The new business combinations standard: IFRS 3

IFRS 3, ‘Business Combinations’, is the IFRS accounting standard that outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition or merger). The standard does not apply to the acquisition of an asset or group of assets that do not meet the definition of a business.

By Akinyemi Awodumila

Differences in accounting between business combinations and asset acquisitions include, among other things, the recognition of goodwill, recognition and measurement of contingent consideration, accounting for transaction costs and deferred tax accounting.

On 22 October 2018, the IASB issued amendments to the guidance in IFRS 3 that revises the definition of a business. According to feedback received by the IASB, application of the current guidance is commonly thought to be too complex, and it results in too many transactions qualifying as business combinations.

What is the issue? To be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs. The new guidance provides a framework to evaluate when an input and a substantive process are present (including for early stage companies that have not generated outputs). To be a business without outputs, there will now need to be an organised workforce.

The definition of the term ‘outputs’ is narrowed to focus on goods and services provided to customers, generating investment income and other income, and it excludes returns in the form of lower costs and other economic benefits. It is also no longer necessary to assess whether market participants are capable of replacing missing elements or integrating the acquired activities and assets.

An entity can apply a ‘concentration test’ that, if met, eliminates the need for further assessment. Under this optional test, where substantially all of the fair value of gross assets acquired is concentrated in a single asset (or a group of similar assets), the assets acquired would not represent a business.

What’s the impact and for whom? The changes to the definition of a business will likely result in more acquisitions being accounted for as asset acquisitions across all industries, particularly real estate, pharmaceutical, and oil and gas. Application of the changes would also affect the accounting for disposal transactions. Application of the changes will also affect the accounting for disposal transactions, since the requirements of IFRS 10, ‘Consolidated Financial Statements’, apply to the recognition of proceeds from the sale of a business, whereas the requirements of IFRS 15, ‘Revenue From Contracts With Customers’ apply to the recognition of proceeds from the sale of an asset.

When does it apply? Entities shall apply these amendments to business combinations for which the acquisition date is on or after the beginning of the first annual reporting periods beginning on or after 1 January 2020 and to asset acquisitions that occur on or after the beginning of that period. Early application is permitted.

Akinyemi Awodumila

Associate Director, Assurance at PwC Kenya

E: T: +254 20 285 5000

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