agreement date)
RECOGNISING & MEASURING OF ASSETS, LIABILITIES
AND NCI

RECOGNITION CONDITIONS
(see detail next slide)

MEASUREMENT PRINCIPLE
At acquisition date, all assets and liabilities recognized
Recognising &
at FAIR VALUE
measuring Assets,
Subsequently, in terms of other applicable standards
Liabilities and NCI

Determine fair value based on what

market would do
(regardless of what the acquirer
intends to do) - IFRS 13 principle
3. RECOGNISING & MEASURING OF ASSETS, LIABILITIES
AND NCI
NCI
RECOGNITION PRINCIPLE
identifiable assets = separable
(can be separately sold, transferred, or exchanged or it
arises from contractual or other legal rights)

We have already been doing this for "on book"

Recognising & assets/liabilities:
measuring Assets, Reval PPE at acquisition
Liabilities and NCI Reval Inventory at acquisition

But there is more to it than that:

There are now instances where we raise assets/liabilities
on consolidation that are not even in S's books "off
book"
3. RECOGNISING & MEASURING OF ASSETS,
LIABILITIES AND NCI
RECOGNITION CONDITIONS
1. “recognise identifiable assets acquired and liabilities
assumed”
2. Meet definition ito conceptual framework
3. A/L must be part of exchange in Bus Comb (not part
of separate transaction)
4. Recognize A/L previously not recognized in
Recognising & acquiree's AFS (e.g.. intangible assets)
measuring Assets,
Liabilities and NCI The recognition criteria of IFRS 3 are much wider than
Framework.
To recognise an A/L in BC  definition only
(no recognition criteria - no requirement for a probable
inflow/ outflow of economic benefits. Probability is taken
into account in determining Fair value)
By implication there is still however the requirement that
the amount must be reliably measurable, since
assets/liabilities acquired in a business combination are
measured at their fair values
RECOGNITION AND MEASUREMENT EXCEPTIONS

Intangible Assets
Recognition
Definition (includes separable), measureable?
(Existing goodwill is never an identifiable asset)
Recognising & Initial measurement
measuring Assets, At determinable FV
Liabilities and NCI Subsequent measurement
Amortize over remaining useful life
RECOGNITION AND MEASUREMENT
EXCEPTIONS
Contingent liabilities
Recognition
Exists if there is a present obligation from past events
and the fair value can be measured reliably.

Initial measurements
Recognise at fair value, irrespective of how probable
Recognising & the outflow of economic benefits are.
measuring Assets, (In the absence of a present obligation – no liability
Liabilities and NCI raised on consolidation)

Subsequent measurement
At higher of IAS 37 amount (if it becomes a provision)
or initial IFRS 3 amount less cumulative amortization
in terms of IAS 18 (discounted)

Reverse when obligation extinguished

RECOGNITION AND MEASUREMENT
EXCEPTIONS
Exception to Recognition Principle
1) Contingent Liabilities
2) Intangible Assets
Exception to Recognition and Measurement Principle
2) Income Taxes  acc IAS 12 not at FV, Initial recognition
exemption
3) Employee Benefits  acc IAS 19
4) Indemnification Assets (see detail)
Exception to measurement Principle
5) Reacquired Rights (see detail)
6) Share-based payments (equity/liability)  Ito IFRS 2
7) Non-current assets held for sale  Ito IFRS 5
RECOGNITION AND MEASUREMENT EXCEPTIONS

Exception to Recognition and Measurement Principle

2) Indemnification Assets
Indemnify – to guard/secure against loss; give security against loss
E.g. A seller may guarantee that an acquirer’s liability will not exceed a specified amount.
(indemnification asset vs indemnified liability)
• Recognize separate indemnification asset (right to indemnification or
reimbursement) at the same time it recognizes the related liability.
• Measure on same basis as the indemnified item (@ fair value or
another basis due to exceptions in the standard e.g.. allowance for
credit losses).
• Test for impairment.
• Subsequent measurement on same basis as indemnified item.
• Only derecognize if expire or cancelled.
RECOGNITION AND MEASUREMENT
EXCEPTIONS

Exception to measurement Principle

5) Reacquired Rights
Right (e.g. franchise) previously granted to acquiree, now reacquired – therefore the acquirer has the benefit
of being able to grant to another party.
• In acquirer's FS: if contract includes terms that are favourable/unfavourable when
compared with current market transactions: recognise a p/l as part of investment in (S)
• In cons. FS: Recognise intangible asset at value which only takes into account the remaining
contractual term (fair value excluding p/l).
• Amortise over remaining contractual term.
• Ignore possibility of renewals when accounting for amortisation.
3. RECOGNISING & MEASURING OF ASSETS, LIABILITIES AND NCI

Mea
2 possible measurements (choice exercised @
su each separate business combination):
cont ring NC
ro l l i
ng in I (non-  at its % of fair value of net identifiable assets
teres (proportional method); or
t)
 at fair value.

Can only choose proportional method if NCI has proportional right in the entity's net assets upon
liquidation (standard provision of the Companies Act ) and they already hold the shares.

NCI at Proportional value method: Goodwill = x%

(partial goodwill)

NCI at FV: Goodwill = 100% (full goodwill)

GOODWILL FORMULA IN IFRS 3
What did you Fair value of identifiable
pay for? net assets and liabilities

Less: Non-controlling interest

What was paid/given Consideration by acquirer

for this?
Difference:
Goodwill  Recognise GW as asset in consol AFS
Gain Paid less than what received, recognise a gain from a
bargain purchase in p/l
THANK YOU