SUMMARY OF IFRS 3

Background

On 10 January 2008, the IASB published a revised IFRS 3 Business Combinations [IFRS
3(2008)] and related revisions to IAS 27 Consolidated and Separate Financial Statements. The
amendments result from proposals that were in an Exposure Draft of Proposed Amendments
to IFRS 3 published by the Board in June 2005.

IFRS 3(2008) replaced IFRS 3(2004) effective for business combinations on or after 1 July
2009. Earlier application is permitted, but not for periods beginning before 1 July 2007. Click
for IASB Press Release on IFRS 3(2008) (PDF 60k).

IFRS 3(2008) resulted from a joint project with the US Financial Accounting Standards Board.
FASB issued a similar standard in December 2007 (SFAS 141(R)) – see our News Story of 5
December 2007. The revisions will result in a high degree of convergence between IFRSs and
US GAAP in these areas, although some potentially significant differences remain. Among the
differences: the FASB standard requires (rather than permits) the full goodwill method. There
are also differences in scope, the definition of control, and how fair values, contingencies, and
employee benefit obligations are measured, as well as several disclosure differences. A
booklet of illustrative examples issued along with the revised IFRS 3 and IAS 27 includes a
comparison with SFAS 141(R).

Deloitte has published a Special Edition of our IAS Plus Newsletter dealing with the January
2008 revisions to IFRS 3 and IAS 27 (PDF 123k).

Deloitte expects to publish a comprehensive guide to applying IFRS 3(2008) in late May or
June 2008.

The information below reflects the 2008 revisions.

Scope

Definition of a business combination. A business combination is a transaction or event in

which an acquirer obtains control of one or more businesses.. A business is defined as an
integrated set of activities and assets that is capable of being conducted and managed for the
purpose of providing a return directly to investors or other owners, members or participants.

Acquirer must be identified. Under IFRS 3, an acquirer must be identified for all business
combinations.

Scope changes from IFRS 3(2004). IFRS 3(2008) applies to combinations of mutual entities
and combinations without consideration (dual listed shares). These are excluded from IFRS
3(2004).

Scope exclusions. IFRS 3 does not apply to the formation of a joint venture, combinations of
entities or businesses under common control. The IASB added to its agenda a separate
agenda project on Common Control Transactions in December 2007. Also, IFRS 3 does not
apply to the acquisition of an asset or a group of assets that do not constitute a business.

Method of Accounting for Business Combinations

Acquisition method. The acquisition method (called the 'purchase method' in the 2004
version of IFRS 3) is used for all business combinations.
Steps in applying the acquisition method are:

1. 1. Identification of the 'acquirer' - the combining entity that obtains control of the
acquiree.
2. 2. Determination of the 'acquisition date' - the date on which the acquirer obtains
control of the acquiree.
3. 3. Recognition and measurement of the identifiable assets acquired, the liabilities
assumed and any non-controlling interest (NCI, formerly called minority interest) in
the acquiree.
4. 4. Recognition and measurement of goodwill or a gain from a bargain purchase
option.

Measurement of acquired assets and liabilities. Assets and liabilities are measured at their
acquisition-date fair value (with a limited number of specified exceptions).

Measurement of NCI. IFRS 3 allows an accounting policy choice, available on a transaction

by transaction basis, to measure NCI either at:

• fair value (sometimes called the full goodwill method), or

• the NCI's proportionate share of net assets of the acquiree (option is available on a
transaction by transaction basis).

Example: P pays 800 to purchase 80% of the shares of S. Fair value of 100% of S's
identifiable net assets is 600. If P elects to measure noncontrolling interests as their
proportionate interest in the net assets of S of 120 (20% x 600), the consolidated
financial statements show goodwill of 320 (800 +120 - 600). If P elects to measure
noncontrolling interests at fair value and determines that fair value to be 185, then
goodwill of 385 is recognised (800 + 185 - 600). The fair value of the 20%
noncontrolling interest in S will not necessarily be proportionate to the price paid by
P for its 80%, primarily due to control premium or discount as explained in paragraph
B45 of IFRS 3.
Acq1uired intangible assets. Must always be recognised and measured. There is no 'reliable
measurement' exception.

Goodwill

Goodwill is measured as the difference between:

• the aggregate of (i) the acquisition-date fair value of the consideration transferred, (ii)
the amount of any NCI, and (iii) in a business combination achieved in stages (see
Below), the acquisition-date fair value of the acquirer's previously-held equity interest
in the acquiree; and
• the net of the acquisition-date amounts of the identifiable assets acquired and the
liabilities assumed (measured in accordance with IFRS 3).

If the difference above is negative, the resulting gain is recognised as a bargain purchase in
profit or loss.

Business Combination Achieved in Stages (Step Acquisitions)

Prior to control being obtained, the investment is accounted for under IAS 28, IAS 31, or IAS
39, as appropriate. On the date that control is obtained, the fair values of the acquired entity's
assets and liabilities, including goodwill, are measured (with the option to measure full goodwill
or only the acquirer's percentage of goodwill). Any resulting adjustments to previously
recognised assets and liabilities are recognised in profit or loss. Thus, attaining control triggers
remeasurement.

Provisional Accounting

If the initial accounting for a business combination can be determined only provisionally by the
end of the first reporting period, account for the combination using provisional values.
Adjustments to provisional values within one year relating to facts and circumstances that
existed at the acquisition date. No adjustments after one year except to correct an error in
accordance with IAS 8.

Cost of an Acquisition

Measurement. Consideration for the acquisition includes the acquisition-date fair value of
contingent consideration. Changes to contingent consideration resulting from events after the
acquisition date must be recognised in profit or loss.

Acquisition costs. Costs of issuing debt instruments are accounted for under IAS 39, and
costs of issuing equity instruments are accounted for under IAS 32. All other costs associated
with the acquisition must be expensed, including reimbursements to the acquiree for bearing
some of the acquisition costs. Examples of costs to be expensed include finder's fees;
advisory, legal, accounting, valuation, and other professional or consulting fees; and general
administrative costs, including the costs of maintaining an internal acquisitions department.

Contingent consideration. Contingent consideration must be measured at fair value at the

time of the business combination. If the amount of contingent consideration changes as a
result of a post-acquisition event (such as meeting an earnings target), accounting for the
change in consideration depends on whether the additional consideration is an equity
instrument or cash or other assets paid or owed. If it is equity, the original amount is not
remeasured. If the additional consideration is cash or other assets paid or owed, the changed
amount is recognised in profit or loss. If the amount of consideration changes because of new
information about the fair value of the amount of consideration at acquisition date (rather than
because of a post-acquisition event) then retrospective restatement is required.

Pre-existing Relationships and Reacquired Rights

If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the
acquirer had granted the acquiree a right to use its intellectual property), this must must be
accounted for separately from the business combination. In most cases, this will lead to the
recognition of a gain or loss for the amount of the consideration transferred to the vendor
which effectively represents a 'settlement' of the pre-existing relationship. The amount of the
gain or loss is measured as follows:

• for pre-existing non-contractual relationships (for example, a lawsuit): by reference to

fair value
• for pre-existing contractual relationships: at the lesser of (a) the
favourable/unfavourable contract position and (b) any stated settlement provisions in
the contract available to the counterparty to whom the contract is unfavourable.

However, where the transaction effectively represents a reacquired right, an intangible asset is
recognised and measured on the basis of the remaining contractual term of the related
contract excluding any renewals. The asset is then subsequently amortised over the remaining
contractual term, again excluding any renewals.
Other Issues

In addition, IFRS 3 provides guidance on some specific aspects of business combinations

including:

• business combinations achieved without the transfer of consideration;

• reverse acquisitions;
• identifying intangible assets acquired;
• the reassessment of the acquiree's contractual arrangements at the acquisition date.

Parent's Disposal of Investment or Acquisition of Additional Investment in

Subsidiary

Partial disposal of an investment in a subsidiary while control is retained. This is

accounted for as an equity transaction with owners, and gain or loss is not recognised.

Partial disposal of an investment in a subsidiary that results in loss of control. Loss of

control triggers remeasurement of the residual holding to fair value. Any difference between
fair value and carrying amount is a gain or loss on the disposal, recognised in profit or loss.
Thereafter, apply IAS 28, IAS 31, or IAS 39, as appropriate, to the remaining holding.

Acquiring additional shares in the subsidiary after control was obtained. This is
accounted for as an equity transaction with owners (like acquisition of 'treasury shares').
Goodwill is not remeasured.

Disclosure

Disclosure of information about current business combinations

The acquirer shall disclose information that enables users of its financial statements to
evaluate the nature and financial effect of a business combination that occurs either during the
current reporting period or after the end of the period but before the financial statements are
authorised for issue.

Among the disclosures required to meet the foregoing objective are the following:

• name and a description of the acquiree.

• acquisition date.
• percentage of voting equity interests acquired.
• primary reasons for the business combination and a description of how the acquirer
obtained control of the acquiree. description of the factors that make up the goodwill
recognised
• acquisition-date fair value of the total consideration transferred and the acquisition-
date fair value of each major class of consideration
• details of contingent consideration arrangements and indemnification assets
• details of acquired receivables
• the amounts recognised as of the acquisition date for each major class of assets
acquired and liabilities assumed.
• details of contingent liabilities recognised
• total amount of goodwill that is expected to be deductible for tax purposes
• details of any transactions that are recognised separately from the acquisition of
 assets and assumption of liabilities in the business combination
• information about a bargain purchase ('negative3 woodwill')
• for each business combination in which the acquirer holds less than 100 per cent of
the equity interests in the acquiree at the acquisition date, various disclosures are
required
• details about a business combination achieved in stages
• information about the acquiree's revenue and profit or loss
• information about a business combination whose acquisition date is after the end of
the reporting period but before the financial statements are authorised for issue

Disclosure of information about adjustments of past business combinations

The acquirer shall disclose information that enables users of its financial statements to
evaluate the financial effects of adjustments recognised in the current reporting period that
relate to business combinations that occurred in the period or previous reporting periods.

Among the disclosures required to meet the foregoing objective are the following:

• Details when the initial accounting for a business combination is incomplete for
particular assets, liabilities, non-controlling interests or items of consideration (and the
amounts recognised in the financial statements for the business combination thus
have been determined only provisionally)
• Follow-up information on contingent consideration
• Follow-up information about contingent liabilities recognised in a business
combination
• A reconciliation of the carrying amount of goodwill at the beginning and end of the
reporting period, with various details shown separately
• the amount and an explanation of any gain or loss recognised in the current reporting
period that both:
o (i) relates to the identifiable assets acquired or liabilities assumed in a
business combination that was effected in the current or previous reporting
period; and
o (ii) is of such a size, nature or incidence that disclosure is relevant to
understanding the combined entity's financial statements.

Transition Requirements

IFRS 3(2008) must generally be applied on a prospective basis, with some exceptions. The
prospective application will impact post-transition changes in ownership interests in
subsidiaries and deferred taxes, but will not impact accounting for contingent consideration
related to business combinations with an acquisition date prior to the date of transition.