Profe03 - Chapter 1 Business Combinations Recognition and Measurement

Module PROFE03 ACCOUNTING FOR BUSINESS COMBINATIONS
CHAPTER 1 BUSINESS COMBINATIONS RECOGNITION AND MEASUREMENT
Learning Objectives:
Define a business combination.
Explain briefly the accounting requirements for a business combination.
Compute for goodwill.
Definition of a Business Combination
A business combination is “a transaction or other event in which an acquirer obtains

control of one or more businesses.” (PFRS 3)
Control
• An investor controls an investee when the investor is exposed, or has rights, to

variable returns from its involvement with the investee and has the ability to affect
those returns through its power over the investee.
• Control is normally presumed to exist when the ownership interest acquired in

the voting rights of the acquiree is more than 50% (or 51% or more).
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• Control may exist even if the acquirer holds less than 50% interest in the voting
rights of acquiree, such as in the following cases:
1. The acquirer has the power to appoint or remove the majority of the board
of directors of the acquiree; or
2. The acquirer has the power to cast the majority of votes at board meetings
or equivalent bodies within the acquiree; or
3. The acquirer has power over more than half of the voting rights of the
acquiree because of an agreement with other investors; or
4. The acquirer has power to control the financial and operating policies of
the acquiree because of a law or an agreement.
Accounting for business combinations
• Business combinations are accounted for using the acquisition method. This
method requires the following:
1. Identifying the acquirer;
2. Determining the acquisition date; and
3. Recognizing and measuring goodwill. This requires recognizing and

measuring the following:
2
a. Consideration transferred
b. Non-controlling interest in the acquiree
c. Previously held equity interest in the acquiree
d. Identifiable assets acquired and liabilities assumed on the business

combination.
Identifying the acquirer
• The acquirer is the entity that obtains control of the acquiree. The acquiree is the
business that the acquirer obtains control of in a business combination.
• The acquirer is normally the entity that:
a. Transfers cash or other assets and incurs liabilities;
b. Issues its equity interests (except in reverse acquisitions);
c. Receives the largest portion of the voting rights;
d. Has the ability to elect or appoint or to remove a majority ;
e. Dominates the management of the combined entity;
f. Significantly larger of the combining entities;
g. Initiated the combination
Determining the acquisition date
• The acquisition date is the date on which the acquirer obtains control of the
acquiree.
3
Recognizing and measuring goodwill
Consideration transferred xx
Non-controlling interest in the acquiree (NCI) 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
On acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset.
b. Gain on a bargain purchase as gain in profit or loss.
Consideration transferred
• The consideration transferred in a business combination is measured at fair

value.
• Examples of potential forms of consideration include:
1. Cash,
2. Other assets,
3. A business or a subsidiary of the acquirer,
4. Contingent consideration,
4
5. Ordinary or preference equity instruments, options, warrants and member

interests of mutual entities.
Acquisition-related costs
• Acquisition-related costs are costs the acquirer incurs to effect a business

combination.
• Acquisition-related costs are recognized as expenses in the periods in which

they are incurred, except for the following:
a. Costs to issue debt securities measured at amortized cost – included in

the initial measurement of the resulting financial liability.
b. Costs to issue equity securities – are accounted for as deduction from

share premium. If share premium is insufficient, the issue costs are
deducted from retained earnings.
Non-controlling interest (NCI)
• Non-controlling interest (NCI) is the equity in a subsidiary not attributable, directly

or indirectly, to a parent.
• NCI is measured either at:
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a. Fair value, or
b. The NCI’s proportionate share of the acquiree’s identifiable net assets.
Previously held equity interest in the acquire
• Previously held equity interest in the acquiree pertains to any interest held by the
acquirer before the business combination.
Net identifiable assets acquired
• On acquisition date, the acquirer shall recognize, separately from goodwill, the
identifiable assets acquired, the liabilities assumed and any non-controlling
interest in the acquiree.
• Any unidentifiable asset of the acquiree (e.g., any recorded goodwill by the
acquiree) shall not be recognized.
• The identifiable assets acquired and the liabilities assumed are measured at their
acquisition-date fair values.
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 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.
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• Such would be the case when the entity has a present obligation as of the
acquisition date evidenced by a detailed formal plan developed by the acquiree
that has been announced publicly on or before the acquisition date.
Specific recognition principles
1. Operating leases (whereby the acquiree is the lessee) - If the terms of an

operating lease relative to market terms is:
1. Favorable – the acquirer shall recognize an intangible asset.
2. Unfavorable – the acquirer shall recognize a liability.
2. Intangible assets – The acquirer recognizes the identifiable intangible assets

acquired in a business combination if they meet either the (a) separability
criterion or the (b) contractual-legal criterion.
Exception to the recognition principle – Contingent liabilities
• A contingent liability assumed in a business combination is recognized if:
1. it is a present obligation that arises from past events and
2. Its fair value can be measured reliably.
• A contingent liability assumed in a business combination is recognized if the

criteria above are met even if the contingent liability has an improbable outflow.
7
 full PFRSs vs. the PFRS for SMEs:
8
Sample Problem:
1. On January 1, 20x1, SMUTTY acquired all of the identifiable assets and assumed all
of the liabilities of OBSCENE, Inc. On this date, the identifiable assets acquired and
liabilities assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.
SMUTTY incurred the following acquisition-related costs: legal fees, ₱20,000, due
diligence costs, ₱200,000, and general administrative costs of maintaining an internal
acquisitions department, ₱40,000.
Case #1: As consideration for the business combination, SMUTTY Co. transferred
8,000 of its own equity instruments with par value per share of ₱200 and fair value per
share of ₱250 to OBSCENE’s former owners. Costs of registering the shares amounted
to ₱80,000. How much is the goodwill (gain on bargain purchase) on the business
combination?
Solutions:
Case #1:
(1) Consideration transferred (8,000 sh. x P250) 2,000,000
(2) Non-controlling interest in the acquiree -
(3) Previously held equity interest in the acquiree -
9
Total 2,000,000
Fair value of net identifiable assets acquired (1,400,000)
Goodwill 600,000
Case #2: As consideration for the business combination, SMUTTY Co. issued bonds
with face amount and fair value of ₱2,000,000. Transaction costs incurred in issuing the
bonds amounted to ₱100,000. How much is the goodwill (gain on bargain purchase) on
the business combination?
Solutions:
(1) Consideration transferred (fair value of bonds) 2,000,000
Total 2,000,000
Goodwill 600,000
2. On January 1, 20x1, ENTREAT Co. acquired all of the identifiable assets and
assumed all of the liabilities of BEG, Inc. by paying cash of ₱2,000,000. On this
date, the identifiable assets acquired and liabilities assumed have fair values of
₱3,200,000 and ₱1,800,000, respectively.
ENTREAT Co. has estimated restructuring provisions of ₱400,000 representing costs

of exiting the activity of BEG, costs of terminating employees of BEG, and costs of
relocating the terminated employees.
Requirement: Compute for the goodwill (gain on bargain purchase).

10
Solution:
(1) Consideration transferred 2,000,000
Total 2,000,000
Goodwill 600,000
3. On January 1, 20x1, HISTRIONAL Co. acquired all of the identifiable assets and
assumed all of the liabilities of THEATRICAL, Inc. by paying cash of ₱2,000,000. On
this date, the identifiable assets acquired and liabilities assumed have fair values of
Case #1:
As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being
rented out to THEATRICAL, Inc. under operating leases. HISTRIONAL has
determined that the terms of the operating lease on the building compared with market
terms are favorable. The fair value of the differential is estimated at ₱40,000.

Solutions:
Total 2,000,000
11
Fair value of net identifiable assets acquired* (1,440,000)
Goodwill 560,000
*The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired , including
intangible asset on the operating lease with
favorable terms (P3.2M + P40K) 3,240,000
Fair value of liabilities assumed (1,800,000)
Fair value of net identifiable assets acquired 1,440,000
Case #2:
determined that the terms of the operating lease on the patent compared with market
terms are unfavorable. The fair value of the differential is estimated at ₱40,000.

Solutions:
Goodwill (gain on bargain purchase) is computed as follows:
Total 2,000,000
12
Goodwill 640,000
* The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired 3,200,000
Fair value of liabilities assumed, including liability
on the operating lease with unfavorable terms
(P1.8M + P40K) (1,840,000)
Case #3:
As of January 1, 20x1, HISTRIONAL is renting a building and a patent from
THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms
of the operating lease on the building compared with market terms are favorable. The
fair value of the differential is estimated at ₱40,000.

Solutions:
Total 2,000,000
Goodwill 600,000
13
Sample Problem
Fact pattern
4. On January 1, 20x1, SMUTTY acquired all of the identifiable assets and assumed all
of the liabilities of OBSCENE, Inc. On this date, the identifiable assets acquired and
liabilities assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.
SMUTTY incurred the following acquisition-related costs: legal fees, ₱20,000, due
diligence costs, ₱200,000, and general administrative costs of maintaining an internal
acquisitions department, ₱40,000.
Case #1: As consideration for the business combination, SMUTTY Co. transferred
8,000 of its own equity instruments with par value per share of ₱200 and fair value per
share of ₱250 to OBSCENE’s former owners. Costs of registering the shares amounted
to ₱80,000. How much is the goodwill (gain on bargain purchase) on the business
combination?
Solutions:
Case #1:
(1) Consideration transferred (8,000 sh. x P250) 2,000,000
Total 2,000,000
Goodwill 600,000
Case #2: As consideration for the business combination, SMUTTY Co. issued bonds
with face amount and fair value of ₱2,000,000. Transaction costs incurred in issuing the
bonds amounted to ₱100,000. How much is the goodwill (gain on bargain purchase) on
the business combination?
Case #2:
14
(1) Consideration transferred (fair value of bonds) 2,000,000
Total 2,000,000
Goodwill 600,000
5. On January 1, 20x1, ENTREAT Co. acquired all of the identifiable assets and
assumed all of the liabilities of BEG, Inc. by paying cash of ₱2,000,000. On this
date, the identifiable assets acquired and liabilities assumed have fair values of
ENTREAT Co. has estimated restructuring provisions of ₱400,000 representing costs

of exiting the activity of BEG, costs of terminating employees of BEG, and costs of
relocating the terminated employees.

Solution:
Total 2,000,000
Goodwill 600,000
15
Fact pattern
6. On January 1, 20x1, HISTRIONAL Co. acquired all of the identifiable assets and
assumed all of the liabilities of THEATRICAL, Inc. by paying cash of ₱2,000,000. On
this date, the identifiable assets acquired and liabilities assumed have fair values of
Case #1:
determined that the terms of the operating lease on the building compared with market
terms are favorable. The fair value of the differential is estimated at ₱40,000.

Solutions:
Case #1:
Total 2,000,000
Goodwill 560,000
*The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired , including
intangible asset on the operating lease with
favorable terms (P3.2M + P40K) 3,240,000
16
Fair value of liabilities assumed (1,800,000)
Case #2:
determined that the terms of the operating lease on the patent compared with market
terms are unfavorable. The fair value of the differential is estimated at ₱40,000.

Case #2:
Total 2,000,000
Goodwill 640,000
* The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired 3,200,000
Fair value of liabilities assumed, including liability
on the operating lease with unfavorable terms
(P1.8M + P40K) (1,840,000)
17
Case #3:
As of January 1, 20x1, HISTRIONAL is renting a building and a patent from
THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms
of the operating lease on the building compared with market terms are favorable. The
fair value of the differential is estimated at ₱40,000.

Case #3:
Total 2,000,000
Goodwill 600,000
18
Reference:
ACCOUNTING FOR BUSINESS COMBINATIONS (ADVANCE ACCOUNTING 2) LECTURE

AID 2018 BY ZEUS VERNON B. MILLAN
Lecture Notes Compilation by Dean Rene Boy. R. Bacay, CPA, CrFA, CMC, MBA, FRIAcc
For further discussion please refer to the link provided:
Introduction to Business Combination Part 1- https://www.youtube.com/watch?v=oc-zAe1cC0o
Introduction to Business Combination Part 2- https://www.youtube.com/watch?v=oFZyYMo15Zk
Acquisition Method- https://www.youtube.com/watch?v=nf5tgyVT50E
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Module PROFE03 ACCOUNTING FOR BUSINESS COMBINATIONS

CHAPTER 1 BUSINESS COMBINATIONS RECOGNITION AND MEASUREMENT

Define a business combination.

Explain briefly the accounting requirements for a business combination.

Compute for goodwill.

Definition of a Business Combination

A business combination is “a transaction or other event in which an acquirer obtains

• An investor controls an investee when the investor is exposed, or has rights, to

• Control is normally presumed to exist when the ownership interest acquired in

Accounting for business combinations

1. Identifying the acquirer;

2. Determining the acquisition date; and

3. Recognizing and measuring goodwill. This requires recognizing and

b. Non-controlling interest in the acquiree

c. Previously held equity interest in the acquiree

d. Identifiable assets acquired and liabilities assumed on the business

Identifying the acquirer

• The acquirer is normally the entity that:

a. Transfers cash or other assets and incurs liabilities;

b. Issues its equity interests (except in reverse acquisitions);

c. Receives the largest portion of the voting rights;

d. Has the ability to elect or appoint or to remove a majority ;

e. Dominates the management of the combined entity;

f. Significantly larger of the combining entities;

g. Initiated the combination

Determining the acquisition date

Recognizing and measuring goodwill

Non-controlling interest in the acquiree (NCI) xx

Previously held equity interest in the acquiree xx

Less: Fair value of net identifiable assets acquired (xx)

Goodwill / (Gain on a bargain purchase) xx

On acquisition date, the acquirer recognizes a resulting:

b. Gain on a bargain purchase as gain in profit or loss.

• The consideration transferred in a business combination is measured at fair

• Examples of potential forms of consideration include:

3. A business or a subsidiary of the acquirer,

5. Ordinary or preference equity instruments, options, warrants and member

• Acquisition-related costs are costs the acquirer incurs to effect a business

• Acquisition-related costs are recognized as expenses in the periods in which

a. Costs to issue debt securities measured at amortized cost – included in

b. Costs to issue equity securities – are accounted for as deduction from

Non-controlling interest (NCI)

• Non-controlling interest (NCI) is the equity in a subsidiary not attributable, directly

• NCI is measured either at:

b. The NCI’s proportionate share of the acquiree’s identifiable net assets.

Previously held equity interest in the acquire

Net identifiable assets acquired

• Restructuring is a program that is planned and controlled by management, and

a. the scope of a business undertaken by an entity; or

b. The manner in which that business is conducted.

• Restructuring provisions are generally not recognized as part of business

Specific recognition principles

1. Operating leases (whereby the acquiree is the lessee) - If the terms of an

1. Favorable – the acquirer shall recognize an intangible asset.

2. Unfavorable – the acquirer shall recognize a liability.

2. Intangible assets – The acquirer recognizes the identifiable intangible assets

Exception to the recognition principle – Contingent liabilities

• A contingent liability assumed in a business combination is recognized if:

1. it is a present obligation that arises from past events and

2. Its fair value can be measured reliably.

• A contingent liability assumed in a business combination is recognized if the

 full PFRSs vs. the PFRS for SMEs:

 full PFRSs vs. the PFRS for SMEs: