BUSINESS

COMBINATION
LECTURE 001
LEARNING OBJECTIVES
1.Define Business Combination 
2.Identify the Essential elements of Business
Combination 
3.Discuss ‘Business’ 
4.Discuss ‘Control’
5.Identify the possible reasons for Business
Combination 
6.Enumerate  the different structures  of Business
Combination 
7.Enumerate the Legal forms of Business
Combination 
8.Define Asset Acquisition 
9.Define Stock Acquisition
10. Define the Acquisition Method
11. Identify the Acquirer
12. Identify the date of acquisition
BUSINESS COMBINATION DEFINED

A business combination is a “transaction or

other event in which an acquirer obtains
control of one or more business.”

Transactions referred to as ‘true mergers’ or

‘mergers of equals’ are also business
combination under PFRS 3. (PFRS 3.
Appendix A)
 The essential elements of Business Combination
DEFINITION
A business combination is a “transaction or other event in which an acquirer obtains control of one or more business.”
Transactions referred to as ‘true mergers’ or ‘mergers of equals’ are also business combination under PFRS 3. (PFRS
3. Appendix A)

Identifying a Business Combination

requires determination of whether:

What is acquired
Control has been
constitutes a
‘Business’ obtained

Business and Control

Identifying a Business Combination
An entity shall determine whether the transaction or other event is
a business combination by applying the definition provided in PFRS 3
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 an
asset acquisition.
The essential elements of Business Combination
Identifying a Business

PFRS 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 return in the form of dividends,
lower costs of other economic benefits directly to investors or other
owners, members, or participants.

The purpose of defining a business is to distinguish between the

acquisition of a group of assets such as a number of chairs,
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 standard such as PAS 16 Property, Plant and
Equipment rather than PFRS 3.
 Input - Any economic resource
input that results to an output when
one or more processes are
input applied

process input
Process – any system,
standard, protocol,
convention or rule that
when applied to an input Output – the result of Input
creates output. and process that provides
goods or services to
customers, investment income
or other income from ordinary
output activities.

BUSINESS
 The essential elements of Business Combination
What is Control?

An investor controls an investee when the investor has the power to direct the
investee’s relevant activities (i.e., operating and financing policies), thereby affecting the
variability of the investor’s investment returns from the investee.

Control is normally presumed to exist when the acquirer holds more than 50% (or
51% or more) interest in the acquiree’s voting rights. However, this is only a
presumption because control can be obtained in some other ways, such as when:

a. The acquirer has the power to appoint or remove the majority of the board of directors
b. The acquirer has the power to cast the majority of votes at board meetings or equivalent
bodies within the acquiree; or
c. The acquirer has power over more than half of the voting rights of the acquiree because of an
agreement with other investors; or
d. The acquirer controls the acquiree’s operating and financial policies because of a law or an
agreement

Control
An acquirer may obtain control of an acquiree in a
variety of ways, for example:

a. by transferring cash or other assets;

b. by incurring liabilities;
c. by issuing equity interests;
d. by providing more than one type of consideration; or
e. without transferring consideration, including contract
alone
 The essential elements of control
Exposure Ability to
or rights to use power
Control
Power variable to affect
returns returns

Existing rights that give Returns that are not

the current ability to fixed and have the
Link between power
direct the relevant potential to vary with
and returns
activities of the performance of the
investee investee

The New Control Model / IFRS 10

 APPLICATION
Determine the existence of control under the following independent situations
1. ABC Co., acquires 51% ownership interest in XYZ, Inc.’s ordinary shares
2. ABC Co., acquires 100% of XYZ, Inc.’s preference shares
3. ABC Co., acquires 40% ownership interest in XYZ, Inc. There is an agreement with
the shareholders of XYZ that ABC will control the appointment of the majority of the
board of directors of XYZ.
4. ABC Co., acquires 45% ownership interest in XYZ, Inc. ABC has an agreement with
EFG, CO., which owns 10% of XYZ, CO., whereby EFG will always vote in the same
way as ABC.
5. ABC CO., acquires 50% of XYZ, Inc.’s voting shares. The board of directors of XYZ
consists of 8 members. ABC appoints 4 of them and XYZ appoints the other 4.
When there are deadlocks in casting votes at meetings, the decision always lies with
the directors appointed by ABC.
APPLICATION
Determine the existence of control
1. ABC Co., acquires 51% ownership interest in XYZ, Inc.’s ordinary shares

“Control is normally presumed to exist when the acquirer holds

more than 50% (or 51% or more) interest in the acquiree’s voting
rights.”

ABC is presumed to have obtained control over XYZ because of

the ownership interest acquired in the voting rights of XYZ is more
than 50%.
APPLICATION
Determine the existence of control
2. ABC Co., acquires 100% of XYZ, Inc.’s preference shares

“Control is normally presumed to exist when the acquirer holds more

than 50% (or 51% or more) interest in the acquiree’s voting rights.”

ABC does not obtain control over XYZ because preference shares
do not give the holder voting rights over the financial and operating
policies of the investee.
APPLICATION
Determine the existence of control
3. ABC Co., acquires 40% ownership interest in XYZ, Inc. There is an agreement with
the shareholders of XYZ that ABC will control the appointment of the majority of the
board of directors of XYZ.
“The acquirer has the power to cast the majority of votes at board
meetings or equivalent bodies within the acquiree”
ABC has control over XYZ because, even though the ownership interest is only 40%,
ABC has the power to appoint the majority of the board of directors of XYZ.
 APPLICATION
Determine the existence of control
4. ABC Co., acquires 45% ownership interest in XYZ, Inc. ABC has an agreement
with EFG, CO., which owns 10% of XYZ, CO., whereby EFG will always vote in the
same way as ABC.
“The acquirer has power over more than half of the voting rights of the
acquiree because of an agreement with other investors;”

ABC has control over XYZ because it controls more than 50% of the
voting rights over XYZ (i.e., 45% plus 10%, per agreement with EFG)
APPLICATION

Determine the existence of control

5. ABC CO., acquires 50% of XYZ, Inc.’s voting shares. The board of directors of XYZ
consists of 8 members. ABC appoints 4 of them and XYZ appoints the other 4.
When there are deadlocks in casting votes at meetings, the decision always lies with
the directors appointed by ABC.
ABC has control over XYZ because it controls more than 50% of the
voting rights over XYZ in the event there is no majority decision.
REASONS FOR BUSINESS COMBINATION
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 take over
attempts by other companies.
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 forma of
expansion for business tax advantage (for example, tax-loss carry forwards), for
personal income and estate-tax advantages, or for personal reasons.
 Types of Business Combinations
Merger
Business Asset Acquisition
combination Consolidation
according to its
methods/ legal
Stock Acquisition
forms

Horizontal Combination
Business
Vertical Combination
combination
according to its Conglomerate Combination

structure Circular Combination

STRUCTURE OF BUSINESS COMBINATION

 Horizontal Integration – this type of combination is one that involves companies within
the same industry that have previously been competitors.
 Vertical Integration – this type of combination takes place between two companies
involved 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.
 
Factors to consider / Possible Structures
a. one business becomes a subsidiary of other;
b. two entities are legally merged into one entity;
c. one entity transfers its net assets to another entity;
d. an entity's owners transfer their equity interests to the owners of another entity;
e. two or more entities transfer their net assets, or the owners transfer their equity interests,
to a newly formed entity( sometimes termed a ‘roll-up’ or ‘put-together’ transaction): and
f. a group of former owners of one entity obtains control of a combined entity.
Methods/Legal Forms of Effecting
Business Combinations

1.Net Asset Acquisition

2.Stock Acquisition
Methods / Legal forms of Effecting Business
Combinations
1. Net asset Acquisition –The books of the acquired (acquiree)
company are closed out, and its assets and liabilities are transferred to the books of the
acquirer (or the acquiring/ surviving company). In this aspect of combination, sometimes
one enterprise acquires another enterprise’s net assets through direct negotiations with its
management.
The acquiree (acquired) company generally distributes to its stockholders the assets or
securities or debt instruments received in the combination form the acquirer (acquiring)
company and liquidates. The acquired (acquiring) company accounts for the combination
by recording each asset required, each liability assumed, and the consideration given in
exchange.
FEATURES OF ASSET ACQUISITION
a. The acquirer acquires from another enterprise all or most of the gross
assets or net assets of the other enterprise for cash or other property,
debt instruments, and equity instruments (common or preferred stock), or
a combination thereof.
b. The acquirer must acquire 100% of the net assets of the acquired
(acquiree) company.
c. It involves only when the acquirer (acquiring) company survives.
 TYPES OF ASSET ACQUISITION
Under the Corporation code of the Philippines, a business combination
effected through asset acquisition may be either:

Merger Consolidation
Merger – occurs when two or more Consolidation – occurs when two or more
companies merge into a single entity which companies consolidate into a single entity
shall be one of the combining companies. which shall be the consolidated company.
A Co. + B Co. = A Co.
or A Co. + B Co. = C. Co.
A Co. + B Co. = B Co.
The board of directors of the companies involved Stockholders of the acquired companies (A and B)
normally negotiates the terms of a plan of merger, become stockholders in the new entity (C). The
which must then be approved by the stockholders acquired companies in a statutory consolidation may
of each company involved. Laws or corporation be operated as separate divisions of the new
by-laws dictate the percentage of positive votes corporation, just as they may be under a statutory
required for approval of the plan. merger. Statutory consolidations require the same type
of stockholder approval as a statutory mergers do.
On January 1, 20x1, Atthismo Co. Books of Atthismo Co. (ACQUIRER)
Petty Cash P 10,000  The acquirer records the
acquired all of the assets and assets acquired and
assumed all of the liabilities of Receivables 120,000
Inventory 1,000,000 liabilities assumed in the
Piledriver , Inc. Atthismo Co. paid business combination in its
P2,500,000 cash as consideration Building 1,500,000
Payables 130,000 books of accounts.
for the assets and liabilities of
Piledriver, Inc. As of this date the Cash 2,500,000
To record the assets acquired and liabilities assumed
fair values of the assets and on a business combination
liabilities of Piledriver, Inc acquired Books of Piledriver, Inc.
by Atthismo Co. are shown below (ACQUIREE)
Cash P 2,500,000  The acquiree shall account
Fair values for the business combination
Assets Payables 130,000
Petty Cash 10,000 as a liquidation of a
Petty Cash P 10,000 business.
Receivables 120,000 Receivables 120,000
Inventory 1,000,000  All assets, liabilities, and
Inventory 1,000,000 equity are derecognized
Building 1,500,000 Building 1,500,000
To record the liquidation of the business
Total assets P 2,630,000
Share Capital 2,500,000
Liabilities
Cash
Payables P 130,000
2,500,000
` To record the settlement of owner’s equity
Note: For the simplicity of the illustration, the consideration is equal to the Fair Value Net assets of the
acquiree
Asset Acquisition
Methods / Legal forms of Effecting Business Combinations
2. Stock acquisition – instead of acquiring the assets and assuming liabilities of the
acquiree; the acquirer obtains control over the acquiree by acquiring a majority
ownership interest (e.g., more than 50%) in voting rights of the acquiree.
In stock acquisition, the acquirer is known as the parent while the acquiree is
known as the subsidiary. After the business combination, the parent and the
subsidiary retain their separate legal existence. However, for financial reporting
purposes, both the parent and the subsidiary are viewed as single reporting entity.
After the business combination, the parent records the ownership interest
acquired as “Investment in Subsidiary” in its separate accounting books. However,
the investment is eliminated when the group prepares consolidated financial
statements.
A business 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.
Features of stock acquisition

a. The acquirer acquires voting (common) stock from another

enterprise for cash or other property, debt instruments, and equity
instruments (common or preferred stock), or a combination thereof.
b. The acquirer must obtain control by purchasing 50% or more of
the voting common stock or possibly less when other factors are
present that lead to the acquirer gaining control. The total of the
shares of an acquired company not held by the controlling
shareholder is called the non-controlling interest.
c. The acquired company need not be dissolved; that is, the acquired
company does not have to go out of existence. Both the acquirer
(acquiring) company and the acquiree (acquired) company remain
as separate legal entity.
  The parent records the
Books of Atthismo Co. (PARENT) ownership interest
acquired as “Investment
On January 1, 20x1, Atthismo Co. Investment in Subsidiary P 2,500,000 in Subsidiary” in its
acquired all of the voting shares of Cash 2,500,000 separate accounting
Piledriver , Inc. On this date, To record the acquisition of shares of Piledriver, Inc.
books
Piledriver, Inc’s identifiable assets
and liabilities have fair values of To include Piledriver, Inc. (SUBSIDIARY)
P2,630,000 and P130,000, in Atthismo Co.’s consolidated financial
statement  The investment is
respectively. Atthismo Co. paid
eliminated when the
P2,500,000 for the acquired shares.
Identifiable assets acquired P 2,630,000 group prepares
Liabilities assumed consolidated financial
130,000 statements
Investment in Subsidiary
2,500,000

Note: For the simplicity of the illustration, the consideration is equal to the
Fair Value of the Identifiable assets and liabilities of the acquiree
Stock Acquisition
 THE ACQUISITION METHOD
The required method of accounting for a business combination under paragraph 4 of
PFRS 3 is the acquisition method. Under the acquisition method, the general approach
to accounting business combinations is a five step process:
1. identify the acquirer;
2. Determine the acquisition date;
3. Calculate the fair value of the purchase consideration transferred (i.e., the cost of
purchase)
4. Recognize and measure the identifiable assets and liabilities of the business, and
5. Recognize and measure either goodwill or a gain from a bargain purchase, if either
exists in the transaction.
• If an acquirer gains control by purchasing less than 100% of the acquired entity, then
the fourth step includes measuring and recognizing the non-controlling interests
(NCI)
 ACCOUNTING FOR BUSINESS COMBINATION
The Acquisition Method
Business combinations are accounted for using the acquisition method.
This method requires the following:

Step 1 Step 2 Step 3 Step 4

Recog­ni­tion and mea­sure­ment of Recog­ni­tion and
the iden­ti­fi­able assets acquired,
Determine the Determine the the li­a­bil­i­ties assumed and any mea­sure­ment of goodwill
‘Acquirer’ ‘Acquisition date ’ non-con­trol­ling interest (NCI,
formerly called minority interest)
or a gain from a bargain
in the acquiree
purchase

Steps in Acquisition Method

 Determine the Acquirer
What is the importance of Identifying the Acquirer?

The acquisition method is applied from the point of view of the acquirer. The acquirer is the
entity that obtains control of the acquiree. The acquiree is the business that the acquirer obtains
control of in a business combination. An acquirer must therefore be identified for each business
combination.

In most business combinations identifying the acquirer is straightforward and is consistent with
legal ownership. However, the identification can be more complex for business combinations in
which, for example:

• businesses are brought together by contract alone such that neither entity has legal ownership of
the other
• a combination is effected by legal merger of two or more entities or through acquisition by a
newly created parent entity
• a smaller entity arranges to be acquired by a larger one.

In the analysis of ‘who is the acquirer’ PFRS 3 provided us guidance:

Acquisition Method: Step 1

 FACTORS TO CONSIDER Who is usually the ACQUIRER?

Consideration settled by transferring cash, other assets or the entity that transfers cash or other assets or incurs the liabilities
incurring liabilities

Combination effected primarily by exchanging equity the entity that issues its equity interests
interests Except in Reverse Acquisition

Relative voting rights in the combined entity the entity whose owners as a group retain or receive the largest
portion of the voting rights in the combined entity

Composition of the governing body of the combined entity the entity whose owners have the ability to elect or appoint or
remove a majority of the members of the governing body of the
combined entity

Senior management of the combined entity the entity whose (former) management dominates the combined
management

GUIDANCE IN IDENTIFYING
THE ACQUIRER Acquisition Method: Step 1
 FACTORS TO CONSIDER Who is usually the ACQUIRER?
Terms of the exchange of equity interest the entity that pays a premium over the pre-combination fair value
of the equity interest of the other combining entity or entities
Relative size the entity whose size is significantly greater than that of the other
combining entity or entities
More than two entities involved • the entity that initiated the combination
A new entity is formed to effect a new business combination • if the new entity is formed to issue equity instruments, one of the
existing combining entities is the acquirer

• if the new entity transfers cash or other assets or incurs

liabilities, the new entity may be the acquirer

GUIDANCE IN IDENTIFYING
THE ACQUIRER Acquisition Method: Step 1
Determining the acquisition date
What is the importance of Identifying the date of acquisition?

The acquisition date is critical because it determines when the acquirer recognizes and
measures the consideration, the assets acquired and liabilities assumed. The acquiree’s
results are consolidated from this date. The acquisition date materially impacts the overall
acquisition accounting, including post-combination earnings.

PFRS 3 defines the acquisition date as the date on which the acquirer obtains control of the
acquiree. This is normally the closing date or the completion date (i.e., the date on which the
acquirer legally transfers the consideration, acquires assets and assumes liabilities of the
acquiree.) However, the acquirer might obtain control on a date that is either or later than the
closing date, for example when there is a written agreement to that effect.

Acquisition Method: Step 2

Determining the acquisition date
Other dates that are important during the process of business
combination may be:
 The date the contract is signed;
 The date the consideration is paid;
 A date nominated in the contract;
 The date on which assets acquired are delivered to the acquirer;
and
 The date on which an offer becomes unconditional.
 Determining the acquisition date
There are four main areas where the selection of the date affects the accounting for a
business combination:
1. The identifiable assets acquired and liabilities assumed by the acquirer are measured at the fair
value on the acquisition date. The choice of fair value is affected by the choice of the acquisition
date.
2. The consideration paid by the acquirer is determined as the sum of the fair values of assets given,
equity issued and/or liabilities undertaken in an exchange for the net assets or shares of another
entity. The choice of date affects the measure of fair value.
3. The acquirer may acquire only some of the shares of the acquiree. The owners of the balance of
the shares of the acquiree are called the non-controlling interest - defined in the Appendix A as the
equity in a subsidiary not attributable, directly or indirectly, to a parent. This non-controlling interest
is also measured at fair value on acquisition date.
4. The acquirer may have previously held an equity interest in the acquiree prior to obtaining control
of the acquiree. For example, entity X may have previously acquired 20% of the shares of entity Y,
and now acquires the remaining 80% giving it control of entity Y. The acquisition date is the date
when entity X acquired the 80% interest. The 20% share holding will be recorded as an asset in
the records of entity X. On acquisition date, the fair value of this investment is measured.
 END OF LESSON 001
BUSINESS COMBINATION

REFERENCES:
Advanced Accounting 2. DAYAG, A.J.
Business Combination. MILLAN,V.
PFRS 3 – BUSINESS COMBINATION