Business Combinations - Statutory [Moaute +] Mergers and Statutory Consolidation © Introduction Figure 1. Retrieved from: https,//www.companysuggestion.com/nd-as-1U5-business-combination) Accounting for business combinations is one of the most significant and interesting topics of accounting theory and practice. Simultaneously, it is multifaceted and civisive. Business combinations involve financial transactions of immeasurable magnitudes, business empires, iriumphant stories and individual fortunes, managerial genius, and management debacles. By their nature, they affect the destiny of entire companies. Each is exceptional and must be evaluated in terms of its economic substance, regardless of its legal form. Why do business entities enter into a business combination? Although a number of reasons. have been cited, the overriding reason is probably growth. Growth is a mojor objective of many business organizations. A company may grow slowly, may gradually expand its product lines, facilities, or services, or may skyrocket overnight. Some monagers consider growth so important that they say their companies must "grow or die” Other reasons often advanced in support of business combination are obtaining new management strength or better use of existing management, and achieving manufacturing or other operating economies. Further, a business combination may be undertaken for the income tax benefit available to one or more parties to the combination Business combinations may destroy value rather than create in some instances. For example. if the managers of merged firm transfer resources to subsidize money-losing segments instead of shutting them down, the result will be a suboptimal allocetion of capital. This situation may arise because of reluctance to elirrinate jobs or to acknowledge s past mistake. This module presents the reasons tor the popularity of business combination, the methads, and techniques in dealing with them outlined in four lessons as follows: Lesson 1: Definition, Scope, Nature & Types of Business Combination Lesson 2: Method of Accounting for Business Combination Lesson 3: Journal Entries and Consolidated Balance Sheet at Date of Acquisition Lesson 4: Provisional Values, Contingent Consideration & Measurement Period So, are you now ready to embark on this journey® | wish you an enriching and productive learning experience.Definition, Scope, Nature & Types of Business Combination Learning outcomes: At the end of the lesson you will be able to: Define business combination Discuss the scope of PFRS 3 (Business Combination) Demonstrate the reasons why businesses enter into a business combination. Discuss the nature of business combination. Identify and explain the types of business combination according to its structure, methods and legal forms. llustrate statutory merger and statutory consolidation i PFRS 3 (Business Combination) Revised 2008 — Definition of Terms 4 PFRS 3 Appendix A defines “Business Combination” as a transaction or event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as “true mergers” or “mergers of equal” are also business combinations. A first key aspect in this definition is “Control”. Control is the power over the investee; or the power to govern the financial and operating policies of an investee so as to obtain benefits. An investor controls an investee if and only if the investor has all of the following three elements of control: 1. Power over the investee. Powers the ability to direct those activities which significantly affect the investee's returns. It arises from rights, which may be straightforward (e.g. through voting tights) or complex (e.g. through one or more contractual arrangements). 2. Exposure or rights to variable retums from involvement with the investee. Returns must have the potential to vary as a result of the investee's performance and can be positive, negative or both. 3. The ability to use power over the investee to affect the amount of the investor's returns. The second key aspect of the definition is that acquirer obtains control of a business. PERS 3 Appendix A defines the term “Business” as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return directly to investors or other owners, members or participants. The purpose of defining the business is to distinguish between the acquisitions of a group of assets such as a number of chaiis, bookshelves and filing cabinets — and the acquisition of an entity that is capable of producing some form of output. Accounting for a group of assets is based on standards such as PAS 16 Property, Plant and Equipment rather than PFRS 3.Scope of PFRS 3 (Business Combination) Revised Combination involving mutual enfifies (@.9. cooperatives, credit union, etc.) ‘Combinations achieved by contract alone (dual listing, stapling) Formation of all types of joint arrangement (joint venture and joint operations) Entities under common control ‘Acquisition of an asset (a group of assets) that is not a business >] ><] |S] X= not within the scope / =within the scope are corporations. This type of organization undoubtedly meets the defi The most common type of businesses that normally undergoes business combinations ition of business that is within the scope of PFRS 3. In addition to it, the following transactions are also specifically identified to be within the scope of PFRS 3: ly Combinations involving mutual entities. A mutual entity is defined as an entity, other than an investor-owned entity, that provides dividends, lower costs or other economic benefits directly to its owners, members or participants, e.g. a mutual insurance company, a credit union and a cooperative entity. Combinations achieved by contract alone (dual listing, stapling). In a combination achieved by contract alone, two entities enter into @ contractual arrangement which covers for example, operation under a single management | and equalization of voting power and eamings attributable to both entities’ equity investors. Such structure may involve a “stapling” or a formation of a dual listed corporation (Note: Accounting for business combination by contract under PFRS requires one of the combining entities to be identified as the acquirer, and one to be identified as the acquiree.) On the other hand, the following transactions are not within the scope of PFRS 3: Ty Where the business combination results in the formation of all types of joint arrangements (joint ventures and joint operations) and the scope exception only applies to the financial statements of the joint venture or the joint operation itself and not the accounting for the interest in a joint arrangement in the financial statements of party to the joint arrangement. Where the business combination involves entities or businesses under common control. Common control is a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the combination, and that control is not transitory. Where the acquisition of an asset or a group of assets does not constitute a business. The term used to indicate this transaction is “asset acquisition". In such circumstances, the acquirer: a. Identifies and recognizes the individual identifiable assets acquired and liabilities assumed; and b. Allocates the cost of the group of assets and liabilities to the individual assets and liabilities on the basis of their relative fair value at the date of purchase. Such transaction or event does not give rise to goodwill.Reasons for Business Combination There are several ways of business expansion: it may either be through ‘acquisition or construction of new amenities or through business combination. Following are the reasons why business combination may be preferred as compared to other means. 1. Cost Advantage. It is commonly less expensive for a firm to obtain needed amenities through combination rather than through development. 2. Lower Risk. The acquisition of reputable product lines and markets is usually less risky than developing new products and markets. The threat is especially low when the purpose is diversification. 3. Avoidance of Takeovers. Many companies combine to evade being acquired themselves. Smaller companies tend to be more susceptible to corporate takeovers; therefore, many of them adopt forceful buyer strategies to defend against takeover attempts by other corporations. 4. Acquisition of Intangible Assets. Business combinations bring together both intangible and tangible resources. 5. Other Reasons. Entities may choose a business combination over other forms of expansion for business tax advantages (for example, tax-loss carry forwards), for personal income and estate-tax advantages, or for personal reasons. A business combination may be friendly or unfriendly (hostile takeovers) * Friendly Combination — the board of directors of the potential combining companies negotiates mutually agreeable terms of a proposed combination. The proposal is submitted to the stockholders of the involved companies for approval. Normally, a two-thirds or three- fourths positive vote is required by corporate by-laws to bind all stockholders to the combination. Combination (Hostile Takeover) - the board of director of a company targeted ion resists the combination. A formal tender offer enables the acquiring firm to deal directly with individual stockholders. If a sufficient number of shares are not made available, the acquiring form may reserve the right to withdraw the offer. Because they are relatively quick and easily executed (often in about a month), tender offers are the preferred means of acquiring public companies. Although tender offers are the preferred method for presenting hostile bids, most tender offers are friendly ones, done with support of the target company's management. Nonetheless, hostile takeovers have become sufficiently common that a number of mechanisms have emerged to resist takeover. Resistance often involves various moves by the target company, generally with colorful terms. Whether such defenses are ultimately beneficial to shareholders or not remains a controversial issue. In unfriendly (hostile) takeover, the following are the defensive tactics or moves to resist the proposed business combination with the following colorful designations:Resistance on Hostile Takeovers: Defensive Tactics or Moves to Resist the Proposed Business Combination 1.Poison Pill ‘An amendment of the articles of incorporation or by-laws fo make it more difficult to obtain stockholder approval for a takeover. 2.Greenmail ‘An acquisition of common stock presently owned by the prospective acquiring (acquirer) company at a price substantially lower in excess of prospective acquirer's cost, with the stock thus placed in the treasury or retired. The purchased shares are then held as treasury stock or retired. 3.White Knight or Asearch for a candidate fo be the acquirer om a friendly takeover. This White Square is simply encouraging a third company more acceptable to the target company. 4.Pac-man Defense _| Attempting an unfiiendly takeover of the would-be acquifing company. 5.Seling the Crown _| The sale of valuable assets fo other to make the firm less attractive to Jewels or the would-be acquirer. The negative aspect is that the firm, if it survives, Scorched Earth is left without some important assets. 6.Shark Repellant An acquisition of substantial amounts of outstanding common stock for the treasury or for retirement, or the incurring of substantial long-term debt in exchange for outstanding common stocks. 7.Leveraged Buyouts | When management desires to own the business, it may arrange to buy out the stockholders using the company's assets to finance the deal. The bonds issued often take the form of high-interest, high-risk “junk” bonds. 8.The Mudslinging | When the acquiring company offers stock instead of cash, the Defense prospective acquiing (acquirer) company's management may try to convince the stockholders that the stock would be a bad investment. 9.The Defensive When a major reason for an attempted takeover is the prospective Acquisition Tactic | acquiring (acquirer) company's favorable cash position, the prospective acquiring (acquirer) may try to tid itself of this excess cash by attempting to takeover of its own. (4 Types of Business Combination according to Structure | U Business combinations may be classified under three schemes based on the following: * based on structure of the combination * based on the methods/legal forms used to accomplish the combination * based on the accounting method used In general terms, business combinations unite previously separate business entities. These combinations can be classified by structure into four types: 1, Horizontal Integration — this type of combination is one that involves companies within the same industry that have previously been competitors (e.g. a bank acquires another bank). 2. Vertical Integration - this type of combination takes place between companies involved in the same industry but at different levels. It normally involves a combination of a company and its supplier or customers. 3. 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 (e.g. real estate developer acquires a bank). 4. Circular Combination - entails some diversification but does not have a drastic change in operation as a conglomerate (e.g. San Miguel Corporation putting up Magnolia)Types of Business Combination according to Methods/ Legal Forms of Effecting Business Combination U From an accounting perspective, the specific procedures to be used in accounting for @ business combination is effected through an (1) acquisition of assets or an (2) acquisition of stock, the distinction of which is most important at this stage. 1. Acquisition of Assets (Asset Acquisition) The books of the acquired (acquiree) company are closed out, andits assets and liabilities are transferred to the books of the acquirer (surviving company}. In this aspect of combination, sometimes one enterprise acquires another enterprise's net assets through direct negotiations with its management. * The acquire (acquired) company generally distributes to its stockholders the asset or securities or debt instruments received in the combination from acquirer (acquiring) company and liquidates. * The acquirer (acquiring) company accounts for the combination by recording each asset acquired, each liability assumed, and the consideration given in exchange. * Asset Acquisition as a method of effecting the business combination can be classified into: a. Statutory Merger b. Statutory Corvelidation _}- s2€ discussion on the next page. 2. Acquisition of Common Stock (Stock Acquisition) - The books of the acquirer (parent) company and acquire (subsidiary) company remain intact and consolidated financial statements are prepared periodically. * In such cases, the acquirer (acquiting company) debits an account “Investment in Subsidiary”, the stock of the acquired company Is recorded as an intercorporate investment rather than transferring the underlying assets and liabilities onto its own books. * Abusiness combination effected through a stock acquisition does not necessarily have to involve the acquisition of all of a company’s outstanding voting (common) shares. In those cases, control of another company is acquired. Following are the differences on the features of an asset acquisition and stock acquisition: Asset Acquisition Stock Acquisition . The acquirer acquires from another |1.The acquirer acquires voting (common) stock enterprise all or most of the gross assets | from another enterprise for cash or other or net assets of the other enterprise for| property, debt instruments, and equity cash or other property, debt | instruments (common or preferred stock}, or a instruments, and equity instruments | combination thereof (common or preferred stock), or a combination thereof B. The acquirer must acquire 100% of the |2.The acquirer must obtain control by purchasing net assets of the acquired (acquire) | more than 50% of the voting common stock or company. possibly less when other factors are present that lead to the acquirer gaining control. B. If involves only when the acquiring [3.The acquired company need not be dissolved; (acquirer) company survives thatis the acquired company doesnot have to go out of existence. Both the acquirer and the acquire remain as separate legal entity.( Asset Acquisition: Statutory Merger & Statutory Consolidation " Statutory Merger A statutory merger entails that acquiing company survives, 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. The board of directors of the companies involved normally negotiates the terms of a plan of merger, which must then be approved by the stockholders of each company involved. Laws or corporation by-laws dictate the percentage of positive votes required for approval of the plan. Statutory Consolidation A statutory consolidation results when a new corporation is formed to acquire two or more other corporations; the acquired corporations then cease to exist (dissolve) as separate legal entities. Stockholders of the acquired companies become stockholders in the new entity. The acquired comparies in a statutory consolidation may be operated as separate divisions of the new corporation. Statutory consolidation requires the same type of stockholder approval as statutory mergers do. The differences on the three methods of effecting the business combination could be expressed as follows: 1. Asset Acquisitions: a. Statutory Merger > ACompany + B Company = A or 8 Company b. Statutory Consolidation > A Company + B Company = C Company 2. Stock Acquisition: > FS of A Co. + FS of B Co. = Consolidated FS of A Co. & B Co. (Note: FS means “Financial Statements”)Method of Accounting for Business Combination Learning outcomes: At the end of the lesson you will be able to: Discuss the acquisition method of accounting for business combination. Identify the acquirer in a business combination. Determine the acquisition date of business combination. Measure and compute the fair value of the consideration transferred and the assets and lidblities acquired in a business combination. Compute goodwill and bargain purchase gain as a result of business combination. Summarize the accounting treatment of different acquisition-related costs Method of Accounting for Business Combination The acquisition method (called the ‘purchase method’ in 2004 version of PFRS 3) is currently the only method to be used for all business combination. The pooling of interest, the second method Under the old standard, is new prohibited. Under the acquisition method, the general approach to accounting business combination is a five-step process: 1. Identify the acquirer. . Determine the acauisition date. . Calculate the fair value of the purchase consideration transferred. |. Recognize and measure the identifiable assets and liabilities of the business acquired. . Recognize and measure either goodwill or bargain purchase gain. Step 1. Identifying the Acquirer PERS 3 paragraph 7 states that “the acquirer is the combined entity that obtains control of the other combining entities or businesses”. Paragraph 6 requires that in each business combination, one of the combining entities should be identified as the acquirer. PFRS 3 provides the following guidance in identifying the acquirer stated as follows: 1. The acquirer is usually the combining entity whose relative size (measured in, for example, assets, revenues or profit) is significantly greater than that of the other combining entity or entities. In a business combination effected primarily by transfering cash or other assets, the acquirer is usually the entity that transfer the cash or other assets. 3. The acquirer is usually the dominant entity whose management is able to dominate the selection of management of the combined entity.Step 2. Determining the Acquisition Date PFRS 3 Appendix A defines “acquisition date" as the date on which the acquirer obtains control of the acquiree. This is the date the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquire. It is generally the closing date. As noted in paragraph 9 of PFRS 3, on the closing date of the combination, the acquirer legally transfers the consideration and acquires the assets and liabililies of the acquiree. However, in some cases, this may not be the acquisition date. Other dates that are important during the process of business combinations may be: * The date the contract is signed; * The date the consideration is paid; * Adate nominated in the contract; * The date on which assets acquired are delivered to the acquirer: and * The date on which an offer becomes unconditional These dates may be important but determination of acquisition date does not depend on the date the acquirer receives physical possession of the assets acquired or actually pays ‘out the consideration to the acquiree. Step 3. Calculating the Fair Value of Purchase Consideration Transferred (of the Acquirer) 1. Cash or Other Monetary Assets * The Fair Value is the amount of cash or cash equivalent dispersed. * For deferred payment, the Fair Value is the amount the entity would have to borrow to settle the debt immediately, hence, the present value of the obligation. The discount rate to be used is the entity's incremental borrowing rate. 2. Non-monetary Assets * Nonmonetary assets are assets such as property, plant and equipment, investments, licenses, and patents. if active market second-hand market exists, fair values can be obtained by reference to those markets. * In this case, the acquirer is in effect selling the non-monetary asset to the acquiree. The difference between the fair value and carrying amount is recognized as gain or loss at acquisition date. 3. Liabilities Undertaken — The Fair Values of liabilities are best measured by the present value of expected future cash flows. 4, Equity Instruments — If an acquirer issues its own shares as consideration, it needs to determine its fair value of those shares at acquisition date. For listed entities, reference is made to the quoted price of the shares. 5. Contingent Consideration - defined as “usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquire if specified future events occur or conditions are met”. It will be classified as either liability or equity depending on its nature os follows: * Asa Liability — if it will be paid in the form of cash. It is measured at FV at each reporting date until the contingency is resolved. Changes in FV shall be recognized in profit or loss. * As Equity — ifissuing additional shares will satisfy the contingent consideration. Itwill not be remeasured until the contingency is resolved. The subsequent settlement is reflected and accounted within the equity accounts. 4. Share-based payment awards - Acquirer share-based payment awards exchanged for awards held by the acquiree's employees. These are measured in accordance with PFRS 2 (referred to as the “market-based measure) rather than at fair value.Step 4. Valuation of Identifiable Assets and Liabilities (of the Acquiree) 2. Identifiable Tangible Assets |. Current Assets - recorded at estimated fair values. An acquirer is not permitted to recognize a separate valuation allowance as of the acquisition date (e.g. Accounts and Notes Receivable) . Assets held for sale — measured in accordance PFRS 5, at fair value less cost to sell. Property Plant and Equipment - recorded at estimated fair value with no separate accumulated depreciation account. Investments in equity-accounted entities — FV should be determined on the basis of the value of the shates (e.g. Investment in Associate, Financial Assets at FVTPL, FA at FVOCI) Identifiable Intangible Assets — An intangible asset is identifiable if it meets the separability criterion or contractual-legal criterion. * Market-Related — trademarks, trade names, service marks, collective marks, certification marks, trade dress, newspaper mastheads, intemet domain names, non- competition agreements Customer-Related — order/production backlog. customer contracts and the related customer relationships, non-contractual customer relationships, customer lists Artistic-Related - plays, operas, ballets, books, magazines, newspapers, other literary works, musical works (e.g. composition, song lyrics, & advertising jingles}, pictures, photographs, video & audio-visual material, motion pictures or films, music videos and TV programs Contract-based — Licensing royalty and standstill agreements, advertising construction, management, service or supply contracts, lease agreements, construction permits, franchise agreements, operating and broadcasting rights, use of rights (e.g. driling, water, cir, mineral, timber-getting, and route authorities), servicing contracts, employment contracts Technological-based - patented technology. computer software, unpatented technology, databases including file plants, trade secrets such as secret formula, processes or recipes Emission Rights Reacquired Rights In process-research and development Favorable (unfavourable) terms on operating lease (when the acquire is the lessee) . Existing Liabilities — recorded at fair values (present value). }. Contingent Liabilities — required to be recognized at acquisition date fair value regardless 5. 6. of the probability. liobilities Associated with restructuring or exit activities Other Assets/Liabilities Employee Benefit Plans - in accordance with PAS 19 Revised Indemnification Assets - to be recognize at the same time that the acquirer recognizes the indemnified asset or liability. Income Taxes - recognize and measure deferred tax asset or liability in accordance with PAS 12. Employee benefits - in accordance with PAS 19 Revised Items Included in Goodwill (do not qualify as assets at acquisition date) 1 2. 3. 4, Assembled Workforce of the acquiree Potential Contracts with new customers Contingent Assets Future Contracts RenewalStep 5. Measuring Goodwill or Bargain Purchase Gain » Goodwill - defined in PFRS 3 Appendix as “an asset representing the future economic benefits arising from other assets as acquired in a business combination that are not individually identified and separately recognized”. - is accounted for as an asset, recorded on the acauirer's books, along with the fair values of the other assets and liabilities acquired. > Bargain Purchase Gain - When the acatirer's interest in net fair value of the acquiree’s identifiable assets and liabilities is greater than the consideration transferred, the difference is called “bargain purchase gain”. =a gain on acquisition that is recognized in the profit or loss by the acquirer in its income statement. Computation for Goodwill (Bargain Purchase Gain) under 100% ASSET A\ Fair Value of Consideration Transferred (FVCT): Cash Paid Px Non-Monetary Assets Given iobilties Incuted Equity Instruments Issued Contingent Consideration Total Px Less: Fair Value of Net Assets Acquired (FVNAA) FV of Identifiable Assets Acquired Px - FV of Liabilities Assumed (xx) xx Goodwill (Bargain Purchase Gain) Bx Acquisition-Related Costs In addition to the consideration transferred by the acquirer to the acquiree, a further item to be considered in determining the cost of the business combination is the acquisition-related costs. Acquisition-related costs are excluded in the measurement of the consideration paid because such costs are not part of the fair value of the acquiree and are not assets. Belowis the summary of the accounting treatment of the different acquisition-related costs: Acquisition-related Examples Treatment Costs 1. Directly Professional fees paid to accountants, legal advisers, Expenses Attributable Costs | valuers, and other consultant (finders and brokerage fees) to effect the combination 2. Indirect General and administrative costs, including the cost of Expenses Acquisition Costs maintaining an internal acquisitions department (management salaries, depreciation, rent, and costs incurred to duplicate facilities) and other costs of which cannot be directly attributed to the combination 3. Costs of issuing _| Transaction costs such as stamp duties, professional Debit fo “Share Equity Instruments | adviser's fees, underwtiting costs and brokerage fees Premium may be incurred (aPic)” 4. Cost of Issuing | Professional adviser's fees, underwriting costs and Bond sue Debt Instruments _| brokerage fees incurred CostsJournal Entries and Consolidated Balance Sheet at Date of Acquisition Learning outcomes: At the end of the lesson you will be able to: Y Prepare journal entries to record the business combination. ¥ Prepare journal entries to record the acquisition related costs. ¥ Prepare Consolidated Balance Sheet at the date of acquisition. Journal Entries Proforma Journal Entries to record the business combination: Case 1. Assuming the business combination results to Goodwill, that is when the Fair Value of Consideration Transferred (FVCT) is greater than the Fair Value of Net Assets Acquired (FVNAA) Identifiable Assets Acquired Goodwill abilities Assumed Consideration Transferred # Case 2. Assuming the business combination results to Bargain Purchase Gain, that is when the. FV of Consideration Transferred (FVCT) is less than the FV of Net Assets Acquired (FVNAA) Identifiable Assets Acquired liabilities Assumed Consideration Transferred Bargain Purchase Goin # Note: When nonmonetary assets are part of the consideration transferred, it will be joumalized at book valve. And so, any difference between the fair values and book values of such assets shall be recorded 05 a separate account, either gain on sale (credit) or loss on sale (debit). Proforma Journal Entries to record the acquisition related costs: Case 1. To record the (1) directly attributable costs and (2) indirect acquisition costs: Acquisition-related Expenses Cash # Case 2. To record the (3) costs of Issuing equity instruments (e.g. ordinary shares): Share Premium / Additional Paid-in Capital Cash # Case 3. To record the (4) costs of issuing debt instruments (e.g. Bonds): Bond Issue Costs Cash #Balance Sheet at the Date of Acquisition As required by the standard, companies should prepare a full set of financial statements: (1) Statement of Financial Position (Balance Sheet); (2) Statement of Comprehensive Income; (3) Statement of Cash Flows, (4) Statement of Changes in Equity; and (5) Notes to Financial Statements. However, as of the date of acquisition, the only relevant financial statements to be prepared is the Balance Sheet (Statement of Financial Position). Preparation of other financial statements becomes important with the passage of fime. Name of the Acquirer’s Business Statement of Financial Position Date of Acquisition ASSETS Current Assets: Cash Pox Receivables xx Inventories xx Other current assets —x Total Current Assets Px Noncurrent Assets: land P xx Depreciable PPE Pxx Less: Accumulated Depreciation _ bod) xx Identifiable Intangible Assets xx Goodwill the business combination results to Goodwill) x Total Noncurrent Assets x TOTAL ASSETS Pix LIABITIES & SHAREHOLDERS’ EQUITY Liabilities: Accounts Payable P xx Other Current Liabilities xx Notes Payable xx Bonds Payable xx Other Noncurent Liabilities x Total Liabilities P xx Shareholders’ Equity: Common Stocks/Ordinary Share Capital Pox Additional Paid-in Capital/Share Premium x Retained Earnings (bargain purchase gain, itany. is closed to this account) _XX Total Shareholders’ Equity TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY EkCash Non-monetary Assets Total Assets Acquirer at Book Value (BV) ‘Acquirer at Book Value (BV) ‘Acquirer at BV + Acquiree at Fair Value (FV) + Acauiree at Fair Value (FV) + Acauiree at FV — Cash Consideration Paid —Nonmonetary Consideration ait Book Value (BV) — Cash Consideration ~Nonmonetary Consideration —Acauisifionrelated Costs —Acquiifiontelated Costs + Goodwill (iFany) Liabilities ‘Acquirer at Book Valve (BV) + Acquiree at Fair Value (FV) + Liability Consideration at FV. Share Capital APIC/Share Premium Retained Earnings ‘Acquirer at Book Value (BV) ‘Acquirer at Book Value (BV) ‘Acquirer at Book Value (BV) + Equity Consideration at Par Volue + Excess over par value of Equity Consideration + Gains (Losses) on Sale (FV - BV of Nonmonetary Consideration) ~ Acquisition Related Costs + Bargain Purchase Gain (ifany) Note: If there are contingent considerations, it will be included as another line item in the balance sheet either as liability or equity depending on its classification. Differences between Full PFRS and PFRS for SME's Recognition Full PFRS (Non-SME) SME Direct Acquisition Cost Expensed Capitalized Method used for Goodwill | Full goodwill*/Portial goodwill Parfial-goodwill Subsequent measurement for goodwill Tested for impairment ‘Amorlized™ and tested for impairment *Full-goodwill approach is preferred over the other method if the problem is silent. **Use 10 years to amortize if period is not given.Provisional Values, Contingent Consideration & Measurement Period s Learning outcomes: At the end of the lesson you will be able to: ¥ Explain the use of provisional values in a business combination. Y Apply the accounting principles in adjusting the provisional values subsequent to date of acquisition. Y¥ Determine and compute the contingent consideration involved in a business combination Determine the measurement period allowed in a business combination. Provisional Values Use of Provisional Values If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the financial statements should be prepared using the provisional values for the items for which the accounting is incomplete. Adjustments to Provisional Values. PFRS 3 permits adjustments to items recognized in the original accounting for a busines combination as long as it is within the measurement period. Any such adjustments are made retrospectively as if those adjustments had been made on the acquisition date. * During the Measurement Period - the acquirer can retrospectively adjust the provisional amounts, by means of a decrease (increase) in goodwill, to reflect new information about facts and circumstances existed as of acquisition date that would have altered the measurement ifit had been known on that date. + After the Measurement Period — any correction of errors will be deemed as prior-period adjustment in accordance with PAS 8. However, any change in estimate arising from new information should be recognized in the current period subsequent to the initial accounting after acquisition date. They are: 1. Goodwill. Having recognized goodwill arising in the business combination, the subsequent accounting is directed from other accounting standards (PAS 38 and PAS 36). 2. Contingent Liabilities. The liability is initially recognized at fair value. Subsequent to the acauisition date, according to par. 56 of PFRS 3, the liability is measured as the higher of i. The amount that would have been recognized in accordance with PAS 37. ii. The amount initially recognized less cumulative amortization in accordance with PAS 18. 3. Contingent Consideration - see discussion on the next page. In summary, there are normally three areas where adjustments need to be madelJ Contingent Consideration PERS 3 requires that contractual contingencies, as well as non-contractval liabilities for which it is more likely than not that an assets or liability exist, be measured and recognized at fair value on the acquisition date. This includes contingencies based on earnings, guarantee of future secutity prices, and contingent payouts based on the outcome of lawsul. The contingency's fair value on acquisition date is recognized as part of the acquisition regardless of wnether based on future performance of the target firm or the future stock prices of the acquirer. These two will result to two contingent considerations either as equity or liabblity: ‘* Future Performance - where the future income or cash flows of the acquitee is regarded as uncertain, the agreement contains a clause that require the acquirer to provide additional consideration to the acquiree if the income/cash flows of the acquiree is not equal or exceeds as specified amount over some specified period. Future Stock Prices - where the acquirer issues shares to the acquire and the acquiree is concemed that the issue of these shares may make the market price of the acquirer's shares decline over time. Contingent Consideration will be classified as either liability or equity depending on its nature: ‘* Asa Liability — if it wil be paid in the form of cash. It is measured at FV at each reporting date until the contingency is resolved. Changes in FV shall be recognized in profit or loss. ‘© As Equity - if issuing additional shares will satisfy the contingent consideration. It will not be remeasured until the contingency is resolved. The subsequent settlement is reflected and accounted within the equity accounts. The measurement period is the period after the initial acquisition date during which the acquirer may adjust the " provisional amounts” recogrized at the acquisition date. This period allows a reasonable time to obtain information necessary to identify and measure the fair value of the acquiree's assets and liabilities, as well as the fair value of consideration transferred. The one-year period is known as the “measurement period”. However, it is necessary to note that Information that relates to events and circumstances arising after the measurement date do not lead to measurement adjustments. Therefore, measurement period ends at the earlier of: a. one year after acquisition date, or b. the date when the acauirer receives needed information about facts and circumstances existed as of acquisition date It should be noted carefully that the choice between reporting fair value changes as adjustments of the acquisition entry or as gains or losses as prior-period adjustments under PAS 8 depends on whether the changes affect value as of the acquisition date, or value changes caused by subsequent events. Accountants cannot assume that all changes within the first year are adjustments of the original acquisition entry.