Business Combinations – A 39 Year Journey but have we arrived?

By Lim Ju May

Mergers, acquisitions, takeovers and corporate restructurings are significant cornerstones that determine the growth and way forward for businesses and corporations. These events and transactions in accounting language are termed business combinations (“BC”) and the accounting requirements are set out in IFRS/SFRS(I) 3 Business Combinations.

The business combination accounting standard was first issued in 1983 and looking back over three decades, not so much has changed. Yes, you heard me right – 39 years from when it was first IAS 22 Accounting for Business Combinations in the 1983 to IFRS/SFRS(I) 3 Business Combinations today.


What fundamentally changed?

In my view, there are two main fundamental developments in the accounting for BC. First – the determination of what is to be scoped in or scoped out of the BC accounting standard albeit the BC definition. Second – the requirement for only the Acquisition Method of accounting to be used. The other changes were mainly the finetuning of the definition of business and the Acquisition Method of accounting.

IFRS 3 (2004) essentially retained the definition of BC from IAS 22 except that it explicitly scoped out business combinations under common control (“BCUCC”). However, IFRS 3 (2008) definition of BC substantially shifted from a conceptual definition to a definition which is similar to the definition of “Acquisition” under IAS 22 whereby an ACQUIRER obtains control of one or more businesses. Upon scrutiny, it does appear as though the definition of BC had been removed and the old definition of Acquisition in IAS 22, which was removed in IFRS 3 (2004), was reintroduced back into IFRS 3 (2008) but in the form of BC.

Definition of Business Combinations (“BC”)
IAS 22 IFRS 3 (2004) IFRS 3 (2008)
The bringing together of separate enterprises into one economic entity as a result of one enterprise uniting with or obtaining control over the net assets and operations of another enterprise. The bringing together of separate entities or businesses into one reporting entity.

Provides a definition of business.

A transaction or other event in which an ACQUIRER obtains control of one or more businesses. Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in this FRS.

Definition of business refined.


How the Acquisition Method became the dominant accounting method for business combinations (“BC”)

This decision to require the Acquisition Method to be used for all BC was made by the International Accounting Standards Board (IASB or Board) back in 2004 because they concluded back then that virtually all BC are acquisitions i.e. a purchase transaction whereby the ACQUIRER purchases the net assets or equity interests of the acquiree by transferring cash or other assets or incurs liabilities. Hence the Acquisition Method would be the appropriate method for these types of BC.

What does “acquisitions” mean in a BC? In simple language, it means that there exists an ACQUIRER that purchases a business from the owners of the business, and in so doing, obtains the ability to control the business (the acquiree).


Problem with the existing definition of BC

In my view, not all BC are acquisitions and not all acquisitions are BC. The US Financial Accounting Standards Board (FASB) acknowledged back in 2001 when FASB Statement No. 141 Business Combinations was issued that some BC might not be acquisitions and said that it intended to consider in another project whether BC that are not acquisitions should be accounted for using the fresh start method rather than the purchase method. Neither the IASB nor the FASB has on its agenda a project to consider the fresh start method.

The existing definition of BC which in substance is the definition for an acquisition type of BC presupposes that all BC are true-blue acquisitions.  However, especially in recent times, citing for example Special Purpose Acquisition Company (“SPAC”), where a transaction may not clearly qualify as an acquisition or business combination, or where an acquirer cannot be identified, the appropriate accounting would require careful consideration of all pertinent facts and circumstances, could warrant the consideration of substance over form and would be complex or highly judgmental.


Complications with the Acquisition Method of accounting

The Acquisition Method requires that the ACQUIRER be identified from one of the combining entities. The other combining entity(s) would be the acquiree, needs to be a business and their assets / liabilities are to be recognised in accordance with the conceptual framework and measured at their acquisition-date fair values. A goodwill or bargain purchase would be recognised.

What this means is that certain internally generated intangible assets which would not qualify for recognition under IAS 38 / SFRS(I) 1-38 Intangible Assets would be recognised in the BC at their acquisition-date fair values if they qualify as assets under the conceptual framework. These acquired identifiable intangible assets typically includes brand names, patent or customer relationship.

Complications arise when it is not clear which party in the BC is the ACQUIRER. This is especially so for BC affected through the exchange of equity interests such as roll-ups, mergers of equals and legal reorganisations or recapitalizations. Complications give rise to uncertainties and with uncertainties, structuring opportunities to arrive at a predetermined outcome. Another complication arises with the requirement for the acquisition-date fair value measurement of the ACQUIRER’S consideration transferred when the consideration transferred is equity interest in the newly combined entity. Fair values provide relevant financial information for decision making but fair values are also accounting estimates, requiring valuation techniques, significant judgments and assumptions.


IFRS 3 and before

IFRS/SFRS(I) 3 Business Combinations is the main accounting standard that deals with the accounting for business combinations (“BC”). It first came into effect in 2004 together with revised versions of IAS 36 Impairment of Assets and IAS 38 Intangible Assets, replacing IAS 22 and three related Interpretations (SIC-9 BC – Classification either as Acquisitions or Unitings of Interests, SIC-22  BC – Subsequent Adjustment of Fair Values and Goodwill Initially Reported and SIC-28 BC – ‘Date of Exchange’ and Fair Value of Equity Instruments).  IFRS 3 (2004) was subsequently revised to IFRS 3 (2008) as a result of a joint project between the IASB and the FASB. The FASB also issued a similar standard in December 2007 (SFAS 141(R)).


IFRS 3 [2004] – key conclusions and changes from IAS 22

  • Requires all BC within its scope to be accounted for by applying the purchase method
  • Scopes out business combinations under common control (“BCUCC”)
  • Requires an ACQUIRER to be identified for every BC within its scope
  • Costs of a BC to include any costs directly attributable to the BC


IFRS 3 (2008) – key conclusions and changes from IFRS 3 [2004]

  • Replaced the term “purchase method” with “acquisition method”
  • Broadens its scope by including BC involving mutual entities & BC achieved by contract alone
  • Scopes out acquisition of assets that does not constitute a business
  • Acquisition-related costs to be expensed with exception of costs to issue debt or equity securities to be recognised in accordance with FRS 32 and FRS 39

IFRS 3 (2008) and SFAS 141(R) were carried forward without reconsidering the primary conclusions each Board reached in IFRS 3 (2004) and SFAS 141 (2001).


From IFRS 3 (2008) to 2022

  • October 2018 amendments narrowed and clarified the definition of a business. It permitted a simplified assessment of whether an acquired set of activities and assets is a group of assets rather than a business
  • May 2020 amendments to make reference to the Conceptual Framework and related amendments to avoid unintended consequences from the updated reference


Have we Arrived?

The IASB has embarked on a research project on BCUCC to consider how to fill the gap in IFRS Accounting Standards. The project scope covers transactions under common control in which a reporting entity obtains control of one or more businesses, regardless of whether:

  • the reporting entity can be identified as the ACQUIRER;
  • the transaction is conditional on a future sale of the combining parties, such as in an IPO;
  • the transaction is either preceded by an external acquisition of one or more combining parties, or followed by an external sale of the combining parties, or both.

However, this BCUCC project does not address the issues with the existing definition of BC and the complications of the Acquisition Method of accounting as highlighted in this article.

Perhaps a re-examination of the fundamental premise in IFRS 3 that all BC are acquisitions and hence to be accounted for under the Acquisition Method is warranted to assess whether the existing notion is still fit for purpose today.


Lim Ju May is Technical Director, Assurance Principal, CLA Global TS.


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