Business Combinations Phase I

Date recorded:

Definition of Joint Control

In June 2003, the Board considered whether to modify the amendments it proposed in ED 3 to the definitions of joint control in IAS 28, Accounting for Investments in Associates, and in IAS 31, Financial Reporting of Interests in Joint Ventures. The Board noted that the definition proposed in ED 3 might be too narrow because it could be viewed as suggesting that a joint venture exists only when unanimous consent is required for all financial and operating decisions. On the other hand, the current definition may make it easier for an entity to structure a business combination as a joint venture to circumvent the proposals in ED 3, Business Combinations.

The Board considered the definition joint control from a G4+1 paper:

Joint control over an enterprise exists when no one party alone has the power to control its strategic operating, investing, and financing decisions, but two or more parties together can do so, and each of the parties sharing control (joint venturers) must consent.

The Board noted that based on the current definitions in IAS 31 of 'joint venture' and 'joint control', a business combination would be excluded from the scope of the IFRS resulting from ED 3, and therefore from the purchase method requirement, only if that combination results in the formation of reporting entity over which the owners of the combining entities or operations contractually agree to share control such that no single party is in a position to control the activities of the reporting entity.

The G4+1 definition of joint control differs from the existing IAS 31 definition in three respects:

  • The G4+1 definition reflects the view that joint control can sometimes exist without a contract or even an explicit agreement.
  • The IAS 31 definition applies broadly to economic activities while the G4+1 definition refers to enterprises.
  • The G4+1 definition contemplates unanimous consent to strategic operating, investing and financing decisions while IAS 31 allows for the possibility that some such decisions might require only a majority of the venturers.

The staff recommended that the Board retain the existing definition of joint control in IAS 28 and IAS 31 and the related commentary in paragraph 6 of IAS 31, pending a more fundamental review of those Standards.

Some Board members expressed concern that not including a 'unanimous' criterion could lead to a combination being effectively accounted for as a pooling of interests. It was agreed to include this criterion in respect of the venturers and not any other shareholders.

Subsequent Measurement of Contingent Liabilities

ED 3 proposed that:

  • Contingent liabilities recognised as part of allocating the cost of a combination should be measured after initial recognition at fair value, with changes in fair value recognised in profit or loss.
  • The acquirer should measure the fair value of a contingent liability as the amount that a third party would charge to assume that contingent liability. Such an amount should reflect all expectations about possible cash flows and not the single most likely or the expected maximum or minimum cash flow.

The Board agreed to clarify that this requirement did not apply to certain items as follows:

The requirement in paragraph 46 does not apply to the following items assumed in a business combination:

  • Financial instruments within the scope of IAS 39.
  • Financial guarantees excluded from the scope of IAS 39 and required to be accounted for under IAS 37 as set out in paragraph 2(f)of IAS 39.
  • Commitments to provide loans at below-market interest rates and required to be accounted for under paragraph 2(i)of IAS 39.

The staff recommended that the Board proceed with the proposal in paragraph 46 of ED 3 that contingent liabilities recognised as part of allocating the cost of a combination be measured after initial recognition at fair value, with changes in fair value recognised in profit or loss.

Some Board members had previously noted that this proposal is inconsistent with the accounting for financial guarantees under the proposed improvements to IAS 39, Financial Instruments: Recognition and Measurement, and suggested that contingent liabilities should be subsequently measured at the higher of their initially recognised amount or their value determined in accordance with IAS 37, Provisions, Conntingent Liabilities and Contingent Assets.

As there was uncertainty as to the future accounting under Phase II it was agreed to use the latter in the Phase I standard. This would not apply to contracts accounted for under IAS 39.

Measuring Value in Use

Where the price paid for the unit (part of the acquired entity) was based on projections that included a major restructuring expected to result in a substantial increase in the net cash inflows derived from the unit and there is no observable market from which to estimate the unit's net selling price, there is some concern that if the net cash inflows arising from the restructuring are not reflected in the unit's value in use, comparison of the unit's recoverable amount and carrying amount immediately after the acquisition will result in the recognition of an impairment loss.

Although the Board acknowledged the problem, they did not believe it could be adequately addressed at the moment. They concluded that the Basis for Conclusions should note that the best evidence of net selling price is the past transaction.

The second issue relates to an asset or unit that has been held for some time, but which the entity plans to abandon as part of a restructuring. The issue arises because of what some believe is a conflict (more precisely, a timing conflict) between the requirements in paragraphs 27(b)and 37 of IAS 36, Impairment of Assets. If a planned restructuring includes plans to abandon an asset or unit and the effects of that planned restructuring have been reflected in the financial budgets approved by management, but they have not yet met the criteria in IAS 37 Provisions, Contingent Liabilities and Contingent Assets for recognition as a liability, at issue is whether the value in use of the asset or unit:

a. should reflect the effects of the restructuring, which would give rise to an immediate impairment loss for the asset or unit; or

b. should reflect the continuing use of the asset or unit until the entity is committed to the restructuring. This would result in the impairment loss for the asset or unit being recognised at the same time as any restructuring provision is recognised under IAS 37.

The staff recommended that paragraph 27(b) be reworded as follows:

"Cash flow projections shall be based on the most recent financial budgets/forecasts that have been approved by excluding any estimated future cash inflows or outflows expected to arise from future restructurings or capital expenditure as described in paragraph 37. Projections based on these budgets/forecasts shall cover a maximum period of five years, unless a longer period can be justified; and...."

Measuring Value in Use Using Pre-Tax Cash Flows and Discount Rates

In July the Board considered respondents' and field visit participants' concerns regarding the requirement in IAS 36 to use pre-tax cash flows and pre-tax discount rates when measuring value in use. Many participants and respondents stated that using pre-tax cash flows and pre-tax discount rates will represent a significant implementation issue for companies because typically a company's accounting, corporate finance, planning/budgeting, and strategic decision making systems are fully integrated and use post-tax cash flows and post-tax discount rates to arrive at present value measures. The participants and respondents believe that the IAS 36 requirement to use pre-tax cash flows and pre-tax discount rates would prevent companies from integrating the value in use calculations with their existing internal management systems, and instead would oblige them to develop additional 'pre-tax' systems, separate from their existing integrated 'post-tax' systems. Although IAS 36 currently requires the use of pre-tax cash flows and pre-tax discount rates, the companies believe this issue is exacerbated by the proposal for the recoverable amount of cash-generating units containing goodwill and/or intangible assets with indefinite useful lives to be calculated at least annually.

The staff recommended that no amendments be made at this time to the requirement in IAS 36 to use pre-tax cash flows and pre-tax discount rates when measuring value in use. Any decision on the treatment of tax in value in use calculations should be considered as part of the conceptual project on measurement.

The Board agreed, and also agreed to include a discussion of the different ways this can be achieved in the Basis for Conclusions.

Treatment of Forward Contracts in a Business Combination

During the pre-ballot process for IAS 39, one Board member suggested that when an acquirer and vendor in a business combination agree the cost of the combination before the acquisition date (that is, before the date the acquirer obtains control of the acquiree), a forward contract arises that, in theory, should be accounted for under IAS 39, Financial Instruments: Recognition and Measurement. Board members considered this issue and agreed that it should not be dealt with as part of the Financial Instruments project. Instead, the issue should be considered by the Board in finalising Phase I of the Business Combinations project.

The staff recommended that the following amendment be added to the scope of IAS 39:

This Standard shall be applied by all entities to all types of financial instruments except:

"g. contracts between an acquirer and a vendor in a business combination to buy or sell an acquiree at a future date."

A number of Board members expressed concern that this could be abused in other areas. Others believed that the reference to a business combination provided the necessary limitation. The Board agreed with the staff (11-3).

The Definition of an 'Operation'

The Board considered additional guidance on identifying when an entity or a group of assets or net assets constitutes an 'operation'. The staff recommended that the references to 'operations' should be replaced with references to 'business' and the term 'business' should be defined.

The staff proposed the following definition and related guidance:


A business is an integrated set of activities and assets conducted and managed for the purpose of providing:

a. a return to investors; or

b. lower costs or other economic benefits directly and proportionately to policyholders or participants.

A business generally consists of (a) inputs, (b) processes applied to those inputs, and (c) resulting outputs that are, or will be, used to generate revenues.


The elements of a business will vary by industry and by how an entity structures its operations, but would normally include the following:


  • Long-lived assets, including intangible assets, or rights to the use of long-lived assets.
  • Intellectual property.
  • The ability to obtain access to necessary materials or rights.
  • Employees.


  • The existence of systems, standards, protocols, conventions, and rules that act to define the processes necessary for normal operations, such as (i) strategic management processes,(ii) operational processes, and (iii) resource management processes.


  • The ability to obtain access to the customers that purchase, or will purchase, the outputs of the transferred set.

f goodwill is present in a transferred set of activities and assets, the transferred set shall be presumed to be a business.

The assessment of whether a transferred set is a business shall be made without regard to how the transferee intends to use the transferred set. In other words, it is not relevant to the evaluation of whether the transferred set is a business whether the transferee will actually operate the set on a stand-alone basis or intends to continue using the transferred set in the same manner as the transferor.

The staff further proposed to relocate paragraph 14 of ED 3 to the beginning of the section in ED 3 titled 'Identifying a Business Combination' and amend it as follows:

The result of nearly all business combinations is that one entity, the acquirer, obtains control of one or more other businesses, the acquiree. If an entity obtains control of one or more other entities that are not businesses, the bringing together of those entities is not a business combination.

The Board agreed to incorporate the definition into the standard and include the presumption that if goodwill is present in a transferred set of activities and assets, the transferred set shall be presumed to be a business.

The staff indicated they would be proceeding with a pre-ballot draft of the three standards.

Three Board members indicated they would be dissenting to the package of standards.

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