Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Financial Reporting Standards (PFRS) 3, Business Combinations, to assist preparers of financial statements and those charged with the governance of reporting entities understand the requirements set out in PFRS 3 and revisit some areas where confusion has been seen in practice.

Overview

PFRS 3 contains the requirements for a business combination. This article sets out the definition and underlying principles of fair value, gives a brief overview of permissible valuation techniques and presents PFRS 3’s specific guidance on fair value measurement.

PFRS 3’s measurement principle

The identifiable assets acquired, and liabilities assumed in a business combination are measured in accordance with the general measurement principle in PFRS 3 which states that they should be measured at their acquisition-date fair values.

Fair value is defined in PFRS 13, Fair Value Measurement, as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

PFRS 3 defines fair value (consistently with PFRS 13) but does not provide detailed guidance on the valuation methodology and instead refers to PFRS 13 for valuation models and techniques.

With respect to PFRS 13, the standard notes there are three widely used ‘families’ of valuation techniques that can be grouped into three broad approaches as listed below and states entities should use valuation techniques consistent with one or more of them to measure fair value:

1. Market Approach - Uses prices and other relevant information generated by market transactions involving identical or comparable (i.e., similar) assets, liabilities or a group of assets and liabilities, such as a business.
2. Income approach - Converts future amounts (e.g., cash flows or income and expenses) to a single current (i.e., discounted) amount. The fair value measurement reflects current market expectations about those future amounts.
3. Cost Approach - Reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost).

Whichever technique is used, the resulting valuation should be consistent with the definition and underlying concepts of fair value.

Guidance on fair value measurement of specific items

Guidance on fair value measurement of specific items which include inventories and deferred revenue is also presented in the accounting alert attached to this email.

See attached Accounting Alert for further details and illustrative examples.