Executive Summary
The International Accounting Standards Board (IASB) has introduced requirements in the last few years to make those involved in business combinations more accountable for the transactions that have taken place. In particular:
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All business combinations must now be accounted for using the acquisition accounting method.
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The intangible assets arising from a business combination must be identified and recognized separately from purchased goodwill.
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Purchased goodwill is no longer permitted to be amortized; instead, it must be tested for impairment each year.
Introduction
The accounting for business combinations under IFRS is governed by four key standards:
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IFRS 3, Business Combinations;
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IAS (International Accounting Standards) 27, Consolidated Financial Statements;
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IAS 36, Impairment of Assets;
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IAS 38, Intangible Assets.
IFRS 3 sets out the requirements to be followed in accounting for a business combination. Its introduction in 2004 represented a substantial change from the standard it superseded, IAS 22. IFRS 3 signaled the end of the benign method of accounting for business combinations known as “merger accounting.” Instead, all business combinations must be accounted for using the acquisition accounting method. This requires that both acquirer and acquiree are identified for each transaction, that a fair value exercise is performed on the acquiree’s assets and liabilities, and that purchased goodwill arising from the transaction is capitalized in the balance sheet.
A further consequence of the introduction of IFRS 3 is that intangible assets must be recognized separately from purchased goodwill instead of being subsumed within purchased goodwill. Purchased goodwill itself is not amortized, but must be reviewed for impairment annually. The performance of the impairment review is covered by IAS 36, Impairment of Assets, and the identification and recognition of intangible assets is covered by IAS 38, Intangible Assets.
The tightening up of business combination accounting was noted by accountants PricewaterhouseCoopers: “The acquisition process will need to become more rigorous, from planning to execution.”1
The following steps are involved in accounting for a business combination under IFRS 3:
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identification of the acquirer and the acquiree;
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performance of a fair value exercise on the acquiree’s assets and liabilities;
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identification and measurement of the fair value of the intangible assets arising;
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measurement of the amount of any non-controlling interest in the acquiree;
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measurement of the amount of goodwill arising from the transaction.
A revised version of IFRS 3 was issued by the IASB in January 2008, and its requirements will be mandatory for accounting periods from July 2009 onward. While the revision is quite comprehensive, it does not change the overall approach set out above. The revision is part of the Convergence Program underway between the IASB and the Financial Accounting Standards Board (FASB), aimed at reducing the number of differences between IFRS requirements and US Generally Accepted Accounting Principles (US GAAP). In addition to tightening up certain areas, the revision developed the previous IFRS 3 by:
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providing additional guidance regarding the recognition and fair value measurement of the acquiree’s assets and liabilities;
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changing the requirements for measuring goodwill and the remaining noncontrolling interest when less than a 100% stake in the acquiree is purchased or when an increase in an existing stake is involved.
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