Mergers and acquisitions (business combinations) can have a fundamental impact on the acquirer’s operations, resources and strategies. For most entities such transactions are infrequent, and each is unique. IFRS 3 ‘Business Combinations’ sets out the accounting requirements for these transactions, which can be challenging to apply in practice.

Our ‘Insights into IFRS 3’ series summarises the key areas of the Standard, highlighting aspects that are more difficult to interpret and revisiting the most relevant features that could impact your business. IFRS 3 has specific guidance on how some items are recognised and measured. This guidance is described as a series of exceptions to the general recognition and measurement principles. This article summarises this specific guidance and provides examples to illustrate its application.

Identifiable assets and liabilities subject to specific IFRS 3 guidance (exceptions)

Under IFRS 3, the general recognition principle is that the identifiable assets acquired and liabilities assumed should meet the definition of assets and liabilities in accordance with the 2018 issued Conceptual Framework for Financial Reporting (Conceptual Framework) at the acquisition date. However, some recognition and measurement exceptions have been included for particular types of assets acquired and liabilities assumed.

Recognition exceptions

Liabilities and contingent liabilities in the scope of IAS 37 or IFRIC 21 - This exception applies to liabilities and contingent liabilities that would be in the scope of IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ or IFRIC 21 ‘Levies’ as if they were incurred separately rather than part of the business combination. This has been included because IFRS 3 refers to the definition of liability in the new Conceptual Framework, which, if applied at the date of acquisition, could create a day two gain (see note below). Accordingly:

  • for a provision or contingent liability that would be within the scope of IAS 37, the acquirer applies IAS 37 to determine whether at the acquisition date a present obligation exists as a result of past events.
  • for a levy that would be within the scope of IFRIC 21, the acquirer applies IFRIC 21 to determine whether the obligating event that gives rise to a liability to pay the levy has occurred by the acquisition date.• if the present obligation then identified meets the definition of a contingent liability, then the contingent liabilities recognition exception applies.

This exception applies from 1 January 2022, although it can be adopted early if at the same time (or earlier) an entity also applies all the amendments to IFRS Standards resulted from ‘Amendements to References to the Conceptual Framework’ issued in March 2018.

Note: For example, applying the definition of a liability in the Conceptual Framework and not IFRIC 21 may result in recognising (at the acquisition date) a liability to pay a levy that would not be recognised subsequently when applying IFRIC 21 (which would have created a day 2 gain).

Applying IFRIC 21, an entity recognises a liability to pay a levy only when it conducts the activity that triggers the payment of the levy, whereas applying the Conceptual Framework, an entity recognises a liability when it conducts an earlier activity.

Contingent liabilities - A contingent liability assumed in a business combination is recognised at the acquisition date:

  • only if it is a present obligation that arises from past events and its fair value can be measured reliably, and
  • even if an outflow of economic benefits is not probable (uncertainty is considered in the determination of fair value).

Other contingent liabilities are not recognised.
NB: Contingent assets acquired in a business combination are not recognised.

Measurement exceptions

Share-based payment awards - Measured in accordance with IFRS 2 ‘Share-based Payment’ which refers to there being a ‘market-based measure’. This means vesting conditions, such as service conditions and performance conditions (but other than market conditions), should not be taken into account when estimating the ‘fair value’ of the shares or share options granted as part of the award.

Insurance contracts (exception applicable to business combinations with an acquisition date after the earlier of when IFRS 17 is first applied or 1 January 2023) - A group of contracts within the scope of IFRS 17 ‘Insurance Contracts’ acquired in a business combination, and any assets for insurance acquisition cash flows as defined in IFRS 17, is measured as a liability or asset in accordance with IFRS 17 at the acquisition date.

Assets held for sale - Measured at fair value less costs to sell in accordance with IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’.

Note: A non-current asset (or disposal group) is classified as held for sale at the acquisition date only if the saleis expected to be completed within one year from the acquisition, and it is highly probable that any other criteria not met at the acquisition date will be met withina short period following the acquisition (usually within three months). The other criteria being (i) the asset is available for immediate sale in its present condition, (ii) the appropriate level of management is committed to a plan to sell the asset, and (iii) an active programme to locate a buyer and complete the plan has been initiated.

Recognition and measurement exceptions

Deferred taxes - Deferred tax balances are recognised if related to temporary differences and loss carry-forwards at the acquisition date of the acquiree or if they arise as a result of the acquisition. They are measured in accordance with IAS 12 ‘Income Taxes’.

Leases in which the acquiree is the lessee - For leases where the acquiree is the lessee, the acquirer recognises right-of-use assets and lease liabilities in accordance with IFRS 16 ‘Leases’.

The acquirer is not required to recognise right-of-use assets and lease liabilities for leases for which:

  • the lease term as defined in IFRS 16 is less than 12 months from the acquisition date (short-term lease), or
  • the underlying asset is of low value (low value lease).

The lease liability is measured at the present value of the remaining lease payments as if the acquired lease were a new lease at the acquisition date. The right-of-use asset is measured at an amount equal to the related lease liability, but adjusted to reflect favourable or unfavourable terms of the lease compared to market terms.

Indemnification assets - Indemnification assets are assets arising from the acquiree’s former owners contractually indemnifying the acquirer for a particular uncertainty. The indemnification asset is measured and recognised on the same basis as the related/indemnified item (ie at the same time and for an amount that is measured consistently with how the indemnified item is measured), subject to the contractual provisions or any collectability considerations. If the indemnified item is not recognised as a contingent liability at the acquisition date because its fair value is not reliably measurable, then, no indemnification asset is recognised at that date.

Employee benefits - Employee benefits are recognised and measured in accordance with IAS 19 ‘Employee Benefits’. Post-employment benefits and other long-term benefits are measured using actuarial assumptions as at the acquisition date. Those assumptions should be determined as at the acquisition date on the basis of the conditions existing at that date.

Any previous actuarial gains or losses recognised in other comprehensive income in the acquiree’s statement of financial position before the business combination takes place are not part of the business combination and should not be carried forward post business combination. Any net plan asset related to post-employment benefits and other long-term benefits recognised is limited to the extent that it will be available to either the acquirer or the acquiree, as the case may be, as refunds from the plan or a reduction of future contributions.

The effect of any settlement or curtailment is recognised in the measurement of the obligation only if it occurred before the acquisition date and if the decision to do a settlement or curtailment is not the decision of the acquirer. Any acquiree’s curtailment/settlement initiated at the request of the acquirer before the business combination is completed should not be part of the combination.

Alternatively, any amendment to the acquiree’s postemployment benefit plan conditioned to the business combination is a post combination event that should affect the acquirer post combination financial statements. Even if it is expected that the acquiree’s employees will benefit from the acquirer’s post-employment plan as from the acquisition date, this should not be taken into account when measuring the acquiree’s defined benefit obligation at the acquisition date.

Reacquired rights - Fair value is determined based on remaining contractual term of the related contract without attributing value to possible renewals. If the acquirer previously granted a right to the acquiree to use the acquirer’s intellectual property or other asset (such as a trade name or licensed technology), a separate ‘reacquired right’ intangible asset is recognised even if the underlying asset was not previously reported.

How should the identifiable assets and liabilities be measured?
How should the identifiable assets and liabilities be measured?
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IFRS 3’s specific guidance for reacquired rights

In a business combination, the acquirer may reacquire a right it had previously granted to the acquiree to use an acquirer’s asset. Such a reacquired right is an identifiable asset recognised separately, irrespective of whether the underlying asset was previously capitalised in the acquirer’s financial statements. For example, the acquirer may have previously granted the acquiree the right to use its trade name or a licence to use its technology. The business combination then results in the acquirer reacquiring this right, even if it continues in legal existence and will be used in the acquiree’s business in the future.

If the terms of the contract that gives rise to the reacquired right are either favourable or unfavourable compared to current market terms, the acquirer recognises a gain or loss on the acquisition date, separately from the business combination for the effective settlement of the pre-existing relationship. This latter aspect is discussed in our article ‘Insights into IFRS 3 – Determining what is part of a business combination transaction’.

Recognising and measuring deferred taxes when applying IFRS 3

IFRS 3 requires deferred taxes in a business combination to be recognised in accordance with IAS 12. Items to be recognised and measured in accordance with IAS 12 are as follows:

  • any deferred tax asset or liability arising from the assets acquired and liabilities assumed in the business combination, and
  • potential tax effects of temporary differences, carry forwards and income tax uncertainties of the acquiree that exist at acquisition date or that arise as a result of the combination.
Deferred tax assets
  • Acquirer perspective - As a result of a business combination, the probability of realising a pre‑acquisition deferred tax asset of the acquirer could change. Consequently, the acquirer recognises a change in the deferred tax asset in the period of the business combination. However, the acquirer does not include it as part of the accounting for the business combination. The probability may change if the acquirer now considers it probable that it will recover its own deferred tax asset that was not recognised before the business combination. For example, the acquirer may be able to utilise the benefit of its unused tax losses against the future taxable profit of the acquiree.

  • Acquiree perspective - The business combination may create new perspectives for the acquiree to use its existing tax losses because the acquiree may benefit from: • synergies generated by the acquisition • new distribution channel to sell its products, and • economies of scale that will affect its future earnings and capacity to consume its tax losses. These new factors could lead to the recognition of deferred tax assets on tax losses carry forward that were not recognised by the acquiree on its own.

When applying the above requirements, the acquirer does not recognise the historical deferred tax balances recorded in the acquiree’s own financial statements. Instead, a new acquisitiondate exercise is performed to determine deferred tax balances to be recognised. This may require careful analysis and judgement, taking into account:

  • the relevant tax laws in the jurisdiction(s) where the acquiree operates
  • the tax status of the acquiree
  • the nature of assets and liabilities recognised as part of the business combination
  • the specific tax rules that may give rise to differences between amounts recognised and the related tax bases, and
  • any tax losses carry forwards, uncertainties or other tax attributes of the acquiree.

How we can help

We hope you find the information in this article helpful in giving you some insight into IFRS 3. If you would like to discuss any of the points raised, please speak to your usual Grant Thornton contact or your local member firm.

IFRS 3 - Recognition principle
IFRS 3 - Recognition principle
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