International Financial Reporting Standard (IFRS) 3 «Business Combinations»

contingent liability

Contingent liability has the meaning given to it in IAS 37

Provisions, Contingent Liabilities and Contingent Assets, ie:

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

(b) a present obligation that arises from past events but is not recognised because:

(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

(ii) the amount of the obligation cannot be measured with sufficient reliability.

control The power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities.

date of exchange When a business combination is achieved in a single exchange transaction, the date of exchange is the acquisition date. When a business combination involves more than one exchange transaction, for example when it is achieved in stages by successive share purchases, the date of exchange is the date that each individual investment is recognised in the financial statements of the acquirer.

fair value The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

goodwill Future economic benefits arising from assets that are not capable of being individually identified and separately recognised.

intangible asset Intangible asset has the meaning given to it in IAS 38 Intangible Assets, ie an identifiable non-monetary asset without physical substance.

joint venture Joint venture has the meaning given to it in IAS 31 Interests in Joint Ventures, ie a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control.

minority interest That portion of the profit or loss and net assets of a subsidiary

attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent.

mutual entity An entity other than an investor-owned entity, such as a mutual insurance company or a mutual cooperative entity, that provides lower costs or other economic benefits directly and proportionately to its policyholders or participants.

parent An entity that has one or more subsidiaries.

probable More likely than not.

reporting entity An entity for which there are users who rely on the entity's general purpose financial statements for information that will be useful to them for making decisions about the allocation of resources. A reporting entity can be a single entity or a group comprising a parent and all of its subsidiaries.

subsidiary An entity, including an unincorporated entity such as a partnership, that is controlled by another entity (known as the parent).

Appendix B

Application supplement

This appendix is an integral part of the IFRS.

Reverse acquisitions

B1 As noted in paragraph 21, in some business combinations, commonly referred to as reverse acquisitions, the acquirer is the entity whose equity interests have been acquired and the issuing entity is the acquiree. This might be the case when, for example, a private entity arranges to have itself 'acquired' by a smaller public entity as a means of obtaining a stock exchange listing. Although legally the issuing public entity is regarded as the parent and the private entity is regarded as the subsidiary, the legal subsidiary is the acquirer if it has the power to govern the financial and operating policies of the legal parent so as to obtain benefits from its activities.

B2 An entity shall apply the guidance in paragraphs B3-B15 when accounting for a reverse acquisition.

B3 Reverse acquisition accounting determines the allocation of the cost of the business combination as at the acquisition date and does not apply to transactions after the combination.

Cost of the business combination

B4 When equity instruments are issued as part of the cost of the business combination, paragraph 24 requires the cost of the combination to include the fair value of those equity instruments at the date of exchange. Paragraph 27 notes that, in the absence of a reliable published price, the fair value of the equity instruments can be estimated by reference to the fair value of the acquirer or the fair value of the acquiree, whichever is more clearly evident.

B5 In a reverse acquisition, the cost of the business combination is deemed to have been incurred by the legal subsidiary (ie the acquirer for accounting purposes) in the form of equity instruments issued to the owners of the legal parent (ie the acquiree for accounting purposes). If the published price of the equity instruments of the legal subsidiary is used to determine the cost of the combination, a calculation shall be made to determine the number of equity instruments the legal subsidiary would have had to issue to provide the same percentage ownership interest of the combined entity to the owners of the legal parent as they have in the combined entity as a result of the reverse acquisition. The fair value of the number of equity instruments so calculated shall be used as the cost of the combination.

B6 If the fair value of the equity instruments of the legal subsidiary is not otherwise clearly evident, the total fair value of all the issued equity instruments of the legal parent before the business combination shall be used as the basis for determining the cost of the combination.

Preparation and presentation of consolidated financial statements

B7 Consolidated financial statements prepared following a reverse acquisition shall

be issued under the name of the legal parent, but described in the notes as a continuation of the financial statements of the legal subsidiary (ie the acquirer for accounting purposes). Because such consolidated financial statements represent a continuation of the financial statements of the legal subsidiary:

(a) the assets and liabilities of the legal subsidiary shall be recognised and measured in those consolidated financial statements at their pre-combination carrying amounts.

(b) the retained earnings and other equity balances recognised in those consolidated financial statements shall be the retained earnings and other equity balances of the legal subsidiary immediately before the business combination.

(c) the amount recognised as issued equity instruments in those consolidated financial statements shall be determined by adding to the issued equity of the legal subsidiary immediately before the business combination the cost of the combination determined as described in paragraphs B4-B6. However, the equity structure appearing in those consolidated financial statements (ie the number and type of equity instruments issued) shall reflect the equity structure of the legal parent, including the equity instruments issued by the legal parent to effect the combination.

(d) comparative information presented in those consolidated financial statements shall be that of the legal subsidiary.

B8 Reverse acquisition accounting applies only in the consolidated financial

statements. Therefore, in the legal parent's separate financial statements, if any, the investment in the legal subsidiary is accounted for in accordance with the requirements in IAS 27 Consolidated and Separate Financial Statements on accounting for investments in an investor's separate financial statements.

B9 Consolidated financial statements prepared following a reverse acquisition shall reflect the fair values of the assets, liabilities and contingent liabilities of the legal parent (ie the acquiree for accounting purposes). Therefore, the cost of the business combination shall be allocated by measuring the identifiable assets, liabilities and contingent liabilities of the legal parent that satisfy the recognition criteria in paragraph 37 at their fair values at the acquisition date. Any excess of the cost of the combination over the acquirer's interest in the net fair value of those items shall be accounted for in accordance with paragraphs 51-55. Any excess of the acquirer's interest in the net fair value of those items over the cost of the combination shall be accounted for in accordance with paragraph 56.

Minority interest

B10 In some reverse acquisitions, some of the owners of the legal subsidiary do not exchange their equity instruments for equity instruments of the legal parent. Although the entity in which those owners hold equity instruments (the legal subsidiary) acquired another entity (the legal parent), those owners shall be treated as a minority interest in the consolidated financial statements prepared after the reverse acquisition. This is because the owners of the legal subsidiary that do not exchange their equity instruments for equity instruments of the legal parent have an interest only in the results and net assets of the legal subsidiary, and not in the results and net assets of the combined entity. Conversely, all of the owners of the legal parent, notwithstanding that the legal parent is regarded as the acquiree, have an interest in the results and net assets of the combined entity.

B11 Because the assets and liabilities of the legal subsidiary are recognised and measured in the consolidated financial statements at their pre-combination carrying amounts, the minority interest shall reflect the minority shareholders' proportionate interest in the pre-combination carrying amounts of the legal subsidiary's net assets.

Earnings per share

B12 As noted in paragraph B7(c), the equity structure appearing in the consolidated financial statements prepared following a reverse acquisition reflects the equity structure of the legal parent, including the equity instruments issued by the legal parent to effect the business combination.

B13 For the purpose of calculating the weighted average number of ordinary shares outstanding (the denominator) during the period in which the reverse acquisition occurs:

(a) the number of ordinary shares outstanding from the beginning of that period to the acquisition date shall be deemed to be the number of ordinary shares issued by the legal parent to the owners of the legal subsidiary; and

(b) the number of ordinary shares outstanding from the acquisition date to the end of that period shall be the actual number of ordinary shares of the legal parent outstanding during that period.

B14 The basic earnings per share disclosed for each comparative period before the acquisition date that is presented in the consolidated financial statements following a reverse acquisition shall be calculated by dividing the profit or loss of the legal subsidiary attributable to ordinary shareholders in each of those periods by the number of ordinary shares issued by the legal parent to the owners of the legal subsidiary in the reverse acquisition.

B15 The calculations outlined in paragraphs B13 and B14 assume that there were no changes in the number of the legal subsidiary's issued ordinary shares during the comparative periods and during the period from the beginning of the period in which the reverse acquisition occurred to the acquisition date. The calculation of earnings per share shall be appropriately adjusted to take into account the effect of a change in the number of the legal subsidiary's issued ordinary shares during those periods.

Allocating the cost of a business combination

B16 This IFRS requires an acquirer to recognise the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the relevant recognition criteria at their fair values at the acquisition date. For the purpose of allocating the cost of a business combination, the acquirer shall treat the following measures as fair values:

(a) for financial instruments traded in an active market the acquirer shall use current market values.

(b) for financial instruments not traded in an active market the acquirer shall use estimated values that take into consideration features such as price-earnings ratios, dividend yields and expected growth rates of comparable instruments of entities with similar characteristics.

(c) for receivables, beneficial contracts and other identifiable assets the acquirer shall use the present values of the amounts to be received, determined at appropriate current interest rates, less allowances for uncollectibility and collection costs, if necessary. However, discounting is not required for short-term receivables, beneficial contracts and other identifiable assets when the difference between the nominal and discounted amounts is not material.

(d) for inventories of:

(i) finished goods and merchandise the acquirer shall use selling prices less the sum of (1) the costs of disposal and (2) a reasonable profit allowance for the selling effort of the acquirer based on profit for similar finished goods and merchandise;

(ii) work in progress the acquirer shall use selling prices of finished goods less the sum of (1) costs to complete, (2) costs of disposal and (3) a reasonable profit allowance for the completing and selling effort based on profit for similar finished goods; and

(iii) raw materials the acquirer shall use current replacement costs.

(e) for land and buildings the acquirer shall use market values.

(f) for plant and equipment the acquirer shall use market values, normally determined by appraisal. If there is no market-based evidence of fair value because of the specialised nature of the item of plant and equipment and the item is rarely sold, except as part of a continuing business, an acquirer may need to estimate fair value using an income or a depreciated replacement cost approach.

(g) for intangible assets the acquirer shall determine fair value:

(i) by reference to an active market as defined in IAS 38 Intangible Assets', or

(ii) if no active market exists, on a basis that reflects the amounts the acquirer would have paid for the assets in arm's length transactions between knowledgeable willing parties, based on the best information available (see IAS 38 for further guidance on determining the fair values of intangible assets acquired in business combinations).

(h) for net employee benefit assets or liabilities for defined benefit plans the acquirer shall use the present value of the defined benefit obligation less the fair value of any plan assets. However, an asset is recognised only to the extent that it is probable it will be available to the acquirer in the form of refunds from the plan or a reduction in future contributions.

(i) for tax assets and liabilities the acquirer shall use the amount of the tax benefit arising from tax losses or the taxes payable in respect of profit or loss in accordance with IAS 12 Income Taxes, assessed from the perspective of the combined entity. The tax asset or liability is determined after allowing for the tax effect of restating identifiable assets, liabilities and contingent liabilities to their fair values and is not discounted.

(j) for accounts and notes payable, long-term debt, liabilities, accruals and other claims payable the acquirer shall use the present values of amounts to be disbursed in settling the liabilities determined at appropriate current interest rates. However, discounting is not required for short-term liabilities when the difference between the nominal and discounted amounts is not material.

(k) for onerous contracts and other identifiable liabilities of the acquiree the acquirer shall use the present values of amounts to be disbursed in settling the obligations determined at appropriate current interest rates.

(l) for contingent liabilities of the acquiree the acquirer shall use the amounts that a third party would charge to assume those contingent liabilities. Such an amount shall reflect all expectations about possible cash flows and not the single most likely or the expected maximum or minimum cash flow.

B17 Some of the above guidance requires fair values to be estimated using present value techniques. If the guidance for a particular item does not refer to the use of present value techniques, such techniques may be used in estimating the fair value of that item.

Appendix C

Amendments to other IFRSs

The amendments in this appendix shall be applied to the accounting for business combinations for which the agreement date is on or after 31 March 2004, and to the accounting for any goodwill and intangible assets acquired in those business combinations. In all other respects, these amendments shall be applied for annual periods beginning on or after 31 March 2004.

However, if an entity elects in accordance with paragraph 85 to apply JFRS 3 from any date before the effective dates outlined in paragraphs 78-84, it shall also apply these amendments prospectively from that same date.

The amendments contained in this appendix when this JFRS was issued in 2004 have been incorporated into the relevant pronouncements published in this volume.

Approval of IFRS 3 by the Board

International Financial Reporting Standard 3 Business Combinations was approved for issue by twelve of the fourteen members of the International Accounting Standards Board. Professor Whittington and Mr Yamada dissented. Their dissenting opinions are set out after the Basis for Conclusions on IFRS 3.

Sir David Tweedie Chairman

Thomas E Jones Vice-Chairman

Mary E Earth

Hans-Georg Bruns

Anthony T Cope

Robert P Garnett

Gilbert Gelard

James J Leisenring

Warren J McGregor

Patricia L O'Malley

Harry K Schmid

John T Smith

Geoffrey Whittington

Tatsumi Yamada

DISSENTING OPINIONS ON IFRS 3

Basis for Conclusions on

IFRS 3 Business Combinations

This Basis for Conclusions accompanies, but is not part of, IFRS 3.

Introduction

BC1 This Basis for Conclusions summarises the Board's considerations in reaching the conclusions in IFRS 3 Business Combinations. Individual Board members gave greater weight to some factors than to others.

BC2 IAS 22 Business Combinations (revised in 1998) specified the accounting for business combinations. In 2001 the Board began a project to review IAS 22 as part of its initial agenda, with the objective of improving the quality of, and seeking international convergence on, the accounting for business combinations. The Board's project on business combinations has two phases. As part of the first phase, the Board published in December 2002 ED 3 Business Combinations, together with an Exposure Draft of proposed related amendments to IAS 38 Intangible Assets and IAS 36 Impairment of Assets, with a comment deadline of 4 April 2003. The Board received 136 comment letters.

BC3 The first phase resulted in the Board issuing simultaneously the IFRS and revised versions of IAS 36 and IAS 38. The Board's intention in developing the IFRS as part of the first phase of the project was not to reconsider all of the requirements in IAS 22. Instead, the Board's primary focus was on:

(a) the method of accounting for business combinations;

(b) the initial measurement of the identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination;

(c) the recognition of liabilities for terminating or reducing the activities of an acquiree;

(d) the treatment of any excess of the acquirer's interest in the fair value of identifiable net assets acquired in a business combination over the cost of the combination; and

(e) the accounting for goodwill and intangible assets acquired in a business combination.

BC4 Therefore, a number of the requirements in the IFRS were carried forward from IAS 22 without reconsideration by the Board. This Basis for Conclusions identifies those requirements but does not discuss them in detail.

BC5 The second phase of the Business Combinations project includes consideration of:

(a) issues arising in respect of the application of the purchase method, including its application to:

(i) business combinations involving two or more mutual entities; and

(ii) business combinations in which separate entities are brought together to form a reporting entity by contract alone without the

obtaining of an ownership interest. This includes combinations in which separate entities are brought together by contract to form a dual listed corporation.

(b) the accounting for business combinations in which separate entities or businesses are brought together to form a joint venture, including possible applications for 'fresh start' accounting.

(c) the accounting for business combinations involving entities under common control.

Definition of a business combination

BC6 A business combination is defined in the IFRS as 'the bringing together of separate entities or businesses into one reporting entity'.

BC7 The Board concluded that the definition of a business combination should be broad enough to encompass all transactions that meet the business combination definition in IAS 22, ie all transactions or other events in which separate entities or businesses are brought together into one economic entity, regardless of the form of the transaction. In developing ED 3 and the ensuing IFRS, the Board considered the following description contained in the US Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 141 Business Combinations (SFAS 141):

a business combination occurs when an entity acquires net assets that constitute a business or acquires equity interests of one or more other entities and obtains control over that entity or entities, (paragraph 9)

BC8 The Board was concerned whether the above description would, in fact, encompass all transactions or other events in which separate entities or businesses are brought together into one economic entity. That concern stemmed from the use of the term 'acquires’ in the above description, and its implication that a business combination is always the result of one entity acquiring control of one or more other entities or businesses, ie that all business combinations are acquisitions. The Board concluded that it should not rule out the possibility of some transaction or other event occurring or being structured in which separate entities or businesses are brought together into one economic entity, but without one of the combining entities acquiring control of the other combining entities or businesses. Therefore, the Board decided to develop a more general definition.

BC9 Given the Board's desire for the definition to encompass all transactions or other events that are, in substance, business combinations, regardless of their form, the Board decided to retain the IAS 22 definition, but with two modifications. The first was to remove the reference in that definition to the form that IAS 22 asserts a business combination might take (ie a uniting of interests or an acquisition). The second was to replace the reference to ‘economic entity’ with 'reporting entity’ for consistency with the lASB's Framework for the Preparation and Presentation of Financial Statements. Paragraph 8 of the Framework states that it is concerned with the financial statements of reporting enterprises, and that a reporting enterprise is 'an enterprise for which there are users who rely on the financial statements as their major source of financial information about the enterprise.' The definition of reporting entity in the IFRS also clarifies that a reporting entity can be a single entity or a group comprising a parent and all of its subsidiaries.

Definition of a business

BC10 ED 3 proposed to define a business combination as 'the bringing together of separate entities or operations of entities into one reporting entity’. Many respondents to ED 3 asked for additional guidance on identifying when an entity or a group of assets or net assets comprises an operation and when, therefore, the acquisition of an entity or a group of assets or net assets should be accounted for in accordance with the IFRS. As a result:

(a) references in ED 3 to 'operations' have been replaced in the IFRS with 'businesses’.

(b) 'business’ has been defined in the IFRS (Appendix A) as follows:

An integrated set of activities and assets conducted and managed for the purpose of providing:

(a) a return to investors; or

(b) lower costs or other economic benefits directly and proportionately to policyholders or participants.

A business generally consists of inputs, processes applied to those inputs, and resulting outputs that are, or will be, used to generate revenues. If goodwill is present in a transferred set of activities and assets, the transferred set shall be presumed to be a business.

(c) additional guidance has been included in the IFRS to clarify that if an entity obtains control over one or more other entities that are not businesses, the bringing together of those entities is not a business combination. When a group of assets that does not constitute a business is acquired, the cost of the group of assets should be allocated between the individual identifiable assets in the group based on their relative fair values.

Replacing 'operations' with 'businesses'

EC11 As noted above, ED 3 proposed to define a business combination as 'the bringing together of separate entities or operations of entities into one reporting entity’. The Board observed that the definition of a discontinuing operation in IAS 35 Discontinuing Operations incorporates a definition of an operation for the purpose of applying the requirements in IAS 35. Similarly, the IFRS arising from ED 4 Disposal of Non-current Assets and Presentation of Discontinued Operations will include a definition of an operation to ensure its consistent application. The Board decided that it should eliminate any possible connection between the IFRS and the notion of an operation embedded in any current or future Standard on discontinuing operations. Therefore, the Board decided to replace references to operations in ED 3 with businesses, and to include in the IFRS guidance on identifying when an entity or a group of assets or net assets constitutes a business.

Defining a business

BC12 Given its objective of seeking international convergence on the accounting for business combinations, the Board considered as its starting point the definition of a business and the related guidance in the US Emerging Issues Task Force (EITF) Consensus 98-3 Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business. For the reasons discussed in paragraphs BC13-BC15, the Board decided to proceed with a definition of a business that differs from the EITF's definition in the following ways:

(a) the IFRS definition does not require a business to be self-sustaining;

(b) the IFRS definition does not include a presumption that a transferred set of activities and assets in the development stage that has not commenced planned principal operations cannot be a business;

(c) the IFRS definition includes a presumption that a transferred set of activities and assets is a business when that transferred set includes goodwill; and

(d) the IFRS definition can also be applied in assessing whether an integrated set of activities and assets of a mutual entity is a business.

BC13 A transferred set of activities and assets must be self-sustaining to meet the EITF's definition of a business. The Board concluded that such a requirement is too narrow because it excludes some transferred sets of activities and assets that include goodwill (ie future economic benefits arising from assets that are not capable of being individually identified and separately recognised) and are, in substance, businesses. For example, the EITF's definition excludes from business combination accounting transactions in which one entity (the acquirer) acquires a business (the acquiree) with the intention of completely integrating the acquiree with its existing operations, but without taking over the acquiree's systems and senior management. Indeed, not taking over the existing systems and senior management may be a major part of the synergistic cost savings the acquirer is striving to achieve through the business combination. The Board concluded that an acquirer's decision not to retain all of the employees and not to acquire systems does not mean the net assets it acquired are not a business.

BC14 EITF 98-3 includes the presumption that if a transferred set of activities and assets is in the development stage and has not commenced planned principal operations, the set cannot be a business. The Board observed that a development stage entity might often include significant resources in the nature of goodwill. Those resources might arise, for example, from employment contracts with development engineers, a new technology nearing the final stage of development, the work performed to develop markets and customers or protocols and systems. The Board concluded that it would be more representationally faithful to account for the acquisition of such a transferred set as a business combination, thereby recognising any goodwill as a separate asset rather than having the value attributable to that goodwill subsumed within the carrying amounts of the other assets in the transferred set. Therefore, the Board decided not to include a similar presumption in the IFRS. The Board further concluded that to be representationally faithful, any transferred set of assets that includes goodwill should be accounted for as a business combination. Therefore, the Board decided that the definition of a business should include a presumption that if a transferred set of activities and assets includes goodwill, the transferred set should be presumed to be a business.

BC15 The EITF's definition states that the set of assets must be managed for the purpose of 'providing a return to investors'. The Board agreed that this would preclude sets of activities and assets of mutual entities from being regarded as businesses when those sets are, in substance, businesses. This is because a mutual entity is defined in the IFRS as 'an entity other than an investor-owned entity, such as a mutual insurance company or a mutual cooperative entity, that provides lower costs or other economic benefits directly and proportionately to its policyholders or participants.' The Board decided that:

(a) the definition of a business should be able to be applied in assessing whether an integrated set of activities and assets of a mutual entity is a business; and

(b) therefore, a business should be defined in the IFRS as an integrated set of activities and assets conducted and managed for the purpose of providing a return to investors or lower costs or other economic benefits directly and proportionately to policyholders or participants.

Scope

Scope exclusions (paragraphs 2 and 3)

BC16 The IFRS does not apply to:

(a) business combinations in which separate entities or businesses are brought together to form a joint venture.

(b) business combinations involving entities or businesses under common control.

(c) business combinations involving two or more mutual entities.

(d) business combinations in which separate entities or businesses are brought together to form a reporting entity by contract alone without the obtaining of an ownership interest (for example, combinations in which separate entities are brought together by contract alone to form a dual listed corporation).