Business Combination – 10
IFRS Watch - Issue 46
Measuring goodwill or a gain from a bargain purchase
Goodwill arising from a business combination is determined as: [IFRS 3:32]
In a business combination in which the acquirer and the acquiree (or its former owners) exchange only equity interests, the fair value of the acquiree's equity interests may be more reliably measurable than the fair value of the acquirer's equity interests. If so, the acquirer should determine the amount of goodwill by using the fair value of the acquiree's equity interests rather than the fair value of the equity interests transferred. [IFRS 3:33]
Business combinations with no consideration
Paragraph 33 of IFRS 3 also deals with the situation of a business combination in which no consideration is transferred. This could occur when the acquiree repurchases equity interests from other investors such that the acquirer's unchanged equity interest becomes a controlling interest, or a business combination achieved by contract alone.
In a business combination achieved without the transfer of consideration, goodwill is determined by using the acquisition-date fair value of the acquirer's interest in the acquiree rather than the acquisition-date fair value of the consideration transferred. [IFRS 3:33]
The acquirer measures the fair value of its interest in the acquiree using one or more valuation techniques that are appropriate in the circumstances and for which sufficient data is available. If more than one valuation technique is used, the acquirer should evaluate the results of the techniques, considering the relevance and reliability of the inputs used and the extent of the available data. [IFRS 3:B46]
When two mutual entities combine, the entity identified as the acquirer gives member interests in itself in exchange for the member interests in the acquiree. Thus, consideration is paid, but its fair value is not readily measurable by reference to a market. IFRS 3 recognises that it may be more reliable to fair value the entire member interest of the acquiree, rather than the incremental member interests given by the acquirer.
Accordingly, IFRS 3 provides that when the fair value of the equity or member interests in the acquiree (or the fair value of the acquiree) is more reliably measurable than the fair value of the member interests transferred by the acquirer, the acquirer should determine the amount of goodwill by using the acquisition-date fair value of the acquiree's equity interests instead of the acquisition-date fair value of the acquirer's equity interests transferred as consideration. [IFRS 3:B47]
This is an example of IFRS 3 using the fair value of the acquiree to measure consideration because it is more reliably measurable than consideration given by the acquirer.
Basis of valuation
Although they are similar in many ways to other businesses, mutual entities have distinct characteristics that arise primarily because their members are both customers and owners. Members of mutual entities generally expect to receive benefits for their membership, often in the form of reduced fees charged for goods and services or patronage dividends. The portion of patronage dividends allocated to each member is often based on the amount of business the member did with the mutual entity during the year. [IFRS 3:B48]
A fair value measurement of a mutual entity should include the assumptions that market participants would make about future member benefits as well as any other relevant assumptions market participants would make about the mutual entity. For example, a present value technique may be used to measure the fair value of a mutual entity. The cash flows used as inputs to the model should be based on the expected cash flows of the mutual entity, which are likely to reflect reductions for member benefits, such as reduced fees charged for goods and services. [IFRS 3:B49]
Identifiable net assets acquired
The acquirer in a combination of mutual entities recognises the acquiree's net assets as a direct addition to capital or equity in its statement of financial position, not as an addition to retained earnings, which is consistent with the way in which other types of entities apply the acquisition method. [IFRS 3:B47]
Member interests given by the acquirer will be recognised directly in equity. IFRSs do not usually prescribe where within equity such items are classified. In this case, however, IFRS 3 is specific that the amount recognised (equal to the acquiree's identifiable net assets) should not be added to retained earnings.
IFRS 3:B47 takes precedence over local legal requirements which may require such amounts to be reflected in retained earnings. Therefore, in accounting for a combination of mutual entities, recognition of member interests in retained earnings is prohibited. However, neither IFRS 3 nor any other Standard prohibits the acquirer from transferring the equity balance to retained earnings subsequently. Such a transfer is acceptable provided that it is not prohibited by local laws.
A bargain purchase is a business combination in which the net fair value of the identifiable assets acquired and liabilities assumed exceeds the aggregate of the consideration transferred, the NCIs and the fair value of any previously held equity interest in the acquiree.
A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion.
Accounting for a bargain purchase gain
If, after applying the appropriate test it is determined that the acquisition is a bargain purchase, the acquirer recognises the resulting gain in profit or loss on the acquisition date. The gain is attributed to the acquirer. [IFRS 3:34]
Consequences of identifying a bargain purchase
An acquirer's initial calculations under IFRS 3:32 may indicate that the acquisition has resulted in a bargain purchase. Before recognising any gain, the Standard requires that the acquirer should reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed. The acquirer should recognise any additional assets or liabilities that are identified in that review. [IFRS 3:36]
The acquirer is then required to review the procedures used to measure the amounts that IFRS 3 requires to be recognised at the acquisition date for all of the following:
- the identifiable assets acquired and liabilities assumed;
- the non-controlling interest in the acquiree, if any;
- for a business combination achieved in stages, the acquirer's previously held equity interest in the acquiree; and
- the consideration transferred.
The objective of the review is to ensure that the measurements appropriately reflect consideration of all available information as of the acquisition date. [IFRS 3:36]