1

Title
IFRS 3 Business Combinations
IAS 28 Associate
IFRS 11 Joint Arrangements

Coverage
The video and these accompanying notes will cover
theoretical base of consolidations, recap on associates
and equity accounting and introduce you to the
accounting and identification of joint arrangements.

Exam context
It is important that you know and are able to explain and
apply key terms such as “a business” “the acquirer”
“control” “significant influence” “joint arrangement” and
“equity accounting”. These are often examined in the
exam by way of small case studies for say 4 marks; thus
we will be looking at many scenarios to give you the
necessary understanding of the principles.

Tom Clendon
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IFRS3 Business Combinations

Group accounts are prepared where there has been a
“business combination”.
Definition of a business combination.
A business combination is a transaction or event in
which an acquirer obtains control of one or more
businesses.
This raises three questions
1. What is a business?
2. How do you identify the acquirer?
3. What is meant by control?

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What is a business?
A business is defined as an integrated set of activities
and assets that is capable of being conducted and
managed for the purpose of providing a return directly to
investors or other owners, members or participants.
A business generally has three elements.
• Inputs – an economic resource (e.g. non-current
assets, intellectual property) that creates outputs
when one or more processes are applied to it
• Process – a system, standard, protocol, convention
or rule that when applied to an input or inputs,
creates outputs (e.g. strategic management,
operational processes, resource management)
• Output – the result of inputs and processes applied
to those inputs.

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Q Alban – is it a business?
Alban, the parent of the Alban group, has purchased all
the equity shares in the limited liability company Milk
that has as its only assets land. The land is not farmed
nor rented out. The company has no employees and
there is no operational activity so Milk has no rental
income.

Required
Discuss how Alban should account for the
acquisition of Milk.

Tom Clendon
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A Alban – is it a business?

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Identification of the acquirer

IFRS 3 requires that in a business combination an
acquirer must be identified for all business
combinations.
The identification of the acquirer is important the other
entity becomes the acquiree. It is acquiree that is
subject to acquisition accounting i.e. goodwill is
calculated for the acquiree, fair value adjustments are
made on the acquiree’s net assets and it is the
acquiree’s post-acquisition profits that are consolidated.
In the vast majority of cases the acquirer will be the
parent company and the acquiree is the subsidiary,
however the identification of the acquirer must follow
substance. Whenever substance is applied then
judgment is required.
Where the highly unusual (and bizarre) situation occurs
that the subsidiary is the acquirer then this group
structure is known as a reverse acquisition.

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How to determine who is the acquirer

IFRS 3 provides the following guidance in determining
which party to the business combination is the acquirer.
1. The acquirer is usually the entity that transfers
cash, where the business combination is effected in
this manner.

2. The acquirer is usually, but not always, the entity

issuing equity interests where the transaction is
effected in this manner.

3. The acquirer is usually the entity with the largest

relative size (assets, revenues or profit)

However the entity also considers other pertinent

facts and circumstances including:

• relative voting rights in the combined entity

after the business combination
• the composition of the governing body and
senior management of the combined entity
• the terms on which equity interests are
exchanged

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Q International Conglomerate – who is the

acquirer?
An unlisted company, International Conglomerate, has
approached the directors of District wishing to enact a
business combination to form a new group. District is a
quoted company with its shares listed on a recognised
stock exchange and has a market capitalisation of $200
million. The shareholders of International Conglomerate
wish to obtain a stock exchange listing. International
Conglomerate has a market capitalisation of $10,000
million. It has been agreed that the combination is to be
effected by means of a share for share exchange with
District becoming the legal parent company of the group
by issuing a very large amount of its equity in exchange
for acquiring the shares in International Conglomerate.
In the newly formed group the former directors of
International Conglomerate will be appointed on the
board of District replacing the previous directors.

Required
Identify the acquirer in the business combination of
International Conglomerate and District.

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A International Conglomerate – who is the

acquirer?

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What is control?
An investor determines whether it is a parent by
assessing whether it controls the investee.
Control is normally (but not exclusively evidenced by the
investor holding a majority (50% +) of the voting rights.
An investor controls an investee if and only if the
investor has all of the following elements:
Power over the investee
The investor has existing rights that give it the ability to
direct the relevant activities (the activities that
significantly affect the investee's returns). Power arises
from rights. Such rights can be straightforward (e.g.
through voting rights) or be complex (e.g. embedded in
contractual arrangements).
Exposure to variable returns
An investor must be exposed, or have rights, to variable
returns from its involvement with an investee to control
the investee. Such returns must have the potential to
vary as a result of the investee's performance and can
be positive, negative, or both.
The ability to use the power
A parent must also have the ability to use its power over
the investee to affect its returns from its involvement
with the investee.

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Consider all circumstances

An investor will also have to consider all relevant facts
and circumstances when assessing whether it controls
an investee.
e.g options / warrants
e.g shareholder agreements
e.g. the size and dispersal of other holdings.

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Q Fred & Wilma – is there control?

On 15 November 20X5, Fred purchased shares in

Wilma which gave Fred a 45% shareholding in Wilma.
On the same date, Fred purchased an option which
gave Fred the right to acquire an additional 10% of the
shares in Wilma from the existing shareholders. This
option is exercisable at any time between 15 November
20X5 and 30 September 20X7 at a price which makes it
highly likely the option will be exercised during that
period. The directors of Fred are unsure how to treat
Wilma in the consolidated financial statements for the
year ended 30 September 20X6.

Required

Advice the directors of Fred on the appropriate

treatment of Wilma in the consolidated financial
statements for the year ended 30 September 20X6
PRIOR to any exercising of the option.

Tom Clendon
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A Fred & Wilma – is there control?

Tom Clendon
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Q Water – is it a subsidiary?

Alpha has acquired 40% of the equity capital and voting

rights of Water and twelve other investors each hold 5%
of the voting rights of the investee. A shareholder
agreement grants investor Alpha the right to appoint,
remove and set the remuneration of management
responsible for directing the relevant activities. To
change the agreement, a two thirds majority vote of the
shareholders is required.

Required:
Discuss how the purchase of the shareholding in
Water should be accounted for in the consolidated
financial statements of Alpha.

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A Water – is it a subsidiary?

Tom Clendon
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Q Gamma – is it a subsidiary?

Alpha has acquired 40% of the equity capital and voting

rights of Gamma. The other 60% of Gamma’s shares
are held by a wide variety of investors, none of whom
owns more than 0·5% individually. None of the other
shareholders has any arrangements to consult any of
the others or make collective decisions. Since Alpha
purchased the investment it has actively participated in
establishing the operating and financial policies of
Gamma.

Required:
Discuss how the purchase of the shareholding in
Gamma should be accounted for in the consolidated
financial statements of Alpha.

Tom Clendon
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A Gamma – is it a subsidiary?

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Determining the acquisition DATE ie. when does the

acquirer obtain control over the acquiree.
All pertinent facts and circumstances have to be
considered when determining the acquisition date.
IFRS 3 does not provide detailed guidance on the
determination of the acquisition date, but considerations
might include,
• when a public offer becomes unconditional (with a
controlling interest acquired),
• the date when the acquirer can effect change in the
board of directors of the acquiree,
• the date of acceptance of an unconditional offer,
• the date when the acquirer starts directing the
acquiree's operating and financing policies,
• the date competition or other authorities provide
necessarily clearances

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IAS 28 Investments in Associates

Associates

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Associates

An associate is an entity over which the investor (the

parent) has significant influence.

Significant influence is the power to participate in the

financial and operating policy decisions of the investee
but is not control or joint control of those policies.

Where the investor holds 20% or more of the voting

power on an investee, it will be presumed the investor
has significant influence unless it can be clearly
demonstrated that this is not the case.

If the holding is less than 20%, the entity will be

presumed not to have significant influence unless such
influence can be clearly demonstrated.

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What is significant influence?

The existence of significant influence by an entity is

usually evidenced in one or more of the following ways:

• representation on the board of directors or

equivalent governing body of the investee;
• participation in the policy-making process, including
participation in decisions about dividends or other
distributions;
• material transactions between the entity and the
investee;
• interchange of managerial personnel; or provision of
essential technical information

Associates are accounted for in the group using equity

accounting.

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Group statement of financial position & equity

accounting

The investment in the associate is initially recognised at

cost and thereafter increased by the share of the post-
acquisition retained earnings of the associate.

No assets or liabilities of the associate are consolidated.

Intercompany balances between the associate and the

parent or subsidiary are not eliminated on consolidation.

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Group statement of comprehensive income & equity

accounting

The group's profit or loss includes its share of the

associate’s profit after tax.

No income or expenses of the associate are

consolidated.

The group’s other comprehensive income includes its

share of the investee's other comprehensive income.

Intercompany transactions between the associate and

the parent or subsidiary are not eliminated on
consolidation.

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Q June – application of equity accounting

On 1 January 20X7 William purchased a 30% interest in

June for $200,000 and this meant that it acquired
significant influence over the financial and operating
activities of June. June has reported a profit for the year
ended 31 December 20X7 of $60,000. June has paid
dividend of $10,000. At the reporting date William’s
investment in June is impaired by $5,000.

Required

Applying equity accounting

a) Calculate the carrying value of the investment in

June in the William group statement of financial
position as at 31 December 20X7

b) Calculate the share of profit of June that is

included in the group statement of profit or loss.

Tom Clendon
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A June – application of equity accounting

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Discontinuing the equity method.

Use of the equity method should cease from the date

that significant influence ceases:

If more shares are acquired such that the investment

becomes a subsidiary, then the group consolidates
using acquisition accounting (IFRS 3).

If an associate is going to be sold; and meets the

conditions set out in IFRS 5 Discontinued Operations –
then the associate is accounted for as “held for sale”.

If shares are sold, and there is a retained interest with

no influence; then the group has a financial asset that
has to be measured at fair value (IFRS 9).

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Losses in excess of investment.

If an investor's share of losses of an associate equals or

exceeds its interest in the associate, the investor
discontinues recognising its share of further losses.

After the investor's interest is reduced to zero, no further

losses are recognised UNLESS the investor has
incurred legal or constructive obligations or made
payments on behalf of the associate.

If the associate subsequently reports profits, the investor

only resumes recognising its share of those profits only
after its share of the profits equals the share of losses
not recognised.

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IFRS 11 Joint Arrangements

Joint arrangements are arrangements where two or

more parties have joint control.

Joint control will only apply if the relevant activities

require unanimous consent of those who collectively
control the arrangement.

Types of Joint Arrangements

The classification of a joint arrangement depends on an
assessment of their rights and obligations that arise in
the ordinary course of business.
Joint arrangements may take the form of either joint
operations or joint ventures.

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Joint operations

Joint operations are defined as joint arrangements

whereby the parties that have joint control have rights to
the assets and obligations for the liabilities.

Normally, there will not be a separate entity established

to conduct joint operations.

The standard requires that joint operators each

recognise their share of assets, liabilities, revenues and
expenses of the joint operation. This is proportional
consolidation.

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Joint ventures

Joint ventures are defined as joint arrangements

whereby the parties have joint control of the
arrangement and have rights to the net assets of the
arrangement.

This will normally be established in the form of a

separate entity to conduct the joint venture activities.

The equity method of accounting should be used in this

situation i.e. as per associates.

Tom Clendon
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Q Zoo & Mountain

Zoo has entered into an agreement with Mound and
Valley. All three companies are in the retail trade. It has
been agreed that the three companies will hold equal
equity shares in a newly formed company Mountain.
Mountain will commence trade by importing goods and
retailing these goods online. All investors will be
represented on the board of Mountain. It has been
agreed that any decisions regarding the operations and
financial policies relating to Mountain have to be
approved by two thirds of the investors.

Required
Discuss how Zoo’s investment in Mountain will be
classified and treated in the group financial
statements of Zoo.

Tom Clendon
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A Zoo & Mountain

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Q Joseph - accounting for both types of joint

arrangements

Alpha and Joseph are domestic competitors but have

decided to join forces to export goods. Under the
agreement that they reach both Alpha and Joseph have
to mutually agree on all major operating, financial and
other decisions relating to the exporting business. In
addition they have agreed to share profit and losses
equally.

They identify the need for the new joint arrangement to

have initial capital of $20,000 which both parties will
equally contribute.

The budgeted activities for the joint arrangement in the

initial period will to be to buy an item of plant for $8,000
for cash, to purchase goods $5,000 for cash which will
all be sold for $12,000 on credit. Depreciation will be
$1,000.

Proposal one is to form a joint venture by incorporating

as a new company Export Ltd with each party
contributing $10,000 as an initial investment in return for
50% of the equity shares. Both Alpha & Joseph
therefore have a right to the net assets of Export Ltd.

Proposal two is that they form a joint operation where

both parties have rights to the assets and have a joint
and several liability for any liabilities incurred by the joint
operation. Each party will contribute $10,000 into a new
joint bank account.

Tom Clendon
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Required

a) Show the accounting in the accounts of Alpha if

the joint arrangement with Joseph through the
joint venture of Export Ltd – proposal one

b) Show the accounting in the accounts of Alpha if

the joint arrangement with Joseph is a joint
operation – proposal two

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A Joseph

Tom Clendon
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Tom Clendon
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A. Alban

A business combination is a transaction or event in which an acquirer obtains control

of one or more businesses.

A business is defined as an integrated set of activities and assets that is capable of

being conducted and managed for the purpose of providing a return directly to
investors or other owners, members or participants in the form of dividends, lower
costs or other economic benefits to investors or owners.

Milk does not meet the definition of a business in IFRS 3 (Revised) Business
Combinations as it does not have any processes such as real estate management
which are applied to the property that is owned. Milk does not generate any outputs
such as rental income.

Therefore the acquisition should be treated as a purchase of assets.

A. District & International Conglomerate

In the vast majority of circumstances the legal parent company of the group is the
acquirer and the significance of being identified as the acquirer means that the other
party to the combination has been acquired / bought i.e. is the acquiree.

Now when we prepare group accounts we only calculate goodwill on the entity that
has been acquired i.e. the acquiree and it is this entity’s net assets that are subject
to fair value adjustments. It also follows that it is only the acquiree’s post-acquisition
profits are reported in the group accounts. I repeat in the vast majority of
circumstances the acquiree is the subsidiary.

Thus when we prepare group accounts the entity that is identified as the acquirer
does not have fair value adjustments, or goodwill and all its profits both pre and post
the business combination are reported in the group accounts. I repeat in the vast the
majority of circumstances the acquirer is the parent company.

In this case the legal parent of the group is District, as District is issuing shares and
will hold an investment in the shares of International Conglomerate. However it is not
automatic that the legal parent is the acquirer. We should always report the
economic substance of the combination, to make a faithful representation of the
business combination.

What is proposed actually is quite odd – though as we shall see understandable.

What is happening is that the small, but quoted company, District becomes the legal
parent by issuing lots of shares to a much larger entity so that its original
shareholders are just swamped. This type of group structure is known as a reverse
acquisition.

A reverse acquisition usually involves the smaller listed company (District) issuing a
large number of shares to the acquiring company (International Conglomerate) so
that the acquiring company’s shareholders end up controlling the listed company.
This is a way of obtaining a stock exchange listing as a private company may

Tom Clendon
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arrange to have itself ‘acquired’ by a smaller public company as a means of

obtaining a listing.

Although the public company that issues shares (District) is regarded as the legal
parent and the private company (International Conglomerate) is regarded as the
legal subsidiary, the private company that initiated and arranged the combination is
deemed to be the acquirer if it is determined to have obtained control over the
financial and operating policies of the public company, rather than vice versa.

Therefore, for financial reporting purposes in a reverse acquisition, the legal parent is
the acquiree and the legal subsidiary is the acquirer. The carrying amounts of the
assets and liabilities of the legal subsidiary (International Conglomerate) do not
change as a result of the acquisition; it is the assets and liabilities of the legal parent
(District) which are re-measured at fair value. The consideration is deemed to be the
fair value of the equity shares in the legal subsidiary (International Conglomerate)
issued to the owners of the legal parent (District).

To conclude regardless of the legal group structure International Conglomerate is the

acquirer and District the acquiree.

A. Fred & Wilma – IFRS 10

According to IFRS 10 – Consolidated Financial Statements – Wilma is a subsidiary

of Fred if Fred controls Wilma.

A key aspect of determining control is considering whether Fred has power to direct
the relevant activities of Wilma. Based on its current shareholding, Fred cannot
exercise that power by voting rights as Fred owns only 45% of the shares.

However, IFRS 10 states that where potential voting rights (e.g. share options) are
currently exercisable, they should be taken into account in considering whether
control exists.

If Fred exercised its options, this would take its total shareholding in Wilma to 55%.
On this basis, the directors of Fred should regard Wilma as a subsidiary.

Tom Clendon
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A. Water

On a first review, Alpha does not have the power to control Water simply on account
of its the absolute size of the investor’s holding and the relative size of the other
shareholdings alone as in this case these are not conclusive in determining whether
the investor has rights sufficient to give it power.

An investor controls an investee if and only if the investor has all of the following
elements:

1. power over the investee, i.e. the investor has existing rights that give it the
ability to direct the relevant activities (the activities that significantly affect the
investee's returns)
2. exposure, or rights, to variable returns from its involvement with the investee
3. the ability to use its power over the investee to affect the amount of the
investor's returns.

An investor will also have to consider all relevant facts and circumstances when
assessing whether it controls an investee.

So when we consider the relevant facts that it is investor Alpha that has a contractual
right to appoint, remove and set the remuneration of management, this is sufficient to
conclude that it has power over the investee.

The fact that investor Alpha might not have exercised this right or the likelihood of
investor Alpha exercising its right to select, appoint or remove management shall not
be considered when assessing whether investor Alpha has power.

Water is a subsidiary of Alpha.

A. Gamma

On a first review, Alpha does not have the power to control Gamma simply on
account of its the absolute size of the investor’s holding and the relative size of the
other shareholdings alone as in this case these are not conclusive in determining
whether the investor has rights sufficient to give it power.

An investor controls an investee if and only if the investor has all of the following
elements:

4. power over the investee, i.e. the investor has existing rights that give it the
ability to direct the relevant activities (the activities that significantly affect the
investee's returns)
5. exposure, or rights, to variable returns from its involvement with the investee
6. the ability to use its power over the investee to affect the amount of the
investor's returns.

An investor will also have to consider all relevant facts and circumstances when
assessing whether it controls an investee.

Tom Clendon
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So when we consider the relevant facts that none of the other shareholders has any
arrangements to consult any of the others or make collective decisions and that
since Alpha purchased the investment it has actively participated in establishing the
operating and financial policies of Gamma we can conclude that Gamma is
controlled.

Gamma is therefore a subsidiary of Alpha.

A. William & June – equity accounting

Group statement of financial position

NCA - Investment in the Associate W1 210,000

Group statement of profit or loss

Income from Associate W2 13,000
Profit before Tax XXXXX

W1Parent’s investment 200,000

Plus % of the post-acquisition (30% x (60,000 – 10,000)) 15,000
retained earnings
{OR plus % of the earnings less {30% x 60,000} less {30% x
the % of the dividend received} 10,000} also equals 15,000
Less the impairment loss (5,000)
210,000

W2 Share of profit after tax (30% x 60,000) 18,000

Less impairment loss (5,000)
13,000

A. Zoo and Mountain

A joint arrangement is defined by IFRS 11 Joint Arrangements, as “an arrangement

of which two or more parties have joint control”. Joint control is identified as being
“contractually agreed sharing of control which requires unanimous consent of the
parties sharing control”. Joint arrangements are then classified into being either a
joint operation or a joint venture.

Based upon the information in the question, it states that decision-making related to
Mountain can be made by a majority of the three equity-holders. Consequently, it
would appear that the investment in Mountain cannot be regarded as being a joint
arrangement within the definition of the standard.

An associate is defined as an investment over which significant influence is

exercised. Zoo is a director of Mountain. Zoo owns one third of its equity. This is
evidence of being able to exercise significant influence. Zoo it would appear is able
to exercise significant influence over Mountain.

Tom Clendon
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In conclusion, in Zoo’s group accounts Mountain is an associate and will be

accounted using equity accounting.

A Joseph’s joint arrangement

The joint arrangement is creating a profit being made of $6,000 ($12,000 revenue
less the cost of sales $5,000 and the depreciation $1,000).

a) Joint Venture

As a joint venture each party will apply equity accounting and thus recognise its
share of the profit in a single line.

In the group statement of financial position there will be a single line of a non-current
asset investment – cost plus % of profit

Investment in the JV (10,000 + (50% x 6,000)) $13,000

In the group statement of profit or loss there will be a single line

Income from the JV (50% x $6,000) $3,000

b) Joint Operation

As a joint operation each party will account for its share of the assets (and any
liabilities) in the group statement of financial position
$
NCA – PPE (50% x (8,000 – 1,000)) 3,500

CA – Bank (50% x (20,000 – 8,000 – 5,000)) 3,500

CA – Receivable (50% x 12,000) 6,000

As a joint operation each party will account for its share of the income and expenses
in the group statement of profit or loss

$
Revenue (50% x 12,000) 6,000

Cost of sales (50% x 5,000) (2,500)

Depreciation (50% x 1,000) (500)

Tom Clendon