Business combinations are infrequent transactions that are unique for each occurrence. IFRS 3 ‘Business Combinations’ contains the requirements and despite being fairly stable in the ten years since its been released, still provides challenges when accounting for these transactions in practice.
The acquisition method set out in IFRS 3 is applied from the point of view of the acquirer – the entity that obtains control over an acquiree which meets the definition of a business. An acquirer must therefore be identified whenever there is a business combination. This article explains how to identify the acquirer.
A critical point to note is the acquirer for IFRS 3 purposes (the accounting acquirer) may not always be the legal acquirer (the entity that becomes the legal parent, typically through ownership of majority voting power in the other combining entity).
What is IFRS 3’s approach to identifying the acquirer?
IFRS 3 initially directs an entity to IFRS 10 ‘Consolidated Financial Statements’ to identify the acquirer, and to consider which entity controls the other (ie the acquiree). In most business combinations identifying the acquirer is straightforward and is consistent with the transfer of legal ownership. However, the identification can be more complex for business combinations when:
- businesses are brought together by contract alone such that neither entity has legal ownership of the other
- a combination is affected by legal merger of two or more entities or through acquisition by a newly created parent entity
- there is no consideration transferred (combination by contract), or
- a smaller entity arranges to be acquired by a larger one.
In these more complex situations, IFRS 3 takes an in-substance approach to identifying the acquirer rather than relying solely on the legal form of the transaction. This in-substance approach looks beyond the rights of the combining entities themselves. It also considers the relative rights of the combining entities’ owners before and after the transaction. Combinations, where the acquirer of a business is the acquiree rather than the acquirer are reverse acquisitions and IFRS 3, provides specific guidance on how to account for these. Refer to page 6 for more details.
This means if, when applying the control guidance in IFRS 10, it is not clear which of the entities being combined is the acquirer, entities should revert back to IFRS 3 which provides additional indicators to consider, as outlined in the full article.
Examples involving the creation of a new entity
In practice, one of the most common situations, where the process of identifying the acquirer requires a more in-depth analysis, is when a new entity is formed to bring about a business combination. This can be done in many ways and sometimes can result in a ‘reverse acquisition’ which is explained on page 6. The full article also provides two examples of situations of when a new entity might be formed to bring about a business combination.
Business combination effected by exchanging equity interests
When considering a combination effected primarily by exchanging equity interests, other factors and circumstances shall also be considered such as:
- Relative voting rights in the combined entity - the acquirer is usually the entity whose owners as a group retain or receive the largest portion of the voting rights in the combined entity (see Example 3 [ 164 kb ]).
- Existence of a single large minority interest in the combined entity - the acquirer is usually the entity whose single owner or organised group of owners holds the largest minority voting interest in the combined entity, if no other owner or organised group of owners has a significant voting interest.
- Composition of the governing body of the combined entity - the acquirer is usually the entity whose owners have the ability to elect or appoint
or remove a majority of the members of the governing body of the combined entity.
- Senior management of the combined entity - the acquirer is usually the entity whose (former) management dominates the combined management.
- Terms of the exchange of equity interest - the acquirer is usually the entity that pays a premium over the pre-combination fair value of the equity interest of the other combining entity or entities.
It is important to note there is only ever one acquirer in a business combination. In those that involve more than two entities, it is important to consider which entity initiated the combination and the relative size of the combining entities.
Another common situation where the process of identifying the acquirer requires some in-depth analysis is when shares are exchanged, and the result is that the accounting acquirer is not the legal acquirer. Normally it is the entity who issues shares to acquire a business who obtains the control of the business it acquired. It is then identified as the acquirer. However, it could happen that following the issuance of the shares by the entity (legal acquirer), it is instead the legal subsidiary that is identified as the acquirer. These are known as reverse acquisitions.
One situation in which reverse acquisitions often arise is when a private operating entity is looking for a fast-track to a public listing. To accomplish this, the private entity arranges for its equity interests to be acquired by a smaller, publicly-listed entity. The listed entity effects the acquisition by issuing shares to the owners of the private operating entity. After the exchange of shares, the former shareholders of the private entity, as a group, hold the majority of the voting rights of the combined entity. In addition, the former shareholders of the private entity have appointed the majority of the members of the new combined entity’s board.
In this case, although the publicly-listed entity issued shares to acquire the private entity, the listed entity will be identified as the accounting acquiree and the private entity as the accounting acquirer. This is because the former shareholders of the private entity, as a group, have retained control over the private entity.
The accounting for reverse acquisitions depends on whether the accounting acquiree is a business. When the accounting acquiree is a business, the recognition and measurement principles in IFRS 3 apply, including the requirement to recognise goodwill. If the accounting acquiree is not a business, then it is outside the scope of IFRS 3.
Business combinations by contract alone
When a business combination is achieved by contract alone, such as a stapling arrangement, with no combining entity obtaining control of the other combining entities, the acquirer should usually be the combining entity whose owners (as a group) receive the largest portion of the voting rights in the combined entity. This matter was considered by the IFRIC and an agenda decision confirming this accounting treatment was issued in May 2014.
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, download our publication and speak to our Grant Thornton Bahrain contacts.