Finance & Accounting

Accounting for Business Combinations under IFRS 3


A business combination is the consolidation of two or more independent entities or enterprises into a single reporting entity. Almost all business combinations result in the acquisition of one or more other businesses by one company, called the acquirer.

Scope of IFRS 3

With a few exceptions, such as business combinations among organizations under common control and combinations comprising two or more mutual entities, IFRS 3 describes a business combination as the integration of separate entities or businesses into one single reporting entity and provides that the purchase method of accounting must be applied to all such transactions.

It is not a business combination if an entity gains control of one or more non-business entities and brings them together. The term ‘business’ is defined as an integrated set of operations and assets that can be conducted and managed for the goal of supplying goods or services to consumers, earning investment income (such as dividends or interest), or earning other income through routine activities.

The objective of IFRS 3

The IFRS 3 aims to improve the relevance, trustworthiness, and comparability of information provided in financial statements by an entity about a business combination and its implications. It establishes standards and requirements for how an acquirer accounts for and assesses the identifiable assets purchased, the liabilities assumed, and any non-controlling interest in the acquiree in its financial statements.

Further, the Standard also acknowledges and calculates the value of goodwill obtained as part of a business combination or a profit from a bargain purchase. This IFRS assists in determining what information to disclose so that users of financial statements may analyze the type and financial consequences of the relevant business combination.

The underlying principle of IFRS 3

An acquirer of a firm (business) records the assets purchased and liabilities assumed at their purchase-date fair values and demonstrates information that allows the users to assess the nature and financial consequences of the transaction.

Determination of business combination

IFRS 3 contributes to the guidelines on establishing whether a transaction qualifies as a business combination and should be accounted for accordingly. The following are some examples of this advice:

  • Business combinations can occur in a variety of ways, including the transfer of cash, the incurrence of obligations, the issuance of stock instruments (or any combination of these), or the absence of any compensation at all (i.e., by contract alone).
  • Business combinations can be organized in a variety of ways to meet legal, taxes, and other goals, such as one corporation becoming a subsidiary of another business concern or the transferring of net assets from one enterprise to another or to a new enterprise.
  • The exercise of acquisition of a business must be part of the business combination, which usually consists of three components: Inputs, Process, and Output. Where one or more processes are applied to an economic resource or inputs (for example, non-current assets or intellectual property[1]), it produces outputs. When applied to an input or inputs, a process is a system, standard, protocol, convention, or norm that produces outputs (e.g., strategic management, operational processes, resource management). The result of inputs and the processes that are applied to those inputs is output.
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Purchase method under IFRS 3

The acquirer, or the entity that takes control of the other business, is always recognized as one of the parties to a business combination. Business combinations do not include the formation of a joint venture or the purchase of an asset or the purchase of a group of assets that do not represent a business.

The International Financial Reporting Standards (or IFRS) outline criteria for identifying and quantifying identifiable assets acquired, liabilities undertaken, and any non-controlling interest in the acquiree. Any classifications or designations made in recognition of these things must be made in line with the contract terms, macro-economic conditions, the acquirer’s operations or accounting procedures, and other considerations in effect at the time of acquisition.

Financial reporting for Business Combinations should indeed be handled using the purchase method of accounting, according to IFRS 3. The identifiable assets & liabilities attained should always be measured at their fair value on the date of purchase/acquisition under the purchase method of accounting. Such a method of accounting appears to demand considerably more effort than the ‘pooling of interests’ method and it typically results in the recognition of goodwill or negative goodwill on acquisition.

Hence, each identified asset and liability is valued at its fair value as of the acquisition date. Non-controlling interests in an acquiree are valued at fair market value or as a proportionate percentage of the acquiree’s net identified assets.

There are some exceptions to the principles of recognition and measurement. These are as follows:

  • Leases and insurance contracts must be classified based on the contractual terms and other variables at the time of the contract’s inception (or when the parameters have changed), rather than the factors in place at the time of purchase.
  • Only those contingent liabilities that are a present obligation and can be measured accurately are recognized in a business combination.
  • There are a few assets & liabilities that are needed to be recognized or assumed in line with the provisions of other IFRSs, rather than at the acquisition-date fair value. Some of those assets and liabilities falling under the scope of other IFRSs are assets & liabilities under IAS 12 for Income Taxes, IAS 19 for Employee Benefits, IFRS 2 for Share-based Payments, and IFRS 5 for Non-current Assets Held for Sale & Discontinued Operations.
  • A reacquired right must be measured according to specific guidelines.
  • Even if the measure used is not fair value, indemnification assets are recognized and quantified on a basis that is commensurate with the item covered by the indemnity.
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After recognizing the identifiable assets, liabilities, and any non-controlling interests, the acquirer is required by the IFRS to identify any differences between:

  • the sum of the transferred consideration, any non-controlling interest in the acquiree, and, in the case of a phased business combination, the acquisition-date fair value of the acquirer’s previously held equity stake in the acquiree, and
  • the net identifiable assets that are taken.

Goodwill shall be recognized as a result of the difference. If the acquirer makes a profit as a result of a bargain purchase, then such gain shall be recorded in the profit or loss.

As per IFRS 3, the fair value of the consideration (including any contingent consideration) transferred in a business combination is determined.

According to IFRS 3, the cost of a business combination shall be properly calculated as the sum of the fair values existent at the date of exchange/transfer of the assets given, liabilities incurred, and any equity instruments that are issued by the acquirer in exchange for control of the acquiree, as well as any costs that are directly attributable to the business combination incurred by the acquirer.

If the Equity Instruments are issued as part of the acquisition, the market price of the equity instruments as may be existent on the date of exchange is regarded as the best evidence of fair value. Other valuation procedures are used to estimate the fair value when the market price does not exist or is not regarded as a dependable source of information.

In practice, after a business combination has been finalized, an acquirer measures and accounts for assets acquired and liabilities taken or incurred in accordance with other applicable IFRSs. However, the International Financial Reporting Standard (or IFRS) establishes accounting principles for reacquired rights, contingent consideration, contingent liabilities, and indemnification assets.

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Disclosure requirements under IFRS 3

According to IFRS 3, the acquirer must disclose information that enables users of its financial statements to assess or examine the nature and financial impact of business combinations that have taken place during the present reporting period or after the reporting date but prior to the date when the financial statements are authorized for issue.

In addition, following a business combination, the acquirer is required to disclose any adjustments made in the present reporting period that relate to business combinations that took place in the present or previous reporting periods.


When an acquirer obtains control of a business, the IFRS 3 on Business Combinations explains how to account for it (e.g., an acquisition or merger). The ‘acquisition method’, which basically states that assets purchased & liabilities assumed are to be measured at their fair values at the acquisition date, is used to account for such business combinations.

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