This article was first published in the November/December 2008 edition of Accounting and Business magazine.

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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.

Purchase consideration

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 subsidiary results 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.

  1. 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.
  2. 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:

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Missile - partial goodwill

Identifiable net assets - fair value 2,170
Non-controlling interest
(30% x 2,170)
Net assets required 1,519
Purchase consideration (2,145)
Goodwill 626

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Full goodwill

Identifiable net assets - fair value 2,170
Non-controlling interest (683)
Net assets required 1,487
Purchase consideration (2,145)
Goodwill 658

It can be seen that goodwill is effectively adjusted for the change in the value of the non-controlling interest which represents the goodwill attributable to the NCI.

This choice of method of accounting for NCI only makes a difference in an acquisition where less than 100% of the acquired business is purchased. The full goodwill method will increase reported net assets on the balance sheet which means that any future impairment of goodwill will be greater. Although measuring non-controlling interest at fair value may prove difficult, goodwill impairment testing may be easier under full goodwill, as there is no need to gross-up goodwill for partially owned subsidiaries.

Fair valuing assets and liabilities

The revised IFRS 3 has introduced some changes to the assets and liabilities recognised in the acquisition balance sheet. The existing requirement to recognise all of the identifiable assets and liabilities of the acquiree is retained.

Most assets are recognised at fair value, with exceptions for certain items such as deferred tax and pension obligations. The IASB has provided additional clarity that may well result in more intangible assets being recognised. Acquirers are required to recognise brands, licences and customer relationships, and other intangible assets.

There is very little change to current guidance under IFRS as regards contingencies. Contingent assets are not recognised, and contingent liabilities are measured at fair value. After the date of the business combination, contingent liabilities are re-measured at the higher of the original amount and the amount under the relevant standard.

There are other ongoing projects on standards that are linked to business combinations (for example, on provisions (IAS 37) and on deferred tax (IAS 12)), that may affect either recognition or measurement at the acquisition date or the subsequent accounting.

The acquirer can seldom recognise a reorganisation provision at the date of the business combination. There is no change from the previous guidance in the new standard: the ability of an acquirer to recognise a liability for terminating or reducing the activities of the acquiree is severely restricted.

A restructuring provision can be recognised in a business combination only when the acquiree has, at the acquisition date, an existing liability, for which there are detailed conditions in IAS 37, but these conditions are unlikely to exist at the acquisition date in most business combinations.

An acquirer has a maximum period of 12 months to finalise the acquisition accounting. The adjustment period ends when the acquirer has gathered all the necessary information, subject to the one year maximum. There is no exemption from the 12-month rule for deferred tax assets or changes in the amount of contingent consideration. The revised standard will only allow adjustments against goodwill within this one-year period.

The financial statements will require some new disclosures, which will inevitably make financial statements longer. Examples are: where non-controlling interest is measured at fair value, the valuation methods used for determining that value, and in a step acquisition, disclosure of the fair value of any previously held equity interest in the acquiree and the amount of gain or loss recognised in the income statement resulting from re-measurement.

IAS 27 Revised, Consolidated and Separate Financial Statements

The revised standard moves IFRS to the use of the economic entity model. Current practice is the parent company approach. The economic entity approach treats all providers of equity capital as shareholders of the entity, even when they are not shareholders in the parent company. The parent company approach sees the financial statements from the perspective of the parent company shareholders.

For example, disposal of a partial interest in a subsidiary in which the parent company retains control, does not result in a gain or loss but in an increase or decrease in equity under the economic entity approach. Purchase of some or all of the non-controlling interest is treated as a treasury transaction and accounted for in equity.

A partial disposal of an interest in a subsidiary in which the parent company loses control but retains an interest as an associate creates the recognition of gain or loss on the entire interest. A gain or loss is recognised on the part that has been disposed of and a further holding gain is recognised on the interest retained, being the difference between the fair value of the interest and the book value of the interest.

The gains are recognised in the statement of comprehensive income (income statement). Amendments to IAS 28, Investments in Associates and IAS 31, Interests in Joint Ventures extend this treatment to associates and joint ventures.


On 1 January 2008, A acquired a 50% interest in B for $60m. A already held a 20% interest which had been acquired for $20m but which was valued at $24m at 1 January 2008. The fair value of the non-controlling interest at 1 January 2008 was $40m and the fair value of the identifiable net assets of B was $110m. The goodwill calculation would be as follows using the full goodwill method:

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  $m $m
1 January 2008 consideration 60  
Fair value of interest held 24  
Identifiable net assets 110  
Non-controlling interest (40) (70)
Goodwill   14

A gain of $4m would be recorded on the increase in the value of the previous holding in B.