Example of business combination

In the following article, we will make a practical example of a business combination.

With the help of this example, you will quickly understand the acquirer method set out in IFRS 3.

The acquire method is composed of the following steps.

  1. Identifying the acquirer;

  2. Determining the acquisition date;

  3. Recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and

  4. Recognising and measuring goodwill or a gain from a bargain purchase.

What is a business combination

A business combination is a union of two or more entities into a single reporting entity.

Practical example business combination

In December of year 1, company A acquired 90% of the interest of entity B for 37,000

Entity B’s financial statements are shown below.

Example business combination

Within the financial statements of entity B, a client list was not recognized as it was generated internally, under paragraph 63 of IAS 38.

This intangible has a fair value of 9,000.

In addition, entity B disclosed a contingent liability for a civil lawsuit in its notes to the financial statements.

The fair value of this liability amounts to 14,000.

On the other hand, company A financial statement is as follows:

Example business combination

As can be seen, within company A financial statements, there is a recognized investment of 37,000, which is equivalent to the amount of the consideration paid for 90% of the shares of entity B.

Based on the above information, determine the identifiable assets and liabilities, the generated goodwill, and the non-controlling interest.

Before continuing to read the post, put your knowledge into practice.

Example of business combination questions

To solve this exercise, we will first determine the identifiable assets and liabilities.

IFRS 3 establishes that when a business combination is carried out, identifiable assets and liabilities must be recognized at fair value.

As we can see in the example, there is a list of clients, which entity B did not recognize because it was generated internally.

However, according to paragraph 13 of IFRS 3, intangibles recognized in a business combination must comply with the principles of identifiability, be non-monetary, and without physical appearance.

An asset is identifiable when it can be sold, exploited or is capable of being separated or divided from the entity and sold, transferred, exploited, leased or exchanged, either individually together with a contract, an asset or a related liability.

This means that expenditures related to an internally generated intangible asset must be recognized in profit and loss.

This taking into account that it is impossible to separate between the disbursements to generate this asset, and the disbursements to operate the business.

For this reason, IAS 38 establishes that these expenditures are recognized in profit or loss, and not as part of an asset.

However, when a business combination is carried out, internally generated intangible assets behave as an asset acquired separately.

For this reason, these assets must be recognized by the acquiring entity.

Thus, the identifiable assets and liabilities are the following:

Property, plant and equipment: 29,000

Licenses: 22,000

Client list: 9,000

Total assets: 60,000

Financial obligations: -18,000

Contingent liabilities: -14,000

Total liabilities: -32,000

Net Identifiable Assets and Liabilities: 28,000

The next step is the calculation of the non-controlling interest

Non-controlling interest: 2,800 (28,000 x 10%)

This interest represents the percentage of entity B, which company A does not control.

Now we are going to calculate the goodwill generated in the business combination.

For this, it’s necessary to use the following formula.

Goodwill = consideration paid + non-controlling interest – Net assets and liabilities identifiable.

Goodwill = 37,000 + 2,800 – 28,000 = 11,800

Company A must make the following accounting entries in its consolidated financial statements.

Example business combination

The consolidated financial statements are shown below

Example business combination

Example of business combination questions

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