Acquisitions and mergers as per IFRS 3

Acquisitions and mergers

Acquisitions and mergers are becoming more and more common as entities aim to achieve their growth objectives. IFRS 3 ‘Business Combinations’ contains the requirements for these transactions, which are challenging in practice.

This narrative sets out how an entity should determine if the transaction is a business combination, and whether it is within the scope of IFRS 3.

Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or Acquisitions and mergersmerger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination (see case below).

Case – Straightforward business combination

Entity T is a clothing manufacturer and has traded for a number of years. Entity T is deemed to be a business.

On 1 January 2020, Entity A pays CU 2,000 to acquire 100% of the ordinary voting shares of Entity T. No other type of shares has been issued by Entity T. On the same day, the three main executive directors of Entity A take on the same roles in Entity T.

Consider this…..

Entity A obtains control on 1 January 2020 by acquiring 100% of the voting rights. As Entity T is a business, this is a business combination in accordance with IFRS 3.

However, a business combination may be structured, and an entity may obtain control of that structure, in a variety of ways.

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M and A

M and A or Mergers and Acquisitions

in IFRS language Business Combinations.

1 Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or merger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination (see Simple case – Straightforward business combination below). However, a business combination (M and A) may be structured, and an entity may obtain control of that structure, in a variety of ways.

Examples of business combinations structurings

Examples of ways an entity may obtain control

A business becomes the subsidiary of an acquirer

The entity transfers cash, cash equivalents or other assets(including net assets that constitute a business)

Net assets of one or more businesses are legally merged with an acquirer

The entity incurs liabilities

One combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners

The entity issues shares

The entity transfers more than one type of consideration, or

Two or more entities transfer their net assets, or the owners of those entities transfer their equity interests to a newly created entity, which in exchange issues shares, or

The entity does not transfer consideration and obtains control for example by contract alone Some examples of this:

  • ‘dual listed companies’ or ‘stapled entity structures’
  • acquiree repurchases a sufficient number of its own shares for an existing shareholder to obtain control
  • a condition in the shareholder agreement that prevents the majority shareholder exercising control of the entity has expired, or
  • a call option over a controlling interest that becomes exercisable.

A group of former owners of one of the combining entities obtains control of the combined entity, i.e. former owners, as a group, retain control of the entity they previously owned.

Therefore, identifying a business combination transaction requires the determination of whether:

  • what is acquired constitutes a ‘business’ as defined in IFRS3, and
  • control has been obtained.

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Leveraged buyout IFRS 3 best reporting

Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting

1 The process and business reason

The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more

IFRS 3 Identify a business

IFRS 3 Identify a business – An entity shall determine whether a transaction or other event is a business combination by applying the definition in IFRS 3, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisitionSee also the accounting treatment acquisition of a business or asset(s) 

Guidance on identifying a business combination and the definition of a business are as follows:

The definition of a business: An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.

Identifying a business combination [IFRS 3 B5 – B6] IFRS 3 Identify a business

IFRS 3 defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. An acquirer might obtain control of an acquiree in a variety IFRS 3 Identify a businessof ways, for example:

  1. by transferring cash, cash equivalents or other assets (including net assets that constitute a business);
  2. by incurring liabilities; IFRS 3 Identify a business
  3. by issuing equity interests; IFRS 3 Identify a business
  4. by providing more than one type of consideration; or
  5. without transferring consideration, including by contract alone.

A business combination may be structured in a variety of ways for legal, taxation or other reasons, which include but are not limited to:

  1. one or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer;
  2. one combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners;
  3. all of the combining entities transfer their net assets, or the owners of those entities transfer their equity interests, to a newly formed entity (sometimes referred to as a roll-up or put-together transaction); or
  4. a group of former owners of one of the combining entities obtains control of the combined entity.

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Accounting treatment acquisition of a business or assets

acquisition of a business or assetsAccounting treatment of a business or assets – An entity has to determine whether a transaction or other event is a business combination, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the … Read more

New on IFRS 3 The Optional concentration test

New on IFRS 3 The Optional concentration testNew on IFRS 3 The Optional concentration test – Whilst applying the definition of a business might involve significant judgement, there was little or no guidance to identify situations where an acquired set of activities and assets is not a business. To address those concerns, the IASB introduced an optional fair value concentration test. The purpose of this test is to permit a simplified assessment of whether an acquired set of activities and assets is not a business.

Important – Entities may elect whether or not to apply the concentration test on a transaction-by-transaction basis. AND once starting the optional concentration tests an entity can always back off! New on IFRS 3 The Optional concentration test

The concentration test … Read more

Overview of the amendments IFRS 3

Overview of the amendments IFRS 3 – In May 2019 amendments to IFRS 3 Business Combinations were published by IASB.

IFRS 3 continues to adopt a market participant’s perspective to determine whether an acquired set of activities and assets is a business. The amendments: clarify the minimum requirements for a business; remove the assessment of whether Read more

IFRS 3 Redefinition of a business

IFRS 3 Redefinition of a business – In summary:IFRS 3 Redefinition of a business IFRS 3 Redefinition of a business

  • The IASB issued narrow-scope amendments to IFRS 3 to help entities determine whether an acquired set of activities and assets is a business or not.
  • The amendments clarify the minimum requirements to be a business, remove the assessment of a market participant’s ability to replace missing elements, and narrow the definition of outputs.
  • The amendments add guidance to assess whether an acquired process is substantive and add illustrative examples.
  • The amendments introduce an optional concentration test to permit a simplified assessment.
  • The amendments are effective for annual reporting periods beginning on or after 1 January 2020 and apply prospectively. Earlier application is permitted.
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IFRS 3 Acquired process is substantive?

IFRS 3 Acquired process is substantive? – IFRS 3 requires a business to include, as a minimum, an input and a substantive process that together significantly contribute to the ability to create output. Because all asset include inputs, the existence of a substantive process is what distinguishes an asset or … Read more

IFRS 3 Application of the definition of a business

IFRS 3 Application of the definition of a business – Highlights

In October 2018, the International Accounting Standards Board (IASB or Board) issued amendments to the definition of a business in IFRS 3 Business Combinations. The amendments are intended to assist entities to determine whether a transaction should be accounted for as a business combination or as an asset Read more