Business Com Part 1

MA315 – Accounting for Business Combinations
Module 1: Business Combination: Recognition and Measurement
MODULE 1
BUSINESS COMBINATION: RECOGNITION AND MEASUREMENT
LEARNING OUTCOME
1. Define a business combination.
2. Explain briefly the accounting requirements for a business combination.
3. Compute for goodwill.
INTRODUCTION
A business combination occurs when one company acquires another or when two or more
companies merge into one. After the amalgamation, one company gains control over the other(s).
The company that obtains control over the other is referred to as parent or acquirer. The
other company that is controlled is the subsidiary or acquiree.
Business combinations are commonly effected through:

1. Asset acquisition - is a business combination whereby the acquirer purchases the assets and
assumes the liabilities of the acquiree in exchange for cash or other non - cash consideration
(which may be the acquirer's own shares). After the acquisition, the acquired entity ceases to
exist as a separate legal or accounting entity. The acquirer shall record in its accounting records
the assets acquired and liabilities assumed in the business combination.
Under the Corporation Code of the Philippines, a business combination effected
through asset acquisition may either be:
a. Merger – occurs when two or more companies merge into a single entity which shall be
one of the combining companies. For example: A Co.+ B Co.=A Co.or B Co.
b. Consolidation - occurs when two or more companies consolidate into a single entity which
shall be the consolidated company. For example: A Co.+ B Co.= C Co.
2. Stock acquisition - is a business combination whereby, instead of acquiring the assets and
assuming the liabilities of the acquiree, the acquirer obtains control over the acquiree by
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acquiring a majority ownership interest (e.g., 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 the subsidiary retain their
separate legal existence. However, for financial reporting purposes, both the parent and the
subsidiary, shall be viewed as a single reporting entity.
The parent and the subsidiary shall maintain their separate accounting records. Each
shall record separately the assets it, controls, tie liabilities it incurs, and the transactions it
enters into'
The parent shall record the ownership interest acquired as investment in subsidiary in
its separate accounting records. However, the investment shall be eliminated when the group
prepares consolidated financial state ments.
A business combination may also be described as:

1. Horizontal combination - a business combination of two or more entities with similar
businesses. For example, a bank acquires another bank.
2. Vertical combination - a business combination of two or more entities operating at different
levels in a marketing chain. For example, a manufacturer acquires its supplier of raw
materials.
3. Conglomerate - a business combination of two or more entities with dissimilar businesses.
For example, a real estate developer acquires a bank.
Advantages of a business combination

a. Competition is eliminated or lessened. Competition between the combining constituents with
similar businesses is eliminated while the threat of competition from other market participants
is lessened.
b. Synergy. Synergy occurs when the collaboration of two or more entities results to greater
productivity than the sum of the productivity of each constituent working independently.
Synergy is most commonly described as "the whole is greater than the sum of its parts." It can
be simplified by the expression "1 plus 1 = 3."
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c. Increased business opportunities and earnings potential - business opportunity and earnings
potential may be increased through
i. An increased variety of products or services available and a decreased dependency on
limited number of products and services;
ii. Widened dispersion of products or services and better access to new markets;
iii. Access to either of the acquirer's or acquiree's technological know - hows, research and
development, secret processes, and other information;
iv. Increased investment opportunities due to increased capital;or
v. Appreciation in worth due to an established trade name by either one of the combining
constituents.
d. Reduction of operating costs - operating costs of the combined entity may be reduced.
i. Under a horizontal combination' operating costs may be reduced by the elimination of
unnecessary duplication of costs (e.g., cost of information systems, registration and
licenses; some employee benefits and costs of outsourced services).
ii. Under a vertical combination, operating costs may be reduced by the elimination of costs
of negotiation and coordination between the companies and mark - ups on purchases.
e. Combinations utilize economies of scale. Economies of scale refer to the increase in productive
efficiency resulting from the increase in the scale of production. An entity that achieves
economies of scale decreases its average cost per unit as production is increased because fixed
costs are allocated over an increased number of units produced.
f. Cost of savings on business expansion - the cost of business expansion may be lessened when
a company acquires another company instead of putting up a branch. There may be various
regulations (e.g., in the case of banks) which may restrict the company from branching out,
such as regulatory required.
g. Favorable tax implications – deferred tax assets may be transferred in a business combination.
Also, business combinations affected without transfers of considerations may not be subjected
to taxation.
Disadvantages of a business combination
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a. Business combination brings monopoly in the market which may have a negative impact on
the society.
b. The identity of one or both of the combining constituents may cease.
c. Management of the combined entity may become difficult due to incompatible internal
cultures, systems and policies.
d. Business combination may result in overcapitalization.
e. The combined entity may be subjected to strict regulation and scrutiny by the government.
BUSINESS COMBINATION
A business combination is a transaction or other event in which an acquirer obtains control
of one or more businesses. Transactions referred to as true mergers or merger of equals are also
business combinations under PFRS 3.
Essential elements of business combination

1. Control
2. Business
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 presumed to exist when the ownership interest acquired in the voting rights of
the acquiree is more than 50% (or 51% or more). However, this is only a presumption because
control may still be obtained without necessarily acquiring more than half of the acquiree's voting
rights, such as in the following instances:
a. The acquirer has the power to appoint or remove the majority of the board of directors of the
acquiree; or
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
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d. The acquirer has power to control the financial and operating policies of the acquiree because
of a law or an agreement.
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 by contract alone.
Illustration: Determining the existence of control

Example 1.
ABC Co. acquires 51% ownership interest in XYZ, Inc.’s ordinary shares.
Analysis: 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%.
Example 2.
ABC Co. acquires 100% of XYZ, Inc.'s preference shares.
Analysis: 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.
Example 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.
Analysis: 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.
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Example 4.
ABC Co. acquires 45% ownership interest in XYZ, Inc. ABC has an agreement with EFG Co.,
which owns 10% of XYZ, whereby EFG will always vote in the same way as ABC.
Analysis: 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, Co).
Example 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.
Analysis: 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.
Business
Business is an integrated set of activities and assets that is capable of being conducted and
managed for the purpose of providing goods or services to customers, generating investment
income, (such as dividends or interest) or generating other income from ordinary activities. PFRS3
Appendix A).
The three elements of a business are defined as follows:

a. Input
b. Process
c. Output
Identifying a business combination

An entity shall determine whether a transaction is a business combination in relation to the
definition provided under PFRS 3".
If the assets acquired (and related liabilities assumed) do not constitute a business, the
reporting entity shall account for the transaction as an asset acquisition and not a business
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combination. Accordingly, the entity applies other applicable standards (e.g., PAS 2 for
Inventories acquired, PAS 16 Property, plant, and equipment for PPE acquired, etc.)
Accounting for business combination

Business combination to be accounted for using the acquisition method. These method requires
the following:
a. Identifying the acquirer;
b. Determining the acquisition date;
c. Recognizing and measuring goodwill. This requires recognize and measuring the following:
i. Consideration transferred
ii. Non – controlling interest in the acquiree.
iii. Previously held interest in the acquiree.
iv. Identifiable assets acquired and liabilities assumed on the business combination.
Identifying the acquirer

For each business combination, one of the combining entities shall be identified as the
acquirer. Acquirer is the entity that obtains control of the acquiree. Acquiree is the business or
businesses that the acquirer obtains control of in a business combination.
PFRS 3 provides the following guidance in identifying the acquirer:

a. The transferor of cash and other resources and assumes liabilities
b. The issuer of shares
c. Larger
d. Initiator of the acquisition
e. Substance over form
Illustration: Identifying the Acquirer

Example 1.
ABC Co. and XYZ, Inc., both listed entities, agreed to combine their businesses. The terms of the
business combination is that ABC will offer 5 shares for every share of XYZ. There is no cash
consideration. ABC's market capitalization is P900 million and XYZ's is P100 million. After the
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combination, the board of directors of XYZ shall comprise only directors from ABC. Three months
after the acquisition, 20% of XYZ is sold.
Analysis: ABC is the acquirer based on the following indicators:

 ABC is the issuer of shares and the initiator of the business combination.
 ABC is the larger entity of the two combining constituents.
 ABC’s (former) management dominates the management of the combined entity.
 Part of XYZ is sold after the acquisition. This provides additional indicator that ABC is the
acquirer.
Determining the acquisition date

The acquirer shall identify the acquisition date, which is the date on which it obtains control
of the acquiree. The date on which the acquirer obtains control of the acquiree is generally the
closing date. The closing date is the date on which the acquirer legally transfers the consideration,
acquires the assets and assumes the liabilities of the acquiree.
However, the acquirer might obtain control on a date that is either earlier or later than the
closing date, For example, the acquisition date precedes the closing date if a written agreement
provides that the acquirer obtains control of the acquiree on a date before the closing date.
Recognizing and Measuring Goodwill

On acquisition date, the acquirer computes and recognizes goodwill (or gain on a bargain
purchase) using the following:
Consideration transferred xx
Non-controlling interest in the acquiree xx
Previously held equity interest in the acquiree xx
Total xx
Fair value of net identifiable assets acquired (xx)
Goodwill (gain on bargain purchase) xx
A negative amount resulting from the formula is called gain on bargain purchase or
negative goodwill.
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A bargain purchase may occur, for example, in a business combination that is forced sale
in which acquiree is acting under compulsion. However, a bargain purchase may also occur in
other instances such as when the application of the recognition and measurement exceptions for
particular items provided under PFRS 3 results in gain on bargain purchase.
On acquisition date, the acquirer recognizes a resulting:

a. Goodwill as an asset.
b. Gain on bargain purchase as gain in profit or loss.
However, before recognizing a gain on a bargain purchase, the acquirer shall reassess
whether it has correctly identified all of the assets acquired and all of the liabilities assumed and
shall recognize any additional assets or liabilities that are identified in that view. This is an
application of the concept of conservatism.
Consideration transferred
The consideration transferred in a business combination shall be measured at fair value,
which shall be calculated as the sum of the acquisition - date fair values of the assets transferred
by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree and the
equity interests issued by the acquirer.
Examples of potential forms of consideration include:

a. Cash
b. Non – cash assets
c. Equity instruments, e.g., shares, options and warrants
d. A business or a subsidiary of the acquirer
e. Contingent consideration
Acquisition - related costs

Acquisition - related costs are costs the acquirer incurs to effect a business combination. Examples:
a. Finder's fees
b. Professional fees, such as Advisory, legal, accounting, valuation and consulting fees
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c. General administrative costs, including the costs of maintaining an internal acquisitions

department
d. Costs of registering and issuing debt and equity securities.
Acquisition - related costs as expensed when incurred, except the following:

a. Costs to issue debt securities measured at amortized cost shall be included in the initial
measurement of the securities, e.g., bond issue cost are included (as deduction) in the
carrying amount of bonds payable.
b. Costs to issue equity securities are deducted from share premium. If share premium is
insufficient, the issue costs are deducted from retained earnings.
Non-controlling interest
Non-controlling interest (NCI) is the "equity in a subsidiary not attributable, directly or
indirectly, to a parent." (PFRS 3 Appendix A). Non-controlling interest is also called "minority
interest."
For example ABC Co. acquires 80% interest in XYZ, Inc. The controlling interest is 80%,
while the non-controlling interest is 20% (100% - 80%). If ABC Co. acquires 100% interest in
XYZ, Inc., the non-controlling interest is zero
For each business combination, the acquirer measures any Non-controlling interest in the
acquiree either at:
a. Fair value; or
b. The NCI proportionate share in the acquiree's net identifiable assets.
Previously held equity interest in the acquiree

Previously held equity interest in the acquiree pertains to any interest held by the acquirer
before the business combination. This affects the computation of goodwill only in business
combinations achieved in stages.
Net identifiable assets acquired

Recognition principle
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On acquisition date, the acquirer recognizes the identifiable assets acquired, the liabilities
assumed and any NCI in the acquiree separately from goodwill.
Unidentifiable assets are not recognized. Examples of unidentifiable assets:
a. Goodwill recorded by the acquiree prior to the business combination.
b. Assembled workforce.
c. Potential contracts that the acquiree is negotiating with prospective new customers at
the acquisition date.
Recognition conditions
a. To quality for recognition, identifiable assets acquired and liabilities assumed must meet the
definitions of assets and liabilities provided under the Conceptual Framework at the acquisition
date.
b. The identifiable assets acquired and liabilities assumed must be part of what the acquirer and
the acquiree (or its former owners) exchanged in the business combination transaction rather
than the result of separate transactions.
c. Applying the recognition principle may result to the acquirer recognizing assets and liabilities
that the acquiree had not previously recognized in its financial statements.
Classifying identifiable assets acquired and liabilities assumed Identifiable assets acquired
and liabilities assumed are classified at the acquisition date in accordance with other PFRSs that
are to be applied subsequently.
Measurement principle
Identifiable assets acquired and liabilities assumed are measured at their acquisition - date
fair values.
Separate valuation allowances are not recognized at the acquisition date because the effects
of uncertainty about future cash flows are included in the fair value measurement. All acquired
assets are recognized regardless of whether the acquirer intends to use them.
Illustration 1: Measuring goodwill / gain on bargain purchase

Fact pattern
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On January 1, 2020, ABC Co. acquired all of the assets and assumed all of the liabilities
of XYZ Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of
XYZ acquired by ABC are shown below:
Carrying amounts Fair values
Assets
Petty cash fund 10,000 10,000
Receivables 200,000
Allowance for doubtful accounts (30,000) 120,000
Inventory 520,000 350,000
Building – net 1,000,000 1,100,000
Goodwill 100,000 20,000
Total assets 1,800,000 1,600,000
Liabilities
Payables 400,000 400,000
On the negotiation for the business combination, ABC Co incurred transaction costs
amounting to P100,000 for legal, accounting, and consultancy fees
Case 1: If ABC Co. paid P1,500,000 cash as consideration for the assets and liabilities of XYZ
Inc., how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Consideration transferred 1,500,000
Non - controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,180,000)
Goodwill 320,000
Notes:
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 The consideration transferred refers to the cash paid as consideration for the assets and
liabilities of XYZ, Inc.
 There is no non-controlling interest in the acquiree because ABC Co acquired all of XYZ's
assets and liabilities.
 Previously held equity interest in the acquirer affects the computation of goodwill only in
business combinations achieved in stages. This is discussed in the next chapter.
 The fair value of the net identifiable assets of the acquiree is computed as follows:
Fair value of identifiable assets acquired excluding goodwill (1.6M- 20K)* 1,580,000
Fair value of liabilities assumed (400,000)
Fair value of net identifiable assets acquired 1,180,000
*The goodwill recorded by the acquiree is excluded from the identifiable assets acquired because
goodwill is unidentifiable. Only identifiable assets acquired are recognized.
The entries in the books of the acquirer are as follows:

Petty cash fund 10,000
Receivables 120,000
Inventory 350,000
Building – net 1,100,000
Goodwill 320,000
Payables 400,000
Cash 1,500,000
to record the assets acquired and liabilities not on a business combination
Professional fees expense 100,000

Cash 100,000
to record the acquisition-related costs
Notes:
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 No allowance is recorded for the acquired receivables because the receivables are
recognized at acquisition date fair value.
 The acquisition-related costs are expensed.
 The illustration above is an example of a business combination effected through "asset
acquisition."
XYZ, Inc. (the acquiree) shall account for the business combination as a liquidation of a
business. Accordingly, all of the assets, liabilities, and equity are derecognized and the difference
between the carrying amount of the items derecognized and the disposal proceeds (amount
received from the business combination) is treated as a gain or loss on disposal of business.
XYZ shall recognize a gain on disposal of business of P100,000 (P1.5M proceeds minus
P1.4M carrying amount of net assets). The entries in XYZ's books are as follows:
Cash 1,500,000
Allowance for doubtful accounts 30,000
Payables 400,000
Receivables 200,000
Inventory 520,000
Building 1,000,000
Goodwill 100,000
Gain on disposal of business 100,000
to record the liquidation of the business
Share capital (and other accounts) (1.6M - 4M) 1,400,000

Gain on disposal of business 100,000
Cash 1,500,000
to record the settlement of owner's equity
Case 2: If ABC Co. paid P1,000,000 cash as consideration for the assets and liabilities of XYZ,
Inc., how much is the goodwill (gain on bargain purchase) on the business combination?
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Solution:
Non - controlling interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (1,180,000)
Goodwill (Gain on a bargain purchase) (180,000)
ABC Co. reassesses first whether it has correctly identified all of the assets (liabilities)
acquired (assumed). If after the reassessment a negative amount still exists, ABC Co. recognizes
that amount as gain in its 2020 profit or loss.
The entries are as follows:

Receivables 120,000
Inventory 350,000
Building 1,100,000
Payables 400,000
Cash 1,100,000
Gain on bargain purchase 180,000
Professional fees expense 100,000

Cash 100,000
Illustration 2: Non-controlling interests

Fact pattern
On January 1, 2020, ABC acquired 80% of the voting shares of XYZ, Inc. On this date,
XYZ's identifiable assets and liability have fair values of P1,200,000 and P400,000, respectively.
Case 1: Non-controlling interest measured fair value
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ABC elects the option to measure non - controlling interest at fair value. The independent
consultants engaged by ABC Co. determined that the fair value of the 20% non - controlling
interest in XYZ Inc. is P155,000 ABC Co paid P1,000,000 for the interest in XYZ, Inc. How much
is the goodwill?
Solution:
Non-controlling interest in the screen 155,000
Previously held equity Interest in the acquiree -
Total 1,155,000
Fair value of net identifiable sound (800,000)
Goodwill 355,000
The entries are as follows

To record the acquisition in ABC’s separate books of accounts:
Investment in subsidiary 1,000,000
Cash 1,000,000
To include XYZ in ABC's consolidated financial statements:

Identifiable assets acquired 1,200,000
Goodwill 355,000
Liabilities assumed 400,000
Investment in subsidiary 1,000,000
Non-controlling interest in XYZ, Inc. 155,000
Notes:
 The non-controlling interest is presented in the consolidated statement of financial
position within equity but separately from the equity of the owners of ABC Co.
(parent).
 The illustration above is an example of a business combination effected through "stock
acquisition.
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Case 2: Non-controlling interest measured at fair value

ABC Co. elects to measure non - controlling interest at fair value. A value of P250,000 is
assigned to the non - controlling interest in XYZ Inc., (P1M/ 80%) x 20% = P250,000. The
consideration transferred is P1,000,000. How much is the goodwill?
Solution:
Non-controlling interest in the acquiree (fair value) 250,000
Previously held equity interest in the acquire -
Total 1,250,000
Fair value of net identifiable assets acquired (800,000)
Goodwill 450,000
Case 3: NCI proportionate share in net assets

ABC Co. elects the option to measure the non-controlling interest at the non-controlling
interest proportionate share of XYZ, Inc.'s net identifiable assets. ABC Co. paid P1,000,000 for
the interest acquired in XYZ Inc. How much is the goodwill?
Solution:
Non-controlling interest in the acquiree* 160,000
Total 1,160,000
Fair value of net identifiable assets acquired (1.2M – 400,000) (800,000)
Goodwill 360,000
* The NCI's proportionate share in XYZ's net assets is computed as follows:

Fair value of net identifiable assets acquired (P1.2M – 400,000) 800,000
Multiply by: Non-controlling interest 20%
NCI's proportionate share in net identifiable assets 160,000
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Illustration 3: Transaction costs

Fact pattern
On January 1, 2020, ABC acquired all the assets and assumed all the liabilities of XYZ,
Inc. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.
ABC incurred the following acquisition-related costs: legal fees, P10,000, due diligence
costs, P100,000, and general administration costs of maintaining an internal acquisitions
department, P20,000.
Case 1: As consideration for the business combination, ABC Co transferred 8,000 of its own equity
instruments with par value per share of P100 and fair value per share of P125 to XYZ's former
owners. Costs of registering the shares amounted to P40,000. How much is the goodwill?
Solution:
Consideration transferred (8,000 sh. x P125) 1,000,000
Non-controlling interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 300,000
The entries are as follows:

Goodwill 300,000
Share capital (8,000 x P100 par) 800,000
Share premium 200,000
to record the issuance of shares as consideration for the business combination
Share premium 400,000
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Cash in bank 400,000

to record the costs of equity transaction
Professional fees expense (10,000 + 100,000) 110,000

General and administrative costs 20,000
Cash in bank 130,000
to record the acquisition – related costs
The acquisition-related costs are expensed, except for the stock issuance costs which are
deducted from share premium.
Case 2: As consideration for the business combination, ABC Co. issued bonds with face amount
and fair value of P1,000,000 Transaction costs incurred in issuing, the bonds amounted to P50,000.
How much is the goodwill?
Solution:
Consideration transferred (fair value of bonds) 1,000,000
Total 1,000,000
FV of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 300,000
The entries are:

Goodwill 300,000
Bonds payable 1,000,000
to record the issuance of bonds as consideration for the business combination
Bond issue costs 50,000
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Cash 50,000
to record the bond issue costs
Professional fees expense (10,000 + 100,000) 110,000

General and administrative costs 20,000
Cash 130,000
Restructuring provisions
Restructuring is a program that is planned and controlled by management, and materially changes
either:
a. The scope of a business undertaken by an entity, or
b. The manner in which that business is conducted.
Restructuring provisions may include the costs of an entity's plan

a. To exit an activity of the acquiree
b. To involuntarily terminate employees of the acquiree, or
c. To relocate non - continuing employees of the acquiree.
The costs above are sometimes referred to as "liquidation costs.
Restructuring provisions do not include such costs as (a) retraining or relocating continuing
staff; (b) marketing; or (c) investment in new systems and distribution networks.
Restructuring provisions are generally not recognized as part of business combination
unless the acquiree has, at the acquisition date, an existing liability for restructuring that has been
recognized in accordance with PAS 37 Provisions, Contingent Liabilities and Contingent Assets.
A restructuring provision meets the definition of a liability at the acquisition date if the
acquirer incurs a present obligation to settle the restructuring costs assumed, such as when the
acquiree developed a detailed formal plan for the restructuring and raised a valid expectation in
those affected that the restructuring will be carried out by publicly announcing the details of the
plan or has begun implementing the plan on or before the acquisition date.
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If the acquiree's restructuring plan is conditional on it being acquired, the provision does
not represent a present obligation, nor is it a contingent liability, at acquisition date.
Restructuring provisions that do not meet the definition of a liability at the acquisition date
are recognized as post combination expenses of the combined entity when the costs are incurred.
Illustration: Restructuring provisions

On January 1, 2020, ABC Co, acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. On this date XYZ's assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.
ABC Co. has estimated restructuring provisions of P200,000 representing costs of exiting
the activity of XYZ, including costs of terminating and relocating the employees of XYZ
Requirement: Compute for the goodwill.
Solution:
Previously held equity interest in the acquire -
Total 1,000,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 300,000
The restructuring provisions are simply ignored in the computation of goodwill. These are
considered only when they qualify for recognition under PAS 37 as at the acquisition date (see
discussion above). Restructuring provisions that do not meet the recognition criteria as at the
acquisition date are recognized as post - combination expenses (i.e., expenses after the business
combination).
Specific recognition principles PFRS 3 provides the following specific recognition principles:
1. Operating leases
Acquiree is the lessee
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General rule:
The acquirer does not recognize any assets or liabilities related to an operating lease in
which the acquiree is the lessee.
Exception:
The acquirer determines whether the terms of each operating lease in which the
acquiree is the lessee are favorable or unfavorable.
If the terms of an operating lease relative to market terms is:

a. Favorable - the acquirer recognizes an intangible asset.
b. Unfavorable - the acquirer recognize a liability.
Acquiree is the lessor

If the acquiree is the lessor, the acquirer does not recognize any separate intangible
asset or liability regardless of whether the terms of the operating lease are favorable or
unfavorable when compared with market terms
Illustration: Specific recognition principles - Operating leases

Fact pattern
On January 1, 2020, ABC Co acquired all the assets and liabilities of XYZ, Inc. for P
1,000,000. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and
P900,000, respectively.
Case 1: Acquiree is the lessee - terms are favorable

ABC is renting out a building to XYZ, Inc. under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is P20,000
Requirement Compute for the goodwill.
Solution:
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Total 1,000,000
Fair value of net identifiable assets acquired* (720,000)
Goodwill 280,000
*Fair value of identifiable assets acquired, including intangible

asset on the operating lease with favorable terms (P1.6M - P20,000) 1,620,000
Fair value of net identifiable assets acquired 720,000
Case 2: Acquiree is the lessee - terms are unfavorable

ABC is renting out a patent to XYZ, Inc. under an operating lease. The terms of the
lease compared with market terms are unfavorable. The fair value of the differential is P20,000
Solution:

Total 1,000,000
Goodwill 320,000
*Fair value of identifiable assets acquired 1,600,000

Fair value of liabilities assumed, including liability on the
operating lease with unfavorable terms (P900,000 + P20,000) (920,000)
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Case 3: Acquiree is the lessor

ABC is renting a building from XYZ, Inc. under an operating lease. The terms of the
operating lease compared with market terms are favorable. The fair value of the differential is
P20,000.
Solution:
Total 1,000,000
Fair value of net identifiable assets acquired (1.6M - .9M)* (700,000)
Goodwill 320,000
* No intangible asset or liability is recognized, regardless of terms of the operating lease,

because the acquiree is the lessor.
2. Intangible assets
Identifiable intangible assets acquired in a business combination are recognized
separately from goodwill. An intangible asset is identifiable if it is either (a) separable or (b)
arises from contractual or other legal rights.
Separability criterion
An intangible asset is separable if it can be separated from the acquiree and sold,
transferred, licensed, rented or exchanged, either individually or together with a related
contract, identifiable asset or liability.
An intangible asset is also separable if there is evidence of exchange transactions for
that type of asset or similar asset, even if those transactions are infrequent and the acquirer is
not involved in them.
24
An intangible asset is separable wen if the acquirer does not intend to sell, license or
otherwise exchange it.
Contractual-legal criterion
An intangible asset that is not separable is nonetheless identifiable if it arises from
contractual or other legal rights.
Example:
Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity
B's license to operate the nuclear power plant. However, the terms of the license prohibit Entity
A from selling or transferring the license to another party.
Analysis:
The license is an identifiable intangible asset because, although it is not separable, it
meets the contractual-legal criterion.
Illustration 1: Intangible assets

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,500,000. Relevant
information follows:
Carrying Amounts Fair Values
Other assets 1,600,000 1,480,000
Computer software 100,000 -
Patent - 50,000
Goodwill 100,000 20,000
Assets 1,800,000 1,550,000
Liabilities 400,000 450,000
Additional information:
 The computer software is considered obsolete.
 The patent has a remaining useful life of 10 years and a remaining legal life of 12 years.
25
 XYZ has research and development (R&D) projects with fair value of P50,000. However,
XYZ, Inc. recognized the R&D costs as expenses when they were incurred.
Solution:
Total 1,500,000
Fair value of net identifiable assets acquired (1.6M - .9M)* (1,130,000)
Goodwill 370,000
* Fair value of identifiable assets acquired, excluding computer software

and recorded goodwill be including patent and R&D
(P1.55M – 20,000 GW + 50,000 R&D) 1,580,000
An acquirer recognizes an acquiree's R&D as intangible asset even if the acquiree

has already expensed the related costs.
Illustration 2 Intangible assets

ABC acquire all the assets and liabilities of XYZ Inc. for P1,000,000. XYZ’s assets
and liabilities have fair values of P1,600,000 and P900,000, respectively. Not included in the
fair value of assets are the following unrecorded intangible assets:
Type of intangible asset Fair value

Customer list 40,000
Customer contract 1 30,000
Customer contract 2 20,000
26
Order (production) backlog 10,000

Internet domain name 15,000
Trademark 25,000
Trade secret processes 35,000
Mask works 45,000
Total 220,000
 Customer contract 1 refers to an agreement between XYZ Inc. and a customer, wherein
XYZ, Inc. is to supply goods to the customer over a period of 5 years. The remaining
term of the contract-end, but is not separable
 Customer contract 2 refers to XYZ's insurance segment's portfolio of one-year motor
insurance contracts that are cancellable by policyholders.
 XYZ, Inc. transacts with its customers solely through purchase and sales orders. As of
acquisition date, XYZ has a backlog of customer purchase orders from 60% of its
customers, all of whom are recurring customers. The other 40% are also recurring
customers but XYZ has no open purchase orders with these customers.
 The internet domain name is registered
Solution:
Total 1,000,000
Goodwill 80,000
*Fair value of identifiable assets acquired, including all of the

Unrecorded intangible assets (P1.6M + P220,000) 1,820,000
27
Exception to the recognition principle - Contingent liabilities

The acquirer applies PFRS 3, rather than PAS 37, when accounting for contingent liabilities
related to business combinations.
Under PFRS 3, a contingent liability assumed in a business combination is recognized if:
a. It is a present obligation that arises from past events; and
b. Its fair value can be measured reliably.
So, contrary to PAS 37, a contingent liability with improbable outflow may nevertheless
be recognized if both the conditions above are satisfied.
Illustration: Contingent liability

ABC Co. acquires 90% interest in XYZ, Inc. for P1,000,000. XYZ's recognized assets and
liabilities have fair values of P,1,600,000 and P900,000, respectively. ABC opts to measure the
non - controlling interest at fair value. The NCI fair value is P80,000.
XYZ is a defendant in a pending litigation, for which no provision was recognized because
XYZ strongly believes that it will win the case. The fair value of settling the litigation is P50,000.
Solution:
Non-controlling interest in the acquiree 80,000
Previously held equity interest in the acquiree - -
Total 1,080,000
Goodwill 430,000
*Fair value of identifiable assets acquired 1,600,000

28
Contingent Liability (pending litigation) 50,000 (950,000)

The contingent liability is recognized even if it improbable because it (a) represents a

present obligation and has a fair value.
Exceptions principles to both the recognition and measurement principles

The following items are recognized and measured as at acquisition date under other
applicable standards rather than PFRS 3:
a. Income taxes are accounted for using PAS 12 Income Taxes. For example, deferred taxes are
measured based on temporary differences arising from the measurement of identifiable assets
and liabilities acquired at the acquisition date.
b. Employee benefits are accounted for using PAS 19 Employee Benefits. For example, defined
benefit obligations are measured using actuarial valuations.
c. Indemnification assets - An indemnification asset arises when the former owners of the
acquiree agree to reimburse the acquirer for any payments the acquirer eventually makes upon
settlement of a particular liability.
Illustration: Deferred taxes

ABC Co, acquired all the assets and liabilities of XYZ, Inc. for P1,500,000. Relevant
information follows:
Assets Carrying amount Fair values

Cash 10,000 10,000
Receivables 200,000 120,000
AFDA (30,000)
Inventory 520,000 350,000
Building - net 1,000,000 1,100,000
Goodwill 100,000 20,000
Total assets 1,800,000 1,600,000
29
Liabilities
Payables 400,000 400,000
 XYZ, Inc. has unrecorded patent with fair value of P30,000 and contingent liability with
fair value of P20,000. The contingent liability is a present obligation but its outflow is
improbable.
 Fair value adjustments to the carrying amounts of assets and liabilities do not affect their
tax bases. All adjustments result to temporary differences. ABC's tax rate is 30%.
Requirement: Compute for the goodwill
Solution:
The deferred taxes are computed as follows:
Fair values (CA for Previous Carrying amounts TTD (DTD)

Financial reporting) (TB for taxation)
Cash 10,000 10,000 -
Receivables 120,000 170,000 (50,000)
Inventory 350,000 520,000 (170,000)
Building - net 1,100,000 1,000,000 100,000
Patent 30,000 - 30,000
Payables 400,000 400,000 -
Contingent Liability 20,000 (20,000)
Taxable temporary difference (TTD) (100,000 + 30,000) 130,000

Multiply by: Tax rate 30%
Deferred tax liability 39,000
Deductible temporary difference (30K,000 + 170,000 + 20,000) 240,000

Multiply by: Tax rate 30%
Deferred tax asset 72,000
30

Previously held equity interest in the acquiree - -
Total 1,500,000
Fair value of net identifiable assets acquired* (1,223,000)
Goodwill 277,000
*Fair value of identifiable assets acquired, excluding

Recorded goodwill (1.6M – 20,000 GW + 30,000
Unrecorded patent + 72,000 DTA 1,682,000
Fair value of liabilities assumed (400,000 + 20,000
Contingent liability + 39,000 DTL)
Contingent Liability (pending litigation) (459,000)
SUMMARY
 A business combination is one in which an acquirer obtains control of one or more businesses.
 Control is presumed to exist when an investor holds more than 50% interest in the acquiree's
voting rights.
 Business combinations are accounted for using the acquisition method. This method requires
the following:
a. Identifying the acquirer;
b. Determining the acquisition date;
c. Recognizing and measuring goodwill (or negative goodwill) - this requires accounting for
the following:
i. Consideration transferred,
ii. Non-controlling interest,
iii. Previously held equity interest, and
31
iv. Identifiable assets acquired and liabilities assumed.

 The enquirer (parent) is the entity that obtains control after the business combination. The
controlled entity is the acquiree (subsidiary)
 The acquisition date is the date on which the acquirer obtains control of the acquiree (e.g., the
closing date).
 Goodwill is computed using the following formula:
Consideration transferred xx
Non-controlling interest in the acquire xx
Previously held equity interest in the acquiree xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill (Gain on a bargain purchase) xx
 The consideration transferred is measured at fair value.

 NCI is measured either at fair value or proportionate share in the acquiree's net identifiable
assets.
 A gain on a bargain purchase" is recognized in profit or loss in the year of acquisition only
after reassessment of the assets acquired and liabilities assumed in the business combination.
 Only identifiable assets acquired are recognized. Unidentifiable assets are not recognized.
 Acquisition - related costs are expensed, except costs of issuing equity and debt instruments.
Acquisition - related costs do not affect the measurement of goodwill.
 Restructuring provisions are generally not recognized as part of business combination but
rather as post - combination expenses of the combined entity when the costs are incurred.
32
EXCERCISES
TRUE OR FALSE
1. The two important elements in the definition of business combination under PFRS 3 are
"business" and "combination.
2. PFRS 3 requires the use of the purchase method in accounting for business combinations.
3. The entity that obtains control in a business combination is called the acquiree.
4. The acquisition date in a business combination is normally the closing date.
5. Non-controlling interests are measured at fair value only.
6. If the controlling interest is 80%, the non-controlling interest is 20%.
7. A gain on a bargain purchase (negative goodwill) is recognized as an allocated deduction to
the net identifiable assets acquired in the year of business combination.
8. An intangible asset that is unrecorded by the acquiree may nevertheless be recognized by the
acquirer in a business combination.
9. A noncurrent asset acquired in a business combination that is classified as held for sale is
measured at fair value
10. If the consideration transferred in a business combination is deferred, the consideration may
be measured at present value.
11. Entity A acquires 100% interest in the voting shares of Entity for P100. Entity B's identifiable
assets and liabilities have fair values of P200 and P120, respectively. The goodwill is P80.
Use the following information for the next two items:

Entity A acquires 90% interest in the voting shares of Entity B for P100. Entity B's identifiable
assets and liabilities have fair value P200 and P120, respectively.
12. If the NCI is measured at its proportionate share in the acquiree's net identifiable assets, the
goodwill would be P28.
13. If the NCI is measured at a fair value P10, the goodwill would be P18.
Use the following information for the next seven items:
33
Entity A acquires all the identifiable assets and assumes all the liabilities of Entity B for P100.
Entity B's identifiable assets and liabilities have fair values of P200 and P120, respectively.
14. Entity A incurred legal fees of P20 in negotiating the business combination. The goodwill is
P40.
15. Entity A estimates liquidation costs of P10 in exiting the business activities of Entity B. The
goodwill is P20.
16. Entity A is renting out a license to Entity B under an operating lease. The terms of the lease
compared with market terms are favorable. The fair value of the differential is P5. The goodwill
is P25.
17. Entity B has an unrecorded patent with fair value of P30. The gain on bargain purchase is P10.
18. Entity B has an unrecognized contingent liability with fair value of P30. The contingent
liability is a present obligation but has an improbable outflow of economic resources. The
goodwill is P50.
19. Entity B's assets and liabilities have carrying amounts of P150 and P120, respectively. Fair
value adjustments to the acquired assets and liabilities have deferred tax consequences but do
not affect their tax bases. The income tax rate is 30%. The goodwill is P53.
20. Entity A agreed to share its trade secret processes with Entity B after the business combination.
The trade secret processes have a fair value of P25. The goodwill is P20,
STRAIGHT PROBLEM
Problem 1. A Co, issued bonds with face amount of P1M and fair value of P1.2M in exchange for
all the assets and liabilities of B Co. A Co. incurred bond issue costs of P30,000 and legal fees
P10,000 in negotiating the business combination. The carry on amounts and fair values of B's
assets and liabilities at the acquisition date are shown below:
Assets Carrying amounts Fair Values

Receivables – net 300,000 200,000
Inventory 600,000 450,000
Land 800,000 1,000,000
Goodwill 80,000 50,000
34
Total assets 1,780,000 1,700,000
Liabilities
Payables 320,000 390,000
Requirement:
1. Compute for the goodwill (gain on bargain purchase)
Use the following information for the next two requirements:

A Co. acquired 80% interest in B Co. for P1,200,000. On acquisition date, B's identifiable assets
and liabilities have fair values of P1,700,000 and P400,000, respectively.
2. How much is the goodwill if A Co. opts to measure the non - controlling interest at the NCI's
proportionate share in B Co.'s net identifiable assets?
3. How much is the goodwill if A Co. opts to measure the non - controlling interest at fair value?
(An independent appraiser valued the NCI at P300,000.)
4. A Co. acquired all the assets and liabilities of B Co. by issuing 10,000 shares with par value of
P20 per share and fair value of P100 per share. A Co incurred P40,000 in issuing the shares
and P60,000 in professional fees and administrative costs in affecting the business
combination. On acquisition date, B's identifiable assets and liabilities have fair values of
P1,800,000 and P900,000, respectively. After the business combination, A Co will close some
of the operating segments of B Co. The closure costs are estimated at P400,000.
Requirement: Compute for the goodwill gain on bargain purchase)
5. A Co. acquired 60% interest in the net assets of B Co, for P1,500,000. On acquisition date, B
Co.'s identifiable assets and liabilities have fair values of P5,000,000 and P2,800,000,
respectively.
35
 B Co. has an unrecorded customer list with fair value of P80,000, The customer list is
separable.
 A Co. is renting out a license to B Co. under an operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential is P30,000.
 A Co. opted to measure the NCI at fair value. An independent valuer assessed the fair value
of the NCI to be P800,000.
6. A Co. acquired all the assets and liabilities of B Co. for P1,600,000. Information on B's
identifiable assets and liabilities as at the acquisition date is as follows:
Carrying amounts Fair values

Assets 3,800,000 3,500,000
Liabilities 2,000,000 1,900,000
 As at the acquisition date, B Co. has breached a contract with a customer. The customer is
seeking damages amounting to P250,000. However, B Co. is currently disputing customer's
claim and B Co.'s legal counsel believes they will win the case. Accordingly, B Co. did not
recognize a provision. The fair value of settling the claim is P100,000.
 Fair value adjustments to the assets acquired and liabilities assumed have deferred tax
consequences, but do not affect the tax bases of the assets and liabilities. The tax rate is
30%.
7. Entity A acquired all the assets and assumed all the liabilities of Entity B for P1,800,000.
Information on Entity B's assets and liabilities as at the acquisition date is shown below:
Assets Carrying amounts Fair Values
36
Receivables – net 200,000 100,000

Inventory 600,000 450,000
Land 1,200,000 1,800,000
Goodwill 100,000 20,000
Total assets 2,100,000 2,370,000
Liabilities
Payables 900,000 700,000
Requirement: Compute for the goodwill (gain on bargain purchase).
Non – controlling interest

Use the following information for the next two items:
Entity A acquired 75% of the outstanding voting shares of Entity B for P2,000,000. On acquisition
date, Entity B's identifiable assets and liabilities have fair values of P4,000,000 and P1,600,000,
respectively.
8. How much is the goodwill if Entity A opts to measure the non - controlling interest at the NCI
proportionate share in Entity B's net identifiable assets?
9. Entity A opts to measure the non-controlling interest at fair value. An independent valuer
assessed the NCI fair value to be P540,000, How much is the goodwill?
Acquisition-related costs and Restructuring provisions

10. Entity A acquired all the assets and liabilities of Entity B by issuing 18,000 shares with par
value of P10 per share and fair value of P100 per share. On acquisition date, Entity B's
identifiable assets and liabilities have fair values of P3,800,000 and P1,900,000 respectively.
Entity A incurred stock issuance costs of P36,000 and finder's fees related to the business
combination of P60,000. Moreover, Entity A expects to incur liquidation costs of P280,000 in
terminating Entity B's activities.
37
Requirement: Compute for the goodwill (gain on bargain purchase).
Operating leases and Intangible assets

11. Entity A acquired all the assets and assumed all the liabilities of Entity B for P2,800,000. On
acquisition date, Entity B's identifiable assets and liabilities have fair values of P4,000,000 and
P1,600,000 respectively.
 Entity B has an unrecorded patent with fair value of P100,000.
 Entity B has research and development (R&D) projects with fair value of P160,000. Entity
B charged the R&D costs as expenses when they were incurred.
 Entity A is renting out a property to Entity B under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
P40,000.
Contingent liabilities
12. Entity A acquired 75% of the outstanding voting shares of Entity B for P1,800,000. On
acquisition date, Entity B's identifiable assets and liabilities have fair values of P4,000,000 and
P1,600,000 respectively.
 Entity A replaces Entity B as a guarantor on a loan of a third party. As at the acquisition
date, the third party has defaulted on the loan. However, because negotiations for debt
restructuring are ongoing with the lender and Entity B strongly believes that the lender will
agree on the proposed terms, no provision was recognized. The fair value of the guarantee
is P200,000.
38
 Entity A chose to measure the non - controlling interest at the NCI's proportionate share in
the acquiree's net identifiable assets.
Recommended learning materials and resources for supplementary reading

PFRS 3 Business Combinations
Section 19 of the PFRS for SMEs
REFERENCES
Balocating, R., 2015. Advance Accounting, Volume 2. C&E Publishing, Inc.
Dayag, A., 2021. Advance Financial Accounting.
Millan, Z.V., 2019. Accounting for Business Combination. Bandolin Enterprise (Publishing and Printing)
39

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MA315 – Accounting for Business Combinations

Module 1: Business Combination: Recognition and Measurement

Business combinations are commonly effected through:

A business combination may also be described as:

Advantages of a business combination

Disadvantages of a business combination

Essential elements of business combination

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

Illustration: Determining the existence of control

The three elements of a business are defined as follows:

Identifying a business combination

Accounting for business combination

Identifying the acquirer

PFRS 3 provides the following guidance in identifying the acquirer:

Illustration: Identifying the Acquirer

Analysis: ABC is the acquirer based on the following indicators:

Determining the acquisition date

Recognizing and Measuring Goodwill

On acquisition date, the acquirer recognizes a resulting:

Examples of potential forms of consideration include:

Acquisition - related costs

c. General administrative costs, including the costs of maintaining an internal acquisitions

Acquisition - related costs as expensed when incurred, except the following:

Previously held equity interest in the acquiree

Net identifiable assets acquired

Illustration 1: Measuring goodwill / gain on bargain purchase

The entries in the books of the acquirer are as follows:

Professional fees expense 100,000

Share capital (and other accounts) (1.6M - 4M) 1,400,000

The entries are as follows:

Professional fees expense 100,000

Illustration 2: Non-controlling interests

Case 1: Non-controlling interest measured fair value

The entries are as follows

To include XYZ in ABC's consolidated financial statements:

Case 2: Non-controlling interest measured at fair value

Case 3: NCI proportionate share in net assets

* The NCI's proportionate share in XYZ's net assets is computed as follows:

Illustration 3: Transaction costs

The entries are as follows:

Share premium 400,000

Cash in bank 400,000

Professional fees expense (10,000 + 100,000) 110,000

The entries are:

Bond issue costs 50,000

Professional fees expense (10,000 + 100,000) 110,000

Restructuring provisions may include the costs of an entity's plan

The costs above are sometimes referred to as "liquidation costs.

Illustration: Restructuring provisions

Requirement: Compute for the goodwill.

If the terms of an operating lease relative to market terms is:

Acquiree is the lessor

Illustration: Specific recognition principles - Operating leases

Case 1: Acquiree is the lessee - terms are favorable

Requirement Compute for the goodwill.

Non-controlling interest in the acquiree -

*Fair value of identifiable assets acquired, including intangible

Case 2: Acquiree is the lessee - terms are unfavorable

Requirement: Compute for the goodwill.

Consideration transferred 1,000,000

*Fair value of identifiable assets acquired 1,600,000

Case 3: Acquiree is the lessor

Requirement: Compute for the goodwill.

* No intangible asset or liability is recognized, regardless of terms of the operating lease,