Chapter 1: Overview and Scope

Overview

IFRS 3 Business Combinations outlines the accounting when an acquirer obtains control of a business (e.g., an acquisition or a merger). Business combinations within the scope of IFRS 3 are accounted for using the ‘acquisition method’, which generally requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date.

Scope

IFRS 3 applies to a transaction or other event that meets the definition of a business combination.

The requirements of IFRS 3 do not apply to the acquisition by an investment entity (as defined in IFRS 10 of an investment in a subsidiary that is required to be measured at fair value through profit or loss.

What are the transactions that are excluded from the scope of IFRS 3?

The acquisition of a group of assets is not a business combination. Such transactions are nevertheless specifically excluded from IFRS 3’s scope for the sake of clarity, and the standard provides some guidance on accounting for asset acquisitions. The formation of a joint arrangement might involve the transfer of one or several businesses into one entity. From the perspective of the investors, this is not a business combination, because no one party gains control of the joint arrangement. There is a scope exception and IFRS 3 does not apply.

There is no guidance on the accounting in the financial statements of a joint arrangement. The joint venture needs to select its accounting policies for such transactions using the guidance in IAS 8. In practice, the joint venture has a choice of accounting policy, and it can record the business contributed either at fair value (including goodwill) or at the previous carrying amount in the financial statements of the venturer. This policy must be disclosed and consistently applied.

The scope of IFRS 3 includes business combinations involving mutual entities and business combinations achieved by contract alone

What is Business combination or assets acquisition (current definition)?

Appendix A to IFRS 3 provides the following definitions for terms in the Standard.

A business combination is “a transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in this IFRS”.

A business is “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing good or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities”.

What is a common control transaction?

A combination of entities or businesses under common control (commonly referred to as a ‘common control transaction’) is “… a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the combination, and that control is not transitory”.

Examples of ultimate controlling parties include:

• an individual, or a group of individuals who, because of contractual arrangements, collectively control an entity (even when those individuals are not subject to financial reporting requirements); and
• a parent entity (even when the controlled entity is excluded from its consolidated financial statements).

There is currently no specific guidance on accounting for common control transactions under IFRS Standards. In the absence of specific guidance, entities involved in common control transactions should select an appropriate accounting policy using the hierarchy described in paragraphs 10 to 12 of IAS 8, including the guidance on whether the comparative information should be restated. Because the hierarchy permits the consideration of pronouncements of other standard-setting bodies, the guidance on group reorganisations in both UK GAAP and US GAAP may be useful in some circumstances – this guidance produces a result that is like pooling

Difference in the accounting for an asset acquisition versus a business combination?

For a transaction to meet the definition of a business combination and for the acquisition method of accounting to apply, an entity must gain control of an integrated set of assets and activities that is more than a collection of assets or a combination of assets and liabilities.

It is often straightforward to determine whether a business has been acquired. A business would normally be carrying on a continuing trade with identifiable revenue. The assets or combination of assets and liabilities of the acquired entity interact with each other and with the people who operate the assets as a business. However, determining whether a business has been acquired might not be easy and might require judgement. Some of the key differences between accounting for a business combination and an asset acquisition are summarised in the table below:

Definition of a business

Overview of the new definition of a business

As a result of amendments to IFRS 3 issued by the IASB in 2018, the new definition of a business creates a ‘framework’ for entities to use in evaluating whether an integrated set of assets and activities (collectively a ‘set’) should be accounted for as an acquisition of a business or a group of assets. The new definition of a business was developed because many stakeholders believed that the definition of a business was being applied too broadly.

It adds an optional concentration test to determine if substantially all of the fair value of the gross assets acquired is concentrated in a single asset or group of similar assets. If the concentration test is met, the set is not a business. The new framework also specifies the minimum required inputs and processes necessary to be a business, and it removes the need to consider a market participant’s ability to replace missing elements.

The concentration tests

The concentration test is an optional test that permits a simplified assessment of whether an acquired set of activities and assets is not a business. It was designed to identify, with little cost or effort, a transaction that is clearly more akin to an asset acquisition and remove it from the scope of the business combinations guidance. In applying the concentration test, an entity determines whether substantially all of the fair value of the gross assets acquired is concentrated in a single asset or group of similar assets. If so, the set is not considered a business. While the standard does not define what constitutes ‘substantially all’, there is no bright line. Some might interpret it to mean at least 90%.

If the concentration test is not met (i.e. substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets), this does not necessarily mean that the transaction is a business combination. To conclude whether the transaction is an asset acquisition or a business combination, the entity must assess if the acquired set of activities and assets includes, at a minimum, an input and a substantive process.

Single asset A single asset for the purpose of the concentration test includes any individual asset or group of assets that could be recognised and measured as a single asset in a business combination. The guidance specifies certain assets that must be grouped for the purpose of applying the concentration test.

This grouping is only applicable for the concentration test, and all assets acquired continue to be recorded separately where required by other IFRSs.

For example, a tangible asset that is attached to another tangible asset should be considered a single asset. This includes an intangible asset representing the right to use a tangible asset (such as a building with an associated ground lease). To be considered attached, assets cannot be physically removed and used separately without incurring significant costs or significant diminution in utility or fair value to either asset. For example, land and a building would generally be recognised as separate assets in a business combination, but they would be considered a single asset when performing the concentration test.

Optional test to identify concentration of fair value

IFRS 3 has an optional, simplified approach for assessing whether an entity has acquired a business or assets. Under this optional concentration test (which an entity can elect to apply on a transaction by transaction basis), if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, an entity can conclude that the acquisition is not a business combination. The acquisition would instead be accounted for as an asset acquisition.

If the concentration test is not met (i.e. substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets), this does not necessarily mean that the transaction is a business combination. In order to conclude whether the transaction is an asset acquisition or a business combination, the entity must assess if the acquired set of activities and assets includes, at a minimum, an input and a substantive process.

As explained in IFRS 3: BC21, the Board designed the concentration test with the aim of making it easy to understand and, in some straightforward cases, simple to operate and less costly than applying the detailed assessment otherwise required by IFRS 3. As a result, the concentration test focuses on a single identifiable asset or a single group of similar identifiable assets. The Board does not expect entities to carry out detailed calculations to apply the test, because detailed calculations would defeat the purpose of the test, which is to permit a simplified assessment.

In theory, in some circumstances, the concentration test may result in a “false positive”, i.e. identifying a transaction as an asset acquisition when a detailed assessment would identify it as a business combination. The Board was aware of this possibility when it introduced the concentration test in IFRS 3 and designed the test to minimise the risk that a false positive would deprive users of financial statements of useful information.

3 step tests:

Step 1 – Measure the fair value of gross assets acquired

The fair value of gross assets acquired includes any non-controlling interests in a partial acquisition and any previously held interests in a step-acquisition, such that the concentration test is performed by comparing 100 per cent of the fair value of a single identifiable asset (or group of similar assets) to 100 per cent of the fair value of gross assets acquired.

For the purposes of the concentration test, gross assets acquired exclude cash and cash equivalents, deferred tax assets and goodwill resulting from the effects of deferred tax liabilities. However, the gross assets acquired include goodwill not resulting from the effects of deferred tax liabilities, i.e. the excess of any consideration transferred (plus the fair value of any non-controlling interest and of previously held interest) in excess of the fair value of net identifiable assets acquired.

Instead of measuring the fair value of gross assets acquired directly (i.e. by determining the fair value of identifiable assets acquired and any goodwill other than goodwill arising from deferred tax liabilities), IFRS 3 indicates that fair value of gross assets acquired may generally be determined indirectly as the total obtained by adding the fair value of the consideration transferred (plus the fair value of any non-controlling interest and the fair value of any previously held interest) to the fair value of the liabilities assumed (other than deferred tax liabilities), and then excluding the items listed in IFRS 3 (namely cash and cash equivalents, deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities).

Step 2 — identify a single identifiable asset or group of similar identifiable assets

An identifiable asset is an asset, or group of assets, that would be recognised and measured as a single identifiable asset in a business combination.

The following are examples provided in IFRS 3 and IAS 38 of acquired assets that may be recognised as a single identifiable asset for financial reporting purposes.

• A group of complementary intangible assets that have similar useful lives, for example a trademark (or service mark) and its related trade name, formulas, recipes and technological expertise.
• A licence to operate a nuclear power plant and the power plant.
• A copyright intangible asset and any related assignments or licence agreements.

In each example, the assets that are combined for financial reporting purposes have similar useful lives. Determining whether it is appropriate to combine assets into a single unit of account may require considerable judgement, particularly when it comes to combining tangible and intangible assets.

In addition, for the purposes of the concentration test only, if a tangible asset is attached to, and cannot be physically removed and used separately from, another tangible asset (or from an underlying asset subject to a lease), without incurring significant cost, or significant diminution in utility or fair value to either asset (for example, land and buildings), those assets are considered as constituting a single identifiable asset.

Whilst these assets may be combined for purposes of the concentration test, they are recognised separately for financial reporting purposes, regardless of whether the acquired set of activities and assets is a business or group of assets.

Similar identifiable assets are considered as a group for the purposes of the concentration test. When assessing whether assets are similar, an entity considers the nature of each single identifiable asset and the risks associated with managing and creating outputs from the assets.

IFRS 3: Clarifies that the following assets are not similar:

• a tangible asset and an intangible asset;

• tangible assets in different classes (for example, inventory, manufacturing equipment and automobiles) unless they meet the criteria in to be considered as a single identifiable asset;
• identifiable intangible assets in different classes (for example, brand names, licences and intangible assets under development);
• a financial asset and a non-financial asset;
• financial assets in different classes (for example, accounts receivable and investments in equity instruments); and

• identifiable assets that are within the same class of asset but have significantly different risk characteristics.

Factors to consider in assessing whether identifiable assets of a same class are similar In accordance with IFRS 3, entities cannot combine identifiable assets that are within the same class of assets if they have significantly different risk characteristics. Entities in different industries are typically affected by different types of risks. For example, in the real estate industry, entities may consider risk characteristics associated with the type of property (e.g. commercial versus residential), size (e.g. single tenant versus multitenant), geographic location (e.g. high-growth areas versus low-growth areas), and class of customer (e.g. high default-risk tenants versus low default-risk tenants). By contrast, in the life sciences industry, entities may evaluate risk characteristics associated with the stage of drug development (e.g. compounds in early development stages versus later stages), class of customer (e.g. compounds that treat one medical condition versus another medical condition) and market risk (e.g. products for use in Jurisdiction A versus Jurisdiction B). In the extractive industry, the type of mineral and grade, the stage of development and the geographical location (reflecting country and political risks) may be relevant factors in assessing whether mineral properties have significantly different risk characteristics. Entities should consider all relevant facts and circumstances in making their determination. For example, an entity acquires a research company that has been developing medication for the treatment of fibromyalgia. The company has been developing two potential pathways for administering the drug, oral and injection. If the drug can be developed for oral use the company will discontinue work on the injectable solution. Because of the different means of administering the medication, the approving authorities treat them as different drugs and each would need to pass separate human trials. The acquirer assesses that, for the purposes of the concentration test, the two drug candidates are similar identifiable assets. Although they would need to be submitted for approval separately, at this stage of the development they are intended to treat the same medical condition and the potential customer base is the same. Application of the concentration test: acquired assets include a contract with a lease and non-lease components – example. Entity A acquires all of the shares in Entity B. Entity B owns a specialist vessel, crewed by its employees, which is used for transporting oil and gas products. Entity B also has a time charter contract that commits it to provide that vessel to the charterer with a full crew and shore-based support services for a non-cancellable period of five years. Applying IFRS 16, the charter contract is determined to consist of an operating lease component and a service component. For the purposes of performing the concentration test, the fair value of the operating lease is incorporated as part of the fair value of the specialist vessel. This is because the specialist vessel and the operating lease would be recognised and measured as a single identifiable asset in a business combination. The service component of the time charter contract is recognised as a separate customer-contract intangible asset.

Step 3 – determine if substantially all of the fair value of gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets

The concentration test is met if substantially all of the fair value of the gross assets acquired (as determined in step 1) is concentrated in a single identifiable asset or group of similar identifiable assets (as determined in step 2).

Meaning of ‘substantially all’ for the purposes of the concentration test IFRS 3 does not define what percentage constitutes ‘substantially all’. Consistent with the guidance at and, which discuss the meaning of ‘substantially all’ in the context of classifying a joint arrangement and of applying IFRS 16, respectively, it should generally be presumed that the concentration test is met if 90 per cent of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar asset. Accordingly, if an entity that chooses to perform the concentration test determines that the single identifiable asset or group of similar assets does not represent 90 per cent of all of the fair value of the gross assets acquired, it must perform a more detailed assessment to conclude whether an acquired set of activities and assets constitutes a business combination. An entity that has performed the concentration test and concluded that the acquired set of activities and assets is not a business may disregard the outcome of the concentration test and instead perform the detailed assessment required to determine whether the transaction is a business combination.

Elements of a business

If an entity chooses not to perform the optional concentration test or performs the optional concentration test and determines that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets, it must assess if the acquired set of activities and assets comprises all of the required elements of a business.

A business consists of inputs, and processes applied to those inputs, that have the ability to contribute to the creation of outputs. The three elements of a business are defined as follows.

• Input – any economic resource that creates outputs, or has the ability to contribute to the creation of outputs, when one or more processes are applied to it. Examples include non-current assets (including intangible assets or rights to use non-current assets), intellectual property, the ability to obtain access to necessary materials or rights and employees.
• Process – any system, standard, protocol, convention or rule that, when applied to an input or inputs, creates outputs or has the ability to contribute to the creation of outputs. Examples include strategic management processes, operational processes and resource management processes. These processes typically are documented, but the intellectual capacity of an organised workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. Accounting, billing, payroll and other administrative systems typically are not processes used to create outputs.
• Output – the result of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities.

To be a business, an integrated set of activities and assets must include at a minimum, an input and a substantive process that together significantly contribute to the ability to create output. However, outputs are not required for an integrated set of activities and assets to qualify as a business.

If an acquired set of activities and assets has outputs, continuation of revenue does not on its own indicate that both an input and substantive process have been acquired.

A business may or may not have liabilities and, conversely, an acquired set of activities and assets that is not a business may include liabilities.

The assessment as to whether a particular set of activities and assets is a business is made by reference to whether the integrated set is capable of being conducted and managed as a business by a market participant. Therefore, whether the seller operated the set as a business or whether the acquirer intends to operate the set as a business is not relevant when making that assessment.

Elements of a business – process

A process is “any system, standard, protocol, convention or rule that, when applied to an input or inputs, creates or has the ability to create outputs”.

Types of process include:

• strategic management processes – for setting the overall strategy and direction of operations;
• operational processes – for obtaining contracts or customers, or developing, fulfilling or producing outputs; and
• resource management processes – for obtaining inventory and managing operational employees.

Whilst processes are usually documented, they need not be. For example, employees are an input, but they may form an organised workforce whose knowledge and ability may be considered a process, even if that process is not documented.

Similar assets

The concentration test can also be met if the fair value of the set is concentrated in a group of similar assets. Entities should consider the nature of the assets, and the risks associated with managing and creating outputs, when determining if assets should be grouped as similar. If the risks are not similar, the assets cannot be combined for the concentration test. Identifying similar assets based on the nature of the assets and their risk characteristics is an area that will require significant judgement.

The following should not be considered similar assets for the purpose of performing the concentration test: A tangible asset and a separate intangible asset. Tangible assets in different classes, unless considered a single identifiable asset for the purpose of the concentration test (for example, because physically attached).

Intangible assets in different intangible asset classes (for example, brand names, licences and intangible assets under development). A financial asset and a non-financial asset. Financial assets in different classes (for example, accounts receivable investments in equity instruments). Assets within the same class of asset but with significantly different risk characteristics (for example, real estate investments that consist of residential and commercial properties).

Gross assets

For the purpose of the concentration test, the fair value of the gross assets acquired is not necessarily the same as the consideration transferred. This could be caused, for example, by liabilities assumed, which are factored into the determination of purchase price but are excluded from gross assets in the denominator of the concentration test.

The fair value of gross assets will also differ from the consideration transferred in a partial acquisition (that is, it is impacted where there are non- controlling interests and previously held interests). Where a transaction results in control of a legal entity being obtained, even if less than 100% of the entity is acquired, gross assets used in the concentration should include the consideration transferred plus the fair value of any non-controlling interests and previously held interests.

For example, in the acquisition of a 60% controlling interest in an entity, the gross assets would include the 60% acquired interest plus the 40% non-controlling interest. Gross assets acquired exclude the following items: cash and cash equivalents; deferred tax assets; and goodwill resulting from the effects of deferred tax liabilities. These items are excluded because the IASB did not believe that the tax form of the transaction, and whether cash and cash equivalents were included, should affect the determination of whether the set is a business.

The framework

In order to be a business, a set needs to have an input and a substantive process that together significantly contribute to the ability to create outputs.

The guidance provides a framework to evaluate when an input and a substantive process are present (including for early-stage companies that have not generated outputs). It includes more stringent criteria for sets without outputs to be considered businesses.

The new guidance narrows the definition of ‘outputs’ to the result of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities. The assessment of whether a set is capable of being conducted and managed as a business should be performed using a market participant view. Therefore, how the seller previously managed, and how the buyer intends to manage, the acquired set is not relevant to the analysis. Even though individual processes that are used to create outputs might be insignificant on their own, entities should consider whether they could be substantive in aggregate. Furthermore, while processes are usually documented, they do not need to be. This could be the case with an organised workforce. An organised workforce could be an input, a process, or both.

For example, a consulting firm might include employees (inputs) that use their intellectual capacity (a process) to generate outputs. Evaluating the framework where outputs are not present Where a set does not have outputs, an acquired process (or group of processes) should be considered substantive only if:

1. it is critical to the ability to develop or convert an acquired input or inputs into outputs; and
2. the inputs acquired include both an organised workforce that has the necessary skill, knowledge or experience to perform that process (or group of processes) and other inputs that the organised workforce could develop or convert into outputs. Other inputs could include intellectual property that could be used to develop a good or service; resources that could be developed to create outputs; and access to necessary materials or rights that enable the creation of future outputs.

Evaluating the framework where outputs are present A set will have outputs where there are outputs being generated at the acquisition date. However, outputs at the acquisition date do not, on their own, indicate that both an input and a substantive process have been acquired. If a set has outputs at the acquisition date, an acquired process (or group of processes) is considered substantive if, when applied to an acquired input or inputs, it:

1. is critical to the ability to continue producing outputs, and the inputs acquired include an organised workforce with the necessary skills, knowledge or experience to perform that process (or group of processes); or
2. significantly contributes to the ability to continue producing outputs and:
3. is considered unique or scarce; or
4. cannot be replaced without significant cost, effort or delay in the ability to continue producing outputs.

Other considerations

The guidance requires the inputs to be substantive and to have the ability to create, or contribute to the creation of, outputs when one or more processes are applied to it. Ancillary assets (that is, those that do not contribute to producing outputs) would not be considered inputs for the purpose of determining whether the set has inputs. An acquired contract is an input and not a substantive process. Nevertheless, an acquired contract could give access to an organised workforce (such as outsourced property management or outsourced asset management). An entity would need to assess whether an organised workforce accessed through such a contract is substantive. Factors to be considered include the duration of the contract and its renewal terms. Difficulty replacing an organised workforce might indicate that the acquired organised workforce performs a process that is critical to the ability to create outputs. A process is not critical if, for example, it is ancillary or minor in the context of all of the processes required to create outputs.

Example : if is it a business (current definition)? Phone entity A acquires 100% of the shares of phone entity B. The inputs are: land, buildings, infrastructure (for example, call centres, cell tower leases, switches, software, licences and retail stores), furniture, computer software, customer and supplier relationships, reputation, customer contracts, brand, market share, market knowledge, experienced work staff and management expertise. The processes are management processes, corporate governance, organisational structures, strategic goal-setting, operational processes and human and financial resource management. The outputs are: ability to place calls which generate revenue from customers, access to new markets, increased efficiency, synergies, customer satisfaction and reputation. A business has been acquired, because assets and activities that are capable of providing a return are included.

Example:  Is it a business with no outputs (current definition)? Computer entity A acquires software development entity B. Entity B was founded to make hand-held device applications. The current activities of the entity include researching and developing its first product and creating a market for the product. The entity has not generated any revenues and has no existing customers. Entity B’s workforce is composed primarily of programmers. Entity B has the intellectual property, software and fixed assets required to develop applications. The elements in the acquisition contain both inputs and processes. The inputs are intellectual property used to design the applications, fixed assets and employees. The processes are strategic and operational processes for developing the applications. It is likely that a business has been acquired, because entity B has access to the inputs and processes necessary to manage and produce outputs. The lack of outputs, such as revenue and a product, does not prevent the entity from being considered a business.

Distinguishing a business from an asset or a group of assets

Example: Distinguishing a business from an asset or a group of assets (current definition of a business)

The flow chart below combines the components defined under IFRS 3 with the decision-making framework:

Step 1: The starting point for the analysis is to understand the inputs, processes and potential outputs. It can be useful to consider existing processes, physical assets, inputs used in the past and processes of similar businesses. Another approach is to consider the inputs and outputs together, in order to identify associated processes that would be necessary to create the outputs.

For example, what processes does an automotive entity perform to sheet metal and acquired parts in order to produce a car? Outputs are not required for a business to exist.

For example, a start-up company with no products, revenue or customers can be a business. The results of research and development could provide a return to investors.

Step 2: The acquirer needs to consider whether the inputs acquired and any processes transferred can produce outputs. There might be inherent processes attached to inputs. If a workforce is transferred, for example, it is reasonable to assume that the workforce has processes to produce the output. These types of inherent processes need to be considered.

Step 3: Missing elements do not automatically mean that a group of assets and liabilities is not a business. A market participant might be capable of supplying the missing elements and producing outputs. The missing elements could be replaced through integrating the acquired group into an entity’s own operations. Market participants are theoretical third parties that could either be trade buyers or financial investors and are knowledgeable willing parties. The acquirer does not need to be a market participant in the same industry. The analysis of supplying the missing elements to produce outputs should have the same result, whether the acquirer is a financial investor or a trade buyer. The question of whether missing elements can be replicated or obtained by market participants is not buyer specific.

For example, if a financial investor acquires a hotel, it might not have processes in place to run it. The financial investor could acquire relevant processes from a market participant, such as a hotel management group. The easier it is to obtain the missing elements in a relatively short period, the more likely the set of assets and activities is a business. This determination requires judgement; entities need to consider the relevant facts and circumstances, including the nature and stage of the business and the transaction structure. We also believe that missing elements that can be easily replicated or obtained should be considered replaceable by market participants.

If market participants are not expected to be able to replace the missing elements, and thus manage the acquired group in a way that is capable of providing a return to their investors, the acquired group would not be considered a business. The ability of market participants to continue to manage the acquired group to provide a return without the missing inputs and processes is a matter of judgement and is based on the individual facts and circumstances. IFRS 13 brings the definition of ‘market participant’ into IFRS. Specific market participants need not be identified. Rather, market participants are buyers and sellers in the principal, or most advantageous, market for an asset that are independent, knowledgeable, able, and willing to transact for the asset. It is not relevant whether either the seller or the acquirer intends to operate the set of assets and activities as a business; what is relevant is whether a market participant could operate the set.

Examples

Mining industry: exploration assets (current definition of a business)

Background

A multi-national energy and mining entity, W, has acquired a small coal exploration company, entity X. Entity X has a sizeable portfolio of properties with potential coal reserves in a basin where other coal mining companies have recently discovered large proven coal reserves. Entity X has an active exploration programme in place at all of its properties, but none of them are yet in development. Studies have been conducted on the properties, and the results are included in the transaction. Several of entity X’s key management team were involved in previous successful exploration, development and production projects, and they will transfer into the W group. Entity X does not own equipment to extract the reserves, but it has acquired licences and equipment necessary to develop the properties. Entity X’s office building was included in the transaction. Entity X had an engineer and geologist team, accounting staff and payroll clerk, but these employees will not continue in employment after the acquisition.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: an office building and equipment necessary for exploration of the potential coal reserve properties; intangible items: exploration and production licences for a number of potential coal mining properties, computer software and software licences; and other items not necessarily in the financial statements: a management team, the process and know-how of coal exploration, studies and test results of the properties, market knowledge, relationships with the licensing body, and management knowledge of the industry. The processes acquired include: management team processes, expertise and industry knowledge. The outputs include: access to the exploration results, access to potential coal reserves, and access to entity X’s strategic plans.

Step 2: Assess the capability of the group to produce outputs Production has not begun, but there is an active exploration programme at the portfolio of properties. The exploration results are an output. Some of the inputs and processes necessary to produce the exploration results appear to have been acquired. There might be inherent processes attached to the inputs, because exploration equipment, software and a skilled management team are being transferred. The management team might possess the know-how to provide a return from the exploration studies. The missing inputs include the engineer and geologist team, accounting staff and payroll clerk. The accounting staff and payroll clerk could be considered administrative and would not impact the conclusion. The absence of the geologist and engineer team might be more fundamental.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist Management needs to consider whether market participants could produce exploration results with the established inputs and processes. Other market participants would be strategic buyers that have an existing engineer and geologist team. The missing engineer and geologist team might not alone preclude the acquired group from being a business. It is irrelevant whether the buyer has an existing engineer and geologist team. The buyer must evaluate whether the engineer and geologist team can easily be replicated by a market participant. This will require judgement and will be based on the facts and circumstances in each situation. A business might have been acquired if the buyer determines that the engineer and geologist team can be replicated. A group of assets might have been acquired if the buyer determines that a market participant could not assemble an engineer and geologist team. It is unlikely that the buyer would wish to acquire these types of assets without either keeping key people or being able to find their equivalents in the market.

Conclusion

Entity X is a business. The missing engineer and geologist team could easily be replicated by a market participant. The acquired input of the management team is accompanied by inherent processes.

Hotel industry: hotels (current definition of a business)

Background

A multi-national hotel group enters into an agreement with a local hotel group in country A. The local hotel group operates 80 hotels in country A and wishes to re-focus its operations to concentrate on 30 key hotels. The multi-national hotel group enters into a master agreement with the local hotel group to take over existing leases for 50 non-core hotels. Customer lists associated with these hotels, fixtures and fittings at each property, as well as the staff employed at each hotel, will also be transferred to the multi-national hotel group. The multi-national group will be entitled to all revenue arising on any bookings existing at the agreement date. The multi-national group will rebrand the hotels after this transfer, and it will also transfer all hotels to its own IT system.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: fixtures and fittings at each hotel; intangible items: leases for each property and customer lists; and other items not necessarily in the financial statements: staff employed at each hotel. The processes acquired include: relevant management and operational processes, as a result of acquiring staff required to operate each hotel. The outputs include: access to economic benefits arising from current and future bookings.

Step 2: Assess the capability of the group to produce outputs The acquired group is not contained within a corporate entity. The multi-national group has effectively acquired 50 hotel leases accompanied by fixtures and fittings, customer lists, an existing order book and relevant staff. The items included in the acquired group are capable of producing revenue. The key elements that enable the acquired group of properties to produce outputs as hotels, with the appropriate fixtures and fittings, are the customer lists and the relevant staff and processes.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist There are few missing elements in this case before a market participant could produce outputs. The multi-national group intends to re-brand and replace specific processes, to align these hotels with the rest of its portfolio. The acquired properties have the current ability to produce outputs without these changes.

Conclusion:

The acquired group of hotels is considered to be a business, because there are inputs, processes and the ability to produce output. The acquirer will re-brand and change processes, but a market participant would not need to do so to operate the hotels.

Port industry: warehouse facilities are a business (current definition of a business)

Background

An international shipping entity purchased a storage and warehouse facility at an Asian port. The warehouse earned rental on storage units and associated service fees, by using its existing assets and labour workforce before the acquisition. The warehouse has not been profitable for three years. The shipping entity believes that this is due to inefficiencies from outdated computer software that automates the handling of the supply and delivery of the goods. The shipping entity hired specialist software companies to investigate and develop replacement software as a result of the acquisition. The shipping entity acquired all other assets, excluding the existing software. It kept the management team and labour workforce for their experience and relationship with the local port authorities. It did not retain any customers, because the warehouse will only be used by the acquirer to offer extended services to its own customers. The purchased storage and warehouse facility is expected to generate cost savings, because the entity will not need to use third-party storage facilities.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: storage infrastructure, loading machineries and office equipment; intangible items: land use rights and current supplier relationships; and other items not necessarily in the financial statements: labour force and management team. The processes acquired include: expertise and industry knowledge, other operational processes (such as warehouse management process and supplier’s management processes). The outputs include: expanded services offered and cost savings through vertical integration.

Step 2: Assess the capability of the group to produce outputs The acquirer’s intention and future plans for the assets or business acquired are not considered. The key assessment is whether the warehouse is able to produce outputs without the missing elements, such as customer contracts and the warehouse software system. The missing inputs, such as customers, would not impact the group’s ability to produce outputs, so it would not impact the conclusion. The absence of the warehouse computer software management system might be more fundamental, because it automates a key process of the facility.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist

The warehouse was operating with outdated software, which it was using to generate revenue. The shipping entity must evaluate whether the outdated software is a significant input. This includes evaluating whether the software can be easily replicated by a market participant. This requires judgement and will be based on the facts and circumstances in each situation. The owner of the warehouse was keen to sell its assets to the shipping company, and it granted full access to a software specialist firm hired by the acquirer. The new software has been developed and is ready to be installed immediately after acquisition. It can be argued that the missing element of computer software is easily replicated on the market within a short period.

Conclusion

The acquired warehouse facility is considered to be a business. The missing processes generated by the software could easily be replicated by a market participant in a relatively short period. A market participant could also replicate existing software functions, by running the warehouse manually. The software is important to the business, but the management team and labour workforce could produce outputs, either without software or with new software.

Port industry: warehouse facilities are a group of assets (current definition of a business)

Background

An existing port operating entity (‘the operator’) acquired the right of operation for an existing terminal from the local port authority. The local port authority also owns other terminals at this location. This transaction is structured as a carve-out, where legally certain assets are transferred to the operator. The port is a cargo container port, but also includes supporting paperwork-handling and storage facilities. No employees or customers are included in this transaction. All existing employees will be redeployed by the local port authority. All existing customers will continue to be serviced by the local port authority from other terminals. The operator plans to improve the terminal by installing more advanced computer systems (to replace the systems retained by the local port authority), increasing the number of cranes and upgrading the lifting equipment.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: port infrastructure, such as berths, cranes and roads connecting the terminal to the warehouse and an office and storage facilities; intangible items: land use rights and operating rights; and other items not necessarily in the financial statements: location. No processes have been acquired. The outputs include: expanded service offering.

Step 2: Assess the capability of the group to produce outputs The acquirer’s intention and future plans for the assets or business acquired are not relevant. The assessment is whether the operator is able to produce outputs without the missing elements, including employees, customers, software and all processes. The missing customers and employees could be significant for the group’s ability to produce outputs for a port operation.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist

The operator must evaluate whether the facilities could be operational and whether missing elements could easily be replicated by a market participant in a relatively short period. This requires judgement and will be based on the facts and circumstances in each situation. For example, when the inputs (berth, warehouse and existing cranes) are present without processes, how difficult will it be for the operator to hire new employees, find customers and implement procedures for port-related services? The missing inputs and required processes in this example might be sufficiently significant to conclude that the property acquired is a group of assets.

Conclusion The acquired warehouse facility is considered to be an asset acquisition. No processes were acquired. The acquisition did not include employees or existing customers. The missing employees, customer contracts and processes are significant in generating output. It would be difficult for a market participant to replicate the missing processes quickly.

Real estate industry: asset acquisition (current definition of a business)

Background

A real estate investment entity, Properties Inc, has acquired an empty building during the year. The building has no tenants on acquisition. The building contains no furniture. Properties Inc will undertake the day-to-day property management. No existing employees were hired by Properties Inc.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: the building; intangible items: none; and other items not necessarily in the financial statements: none. No processes have been acquired. The outputs include: access to economic benefits arising from future tenant leases.

Step 2: Assess the capability of the group to produce outputs Processes that allow Properties Inc to find tenants, run the day-to-day operations and strategically position the property in order secure future tenants are missing. These would include: marketing to new tenants; management of the property’s leasing profile and tenant mix; management of capital expenditure on the property (for example, decisions to repair, renovate, redevelop and/or expand the commercial office tower); and management of the initial and continued funding of the property. Properties Inc will not be able to produce outputs without these processes.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist Properties Inc is an owner and manager of real estate. No tenants or management of the building were acquired. The building will form part of its larger portfolio going forward; Properties Inc’s management will perform this role.

Conclusion

The acquired building is considered an asset acquisition. No contracts with existing tenants were acquired (that is, an important input). No processes were acquired as part of the transaction. The missing processes cannot be easily replicated by a market participant in a relatively short period.

Real estate industry: business combination (current definition of a business)

Background

A real estate investment entity (REIE) is an owner and manager of commercial office towers across the east coast of Australia. REIE’s management has decided to expand and diversify its existing operations by purchasing a portfolio of commercial properties on Australia’s west coast. REIE has no existing operations in this location and limited local market knowledge and experience. The acquired portfolio of commercial property has 85% occupancy on average, with leases being executed between the tenants and the property’s freeholder.

REIE becomes a party to these lease agreements on acquisition of the freehold title to the commercial properties. Existing security, cleaning and maintenance contracts are novated to REIE on acquisition of the property. The existing property management agreement will be terminated.

REIE will undertake all property management functions tenant management, collection of rent and supervision of contract work at the commercial properties. REIE will employ a number of the seller’s employees, including the regional leasing managers and other management personnel. These employees will be responsible for: the property’s leasing profile and tenant mix; capital expenditure on the property (for example, decisions to repair, renovate, redevelop and expand); additional investment and divestment decisions (for example, to buy or sell additional properties); and other decisions concerning the strategic positioning of the west coast portfolio. The acquisition price has been based on an independent valuation of the commercial properties individually, using discounted net cash flows, and taking into consideration rental returns less cash outflows on property outgoings, over a 10-year period.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: the commercial office towers; intangible items: existing lease agreements with tenants, security, cleaning and maintenance contracts; and other items not necessarily in the financial statements: management team, management knowledge of the west coast Australian market and portfolio. The processes acquired include: management team processes, expertise and industry knowledge. The outputs include: the right to receive cash flows in the form of rental returns and potential capital growth in the property.

Step 2: Assess the capability of the group to produce outputs Processes in the strategic management of the commercial properties have been acquired by REIE. These processes will allow REIE to realise the value of the commercial properties and generate outputs, through both rental returns and future growth in the valuation of the properties.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist Inputs and processes have been acquired by REIE that allow outputs to be generated. No further analysis concerning the capability of a market participant to produce outputs is required. Conclusion The acquired portfolio is considered to be a business. This FAQ and FAQ 29.19.6 are consistent with the IASB’s improvement to IAS 40, which states that judgement is needed to determine whether the acquisition of an investment property is the acquisition of an asset or a business combination. The judgement is based on the guidance in IFRS 3. [IAS 40 para 14A].

 Pharmaceutical industry: research and development assets (current definition of a business)

Background

Laboratory Inc is a pharmaceutical entity that owns the rights to several product (drug compound) candidates. Laboratory Inc’s current activities include researching and developing the product candidates. Laboratory Inc does not have a manufacturing facility, and it has no revenues or commitments from customers if any of the product candidates become marketable. Laboratory Inc employs management and administrative personnel, as well as scientists who are instrumental to product testing and development, and who have established protocols and procedures to carry out these functions. Pharmaceutical Inc is an established pharmaceutical entity with a large sales force. Pharmaceutical Inc acquires certain assets of Laboratory Inc, including the rights to the product candidates and related testing and development equipment. Pharmaceutical Inc hires the scientists formerly employed by Laboratory Inc.

Analysis

Step 1: Identify he elements of the acquired group

The inputs acquired include: tangible items: testing and development equipment; intangible items: rights to the product candidates and associated research and development; and other items not necessarily in the financial statements: scientists formerly employed by the seller. The processes acquired include: procedures developed and applied by the scientists and operating protocols. The absence of revenues or commitments from customers does not preclude the existence of outputs. The outputs could include access to potential marketable product candidates from the testing and development programme, or additional intellectual property derived from further research and development.

Step 2: Assess the capability of the group to produce outputs

There is an active research and development programme to develop marketable product candidates. The inputs and processes necessary to produce the testing and development results appear to have been acquired. The acquisition of the rights to product candidates and operational protocols either represent processes or suggest that inherent processes might be attached to the inputs acquired. The missing inputs include manufacturing capabilities, management and sales personnel.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist

The lack of manufacturing capabilities, management and sales personnel might not prevent the acquired group from being a business. Pharmaceutical Inc might determine that the likely market participants are strategic buyers in the pharmaceutical industry that either have the missing elements or could easily obtain them. Conclusion The acquired group is considered to be a business. The acquired inputs (scientists and rights to product candidates) and processes (protocols) applied to those inputs have the ability to generate outputs (the results of the testing and development of product candidates) and collectively appear capable of providing a return to investors.

Retail wholesaler: operations acquired with no sales force (current definition of a business)

Background

Entity B purchases the organic food operations of entity C, a large multi-national conglomerate. Entity C intends to continue the organic food operations as a separate division. Entity C is organised so that the organic food operations are separate legal entities in some countries and separate divisions in other countries. Management, employees, product distribution agreements, brand names, copyrights and key systems (for example, ordering, billing and inventory) are included in the acquired organic food operations. The sales force that sells entity C’s products is not part of the transaction.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: commercial sites; intangible items: distribution agreements, brand names and copyrights; and other items not necessarily in the financial statements: management and some employees. The processes acquired include: key operating systems and associated processes, management team processes, expertise and industry knowledge. The outputs include: access to economic benefits arising from current and future retail sales.

Step 2: Assess the capability of the group to produce outputs The acquired group did not include all of the inputs and associated processes necessary to manage and produce outputs. The lack of a sales force impacts the acquired group’s ability to produce economic benefits.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist Likely market participants would be strategic buyers that have an existing sales force. Therefore, the missing sales force would not prevent the acquired group from being a business. Entity B’s intent to continue the organic food operations as a business does not affect the evaluation of whether the acquired group is a business. The acquired group would still be considered a business, even if entity B entered into the transaction with the intent to eliminate a competitor and cease the acquired group’s operations. The acquired group might still be considered a business if the missing input (that is, sales force) can be easily replicated or obtained. This will require judgement and will be based on the facts and circumstances in each situation. Conclusion The organic food operations are a business.

Outsourcing arrangement (current definition of a business)

Background

Entity D provides information technology outsourcing services. Entity E generates and supplies electricity. Entity E’s billing and other information technology systems consume significant computer and staff resources. Entity E uses these systems to provide billing and accounting services to a number of smaller utilities. Entities D and E have entered into an agreement under which entity D will provide all of entity E’s information technology services for 15 years. Entity D will acquire all of entity E’s back-office computer equipment, related buildings and third-party service contracts. All staff currently employed by entity E in its information technology function will transfer to entity D. Entity D will, in addition to providing information technology services, restructure the information technology operations to improve efficiency and reduce the number of employees.

Analysis

Step 1: Identify the elements of the acquired group The inputs acquired include: tangible items: buildings and computer equipment; and other items not necessarily in the financial statements: employees. The processes acquired include: computer systems and operating processes. The outputs include: existing contracts with other utilities, and a new service contract with entity E.

Step 2: Assess the capability of the group to produce outputs Processes have been acquired that allow entity D to generate outputs from the contract with entity E and the contracts with other third parties.

Step 3: Assess the capability of a market participant to produce outputs if missing elements exist Inputs and processes have been acquired by entity D that allow outputs to be generated. There are no missing elements and, therefore, no further analysis concerning the capability of a market participant to produce outputs is required. Conclusion The integrated set of assets and activities is a business.

Pharmaceutical industry: acquisition of a biotech industry (new definition of business)

Example 1 – Acquisition of a Biotech entity: two IPR&D projects Pharma Co purchases from Biotech a legal entity that contains rights to two Phase 3 compounds developed to treat diabetes and Alzheimer’s. Included in the in-process research and development (IPR&D) is the historical knowhow, formula protocols, designs, and procedures expected to be needed to complete the related phase of testing. The legal entity also holds an ‘at market value’ contract research organisation (CRO) contract. The research could be performed by a number of CROs. No employees, other assets or other activities are transferred. Is the arrangement the acquisition of a business? Analysis No. Pharma Co would conclude that this is an asset acquisition. If the optional concentration test were applied, it would not be passed, since all of the fair value is not concentrated in a single identifiable asset; this is because two dissimilar IPR&D compounds are acquired. Pharma Co would then analyse the transaction, referring to the framework without outputs. The acquisition includes an input of IPR&D and a CRO contract. The contract gives access to an organised workforce. It is likely that the organised workforce would not be considered to be substantive, given that the services could be replaced at no significant cost with another CRO.

Example 2 – Acquisition of a Biotech entity: several IPR&D projects Pharma Co purchases from Biotech a legal entity that contains: rights to several dissimilar IPR&D projects (each having significant fair value); senior management and scientists who have the necessary skills, knowledge or experience to perform R&D activities; and tangible assets (including a corporate headquarters, a research lab and lab equipment). Biotech does not yet have a marketable product, and it has not yet generated revenues. Is the arrangement the acquisition of a business? Analysis Yes. Pharma Co would conclude that this is a business combination. The concentration test is not applied, because the fair value of the assets acquired is not concentrated in a single asset or a group of similar identifiable assets. Further analysis is required, following the framework without outputs, to assess whether a process is acquired and whether the process is substantive. A business is acquired, because the organised workforce is a substantive process that is critical to the ability to develop and convert the inputs (that is, workforce, IPR&D and tangible assets) into outputs.

Real estate industry examples (new definition of business)

Example 1 – Acquisition of a residential real estate portfolio – determined to be an asset acquisition

Property Co purchases a portfolio of 10 residential homes. Each home is considered to be a separate investment property for accounting purposes. All homes are leased out to separate tenants, and they comprise land and buildings. Each home has a different design and layout, but all homes are located in the same geographical area and the risk profile of the real estate market across that area is similar. No employees, other assets or other activities are transferred. Is the arrangement the acquisition of a business?

Analysis

No. Property Co elects to apply the optional concentration test and would conclude that this is an asset acquisition, because substantially all of the fair value is concentrated in a group of similar assets. A transaction is not automatically a business combination if the optional concentration test does not result in an asset classification. If the concentration test failed or was bypassed, an entity would need to assess the transaction under the full framework in IFRS 3.

Example 2 – Acquisition of a residential and office real estate portfolio – determined to be an asset acquisition

Property Co purchases a portfolio of 10 residential homes (the nature of these homes being as outlined in the example above) as well as an office park containing five fully let office buildings. It also acquires an outsourcing contract for maintenance services for the office park. The maintenance services are considered ancillary or minor in the context of generating rental income at the office park. No employees, other assets or other activities are transferred. Is the arrangement the acquisition of a business?

Analysis

No, Property Co would conclude that this is an asset acquisition. The concentration test is not passed, since all of the fair value is not concentrated in a single identifiable asset or a group of similar identifiable assets; this is because two dissimilar classes of real estate with different risk profiles are acquired. Since there are leases in place for both the residential homes and the office park buildings, Property Co would analyse the transaction, referring to the framework with outputs and considering whether the acquired processes are substantive. No organised workforce is acquired, and the maintenance services are considered ancillary or minor in the context of generating rental income.

Further, the maintenance services do not significantly contribute to the ability to generate rental income and could be replaced without significant cost. Would the answer be different if there were no in-place lease contracts and, therefore, no outputs?

Analysis

No, Property Co would still conclude that this is an asset acquisition. In order for the definition of a business to be met where there are no outputs, an organised workforce with the necessary skills critical to the ability to develop and convert the inputs into outputs would need to be present. Since no such organised workforce is acquired, the definition of a business is not met.

Example 3 – Acquisition of a residential and office real estate portfolio – determined to be a business combination

Property Co acquires a portfolio of residential and office assets (the nature of these assets being as outlined in the example above), and it also acquires employees who are responsible for operational management of the assets as well as all tenant management and leasing activity. Is the arrangement the acquisition of a business?

Analysis

Yes. Property Co would conclude that this is a business combination. The concentration test is not applied, because the fair value of the assets acquired is not concentrated in a single asset or a group of similar identifiable assets. Further analysis is required, following the framework with outputs, to assess whether a process is acquired and whether the process is substantive. A business is acquired, because the organised workforce is a substantive process with the necessary skills that is critical to the ability to develop and convert the inputs (that is, land, buildings and in-place leases) into outputs.

Identifying a business combination

What is control?

To meet the definition of a business combination, an acquirer must obtain control. This means that there must be a triggering economic event or transaction and not, for example, merely a decision to start preparing combined or consolidated financial statements for an existing group.

Economic events that might result in an entity obtaining control include:

(a) transferring cash or other assets (including net assets that constitute a business);

(b) incurring liabilities;

(c) issuing equity instruments;

(d) a combination of the above; and

(e) a transaction not involving consideration, such as a combination by contract alone (e.g., a dual listed structure)

Other examples of events that might result in an entity obtaining control:

• an investee undertaking a selective buy-back transaction which results in the entity achieving a majority ownership in the investee without changing the number of equity instruments held in the investee;
• the expiry of an agreement with other shareholders when that agreement prevented the entity from controlling the investee (e.g., another shareholder had participative rights (right of veto) over major financing and operating policy decisions); and
• a ‘creep acquisition‘of equity instruments in an investee through a dividend reinvestment plan or bonus issue that increases the entity’s holding to a controlling level.

Possible structures

The structure of a business combination may be determined by a variety of factors, including legal and tax strategies. Other factors might include market considerations and regulatory considerations. Examples of structures include:

• one business becomes a subsidiary of another;
• two entities are legally merged into one entity;
• one entity transfers its net assets to another entity;
• an entity’s owners transfer their equity interests to the owners of another entity;
• two or more entities transfer their net assets, or the owners transfer their equity interests, to a newly formed entity (sometimes termed a ‘roll-up’ or ‘put-together’ transaction); and a group of former owners of one entity obtains control of a combined entity.

Examples of other legal structures that might be used to effect business combinations include:

Share repurchases by investee

Entity A owns an equity investment in an investee (that meets the definition of a business) that gives it significant influence but not control. The investee repurchases its own shares from other parties, and the proportional interest of entity A increases. Entity A obtains control over the investee. This is a business combination without transfer of consideration, and the acquisition method is applied by the investor.

Change in the rights of other shareholders

Entity B owns a majority share of its investee’s voting equity interests. The investee meets the definition of a business. Entity B is precluded from exercising control over the investee, due to contractual rights held by the other investors in the investee. The rights expire, and entity B obtains control over the investee. This is a business combination without consideration, and the acquisition method would be applied by entity B.

Contracts or other arrangements

Entities C and D enter into a contractual arrangement to combine. Both entities meet the definition of a business. Entity C will control the operations of both entities C and D under the contract terms. This is a business combination without consideration, and the acquisition method would be applied to the arrangement. Entity C reflects this transaction as a business combination in which it obtained control of entity D.

Exchange of assets resulting in acquisition of a business

Entity A transfers a radio broadcast licence to entity B in exchange for a radio station. Entity A determines that the radio station that it receives is a business, while entity B determines that the radio broadcast licence that it receives is an asset.

How should each entity treat the transaction?

Entity A would account for the acquired radio station as a business combination by applying the acquisition method. The consideration transferred is the fair value of the radio broadcast licence. Entity B accounts for the radio broadcast licence as an asset acquisition under the applicable IFRS.

What is a stapling transaction and dual-listed entities?

Stapling transactions and dual-listed entities are rare, and they occur only in certain territories. A stapling transaction is a contractual arrangement between two legal entities. One legal entity issues equity security that are combined with (that is, stapled to) the securities issued by the other legal entity. The stapled securities are quoted at a single price and cannot be traded or transferred independently. A dual-listed entity is typically an arrangement between two listed legal entities, in which their activities are managed under contractual arrangements as a single economic entity while retaining their separate legal identities.

The securities of each entity normally are quoted, traded and transferred independently in different capital markets. One entity has not acquired an ownership interest in the other entity, and the individual legal entities have not been combined to form a new legal entity. However, this is considered a business combination from an accounting perspective.

Stapling arrangements were discussed by the IFRS IC in May 2014. A stapling arrangement that combines separate entities and businesses by the unification of ownership and voting interests in the combining entities is a business combination, as defined by IFRS 3. Stapling transactions and the formation of dual-listed entities typically occur without the transfer of consideration.

Merger of equals, mutual enterprises, and ‘roll-up’ or ‘put together’ transactions

Combinations of mutual enterprises are also within IFRS 3’s scope. The IASB acknowledged some differences between mutual enterprises and corporate business entities,  but concluded that such differences were not substantial enough to warrant separate accounting. The entity deemed to be the acquirer in a combination of mutual enterprises should account for the transaction using the acquisition method. ‘Roll-up’ or ‘put-together’ transactions typically result where several unrelated entities in the same market, or in similar markets, combine to form a larger entity. The IASB concluded that, although these transactions might not cause a single entity to obtain control of the combined entity, they are similar to other types of business combination, and the acquirer should account for the transaction using the acquisition method.