IFRS 3 Business Combinations requires every business combination to be accounted for using the acquisition method. The acquirer recognises what it has bought at fair value, and measures goodwill as the residual.
Is it a business at all?
IFRS 3 applies only when the acquired set of activities and assets is a business: an integrated set capable of being conducted and managed to provide goods or services, generate investment income or other income. An entity may apply an optional concentration test: if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset (or group of similar assets), the set is not a business and is accounted for as an asset acquisition, with no goodwill and no deferred tax on the initial difference in most cases.
The acquisition method
- Identify the acquirer, the entity that obtains control.
- Determine the acquisition date, the date control passes.
- Recognise and measure the identifiable assets acquired, the liabilities assumed and any non-controlling interest (NCI) in the acquiree.
- Recognise and measure goodwill or a gain from a bargain purchase.
Identifiable assets and liabilities are generally measured at their acquisition-date fair values, with specific exceptions (deferred tax under IAS 12, employee benefits under IAS 19, and share-based payment awards, among others). The acquirer may recognise intangible assets the acquiree never recorded, such as customer relationships, brands and technology.
The goodwill formula
Goodwill is the excess of:
- the consideration transferred, plus
- the amount of any non-controlling interest, plus
- the fair value of any previously held equity interest in the acquiree,
over the net of the identifiable assets acquired and liabilities assumed, measured at acquisition-date fair value.
Non-controlling interest: a measurement choice
For each business combination, the acquirer chooses to measure NCI that is a present ownership interest either at fair value (which produces "full goodwill", including the NCI's share) or at the proportionate share of the acquiree's identifiable net assets (which produces goodwill attributable to the parent only).
A simple worked example
Entity A buys 80% of Entity B for cash of 900. B's identifiable assets have a fair value of 1,000 and its liabilities 300, so net identifiable assets are 700.
- NCI at proportionate share: 20% × 700 = 140. Goodwill = 900 + 140 − 700 = 340.
- NCI at fair value (assume 200): Goodwill = 900 + 200 − 700 = 400.
The difference of 60 is goodwill attributable to the NCI that is recognised only under the fair value option.
Bargain purchase
If the net identifiable assets exceed the sum above, the difference is a bargain purchase. The acquirer must first reassess that it has correctly identified and measured all assets, liabilities and consideration. Any remaining excess is recognised in profit or loss on the acquisition date.
Consideration, contingent consideration and costs
- Consideration is measured at fair value, including cash, assets transferred, equity issued and liabilities incurred.
- Contingent consideration is recognised at fair value at the acquisition date. If it is classified as a liability, later changes in fair value go to profit or loss. If it is classified as equity, it is not remeasured.
- Acquisition-related costs (advisory, legal, due diligence) are expensed as incurred. They are not part of the consideration. The costs of issuing debt or equity are accounted for under IFRS 9 and IAS 32.
The measurement period
If the initial accounting is incomplete at the end of the reporting period, the acquirer reports provisional amounts and may adjust them for up to one year from the acquisition date, to reflect new information about facts that existed at that date.
After the acquisition
Under IFRS Accounting Standards, goodwill is not amortised. It is tested for impairment at least annually under IAS 36 and carried at cost less accumulated impairment losses. Changes in a parent's ownership that do not result in loss of control are accounted for as equity transactions under IFRS 10.
Where this typically goes wrong
- Treating an asset acquisition as a business combination (or the reverse) without applying the definition and concentration test
- Not identifying acquired intangibles separately, leaving everything in goodwill
- Capitalising acquisition costs into the consideration
- Forgetting the deferred tax effect of fair value adjustments on the net assets acquired
- Failing to track the measurement period and finalise provisional amounts within a year
- Allocating goodwill to CGUs without considering which units benefit from the synergies