IFRS 3 requires every acquisition of a business to be accounted for using the acquisition method: identify the acquirer, fix the acquisition date, recognise the target’s identifiable assets and liabilities at fair value, and treat the balance of the price as goodwill. Goodwill is not amortised under IFRS. Instead IAS 36 requires it to be tested for impairment every year, and an impairment of goodwill can never be reversed.

Who applies IFRS 3 in the UK?

IFRS 3 applies to groups and companies that prepare accounts under UK adopted international accounting standards. That includes every parent whose securities are admitted to trading on a UK regulated market, because section 403(1) of the Companies Act 2006 requires its group accounts to follow those standards (see when UK companies must use IFRS). Groups reporting under FRS 102 apply Section 19 instead, which follows the same broad logic but differs on costs, goodwill and non controlling interests; that framework is covered in FRS 102 Section 19: business combinations and goodwill.

Paragraph 2 excludes three things from its scope: the formation of a joint arrangement in the joint arrangement’s own accounts, the purchase of assets that do not form a business, and combinations of entities under common control, such as a group reorganisation (see merger accounting for group reconstructions).

What counts as a business under IFRS 3?

Appendix A defines a business as an integrated set of activities and assets that is capable of being conducted and managed to provide goods or services to customers, generate investment income or generate other income from ordinary activities. Paragraph B7 breaks this into inputs, processes and outputs, and paragraph B8 says that at a minimum the set must include an input and a substantive process that together significantly contribute to the ability to create output. Outputs themselves are not essential.

Two points in the application guidance decide most borderline cases:

  • The view is a market participant’s. Paragraph B11 says it does not matter whether the seller ran the set as a business or whether the buyer intends to.
  • A substantive process usually needs people. Where the set has no outputs, paragraph B12B treats a process as substantive only if the inputs include an organised workforce with the necessary skills plus other inputs it could develop, such as intellectual property or technology.

Paragraphs B7A and B7B add an optional concentration test, which can be elected deal by deal. If substantially all of the fair value of the gross assets acquired sits in a single identifiable asset or a group of similar identifiable assets, the set is not a business and no further analysis is needed. Cash, deferred tax assets and goodwill arising from deferred tax liabilities are excluded from gross assets, and paragraph B7B(d) treats a building and the ground it stands on as a single asset. A purchase of one let building with no staff will often pass the test.

If the set is not a business, paragraph 2(b) requires the cost to be allocated to the individual assets and liabilities on the basis of their relative fair values, and no goodwill arises.

How does the acquisition method work?

Paragraph 5 sets out four steps.

  1. Identify the acquirer. This is the entity that obtains control of the other, judged using IFRS 10 (paragraph 7).
  2. Determine the acquisition date. This is the date control is obtained (paragraph 8). It is usually completion, but paragraph 9 notes that a written agreement can pass control earlier.
  3. Recognise and measure the identifiable assets, liabilities and any non controlling interest. Items must meet the Conceptual Framework definitions of assets and liabilities at the acquisition date (paragraph 11), so restructuring costs the buyer plans but is not obliged to incur are not liabilities of the target. Assets and liabilities are measured at acquisition date fair value (paragraph 18), using IFRS 13 fair value measurement. Paragraph B31 requires identifiable intangible assets, such as customer contracts, brands and technology, to be recognised separately from goodwill if they are separable or arise from contractual or legal rights.
  4. Recognise goodwill or a gain from a bargain purchase.

Paragraph 19 gives a choice, made for each combination, to measure non controlling interests that are present ownership interests either at fair value or at their proportionate share of the identifiable net assets. Consideration, including any contingent consideration, is measured at acquisition date fair value (paragraphs 37 and 39). Paragraph 53 requires acquisition related costs, such as legal, due diligence, valuation and finder’s fees, to be expensed as incurred; only the costs of issuing debt or equity follow IAS 32 and IFRS 9.

How is goodwill calculated?

Paragraph 32 measures goodwill as the consideration transferred, plus any non controlling interest, plus the fair value of any interest already held, less the net identifiable assets. When control is achieved in stages, paragraph 42 requires the previously held interest to be remeasured to fair value, with the gain or loss in profit or loss or other comprehensive income as appropriate.

If net assets exceed that total, paragraph 36 requires the acquirer to recheck that it has identified every asset and liability and reviewed every measurement. Any excess left is a bargain purchase gain recognised in profit or loss on the acquisition date (paragraph 34). The UK GAAP treatment is different; see negative goodwill.

Illustration only. Alpha plc buys 80% of Beta Ltd for £8.0m in cash plus an earn out with an acquisition date fair value of £0.5m. Beta’s identifiable net assets at fair value are £7.0m and Alpha pays £0.3m of advisers’ fees.

Item Proportionate share method Fair value method
Consideration (cash plus earn out) £8.5m £8.5m
Non controlling interest £1.4m (20% of £7.0m) £2.0m (assumed fair value)
Less identifiable net assets (£7.0m) (£7.0m)
Goodwill £2.9m £3.5m

The £0.3m of fees is an expense in either case. If Beta later beats its target and the earn out liability rises to £0.8m, paragraph 58 requires the £0.3m increase to go through profit or loss, not goodwill, because it results from events after the acquisition date.

What happens in the year after the acquisition?

If the accounting is incomplete at the reporting date, paragraph 45 requires provisional amounts. During the measurement period the acquirer adjusts them retrospectively for new information about facts and circumstances that existed at the acquisition date. The period ends when that information is obtained or found to be unobtainable, and cannot exceed one year from the acquisition date. Later changes are not measurement period adjustments. For contingent consideration, paragraph 58 says amounts classified as equity are not remeasured, while other contingent consideration is measured at fair value at each reporting date with changes in profit or loss.

How is goodwill tested for impairment under IAS 36?

Paragraph 10(b) of IAS 36 requires goodwill to be tested annually whether or not there is any sign of impairment. The main rules are:

  • Allocation. From the acquisition date goodwill is allocated to the cash generating units, or groups of units, expected to benefit from the synergies. Each must be the lowest level at which goodwill is monitored internally and no larger than an operating segment under IFRS 8 before aggregation (paragraph 80). If the initial allocation cannot be finished in the year of the deal, paragraph 84 allows until the end of the following annual period.
  • The test. The carrying amount of the unit, including goodwill, is compared with its recoverable amount, which paragraph 18 defines as the higher of fair value less costs of disposal and value in use (paragraph 90).
  • Timing. The test can be done at any time of year provided it is the same time every year, but a unit holding goodwill acquired in the current year must be tested before the year end (paragraph 96).
  • Allocating a loss. An impairment loss reduces goodwill first, then the other assets of the unit pro rata (paragraph 104).
  • No reversal. Paragraph 124 prohibits reversing a goodwill impairment, because any later increase is treated as internally generated goodwill.

Paragraph 134 requires disclosure, for each unit with significant goodwill, of the basis of recoverable amount and the key assumptions to which it is most sensitive. The IASB published an exposure draft on business combination disclosures, goodwill and impairment in March 2024 and is still redeliberating it, so these rules remain in force.

How does IFRS 3 differ from FRS 102?

  • Deal costs. FRS 102 paragraph 19.11 includes directly attributable costs in the cost of the combination; IFRS 3 expenses them.
  • Goodwill after acquisition. FRS 102 paragraph 19.23 treats goodwill as having a finite life and amortises it, over no more than 10 years where the life cannot be reliably estimated (see goodwill useful life and amortisation). IFRS relies on annual impairment testing instead.
  • Non controlling interests. FRS 102 paragraph 19.14A measures them at their share of net identifiable assets, with no fair value option.

What mistakes come up most often?

  • Capitalising due diligence and legal fees into goodwill in IFRS accounts.
  • Treating payments to selling shareholders as consideration when they are forfeited if the seller leaves. Paragraph B55(a) says such payments are remuneration for services after the combination.
  • Leaving customer relationships and brands inside goodwill instead of recognising them separately under paragraph B31.
  • Allocating goodwill to a unit larger than an operating segment, or testing it at a different date each year.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.