Chapter 3: Business Combinations (IFRS-3)

• Learning objectives
• To define Key terms in Business combination
• Reasons for Business Combinations
• Scope of IFRS-3
• Types of business combination
• Methods (Techniques) of Arranging Business Combination
• Accounting for business combinations

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 Part I

Basic concepts of Business Combination

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 3.1 Key definitions in (IFRS-3)
• Business
• An integrated set of activities and assets that is capable of
being conducted and managed for the purpose of providing
goods or services to customers, generating investment
income (such as dividends or interest) or generating other
income from ordinary activities.

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Key definitions in (IFRS-3)
• Business Combinations
• A transaction or other event in which an acquirer obtains control of
one or more businesses.
• The most common business combination is a purchase transaction in
which the acquirer purchases the net assets or equity interests of a
business for some combination of cash or shares.

• IFRS 3 Business Combinations outlines the accounting when an

acquirer obtains control of a business (e.g. an acquisition or merger).
Such business combinations are accounted for using the 'acquisition
method', which generally requires assets acquired and liabilities
assumed to be measured at their fair values at the acquisition date.
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 Key definitions
• Acquisition date
• The date on which the acquirer obtains control of the acquiree or
the date may be a date that is earlier or later than the closing date.
• Acquirer (Combiner)
• The entity that obtains control of the acquiree or the entity that
transfers cash or other assets to acquire other entity (purchase the
asset of other)
• Acquiree (Combinee)
• The business or businesses that the acquirer obtains control of in a
business combination (one who sale its asset)
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 Key definitions
• Contingent consideration: is additional purchase price
payable depending on a future outcome or events.
• Sometimes when a business combination takes place,
there will be contingent consideration in place.
• For example, the shareholders of the acquiree may receive
extra money from acquirer if the acquiree reaches certain
targets. Contingent consideration is additional purchase
price payable depending on a future outcome or events.
• The contingent consideration should be recognized as part
of the cost of the acquisition.
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 Key definitions
• Consideration transferred/paid/
• The amount of cash paid, common stock issued at fair value/bond
issued at present value.
• Control:
• The power to govern the financial and operating policies of an entity
so as to obtain benefits from its activities.
• Parties involved
• The transaction may be between the shareholder of the combining
entities or between one entity and the share holders of another
entity. It may involve the establishment of a new entity to control the
combining entities or net assets transferred, or the restructuring of
one or more of combining entities.
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 Key definitions
 Non-controlling interest: is an ownership position
where a shareholder owns less than 50% of a
company's shares and has no control over decisions.
• For example, if the organization owns 70% of the
subsidiary and a minority partner owns 30% and
subsidiaries net income say $1M. The non-controlling
interest would be calculated as $1M x 30% =
$300,000.

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 3.2 Reasons for Business Combinations
• To eliminate competition • Growth in terms of profit or
asset
• Economies of Large-scale • Obtaining new management
Production (reducing the skills
per-unit cost of production) • For capital advantages
• To improve market share • Government Pressure.
• Control of the target market • Partnership for vertical
integration
• Technological advantage • To obtain financial sources

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 3.3 Scope of IFRS-3
• IFRS 3 must be applied when accounting for business combinations, but
does not apply to:
• The formation of a joint venture

• The acquisition of an asset or group of assets that is not a business,

• Combinations of entities or businesses under common control (the IASB

has a separate agenda project on common control transactions

• Acquisitions by an investment entity of a subsidiary that is required to be

measured at fair value through profit or loss under IFRS 10 Consolidated
Financial Statements.
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 3.4 Types of business combination

• 1) Horizontal Combination- the combination between two

companies in the same industry
• E.g. Construction and business bank was combined with commercial
bank of Ethiopia
• 2) Vertical Combination- the combination manufacturing company
with its supplier
• E.g. Food Processing company combined with wheat farming owning
company
• 3) Conglomerate Combination-the combination between two
companies in the different industry
• E.g. Dashen Bank combined with manufacturing company
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 3.4 Types of business combination
• 4) Market extension merger: The merging companies typically offer similar
products and services in different markets.
• A hypothetical example of a market extension merger could be the
merger of Amazon and Alibaba. Both Amazon and Alibaba are highly
similar e-commerce businesses.
• However, they serve very different markets.
• For example1; The merger of Amazon and Alibaba will result in the combined
entity becoming a global e-commerce business providing services to both
North America and Asia.
• For example2, an automobile manufacturer acquires another automobile
manufacturer in another country.
• The main benefit of a market extension merger is that two companies with
similar products can tap into a larger market and reach more clients to
distribute their products andPrepared
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services.
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 3.4 Types of business combination
5) A product extension merger: a product extension merger is a type
of merger where the merging companies are looking to expand their
product lines.
• Generally, the merging companies do not produce similar goods and
services.
• By merging, the companies are looking to add additional products to
their product list and get access to a bigger set of consumers.
• This ensures that they earn higher profits. The acquisition of
Mobilink Telecom, Inc. which develops, manufactures, and markets global
systems for mobile communication by Broadcom Inc. is a global
technology leader that designs, develops and supplies software
solutions is a proper example of product extension merger.
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3.5 Methods (Techniques) of Arranging Business Combination
• In business combination, there are different ways companies
can acquire one another.
• An acquisition is when an acquiring company buys another
company and keeps the target company’s name and structure.
• E.g. Assume company ‘A’ acquired company ‘B’, company ‘A’
become legal entity but ‘B’ losses
personality/Liquidated/dissolved/
• A consolidation is when a new company is created, focusing on its
core business and abandoning the previous corporate structure.
• E.g company ‘A’ and ‘B’ combine their F/S to create new company
“C”. A&B companies loss their legal personality.
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3.5 Methods Business Combination
• Acquisition of common stock (hostile takeover) Assume
company ‘A’ acquired more than 50% common stock of company
‘B’. Company “B” becomes subsidiary of company ‘A’ so that
company ‘A’ has controlling interest. Investor and investee
relatioship
• Acquisition of assets is when one company buys the assets of the
other company without acquiring the legal entity owning the
assets.
• E.g. Assume company ‘A’ acquired asset of company ‘B’. There is
combiner and Combinee relationship. company ‘B’ has two
alternatives dissolve or continue as legal entity but affiliate with
company ‘A’
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Greetings of the day before starting part II

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 Part II

Accounting for Business Combination

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 3.6 Accounting for Business Combination
• Generally, there are two types of accounting methods of
business combination. These are:
• 1) Purchase accounting method
• 2) Pooling of interest accounting methods

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Accounting for Business Co………………..
Purchase Accounting
• It is commonly known as the
acquisition method
• Acquirer (combinor) has controlling
interest over Combinee
• Goodwill is recorded
• The assets of the acquired and the
assumed liabilities are recorded as
assets of the acquirer at fair market
value.
• This method of accounting increases
the fair market value of the acquiring
company.
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Pooling of interest methods
• Combining the balance sheets of the
two firms into one.
• All assets and liabilities of two
companies are recorded at carrying
(book) value (historical values)
• Intangible assets are not incorporated
in the consolidated balance sheet
• No goodwill is recorded in relation to
the business combination
• No controlling interest
• Applied in the case of merger.
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The acquisition (purchase) method-IFRS-3
• IFRS-3 in particular specifies that all business
combination should be accounted for by applying the
purchase method, Therefore the acquirer recognize the
acquires identifiable assets, liabilities and contingent
liabilities at their fair value at the acquisition date and
also recognize good will, which is subsequently tested for
impairment rather than automatized.
• The difference between the fair values of the
identifiable asserts and liabilities and the amount paid
(purchase price) is recorded as goodwill.
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Determining (purchase price)-Cost of combine-GAAP

• Total consideration paid in cash/fair value of share

issued/present value of bond issued
• Direct out of pocket cost ( finder fee, legal fee,
accounting fee)
• Fair value of contingent consideration

• Cost of combine (purchase price) = Total consideration paid

+ Direct out of pocket cost + contingent consideration

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Determining (purchase price)-Cost of combine-IFRS

• Total consideration paid in cash/fair value of share

issued/present value of bond issued
• Fair value of contingent consideration
Note: In accordance with the revised IFRS 3, because
acquisition-related costs are not part of the exchange
transaction between the acquirer and the acquiree (or its
former owners), they are not considered part of the business
combination
• Cost of combine (purchase price) = Total consideration paid
+fair value of contingent consideration
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 Exceptions on cost of combine
Exceptions under GAAP Exceptions under IFRS

• Cost of issuing issue debt or • Direct out of pocket cost

equity securities ( finder fee, legal fee,
• Indirect out of pocket (salary accounting fee)
paid to employees of • Cost of issuing issue debt or
combinor) entity to account equity securities
for acquisition-related costs • Indirect out of pocket (salary
as expenses in the periods in paid to employees of
which the costs are incurred combinor)
and the services are received.
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Steps in applying the acquisition method:
1) Identification of the acquirer
2) Determination of the acquisition date
3) Recognition and measurement of the identifiable assets acquired,
the liabilities assumed and any non-controlling interest (NCI) IFRS 3
the acquirer measures any non-controlling interest in the
acquiree either at (1) fair value or (2) the NCI’s
proportionate share in the acquiree’s net identifiable assets
• 4) Recognition and measurement of goodwill (apply full/partial method)
• The acquirer recognizes a resulting gain on a bargain purchase as gain
in profit or loss. Goodwill, on the other hand, is recognized as an asset

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Full Good will determination method
• Good will= Cost of combine (purchase price)
minus identifiable assets acquired

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Partial Good will determination method
• Goodwill = Consideration transferred + Amount of
non-controlling interests + Fair value of previous
equity interests - Net assets recognized Asset

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Example 1: applying the acquisition method
• Company A acquires all of the equity of Company B in a business
combination. Company A applied the acquisition method based on the
following information on the acquisition date (31/12/2021):
• Company A pays $100 million in cash to acquire all outstanding equity of
Company B.
• Company A incurs $15 million of expenses related to the acquisition. The
expenses incurred include legal, accounting, and other professional fees.
• Company A agreed to pay $6 million in cash if the acquiree’s first year’s
post combination revenues are more than $200 million. The fair value of
this contingent consideration arrangement at the acquisition date is $2
million.

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Example 1: applying the acquisition method
• The fair value of tangible assets and assumed liabilities on the
acquisition date is $70 million and $35 million, respectively.
• The fair value of identifiable intangible assets is $25 million.
• Company A intends to incur $18 million of restructuring costs by
severing employees and closing various facilities of Company B shortly
after the acquisition.
• There are no measurement period adjustments.
• Company A obtains control of Company B on the closing date.
• Required
• How should the acquisition be recorded?

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Solution on Example 1: Analysis by applying the 4 steps

• The following analysis excludes the accounting for any tax effects of
the transaction.
• 1) Identifying the acquirer
• Company A is identified as the acquirer because it acquired all of
Company B’s equity interests for cash. The acquirer can be identified
based on the guidance in IFRS-3
• 2) Determining the acquisition date
• The acquisition date is the closing date which is 31/12/2021

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Solution on Example 1: Analysis by applying the 4 steps

• 3) Recognition and measurement on the acquisition date

• Company A would recognize and measure all identifiable
assets acquired and liabilities assumed at the acquisition date.
There is no controlling interest because Company A acquired
all of the equity of Company B. Company A would record the
acquired net assets of Company B in the amount of $60
million ($95 million of assets less $35 million of liabilities),
excluding goodwill, as follows (in millions):

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 Calculation of INA figures in millions
Fair value of tangible assets $70

(plus) Fair value Intangible assets 25

(less) Liabilities 35

Identifiable Acquired net assets $60

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Solution on Example 1: Analysis by applying the 4 steps

• Company A would not record any amounts related to its

expected restructuring activities as of the acquisition date
because Company A did not meet the relevant criteria. The
recognition of exit/restructuring costs would be recognized in
post combination periods.

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Solution on Example 1: Analysis by applying the 4 steps

4) Recognizingand measuring goodwill

Acquisition costs are not part of the business
combination and will be expensed as incurred.
Company A would make the following entry (in
millions):
Expense - acquisition costs
$15 Dr.
Cash $15 Cr

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Solution on Example 1: Analysis by applying the 4 steps

•The consideration transferred (purchase price/Cost of

combine) is $102 million, which is calculated as follows (in
millions):
Cash $100
+ Contingent consideration—liability 2
Total consideration transferred $102
(purchase price/Cost of combine)

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 Full good will determination
• The acquisition results in goodwill because the $102
million consideration transferred is in excess of the $60
million identifiable net assets acquired, excluding
goodwill, of Company B. Goodwill resulting from the
acquisition of Company B is $42 million and is
measured as follows (in millions):

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Determining the good will
• Goodwill is measured as the difference between:
• the aggregate of (i) the value of the consideration
transferred (generally at fair value), (ii) the amount of
any non-controlling interest (NCI), and (iii) in a business
combination achieved in stages ), the acquisition-date
fair value of the acquirer's previously-held equity
interest in the acquiree, and the net of the acquisition-
date amounts of the identifiable assets acquired and
the liabilities assumed (measured in accordance with
IFRS 3).
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Full good will determination figures in millions

Total consideration transferred $102

Less: acquired net assets of (60)
Company B
Goodwill to be recognized $42

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Example 2: Partial good will
determination
• X Ltd pays $800,000 to purchase 80% of the shares of
Y Ltd. Fair value of 100% of Y's identifiable net assets is
$600,000.
Required: calculate partial goodwill
A) non-controlling interests measured % of identifiable
net assets
B) non-controlling interests measured at fair value

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 Formula Partial Determining the good will
• We can apply in simplified equation form as follows:

Goodwill = Consideration + Amount of + Fair value of - Net assets

transferred non- previous recognized
controlling equity
interests interests

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Solution on Partial good will determination

• A) If X chooses to measure non-controlling interests as their

proportionate interest in the net assets of Y of 120,000 (20% x
600,000), the consolidated financial statements show goodwill of
320,000 (800,000 +120,000 – 600,000).

• B) If X chooses to measure non-controlling interests at fair value and

determines that fair value to be 185,000 then goodwill of 385,000 is
recognized (800,000 + 185,000 – 600,000).
• IFRS allows the company shall use higher of fair value NCI or NCI as
%INA

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Summary of partial determining the good will applying two cases
Particulars NCI based on fair value NCI based on net assets
Consideration
transferred $800,0000 $800 ,000
Non-controlling
interest $185,000 (1) $120,000 (2)

Purchase price 985,000 920 ,000

Less Net assets (600,000) (600,000)

Goodwill $385,000 $320 ,000

Note: So, the actual goodwill recognized by X Br 385,000 is recognized (985,000 –

600,000).

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Example 3: Partial good will determination
• Entity A acquired 75% of the outstanding voting shares of
Entity B for 2,000,000. On acquisition date, Entity B’s
identifiable assets and liabilities have fair values of Br
4,000,000 and Br1,600,000 respectively.
• Required
• How much is the goodwill if Entity A choses to measure the
non-controlling interest at the NCI’s proportionate share in
the Entity B’s net identifiable assets?

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Solution on Example 3:
• Consideration transferred……………………..Br 2,000,000
• NCI………………………………………..[(4M-1.6M)x25%] 600,000
• Previously held equity interest in the acquiree……….. 0
• Total cost of Combinee…………………………..…2,600,000
• Less: Fair value of net identifiable assets acquired
[4M-1.6M]…………………………………………….. (2,400,000)
• Goodwill / (Gain on a bargain purchase) …….....Br200,000

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Test 1 (15%)
Part one (True or False)
1. The two important elements in the definition of business
combination under PFRS-3 are "business and combination
2. Entity A acquires 100% interest in the voting shares of Entity B for
Br 100,000. Entity B’s identifiable assets and liabilities have fair
values of 200,000 and 140,000 respectively. The goodwill is
40,000.
3. The acquisition date in a business combination is normally the
closing date
4. If the controlling interest is 80%, the non-controlling interest is
20%.
5. Non-controlling interests are measured at fair value only
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Part 2: Multiple choice
1. In which of the following instances is a business combination least
likely to occur?
a. Entity A acquires all the assets and assumes all the liabilities of entity B
in exchange for Entity A’s shares of stocks.
b. Entity A purchases 80% of entity B’s outstanding voting shares.
c. Entity A acquires 30% interest in Entity B’s voting shares. All other
shares of entity B are held by various shareholders in very small
denominations. Accordingly, entity A has the power to appoint the
majority of the board of directors of entity
d. Entity A acquires a group of assets from entity B that does not
constitute a business (not business assets).
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Part 2: Multiple choice
2. IFRS 3 must be applied when accounting for business combinations,
but does not apply to:
a. The formation of a joint venture
b. The acquisition of an asset or group of assets that is not a business,
c. businesses under common control
d. All of the above are correct answers

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Part 2: Multiple choice
3. Which of the following is a reason why a company would expand
through a combination, rather than by building new facilities?
a. A combination might provide cost advantages.
b. A combination might provide fewer operating delays.
c. A combination might provide easier access to intangible assets.
d. All of the above are possible reasons that a company might choose a
combination

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Part 2: Multiple choice
4. A business combination in which a new corporation is created
and two or more existing corporations are combined into the
newly created corporation is called a
a. Merger.
b. Purchase transaction.
c. Pooling-of-interests.
d. Consolidation

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Part 2: Multiple choice
• 5. A business combination occurs when a company acquires an equity
interest in another entity and has
a. at least 20% ownership in the entity.
b. more than 50% ownership in the entity.
c. 100% ownership in the entity.
d. control over the entity, irrespective of the percentage owned

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Part 2: Multiple choice
• 6. Raphael Company paid $2,000,000 for the net assets of Paris
Corporation and Paris was then dissolved. Paris had no liabilities. The
fair values of Paris’ assets were $2,500,000. Paris’s only non-current
assets were land and equipment with fair values of $160,000 and
$640,000, respectively. At what value will the equipment be recorded
by Raphael?
• a. $640,000
• b. $240,000
• c. $400,000
• d. $0

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Part III: Workout (5%)
• Entity A acquires 100% interest in the voting shares of Entity
B for Br100,000. Entity B’s identifiable assets and liabilities
have fair values of 200 and 120 respectively.

• Required
• Calculate the goodwill is ?

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 The end of chapter 3

“Life is like accounting, everything must be

balanced”

Source– unknown

• Thank you for coming!

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