IFRS 3 Business Combinations

 Scope: The standard does not cover

 Combination in which separate entities are brought together to form a joint venture.
 Combination involving entities or businesses under common control
 Combination involving two or more mutual entities.
 Combinations whereby the entities are brought together by contract alone, without
any ownership interest arising
 Business Combination involving entities or businesses under common control

Entity A Entity A

Entity B
Entity B Entity X

Entity C Entity X
Entity C Entity Y

Entity Y
IFRS 3 Business Combinations Contd…
 Business Combination: The bringing together of separate entities or businesses into
one reporting entity.

 Method of accounting: Purchase method

 Application of the purchase method: It involves

 Identifying an acquirer
 Determining the acquisition date
 Measuring the cost of the business combination
 Allocating, at the acquisition date, the cost of the business combination to the assets
acquired and liabilities and contingent liabilities assumed.

 Identifying the acquirer: An entity that obtains control of other combining entities
or businesses.

 Control is the power to govern the financial and operating policies of an entity or
businesses so as to obtain benefits from its activities.
IFRS 3 Business Combinations Contd…

 Acquisition of less than or equal to 50% of ownership can result in control, if one of the
combining entities obtains:
 power over more than 50% of the voting rights by virtue of an agreement with other
investors
 power to govern the financial and operating policies of the other entity under a
statute or an agreement
 power to appoint or remove the majority of the members of the board of directors or
equivalent governing body
 power to cast the majority of votes at meetings of the board of directors or
equivalent governing body

 Determining the acquisition date: date on which the acquirer effectively obtains
control of the acquiree. This is normally the date on which the acquirer legally transfers
the consideration, acquires the assets and assumes the liabilities of the acquiree.
IFRS 3 Business Combinations Contd…

 Cost of a business combination: Fair value at the date of exchange, of

 assets given
 liability incurred or assumed and
 equity instruments issued by the acquirer
+
any cost directly attributable to the business combination.

 Costs included in the cost of a business combination: Fees payable to merchant

banks, lawyers, accountants and other advisors for:
 Valuing the acquiree
 Undertaking due diligence work
 Auditing the completion accounts
 Negotiating the price and completing the transaction

 Costs excluded from the cost of a business combination:

 Cost of maintaining the acquisition department
 Professional fees paid to investigate potential acquisition targets
 Costs of issuing debt securities.
 Costs of registering and issuing equity securities
IFRS 3 Business Combinations Contd…
 Contingent consideration:
 When a business combination agreement provides for an adjustment to the cost of
the combination contingent on future events, it should be included in the cost of the
combination if payment is probable and can be measured reliably.
 Subsequent payment to compensate for reduction in value of the assets given,
equity/debt instruments issued in exchange for control of the acquiree.
 Allocating the cost of business combination: Recognise cost of identifiable assets,
liabilities and contingent liability at fair value except for non-current assets (or disposal
groups) that are classified as held for sale in accordance with IFRS 5, which shall be
recognised at fair value less costs to sell.
 in case of an asset other than an intangible asset, it is probable that any associated
future economic benefits will flow to the acquirer, and its fair value can be measured
reliably.
 in the case of liability other than a contingent liability, it is probable that an outlfow of
resources embodying economic benefits will be required to settle the obligation, and
its fair value can be measured reliably,
 in the case of intangible asset or a contingent liability, its fair value can be measured
reliably.
IFRS 3 Business Combinations Contd…
 Determination of Fair Value
 Land and Buildings: at market value
 Plant and equipment: at market value or depreciated replacement cost
 Intangible assets: by reference to an active market, if one exists or
if no active market exists, on a basis that reflects the amounts the acquirer would
have paid for the assets in arm’s length transactions between knowledgeable willing
parties.
 Financial Instruments: Instruments traded in an active market at their current
market values
for other at their estimated values that take into consideration price earnings ratio,
dividend yield and expected growth rates of comparable instruments of entities with
similar characteristics
 Finished goods and merchandise: at selling price less the cost of disposal and a
reasonable profit allowance for the selling effort of the acquirer
 Work in progress: at selling price less the sum of costs to complete, costs of
disposal and a reasonable profit allowance for the completing and selling effort of
the acquirer
 Raw materials: at current replacement cost
IFRS 3 Business Combinations Contd…
 Receivables: at the present values of the amounts to be received, determined at
appropriate current interest rates, less allowance for uncollectibility and collection
costs.
 Accounts and Notes payable, long-term debt, liabilities, accruals and other
claims payable: at the present values of the amounts to be disbursed, determined
at appropriate current interest rates
 Onerous contracts and other identifiable liabilities: at the present values of the
amounts to be disbursed, determined at appropriate current interest rates
 Defined benefit plans: at the present value of the defined benefit obligation, less
the fair value of any plan assets.
 Tax assets and liabilities: at the amount of tax benefit arising form tax losses or the
taxes payable in respect of profit or loss in accordance with IAS 12. Deferred tax
assets and liabilities are recognised for differences from assigning fair values to net
assets that are different from their tax bases.
 Contingent Liabilities: at the amount that a third party would charge to assume
those contingent liaiblities.
 Liabilities for future losses and restructuring provisions – not to be recognised
IFRS 3 Business Combinations Contd…

 Subsequent Valuation of Contingent Liability (other than covered by IAS 39): At

the higher of
 the amount that would be recognised in accordance with IAS 37, and
 the amount initially recognised less, when appropriate, cumulative amortisation
recognised in accordance with IAS 18, ‘Revenue’.

 Provisional fair values: Should be adjusted and finalised, if necessary, within 12

months of the acquistion date. Corresponding adjustment should be made to goodwill
and comparative information should be revised.

 Subsequent adjustments to goodwill: No time limit

 Contingent consideration
 Recognising deferred tax assets after the initial accounting is complete
 To correct an error in accordance with IAS 8.
IFRS 3 Business Combinations Contd…

 Measurement of Goodwill: Goodwill is measured as the excess of the cost of

business combination over the acquirer’s interest in the net fair value of the assets.
 Negative goodwill: Reassess the identification and measurement of the acquiree’s
identifiable assets, liabilities and contingent liabilities and the measurement of the
combination’s cost and recognise immediately in profit or loss any excess remaining
after that reassessment.
 No amortisation, tested for impairment annually.
 Business Combination achieved in stages:
 Accounting for business combination comments from the acquisition date, i.e. the
date from which the control is obtained.
 For goodwill calculation, each exchange transaction is treated separately.
 Any adjustment to fair values of the acquiree’s identifiable assets, liabilities an
dcontingent liabilities relating to the acquirer’s previously held interests is accounted
for as revaluation surplus.
 Changes in the investee’s retained earnings and other equity balances after each
exchange transaction should be included in the post-combination consolidated
financial statements to the extent that they relate to the previously held ownership
interests.
IFRS 3 Business Combinations Contd…

 Example: Entity A acquired 10% equity shares in entity B for Rs 2 crores on 1st Jan, 04,
when the fair value of its net assets was Rs 15 crores. Subsequently on 1st Jan, 08 it
acquired, further 50% of equity in entity B for Rs 12 crores. Fair value of net assets on
this date was Rs 20 crores (entire increase in fair value from Rs 15 crores to Rs 20
crores is attributable to property).
 (Rs Crores)
Goodwill
1st Jan, 04 transaction
Cost 2.00
Net assets at fair value (15 * 10%) 1.50
Goodwill 0.50

1st Jan, 08 transaction

Cost 12.00
Net assets at fair value (20 * 50%) 10.00
Goodwill 2.00
IFRS 3 Business Combinations Contd…

 Net assets are accounted for as follows:

(Rs crores)
Net Assets (at fair value at acquisition date) 20.00

Goodwill ( 0.50 + 2.00) 2.50

Revaluation gain ((20 – 15) * 10%) (0.50)

Minority Interest (20 * 40%) ( 8.00)

Overall cost of the combination 14.00