BUSINESS COMBINATIONS

Advanced Accounting II
DEFINITION
 IFRS 3 (2008)

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
is capable of being conducted and managed for the purpose of
providing return directly to investors or other owners, members or
participants.

NOTE: An acquirer must be identified for all business

combinations.
DEFINITION

 The term business combination refers in general to any set

of conditions in which two or more organizations are joined
together through common ownership. It is the term applied to
external expansion in which separate enterprises are brought
together into one economic entity as a result of one enterprise
uniting with or obtaining control over the net assets and
operations of another enterprise.

SCOPE: PFRS 3 Revised applies to all business combinations except

the formation of a joint venture, the acquisition of an asset or a group of
assets that does not constitute a business and a combination between
entities or businesses under common control.
DEFINITION
IFRS 3 (paragraph 3)
 An entity shall determine whether a transaction or other
event is a business combination by applying the
definition in this IFRS, which requires that the assets
acquired and liabilities assumed constitute a business.
 If the assets acquired are not a business, the reporting
entity shall account for the transaction or other event as
asset acquisition.
CLASSIFICATION OF BUSINESS COMBINATION

Structure of the Combination (Business Point of View)

 Horizontal Integration-this type of combination is one that
involves companies within the same industry that have been
previously competitors.
 Vertical Integration- this type of combination takes place
between two companies involve in the same industry but at
different levels. It normally involves a combination of a
company and its suppliers or customers.
 Conglomerate Combination- is one involving companies in
unrelated industries having little, if any, production or market
similarities for the purpose of entering into new markets or
industries.
 Circular Combination- entails some diversification, but
does not have a drastic change in operation as a
conglomerate. For example, San Miguel Corporation
accomplished this when they diversify their activities by
putting up Magnolia.
CLASSIFICATION OF BUSINESS COMBINATION

Methods of Combination (Legal Point of View)

1. Acquisition of Assets
 Statutory Merger- results when one company acquires
all the net assets (assets and liabilities) of one or more
other companies through an exchange of stock, payment
of cash or other property, or the issue of debt instruments
(or a combination of these methods). The acquiring
company survives (remains in existence), whereas the
acquired company (or companies) ceases to exist as a
separate legal entity, although it may be continued as a
separate division of the acquiring company.
 Statutory Consolidation – results when a new
corporation is formed to acquire the net assets (assets and
liabilities) of two or more other corporations. The acquired
company, then, ceases to exist as a separate legal entity.
CLASSIFICATION OF BUSINESS COMBINATION
2. Stock Acquisition- an acquiring corporation may
acquire majority ownership interest of outstanding
voting stock or control of a corporation and the
separate legal entity of each enterprise is
preserved. In this case, the acquiring corporation is
known as the parent and the acquired corporation
as subsidiary.
What are the positive impacts of a business
combination on the part of the acquirer? On the part
of the acquiree?

What are the limitations and risks involved in a

business combination?
ACQUISITION OF CONTROL
Control of another company may be achieved by
 Acquiring the assets of the target company, or
 Acquiring a controlling interest in the target company
(usually over 50%)

ACQUISITION OF ASSETS

Statutory Consolidation: Refers to the combining of two or more

existing legal entities into one new legal entity

Statutory Merger: Refers to the absorption of one or more

existing legal entities by another existing company that continues
as the sole surviving entity
ACQUISITION OF CONTROL

STOCK ACQUISITION

A controlling interest of another company’s voting common stock

is acquired. The acquiring company is called “parent” (also the
acquirer) and the acquired company is termed as “subsidiary”
(also the acquiree).

Both the parent and the subsidiary remain separate legal

entities and maintain their own financial records and
statements. However, for external financial reporting
purposes, the companies will usually combine their individual
financial statements into a single set of consolidated
statements.
METHODS OF BUSINESS COMBINATIONS
 Under the old standard, two methods were used to
account for business combinations.
 Purchase method (acquisition method under the revised
IFRS 3)
 Pooling of interests method (eliminated under the
revised IFRS 3)
ACQUISITION METHOD
Steps in the application of acquisition method
1. Identify the acquirer
 The company transferring cash or other assets and/or
assuming liabilities is the acquiring company
 In a stock acquisition, the company transferring cash
or other assets for a controlling interest in the voting
stock of the acquiree
 The company issuing the voting stock is the acquirer
 In some cases, the acquiree may issue the stock in
the acquisition-”reverse acquisition”
ACQUISITION METHOD
2. Determine the acquisition date.
 The acquisition date is the date on which the
acquirer obtains control of the acquiree.
 IFRS 3 explains that the date on which the acquirer
obtains control of the acquiree is generally the date
on which the acquirer legally transfers the
consideration, acquires the assets and assumes
the liabilities of the acquiree-the closing date
 Acquisition date may be earlier or later than the
closing date
 The acquisition date is critical because it is the date
used to establish the fair value of the acquired
company
ACQUISITION METHOD

3. Determine the consideration given (price paid) by

the acquirer
 Generally, the consideration given (price paid) by the
acquirer is assumed to be the fair value of the acquiree
as an entity.
 IFRS 3 (2008) requires the consideration given in a
business combination to be measured at fair value.
 This is calculated as the sum of the acquisition-date fair
values of
 The assets transferred by the acquirer
 The liabilities incurred by the acquirer to former owners of the
acquiree, and
 The equity interests issued by the acquirer
ACQUISITION METHOD

4. Recognize and measure the identifiable assets

acquired, the liabilities assumed and any non-
controlling interest (formerly called minority interest)
in the acquiree. Any resulting goodwill or gain from
a bargain purchase should be recognized.

When the price paid exceeds the fair values assigned to net assets, the
excess is treated as goodwill. Goodwill is later on tested for impairment.

When the price paid is less than the fair values assigned to net assets, a
“bargain purchase” has occurred. The excess is recorded as gain on the
acquisition.
CONTINGENT CONSIDERATION
Contingent consideration is an agreement to issue
additional consideration (asset or stock) at a later
date if specified events occur.
 The most common agreements focus on a targeted
sales or income performance by the acquiree company
 Contingent consideration is measured at its acquisition-
date fair value
 Changes that are the result of the acquirer obtaining
additional information about facts and circumstances
that existed at the acquisition date, and that occur within
the measurement period (maximum of one year from
acquisition date) are recognized as adjustments against
the original accounting for the acquisition.
ACQUISITION-RELATED COSTS
 These are costs the acquirer incurs to effect a
business combination
 These are not included in the price of the company
acquired and are expensed.
 Where the consideration given is the stock of the
acquirer, the issue costs are usually deducted from
the additional-paid in capital or share premium.
UNRECOGNIZED ASSETS AND LIABILITIES
The acquirer may recognize some assets and
liabilities that the acquiree had not previously
recognized in its financial statements.
ASSETS WITH UNCERTAIN CASH FLOWS

 The acquirer shall not recognize a separate

valuation allowance as of the acquisition date for
assets acquired in a business combination that are
measured at their acquisition-date fair values
because the effects of uncertainty about future cash
flows are included in their fair value measure.
 For example, in the case of receivables and loans on
acquisition date, no separate valuation allowance is
recognized for the contractual cash flows that are
deemed to be uncollectible at that date.
 This also applies to property, plant and equipment
APPLICATION-ACQUISITION OF NET ASSETS
Compute for the goodwill or gain on acquisition
(bargain purchase gain) given the following cases.

 Case 1. Big Net agrees to pay P 3,000,000 in exchange for all

of Smallport’s assets and liabilities. Big Net transfers to the
former owners of Smallport consideration of P1,000,000 in
cash plus 20,000 shares of common stock with a fair value of
P100 per share.

 Case 2. Big Net transfers consideration of P2,000,000 to the

owners of Smallport in exchange for their business. Big Net
conveys no cash and issues 20,000 shares of common stock
having a P100 per share fair value.