What Is a business combination?

Explanation of business combination

A business combination arises when one entity gains control over another business, giving it the power to govern financial and operating policies to obtain economic benefits. These transactions are used to expand operations, enter new markets, acquire skills or technology, or achieve efficiencies through scale.

In the UK, business combinations are most frequently accounted for under IFRS, particularly IFRS 3 Business Combinations, or under UK GAAP where relevant. The accounting treatment focuses on identifying the acquiring entity, measuring the consideration transferred, and recognising the acquired assets, liabilities, and any goodwill at the acquisition date.

Business combinations differ from simple asset purchases because they involve acquiring an integrated set of activities capable of being managed as a business. They are relevant across many sectors and apply to both private companies and groups preparing consolidated financial statements.

Key characteristics of business combinations

The key characteristics of business combinations include the following:

• One entity gains control over another business.
• The transaction creates a single entity for financial reporting purposes.
• Consideration is paid in cash, shares, other assets, or a combination.
• Identifiable assets and liabilities of the acquired business are recognised at fair value.
• Goodwill or a gain on bargain purchase may arise.
• The transaction has implications for consolidation and group reporting.

How business combinations work

A business combination typically follows these stages:

1. An acquiring entity is identified based on control.
2. The acquisition date is determined as the point when control is obtained.
3. Consideration transferred is measured.
4. Identifiable assets and liabilities of the acquired business are recognised and measured.
5. Goodwill or a gain is calculated and recorded in the financial statements.

Example of a business combination in practice

A UK limited company acquires all the shares of another trading company to expand into a new market. Following completion, the acquiring company controls the acquired business and includes its results within group financial statements. The acquired company’s assets and liabilities are recognised at fair value, with any excess of purchase price over net assets recorded as goodwill.