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Section 19-Business Combinations and Goodwill
Section 19 deals with the accounting for business combinations including goodwill. It provides guidance on identifying the acquirer, measuring the cost of the business combination, allocating the costs of the acquired assets and determining the fair value of all assets and liabilities and how goodwill should be determined and accounted for.
Scope
Extracts from FRS102-Sections 19.1–19.2A
19.2 This section specifies the accounting for all business combinations except:
(a) the formation of a joint venture; and
(b) acquisition of a group of assets that does not constitute a business.
PBE19.2A In addition, public benefit entities shall consider the requirements of Section 34 Specialised Activities in accounting for public benefit entity combinations.
OmniPro comment
The formation of a joint venture is accounted for under Section 15-Investment in Joint Ventures. However where a joint venture enters into a business combination after creation this is accounted for under Section 19.
Section 19.2 refers to instances where assets are just acquired but not a business. In this case depending on the types of assets these will be accounted for in accordance with the relevant section of FRS 102.
Business combinations defined
Extracts from FRS 102 – Section 19.3
19.3 A business combination is the bringing together of separate entities or businesses into one reporting entity. The result of nearly all business combinations is that one entity, the acquirer, obtains control of one or more other businesses, the acquiree. The acquisition date is the date on which the acquirer obtains control of the acquiree.
OmniPro comment
Appendix I of FRS 102 defines a business as ‘an integrated set of activities and assets conducted and managed for the purpose of providing:
- A return to investors; or
- Lower costs or other economic benefits directly and proportionately to policyholders or participants.
A business generally consists of inputs, processes applied to those inputs and resulting outputs that are, or will be, used to generate revenues. If goodwill is present in a transferred set of activities and assets, the transferred set shall be presumed to be a business.’
FRS 102 does not define inputs, processes and outputs however IFRS 3 provides further guidance as follows:
- Input: examples include fixed assets, intellectual property, intangible assets, ability to gain access to certain materials or rights and employees.
- Processes: any system, standard, protocol is a process if when applied to an input/inputs, that either creates or has the ability to create outputs. Examples include strategic management processes, operational processes and resource management processes. An organised workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs.
- Output: the results of inputs, processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.
Appendix I of FRS 102 states where goodwill arises on acquisition there is a rebuttable presumption that a business has been acquired. However lack of goodwill does not automatically exclude a transaction from being a business.
Example 1: Determining a Business
Company A is a building contractor. Company A purchased land and buildings from a third party. In this case this is not a business it is merely assets.
Example 2: Determining a Business
Company A acquired the stock, fixed assets, creditors, customers lists, (employees were also transferred) from a third party which produced customer products and which will continue to produce these products.
In this instance as they have acquired the fixed assets, stock (i.e. the inputs), and have the processes (i.e. the employees, customers) to produce the output (i.e. being the product), this would be classed as a business.
Structure of a business combination
Extracts from FRS 102 – Section 19.4–19.5A
19.4 A business combination may be structured in a variety of ways for legal, taxation or other reasons. It may involve:
- the purchase by an entity of the equity of another entity,
- the purchase of all the net assets of another entity,
- the assumption of the liabilities of another entity, or the purchase of some of the net assets of another entity that together form one or more businesses.
19.5 A business combination may be effected by the issue of equity instruments, the transfer of cash, cash equivalents or other assets, or a mixture of these. The transaction may be between the shareholders of the combining entities or between one entity and the shareholders of another entity. It may involve the establishment of a new entity to control the combining entities or net assets transferred, or the restructuring of one or more of the combining entities.
OmniPro comment
It is clear from the above that whatever the legal structure, if it meets the definition of a business combination it comes within the remit of Section 19.
Therefore where the goodwill and net assets of a business are purchased (i.e. not through the purchase of shares), although it does not create a subsidiary/parent relationship it should still be accounted for as a business combination.
An entity does not have to physically pay cash in order to come within the remit of section 19. Examples would include instances where the entity previously had a significant influence but as a result of a share buyback of main shareholders or a change of rights to the shares, the entity then becomes the controlling party, this is then accounted for as a business combination and accounted for under the purchase method.
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