Business Combination

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Meaning and Definition of Business Combination

A business combination is essentially an event or transaction in which an acquirer obtains control of a business. A business may also be defined as a set of integrated assets and activities that are capable of being managed and operated for the purpose of providing a return to the investing members or other participants, owners and members.  In general, business combinations refer to transactions in which one entity acquires control, or at least a controlling interest, in another entity. A business combination can be aptly defined as the combination of the assets of two or more entities for their consolidation as a single entity under a single ownership. A business combination can easily be accomplished through a voluntary acquisition, a merger, or a hostile takeover. In many cases, a preferred means of completing a business combination may be through the acquisition of a controlling amount of stock.

IFRS 3 Business Combinations is about accounting at a time when the acquirer successfully acquires control of a particular business (for example, merger or acquisition). It is these kinds of business combinations that are recognized by utilizing the ‘acquisition method’ that usually requires liabilities and assets that are assumed for measurement on the basis of fair value on the date of acquisition.

A very common approach to business combinations is merger. As per this particular model, two entities operating in similar area combines their assets with an intention to set up a new entity, which is very strong and efficient in handling competition than would they could have accomplished on their own. Such a merger enables a the newly formed entity in retaining existing customers whereas it also gets an opportunity to position itself in a manner that it is able to acquire new customers.

The IFRS 3 new version was issued in the month of January in 2008 after revision and is applicable to business combinations that occur in an organization’s first annual year beginning after or on 1st of July 2009.

Method of accounting for business combinations

In accordance with IFRS 3, business combinations are accounted for using the acquisition method. All types of business combinations are accounted for using this specific method. When applying this method, the acquirer must first be identified. Then the acquisition date must be determined. Once the acquisition date has been determined, it is necessary to measure and recognize identifiable assets and liabilities. It is also necessary to measure and recognize any non-controlling interest (NCI) in the acquiree. It also requires the measurement and recognition of any gain or goodwill from a bargain purchase and the measurement of liabilities and assets acquired on a fair value basis. The method also involves measuring the NCI either at fair value or at the NCI's proportionate share of the acquiree's net assets.

IFRS 3, "Business Combinations", provides guidance on accounting for business combinations and applies to the acquisition of one or more businesses by another business. The standard requires the acquirer to recognize the assets, liabilities and non-controlling interests of the acquiree at their fair values at the acquisition date. The difference between the fair value of the consideration transferred and the fair value of the net assets acquired is recorded as goodwill. Any bargain purchase is recognized as a gain in the income statement. The acquirer is also required to recognize any contingent liabilities and assets at fair value and any non-controlling interest in the acquiree. The acquirer is required to use the acquisition method to account for business combinations.

Different types of Business Combinations

Business combinations can be categorized into the following four types:

1. Vertical combination

This is a business combination wherein various departments of large industrial units come together under single management. Under this business combination all the stages, from purchase to selling of product, are linked by units. The key objectives of a vertical combination include:

i. minimizing the per unit cost

ii. elimination competition

iii. hiring the experts’ services

iv. supplying goods at lowest prices

v. avoiding over production

vi. improving production methods

vii. achieving large scale benefits

viii. finding proper market for their product

ix. supervising the management

x. reducing the middleman commission

xi. earning maximum profit

2. Horizontal combination

Also referred as voluntary combination, it is an association of two or more business units of same nature under a single management. Both the business units involved in combination are engaged in same activity and their combination is, therefore, referred as horizontal combination. The key objectives of this business combination are the same as those of a vertical combination.

A horizontal combination is a merger or acquisition between two companies operating in the same industry and at the same level of the supply chain. This type of combination involves two companies that are competitors or have complementary products or services. The main objective of a horizontal combination is to achieve economies of scale and increase market share, which can be achieved by combining similar operations, such as manufacturing or distribution, or by eliminating duplicate functions, such as research and development or sales and marketing. Horizontal combinations may take the form of a merger, in which two companies combine to form a new entity, or an acquisition, in which one company takes over the assets and liabilities of another.

3. Circular combination

This business combination type involves different business units coalesce themselves under a single management. For instance, a shoes industry combining with cloth and sugar industry exemplifies mixed combination. The key objective of this benefit is securing the benefits of administrative ability by the way of common management.

A circular combination, also known as a circular merger or triangular merger, is a type of merger or acquisition in which a third company (often called an "acquisition vehicle" or "newco") is formed to acquire one of the other two companies involved in the transaction, and then the acquired company is merged with the remaining company.

The primary purpose of a circular merger is usually to achieve tax benefits or to avoid regulatory hurdles that may be present in a direct merger between the two original companies. This can be done by allowing the companies to transfer assets to the new company without incurring tax, or by allowing the companies to merge without having to obtain regulatory approval.

It's important to note that circular combinations are less common than other types of combinations, and not all countries have the same rules regarding this type of merger.

4. Diagonal combination

A diagonal combination, also known as a diagonal merger or cross-border merger, is a type of merger or acquisition in which companies from different countries or in different industries combine.

The primary goal of a diagonal combination is to expand a company's operations into new markets or industries, gain access to new technologies, products or services, and diversify the company's revenue streams. The companies may not have common businesses or be in direct competition, but they can complement each other with their expertise, products, services and market reach.

Diagonal combinations can be more complex than other types of combinations because they typically involve regulatory and cultural differences between the companies involved. As a result, companies may face integration, communication and compliance challenges.

Quote Waseem Khan, 19 March, 2015
In first line of second paragraph,IFRS is mentioned with the name of Business Combinations instead of IFRS 3.Kindly note that Business Combinations is dealt by IFRS 3 not IFRS 2.

Kindly Note that:

IFRS 3 -Business Combinations
IFRS 2- Share Base Payments

Admin Please correct it.

Best Wishes,
Waseem Khan
Quote Vit. A., 19 March, 2015
Thanks, Waseem Khan! Corrected.

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