## **Learning Outcomes**

After reading this article, you will be able to explain the scope and core principles of IFRS 3 for business combinations, identify when a business combination has occurred, outline each step of the acquisition method, distinguish between the two methods of measuring non-controlling interest (NCI), and accurately calculate and account for goodwill (including impairment) in consolidated financial statements. You will also recognise common exam pitfalls and apply acquisition accounting to practical SBR scenarios.

## **ACCA Strategic Business Reporting (SBR) Syllabus**

For ACCA Strategic Business Reporting (SBR), you are required to understand and apply the main requirements of IFRS 3 Business Combinations, especially as they relate to group accounting and consolidated statements. Be prepared to:

- Determine whether a transaction is a business combination under IFRS 3
- Evaluate and apply the acquisition method, including identifying the acquirer and acquisition date
- Recognise and measure the subsidiary’s identifiable net assets at fair value, including intangible assets and contingent liabilities
- Calculate and account for goodwill (and any gain on bargain purchase)
- Distinguish and apply the two methods for measuring non-controlling interest at acquisition
- Account for post-acquisition impairment of goodwill, allocating impairment between group and NCI
- Prepare consolidation adjustments for business combinations in line with SBR exam requirements

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Under IFRS 3, what are the four main steps of the acquisition method?
2. Entity A acquires 70% of Entity B and pays \$2 million cash plus \$1 million shares (total fair value). The fair value of B's identifiable net assets is \$3.5 million. Non-controlling interest (NCI) at acquisition is measured at \$1.2 million. Calculate the goodwill arising on acquisition.
3. True or false? Internally generated brands acquired in a business combination are never recognised separately from goodwill.
4. How does the consolidation accounting differ if NCI is measured at (a) fair value versus (b) proportionate share of net assets? Briefly explain.
5. Explain what “contingent consideration” is, and how it is measured in the acquisition method.

## **Introduction**

Business combinations are fundamental to group accounting. IFRS 3 _Business Combinations_ sets out the rules for accounting for acquisitions, ensuring consolidated statements reflect the economic substance of the transaction. Its principles apply whenever an entity obtains control of a business, not just the purchase of shares.

At the centre of IFRS 3 is the **acquisition method**, which aims to represent the combination faithfully by recognising all identifiable assets and liabilities at fair value and recognising any goodwill or gain on bargain purchase. This article provides a focused guide to the key steps, NCI choices, calculation and subsequent review of goodwill, and related consolidation adjustments.

> **Key Term: business combination**
> A transaction or event in which an acquirer obtains control of a business (an integrated set of activities and assets capable of being conducted for economic benefit).
>
> **Key Term: acquisition method**
> The process required by IFRS 3 for accounting for business combinations, involving identification of the acquirer, determination of the acquisition date, recognition and measurement of the identifiable assets and liabilities, and recognition of goodwill or a gain on bargain purchase.

## **Identifying a Business Combination**

A business combination only occurs when one entity obtains **control** over a business. Control usually arises when more than 50% of voting rights are acquired, but can also result from contractual arrangements or existing rights.

The target must meet the **business** definition, meaning it has inputs and processes applied to those inputs capable of producing outputs. Purchasing a collection of assets that does not constitute a business is accounted for as an asset purchase, not under IFRS 3.

> **Key Term: control**
> The power to govern the financial and operating policies of an entity to obtain benefits from its activities.

## **The Acquisition Method: Core Steps**

IFRS 3 requires application of the **acquisition method**, comprising four mandatory steps:

1. **Identify the acquirer** – the entity obtaining control.
2. **Determine the acquisition date** – when the acquirer obtains control.
3. **Recognise and measure the identifiable net assets acquired and any non-controlling interest**, all at fair value.
4. **Recognise goodwill (or a gain on bargain purchase)**, calculated as the difference between consideration transferred (plus NCI) and net assets acquired.

### Acquisition Method in Detail

### 1. Identify the Acquirer

The acquirer is generally the combining entity that transfers cash, assets, or incurs liabilities to effect the combination. If not obvious, consider factors such as who has the largest voting interest or who holds the majority representation on the new board.

### 2. Acquisition Date

The acquisition date is the date when the acquirer effectively takes control of the business. All assets, liabilities, and NCI values are determined at this point.

### 3. Recognition and Measurement of Net Assets and NCI

All identifiable assets and liabilities of the subsidiary must be recognised at fair value at the acquisition date, including:

- Tangible and intangible assets (such as brands or customer relationships)
- Contingent liabilities (if their fair value can be measured reliably)
- Deferred tax assets/liabilities, measured per IAS 12

NCI can be measured in two ways:

- At **fair value** (full goodwill method)
- At the NCI’s **proportionate share of the subsidiary’s net identifiable assets** at fair value (partial goodwill method)

> **Key Term: non-controlling interest (NCI)**
> The equity in a subsidiary not attributable, directly or indirectly, to the parent.
>
> **Key Term: goodwill**
> The excess of (a) the sum of the consideration transferred, any NCI, and any previously held interest over (b) the fair value of the identifiable net assets acquired.

### 4. Measurement and Recognition of Consideration

Consideration transferred includes cash, shares issued, contingent consideration, and fair value of any previously held interests. Contingent consideration is measured at fair value on the acquisition date, regardless of probability of settlement.

Transaction costs (e.g., legal and advisory fees) are **expensed** as incurred. Only costs that relate to issuing equity or debt instruments may be included in the measurement of those instruments.

> **Key Term: contingent consideration**
> Additional consideration payable or receivable contingent on future events, measured at fair value at the acquisition date.

## **Goodwill Calculation and Recognition**

Goodwill is recognised when the total consideration (including NCI) exceeds the fair value of net identifiable assets acquired. If the calculation yields a negative figure, a gain on bargain purchase is recognised immediately in profit or loss, after reassessment of asset and liability values.

Goodwill is not amortised. Instead, it must be tested for impairment annually, or sooner if there is an indication of impairment. The impairment loss is allocated first to goodwill and then to other assets of the cash-generating unit.

The method chosen to value NCI at acquisition (fair value or proportionate share of net assets) affects both the amount of goodwill recognised and how impairment losses are allocated between parent and NCI.

### Worked Example 1.1

**Koco Ltd acquires 70% of Lema Ltd for \$2 million cash and \$1 million in the acquirer’s own shares (fair value). The identifiable net assets of Lema have a fair value of \$3.5 million. The fair value of NCI at acquisition is \$1.2 million. What is the goodwill arising on acquisition?**

> **Answer:**
> Total consideration = \$2 million (cash) + \$1 million (shares) = \$3 million. Add NCI at fair value: \$1.2 million. Aggregate: \$4.2 million.  
> Deduct net assets acquired: \$4.2 million – \$3.5 million = **\$0.7 million goodwill** is recognised.

### **Worked Example 1.2**

**Star plc purchases 80% of Parker Ltd for \$4 million. The fair value of Parker’s identifiable net assets is \$5 million. NCI at acquisition is measured as 20% of net assets (\$1 million). Calculate goodwill using the (a) fair value method and (b) proportionate share method.**

> **Answer:**
> (a) Fair value method: Consideration \$4m + NCI fair value (\$1.2m, e.g., if a quoted market price) – Net assets \$5m = Goodwill \$0.2m  
> (b) Proportionate net assets method: Consideration \$4m + NCI at 20% × \$5m = \$1m – Net assets \$5m = Goodwill \$0m  
> The choice of NCI valuation alters the amount of goodwill recognised.

### **Worked Example 1.3**

**On acquisition, Millar Ltd identifies an unrecognised brand in the subsidiary with a fair value of \$400,000. Should Millar recognise this brand separately from goodwill in the group accounts?**

> **Answer:**
> Yes. If the brand is separable or arises from contractual rights and its fair value can be reliably measured, it is recognised as a separate intangible asset at fair value. It reduces the amount attributed to goodwill.

### **Exam Warning**

> In calculation or discussion questions, always specify the method used to measure NCI. Give clear workings for goodwill, showing all elements (consideration, NCI, identifiable net assets). Mistaking the treatment of transaction costs or contingent consideration is a frequent source of lost marks.

## **Impairment of Goodwill and Allocation**

After initial recognition, goodwill is reviewed for impairment at least annually. An impairment loss reduces the carrying amount of goodwill and is recognised in profit or loss. Under the fair value method, impairment is split between the group and NCI according to shareholding percentages. Under the proportionate method, only the group's share is recognised in consolidated profit or loss.

> **Key Term: impairment**
> A reduction in the recoverable amount of an asset or cash-generating unit (including goodwill) below its carrying amount.

## **Summary**

The IFRS 3 acquisition method ensures group financial statements show a faithful representation of a business combination. The acquirer recognises all identifiable net assets of the acquired business at fair value, measures NCI using the chosen method, and recognises any goodwill or gain on bargain purchase. Goodwill is subject to regular impairment review, with the method of NCI measurement affecting subsequent impairment allocation.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define a business combination under IFRS 3 and identify when it applies
- Outline the four steps of the acquisition method
- Distinguish between the fair value and proportionate share methods of measuring NCI
- Calculate and recognise goodwill (and gain on bargain purchase)
- Explain the recognition of transaction costs and contingent consideration
- Understand post-acquisition impairment of goodwill and allocation between group and NCI

## **Key Terms and Concepts**

- business combination
- acquisition method
- control
- non-controlling interest (NCI)
- goodwill
- contingent consideration
- impairment

Business combinations (ifrs 3) - Acquisition method and goodwill