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Business Combinations Phase II

Date recorded:

- Application of the purchase method.

Working Principle

The Board discussed the following working principle with the intention of clarifying certain aspects thereof.

The accounting for a business combination assumes that the transaction is an exchange of equal values. The total amount to be recognized should be measured at either the fair value of the consideration paid or the fair value of the net assets acquired, whichever is a better measure of the fair value of the transaction.

  • If the consideration paid is cash or other assets (or liabilities incurred) of the acquiring entity, the fair value of the consideration paid generally determines the total amount to be recognised in the financial statements of the acquiring entity.
  • If the consideration paid is in the form of equity instruments, the fair value of the equity instruments ordinarily is more clearly evident than the fair value of the net assets acquired and, thus, generally will determine the total amount to be recognized by the acquiring entity.

In a business combination, the acquiring entity obtains control over the acquired entity and therefore is responsible for the assets and liabilities of the acquired entity. The identifiable acquired assets and assumed liabilities should be recognised on the date control is obtained, and measured at their fair values at that date:

  • If the total fair value of the acquired business exceeds the sum of the fair values of the recognised identifiable assets acquired and liabilities assumed, that excess amount (which is the implied fair value of goodwill) should be recognised as an asset.
  • If the total fair value of the acquired business is less than the sum of the fair values of the recognised identifiable assets acquired and liabilities assumed, that amount should be recognised as a gain in the income statement (rather than as negative goodwill in the balance sheet).

The Board agreed that the reference to a "business combination" in the first sentence of the working principle should be replaced by a reference to an acquisition as all business combinations would be deemed to be acquisitions and this would avoid any ambiguity.

There was some concern raised that the working principle could be seen to be circular. The staff agreed that they would consider this concern.

A Board member queried whether this principle placed a cap on the amount of negative goodwill/gain arising in a bargain purchase acquisition by not requiring the goodwill in the acquired business to be recognised before the negative goodwill is determined. The staff agreed to consider this.