F1 6.01 IFRS 3 Business Combinations

In this session we shall look at IFRS 3 Business Combinations. This standard defines what a business is and describes what should happen when one company takes control of another.

Businesses and business combinations

IFRS 3 tells us that a business is an integrated set of activities and assets that is capable of being conducted and managed to provide a return to its owners.

Sometimes, one business might obtain control over another business. This can happen when a business has paid cash for another business, or has agreed to take over the other business’ liabilities or has obtained control through a contract. This process where a business takes over another business is called a business combination.

Business combinations

Where there is a business combination there is an acquirer, an acquiree and and acquisition date.

Identifying a business combination

Whenever an entity purchases any assets from another business it should consider whether the purchase represents a business combination. So it will ask itself whether as a result of the purchase, it now controls another business.

If the assets acquired are not a business, the entity will simply record their purchase as acquisitions of separate assets so, for example, a business buying goods for resale would record these as Purchases. If however, the entity has acquired another business then is a business combination has taken place and the purchase shall be accounted for using something called the “Acquisition Method.”


A company purchases a van from a wholesale business and agrees to take over the repayments of a loan associated with the vehicle. At the same time, the company purchases all the assets of a retail business and intends carrying on its trade.

The purchase of the van would not be considered a business combination as the van is not a business by itself. The purchase would therefore be recorded simply as the purchase of a motor vehicle and be added to the company’s Property, Plant and Equipment. The purchase of the retailer’s assets is the purchase of another business as all the assets have been acquired and the company intends to keep the business trading. This business combination will therefore be recorded using the acquisition method.

Axe Ltd has purchased the assets and taken over the liabilities of Handle & Co, a business previously owned and managed by Rex Handle. The assets that were purchased and the liabilities that were taken over were as described below:
1. All of Handle & Co’s property, plant and equipment except for a vehicle used by Rex Handle for both business and private travel
2. All of Handle & Co’s inventories and its trade receivables
3. All of Handle & Co’s trade payables
All other business assets (i.e. its bank balances) were taken by Rex Handle and other business liabilities (i.e. its VAT liability) were settled by Rex Handle.
Explain whether or not you believe the above purchase represents a business combination
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The transaction is a business combination. Axe Ltd has clearly purchased all the assets required in order to keep the business going and there is also an intention on the part of Axe Ltd to keep it trading. Those assets and liabilities that have not been taken over by Axe Ltd will not prevent the business from trading.

The Acquisition Method

The acquisition method consists of a series of steps.

Step 1 Identify the acquirer

For each business combination, one of the combining entities shall be identified as the acquirer (i.e. the entity that obtains control over the other) and the other shall be identified as the acquiree (i.e. the entity controlled by the other). In the vast majority of business combinations, identifying the acquirer is very simple and straightforward.

Clipper Ltd has purchased the share capital of Tea Ltd and on the same day it appointed three directors to manage Tea Ltd.
a) Who is the acquirer?
b) Who is the acquiree?
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a) Clipper Ltd

b) Tea Ltd

Step 2 Identify the acquisition date

The acquirer shall identify the acquisition date which is the date on which it obtained control of the acquiree.

The acquisition date is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree.

On 4th January 2021 Elver Ltd offered to purchase the share capital of Eel Ltd for £600,000. On 6th January 2021, the shareholders of Eel Ltd agreed to the offer subject to contract. On 23rd January 2021, the directors of both Elver Ltd and Eel Ltd signed the associated contract and the payment was made by Elver Ltd’s solicitors on the same day.
What is the acquisition date?

The acquisition date is 23rd January 2021 when payment was made and the contract was completed.

Step 3 Recognising and measuring assets, liabilities and non-controlling interests at the acquisition date

Assets at the acquisition date

The acquirer will record the values of all identifiable assets acquired from the business combination. By identifiable we mean that the assets can be separated from the entity and sold or they have arisen from contractual or legal rights (so it will record the values of property, plant and equipment, inventories, trade receivables and so on).

These different assets shall be measured at their fair value; that is the amount that they could be sold for in an orderly transaction between market participants (i.e. knowledgeable unrelated entities). In many cases, the assets’ fair values will be the same as their carrying values (i.e. the value recorded in the business’ books) but this is not necessarily so.

Liabilities at the acquisition date

The acquirer will also record the values of all liabilities taken over as a result of the business combination (e.g. trade payables, loans). These will again be measured at their fair values, that is, the price that would be paid to settle (or pay off) the liability in an orderly transaction between market participants.

Non-controlling interests

Lastly, the acquirer will calculate and record the value of the non-controlling interests in the acquiree. Sometimes an acquirer will obtain control of an acquiree but will not own all of the acquiree. For example, Company A might purchase, say 80% of Company B’s voting share capital. Company A will control Company B but 20% of Company B will be owned by other shareholders, and their share of Company B’s equity is known as the Non-Controlling Interests.

Ice Ltd has purchased the assets of Cube Ltd in a business combination. Included in these assets was a property with a carrying value of £125,000 and a fair value of £415,000.
At what value should the property acquired be recorded when using the acquisition method?
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The property should be recorded at its fair value; that is £415,000

Step 4 Recognise an measure goodwill or a gain from a bargain purchase

When one company purchases another, there is usually some goodwill generated on the purchase. IFRS 3 defines goodwill as “an asset representing the future economic benefits arising from the other assets acquired in a business combination that are not individially identified and separately recognised.”

To put it another way, when a business acquires another business it often pays more for it than the fair value of the identifiable assets and liabilities acquired. This additional amount is called goodwill and represents the value of assets that businesses do not measure in their books such as the value of staff and customer loyalty and good links with suppliers.

Bargain purchases

A bargain purchase is the opposite of goodwill (i.e. negative goodwill). It occurs when an acquirer obtains control over an acquiree at a price that is less than the value of their share of the identifiable assets and liabilities acquired. So they have obtained assets for less than they are really worth.

Bargain purchases are quite rare in practice but can be seen when the seller is acting under compulsion. For example, lets say that a chain of retail stores is having cash flow problems. In order to raise cash it decides to sell one of the stores and as it needs to raise cash quickly it offers the store at a low price to encourage buyers.

Measuring goodwill or a bargain purchase at the acquisition date

NB. Examples of how goodwill and bargain purchases are calculated in practice can be seen in session 6.03 Calculating Goodwill

On 1st March, Onyx Ltd purchased the whole share capital of Ebony Ltd for £750,000. On the same day, Ebony Ltd’s net identifiable assets had a carrying value of £492,000 and a fair value of £561,000.
What is the value of the goodwill arising from the purchase?
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The goodwill on acquisition was £189,000 (i.e. the amount paid of £750,000 less the fair value of the net identifiable assets of £561,000)

Treatment of Goodwill and Bargain Purchases

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