Chapter 25

Question 1

How does IFRS 3 define business combinations?

Answer 1

IFRS 3 Business Combinations defines a business combination as a ‘transaction or other event in which an acquirer obtains control of one or more businesses’.

Question 2

What are characteristics of a business?

Answer 2

The characteristic of a business is that it is an integrated set of activities and assets, including, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output.

Question 3

In what concept is control essential?

Answer 3

An acquirer or investor controls an acquiree or investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The essential features are the existence of power and the use of this power to affect the (variable) returns.

Question 4

What does IFRS 3 require of a entity to account for?

Answer 4

IFRS 3 requires an entity to account for each business combination by applying the acquisition method

Question 5

What are the requirements when applying the acquisition method?

Answer 5

• identifying the acquirer
• determining the acquisition date
• determining the purchase price
• recognizing and measuring the identifiable assets acquired and the liabilities assumed
• accounting for goodwill.

Question 6

What is an acquisition date?

Answer 6

The acquisition date is the date on which the acquirer obtains control of the acquiree (IFRS 3, Para. 8). This is generally the so-called closing date: the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree.

Question 7

What is the cost of combination?

Answer 7

The cost of the combination (the acquisition price or purchase price) is the fair value of the consideration without including acquisition costs.

Question 8

What does IFRS require when it comes down to the purchase price?

Answer 8

IFRS 3 requires us to allocate the purchase price, a procedure that is commonly known as purchase price allocation (PPA). PPA requires recognizing the assets, liabilities and contingent liabilities at their fair values, except for non-current assets (or disposal groups) that are classified as held for sale.

Question 9

What is the difference between the purchase price and the fair value?

Answer 9

The difference between the purchase price and the fair value of the net assets (assets minus liabilities) is recognized as goodwill.

Question 10

When is separate recognition only applicable?

Answer 10

Separate recognition is only applicable if the acquiree’s identifiable assets, liabilities and contingent liabilities

Question 11

What are the criteria at the date of separate recognition?

Answer 11

• In the case of an asset other than an intangible asset, it is probable that any associated future economic benefits will flow to the acquirer and its fair value can be measured reliably.
• In the case of a liability other than a contingent liability, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and its fair value can be measured reliably.
• In the case of an intangible asset or a contingent liability, its fair value can be measured reliably.

Question 12

What is necessary when determining the fair value?

Answer 12

Note that it is necessary to determine the fair values of the assets and liabilities and that the acquirer cannot determine the amount of goodwill on the basis of the book values in the financial statements of the acquiree.

Question 13

What is goodwill?

Answer 13

Goodwill is the difference between the purchase price and the fair value of the net assets. Goodwill is defined in IFRS 3 (Appendix A) as ‘Future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized’.

Question 14

How will the fair values of share be determined?

Answer 14

The fair value of the shares will normally be determined by reference to the present value of the cash flows from the entity. This present value is normally not fully reflected in assets and liabilities and can be related to ‘intangibles’ like workforce, reputation, innovative capacity, market power, etc.

Question 15

In what ways can goodwill on acquisition be treated after recognition?

Answer 15

1. 1 Carry it as an asset and amortize it over its estimated useful life through profit or loss.
2. 2 Carry it as an asset and amortize it over its estimated useful life by writing it off against reserves.
3. 3 Eliminate it against reserves immediately on acquisition.
4. 4 Retain it in the accounts indefinitely, unless a permanent reduction in its value
   becomes evident, when an impairment is recognized.
5. 5 Charge it as an expense against profits in the period when it is acquired.
6. 6 Show it as a deduction from shareholders’ equity (and either amortize it or carry it indefinitely).
7. 7 Revalue it annually to incorporate later non-purchased goodwill.

Question 16

What is a need for goodwill?

Answer 16

Goodwill needs to be amortized over its useful life, with impairment reviews to be made when indications for impairment would exist. In the exceptional situations that a reliable useful life cannot be determined, the useful life will be set at a maximum of ten years.

Question 17

What is the excess of cost?

Answer 17

The excess of cost over the net fair value of the identifiable assets is the goodwill on acquisition figure. Goodwill is not itself an identifiable asset or liability but a residual amount.

Question 18

What does IFRS 3 require after initial recognition?

Answer 18

IFRS 3 requires that after initial recognition, the business combination goodwill should be measured at cost less any accumulated impairment losses. Thus, this goodwill is not amortized.

Question 19

What is the rationale for carrying goodwill on the statement of financial position?

Answer 19

The rationale for carrying goodwill on the statement of financial position of the combined business at its impaired cost as opposed to amortizing that goodwill through the profit or loss account is outlined in the International Accounting Standards Board (the Board)’s Basis for Conclusions to IFRS 3.

Question 20

Which three possible treatments of goodwill arising on business combinations do the board consider?

Answer 20

1. (a) straight line amortization, but with an impairment test whenever there was an indication that the goodwill might be impaired
2. (b) non-amortization, but with an impairment test annually or more frequently if events or changes in circumstances indicated that the goodwill was impaired
3. (c) permitting entities a choice between (a) and (b).

Question 21

When can goodwill be a negative amount?

Answer 21

Goodwill is not necessarily a positive amount. The fair value of the net assets might be higher than the purchase price. That is not always a fair description, as the acquiree might have a history of trading losses, together with a forecast future of losses. This discount on the purchase price at the date of acquisition may thus be thought of as compensation for anticipated future losses to the acquiring group.

Question 22

What does IFRS state about the acquirer’s interest in the net fair value of identifiable assets?

Answer 22

IFRS 3 states that if the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities, recognized, exceeds the cost of the business combination.

Question 23

What shall the acquirer do with its interest?

Answer 23

• reassess the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the combination
• recognize immediately in profit or loss any excess remaining after that reassessment.

Question 24

What happens when goodwill is amortised?

Answer 24

When goodwill is amortized over its useful life (as currently required by the EU Accounting Directive), an impairment review is required whenever there are indications that such an impairment may be required.

Question 25

What is the recoverable amount of an asset?

Answer 25

The recoverable amount of an asset is the higher of its fair value less costs of disposal and its value in use.

Question 26

What is goodwill by definition?

Answer 26

Goodwill, by definition, does not generate cash flows independently from other assets or groups of assets and, therefore, the recoverable amount of goodwill as an individual asset cannot be determined.

Question 27

How is the recoverable amount determined?

Answer 27

The recoverable amount is determined for the cash-generating unit to which the goodwill belongs. This amount is then compared to the carrying amount of this cash-generating unit and any impairment loss is recognized and attributed first to the goodwill

Question 28

What does the standard require?

Answer 28

The Standard requires goodwill acquired in a business combination to be tested for impairment as part of impairment testing the cash-generating unit(s) to which it relates.

Question 29

What does the standard clarify?

Answer 29

1. 1 The goodwill should, from the acquisition date, be allocated to each of the acquirer’s cash-generating units or groups of cash-generating units that are expected to benefit from the synergies of the business combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units.
2. 2 Each unit or group of units to which the goodwill is allocated should:
   (a) represent the lowest level within the entity at which the goodwill is monitored
   for internal management purposes
   (b) not be larger than an operating segment as defined by Paragraph 5 of IFRS 8

Question 30

What does the standard clarify on the operating segments?

Answer 30

(c) If the initial allocation of goodwill acquired in a business combination cannot be completed before the end of the annual period in which the business combination occurs, that initial allocation should be completed before the end of the annual period beginning after the acquisition date.
4 When an entity disposes of an operation within a cash-generating unit (group of units) to which goodwill has been allocated, the goodwill associated with that operation should be:
1. (a) included in the carrying amount of the operation when determining the gain or loss on disposal
2. (b) measured on the basis of the relative values of the operation disposed of and the portion of the cash-generating unit (group of units) retained, unless the entity can demonstrate that some other method better reflects the goodwill associated with the operation disposed of.
5 When an entity reorganizes its reporting structure in a manner that changes the composition of cash-generating units (groups of units) to which goodwill has been allocated, the goodwill should be reallocated to the units (groups of units) affected. This reallocation should be performed using a relative value approach similar to that used when an entity disposes of an operation within a cash-generating unit (group of units), unless the entity can demonstrate that some other method better reflects the goodwill associated with the reorganized units (groups of units).

Question 31

What does the standard permit?

Answer 31

The Standard also permits the most recent detailed calculation made in a preceding period of the recoverable amount of a cash-generating unit (group of units) to which goodwill has been allocated to be used in the impairment test for that unit (group of units) in the current period,

Question 32

Which specified criteria are met, with what the standard permits?

Answer 32

• The assets and liabilities making up the unit have not changed significantly since the most recent recoverable amount calculation.
• The most recent recoverable amount calculation resulted in an amount that exceeded the carrying amount of the unit by a substantial margin.
• Based on an analysis of events that have occurred and circumstances that have changed since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the current carrying amount of the unit is remote.

Question 33

What does IFRS 3 allow on the view of measurements gf goodwill?

Answer 33

But IFRS 3 allows two views on the measurement of non-controlling interests and related goodwill

Question 33

How are non-controlling interest in the acquire required to be measured?

Answer 33

• 1 The non-controlling interest’s proportionate share of the acquiree’s identifiable net assets at fair value (the view above).
• 2 Fair value (the new and preferred view).

Question 34

What does the second view imply?

Answer 34

The second view implies that the purchase price allocation will not be based on the purchase price that the acquirer paid, but on the purchase price that the acquirer would have paid when it acquired 100 per cent of the shares. depending upon which method is chosen, to value the non-controlling interest will result in different figures in the consolidated financial statements in respect of the non-controlling interest and goodwill.

Question 35

What does the acquire sometimes obtain?

Answer 35

An acquirer sometimes obtains control of an acquiree in which it already holds some of the equity shares.

Question 36

What does IFRS require to be remeasured?

Answer 36

IFRS 3 requires us to remeasure the previously held equity interest at its acquisition date fair value, recognizing the resulting gain or loss in profit or loss. The purchase consideration is now the aggregate of the fair value of the non-controlling interest previously held, plus the consideration given for the new purchase to obtain control.

Question 37

What does IFRS allows to be included?

Answer 37

IFRS 3 allows the inclusion of provisional amounts in the consolidation process. IFRS 3 identifies a measurement period within which adjustments can be made to these provisional amounts to ensure compliance with IFRS 3 requirements.

Question 38

What are acquisition agreements?

Answer 38

Acquisition agreements often provide for adjustment to the acquisition price of an acquisition dependent on future events. In terms of IFRS 3, this is a contingent consideration: the consideration (acquisition price) is contingent upon future events.

Question 39

What can future events entail for acquisitions agreements?

Answer 39

• the results of the acquiree’s operations exceeding or falling short of an agreed level
• changes in the market price of securities issued as part of the purchase consideration.

Question 40

In what other ways can an investor stay in control?

Answer 40

A parent can also sell shares to other parties and remain in control. These transactions are also accounted for in equity and do not result in a profit or loss.

Question 41

When can an investor lose control of a subsidiary?

Answer 41

• selling part of its ownership such that it is left with less than 50 per cent
• the subsidiary becoming subject to control by a government, court administrator or regulator
• the subsidiary becoming subject to some other contractual agreement that results in another investor gaining control.