international financial reporting standard 3

for Accounting Professionals

IFRS 3 - BUSINESS COMBINATIONS

Business Combinations

CONTENTS

1.BUSINESS COMBINATIONS - INTRODUCTION 3

2. DEFINITIONS 4

3. IDENTIFYING A BUSINESS COMBINATION 5

4. METHOD OF ACCOUNTING 6

5. ALLOCATING THE COST OF A COMBINATION 13

6. INTANGIBLE ASSETS 13

7. GOODWILL 14

8. PROVISIONAL ACCOUNTING 16

9. REVERSE ACQUISITIONS 17

10. PRACTICAL ISSUES 20

11. COMBINATIONS INVOLVING UNDERTAKINGS UNDER COMMON CONTROL OUTSIDE THE SCOPE OF IFRS 3 21

12. DISCLOSURE 21

13. PROPOSED AMENDMENTS TO IFRS 3 23

14. MULTICHOICE QUESTIONS 23

15. Answers to Multiple Choice Questions 27

1. Business Combinations - Introduction

OVERVIEW

AIM

The aim of this workbook is to assist the individual in understanding the IFRS 3 treatment of Business Combinations.

IFRS 3 supersedes IAS 22.

ACCOUNTING

Business combinations within the scope of IFRS 3 are accounted for using the ‘purchase method’.

The acquirer records the acquiree’s identifiable assets, liabilities and contingent liabilities at their fair values at the acquisition date and also records goodwill, which is subsequently tested for impairment.

Assets acquired and assumed(i) Recognition

If there is an existing restructuring liability per IAS37 it is included in the goodwill calculation.

If fair values can be measured reliably, the acquirer must record separately the acquiree’s contingent liabilities at the acquisition date, as part of allocating the cost of a business combination. If the contingent liabilities cannot be measured, they are not included in the allocation of cost.

(ii) Measurement

IFRS 3 requires the acquiree’s identifiable assets, liabilities and contingent liabilities to be measured initially at their fair values, at the acquisition date.

Any minority interest in the acquiree is the minority’s proportion of the net fair values.

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Goodwill IFRS 3 requires goodwill to be measured after initial recognition at cost, less any accumulated impairment losses. Goodwill is not amortised but must be tested for impairment annually, or more frequently.

Negative goodwill

IFRS 3 requires that negative goodwill must be credited by the acquirer immediately to the income statement.

The acquirer records the acquiree’s identifiable assets, liabilities and contingent liabilities at their fair values at the acquisition date and also records goodwill, which is subsequently tested for impairment.

SCOPE IFRS 3 does not apply to:

(i) joint ventures (see IAS 31).(ii) businesses under common control.(iii) combinations involving two or more mutual undertakings.

2. DEFINITIONSacquisition date The date on which the acquirer effectively obtains

control of the acquiree.agreement date The date that an agreement between the combining

parties is reached.In the case of publicly listed undertakings, the date

that is announced to the public. In the case of a hostile takeover, the earliest date

that an agreement between the combining parties is reached. This is the date that a sufficient number of the acquiree’s owners have accepted the acquirer’s offer, for the acquirer to obtain control of the acquiree.

business An integrated set of activities and assets, conducted and managed, for the purpose of providing:

i a return to investors; orii lower costs or other benefits directly and

proportionately to participants. This relates to mutual undertakings.

A business generally consists of inputs, processes and resulting outputs that are used to generate revenues. If goodwill is present, an organisation is presumed to be a business.

business combination The bringing together of separate businesses into one reporting undertaking.

business combination involving businesses under common control

A business combination in which all of the combining businesses ultimately are controlled by the same party or parties, both before and after the combination and that control is not transitory.

contingent liability Contingent liability has the meaning given to it in IAS 37 Provisions:

a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence(1) of one or more uncertain future events, not

wholly within the control of the undertaking; or

(2) a present obligation that arises from past events, but is not recorded because:

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i it is not probable that payment will be required to settle the obligation; or

ii the amount of the obligation cannot be measured with sufficient reliability.

control The power to govern the financial and operating policies of a business.

date of exchange When a business combination is achieved in a single exchange transaction, the date of exchange is the acquisition date. When a business combination involves more than one exchange transaction for example when it is achieved in stages by successive share purchases, the date of exchange is the date that each individual investment is recorded in the financial statements of the acquirer.

fair value The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, independent parties.

goodwill Benefits arising from assets that are not capable of being individually identified and separately recorded.

intangible asset Intangible asset has the meaning given to it in IAS 38: an identifiable non-monetary asset without physical substance.

joint venture Joint venture has the meaning given to it in IAS 31: a contractual arrangement, whereby parties undertake an activity, that is subject to joint control.

minority interest That portion of the income statement and net assets of a subsidiary attributable to shares that are not owned directly or indirectly by the parent.

mutual undertaking An undertaking other than an investor-owned undertaking, such as a mutual insurance company, or a mutual cooperative undertaking, that provides lower costs, or other economic benefits, directly and proportionately to its participants.

parent An undertaking that has one or more subsidiaries.probable More likely than not.reporting undertaking An undertaking for which there are users who rely

on the undertaking’s financial statements for information, which will be useful to them for making decisions about the allocation of resources. A reporting undertaking can be a single undertaking, or a group.

subsidiary An undertaking including an unincorporated

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undertaking such as a partnership, which is controlled by the parent.

3. Identifying a business combination

A combination is the bringing together of separate undertakings into one reporting undertaking.

The result of nearly all combinations is that the ‘acquirer’ obtains control of one, or more, other businesses, the ‘acquiree’.

When an undertaking acquires a group of assets that does not constitute a business, it must allocate the cost between the individual identifiable assets and liabilities in the group, based on their relative fair values at the date of acquisition.

EXAMPLE-Buying assetsYou buy some assets, including lists of clients, from a firm that is being liquidated. This is not a combination and should be treated as a purchase of assets. The cost will be allocated to the assets purchased, based on their fair values.

A combination may be structured in a variety of ways for legal, taxation, or other reasons. It may involve

(i) purchase of the equity of another undertaking, (ii) purchase of all the net assets of another undertaking, (iii) assumption of the liabilities of another undertaking, or (iv) purchase of some of the net assets of another undertaking, that

together form one or more businesses.

It may be effected by the issue of shares, the transfer of cash, cash equivalents or other assets, or a combination thereof.

In the following examples, I/B refers to Income Statement and Balance Sheet.

EXAMPLE-Buying a business using cash and sharesYou buy 100% of a business for $10m. You pay $4m in cash and issue $6m of equity to finance the purchase.

I/B DR CR

Investment in subsidiary B $10mCash B $4mShare capital B $6mPurchase of business

The transaction may be between the shareholders of the combining undertakings, or between one undertaking and the shareholders of another undertaking. It may involve the establishment of a new undertaking to control the combining undertakings or net assets transferred, or the restructuring of one or more of the combining undertakings.

EXAMPLES-Methods of purchase1. Your shareholders and the shareholders of another company merge

your companies by issuing shares in a new company that will encompass both companies.

2. Your company pays cash to the shareholders of another company to buy their business.

A business combination may result in a parent-subsidiary relationship in which the acquirer is the parent and the acquiree its subsidiary. In such circumstances, the acquirer applies IFRS 3 in its consolidated financial statements.

EXAMPLE-Buying a business - parent-subsidiary relationshipYour company the acquirer buys 100% of another company the acquiree. Your company is the parent. The acquiree is the subsidiary.

It includes its interest in the acquiree, in any separate financial statements, as an investment in a subsidiary see IAS 27.

A combination may involve the purchase of the net assets, including any goodwill, rather than the purchase of the equity. Such a combination does not result in a parent-subsidiary relationship.

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EXAMPLE-Buying assets, including goodwillYou pay $5m to buy assets worth $3m from a firm that is being liquidated. The additional $2m premium is called goodwill. This is not a combination and should be treated as a purchase of assets. The cost will be allocated to the assets purchased, based on their fair values.

I/B DR CRAssets various B $3mCash B $5mGoodwill B $2mPurchase of assets

4. METHOD OF ACCOUNTING

All combinations must be accounted for by applying the purchase method. The purchase method views a combination from the perspective of the acquirer. This means that the accounting will always reflect one undertaking buying another, even if the combination is regarded as a merger of equals.

The acquirer purchases net assets and records the assets, liabilities and contingent liabilities. APPLICATION OF THE PURCHASE METHOD

Applying the purchase method involves the following steps: (i) identifying an acquirer;(ii) measuring the cost of the combination; and(iii) at the acquisition date, allocating, the cost of the combination to

the assets, liabilities and contingent liabilities acquired .

As the purchase method views a combination from the acquirer’s perspective, it assumes that one of the parties can be identified as the acquirer.

ControlControl is the power to govern the financial and operating policies of an undertaking.

An undertaking is presumed to have obtained control of another undertaking when it acquires more than one-half of that other undertaking’s voting rights, unless it can be demonstrated that such ownership does not constitute control.

EXAMPLES- Control

1.You buy 60% of a company. This entitles you to 60% of the votes at shareholders meetings. You have control, even though the other 40% of the votes are in the hands of others.2. You own 100% of a firm in the defence industry. The government appoints the directors of this firm. You do not have control, as the government-appointed directors may not follow your policies.

Even without one-half of the voting rights control may be obtained in other ways.i power over more than one-half of the voting rights of the other undertaking,

by virtue of an agreement with other investors; or

EXAMPLE- Control by agreementYou buy 40% of the voting shares in a foreign company. Other investors, representing 35% of the company wish you to manage their investment and sign an agreement that gives you their votes in all matters relating to the company. You have control of the company

ii power to govern the financial and operating policies of the other undertaking under a statute, or an agreement; or

EXAMPLE- Control by statute Your firm is providing electricity. The government controls all sales tariffs and your purchase prices. The government has control of your financial policies, so has control of the firm.

iii power to appoint or remove the majority of the members of the board of directors or equivalent of the other undertaking; or

EXAMPLE- Control of board appointmentsYou own 100% of a firm in the defence industry. The government appoints the directors of this firm. You do not have control, as the government-appointed directors may not follow your policies.

iv power to cast the majority of votes at meetings of the board of directors or equivalent of the other undertaking.

EXAMPLE- Control of votes

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You buy 20% of the shares of a company. The capital structure of the company entitles you to 60% of the votes at shareholders meetings. You have control, even though the other 80% of the shares are in the hands of others.

Identifying the AcquirerAlthough sometimes it may be difficult to identify an acquirer, there are usually indications that one exists. For example:

i if the fair value of one of the undertakings is greater than that of the other, the greater is likely to be the acquirer;

EXAMPLE- Acquirer – the larger undertakingYour firm has a market value of $100m. You merge with another firm with a market value of $5m. As your firm is larger, it will be the acquirer.

ii if the combination is effected through an exchange of voting ordinary shares for cash or other assets, the undertaking giving up cash or other assets is likely to be the acquirer; and

EXAMPLE- Acquirer –Issuing sharesYour firm merges with another. Your firm pays $50m for the shares of the other firm. Your firm is the acquirer.

I/B DR CRInvestment in subsidiary B $50mShare capital B $50mPurchase of business- Issuing shares

iii if the combination results in the management of one of the undertakings being able to run the combined undertaking, the dominant management is likely to be the acquirer.

EXAMPLE- Acquirer – management controlYour firm has a market value of $100m. You merge with another firm with a market value of $120m. Your directors and management will run the combination. As your firm has management control, your firm will be the acquirer.

In a combination effected through an exchange of shares, the undertaking that issues the shares is normally the acquirer. In ‘reverse acquisitions’, the acquirer ‘s shares are acquired.

EXAMPLE- Reverse acquisitionA private undertaking arranges to have itself ‘acquired’ by a smaller public undertaking, as a means of obtaining a stock exchange listing.

‘Small’, a listed company, buys ‘Big’ a private company, in a reverse acquisition. Big wants to become a quoted group, and this method is used.

The shareholders of Big buy the shares of Small. Big’s directors take control of Small. Small then buys Big, in exchange for shares.

Small is the legal parent, but Big is the acquirer as it dictates the financial and operating policies of Small.

The allocation of the cost of the combination and the calculation of goodwill, is based on the net assets of Small.

Big’s assets are not revalued to fair value but Small’s are to establish the cost of combination and goodwill.

The power to govern the financial and operating policies defines the acquirer.

When a new undertaking is formed to issue shares to effect a combination, one of the undertakings that existed before the combination must be identified as the acquirer, on the basis of the evidence available.

EXAMPLE – New company formed for combinationNatasha and Alexandra companies merge. Their net assets are transferred into a new company, Gemini and the original companies liquidated. Either Natasha or Alexandra will be identified as the acquirer, based on the tests described above. Even though the two companies have been liquidated, one must be identified as the acquirer for accounting purposes.

Similarly, when a combination involves more than two undertakings, one that existed before the combination must be identified as the acquirer on the basis of the evidence available. Determining the acquirer in such cases must include consideration of which of the undertakings initiated the combination and whether the assets or revenues of one of the undertakings exceed those of the others.

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EXAMPLE- InitiatorYour company makes a bid for another listed company. The merger is agreed.Following tax advice, the other company buys the shares of your company and becomes the legal parent. Nonetheless, your company is the acquirer, as you initiated the combination.

Cost of a combination

The acquirer must measure the cost of a combination as the aggregate of:i the fair values at the date of exchange of net assets given in exchange for

control of the acquiree; plusii any costs directly attributable to the combination.

EXAMPLE-Cost of a combinationYou buy a company for $100m. You have incurred legal costs of $2m.Your total cost is $102m

I/B DR CRInvestment in subsidiary B $102mCash B $100mLegal costs I $2mPurchase of business - Cost of a combination

The acquisition date is the date on which the acquirer effectively obtains control of the acquiree.

When this is achieved through a single exchange transaction, the date of exchange coincides with the acquisition date.

A combination may involve stages of successive share purchase. When this occurs: i the cost of the combination is the aggregate cost of the individual

transactions; andii the date of exchange is the date of each exchange transaction

This is that each individual transaction is recorded in the financial statements of the acquirer.

EXAMPLE-combination in stages of successive share purchasesOn 1st January, you agree to buy a company. You will buy 20% of the shares on January 1st, another 50% on March 1st and the final 30% on June 1st.

You will pay a total of $200m for all the shares. This is the cost of the combination.

The dates of exchange are January 1st, March 1st and June 1st.The acquisition date is March 1st, as that is when you acquired voting control of the company.

Assets and liabilities in exchange for control of the acquiree must be measured at their fair values at the date of exchange.

If settlement of any part of the cost of a combination is deferred, the fair value of the part is determined by discounting the costs to their present value.This is at the date of exchange including any premium or discount, incurred in settlement.

The published price at the date of exchange of a quoted equity instrument provides the best evidence of the instrument’s fair value and must be used.

EXAMPLE – Fair value- share price on the date of exchangeYou offer 1million of your shares for a company. You offer is accepted.At the date of exchange, your shares are quoted at $33 per share.Their par value is $10, so $23 (33-10) is treated as share premium.

I/B DR CRInvestment in subsidiary B $33mShare capital B $10mShare premium B $23mPurchase of business- share price on the date of exchange

The cost of a combination includes liabilities incurred or assumed by the acquirer, in exchange for control of the acquiree.

The cost includes any costs directly attributable to the combination, such as professional fees paid to accountants, legal advisers, valuers and other consultants to effect the combination.

General administrative costs, including the costs of maintaining an acquisitions department, are not included in the cost of the combination but are expensed when incurred.

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EXAMPLE – Costs included in a combinationThe company costs $60m. Accounting costs are $5m, legal costs are $6m.These are included in the cost of the combination.General overheads, relating to the acquisition team of $2m are expensed.

I/B DR CRInvestment in subsidiary B $71mCash B $60mAccounting costs I $5mLegal costs I $6mPurchase of business-cost aggregation

Future losses or other costs expected to be incurred as a result of a combination, are not liabilities incurred for control of the acquiree and are not included as part of the cost of the combination.

EXAMPLE-Future lossesYou buy a company for $30m. You plan to make staff cuts costing $4m to make the company profitable. These are future losses and will not be included as part of the cost of the combination.

I/B DR CRInvestment in subsidiary B $30mCash B $30mPurchase of business

Contingent liabilities are not future losses. They are liabilities from the past, which have been estimated, or there is uncertainty as to whether they will be paid.

The costs of arranging and issuing financial liabilities eg a debt issue, are part of the issue costs, even when the liabilities are issued to effect a combination. They are not costs of the combination. Such costs reduce the proceeds from the equity issue. (See IAS 39)

Adjustments to the cost of a combination contingent on future events

When a combination agreement provides for an adjustment to the cost contingent on future events, the acquirer must include 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.

EXAMPLE- Adjustments to the cost, contingent on future events

You buy a company for $60m. You will pay an additional $10m, if the profit for the coming year is more than last year’s profit. This will be an adjustment to the cost, which is contingent on future events. If it is probable that the target will be achieved, you will include the amount of that adjustment in the cost of the combination, at the acquisition date.

It is usually possible to estimate the amount of any such adjustment but if events do not occur or the estimate needs to be revised, the cost of the combination must be adjusted accordingly.

An adjustment is not included in the cost if it either is not probable, or cannot be measured reliably. An adjustment that then becomes probable must be adjusted on the cost.

In some circumstances, the acquirer may be required to make a subsequent payment to the seller.

EXAMPLE- Compensation for a reduction in shares issuedYou buy a firm for $50m. Your seller wants cash. You prefer to issue shares.You agree to issue 50m shares priced at $1 per share. If the price falls within the first 3 months, you will issue more shares as compensation.The shares fall to $0,80. You provide an extra 12,5m shares in compensation.

In such cases, no increase in the cost of the combination is recorded. In the case of shares, the fair value of the additional payment is offset by an equal reduction in the value, attributed to the shares initially issued.

EXAMPLE-additional payment offset by a reduction in initial shares.You buy a firm for $50m. Your seller wants cash. You prefer to issue shares.You agree to issue 50m shares priced at $1 per share. (The par value of each share is $0,10.) If the price falls within the first 3 months, you will issue more shares as compensation.The shares fall to $0,80. You provide an extra 12,5m shares in compensation.

I/B DR CRNet Assets-various B $50m

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Shares B $5mShare premium B $45mFirst issue of sharesShare premium B $10mShares (12,5m * $0,80) B $1mShare premium B $9mSecond issue of shares

In the case of debt instruments, the additional payment is regarded as a reduction in the premium or an increase in the discount on the initial issue.

EXAMPLE-additional payment offset by a reduction in debt instruments.You buy a firm for $100m. Your seller wants cash. You prefer to issue bonds.You agree to issue 100m shares priced at $1 each. If the price falls within the first 3 months, you will issue more bonds as compensation.

The bonds fall to $0,80. You provide an extra 25m bonds in compensation.I/B DR CR

Net Assets-various B $100mBonds B $100mFirst issue of bondsDiscount on bonds B $20mBonds (25m * $0,80) B $20mSecond issue of bonds

Allocating the cost to the assets acquired. At the acquisition date, the acquirer must allocate the cost of a combination according to the fair values of identifiable assets and liabilities acquired.

The exceptions are non-current assets or disposal groups that are classified as ‘held for sale’ in accordance with IFRS 5, which must be recorded at ‘fair value, less costs to sell’.

EXAMPLE- cost allocationYou buy a group of companies for $45m. You are going to sell one division and no selling cost will be incurred. Its ‘fair value, less costs to sell’ is $8m. The remaining business assets are worth $50m, liabilities are worth $11 and contingent liabilities are worth $2m. For cost allocation purposes, the following analysis is made:

I/B DR CRAssets-various B $50m

Cash B $45mLiabilities-various B $11mContingent liabilities B $2mAssets ‘held for sale’ B $8mPurchase of business-cost allocation

The acquirer must record separately the acquiree’s identifiable assets, liabilities and contingent liabilities at the acquisition date only if they satisfy the following criteria, at that date if: i assets other than an intangible assets – it is probable that any

associated benefits will flow to the acquirer and its fair value can be measured reliably;

ii liability other than a contingent liability - it is probable that payment will be required to settle the obligation and its fair value can be measured reliably;

iii intangible assets or a contingent liabilities - its fair value can be measured reliably.

The consolidated accounts must reflect the values at acquisition. For example an asset in the acquiree’s book at $5m may have, at acquisition, a value of $7m. In the consolidated accounts the depreciation charge made in the subsidiary income statement will be based on $7m.

EXAMPLE-income statement, based on the costs to the acquirerYou buy a foreign company. It has a building that cost $80m, 10 years before the merger. It is being depreciated over 20 years, at $4million per year. It now has a carrying value of $40m (80m-10years*4m). You are told that you cannot revalue the property in the local accounts. The building will continue to be depreciated at $4million per year, in the local accounts.In your consolidated accounts, the fair value is now $100m. You will depreciate it over the remaining 10 years of its life, at $10m per year. Your consolidation adjustments will be:

I/B DR CRProperty –cost B $80mProperty-accumulated depreciation B $40mProperty –revalued B $100mRevaluation reserve B $60mConsolidation adjustment at acquisitionProperty –depreciation I $6m

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Property-accumulated depreciation B $6mYear 1 additional charge in consolidated accountsRevaluation reserve B $6mRetained earnings B $6mReserve movement see IAS16 workbook

Application of the purchase method starts from the acquisition date, which is the date on which the acquirer effectively obtains control of the acquiree.

It is not necessary for a transaction to be finalised before the acquirer obtains control. All pertinent facts surrounding a combination must be considered, in assessing when the acquirer has obtained control.

EXAMPLE – Control, but transaction to be finalisedYou buy a company. You have paid, have a binding agreement, but some registrations have yet to be completed before you become the legal owner.Nonetheless, you have control, for accounting purposes.

As the acquirer records the acquiree’s identifiable assets, liabilities and contingent liabilities at their fair values at the acquisition date, any minority interest in the acquiree is stated at the minority’s proportion of the net fair value of those items.

EXAMPLE- minority’s proportion of the net fair value You have bought 80% of a company for $400m. Its assets are valued at $700m and its liabilities are valued at $500m. It will be consolidated at the date of purchase as follows:

I/B DR CRAssets-various B $700mLiabilities-various B $500mMinority interests 20% * $500m B $40mGoodwill $240mInvestment in subsidiary B $400mConsolidation adjustment at acquisition

Acquiree’s identifiable assets and liabilities

(i) As part of allocating the cost of the combination, the acquirer must record existing liabilities for restructuring or for reducing the activities of the acquiree.

EXAMPLES- liability for restructuring1. You buy a group of companies. A month before the purchase, the previous management had announced plans to close a division and made a provision for restructuring. This provision can be used by you as part of allocating the cost of the combination.2. You buy a company for $80m. You plan to make staff cuts costing $5m to make the company profitable. These are future losses and will not be included as part of the cost of the combination. The acquiree did not have an existing liability for restructuring at the balance sheet date.

(ii) the acquirer, when allocating the cost of the combination, must not record liabilities for future losses or other costs expected to be incurred, as a result of the combination.

A payment that an undertaking is contractually required to make is regarded as a contingent liability, until it becomes probable that a combination will take place.

EXAMPLE-Golden parachutesYour board members will each be paid $1m if the company is sold‘golden parachutes’. This is a contingent liability, until it is likely that the company will be sold. It is then reclassified as a liability and recorded by the acquirer, as part of allocating the cost of the combination.

The contractual obligation is recorded when a combination becomes probable and the liability can be measured reliably.

When the combination is effected, such a liability of the acquiree is recorded by the acquirer, as part of allocating the cost of the combination.

An acquiree’s restructuring plan conditional upon being acquired is neither a present obligation nor a contingent liability before the combination.

Therefore, an acquirer must not record a liability for such restructuring plans, as part of allocating the cost of the combination.

EXAMPLE- conditional restructuring plansYou are going buy a group of companies. A condition is that the acquiree records provisions for restructuring, that will occur if the merger occurs. These provisions cannot be used as part of allocating the cost of the combination.

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The identifiable assets and liabilities include all of the acquiree’s financial assets and financial liabilities.

They might also include assets and liabilities not previously recorded in the acquiree’s financial statements, eg because they did not qualify for recognition before the acquisition.

EXAMPLE- assets not previously recorded in the acquiree’s financial statementsYou buy a business that has been generating tax losses for many years. The tax credits have not been recorded, as there was no likelihood of them being used. You will bring in contracts that will make the business profitable. The tax authorities have confirmed that you will be able to use the brought-forward losses. These tax losses can be valued as an asset as part of allocating the cost of the combination.

Combination achieved in stages

A combination may involve more than one exchange transaction, for example when it occurs in stages by successive share purchases.

If so, each exchange transaction must be treated separately by the acquirer.

The cost of the transaction and fair value information at the date of each exchange transaction is used to determine the amount of any goodwill associated with that transaction.

This results in a step-by-step comparison of the cost and fair values at each step. The fair values of the acquiree’s net assets may be different at the date of each exchange transaction.

As:i the acquiree’s net assets are notionally restated to their fair values at

the date of each exchange transaction to determine the amount of any goodwill associated with each transaction; and

ii the acquiree’s net assets must then be recorded by the acquirer at their fair values at the acquisition date,

any adjustment to those fair values, relating to previously held interests of the acquirer and must be accounted for as a revaluation.

EXAMPLE - Property, Plant and Equipment acquiredYou buy a company whose fixed assets are in the acquiree’s books at $12m.Their fair value is $14m, which you record in your consolidated statements.

I/B DR CRProperty, Plant and Equipment B $2mRevaluation reserve B $2mProperty, Plant and Equipment revaluation

For the classifications of IAS 16 Property, Plant and Equipment, the fair value of the assets when acquired is their cost to the group, not a revaluation.

EXAMPLE - Property, Plant and Equipment acquiredYou buy a company whose fixed assets are in the acquiree’s books at $12m.Their fair value is $14m, which you record in your consolidated statements.These are classified as ‘Property, Plant and Equipment stated at cost’ in the notes not as ‘Property, Plant and Equipment at valuation’.

Before qualifying as a combination, a transaction may qualify as an investment in an associate and be accounted for in accordance with IAS 28, using the equity method. In applying the equity method to the investment., the fair values of the investee’s identifiable net assets at the date of each earlier exchange transaction will have been determined previously, EXAMPLE - Combination achieved in stages You agree to buy a company. You will buy 20% of the shares on January 1st, another 50% on March 1st and the final 30% on June 1st.On January 1st the company will be an associate. On March 1st it will become a subsidiary.

5. Allocating the cost of a combination

IFRS 3 requires an acquirer to record the acquiree’s net assets, at their fair values, at the acquisition date. For the purpose of allocating the cost of a combination, the acquirer must treat the following measures as fair values:1 for financial instruments, traded in an active market, the acquirer must

use current market values.

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2 for financial instruments not traded in an active market, the acquirer must use estimated values that take into consideration features such as price-earnings ratios, dividend yields and expected growth rates of comparable instruments of undertakings with similar characteristics.

3 for receivables, beneficial contracts and other identifiable assets, the acquirer must use the present values of the amounts to be received, determined at appropriate current interest rates, less allowances for doubtful debts and collection costs.

Discounting is not required for short-term receivables, beneficial contracts and other identifiable assets, unless the impact is material.

(4) for inventories of:i finished goods and merchandise, use selling prices less the sum of the

costs of disposal and a reasonable profit allowance. Profit is based on the selling effort, and profit for similar finished goods and merchandise;

ii work in progress, use selling prices of finished goods less the sum of:(1) costs to complete, costs of disposal and a reasonable profit allowance for

the completing and selling effort based on profit for similar finished goods; iii raw materials, use current replacement costs.

5 for land and buildings, use market values.6 for plant and equipment, use market values, normally determined by

appraisal. If there is no market-based evidence of fair value, because of the specialised nature of the item of plant and equipment and the item is rarely sold, except as part of a continuing business, estimate fair value, using an income, or a depreciated replacement cost, approach. 7 for intangible assets, the acquirer must determine fair value:i by reference to an active market, as defined in IAS 38; orii if no active market exists, on a basis that reflects the amounts the

acquirer would have paid for the assets, in transactions between independent willing parties, based on the best information available see IAS 38.

8 for net employee benefit assets or liabilities for defined benefit plans, the acquirer must use the present value of the defined benefit obligation, less the fair value of any plan assets.

9 for tax assets and liabilities, the acquirer must use the amount of the tax benefit arising from tax losses or the taxes payable in accordance with IAS 12 Income Taxes, assessed from the perspective of the combined undertaking.

The tax asset or liability is determined, after allowing for the tax effect of restating net assets to their fair values and is not discounted.

10 for accounts and notes payable, long-term debt, liabilities, accruals and other claims payable, use the present values of amounts to be paid in settling the liabilities, determined at appropriate current interest rates. Discounting is not required for short-term liabilities, unless the impact is material.

11 for onerous contracts and other identifiable liabilities of the acquiree, the acquirer must use the present values of payments in settling the obligations, determined at appropriate current interest rates.

12 for contingent liabilities of the acquiree, the acquirer must use the amounts that a third party would charge to assume those contingent liabilities. Such an amount must reflect all expectations about possible cash flows and not the single most likely nor the expected maximum, or minimum, cash flow.

Present value techniques may always be used in estimating the fair values.

6. Intangible assets

The acquirer records an intangible asset at the acquisition date, only if it meets the definition of an intangible asset in IAS 38.

EXAMPLE – acquiree intangible assetsThe acquirer records as an asset separately from goodwill an in-process research and development project of the acquiree, as it meets the definition of an intangible asset and its fair value can be measured reliably.

Identifiability criteria

Is the intangible asset:i is separable, capable of being separated or divided from the undertaking

and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or

ii arises from contractual or legal rights, regardless of whether those rights are transferable or separable from the undertaking, or from other rights and obligations.

Previously recorded intangible assets

The carrying amount of an item classified as an intangible asset that either:

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i was acquired in a combination before 31 March 2004 orii arises from an interest in a jointly-controlled undertaking obtained

before 31 March 2004 and accounted for by applying proportionate consolidation

must be reclassified as goodwill at the beginning of the first annual period beginning on or after 31 March 2004, if that intangible asset does not at that date meet the identifiability criterion in IAS 38.

EXAMPLE- Previously recorded intangible assets You have $36m of assets that were classified as intangibles, prior to 31 March 2004. They no longer meet the IAS 38 criteria. They will be written off, by reclassifying them as goodwill.

I/B DR CRGoodwill B $36mIntangible assets- net B $36mIntangible assets reclassified as goodwill

Acquiree’s contingent liabilities

The acquirer records separately a contingent liability as part of allocating the cost of a combination, only if its fair value can be measured reliably. If fair value cannot be measured reliably: i there is a resulting effect on the amount recorded as goodwill; andii the acquirer must disclose the information about that contingent

liability see IAS 37.

After their initial recognition, the acquirer must measure contingent liabilities at the higher of:i the amount that would be recorded under IAS 37 and ii the amount initially recorded.

The acquirer must disclose for those contingent liabilities, the information required by IAS 37, for each class of provision.

7. Goodwill

The acquirer must, at the acquisition date: i record goodwill acquired in a combination as an asset; and

ii initially measure that goodwill at its cost. This is the net fair value of the identifiable assets, liabilities and contingent liabilities less the cost.

EXAMPLE- Goodwill calculationYou buy a group for $55m. You are going to sell one division no selling cost will be incurred. Its ‘fair value, less costs to sell’ is $8m. For the remaining business, assets are worth $50m, liabilities are worth $11 and contingent liabilities are worth $2m. The premium that you have paid for the group is $10m, as you have net assets of only $45m for the $55m you have paid:

I/B DR CRGoodwill B $10mAssets-various B $50mCash B $55mLiabilities-various B $11mContingent liabilities B $2mAssets ‘held for sale’ B $8mPurchase of business-cost allocation

Goodwill represents a payment made by the acquirer, in anticipation of benefits from assets, that are not capable of being individually identified and separately recorded.

After initial recognition, the acquirer must test goodwill acquired for impairment annually or more frequently and measure at cost, less any accumulated impairment losses.

EXAMPLE-Goodwill ImpairmentYou purchase a group and pay $20m for the goodwill. You do not amortise it.You test it for impairment each year. At the end of the third year, you find that it is worth only $14m. You record an impairment loss of $6m.

I/B DR CRGoodwill B $6mImpairment loss - goodwill I $6mYear 3 Impairment loss

Previously-recorded goodwill

For any goodwill that has been amortised, an undertaking must:

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i from the beginning of the first annual period beginning on or after 31 March 2004, discontinue amortising such goodwill;

ii at the beginning of the first annual period beginning on or after 31 March 2004, eliminate the carrying amount of the related accumulated amortisation, with a corresponding decrease in goodwill; and

EXAMPLE - Revised accounting for goodwillYou bought a group for $800m. When the initial accounting for a combination was complete, you value net assets at $720m so goodwill is $80m (800m-720m). At 31 March 2004, accumulated amortisation of the goodwill was $12m. You eliminate the accumulated amortisation, with a corresponding decrease in goodwill.

I/B DR CRGoodwill – Accumulated amortisation B $12mGoodwill B $12mElimination of accumulated amortisation of goodwill

iii from the beginning of the first annual period beginning on or after 31 March 2004, test the goodwill for impairment in accordance with IAS 36.

EXAMPLE-Goodwill ImpairmentYou purchase a group and pay $40m for the goodwill. You do not amortise it.You test it for impairment each year. At the end of the third year, you find that it is worth only $34m. You record an impairment loss of $6m.

I/B DR CRGoodwill B $6mImpairment loss - goodwill I $6mYear 3 Impairment loss

If goodwill was previously recorded as a deduction from equity, it must not be recorded in the income statement:(ii) on disposal of all or part of the business, to which that goodwill relates(iii) on impairment of a cash-generating unit to which the goodwill relates

Negative goodwill

If the net assets acquired are worth more than the price paid, the surplus negative goodwill is recorded immediately in the income statement.

Before doing so, all assets, liabilities and contingent liabilities should be reviewed to ensure that they have been properly accounted for.

EXAMPLE-Negative goodwillYou buy a group for $150m. The fair value of the net assets is $155m.The $5m is credited to the income statement.

I/B DR CRNet assets-various B $155mCash B $150mNegative goodwill I $5mNegative goodwill taken to the income statement

Previously-recorded negative goodwill

The carrying amount of negative goodwill at the beginning of the first annual period beginning on or after 31 March 2004 that arose from eitheri a combination, for which the agreement date was before 31 March

2004 orii an interest in a jointly-controlled undertaking obtained before 31 March

2004 and accounted for by applying proportionate consolidation must be derecognised at the beginning of that period, with a corresponding adjustment to the opening balance of retained earnings.

EXAMPLE – Negative goodwill derecognitionAt 31 March 2004, you are carrying negative goodwill of $55m, relating to an earlier acquisition. You credit it to the opening balance of retained earnings.

I/B DR CROpening retained earnings B $55mNegative goodwill B $55mNegative goodwill derecognition

8. Provisional Accounting

If the initial accounting for a combination can be determined only provisionally by the end of the period in which the combination is effected, the acquirer must account for the combination using those provisional values.

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EXAMPLE provisional valuesYou buy a group in November. At your year-end in December, some foreign assets have yet to be fair valued. Provisional values can be used.

The acquirer must record any adjustments to those provisional values:1 within twelve months of the acquisition date; and 2 use the correct values as of the acquisition date.

Any depreciation will be applied from the acquisition date (not the adjustment date,

EXAMPLE – Date relating to the valuationYou buy a group in November. At your year-end in December, some foreign assets have yet to be fair valued. When they are finally valued, the valuation relates to the purchase date in November, not the date of the actual valuation.

3. Goodwill must be adjusted from the acquisition date, to balance any adjustment to the provisional values.

EXAMPLE-Provisional valuation and the impact on goodwillYou buy a group in November for $700m. At your year-end in December, some foreign assets have yet to be fair valued. Your provisional figures plus the actual valuations of other assets value net assets at $680m. This yields a goodwill figure of $20m 700m-680m. When all the valuations are finalised, the value of all the net assets falls to $650m. You increase goodwill to $50m 700m-650m.

I/B DR CRGoodwill B $30mNet assets-various B $30mRevision of provisional valuation

4. comparative information is adjusted for revisions to the provisional figures.

Adjustments after the initial accounting is complete

After the initial accounting is complete, adjustments must be recorded only to correct an error in accordance with IAS 8.

EXAMPLE – Valuation errorsYou buy a group. After you have completed the initial accounting for a combination, you find that $7m of consignment inventory never existed.

This must be recorded as an error. See IAS 8

Adjustments to the initial accounting for a combination, after that accounting is complete, must not be recorded for the effect of changes in estimates.

IAS 8 requires an undertaking to account for an error correction retrospectively and to present financial statements as if the error had never occurred, by restating the comparative information for the prior periods in which the error occurred.

The carrying amount requiring correction must be calculated as if its fair value had been recorded from the acquisition date.Goodwill must be adjusted retrospectively by an equal amount.

EXAMPLE - Revised accounting for a combination and goodwillYou buy a group for $700m. When the initial accounting for a combination is complete, you value net assets at $680m so goodwill is $20m (700m-680m). When an error is found, the value of all the net assets falls to $650m. You increase goodwill to $50m 700m-650m.

I/B DR CRGoodwill B $30mNet assets-various B $30mRevision of valuation

Recognition of deferred tax assets after the initial accounting is complete

If the potential benefit of the acquiree’s income tax loss carry-forwards or other deferred tax assets did not initially satisfy the criteria for separate recognition, but is subsequently realised, the acquirer must record that benefit as income in accordance with IAS 12 Income Taxes.

In addition, the acquirer must reduce the carrying amount of goodwill and expense the amount of the reduction. The creation or increase in negative goodwill must not result.

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EXAMPLE - Revised accounting for deferred tax and goodwillYou bought a group for $800m. The initial value net of assets was $725m so goodwill was $75m (800m-725m). A deferred tax asset of $15m has since been realised. It had not been recognised within the $725. Goodwill is decreased to $60m 800m-740m.The deferred tax asset is shown as income and the goodwill reduction is expensed.

I/B DR CRGoodwill – write off I $15mGoodwill B $15mDeferred tax asset B $15mTax I $15mDeferred tax asset recognition

EXAMPLE - deferred tax less than goodwillYou bought a group for $800m and you value net assets at $725m so goodwill is $75m (800m-725m). In this example the goodwill is less than the deferred tax asset:A deferred tax asset of $90m has since been realised. It had not been recognised within the $725. Goodwill is eliminated, but no negative goodwill is created.The deferred tax asset is shown as income and the goodwill reduction is expensed.

I/B DR CRGoodwill – write off I $75mGoodwill B $75mDeferred tax asset B $90mTax I $90mDeferred tax asset recognition

Limited retrospective application

An undertaking is permitted to apply the requirements of IFRS 3 to goodwill existing at any date before 31 March 2004, provided the undertaking also applies IAS 36 and IAS 38 prospectively. All valuations and other information must be obtained at the time of initial accounting for the combinations.

9. Reverse acquisitions

In reverse acquisitions, the acquirer’s shares are acquired and the issuer is the acquiree.

For example, a private undertaking arranges to have itself ‘acquired’ by a smaller listed company to obtain a stock exchange listing.

Legally the issuer is regarded as the parent and the acquiree is regarded as the subsidiary. In control terms subsidiary may have the power to control the financial and operating policies of the legal parent.

EXAMPLE-Reverse acquisition-parent and acquirer‘Small’ buys ‘Big’ in a reverse acquisition.

Small is the legal parent, but Big is the acquirer as it dictates the financial and operating policies of Small.

The allocation of the cost of the combination and the calculation of goodwill, is based on the net assets of Small.

Big’s assets are not revalued to fair value but Small’s are to establish the cost of combination and goodwill.

Reverse acquisition accounting determines the allocation of the cost of the combination as at the acquisition date and does not apply to transactions after the combination.

Cost of the combination

The cost of the combination includes the fair value of shares are issued as part of the cost of the combination.

If there is no published price, the fair value of the shares can be estimated, by reference to the fair value of the acquirer, or the fair value of the acquiree, whichever is clearer.

In a reverse acquisition, the cost of the combination is deemed to have been incurred by the legal subsidiary (legal acquirer).

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EXAMPLE- Reverse acquisition-cost of combination‘Small’ buys ‘Big’ in a reverse acquisition. The cost of the combination is deemed to have been incurred by Big, in the form of shares issued by Big to Small.

Preparation and presentation of consolidated financial statements

Consolidated financial statements, prepared following a reverse acquisition, must be issued under the name of the legal parent, but described in the notes as a continuation of the financial statements of the legal subsidiary ie the acquirer for accounting purposes.

EXAMPLE- Reverse acquisition-cost of combination‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements will be issued in the name of Small, but described as a continuation of those of Big.

As such consolidated financial statements represent a continuation of the financial statements of the legal subsidiary:(i) the assets and liabilities of the legal subsidiary must be recorded in

those consolidated financial statements, at their pre-combination carrying amounts.

EXAMPLE- Reverse acquisition-no asset revaluation to fair value‘Small’ buys ‘Big’ in a reverse acquisition. Big’s assets are not revalued to fair value, but remain at their carrying amounts from before the combination. Small’s assets would be revalued, to establish the cost of combination and goodwill. Small’s net assets were $15m, revalued to $20m. Big’s net assets were $100m, and have not been revalued. (ii) the retained earnings and other equity balances must be the retained

earnings and other equity balances of the legal subsidiary, immediately before the combination.

EXAMPLE- Reverse acquisition-retained earnings‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements will use Big’s retained earnings and other equity balances, rather than those of small.

(iii) the amount recorded as issued shares must be determined by adding the cost of the combination, to the issued equity of the legal subsidiary, immediately before the combination.

EXAMPLE- Reverse acquisition-shares‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements show the amount of Big’s issued shares from before the merger, plus the amount of additional shares issued by Small. This provides the total value.The description of the number and type of shares will relate to the legal capital of Small.

However, the equity the number and type of shares issued must reflect the equity structure of the legal parent, including the shares issued by the legal parent, to effect the combination.iv comparative information must be that of the legal subsidiary.

EXAMPLE- Reverse acquisition- comparative information ‘Small’ buys ‘Big’ in a reverse acquisition. Consolidated financial statements show the comparative figures of Big for previous periods.

Reverse acquisition accounting applies only in the consolidated financial statements.

In the legal parent’s separate financial statements, the investment in the legal subsidiary is accounted for in accordance with the requirements in IAS 27.

EXAMPLE- Reverse acquisition- parent’s separate financial statements‘Small’ buys ‘Big’ in a reverse acquisition. Small’s parent company balance sheet shows Big as an investment in subsidiary.

Consolidated financial statements, prepared following a reverse acquisition, must reflect the fair values of the net assets and contingent liabilities of the legal parent the acquiree for accounting purposes.

EXAMPLE- Reverse acquisition- minority interests 2‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders choose not to sell to Small. They will be interested only in the results of Big, as they have no stake in Small.

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The cost of the combination must be allocated by measuring the identifiable assets, liabilities and contingent liabilities of the legal parent, at their fair values at the acquisition date.

Any excess of the cost of the combination, over the net fair value of those items, must be accounted for as goodwill. The reverse is negative goodwill.

Minority interest

Some of the owners of the legal subsidiary may not exchange their shares for those of the legal parent and they must be treated as a minority interest in the consolidated financial statements, prepared after the reverse acquisition.

EXAMPLE- Reverse acquisition- minority interests 1‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders choose not to sell to Small. They will be minority interests in the consolidated financial statements.

The owners of the legal subsidiary that do not exchange their shares for shares of the legal parent have an interest only in the results and net assets of the legal subsidiary and not in the results and net assets of the combined undertaking.

EXAMPLE- Reverse acquisition- minority interests 2‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders choose not to sell to Small. They will be interested only in the results of Big, as they have no stake in Small.

Conversely, all of the owners of the legal parent, notwithstanding that the legal parent is regarded as the acquiree, have an interest in the results and net assets of the combined undertaking.

EXAMPLE- Reverse acquisition- minority interests 3‘Small’ buys ‘Big’ in a reverse acquisition. Some of Big’s shareholders choose not to sell to Small. All Small’s shareholders have an interest in both Small and Big..

As the assets and liabilities of the legal subsidiary are recorded in the consolidated financial statements, at their pre-combination carrying amounts, the minority interest must reflect the minority shareholders’ proportionate interest in the pre-combination carrying amounts of the legal subsidiary’s net assets.

EXAMPLE- Reverse acquisition- minority interests 4‘Small’ buys ‘Big’ in a reverse acquisition. 25% of Big’s shareholders choose not to sell to Small. As Big’s net assets have not been revalued to fair values and remain at their $100m carrying value, from just prior to the merger. The minority interests’ share remains at $25m, based on Big’s pre-combination carrying amounts .

Earnings per share

The equity structure appearing in the consolidated financial statements, following a reverse acquisition, reflects the equity structure of the legal parent, including the shares issued by the legal parent to effect the combination. EXAMPLE- Reverse acquisition- EPS 1‘Small’ buys ‘Big’ in a reverse acquisition. The shares of Small are used for the consolidated financial statements.

For the purpose of calculating the weighted-average number of ordinary shares outstanding the denominator, during the period in which the reverse acquisition occurs: (i) the number of ordinary shares, outstanding from the beginning of that

period to the acquisition date, must be deemed to be the number of ordinary shares issued by the legal parent to the owners of the legal subsidiary; and

(ii) the number of ordinary shares, outstanding from the acquisition date to the end of that period, must be the actual number of ordinary shares of the legal parent outstanding during that period.

EXAMPLE- Reverse acquisition- EPS 2‘Small’ buys ‘Big’ in a reverse acquisition. Small had 100 shares issued prior to the merger. It then issued 2.000 shares to Big’s owners.For calculating the EPS, 2.000 not 100 is the number of shares for the period prior to the merger. 2.100 is the number following the merger.

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The earnings per share for each comparative period before the acquisition date, must be calculated by dividing the income of the subsidiary by the number of shares issued by the parent to the owners of the subsidiary in the reverse acquisition.

EXAMPLE- Reverse acquisition- EPS 3‘Small’ buys ‘Big’ in a reverse acquisition. Small had 100 shares issued prior to the merger. It then issued 2.000 shares to Big’s owners. Comparative EPS figures for previous figures should use Big’s earnings for the period and divide them by 2.000 shares.

This assumes that there were no changes, in the number of the legal subsidiary’s issued ordinary shares during the comparative periods and during the period, from the beginning of the period in which the reverse acquisition occurred, to the acquisition date.

The calculation of earnings per share must be adjusted, to take into account a change in the number of the legal subsidiary’s issued ordinary shares, during those periods. See IAS 33.

10. PRACTICAL ISSUES

FAIR VALUE EXERCISE

In-progress research and development is regarded as an intangible asset when purchased.

Intangible assets do not need to be individually separable and should be recorded, even if negative goodwill arises.

Measurable contingent liabilities are now required to be recorded when purchased.

ALLOCATING GOODWILL TO CASH-GENERATING UNITS CGU’s

Allocation of goodwill needs objective support for each decision. The anticipated synergies of the merger should be identified, as the CGU’s (Cash Generating Units) will have to support the recoverable amount of goodwill or suffer an impairment charge.The disclosure requirements are exhaustive.

They include information about goodwill and the CGU’s to which it is allocated.

Allocation should be made before the end of the accounting period following the acquisition. Failure to do so has to be explained and may suggest that the acquisition was made without a clear strategic view.

IMPAIRMENT TESTS

Impairment tests must now be carried out annually for all CGU’s with goodwill, or indefinite-lived intangible assets. Impairment tests have become a core element in the day-to-day internal financial reporting process. The consistency and robustness of management’s assertions over time is crucial.

Goodwill amortisation has disappeared, but the transition rules do not require restatement of past transactions, so there may be an immediate positive impact on earnings. More intangible assets will result in more amortisation. The new treatments of limiting restructuring provisions and liquidating negative will impact earnings.

The acquisition process will become more rigorous, from planning to execution. More thorough evaluation of targets and structuring of deals will be required, in order to withstand greater market scrutiny.

TRANSITION PROVISIONS First-time adopters. Having a reporting date of 31 March 2004, or later, they must use IFRS 3, IAS 36 and IAS 38 for all periods covered by the first set of financial statements. All comparative information for prior periods, must also apply these standards.If the reporting date is 30 June 2004 and 2 years of comparatives are presented, the firm must apply the rules from 1 July 2001.

Current preparer – no retrospective application

Calendar-year preparers will continue to amortise goodwill during 2004. Amortisation will cease at 1 January 2005 and impairment tests will be carried out during 2005, on historical goodwill.

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Current preparer –retrospective application but no covered transactions

IFRS 3 may be retrospectively applied. This is easiest when there have been no combinations in the prior periods. An early adopter does not amortise goodwill in 2004, but must carry out an impairment test during 2004.

Current preparer –retrospective application transactions in the period

All relevant fair value information for purchase price allocation, for historic mergers, must be available. It should have been collected when the transactions occurred; it cannot be re-created after the fact.A preparer will have the majority of the required information if it has reconciled its financial statements to USGAAP, during the relevant periods, as the procedures are similar.

11. Combinations involving undertakings under common control outside the scope of IFRS 3

A combination involving undertakings under common control is a combination in which all of the combining undertakings are ultimately controlled by the same party or parties, both before and after the combination and that control is not transitory.

A group of individuals must be regarded as controlling an undertaking when as a result of contractual arrangements they collectively have the power to govern its financial and operating policies.

A combination is outside the scope of IFRS 3 when the same group of individuals has ultimate collective power to govern the financial and operating policies of each of the combining undertakings and that power is not transitory.

An undertaking can be controlled by an individual or by a group, acting together under a contractual arrangement and that individual or group may not be subject to the financial reporting requirements of IFRSs.

The extent of minority interests in each of the combining undertakings before and after, the combination is not relevant to determining whether the combination involves undertakings under common control.

12. DISCLOSURE

An acquirer must disclose information that enables users to evaluate the nature and financial effect, of combinations that were effected:i during the period.ii after the balance sheet date, but before the financial statements are

approved for issue.

The acquirer must disclose, for each combination that was effected during the period:i names and descriptions of the combining undertakings.ii acquisition date.iii percentage of voting shares acquired.iv cost of the combination and the components of that cost, including any

costs directly attributable to the combination. When shares are issued or issuable as part of the cost, the following must also

be disclosed:i number of shares issued or issuable; andii fair value of those shares and the basis for determining that fair value. If a published price does not exist for the shares at the date of exchange, the assumptions used to determine fair value must be disclosed.If a published price exists at the date of exchange, but was not used as the basis for determining the cost of the combination, that fact must be disclosed together with:

- reasons the published price was not used; - method and assumptions used to attribute a value to the shares; and- aggregate amount of the difference between the value attributed to

and the published price of, the shares.iii details of any operations the undertaking has decided to dispose of, as a

result of the combination.iv amounts recorded at the acquisition date for each class of the acquiree’s

assets, liabilities and contingent liabilities and unless disclosure would be impracticable the carrying amounts of each of those classes, determined in accordance with IFRSs, immediately before the combination.

If such disclosure would be impracticable, that fact must be disclosed, together with an explanation of why.v amount recorded in the income statement in as negative goodwill and

the line item in the income statement in which it is recorded.

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vi description of the factors that contributed to a cost that results in the recognition of goodwill—a description of each intangible asset that was not recorded separately from goodwill and an explanation of why the intangible asset’s fair value could not be measured reliably—or a description of the nature of any negative goodwill.

vii amount of the acquiree’s profit since the acquisition date included in the acquirer’s the income statement for the period, unless disclosure would be impracticable. If impracticable, that fact must be disclosed, together with an explanation of why this is the case.

The information must be disclosed in aggregate, for combinations effected during the reporting period, that are individually immaterial.

If the initial accounting for a combination that was effected during the period was determined only provisionally, that fact must also be disclosed, together with an explanation of why this is the case. The acquirer must disclose the following information, unless impracticable:i the revenue of the combined undertaking for the period, as though the

acquisition date for all combinations effected during the period had been the beginning of that period.

ii the profit of the combined undertaking for the period, as though the acquisition date for all combinations effected during the period had been the beginning of the period.

If impracticable, that fact must be disclosed, together with an explanation of why this is the case.

The acquirer must disclose the information for each combination effected after the balance sheet date, but before the financial statements are approved for issue, unless impracticable.

If impracticable, that fact must be disclosed, together with an explanation of why this is the case.

An acquirer must disclose information that enables users to evaluate the financial effects of gains, losses, error corrections and other adjustments, recorded in the current period, that relate to combinations that were effected in the current or in previous periods.

The acquirer must disclose the following information:

1 the amount and an explanation, of any gain or loss recorded in the current period that:

i relates to the identifiable assets acquired or liabilities, or contingent liabilities assumed in a combination, that was effected in the current, or a previous, period; and

ii is of such size, nature or incidence, that disclosure is relevant to an understanding of the combined undertaking’s financial performance.

2 if the initial accounting for a combination, that was effected in the immediately preceding period, was determined only provisionally at the end of that period, the amounts and explanations of the adjustments to the provisional values, recorded during the current period.

3 the information about error corrections, required to be disclosed by IAS 8, for any of the acquiree’s identifiable assets, liabilities or contingent liabilities, or changes in the values assigned to those items.

An undertaking must disclose information, which enables users to evaluate changes in the carrying amount of goodwill, during the period.

The undertaking must disclose a reconciliation of the carrying amount of goodwill, at the beginning and end of the period, showing separately:i the gross amount and accumulated impairment losses at the

beginning of the period;ii additional goodwill recorded during the period, except goodwill

included in a disposal group that, on acquisition, meets the criteria to be classified as held for sale, in accordance with IFRS 5;

iii adjustments resulting from the subsequent recognition of deferred tax assets, during the period;

iv goodwill, included in a disposal group classified as held for sale, in accordance with IFRS 5 and goodwill derecognised during the period, without having previously been included in a disposal group classified as held for sale;

v impairment losses recorded during the period, in accordance with IAS 36;

vi net exchange differences arising during the period, in accordance with IAS 21;

vii any other changes in the carrying amount during the period; andviii the gross amount and accumulated impairment losses, at the end of

the period.

The undertaking discloses information about the recoverable amount and impairment of goodwill.

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13. PROPOSED AMENDMENTS TO IFRS 3

Business combinations of mutual entities and undertakings brought together by contract alone were excluded from IFRS3, when it first appeared.The IASB proposes to amend this to include both types of merger within IFRS 3. Such mergers would differ in measuring the cost of combination.

When both parties are mutual entities, the cost will be the aggregate of the following:-fair value of the acquiree’s net assets-purchase price paid by the acquirer.

Costs directly attributable to the merger, such as professional and legal fees, will be expensed and not included in the cost.

When the combination is created by contract alone, the cost will be the fair value of the acquiree’s net assets. Costs directly attributable to the merger, such as professional and legal fees, will be expensed and not included in the cost.

14. MULTICHOICE QUESTIONS

1. IFRS 3:1. Allows either the unitings of interest method, or the purchase

method.2. Allows only the unitings of interest method.3. Allows only the purchase method.

2. Under IFRS 3, acquired contingent liabilities are:1. Always included in the cost of combination.2. Included in the cost of combination, only if they can be reliably

measured.3. Included in goodwill.

3. Goodwill should be:1.Tested annually for impairment.2. Held at cost.3. Amortised.

4. Negative goodwill should be:1. Matched to future losses.2. Allocated to non-current assets.3. Recorded in the income statement.

5. The result of nearly all combinations is that the:1. ‘Acquirer’ obtains control of the ‘acquiree’.2. ‘Acquiree’ obtains control of the ‘acquirer’.3. ‘Acquirer’ is a partner of the ‘acquiree’.

6. A combination may involve:(i) The purchase of the equity of another undertaking.(ii) The purchase of all the net assets of another

undertaking.(iii) The assumption of the liabilities of another

undertaking.(iv) The purchase of some of the net assets of another

undertaking, that together form one or more businesses.

(v) The purchase of assets from a firm in liquidation.

1. i – ii2. i – iii3. ii – iii4. i – iv5. i – v

7. Applying the purchase method involves the following steps: i Identifying an acquirer.ii Measuring the cost of the combination.iii Allocating, at the acquisition date, the cost of the combination to the

assets acquired and liabilities and contingent liabilities assumed.iv Amortising the goodwill.

1. i – ii2. i – iii3. ii – iii4. i – iv

8. Control is the power:

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1. To govern the financial and operating policies of an undertaking.

2. To control more than 40% of the ordinary shares.3. Appoint board members in proportion to your shareholding.

9. To identify an acquirer, indications that one exists are:.i If the fair value of one of the undertakings is greater than that of the

other, the greater is likely to be the acquirer.ii If the combination is effected through an exchange of voting ordinary

equity instruments for cash or other assets, the undertaking giving up cash or other assets is likely to be the acquirer.

iii If the combination results in the management of one of the undertakings being able to run the combined undertaking, the undertaking whose management is able to dominate is likely to be the acquirer.

iv In a combination effected through an exchange of shares, the undertaking that issues the shares is normally the acquirer.

v In a combination effected through an exchange of shares, the older undertaking is normally the acquirer.


10. When a new undertaking is formed to effect a combination:1. There will be no acquirer.2. 0ne of the undertakings that existed before the combination

must be identified as the acquirer.3. The new undertaking will be the acquirer.

11. The cost of a combination includes:(i) Liabilities incurred or assumed by the acquirer.(ii) Professional fees paid to accountants.(iii) Legal advisers’ fees.(iv) Valuers’ fees.(v) General administrative costs

1. i – ii2. i – iii

3. ii – iii4. i – iv5. i – v

12. Future losses are:1. Liabilities incurred for control of the acquiree.2. Included as part of the cost of the combination.3. Neither 1 nor 2.

13. For an adjustment to the cost of the combination contingent on future events, the acquirer must include the amount of that adjustment in the cost of the combination at the acquisition date, if the adjustment is:

1. Probable and can be measured reliably. 2. Certain and exactly measurable.3. Payable within one year.

14. The acquirer may be required to make a subsequent payment to the seller, as compensation for a reduction in the value of the shares issued for control of the acquiree. In such cases:

1. An increase in the cost of the combination is recorded. 2. The fair value of the additional payment is offset by an equal reduction

in the value, attributed to the shares initially issued.3. An increase in goodwill is recorded.

15. The acquirer must allocate the cost of a combination, by recording the acquiree’s identifiable:

(i) Assets.(ii) Liabilities(iii) Contingent liabilities.(iv) Non-current assets that are as ‘held for sale’.(v) Non-current liabilities that are as ‘held for sale’.


16. A building has a cost in the books of the acquiree of $200m. It is being depreciated over 20 years, the length of the lease. After 15 years,

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you buy the company and fair value the property at $400m. In the consolidated books of account, annual depreciation will be recorded as:

1. $10m.2. $20m3. $27m4. $80m

17. You buy a company. You have paid, have a binding agreement, but some registrations have yet to be completed before you become the legal owner.

1. You have control, for accounting purposes. 2. You do not have control, for accounting purposes. 3. You have partial control, for accounting purposes.

18. Minority interest in the acquiree is stated:1. Zero.2. The minority’s proportion of the fair value the net assets.3. The minority’s proportion of the fair value the assets.

19. An acquiree’s restructuring plan, whose execution is conditional upon its being acquired in a combination is:

1. Not a present obligation of the acquiree.2. A contingent liability.3. A liability.

20. A tax benefit arising from the acquiree’s tax losses that was not recorded by the acquiree:

1.Qualifies for recognition as an identifiable, if it is probable that the acquirer will have future taxable profits, against which the unrecorded tax benefit can be applied.2. Will be included in goodwill.3. Will not be recognised.

21. The acquirer records an in-process research and development project of the acquiree, if the project meets the definition of an intangible asset and its fair value can be measured reliably:

1. As goodwill.2. As an asset separately from goodwill.3. Research as an expense, development as an intangible asset.

22. The carrying amount of an item classified as an intangible asset that was acquired in a combination, if that intangible asset does not at that date meet the identifiability criterion in IAS 38, for which the agreement date was before 31 March 2004, is recorded:

1. As goodwill.2. As an asset separately from goodwill.3. Research as an expense, development as an intangible asset.

23. After their initial recognition, the acquirer must measure contingent liabilities at:

(1) The amount that would be recorded under IAS 37. (2) The amount initially recorded. (3) The lower of 1 and 2.(4) The higher of 1 and 2.

24. Goodwill acquired in a combination must be:1. Amortised. 2. Tested for impairment annually.3. Tested for impairment annually, or more frequently, if required.

25. To eliminate amortisation on previously-recorded goodwill:1. Credit to the income statement.2. Eliminate the carrying amount, with a corresponding decrease in

goodwill.3. Eliminate the carrying amount, with a corresponding increase in

opening retained earnings.

26. To eliminate previously-recognised negative goodwill:1. Credit to the income statement.2. Eliminate the carrying amount, with a corresponding decrease in

goodwill.3. Eliminate the carrying amount, with a corresponding increase in

opening retained earnings.

27. When provisional values of net assets need to be amended, the difference goes to:

1. The income statement.2. Goodwill.3. Opening retained earnings.

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28. When provisional values of net assets need to be amended, the differences will be applied:

1. From the date of acquisition.2. From the date of amendment.3. Over the following 3 years.

29. Adjustments to the initial accounting for a combination, after that initial accounting is complete, must be recorded:

1. Directly to the income statement.2. As an error in accordance with IAS 8.3. As an impairment.

30. A reverse acquisition is:1. A sale of a business.2. When a larger firm is bought by a smaller firm.3. When a private firm buys a listed firm.

31. In a reverse acquisition, consolidated accounts are prepared in the name of:

1.The parent.2.The subsidiary.3. Either 1 or 2.

32. In a reverse acquisition, the opening retained earnings are those of:1.The parent.2.The subsidiary.3. Either 1 or 2.

33. In a reverse acquisition, the comparative figures are those of:1.The parent.2.The subsidiary.3. Either 1 or 2.

34. In a reverse acquisition, the minority interests have shares in:

1.The parent.2.The subsidiary.3. Either 1 or 2.

35. In a reverse acquisition, the company whose assets are revalued are those of:

1.The parent.2.The subsidiary.

3. Either 1 or 2.

36. ‘Small’ buys ‘Big’ in a reverse acquisition. Small had 500 shares issued prior to the merger. It then issued 10.000 shares to Big’s owners.For calculating the EPS, the number of shares for the period prior to the merger is:

1. 500.2. 10.0003. 10.500

37. ‘Small’ buys ‘Big’ in a reverse acquisition. Small had 500 shares issued prior to the merger. It then issued 10.000 shares to Big’s owners. Comparative EPS figures for previous figures should use Big’s earnings for the period and divide them by:

1. 500 shares.2. 10.000 shares.3. 10.500 shares.

38. The proposed amendment includes mutual undertakings under the scope of IFRS 3.The main difference would be:

1. Costs directly attributable to the merger, such as professional and legal fees, will be expensed and not included in the cost.

2. Goodwill would not be subject to impairment tests.3. Fair values would not be used.

15. Answers to multiple choice questions

Question Answer1. 32. 23. 14. 35. 16. 47. 28. 19. 410. 2

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11. 412. 313. 114. 215. 216. 417. 118. 219. 120. 121. 222. 123. 424. 325. 226. 327. 228. 129. 230. 231. 132. 233. 234. 235. 136. 237 238 1

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international financial reporting standard 3

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