Chapter 31 – Consolidation Page 414
9 Self Test Questions
Chapter 31
1. Which ONE of the following terms best describes the financial statements of a
parent in which the investments are accounted for on the basis of the direct equity interest?
A Single financial statements
B
Combined financial statements
C
Separate financial statements
D Consolidated financial statements
2. Are the following statements true or false, according to IAS27 Consolidated
and separate financial statements? 1
Consolidated financial statements must be prepared using uniform accounting policies.
2 The non-controlling interest in the net assets of subsidiaries may be
shown by way of note to the consolidated statement of financial position.
Statement 1 Statement 2
A
False False
B False
True
C
True False
D True
True
3. The Cavy Company owns 75 of The Haldenby Company. The following
figures are from their separate financial statements: Cavy:
Trade receivables CU1,040,000, including CU30,000 due from Haldenby.
Haldenby: Trade receivables CU215,000, including CU40,000 due from
Cavy. According to IAS27 Consolidated and separate financial statements, what
figure should appear for trade receivables in Cavys consolidated statement of financial position?
A CU1,215,000
B CU1,225,000
C CU1,255,000
D CU1,185,000
Chapter 31 – Consolidation Page 415
4. The Whight Company acquired an 80 interest in The Pouting Company
when Poutings equity comprised share capital of CU100,000 and retained earnings of CU500,000.
Poutings current statement of financial position shows share capital of CU100,000, a revaluation reserve of CU400,000 and retained earnings of
CU1,400,000.
Under IAS27 Consolidated and separate financial statements, what figure in respect of Poutings retained earnings should be included in the consolidated
statement of financial position?
A CU720,000
B CU1,440,000
C CU1,040,000
D CU1,520,000
5. The Elysium Company acquired a 60 interest in The Pindus Company when
Pinduss equity comprised share capital of CU100,000 and retained earnings of CU150,000.
Pinduss current statement of financial position shows share capital of CU100,000, a revaluation reserve of CU75,000 and retained earnings of
CU300,000.
Under IAS27 Consolidated and separate financial statements, what figure in respect of the non-controlling interest should be included in Elysiums
consolidated statement of financial position?
A CU150,000
B CU160,000
C CU190,000
D CU90,000
6. The Marsupial Company holds a 70 interest in The Hyaena Company. At
the current year end Marsupial holds inventory purchased from Hyaena for CU270,000 at cost plus 20.
The groups consolidated statement of financial position has been drafted without any adjustments in relation to this holding of inventory.
Under IAS27 Consolidated and separate financial statements, what adjustments should be made to the draft consolidated statement of financial
position figures for non-controlling interest and retained earnings?
Non-controlling interest Retained earnings
A
No change Reduce by CU45,000
B
No change Reduce by CU54,000
C Reduce by CU16,200
Reduce by CU37,800
D
Reduce by CU13,500 Reduce by CU31,500
Chapter 31 – Consolidation Page 416
7. The Seedsnipe Company owns 65 of The Gennis Company. On the last
day of the accounting period Gennis sold to Seedsnipe a non-current asset for CU200,000. The asset originally cost CU500,000 and at the end of the
reporting period its carrying amount in Genniss books was CU160,000.
The groups consolidated statement of financial position has been drafted without any adjustments in relation to this non-current asset.
Under IAS27 Consolidated and separate financial statements, what adjustments should be made to the consolidated statement of financial
position figures for non-current assets and retained earnings?
Non-current assets Retained earnings
A
Increase by CU300,000 Increase by CU195,000
B
Reduce by CU40,000 Reduce by CU26,000
C Reduce by CU40,000
Reduce by CU40,000
D
Increase by CU300,000 Increase by CU300,000
8. The Larkspur Company owns 75 of The Vitex Company. On 31 December
20X7, the last day of the accounting period, Vitex sold to Larkspur a non- current asset for CU200,000. The assets original cost was CU500,000 and
on 31 December 20X7 its carrying amount in Vitexs books was CU160,000.
The groups consolidated statement of financial position has been drafted without any adjustments in relation to this non-current asset.
Under IAS27 Consolidated and separate financial statements, what adjustments should be made to the consolidated statement of financial
position figures for retained earnings and non-controlling interest?
Retained earnings Non-controlling interest
A Increase by CU225,000
Increase by CU75,000
B Increase by CU300,000
No change
C
Reduce by CU30,000 Reduce by CU10,000
D Reduce by CU40,000
No change
Chapter 31 – Consolidation Page 417
9. The Virdi Company owns 65 of The Mintaka Company. On 31 December
20X7, the last day of the accounting period, Virdi sold to Mintaka a non- current asset for CU1,000. The assets original cost was CU2,500 and on 31
December 20X7 its carrying amount in Virdis books was CU800.
The groups consolidated statement of financial position has been drafted without any adjustments in relation to this non-current asset.
Under IAS27 Consolidated and separate financial statements, what adjustments should be made to the consolidated statement of financial
position figures for non-current assets and non-controlling interest?
Non-current assets Non-controlling interest
A
Increase by CU1,500 Increase by CU525
B
Reduce by CU200 No change
C Reduce by CU200
Reduce by CU70
D
Increase by CU1,500 No change
10. The Rogers Company acquired equipment on 1 January 20X4 at a cost of
CU800,000, depreciating it over 8 years with a nil residual value. On 1 January 20X7 The Mulberry Company acquired 100 of Rogers and
estimated the fair value of the equipment at CU460,000, with a remaining life of 5 years. This fair value was not incorporated into Rogerss books and the
depreciation expense continued to be calculated by reference to original cost.
Under IAS27 Consolidated and separate financial statements, what adjustments should be made to the depreciation expense for the year and the
statement of financial position carrying amount in preparing the consolidated financial statements for the year ended 31 December 20X8?
Depreciation expense Carrying amount
A Increase by CU8,000
Increase by CU24,000
B
Increase by CU8,000 Decrease by CU24,000
C Decrease by CU8,000
Increase by CU24,000
D
Decrease by CU8,000 Decrease by CU24,000
Chapter 32 – Hyperinflationary Economies Page 419
Chapter 32 HYPERINFLATIONARY ECONOMIES
1 Business Context
Hyperinflationary economies are those with very high rates of general inflation which have such a depreciating effect on the country’s currency that it loses its purchasing power at a
very fast rate.
This causes particular problems for businesses operating in such economies, since money loses its purchasing power at such a high rate that comparisons are at best unhelpful, and
potentially misleading. This includes the comparison of results between accounting periods and for similar transactions within the same accounting period.
Thus, where an entity has operations in a hyperinflationary economy, it is likely that, without restatement, the reporting of operating results and the financial position in the local currency
will become distorted over time.
There are two types of price changes: general inflation: being an average increase in a price index of different goods
typically purchased. This is a measure of the general purchasing power of money; and
specific inflation: this is a measure of changes in prices of specific types of goods. For example, the price of land and property may be rapidly increasing while inventories
may be experiencing only modest increases.
2 Chapter Objectives
This chapter covers the accounting and disclosure requirements for entities operating in hyperinflationary economies in accordance with IAS 29 Financial reporting in
hyperinflationary economies.
On completion of this chapter you should be able to: understand the scope and objectives of IAS 29;
understand and demonstrate knowledge of the key principles concerning recognition and measurement in hyperinflationary conditions; and
demonstrate knowledge of the principal disclosure requirements of IAS 29.
3 Objectives, Scope and Definitions of IAS 29
The objective of IAS 29 is to present financial information of an entity operating in a hyperinflationary economy without distorting the entity’s actual performance. IAS 29 applies
to all entities whose functional currency is that of a hyperinflationary economy. An entity’s functional currency is defined in IAS 21 The effect of changes in foreign exchange rates as
the currency of the primary economic environment in which the entity operates. [IAS 29.1, IAS 21.8]
IAS 29 adjusts financial statements using a general price index to provide users of the financial statements with more meaningful information and to allow useful comparisons to be
made.
Chapter 32 – Hyperinflationary Economies Page 420
IAS 29 does not identify an absolute rate at which hyperinflation is deemed to arise. Instead it lists indicators that suggest that hyperinflation is present. It is a matter of judgement when
restatement under IAS 29 becomes necessary.
There is no universally accepted definition of hyperinflation. The only quantitative guidance given in IAS 29 is that a cumulative inflation rate over three years approaching, or exceeding,
100 is indicative of hyperinflation.
Other indications of hyperinflation include the tendency for people to keep their wealth in non-monetary assets such as property and monetary amounts being expressed in a stable
currency, such as the US dollar, rather than in terms of the local currency.
IAS 29 interacts with IAS 21 in accounting for foreign currencies. IAS 29 applies independently of IAS 21 where entities operate in hyperinflationary economies but have no
overseas transactions or operations.
4 The Restatement of Financial Statements
4.1 Introduction
IAS 29 requires the primary financial statements of an entity that reports in the currency of a hyperinflationary economy to be expressed in terms of the measuring unit at the end of the
reporting period. This requires all values initially measured at an earlier date to be restated by reference to the change in the general price index between the date of initial measurement
and the end of the reporting period. The same requirement applies whether the financial statements have been prepared using the historical cost basis i.e. transactions or events are
recorded at the amount which was relevant on the day that they took place or occurred, for example actual purchase price or using a current cost approach which takes account of
changes in asset values. [IAS 29.8]
The restatement using the current measuring unit required by IAS 29 applies to both the current year and to comparative information presented. [IAS 29.8]
4.2 Restatement of historical cost financial statements
4.2.1 The statement of financial position
To make the necessary adjustments to the statement of financial position it is important to distinguish between:
non-monetary items, such as plant, property, inventories, investments, goodwill and intangible assets. Such items are not fixed in monetary terms; and
monetary items, such as cash, receivables, payables and loans which are fixed in monetary terms.
Non-monetary items are adjusted using a general price index, because they are stated at amounts that were current at the date of their acquisition and not the date to which
the statement of financial position is prepared. Monetary items are not adjusted, as they are already carried at amounts that are current at the end of the reporting period.
4.2.2 The statement of comprehensive income
All items recognised in profit or loss or other comprehensive income should be expressed in terms of the measuring unit current at the end of the reporting period.
This requires all amounts to be restated by applying the change in the general price index from the dates when the items of income and expenditure were initially recorded
to the date to which the statement of financial position is prepared.
Chapter 32 – Hyperinflationary Economies Page 421
4.2.3 Gain or loss on net monetary position
If an entity holds CU1,000 in cash for a year while the price index doubles, then the real value of that cash will fall by CU500 i.e. half its amount, which represents the
loss on the monetary position. The same applies to other monetary assets such as receivables.
Conversely, if an entity owes CU5,000 at the beginning of a year and the price index doubles over the year, the real value of that loan will fall by CU2,500 i.e. half its
value. In this scenario the entity has made a monetary gain of CU2,500.
By adding all monetary assets and liabilities together, a gain or loss on the net monetary position can be calculated and should be included in the profit or loss for the
period. [IAS 29.9]
The gain or loss may be estimated by applying the change in a general price index for the period to the weighted average of the difference between monetary assets and
monetary liabilities.
Illustration 1
An entity in a hyperinflationary economy commenced business on 1 January 2007. It is required to restate its financial statements in accordance with IAS 29. All non-monetary
assets were acquired on the first day of trading. There is no depreciation and inventories are purchased on a just-in-time basis.
At 1 January 2007, net monetary assets were CU2,000. Assume profits generate cash evenly over the year.
The relevant indices are: 1 January 2007
100 30 June 2007
110 31 December 2007
120 The following table sets out the amounts recorded in the unadjusted statement of
financial position and the adjustments required under IAS 29. Balances at
31 December 2007 Unadjusted
statement of financial position
CU Adjustment
Inflation adjusted
balances CU
Non-monetary assets 10,000
120100 12,000
Net monetary assets 5,000
5,000 15,000
17,000 Opening equity
12,000 120100
14,400 Profit for the year
3,000 120110
3,273 15,000
Loss on monetary assets: CU2,000 held all year
120-100100 400
CU3,000 generated during year 120-110110
273 17,000
Chapter 32 – Hyperinflationary Economies Page 422
4.3 Restatement of current cost financial statements
4.3.1 The statement of financial position
Assets and liabilities recorded on a current cost basis in the statement of financial position already reflect the value of current prices and therefore no adjustment is necessary to restate
the statement of financial position at the year-end.
4.3.2 The statement of comprehensive income
Transactions recorded in a current cost statement of comprehensive income reflect the cost of the transaction at the transaction date. Expenses such as depreciation will be charged at
the current value at the time of consumption. It is therefore necessary to adjust all figures in the statement of comprehensive income by the general price index, in a similar way to that
described above under the historical cost basis.
4.3.3. Gain or loss on net monetary position
The same principles apply for calculating the gain or loss on the net monetary position as that explained above in relation to historical cost accounting.
4.4 Statement of cash flows
All items in the statement of cash flows should be restated to take account of changes in the general price index.
4.5 Initial application of IAS 29
IFRIC 7 was published in November 2005 to provide guidance to entities when they are required to restate their financial statements in a period because of the existence of
hyperinflation in the economy of the entity’s functional currency and hyperinflation did not exist in the previous period. IFRIC 7 sets out that the financial statements should be restated
as if the effects of hyperinflation had always existed.
Non-monetary items that are measured at historical cost at the start of the earliest period presented are restated to reflect the hyperinflationary effects from the date that the asset was
acquired or the liabilities were incurred until the end of the reporting period. Non-monetary items that are measured at a revalued amount should be restated for the hyperinflationary
effects from the date of the revaluation to the end of the reporting period.
IFRIC also confirmed that deferred tax recognised in the opening statement of financial position should be restated by adjusting for the effects of inflation from the date of acquisition
of the non-monetary item to the end of the earliest period reported. IAS 12 Income taxes should then be applied to the restated amounts in the opening statement of financial position,
and these amounts should then be restated for the effects of inflation between the end of the earliest and latest reporting periods presented.
5 Economies Ceasing to be Hyperinflationary
Where an entity operates in an economy that ceases to be hyperinflationary, it is no longer required to apply IAS 29. The restated amounts that are recorded in the last reported financial
statements should be used as the carrying amounts going forward. There should be no adjustment to restate amounts back to their original value under the appropriate accounting
basis. [IAS 29.38]
Chapter 32 – Hyperinflationary Economies Page 423
6 Disclosures
An entity should explain that the financial statements and the comparative information have been adjusted to take account of general inflationary increases by applying the measuring
unit current at the end of the reporting period. It should also disclose the basis of preparation of its financial statements, for example the historical cost method. [IAS 29.39]
Information on changes in the price index should be disclosed; this should include the rate at the end of the reporting period and the movement in the index in the current and previous
period. [IAS 29.39]
7 Chapter Review
This chapter has been concerned with financial reporting in hyperinflationary economies. This chapter has covered:
the objectives and scope of IAS 29; the key principles concerning recognition and measurement in
hyperinflationary conditions; and the principal disclosure requirements of IAS 29.
Chapter 32 – Hyperinflationary Economies Page 424
8 Self Test Questions
Chapter 32
1. According to IAS29 Financial reporting in hyperinflationary economies, which
TWO of the following would indicate that hyperinflation exists?
A
Non-monetary items increase in value, but monetary items do not
B The cumulative inflation rate over three years is approaching, or
exceeds, 100
C
Inflation rates have exceeded interest rates in three successive years
D The general population prefers to keep its wealth in non-monetary
assets
2. According to IAS29 Financial reporting in hyperinflationary economies, which
ONE of the following would indicate that hyperinflation exists?
A Sales on credit are at lower prices than cash sales
B Inflation is approaching, or exceeds, 20 per year
C
Monetary items do not increase in value
D People prefer to keep their wealth in non-monetary assets or a stable
foreign currency
3. An entity is reporting according to IAS29 Financial reporting in
hyperinflationary economies. Its monetary assets exceed its monetary liabilities.
Are the following statements true or false? 1
There will be a loss on the net monetary position. 2
Any gain or loss in the net monetary position of the company is recognised in other comprehensive income.
Statement 1 Statement 2
A
False False
B
False True
C True
False
D
True True
4. According to IAS29 Financial reporting in hyperinflationary economies, which
TWO of the following are monetary items?
A Trade payables
B
Inventories
C
Administration costs paid in cash
D Loan repayable at par value
Chapter 33 – Business Combinations Page 425
Chapter 33 BUSINESS COMBINATIONS
1 Business Context
Entities may increase their market share, diversify their business or improve vertical integration of their activities in a number of ways, including by organic growth or through
acquisitions. The acquisition of a competitor may offer rapid expansion or access to new markets and is often seen as more attractive than expansion through organic growth.
The takeover of Airtouch and Mannesman by Vodafone led to it becoming Europe’s most valuable company immediately after the acquisitions and one of the world’s top ten.
To ensure that users of financial statements are able to distinguish between organic growth and growth through acquisition, the separation of results is essential and comprehensive
disclosures with explanation should be presented.
2 Chapter Objectives
This chapter deals with the treatment by an investing entity acquirer when it acquires a substantial shareholding in another entity acquiree. The transaction which brings these two
parties together is known as a business combination and creates a group of entities.
The routine processes by which a group of entities annually presents financial information about its activities, as those of a single economic entity, are not discussed in this chapter,
because they are governed by IAS 27 Consolidated and separate financial statements.
Situations where the investor gains joint control or significant influence are covered by IAS 31 Interests in joint ventures and IAS 28 Investments in associates respectively.
On completion of this chapter you should be able to: understand the objectives and scope of IFRS 3 Business combinations;
interpret the important terminology and definitions which relate to the treatment of business combinations in financial statements;
identify the key principles relating to the recognition and measurement of business combinations; and
demonstrate knowledge of the principal disclosure requirements of IFRS 3.
3 Objectives, Scope and Definitions of IFRS 3
The objective of IFRS 3 is to set out the accounting and disclosure requirements for a business combination, to improve the relevance, reliability and comparability of information
presented in the financial statements. A business combination is simply “a transaction or other event in which an acquirer obtains control of one or more businesses”. Control of an
entity is where one party or a number of parties has the power over another to “govern its financial and operating policies so as to obtain the benefits from its activities ”
[IFRS 3 Appendix A]
In a straightforward business combination one entity will acquire another, resulting in a parent-subsidiary relationship.
Chapter 33 – Business Combinations Page 426
In terms of scope, IFRS 3 should be applied to all business combinations, except in the following circumstances:
where two or more quite separate businesses are brought together to operate as one entity in the form of a joint venture;
where a number of entities that are under common control, i.e. they are ultimately controlled by the same party are reorganised as part of a business combination. A
typical example is where subsidiaries within a group are moved around the group so that their immediate parent entity changes although the overall parent entity of the
group remains the same; and
where an asset or a group of assets have been acquired and they do not constitute a business. In such circumstances, the acquirer should recognise the individual assets
and any related liabilities in its own financial statements. IFRS 3 was originally published in 2004 as the outcome of the IASB’s first phase of its
business combinations project. It set out that all business combinations should be recognised using the purchase method of accounting. The second phase of the project was undertaken
with the US standard setter, the Financial Accounting Standards Board FASB, and addressed the application of the purchase method of accounting. The second edition of
IFRS 3 was published in January 2008, and the rest of this chapter is based on this revised version. The revised version of IFRS 3 replaces the term ‘purchase method’ with ‘acquisition
method’, which is used in the rest of this chapter.
The revised version of IFRS 3 should be applied prospectively for business combinations that have an acquisition date on or after the beginning of the first annual reporting period
beginning on or after 1 July 2009. However, an entity is permitted to adopt the standard in an annual reporting period that begins on or after 30 June 2007. If an entity adopts IFRS 3 early,
then the revised version of IAS 27 should also be adopted.
3.1 Identifying a business combination
An entity should assess whether a particular transaction is a business combination by applying the definition of a business combination, i.e. has the entity gained control of one or
more businesses? [IFRS 3.3]
A business is defined as being ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends,
lower costs or other economic benefits directly to investors or other owners, members or participants’. [IFRS 3 Appendix A]
A business combination may be structured in a number of different ways, and therefore the facts of each transaction should be assessed carefully. Application guidance accompanying
IFRS 3 provides a list of examples of business combinations, including:
one or more businesses become subsidiaries of an acquirer; one entity transfers its net asset to another entity;
all entities that are party to the business combination transfer their net assets to a newly formed entity; or
a group of former owners of one of the combining entities obtains control of the combined entity.
Chapter 33 – Business Combinations Page 427
3.2 Acquisition method of accounting
All business combinations should be accounted for by the acquisition method, whereby: [IFRS 3.4]
one party to the transaction is identified as the acquirer, with the other being the acquiree. It is assumed that it will always be possible to identify an acquirer;
the acquisition date is determined; the identifiable assets acquired, the liabilities assumed and the non-controlling
minority interest are recognised and measured; and the resulting goodwill or gain from a bargain purchase is recognised and measured.
The application of the acquisition method does not result in changes to the recognition or measurement of the acquirer’s own assets and liabilities, because these items are not part of
the acquisition transaction.
4 Identifying the Acquirer
The first step in applying the acquisition method to a business combination is to identify the acquirer. The acquirer is the party to the transaction that gains control over the other party.
[IFRS 3.6]
A combining entity is assumed to have control of another when it acquires more than half of the other entity’s voting rights. It is not, however, an essential attribute of control that over half
of the voting rights are owned, and there are other circumstances in which control exists, for example where the entity has the ability to appoint or remove the majority of the members of
the board of the acquiree. The control concept is discussed in more detail in IAS 27.
In most business combinations the identification of the acquirer is clear. However, where this is not the case, IFRS 3 sets out a number of indicators that may help with the identification.
These are:
the combining entity whose owners as a group receive the largest proportion of the voting rights in the combined entity is likely to be the acquirer;
where there is a large minority interest in the combined entity and no other owner has a significant voting interest, the holder of the large minority interest is likely to be the
acquirer; where one of the entities has the ability to select the management team, or the
majority of the members of the governing body, of the combined entity, that party is likely to be the acquirer; or
where a premium has been paid over the fair value of one or more of the combining entities prior to the combination, the acquirer is likely to be the entity that has paid the
premium.
Chapter 33 – Business Combinations Page 428
5 Determining the Acquisition Date
It is the acquirer’s responsibility to identify the acquisition date. The acquisition date is defined as being ‘the date on which the acquirer obtains control of the acquiree’.
[IFRS 3.8, Appendix A]
The acquisition date is normally the date on which the acquirer legally transfers the consideration for the business. However, it is possible for control to pass to the acquirer
before or after this date. Where several dates are key to the business combination, it is the date on which control passes that determines the date on which the acquisition occurs.
Illustration 1
LMN’s acquisition of GHI for cash proceeded as follows: 23 January
Approach made to the management of GHI seeking endorsement of the acquisition
20 March Public offer made for 100 of the equity shares of GHI, conditional on
regulatory approval, shareholder approval and receiving acceptances representing 60 of GHI’s shares
14 June Regulatory approval received
1 July Shareholder approval received
30 July Acceptances received to date represent 50 of GHI’s shares
15 August Acceptances received to date represent 95 of GHI’s shares
25 August Cash paid out to GHI’s accepting shareholders
13 November Cash paid out to the remaining shareholders under a compulsory share
acquisition scheme The acquisition date, being the date on which LMN obtains control over GHI, is 30 July.
6 Consideration Transferred in a Business Combination
6.1 General principle
The consideration transferred in a business combination is the total of the fair values at the acquisition date of the consideration given by the acquirer.
The consideration transferred may take a number of forms, such as: cash or other assets given up;
liabilities assumed, such as taking on the liability for a bank loan of the acquiree. But future losses or other costs expected to be incurred in the future do not form part of
the consideration; or the issue of equity instruments, such as ordinary shares.
Fair value is the amount which an entity will pay for, say, an asset when it is exchanged between unrelated and willing parties i.e. not in a forced sale.
Chapter 33 – Business Combinations Page 429
Any costs incurred by the acquirer to achieve the business combination should not form part of the consideration transferred; instead such expenses, for example legal and professional
fees, should be recognised in profit or loss in the period in which they are incurred. The exception to this general requirement is that where costs have been incurred in issuing debt
or equity, such costs should instead be recognised in accordance with IAS 32 Financial instruments: Presentation and IAS 39 Financial instruments: Recognition and measurement.
This usually results in these costs being deducted from the carrying amount of the equity or liability.
Illustration 2
An entity acquires the entire share capital of another entity by issuing 100,000 new CU1 ordinary shares at a fair value at the acquisition date of CU2.50. The professional fees
associated with the acquisition are CU20,000 and the issue costs of the shares are CU10,000.
The consideration transferred in the business combination is CU250,000, calculated as the fair value of the new shares issued CU2.5 x 100,000. The professional fees CU20,000
should be recognised in profit or loss and the issue costs deducted from the share premium recorded on issue of the shares.
6.2 Specific issues
The consideration transferred should include any contingent consideration payable, e.g. additional cash or equity shares to be transferred by the acquirer if specified future events or
conditions are met. A common example is the transfer of additional consideration if agreed profit targets are met by the acquiree in the post-acquisition period. Contingent consideration
should be measured at its fair value at the acquisition date and recognised by the acquirer as either a liability or as equity according to its nature.
The consideration transferred should only include the consideration transferred by the acquirer for the business exchanged in the business combination. Where, for example, there
is already a trading relationship between the acquirer and acquiree, any consideration that is paid in relation to this existing trading relationship, for example a supply contract, should not
form part of the business combination. Disclosure should be made of any such amounts paid. [IFRS 3.51]
Illustration 3
The terms of an acquisition include the following: 1
If the acquiree’s profits for the first full year following acquisition exceed CU2 million, the acquirer will pay additional consideration of CU6 million in cash three months
after that year end. It is doubtful whether the acquiree will achieve this profit, hence the acquisition-date fair value of this contingent consideration is CU100,000.
2 A contract exists whereby the acquirer will buy certain components from the acquiree
over the next five years. The contract was signed when market prices for these components were markedly higher than they are at the acquisition date. At the
acquisition date the fair value of the amount by which the contract prices are expected to exceed market prices over the next five years is CU1.5 million.
These should be dealt with as follows at the acquisition date: 1
The consideration transferred should be increased by the fair value of the contingent consideration of CU100,000, this amount should be recognised as a liability.
Chapter 33 – Business Combinations Page 430
2 The acquirer now controls the acquiree and can therefore cancel this contract; it is
not part of the business combination. CU1.5 million of the consideration should be recognised as an expense i.e. cancelling the contract in profit or loss, rather than
treated as transferred in the business combination.
6.3 A business combination achieved in stages
A business combination may be achieved in stages, such as where a 30 equity interest in an acquiree was held and the acquirer subsequently purchases another 25 equity interest
to gain control. In these circumstances the whole of the consideration transferred should still be measured at its fair value at the acquisition date, so the previously recognised equity
interest in the acquiree should be remeasured to fair value at that date. Any resulting gain or loss should be recognised directly in profit or loss. Specific disclosures are required where a
business combination has been achieved in stages.
6.4 Subsequent accounting for contingent consideration
The treatment of subsequent changes to the amount recognised at the acquisition date for contingent consideration depends on the reason for the change.
If the change results from additional information about conditions at the acquisition date and it arises within the measurement period i.e. within 12 months of the acquisition date – see
below, the change should be related back to the acquisition date, with a possible effect on the goodwill acquired.
If the change results from events after the acquisition date, such as when it becomes clear that the acquiree has met an earnings target and additional consideration is to be transferred,
then:
where the contingent consideration is classified as equity, this amount should not be remeasured and instead the final settlement of the consideration should be
recognised as part of equity; where the contingent consideration is classified as a liability and is recognised as a
financial instrument in accordance with IAS 39, it should be measured at fair value with any gain or loss being recognised in profit or loss or in other comprehensive
income in accordance with IAS 39; or
where the contingent consideration is classified as a liability but is not within the scope of IAS 39, it should be accounted for in accordance with IAS 37 Provisions,
contingent liabilities and contingent assets or another more appropriate standard.
Illustration 4
Using the facts from Illustration 3 and assuming the acquiree achieves its earnings target. Additional consideration should be recognised, measured at CU5.9 million CU6 million
payable – CU100,000 recognised at the acquisition date. The additional consideration relates to events after the acquisition date, so should be recognised as an expense in profit
or loss.
Chapter 33 – Business Combinations Page 431
7 Recognition and Measurement of the Identifiable Net Assets Acquired
7.1 Overview
IFRS 3 requires the acquirer to recognise at the acquisition date the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. [IFRS 3.10]
The definition of an identifiable asset is the same as that used in IAS 38 Intangible assets, i.e. that the asset is either separable it could be sold or otherwise disposed of by the owner or
arises from contractual or legal rights even though those rights are not separable.
7.2 Classifying and measuring the identifiable net assets acquired
The identifiable net assets acquired in a business combination should be classified or designated according to their nature at the date of acquisition, to ensure that other
international standards can be applied subsequent to the acquisition. Two exceptions to this basic principle exist, in relation to lease contracts, classified as operating or finance in
accordance with IAS 17 Leases, and an insurance contract classified in accordance with IFRS 4 Insurance contracts. For these two exceptions, it is the date of the inception of the
contract which will be prior to the acquisition date that is used for classification purposes. [IFRS 3.15]
The acquirer shall, at the acquisition date, measure the acquiree’s identifiable assets and liabilities at their fair value. In addition to the identifiable net assets acquired, the acquirer
should recognise any non-controlling interest in the acquiree at either fair value or at the non- controlling interest’s proportionate share of the acquiree’s identifiable net assets. This choice
is available separately for each acquisition. [IFRS 3.18]
Illustration 5
ABC acquired 750,000 of the 1 million equity shares of LMN at a price of CU5 each at the time when the total fair value of LMN’s assets less liabilities was CU4 million. ABC estimated
that the price paid included a premium of CU0.50 per share in order to gain control over LMN.
The fair value of the non-controlling interest is measured at CU1,125,000 250,000 shares × CU5.00 – 0.50.
The non-controlling interest’s proportionate share of the acquiree’s identifiable net assets is measured at CU1 million CU4 million × 25.
ABC may measure the non-controlling interest at either of these two amounts. A number of exceptions to the recognition andor measurement criteria in IFRS 3 apply in
relation to:
contingent liabilities – these should be recognised if there is a present obligation as
a result of a past event and the amount can be measured reliably in accordance with IAS 37. For a contingent liability to be recognised as part of a business combination,
it is not a requirement for an outflow of resources i.e. cash or other assets required to settle the obligation to be probable;
income taxes – any deferred tax asset or liability arising from the recognition of the
identifiable net assets should be recognised in accordance with IAS 12 Income taxes, not at fair value;
employee benefits – any asset or liability related to the acquiree’s employee benefit
