HKFRS 3 - Business Combinations

HKFRS 3 - Business Combinations

OBJECTIVE OF HKFRS 3

The objective of HKFRS 3 is to improve the relevance, reliability and comparability of information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish this, HKFRS 3 establishes principles and requirements for how the acquirer:

Recognises and measures the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree

Recognises and measures goodwill acquired or a gain from a bargain purchase

Determines what information to disclose to enable users to evaluate the nature and financial effects of the business combination

SCOPE (Paragraphs 2-2A)

HKFRS 3 applies to any transaction or other event that meets the definition of a business combination.

Exclusions from scope:

(a) Accounting for the formation of a joint arrangement in the financial statements of the joint arrangement itself

(b) Acquisition of an asset or group of assets that does not constitute a business (accounted for as asset acquisition - cost allocated based on relative fair values; no goodwill arises)

(c) Combinations of entities or businesses under common control

Additional exclusion (Paragraph 2A):

The requirements do not apply to the acquisition by an investment entity (as defined in HKFRS 10) of an investment in a subsidiary that is required to be measured at fair value through profit or loss

IDENTIFYING A BUSINESS COMBINATION (Paragraph 3)

An entity shall determine whether a transaction is a business combination by applying the definition, which requires that the assets acquired and liabilities assumed constitute a business.

If the assets acquired are not a business, the transaction is accounted for as an asset acquisition.

Definition of a Business (Appendix 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.

Three Elements of a Business (Paragraph B7)

Element	Description	Examples
Input	Any economic resource that creates outputs	Non-current assets, intellectual property, employees, access to materials
Process	Any system, standard, protocol, convention or rule that when applied to inputs creates outputs	Strategic management, operational processes, resource management
Output	Result of inputs and processes applied	Goods or services to customers, investment income, other income

Optional Concentration Test (Paragraphs B7A-B7C)

An entity may elect to apply a concentration test for a simplified assessment of whether an acquired set is not a business.

The 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.

Consequences:

If test is met → The set is not a business (no further assessment needed)

If test is not met or entity elects not to apply → Perform full assessment under paragraphs B8-B12D

Gross assets acquired exclude:

Cash and cash equivalents

Deferred tax assets

Goodwill resulting from effects of deferred tax liabilities

Assets NOT considered similar:

Tangible asset and intangible asset

Tangible assets in different classes

Identifiable intangible assets in different classes

Financial asset and non-financial asset

Financial assets in different classes

Identifiable assets in same class with significantly different risk characteristics

Assessing Whether an Acquired Process is Substantive (Paragraphs B12-B12D)

If the set does NOT have outputs at acquisition date:

A process is substantive only if:

(a) It is critical to the ability to develop or convert inputs into outputs; AND

(b) The inputs acquired include both an organised workforce with necessary skills AND other inputs that could be developed or converted into outputs

If the set HAS outputs at acquisition date:

A process is substantive if:

(a) It is critical to continuing production AND inputs include an organised workforce; OR

(b) It significantly contributes to continuing production AND is unique/scarce or cannot be replaced without significant cost

THE ACQUISITION METHOD (Paragraphs 4-5)

An entity shall account for each business combination by applying the acquisition method.

Four steps required:

Identify the acquirer

Determine the acquisition date

Recognise and measure identifiable assets acquired, liabilities assumed, and any non-controlling interest

Recognise and measure goodwill or a gain from a bargain purchase

IDENTIFYING THE ACQUIRER (Paragraphs 6-7)

For each business combination, one combining entity shall be identified as the acquirer - the entity that obtains control of another entity (the acquiree).

Guidance from HKFRS 10 is used to identify the acquirer.

Additional factors when HKFRS 10 does not clearly indicate (Paragraphs B14-B18):

Factor	Indicator
Transfer of cash/assets	Usually the entity that transfers cash or incurs liabilities
Exchange of equity interests	Usually the entity that issues equity interests (except reverse acquisitions)
Relative voting rights	Owners retaining largest portion of voting rights
Large minority interest	Single owner or organised group holding largest minority voting interest
Governing body composition	Owners able to elect/appoint/remove majority of governing body members
Senior management	Former management dominating combined entity management
Premium paid	Entity paying premium over pre-combination fair value
Relative size	Significantly larger in assets, revenues or profit
Multiple entities	Which entity initiated the combination

Reverse Acquisitions (Paragraphs B19-B27)

A reverse acquisition occurs when the entity that issues securities (legal acquirer) is identified as the acquiree for accounting purposes.

Example: Private operating entity wants to become public - public entity acquires private entity's equity interests. The public entity is the legal acquirer, but the private entity is the accounting acquirer.

Key accounting treatments:

Consolidated financial statements issued under legal parent's name but described as continuation of legal subsidiary's financial statements

Assets and liabilities of legal subsidiary (accounting acquirer) at pre-combination carrying amounts

Assets and liabilities of legal parent (accounting acquiree) at fair value

Retained earnings and other equity balances of legal subsidiary before combination

Non-controlling interest reflects proportionate share of legal subsidiary's pre-combination carrying amounts

DETERMINING THE ACQUISITION DATE (Paragraphs 8-9)

Acquisition date: The date on which the acquirer obtains control of the acquiree.

Generally the closing date (when consideration is legally transferred)

May be earlier or later than closing date if control is obtained at a different time

All pertinent facts and circumstances must be considered

RECOGNISING AND MEASURING IDENTIFIABLE ASSETS ACQUIRED, LIABILITIES ASSUMED, AND NON-CONTROLLING INTEREST (Paragraphs 10-31A)

Recognition Principle (Paragraph 10)

As of the acquisition date, the acquirer shall recognise separately from goodwill:

Identifiable assets acquired

Liabilities assumed

Any non-controlling interest in the acquiree

Recognition Conditions (Paragraphs 11-14)

Condition 1: Assets and liabilities must meet the definitions in the Conceptual Framework at the acquisition date

Example: Future costs to exit an activity or terminate employees are NOT liabilities at acquisition date

Condition 2: Assets and liabilities must be part of the exchange for the acquiree, not separate transactions

Result: Some assets and liabilities may be recognised that the acquiree had not previously recognised (e.g., internally developed brand names, patents, customer relationships)

Classification/Designation (Paragraphs 15-17)

At acquisition date, the acquirer shall classify/designate assets and liabilities based on:

Contractual terms

Economic conditions

Operating or accounting policies

Other pertinent conditions at acquisition date

Examples of classifications:

Financial assets/liabilities as FVTPL, amortised cost, or FVTOCI

Designation of derivative as hedging instrument

Whether embedded derivative should be separated

Exception: Lease contracts (acquiree as lessor) classified at inception of contract, not acquisition date

Measurement Principle (Paragraphs 18-20)

Identifiable assets acquired and liabilities assumed shall be measured at their acquisition-date fair values.

Non-controlling interest measurement options (for present ownership interests):

(a) Fair value; OR

(b) Proportionate share of recognised amounts of acquiree's identifiable net assets

All other components of non-controlling interests measured at acquisition-date fair value

EXCEPTIONS TO RECOGNITION OR MEASUREMENT PRINCIPLES (Paragraphs 21-31A)

Exceptions to Recognition Principle

Contingent Liabilities (Paragraphs 21A-23)

For provisions/contingent liabilities within scope of HKAS 37:

Apply paragraphs 15-22 of HKAS 37 to determine if present obligation exists at acquisition date

For levies within scope of HK(IFRIC)-Int 21:

Apply HK(IFRIC)-Int 21 to determine if obligating event occurred by acquisition date

Contingent liabilities assumed in business combination:

Recognised at acquisition date if it is a present obligation arising from past events AND fair value can be measured reliably

Even if it is not probable that an outflow will be required (contrary to HKAS 37)

Contingent assets:

NOT recognised at acquisition date

Exceptions to Both Recognition and Measurement Principles

Income Taxes (Paragraphs 24-25)

Recognised and measured in accordance with HKAS 12

Employee Benefits (Paragraph 26)

Recognised and measured in accordance with HKAS 19

Indemnification Assets (Paragraphs 27-28)

Recognised at same time as indemnified item

Measured on same basis as indemnified item

Subject to valuation allowance for uncollectible amounts

If indemnification relates to item not recognised (e.g., contingent liability with unreliable fair value), recognised using consistent assumptions

Leases (Acquiree as Lessee) (Paragraphs 28A-28B)

Recognise right-of-use assets and lease liabilities for leases identified under HKFRS 16

Exemptions: Leases ending within 12 months of acquisition date; low-value leases

Measure lease liability at present value of remaining lease payments as if new lease at acquisition date

Measure right-of-use asset at same amount as lease liability, adjusted for favourable/unfavourable terms

Exceptions to Measurement Principle

Reacquired Rights (Paragraph 29)

Measured based on remaining contractual term

Do not consider potential contractual renewals

Share-based Payment Transactions (Paragraph 30)

Measured in accordance with HKFRS 2 (market-based measure)

Assets Held for Sale (Paragraph 31)

Measured at fair value less costs to sell in accordance with HKFRS 5

Insurance Contracts (Paragraph 31A)

Measured in accordance with HKFRS 17

RECOGNISING AND MEASURING GOODWILL OR GAIN FROM BARGAIN PURCHASE (Paragraphs 32-40)

Goodwill Calculation (Paragraph 32)

Goodwill is measured as the excess of (a) over (b):

(a) Aggregate of:

Consideration transferred (acquisition-date fair value)

Amount of any non-controlling interest

In a business combination achieved in stages: acquisition-date fair value of previously held equity interest

(b) Net of:

Acquisition-date amounts of identifiable assets acquired and liabilities assumed

Bargain Purchases (Paragraphs 34-36)

A bargain purchase occurs when (b) exceeds (a).

Before recognising gain:

Reassess whether all assets acquired and liabilities assumed have been correctly identified

Review measurement procedures for:

Identifiable assets and liabilities

Non-controlling interest

Previously held equity interest (if applicable)

Consideration transferred

After review: Recognise resulting gain in profit or loss on acquisition date

Consideration Transferred (Paragraphs 37-38)

Measured at fair value = Sum of acquisition-date fair values of:

- Assets transferred by acquirer

- Liabilities incurred by acquirer to former owners

- Equity interests issued by acquirer

Forms of consideration: Cash, other assets, business or subsidiary, contingent consideration, ordinary/preference equity instruments, options, warrants, member interests

If transferred assets/liabilities have carrying amounts different from fair values:

Remeasure to fair value at acquisition date

Recognise gains/losses in profit or loss

Exception: If assets/liabilities remain within combined entity (acquirer retains control), measure at carrying amounts immediately before acquisition date

Contingent Consideration (Paragraphs 39-40)

Recognised at acquisition-date fair value as part of consideration transferred

Classified as financial liability or equity based on HKAS 32 definitions

Right to return of previously transferred consideration classified as asset

ADDITIONAL GUIDANCE FOR PARTICULAR TYPES OF BUSINESS COMBINATIONS (Paragraphs 41-44)

Business Combination Achieved in Stages (Step Acquisition) (Paragraphs 41-42A)

Treatment:

Remeasure previously held equity interest at acquisition-date fair value

Recognise resulting gain/loss in profit or loss (or OCI as appropriate)

Amounts previously recognised in OCI are reclassified as if the previously held interest was disposed of

Joint operation obtaining control (Paragraph 42A):

Also treated as business combination achieved in stages

Remeasure entire previously held interest in joint operation

Business Combination Without Transfer of Consideration (Paragraphs 43-44)

Examples:

Acquiree repurchases own shares for acquirer to obtain control

Minority veto rights lapse

Combination by contract alone (stapling arrangement, dual listed corporation)

For contract alone combinations:

Attribute acquiree's net assets to owners of acquiree

Equity interests held by parties other than acquirer = non-controlling interest

Even if all equity interests are attributed to non-controlling interest

MEASUREMENT PERIOD (Paragraphs 45-50)

Measurement period: The period after acquisition date during which the acquirer may adjust provisional amounts. Maximum: 1 year from acquisition date.

If initial accounting is incomplete:

Report provisional amounts in financial statements

During measurement period, retrospectively adjust provisional amounts to reflect new information about facts and circumstances that existed at acquisition date

Recognise additional assets or liabilities if new information indicates they should have been recognised

End of measurement period:

As soon as acquirer receives information sought or learns more information is not obtainable

Cannot exceed one year from acquisition date

Adjustments during measurement period:

Increase (decrease) in provisional amount for asset (liability) → Decrease (increase) in goodwill

Revise comparative information as needed

After measurement period ends → Only correct errors under HKAS 8

DETERMINING WHAT IS PART OF THE BUSINESS COMBINATION TRANSACTION (Paragraphs 51-53)

The acquirer shall identify amounts that are not part of the exchange for the acquiree and account for them separately.

Examples of Separate Transactions (Paragraph 52)

Type	Description
Settling pre-existing relationships	Transactions that effectively settle relationships between acquirer and acquiree
Remuneration for future services	Payments to employees or former owners for future services
Reimbursement of acquisition-related costs	Reimbursing acquiree or its former owners for paying acquirer's costs

Indicators of Separate Transactions (Paragraph B50)

Factor	Indicator of Separate Transaction
Reasons	Primarily for benefit of acquirer or combined entity
Who initiated	Initiated by acquirer
Timing	During negotiations of business combination terms

Effective Settlement of Pre-existing Relationships (Paragraphs B51-B53)

Non-contractual relationship (e.g., lawsuit): Recognise gain/loss at fair value

Contractual relationship: Recognise gain/loss at the lesser of:

(i) Amount contract is favourable/unfavourable compared to current market terms

(ii) Amount of any stated settlement provisions

Acquisition-Related Costs (Paragraph 53)

Acquisition-related costs: Finder's fees, advisory, legal, accounting, valuation, other professional fees, general administrative costs, costs of registering and issuing debt and equity securities

Accounting treatment:

Expensed as incurred (when services are received)

Exception: Costs to issue debt or equity securities → Recognised in accordance with HKAS 32 and HKFRS 9

SUBSEQUENT MEASUREMENT AND ACCOUNTING (Paragraphs 54-58)

General Principle (Paragraph 54)

Subsequently measure and account for assets, liabilities, and equity instruments in accordance with other applicable HKFRSs.

Specific Guidance

Reacquired Rights (Paragraph 55)

Amortised over remaining contractual period

When sold, include carrying amount in determining gain/loss

Contingent Liabilities (Paragraph 56)

Measure at the higher of:

(a) Amount under HKAS 37

(b) Amount initially recognised less cumulative income recognised under HKFRS 15 principles

Does not apply to contracts under HKFRS 9

Indemnification Assets (Paragraph 57)

Measure on same basis as indemnified liability/asset

Subject to contractual limitations and management's assessment of collectibility

Derecognise only when collected, sold, or right is lost

Contingent Consideration (Paragraph 58)

Classification and subsequent accounting:

Classification	Subsequent Treatment
Equity	Not remeasured; settlement accounted for within equity
Financial liability (within HKFRS 9)	Measured at fair value each reporting date; changes in profit or loss
Other (not within HKFRS 9)	Measured at fair value each reporting date; changes in profit or loss

Measurement period adjustments: Changes due to additional information about facts and circumstances existing at acquisition date

Not measurement period adjustments: Changes from events after acquisition date (e.g., meeting earnings target, reaching share price, R&D milestone)

DISCLOSURES (Paragraphs 59-63)

Objective (Paragraph 59)

Disclose information that enables users to evaluate the nature and financial effect of business combinations that occur:

(a) During the current reporting period; OR

(b) After the reporting period but before financial statements are authorised for issue

Objective for Adjustments (Paragraph 61)

Disclose information that enables users to evaluate the financial effects of adjustments recognised in the current period that relate to business combinations in current or previous periods.

Specific Disclosure Requirements (Paragraphs B64-B67)

For current period business combinations:

Name and description of acquiree

Acquisition date

Percentage of voting equity interests acquired

Primary reasons for business combination

Description of how acquirer obtained control

Acquisition-date fair value of consideration transferred

Amounts recognised for each major class of assets and liabilities

Contingent consideration arrangements

Acquired receivables

Contingent liabilities recognised

Goodwill amount and factors contributing to recognition

Bargain purchase gain and reasons

Non-controlling interest measurement basis

Revenue and profit/loss of acquiree since acquisition date

Pro forma revenue and profit/loss as if acquisition occurred at beginning of period

For adjustments in current period:

Adjustments to provisional amounts

Changes in contingent consideration

Changes in contingent liabilities

Changes in indemnification assets

Goodwill adjustments

EFFECTIVE DATE AND TRANSITION (Paragraphs 64-68)

Effective Date (Paragraph 64)

Prospectively to business combinations with acquisition date on or after the beginning of the first annual reporting period beginning on or after 1 July 2009

Earlier application permitted (only at beginning of annual period beginning on or after 30 June 2007)

If applied before 1 July 2009, must also apply HKAS 27 (as amended in 2008)

Transition (Paragraphs 65-67)

Assets and liabilities from business combinations with acquisition dates before application of HKFRS 3 shall not be adjusted

Contingent consideration balances from pre-application combinations shall not be adjusted upon first application

For mutual entities that have not yet applied HKFRS 3: Apply transition provisions in paragraphs B68-B69

Reference to HKFRS 9 (Paragraph 67A)

If an entity applies this Standard but does not yet apply HKFRS 9, any reference to HKFRS 9 should be read as a reference to HKAS 39.

APPENDIX A - DEFINED TERMS

Term	Definition
Acquiree	The business or businesses that the acquirer obtains control of in a business combination
Acquirer	The entity that obtains control of the acquiree
Acquisition date	The date on which the acquirer obtains control of the acquiree
Business	An integrated set of activities and assets capable of being conducted and managed for providing goods/services, generating investment income, or generating other income from ordinary activities
Business combination	A transaction or other event in which an acquirer obtains control of one or more businesses
Contingent consideration	Usually an obligation to transfer additional assets/equity interests if specified future events occur; may also give right to return of previously transferred consideration
Fair value	The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Goodwill	An asset representing future economic benefits from other assets acquired that are not individually identified and separately recognised
Identifiable	An asset is identifiable if it is separable OR arises from contractual or other legal rights
Intangible asset	An identifiable non-monetary asset without physical substance
Non-controlling interest	The equity in a subsidiary not attributable, directly or indirectly, to a parent

APPENDIX B - APPLICATION GUIDANCE HIGHLIGHTS

Business Combinations Under Common Control (Paragraphs B1-B4)

Not within scope of HKFRS 3 if:

All combining entities are ultimately controlled by the same party/parties both before and after the combination

That control is not transitory

Key points:

A group of individuals may be regarded as controlling through contractual arrangements

Combining entities need not be in same consolidated financial statements

Extent of non-controlling interests is not relevant

Identifying the Acquirer (Paragraphs B13-B18)

Primary guidance: HKFRS 10

Additional factors when unclear:

Entity transferring cash or incurring liabilities

Entity issuing equity interests (except reverse acquisitions)

Relative voting rights in combined entity

Large minority voting interest

Composition of governing body

Composition of senior management

Terms of exchange of equity interests

Relative size (assets, revenues, profit)

Which entity initiated combination

Recognising Intangible Assets (Paragraphs B31-B40)

Identifiability criteria:

Contractual-legal criterion: Arises from contractual or other legal rights

Separability criterion: Capable of being separated from entity and sold, transferred, licensed, rented, or exchanged

Examples of intangible assets:

Brand names

Patents

Customer relationships

Licences

Technology

Not separately identifiable:

Assembled workforce (subsumed into goodwill)

Potential contracts being negotiated (subsumed into goodwill)

Measuring Fair Value of Particular Assets (Paragraphs B41-B45)

Assets with uncertain cash flows:

No separate valuation allowance at acquisition date (uncertainty included in fair value measure)

Assets subject to operating leases (acquiree as lessor):

Take lease terms into account in fair value measurement

No separate asset/liability for favourable/unfavourable terms

Assets acquirer intends not to use or use differently:

Measure at fair value assuming highest and best use by market participants

Non-controlling interest:

May be measured at fair value

Per-share fair value may differ from acquirer's interest due to control premium/discount

Determining What is Part of the Business Combination (Paragraphs B50-B62)

Factors to consider:

Reasons for transaction - Primarily for benefit of acquirer/combined entity vs. acquiree

Who initiated - Acquirer initiation suggests separate transaction

Timing - During negotiations suggests contemplation of combination

Settlement of pre-existing relationships:

Non-contractual: Fair value

Contractual: Lesser of (i) favourable/unfavourable amount vs. market terms, (ii) stated settlement provisions

Contingent payments to employees/selling shareholders:

Consider indicators: continuing employment, duration, level of remuneration, incremental payments, number of shares owned, linkage to valuation, formula for determining consideration

Share-based payment awards:

Replacement awards accounted for as modifications under HKFRS 2

Portion attributable to pre-combination service included in consideration transferred

Portion attributable to post-combination service recognised as remuneration cost

KEY TAKEAWAYS SUMMARY

Topic	Key Points
Scope	Applies to business combinations; excludes joint arrangements, asset acquisitions, common control combinations
Acquisition Method	Four steps: identify acquirer, determine date, recognise/measure assets/liabilities/NCI, recognise goodwill/bargain gain
Recognition	Recognise identifiable assets and liabilities separately from goodwill at acquisition-date fair value
Measurement	Fair value for most items; exceptions for taxes, employee benefits, indemnification assets, leases, reacquired rights, share-based payments, assets held for sale, insurance contracts
Goodwill	Excess of (consideration + NCI + previously held interest) over net identifiable assets acquired
Bargain Purchase	When net identifiable assets exceed consideration; recognise gain in profit or loss after reassessment
Measurement Period	Up to 1 year to adjust provisional amounts; retrospective adjustments
Separate Transactions	Identify and account separately from business combination; expense acquisition-related costs
Subsequent Measurement	Generally per other HKFRSs; specific guidance for reacquired rights, contingent liabilities, indemnification assets, contingent consideration
Disclosures	Enable evaluation of nature and financial effects of current and prior period business combinations