IFRS 3
BUSINESS COMBINATIONS.
LACPA – Roger Nasr
July 6, 2006
AGENDA



Introduction
Scope
Application of the purchase method
– including impairment of goodwill (IAS 36) & acquired
intangible assets (IAS 38)
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Changes from IAS 22
Questions
INTRODUCTION

IFRS 3, Business Combinations
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Revised versions
• IAS 36, Impairment of Assets
• IAS 38, Intangible Assets
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Supersedes IAS 22, Business Combinations (1998)
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SIC 9, 22 and 28 withdrawn
Main Changes in IFRS 3
Method?
Must be accounted for using
the purchase method
Assets and liabilities
acquired?
More intangible assets &
contingent liabilities
recognised and measured at
fair values
Goodwill?
Not amortised and tested
for impairment annually
Negative goodwill?
Recognised in profit or loss
immediately
Restructuring costs?
Only recognised to the
extent acquiree’s liability
exists at acquisition date
SCOPE

Business combination = A business combination is
the bringing together of separate entities or
businesses into one reporting entity

IFRS 3 applies to all business combinations except
– combinations of entities under common control
– combinations by contract without exchange of ownership
interest
– formations of joint ventures
APPLICATION OF THE
PURCHASE METHOD

All business combinations are accounted for by the
purchase method

Applying the purchase method
• An acquirer is identified
• The cost of the business combination is measured
• The cost is allocated, at acquisition, to the assets,
liabilities and contingent liabilities
Identifying an acquirer

An acquirer must be identified

The acquirer is the entity that
obtains control of the other
entities

IFRS 3 contains significant
guidance on identifying the
acquirer (e.g. relative fair
values)

The acquirer for accounting
purposes may not always be
the legal acquirer (reverse
acquisitions)
Cost of a business
combination

An acquirer measures the cost as the total of
– fair values at date of exchange of assets given, liabilities
incurred and equity instruments issued, plus
– any directly attributable costs

Equity instruments
– If market price exists - use price at date of exchange
– If market price doesn’t exist/unreliable - use other
valuation technique
Cost adjustments

Accounting for adjustments to the cost of a
business combination which are contingent on
future events
– include in the cost of combination if probable and can
be measured reliably at acquisition date
– treat as an adjustment to cost if subsequently meets
condition
– otherwise exclude
Allocating the cost
• Allocate cost by recognising, at fair values,
identifiable assets, liabilities and contingent
liabilities of acquiree
• Goodwill =
• Cost of acquisition - Total of net assets
IAS 38 Intangible
assets (recognition)
• Recognised separately from goodwill if:
• meet the definition of an asset
- controlled by the entity
- provide economic benefits
• either separable or arise from contractual/legal rights
• fair value can be measured reliably
IAS 38 Intangible Assets
(measurement)

Cost model
– Cost less accumulated amortisation and/or impairment
losses
OR

Revaluation model
– Fair value at date of revaluation less accumulated
amortisation and/or impairment losses
– Only allowed if an active market exists
IAS 38 Intangible Assets
(measurement)

Subsequent expenditure
– Only capitalise if will generate future economic
benefits in excess of originally assessed standard of
performance
IAS 38 Intangible
assets (classification)
Intangible assets
Indefinite useful lives
Definite useful lives
No amortisation
Impairment test
(annually and whenever
indication of impairment)
Amortisation
(systematically over useful life)
Impairment test
(if indication)
Contingent liabilities
• Initial recognition - Recognised separately if fair
value can be measured reliably
• Subsequent recognition – Remeasure at the higher
of
• IAS 37 value
• Initial amount less amortisation
Goodwill

Recognised as an asset
– cost of acquisition - total of net assets

Annual impairment test in accordance with IAS 36
– amortisation not allowed
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No negative goodwill
– total of net assets > cost of acquisition
– reassess fair values and cost of acquisition
– recognise immediately as a gain
IAS 36 Impairment of
Goodwill

Allocate goodwill to cash generating units (CGU)
before impairment test
– the smallest group of assets generating independent
cash inflows
– represents the lowest level at which goodwill is
monitored internally
– not larger than a segment (IAS 14)

Impairment test annually per CGU
– not necessarily at year end
IAS 36 - Impairment
model (reminder)
New carrying amount
(after write-down)
Lowest of
Carrying amount before
the impairment test
Recoverable amount
Highest of
Fair value less
costs to sell
Value in use
IAS 36 – Allocation of
impairment loss

The impairment loss is allocated in the following
order
– 1st reduce the carrying amount of any goodwill allocated
to the CGU (or group of units)
– 2nd reduce the carrying amounts of the other assets (pro
rata based on carrying amounts)


A write-down due to an impairment is recognised in
profit or loss
Reversal of write-down of goodwill is prohibited
IFRS 3
BUSINESS
COMBINATIONS.
(Case Studies)
IFRS 3 Business Combinations
Scope

Facts
– Strawberry Ltd acquired the shares in Lemon Ltd on 1 July
2004, based on a valuation performed by corporate
financiers, for Euro 15 million.
– The sole asset of Lemon was the patent right for
genetically engineered fruit technologies.
– Strawberry recognised Euro 15 million as goodwill.
IFRS 3 Business Combinations
Scope (cont)

Question
– Is this treatment correct?
Strawberry
100%
Lemon
(Patent)
IFRS 3 Business Combinations
Scope (cont)
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Definition of business
– Integrated set of activities and assets conducted and
managed for the purposes of providing:
A return to investors or
 Lower costs or other economic benefits
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– Consists of:
Inputs
 Process applied to inputs
 Outputs used to generate revenues
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IFRS 3 Business Combinations
Scope (cont)
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Guidance
– Inputs

PPE, Intangibles, Intellectual property, Ability to
obtain access to necessary materials, Employees
– Processes
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Systems, standards, protocols that define
processes
– Outputs

Ability to obtain access to customers that
purchase output
IFRS 3 Business Combinations
Acquisition date

Facts
– A company acquires a business.
– The acquisition needs approval from a Competitions
Authority (antitrust legislation) before acquisition can be
implemented.

Question
– Is this approval necessary prior to the recognition of the
acquisition as a business combination?
IFRS 3 Business Combinations
Identification of acquirer

Facts
– Nedcor makes partial offer for Stanbic on the basis of 1
Nedcor share for every 5.5 Stanbic shares
– Value of bid
Nedcor ZAR 27 750 million
 Stanbic ZAR 29 238 million

– Market capitalisation
Nedcor ZAR 27 039 million
 Stanbic ZAR 29 624 million
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IFRS 3 Business Combinations
Identification of acquirer (cont)
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Facts (cont)
– aStatement of intent
“Nedcor intends, in conjunction with Stanbic management
to realise benefits of merger. Nedcor intends to retain key
staff and clients in both banks to ensure that both parties
participate in new entity.”

Question
– Who is the acquirer?
IFRS 3 Business Combinations
Identification of acquirer (cont)

Theory
– “the combining entity that obtains control of other
combining entities”
– Indicators
Fair value
 Entity giving up cash or assets
 Management

IFRS 3.
(IFRS 2 Link)
IFRS 3 Cost of acquisitionIFRS 2 link

Facts
– Company A purchases 100% of Company B’s shares from
management for a combination of cash and shares.
– In addition, Company A will pay additional consideration
to the previous owners/management if revenues exceed
100 million over the next year.
– Each individual must be employed with the new company
for the duration of the contingency period to receive the
additional consideration.
IFRS 3
Cost of acquisition - IFRS 2 link
(cont)

Question
– Would such transactions be within the scope of IFRS 2 or
IFRS 3?
IFRS 3 Business Combinations

Questions?