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Home > Mergers and Acquisitions Best Practice > Accounting for Business Combinations in Accordance with International Financial Reporting Standards (IFRS) Requirements

Mergers and Acquisitions Best Practice

Accounting for Business Combinations in Accordance with International Financial Reporting Standards (IFRS) Requirements

by Shân Kennedy

Executive Summary

The International Accounting Standards Board (IASB) has introduced requirements in the last few years to make those involved in business combinations more accountable for the transactions that have taken place. In particular:

  • All business combinations must now be accounted for using the acquisition accounting method.

  • The intangible assets arising from a business combination must be identified and recognized separately from purchased goodwill.

  • Purchased goodwill is no longer permitted to be amortized; instead, it must be tested for impairment each year.


The accounting for business combinations under IFRS is governed by four key standards:

  • IFRS 3, Business Combinations;

  • IAS (International Accounting Standards) 27, Consolidated Financial Statements;

  • IAS 36, Impairment of Assets;

  • IAS 38, Intangible Assets.

IFRS 3 sets out the requirements to be followed in accounting for a business combination. Its introduction in 2004 represented a substantial change from the standard it superseded, IAS 22. IFRS 3 signaled the end of the benign method of accounting for business combinations known as “merger accounting.” Instead, all business combinations must be accounted for using the acquisition accounting method. This requires that both acquirer and acquiree are identified for each transaction, that a fair value exercise is performed on the acquiree’s assets and liabilities, and that purchased goodwill arising from the transaction is capitalized in the balance sheet.

A further consequence of the introduction of IFRS 3 is that intangible assets must be recognized separately from purchased goodwill instead of being subsumed within purchased goodwill. Purchased goodwill itself is not amortized, but must be reviewed for impairment annually. The performance of the impairment review is covered by IAS 36, Impairment of Assets, and the identification and recognition of intangible assets is covered by IAS 38, Intangible Assets.

The tightening up of business combination accounting was noted by accountants PricewaterhouseCoopers: “The acquisition process will need to become more rigorous, from planning to execution.”1

The following steps are involved in accounting for a business combination under IFRS 3:

  • identification of the acquirer and the acquiree;

  • performance of a fair value exercise on the acquiree’s assets and liabilities;

  • identification and measurement of the fair value of the intangible assets arising;

  • measurement of the amount of any non-controlling interest in the acquiree;

  • measurement of the amount of goodwill arising from the transaction.

A revised version of IFRS 3 was issued by the IASB in January 2008, and its requirements will be mandatory for accounting periods from July 2009 onward. While the revision is quite comprehensive, it does not change the overall approach set out above. The revision is part of the Convergence Program underway between the IASB and the Financial Accounting Standards Board (FASB), aimed at reducing the number of differences between IFRS requirements and US Generally Accepted Accounting Principles (US GAAP). In addition to tightening up certain areas, the revision developed the previous IFRS 3 by:

  • providing additional guidance regarding the recognition and fair value measurement of the acquiree’s assets and liabilities;

  • changing the requirements for measuring goodwill and the remaining noncontrolling interest when less than a 100% stake in the acquiree is purchased or when an increase in an existing stake is involved.

Identification of Acquirer and Acquiree

IAS 27 demands that the acquirer in a business combination be identified as the party that gains control, with control being defined as “the power to govern the financial and operating policies of an entity so as to benefit from its activities.” Control is presumed to exist if one entity owns more than 50% of the voting power of the other, unless it can be demonstrated that this voting power does not constitute control. Conversely, control can be seen to exist when one entity owns less than 50% of the voting rights in the other but controls it through some other means, such as a shareholder agreement. This situation was seen when ABN AMRO was acquired by the Royal Bank of Scotland (RBS)—RBS owns only 38% of the issued share capital of ABN AMRO but is able to control it through a consortium agreement with the other owners, Fortis and Santander. Thus, RBS consolidates ABN AMRO in its financial statements.

Other guidance provided in IAS 27 for identifying the acquirer includes that, generally, the acquirer is:

  • larger than the acquiree;

  • the party issuing equity or paying cash as consideration;

  • the party that has more seats on the board of directors of the combined entity.


IFRS 3 does, however, also deal with reverse acquisitions in which smaller companies acquire larger ones through the issue of significant amounts of equity.

Fair Value Exercise on the Acquiree’s Assets and Liabilities

Consistent with any acquisition accounting exercise, IFRS 3 requires that the acquired assets and liabilities are recognized initially at fair value in the consolidated financial statements of the combined entity. The standard provides some clarification regarding identification of these assets and liabilities. For instance, IFRS 3 prohibits the setting up of acquisition reorganization provisions since these are not liabilities of the acquirer at the acquisition date. Prior to IFRS 3, acquiring companies often set up substantial acquisition reorganization provisions. Costs, such as those relating to redundancy and factory closures, were charged to these provisions post acquisition rather than to the profit and loss account. Now, such costs must be charged to the profit and loss account of the combined entity post acquisition.

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Further reading



  • Company Reporting, comments on the types of intangible asset being recognized in company accounts are regularly made by this UK-based organization:
  • International Accounting Standards Board (IASB), from whom copies of the relevant IFRS and technical summaries of each standard can be obtained:
  • International Actuarial Association (AAI/IAA):
  • International Valuation Standards Committee (IVSC):

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