How to Audit Business Combinations Under IFRS 3

What IFRS 3.18 actually requires on your file

IFRS 3 uses the acquisition method for all business combinations. The standard requires four steps, and your audit procedures map directly to them. First, identify the acquirer (IFRS 3.6). Second, determine the acquisition date (IFRS 3.8). Third, recognise and measure the identifiable assets acquired, liabilities assumed, and any non-controlling interest (IFRS 3.18). Fourth, recognise and measure goodwill or a gain from a bargain purchase (IFRS 3.32).

Most of your audit effort sits in step three. IFRS 3.18 requires recognition of identifiable assets and liabilities at acquisition-date fair value, regardless of whether the acquiree previously recognised them. This is where it diverges from what many clients expect. A client that buys a business for €14M and finds €9.2M of book value on the target’s balance sheet does not have €4.8M of goodwill. That client has €4.8M of unallocated purchase price that needs to be broken down into identifiable intangible assets, fair value adjustments to tangible assets, deferred tax effects, and only then, a residual called goodwill.

The recognition principle in IFRS 3.10 through IFRS 3.12 sets the bar. An asset or liability qualifies for recognition if it meets the definition of an asset or liability in the Conceptual Framework and is part of what the acquirer and acquiree exchanged in the business combination (not a separate transaction). Contingent liabilities get special treatment under IFRS 3.22: the acquirer recognises them at acquisition date if they represent a present obligation arising from a past event and their fair value can be measured reliably, even if an outflow isn’t probable. This is a lower threshold than IAS 37.

Your file needs to demonstrate that the engagement team evaluated each of these recognition criteria, not just accepted the client’s allocation.

Why goodwill is where the risk concentrates

Goodwill is a residual. IFRS 3.32 defines it as the excess of the consideration transferred over the net identifiable assets acquired. The audit risk is straightforward: if the client underidentifies intangible assets, goodwill is overstated. If goodwill is overstated at initial recognition, the impairment test under IAS 36 starts from an inflated base, and every subsequent period carries that error forward.

The practical problem is that most non-Big 4 clients acquiring businesses in the €5M to €80M range do not commission a full independent purchase price allocation. They record the transaction using the target’s book values, call the difference goodwill, and move on. Some commission a PPA from a valuation specialist, but the specialist’s report arrives months after the acquisition closes. The auditor receives it at or near the reporting date, sometimes after. In the worst cases, the PPA is still in draft when the audit opinion is due.

Anticipate this at planning. When you know a business combination occurred or is expected, assess whether management intends to engage a specialist, what the timeline is, and whether provisional accounting under IFRS 3.45 will apply. If the client has no PPA and no specialist engagement, raise it with the engagement partner before fieldwork begins.

The purchase price allocation: what you’re testing

The purchase price allocation is the document (usually from a valuation specialist, sometimes prepared by management) that breaks the total consideration into its components. Your audit work on the PPA covers four areas.

The first is completeness of identified intangible assets. IFRS 3.13 requires the acquirer to classify or designate the identifiable assets and liabilities based on the conditions at acquisition date. IAS 38.12 provides the recognition criteria for intangible assets: identifiability (separable or arising from contractual/legal rights), control, and expected future economic benefits. Your job is to evaluate whether the PPA captures all intangible assets that meet these criteria.

The second area is the valuation methodology applied to each identified asset. Common methods include the multi-period excess earnings method for customer relationships, the relief-from-royalty method for brands and technology, and the replacement cost method for assembled workforce (which, under IFRS 3.B37, cannot be separately recognised but affects the valuation of other intangibles). You don’t need to be a valuation expert, but you do need to evaluate whether the inputs to these models are reasonable. If the client’s specialist applies a 15-year customer attrition rate to a business where the top five customers generate 70% of revenue, that assumption needs challenge.

The third area is the deferred tax impact. IAS 12.66 requires recognition of deferred tax on the difference between the fair values assigned in the PPA and the tax bases of those assets and liabilities. Most PPAs include a deferred tax calculation, but the interaction between the identified intangibles and the residual goodwill figure is where errors concentrate. An increase in the fair value of an identified intangible creates a deferred tax liability, which reduces the net identifiable assets and therefore increases goodwill. Clients and their specialists sometimes miss this circular calculation.

The fourth is the consideration transferred. IFRS 3.37 measures the consideration at acquisition-date fair value. For straightforward cash deals, this is simple. When the deal includes contingent consideration (earn-outs, performance payments), deferred consideration, or equity instruments issued by the acquirer, the fair value of the total consideration requires its own measurement exercise. Your file needs to test each component.

Intangible assets the client almost certainly missed

This is worth its own section because it accounts for the majority of PPA audit adjustments in practice. Clients acquiring businesses in the mid-market routinely fail to identify intangible assets that meet the IAS 38.12 recognition criteria.

Customer relationships are the most commonly underidentified. If the target has long-standing contracts, recurring revenue, or a concentrated customer base, those relationships have a fair value. The contractual-legal criterion under IAS 38.12(a) is met when contracts exist. Even without contracts, the separability criterion under IAS 38.12(b) is met if the customer relationships could be sold, licensed, or transferred. This single category often accounts for 40% to 60% of the total identified intangible value in mid-market acquisitions.

Order backlogs at the acquisition date have a fair value under IFRS 3.B37 if they meet the contractual-legal criterion. Technology and patents meet the contractual-legal criterion when registered, and may meet the separability criterion even when unregistered if the acquirer could license them.

Non-compete agreements have a fair value when they are part of the acquisition agreement. Brand names meet the criteria when they are identifiable and the acquirer controls them. For each of these, your file should document whether the asset was considered, whether it meets the IAS 38.12 criteria, and if so, what fair value was assigned. If the PPA does not address a category, your working paper should note that the omission was evaluated and explain why the team concluded the asset either does not exist or is immaterial.

Worked example: Van Houten Packaging B.V. acquires Rijnmond Plastics B.V.

Scenario: Van Houten Packaging B.V. (revenue €62M) acquired 100% of Rijnmond Plastics B.V. (revenue €18M) on 1 September 2025 for €22M in cash. Rijnmond’s balance sheet at acquisition date shows net assets of €13.4M. The client recorded €8.6M of goodwill. No PPA was performed. Your firm audits Van Houten.

Step 1: Determine the acquisition date and identify the acquirer

The share purchase agreement was signed 15 August 2025. Control transferred on 1 September 2025 when Van Houten obtained voting rights and board seats. IFRS 3.8 and 3.9 define the acquisition date as the date the acquirer obtains control.

Step 2: Assess the identifiable intangible assets

Rijnmond has 14 active customer contracts, with the top four customers representing 68% of revenue. Contracts run for two to five years with renewal histories averaging eight years. Rijnmond holds two registered patents on a proprietary extrusion process. The Rijnmond brand is used on product labelling and trade literature.

Applying IAS 38.12: customer relationships meet both the contractual-legal criterion (active contracts) and the separability criterion (could be transferred with the business). The patents meet the contractual-legal criterion. The brand name meets the separability criterion.

Step 3: Challenge management’s allocation

The client did not engage a specialist. You raise this with the engagement partner, who discusses it with Van Houten’s CFO. Management engages an external valuer. The valuer’s report allocates: customer relationships €4.1M (multi-period excess earnings), patents €1.8M (relief-from-royalty), brand name €0.6M (relief-from-royalty), order backlog €0.3M (excess earnings on the current book at acquisition date).

Total identified intangibles: €6.8M. Net identifiable assets increase from €13.4M to €20.2M before deferred tax.

Step 4: Account for deferred tax

The identified intangibles of €6.8M have a tax base of zero (they were not recognised in Rijnmond’s tax accounts). The Dutch corporate tax rate is 25.8%. Deferred tax liability: €6.8M × 25.8% = €1.75M. Net identifiable assets after deferred tax: €20.2M minus €1.75M = €18.45M.

Revised goodwill: €22M minus €18.45M = €3.55M. The original €8.6M was overstated by €5.05M.

Conclusion: The file now shows a purchase price allocation with separately identified intangible assets of €6.8M, a deferred tax liability of €1.75M, and goodwill of €3.55M. A reviewer sees the rationale for each identified asset, the valuation method applied, and the deferred tax impact. The original €8.6M goodwill figure would have been indefensible.

Provisional accounting under IFRS 3.45: what to do when the PPA isn’t done

IFRS 3.45 permits provisional accounting when the initial accounting for a business combination is incomplete at the end of the reporting period. The acquirer recognises provisional amounts for the items where accounting is incomplete and adjusts those amounts during the measurement period. The maximum measurement period is one year from the acquisition date (IFRS 3.45).

On your file, provisional accounting creates two audit obligations. At the initial year-end, you need to evaluate whether the provisional amounts are reasonable estimates and whether the disclosures under IFRS 3.B67(a) explain which items are provisional and why. At the subsequent year-end, you need to test the measurement period adjustments (which are retrospective under IFRS 3.49) and verify that the comparative period financial statements have been restated. Both of these checkpoints need to be documented separately, with cross-references between the initial and subsequent year files.

Clients treat the measurement period as a reason to delay the PPA indefinitely. Your file should document the expected timeline for the PPA completion, what information is outstanding, and management’s assessment of why the provisional amounts are the best estimates available. If the measurement period expires and no PPA has been completed, the provisional amounts become final. Goodwill at the provisional amount cannot be adjusted retrospectively after the measurement period closes.

Track the Financial Ratio Calculator if you need to reconstruct key ratios with and without the acquisition to assess the impact on financial statement analysis.

Contingent consideration: the second-highest risk area

After intangible asset identification, contingent consideration is the area most likely to generate audit findings on business combination files. IFRS 3.39 requires the acquirer to recognise contingent consideration at acquisition-date fair value as part of the total consideration for the acquiree.

The common structure in mid-market deals is an earn-out: additional payments contingent on the target meeting revenue or EBITDA targets over one to four years. Under IFRS 3.39, this is measured at fair value on day one, requiring assumptions about probability, time value of money, and the acquirer’s credit risk.

After initial recognition, the accounting depends on classification. IFRS 3.40 requires contingent consideration classified as equity to remain at the initial amount (no remeasurement). Contingent consideration classified as a liability (the far more common case for earn-outs) gets remeasured to fair value at each reporting date, with changes recognised in profit or loss. The distinction matters because it determines whether subsequent changes in the earn-out estimate affect goodwill or the income statement.

Your audit work covers two phases. At the acquisition date, test the fair value of the contingent consideration: examine the earn-out agreement, the probability assumptions, and the discount rate. In subsequent periods, test the remeasurement by comparing the updated probability assessment against actual performance data. If the target exceeded its first-year revenue threshold, the probability weighting on the higher payment tranches should have shifted. A static day-one estimate left unchanged at year-end despite actual results is one of the most straightforward findings for a reviewer to identify.

The most common error is failing to remeasure. Clients record the day-one fair value and leave it unchanged at subsequent reporting dates even when actual performance data changes the probability distribution. Your file should include a comparison of the acquisition-date assumptions against actual results at each reporting date.

Practical checklist for your next business combination file

1. At planning, confirm whether a business combination occurred or is expected. Assess whether management has engaged (or will engage) a valuation specialist for the PPA. If not, raise this with the engagement partner before fieldwork starts. IFRS 3.18 does not permit a goodwill-only allocation.
2. Obtain the share purchase agreement and identify the acquisition date per IFRS 3.8. Confirm when control transferred by reference to IFRS 3.B13 through IFRS 3.B18 indicators.
3. Prepare a schedule of all intangible asset categories (customer relationships, technology, patents, brands, order backlogs, non-compete agreements) and document whether each meets the IAS 38.12 recognition criteria. For any category not recognised, document why.
4. If a specialist PPA exists, evaluate the valuer’s competence, objectivity, and scope. Test the key assumptions in each valuation model. Cross-reference the identified intangibles against your own schedule from step 3.
5. Calculate the deferred tax impact on all fair value adjustments per IAS 12.66. Verify the circular effect on goodwill. Show the reconciliation from book value net assets to acquisition-date fair value net assets to goodwill.
6. For contingent consideration, obtain the earn-out agreement, test the acquisition-date fair value, classify as equity or liability per IFRS 3.40, and at each subsequent reporting date, test the remeasurement against actual performance data.

Common mistakes

• Recording goodwill as the full difference between purchase price and book value net assets without performing a purchase price allocation. The AFM’s thematic reviews on fair value measurement have repeatedly noted that incomplete identification of intangible assets in business combinations leads to overstated goodwill and inadequate disclosures.
• Failing to remeasure contingent consideration classified as a financial liability at subsequent reporting dates. The FRC’s annual inspection findings include cases where earn-out liabilities were recorded at day-one fair value and left unchanged despite material changes in actual performance against targets.
• Allowing the measurement period under IFRS 3.45 to expire without completing the PPA, resulting in provisional goodwill becoming final by default rather than by analysis.

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Further reading and source references

• IFRS 3, Business Combinations: the source standard governing the acquisition method, purchase price allocation, and goodwill measurement.
• IAS 38, Intangible Assets: provides the recognition criteria (identifiability, control, future economic benefits) for intangible assets identified in a business combination.
• IAS 12, Income Taxes: governs the deferred tax impact on fair value adjustments in the PPA.
• IAS 36, Impairment of Assets: applies to goodwill impairment testing after initial recognition in a business combination.