COMBINATIONS
Lesson 1: Introduction
What is a business?
A business is defined as an integrated set of activities and assets that
is capable of being conducted and managed for the purpose of
providing a return in the form of dividends, lower costs or other
economic benefits directly to investors or other owners, members or
participants.
Key points on a business:
To be capable to conduct and manage a set of activities and
assets, a business needs inputs and processes applied to those
inputs that have the ability to create outputs. Although businesses
usually have outputs, outputs are not required for an integrated
set of activities and assets to qualify as a business.
However, a business need not include all of the inputs or
processes that the seller used in operating that business if market
participants are capable of acquiring the business and continuing
to produce outputs, for example, by integrating the business with
their own inputs and processes.
The nature of the elements of a business varies by industry and
by the structure of an entitys operations (activities), including the
entitys stage of development.
Nearly all businesses also have liabilities, but a business need
not have liabilities.
In the assessment of whether an entity is a business, it is not
relevant whether a seller operated the set of activities as a
business or the acquirer intends to operate the set as a business,
only that the acquirer is capable of doing so.
Scope of IFRS 3
A business combination is defined in IFRS 3 as a transaction or other
event in which an acquirer obtains control of one or more businesses.
IFRS 3 notes that such transactions might be structured in a variety of
ways for legal, taxation or other reasons. It could involve:
One or more businesses becoming subsidiaries of an acquirer or
the net assets of one or more businesses being legally merged
into the acquirer
One entity transferring its net assets, or its owners transferring
their equity interests, to another entity
All of the entities transferring their net assets to a newly-formed
entity
A group of former owners of one of the entities obtaining control
of the combined entity
The standard does not cover combinations in which separate entities
are brought together to form a joint venture, nor the acquisition of an
asset or group of assets that does not constitute a business or those
that involve entities under common control.
Question 1
Question 1
Question 2
As uncertainties about future cash flows are included in the fair value
measure, a separate valuation allowance is not necessary at
acquisition date. There are, however, some exceptions to this basic
principle. I will send you a summary of these.
Future losses/costs
The acquirer cannot recognize liabilities for future losses or costs of
the acquiree based on its intentions for the future as these do not
represent liabilities of the acquiree at the acquisition date.
Existing obligations
Liabilities that were existing obligations of the acquiree at the
acquisition date must be recognized. Items that do not meet the
definition of a liability are not liabilities at that date and are recognized
as post-combination activities or transactions of the combined entity
when the costs are incurred (examples are costs associated with
restructuring or exiting an acquiree's activities).
Intangible assets
Identifiable intangible assets must be recognized separately from
goodwill if they meet the definition of an intangible asset under IAS 38
Intangible Assets: an identifiable, non-monetary asset without physical
substance that must be separable from the entity or arise from
contractual or other legal rights. If these items cannot be distinguished
from goodwill, they are absorbed within goodwill, with the result that
the subsequent accounting treatment would be less discriminating.
Measurement period
If the initial accounting for a business combination is incomplete by the
end of the reporting period in which the combination occurs, the
acquirer reports provisional amounts. As new information becomes
available during the measurement period, these provisional amounts
are adjusted if it would have affected the measurement of the amounts
recognized as of the date of acquisition. This involves retrospective
restatement of goodwill and the comparative figures.
During the measurement period, the acquirer also recognizes
additional assets or liabilities, if any, based on new information
obtained. The measurement period ends as soon as the acquirer
receives the information it was seeking about facts and circumstances
that existed as of the acquisition date or learns that more information
is not obtainable. However, the measurement period cannot exceed
one year from the acquisition date.
After the measurement period ends, the acquirer revises the
accounting for a business combination only to correct an error in
accordance with IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors.
Operating leases (acquire is a lessee)
The acquirer does not normally recognize assets or liabilities related to
an operating lease in which the acquiree is the lessee except when
the terms of the lease are favorable (intangible asset) or unfavorable
(liability) relative to market terms. An identifiable intangible asset may
be associated with an operating lease, which may be evidenced by
market participants' willingness to pay a price for the lease even if it is
at market terms. For example, a lease of gates at an airport or of retail
space in a prime shopping area might provide entry into a market or
other future economic benefits that qualify as identifiable intangible
assets; for example, as a customer relationship. In that situation, the
acquirer recognizes the associated identifiable intangible asset(s).
Assets subject to operating leases (acquire is a lessor)
In measuring the acquisition-date fair value of an asset, such as a
building or a patent that is the subject of an operating lease, the
acquirer takes into account the terms of the lease. No separate asset
or liability is recognized if the terms of an operating lease are either
favorable or unfavorable when compared with market terms.
Pre-existing relationship between acquirer and acquire
A pre-existing relationship between the acquirer and acquiree may be
contractual (vendor and customer or licensor and licensee) or non-
Question 3
Consideration transferred
The consideration transferred is the sum of the acquisition-date fair
values of the assets transferred (usually cash), liabilities incurred or
assumed and equity interest issued by the acquirer.
When the fair value of transferred assets or liabilities of the acquirer
differs from the carrying amounts in the acquirer's accounts, the
acquirer recognizes a gain or loss in profit or loss, unless the
transferred assets or liabilities remain within the combined entity after
the business combination. However, this gain or loss is reversed on
consolidation such that the carrying amounts are used.
Acquisition-related costs are expensed in the period in which the costs
are incurred and the services are received. Acquisition-related costs
are costs the acquirer incurs to effect a business combination. Some
examples are finder's fees, advisory, legal, accounting, valuation and
other professional or consulting fees. The costs of issuing shares or
debt instruments are an integral part of the debt or share issue
transaction and are not part of the acquisition cost.
No consideration transferred
An acquirer sometimes obtains control of an acquiree without
transferring consideration. The acquisition method of accounting for a
business combination applies to those combinations.
Such circumstances include:
a. The acquiree repurchases its own shares such that an existing
investor (the acquirer) obtains control.
b. Minority veto rights lapse that previously kept the acquirer from
controlling an acquiree in which the acquirer held the majority
voting rights.
c. The acquirer and acquiree agree to combine their businesses by
contract alone. The acquirer transfers no consideration in
exchange for control of an acquiree and holds no equity interests
in the acquiree, either on the acquisition date or previously.
Examples of business combinations achieved by contract alone
include bringing two businesses together in a stapling
arrangement or forming a dual-listed corporation.
In a business combination achieved by contract alone, the acquirer
attributes to the owners of the acquiree the amount of the acquiree's
net assets recognized in accordance with this IFRS. In other words,
the equity interests in the acquiree held by parties other than the
acquirer are a non-controlling interest in the acquirer's postcombination financial statements even if the result is that all of the
equity interests (100%) in the acquiree are attributed to the noncontrolling interest.
In order to measure the goodwill or gain on a bargain purchase, the
acquirer substitutes the acquisition-date fair value of its interest in the
acquiree for the acquisition-date fair value of the consideration
transferred.
Question 4
Binfathi has completed the assessment of the fair value of the net
asset of Colorado Ltd. to amount to 19,560. The consideration payable
for the acquisition equals 19,000. Additional transaction costs amount
to 1,100. What must be recognized and recorded?
A. Binfathi will book a gain of 560 through profit or loss and expense
transaction costs.
B. Binfathi will book a gain of 560 through other comprehensive
income and expense transaction costs.
C. Binfathi will book a goodwill of 540 as an asset.
D. Binfathi will book a negative goodwill of 560 as a liability and
expense the transaction costs.
The difference between the consideration transferred of 19,000 and the net
asset acquired measured at their fair value of 19,560 is a gain from a bargain
purchase and is recorded through profit or loss. Transactions costs are
expensed.
Question 1
Binfathi has acquired 80% interest in Colorado Ltd. The 20% noncontrolling interest, measured at their fair value, amounts to 30,000.
The fair value was measured using a discounted cash-flow model.
Binfathi would like to keep the disclosures as short as possible. In
respect of non-controlling interest, Binfathi shall at least disclose which
of the following?
A. There are no mandatory disclosures relating to non-controlling
interests.
B. Binfathi shall disclose that the 20% non-controlling interest amounts
to 30,000 and has been measured at fair value.
C. Binfathi shall disclose that the 20% non-controlling interest amounts
to 30,000 and has been measured at fair value.
Additionally, it shall disclose that the fair value has been measured
using a discounted cash-flows model.
D. Binfathi shall disclose that the 20% non-controlling interest amounts
to 30,000 and has been measured at fair value. Additionally, it shall
disclose that the fair value has been measured using a discounted
cash-flows model and
describe the key inputs used for the valuation.
First-time adoption
According to IFRS 1 First-time Adoption of International Financial
Reporting Standards appendix C.C1, if a first-time adopter restates
any business combination to comply with IFRS 3, then it must also
restate all later business combinations and it must also apply the
revised versions of IAS 36 Impairment of Assets and IAS 38 Intangible
Assets from the same date.
In summary, a first-time adopter has the following options:
Restate all past business combinations (apply IFRS 3
retrospectively) that occurred before the date of transition to IFRS
or restate business combinations that have occurred since the
date elected by the entity to restate business combinations (this
applies equally to past acquisitions of investments in associates
and of interests in joint ventures)
Not restate any business combinations that occurred before the
date of transition to IFRS
Question 2
Where the entity does not take advantage of the exemption and
therefore restates previous business combinations in accordance with
IFRS 3, the main consequences are summarized below. Note that the
transitional provisions of IFRS 3 do not apply.
The entity applies IFRS 3 retrospectively with respect to:
Determining the classification of business combinations (as
acquisitions or reverse acquisitions)
Recognizing and measuring, at the acquisition date, the
identifiable assets acquired, liabilities and contingent liabilities
assumed and non-controlling interest
Recognizing and measuring goodwill or bargain purchase
Question 3
Recognize all assets and liabilities at the date of transition to IFRS that
were acquired or assumed in a past business combination, except
certain financial assets and liabilities derecognized under previous
GAAP, and items that were not recognized under previous GAAP in
the acquirer's consolidated balance sheet and also would not qualify
for recognition under IFRS in the separate balance sheet of the
acquiree.
Exclude from the opening IFRS balance sheet any item recognized
under previous GAAP that does not qualify for recognition as an asset
or liability under IFRS.
Adjustments are taken to retained earnings, except any that require an
intangible asset to be reclassified as goodwill or vice versa.
You measure the assets acquired and liabilities assumed in different
ways depending on whether they had been recognized under previous
GAAP.
For assets acquired and liabilities that were recognized under previous
GAAP, if measured on the basis of cost, then the carrying amount
under previous GAAP immediately after the business combination is
the deemed cost under IFRS at that date. If measured on another
basis, such as fair value, then the assets and liabilities are measured
on that basis at the date of transition, even if they arose from a past
business combination. If IFRS requires a cost-based measurement of
those assets and liabilities at a later date, the deemed cost shall be
the basis for cost-based depreciation or amortization from the date of
the business combination.
Assets acquired or liabilities assumed in a past business combination
that were not recognized under previous GAAP do not have a deemed
cost of zero in the opening balance sheet. Instead, the acquirer
recognizes and measures them in the consolidated balance sheet on
the basis that IFRS would require in the separate balance sheet of the
acquiree.
What are some examples of assets and liabilities not recognized
under previous GAAP?
Suppose, for example, the acquirer had not capitalized under previous
GAAP finance leases acquired in a past business combination. Then it
must capitalize those leases in its consolidated financial statements,
Question 4
ASSESSMENT
Question 1
Group A has acquired the following. Which of the following acquisitions are
business combinations under IFRS 3?
A. Land and a vacant building from Company B. No processes, other
assets or employees are acquired. Group A does not enter into any of
the contracts of Company B.
B. An operating hotel, the hotels employees, the franchise agreement,
inventory, reservations system and all back office operations.
C. All of the outstanding shares in Biotech D, a development stage
company that has a license for a product candidate. Phase I clinical trials
are currently being performed by Biotech D employees. Biotech Ds
administrative and accounting functions are performed by a contract
employee.
A. All three acquisitions are business combinations under IFRS 3.
B. A and B acquisitions are business combinations under IFRS 3.
C. A and C acquisitions are business combinations under IFRS 3.
D. B and C acquisitions are business combinations under IFRS 3.
Question 2
Entity A acquired Entity B. On the acquisition date, Entity B had an operating
lease as a lessee with a remaining period of two years out of the original four
years. Due to significant changes in the market, Entity B is paying less than
what you would expect to currently pay for a similar lease. The value of the
existing lease based on the current terms is 10,000 and that of a lease based
on relative market terms is 13,000. How should Entity A account for this?
A. Entity A should disregard this, as this is an operating lease of Entity B and
no asset or liability is recognized
related to operating leases.
B. Entity A determines whether the terms of each operating lease in which
Entity B is the lessee are favorable or unfavorable. Entity A should account
for the difference between the value of the existing lease terms and the
market terms in profit or loss.
C. Entity A determines whether the terms of each operating lease in which
Entity B is the lessee are favorable or unfavorable. Entity A should
recognize an intangible asset separate from goodwill for the favorable
portion of the operating lease relative to market terms.
D. None of the above.
Question 3
Binfathi Group acquired an 80% interest in Entity B. The consideration for the
80% interest in Entity B was 36,000 in shares in Binfathi and 12,000 in cash.
To issue the shares, Binfathi incurred a cost of 2,000 and incurred costs of
1,400 associated with legal fees and the valuation of Entity B. The fair value of
the net assets of Entity B amounted to 64,000. How should Binfathi account
for this acquisition?
A. Binfathi shall book a gain (negative goodwill) through profit or loss of 3,200
related to the acquisition, recognize expenses of 1,400 and deduct from
equity 2,000 relative to the cost of issuing the shares.
B. Binfathi shall book goodwill as an asset of 200.
C. Binfathi shall book a gain (negative goodwill) through profit or loss of 1,200
and recognize the costs of legal fees of 1,400 as expenses in profit or loss.
D. Binfathi shall book a gain (negative goodwill) though profit or loss of 3,200
and recognize expenses of 3,400, relative to the costs of issuing shares,
paying legal fees and performing the valuation of Entity B, in profit or loss.
Question 4
The consideration transferred in the business combination was 55,000.
Transaction costs amount to 1,000. The fair value of the acquirees net assets
at the acquisition date was 63,000. The acquirer has not yet decided whether
to measure the 20% non-controlling interest (NCI) in the acquiree at the NCIs
proportionate share of the fair value of the acquirees net assets, which is
12,600, or at the NCIs fair value, which is 13,000. Does the choice of
accounting policy for NCI impact the determination of goodwill at the
acquisition date?
A. No, the accounting policy choice for NCI does not impact goodwill at the
acquisition date.
B. Yes, it does. If the acquirer values the NCI at its proportionate share of the
fair value of the acquired business, the goodwill amounts to 4,600; if the
acquirer values the NCI at its fair value, then the goodwill amounts to 5,000.
C. Yes, it does. If the acquirer values the NCI at its proportionate share of the
fair value of the acquired business, the goodwill amounts to 5,600; if the
acquirer values the NCI at its fair value, then the goodwill amounts to 6,000.
D. No, it does not. However, the accounting policy choice for NCI impacts the
fair value of the acquirees net assets. If the acquirer values the NCI at its
proportionate share of the fair value of the acquired business, the
acquirees net assets amount to 63,000; if the acquirer values the NCI at its
fair value, then the acquirees net assets amount to 63,400
Question 5
Entity A had several business acquisitions during the reporting period and
after the reporting period. Entity A will disclose, among other information, the
following:
a. The name and a description of the acquiree
b. The acquisition date
c. The percentage of voting equity interests acquired
d. The primary reasons for the business combination and a description of
how the acquirer obtained control of the acquiree
A. These disclosures shall be done for each business combination that
occurred in the reporting period only, but are not required for business
combinations that occurred after the end of the reporting period.
Question 6
Entity A acquired Entity B, which is a material business combination, during
the reporting period. Among the assets acquired, trade accounts receivable
were provisionally accounted for at fair value of 1,736. Which of the following
information shall be provided additionally to the fair value amount of the trade
accounts receivable? Select all that apply.
A. Entity A does not need to disclose any further information.
B. Entity A must disclose that the fair value of the accounts receivable was
determined provisionally.
C. Entity A must disclose the nominal value of the accounts receivable.
D. Entity A must disclose the amount of the contractual cash flows that it does
not expect to collect.
Question 7
The goodwill resulting from the acquisition of Entity C by Entity B amounts to
50,000. Which disclosures does Entity B provide relating to the goodwill?
Select all that apply.
A. Entity B shall describe the factors that make up the goodwill to be
recognized.
B. Entity B shall disclose the total amount of goodwill deductible for tax
purposes.
C. Entity B shall disclose the amortization period of goodwill for tax purposes.
Question 8
Entity A is a first-time adopter with the transition date 1 January 2011. Entity A
acquired Entity C in 2007 and Entity D in 2009. Which are the alternative
accounting treatments in respect of the two business combinations?
A. Under the current IFRS 3, Entity A can choose to restate the acquisition
that occurred in 2007 and the acquisition that occurred in 2009 or just the
acquisition that occurred in 2009 or choose not to restate either one.
B. Under the current IFRS 3, Entity A needs to restate the business
combination that occurred in 2009 and has the choice to not restate or to
restate the acquisition that occurred in 2007.
C. Under the current IFRS 3, Entity A can decide to restate the acquisition that
occurred in 2007, but not to restate the acquisition that occurred in 2009.
D. Entity A has no choice and cannot restate any past business combinations.
Only business combinations that occurred/which will occur after the date of
transition will be accounted for under IFRS 3.
Question 9
Entity A is a first-time adopter with the transition date 1 January 2011. Entity A
acquired Entity C in 2007 and recognized the goodwill of 50,000 as a
deduction from equity as allowed under previous GAAP. Which is the
accounting treatment for the goodwill?
A. Entity A does not need to restate the goodwill if it decides not to restate the
business combination under IFRS 3. However, in case of disposal of Entity
C, goodwill will be recycled through profit or loss and decrease the gain or
increase the loss from disposal.
B. Entity A does not need to restate the goodwill, if it decides to not restate the
business combination under IFRS 3.
C. Entity A shall restate the business combination under IFRS 3 and
recalculate the goodwill which will be then
capitalized. However, an impairment test under IAS 36 has to be
performed.
D. Entity A does not need to restate the goodwill if it decides not to restate the
business combination under IFRS 3. However, Entity A shall reclassify the
50,000 from equity to goodwill which is shown under intangible assets.
Question 10
Entity A is a first-time adopter with the transition date 1 January 2011. Entity A
acquired Entity C in 2007. Entity A applies the business recognition exception