Business combinations (ifrs 3) - Step acquisitions and conti...

Learning Outcomes

After reading this article, you should be able to explain the accounting treatment for business combinations achieved in stages (step acquisitions) under IFRS 3. You will understand how to remeasure previously held interests at fair value, recognize resulting gains or losses, and account for contingent consideration as part of the cost of the business combination. You will be equipped to apply these principles to ACCA SBR exam scenarios.

ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you are required to understand both the technical requirements and fundamental reasoning for group accounting issues. This article links to the following ACCA SBR syllabus areas:

• Evaluate and apply the principles behind business combinations, including identifying an acquirer and determining the cost of a business combination.
• Evaluate and apply the accounting principles relating to business combinations achieved in stages (step acquisitions).
• Justify the recognition and measurement criteria used for contingent amounts (including contingent consideration) in business combinations.
• Determine and apply appropriate procedures for preparing consolidated financial statements following changes in group structure.

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. When an entity increases its interest in a company from 30% to 60%, thereby gaining control, how must the previously held interest be accounted for under IFRS 3?
   1. Continue using the existing carrying amount
   2. Measure at fair value, recognize any gain or loss in profit or loss
   3. Ignore the prior interest
   4. Measure at cost
2. Which of the following best describes contingent consideration in a business combination?
   1. A purchase price adjustment based on future results, always recorded as an expense
   2. An amount payable or receivable depending on future events, included in the acquisition cost at fair value
   3. Any unpaid tax liability acquired in a business combination
   4. A payment required only if the acquiree has unrecognized assets

3. True or false? If contingent consideration is paid after the acquisition, its fair value at the acquisition date is included in goodwill.

4. When does a "step acquisition" occur, and what are the key financial reporting implications under IFRS 3?

Introduction

Business combinations frequently occur over time, with an investor obtaining shares in several stages rather than in a single transaction. When an entity achieves control over another entity in stages, this is known as a step acquisition. IFRS 3 requires specific accounting for these events, ensuring all previous interests are measured at fair value and that any resulting gains or losses are recognized immediately.

Additionally, business combinations often include contingent consideration—future amounts payable or receivable dependent on defined outcomes. IFRS 3 mandates that such contingent amounts are measured at fair value on acquisition and included in determining goodwill.

Clear understanding and correct application of these rules is essential for the SBR exam, as scenarios often combine group changes, remeasurement entries, and the assessment of contingent elements.

Key Term: Step Acquisition
A business combination achieved in stages by which the acquirer obtains control over the acquiree by purchasing interests at different points in time.

ACCOUNTING FOR STEP ACQUISITIONS

A step acquisition occurs when an investor previously held an equity interest in an entity (such as an associate or other financial asset) and then acquires sufficient additional shares to obtain control.

The core principle is that on the date of obtaining control:

• The acquirer must remeasure any previously held interest in the acquiree to its fair value.
• Any gain or loss resulting from remeasurement is recognized in profit or loss (unless that interest was measured through other comprehensive income, in which case accumulated OCI relating to the investment may be reclassified).
• The fair value of the previously held interest, together with the fair value of the new consideration paid and the non-controlling interest, forms the total consideration for goodwill calculation.

Key Term: Fair Value Remeasurement
The process of updating the carrying amount of a previously held equity interest to current fair value, with any resulting gain or loss taken to profit or loss.

Worked Example 1.1

On 31 March 20X7, Atlas held 25% of the shares in Sigma, accounted for as an associate at $200,000. On this date, Atlas acquired an additional 55% of Sigma for $750,000, gaining control. At acquisition, the fair value of the initial 25% holding was $250,000, and Sigma’s identifiable net assets were valued at $850,000.

Question: Calculate the gain or loss to be recognized on remeasurement, and determine the amount of goodwill to recognize on consolidation.

Answer:

• The existing interest is remeasured: Gain = $250,000 (FV) – $200,000 (CV) = $50,000, recognized in profit or loss.
• Goodwill = $250,000 (previous holding FV) + $750,000 (cost of new shares) + NCI (assume NCI FV of $170,000) – $850,000 (net assets) = $1,170,000 – $850,000 = $320,000 goodwill.

Exam Warning

Always remeasure the prior interest at the date control is achieved. Failing to do so may lead to double-counting or omission of significant gains or losses.

CONTINGENT CONSIDERATION IN BUSINESS COMBINATIONS

Contingent consideration is any additional amount—in cash, shares, or other assets—that may become payable (or receivable) depending on future events or performance after the acquisition date.

At acquisition, contingent consideration must be:

• Measured at its fair value and included as part of the total consideration transferred.
• The probability of payment is reflected in the fair value, not by excluding improbable outcomes.
• Added to the cost in goodwill calculation, regardless of when (or if) the payment is actually made.

Subsequent changes:

• If contingent consideration is a financial liability, it is remeasured at fair value at each reporting date with gains or losses recognized in profit or loss.
• If it is equity, it is not remeasured after the acquisition date.

Key Term: Contingent Consideration
Any part of the purchase price of a business combination that is dependent on future events or performance, recognized initially at fair value as part of total consideration.

Worked Example 1.2

Beta acquires 80% of the shares in Delta for $4 million cash plus a further $500,000 payable if Delta’s first-year profits exceed $2 million. On the acquisition date, it is estimated that there is a 60% chance the condition will be met. The fair value of the contingent consideration is calculated at $300,000. Non-controlling interest is valued at $1.2 million. Net assets acquired are $5 million.

Question: How should the contingent consideration be recognized on acquisition? What is the total consideration and goodwill?

Answer:

• Fair value of contingent consideration ($300,000) is included in the purchase consideration.
• Total consideration: $4,000,000 + $300,000 = $4,300,000.
• Goodwill = $4,300,000 + $1,200,000 (NCI) – $5,000,000 (net assets) = $500,000.

Worked Example 1.3

Suppose in the following year, Beta pays $600,000 in contingent consideration due to Delta’s profits exceeding the threshold. At acquisition, $300,000 was recorded. The contingent consideration is a liability.

Question: How is the additional payment treated?

Answer:

• Increase of $300,000 ($600,000 paid less $300,000 initial fair value) is recognized in profit or loss, not as an adjustment to goodwill.

Exam Warning – Contingent Consideration

Only the initial fair value at acquisition affects goodwill. Later changes to liability-type contingent consideration impact profit or loss—not goodwill.

DISCLOSURE REQUIREMENTS

IFRS 3 requires comprehensive disclosure of:

• The amount and nature of contingent consideration arrangements.
• The fair value methods and key assumptions used for measurement.
• The gains or losses recognized from remeasuring prior holdings in step acquisitions.

Key Term: Goodwill
The excess of the aggregate of the consideration transferred, the non-controlling interest, and the fair value of previously held interest over the identifiable net assets acquired.

Summary

Step acquisitions require remeasuring any previously held interest to fair value at the acquisition date, recognizing gains or losses immediately. Total consideration for goodwill includes all elements—previously held interest, payment for new shares, fair value of the non-controlling interest, and fair value of any contingent consideration. Subsequent changes in contingent consideration classified as liabilities affect profit or loss, not goodwill.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain what constitutes a step acquisition and the requirement to remeasure prior interests at fair value.
• Calculate and recognize gains or losses on remeasurement of previously held interests in business combinations.
• Define and account for contingent consideration at fair value in acquisition accounting.
• Distinguish the impact of subsequent remeasurement of contingent consideration liabilities.
• Identify the disclosure requirements for step acquisitions and contingent arrangements.

Key Terms and Concepts

• Step Acquisition
• Fair Value Remeasurement
• Contingent Consideration
• Goodwill