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 has specific guidance on how the following items are recognized and measured. For Recognition, it covers (a) Liabilities and contingent liabilities in the scope of PAS 37, Provisions, Contingent Liabilities and Contingent Assets or IFRIC 21, Levies, and (b) Contingent liabilities. For Measurement, it covers (a) Share-based payment awards, (b) Assets held for sale, and (c) Insurance contracts. And, for both Recognition and Measurement, it covers (a) Deferred taxes, (b) Employee benefits, (c) Indemnification assets, (d) Leases in which the acquiree is the lessee, and (e) Reacquired rights.
Recognition exceptions
Liabilities and contingent liabilities in the scope of PAS 37 or IFRIC 21
This exception applies to liabilities and contingent liabilities that would be in the scope of PAS 37 or IFRIC 21 as if they were incurred separately rather than part of the business combination. This has been included because PFRS 3 refers to the definition of liability in the new Conceptual Framework, which, if applied at the date of acquisition, could create a day 2 gain (see note below).
Accordingly:
- for a provision or contingent liability that would be within the scope of PAS 37, the acquirer applies PAS 37 to determine whether at the acquisition date a present obligation exists as a result of past events.
- for a levy that would be within the scope of IFRIC 21, the acquirer applies IFRIC 21 to determine whether the obligating event that gives rise to a liability to pay the levy has occurred by the acquisition date.
- if the present obligation then identified meets the definition of a contingent liability, then the contingent liabilities recognition exception applies.
This exception applies from 1 January 2022, although it can be adopted early if at the same time (or earlier) an entity also applies all the amendments to PFRS standards resulted from ‘Amendments to References to the Conceptual Framework’ issued in March 2018.
Note: For example, applying the definition of a liability in the Conceptual Framework and not IFRIC 21 may result in recognizing (at the acquisition date) a liability to pay a levy that would not be recognized subsequently when applying IFRIC 21 (which would have created a day 2 gain). Applying IFRIC 21, an entity recognizes a liability to pay a levy only when it conducts the activity that triggers the payment of the levy, whereas applying the Conceptual Framework, an entity recognizes a liability when it conducts an earlier activity.
Contingent liabilities
A contingent liability assumed in a business combination is recognized at the acquisition date:
- only if it is a present obligation that arises from past events and its fair value can be measured reliably; and,
- even if an outflow of economic benefits is not probable (uncertainty is considered in the determination of fair value).
Other contingent liabilities are not recognized. Contingent assets acquired in a business combination are not recognized.
Measurement exceptions
Share-based payment awards
Measured in accordance with PFRS 2, Share-based Payment, which refers to there being a market-based measure. This means vesting conditions, such as service conditions and performance conditions (but other than market conditions), should not be taken into account when estimating the ‘fair value’ of the shares or share options granted as part of the award.
Assets held for sale
A non-current asset (or disposal group) is classified as held for sale at the acquisition date only if the sale is expected to be completed within one year from the acquisition, and it is highly probable that any other criteria not met at the acquisition date will be met within a short period following the acquisition (usually within three months).
The other criteria being (i) the asset is available for immediate sale in its present condition, (ii) the appropriate level of management is committed to a plan to sell the asset, and (iii) an active programmed to locate a buyer and complete the plan has been initiated.
Insurance contracts (exception applicable to business combinations with an acquisition date after the earlier of when PFRS 17 is first applied or 1 January 2023)
A group of contracts within the scope of PFRS 17, Insurance Contracts, acquired in a business combination, and any assets for insurance acquisition cash flows as defined in PFRS 17, is measured as a liability or asset in accordance with PFRS 17 at the acquisition date.
Recognition and Measurement exceptions
Deferred taxes
Deferred tax balances are recognized if related to temporary differences and loss carry-forwards at the acquisition date of the acquiree or if they arise as a result of the acquisition. They are measured in accordance with PAS 12, Income Taxes.
Employee benefits
Post-employment benefits and other long-term benefits are measured using actuarial assumptions as at the acquisition date. Those assumptions should be determined as at the acquisition date on the basis of the conditions existing at that date.
Indemnification assets
Indemnification assets are assets arising from the acquiree’s former owners contractually indemnifying the acquirer for a particular uncertainty. The indemnification asset is measured and recognized on the same basis as the related/indemnified item (i.e. at the same time and for an amount that is measured consistently with how the indemnified item is measured), subject to the contractual provisions or any collectability considerations. If the indemnified item is not recognized as a contingent liability at the acquisition date because its fair value is not reliably measurable, then, no indemnification asset is recognized at that date.
Leases in which the acquiree is the lessee
For leases where the acquiree is the lessee, the acquirer recognizes right-of-use assets and lease liabilities in accordance with PFRS 16, Leases.
The lease liability is measured at the present value of the remaining lease payments as if the acquired lease were a new lease at the date of acquisition. The right-of-use asset is measured at an amount equal to the related lease liability but adjusted to reflect favourable or unfavourable terms of the lease compared to market terms.
Reacquired rights
Fair value is determined based on the remaining contractual term of the related contract without attributing value to possible renewals. If the acquirer previously granted a right to the acquiree to use the acquirer’s intellectual property or other asset (such as a trade name or licensed technology), a separate ‘reacquired right’ intangible asset is recognized even if the underlying asset was not previously reported.
See attached Accounting Alert for further details and illustrative examples.
