Document classification: Internal
ACCM4300
Financial Reporting
Workshop 7:
Business Combination (AASB 3)
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Unless otherwise specifically referenced, material in this slide deck has been adopted from
Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke,
Hong Ang, Karyn Byrnes. Second edition. John Wiley & Sons Australia, Ltd; Leo, K, Knapp, J,
McGowan, S, Sweeting, J & Meng, L, Company Accounting, 12th edition, John Wiley & Sons
Australia, Ltd, Queensland.
Prepared by © Kaplan Business School
Document classification: Internal
Learning objectives
1. Demonstrate an understanding of the nature
of a business combination and its various
forms
2. Determine the basic steps in the acquisition
method of accounting for business
combinations
3. Recommend the accounting requirements for
a business combination in the books of the
acquirer
4. Determine the requirements for subsequent
adjustments to the initial accounting for a
business combination.
Document classification: Internal
Learning objectives
1. Demonstrate an understanding of the nature
of a business combination and its various
forms
2. Determine the basic steps in the acquisition
method of accounting for business
combinations
3. Recommend the accounting requirements for
a business combination in the books of the
acquirer
4. Determine the requirements for subsequent
adjustments to the initial accounting for a
business combination.
Document classification: Internal
The nature of a business
combination
• A business combination is defined in Appendix A to
AASB 3/IFRS 3 as: A transaction or other event in which
an acquirer obtains control of one or more businesses.
• 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.
Document classification: Internal
The nature of a business combination
Assuming the existence of two companies, A Ltd and B Ltd,
the following general forms of business combinations are
covered in this workshop:
1. A Ltd acquires all the assets and liabilities of B Ltd. B
Ltd continues as a company, holding shares in A Ltd.
2. A Ltd acquires all the assets and liabilities of B Ltd. B
Ltd liquidates.
3. C Ltd is formed to acquire all the assets and liabilities
of A Ltd and B Ltd. A Ltd and B Ltd liquidate.
Document classification: Internal
The nature of a business combination
4. A Ltd acquires a group of net assets of B Ltd, the
group of net assets constituting a business, such as
a division, branch or segment, of B Ltd. B Ltd
continues to operate as a company.
A business combination could also occur without any
exchange of assets or equity between the entities
involved in the exchange.
Document classification: Internal
Workshop Activity 1
Discuss the importance of identifying the
acquisition date
Document classification: Internal
Learning objectives
1. Demonstrate an understanding of the nature
of a business combination and its various
forms
2. Determine the basic steps in the acquisition
method of accounting for business
combinations
3. Recommend the accounting requirements for
a business combination in the books of the
acquirer
4. Determine the requirements for subsequent
adjustments to the initial accounting for a
business combination.
Document classification: Internal
Accounting for business
combinations-basic principles
The four key steps in this method are noted in paragraph
5 of standard AASB 3.
1. Identify the acquirer.
2. Determine the acquisition date.
3. Recognise and measure the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.
4. Recognise and measure goodwill or a gain from a
bargain purchase.
Document classification: Internal
Accounting for business
combinations-basic principles
Identifying the acquirer [step 1]
• Appendix A of AASB 3/IFRS 3 provides the following
definitions:
̶ Acquiree: The business or businesses that the
acquirer obtains control of in a business
combination.
̶ Acquirer: The entity that obtains control of the
acquiree.
Document classification: Internal
Accounting for business
combinations-basic principles
Identifying the acquirer [step 1]
• Consider the situation where entity A combines with
entity B.
• To effect the combination, a new company (entity C) is
formed, which issues shares to acquire all the shares of
both entities A and B.
• As entity C is created solely to formalise the
organisation structure, it is not the acquirer although it
may be considered to be the legal parent of both the
other entities.
Document classification: Internal
Accounting for business
combinations-basic principles
Determining the acquisition date [step 2]
• Acquisition date is defined in Appendix A to AASB
3/IFRS 3 as follows:
• The date on which the acquirer obtains control of the
aquiree.
• A business combination involves the joining together of
assets under the control of a specific entity.
• Therefore, the business combination occurs at the date
the assets or net assets are under the control of the
acquirer.
Document classification: Internal
Accounting for business
combinations-basic principles
Determining the acquisition date [step 2]
• Other dates that are important during the process of
the business combination may be:
1. The date the contract is signed
2. The date the consideration is paid
3. A date nominated in the contract
4. The date on which assets acquired are delivered to
the acquirer
5. The date on which an offer becomes unconditional.
Document classification: Internal
Accounting in the records of the
acquirer
• Account for a business combination in the records of
the acquirer.
• Where the acquirer purchases assets and assumes
liabilities of another entity, it has to consider:
1. The recognition and measurement of the
identifiable assets acquired and the liabilities
assumed (step 3 of the acquisition method)
2. The recognition and measurement of goodwill or a
gain from a bargain purchase (step 4 of the
acquisition method).
Document classification: Internal
Workshop Activity 2
White Ltd has been negotiating with Cloud Ltd for several months,
and agreements have finally been reached for the two companies
to combine. In considering the accounting for the combined entities,
management realises that, in applying AASB 3/IFRS 3, an acquirer
must be identified. However, there is debate among the accounting
staff as to which entity is the acquirer.
Required
a) What factors/indicators should management consider in
determining which entity is the acquirer?
b) Why is it necessary to identify an acquirer? In particular, what
differences in accounting would arise if White Ltd or Cloud Ltd
were identified as the acquirer?
Document classification: Internal
Learning objectives
1. Demonstrate an understanding of the nature
of a business combination and its various
forms
2. Determine the basic steps in the acquisition
method of accounting for business
combinations
3. Recommend the accounting requirements for
a business combination in the books of the
acquirer
4. Determine the requirements for subsequent
adjustments to the initial accounting for a
business combination.
Document classification: Internal
Recognition and measurement of
assets acquired and liabilities assumed
[step 3]
Recognition
• The assets acquired and liabilities assumed are
measured at fair value.
• That fair value will reflect expectations about the
probability of inflows or outflows of benefits.
• The probability criterion is then unnecessary where fair
values are used as the measurement method.
• In recognising the assets and liabilities, it is necessary to
classify or designate them.
Document classification: Internal
Recognition and measurement of
assets acquired and liabilities
assumed [step 3]
• Fair value is defined in Appendix A of AASB 3/IFRS 3 as:
the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between
market participants at the measurement date.
• Fair value is basically a market-based measure in a
transaction between unrelated parties.
• Fair value is measured in accordance with AASB 13/IFRS
13 Fair Value Measurement.
Document classification: Internal
Recognition and measurement of
assets acquired and liabilities
assumed [step 3]
AASB 13/IFRS 13 describes three valuation techniques
that an entity might use to determine fair value:
̶ The market approach
̶ The income approach
̶ The cost approach.
Document classification: Internal
Accounting by the acquirer:
shares acquired in an acquiree
• The investment is measured at fair value because the
investment is not held within a business model whose
objective is to hold assets in order to collect contractual
cash flows.
• The investment is measured at the fair value of the
consideration transferred.
• It is expected that in most exchanges the fair value of
the shares acquired will equal the fair value of the
consideration transferred.
Document classification: Internal
Accounting by the acquirer:
shares acquired in an acquiree
Existence of a previously held equity interest
• As a business combination occurs when the acquirer
obtains control of the acquiree, it is on the date of the
second acquisition of shares that the business
combination occurs.
• In AASB 3/IFRS 3, this is referred to as a business
combination achieved in stages — sometimes called a
step acquisition.
Document classification: Internal
Accounting in the records of the
acquiree
• Where the acquirer purchases the acquiree’s assets
and liabilities, the acquiree may continue in existence
or may liquidate.
• The acquiree accounts affected by the business
combination will differ according to the actions of the
acquiree.
Document classification: Internal
Accounting in the records of the
acquiree
Acquiree does not liquidate
• Under AASB 116/IAS 16 Property, Plant and Equipment,
when an item of property, plant and equipment is sold,
gains or losses are recognised in the statement of profit
or loss and other comprehensive income.
• Similarly, on the sale of a business, the acquiree
recognises a gain or loss.
Document classification: Internal
Accounting in the records of the
acquiree
Acquiree liquidates
• The accounts of the acquiree are transferred to two
accounts, the Liquidation account and the Shareholders’
Distribution account.
• To the Liquidation account are transferred:
̶ All liabilities taken over
̶ The expenses of liquidation if paid by the acquiree
̶ Additional expenses to be paid by the acquiree but
not previously recognised by the acquiree.
Document classification: Internal
Accounting in the records of the
acquiree
Acquirer buys only shares in the acquiree
• When the acquirer buys only shares in the acquiree,
there are no entries in the records of the acquiree
because the transaction is between the acquirer and
the shareholders of the acquiree entity.
• The acquiree itself is not involved.
Document classification: Internal
Workshop Activity 3
The trial balance of Jackman Ltd at 1 January 2022 was as
follows:
Document classification: Internal
Workshop Activity 3 (Contd.)
•
At this date, all the assets and liabilities of Jackman Ltd are sold to Hugh Ltd, with Jackman Ltd going
into voluntary liquidation. The terms of acquisition are:
•
Hugh Ltd is to take over all the assets of Jackman Ltd, as well as the accounts payable of Jackman Ltd.
•
Costs of liquidation of $700 are to be paid by Jackman Ltd with funds supplied by Hugh Ltd.
•
Preference shares in Jackman Ltd are to receive two fully paid shares in Hugh Ltd for every three
shares held, or alternatively, $0.80 per share in cash payable at the acquisition date.
•
Ordinary shareholders of Jackman Ltd are to receive two fully paid ordinary shares in Hugh Ltd for
every share held or, alternatively, $2.50 in cash payable half at the acquisition date and half in one
year’s time.
•
Debenture holders of Jackman Ltd are to be paid in cash out of funds provided by Hugh Ltd. The
debentures have a fair value of $102 per $100 debenture.
•
All shares issued by Hugh Ltd have a fair value of $1.20 per share.
•
Costs of issuing and registering the shares issued by Hugh Ltd amount to $80 for the preference shares
and $200 for the ordinary shares.
•
Legal and accounting costs associated with the acquisition of Jackman Ltd amount to $2000.
•
The two parties agree on the terms of the arrangement, and holders of 6 000 preference shares and
10 000 ordinary shares elect to receive cash.
Document classification: Internal
Workshop Activity 3 (Contd.)
Hugh Ltd assesses the fair values of the identifiable assets and liabilities of Jackman Ltd to
be as follows:
Hugh Ltd has an incremental borrowing rate of 10%.
Required
A. Prepare the acquisition analysis in relation to the above acquisition by Hugh Ltd.
B. Prepare the journal entries in the records of Hugh Ltd at the date of acquisition.
C. Prepare the journal entry for the payment of the deferred consideration in one year’s
time
Document classification: Internal
Learning objectives
1. Demonstrate an understanding of the nature
of a business combination and its various
forms
2. Determine the basic steps in the acquisition
method of accounting for business
combinations
3. Recommend the accounting requirements for
a business combination in the books of the
acquirer
4. Determine the requirements for subsequent
adjustments to the initial accounting for a
business combination.
Document classification: Internal
Subsequent adjustments to the
initial accounting for a business
combination
• Account for subsequent adjustments to the initial
accounting for a business combination.
• Three areas where adjustments may need to be made
subsequent to the initial accounting after acquisition
date are:
̶ Goodwill
̶ Contingent liabilities
̶ Contingent consideration.
Document classification: Internal
Subsequent adjustments to the
initial accounting for a business
combination
Goodwill
• Having recognised goodwill arising in the business
combination, the subsequent accounting is directed
from other accounting standards.
̶ Goodwill is not subject to amortisation but is
subject to an annual impairment test as detailed in
AASB 136/IAS 36 Impairment of Assets.
̶ Goodwill cannot be revalued because AASB 138/IAS
38 Intangible Assets does not allow the recognition
of internally generated goodwill.
Document classification: Internal
Subsequent adjustments to the
initial accounting for a business
combination
Contingent liabilities
• Having recognised any contingent liabilities of the
acquiree as liabilities, the acquirer must then determine
a subsequent measurement for the liability.
• Under AASB 137/IAS 37 paragraph 36, the liability
would be measured at the best estimate of the
expenditure required to settle the present obligation at
the end of the reporting period.
Document classification: Internal
Subsequent adjustments to the
initial accounting for a business
combination
Contingent consideration
• Subsequent to the business combination, paragraph 54
of AASB 3/IFRS 3 requires the accounting for contingent
consideration to be in accordance with the accounting
standard that would normally apply to these accounts.
• Where the contingent consideration is a financial
liability, it will be accounted for under AASB 9/IFRS 9
and measured at fair value with movements being
accounted for in accordance with that standard.
Document classification: Internal
Disclosure — business
combinations
• Paragraphs 59–63 of AASB 3/IFRS 3 contain information
on disclosures required in relation to business
combinations.
• Goodwill is not to be considered just a residual
calculation
• An understanding of where the synergies exist will assist
management in managing the earnings from goodwill as
well as in any later impairment tests of goodwill.
Document classification: Internal
Workshop Activity 4
On 1 July 2022, the financial position of Thurman Ltd was as follows:
Document classification: Internal
Workshop Activity 4 (Contd.)
Uma Ltd acquired all the assets and assumed all the liabilities of
Thurman Ltd on 1 July 2022. In exchange, Uma Ltd agreed to:
• issue 5 Uma Ltd shares for every Thurman Ltd share held. Uma Ltd
shares were assessed to have a fair value of $8 per share.
• Costs of share issue were $600.
• transfer a patent to the former shareholders of Thurman Ltd; the
patent had been internally generated by Uma Ltd and was carried at
$400 000. It was considered to have a fair value of $1 200 000.
• pay cash of $2.00 per share to the former shareholders of Thurman
Ltd for each share held in Thurman Ltd.
Document classification: Internal
Workshop Activity 4 (Contd.)
• At 30 June 2022, Thurman Ltd had reported a contingent liability
relating to a guarantee given by that company to another entity.
Thurman Ltd did not record the guarantee as a liability because of the
difficulty of measuring the liability. The fair value of this contingent
liability was assessed as $20 000.
• Uma Ltd incurred $9000 in costs in relation to accounting and legal
fees in relation to its acquisition of Thurman Ltd.
Required
Prepare the journal entries in the records of Uma Ltd in relation to its
acquisition of Thurman Ltd at 1 July 2022.
Document classification: Internal
Key Terms
Acquirer The entity that obtains control of the acquiree.
Acquisition date The date on which the acquirer obtains control of the
acquiree.
Business combination A transaction or other event in which an acquirer
obtains control of one or more businesses.
Fair value The price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date.
Goodwill An asset representing the future economic benefits arising from
other assets acquired in a business combination that are not individually
identified and separately recognised.
Document classification: Internal
Additional Readings and Resources
Please refer to the additional resources listed below, available under
Weekly Content > Week 7 on your Resource List.
Australian Accounting Standards Board (AASB), 2023, AASB 3 Business
Combinations, AASB.
CPDbox, S 2021, IFRS 3 Business Combinations - summary 2021,
[online video] YouTube.
Loftus, J., Leo, K., Daniliuc, S., Luke, B., Ang, H.N., Bradbury, M., Hanlon,
D., Boys, N. & Byrnes, K. (2022). Financial Reporting. 4th ed. John Wiley
& Sons Australia, Ltd.
Document classification: Internal