Lesson 1: Concept of Business Combination

When the business reaches the point for expansion as it seeks to generate more profits and try to increase
its operational efficiency, the business may consider either to construct new amenities such as opening of
branches or acquiring an existing business thru business combination. In deciding on setting up a branch
or acquiring an existing business would depend on the activities to be taken by the parent.
The main advantages of business combination are:
(1) elimination or reduction of competition;
(2) control over the value chain; and
(3) reduced investment risk due to diversification.

What is Business Combination?

Business Combination, under the Philippine Financial Reporting Standards, is defined as “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”.
Under this definition, three elements must be present in a business combination namely:
Acquirer – the entity that obtain control
Acquiree – the entity that is being controlled
Control – an act or power to dominate or rule

Business combination is essentially a transaction wherein one company gains control over one or more
other companies through voluntary acquisition or aggressive takeover. Acquiring a controlling number of
shares of stock in a company is the customary means that companies uses to achieve business
combination. Companies involved in business combination are treated as single economic entity for
reporting purposes. Accordingly, to enhance relevance in reporting the controlling company shall provide
consolidated financial statements.
Discussions does NOT apply to:
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.
b. Joint venture
c. Combination under common control

When do we have CONTROL?

Under the accounting standards, there is control when: “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.”
General rule:
Acquisitions may be classified as follows:

SIGNIFICANT INFLUENCE (at least 20%-50%) ASSOCIATE

CONTROL (50 + 1 percent) ACQUIRER
 Exemption: There is control even at 50% or less under the following:
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 majority of the members of the BOD or equivalent governing body or
d. Power to cast majority of votes at meetings of the BOD or governing equivalent body.

Generally, control refers to owning enough voting rights of a company to make corporate decisions. Control
denotes authority over significant company operations and policies including capital allocation, acquisitions,
production, finance and top management decisions. Although ownership signifies control, it is important to
understand that control is not the same as ownership. Control over a company can exist even without more than
50% firm ownership. Accordingly, control can be achieved when an entity has significant portion of the voting
shares as not every share carries a vote in the shareholders meeting. Power over the board of directors or
equivalent governing body in charge of decision making is also an indication of control.

What are the objectives of doing business combination?

1.Profitability
2. Operating efficiencies

a) Vertical Integration – Combination of firms with different but successive, stages of production. In business
combination, the acquirer obtains control of the acquirees.  Accordingly, vertical integration would result to
strengthening the company’s value chain.  Under vertical integration, the acquirer company would be able to
increase profit by reducing costs due to a more efficient production process that cuts down delays in delivery. 
Vertical integration can either be forward or backward integration.  Although vertical integration would avoid
supply disruption, it also reduces company’s flexibility in dealing with changes because the company is forced to
follow the trends in the segment they integrated.

b)  Horizontal Integration – Combination of firms with the same business lines and market. One common way of
business combination is merger of two entities operating in the same industry by combining their assets to form a
new entity which would be stronger in handling competition better than two entities operating independently. 
Horizontal integration is also used to gain access to new markets in far places when a company choose to merge
with a similar firm in another country to start operations overseas.   
Although horizontal integration may be good in a business perspective, there is a downside in the supply chain. 
Cutting down competition would reduce the choices available to customers and eventually could lead to monopoly
where one company controls availability and prices of products or services.
c) Conglomeration – Combination of firms with unrelated and diverse products and/or service functions.
Diversification across industries would reduce investment risk because an adverse condition in one sector can be
compensated by a favorable condition in another sector.  Aside from risk reduction, conglomeration also
increases market share thru synergy and cross-selling opportunities.
Conglomeration also has its disadvantages like difficulty to manage unrelated and well diversified businesses
effectively.  At the same time, culture differences among diverse companies may cause a problem because what
may work for one company may be the opposite to another.

Lesson 2: Acquisition of Assets and Liabilities

What are the ways of doing business combination?
Under our standards, a business combination may be structured in a variety of ways for legal, taxation or other
reasons.  It may involve
(1) the purchase by an entity of the equity of another entity,
(2) 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.

1. ASSET ACQUISITION/FUSION or acquisition by one enterprise of the net assets of another enterprise and
integrating these into its own operations (no parent-subsidiary relationship).  Also referred to as Legal Merger.
Under asset acquisition, the acquiree/s shall cease to exist after the business combination and their assets and
liabilities will be directly transferred and merged with the acquirer’s assets and liabilities.

2. STOCK ACQUISITION/STOCK CONTROL or acquisition by one enterprise of the majority shares of another
enterprise. There is 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.  The acquirer includes it's interest in the acquiree in any separate
financial statements it issues as an investment in a subsidiary. In such circumstances, the acquirer applies this
PFRS on consolidated financial statements.   
Business combination may be done by the issuance 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.
What are the steps in doing business combination?
Under the accounting standards, all business combination shall be accounted for by applying the ACQUISITION
METHOD
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.
The ACQUIRER is the combining entity that obtains control of the other combining entities or businesses.
Usual indicators:
1. The entity with the greater fair value is likely to be the acquirer;
2. The entity giving up cash or other assets is likely to be the acquirer; and
3. The entity whose management can 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.
ACQUISITION DATE- is the date on which the acquirer obtains control of the acquiree. This is also the
measuring date of the asset acquired and liabilities assumed. Typically, the acquisition date would be the date
when payment or consideration is transferred whether in the form of assets given, liabilities incurred or assumed,
and equity instruments issued.
 But in some cases, control can be obtained even without exchanging any consideration like securing an
agreement. Control can also be achieved over time or in stages, this is called “step acquisition”
The ASSETS ACQUIRED and LIABILITY ASSUMED in a business combination are measured at acquisition
date fair values. An acquirer classifies and designates asset acquired and liabilities assumed based on the
contractual terms, economic conditions, operating and accounting policies and other pertinent conditions
existing at acquisition date.
After identifying the assets and liabilities acquired, the acquirer must also determine the existence of non-
controlling interest. The value of non-controlling interest is often ascertained based on the number of shares
held by the non-controlling interest. PFRS allows an accounting policy choice available on a transaction by
transaction basis,
to measure NON-CONTROLLING INTEREST (NCI) either at:
o fair value (sometimes called the full goodwill method), or
o the NCI's proportionate share of net assets (sometimes called partial goodwill method) of the acquiree.

Under full goodwill method, non-controlling interest will share in the goodwill that may arise out of the business
combination. Under partial goodwill method, non-controlling interest do not have a share in the goodwill.

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

The key points to remember are as follows:

The entity who obtained control is the acquirer. It is important that you identify the acquirer because the
acquirer will be the reporting entity for the business combination. Our discussion will focus on the
acquirer’s point of view.
Asset acquired and liability assumed are measured at acquisition date fair value
Cost of acquisition or consideration transferred are also measured at acquisition date fair value.
Non-controlling interest (NCI) percentage of interest is equal to 100% less Parent percentage of interest.
The computation of NCI will differ depending on its participation to goodwill. Under full goodwill approach,
goodwill shall be attributable to both parent and NCI while partial goodwill approach considers goodwill to
be attributable to parent only.

Lesson 3: Recognizing and Measuring Goodwill

 In an acquisition of a company, the acquirer is buying more than the assets and liabilities found in its
financial statements. The acquirer is also buying the company’s reputation, its customer’s loyalty,
expertise of its employees and other unrecorded potentials of said company. In this regard, the
acquisition price would normally be higher than the value of its net assets, but it does not necessarily
mean overpayment rather a recognition of GOODWILL.
What is goodwill?
Goodwill can be defined as an established reputation of a company resulting from its good name,
good location, good performance, or even good customer relations. In accounting, goodwill is
classified as a long-term asset categorized as an intangible quantifiable asset represented by the
excess of price paid over the fair value of interest acquired from an acquisition of a business. Before
acquiring an existing business, a forecast of future income is made to arrive at a logical purchase
price and the payment for expected earnings in excess of normal future earnings is considered
goodwill.
How do we measure 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 non-controlling interest (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 at fair values).
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 Enterprises
(SME) are allowed to amortized goodwill (10 years) based on accounting standard for SME.
ILLUSTRATION: (100% Acquisition)

Ama Inc. acquired 100% of Anak Co. for P10,000,000.  The carrying value of the net assets of Anak
Co. is P8,500,000 and the fair value of the net assets is also P8,500,000.
Compute for goodwill:

Consideration transferred  P10,000,000

Less book value of net assets     8,500,000
Goodwill  P  1,500,000
 Let us assume instead, Ama Inc. acquired 100% of Anak Co. for P10,000,000.  The carrying value
of the net assets of Anak Co. is P8,500,000 and the fair value of the net assets is P9,000,000.
Compute for goodwill:

Consideration transferred  P10,000,000

Less book value of net assets     8,500,000
Allocated excess  P  1,500,000
Less over/under valuation of assets and liabilities (9,000,000 – 8,500,000)         500,000
Goodwill P  1,000,000

Note:  It is important to determine the allocation for the excess between the consideration transferred and
the book value or carrying value of the interest acquired for appropriate recording of the transaction.
Remember: that under 100% acquisition, there is no non-controlling interest (NCI) that is why it
is irrelevant to determine whether full goodwill or partial goodwill is approach is used.
ILLUSTRATION: (Less Than 100% Acquisition)
Ama Inc. acquired 80% of Anak Co. for P10,000,000.  The carrying value of the net assets of Anak Co. is
P8,500,000 and the fair value of the net assets is P9,000,000.
PARTIAL GOODWILL APPROACH
Compute for goodwill:

Consideration transferred  P10,000,000

Less book value of net assets (8,500,000 x 80%)      6,800,000
Allocated excess  P  3,200,000
Less over/under valuation of assets and liabilities (9,000,000 – 8,500,000) x 80%         400,000
Goodwill (Partial Goodwill) P  2,800,000

Compute non-controlling interest:

Book value of net assets  P8,500,000

Over/under valuation of assets and liabilities (9,000,000 – 8,500,000)        500,000
Fair value of net assets P9,000,000
NCI % (100% - 80%)                 20%
NCI (Proportionate share or partial goodwill)  P1,800,000

 Take note that under partial goodwill method, NCI do not have a share in the goodwill.  The goodwill
amounting to P2,800,000 is attributable to the parent alone.
 FULL GOODWILL APPROACH
Compute for goodwill:

Consideration transferred (10,000,000 / 80%) P12,500,000

Less book value of net assets      8,500,000
Allocated excess  P  4,000,000
Less over/under valuation of assets and liabilities (9,000,000 – 8,500,000)          500,000
Goodwill (Full Goodwill) P  3,500,000

Compute non-controlling interest:

Book value of net assets  P8,500,000

Over/under valuation of assets and liabilities (9,000,000 – 8,500,000)        500,000
Fair value of net assets P9,000,000
Goodwill      3,500,000
Total   P12,500,000
NCI % (100% - 80%)                 20%
NCI (Fair value or full goodwill)  P2,500,000

Take note that goodwill is attributable to both parent and NCI as follows:

Parent share (3,500,000 x 80%)  P2,800,000

NCI share (3,500,000 x 20%)         700,000
Total goodwill (full goodwill) P3,500,000

The amount paid by Ama Inc. amounting to P10,000,000 is assumed as payment for the 80% interest
in Anak Co.  Accordingly, the implied value of Anak Co. would be P12,500,000 or computed as
P10,000,000 divided by 80%.  Taking this into consideration non-controlling interest (NCI) would
amount to P2,500,000 or computed as P12,500,000 multiplied by 20%.  The amount of goodwill
attributable to the parent or controlling interest remains the same regardless of approach used.

ILLUSTRATION (FV of NCI is given)

Ama Inc. acquired 80% of Anak Co. for P10,000,000.  The carrying value of the net assets of Anak
Co. is P8,500,000 and the fair value of the net assets is P9,000,000.  Additional information showed
that non-controlling interest was assigned a fair value of P2,300,000
Computation of goodwill and non-controlling interest under PARTIAL GOODWILL is not affected by
the additional information. Partial goodwill will remain at P2,800,000 and NCI at P1,800,000 (refer to
Module 1.3.2 Illustration)
 FULL GOODWILL APPROACH
Compute for goodwill:

Consideration transferred P10,000,000

Fair value of NCI  2,300,000**
Fair value of subsidiary P12,300,000
Less book value of net assets      8,500,000
Allocated excess  P  3,800,000
Less over/under valuation of assets and liabilities (9,000,000 – 8,500,000)          500,000
Goodwill (Full Goodwill) P  3,300,000

Full goodwill P3,300,000

Less goodwill attributable to parent 2,800,000
Goodwill attributable to NCI P    500,000

Compute non-controlling interest:

Book value of net assets P  8,500,000

Over/under valuation of assets and liabilities (9,000,000 – 8,500,000)        500,000
Fair value of net assets P  9,000,000
NCI % (100% - 80%)             20%
NCI share on net assets P  1,800,000
Add NCI share in goodwill       500,000
NCI (Fair value or full goodwill) P  2,300,000

 
** This amount should not be lower compared to fair value of NCI computed at fair value of net assets
(9,000,000 x 20% = 1,800,000).  Otherwise, the higher amount should be used.
Take note that allocation of goodwill is based on separate fair values which may not correspond with the
proportion of percentage of interest the parent and NCI.  The amount of goodwill attributable to the parent or
controlling interest remains the same regardless of approach used.

Lesson 4: Journal Entries

 Journal entries on business combination will depend on the way the combination was made.  Under
asset-acquisition or fusion, the acquirer acquires the assets and assumes the liabilities of the acquiree
thereby consolidating them to its own assets and liabilities after which the acquiree would no longer
exist. Whereas under stock-acquisition or stock control the acquirer purchased shares of stocks or
equity of the acquiree and gain control. Stock control creates a parent-subsidiary relationship with both
acquirer and acquiree continuing to exist.
It should also be noted that business combination as it is defined involves two parties, the acquirer and
acquiree.  The focus of discussion for this course would be acquirer’s point-of-view with some
selected discussion on the acquiree’s books.
What are the journal entries for ASSET ACQUISITION/FUSION (no parent-subsidiary
relationship?
Books of the ACQUIRER:
1. Consideration Transferred
Investment in Acquiree (to be reversed upon transfer of net assets) xx
Cash/property/liabilities/equity/combination thereof at fair value xx
2. Acquisition related cost
Expense (if any) for direct or indirect acquisition related cost xx
Share premium (if any) for cost of issuing equity securities xx
Bond issue cost (if any) for cost of arranging and issuing debt securities xx
Cash xx

3. Receipt of Net Assets

Itemized assets acquired at fair value xx

Goodwill if any xx
Itemized liabilities assumed at fair value xx
Gain on Bargain Purchase if any xx
Investment in Acquiree xx

Take note: that the Investment in Acquiree account will be closed after business combination and any
goodwill or gain is recognized for the difference between assets and liabilities acquired and
consideration transferred.

The following procedures will be made on the books of the ACQUIREE.

1. Adjust and close the nominal accounts and transfer the profit to date of combination to retained
earnings.
2. Revalue the assets to its fair value against retained earnings. Any goodwill in the books of the
acquiree before the combination are also closed to retained earnings.
3. Close the asset and liability accounts for the transfer of net assets to a receivable account to be
collected from the acquirer.
4. Record the receipt the consideration transferred as payment by the acquirer
5. Record the distribution of consideration transferred as final settlement to the shareholders.
ILLUSTRATIONZ Corp. agreed to a merger on March 1 with A Corp.  A Corp. will issue 1,200 shares of
stock to acquire the assets and assume the liabilities of Z Corp.  Their balance sheet just before the
combination are as follows:

A Corp Z Corp

Cash 300,000 10,000

Receivables 25,000

Inventories  60,000 20,000

F & F (net)   80,000 50,000

Equipment (net)  120,000    70,000

Total  585,000 150,000

Accounts payable 55,000 15,000

Capital stock, par P100 300,000

Capital stock, par P100 100,000

Share premium 120,000 20,000

Retained earnings 110,000   15,000

Total  585,000 150,000

Additional information:       

Equipment’s FMV P100,000

Accrued expenses to be recognized 5,000

Market value of A’s stock P180

 Additional costs incurred by A Corp.:

Legal fees for business combination P10,000

Legal and audit fees for the registration 25,000

SEC registration fees 1,000

Brokerage fees 28,125

Printing cost of securities  1,200

REQUIRED:  Prepare journal entries for the business combination

 Books of A Corporation:

1. Consideration transferred:

Investment in Z Corp.  216,000

Capital stock (1,200 x P100) 120,000 
Share Premium (1,200 x P80) 96,000

2. Acquisition related costs:                              

Expense (10,000 + 28,125) 38,125

Share Premium (25,000 + 1,000 + 1,200)  27,200
Cash  65,325

3. Receipt of net assets:

Cash 10,000
Inventories 20,000
F&F 50,000
Equipment  100,000
Goodwill 56,000
Accts. Payable   15,000
Accrued Expense   5,000
Investment in Z Corp.   216,000

                               
Supporting computation:

Consideration transferred:
Stock issued (1,200xP180) P216,000 
Net assets of acquired:
Cash 10,000
Inventories 20,000
F & F (net) 50,000
Equipment (net) 100,000
Accounts payable (15,000)
Accrued expenses      (5,000) 160,000
Goodwill  P   56,000

The preceding illustration highlighted acquisition related costs. Remember from our previous
discussion that:
 1. Cost of arranging and issuing financial liabilities are recorded under bond issue cost and cost of
arranging equity instruments are recorded under share premium. These items shall not be included
in the cost of business combination.
2. 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.

Take note that the legal and audit fees amounting to P25,000 are for the registration of the securities
that is why it was charged to share premium instead of expense.

Using the data in Illustration 1.4.1 but assume that a CASH PAYMENT of P105,000 is given by A
Corp. for the net assets (except for the cash) of Z Corp. and that direct out of pocket costs such
legal fees of P10,000 and brokerage fees of P28,125 were incurred.  The other cash outlays in
Illustration 1.4.1 are irrelevant as these are cost incurred only when stocks are issued.

REQUIRED:  Prepare journal entries for the business combination

Books of A Corporation:

1. Consideration transferred: 

Investment in Z Corp. 105,000

Cash   105,000

2. Acquisition related costs:       

Expense (10,000 + 28,125) 38,125

Cash 38,125

3. Receipt of net assets:                     

Inventories 20,000
F&F 50,000
Equipment 100,000
Accounts payable 15,000
Accrued expense 5,000
Investment in Z Corp. 105,000
Gain on Bargain Purchase 45,000

Supporting computation:
 Consideration transferred:
Cash price P105,000
Net assets of acquired:
Inventories 20,000
F & F (net) 50,000
Equipment (net) 100,000
Accts. Payable (15,000)
Accrued expenses      (5,000) 150,000
Gain on bargain purchase P (45,000)

In a business combination effected by issuance of share capital which involves two or more acquirees, it
is important that to prepare an EQUITABLE STOCK DISTRIBUTION PLAN to determine the number of
shares to be issued by the acquirer to recognize the contribution of each of the acquiree companies.  A
satisfactory allocation of individual contribution of the acquiree companies is affected by (1) net asset
contribution and (2) earnings contribution or goodwill.  When earning rates are approximately the
same, parties may agree that shares be issued based on net asset contribution alone.  Goodwill or
earning contribution may be computed as follows:

1. By capitalizing or dividing excess earnings at a certain agreed rate

2. Excess of total contribution over net asset contribution where total contribution
is determined by capitalizing estimated earnings.

The issuance of share capital maybe through a single class of share capital or two classes of share
capital. 
When a SINGLE SHARE CAPITAL is to be issued, parties may provide that earnings above normal be
the basis for measuring goodwill or earning contribution which is to be added to net asset contribution to
determine the company’s total contribution.  The parties may agree that goodwill will not be recognized
but computed only for the purpose of an equitable allocation of stocks to be issued. 
 M Corp., P Corp. and R Corp. are parties to a merger whereby M will take over the assets and assume
the liabilities of P and R.  You are given the following data:

P Corp R Corp  Total

Total assets  P600,000 P400,000 P1,000,000
Total liabilities 400,000 100,000 500,000
Average annual earnings 56,000 42,000 98,000

Normal profit for the industry is 10% of net assets with the excess earnings capitalized at 20% in
recognition of goodwill.  Assume that M’s stock has a par value of P200 and will distribute shares of
stock equal to contribution of the acquirees.
Requirements:
1. Prepare Equitable Distribution Plan
2. Journal entries for business combination
a.  Goodwill is recognized
b.  Goodwill is not recognized
 Answers:

1. Equitable Stock Distribution Plan: 

P Corp R Corp  Total

Net assets P200,000 P300,000 P500,000
Ave. Earnings 56,000  42,000 98,000
Normal Earnings (10%)     20,000     30,000     50,000
Excess Earnings 36,000 12,000 48,000
Capitalization rate        20%        20%       20%
Goodwill P180,000 P  60,000 P240,000
Total Contribution P380,000 P360,000 P740,000

2. A)   Goodwill is recognized:               

1. Consideration transferred:

Investment in P & R  P740,000

Capital stock    P740,000

2. Receipt of net assets:

Assets (in detail)  P1,000,000

Goodwill 240,000
Liabilities (in detail)          P500,000
Investment in P & R   740,000

 Supporting computation:

Shares to be issued based on P740T

P Corp (3,700 x (380,000 / 740,000)  = 1,900 shares @ P200
R Corp (3,700 x (360,000 / 740,000) = 1,800 shares @ P200 
Total    (740,000 / 200) = 3,700 shares

2. B) Goodwill is NOT recognized:                 

1. Consideration transferred:  
 Investment in P & R  P500,000
Capital stock           P500,000

2. Receipt of net assets:              

Assets (in detail)        P1,000,000

Liabilities (in detail)        P500,000 
Investment in P & R   500,000

Supporting computation:

Shares to be issued based on P740T

P Corp (2,500 x (380,000 / 740,000) = 1,284 shares @ P200
R Corp (2,500 x (360,000 / 740,000) = 1,216 shares @ P200
Total    (500,000 / 200)

Two Classes of Share Capital

The following procedures are generally applied in the allocation of TWO CLASSES OF SHARE
CAPITAL of the acquirer to the acquirees:

1. Estimated earnings of the acquirees are capitalized at a certain rate to

determine the total share capital to be issued to each acquiree. This rate must not exceed the
earnings rate of any of the acquirees
2. Preference share capital is distributed equal to the net assets contribution of
each of the acquirees. This share capital is fully participating and is preferred as to assets upon
dissolution, and the dividend rate does not exceed the capitalization rate.
3. Ordinary share capital is issued to each company for the difference between
the total contribution and the amount of preference share capital and it shall represent payment
for goodwill. If no goodwill is recorded, the value of net assets is allocated between the
preference shares and the ordinary shares on a rational manner.

ILLUSTRATION
Using 1.4.3 Illustration, assume that earnings are to be capitalized at 10% in determining the total
contributions of P Corp and R Corp.  8% preference shares, fully participating are to be distributed in
proportion to the net assets contributions.  Ordinary shares are to be distributed for the difference
between the total contributions and the net assets contributions.  Both shares have par values of
P200 each.
Requirements:

1. Prepare Equitable Distribution Plan

2. Journal entries for business combination
a.  Goodwill is recognized
b.  Goodwill is not recognized

Answers:

1. Equitable Stock Distribution Plan               

 P Corp R Corp  Total

Net assets (PS) P200,000 P300,000 P500,000

Ave. Earnings 56,000 42,000 98,000

Capitalization rate        10%       10%         10%

Total Contribution P560,000 P420,000 P980,000

Goodwill (CS)  P360,000 P120,000 P480,000

2.a. Goodwill is recognized:

1. Consideration transferred:

Investment in P & R 980,000 

Preference share capital   500,000
Ordinary share capital   480,000

2. Receipt of net assets:

Assets (in detail) 1,000,000

Goodwill 480,000
Liabilities (in detail) 500,000
Investment in P & R 980,000

 Supporting computation: 

P Corp R Corp  Total

Number of preference shares

(500,000 / P200)  2,500
(2,500 x (200T/500T) 1,000
(2,500 x (300T/500T) 1,500
Number of ordinary shares
(480,000 / P200) 2,400
(2,400 x (360T / 480T)  1,800
(2,400 x (120T / 480T) 600

   

 2.b. Goodwill is NOT recognized:               

1. Consideration transferred:

Investment in P & R 500,000 

 Preference share capital (1,276 x P200)   255,200
Ordinary share capital (1,224 x P200)   244,800

2. Receipt of net assets:

Assets (in detail) 1,000,000

Liabilities (in detail) 500,000
Investment in P & R 500,000

Supporting computation: 

P Corp R Corp  Total

Number of preference shares
((500,000 x (500T/980T) / P200) 1,276
(1,276 x (200T / 500T) 510
(1,276 x (300T/500T)  766
Number of ordinary shares
((500,000 x (480T/980T) / P200) 1,224
(1,224 x (360T/480T) 918
(1,224 x (120T/480T) 306

Stock Acquisition- Under stock acquisition, the acquirer purchases equity shares to control the
activities of the acquiree/s but does not dissolve the later resulting in a parent-subsidiary
relationship. Thus, both the acquirer (parent) and acquiree/s (subsidiary) will continue to operate
separately. Accordingly, all parties continue to maintain its separate books of accounts and issues
its corresponding separate financial statements.

Upon business combination. The acquiree/s records the issuance of their corresponding shares and
the acquirer shall include its interest in the acquiree in any separate financial statements it issues as
an INVESTMENT IN SUBSIDIARY.
What are the journal entries for STOCK ACQUISITION/STOCK CONTROL (with parent-subsidiary
relationship?

Books of the ACQUIRER:

1. Consideration Transferred:
Investment in Subsidiary xx
Cash/property/liabilities/equity/combination thereof at fair value xx
2. Acquisition related cost:
 Expense (if any) for direct or indirect acquisition related cost xx
Share premium (if any) for cost of issuing equity securities xx
Bond issue cost (if any) for cost of arranging and issuing debt securities xx
Cash xx
Note: Any difference between fair value interest acquired and consideration transferred shall be
taken into consideration upon consolidation of financial statements.

ILLUSTRATION:
The following are the balance sheet of P and S Co. at March 1, 2019 just before the stock
acquisition:

P Company S Company
Cash  140,000 40,000
Inventories 160,000 80,000
Investment in MS 100,000  100,000
Plant & Equipment 475,000 300,000
Patents                          20,000
Total P875,000 P540,000
Liabilities 351,000 150,000
Capital stock, par P10 300,000 200,000
Share premium 90,000 60,000
Retained earnings  134,000   130,000
Total P875,000 P540,000

P acquired ALL of the stocks of S by issuing 10,000 of its shares of stock currently selling at
P40.  Paid direct cost of P50,000
Fair value of some of S assets:  Inventories, P110,000; PPE, P350,000; and Patents,
P50,000.
REQUIRED: Prepare journal entries for business combination
 

ANSWER:
Books of P Corporation:

1. Consideration transferred:              

Investment in S Co. 400,000

Capital stock   100,000
 Share premium    300,000

2. Acquisition related cost

Expense 50,000
Cash   50,000
ILLUSTRATION:

The following are the balance sheet of P  and S Co. when P decided to acquire 4,500
shares of S for P580,000 including direct cost of P30,000:

P Company S Company
Cash 850,000 50,000
Receivables 200,000 100,000
Inventories 600,000 200,000
Plant & Equipment 1,260,000   450,000
Total 2,910,000 800,000
Liabilities 300,000 200,000
Capital stock, par P100 2,000,000 500,000
Share premium 400,000
Retained earnings   210,000   100,000
Total P2,910,000 P800,000

On this date the market values of S inventories and PPE are P210,000 and P470,000
respectively
Required: Prepare journal entries for business combination
ANSWER:
Books of P Corporation:

1. Consideration transferred:              

Investment in S Co. (580T – 30T) 550,000

Cash   550,000

2. Acquisition related cost:

Expense 30,000
Cash   30,000

Assume that P acquired 4,500 shares of stocks of S by issuing 5,000 of its shares with a market value
of P116 and paid printing cost of said securities amounting to P3,000. 
Required: Prepare journal entries for business combination
 ANSWER:
Books of P Corporation:
1. Consideration transferred:
Investment in S Co.  580,000
Capital stock (5,000 x 100)   500,000
Share premium (5,000 x (116 – 100))    80,000

2. Acquisition related cost:

Share Premium 3,000

Cash   3,000

 Take note: that under the previous illustrations for stock acquisition, fair value of assets acquired are
ignored in recording the business combination transaction. But these fair values shall be taken into
consideration in the valuation of interest acquired during the consolidation process
What are the financial statement disclosures required for business combination?
The acquirer shall disclose information that enables users of its financial statements to evaluate the nature
and financial effect of a business combination that occurs either during the current reporting period or after
the end of the period but before the financial statements are authorized for issue. Among the disclosures
required to meet the foregoing objective are the following:

 name and a description of the acquiree.

 acquisition date.
 percentage of voting equity interests acquired.
 primary reasons for the business combination and a description of how the acquirer obtained
control of the acquiree. description of the factors that make up the goodwill recognized
 acquisition-date fair value of the total consideration transferred and the acquisition-date fair
value of each major class of consideration
 details of contingent consideration arrangements and indemnification assets
 details of acquired receivables
 the amounts recognized as of the acquisition date for each major class of assets acquired and
liabilities assumed.
 details of contingent liabilities recognized
 total amount of goodwill that is expected to be deductible for tax purposes
 details of any transactions that are recognized separately from the acquisition of assets and
assumption of liabilities in the business combination
 information about a bargain purchase
 for each business combination in which the acquirer holds less than 100 per cent of the equity
interests in the acquiree at the acquisition date, various disclosures are required
 details about a business combination achieved in stages
 information about the acquiree's revenue and profit or loss
 information about a business combination whose acquisition date is after the end of the
reporting period but before the financial statements are authorized for issue