IFRS 3 or Indas 103 "Business Combination"

 Summary

Note: IFRS is international financial reporting Standards and IndAs is Indian Accounting Standards

A business combination is a transaction in which the acquirer obtains control of another business (the acquiree). 

Control: Control is defined by IFRS 10 or Ind As 110 

An investor controls an investee if and only if the investor has all the following:

• Power over the investee;
• exposure or rights to variable returns from its involvement with the investee; and
• the ability to use its power over the investee to affect the amount the investor's  return.

The above definition is very wide and control assessment does not depend only on voting rights instead it depends on the following as well:

• Potential voting rights;
• Rights of Non-controlling Shareholders (NCI);
• Other contractual right of the investor if those are substantive in nature.

TO ascertain control not only voting rights but also control over the board, potential voting rights shall also be considered.

To gain more understanding on Control one has to refer IFRS 10 or Ind As 110 as may be applicable.

Business:

The term 'business' is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities. 

Elements of Business:  Input----> Process----> output

• Input: Any economic resource that creates outputs or has the ability to contribute to the creation of outputs, when one or more processes are applied to it.
• Process: Any system, standard, protocol, convention or rule that when applied to an input or inputs, creates output or has the ability to contribute to the creations of outputs. 
• Output: The result of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities.  

To be capable of being conducted and managed for the purpose identified in the definition of a business, an integrated set of activities and assets requires two essential elements—inputs and processes applied to those inputs. Therefore, an integrated set of activities and assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output.

Concentration test to ascertain if the transaction constitute acquisition of Business or Acquisition of Assets. Ascertaining whether transaction is Business or Acquisition of asset is necessary because different accounting treatment is necessary for Business acquisition and asset acquisition.

Based on the concentration test:

If test is met ----> It is not a business (i.e it is an asset acquisition) and no further assessment is needed.

If test is not met ----> Further assessment is needed to conclude it as Business.

What is Concentration Test?

Concentration test is optional test and the decision to apply is made on a transaction to transaction basis.

It is a test to determine if substantially all of the fair value of Gross assets acquired is concentrated on single identifiable asset or Group of similar identifiable asset. ( For simplicity If fair value of all assets acquired is Rs. 100 and single Building out of such asset acquired has value of 90 then we can say that value of transaction is concentrated on single Building/asset ,so it's asset acquisition rather than business acquisition and shall be outside the purview of IFRS 3 or Ind As 103)

Test Process:

Fair Value of Gross Asset acquired calculation:

1. Calculate Fair value of consideration transferred (including fair value of non-controlling interest and fair value of previously interest held)
2. Calculate Fair value of liabilities assumed. 
3.  Add 1 and 2
4. Subtract :Cash and cash equivalent and deferred tax assets and goodwill resulting from DTL’s.

Method of Accounting under Business Combination:

Acquisition method of accounting is prescribed by Standard to account for Business Combination.

The Following are the key steps  involved in the acquisition accounting for business combinations:

• Step 1:  Identify the acquirer (This is necessary because acquisition accounting is done in the books of Accounting Acquirer).
• Step 2: Determine the Acquisition Date ( This is necessary because accounting is done on the date of acquisition, and this is the date on which the acquirer obtains control over acquiree. The date on which the acquirer obtains control of the acquiree is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree—the closing date).
• Step 3: Recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree (These three figures are required to be computed in order to derive the figure of step 4, also these are the figures which are to be reflected in the Financial statement of Acquirer); and
• Step 4: Recognising and measuring goodwill or a gain from a bargain purchase (Goodwill arises when asset acquired net of liablilities is less than the consideration transferred and Non-controlling interest (if any) for those assets acquired).

Non-controlling interest (NCI) means Interest of the shareholders of Acquiree entity who donot control the entity. For example: A ltd. acquires 80% interest in B i.e A has 80% right over B and remaining 20 % interest is held by many other investors. Here Those other investors who donot have control have non- controlling interest(i.e have interest but that interest is not sufficient to control), Normally controlling interest is achieved when more than 50% interest is held by the Investor , here in this case it is 80% so A controls B, however IFRS has laid down other criteria as well as stated above like power over board, other contractual terms etc.

In simple words:

On the date of Acquisition( DOA), Acquirer records in its books the assets acquired and liabilities assumed at fair value. Non- controlling Interest on such date is also computed and there are two methods for computing NCI:

• Proportionate share of Identifiable Net assets (INA) acquired (For example fair value of asset acquired is 110 liabilities assumed is 10, then INA is (110-10) 100, suppose 80 % interest is acquired then, 20% is NCI , In value It is 20% of 100= 20, Hence NCI under proportionate share method also called partial Goodwill method is 20)

• Non-controlling interests are measured at fair value : This method of measuring NCI is also known as full goodwill method. In the above example value of 20% NCI is measured at Fair value. i.e for simplicity fair value of 20% shares held are measured at Fair Value. Here in this case Fair value of INA is not considered. 

Apart from the above summary the standard has prescribed the accounting treatment for many other items such as, Share based payment awards, Contingent consideration, Contingent liability and many more... ...