Table of Contents Business Combinations- Statutory Merger And Statutory Consolidation... The Nature of «Business Combination Reasons for Business Combinations Types of Business Combinations Structure of Busness Combination ‘Methods/Legal Forms of Etfecting Business Combinations ‘Acquistion of Net Assets Stotuloy Merger Statutory Consolidation ‘Accounting Concept of Business Combination Definition Identifying o Business Scope of Business Combination The Acquistion Method Ieentitying he Acquirer Determining the Acquistion Date Colcuoting he Fair Voive of the Consideration Transfered: ‘Accounting Records of the Acquirer ‘Acquistion Related Costs Piirciplesin Assessing What is Port ofthe Business Combination Recogniion and Measurement of Assets Acquired and Libifties ‘Assumed: Accounting Record ofthe Acquiter ‘Measurement Priiciple for Assets and Labiies Recognition Principle for Asels and Labiies ‘Measuring ond Recognizing Goodwil ora Gain from Bargain Purchase: Accounting Records of the Acquiter Valuation Techniques Use of Provisional valves Contingent Consideration ‘Measurement Period “Adusiments offer the Measurement Period Costs of suing Equity instruments Costs of suing Debt Instruments Goodwill Bargoin Purchase Gain Retrospective Adjusiments ‘Accounting in the Records ofthe Acquire ‘Acquitee doesnot iquidate/Acquiree Liquidates Business Combinations with No Consideration ‘Combinations by Contract Alone ‘Appication o the Acquistion Method fo & Combination in which No Consideration is Transferred ‘Append: Deferred Tax Assels and Deferred Tax Labities Relating fo. the Foir Valve Diflerentio’s of identifiable Assets and Libities Estimating the Value of Goodwill| Stock Exchange Ratio ~svance of si ' Gases of Sock Pate Stas one ser PERS/IFRS for Small arid Medlum-Sized Entities (SMES) = Ce ‘one (SMES) ~ Business Problems, Multiple Choice Problems, Theories Chopler 2: Separate and Consolidated Financial Statement Date of ‘Acquisition. Levels of investment ‘Acquistion of Ne? Assels versus Acquisition of Stock (Voting) / Equity ‘Classification of intercorporate investment - Pastve and sirategic Equi investments and Reporting Methods under PERS Controled Entities The Concept of Control The Defauit Presumption Investments ot the Date of Acquistion The Acquistion Anaiyss (or Schedule of Determination and ‘location of Excess) Consolidated Baiance Sheet atthe Date of Acquistion Wholly-Owned Subsidiaries Pottaly-Owned Subsiciaries Partial-Goodwil or Proporfionate Bass Fullgoodwill or Far Value Bas's Step-Acquistion Bargain Purchase Gain Eniity Concept/Theory Nature and Presentation of the Non-controling interest (NCI) Consolidated Financial Statements (PERS 10) Consolidation Procedures Using the Acquisition Method! Genero! Approach Direct Approach versus Workpaper Approach to Consolidation Subsidiary has a Recorded Goodwill at Acquistion Date Subsiciary has Recorded Dividends at Acquistion Date Subsidiary Treasury Stock Reverse Acquistion/ : Push-down Accounting Exclusion of a Subsidiary from Consolidation Investment Entity ‘Appendix Variable interest Enfities (VIEs) and Deferred Taxes in Consolidation h PFRS/IFRS for Small and Medium-Sized Entities (SMEs) - Business ‘Combination and Goodwill Problems, Multiple Choice Problems, Theories Chapter -3:_—_‘Separate and Consolidated Financial Statements ~ Subsequent fo Date of Acquistion... » 221-358 Consolidated Statements Subsequent to Date of Acquisition Separate Financial Statements Accounting for Subsidiaries, Associates and Joint Ventures in the Porent's Separate Financial Statements The First Method: Cost Model {formerly called Cost Method or Initial Value Method) The Second Method: Equity Method . Determination of the Method Being Used ‘Choosing between Cost Model (Method) and Equity Method Consolidated Statements Subsequent fo Date of Acquisition Consolidated income Statement Consolidated Retained Eamings Statement ‘Non-Controliing interest‘Chapter 1 - Business Combinations: Statutory Merger and Statutory Consolidation Introduction ‘Accounting for business combinations is one of the mos! significant and inleresing fopics of accounting theory ond practice. Simultaneous, i is mullaceled and divisive. Business combhalions involve financiol transactions of immeasurable magnitudes, business empires, triumphant stories ond! individual fortunes, managerial genius, ond management debacles. By their nature, they affect the destiny of ene ‘companies. Each is exceptional and must be evaluated in ferms of its economic substance, regordless of lislegal form. Why do business entities enter info a business combination? Although a number of reasons have been Ciled, the overriding reason i probably growth, Growth isa major objective of many business organizations, ‘A company may grow slowiy, may gradualy expand its produc! lines, fociles, or services, or may skyrocket almost overnight, Business combinations may deshioy value rather than create, in some instances. For example, i the ‘managers of merged firm transfer resources fo subsidize money-losing segments instead of shulting them down, the result wil be a suboptimal alocation of capital, Ths situation may arse because of reluctance to’ eliminate jobs or fo acknowledge a pos! mistake. This chapter presents reasons for the popularly of business combination, the methods and techniques in dealing with them. The Nature of a Business Combination ‘Abusiness combination may be friendly or untiendly (hostile takeovers): ‘+ Ina friendly combination, the board of directors of the potential combining companies negotiates mutually agreeable terms of a proposed combination. The proposal is submitted to the stockholders of the involved companies for approval. Normally, a two- thirds or three-fourths positive vote is required by corporate by-laws to bind all ‘stockholders to the combination. * An unfriendly (hostile) combination results when the board of directors of a company targeted for acquisition resists the combination. A formal tender offer enables the ‘acquiring firm to deol directly with individual shareholders. If a sufficient number of shares ‘are not made available, the acquiring firm may reserve the right to withdraw the offer. Because they are relatively quick and easly executed (oftertin about o month, tender offers ore the preferred means of acquiting public companies. Although fender offers cre the prefered method for presenting hosfle bids, most fender offers are trendly ‘ones, done with the support of the target company's management. Nonetheless, hosile takeovers have become sufficiently common that a number of mechanisms have emerged to resist takeover. Resistance often involves various moves by the forget company, generally with colorful terms. Whether such defenses are ultimately beneficial fo shareholders or not remains a controversial Issue. Academic research examining the price reaction to defensive ‘Advanced Financial Accounting ~ A Comprehensive: Conceptual & Precedural Approach: : CHAPTER 1 actions has produced mixed resulls, suggesting that the defenses are good fo, stockholders in some cases and bad in others. In untriendly (hostile) takeover, the following are defensive tactics or moves fo resist the proposed business combination with the following colorful designations: 1. Polson Pil, An omendment of the articles of incorporation or by-laws to'make it more difficult to obtain stockholder approval for a takeover. 2. Greenmail. An acquisition of common stock presently owned by the prospective ‘acquiing (acquirer) company at a price substantialy lower in excess of the prospective ‘acquirer's cost, withthe stock thus placed inthe treasury or retired. The purchased shares «ee then held as treasury stock or retired. This tactic is largely ineffective because it may result fo an expensive excise tax: further, from an accounting perspective, the excess of the price paid over the market price is expensed. 3. White Knight or White Squite. A search for a candidate to be the acquier in a friendly fokeover. Tis i simply encouraging a third company more acceptable fo the forget company. 4. Pac-man Defense. Attempting an unitiendly tokeover of the would be acquing company. 5. “Selling the Crown Jewels” or “Scorched Earth”, The sale of valuable assets to others to make the fim less attractive to the "would be acquirer’. The negative aspect is that the firm, itt survives, is left without some important assets. 6, Shark Repellant. An acquisition of substantial amounts of ‘outstanding common stock for the treasury or for retirement, or the incurring of substantial long-term debt in exchange for outstanding common stock. 7. Leveraged Buyouts. When management desires to own the business, it may anange to buy out the stockholders using the company’s assets to finance the deal. The bonds issued often take the form of high-interest, high-risk "junk" bonds, ‘8. The Mudslinging Defense. When the acquiring ‘company offers stock instead of cash, the Prospective acquiring (acquirer) company’s management may try to convince the stockholders that the stock would be a bad investment. 9. The Defensive Acquisition Tactic. When a major reason for an attempted takeover i the Prospective acquiring (acquirer) company's favorable, cash position, the prospective ‘Acquiring (acquirer) company may try to rd itself of this excess cash by attempting fo takeover of its own. Reasons for Business Combinations There are several ways of: business expansion; it may either be through acquisition or Construction of new amenities or through business combination, Following are the feasons why business combination may be preferred as compared to other means. 1. Cost Advantage. it is commonly less expensive for a firm to obtain needed amenities through combination rather than through development. 2. Lower Risk. The acquisition of reputable product lines and markets is usually less risky than developing new products and markets. The threat is especially low when the purpose & diversification, i ‘Advanced Financial Accounting = A Comprehensive: Conceptual & Procedural ApproachBUSINESS COMBINATION ~ STATUTORY MERGER and STATUTORY CONSOLIDATION a 3. Avoidance of Takeovers. Many companies combine to evade being acquired themselves. Smaller companies tend to be more susceplibie 10 corporate takeovers therefore, many of them adopt forceful buyer strategies to defend against toke over attempts by other companies. 4 4, Acquistion of Intangible Assets. Business combinations bring together both intangible ‘and tangible resources, 5. Other Reasons. Entities may choose a business combination over other forms of expansion for business tax advantages (For example, tax-loss camry forwards) for personal income and estate-tax advantages, or for personal reasons. Types of Business Combinations Business combinations may be classified under three schemes: 1. One based on the structure of the combination, 2. One based on the method used fo accomplish the combination, and 3. One based on the accounting method used, ‘Structure of Business Combination 'n general terms, business combinations unite previously separate business entities, The overiding objective of business combinations must be increasing profitability; however, many firms can become mare efficient by horizontally, or vertically integrating operations or by diversifying their risks through conglomerate operations, or by diversifying through change in operation. Because of this reason, combinations are Classified by structure into four types - horizontal, vertical, conglomerate, and circular. ‘+ Horizontal integration - this type of combination is one that involves companies within the some industy that have previously been competitors, Vertical integration ~ this type of combination takes place between two companies involved in the some industry but at diferent levels. It norrnally involves o combination of ‘a. compony and its suppliers or customers, Conglomerate Combination ~is one involving compares in unrelated industries having litle. if any, production or market similarities for the purpose of entering intonew markets or industries. * Circular Combination - entails some diversification, in operation as a conglomerate. Possible Structures but does not have a drastic change The structure of a business combination May be determined by a variety of factors, including legal and tox strategies. Other factors might include market considerations ‘and regulatory considerations include: ‘one business becomes a subsidiary of another; ‘wo entities are legally merged into one entiy ‘one entity transfers its net assets to another entity; {n entity's owners transfer their equity interests to th ‘two or more entities iransfer their net assels, orth ‘@ newly-formed entity {sometimes termed a ‘© group of former owners of one entity obtai owners of another ently: 1e owners lansfer their equity interests, fo “rolkup or ‘put-together’ transaction); and ing contol of a combined entity Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approach ‘Siilieterintinti es eea ' CHAPTER, Methods/Types of Combinations/Legal Forms of Efecting Business Combinations There are four types of combination which can be identified from legal ang organizational perspectives. from legal perspective, accounting and organizational perspective, the speciig ieee Yo be used in accounting for a business combination is effected through on Acquistion of net assets or assets or an acquisition of stock, the distinction of which ‘most important at this stage. |. Acquistion of Net Assets (Assets less obilties). The books of the acquired (acq company cede ands need tie ee hone oe Dat ‘acquirer (or the acquiring /survving company).in ths aspect of combination, sometime, ‘one enterprise acquires another enterprise's net assets through direct negotiations with its monagement, The acquitee (acquired) company generally distributes to its stockholders the asset or secures or debt instruments received in the combination from the acquier (acquiing) company and fauidates. The acquired (acquiring) company accounts for the combination by recording each asset acquired, each liabilly assumed, and the Consideration given in exchange. Following are the features of an asset and liabilities acquisition: + The acquirer acquires from another enterprise all or mos! of the net assels of the ‘other enterprise for cash or other property, debt instruments, and equity instruments (common or prefered stock), or a combination thereot + The acquirer must acquire 100% of the net assels of the acquiree (acquired) ‘company. ‘+ Itinvolves only when the acquirer (acquking) company survives Acquisttions of Net Assets (ossets less abilities) are classified into: ‘A Statutory merger {to be discussed in succeeding poragraphs) 8 Statutory consolidation (to be discussed in succeeding paragraphs) tn thi chapter. we focus on the acquisition of nel assets of the acquired company, {Acquistion of Common Stock (Stock Acquisition). The books of the acquirer (acquking) company and acquiree (acquired) company remain intact and consolidated financiol ‘statements are prepared periodically In such cases, the acquirer (acquiring) company debits an account “Investment in Subsidiary” the stock of the acquired company is recorded as on Iner-corporale Investment: rather thon transfering the underlying assets and fiobillies onto ik own books, {A business combination elfected through a slock acquistion does nol necessary have {0 Involve the acquistion of all of a company’s outstanding voting (common) shores. in those cases, control of another company is acquired. Following ore the features of a stock. ‘acquisition: 2 The acquit aequites voting (common) stock rom another enterprise for cash 0” ther property, debt instruments. and equily instruments [common or prefered stock). or a combination there "Aen Poacel hewatng “A Gorabths Benepe Bag Financlol Accounting ~ A Comprehensive: Conceptual & Procedural ApproachBUSINESS COMBINATION - STATUTORY MERGER and STATUTORY CONSOLIDATION: 5 b. The acquier must obtain control by purchasing 50% or more of the voting common sock oF possibly less when other factors are present that lead to the ocquver gaining Control. The folal of the shares of an acquired company not held by the controling shareholder is called the non-controling interest. c. The acquied company need not be dissolved: that is the acquired company does not have fo go out of existence. Both the acquirer (acquiring) company and the ‘acquiree (acquired) company remain as separate legal entity. Futther discussions and ilustration for the topic “stock acquisition” will be discussed in the succeeding chopters(Chopters 25). I, Asset Acquittion. it reflects the acquisition by one firm of assets (and possibly fabilties) of ‘another fim, but not its shares. The seling firm may continue to survive as a legal entity, ori may liquidate entirely The acquirer typically forgets key assets for acquisition, or buys the acquiree’s assets but does not assume its labilifes. Often the assels acquired are in the form of a division or product line, The acquirer may not buy the enti entity. {f should be noted that asset acquisition is not within the scope of business combination under PRS 3 refer to discussion below). There are Iwo independent issues related to the consummation of a combination: + what is acquired (net assets, stock or assets) and + what is given up (the consideration for the combination). Acquisition of Net Assets (Assets less Liabiliies) The terms mefger and consolidation ore often used synonymously for acquisitions. However, legally and in accounting, there is a difference. The distinction between these categories is largely a technicality, and the ferms mergers, consolidations, and ‘acquisitions are popularly used interchangeably. ‘Statutory Merger AA statutory merger entails that acquiring (acquirer) company survives, wheréas the ‘acquired (acquire) company (or companies) ceases fo exist as a separate legal entity, although it may be continued as a separate division of the acquiring company. Thus, i A Company acquires 8 Company in a statutory merger, the combination is often expressed os: X Company + ¥ Company = X Company or Y Company The board of directors of the companies involved normally negotiates the terms of 0 plon of merger, which must then be approved by the stockholders of each company involved, Laws or coporation byiows dictate the percentage of postive votes requited for opproval of the plan. Statutory Consolidation A statutory consolidation results when a new corporation is formed to acquire two or more other corporations; the acquired corporations then cease to exist (dissolve) as separate legal entities. For example, if C Company is formed to consolidate A ‘Company and B Company, the combination is generally expressed as: X Company + ¥ Company = Z Company ‘Advanced Final Accounting ~ A Comprehensive: Conceptual & Procedural ApproachCHAPTER ? Stockholders of the acquired companies (x and Y} become stockholders in the ney, eniily (2). The acquired companies in a statutory consolidation may be operated «, separate divisions of the new corporation, just as they may be under a statutory Statutory consolidations require the same type of stockholder approval as statutory, mergers do. Future references in ths chapter: The form merger in the technical sense of a business combination in which al but one ot the combining companies go out of existence. «+ Similaty, the term consolidation will be used in its technical sense to refer to a business ‘combination in which all the combining companies are dissolved ond 4 new corporation 1s formed to take over their net assets. «© Consolidation is also used in accounting which refers to the accounting process ey procedures of combining parent and subsidiary financial statements, such a jn the ‘expressions “principles of consolidation”. “consolidation procedures,” and “consolidated financial statements.” In succeeding chapters, the meaning of the term “consolidation* refers fo stock acquisition, As a matier of procedure fo prepare consolidated financig statements, the business combination defined as stock acquisition is expressed as; Financlol Statements + Financial Statements = Consolidated Financial Statements of ‘ofX Company of Y Company X Company and Y Company ‘Accounting Concept of Business Combination The accounting standard relevant for accounting for business combinations is PFRS 3 [Business Combinations) issued by the Intemational Accounting Standards Board (IASB), In reading PERS 3, itis important to note that Appendix A contains different terms while Appendix B contains appiication guidance - both Appendices are an integral part of PERS 3. The IASB hos also published a Basis for Conclusions on PERS 3, but this is not an integral part of the standard. Definition PERS 3 defines “business combination” as a transaction or other event in which an ‘acquirer obtains control of one or more businesses. Transactions sometimes referred to as “rue mergers” or “mergers of equals” also are business combinations. Afist key aspect inthis definition is “control” This means that there must be a triggering economic event or transaction and not, for example, merely a decision to star preparing combined or consolidated financial statements for an existing group. Conk con usually be obtained either by: 1. Buying the assets themselves (which automatically gives control to the buyer], or 2. Buying enough shores in the corporation that owns the assets to enable the investor [acauiter| fo control the investee (acquire) corporation (which makes the purchased corporation a subsidiary) Economic events that might result in an entity obtaining control include: + fronsterring cash or other assets (including net assets thet constitute a business}; + incuring labiites © issuing equity instruments: "Tarenad Peon Ianuang | Financtal Accounting - A Comprehensive: Conceptucl & Procedural Approach[BUSINESS COMBINATION ~ STATUTORY MERGER and STATUTORY CONSOLIDATION. 7 * acombination of the above; and * @ transaction not involving consideration, such as combination by contract alone (e.g. a dual isted structure) The meaning of “control” wil be discussed later in Chapter, 2 and the accounting procedures are thoroughly discussed in succeeding chapters. The second key aspect of the definition is that the acquirer obtains control of a “business”, Identifying a Business PERS 3 defines the term “business” as “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services fo customers, generating investment income (such as dividends or interes!) or generating other income from ordinary activities.” ‘The definition of business was narrowed by: * focusing on providing goods and services to customers + removing the emphasis from providing a retum to shareholders * removing the reference to ‘lower costs or other economics benefits The business combination must involve the acquisition of a business, which generally has three elements: + Inputs ~ on economic resource (e.g. non-curent assets, intellectual property) that merely need to have the ability to contribute to the creation of outputs. + Process - a system, standard, protocol, convention or rule that when applied to Gan input or inputs, creates outputs (e.g. strategic management, operational processes, resource management} + Output the result of inputs and processes applied to those inputs The result of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities. +The intellectual capacity of an organized workforce having the necessary sls and experience in following rules and conventions may provide the necessary processes applied to inouis to create outputs. +The focus on outputs is on returns from goods and services provided investment income, and other income from ordinary activites. The purpose of defining a business is fo distinguish between the acquisitions of a group of assets such os a number of chails, bookshelves and fling cabinets - ond the acquisition of an entity that is capable of producing some form of output. Accounting for a group of assets is based on standards such os PAS 16 Property, Plant and Equipment rather than PFRS 3. Advanced Financial Accounting ~ A Comprehensive: Conceptwal & Procedural Approach8 CHAPTER ! Scope of Business Combination The following transactions are within the scope of PFRS 3: 1. Combinations involving mutual entities. A mutual entity is defined as an enj other than an investor-owned ently, that provides dividends, lower costs or ot, economic benefis directly 1 is owners, members or participants, e.g. « mua, insurance company, a credit union and a cooperative entity. 2. Combinations achleved by contract alone (dual sting stapling). in combination achieved by contract alone, two entities enter into a contractyy rangement which covers, for example, operation under a single managemen, ‘and equalization of voting power ond eamings atfributable to both eniiey equity investors. Such structures may involve a ‘stapling’ or formation of a dug listed corporation. : ‘Accounting for business combination by contract Under PFRS 3 requires one of the combining entities to be identified as the acquirer, and one to be identifies 5 the acquiree. In reaching the conclusion that combinations achieved by contract alone should not be excluded from the scope of PERS 3. On the other hand, the following transactions are not within the scope of PFRS 3: 1. Where the business combination results in the formation of all types of joint ‘arrangements Joint ventures and joint operations) and the scope exception only applies to the financial statements of the joint venture or the joint operation the ‘and not the accounting for the interest in a joint anangement in the financial statements of a party to the joint arrangement, Where the business combination involves entities or businesses under common , Control. Common control Is a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the combination, and that control Is not transitory. Where the acquisition of an asset or a group of assets does not constitute @ business, The term used to indicate this transaction is “asset acquisition”. In such circumstances, the acquirer: x S 2 Identifies and recognizes the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for intangible assets in PAS 38 intangible Assets) and liabilities assumed; and Allocates the cost of the group of assets and liabilities to the individual assets ‘and liabilities on the basis of their relative fair value at the date of purchase. z Such transaction or event does not give rise to goodwill. The Acquisition Method rds The acquisition method is applied on the acquisition date which is the date the acqulet obtains control of the acquiree. The acquisition method approaches a business combination from the perspective of the acquirer (not the acquiree), the entity tho! obtains control of the other entil(es) in the business combination. ‘Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedurel ApproachBUSINESS COMBINATION ~ STATUTORY MERGER and STATUTORY CONSOLIDATION 9 Under the acquisition method, all assets and liabilties are identified and reported at their fair valves. ‘Accounting Procedures for a Business Combination The required method of accounting for a business combination under paragraph 4 of PFRS 3 is the acquisition method. Under the acquisition method, the general approach to accounting business combinations is a five step process: 1. Identity the acquirer; 2. Determine the acquisition date; 3. Colculate the fair value of the purchase consideration transfered (i of purchase) : 4. Recognize and measure the identifiable assets and liabilities of the business, and 5. Recognize and measure either goodwill or a gain from a bargain purchase, it either exists in the transaction. '¥ an acquirer gains control by purchasing less than 100% of the acquired ently, then the fourth step includes measuring and recognizing the non-controling interests (NCI). Discussion of NCI willbe in Chapter 2. Identitying the Acquirer PFRS 3 paragraph 7 states that “the acquirer is the ently that obtains control of the acquire’. Paragraph & requires that in each business combination, one of the Combining entities should be identified os the acquirer, The concept of control under PFRS 3 will be discussed methodically in Chapter 2. PFRS 3, however, recognizes that it may be difficult fo identify which entity has control over ‘other combining entities. In the event that the overriding principle of "control" in PFRS 3 does not conclusively determine the identity of the acquirer, PFRS 3 Provides additional guidance. Determining the Acquisition Date PFRS 3 defines “acquisition date” as the date on which the acquirer obtains control of the acquire, A business combination involves the joining together of assets under the control of a specific entity. Therefore, the business combination occurs at the date of the assets or ‘net assefs are under the control of the acquirer, This date is the acquisition date. * Other dates that are important during the process of business combination may be: the cost The dote the contract is signed; The date the consideration is paid: A date nominated in the contract: The date on which assets acquired are delivered to the ‘acquirer; and The date on which an offer becomes unconditional, * These dates may be important but determination of acquisition date does not depend on the date the acquirer receives physical possession of the assets ‘ecquired, oF actually pays out the consideration to the acquiree. ence eee, Advanced Financial Accounting - A Comprehensive: Conceptual & Procedural Approachwo ee HEP Trey «The use of control os the key criterion !o determine acquisition date ensures tha the substance of the transaction determines the accounting rather than the form, of the transaction. For example, assets acquired may be delivered in slages or payments made for there ‘assets may be made over a period of time with a number of payments being requreg, [As noted in paragraph 9 of PFRS 3, on the closing date of the combination, the acauiay Jegay transfers the Consideration = cash of shares - and acauites the assets and fiabilteg of the acquire, However, in some cases this may nol be the acquisition date. ‘The defintion of acquisition date then relates to the point In time when the ney assets of the acquiee become the net assels of the acquiter - in essence tha date on which the acquirer can recognize the net assels acquired in its own, records, There ore four main areos where the selection of the date affects the accounting for q business combination: 1. The identifiable assets acquired and liabilities assumed by the acquirer ce measured at the fair value on the acquisition date. The cholce of fair valve is affected by the choice of the acquisition date. 2. The consideration paid by the acquirer is determined as the sum of the fair valves of assefs given, equity issued and/or liabilities undertaken in an exchange for the net assets or shares of another entity. The choice of date affects the measure of fair value. 3. The acquirer may acquire only some of the shares of the acquiree. The owners of the balance of the shares of the acquitee are called the non-controling interes! defined in the Appendix A as the equily in a subsidiary not attributable, directy or indirectly, 10 a parent. This non-controlling interest Is also measured of for value on acquisition date. (This concept will be discussed and ilustrated in Chapter 2) . The acquirer may have previously held an equity interes! in the acquiree prior lo obtaining control of the acquire. For example, entily X may have previousy ‘acquired 20% of the shares of entity Y, ond now acquires the remaining 80% Giving it control of entity ¥. The acquisiion date Is the date when entfiy x ‘acquired the 80% interest. The 20%, shareholding will be recorded as an asset in the records of entity X. On acquisition date, the fair value of this investment i measured. (This concept will be discussed and iilustraled in Chapter 2) The effect of determining the acquisition date is that the financial position of the combined entity on acquisition date should report the assets and liabilities of the acquiree on that date ond any profits reports as a result of the acquiree’s operation within the business combination should reflect profits earned affey the acquisition date. Colcvlating the Fak Valve of the Consideration Transferred: Accounting Records of the Acquirer : ‘According fo PFRS 3 paragraph 37, the consideration transferred: * ismeasured at fair value at acquisition date * iscalculated as the sum of the acquisition date fair values of: ‘Advanced Financial Accounting - A Comprehensive: Conceptual & Procedural ApproachBUSINESS COMBINATION ~ STATUTORY MERGER ond STATUTORY CONSOLIDATION aia |, the assets transfemed by the acquirer; 2. the liabilities incued by the acquirer lo former owners of the acquiree; and 3. the equity interest issued by the acquirer, 'n.a specific exchange, the consideration transfered fo the acquirer could include just one form of consideration, such as cash, bu! could ‘equally well consist of a number of forms such as cash, other assels, @ business or a subsidiary of the acquirer, contingent Consideration, equity instruments (common or preferred stock) and debt Instruments, options, warrants and member interests of mutual entities, The consideration transferred Includes the following items: 1. Cash or Other Monetary Assets. The fair value is the amount of cash or cash equivalent dispersed. The amount is usvally readily determinable, One problem that may occur arses when the settlement Is deferred 10 a time after the ‘acquisition date. For deferred payment, the fair valve fo the acquker is the amount the entity would have fo borrow to settle the debt immediately (Le.. the presen! valve of the obligation). Hence, the discount rate used is the entity's incremental borrowing rate, Non-monetary Assets. Non-monetary assets are assels such as property, plant and equipment, investments, licenses and patents. As noted earler, if active second-hand market exists, falr values can be obtained by reference fo those markets. In this case, the acquirer is in effect seling the non-monetary asset to the acquiree. Thus, itis eaming an income equal to the fair value on the sale of the asset. If the carrying amount of the asset in the records of the acquirer is different from fair vaiue. a gain or loss on the asset is recognized al acquisition date. This principle is in compliance with paragraph 38 of PFRS 3. 3. Equity Instruments. if an acquirer issues its own shares os consideration, it needs to determine the fal valve of those shares at acquisition date, For listed entitles, telerence Is made to the quoted prices of the shares, Acquisition date model (equity instruments would be measured on the date the ‘acquirer obtains control over the business acquired). '. Uabllitles Undertaken. The fair values of liabilities are best measured by the present valves of expected future cash outflows. Future losses or other costs expected fo be Incured as a result of the combination are not liabilties of the acquirer and are therefore not included in the calculation of the fair value of consideration paid. Contingent Consideration, The contingent consideration may include the distibution of cash or other assets or the issuance of debt or equity secures, PFRS 3 provides the following definition of Contingent consideration, “Usually, an obligation of the acquirer fo transfer additional assets or equity interests to the s s ‘Advanced Finencial Accounting ~ A Comprehensive: Conceptual & Procedural Approachye eRe Oe Te a ml 2 CHAPTER Y former owners of an acquire as part of the exchange for contol of the acquitee it specified under future events occur or conditions ore mel. However, contingent consideration also may give the acquirer the right lo the retum op previously transfered consideration If specified conditions are met" Contingent consideration is on add-on to the base acquisition price that s boseq on evenis occuring or conditions being met sore time after the purchase lakes place. This topic will be discussed further later in this chapter with illustrations. 6. Share-based payment awards (Acquirer shate-based payment awards exchanged for awards held by the acquiree’s employees). The share-bated poyment transactions of the acquitee or the replacement of an acquiee's share-based payment transactions with share-based transactions of the acquirer are measured in accordance with PFRS 2 refered to as the “market based measure". The acavireris obliged to replace the acquiree’s awards, ether all or a portion of the markel-based measure of the acquirer's replacement awards is included in measuring consideration transferred in the business combination. The acquirers considered to be obliged to replace the awards if the acquitee or its employees have the ability to enforce replacement. Acquisttion-Related Costs 'n addition fo the consideration transfered by the acquirer to the acquiree, further item to be considered in determining the cost of the business combination Is the acquisition-related costs. Acquisition-related costs are excluded from the measurement of the consideration paid, because such costs are not part of the fair value of the acquiree and are not assets. They are as follows: |. Costs directly attributable to the combination which includes costs such as legd fees, finder’s and brokerage fee, advisory, accounting, valuation and other professional or consulling fees. Indirect, ongoing costs, general costs including the cost to maintain an internal ‘acquisition department (mergers and acquisitions department), as well os general and administrative costs such as managerial {including the costs of maintaining on intemal acquisitions department (management salaries. depreciation, rent, and costs incured to duplicate facilities), overhead Ihat ore allocated fo the merger but would have existed in its absence and other costs o! which cannot be directly altibuted to the parficular acquisition. The PFRS 3 accounting for these outlays is a result of the decision fo record the identifiable assets acquired and liabilties assumed at fair value, The acquisfion-related costs associated with a business combination are accounted i (8 expenses in the periods in which they are incumed and the services ore recelved. ‘Advanced Financial Accounting - A Comprehensive: Conceptual & Procedural ApproachBUSINESS COMBINATION ~ STATUTORY MERGER ond STATUTORY COMPOLIOATION The key reasons given for this approach ar + Acqubitiontelated costs are no! part of the fal value exchange between the buyer and seller, * They are separate transactions for which the buyer pays the foir value for the services received, * These amounts do nol generally represent assets of the acquirer at acauiition date because the benefits obtained are consumed as the services are received, |n contrast 10 PAS 16 Property, Plant and Equipment and PAS 38 Intangible Assets, oxsets acquired are initially recorded at cost, so directly attrbulable costs ore conidered 0% Par of the cost of acquisition and capitalized into the cost of the asset acquired, Costs of Issuing Equity Inshuments / Share Issuance Costs The costs of Issuing equity Instruments Is also excluded from the consideration and accounted for separately. In issuing equity instruments such as shares as part of the consideration paid, transaction Costs such as documentary stamp dutles on new shares, professional adviser's lees, underwnting costs and brokerage fees may be Incuned, As noted in paragraph 53 of PFRS 3, these costs are accounted for in accordance with PAS 32 Financial instruments: Disclosure and Presentation. Poragraph 35 of PAS 22 states that these outlays should be treated as a reduction In the shore capital of the entity os such costs reduce the proceeds from the equity Issue (meaning reducing the additional Pald-in capital), net of any related Income lax benefit. Further, if the share premium or additional paid-in caplial fom the related Issuance is Not enough fo absorb such costs, the Philippine Interpretations Commrittee (PIC) Concluded thal the excess shall be debited fo "Shore Issuance Costs” which will be treated as a contra shareholders’ equity account as o deduction In the lotoving order of priority: 1. Share Premium from previous share issuance; or* 2. Retained Earnings with appropriate disclosure. ‘on a personal note, the word “or Indicated onthe Pillppine Inferprelations Commitee (PIC) OLA (1 publihed should be removed since Its que misleading because the watement “order of peor” war ateady in used, Companies offen incur additional acquisition-related restructuring costs, including shutting-down departments, reassigning or eliminating jobs, and changing suppliers or production practices in connection with business combinations, Unless represented by Acquisition-date liabilities, these costs are expensed as incuned and do not affect ‘acquisition cost, In the post, fms have sought fo capitalize these "acquiition elated” restructuring Costs, effectively reporting them as goodwill and not os expenses, The PIC Committee iso considered listing fee for initial public offering of shares as on outight expense. ‘Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedurol Approach