CHAPTER 1

Business Combinations – Part

1
Recognition and
measurement
Introduction
A Business Combination occurs when
1. One company acquires another or
2. 2. when two or more companies merge into one.
After the combination, one company gains control

The company that obtains control over the other is referred to as the parent or
acquirer.

The other company that is controlled is the subsidiary or acquiree

Business Combinations are carried out either through:
1. Asset acquisition; or
2. Stock acquisition

Asset acquisition – the acquirer purchases the assets and assumes the liabilities
of the acquirer. After the acquisition, the acquired entity normally ceases to
exist as a separate legal or accounting entity.

Legal Form of Combination under Asset acquisition

3. Merger
4. Consolidation
• Merger - Occurs when one corporation takes over all the operations of
another business entity and that other entity is dissolved. ( A + B = A or B)

Ex: 1. Company A purchases the assets of Company B for cash, noncash assets,
or Company A debt/equity securities. Company B is dissolved; Company A
survives with Company B’s assets and liabilities. ( A + B = A )

2. Company A purchases Company B stock from its shareholders for cash, other
assets, or Company A debt/equity securities. Company B is dissolved. Company
A survives with Company B’s assets and liabilities.
• Consolidation - Occurs when a new corporation is formed to take over the
assets and operations of two or more separate business entities and dissolves
both entities. ( A + B = C )

Ex: 1 Company C is formed and acquires the assets of Companies A and B by

issuing Company C stock. Companies A and B are dissolved. Company C
survives, with the assets and liabilities of both dissolved firms.

2. Company C is formed acquires Company A and B stock from their respective

shareholders by issuing Company C stock. Companies A and B are dissolved.
Company A survives with the assets and liabilities of both firms.
Stock acquisition – the acquirer obtains control over the acquiree by
purchasing stocks or majority ownership interest ( that is more than 50%) in the
voting rights of the acquiree.

In a stock acquisition, the acquirer is known as the Parent, while the acquiree is
known as the subsidiary. After the business combination, the parent and
subsidiary Retain their separate legal existence. However for Financial
Reporting Purposes, both parent and subsidiary are viewed as a Single
Reporting Entity.
After the business Combination, the parent and subsidiary continue to maintain
their own separate accounting books, recording their assets, liabilities and
transactions.

The Parent records the ownership interest acquired as “Investment in

Subsidiary” in its separate accounting books. However, the “Investment in
Subsidiary account” is Eliminated when the parent and subsidiary Prepares
Consolidated Financial Statement
3 Types of Business Combination
1. Horizontal integration – same business lines and markets
Ex: Banks acquires another Banks
2. Vertical integration – operations in different, but successive stages of
production or distribution, or both
Ex: A Manufacturer acquires its supplier of raw materials
3. Conglomeration – unrelated and diverse products or services
Ex: Real estate developer acquires a bank
Advantages of business combination
1. Competition is eliminated or lessened
2. Synergy
3. Increased business opportunity and earning potential
4. Reduction of operating cost
5. Combinations utilized economies scale ( Increased in production efficiency)
6. Cost savings on business expansion
7. Favorable tax implications
Business combination are accounted for under PFRS 3

The Objective of PFRS 3 is to enhance the relevance, reliability and

comparability of information provided about business combinations (e.g.
acquisitions and mergers) and their effects.

PFRS 3 does not apply to the following:

1. Formation of joint venture
2. Acquisition of asset and related liability that does not constitute a business
3. Combination of entities under common control
Essential element in the definition of business combination
1. Control
2. Business

Control usually exist when the acquirer holds more than 50% of ownership interest.
However, this is only a presumption because control can be obtained in some other
ways, such as when
3. The acquirer has the power to appoint or remove the majority of board of
directors of the acquiree . Or
4. The acquirer has the power to cast majority votes at board meetings
5. The acquirer has the power over more than 50% of voting rights because of
agreement with other investor
6. The acquirer has the power to control the acquiree’s operating and financial
policies.
Determining the existence of control
Essential element in the definition of business combination
1. Control
2. Business

A business is defined as an organization or enterprising entity engaged in

commercial, industrial, or professional activities.

3 elements of business 1. Input, 2. Process, 3. Output

If the asset acquired do not constitute a business, the entity accounts for the
transaction as a regular asset acquisition, accordingly, the entity applies other
applicable standard ( that is use PAS 2 if inventory acquired or PAS 16 for PPE
acquired Etc.)
Accounting for business Combination
An entity shall account for each business combination by applying the
acquisition method.
Applying the acquisition method requires:
(a) identifying the acquirer;
(b) determining the acquisition date;
(c) Recognizing and measuring goodwill or a gain from a bargain purchase
1. Consideration Transferred
2. non- controlling interest in the acquiree
3. Previously held equity interest in the acquiree
4. identifiable assets acquired, the liabilities assumed on the business
combination
1. Identify the Acquirer – is the entity that obtains control of the acquiree
2. Determine the acquisition date – is the date the acquirer obtains control of
the acquiree. This is normally the closing date, that is the date on which the
acquirer transfer the consideration, acquires the asset and assumed liabilities.
3. Recognizing and measuring goodwill
Formula:
Consideration Transferred xxxx
Non- controlling interest in the acquiree xxxx
Previously held equity interest in the acquiree xxxx
Total xxxx
Less: FV Identifiable assets acquired (xxxx)
Goodwill or a gain from a bargain purchase xxxx

1. If Consideration Transferred higher than FV Identifiable assets acquired =

Goodwill ( Asset and recognize at Financial Position)
2. If Consideration Transferred less than FV Identifiable assets acquired = Gain
from a bargain purchase ( Profit/Loss and recognized in income statement)
Consideration Transferred by the Acquirer – shall be measured at Fair Value at
the date of acquisition.

Example of potential forms of consideration include:

1. Cash
2. Non-Cash Assets
3. Equity Instrument ( that is Shares, Options and warrants)
4. A business or subsidiary of the acquirer
5. Contingent consideration
Illustration : Computation of Consideration Transferred
X Company acquires all of Y Company in an acquisition properly accounted for as an asset
acquisition. X issues 80,000 shares of common stock with a par value of P90 per share and a fair
value of P8,000,000 for Y’s net assets. The fair values of Y’s assets and liabilities approximate
their book values, except Y has customer lists valued at P3,000,000 that are not reported on its
balance sheet, and its plant assets are overvalued by P5,000,000. Here are the balance sheets of
X and Y prior to the acquisition:
  X Company Y Company
Assets P30,000,000 P10,000,000
     
Liabilities P16,000,000 P 6,000,000
Common stock, $1 par 1,000,000 100,000
Additional paid-in capital 9,000,000 2,900,000
Retained earnings 4,000,000 1,000,000
  P30,000,000 P10,000,000

Compute for the Consideration Transferred

Acquirer – X Company
X issues 80,000 shares of common stock a fair value of P8,000,000
Acquisition- related cost – acquirer incurs related to business combination and
should be Expense as immediately
Examples:
1. Finders Fees
2. Professional fees ( related Legal, accounting and consulting fees
3. General administrative cost, including the maintaining an internal
acquisition department
4. Cost of registering and issuing debt and equity securities

Acquisition- related cost should be Expense as immediately except for

5. Cost to issue debt securities measured at amortized cost ( deducted to
Carrying amount of debt)
6. Cost to issue equity securities ( deducted to the related share premium, if
none to Retained Earnings )
What Is Non-Controlling Interest?
A non-controlling interest, also known as a minority interest, is an ownership
position wherein a shareholder owns less than 50% of outstanding shares and
has no control over decisions.

A non-controlling interest should be measured either at

1. Fair Value; or
2. The non-controlling interest’s proportionate share of acquiree’s identifiable
net assets
Previously held equity interest
An acquirer may obtain control over acquiree in which it held some equity
interest at the time of obtaining control.

For example: Acquirer Company (AC) has 30% interest in Target Company (TC),
and then it acquires additional 40% which in aggregate gives AC a 70% interest
and control over TC.
This is often referred to as ‘step acquisition’ or ‘piecemeal acquisition’.
In such a case, the 30% interest should be re-measured to fair value at the
acquisition date and any difference between fair value at the date of obtaining
control and carrying value should be recognized as gain/loss in P/L or OCI as if it
was sold
Illustration : Computation of Consideration Transferred
X Company acquires all of Y Company in an acquisition properly accounted for as an
asset acquisition. X issues 80,000 shares of common stock with a par value of P90 per
share and a fair value of P8,000,000 for Y’s net assets. The fair values of Y’s assets and
liabilities approximate their book values, except Y has customer lists valued at
P3,000,000 that are not reported on its balance sheet, and its plant assets are
overvalued by P5,000,000. Here are the balance sheets of X and Y prior to the
acquisition:
  X Company Y Company
Assets P30,000,000 P10,000,000
     
Liabilities P16,000,000 P 6,000,000
Common stock, $1 par 1,000,000 100,000
Additional paid-in capital 9,000,000 2,900,000
Retained earnings 4,000,000 1,000,000
  P30,000,000 P10,000,000

Compute for the Goodwill or Gain from a bargain purchase ?

Consideration Transferred xxxx
Non- controlling interest in the acquiree xxxx
Previously held equity interest in the acquiree xxxx
Total xxxx
Less: FV Identifiable assets acquired (xxxx)
Goodwill or a gain from a bargain purchase xxxx

Solution:

Consideration Transfered   P8,000,000

Fair value of net assets acquired 10,000,000   
Reported assets P 5,000,000  
Customer lists 3,000,000  
Liabilities (6,000,000) 12,000,000
Gain   P4,000,000
END!!!!
Computation of Non Controlling Interest
A non-controlling interest should be measured either at
1. Fair Value; or
2. The non-controlling interest’s proportionate share of acquiree’s identifiable
net assets
Example 1: Non controlling Interest at Fair Value
On May 1, 2013, the ABC Co. paid $1,000,000 for 80% of the outstanding
common stock of XYZ Inc. in a transaction properly accounted for as an
acquisition. XYZ’s identifiable assets and liabilities have fair values of 1,200,000
and 400,000, respectively. ABC Co. elects the option to measure Non
controlling Interest (NCI) at fair value. The independent consultant engage by
ABC Co. determined that the fair value the 20% NCI in XYZ Inc. is 155,000. how
much is the goodwill or gain on bargain purchase on the business combination.
Solution:

Consideration Transferred 1,000,000

Non- controlling interest in the acquiree 155,000
Previously held equity interest in the acquiree 0
Total 1,155,000
Less: FV Identifiable assets acquired (800,000)
Goodwill 355,000
Example 1: Non controlling Interest at Fair Value
On May 1, 2013, the ABC Co. paid $1,000,000 for 80% of the
outstanding common stock of XYZ Inc. in a transaction properly
accounted for as an acquisition. XYZ’s identifiable assets and liabilities
have fair values of 1,200,000 and 400,000, respectively. ABC Co.
elects the option to measure Non controlling Interest (NCI) at fair
value. how much is the goodwill or gain on bargain purchase on the
business combination.
Solution:
Consideration Transferred 1,000,000/ 80% = 1,250,000 total FV
Multiply by 20% NCI
Non- controlling interest 250,000

Consideration Transferred 1,000,000

Non- controlling interest in the acquiree 250,000
Previously held equity interest in the acquiree 0
Total 1,250,000
Less: FV Identifiable assets acquired (800,000)
Goodwill 450,000
Example 1: Non controlling Interest at Proportionate share
On May 1, 2013, the ABC Co. paid $1,000,000 for 80% of the
outstanding common stock of XYZ Inc. in a transaction properly
accounted for as an acquisition. XYZ’s identifiable assets and liabilities
have fair values of 1,200,000 and 400,000, respectively. ABC Co.
elects the option to measure Non controlling Interest (NCI) at
Proportionate share of XYZ’s identifiable assets. how much is the
goodwill or gain on bargain purchase on the business combination.
Solution:
FV of Identifiable assets acquired 800,000
Multiply by 20% NCI
Non- controlling interest 160,000

Consideration Transferred 1,000,000

Non- controlling interest in the acquiree 160,000
Previously held equity interest in the acquiree 0
Total 1,160,000
Less: FV of Identifiable assets acquired (800,000)
Goodwill 360,000
Accounting for Business combination accomplish through share for share
exchange.
General rule : consideration transferred shall be measured at FV of Acquirer
share at date of acquisition

However, the acquisition date FV of acquiree may be more reliably measurable

than the acquisition date FV of the acquirer’s equity interest,
In such case, the acquirer shall determine the amount of goodwill by using the
acquisition date FV of the acquiree equity interest

The use of the acquisition date FV of the acquiree equity interest in this
situation, as an alternative only.
Example : Private Company purchase a Publicly Traded Company
Illustration:
On May 1, 2013, the ABC Co. purchase all shares of XYZ Co.,
ABC Co. shares have a quoted price of P100 per share and recognized goodwill
of P300,000 on the business combination, selected information below:
ABC Co. Combined Entity
before acquisition After acquisition
Share Capital 600,000 700,000
Share Premium 300,000 1,200,000
Total 900,000 1,900,000
Compute the following:
1. Number of shares issued by ABC Co in the business Combination
2. Par Value per share Issued
3. Acquisition Date FV of net asset acquired
Solution: 1. Number of shares issued by ABC Co in the business Combination
Consideration Transferred Less FV of Identifiable assets acquired = Goodwill

ABC Co. Combined Entity Increased

Share Capital 600,000 700,000 100,000
Share Premium 300,000 1,200,000 900,000
Total 900,000 1,900,000 1,000,000

Consideration Transferred 1,000,000

Divided by: FV per share 100
Number of share issued 10,000
Solution: 2. Par Value per share Issued
Formula : Number of share x Par Value = share capital

Increased in Share Capital 100,000

Divided by: Number of share issued 10,000
Par Value 10

Solution: 3. Acquisition Date FV of net asset acquired

Consideration Transferred Less FV of Identifiable assets acquired = Goodwill

1,000,000 – 300,000 = 700,000
Solution: 2. Par Value per share Issued
Formula : Number of share x Par Value = share capital

Increased in Share Capital 100,000

Divided by: Number of share issued 10,000
Par Value 10

Solution: 3. Acquisition Date FV of net asset acquired

Consideration Transferred Less FV of Identifiable assets acquired = Goodwill

1,000,000 – 300,000 = 700,000
Illustration:
On May 1, 2013, the ABC Co. purchase all shares of XYZ Co.,
selected information below:
ABC Co. XYZ Co. Combined Entity
Carrying Amount Fair Value
Identifiable Asset 2,400,000 1,600,000 4,000,000
Liabilities 700,000 900,000 1,600,000
Share Capital 600,000 300,000700,000
Share Premium 300,000 250,000 1,200,000
Retained Earnings 800,000 150,000?
ABC Co. – P10 par value, XYZ Co. P100 par value
Compute the following:
1. Number of shares issued by ABC Co in the business Combination
2. Goodwill recognized
3. Create a Combine Financial Position
Solution: 1. Number of shares issued by ABC Co in the business Combination
Consideration Transferred Less FV of Identifiable assets acquired = Goodwill

ABC Co. Combined Entity Increased

Share Capital 600,000 700,000 100,000
Share Premium 300,000 1,200,000 900,000
Total 900,000 1,900,000 1,000,000

Increased share capital 100,000

Divided by: Par Value share 10
Number of share issued 10,000
Solution: 2. Goodwill recognized

Consideration Transferred 1,000,000

Less: FV Identifiable assets acquired
Identifiable Asset – XYZ 1,600,00
Liability– XYZ (900,000) (700,000)
Goodwill 300,000
 Combined Financial Position
Identifiable Asset 4,000,000
Goodwill 300,000
TOTAL Assets 4,300,000
Liabilities 1,600,000
Share Capital 700,000
Share Premium 1,200,000
Retained Earnings 800,000
TOTAL Liabilities & SHE 4,300,000
Business Combination Achieve in Stages – With Previously held equity interest
in the acquiree (Step Acquisition), shall account as follows:
1. Re-measure the Previously held equity interest in the acquiree at its
acquisition date FV
2. Recognized the gain or loss on the re-measurement in :
a. Profit or loss – if the Previously held equity interest was classified as FVPL,
Investment associates or Investment in joint venture
b. Other Comprehensive Income - if the Previously held equity interest was
Classified at FVOCI
Illustration:
On January 1 2012, ABC Co acquires 15% ownership in XYZ co for 100,000 at the
end of Dec 31 2012 the FV was 150,000.

On May 1, 2013, the ABC Co. purchase additional 60% shares of XYZ Co., for
P800,000. selected information below:
a. The Previously held equity interest of 15% has a FV of 180,000
b. XYZ net identifiable asset has a FV of 1,000,000
c. ABC co. measure NCI at proportionate share
Compute for the goodwill given the following scenario
1. The Previously held equity interest was classifies as FVPL
2. The Previously held equity interest was classifies as FVOCI
Scenario 1: The Previously held equity interest was classifies as FVPL
Consideration Transferred 800,000
Non- controlling interest in the acquiree (1M x 25%) 250,000
Previously held equity interest in the acquiree 180,000
Total 1,230,000
Less: FV of Identifiable assets acquired (1,000,000)
Goodwill 230,000
Scenario 1: The Previously held equity interest was classifies as FVPL
Simple Journal
May 1, 2013 Investment in subsidiary 800,000
Cash 800,000

Held for trading securities 30,000

Unrealized Gain – P/L 30,000

Investment in subsidiary 180,000

Held for trading securities 180,000
Scenario 2: The Previously held equity interest was classifies as FVOCI
Consideration Transferred 800,000
Non- controlling interest in the acquiree (1M x 25%) 250,000
Previously held equity interest in the acquiree 180,000
Total 1,230,000
Less: FV of Identifiable assets acquired (1,000,000)
Goodwill 230,000
Scenario 2: The Previously held equity interest was classifies as FVOCI
Simple Journal
May 1, 2013 Investment in subsidiary 800,000
Cash 800,000

Investment in FVOCI securities 30,000

Unrealized Gain - OCI 30,000

Unrealized Gain – OCI (50k+30k) 80,000

Retained Earnings 80,000

Investment in subsidiary 180,000

Investment in FVOCI securities 180,000
Illustration 2:
On January 1 2012, ABC Co acquires 30% ownership in XYZ co for 100,000.
because the investment gave ABC significant influence over XYZ, the investment
was accounted under equity method (PAS 28)
On 2013, ABC co recognized 50,000 net share in profits and 10,000 share in
dividends therefore the carrying amount is 140,000 ( beg bal + share in profit –
dividend = CA) the ABC Co. purchase additional 60% shares of XYZ Co., for
P800,000. selected information below:
a. The Previously held equity interest of 30% has a FV of 180,000
b. XYZ net identifiable asset has a FV of 1,000,000
c. ABC co. measure NCI at proportionate share

Compute for the goodwill given the following scenario

Consideration Transferred 800,000
Non- controlling interest in the acquiree (1M x 10%) 100,000
Previously held equity interest in the acquiree 180,000
Total 1,080,000
Less: FV of Identifiable assets acquired (1,000,000)
Goodwill 80,000
Simple Journal
Jan 1, 2013 Investment in subsidiary 800,000
Cash 800,000

Investment in Associates 40,000

Unrealized Gain –P/L 40,000

Investment in subsidiary 180,000

Investment in Associates 180,000
Illustration 3: w/o transfer of consideration
On January 1 2012, ABC Co acquires 36,000 shares or 40% ownership in XYZ co,
90,000 outstanding shares.
On 2013, XYZ co reacquires 30,000 of its own shares from the other investors
so that ABC shall obtain control. selected information below:
a. The Previously held equity interest of 40% has a FV of 180,000
b. XYZ net identifiable asset has a FV of 1,000,000
c. ABC co. measure NCI at proportionate share

Compute for the goodwill given the following scenario

Consideration Transferred ( 1M x new % 60%) 600,000
Non- controlling interest in the acquiree (1M x 40%) 400,000
Previously held equity interest in the acquiree 0
Total 1,000,000
Less: FV of Identifiable assets acquired (1,000,000)
Goodwill 0

Simple Journal
Jan 1, 2013 Investment in subsidiary 600,000
Investment in associates 180,000
Gain on Re-measurement –P/L 420,000
END!!!!