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This article was first published in the November/December 2008 edition of Accounting and Business magazine.
IFRS 3 (Revised), Business Combinations, will create significant changes in accounting for business combinations. IFRS 3 (Revised) further develops the acquisition model and applies to more transactions, as combinations by contract alone and combinations of mutual entities are included in the standard.
However, common control transactions and the formation of joint ventures are not dealt with by the standard. IFRS 3 (Revised) affects the first accounting period beginning on or after 1 July 2009. It can be applied early but only to an accounting period beginning on or after 30 June 2007. Importantly, retrospective application to earlier business combinations is not allowed.
Some of the most significant changes are in relation to the purchase consideration. Consideration now includes the fair value of all interests that the acquirer may have held previously in the acquired business. This includes any interest in an associate or joint venture or other equity interests of the acquired business. Any previous stake is seen as being 'given up' to acquire the entity and a gain or loss is recorded on its disposal. If the acquirer already held an interest in the acquired entity before acquisition, the standard requires the existing stake to be re-measured to fair value at the date of acquisition, taking any movement to the income statement together with any gains previously recorded in equity that relate to the existing holding.
If the value of the stake has increased, there will be a gain recognised in the statement of comprehensive income (income statement) of the acquirer at the date of the business combination. A loss would only occur if the existing interest has a book value in excess of the proportion of the fair value of the business obtained and no impairment had been recorded previously. This loss situation is expected to occur infrequently.
The requirements for recognition of contingent consideration have been amended. Contingent consideration is now required to be recognised at fair value even if it is not deemed to be probable of payment at the date of the acquisition. All subsequent changes in debt contingent consideration are recognised in the income statement, rather than against goodwill as it is deemed to be a liability recognised under IAS 32/39.
An increase in the liability for good performance by the subsidiaryresults in an expense in the income statement and under-performance against targets will result in the reduction in the expected payment and will be recorded as a gain in the income statement. These changes were previously recorded against goodwill.
The nature of the contingent consideration is important as it may meet the definition of a liability or equity. If it meets the definition of the latter then there will be no re-measurement as per IAS 32/39.
The new requirement that contingent consideration is fair valued at acquisition and, unless it is equity, is subsequently re-measured through earnings rather than the historic practice of re-measuring through goodwill, is likely to increase the focus and attention on the opening fair value calculation and subsequent re-measurements.
The standard also requires any gain on a 'bargain purchase' (negative goodwill) to be recorded in the income statement as in the previous standard.
Transaction costs no longer form a part of the acquisition price; they are expensed as incurred. Transaction costs are deemed not to be part of what is paid to the seller of a business. They are also not deemed to be assets of the purchased business that should be recognised on acquisition. The standard requires entities to disclose the amount of transaction costs that have been incurred.
The standard clarifies accounting for employee share-based payments by providing additional guidance on valuation, as well as how to decide whether share awards are part of the consideration for the business combination or compensation for future services.
Goodwill and non-controlling interests
The revised standard gives entities the option, on an individual transaction basis, to measure non-controlling interests (minority interest) at the fair value of their proportion of identifiable assets and liabilities or at full fair value.
The first method will result in measurement of goodwill, which is basically the same as with the existing IFRS. However, the second method will record goodwill on the non-controlling interest as well as on the acquired controlling interest. Goodwill continues to be a residual but it will be a different residual under IFRS 3 (Revised) if the full fair value method is used as compared to the previous standard.
This is partly because all of the consideration, including any previously held interest in the acquired business, is measured at fair value but it is also because goodwill can be measured in two different ways.
- Goodwill is the difference between the consideration paid and the purchaser's share of identifiable net assets acquired. This is a 'partial goodwill' method because the non-controlling interest (NCI) is recognised at its share of identifiable net assets and does not include any goodwill.
- Goodwill can also be measured on a 'full goodwill' basis, which means that goodwill is recognised for the non-controlling interest in a subsidiary as well as the controlling interest.
Under the previous version of IFRS 3, NCI was recognised at their share of net assets and did not include any goodwill. Full goodwill means that non controlling interest and goodwill are both increased by the goodwill that relates to the non-controlling interest.
Missile has acquired a subsidiary on 1 January 2008. The fair value of the net assets of the subsidiary acquired were $2,170m. Missile acquired 70% of the shares of the subsidiary for $2,145m. The non-controlling interest was fair valued at $683m.
Goodwill based on the partial and full goodwill methods under IFRS 3 (Revised) would be: