Question

Compare and contrast the requirements of IFRS 3 and IAS 37 in respect of restructuring provisions and contingent liabilities.

Answer 1

Summary of IAS 37

Objective

The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements – planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition.

Scope

IAS 37 excludes obligations and contingencies arising from: [IAS 37.1-6]

• financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition and Measurement (or IFRS 9 Financial Instruments)
• non-onerous executory contracts
• insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other provisions, contingent liabilities and contingent assets of an insurer
• items covered by another IFRS. For example, IAS 11 Construction Contracts applies to obligations arising under such contracts; IAS 12 Income Taxes applies to obligations for current or deferred income taxes; IAS 17 Leases applies to lease obligations; and IAS 19 Employee Benefits applies to pension and other employee benefit obligations

Summary of IFRS 3

IFRS 3 (2008) seeks to enhance the relevance, reliability and comparability of information provided about business combinations (e.g. acquisitions and mergers) and their effects. It sets out the principles on the recognition and measurement of acquired assets and liabilities, the determination of goodwill and the necessary disclosures.

IFRS 3 (2008) resulted from a joint project with the US Financial Accounting Standards Board (FASB) and replaced IFRS 3 (2004). FASB issued a similar standard in December 2007 (SFAS 141(R)). The revisions result in a high degree of convergence between IFRSs and US GAAP in the accounting for business combinations, although some potentially significant differences remain.

Key definitions

[IFRS 3, Appendix A]

A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as 'true mergers' or 'mergers of equals' are also business combinations as that term is used in [IFRS 3]

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*

The date on which the acquirer obtains control of the acquiree

The entity that obtains control of the acquiree

The business or businesses that the acquirer obtains control of in a business combination

*definition narrowed by 2018 amendments to IFRS 3 issued on 22 October 2018 effective 1 January 2020

Scope

IFRS 3 must be applied when accounting for business combinations, but does not apply to:

• The formation of a joint venture* [IFRS 3.2(a)]
• The acquisition of an asset or group of assets that is not a business, although general guidance is provided on how such transactions should be accounted for [IFRS 3.2(b)]
• Combinations of entities or businesses under common control (the IASB has a separate agenda project on common control transactions) [IFRS 3.2(c)]
• Acquisitions by an investment entity of a subsidiary that is required to be measured at fair value through profit or loss under IFRS 10 Consolidated Financial Statements. [IFRS 3.2A]

* Annual Improvements to IFRSs 2011–2013 Cycle, effective for annual periods beginning on or after 1 July 2014, amends this scope exclusion to clarify that is applies to the accounting for the formation of a joint arrangement in the financial statements of the joint arrangement itself.

Determining whether a transaction is a business combination

IFRS 3 provides additional guidance on determining whether a transaction meets the definition of a business combination, and so accounted for in accordance with its requirements. This guidance includes:

• Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing equity instruments (or any combination thereof), or by not issuing consideration at all (i.e. by contract alone) [IFRS 3.B5]
• Business combinations can be structured in various ways to satisfy legal, taxation or other objectives, including one entity becoming a subsidiary of another, the transfer of net assets from one entity to another or to a new entity [IFRS 3.B6]
• The business combination must involve the acquisition of a business, which generally has three elements: [IFRS 3.B7]
  • Inputs – an economic resource (e.g. non-current assets, intellectual property) that creates outputs when one or more processes are applied to it
  • Process – a system, standard, protocol, convention or rule that when applied to an input or inputs, creates outputs (e.g. strategic management, operational processes, resource management)
  • Output – the result of inputs and processes applied to those inputs.