IFRS 3 prescribes the financial reporting by an entity when it undertakes a business combination. A business combination is the bringing together of separate entities or businesses into one reporting entity.

All business combinations are accounted for by applying the purchase method, which views the business combination from the perspective of the acquirer. The acquirer is the combining entity that obtains control of the other combining entities or businesses

(the acquiree)

The acquirer measures the cost of a business combination as the aggregate of:

  • The fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree; plus
  • Any costs directly attributable to the business combination.

Any adjustment to the cost of the combination, that is contingent on future events, is included in the cost of the combination at the acquisition date if the adjustment is probable and can be measured reliably.

The acquirer allocates the cost of the business combination by recognizing the acquiree’s identifiable assets, liabilities and contingent liabilities at their fair value at the date of acquisition, except for non-current assets that are classified as held for sale in accordance with IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations. Such assets held for sale are recognized at fair value less costs to sell.

Goodwill, being the excess of the cost over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities, is recognized as an asset.

Goodwill is subsequently carried at cost less any accumulated impairment losses in accordance with IAS 36 Impairment of Assets. If the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities exceeds the cost of the combination, the acquirer:

  • Reassesses the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the combination; and
  • Recognizes immediately in profit or loss any excess remaining after that reassessment.

IFRS 3 specifies the accounting treatment:

  • For business combinations that are achieved in stages;
  • Where fair values can only be determined provisionally in the period of acquisition;
  • Where deferred tax assets are recognized after the accounting for the acquisition is complete; and
  • For previously recognized goodwill, negative goodwill and intangible assets.

Disclosure Requirements

IFRS 3 also specifies disclosures about business combinations and any related goodwill.

Audit Procedures

The auditor’s procedures as far as goodwill is concerned would include:

  1. Vouching for details as per the purchase agreement of the values attributed to the assets purchased and whether the price obtained was reasonable considering similar businesses.
  2. Review of the accounts of the business concerned and determining whether the business is profitable and can therefore justify the continued recognition of goodwill as an asset.
  3. Consider impairment tests in accordance with IAS 36. (Top down and bottom up tests under IAS 36 Impairment of Assets)
  4. Consider the requirements of ISA 545 Auditing Fair Value measurements