give rise to goodwill. [IFRS 3.2]. Thus, existing book values or values in the acquisition
agreement may not be appropriate.
The cost of the group of assets is the sum of all consideration given and any non-
controlling interest recognised. If the non-controlling interest has a present ownership
interest and is entitled to a proportionate share of net assets upon liquidation, the
acquirer has a choice to recognise the non-controlling interest at its proportionate share
of net assets or its fair value; in all other cases, non-controlling interest is recognised at
fair value, unless another measurement basis is required in accordance with IFRS. An
example could be the acquisition of an incorporated entity that holds a single property,
where this is assessed not to be a business (see Chapter 7 at 3.1.1).
It may be difficult to determine whether or not an acquired asset or a group of assets
constitutes a business (see 3.2 below), yet this decision can have a considerable impact
on an entity’s reported results and the presentation of its financial statements;
accounting for a business combination under IFRS 3 differs from accounting for an
asset(s) acquisition in a number of important respects:
• goodwill or a gain on bargain purchase only arise on business combinations;
• assets acquired and liabilities assumed are generally accounted for at fair value in
a business combination, while they are generally assigned a carrying amount based
on their relative fair values in an asset acquisition;
• directly attributable acquisition-related costs are expensed if they relate to a
business combination, but are generally capitalised as part of the cost of the asset
in an asset acquisition;
• while deferred tax assets and liabilities must be recognised if the transaction is a
business combination, they are not recognised under IAS 12 – Income Taxes – if
it is an asset acquisition (see Chapter 29);
• where the consideration is in the form of shares, IFRS 2 – Share-based Payment
– does not apply in a business combination, but will apply in an asset acquisition;
• another difference may arise where the transaction involves contingent
consideration. While IFRS 3 provides guidance on the accounting for contingent
consideration in the acquisition of a business (see 7.1 below), IAS 16 – Property,
Plant and Equipment – and IAS 38 provide no clear guidance on accounting for
contingent consideration in an asset(s) acquisition (see Chapter 17 at 4.5 and
Chapter 18 at 4.1.9); and
• disclosures are much more onerous for business combinations than for asset
acquisitions.
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The accounting differences above will not only affect the accounting as of the
acquisition date, but will also have an impact on future depreciation, possible
impairment and other costs.
In November 2017, the Interpretations Committee issued an agenda decision that
clarified how an entity accounts for the acquisition of a group of assets that does not
constitute a business. More specifically, the submitter of the request asked for clarity
on how to allocate the transaction price to the identifiable assets acquired and liabilities
assumed when:
(a) the sum of the individual fair values of the identifiable assets and liabilities is
different from the transaction price; and
(b) the group includes identifiable assets and liabilities initially measured both at cost
and at an amount other than cost.
The Interpretations Committee concluded that a reasonable reading of the
requirements in paragraph 2(b) of IFRS 3 on the acquisition of a group of assets that
does not constitute a business results in one of the following two approaches:
(a) Under the first approach, an entity accounts for the acquisition of the group as follows:
(i) it identifies the individual identifiable assets acquired and liabilities assumed
that it recognises at the date of the acquisition;
(ii) it determines the individual transaction price for each identifiable asset and
liability by allocating the cost of the group based on the relative fair values of
those assets and liabilities at the date of the acquisition; and then
(iii) it applies the initial measurement requirements in applicable IFRSs to each
identifiable asset acquired and liability assumed. The entity accounts for any
difference between the amount at which the asset or liability is initially measured
and its individual transaction price applying the relevant requirements.
(b) Under the second approach, for any identifiable asset or liability initially measured
at an amount other than cost, an entity initially measures that asset or liability at
the amount specified in the applicable standard. The entity deducts from the
transaction price of the group the amounts allocated to the assets and liabilities
initially measured at an amount other than cost, and then allocates the residual
transaction price to the remaining identifiable assets and liabilities based on their
relative fair values at the date of the acquisition.
The Interpretations Committee also concluded that an entity should apply its
reading of the requirements consistently to all such acquisitions and an entity
would also disclose the selected approach applying paragraphs 117–124 of IAS 1 –
Presentation of Financial Statements – if that disclosure would assist users of
financial statements in understanding how those transactions are reflected in
reported financial performance and financial position. In addition, the
Interpretations Committee observed that the forthcoming amendment to the
definition of a business in IFRS 3 (see 1.1.2 above) is likely to increase the
population of transactions that constitute the acquisition of a group of assets.
Accordingly, this matter will be monitored after the forthcoming amendments to
IFRS 3 become effective.9
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2.2.3
Business combinations under common control
The application guidance in Appendix B to IFRS 3 gives some guidance on accounting
for business combinations involving entities or businesses under common control and
therefore excluded from the requirements of the standard. [IFRS 3.B1-B4]. These
arrangements are discussed further in Chapter 10.
3
IDENTIFYING A BUSINESS COMBINATION
IFRS 3 requires an entity to determine whether a transaction or event is a business
combination; the definition requires that the assets acquired and liabilities assumed
constitute a business. If the assets acquired and liabilities assumed do not constitute a
business, the transaction is to be accounted for as an asset acquisition (see 2.2.2 above).
[IFRS 3.3].
3.1
Identifying a business combination
IFRS 3 defines a business combination as a ‘transaction or other event in which an
acquirer obtains control of one or more businesses’. [IFRS 3 Appendix A].
IFRS 3 notes that an acquirer might obtain control of an acquiree (i.e. the business or
businesses over which the acquirer obtains control) in a variety of ways, for example:
(a) transferring
cash,
cash
equivalents or other assets (including net assets that
constitute a business);
(b) incurring
liabilities;
(c) issuing equity interests;
(d) providing more than one type of consideration; or
(e) without transferring consideration – including by contract alone (see 7.4 below).
[IFRS 3.B5].
A business combination may be structured in a variety of ways for legal, taxation or
other reasons, which include but are not limited to:
(a) one or more businesses become subsidiaries of an acquirer or the net assets of one
or more businesses are legally merged into the acquirer;
(b) one combining entity transfers its net assets, or its owners transfer their equity
interests, to another combining entity or its owners;
(c) all of the combining entities transfer their net assets, or the owners of those entities
transfer their equity interests, to a newly formed entity (sometimes referred to as
a roll-up or put-together transaction); or
(d) a group of former owners of one of the combining entities obtains control of the
combined entity. [IFRS 3.B6].
3.2
Definition of a business
IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable
of being conducted and managed for the purpose of providing a return in the form
of dividends, lower costs or other economic benefits directly to investors or other
owners, members or participants’. [IFRS 3 Appendix A]. The Basis for Conclusions notes
Business
combinations
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that by focusing on the capability to achieve the purposes of the business, unlike
previous versions, it helps avoid the ‘unduly restrictive interpretations that existed
in accordance with the former guidance’ and, in particular, clarifies that start-up
activities and activities integrated into those of the acquirer may still be businesses
as defined. [IFRS 3.BC18].
In June 2016, in response to stakeholder concerns raised during the PIR of IFRS 3, the
IASB proposed amendments that aim to clarify how to apply the definition of a business
in IFRS 3. These are discussed in detail in 3.2.6 below.
3.2.1
Inputs, processes and outputs
The application guidance to IFRS 3 describes the components of a business as inputs
and processes applied to those inputs that have the ability to create outputs, which
means that outputs do not need to be present for an integrated set of assets and activities
to be a business. The elements are described as follows:
• Input
Any economic resource that creates, or has the ability to create, outputs when one
or more processes are applied to it. Examples include non-current assets (including
intangible assets or rights to use non-current assets), intellectual property, the ability
to obtain access to necessary materials or rights and employees.
• Process
Any system, standard, protocol, convention or rule is a process if, when applied to
an input or inputs, it either creates or has the ability to create outputs. Examples
include strategic management processes, operational processes and resource
management processes. These processes typically are documented, but an
organised workforce having the necessary skills and experience following rules
and conventions may provide the necessary processes that are capable of being
applied to inputs to create outputs. Accounting, billing, payroll and other
administrative systems typically are not processes used to create outputs so their
presence or exclusion generally will not affect whether an acquired set of activities
and assets is considered a business.
• Output
The result of inputs and processes applied to those inputs that provide or have the
ability to provide a return in the form of dividends, lower costs or other economic
benefits directly to investors or other owners, members or participants. Outputs
need not be present at the acquisition date for an integrated set of activities and
assets to be defined as a business. [IFRS 3.B7].
3.2.2
‘Capable of’ from the viewpoint of a market participant
IFRS 3 clarifies that an acquired set of activities and assets does not need to include
all of the inputs or processes necessary to operate that set of activities and assets as
a business, i.e. it does not need to be self-sustaining. If a market participant is
capable of utilising the acquired set of activities and assets to produce outputs, e.g.
by integrating the acquired set with its own inputs and processes, thereby replacing
the missing elements, then the acquired set of activities and assets might constitute
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a business. It is not necessarily relevant whether the seller historically had operated
the transferred set as a business or whether the acquirer intends to operate the
acquired set as a business. What is relevant is whether a market participant is
capable of operating the acquired set of assets and activities as a business.
[IFRS 3.B8, B11]. Moreover, if a market participant does not itself have the elements
that are missing from the acquired set but they are easily replaced or replicated, i.e.
the missing elements are ‘minor’, we believe a market participant would be capable
of operating the acquired set in order to generate a return and the acquired set
should be considered a business.
We believe that, in most cases, the acquired set of activities and assets must have at
least some inputs and processes in order to be considered a business. If an acquirer
obtains control of an input or set of inputs without any processes, we think it is unlikely
that the acquired input(s) would be considered a business, even if a market participant
had all the processes necessary to operate the input(s) as a business.
The guidance in IFRS 3 also notes that the nature of the elements of a business
varies by industry and by the structure of an entity’s operations (activities),
including the entity’s stage of development. Established businesses often have
many different types of inputs, processes and outputs, whereas new businesses
often have few inputs and processes and sometimes only a single output. Nearly
all businesses also have liabilities, but a business need not have liabilities.
[IFRS 3.B9].
3.2.3 Identifying
business
combinations
Although the revision of the definition of a business in 2008 was intended to
improve consistency in the application of the definition of a business, the term
‘capable of’ is sufficiently broad that significant judgement continues to be required
in determining whether an acquired set of activities and assets constitute a business.
The following are examples from extractive industries and real estate that illustrate
the issues.
Example 9.1:
Extractive industries – definition of a business (1)
E&P Co A (an oil and gas exploration and production company) acquires a mineral interest from E&P Co B,
on which it intends to perform exploration activities to determine if reserves exist. The mineral interest is an
unproven property and there have been no exploration
activities performed on the property.
Inputs – mineral interest
Processes – none
Output – none
Conclusion
In this scenario, we do not believe E&P Co A acquired a business. While E&P Co A acquired an input
(mineral interest), it did not acquire any processes. Whether or not a market participant has the necessary
processes in place to operate the input as a business is not relevant to the determination of whether the
acquired set is a business because no processes were acquired from E&P Co B.
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combinations
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Example 9.2:
Extractive industries – definition of a business (2)
E&P Co A acquires a property similar to that in Example 9.1 above, except that oil and gas production
activities are in place. The target’s employees are not part of the transferred set. E&P Co A will take over the
operations by using its own employees.
Inputs – oil and gas reserves
Processes – operational processes associated with oil and gas production
Output – revenues from oil and gas production
Conclusion
In this scenario, we generally consider that E&P Co A acquired a business. The acquired set has all three
components of a business (inputs, processes and outputs) and is capable of providing a return to its owners.
Although the employees are not being transferred to the acquirer, a market participant would generally be
able to produce outputs by:
(1) supplying the employees necessary to continue production; and
(2) integrating the business with its own operations while continuing to produce outputs.
In the real estate industry, IAS 40 notes that where ancillary services (i.e. processes) are
provided and they are insignificant to the overall arrangement, this will not prevent the
classification of the asset as investment property. [IAS 40.11]. The guidance on ancillary
services, [IAS 40.11-14], is intended to distinguish an investment property from an owner-
occupied property, not whether a transaction is a business combination or an asset
acquisition. Entities acquiring investment properties must assess whether the property
is a business in terms of IFRS 3. [IAS 40.14A].
Therefore, evaluating whether it is a real estate business where certain processes are
transferred involves assessing those processes in the light of the guidance in IFRS 3.
Example 9.3:
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