Identifying the acquirer
The acquirer is the combining entity that obtains
control of the other combining entities or businesses
[IFRS3.17].
Control is a question of fact - does one entity
have the power to govern the financial and operating
policies of the other? There is a presumption that
the acquisition of more than one half of the voting
rights of another entity confers control [IFRS3.19].
It would be unusual for an entity to acquire more
than one half of the voting rights and be unable
to exercise control . It is possible
for an entity to gain control without acquiring
the majority of voting rights , although
this situation is rare .
It may be difficult to identify the acquirer, particularly
if none of the combining entities own more than
half of the other's voting rights. However, there
are usually indications of control. An acquirer
is often:
| a) |
the combining entity with the larger fair
value (of its business), especially where the
difference is substantial [IFRS3.20(a)]; |
|
| b) |
the one with assets or liabilities that
significantly exceed those of the others [IFRS3.23]; |
|
| c) |
the entity that initiates the transaction
[IFRS3.23]; |
|
| d) |
the party paying cash (or giving up other
assets) when the business combination is a sale
of shares for cash (or exchange for other assets)
[IFRS3.20(b)]; or |
|
| e) |
the entity that is able to dominate the
selection of management after the combination
[IFRS3.20(c)]. |
Control might arise through the structure of the
supervisory and management boards, key management
appointments, the existence of a single large shareholder
or other factors [IFRS3.19] .
The legal acquirer will not be the identified accounting
acquirer if there is a reverse acquisition (see
section 'Reverse acquisitions') or a new entity is formed to issue
shares to effect a business combination. The legal
acquirer will issue the consolidated financial statements
under its name after the business combination.
When a new entity is formed to issue shares and
effect a business combination, one of the combining
entities that existed before the business combination
is the acquirer. There may be two or more combining
entities legally 'acquired' by a new entity. One
of the pre-existing combining entities will be the
acquirer in these circumstances, not the new entity
[IFRS3.22] .
Newly formed entities are often used in group reorganisations.
The new entity cannot be the acquirer, so one of
the pre-existing entities will be identified as
the acquirer. This requirement can have unexpected
consequences for many reorganisations
.
Recognition
The acquisition date is when the acquirer obtains
control of the acquiree . The date
of exchange is the date on which the acquirer's investment
is recognised in its financial statements. The date
of exchange and the acquisition date are the same
when control is obtained through a single transaction.
Control may however be achieved through stages
by successive share purchases. This is referred
to as a step acquisition. The date of exchange is
the date of each successive exchange transaction.
The acquisition date however is the date when control
was obtained by the acquirer [IFRS3.25].
Initial measurement
Cost of a business combination
The cost of a business combination is the total
fair value of the consideration given at the date
of exchange. Consideration includes cash paid, assets
given, liabilities incurred or assumed, other non-monetary
consideration and equity instruments issued by the
acquirer, in exchange for control, plus direct incremental
costs of the business combination [IFRS3.24] . Valuation
of a single-step cash acquisition is straightforward.
Valuation is more complex when the purchase consideration
takes the form of shares or other non-monetary assets,
or when there is more than one exchange transaction.
Purchase consideration given in the form of the
acquirer's shares is valued at the shares' fair
market value on the date of the exchange. The fair
value is equal to the market value in almost all
circumstances if the shares are publicly traded.
Another value should be used only if it can be clearly
demonstrated that a different price provides a more
reliable measure of fair value [IFRS3.27] .
The fair value of shares issued is estimated by
reference to the fair value of the acquirer's business
or the fair value of the business to be acquired,
whichever is the more clearly evident, if the shares
issued as consideration are not publicly traded
or if no share price is available [IFRS3.27]. Additional
guidance in determining the fair value of equity
instruments is presented in IAS 39 "Financial
Instruments; Recognition and Measurement" .
Non-monetary assets, other than shares in the acquirer,
are often given as consideration in an acquisition.
The fair value of the non-monetary consideration
is the cost of acquisition . If
this is not readily determinable, the fair value
of the acquired business might be used as a substitute
[IFRS3.27].
The amount of consideration payable to the seller
is often finalised at the date control passes but
with some elements to be determined by future events
or transactions. The acquisition agreement may provide
for:
 |
a controlling interest acquired today
with a provision for the subsequent purchase
of the minority interest; |
|
|
a portion of the consideration to be
paid in the future as either an explicit interest
bearing liability or an amount on which interest
will be imputed; |
|
|
a portion of the consideration to
paid as an uncertain future amount calculated
on the basis of a formula, such as a percentage
of net profit that will be paid to the seller
over a number of years; |
|
|
an additional amount payable
in the future based on the outcome of a specific
uncertain future event, such as the regulatory
approval of a new drug; or |
|
|
a combination of the above. |
These are all forms of contingent or deferred consideration
and are dealt with in more detail in the following
sections.
Contingent consideration
The cost of the business combination might be adjusted
based on the outcome of future events or the performance
of the acquired business. The payment of additional
consideration may be contingent upon the occurrence
or non-occurrence of a specific event or vary based
on the performance of the acquired business (i.e.
earn outs). Contingent consideration that can be
reliably estimated and where payment is probable
is recorded in full at the date of the business
combination. The full amount of the potential payment,
subject to discounting to present value, is included
in the initial cost of the business combination
[IFRS3.32] . The potential payment
is recorded when the uncertain future events or
the formula that will result in additional compensation
to the vendors are clearly identified and those
payments are more likely than not to occur
.
The adjustment to the purchase consideration may
vary based upon a range of outcomes. The cost of
the acquisition is adjusted for the most likely
outcome .
Contingent consideration arises only because of
uncertainties that existed at the date of acquisition.
Uncertainties that arise subsequent to the acquisition
are accounted for in accordance with the relevant
standards. An example of an uncertainty existing
at the date of acquisition is a partly developed
drug for which approval might or might not be obtained
in the future. Additional payments to the seller
based on regulatory approval would be recorded as
adjustments to the cost of acquisition if they are
probable and reliably measurable at the acquisition
date.
Adjustments to contingent consideration
The future event might not occur or the amount
of consideration may be different from the original
estimate. The cost of the business combination is
adjusted to reflect the actual outcome and the amount
finally paid [IFRS3.33]. Any increase in contingent
consideration, other than the effect of the unwinding
of the discount, will increase goodwill and any
decrease will reduce goodwill.
The present value of the estimated contingent consideration
is recorded at the date of acquisition . The subsequent accretion of the discount
is recognised as a finance charge in the income
statement.
Contingent consideration is sometimes paid to the
employees of the acquiree. For example, the sellers
of a family owned business may remain with the business
as employees after the business combination. When
the payment of contingent consideration is dependent
on continued employment, the payment must be allocated
between the cost of the business combination and
employee benefit expense. IFRS 2 "Share Based
Payments" does not apply when equity instruments
are issued as purchase consideration in a business
combination. However, when equity instruments are
issued in exchange for post acquisition services,
IFRS 2 is applied to calculate the income statement
charge.
The acquirer sometimes agrees to make a further
payment to the seller to compensate for a fall in
the fair value of the consideration given at the
date of acquisition. The cost of the business combination
is not increased in these circumstances. The further
payment reduces the value initially attributed to
the consideration [IFRS3.35].
Deferred consideration
Consideration that will be paid at a later date
is recorded at its fair value, discounted to its
present value at the acquisition date if the effect
of discounting is material [IFRS3.26]. The discount
rate is the market rate the acquirer would pay for
a similar borrowing obtained from a third party
to finance the acquisition.
An acquirer sometimes uses puts and calls or a
forward purchase agreement to defer the payment
of the cost of the business combination. For example,
the acquirer might purchase 75% of the target at
the date of acquisition and enter into a forward
contract to purchase the remaining 25% at a date
in the future. The acquirer might also issue a written
put to the seller, giving the seller the option
to sell the remaining 25% to the acquirer sometime
in the future. The acquirer's obligations in connection
with a forward contract or a written put are recognised
as liabilities at the date of acquisition in accordance
with IAS 32 [IAS32.23]. These liabilities are incurred
in exchange for control and are added to the cost
of the business combination .
Indemnities and guarantees
Purchase agreements may require the vendor to indemnify
the purchaser against specific contingent liabilities
outstanding at the date of the business combination.
Common examples are environmental liabilities, tax
matters and lawsuits. The indemnity may require
the vendor in substance to refund a portion of the
purchase price if the outcome of the contingency
is unfavourable; this is treated as negative contingent
consideration when received and reduces goodwill.
Cost of a step acquisition
Each step in a step acquisition, until the point
at which control is obtained, is treated separately
for the purpose of determining the cost of the business
combination, and the amount of goodwill [IFRS3.58].
There is a step-by-step comparison of the cost of
each exchange transaction with the fair value of
the additional interest in the identifiable assets,
liabilities, and contingent liabilities acquired
to determine the goodwill arising at each step [IFRS3.58]
.
The total cost of a step acquisition is the aggregate
of the cost each individual step up to and including
the step which results in control for the acquirer.
Total goodwill is the aggregate of the notional
goodwill arising on each step plus the goodwill
arising on the step in which the acquirer obtains
control. The goodwill on the final step is the residual
after the fair value of the purchase consideration
for that step has been allocated to the fair value
of the assets, liabilities and contingent liabilities
acquired in that step. However, all of the assets,
liabilities and contingent liabilities recognised
because the acquirer has obtained control are adjusted
to reflect the fair values at the date at which
control is obtained. The adjustments to the fair
values recognised to calculate the goodwill on previous
steps are revaluations and are recognised as such
in a revaluation reserve. The revaluation arises
on initial recognition of the assets, liabilities
and contingent liabilities acquired. It does not
imply that the acquirer has chosen revaluation as
an accounting policy for subsequent measurement
[IFRS3.59].
Purchase price allocation
The separately identifiable assets, liabilities and
contingent liabilities, are recorded at their fair
values. The difference between the cost of the business
combination and the acquirer's interest in the fair
values of the net assets is goodwill or negative
goodwill. The term negative goodwill is not used
by IFRS 3 which refers instead to the 'excess of
acquirer's interest in the net fair value of the
acquiree's identifiable assets, liabilities and
contingent liabilities' [IFRS3.51-57].
The identifiable assets, liabilities and contingent
liabilities are recognised if the following criteria
are met at the acquisition date:
| a) |
assets other than intangible assets: there
is a probable future inflow of economic benefits
and fair values can be measured reliably ; |
|
| b) |
liabilities other than contingent liabilities:
there is a probable future outflow of economic
costs and fair values can be measured reliably;
and |
|
| c) |
intangible assets and contingent liabilities:
fair values can be measured reliably (the probable
criterion is assumed to be met) [IFRS3.37] . |
It is rare that the acquirer is not able to measure
reliably the fair value of the assets and liabilities
recognised in a business combination. It is not
possible to measure reliably the fair value of an
intangible asset only when the asset arises from
legal or contractual rights and it is not separable,
or it is separable but there is no history or evidence
of market transactions and the estimate of fair
value would be dependent on immeasurable variables
[IAS 38.38].
The acquirer cannot recognise a provision for any
plans to restructure the target or for planned workforce
reductions . The acquiree may have
a plan in place for restructuring that meets the
criteria in IAS 37 at the date of acquisition. If
the acquiree would be able to recognise a restructuring
provision it can be recognised as part of the purchase
price allocation. However, a restructuring plan
that is conditional on the completion of the business
combination is not recognised in the purchase price
allocation. Expected future losses are not recognised
as part of the cost of the business combination
[IFRS3.41]. Other liabilities that arise from the
intentions of the acquirer are not recognised in
the purchase price allocation.
Recognition of additional assets, liabilities
and contingent liabilities
The accounting treatment of the assets and liabilities
identified does not necessarily follow the accounting
treatment the acquiree used previously. Any goodwill
recorded previously in the acquiree's balance sheet
is not an identifiable asset and is subsumed in
the new calculation of goodwill.
The purchase price allocation may result in the
recognition of new assets and liabilities [IFRS3.44]
and adjustments to restate the book values of the
acquiree's existing assets and liabilities to fair
value [IFRS3.36-57]. These adjustments and the goodwill
arising on the business combination are recognised
in the consolidated financial statements, but not
in the acquiree's separate financial statements.
Goodwill, additional assets and liabilities recognised
and fair value adjustments to existing items are
recognised by the parent in purchase accounting.
There is no basis for push down accounting in IFRS.
New assets recognised might be favourable leasehold
interests, advertising contracts, franchise agreements,
or intellectual property such as patents, trade
secrets, copyrights, creative materials, customer
relationships, customer lists, trade marks, internet
domain names and tax assets . When
the acquirer is able to recognise its own deferred
tax assets as a result of a business combination,
the credit is recognised in the income statement,
not as an adjustment to goodwill.
Access to research and development is often a driving
factor in acquisitions. The fair value of research
projects and development assets should be recognised
if their fair values can be reliably measured . Existing assets restated to fair values
might include PPE, intangible assets, inventories,
receivables at present value of expected future
cash flows and net employee benefit assets.
Business combinations are often used to secure
customer relationships. A contractual customer relationship
and the related contract are recognised if their
fair value can be estimated reliably. A customer
relationship is contractual if the acquiree has
a practice of establishing relationships by contract
even if no contracts are in place at the date of
acquisition. Detailed guidance for the recognition
of customer relationships is provided in the implementation
guidance in IFRS 3 [IFRS3.IE1-4]. Non-contractual
customer relationships are recognised only when
market transactions provide evidence that the acquiree
controls the benefits associated with the relationship.
New liabilities recognised might be onerous contracts
and deferred tax liabilities .
Existing liabilities restated to fair values might
include long-term debt remeasured to fair value
using current interest rates and employee benefit
liabilities [IAS19R.108] . The fair
value of a liability is not adjusted to reflect
the probability that the creditor will claim payment.
Contingent liabilities are possible obligations
arising from past events, whose existence is subject
to the occurrence of future events not in the control
of the entity. The existence of a contingent liability
results in the acquirer paying less for the acquiree,
reflecting the reduced amount it has paid to assume
the obligation [IFRS3.BC111]. Contingent liabilities
might include the possible (not probable) unfavourable
outcome of litigation. Contingent liabilities are
subsequently measured at the higher of the amount
that would be recognised in accordance with IAS
37, and the amount initially recognised less, when
appropriate, cumulative amortisation recognised
in accordance with IAS 18 "Revenue" [IFRS3.48].
What is fair value?
Fair value is defined in IFRS 3 as 'the amount for
which an asset could be exchanged, or a liability
settled, between knowledgeable willing parties in
an arm's length transaction'. This definition is
generally accepted as meaning a market based value.
Fair value is not a forced sale price, as both parties
are willing, and does not incorporate the unusual
pricing arrangements that are often found between
related parties. Fair value is the price that would
be paid by a hypothetical market participant. The
identity of the hypothetical purchaser is unknown
and therefore no account is taken of any entity's
particular circumstances; fair value is not entity
specific .
The fair value of an asset is the price that is
typically paid for similar assets in the market
place. When there is no obvious market data, fair
value can be estimated from the asset's cash generating
ability and a potential investor's required rate
of return. The expected cash flows from the use
of an asset are those which would arise from exploiting
its potential over its useful life. These cash flows
exclude any synergy benefits that a specific acquirer
might achieve and disregard the acquirer's intentions
to prematurely stop exploiting the asset . The required rate of return, or discount
rate, to be applied to the cash flows will have
regard to the rates of return required by investors
in the relevant industry and to the risk attaching
to the cash flows.
Detailed guidance on the measurement of fair value
for specific assets and liabilities is set out in
IFRS 3 [IFRS3.AppendixB.16].
Measurement of minority interest
Where the entity has acquired less than 100% of
the acquiree's shares, it records the full fair
value of identifiable assets, liabilities and contingent
liabilities acquired. The minority's interest in
them is also recorded at fair value [IFRS3.40] . The minority interest in goodwill is not
recognised.
Goodwill
The excess of the fair value of the cost of the
business combination over the fair value of acquirer's
interest in the acquiree's identifiable net assets
is described as goodwill and recognised as an asset
[IFRS3.51]. Goodwill is the residual after the cost
of the business combination has been allocated to
the identifiable assets, liabilities and contingent
liabilities [IFRS3.53]. Goodwill is not amortised,
but is tested annually for impairment.
Most acquisitions give rise to positive goodwill.
However, occasionally the acquirer's interest in
the net fair value of acquiree's identifiable assets,
liabilities and contingent liabilities may exceed
the acquisition cost. The amount is sometimes referred
to as negative goodwill. When the purchase price
allocation results in negative goodwill, the acquirer
must reassess the identification and measurement
of the acquired assets, liabilities and contingent
liabilities [IFRS3.56]. Any excess that remains
is recognised immediately in the income statement.
Goodwill arises on consolidation and does not generate
cash flows independently of other assets. Goodwill
must therefore be allocated to cash generating units
(CGUs) for impairment testing
[IAS36.80]. Goodwill is allocated on a rational
basis to the lowest level at which it is monitored
by management. This may be an individual CGU or
group of CGUs but cannot be larger than a segment
[IAS36.80] .
Goodwill is allocated to all CGUs expected to benefit
from the business combination including those to
which acquired assets have not been allocated. The
allocation must be completed by the end of the accounting
year following the year of acquisition [IAS36.84].
The CGUs to which goodwill is allocated reflects
the level at which management monitors the performance
of its acquisitions. The basis of allocation should
reflect as far as possible the factors giving rise
to the goodwill. An arbitrary allocation basis,
such as relative fair values or relative book values
should not be used.
Subsidiaries acquired with the intention
of resale
A subsidiary or business acquired with a view to
sale is not exempt from consolidation. However,
if it meets the definition of a disposal group,
it is recognised initially at the lower of cost
and fair value less costs to sell [IFRS5.16]. The
goodwill arising on the business combination increases
by the anticipated selling expenses since these
assets or groups of assets would otherwise have
been recognised at fair value. The assets and liabilities
of a subsidiary meeting the definition of a disposal
group after the date of acquisition are recognised
at fair value as part of the purchase price allocation
.
A subsidiary acquired with the intention of resale
that meets the definition of a disposal group is
treated as a discontinued operation. The assets
and liabilities of the discontinued operation are
presented separately on the balance sheet and the
net result of the disposal group is presented separately
in the income statement.
A purchase price allocation is required in connection
with a subsidiary or business that meets the definition
of a disposal group at the date of acquisition.
IFRS 5 permits the acquirer to determine the fair
value of the assets of a disposal group by adding
the fair value of its borrowings to its fair value
less cost to sell. This is unlikely to be a practical
approach for most acquirers since it does not provide
the information needed to determine the results
of the discontinued operations or the information
that will be required if the discontinued operation
is not sold and is subsequently included line by
line in the consolidated financial statements. The
approach permitted by IFRS 5 might be feasible when
the acquirer has received an offer from a buyer
for a proposed sale. A notional purchase price allocation
is required in all other circumstances.
There is a window period, as discussed in section
'Changes in estimates of value of assets/liablities' below, during which identifiable assets and
liabilities recognised at the date of acquisition
might be derecognised, based on additional information
or evidence about the circumstances that existed
at the date of acquisition. Goodwill is adjusted
for any derecognition in these circumstances.
Measurement subsequent to initial recognition
Changes in estimates of value of assets/liabilities
The purchase price allocation must be completed
within twelve months of the acquisition date. Provisional
values can be used on a temporary basis if the acquirer
has not completed the identification and measurement
of assets and liabilities by the end of the accounting
period when the combination occurred. The fair values
assigned initially may be revised within the twelve
month window based on additional evidence of fair
value at the date of acquisition .
Fair values should not be revised for specific events
or changes in circumstances that arise after the
date of acquisition.
Any adjustments to the fair values initially recorded
at the date of acquisition as a result of finalising
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