A business combination is: a transaction or event in which acquirer obtains control over a business (e.g. acquisition of shares or net assets, legal mergers, reverse acquisitions). Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in IFRS 3.
The three key elements in the definition of a business combination are the following:
- That which is being acquired must meet the definition of a business. A business includes inputs and processes that are at least capable of producing outputs (i.e., outputs do not have to be part of the transferred set). In some situations, considerable judgment will need to be exercised in determining whether a business (rather than just a group of assets or net assets) was acquired by the buyer. For example, all of the inputs and processes used by the seller to produce outputs do not have to be acquired to conclude that a business has been acquired. Determining whether sufficient inputs and processes have been acquired in these situations to conclude that a business has been acquired often requires considerable judgment to be exercised.
- The buyer (acquiree) must obtain control over a business. The guidance in IFRS 10 shall be used to identify the acquirer—the entity that obtains control of another entity, ie the acquiree. As a result, obtaining control over a business in a business combination is defined/explained along the line of the definition of ‘control of an investee’. An investor controls an investee when the investor 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. Power: when existing rights give an investor the current ability to direct the relevant activities of an investee (ie the activities that significantly affect the investee’s returns). Rights to variable returns: an investor is exposed or has rights to returns that vary as a result of the investee’s performance. Link between power and returns: control exists when an investor has power over an investee and exposure or rights to the investee’s variable returns and has the ability to use its power to affect the investee’s returns. Principal or agent: an investor with power over an investee determines whether it is a principal or an agent. An investor, that is an agent, does not control an investee when it exercises delegated rights.
- Control can be obtained by the buyer through a transaction or other event. An event other than a transaction may occur through no direct action of the buyer. For example, the buyer may obtain control of an investee as a result of that investee acquiring its own shares, which has the effect of increasing the buyer’s ownership interest to that of a controlling interest. Assume that an investor owns 60,000 shares in a business and the business has 150,000 shares outstanding. In this situation, the investor owns a 40 percent interest in the business and accounts for its investment using the equity method. If the business buys or redeems 50,000 of its own shares from other investors, those shares are retired or become treasury shares and are no longer considered outstanding. As a result, the investor’s ownership interest in the business increases to 60 percent (the investor’s 60,000 shares in the business divided by 100,000 shares outstanding). This example illustrates that an investor can become a buyer by obtaining control without transferring consideration and without undertaking any other direct action on its own behalf and be subject to the business combination accounting guidance.
The next step would be using the acquisition method in determining the proper accounting treatment to record a business combination.
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