Accounting Alert

This Accounting Alert is issued to give insights on how to identify a business combination within the Scope of PFRS 3, Business Combination. 

Mergers and acquisitions are becoming more and more common as entities aim to achieve their growth objectives. PFRS 3 ‘Business Combinations’ contains the requirements for these transactions, which are challenging in practice.

Our ‘Insights into PFRS 3’ series summarizes the key areas of PFRS 3, highlighting aspects that are more difficult to interpret and revisiting the most relevant features that could impact your business. This article discusses how to identify a business combination within the scope of PFRS 3. 

Identifying a Business Combination

PFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or merger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination. However, a business combination may be structured, and an entity may obtain control of that structure, in a variety of ways.  Therefore, identifying a business combination transaction requires the determination of whether:

• what is acquired constitutes a ‘business’ as defined in PFRS 3; and,
• control has been obtained.

If an entity acquires an interest in a business entity but does not obtain control, it should apply PAS 28 ‘Investments in Associates and Joint Ventures’, PFRS 11 ‘Joint Arrangements’ or PFRS 9 ‘Financial Instruments’, depending on the nature of the relationship that the interest creates and the level of influence the entity can exert over the investee’s financial and operating policies.

Obtaining Control over the Entity

A business combination involves an entity obtaining control over one or more businesses (this entity is known as ‘the acquirer’). PFRS 10 ‘Consolidated Financial Statements’ and PFRS 3 provide guidance to determine whether an entity has obtained control.

In most cases, control of an investee is obtained through holding the majority of voting rights. Therefore, control is normally obtained through ownership of a majority of the shares that confer voting rights (or through obtaining additional voting rights resulting in majority ownership if some were already held). In transactions where an acquired business is not a separate legal entity (a trade and assets deal), control typically arises through ownership of those assets.

However, control can also be obtained through various other transactions and arrangements – some of which require careful analysis and judgment. The definition of control and relevant guidance issued by both the IASB and IFRIC should then be considered. As well as assessing whether control is obtained, this guidance is also relevant in addressing the related questions of when control transfers and which entity obtains control.

Control requires:

• power over the investee
• exposure, or rights, to variable returns
• ability to use power to affect returns.

If applying the guidance of PFRS 10 does not clearly indicate which of the combining entities is the acquirer, additional factors included within PFRS 3 should be considered. For instance, it is possible for control to be obtained:

• without holding or acquiring a majority of the investee’s voting rights
• without the investor actually being party to a transaction or paying consideration.

Business Combination within the Scope of PFRS 3

PFRS 3 applies to all business combinations identified as such under PFRS 3 with the following three exceptions:

• the formation of a joint arrangement in the financial statements of the joint arrangement itself,
• a combination of entities or businesses under common control (referred to as common control combinations); and,
• the acquisition by an investment entity, as defined in PFRS 10, of an investment in a subsidiary that is required to be measured at fair value through profit or loss  (without exception).

The Accounting Alert also provides examples of ways a business combination may be structured, and an entity may obtain control, definition of control of an investee, and detailed guidance on the three exceptions for a business combination within the scope of PFRS 3.

See attached Accounting Alert for further details.