How to classify liabilities acquired in a business combination under IFRS 18?

Type of liabilities
(IFRS 18, paragraph 59)

When does this occur?

Examples

Type 1 liabilities

Liabilities that arise from transactions that involve only the raising of finance (‘pure financing’ liabilities).

An entity receives finance in the form of cash, or an extinguishment of a financial liability, or receives the entity’s own equity instruments. At a later date, the entity will return in exchange, cash or its own equity instruments.

IFRS 18, paragraph B50

• Debt instruments such as loans, debentures, notes and bonds
• Bonds which are settled through the delivery of an entity’s shares
• Liabilities under supplier finance arrangements when the payable for goods and services is derecognised.

Type 2 liabilities

Liabilities other than those described above - that is, liabilities that arise from transactions that do not involve only the raising of finance.

In addition to financing, the entity receives goods, services or other assets.

• Payables for goods and services
• Contract liabilities (IFRS 15 Revenue from Contracts with Customers)
• Lease liabilities for right-of-use assets (IFRS 16 Leases)
• Asset restoration provisions and litigation provisions (IAS 37 Provisions, Contingent Liabilities and Contingent Assets).

Fact pattern

How are the acquired liabilities classified?

Bank A acquires Bank B in a business combination accounted for in accordance with IFRS 3.

Bank A is identified as the acquirer.

In applying IFRS 3, Bank A recognises the net assets acquired in the business combination, including loans payable.

Bank B entered into the loans payable to raise additional capital to be provided to its customers in the form of loans.

From the perspective of Bank A, these loans payable are initially recognised at fair value at the acquisition date of Bank B.

Assume that Bank A has a specified main business activity of providing financing to customers.

When the underlying loans were originated (i.e. when the contractual terms between Bank B and the lender became effective), Bank B received finance in the form of cash and promised to return it at a later date. Bank B, therefore, classified the loans payable as Type 1.

Applying View two, Bank A classifies the acquired loans payable as Type 1.

As Bank A has a specified main business activity of providing financing to customers, and the Type 1 liabilities relate to that activity, the income and expenses on bank loans are classified in the operating category.  

Fact pattern

How are the acquired liabilities classified?

Entity L acquires Entity M in a business combination accounted for in accordance with IFRS 3.

Entity L is identified as the acquirer.

Applying IFRS 3, Entity L recognises an investment property (e.g. an office building) and the associated mortgage payable on the investment property.

The mortgage payable was entered into by Entity M to finance the acquisition of the investment property a number of years prior to Entity L acquiring Entity M.

Entity L does not have any specified main business activities.

When the underlying mortgage was originated (i.e. when the contractual terms between Entity M and the lender became effective), Entity M received finance in the form of cash to acquire the investment property, and promised to return cash to the lender at a later date. Entity M, therefore, classified the mortgage loan payable as Type 1.

Applying View two, Entity L classifies the acquired mortgage loan as Type 1.

Entity L does not have any specified main business activities, so the income and expenses related to the mortgage loan payable are classified in the financing category.

Fact pattern

How are the acquired liabilities classified?

Entity T acquires Entity U in a business combination under IFRS 3.

Entity T is identified as the acquirer.

Applying IFRS 3, Entity T recognises an intangible asset (e.g. a license Entity U had acquired in a previous transaction) and a liability to a third party, as Entity U had agreed to pay on deferred payment terms over the next five years when the intangible asset was originally acquired by Entity U.

On initial recognition, Entity U classified the acquired liability for deferred payment as Type 2 because when it acquired the intangible asset, it did not receive finance in the form of cash or the extinguishment of a financial liability or the receipt of the entity’s own equity instruments.

Rather, it received an intangible asset, and the liability for deferred payment arose from the acquisition of an asset, like a lease.

Applying View two, Entity T classifies the acquired loans payable as Type 2.

Entity T does not have any specified main business activities, so only the income and expenses related to the liability as set out in paragraph 61(a) of IFRS 18 (primarily interest income and interest expense) are classified in the financing category. All other expenses relating to the liability are classified in the operating category.