Deloitte has published an 84-page book Business Combinations: A Guide to IFRS 3. The guide: Outlines the key features of IFRS 3. Provides illustrative examples to assist in applying the standard. Discusses the requirements of IAS 36 Impairment of Assets and IAS 38 Intangible Assets as they relate to business combinations. Includes guidance on determining fair value for the purposes of accounting for business combinations; an overview comparison between the requirements of IFRS and those of US GAAP; a number of frequently asked questions; and illustrative disclosures.

Special Edition of IAS Plus Newsletter on IFRS 3.

IFRS 3 Replaced IAS 22

Scope

Definition of business combination. A business combination is the bringing together of separate entities or businesses into one reporting entity. [IFRS 3.4]

Scope exclusions. IFRS 3 applies to all business combinations except combinations of entities under common control, combinations of mutual entities, combinations by contract without exchange of ownership interest, and formations of joint ventures. [IFRS 3.3]

Method of Accounting for Business Combinations

Purchase method. All business combinations within the scope of IFRS 3 must be accounted for using the purchase method. [IFRS 3.14] The pooling of interests method is prohibited.

Acquirer must be identified. The old IAS 22 had required the pooling method if an acquirer could not be identified. Under IFRS 3, an acquirer must be identified for all business combinations. [IFRS 3.17]

Identification of an Acquirer

Control. The acquirer is the combining entity that obtains control of the other combining entities or businesses. [IFRS 3.17] IFRS 3 provides considerable guidance for identifying the acquirer. [IFRS 3.19-23]

Cost of a Business Combination

Fair value of consideration given plus costs. The acquirer measures the cost of a business combination at the sum of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree; plus any costs directly attributable to the combination. [IFRS 3.24] If equity instruments are issued as consideration for the acquisition, the market price of those equity instruments at the date of exchange is considered to provide the best evidence of fair value. If a market price does not exist, or is not considered reliable, other valuation techniques are used to measure fair value. [IFRS 3.27]

Cost adjustments contingent on future events. If the cost is subject to adjustment contingent on future events, the acquirer includes the amount of that adjustment in the cost of the combination at the acquisition date if the adjustment is probable and can be measured reliably. [IFRS 3.32] However, if the contingent payment either is not probable or cannot be measured reliably, it is not measured as part of the initial cost of the business combination. If that adjustment subsequently becomes probable and can be measured reliably, the additional consideration is treated as an adjustment to the cost of the combination. [IAS 3.34]

Recognition and Measurement of Identifiable Acquired Assets and Liabilities

Recognition of acquired assets and liabilities. The acquirer recognises separately, at the acquisition date, the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the following recognition criteria at that date, regardless of whether they had been previously recognised in the acquiree's financial statements: [IAS 3.37]

• an asset other than an intangible asset is recognised if it is probable that any associated future economic benefits will flow to the acquirer, and its fair value can be measured reliably;
• a liability other than a contingent liability is recognised if it is probable that an outflow of resources will be required to settle the obligation, and its fair value can be measured reliably; and
• an intangible asset or a contingent liability is recognised if its fair value can be measured reliably.

Measurement of acquired assets and liabilities. The acquired identifiable assets, liabilities, and contingent liabilities are measured initially by the acquirer at their fair values at the acquisition date, irrespective of the extent of any minority interest. In other words, the identifiable assets acquired, and liabilities and contingent liabilities incurred or assumed, must be initially measured at full fair value, including any minority interest's share of the acquired item.

No restructuring provisions. In applying the purchase method, an acquirer must not recognise provisions for future losses or restructuring costs expected to be incurred as a result of the business combination. These must be treated as post-combination expenses. [IFRS 3.41]

Recognition of intangibles. In applying the purchase method, an intangible item acquired in a business combination, including an in-process research and development project, must be recognised as an asset separately from goodwill if it meets the definition of an asset (it is controlled and provides economic benefits), is either separable or arises from contractual or other legal rights, and its fair value can be measure reliably. [IFRS 3.45]

Recognition of contingent liabilities. In applying the purchase method, an acquirer must recognise contingent liabilities assumed in the business combination, if their fair value is reliably measurable. [IFRS 3.47] After their initial recognition, such contingent liabilities must be remeasured at the higher of: [IFRS 3.48]

• (a) the amount that would be recognised in accordance with IAS 37, and
• (b) the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.

A contingent liability recognised under IFRS 3 continues to be recognised in subsequent periods even though it does not qualify for recognition under IAS 37.

Step acquisitions. If a business combination involves more than one exchange transaction, each exchange transaction shall be treated separately by the acquirer, using the cost of the transaction and fair value information at the date of each exchange transaction, to determine the amount of any goodwill associated with that transaction. [IFRS 3.58]

Goodwill

Recognition and measurement of goodwill. Goodwill is recognised by the acquirer as an asset from the acquisition date and is initially measured as the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities. [IFRS 3.51]

No amortisation of goodwill. IFRS 3 prohibits the amortisation of goodwill. Instead goodwill must be tested for impairment at least annually in accordance with IAS 36 Impairment of Assets. [IFRS 3.54]

Negative goodwill. If the acquirer's interest in the net fair value of the acquired identifiable net assets exceeds the cost of the business combination, that excess (sometimes referred to as negative goodwill) must be recognised immediately in the income statement as a gain. Before concluding that "negative goodwill" has arisen, however, IFRS 3 requires that the acquirer reassess the identification and measurement of the acquiree's identifiable assets, liabilities, and contingent liabilities and the measurement of the cost of the combination. [IFRS 3.56]

Disclosure

For each business combination (or in the aggregate for immaterial combinations), required disclosures by the acquirer include: [IFRS 3.67]

• Names and descriptions of the combining entities or businesses.
• Acquisition date.
• Percentage of voting equity instruments acquired.
• Cost of the combination (with separate disclosure of the number and fair values of equity instruments issued and how fair values were determined)
• Amounts recognised at the acquisition date for each class of the acquiree's assets, liabilities, and contingent liabilities, and, unless impracticable, the carrying amounts of each of those classes, determined in accordance with IFRSs, immediately before the combination.
• Amount of any negative goodwill recognised in profit or loss
• Details about the factors that contributed to recognition of goodwill
• Amount of the acquiree's profit or loss since the acquisition date included in the acquirer's profit or loss for the period, unless impracticable.

The following must also be disclosed unless impracticable: [IFRS 3.70]

• Revenue of the combined entity for the period as though the acquisition date for all business combinations effected during the period had been the beginning of that period.
• Profit or loss of the combined entity for the period as though the acquisition date for all business combinations effected during the period had been the beginning of the period.

Ongoing IASB Work on Accounting for Business Combinations

Phase II of the Board's business combinations project is addressing:

• Issues related to applying the purchase method of accounting.
• Accounting for formations of joint ventures and business combinations involving entities under common control.
• Possible applications for 'fresh start' accounting.

Exposure Draft of Proposed Amendments to IFRS 3

On 29 April 2004, the IASB issued an exposure draft: Proposed Amendments to IFRS 3 Business Combinations: Combinations by Contract Alone or Involving Mutual Entities. The amendments would add to the scope IFRS 3:

• Combinations in which separate entities are brought together to form a reporting entity by contract alone without the obtaining of an ownership interest; and
• Business combinations involving mutual entities.

Both were excluded from IFRS 3 when it was issued last month. Including these transactions in IFRS 3 would mean that an acquirer must be identified and the acquirer must account for the combination using the purchase method. The exposure draft would not change the IFRS 3 scope exclusion for combinations involving entities under common control. If finalised, the proposal would be applied to business combinations agreed to on or after 31 March 2004 (same as IFRS 3). The IASB has asked for comments by 31 July 2004.