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 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 case below).
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.
– determines which entities are consolidated in a parent’s financial statements and therefore affects a group’s reported results, cash flows and financial position – and the activities that are ‘on’ and ‘off’ the group’s balance sheet. Under IFRS, this control assessment is accounted for in accordance with IFRS 10 ‘Consolidated financial statements’.
Some of the challenges of applying the IFRS 10 Special control approach include:
identifying the investee’s returns, which in turn involves identifying its assets and liabilities. This may appear straightforward but complications arise when the legal ownership of assets diverges from the accounting depiction (for example, in financial asset transfers that ‘fail’ de-recognition, and in finance leases). In general, the assessment of the investee’s assets and returns should be consistent with the accounting depiction in accordance with IFRS
it may not always be clear whether contracts and other arrangements between an investor and an investee
create rights or exposure to a variable return from the investee’s performance for the investor; or
transfer risk or variability from the investor to the investee IFRS 10 Special control approach
the relevant activities of an SPE may not be obvious, especially when its activities have been narrowly specified in its purpose and design IFRS 10 Special control approach
the rights to direct those activities might also be difficult to identify, because for example, they arise only in particular circumstances or from contracts that are outside the legal boundary of the SPE (but closely related to its activities).
IFRS 10 Special control approach sets out requirements for how to apply the control principle in less straight forward circumstances, which are detailed below: IFRS 10 Special control approach
when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of voting rights and in circumstances involving potential voting rights
when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements IFRS 10 Special control approach
involving agency relationships IFRS 10 Special control approach
when the investor has control only over specified assets of an investee
Overview IFRS 10 Consolidated Financial Statements – Short – To establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities Overview IFRS 10 Consolidated Financial Statements
Longer – IFRS 10 replaces the part of IAS 27 Consolidated and Separate Financial Statements that addresses accounting for subsidiaries on consolidation. What remains in IAS 27 after the implementation of IFRS 10 is the accounting treatment for subsidiaries, jointly controlled entities and associates in their separate financial statements.
The aim of IFRS 10 is to establish a single control model that is applied to all entities including special purpose entities. The changes require those dealing with the implementation of IFRS 10 to exercise … Read more
Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.
Comparing Financial Statements between companies is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to … Read more
Control of an investee exists when an investor controls an investee as it's exposed, or has rights, to variable returns from its involvement with the investee
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,
Continuous assessment of control is part of documenting your consolidation routines. Control is reassessed if facts and circumstances say there are changes
Purpose and design of the investee – When assessing control of an investee, an investor shall consider the purpose and design of the investee in order to identify the relevant activities, how decisions about the relevant activities are made, who has the current ability to direct those activities and who receives returns from those activities.
Proportionate voting rights
When an investee’s purpose and design are considered, it may be clear that an investee is controlled by means of equity instruments that give the holder proportionate voting rights, such as ordinary shares in the investee. In this case, in the absence of any additional arrangements that alter decision-making, the assessment of control focuses on which party, if any, is able … Read more
Potential voting rights – An investor may hold instruments that (if exercised or converted), give the investor power to direct the relevant activities. These are called ‘potential voting rights’ and may be held through ownership of the following types of instrument:
share options and warrants Potential voting rights
convertible bonds Potential voting rights
convertible preference shares. Potential voting rights
Potential voting rights can contribute to control of an investee in combination with current voting rights, or even confer control on their own. However, IFRS 10 requires an assessment to determine whether potential voting rights are substantive. IFRS 10 has no bright lines and so judgment will be required.
IFRS 10’s ‘substantive’ assessment takes into account both:
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.
Potential voting rights – An investor may hold instruments that (if exercised or converted), give the investor power to direct the