Business combinations pt. 1

Business combinations effected by unrelated parties

Table of Contents

A business combination is defined as the “transaction or other event in which an acquirer obtains control of one or more businesses”. [IFRS 3 Business Combinations Appendix A / ASC Master Glossary].

Although IFRS 10 Consolidated Financial Statements and ASC 810 Consolidation provide guidance for assessing whether control is or has been obtained and for consolidation procedures to be applied, then parents shall account for the initial acquisition of subsidiaries in accordance with IFRS 3/ASC 805 Business Combinations. These standards provide guidance for the measurement of specific items to be included in the consolidated financial statements, e.g. goodwill and non-controlling interest arising from the acquisition of a subsidiary.

Hence, from the definition above, parent entity who is acquiring a subsidiary, needs to determine whether the subsidiary constitutes a business in order to apply IFRS 3 / ASC 805.

Is the subsidiary a business?

Entities applying US GAAP are required to start their assessment with screening test (concentration test under IFRS). Entities applying IFRS may but are not required to start their assessment with concentration test. They can jump straight into analysing the existence of three elements of business.

Under the screening test, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the subsidiary is not considered a business. The steps of screening test could be summarised as follows:

  • Determine all identifiable assets
  • Combine any identifiable assets as per exceptions provided in ASC 805-10-55-58
  • Assess whetherthe remaining assets are similar assets
  • Determine fair value of gross assets acquired
  • Compare the fair value of singe identifiable asset/group of similar identifiable assets to the fair value of gross assets acquired
  • Is substiantially all of the fair value of the gross assets acquired concentrated in a single identifiable asset/group of similar identifiable assets?
  • YES > the entity acquired does not constitute a business
    NO > assess whether the three elements of business are

If the screening test is not met, the parent assesses whether the acquired set of assets and activities constitutes a business based on whether it has at a minimum the three elements of business. That assessment is similar under ASC 805 and IFRS 3.

A business is an integrated set of activities and assets that is capable of being conducted and managed with the aim of providing goods or services to customers, generating investment income (e.g. dividends or interest) or generating other income from ordinary activities. The three elements of a business are:

INPUTS Any economic resource that creates or has the ability to contribute to the creation of outputs when one or more processes are applied to it. E.g. non–current assets, intellectual property, the ability to obtain access to necessary materials or rights, employees.
PROCESSES Any system, standard, protocol, convention or rule if applied to inputs, either creates or has the ability to contribute to the creation of outputs. E.g. strategic management processes, operational processes, resource management processes.
OUTPUTS The result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (e.g. dividends or interest), or other revenues.

If the assets acquired and liabilities assumed do not constitute a business, the transaction is accounted for as an acquisition of a group of assets, i.e., the cost of the group is allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase and goodwill is not recognised.

If based on the above analysis an investor determines that it has acquired a business, the business combination shall be accounted for by applying the acquisition method.

Acquisition method of accounting

Involves the following steps:

  • Identifying the acquirer
  • Determining the acquisition date
  • Recognising and measuring the identifiable assets acquired, the liabilities assumed, and any non–controlling interest
  • Recognising and measuring goodwill or a gain from a bargain purchase

Identifying the acquirer

The acquirer is the entity that obtains control of the acquiree.

In a business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities.

In a business combination effected primarily by exchanging equity interests, the acquirer is usually the entity that issues its equity interests, but in some business combinations, so–called ‘reverse acquisitions’, the issuing entity is the acquiree.

The acquirer is usually the combining entity whose relative size is significantly greater than that of the other combining entity.

Determining the acquisition date

Acquisition date is the date on which the acquirer obtains control of the acquiree.

This is generally the closing date, i.e., the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree, however this does not necessarily mean that the transaction has to be closed or finalised at law before the acquirer obtains control over the acquiree.

The acquisition date could also be earlier or later than the closing date, if a written agreement provides that the acquirer obtains control of the acquiree on a date before or after the closing date.

Recognising and measuring the identifiable assets acquired, the liabilities assumed, and any non–controlling interest

All identifiable assets acquired, liabilities assumed and non-controlling interests in the acquiree are recognised separately from goodwill.

An asset or liability, in order to qualify for recognition must meet the respective definition provided by the standards. Further, assets and liabilities should exist at the acquisition date and any assets and liabilities arising after the acquisition are not recognised.

Identifiable intangible assets arising from contractual or legal rights, or which are separable are also recognised separately from goodwill (e.g. customer contracts and related customer relationships, royalties).

The identifiable assets acquired, and liabilities assumed are measured at their acquisition–date fair values, thus adjustments are most probably necessary to the carrying values.

Non-controlling interest is the equity in a subsidiary that is not directly or indirectly attributable to a parent. NCI arises only if the parent acquires less than 100% of the subsidiary.

Non–controlling interests that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation can be measured either:

  • at fair value, or
  • at the non–controlling interest’s proportionate share of the acquiree’s net identifiable assets

Recognising and measuring goodwill or a gain from a bargain purchase

Goodwill at the acquisition date is calculated as the difference between:

  • The aggregate of:
    1. The consideration transferred (generally measured at acquisition–date fair value)
    2. The amount of any non–controlling interest in the acquiree, and
    3. The acquisition–date fair value of the acquirer’s previously held equity interest in the acquiree
  • The net of the acquisition–date fair values (or other amounts recognised in accordance with the requirements of the standard) of the identifiable assets acquired and the liabilities assumed

Positive goodwill is recognised as an intangible asset in the statement of financial position and tested for impairment annually.

In case the negative goodwill arises, the parent should reassess all components of the computation to verify that no error has been made and recognise a gain in profit or loss.

Illustrative example

Parent Co acquired 75% of shares of a Subsidiary for 25 MEUR. At the date of acquisition the following facts and circumstances were identified:

  1. Fair value of PPE amounts to 20 MEUR at date of acquisition
  2. An intangible asset in relation to customer contracts of Subsidiary was identified and valued at 1,5 MEUR
  3. In relation to the restructuring, Parent Co is planning to reduce the workforce of Subsidiary, which results in redundancy fees in the amount of 1 MEUR to be paid out. These plans have recently been communicated to the employees.

Tax rate of 20% applies in the jurisdiction of Parent Co and Subsidiary.

The statement of financial position of the Subsidiary prior to the acquisition together with fair values and purchase price allocation is as follows:

Carrying amount Adjustment Fair value
Cash at bank 6 0006 000
Receivables 4 0004 000
Inventories 5 3005 300
PPE 1 18 000 2 000 20 000
Intangible assets 2 0 1 500 1 500
Total Assets 33 300 3 500 36 800
Payables 6 0006 000
Borrowings 4 0004 000
Deferred income tax liability 3 300 700 1 000
Provisions 4 0 1 000 1 000
Total Liabilities 10 300 1 700 12 000
Share capital 15 00015 000
Retained earnings 5 0005 000
Profit for the year 3 0003 000
Adjustments1 800 1 800
Total Equity 23 000 1 800 24 800
Total Liabilities and Equity 33 300 3 500 36 800
Total Liabilities and Equity 24 800
Non-controlling interest 6 200
Identifiable net assets acquired by the Parent Co 18 600
Consideration transferred 25 000
Goodwill 6 400

Consideration transferred, including any contingent consideration is measured at acquisition date fair value. Any subsequent changes to the consideration transferred will be accounted for depending on the initial assessment of the contingent consideration.

Costs related to the acquisition of a subsidiary shall be expensed in the period the expenses are incurred and respective services received and are not part of the consideration transferred for the acquiree. The costs of registering and issuing debt/equity are recognised in accordance with IAS 32 and IFRS 9, i.e., as a reduction of the proceeds of the debt or equity securities issued.

Rephop helps you record all the information required for business combination and automatically uses this information in the consolidation process, whether you are adhering to IFRS or US GAAP. We also help you handle entities that may be exempt from consolidation and report investments if control does not exist. With our software, you can ensure that your consolidated financial statements are accurate and comply with both IFRS and US GAAP reporting requirements, all while saving time and reducing manual effort.


  1. As was given in the scenario, PPE fair value amounted to 20 MEUR, thus adjustment of 2 MEUR is necessary to the carrying amount.

  2. Identified intangibles are recognised at their fair value of 1,5 MEUR (amount was given)

  3. Deferred income tax liability arises from the fair value uplift related to PPE and identified intangible assets. Tax rate of the jurisdiction to which the activities of identified assets are related to, is applied. In this case 20% applied to the FV uplift (3500*20% = 700).

  4. A provision related to redundancy compensation is recognised upon acquisition.