An entity shall determine whether a transaction or other event is a business combination by applying the definition in IFRS 3, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. See also the accounting treatment acquisition of a business or asset(s)
Guidance on identifying a business combination and the definition of a business are as follows:
The definition of a business: An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.
Identifying a business combination [IFRS 3 B5 – B6] IFRS 3 Identify a business
IFRS 3 defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. An acquirer might obtain control of an acquiree in a variety of ways, for example:
- by transferring cash, cash equivalents or other assets (including net assets that constitute a business);
- by incurring liabilities; IFRS 3 Identify a business
- by issuing equity interests; IFRS 3 Identify a business
- by providing more than one type of consideration; or
- without transferring consideration, including by contract alone.
A business combination may be structured in a variety of ways for legal, taxation or other reasons, which include but are not limited to:
- one or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer;
- one combining entity transfers its net assets, or its owners transfer their equity interests, to another combining entity or its owners;
- all of the combining entities transfer their net assets, or the owners of those entities transfer their equity interests, to a newly formed entity (sometimes referred to as a roll-up or put-together transaction); or
- a group of former owners of one of the combining entities obtains control of the combined entity.
Definition of a business [IFRS 3 B7 – B12D]: IFRS 3 Identify a business
A business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs. The three elements of a business are defined as follows (see below for guidance on the elements of a business):
- Input: Any economic resource that creates outputs, or has the ability to contribute to the creation of outputs when one or more processes are applied to it. Examples include non-current assets (including intangible assets or rights to use non-current assets), intellectual property, the ability to obtain access to necessary materials or rights and employees.
- Process: Any system, standard, protocol, convention or rule that when applied to an input or inputs, creates outputs or has the ability to contribute to the creation of outputs. Examples include strategic management processes, operational processes and resource management processes. These processes typically are documented, but the intellectual capacity of an organised workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. (Accounting, billing, payroll and other administrative systems typically are not processes used to create outputs.)
- Output: The result of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities.
Optional test to identify concentration of fair value IFRS 3 Identify a business
An optional test (the concentration test) is available to permit a simplified assessment of whether an acquired set of activities and assets is not a business. An entity may elect to apply, or not apply, the test. An entity may make such an election separately for each transaction or other event. The concentration test has the following consequences:
- if the concentration test is met, the set of activities and assets is determined not to be a business and no further assessment is needed.
- if the concentration test is not met, or if the entity elects not to apply the test, the entity shall then perform the assessment set out in paragraphs B8–B12D.
The concentration test is met if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets. For the concentration test:
- gross assets acquired shall exclude cash and cash equivalents, deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities.
- the fair value of the gross assets acquired shall include any consideration transferred (plus the fair value of any non-controlling interest and the fair value of any previously held interest) in excess of the fair value of net identifiable assets acquired. The fair value of the gross assets acquired may normally be determined as the total obtained by adding the fair value of the consideration transferred (plus the fair value of any non-controlling interest and the fair value of any previously held interest) to the fair value of the liabilities assumed (other than deferred tax liabilities), and then excluding the items identified in subparagraph (a). However, if the fair value of the gross assets acquired is more than that total, a more precise calculation may sometimes be needed.
- a single identifiable asset shall include any asset or group of assets that would be recognised and measured as a single identifiable asset in a business combination.
- if a tangible asset is attached to, and cannot be physically removed and used separately from, another tangible asset (or from an underlying asset subject to a lease, as defined in IFRS 16 Leases), without incurring significant cost, or significant diminution in utility or fair value to either asset (for example, land and buildings), those assets shall be considered a single identifiable asset.
- when assessing whether assets are similar, an entity shall consider the nature of each single identifiable asset and the risks associated with managing and creating outputs from the assets (that is, the risk characteristics).
- the following shall not be considered similar assets:
- a tangible asset and an intangible asset;
- tangible assets in different classes (for example, inventory, manufacturing equipment and automobiles) unless they are considered a single identifiable asset in accordance with the criterion in subparagraph (d);
- identifiable intangible assets in different classes (for example, brand names, licences and intangible assets under development);
- a financial asset and a non-financial asset;
- financial assets in different classes (for example, accounts receivable and investments in equity instruments); and
- identifiable assets that are within the same class of asset but have significantly different risk characteristics.
The requirements in paragraph B7B do not modify the guidance on similar assets in IAS 38 Intangible Assets; nor do they modify the meaning of the term ‘class’ in IAS 16 Property, Plant and Equipment, IAS 38 and IFRS 7 Financial Instruments: Disclosures.
Elements of a business IFRS 3 Identify a business
Although businesses usually have outputs, outputs are not required for an integrated set of activities and assets to qualify as a business. To be capable of being conducted and managed for the purpose identified in the definition of a business, an integrated set of activities and assets requires two essential elements—inputs and processes applied to those inputs. A business need not include all of the inputs or processes that the seller used in operating that business. However, to be considered a business, an integrated set of activities and assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output. Paragraphs B12–B12D specify how to assess whether a process is substantive.
If an acquired set of activities and assets has outputs, continuation of revenue does not on its own indicate that both an input and a substantive process have been acquired.
The nature of the elements of a business varies by industry and by the structure of an entity’s operations (activities), including the entity’s stage of development. Established businesses often have many different types of inputs, processes and outputs, whereas new businesses often have few inputs and processes and sometimes only a single output (product). Nearly all businesses also have liabilities, but a business need not have liabilities. Furthermore, an acquired set of activities and assets that is not a business might have liabilities.
Determining whether a particular set of assets and activities is a business should be based on whether the integrated set is capable of being conducted and managed as a business by a market participant. Thus, in evaluating whether a particular set is a business, it is not relevant whether a seller operated the set as a business or whether the acquirer intends to operate the set as a business.
Assessing whether an acquired process is substantive IFRS 3 Identify a business
Here is an explanation as to how to assess whether an acquired process is substantive if the acquired set of activities and assets does not have outputs (A) and if it does have outputs (B).
An example of an acquired set of activities and assets that does not have outputs at the acquisition date is an early-stage entity that has not started generating revenue. Moreover, if an acquired set of activities and assets was generating revenue at the acquisition date, it is considered to have outputs at that date, even if subsequently it will no longer generate revenue from external customers, for example because it will be integrated by the acquirer.
(A) If a set of activities and assets does not have outputs at the acquisition date, an acquired process (or group of processes) shall be considered substantive only if:
- it is critical to the ability to develop or convert an acquired input or inputs into outputs; and
- the inputs acquired include both an organised workforce that has the necessary skills, knowledge, or experience to perform that process (or group of processes) and other inputs that the organised workforce could develop or convert into outputs. Those other inputs could include: IFRS 3 Identify a business
- intellectual property that could be used to develop a good or service; IFRS 3 Identify a business
- other economic resources that could be developed to create outputs; or IFRS 3 Identify a business
- rights to obtain access to necessary materials or rights that enable the creation of future outputs.
Examples of the inputs mentioned in subparagraphs (b)(i)–(iii) include technology, in-process research and development projects, real estate and mineral interests.
(B) If a set of activities and assets has outputs at the acquisition date, an acquired process (or group of processes) shall be considered substantive if, when applied to an acquired input or inputs, it:
- is critical to the ability to continue producing outputs, and the inputs acquired include an organised workforce with the necessary skills, knowledge, or experience to perform that process (or group of processes); or
- significantly contributes to the ability to continue producing outputs and:
- is considered unique or scarce; or
- cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs.
The following additional discussion supports both paragraphs A and B: IFRS 3 Identify a business
- an acquired contract is an input and not a substantive process. Nevertheless, an acquired contract, for example, a contract for outsourced property management or outsourced asset management, may give access to an organised workforce. An entity shall assess whether an organised workforce accessed through such a contract performs a substantive process that the entity controls, and thus has acquired. Factors to be considered in making that assessment include the duration of the contract and its renewal terms.
- difficulties in replacing an acquired organised workforce may indicate that the acquired organised workforce performs a process that is critical to the ability to create outputs.
- a process (or group of processes) is not critical if, for example, it is ancillary or minor within the context of all the processes required to create outputs.