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First Impressions: IFRS 3 and FAS 141R Business Combinations January 2008

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Cover designed: Mytton Williams.

Publication name: First Impressions: IFRS 3 and FAS141R Business Combinations

Publication no: 309910

Publication date: January 2008

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Foreword

Convergence takes the next step forward The release of the International Accounting Standards Boards (IASBs) and the U.S. Financial Accounting Standards Boards (FASBs) respective new standards on business combinations and non-controlling (minority) interest is the result of the IASBs and the FASBs first comprehensive test-case in their joint efforts to achieve convergence between International Financial Reporting Standards (IFRSs) and U.S. Generally Accepted Accounting Principles (U.S. GAAP).

The fact that the standards are very similar is a further step towards greater consistency between IFRSs and U.S. GAAP. Although not 100 percent identical, the two Boards worked to reach agreement not just on concepts and principles, but also on using the same wording. Progress on convergence is one of the factors supporting the recently published changes to the U.S. Securities and Exchange Commission (SEC) rules, which allow the use of IFRSs in financial reports filed by foreign private issuers that are registered with the SEC without having to reconcile those results to U.S. GAAP.

The new international standards on business combinations and non-controlling interest require less change for IFRS users than for entities reporting under U.S. GAAP. Partly this is due to the option that is available in the international standards, but not in the U.S. standards, to limit the recognition of goodwill to the controlling interest acquired by the parent. It is also because the Boards drew on the IASBs current business combinations standard, which was issued after the comparable U.S. standard. In several areas existing IFRS requirements were the starting point for the two Boards. The Boards were able to build on progress made to date in a way that reduces the degree of change required for IFRS preparers.

However, the limited changes to existing international standards should not lull companies into complacency. Companies applying IFRSs are advised to look carefully at the new requirements. In particular, the new standards require purchases and sales of non-controlling shareholdings when control is retained to be accounted for fully as equity transactions, which will reduce the current diversity in accounting for such transactions.

Several other changes mean that business combinations are likely to have an immediate impact on reported profits. For example, any pre-existing interests in the acquired company will be remeasured to fair value at the acquisition date, with any gain or loss recognised in profit or loss rather than directly in equity. Additionally, many transaction costs that currently are capitalised will be required instead to be recognised as an expense.

Another area of change is contingent consideration, which will be measured at fair value at the acquisition date; generally subsequent changes will be recognised in profit or loss if the contingent consideration is classified as a liability.

Against this background we hope that this issue of First Impressions: IFRS 3 and FAS 141R Business Combinations will assist in the initial assessment of these standards.

Julie Santoro Paul Munter KPMG IFRG Limited Department of Professional Practice

Audit & Advisory KPMG LLP

2008 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

About this publicationThis publication has been produced jointly by the KPMG International Financial Reporting Group (part of KPMG IFRG Limited) and the Department of Professional Practice of KPMG LLP in the U.S.

We would like to acknowledge the efforts of the principal authors of this publication. Those authors include Julie Santoro and Giuseppe Funiciello of the KPMG International Financial Reporting Group, and Paul Munter, Imam Hasan and Douglas Besch of the Department of Professional Practice of KPMG LLP in the U.S.

Content Our First Impressions publications are prepared upon the release of a new International Financial Reporting Standard (IFRS), interpretation or other significant amendment to the requirements of IFRSs. They include a discussion of the key elements of the new requirements and highlight areas that may result in a change of practice. Examples are provided to assist in assessing the impact of implementation.

This edition of First Impressions considers the requirements of IFRS 3 Business Combinations (2008) and the related amendments to IAS 27 Consolidated and Separate Financial Statements (2008), issued by the International Accounting Standards Board (IASB); as well as FAS 141R Business Combinations and FAS 160 Noncontrolling Interests in Consolidated Financial Statements, issued by the U.S. Financial Accounting Standards Board (FASB).

The text of this publication is referenced to IFRS 3 (2008) and FAS 141R, and to selected other current IFRS and U.S. Generally Accepted Accounting Principles (U.S. GAAP) literature, standards and interpretations, in issue at 15 January 2008. References in the left-hand margin identify the relevant paragraphs of the standards and interpretations; references in blue relate to IFRSs, and references in grey relate to U.S. GAAP.

In many cases further interpretation will be needed in order for an entity to apply IFRSs or U.S. GAAP to its own facts, circumstances and individual transactions. Further, some of the information contained in this publication is based on the initial observations of IFRSs and U.S. GAAP developed by the KPMG International Financial Reporting Group and the Department of Professional Practice of KPMG LLP in the U.S., and these observations may change as practice develops.

We will update and supplement the interpretative guidance and examples in this publication by adding additional interpretative guidance to Insights into IFRS, our practical guide to International Financial Reporting Standards, and to the KPMG Accounting and Reporting Guide, which provides accounting guidance as it relates to U.S. GAAP.

Terminology Throughout this publication we use the following terms as a matter of convenience:

l Consistent with the new standards, the terms acquisition accounting and acquisition method are used to describe the method of accounting for a business combination. Under the old standards the terms purchase accounting and purchase method of accounting were common.

l Consistent with IFRS 3 (2008) and IAS 27 (2008), the term non-controlling interest is used to describe the interest in the equity of a subsidiary not attributable, directly or indirectly, to a parent; FAS 141R and FAS 160 use the term noncontrolling interests. Under the old standards the term minority interests was used.


Other ways KPMG member firms professionals can help We have a range of publications that can assist you further, including Insights into IFRS, IFRS compared to U.S. GAAP, Financial instruments accounting, and illustrative financial statements for interim and annual reporting under IFRSs; and the Derivatives and Hedging Accounting Handbook and Share-Based Payment: An analysis of Statement No. 123R under U.S. GAAP. IFRS-related technical information is available at www.kpmgifrg.com.

For access to an extensive range of accounting, auditing and financial reporting guidance and literature, visit KPMGs Accounting Research Online. This Web-based subscription service can be a valuable tool for anyone who wants to stay informed in todays dynamic environment. For a free 15-day trial, go to www.aro.kpmg.com and register today.

http:www.aro.kpmg.comhttp:www.kpmgifrg.com

Contents1 Overview 6

2 Introduction 8

2.1 Background 8

2.2 Objective 8

2.3 Fundamental principles 8

2.4 Summary of key differences from previous standards 9

3 Scope 11

4 Identifying a business combination 12

4.1 Definition of a business combination 12

4.2 Definition of a business 12

4.3 Acquisition of an integrated set of activities and assets 12

5 The acquisition method 14

6 Identifying the acquirer 15

7 Determining the acquisition date 16

8 Consideration transferred 17

8.1 General requirements 17

8.2 Contingent consideration 18

9 Recognising and measuring the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree 20

9.1 Recognition principle 20

9.2 Measurement principle 24

10 Exceptions to the recognition and / or measurement principles 29

10.1 Exception to the recognition principle 29

10.2 Exceptions to both the recognition and measurement principles 31

10.3 Exceptions to the measurement principle 33

11 Recognising and measuring goodwill or a gain in a bargain purchase 37

11.1 Goodwill 37

11.2 A bargain purchase 38

11.3 Overpayments 38

12 Additional guidance for certain business combinations 39

12.1 Business combination achieved in stages (step acquisition) 39

12.2 Business combination achieved without the transfer of consideration 40

12.3 Business combination between mutual entities 41

13 Measurement period 42


14 Determining what is part of the exchange for the acquiree 43

14.1 Settlement of pre-existing relationships 43

14.2 Arrangements for contingent payments to employees 44

14.3 Reimbursement of transaction costs 45

14.4 Acquisition-related costs 45

15 Disclosures 46

16 Effective date and transition 48

16.1 General requirements 48

16.2 Subsequent recognition of acquired deferred tax benefits 48

17 Amendments to IAS 27 and the issue of FAS 160 49

17.1 Changes in ownership interests while retaining control 49

17.2 Loss of control 50

17.3 Guidance on linkage 52

17.4 Attribution of losses 52

17.5 Disclosures 53

17.6 Effective date and transition 53

18 Changes in the status of associates and jointly controlled entities 54

18.1 Losing significant influence or joint control 54

18.2 Obtaining significant influence or joint control 54

Appendices

Appendix 1: Worked example 55

Appendix 2: IFRS compared to U.S. GAAP 60

Appendix 3: Abbreviations used for pronouncements 64


6 First Impressions: IFRS 3 and FAS 141R Business Combinations

January 2008

1 Overview

l IFRS 3 (2008) and FAS 141R provide guidance on the accounting for business combinations.

l All business combinations are accounted for using the acquisition method, except for specific scope exemptions.

l The acquisition date is the date on which control is transferred to the acquirer.

l Consideration transferred is the sum of the fair values of the assets transferred, liabilities incurred to the previous owners of the acquiree, including any contingent consideration given, and equity interests issued.

l Contingent consideration is recognised initially at fair value and is classified as either a liability or equity based on the definitions in the relevant IFRS and U.S. GAAP literature. Contingent consideration classified as a liability generally is remeasured to fair value each period until settlement, with changes recognised in profit or loss. Contingent consideration also may be an asset.

l Before assets acquired and liabilities assumed can be recognised in a business combination, they must meet the definition of assets and liabilities at the acquisition date and be exchanged as part of the business combination.

l A restructuring provision is recognised only when it is an existing liability of the acquiree at the acquisition date.

l The measurement principle in accounting for the identifiable assets acquired and liabilities assumed in a business combination is full fair value, with limited exceptions.

l Under IFRSs, at the acquisition date, the acquirer measures any non-controlling interest at fair value, or at its proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree. Under U.S. GAAP the acquirer measures any non-controlling interest at fair value at the acquisition date.

l There are certain exceptions to the recognition and fair value measurement principles.

l When the sum of the fair value of the consideration transferred, the fair value of any previously held equity interest in the acquiree and the recognised amount of non-controlling interest exceeds the fair value of the identifiable assets acquired and liabilities assumed, the excess is recognised as goodwill.

l When the fair value of the identifiable assets acquired and liabilities assumed exceeds the sum of the fair value of the consideration transferred, the fair value of any previously held equity interest in the acquiree, and the recognised amount of non-controlling interest, the excess is a bargain purchase that is recognised in profit or loss immediately after reassessing the identification and measurement of the above-listed items.


7 First Impressions: IFRS 3 and FAS 141R Business Combinations January 2008

l When an acquisition is achievedin stages (stepacquisition), the identifiable assets and liabilities are recognisedat full fair value when control is obtained, and a gain or loss is recognised in profitor loss for the difference between the fair value and the carrying amount of the previously held equity interest in the acquiree. Any amount related to previously held equity interests in the acquiree that was recogniseddirectly in equity (e.g., the investmentwas classified as available-for-sale)is reclassified andincluded in the calculation of the gain or loss recognisedin profit or loss.

l Adjustments to provisionally determined amounts in a business combination can be made only within the measurement period, which cannot exceed 12 months from the acquisition date. Adjustments are made retrospectively and comparative information is revised.

l Transaction costs are not included in the acquisition accounting.

l Changes in ownership interests after control is obtained that do not result in a loss of control are accounted for as equity transactions.

l When control is lost, a gain or loss is recognised in profit or loss, comprising a realised gain or loss on the interest disposed of, and an unrealised gain or loss from remeasurement to fair value of any retained non-controlling equity investment in the former subsidiary.

l Losses applicable to the non-controlling interest in a subsidiary are allocated to the non-controlling interest even if this causes the non-controlling interest to be in a deficit position.

l IFRS 3(2008) and IAS27 (2008) are effective for annual periods beginning on or after 1July 2009; early adoption is permitted for annual periods beginning on or after 30 June 2007, but both standards must be adopted at the same time.

l FAS141RandFAS160 are effective for annualperiods beginning on or after 15December 2008;early adoption is prohibited.



2 Introduction

2.1 Background On 4 December 2007 the U.S. Financial Accounting Standards Board (FASB) published FAS 141R Business Combinations, which supersedes FAS 141 issued in 2001, together with FAS 160 Noncontrolling Interests in Consolidated Financial Statements, which amended ARB 51 Consolidated Financial Statements. On 10 January 2008 the International Accounting Standards Board (IASB) published IFRS 3 Business Combinations (2008), which supersedes IFRS 3 as issued in 2004, together with amendments to IAS 27 Consolidated and Separate Financial Statements (2008).

IFRS 3 (2008) and FAS 141R are the outcome of the second phase of the IASBs and the FASBs business combinations project, which was conducted as a joint project of the Boards. The first phase of the project led to the issue of FAS 141 Business Combinations in 2001 and IFRS 3 Business Combinations in 2004. The second phase of the project reconsidered the application of acquisition accounting for business combinations.

The amendments to IAS 27 and ARB 51 by FAS 160 reflect changes to the accounting for non-controlling interest as a consequence of decisions by the Boards in the second phase of the business combinations project. The IASB did not reconsider all of the requirements in IAS 27 (2003); nor did the FASB reconsider other aspects of ARB 51. The changes to IAS 27 and ARB 51 primarily deal with the accounting for changes in ownership interests in subsidiaries after control is obtained, the accounting for the loss of control of subsidiaries, and the allocation of profit or loss to controlling and non-controlling interests in a subsidiary.

While the Boards reached the same conclusions on most aspects of the joint project, some differences remain. These are summarised in Appendix 2 and are discussed in the relevant sections of this publication.

2.2 Objective The objective of the IASBs and the FASBs joint project on business combinations was to improve the completeness, relevance and comparability of financial information about business combinations. IFRS 3 (2008) and FAS 141R specify that all business combinations within their scope must be accounted for by applying the acquisition method.

A business combination is a transaction or other event in which an acquirer obtains control of one or more businesses (the acquiree or acquirees). In accordance with the acquisition method, as of the acquisition date the acquirer recognises and measures the identifiable assets acquired and liabilities assumed (at their full fair values), non-controlling interest (at fair value or at its proportionate interest in the fair value of identifiable assets and liabilities of the acquiree under IFRS 3 (2008), or at fair value under FAS 141R), and goodwill.

2.3 Fundamental principles The new standards include the following fundamental principles of accounting for all business combinations within their scope:

l The acquirer obtains control of the acquiree at the acquisition date, and thereby becomes responsible and accountable for all of the acquirees assets, liabilities and activities, regardless of the percentage of its ownership in the acquiree.

l The identifiable assets acquired and liabilities assumed in a business combination are recognised at their full fair values on the date that control is obtained. The new standards conclude that obtaining control of a business is a significant economic event that results in



remeasurement regardless of how control is obtained. Thus the acquirers accounting for those assets, liabilities and activities begins at the acquisition date. If the acquirer held a non-controlling equity investment in the acquired entity, then its accounting for that interest as an investment ceases and the previously held investment is remeasured to fair value at the acquisition date with a gain or loss recognised in profit or loss.

2.4 Summary of key differences from previous standards The new standards retain the basic requirements in IFRS 3 (2004) and FAS 141 to apply acquisition accounting for all business combinations within their scope, to identify the acquirer, and to determine the acquisition date for every business combination. They also retain most of the guidance in IFRS 3 (2004) and FAS 141 for identifying and recognising intangible assets separately from goodwill. The most significant change is a move from a purchase price allocation approach to a fair value measurement principle.

The main changes from IFRS 3 (2004) and FAS 141 are summarised below:

l The new standards also apply to business combinations involving only mutual entities and business combinations achieved by contract alone, which previously were excluded from the scope of IFRS 3 (2004) and FAS 141.

l The definition of a business combination has been revised to focus on control. l The definition of a business has been amended to clarify that it can include a set of activities and

assets that are not being operated as a business, as long as an acquirer is capable of operating the set as a business. In particular for U.S. GAAP, a number of transactions that previously were treated as asset acquisitions will be treated as business combinations since an integrated set of activities no longer needs to be self-sustaining to be a business (e.g., the acquisition of an early development stage entity that has not commenced planned principal operations).

l All items of consideration transferred by the acquirer are recognised and measured at fair value as of the acquisition date, including contingent consideration. In particular for U.S. GAAP, the fair value of equity securities transferred by the acquirer is measured at the acquisition date rather than at an earlier date as required previously by EITF 99-12 Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination.

l Transaction costs incurred by the acquirer in connection with the business combination are not included in the acquisition accounting. Previously IFRS 3 (2004) and FAS 141 required directly attributable (IFRSs) / direct (U.S. GAAP) transaction costs, excluding costs related to the issue of debt or equity instruments, to be accounted for as part of the business combination transaction.

l In a partial acquisition, consistent with IFRS 3 (2004) but a change for U.S. GAAP, the assets acquired and liabilities assumed are stepped up to their full fair values rather than being stepped up only to the extent of the acquirers ownership interest in the acquiree.

l Consistent with IFRS 3 (2004) but a change for U.S. GAAP, the acquirees in-process research and development (IPR&D) projects are recognised as an intangible asset and measured at fair value rather than being expensed. The IPR&D asset is treated as an asset not yet ready for use (IFRS) / an indefinite-lived intangible asset (U.S. GAAP), and therefore is not subject to amortisation or write-off until the project is completed or abandoned. Instead, an annual impairment test is required. However, post-combination research and development costs will continue to be expensed as incurred under FAS 2 Accounting for Research and Development Costs and evaluated for capitalisation in accordance with IAS 38 Intangible Assets.

l Consistent with IFRS 3 (2004) but a change for U.S. GAAP, a restructuring provision is recognised only when it is an existing liability of the acquiree at the acquisition date.

l Under IFRS 3 (2008) the acquirer can elect to measure any non-controlling interest at fair value at the acquisition date, or at its proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree, on a transaction-by-transaction basis. The second alternative is consistent with the required measurement of non-controlling interest under IFRS 3 (2004). Under U.S. GAAP the acquirer is required to measure any non-controlling interest at fair value at the acquisition date.



l Acquisitions of additional non-controlling equity interests after the business combination are not accounted for using the acquisition method, but rather are accounted for as equity transactions. Previously IFRSs had no guidance for such transactions, whereas U.S. GAAP accounted for these transactions as step acquisitions.

l Disposals of equity interests while retaining control are accounted for as equity transactions. Previously IFRSs had no guidance for such transactions, whereas U.S. GAAP accounted for these transactions as dilution gains or losses.

l Transactions resulting in a loss of control result in a gain or loss being recognised in profit or loss. The gain or loss includes a remeasurement to fair value of any retained equity interest in the investee. Previously IFRSs and U.S. GAAP accounted for the retained equity interest on a carryover basis.


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Scope IFRS 3.2 IFRS 3 (2008) and FAS 141R apply to all transactions or other events that meet the definition of a FAS 141R.2 business combination. However, the standards do not apply to:

l the formation of joint ventures, because an entity does not obtain unilateral control over a joint venture;

l the acquisition of an asset or a group of assets that does not meet the definition of a business; and

l transactions among entities under common control, although FAS 141R does carry forward guidance from FAS 141 and APB 16 Business Combinations on such transactions.

FAS 141R.2 Business combinations between not-for-profit organisations or the acquisition of a for-profit business by a not-for-profit organisation are also excluded from the scope of FAS 141R. Under IFRSs if a not-for-profit organisation chooses to apply IFRSs, then it must comply with IFRS 3 (2008) in full.

The scope exclusion in respect of joint ventures applies only to transactions that give rise to the formation of a joint venture. Accordingly, the requirements of IFRS 3 (2008) and FAS 141R should be applied to a business combination entered into by a joint venture after its formation.

IFRS 3.2(b) The standards carry forward the requirements in IFRS 3 (2004) and FAS 141 that assets acquired FAS 141R.2(b)that do not meet the definition of a business are outside the scope of the standards. When an

entity acquires a group of assets or net assets that do not constitute a business, it allocates the cost of acquisition among the individual identifiable assets and liabilities in the group based on their relative fair values at the acquisition date; therefore no goodwill results.

Main change from IFRS 3 (2004) and FAS 141 The new standards remove the following scope exclusions from IFRS 3 (2004) and FAS 141:

l business combinations involving two or more mutual entities; mutual entities were included in the scope of FAS 141, but the effective date of FAS 141 for such entities was delayed indefinitely; and

l business combinations in which separate entities or businesses are brought together to form a reporting entity by contract alone without obtaining an ownership interest.

As a result, business combinations involving two or more mutual entities, and those in which separate entities or businesses are brought together to form a reporting entity by contract alone, now will be accounted for using the acquisition method.

The expiration of contractual minority participating rights that kept the acquirer, which holds the majority of the voting rights, from controlling also will be accounted for as a business combination. For example, under U.S. GAAP, when the minority or limited partner holders have substantive participating rights as described in EITF 96-16 Investors Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights and EITF 04-5 Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, the expiration of those contractual rights will be accounted for as a business combination.



4 Identifying a business combination

4.1 Definition of a business combination IFRS 3.A The definition of a business combination focuses on control. A business combination is defined as FAS 141R.3(e) a transaction or other event in which an acquirer obtains control of one or more businesses.

4.2 Definition of a business IFRS 3.A A business is defined as an integrated set of activities and assets that is capable of being FAS 141R.3(d)conducted and managed to provide a return to investors (or other owners, members or

participants) by way of dividends, lower costs, or other economic benefits.

IFRS 3.B11 An integrated set of activities and assets does not need to be conducted and managed as a FAS 141R.A8 business as of the acquisition date, as long as it is capable of being conducted and managed for

that purpose. Therefore the activities acquired are assessed as they exist at the acquisition date, rather than based on how they were used by the seller or how they might be used by the acquirer.

4.3 Acquisition of an integrated set of activities and assets IFRS 3.B7-B12 Additional guidance is provided for determining if an integrated set of activities and assets FAS 141R.5, constitutes a business, and clarifications to the meaning of inputs, processes and outputs also are A4-A9 included in the new standards. A business generally consists of inputs, processes applied to

those inputs and the ability to create outputs. For an integrated set of activities and assets to be considered a business, the set must contain two essential elements: inputs and processes. Outputs are not required to qualify as a business as long as the entity has the ability to create outputs. If goodwill is present in a transferred set of activities and assets, then the transferred set is presumed to be a business.

In determining whether goodwill is present and whether the acquired set of activities and assets is a business, the acquirer should consider whether elements of goodwill, such as buyer-specific synergies, are present. However, a business need not have goodwill.

Main change from IFRS 3 (2004) IFRS 3 (2004) defined a business combination as the bringing together of separate entities or businesses into one reporting entity, without mentioning control explicitly. The new definition of a business combination now refers to the acquisition of businesses and not entities.

The new definition clarifies that a business no longer needs to include all of the inputs or processes that the seller used as long as the acquirer is capable of operating the business by integrating it with its own inputs and processes.

As a consequence of the broadened definition of a business, some transactions that previously were accounted for as asset acquisitions might be business combinations.

Main change from FAS 141 EITF 98-3 Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business defined a business as a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors.

Under FAS 141R the definition of a business is expanded such that the set of activities and assets can be organised not only to provide a return to investors, but also to lower costs to investors, as would be the case with mutual and co-operative entities. Additionally, the definition of a business focuses on being capable of being conducted and managed so as to generate a



return or lower costs. As a consequence, unlike the previous definition, a business or group of assets no longer must be self-sustaining to be a business. And the previous presumption that an early development stage entity that has not commenced planned principal operations is not a business has been removed.

As a consequence of the broadened definition of a business, many transactions that previously were accounted for as asset acquisitions will be business combinations.


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The acquisition method IFRS 3.4 IFRS 3 (2008) and FAS 141R require that acquisition accounting be applied to all business FAS 141R.6 combinations within their scope.

IFRS 3.5 The new standards identify four basic steps in applying acquisition accounting for a business FAS 141R.7 combination:

1) Identify the acquirer.2) Determine the acquisition date.3) Recognise and measure the identifiable assets acquired, liabilities assumed, and any non-

controlling interest in the acquiree.4) Recognise and measure goodwill, or a gain in a bargain purchase.

Main change from IFRS 3 (2004) IFRS 3 (2008) retains the requirements of IFRS 3 (2004) with respect to steps (1) and (2), but redefines steps (3) and (4) in order to reflect the change from the purchase price allocation approach to the fair value measurement principle in accounting for business combinations.

Main change from FAS 141 FAS 141R retains the steps from FAS 141. However, in step (1) the identification of the acquirer first focuses on the entity obtaining control as that term is used in ARB 51 and FAS 160 before looking to other factors identified previously in FAS 141 (e.g., which party initiated the transaction, which party paid or received a premium, the size of the combining entities etc.). Additionally, FAS 141R specifies that when the acquiree is a variable interest entity, the primary beneficiary always is the acquirer.

Steps (3) and (4) have been changed to reflect the change from the purchase price allocation approach to the fair value measurement principle. In particular, the fair value of the consideration transferred for the acquiree is measured at the acquisition date. This includes the measurement of equity securities, which previously were measured at an earlier date in accordance with EITF 99-12. The application of steps (3) and (4) will be significantly different from previous U.S. GAAP, particularly for partial acquisitions and step acquisitions. Further, in a bargain purchase, the amounts assigned to certain long-lived assets are not adjusted for the amount of negative goodwill, and a gain on a bargain purchase is not designated automatically as an extraordinary gain (see section 11.2 A bargain purchase).


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Identifying the acquirer IFRS 3.6, 7 An acquirer must be identified for each business combination. The acquirer is the combining entity FAS 141R.8 that obtains control of the other combining businesses. The relationship between the combining

entities determines which entity obtains control, i.e.,:

IAS 27.4 l under IFRSs, which entity has the power to govern the financial and operating policies of the other entity so as to obtain benefits from its activities; or

ARB 51.1 l under U.S. GAAP, which entity has controlling financial interest over the other.

The guidance in IAS 27 (2008) or ARB 51 must be used to help identify the acquirer. This guidance has not changed from IFRS 3 (2004), but is different from the guidance in FAS 141. Additionally, the business combination standards are now cross-referenced to IAS 27 (2008) and ARB 51 instead of repeating the guidance in the new standards.

IAS 27.13 There is a presumption that control exists when the parent owns, directly or indirectly through FAS 141R.9, subsidiaries, more than half of the voting power of an entity. This conclusion may be rebutted ARB 51.2 only if it can be demonstrated clearly that such ownership does not constitute control (e.g., the

minority shareholders have substantive participating rights). Also, under U.S. GAAP, if the acquired entity is a variable interest entity, then the primary beneficiary always will be the acquirer.

IFRS 3.7, In most acquisitions identifying the acquirer will be straightforward because it will be clear that one B14-B18 entity took control of the operations of another entity. However, if the guidance in IAS 27 (2008) FAS 141R. or ARB 51 (for voting interest entities) does not clearly identify the acquirer, then IFRS 3 (2008) and A11-A15 FAS 141R provide additional factors that should be considered. These consist mainly of examining

the form of consideration transferred, the relative size of the combining entities, relative voting rights, and the composition of the board of directors or senior management, and are consistent with the guidance found previously in IFRS 3 (2004) and FAS 141.

Main change from IFRS 3 (2004) IFRS 3 (2008) no longer repeats the IAS 27 criteria to help identify control, but instead the standard includes an explicit cross-reference to IAS 27 (2008); however, the criteria themselves have not changed. If an acquirer cannot be identified using that guidance, then additional criteria specified in IFRS 3 (2008), which are similar to those contained previously in IFRS 3 (2004), are used in identifying the acquirer. Generally we do not expect differences from previous practice in identifying an acquirer.

Main change from FAS 141 FAS 141R first requires the entity to look to ARB 51 or FIN 46R Consolidation of Variable Interest Entities to identify an acquirer. If an acquirer of a voting interest entity cannot be identified using that guidance, then additional criteria specified in FAS 141R, which are similar to those contained previously in FAS 141, are used in identifying the acquirer. While the specific guidance differs from FAS 141, generally we do not expect significant differences in identifying an acquirer.



7 Determining the acquisition date IFRS 3.8, 9 The acquisition date is the date on which control is transferred to the acquirer. This usually will be FAS 141R.10, the closing date, i.e., the date on which the consideration legally is transferred and when the assets 11 are acquired and liabilities are assumed, but this will depend on the facts and circumstances of

each case.

IAS 27.26 Determination of the acquisition date is important because it is only from that date that the ARB 51.11 results of the subsidiary are included in the consolidated financial statements of the acquirer; it also

is the date on which the fair values of the assets acquired and liabilities assumed, non-controlling interest and goodwill are measured.

Main change from IFRS 3 (2004) IFRS 3 (2008) carries forward the guidance from IFRS 3 (2004) in this area.

Main change from FAS 141 It is no longer possible to designate an effective date of acquisition other than the actual date that control is transferred, or to consolidate a subsidiary as of the beginning of the period in which it was acquired.

Determination of the fair value of any equity interest transferred by the acquirer is measured at the acquisition date, rather than at the measurement date as defined in EITF 99-12.



8 Consideration transferred

8.1 General requirements IFRS 3.37 The consideration transferred by the acquirer is measured at fair value as of the acquisition date FAS 141R.39 and is calculated as the sum of the fair values of the:

l assets transferred;l liabilities incurred by the acquirer to the previous owners of the acquiree; andl equity interests issued by the acquirer.

IFRS 3.38 If assets transferred have carrying amounts that differ from their fair values, then these assets are FAS 141R.40 remeasured at fair value and any difference is recognised in profit or loss. However, if the assets

remain in the combined entity after the acquisition because they are transferred to the acquiree and not to the seller, then they are not remeasured.

Consideration transferred includes contingent consideration (see section 8.2 Contingent consideration) and certain elements of share-based payments exchanged for awards held by the acquirees employees (see section 10.3.2 Share-based payment awards).

Consideration transferred does not include acquisition-related costs (see section 14.4 Acquisition-related costs).

IFRS 3.33 There may be circumstances in which the acquirer and the seller exchange only equity interests in FAS 141R.35 a business combination. In these situations, if the fair value at the acquisition date of the acquirees

equity interests is more reliably measurable than those of the acquirer, then the fair value of the acquirees equity interests is used instead of the fair value of the consideration transferred for the determination of goodwill (see section 11.1 Goodwill ). If no consideration is transferred, then the acquirer should determine the fair value of the acquirers interest in the acquiree using a valuation technique, and should use this value instead of the fair value of the consideration transferred for the determination of goodwill (see section 11.1 Goodwill ).

Main change from IFRS 3 (2004) IFRS 3 (2004) required the consideration transferred (cost of acquisition) to be measured at fair value on the date of exchange, which generally was the date that control was obtained. Generally we do not expect differences from previous practice in determining the date on which consideration transferred is determined.

Previously costs directly attributable to the acquisition, excluding costs related to the issue of debt or equity instruments, were included in the cost of a business combination.

Other changes in the calculation of the consideration transferred are discussed in the sections of this publication that follow.

Main change from FAS 141 Under FAS 141 the market price for a few days before and after the date that the terms of the acquisition were agreed to and announced was considered in determining the fair value of equity securities issued.

Previously direct acquisition-related costs, excluding costs related to the issue of debt or equity instruments, were included in the cost of a business combination.



8.2 Contingent consideration Initial recognition and measurement IFRS 3.39, 40 Contingent consideration must be recognised at fair value as of the acquisition date. The obligation FAS 141R.41, to pay contingent consideration is classified as either a liability or equity based on the definitions in 42 IAS 32 Financial Instruments: Presentation and relevant U.S. GAAP (e.g., FAS 133 Accounting

for Derivative Instruments and Hedging Activities, EITF 00-19 Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, and FAS 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity). The right to receive previously transferred consideration is classified as an asset.

Illustrative example Entity A acquires Entity B and pays CU 120,000. Entity A agrees to pay an additional amount equal to five percent of the following years profits that exceed CU 30,000. Entity B historically has made profits of CU 20,000 to CU 30,000 each year. Entity As forecasts and plans, as well as industry trends, would be considered in assessing the expected level of profits. The amount that would be recognised immediately, as a liability for additional consideration transferred, is the fair value of the contingent consideration, even if payment is not probable.*

* This example assumes that the contingent payment does not represent payments for future services (see section 14.2 Arrangements for contingent payments to employees).

Main change from IFRS 3 (2004) Under IFRS 3 (2004) an acquirer recognised contingent consideration as part of the initial accounting for a business combination based on a best estimate of the amount required to settle the obligation at the acquisition date only if the payment was probable and it could be measured reliably.

Main change from FAS 141 Under FAS 141 the acquirers contingent consideration usually was not recognised at the acquisition date; usually it was recognised once the contingency was resolved and consideration was issued or became issuable.

Subsequent measurement IFRS 3.58 Under IFRS 3 (2008), after initial recognition, if contingent consideration was recognised initially as:

l equity, then it is not remeasured and any settlement is accounted for within equity; l a liability or an asset within the scope of IAS 39 Financial Instruments: Recognition and

Measurement, then it is remeasured at fair value, generally through profit or loss; or l a liability or an asset outside the scope of IAS 39, then it is remeasured in accordance with

IAS 37 Provisions, Contingent Liabilities and Contingent Assets or other IFRSs as appropriate.

FAS 141R.65 Under FAS 141R, after initial recognition, contingent consideration must be remeasured at fair value through profit or loss until settlement or expiration if it is classified as an asset or a liability. If it is classified as equity, then it is not remeasured and any settlement is accounted for within equity.

Main change from IFRS 3 (2004) The IAS 39 scope exemption in respect of contracts for contingent consideration has been deleted; therefore contingent consideration subject to IAS 39 is remeasured at each reporting date at fair value, generally through profit or loss. Previously IFRS 3 (2004) required that



any adjustment to contingent consideration be recognised as an adjustment to the cost of acquisition, except for consideration given by the acquirer under a guarantee of the value of its shares or debt issued, as consideration did not increase the cost of acquisition. There was no time limit on such adjustments.

Main change from FAS 141 FAS 141 generally did not give rise to the recognition of contingent consideration until settlement. Additionally, FAS 141 distinguished between contingent consideration that was an adjustment of the purchase consideration (e.g., contingent consideration based on earnings) and contingent consideration that was not an adjustment of the purchase consideration (e.g., contingent consideration based on the acquirers share price). There was no time limit on such adjustments.



9 Recognising and measuring the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree

IFRS 3.18, The new standards require that the identifiable assets acquired and liabilities assumed be BC198-BC204 measured at full fair value, even if the business combination is achieved in stages or if less than FAS 141R.20 100 percent of the equity interests in the acquiree is owned at the acquisition date. B198-B204

Main change from IFRS 3 (2004) IFRS 3 (2008) carries forward the guidance from IFRS 3 (2004) in this area.

Main changes from FAS 141 Under FAS 141, if an ownership interest in an entity of less than 100 percent was acquired, then the net assets of the acquired entity were recognised at fair value to the extent of the ownership interest acquired. Additionally, in a step acquisition, the carrying amounts of previously acquired interests were carried forward in consolidating the acquiree for the first time.

9.1 Recognition principle IFRS 3.11, 12 The new standards introduce conditions that must be met before identifiable assets acquired and FAS 141R. liabilities assumed can be recognised in a business combination. These conditions state that 13, 14 identifiable assets acquired and liabilities assumed must:

l meet the definition of assets and liabilities in the Framework for the Preparation and Presentation of Financial Statements (IFRSs) / CON 6 Elements of Financial Statements (U.S. GAAP) at the acquisition date; and

l be exchanged as part of the business combination instead of as a separate transaction (see section 14 Determining what is part of the exchange for the acquiree).

Costs incurred due to the acquisition, such as the cost of restructuring the acquiree, therefore are not part of the acquisition accounting as they are not liabilities at the acquisition date.

IFRS 3.13 Assets and liabilities not recognised previously by the acquiree are recognised only if they meet FAS 141R.15 the definition of an asset or liability at the acquisition date.

Transactions entered into by or on behalf of the acquirer, or primarily for the benefit of the acquirer or the combined entity, are not considered to be part of the business combination and therefore are accounted for separately (see section 14 Determining what is part of the exchange for the acquiree).

There are limited exceptions to the recognition principle, which are described in section 1 0.1 Exception to the recognition principle and section 10.2 Exceptions to both the recognition and measurement principles.

Main change from IFRS 3 (2004) IFRS 3 (2004) did not specifically require consideration of the definitions of assets and liabilities. While identifiable assets acquired and liabilities assumed were recognised only if they satisfied initial recognition criteria as set out in IFRS 3 (2004), other than in respect of contingent liabilities (see section 10.1.1 Contingent liabilities (contingencies) ) these recognition criteria generally were consistent with the criteria now set out in IFRS 3 (2008).


First Impressions: IFRS 3 and FAS 141R Business Combinations 21 January 2008

Main change from FAS 141 It is no longer possible to recognise a restructuring reserve as part of the acquisition accounting unless the criteria in FAS 146 Accounting for Costs Associated with Exit or Disposal Activities are met by the acquiree at that date.

9.1.1 Classifying and designating assets acquired and liabilities assumed IFRS 3.15 The new standards provide a general principle for classifying and designating assets acquired and FAS 141R.17 liabilities assumed. The acquirer must classify and designate assets acquired and liabilities

assumed on the acquisition date on the basis of the contractual terms, economic conditions, its operating or accounting policies and other pertinent conditions as they exist at the acquisition date. For example, the acquirer could designate and classify certain financial assets as held for trading (IFRSs) or using the fair value option (U.S. GAAP) based on its intentions (IFRSs) or elections (U.S. GAAP), regardless of the classification used by the acquiree.

IFRS 3.16 The standards specify that at the acquisition date an acquirer in a business combination should FAS 141R.18 go through the process of voluntarily designating financial instruments as hedging instruments and

designating any hedge relationships of the acquiree, and reassessing whether separation of an embedded derivative from its host is required.

IFRS 3.17 There are two exceptions to this general principle. The classification determined by the acquiree in FAS 141R.19 accordance with:

l IAS 17 Leases or FAS 13 Accounting for Leases is retained in the acquisition accounting of a lease contract; and

l IFRS 4 Insurance Contracts or FAS 60 Accounting and Reporting by Insurance Enterprises is retained in the acquisition accounting of an insurance contract.

IFRS 3.17 The classification and designation of leases and insurance contracts is based on the contractual FAS 141R.19 terms at inception of the contract, or at the date of the latest modification that resulted in a change

of classification.

Main change from IFRS 3 (2004) IFRS 3 (2004) was silent as to whether a business combination triggered a re-designation or a re-classification of contracts of the acquiree by the acquirer, or whether the acquirer continued with the original assessments or designations by the acquiree.

Main change from FAS 141 While the above guidance was not contained entirely within FAS 141 (e.g., FIN 21 Accounting for Leases in a Business Combination provided additional guidance), the guidance is retained in FAS 141R and we do not expect differences from previous practice.

9.1.2 Recognising particular assets acquired and liabilities assumed 9.1.2.1 Operating leases IFRS 3.B28- If the acquiree is the lessee, IFRS 3 (2008) and FAS 141R require that an intangible asset or liability B30 be recognised for the favourable or unfavourable aspect of the operating lease relative to its market FAS 141R. terms or prices. This does not preclude recognising an intangible asset, such as a customer A17, A18 relationship, related to a lease contract at market rates if it would provide economic benefit to a

market participant who would be willing to pay for such benefits (see section 9.1.2.2 Intangible assets).



January 2008

IFRS 3.B42 If the acquiree is the lessor, then IFRS 3 (2008) requires that the intangible asset or liability from FAS 141R.A17a favourable or unfavourable lease agreement be incorporated into the fair value of the asset

subject to the lease (e.g., building); therefore it is not presented as a separate asset or liability on the balance sheet. Under FAS 141R the asset subject to the lease is valued separately from the intangible asset (favourable lease) or liability (unfavourable lease) resulting in the presentation of two separate assets (or an asset and a liability) under U.S. GAAP. See also section 9.2.1 Measuring the fair value of particular assets.

IAS 16.44 Although the presentation requirements under IFRS 3 (2008) and FAS 141R differ, because IAS 16 Property, Plant and Equipment requires separating property, plant and equipment into components and depreciating these components over their estimated useful lives, generally this will not result in a difference from U.S. GAAP other than in respect of balance sheet presentation. A consequential amendment was made to IAS 16 to clarify that it may be appropriate to depreciate the favourable or unfavourable aspect of an operating lease separately. However, a difference from U.S. GAAP will arise if the property qualifies as investment property that is measured at fair value in accordance with IAS 40 Investment Property. This difference is illustrated below.

Illustrative example On 1 January 20Y0 Entity A acquires 100 percent of Entity B. One of the assets acquired as part of the business combination is a building with an operating lease to a third party, which qualifies as investment property under IFRSs. The lease contract with the third party has 12 years remaining, and the estimated remaining useful life of the building is 30 years. The estimated fair value of the building, excluding any favourable or unfavourable aspect of the operating lease relative to its market terms, is CU 30,000. Because the lease is at a fixed rate that is above current market rates, the lease has an estimated fair value of CU 600, which represents the favourable aspect of the operating lease relative to market terms.

Measurement under the cost model Under IFRS 3 (2008) the building is recognised initially at a fair value of CU 30,600 (CU 30,000 + CU 600). If Entity A subsequently measures investment property based on the cost model under IAS 16, then the building will be depreciated over its remaining useful life of 30 years, and the lease contract will be amortised over its remaining useful life of 12 years. Assuming that Entity A uses the straight-line depreciation method and there is no residual value, then depreciation expense in the first year after the acquisition will be CU 1,050 (CU 30,000/30 + CU 600/12).

Under IFRSs Entity A would record the following entries:

Debit Credit

Initial recognition (as part of the acquisition accounting) Building Consideration transferred

CU 30,600 CU 30,600

Subsequent measurement Depreciation expense Accumulated depreciation building

CU 1,050 CU 1,050



Under FAS 141R Entity A is required to recognise the favourable aspect of the operating lease relative to its market terms separately, and therefore would record the following entries:

Debit Credit

Initial recognition (as part of the acquisition accounting) Building Intangible asset Consideration transferred

CU 30,000 CU 600

CU 30,600

Subsequent measurement Depreciation expense (building) Amortisation expense (intangible) Accumulated depreciation building Intangible asset

CU 1,000 CU 50

CU 1,000 CU 50

The only difference between IFRSs and U.S. GAAP in this example is the balance sheet and income statement presentations on initial recognition and subsequent measurement.

Measurement under the fair value model If under IFRSs Entity A subsequently measures investment property using the fair value model under IAS 40, then the amount recognised initially will be identical to the cost model, i.e., CU 30,600. However, if at 31 December 20Y0 the fair value of the building, including the favourable aspect of the operating lease relative to market terms, increases to CU 35,000, then Entity A would record the following entries:

Debit Credit

Initial recognition (as part of the acquisition accounting) Building Consideration transferred

CU 30,600 CU 30,600

Subsequent measurement Building Profit or loss (35,000 - 30,600)

CU 4,400 CU 4,400

9.1.2.2 Intangible assets Initial measurement IFRS 3.B31, A The new standards require that identifiable intangible assets be recognised at the acquisition date. FAS 141R. An asset is identifiable if it either: A19, 3(k)

l is separable, i.e., capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged (either individually or together with a related contract, identifiable asset, or liability), regardless of whether the entity intends to do so; or

l arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

IFRS 3.B32-34, Several examples are provided of how to apply the definition of intangible assets, by specifically IE16-IE44 addressing the following types of intangible assets: FAS 141R.

A19-A56 l marketing-related; l customer-related;



January 2008

l artistic-related;l contract-based; andl technology-based.

IFRS 3.B37 An acquirees assembled workforce is not recognised as an intangible asset separate from FAS 141R.A25 goodwill.

Main change from IFRS 3 (2004) IFRS 3 (2008) removes the reliability of measurement criterion and the rebuttable presumption that the fair value of intangible assets can be measured reliably in a business combination. Accordingly, there is no longer any exemption from recognising identifiable intangible assets as part of the acquisition accounting.

Main change from FAS 141 FAS 141R carries forward the previous U.S. GAAP requirements of accounting for intangible assets.

Subsequent measurement IAS 38 and FAS 142 Goodwill and Other Intangible Assets prescribe the subsequent accounting for intangible assets.

Main change from IFRS 3 (2004) The subsequent measurement of intangible assets under IAS 38 has not changed.

Main change from FAS 141 The subsequent measurement of intangible assets other than goodwill under FAS 142 has not changed.

9.2 Measurement principle IFRS 3.18 The new standards have shifted from a purchase price allocation approach to a fair value measurement FAS 141R.20 principle. In doing so the standards establish a measurement principle that requires that the

identifiable assets acquired and liabilities assumed as part of the business combination be measured on the acquisition date at their fair values.

There are limited exceptions to the measurement principle, which are described in section 10.2 Exceptions to both the recognition and measurement principles and section 10.3 Exceptions to the measurement principle.

Main change from IFRS 3 (2004) IFRS 3 (2004) was based on a purchase price allocation approach, i.e., the purchase price of the acquisition was allocated to the fair value of the identifiable assets acquired and liabilities assumed.

Additionally, IFRS 3 (2008) no longer contains the guidance from Appendix B of IFRS 3 (2004) on how to determine the fair value of assets acquired and liabilities assumed such as inventories, intangible assets and onerous contracts. In the absence of specific guidance, entities will need to consider how to measure the fair value of such items using the principles of fair value measurement, and any other guidance that may be useful through application of the hierarchy for the selection of accounting policies in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.



Main change from FAS 141 FAS 141 was based on a purchase price allocation approach, i.e., the cost of the acquisition was allocated to the fair value of the identifiable assets acquired and liabilities assumed. FAS 141R no longer contains the guidance from FAS 141 on how to determine the fair value of assets acquired and liabilities assumed, such as inventories, intangible assets and property, plant and equipment. Under FAS 141R fair value is determined in accordance with FAS 157 Fair Value Measurements.

9.2.1 Measuring the fair value of particular assets The standards provide specific guidance on applying the fair value measurement principle to certain assets. Additionally, under U.S. GAAP the guidance in FAS 157 also is relevant.

Assets with uncertain cash flows (valuation allowances) IFRS 3.B41 IFRS 3 (2008) and FAS 141R prohibit recognition at the acquisition date of a separate valuation FAS 141R.A57allowance on assets acquired that are measured at fair value. For example, because accounts

receivable acquired in a business combination are recognised at fair value at the acquisition date, they cannot be recognised on the balance sheet at their gross amounts (contractual amount of the receivable without taking into account credit risk) less a separate valuation allowance based on estimated uncollectable cash flows. The standards do, however, require that the acquirer disclose separately the fair value of the receivables acquired, as well as their gross contractual amounts and the best estimate of the amounts of the contractual cash flows that the acquirer does not expect to collect (see section 15 Disclosures).

Assets subject to operating leases in which the acquiree is the lessor IFRS 3.B42 If the acquiree is the lessor, IFRS 3 (2008) requires an asset subject to an operating lease (e.g., a

building) to be recognised at fair value taking into account the terms of the related lease, i.e., the acquirer does not recognise a separate intangible asset related to the favourable or unfavourable aspect of an operating lease relative to market terms or prices (see also section 9.1.2.1 Operating leases).

FAS 141R.A58FAS 141R requires an asset subject to an operating lease (e.g., a building) to be recognised at fair value not taking into account the terms of the related lease, i.e., the acquirer recognises a separate intangible asset related to a favourable, or a liability related to an unfavourable, aspect of an operating lease relative to its market terms or prices (see also section 9.1.2.1 Operating leases).

Assets that the acquirer intends not to use or to use differently IFRS 3.B43 The standards do not exempt an entity from recognising an asset acquired at the fair value based FAS 141R.A59on market participants use of the asset because the entity does not intend to use that asset, or

intends to use it in a way that is not similar to how market participants would be expected to use it. However, see also section 10.3.3 Assets held for sale.

Illustrative example As part of a business combination an entity acquires a brand name that it does not intend to use, but which market participants would be expected to continue to use. Because market participants would be expected to continue to use the brand name, it is recognised at fair value rather than based on the way in which the acquirer intends to use it (abandonment).

9.2.2 Measuring non-controlling interest in an acquiree IFRS 3.19 Under IFRS 3 (2008) the acquirer can elect to measure any non-controlling interest at:

l fair value at the acquisition date, which means that goodwill includes a portion attributable to the non-controlling interest; see also section 11 Recognising and measuring goodwill or a gain in a bargain purchase for determining how goodwill is measured; or



January 2008

l its proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree, which means that goodwill relates only to the controlling interest acquired.

IFRS 3.19 This election is made on a transaction-by-transaction basis.

FAS 141R.20 Under FAS 141R any non-controlling interest must be measured at fair value; there is no option similar to that under IFRSs, which means that goodwill includes a portion attributable to the non-controlling interest.

IFRS 3.B44 The fair value of the non-controlling interest sometimes can be obtained based on the market FAS 141R.A60 prices of the equity shares traded; otherwise it will be estimated using other valuation techniques.

Illustrative example On 31 December 20Y0 Entity A acquires 60 percent of Entity B for cash of CU 1,000. The fair value of the identifiable net assets of Entity B is CU 1,500 and the carrying amount of Entity Bs net assets is CU 1,200. The fair value of the non-controlling interest is CU 650 based on the market price of the shares that the acquirer does not obtain.

Non-controlling interest at fair value If the acquirer recognises the non-controlling interest at fair value (optional under IFRS 3 (2008) and required under FAS 141R), then in its consolidated financial statements Entity A recognises the identifiable net assets of Entity B at CU 1,500 (full fair value), non-controlling interest at CU 650, and the resulting goodwill at CU 150 (CU 1,000 + CU 650 - CU 1,500); see section 11 Recognising and measuring goodwill or a gain in a bargain purchase for the calculation of goodwill.

Entity A records the following consolidation entry related to its investment in Entity B in preparing its 31 December 20Y0 consolidated financial statements:

Debit Credit

Identifiable net assets of Entity B Goodwill Equity (non-controlling interest) Investment in Entity B (controlling interest)

CU 1,500 CU 150

CU 650 CU 1,000

Non-controlling interest at proportionate interest in the fair value of identifiable assets and liabilities If the acquirer elects to recognise the non-controlling interest at the proportionate interest in the fair value of the identifiable assets and liabilities (prohibited under FAS 141R), then in its consolidated financial statements Entity A recognises the identifiable net assets of Entity B at CU 1,500 (full fair value), non-controlling interest at CU 600 (CU 1,500 x 40 percent), and the resulting goodwill at CU 100 (CU 1,000 + CU 600 - CU 1,500); see section 11 Recognising and measuring goodwill or a gain in a bargain purchase for the calculation of goodwill.

Entity A records the following consolidation entry related to its investment in Entity B in preparing its 31 December 20Y0 consolidated financial statements:

Debit Credit

Identifiable net assets of Entity B Goodwill Equity (non-controlling interest) Investment in Entity B (controlling interest)

CU 1,500 CU 100

CU 600 CU 1,000




The implication of recognising the non-controlling interest at its proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree is that both the non-controlling interest and goodwill are lower because no goodwill is ascribed to the non-controlling interest. This Day 1 difference will result in a smaller impairment loss under IFRSs if a cash-generating unit subsequently is found to be impaired.

It also will impact the equity attributable to the acquirer in subsequent acquisitions of non-controlling interest. Because the amount attributed to the non-controlling interest is lower, and because transactions with non-controlling interest are treated as transactions with equity holders (see section 17 Amendments to IAS 27 and the issue of FAS 160 ), any subsequent acquisition of non-controlling interest at fair value will result in a greater reduction in the controlling interests (parents) share of equity.

Illustrative example Continuing the above example, Entity A subsequently acquires an additional 20 percent of Entity B for CU 500.

Non-controlling interest at fair value If Entity A recognises non-controlling interest at fair value at the acquisition date, then in its consolidated financial statements Entity A recognises the payment of CU 500, the decrease of non-controlling interest at CU 325 (CU 650 x 20/40), and the resulting difference will be recognised as a reduction in the controlling interests (parents) share of equity.

Entity A records the following consolidation entry related to the acquisition of the non-controlling interest in preparing its consolidated financial statements:

Debit Credit

Equity (non-controlling interest) Equity (controlling interest) Cash

CU 325 CU 175

CU 500

Non-controlling interest at proportionate interest in fair value of the identifiable assets and liabilities If Entity A recognises non-controlling interest at the proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree at the acquisition date, then in its consolidated financial statements Entity A recognises the payment of CU 500, the decrease of non-controlling interest at CU 300 (CU 600 x 20/40), and the resulting difference will be recognised as a reduction in the controlling interests (parents) share of equity.

Entity A records the following consolidation entry related to the acquisition of the non-controlling interest in preparing its consolidated financial statements:

Debit Credit

Equity (non-controlling interest) Equity (controlling interest) Cash

CU 300 CU 200

CU 500

The acquisition of the non-controlling interest at fair value (CU 500) resulted in a greater reduction in the controlling interests (parents) share of equity under the proportionate interest in the fair value of the identifiable assets and liabilities method (CU 200) for measuring non-controlling interest than under the fair value method (CU 175).


Main change from IFRS 3 (2004) IFRS 3 (2004) required that non-controlling interest be recognised at the proportionate interest in the fair value of the identifiable assets and liabilities of the acquiree. There was no option to measure non-controlling interest at fair value.

Main change from FAS 141 FAS 141 required that non-controlling interest be recognised based on the historical financial statement carrying amounts of the acquiree.



10 Exceptions to the recognition and / or measurement principles

The new standards provide for certain exceptions to the recognition and / or measurement principles. Additionally, assets and liabilities generally are measured subsequent to the business combination in accordance with the applicable IFRSs or U.S. GAAP for those items. However, in some cases the standards provide specific guidance on subsequent measurement, which is discussed below.

The exceptions to the recognition and / or measurement principles are as follows:

Exception to the recognition principle

Exceptions to both the recognition and measurement principles

Exceptions to the measurement principle

Contingent liabilities (contingencies)

Deferred tax assets and liabilities

Reacquired rights

Indemnification assets Share-based payment awards

Employee benefits Assets held for sale

10.1 Exception to the recognition principle The following exception is from the recognition principle of the new standards only, i.e., there is no

exception from the fair value measurement principle for this item.

10.1.1 Contingent liabilities (contingencies) Initial recognition and measurement IFRS 3.22 Contingent liabilities, as defined in IAS 37, comprise the following:

l a possible obligation that arises from past events whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; and

l a present obligation that arises from past events but is not recognised because (1) it is not probable that economic outflow will be required to settle the obligation; or (2) it cannot be measured with sufficient reliability.

IFRS 3.BC274, Only contingent liabilities that are present obligations are recognised in the acquisition accounting BC275 because they meet the definition of a liability. A possible obligation is not recognised because it is

not a liability.

IFRS 3.23 IFRS 3 (2008) does not require that future economic outflow to settle the liability of a present obligation be probable. Therefore, even if it is not probable that economic outflow will be required to settle the liability, a contingent liability still will be recognised in a business combination if fair value can be measured reliably and the liability is a present obligation that arose from past events.

The restriction on the recognition of contingent liabilities to present obligations raises questions about the appropriate identification of a triggering event (past event) in determining whether there is a present obligation. For example, when an entity is sued, does the present obligation arise when the entity commits the act that led to it being sued, when it receives notification that it is being sued, or at some later date?



It is likely that this issue will not be resolved fully until the IASB completes its project to revise IAS 37, and in the meantime we expect this to be an area of focus under the new standards.

IFRS 3.BC276 Contingent assets are not recognised under IFRS 3 (2008) because a contingent asset (as defined in IAS 37) is a possible asset that does not meet the definition of an asset.

FAS 141R.24 Under FAS 141R the recognition criteria in FAS 5 Accounting for Contingencies do not apply to contingent assets acquired and contingent liabilities assumed in a business combination. Instead, the standard segregates contingencies (assets and liabilities) into two categories:

l A contractual contingency is recognised at fair value on the acquisition date. l A noncontractual contingency is recognised at fair value at the acquisition date only if at the

acquisition date it is more likely than not that the contingency meets the definition of an asset or liability in CON 6.

Main change from IFRS 3 (2004) The measurement guidance on contingent liabilities has been carried forward from IFRS 3 (2004), but IFRS 3 (2008) no longer allows a possible obligation as defined in IAS 37 to be recognised, even if fair value can be measured reliably. Only present obligations that arose from past events can be recognised. The new requirements still do not allow the recognition of contingent assets. However, there is an ongoing project on IAS 37 that may change this guidance in the future.

Main change from FAS 141 Previously a contingent liability was recognised at fair value only if fair value was objectively determinable, which typically was not the case. If fair value was not objectively determinable, then a contingent liability was recognised and measured in accordance with the probability and measurement criteria in FAS 5. As a consequence, a contingent liability was recognised only if it was probable and reasonably estimable, and was measured at the best estimate of the settlement amount rather than at fair value.

Illustrative example FAS 141R An example of a contractual contingency is a contractual penalty in place at the acquisition date if the acquiree does not deliver a product or service by a specified time to one of its customers. The acquirer will recognise the fair value of the contingent liability at the acquisition date whether or not it is more likely than not that the acquiree would have to pay the penalty.

An example of a noncontractual contingency is a lawsuit involving the acquiree at the acquisition date. The acquirer will recognise the fair value of the contingent liability at the acquisition date only if it is more likely than not that the acquiree will have to settle the contingency.

Subsequent measurement IFRS 3.56 Under IFRS 3 (2008) if, after initial recognition, a contingent liability becomes a liability and the

amount that would be recognised under IAS 37 is higher than the fair value recognised at acquisition, then the liability is increased. The additional amount is recognised in profit or loss. If, after initial recognition, the provision required is lower than the amount recognised at acquisition, then the liability continues to be recognised at the fair value at the acquisition date and is only decreased when the contingency no longer exists or, if appropriate, for the amortisation of the contingent liability under IAS 18 Revenue. This remeasurement should occur until the liability is settled.


First Impressions: IFRS 3 and FAS 141R Business Combinations 31 January 2008

FAS 141R.62 Under FAS 141R a contingent liability that is recognised at the acquisition date (i.e., a contractual contingent liability, or a noncontractual contingent liability that met the more likely than not recognition threshold) is measured subsequently at the greater of its then current FAS 5 amount or the acquisition-date fair value. Any adjustments needed until settlement are recognised in profit or loss. A contingent liability that is not recognised at the acquisition date is recognised in accordance with FAS 5.

Main change from IFRS 3 (2004) IFRS 3 (2008) carries forward the previous IFRS 3 (2004) requirements in respect of the subsequent measurement of contingent liabilities.

Main change from FAS 141 Contingent liabilities generally were measured in accordance with FAS 5. Under FAS 141R only contingencies that were not recognised at the acquisition date are subject to the FAS 5 recognition and measurement criteria. Contingencies recognised at the acquisition date are subsequently measured at the higher of the then FAS 5 amount or the acquisition-date fair value.

10.2 Exceptions to both the recognition and measurement principles The following exceptions are to both the recognition and measurement principles of the new standards.

10.2.1 Deferred tax assets and liabilities Initial recognition and measurement

IFRS 3.24 Deferred tax assets and liabilities that arise as a result of the assets acquired and liabilities FAS 141R.26 assumed, as well as any deductible temporary differences or unused tax losses of the acquiree,

are recognised and measured in accordance with IAS 12 Income Taxes or FAS 109 Accounting for Income Taxes rather than at fair value.

IAS 12.67 The new standards retain the previous requirement of IFRS 3 (2004) that deferred tax assets of the FAS 109.266 acquirer that are recognised (or derecognised) as a result of the business combination be excluded

from acquisition accounting, and any subsequent changes to these amounts are recognised in profit or loss.

IAS 12.32A Consequential amendments to IAS 12 and FAS 109 now clarify that any tax deductible goodwill in FAS 109.262 excess of goodwill for financial reporting purposes meets the definition of a temporary difference

and deferred tax must be recognised in the acquisition accounting.

FAS 141R. FIN 48 Accounting for Uncertainty in Income Taxes specifies the accounting for tax uncertainties 27, 51 under U.S. GAAP. FAS 141R clarifies that changes in the assessment of tax uncertainties that

occur during the measurement period (see section 13 Measurement period ) affect the acquisition accounting only if the changes in assessment relate to information that existed at the acquisition date. IFRSs contain no specific guidance on the accounting for tax uncertainties, either in or outside of a business combination.

Main change from IFRS 3 (2004) There are no major changes to the recognition and measurement of deferred tax assets and liabilities, other than the clarification regarding the accounting for tax deductible goodwill in excess of goodwill for financial reporting purposes.



Main change from FAS 141 Changes to a valuation allowance related to the acquirers pre-existing tax benefits as a result of the business combination previously were part of the acquisition accounting. Adjustments to the acquirees tax benefits previously were treated as an adjustment to the acquisition accounting even when the adjustments were made after the measurement period.

Subsequent measurement IAS 12.68 Consequential amendments have been made to IAS 12 and FAS 109 precluding the reduction of FAS 109.30A goodwill for the subsequent recognition of deferred tax benefits acquired in a business

combination that did not satisfy the criteria for recognition at the acquisition date. After the measurement period has elapsed (see section 13 Measurement period ), any revision to deferred taxes is recognised in profit or loss.

Main change from IFRS 3 (2004) Previously when deferred tax assets of the acquiree were realised subsequently in excess of the amount recognised at the acquisition date as part of the acquisition accounting, the additional tax benefit was recognised in profit or loss in the income tax line, and goodwill was adjusted to the amount that would have been recognised if the tax benefit had been recognised as part of the acquisition accounting. There was no time limit on making such an adjustment.

Main change from FAS 141 Under FAS 141 tax benefits of the acquiree recognised subsequent to the business combination (e.g., through a reduction of a valuation allowance) first were applied to reduce to zero any goodwill related to the acquisition, then to reduce to zero other non-current intangible assets related to the acquisition, and finally to income tax expense (benefit), regardless of whether the recognition was during or subsequent to the measurement period.

10.2.2 Indemnification assets Initi

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