IFRS 3, Business combinations – A survival guide to the essentials of takeovers, Part I

Athens, February 2018
Chris Ragkavas, BA, MA, FCCA, CGMA
IFRS technical expert, financial consultant

“Business combinations” is the simple technical term for acquisitions. In each acquisition we need to identify:

  1. The parties involved, i.e. the investor obtaining control of the investee, as a result of this transaction;

  2. The means by which the investor obtains control, i.e. the consideration;

  3. The value of the investee’s net assets on acquisition;

  4. The result of the comparison between 2 and 3, i.e. the goodwill arising on acquisition.

The investor obtains control of the investee, when as a result of the business combination, the investor obtains the power “to govern the financial and operating policies of the investee, so as to obtain benefits from the activities of the investee”. Simply put, the investor, i.e. the controlling interest (CI) obtains the ability to determine all major policies of the investee. This is usually, but not always, achieved by acquiring the majority of the common shares carrying voting rights, which results into the investor appointing the majority of the members of the investee’s board of directors (BoD).

Any residual interest in the investee not owned by CI, is referred to as, the non controlling interest (NCI).

Acquisition method
On the date control is effectively obtained, the investor applies the acquisition method. This simply means that, on that date:

  1. All forms of consideration transferred by the investor to the previous owners of the investee, are measured at their fair value. When consideration is in cash, and it will occur longer than 12 months after the acquisition date, its estimated future value must be discounted on the acquisition date.

  2. Almost all identifiable assets and liabilities, i.e. the net assets (NAV) of the acquiree are also reflected at fair value. Amongst others, this means that some assets and liabilities that had not been previously recognized by the investee, must now be recognized.

  3. NCI’s measurement can be done either at their proportionate value of the investee’s NAV, or at NCI’s fair value.

A acquires 75% of the share capital of B on 16/4/2018, i.e. 75,000 out of 100,000 shares. Details of the forms of consideration, and acquisition date fair values of assets and liabilities acquired are as follows:

  1. A, issue 2 new shares of their own, for every 5 shares of B acquired. Fair value per A share, $50.

  2. A, further transfers to the previous owners of the B shares acquired, control of a fleet of cars carried at historic cost of $ 300,000 at A’s financial statements, the fair value of which is $320,000 on the date of acquisition.

  3. A, will pay a further $ 275,625 to the previous owners of B, on 15/4/2020. A’s cost of capital is 5%.

  4. The residual 25,000 B shares, i.e. NCI, is measured at its fair value. One B share at the date of acquisition is fair valued at $25,-.

NAV of investee (B) on 16/4/2018 were $ 1,870,000. However, the following adjustments are necessary:

  1. B carries its properties at historic cost. Their acquisition date fair value is by $100,000 higher.

  2. The B brand is valued by a group of experts at $ 378,000. This had not been recognized by B until the acquisition date, as IAS 38 Intangible Assets specifically disallows internally generated brands to be recognized. Reason being, they do not have a cost that can be measured reliably. However on the acquisition date, brand is independently valued, and separately negotiated between buyer and seller, it is identifiable, therefore it does have a cost for the acquirer that can be measured reliably. This brand will only be recognized in the consolidated financial statements of A and its subsidiaries.

  3. B inventories are carried at cost according to IAS 2 Inventories. However now, they are sold as part of the business combination, by B to A, therefore they must be reflected at their fair value, which is by $30,000 higher than their cost.

Goodwill calculation

Consideration and NCI         $
Share exchange: 75,000 / 5 x 2 = 30,000 x $ 50 = 1,500,000
Fleet of cars delivered =   320,000
Deferred cash consideration: $ (275,625) x 1,05^2 =    250,000
NCI: 25,000 x $ 25 =    625,000
Total 2,695,000


Unadjusted NAV acquired          1,870,000
Property adjustment =             100,000
Brand valuation =             378,000
Inventories adjustment =               30,000
Total         (2,378,000)

Goodwill arising on acquisition                                       317,000

Attention points, common misconceptions resolved:

  1. NCI has been valued in the example at its fair value. Assuming B is listed, this is a very simple exercise, as its share price is readily available.

  2. The alternative option is to multiply the proportionate value (25%) of NCI with the fair value of B’s NAV on the acquisition date. This is explained in Part II.

  3. The investor, in its consolidated financial statements, can value the NCI of some of its subsidiaries at fair value, and of others at their proportionate value.

  4. The NCI, do not pay any form of consideration to anyone. They are simply valued in one of the two ways explained above.

  5. The various forms of consideration are paid/exchanged by the investor to the previous shareholders of the 75% of the investee. The investee, i.e. the subsidiary, is the object of the transaction and no party to it.

Queries, comments, are welcome at [email protected]

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