IFRS 3 business combinations explained

Is it a business combination?

IFRS 3 applies when the acquirer obtains control of a business. Under the definition of a business, that is an integrated set of activities and assets with inputs and at least one substantive process that together significantly contribute to the ability to create outputs. Since 2020, an optional concentration test lets a company conclude it has bought assets, not a business, when substantially all the fair value of the gross assets is concentrated in a single asset or group of similar assets, such as one building. Buying assets that are not a business is accounted for by allocating the cost to them, with no goodwill.

What are the steps of the acquisition method under IFRS 3?

1. Identify the acquirer: the entity that obtains control, usually the one transferring cash or issuing shares, though reverse acquisitions need care.
2. Determine the acquisition date: the date control passes, usually completion, not signing.
3. Recognise and measure the identifiable assets acquired and liabilities assumed at fair value, and the non-controlling interest.
4. Recognise goodwill or a bargain purchase gain.

How is goodwill calculated?

Goodwill = consideration transferred + non-controlling interest + fair value of any interest held before - identifiable net assets at fair value. In the example in purchase price allocation, a company pays 650 for 80% of a competitor with net assets at fair value of 580, and goodwill is 186. Goodwill is not amortised under IFRS; it is tested for impairment annually. See goodwill impairment testing.

What counts as consideration?

• Cash, other assets, shares issued and liabilities incurred to the former owners, at fair value.
• Contingent consideration, such as an earn-out, at fair value at the acquisition date. Later changes in a liability go to profit or loss; contingent consideration classified as equity is not remeasured.
• Not acquisition costs: advisers', legal and valuation fees are expensed. Costs of issuing debt or shares follow IFRS 9 and IAS 32.
• Not payments for other things, such as remuneration for former owners who stay as employees, which may be post-combination expenses.

What is the measurement period?

If the accounting is incomplete at the first reporting date, provisional amounts are used. During the measurement period, up to one year from the acquisition date, they are adjusted retrospectively for new information about facts that existed at the acquisition date, with goodwill changing accordingly. After that, changes are accounted for normally.

What about step acquisitions?

When an acquirer that already holds an interest, say 30% as an associate, buys enough to gain control, the existing interest is remeasured to fair value at the acquisition date, with any gain or loss in profit or loss, and included in the goodwill calculation.

What is a reverse acquisition?

When a private company merges into a listed shell by having the shell issue shares to the private company's owners, the legal acquirer may be the accounting acquiree. The private company is treated as the acquirer, and the consideration is measured as the shares it would have issued.

What must be disclosed?

For each material combination: the name and description of the acquiree, the acquisition date, the reasons for the acquisition, the consideration and its components, the amounts recognised for each major class of assets and liabilities, the goodwill and what it represents, and the acquiree's revenue and profit since the acquisition date.

Are there exceptions to fair value?

Yes: deferred tax (IAS 12), employee benefits (IAS 19), share-based payment awards (IFRS 2), assets held for sale (IFRS 5), leases where the acquiree is lessee (measured as new leases under IFRS 16), and contingent liabilities, which are recognised if they are present obligations even when an outflow is not probable. See contingent liabilities and non-controlling interests.

This guide is general information. It is not tax or legal advice for your situation.