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101 Concepts for the Level I Exam

Essential Concept 22: Business Combinations


Under IFRS, there is no distinction between business combinations. Under US GAAP, there are four types: merger, acquisition, consolidation, and variable interest entity.

The acquisition method is used for business combinations.

Acquisition method

The major points related to the acquisition method are listed below:

  • Identifiable tangible and intangible assets (brand names, patents etc.) and liabilities of the acquired company are measured at fair value on the date of the acquisition.
  • Assets and liabilities that were not previously recognized by the acquiree must be recognized by the acquirer.
  • The acquirer must recognize any contingent liability if it can be reliably measured and the obligation arises from past events.
  • The acquirer must recognize an indemnification asset on the acquisition date.
  • At the acquisition date, the acquirer can reclassify financial assets and liabilities of the acquiree (for example, from held-to-maturity to available for sale).
  • Recognition of goodwill differs between IFRS and US GAAP:
    • IFRS has two options for goodwill: partial goodwill and full goodwill.
    • Partial goodwill = fair value of the acquisition – acquirer’s share of the fair of all acquiree’s assets and liabilities

      Full goodwill = fair value of the entity as a whole – the fair value of all acquiree’s assets and liabilities

    • US GAAP allows only full goodwill.
  • In an acquisition, when the purchase price is less than the fair value of the target’s (acquiree’s) net assets, the acquisition is considered to be a bargain acquisition. IFRS and US GAAP require the difference between the fair value of the acquired net assets and the purchase price to be recognized immediately as a gain.