Business combinations and goodwill

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Business combinations and goodwill

The differences between FRS 102 Section 19 Business Combinations and Goodwill and IFRS 3 Business Combinations are

IFRS 3 FRS 102 Section 19
IFRS 3 allows non-controlling interest to be measured at fair value or its proportionate share of net assets. Non-controlling interest is always measured at its proportionate share of net assets.
Acquisition-related costs are recognised as an expense in profit or loss as incurred. Acquisition-related costs are added to the cost of the investment in the subsidiary and affect goodwill.
At the acquisition date the fair value of contingent consideration (taking account of both discounting and the amount likely to be paid) is recognised as part of the consideration transferred.

If subsequent adjustments to this fair value occur within the measurement period and are as a result of additional information about facts or circumstances at the acquisition date, those adjustments are related back to the acquisition date, increasing or decreasing goodwill.

However, if subsequent adjustments to this fair value occur either:

- Within the measurement period, but are not as a result of additional information about facts or circumstances at the acquisition date; or

- Are outside the measurement period, they are not related back to the acquisition date but are recognised as an expense in profit or loss. They do not increase or decrease goodwill.

Measurement of the contingent consideration should be reassessed at fair value each year and the difference taken to profit or loss unless the contingent consideration is in shares. If the contingent consideration is in shares (ie classified as equity) then it should be remeasured but its subsequent settlement should instead be recognised as part of equity.
A reasonable estimate of the fair value of the amounts payable as contingent consideration (discounted where appropriate) is added to the cost of the investment at the acquisition date, where it is probable that the amount will be paid and it can be measured reliably.

Where payment was not probable or the amount could not be reliably measured and hence was not recognised, but now is probable and can be measured reliably, the additional consideration should be related back to the acquisition date, increasing or decreasing goodwill.

Finalisation of an estimate of provisional amounts within 12 months from the acquisition date should be related back to the acquisition date, increasing or decreasing goodwill.
IFRS 3 prohibits amortisation and requires annual impairment reviews. Goodwill is amortised over its estimated useful economic life. There is a rebuttable presumption that this is not more than ten years. Impairment reviews are required where evidence of impairment arises.
IFRS 3 requires immediate recognition of negative goodwill as a gain in profit or loss. Negative goodwill is recognised as a separate item within goodwill (in the balance sheet).

Negative goodwill up to the fair values of the non-monetary assets acquired should be recognised in the profit and loss account in the periods in which the non-monetary assets are recovered, whether through depreciation or sale.
More detailed rules on fair valuation. Fewer detailed rules on fair valuation.
In a business combination achieved in stages, IFRS 3 requires the acquirer to remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss. Where control is achieved following a series of transactions, the cost of the business combination is the aggregate of the fair values of the assets given, liabilities assumed and equity instruments issued by the acquirer at the date of each transaction in the series.

Presentation of goodwill calculation

IFRS compares the consideration transferred (price paid) plus the non-controlling interest to 100% of the net assets acquired. 

UK GAAP compares the cost of the combination (price paid) to the group share of net assets acquired.

Illustration: Goodwill calculation under IFRS 3 versus FRS 102

On 1 January 20X8, Pat Co acquired 80% of Smith Co for $125 million. The share capital of Smith Co at that date was $100 million and the retained earnings were $30 million. The non-controlling interest at acquisition is valued at its proportionate share of the subsidiary's net assets. 

Required:
Calculate the goodwill, presenting your calculation under IFRS and UK GAAP. 

Solution:
The goodwill acquired in the business combination on 31 December 20X7

IFRS UK GAAP
$,000 $'000
Cost of investment/consideration transferred 125,000 125,000
Non-controlling interest (IFRS = 20% x $130m) 26,000
---------- ----------
151,000 125,000
Net assets recognised (UK = 80% x ($100m + $30m)) x (130,000) (104,000)
---------- ----------
Goodwill 21,000 21,000
---------- ----------

As you see, the answer is the same if non-controlling interest under IFRS is valued at its proportionate share of net assets rather than at fair value. Under UK GAAP this choice is not allowed.

Below is a more comprehensive Activity, illustrating the NCI presentation, together with a number of other differences previously covered.

Activity: Business combinations and goodwill

On 31 December 20X7 Magnate Ltd acquired 90% of the equity of Tycoon Ltd for a cash payment of $5 million. 

At that date the fair value of the 10% of the equity not acquired was $380,000. 

Magnate Ltd incurred external professional fees in respect of this acquisition of $250,000 and estimated that the amount chargeable to the business combination in respect of the staff who worked on it was $200,000. 

At 31 December 20X7 the carrying amount of the net assets recognised by Tycoon Ltd was $2.8 million, which approximated to their fair value. In addition Magnate Ltd identified the following:

  • A trademark developed by Tycoon Ltd which at the acquisition date had a fair value of $400,000 and a useful life of four years.

Magnate Ltd adopts the following accounting policies:

  • To measure the non-controlling interest at the acquisition date at fair value, where this is permitted.

  • To amortise goodwill over five years, where amortisation is permitted.

Required

Calculate under IFRS and UK GAAP the goodwill acquired in the business combination on 31 December 20X7.

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