IFRS 3 — Internationals Financial Reporting Standards 3 provide a reporting standard to be used for business combination and to guide recognition, measurement and disclosures for an item of financial activity occurring along with an acquirer. It is designed to ensure the manner in which businesses account for acquisitions reflects economic reality and that it furnishes investors with the comparable, understandable information they need. IFRS 3 lays rules for the enterprises to apply the goods acquired, liabilities identified and the goodwill recognition. In these situations, IFRS 3 acquisition is the basic accounting treatment that will apply. It also addresses, among other topics, IFRS 3 goodwill, IFRS 3 fair value, and IFRS 3 disclosures.
IFRS 3 Business Combinations
A business combination occurs when one entity controls another entity. IFRS 3 for business combinations rule the transaction recording. One of the purposes of the rules is to ensure clear, consistent and comparable reporting by a number of companies about how a transaction should be reflected in financial statements from the economic substance of the transaction, instead of the legal form of the transaction. The IFRS 3 acquisition method is applied to all business combinations. It provides the acquirer with IFRS 3 fair value recognition of those assets, liabilities, and goodwill on acquisition date.
The IFRS 3 Acquisition Method
The acquisition method is only permitted under IFRS 3. It follows four key steps:
- Identifying the acquirerThe acquirer is the entity that obtains control over another.
- When to recognize an acquisition: the date on which the acquirer gets control.
- Recognizing and measuring assets, liabilities, and non-controlling interests: All identifiable assets and liabilities shall be measured at their fair value according to IFRS 3.
- Recognition of goodwill or gains from bargain purchases: Goodwill is the excess amount over the net fair value of acquired assets and liabilities that have been paid. If this amount is less, it is treated as a purchase and looked at as a gain.
IFRS 3 Recognition and Measurement
Under the recognition and measurement of IFRS 3, the acquirer records identifiable assets and liabilities at fair value, recognizing as intangible some specific intangibles such as customer relationships and patents, even if these have not previously been identified on the acquired company’s books. Liabilities include contingent liabilities, which are measured and appropriately disclosed.
Disclosures Associated with Business Combinations IFRS 3
Relevant information should be included in IFRS 3 disclosures. Such disclosures include the following:
- Details about the target company and why the target company was acquired,
- Fair value of acquired assets and liabilities,
- Goodwill recognized and reasons for recognition.
- Any contingent liabilities taken on in the acquisition.
- How IFRS 3 requires appropriate disclosures
IFRS 3 Goodwill
When an acquirer pays more significant purchase consideration than fair value for a company’s net assets, goodwill arises. The concept of IFRS 3 goodwilll ensures the registration of intangible goodwill benefits, such as brand reputation, consumer loyalty, and future profit.
Recognition of IFRS 3 Goodwill
Goodwill per IFRS 3 is recorded when the consideration transferred exceeds the fair value of net identifiable assets. Goodwill, thus, is the value assigned to the business that results from future economic benefits not separately identifiable. Goodwill is not amortized, but tested annually for impairment.
Impairment Testing of Goodwill
Goodwill impairment tests determine if the goodwill recorded is an accurate recording of the true economic value. Goodwill impairment loss recognized when goodwill fair value is less than its carrying value. Impairment testing entails;
Goodwill allocation to CGUs, Binding the recoverable amount of the CGU with the carrying amount, and Binding impairment loss for when the carrying amount of the CGU is higher than its recoverable amount.
Treatment of Goodwill for IFRS 3 accounting
According to IFRS 3 Accounting Treatment for Goodwill, businesses are required to recognize goodwill as an intangible asset with an annual impairment test. Impairment Loss: In case of any impairment loss, it must be immediately recognized as an expense. This also ensures that acquired asset values are accurately depicted in financial statements.
IFRS 3 Scope and Exclusions
The definition of the scope in IFRS 3 describes the type of transactions that come under the ambit of this standard. These business combinations include mergers, acquisitions, and purchase of control of other entities. Although most business combinations fall under the scope of IFRS 3, the following transactions are excluded from its scope:
- Joint venture
- Assets acquisition that does not constitute a business
- Transactions under common control
- These exclusions explain that IFRS 3 is applicable to true business combinations.
IFRS 3-Step Acquisition and Treatment
IFRS 3 step-acquisition is where an entity obtains control over one or more transactions over another company. In those circumstances:
- The past interest in the acquiree will get re-measured to fair value;
- The variance between its carrying amount and fair value is recognized as profit or loss;
- The acquirer thereafter applies the IFRS 3 acquisition method in recognizing assets, liabilities, and goodwill.
This obviates the appreciable inaccuracies expected by firms on acquisition fragmentation simply because it has occurred in several transactions.
IFRS 3 Fair Value and Example of Business Combination
According to IFRS 3, fair value is a decisive point in this standard. It describes how assets and liabilities are to be registered at the date of acquisition.
IFRS 3 Fair Value and Its Relevance
IFRS 3 fair value is the price received to sell an asset or paid to transfer a liability in an orderly transaction. Fair value provides transparency in the financial reporting of the acquired company’s assets and liabilities.
Examples of Business Combinations under IFRS 3
A typical example under IFRS 3 relates to acquiring a company at a cost of ₹500 crores. If the acquired company has net assets of ₹400 crores, the additional ₹100 crores is accounted under goodwill as per IFRS 3. The acquired assets and liabilities are recorded at fair value per IFRS 3, and all related disclosures according to IFRS 3 are provided in the financial statements.
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Relevance to ACCA Syllabus
IFRS 3 is a fundamental standard that has a significant focus in the ACCA syllabus, particularly regarding students who sit the Financial Reporting (FR) and Strategic Business Reporting (SBR) papers. Students who know IFRS 3 are equipped to examine business combinations, goodwill, and fair value measurement for assets and liabilities. For accountants involved in mergers, acquisitions, and consolidations, understanding how to interpret financial statements requires knowledge of IFRS 3.
IFRS 3 ACCA Questions
Q1 — What is the main goal of IFRS 3?
A) For the standardization of the accounting of financial instruments
B) Specify the accounting treatment for business combinations
C) Establishing a standard for SMEs financial reporting
D) To analyze the tax consequences of corporate transactions
Ans: B) To define the accounting treatment for business combinations
Q2: How does IFRS 3 require goodwill to be initially measured in a business combination?
A) As the total of the fair value of all assets acquired
B) The difference between the purchase price and the net fair value of identifiable assets and liabilities
C) The fair value of liabilities assumed on the transaction
D) As the cost of acquisition less the net book value of assets
Ans: B) As the excess of the purchase price over the net fair value of identifiable assets and liabilities
Q3: How should acquisition-related costs be treated under IFRS 3?
A) They are part of the acquisition cost
B) They are viewed as a potential asset
C) Expense when incurred
D) They get amortised over periods
Ans: C) They are charged against the income when incurred
Q4: How should contingent consideration be recognized under IFRS 3?
A) It is not taken into account in financial statements
B) It Is Denoted at Fair Value as of the Date of Acquisitions
C) It only counts if you pay for it
D) To be considered as goodwill
Ans: B) Its fair value is recognised on the acquisition date
Q5: What is industy practice for representing a bargain purchase in a business combination?
A) Negative Goodwill is acknowledged by the purchasing entity
B) The acquiring company recognizes a gain in income or loss
C) The transaction gets reversed
D) Excess goes to non-current assets
Ans: B) Gain is recorded by the acquirer in profit or loss
Relevance to US CMA Syllabus
US (Certified Management Accountant) CMA, covers IFRS 3 in Part 1: Financial Reporting, Planning, Performance, and Control. A thorough understanding of IFRS 3 better prepares candidates to work in the areas of business valuation, mergers and acquisitions, and financial statement preparation, all of which are important operational focuses in managerial finance and strategic decision-making.
IFRS 3 US CMA Questions
Q1: What is the requirement of IFRS 3 when measuring identifiable assets and liabilities?
A) Historical cost accounting
B) Recor at fair value as of the acquisition date
C) Use management estimates
D) No ignore assets that cannot be physically verified
Ans: B) Recognized at fair value as of acquisition date
Q2: What is the treatment of step acquisition in IFRS 3?
A) Prior investments are “remeasured” at fair value with any gain or loss recognized in profit or loss
B) Ante underly is at its original value
C) Recalculation of goodwill on historical cost
D) IFRS 3 does not permit step acquisitions
Ans: A) Historical investments are revaluated at a market value with presouled king or hire
Q3: What gets disclosed in financial statements under IFRS 3?
A) How the acquisition was made, what is goodwill, and the effect on financial statements
Fair value of only assets acquired
D) All the liabilities incurred in the transaction
D ) Who pays the transaction fee in WAXP currency while individual items are free
Ans: A) Nature of approach, good will and effect in financial statements
And here is the answer: Q4: What is the usual method for measuring goodwill as per IFRS 3?
A) Net Book Value Method
B) PPA (Purchase Price Allocation)
C) Historical Cost Approach
D) Amortized Cost Model
Ans : B) Purchase Price Allocation (PPA)
Q5: According to IFRS 3, when a company purchases another entity, what must they do unlike non-controlling interest?
A) The non-controlling interest should be recognized at fair value or at the proportionate share of net assets
B) Non-controlling interest is not considered in acquisition accounting
C) Non-controlling interest is always recognised at cost
D) Non-controlling interest is not calculated according to IFRS 3
Ans: A) Non-controlling interest at fair value or proportionate share of net assets
Relevance to US CPA Syllabus
US (Certified Public Accountant) CPA–period IFRS 3 (throughout)–US CPA SOX (USA) The US CPA exam has it in the Financial Accounting and Reporting (FAR) section. Candidates need to know how to report business combinations using purchase method and what to do with any good (or bad) will for the companies they vote on for corporate financial reporting.
IFRS 3 US CPA Questions
Q1: Under IFrS 3, a goodwill impairment is treated as recognized.
A) Annually goodwill is amortized
B) Goodwill is annual tested for impairment, and for impairment.
C)Each year goodwill is remeasured to its fair value
D) Goodwill is recognized instantly as an expense
Ans: B) Goodwill tested for impairment annually or if any triggers for impairment
Q. 2 What is the main approach in IFRS 3 for accounting of business combinations?
A) Purchase Method
B) Pooling of Interests
C) Historical Cost Method
D) Proportional consolidation
Ans: A) Purchase Method
Q3: What is the accounting for identifiable intangible assets acquired in a business combination?
A) If they satisfy the recognition conditions they should be recognised separately
B) Goodwill always bypasses them
C) They are not accounted for in financial statements
D) Amortized over 40 years
Ans: A) If they meet recognition criteria, they must be recognized separately
Q4: Should companies measure deferred tax assets and liabilities in a business combination?
A) Under the acquisition date fair value method
B) Applying tax rates in effect when making the acquisition
C) Omitting them in acquisition accounting
D) Estimating future tax rates using market assumptions
Ans: A) Fair value on the date of acquisition
Q5: What is done with in-process research and development (IPR&D) that is acquired in a business combination?
A) It is expensed immediately
B) Capitalized as Intangible asset if the Criteria is met
C) It is added to goodwill
D) Depreciate it over five years
Ans: B) It is recognized as an intangible asset in the books, if it qualifies
Relevance to CFA Syllabus
IFRS 3: We study IFRS 3 under CFA Level (2) – Financial Reporting and analysis and it is a key concept in business combinations, goodwill and fair value adjustment. Its importance in financial ratios, profitability analysis, investment decisions need to be familiarized by CFA candidates.
IFRS 3 CFA Questions
Q1: What are the effects of goodwill impairment on the financial ratios?
A) It increases net income
B) It lowers return on assets (ROA) and returns on equity (ROE)
C) It is not reflected in financial statements
D) It increases earnings per share (EPS)
Ans: (B) It reduces both ROA and ROE
Q 2: What is the impact of IFRS 3 in acquisition leverage ratios?
A) Leverage ratios could rise because new liabilities are recognized
B) leverage ratios always decline
C) Mergers have no impact on leverage ratios
D) Leverage ratios are not a consideration of IFRS 3
Ans: A) New liabilities recognized may increase leverage ratios
Q3: What is the initial measurement of goodwill in a business combination in terms of IFRS 3?
A) During the difference between the consideration transferred and fair value of net assets acquired
B) As the total of all assets acquired
C) The difference between total liabilities and total assets
D) As an expense to be taken to profit and loss immediately
Ans: A) Difference between consideration transferred and fair value of net assets acquired.
Q4: What is the accounting for contingent consideration at the acquisition date under IFRS 3?
A) It is ignored until paid
B) It is recognized at fair value as a component of the consideration transferred
C) It is charged to the income statement
D) Recognized only if its payment is likely
Ans: B) It is measured at fair value as part of the consideration transferred
Q5: What is the accounting treatment for a bargain purchase under IFRS 3?
A) The acquirer should recognize gain in profit or loss
B) The acquirer recognizes the excess as goodwill
C) The acquiree must return the difference
D) The acquirer must restate the acquisition price
Ans: A) acquirer recognize gain in P/L
