Accounting for Business Combination and Consolidated FS

BUSINESS COMBINATION
The bringing together of separate entities or businesses into one reporting entity. The result is that one entity,
the acquirer, obtains control of one or more other businesses, the acquiree. (PFRS 3 p. 4).

Discussions does NOT apply to: (PFRS 3 p. 3)

a. Acquisition does not constitute a business

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 a return directly to investors or other owners, members or participants.
(PFRS 3 p. 4)

b. Joint venture
c. Combination under common control

CONTROL

General rule:
SIGNIFICANT INFLUENCE
(at least 20%-50%) = ASSOCIATE

CONTROL (50 + 1 percent) = ACQUIRER

Exemption: Control even at 50% or less: (PAS 27 p. 13)

a. Power over more than half of the voting rights by virtue of an agreement with other investors.
b. Power to govern the financial and operating policies of the enterprise under a statute or
agreement.
c. Power to appoint or remove the majority of the members of the BOD or equivalent governing
body or
d. Power to cast the majority of votes at meetings of the BOD or governing equivalent body.

PFRS 10 (2013): Consolidated Financial Statement (Supersedes PAS 27: Consolidated Financial Statements and
Accounting for Investments in Subsidiaries)

“The investor controls an investee when the investor, through its power over the investee, is exposed, or
has rights, to variable returns from its involvement with the investee and has the ability to affect those
returns.”

WAYS OF DOING BUSINESS COMBINATION

PFRS 3 par. 5 A business combination may be structured in a variety of ways for legal, taxation or other reasons. It
may involve the purchase by an entity of the equity of another entity, the purchase of all the net assets of another
entity, the assumption of the liabilities of another entity, or the purchase of some of the net assets of another entity
that together form one or more businesses. It may involve the establishment of a new entity to control the combining
entities or net assets transferred, or the restructuring of one or more of the combining entities.

a. ASSET ACQUISITION/FUSION/MERGER or acquisition by one enterprise of the net assets of another enterprise
and integrating these into it own operations (no parent-subsidiary relationship). Also referred to as Legal Merger.

b. STOCK ACQUISITION/STOCK CONTROL or acquisition by one enterprise of the majority shares of another
enterprise. Parent-subsidiary relationship in which the acquirer is the parent and the acquiree a subsidiary of the
acquirer.

A business combination may result in a parent-subsidiary relationship in which the acquirer is the parent and
the acquiree a subsidiary of the acquirer. In such circumstances, the acquirer applies this PFRS in its
consolidated financial statements. It includes its interest in the acquiree in any separate financial statements it
issues as an investment in a subsidiary (see PAS 27 Consolidated and Separate Financial Statements)

Business combination may be effected by the issue of equity instruments, the transfer of cash, cash equivalents or
other assets, or a combination thereof. The transaction may be between the shareholders of the combining entities or
between one entity and the shareholders of another entity.

ACQUISITION METHOD

All business combination shall be accounted for by applying the acquisition method. (PFRS 3)

Steps in the application of acquisition method:

1. Identification of the 'acquirer‘.
2. Determination of the 'acquisition date'.
3. Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-
controlling interest (NCI, formerly called minority interest) in the acquiree.
4. Recognition and measurement of goodwill or a gain from a bargain purchase option.
 Accounting for Business Combination and Consolidated FS

The ACQUIRER is the combining entity that obtains control of the other combining entities or businesses.

Usual indicators:

a. The entity with the greater fair value is likely to be the acquirer;
b. The entity giving up cash or other assets is likely to be the acquirer; and
c. The entity whose management is able to dominate is likely to be the acquirer

In a business combination effected through an exchange of equity interest, the entity that issues the equity
interest is normally the acquirer. (IPRS 3 p. 21)

ACQUISITION DATE is the date on which the acquirer obtains control of the acquiree

The acquirer shall MEASURE the cost of acquisition /consideration transferred at the fair values, at the date of
acquisition, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in
exchange for control of the acquiree. Consideration for the acquisition includes the acquisition-date fair value of
contingent consideration.

Published price at the date of exchange of a quoted equity instrument provides the best evidence of the instruments
fair value.

Cost of arranging and issuing financial liabilities (PAS 39 under bond issue cost) and equity instruments (PAS 32
under share premium) shall not be included in the cost of business combination.

All other costs associated with the acquisition must be expensed, including reimbursements to the acquiree for
bearing some of the acquisition costs. Examples of costs to be expensed include finder's fees; advisory, legal,
accounting, valuation, and other professional or consulting fees; and general administrative costs, including the costs
of maintaining an internal acquisitions department.

Goodwill internally developed by the acquired company and included in its statement of financial position as part of
assets to be transferred is IGNORED in computing for goodwill from combination or in the consolidation of parent and
subsidiary financial statements

GOODWILL

Goodwill is measured as the difference between:

➢ the aggregate of (i) the acquisition-date fair value of the consideration transferred, (ii) the amount of any
NCI, and in a business combination achieved in stages, the acquisition-date fair value of the acquirer's
previously-held equity interest in the acquiree; and
➢ the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed
(measured in accordance with IFRS 3).

If the difference above is negative, the resulting GAIN is recognized as a bargain purchase in profit or loss.

Goodwill acquired in a business combination shall not be amortized. Instead, the acquirer shall test it for
impairment. After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost
less any accumulated impairment losses. But Small and Medium Enterprise (SME) are allowed to amortized
goodwill (10 years) based on PFRS for SME

PFRS 3 allows an accounting policy choice, available on a transaction by transaction basis, to measure NCI either
at:
➢ fair value (sometimes called the full goodwill method), or
➢ the NCI's proportionate share of net assets (sometimes called partial goodwill method) of the acquiree
(option is available on a transaction by transaction basis).

CONSOLIDATED FINANCIAL STATEMENTS (under Cost Method with NCI measured at proportionate
share of net assets)

PFRS 3 deals with the accounting for a business combination at acquisition date, while PFRS 10 deals with the
preparation and presentation of consolidated financial statements after the business combination

All parent entities are required to prepare consolidated financial statements except:
1. A parent is exempt from presenting consolidated financial statements if:
a. it is a subsidiary of another entity (whether wholly-owned or partially-owned) and all its other
owners do not object to its non-presentation of consolidated financial statements
b. its debt or equity instruments are not traded in a public market (or being processed for such
purpose); and
 Accounting for Business Combination and Consolidated FS

c.its ultimate or any intermediate parent produces consolidated financial statements that are available
for public use and comply with PFRS
2. Post-employment benefit plan or other long-term employee benefit plans to which PAS 19 applies

CONSOLIDATION PROCEDURES:

1. The investment account and the parent’s share of equity interest over the subsidiary are eliminated.

Elimination of investment in subsidiary account will require:

a. measuring the identifiable assets acquired and liabilities assumed in the business combination at their
acquisition-date fair values
b. recognizing the goodwill or gain from the business combination
c. eliminating the subsidiary’s pre-combination equity accounts

2. Intra group balances, transactions, income and expenses shall be eliminated in full
3. Assets and liabilities of the parent and the subsidiary(s) are combined, item by item.
4. If the portion of equity owned by the parent is less than 100%, the share of the non-controlling interest in
the net assets of the subsidiary should be separately presented in the consolidated balance sheet.

CONSOLIDATION AT ACQUISITION DATE

Illustration 1:

The following are the balance sheet of P and S Co. at March 1, 2003 just before P acquired stocks from S:
P Company S Company
Cash P 40,000 P 28,000
Receivables 60,000 52,000
Inventories 60,000 40,000
Plant & Equipments 90,000 50,000
Total P250,000 P170,000

Liabilities P 50,000 P 30,000

Capital stock, par P10 100,000 100,000
APIC 20,000 20,000
Retained earnings 80,000 20,000
Total P250,000 P170,000

Assume P acquired 100% interest over S by issuing 10,000 of its shares of stock which current FV is P25 per share

Entry in the books of P to record the investment:

Investment in stock of S Co. P250,000

Capital stock P100,000
APIC 150,000

Assume further the following FMV:

Market Value
Inventories P 80,000
Plant & Equipments 100,000

Working paper adjustment and elimination entry appears as follows:

Capital stock of S Co. 100,000

APIC of S Co. 20,000
Retained earnings of S Co. 20,000
Inventories 40,000
Plant & Equipments 50,000
Goodwill 20,000
Investment in stock of S Co. 250,000

P Company S Company DEBIT CREDIT CONSOLIDATED

Cash P 40,000 P 28,000 P 68,000

Receivables 60,000 52,000 112,000
Inventories 60,000 40,000 40,000 140,000
Invtmt. in Stocks of S 250,000 250,000 -
Plant & Equipment 90,000 50,000 50,000 190,000
Goodwill 20,000 20,000
Total P500,000 P170,000 P530,000
 Accounting for Business Combination and Consolidated FS

Liabilities P 50,000 P 30,000 P 80,000

Capital stock, par P100 200,000 100,000 100,000 200,000
APIC 170,000 20,000 20,000 170,000
Retained earnings 80,000 20,000 20,000 . 80,000
Total P500,000 P170,000 P250,000 P250,000 P530,000

Illustration 2:

The following are the balance sheet of P and S Co. when P decided to acquire 4,500 shares of S for P580,000:
P Company S Company
Cash P850,000 P 50,000
Receivables 200,000 100,000
Inventories 600,000 200,000
Plant & Equipments 1,260,000 450,000
Total P2,910,000 P800,000

Liabilities P300,000 P200,000

Capital stock, par P100 2,000,000 500,000
APIC 400,000
Retained earnings 210,000 100,000
Total P2,910,000 P800,000

Entry in the books of P to record the investment:

Investment in stock of S Co. P580,000

Cash P580,000

Assume that on this date the market values of S inventories and PPE are P210,000 and P470,000 respectively.

Working paper adjustment and elimination entry appears as follows:

Inventories 10,000
Plant & Equipments 20,000
Capital stock of S Co. 500,000
Retained earnings of S Co. 100,000
Goodwill 13,000
Investment in stock of S Co. 580,000
Non-controlling interest 63,000

P Company S Company DEBIT CREDIT CONSOLIDATED

Cash P850,000 P 50,000 P900,000

Receivables 200,000 100,000 300,000
Inventories 600,000 200,000 10,000 810,000
Invtmt. in Stocks of S 580,000 580,000 -
Plant & Equipment 1,260,000 450,000 20,000 1,730,000
Goodwill 13,000 13,000
Total P3,490,000 P830,000 P3,753,000

Liabilities P300,000 P200,000 P500,000

Capital stock, par P100 2,500,000 500,000 500,000 2,500,000
APIC 480,000 480,000
Retained earnings 210,000 100,000 100,000 210,000
NCI 63,000. 63,000
Total P3,490,000 P830,000 P643,000 P643,000 P3,753,000

CONSOLIDATION SUBSEQUENT TO ACQUISITION DATE

The consolidation procedures subsequent to the acquisition date involve the same procedures however, in this case,
changes in the subsidiary’s net assets since the acquisition date are to be considered.

Illustration 3:

Assume that P Company acquired 8,000 of the voting common shares of S Company and paid P185,000 in cash.
The stockholders’ equity of S Company on this date, January 1, 2003, consist of the following:

Capital Stock, P10 par P100,000

APIC 50,000
 Accounting for Business Combination and Consolidated FS

Retained Earnings 60,000

Total P210,000

Assets are fairly valued. On December 31, 2003, S Company reported a net income of P30,000, declared and paid
P25,000 dividends.

P Company Books:

1. Acquisition of S Co. shares:

Investment in stock of S Co. P185,000

Cash P185,000
(8,000 / (100,000/10) = 80%)

2. Share of P in S Co. net income: (30,000 x 80% = 24,000)

NO ENTRY

3. To record dividends received from S CO.:

Cash 20,000
Dividends Revenue 20,000
(25,000 x 80% = 20,000)

Assume further that the trial balance of the parent and subsidiary as at December 31, 2003 are as follows:

P Company S Company
Cash & Other CA P150,000 P 60,000
Machinery & Equip. (net) 400,000 185,000
Investments in Stocks, S Co. 185,000
Cost of Sales 100,000 75,000
Operating Expenses 50,000 30,000
Dividends 10,000 25,000
Liabilities ( 90,000) ( 30,000)
Capital Stock, P100 par ( 500,000) ( 100,000)
APIC ( 50,000)
Retained Earnings ( 60,000) ( 60,000)
Sales ( 225,000) ( 135,000)
Dividends Revenue ( 20,000) .
Total P 0 P 0

P Company Working Paper Adjustments and Elimination Entries:

1. Capital Stock, S Co. 100,000

APIC, S Co. 50,000
Retained Earnings, S Co. 60,000
Goodwill 17,000
Investment in stock of S Co. 185,000
Non-controlling interest 42,000
#
2. Dividends Revenue 20,000
Non-controlling interest 5,000
Dividends of S Co. 25,000
#
3. NCI profit 6,000
Non-controlling interest 6,000
30,000 x 20% = 6,000

P Company S Company Debit Credit Consolidated

INCOME
STATEMENT

Sales P225,000 P135,000 P360,000

Cost of Sales 100,000 75,000 175,000
Gross Profit P125,000 P 60,000 P185,000
Expenses 50,000 30,000 80,000
Operating Inc. 75,000 30,000 105,000
Div. Rev. 20,000 . 20,000 .
Net Income 95,000 30,000 105,000
NCI (20%) ___ 6,000 6,000
Net Income 95,000 30,000 99,000
 Accounting for Business Combination and Consolidated FS

RETAINED
EARNINGS
STATEMENT

Balance, Jan.1 P 60,000 P 60,000

P 60,000 60,000
Net Income 95,000 30,000 99,000
155,000 90,000 159,000
Dividends 10,000 10,000
25,000 25,000 .
Balance, Dec.31 P145,000 P 65,000 P149,000

BALANCE
SHEET

Cash & OCA P150,000 P 60,000 P210,000

Plant & Equip. 400,000 185,000 585,000
Inv. S Co. 185,000 185,000
Goodwill 17,000 17,000
P735,000 P245,000 P812,000

Liabilities 90,000 30,000 120,000

Capital Stock 500,000 100,000 100,000 500,000
APIC 50,000 50,000
RE 145,000 65,000 149,000
NC Int. 43,000 43,000
Balance, Dec.31 P735,000 P245,000 P253,000 P253,000 P812,000

To continue with Illustration 1, assume that at the end of the second year, S Company earned P50,000 and
declared dividends of P30,000. Impairment of goodwill is P2,000

P Company Working Paper Adjustments and Elimination Entries:

1. To convert cost to equity method as of beginning of the current year:

Investment in stock of S Co. P4,000

Retained earnings of P Co. P4,000
(65,000 – 60,000) x 80% = 4,000

2. To eliminate intercompany dividends:

Dividends Revenue 24,000

Non-controlling interest 6,000
Dividends of S Co. 30,000
(30,000 x 80% = 24,000)

3. Capital Stock, S Co. 100,000

APIC, S Co. 50,000
Retained Earnings, S Co. 65,000
Goodwill 17,000
Investment in stock of S Co. 189,000
Non-controlling interest 43,000
#
4. Impairment loss or expense 2,000
Goodwill 2,000
#
5. NCI profit (50,000 X 20%) 10,000
Non-controlling interest 10,000

What is the amount of Non-controlling Interest?

Capital stock (100,000 x 20%) P 20,000

APIC (50,000 x 20%) 10,000
Retained earnings ((65,000+50,000-30,000) x 20%) 17,000
Total P 47,000
 Accounting for Business Combination and Consolidated FS

OR

Non-controlling interest

6,000 43,000
10,000

47,000

Illustration 4:

P Company acquired on January 1, 2003, 800 shares of stocks for P450,000 from S Company when its stockholders’
equity was as follows:

Capital Stock, P200 par P200,000

APIC 60,000
Retained Earnings 130,000

On this date S Company had assets whose fair market values differ from its book values as follows:

Market Value Book Value Useful Life

Inventories P130,000 P100,000
Machinery & Equip. 175,000 125,000 10 years
Other Plant Assets 50,000 20,000 8 years

Trial balance of P Company and S Company as of December 31, 2003 are as follows:

P Company S Company
Cash & Other CA P170,000 P 50,000
Inventories 250,000 145,000
Machinery & Equip. (net) 475,000 295,000
Other Plant Assets (net) 36,250
Investments in Stocks, S Co. 450,000
Cost of Sales 100,000 120,000
Operating Expenses 80,000 58,750
Dividends 100,000 80,000
Liabilities ( 320,000) ( 135,000)
Capital Stock, P100/P200 par ( 460,000) ( 200,000)
APIC ( 340,000) ( 60,000)
Retained Earnings ( 134,000) ( 130,000)
Sales ( 307,000) ( 260,000)
Dividend Revenue from Subsidiary ( 64,000) .
Total P 0 P 0

P Company Books: (Previous Entries)

1. Acquisition of S Co. shares:

Investment in stock of S Co. P450,000

Cash P450,000
800 shares / (200,000/200) = 80%

2. To record dividends received from S CO.:

Cash 64,000
Dividend Revenue from Subsidiary 64,000
(80,000 x 80% = 64,000)

P Company Working Paper Adjustments and Elimination Entries:

1. Dividend Revenue form Subsidiary P64,000

Non-controlling interest 16,000
Dividends, S. Co. P80,000
#
2. Capital Stock, S Co. P200,000
APIC, S Co. 60,000
Retained Earnings, S Co. 130,000
Inventories 30,000
Machinery & Equip. 50,000
Other Plant Assets 30,000
Goodwill 50,000
 Accounting for Business Combination and Consolidated FS

Investment in stock of S Co. 450,000

Non-controlling interest 100,000
#
3. Cost of Sale P30,000
Depreciation expense (5T+3,750) 8,750
Inventories P30,000
Machinery & Equip. (50T/10)* 5,000
Other Plant Assets (30T/8)* 3,750
#

* Presented at net of accumulated depreciation

4. NCI profit P8,500

Non-controlling interest P8,500
(81,250 – 30,000-8,750) x 20%
#

What is the amount of Non-controlling Interest?

Capital stock (200,000 x 20%) P 40,000

APIC (60,000 x 20%) 12,000
Inventories (30,000 x 20%) 6,000
Machinery & Equip. (50,000 x 20%) 10,000
Other Plant Assets (30,000 x 20%) 6,000
Retained earnings
Beg. NI Div. Adj.
((130,000+81,250-80,000-38,750) x 20%) 18,500
Total P 92,500

OR

Non-controlling interest

16,000 100,000
8,500

92,500

DOWNSTREAM / UPSTREAM Intercompany SALE

For consolidation purposes, affiliates are viewed as one entity, intercompany sales are considered no more than an
internal transfer. Accordingly, no intercompany profits or losses should be recognized by the seller-affiliate until the
asset sold has been re-sold by buyer-affiliate to an outside party.

Parent’s adjustment on unrealized gain for downstream sale (Parent is the seller) is recorded at 100% and only at
its percent of ownership if an upstream sale (Subsidiary is the seller).

Illustration 5 – Downstream

On January 1, 2002 Arman Co. acquired for P400,000, 80% interest from Romy Co. when its stockholders’ equity
amounted to P500,000. On July 1, 2002 Romy Co. purchased one Arman Co.’s machine for P35,000. The
machine has an original cost of P60,000 and was already 50% depreciated. Its remaining life at the date of sale was
3 years. The following additional data were given:
Arman Co. Romy Co.
Capital Stock, Jan. 1, 2002 1,000,000 300,000
Retained Earnings Jan. 1, 2002 1,000,000 200,000
Net Income from Operation 250,000 75,000
Gain from Sale of Machine 5,000
Dividends 500,000 150,000

Arman Co.’s Books:

1. Investment in Romy Co. 400,000

Cash 400,000
#
2. Cash 120,000
Dividend Revenue from Subsidiary 120,000
(150,000 x 80%)
 Accounting for Business Combination and Consolidated FS

Arman Co.’s Working Paper: (Adjustment and elimination entries)

1. Dividend Revenue from Subsidiary 120,000

Non-controlling Interest 30,000
Dividend, Romy Co. 150,000
#
2. Machinery 25,000
Gain on Sale (35T-(60Tx50%)) 5,000
Accum. Depr. 29,167
Depreciation Expense 833
#
3. Capital Stock, Romy Co. 300,000
Retained Earnings, Romy Co. 200,000
Investment in Romy Co. 400,000
Non-controlling Interest 100,000
#
4. NCI profit P15,000
Non-controlling interest P15,000
(75,000 x 20%)

In 2003 Romy Co. reported the same amount of income and dividends for 2003

Arman Co.’s Books:

1. Cash 120,000
Dividend Revenue from Subsidiary 120,000

Arman Co.’s Working Paper: (Adjustment and elimination entries)

1. Retained Earnings, P Co. 75,000

Investment in S Co. 75,000
#
2. Dividend Revenue from Subsidiary 120,000
Non-controlling Interest 30,000
Dividend, Romy Co. 150,000
#
3. Machinery 25,000
Retained earnings (5T-833) 4,167
Accum. Depr. 27,500
Depreciation Expense 1,667
#
4. Capital Stock, Romy Co. 300,000
Retained Earnings, Romy Co. 125,000
Investment in Romy Co. 340,000
Non-controlling Interest 85,000
#
5. NCI profit P15,000
Non-controlling interest P15,000
(75,000 x 20%)

Illustration 6 – Upstream

On December 31, 2002, P Company purchased for P500,000, 80% controlling interest from S. Co. whose net assets
at the fair value were equal to the investment cost. The following is S Co.’s stockholders’ equity on this date.

Capital Stock P500,000

APIC 25,000
Retained Earnings 100,000
Total P625,000

P Company Books: Acquisition of 80% of S Co. voting stocks

Investment in stock of S Co. P500,000

Cash P500,000
 Accounting for Business Combination and Consolidated FS

On July 1, 2003, S Co. sold merchandise to P Co. costing P80,000 but billed at 120%. One fourth of the
merchandise purchased from S Co. remained on hand on December 31, 2003. P Co.’s gross profit rate is 25% above
cost. Assuming these are the only transactions of P Co. and S Co. for the year and that they incurred expenses of
P6,000 and P5,000 respectively.

P Company Working Paper Adjustments and Elimination Entries:

1. Sales 96,000*
Cost of Sales 92,000**
Merchandise 4,000***

*96T sale of S Co. is not a sale under consolidated FS

As a result:
**92T overstatement of COS ((80T-S Co + (96T x ¾)-P Co.) – (80T x ¾)-CoS for Conso FS)
***4T overstatement of Invty-End ((96T x ¼)-per books – (80T x ¼) for Conso FS)

2. Capital Stock, S Co. 500,000

APIC, S Co. 25,000
Retained Earnings, S Co. 100,000
Investment in stock of S Co. 500,000
Non-controlling interest 125,000

3. NCI Profit 1,400

Non-controlling interest 1,400

Upstream Adj
(11,000 – (96T-92T)) x 20%

P Co. sold the remaining merchandise bought from S Co. last year. S Co. reported a net income of P18,000. Assume
no other transaction for the year.

P Company Working Paper Adjustments and Elimination Entries:

1. Investment in stock of S Co. 8,800

Retained Earnings, P Co. 8,800

2. Retained Earnings, P Co. 3,200

Non-controlling Interest 800
Cost of Sales 4,000

3. Capital Stock, S Co. 500,000

APIC, S Co. 25,000
Retained Earnings, S Co. 111,000
(100T+96T-80T-5T)
Investment in stock of S Co. 508,800
Non-controlling interest 127,200

4. NCI Profit 4,400

Non-controlling interest 4,400

Upstream Adj
(18T + 4,000) x 20%