Introduction to IFRS 13 and IFRS 3

Accounting standards serve as the framework for financial reporting, providing consistency and clarity for users of financial statements. Two important standards in the International Financial Reporting Standards (IFRS) framework are IFRS 13 and IFRS 3. Though they might seem similar due to their numbering, they address entirely different aspects of financial reporting.

In this tutorial, we will explore IFRS 13: Fair Value Measurement and IFRS 3: Business Combinations, looking at their individual objectives, key definitions, measurement principles, and disclosures. Most importantly, we will highlight the differences between these two standards, using case studies, journal entries, and practical examples to make the comparison clearer.

1. Overview of IFRS 13

IFRS 13 focuses on how to measure fair value in financial reporting. It was introduced to provide a unified framework for fair value measurement across various standards, ensuring consistency in how entities assess the value of their assets and liabilities.

Key Aspects of IFRS 13

Objective: The main goal of IFRS 13 is to provide guidance on how to determine the fair value of assets and liabilities, and the necessary disclosures related to fair value measurements.
Fair Value Definition: Fair value is defined as “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.”
Scope: IFRS 13 applies when other IFRS standards require or permit fair value measurements or disclosures. It does not introduce new fair value requirements but rather standardizes the measurement and disclosure process.

Fair Value Measurement under IFRS 13

IFRS 13 introduces a three-level hierarchy for fair value measurement, based on the availability of observable inputs:

Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.
Level 3: Unobservable inputs for the asset or liability (often based on entity-specific assumptions).

2. Overview of IFRS 3

IFRS 3 focuses on accounting for business combinations. It deals with how to recognize and measure the assets, liabilities, and any non-controlling interest when one entity acquires another.

Key Aspects of IFRS 3

Objective: The purpose of IFRS 3 is to provide guidance on how an acquirer recognizes and measures identifiable assets acquired, liabilities assumed, and any goodwill or gains from the acquisition.
Definition of a Business Combination: A business combination is a transaction or event in which an acquirer obtains control of one or more businesses. A business is defined as an integrated set of activities and assets that can provide returns through operations rather than through the sale of assets.
Scope: IFRS 3 applies to most business combinations but excludes joint ventures, combinations of entities under common control, and other similar arrangements.

Key Accounting Treatment under IFRS 3

Purchase Method (Acquisition Method): IFRS 3 mandates that all business combinations must be accounted for using the acquisition method, which involves:

Identifying the acquirer: The entity that gains control over another.
Determining the acquisition date: The date when control is transferred.
Recognizing and measuring the identifiable assets, liabilities, and non-controlling interest: This includes both tangible and intangible assets.
Recognizing goodwill: If the purchase price exceeds the fair value of identifiable net assets, the difference is recognized as goodwill. Conversely, if the fair value of net assets exceeds the purchase price, a gain on bargain purchase is recognized.

Goodwill: Goodwill arises when the cost of the acquisition exceeds the fair value of net identifiable assets. Goodwill is tested for impairment annually under IAS 36, not amortized.

3. Key Differences Between IFRS 13 and IFRS 3

Now that we’ve covered the core principles of both IFRS 13 and IFRS 3, let’s explore the differences between the two.

Aspect	IFRS 13 (Fair Value Measurement)	IFRS 3 (Business Combinations)
Primary Focus	Fair value measurement for assets and liabilities	Accounting for acquisitions and mergers (business combinations)
Objective	Provides a consistent definition and framework for fair value	Recognizes and measures assets, liabilities, and goodwill in business combinations
Scope	Applies to all standards that require or permit fair value	Applies specifically to business combinations
Key Measurement Concept	Fair value hierarchy (Level 1, 2, and 3 inputs)	Acquisition method (identifying acquirer, measuring assets/liabilities, goodwill)
Goodwill Treatment	Does not directly address goodwill	Recognizes goodwill as part of the acquisition process
Disclosure Requirements	Extensive disclosures about fair value measurement methods and assumptions	Disclosures regarding the details of the business combination (e.g., purchase price, assets, goodwill)
Practical Use	Applied in revaluation of assets, liabilities, and financial instruments	Applied in accounting for mergers, acquisitions, and takeovers

Case Study: Acquisition and Fair Value Measurement in a Business Combination

To illustrate the interaction between IFRS 13 and IFRS 3, let’s consider the following case:

Scenario:
Company A acquires Company B for $100 million. At the acquisition date, the fair value of Company B’s identifiable net assets is $80 million, including the fair value of financial instruments and property. The acquisition creates goodwill of $20 million, which reflects the expected future synergies.

Here, IFRS 3 guides the accounting for the acquisition. The acquisition method is used to recognize the $80 million in identifiable net assets and the goodwill of $20 million.

However, during the acquisition, Company A uses IFRS 13 to determine the fair value of individual assets and liabilities, especially those measured at fair value like property or financial instruments. IFRS 13 ensures that these values reflect current market conditions and that the hierarchy of inputs is appropriately applied.

Journal Entries for the Acquisition:

Recognizing the acquired net assets at fair value:

   Dr. Assets (at fair value)                     $80 million
       Cr. Liabilities (at fair value)            $50 million
       Cr. Cash (payment for acquisition)        $100 million
       Dr. Goodwill                               $20 million

In this case, IFRS 3 directs the overall accounting treatment, while IFRS 13 informs how fair value is measured for each asset and liability in the acquisition.

4. Practical Application and Disclosures

IFRS 13 Disclosures

For entities that measure assets or liabilities at fair value, IFRS 13 requires extensive disclosures, such as:

The level of fair value hierarchy used in the measurement (Level 1, 2, or 3).
The valuation techniques used and the inputs applied.
A reconciliation of Level 3 fair value measurements, if applicable, showing the changes in those measurements.

For example, if a company revalues a piece of machinery using Level 3 inputs (since there is no active market), it must disclose the valuation technique (e.g., discounted cash flow method) and the key assumptions (e.g., discount rate, expected future cash flows).

IFRS 3 Disclosures

When an entity engages in a business combination, it must disclose:

The names and descriptions of the entities involved.
The acquisition date.
The purchase consideration (price paid).
The fair value of identifiable net assets acquired.
Goodwill or any gain on a bargain purchase.
The reasons for the acquisition, including expected synergies or strategic benefits.

5. Conclusion

In summary, while IFRS 13 and IFRS 3 both touch on valuation principles, they serve entirely different purposes. IFRS 13 provides a universal framework for measuring fair value, applicable to many situations across financial reporting. In contrast, IFRS 3 governs the specific area of accounting for business combinations, including how to measure and recognize assets, liabilities, and goodwill when one company acquires another.

The main takeaway is that IFRS 3 uses IFRS 13 as a tool to determine the fair value of assets and liabilities during an acquisition. This relationship highlights the interconnectedness of accounting standards and the importance of understanding how they work together in practice.