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    2 AFAR - Chapter-2

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    Mary April Masbang

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    © All Rights Reserved
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    of 46
    — — ot = NN y Chapter 2 Business Combinations (Part 2) ess Combinations ctives OO 1, Account for business combinations (a) accomplished throyss chare-forshare exchanges, (b) achieved in stages, pai wed without transfer of consideration. o measurement period” in relation to busines standard: PERS: 3 Busin { rearning Obye achie 2 Explain the combinations. Distinguish what is part of a business combination and wh is part of a “separate transaction.” 4. Account for settlement of pre-existing relationship between x, irer and an acquiree. - Share-for-share exchanges A business combination may be accomplished through exchanz: “ equity interests between the acquirer and the acquiree (or is ee nett The general principle is that the consideration r in this case, the shares i irer) 8 measured at fair value. sone Ur te sem How ee on ‘there may be cases where the fair value of te the ees fia ouch may be more reliably measurable ch cases, the acquirer computes for goo” using the fair val own, ‘lve of the acquiree’s equity interests instead XYZ, Inc * ~ 4 unliste, , listed entity, through a company, acquires ABC Co. @ publ an exchang, * ; inge of ' The fair value of ge of equity instruments. Ly ABC’ F hy quote than < 8 (acquiree) shares may be more - st Le f 8 . n rescue ‘sare (acquirer) because ABC's sh ed sition and, combina Ot. (See additional illustrations in is ion of mutual entities in Chapter 3): wt relia (c)| ess vhat Illustration 1: ABC Co. and XYZ, Inc. combined their businesses through exchange of equity instruments, which resulted to ABC obtaining 100% interest in XYZ. Both entities are publicly listed. At the acquisition date, ABC’s shares are quoted at P100 per share. ABC Co. recognized goodwill of P300,000 on the business combination. Additional information follows: ABC Co. Combined entity (before acquisition) (after acquisition) Share capital 600,000 700,000 Share premium. ‘300,000 1,200,000 Totals » 900,000 1,900,000 Requirements: Compute for the following: a. Number of shares issued by ABC Co. b. Par value per share of the shares issued. c. Acquisition-date fair value of the net identifiable assets of XYZ. Solution: Requirement (a): Number of shares issued The consideration transferred is in. the form of shares. Accordingly, this is reflected on the increase in share capital and share premium: ABC Co. Combined enti Increase Share capital 600,000 700,000 100,000 Share premium 300,000 1,200,000 900,000 Totals 900,000 1,900,000 7,000,000 The fair value of the shares issued as consideration for the business combination is 1,000,000. ; P 1,000,000 Fair value of shares issued P100 Divide by: Fair value per ABC'S share 10,000 Number of shares issued ror v 6s share Ine per Requirement : en aera (cee table above) 770. Incr nn “ f shares issu 10,000 pivide by: Number © rr par value per share ired o); Fait ¢ of the net assets acquir Requirement (o: Fait value of i +000 Consideration transferred (cee Require : , Non-controlling interest in the Cae pire sone aa held equity interest In e act se re held equity _— ot Fair value of net identifiable assets acquired (squeeze) _ (700,000)_ Goodwill (given information) 300,000 Tlustration 2: ABC Co. issued shares in exchange for 100% interest in XYZ, Inc Relevant information follows: ABC Co. XYZ, Inc. Combined entity (carrying amounts) (fair values) Identifiable assets 2,400,000 1, Goodwill - a aa Total assets 2,400,000 1,600,000 2 — Liabili Shore capital 700,000 900,000 1,600,000 Share premium 600,000 300,000 700,000 300,000 250,000 1,200,000 2 Retained e Additional information: ABC's share capi pital consist: an, Of P10 per share, 'sts of 60,000 ordinary shares with pa 8 share capital cons ist: value of P100 per share, ists of 3,000 ordinary shares with pat ¢ A aoye ora \ oe aoe 1? 1 pe par irement: Compute for the following: foramber of shares issued by ABC Ce, p. Fait value per share of the shares issue 4 5 . - 7 ‘ Goodwill recognized on acquisition date ri Retained earnings of the combined entity { the business combination Entity immediately after solutions: Requirement (a): Number of shares issued om ABC Co. eon Combined entity Increase Share capital 700,000 100,060 Increase in ABC’s share capital 100,000 Divide by: ABC's par value per share ‘p10 Number of shares issued 10,000 ——_—_—— Requirement (b): Fair value per share ABC Co. _Combined entity Increase Share capital 600,000 700,000 100,000 Share premium __ 300,000 1,200,000 900,000 Totals 900,000 7,900,000 1,000,000 Fair value of consideration transferred 91,000,000 Divide by: Number of shares issued _— 10.00 100 Acquisition-date fair value per share din the computations XYZ's equity accou! /g (aU psidiary) © ity accounts are eae en ; and replaced a dlini, because an acquiree 7 oe in the consolidated financial sta 4 in the Suen Controlling interest’. consolidatio “ceeding chapters. n is discusse ‘ t ‘ \napter 2 Ee : Requirement (c): Goodwill Consideration transferred (see Requirement b) 1,000.0 trolling interest in the acquiree . Non-con! - . Previously held equity interest in the acquiree — Total Toon Fair value of net identifiable assets acquired (1.6M -.9M) (700,0¢n) Goodwill 20.000 Requirement (d): Retained earnings of the combined entity Because XYZ’s retained earnings are eliminated in the consolidated financial statements, the combined entity's retained earnings are equal to ABC Co.'s retained earnings of 800,000. The statement of financial position of the combined entity immediately after the business combination is shown below: f- L_/. a , Combined entity Identifiable assets 4,000,000 Goodwill a 300,000 = Total assets 4,509,000 Liabilities 1,600,000 Share capital 700,000 PA Share premium 1,200,000 Ss Retained earnings ____800,000_— Total liabilities and equity —_—— ™ Business combination achieved in stages i A business combination is ‘achieved in stages’ when the acquirt obtains control of an acquiree in more than one transaction. For example Entity A acquires 20% interest in Entity B in Year 1. oe ansaction is not a business combination because Entity Ah no ye caaned control of Entity B. In Year 2, Entity A acquit” { s Saar 40% interest in Entity B, thereby bringing its interest : | mm. The second acquisition qualifies as @ busin’ } combinati, i mbination because Entity A has obtained control of Entity | iret For not ives st tO nes? 7 a ee ' mbination achi i pusiness col ieved in st; ; acquisition.” Stages is also called “step In accounting for a busine: sines aoe sage nearer! 'S combination achieved in 1 Remeasures the previously held equity i ; . ar acquisition-date fair value; ae 'Y interest in the acquiree 2, Recognizes the gain or loss on the remeasurement in: a Profit or loss — if the previously held equity interest was classified as FVPL, Investment in Associate, or Investment in Joint Venture; or : b. Other comprehensive income - if the previously held equity interest was classified as FVOCL. [lustration: Business combination achieved in stages On January 1, 20x1, ABC Co. acquired 15% ownership interest in XYZ, Inc. for P100,000. ABC Co. classified the investment as ‘held for trading securities’ (ie., FVPL) in accordance with PFRS 9. On January 1, 20x4, ABC Co. acquired additional 60% ownership interest in XYZ, Inc. for P800,000. Relevant information follows: a The previously held 15% interest has a carrying amount of 170,000 on December 31, 20x3 and fair value of P180,000 on January 1, 20x4. b. XYZ's net identifiable assets have a fair value of P1,000,000. © ABCelected to measure the NCI at ‘proportionate share’. Requirement: Compute for the goodwill. Solution: Consideration transferred Non-controlli ; i P, trolling interest in the aca! A iously held equity interest in the acquiree otal ree (IM 135%") Far value of net identifiable assets aca¥e4 dwill 7 15% + 60%) = 25% ~_~* a Busine se journal entries: Jan. | Held for trading securities l—~ Segue 1 Unrealized gain - P/L (180K - 150K) may ¢ 20x4 to remeasure the previously held equity 3054, interest to acquisition-date fair value contr Jan. | Investment in subsidiary 800,000 Bw 1 Cash ‘ a a 20x4 to recognize the newly acquired shares i o Jan. | Investment in subsidiary 180,000 1 Held for trading securities ; ly ° 20x4 to reclassify the previously held equity . all ce interest a bs ir © Notes: @ The business combination is effected through stock ae acquisition. Accordingly, the acquisition is recorded in the ° parent's separate accounting records through the investment cel in subsidiary account. The carrying amount of this accourt r immediately after the combination is 980,000 (800K considet= r transferred + 180K acquisition-date fair value of the previously held equi interest). > I © When consolidated financial statements are prepared, te c investment in subsidiary is eliminated and the goodwill ané i NCT are recognized. t The same accounting procedures apply if the previous! > I / equity interest was classified as FVOCI, investment in ass0e 7 ° or investment in joint venture. However, if the pre’ ' classification was FVOCI, the remeasurement gain or ta 5 . recognized in other comprehensive income. If the prev us classification was investment in associate or joint ie ws ABC remeasurement gain or loss is also recognized in profit or Inc, | XYZ Business combination without transfer of consideration in Infor The acquisition method also applies to business comp". yg Aa 7 ed :. + m y which the acquirer obtains control without tan) mou consideration. The reason why the “purchase metho 4 with e used. for business combinations has been replace! asl pusiness Combinations (Part 2) 71 agcquisition method” is to emphasize that a busi ae may occur even when 2 purchase transaction oe vo Examples of circumstances where the iret obs ntrol without transferring consideration: 2 ee es | The acquiree repurchases a sufficient number of its own shares from other investors so that the acquirer will be able to obtain control. . For example, ABC Co. holds 40,000 out of the 100,000 outstanding ordinary shares of XYZ, Inc. Subsequently, XYZ repurchases 25,000 shares from other investors. After the treasury share transaction, ABC's ownership interest is jncreased 10 53.33% (40,000 + 75,000). p. Minority veto rights that previously kept the acquirer from controlling the acquiree have lapsed. c. The acquirer and acquiree agree to combine their businesses by contract alone. The acquirer neither transfers consideration nor holds equity interests jn the acquire. > In a business combination achieved without transfer of consideration, the acquisition-date fair value of the acquirer's interest in the acquiree js substituted for the consideration transferred in computing, for goodwill. > Ina business combination achieved by contract alone, the interests held by parties other than the acquirer are attributed to NCI, even if the result is that NCI represents 100% interest in the acquiree. Mlustration 1; Without transfer of consideration ABC Co. owns 36,000 out of the 90,000 outstanding shares of Peal Inc. ABC accounts for the investment ‘under the equity oe XYZ subsequently reacquires 30, shares from other investors. Informati iti js as follows: formation on the acquisition date 16 25 Tair value of 180,000. 2. The previously held 40% inter hase : ¢ 1,000,000. b. Xvz's net identifiable assets 9Y° ee | ; eel teens ad SSN 2 en PE i Busi ‘ABC elects to measure NCI at ‘proportionate share’, c Requirement: Compute for the goodwill. ossut if the i Solution: by th i Consideration transferred (IM x 60%) snp occu Non-controlling interest in the acquiree am x 40%) Ain any o Previously held equity interest in the acquiree oars i as S Total Be iain * Ne Fair value of net identifiable assets acquired Chon, : ee Goodwill aay & Notes: : @ XYZ's treasury share. transaction increased ABC's interest :; 60% [i.e., 36,000 + (90,000 - 30,000)}. Consequently, the NCI is 40%, @& The acquisition-date fair value of ABC’s interest in XYZ is acquis substituted for the consideration transferred (instead of measu attributing an amount to the ‘previously held equity interest adjust because there is no consideration transferred and there is re adjus: change in the number of shares held by ABC. if mont! 7 a error ‘Mustration 2: By contract alone ee ABC Co. and XYZ, Inc. enter into a contract whereby ABC obtais control of XYZ. No consideration is transferred between parties. The fair value of XYZ’s net identifiable assets x acquisition date is P1,000,000. ABC chose to measure NCI * ‘proportionate share’, Requirement: Compute for the goodwill. Solution: Consideration transferred pon-controlling interest in the acquiree (1M x 100%) reviously held equity interest in the acquiree 10000" \ Total 7,008 Fair value of net identifiable assets acquired __ oon Goodwill \ — Measurement period jnitial accounting fc if the jnitial ig for a busines: ara ra business combination is i fie of he mtr pa nw ee red, . quiet can use provisional amon combination any of the following for which the accounting j ae a Consideration transferred ig iencomplete b. Non-controlling interest in the acquiree a previously held equity interest in the acquire a Identifiable assets acquired and liabilities assumed Within 12 months from the acquisition date (ie, the ‘measurement period’), the acquirer retrospectively adjusts the provisional amounts for any new information obtained that provides evidence of facts and circumstances that existed as of the acquisition date, which if known would have affected the measurement of the amounts recognized on that date. Any adjustment to a provisional amount is recognized as an adjustment to goodwill or gainona bargain purchase. Adjustments for new information obtained beyond the 12- month measurement period are accounted for as corrections of error in accordance with PAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, rather than PFRS 3. Ilustration 1: Provisional amounts ~ identifiable assets acquired Fact pattern : - On October 1, 20x1, ABC Co, acquired all the identifiable assets and assumed all the liabilities of XYZ, Inc. for 1,000,000. On ths date, XYZ’s assets and liabilities have fair values of 1,600,000 an 900,000, respectively. Case #1; identifiable asset recosni=ed at prow The assets acquired include 4 puilding eee Provisional amount of 700,000 pecause re aes December 31 complete by the time ABC authorized fF A rtatively assigned @ 20x1 financial statements. puilding ¥2° : ur | con guy 2, 20% f 1 a a jlding’s fait | pug, The building from that date is 5 years ) ~ — a ife and was depreciated for three months in 29, year useful IE Te method: wm - 9M) = 1 (4.6M ~ 700, Be received the valuation report for y, value on October 1, 20x1 is P50% fr, and its ret ining use! | | rents: ane ve the measurement period? |e How should ABC account fOr the new information obtaire: | onjuly 1,202? ; | How much is the adjusted. goodwill? ig Marneamaigem’ | Rr 7 ‘Should-be Solutions: Additional Requirement (a): Measurement period Reteiacurement period is from Cctober 1, 20x1 fo September * en January to J 20x2, or if earlier, (i) the date ABC Co. obtains the information it ws seeking about facts and circumstances that existed as of the acquisitix date ot (ii) the date ABC Co. learns that more information is * obtainable. patent has Requirement (b): Accounting Th provisional amount assigned tothe building is retrospect? an adjusted with a corresponding adjustment to goodwill. The a R ancal statements are restated, including a reer" ace adjustment to depreciation expense. — Requirement (c): Adjusted goodwill ates costed Considerat Provisional AU noi Consideration transferred 1,000,000 1,000.0" Na Previously hel . : Ba Ton ny Meld equity interest . : Tol i : 7,000,000 7,000.0" Fair value Goodwit Fair value of net identifi 1000 Goodwill identifiable assets 700,000)" 90,00” 300,000 500007 — pusiness Combinations (Part 2) nS (w(1.6M + 9M) * 700,000 o(.6M- 700,000 provisional amount 500, +500,000 fair value - 9M) +.9M) = 500,000 Requirement (d): Adjusting entries , | Goodwill (600K - 300k) Building to record the adjustment to the i amount assigned tothe building ent Retained earnings Accumulated depreciation 7,500 to record the adjustment to 20:1 , b depreciation : 200,000 200,000 b ot ‘ e 7,500 Depreciation recognized (P700,000 + 10 years x 3/12) ‘Should-be’ depreciation (P500,000 + 5 years x 3/12) Additional depreciation expense for 20x1 If monthly depreciation expenses were recognized during nN January to June 30, 20x2, those shall also be adjusted accordingly. Case #2: Unrecorded identifiable asset acquired | On July 1, 20x2, ABC obtained new information that XYZ has an unrecorded patent which was not known on October 1, 20x1. The patent has a fair value of P100,000 and remaining useful life of 4 years as of October 1, 20x1. Requirement: Compute for the adjusted goodwill and provide the p> adjusting entries. 7 e Solutions; 7 tS ions: adjusted Adjusted aes Hal 000 1,000,000 \ Consideration transferred um zi Net : : \ Previous! ity i 000,000 ly held equity interest 7,000,000 Total 1,000,000 (800,000) 5 ; ,000) > Fair value of net identifiable assets OD 200,000 2 Goodwin 3 fp (©) (1,6M - 9M) = 700,000 (©) (1.6M +100,000 patent -.9M) = 800,000 Adjusting entries: July, | Patent ae Goodwill Retained earnings (100K + 4 x 3/12) Accumulated amortization 6,250 | Case #3: Information obtained beyond the measurement period On November 1, 20x2, ABC's auditors discovered that a p; with fair value of P100,000 was erroneously omitted from s, valuation listing on October‘, 20x1. The patent has a fair value : 100,000 and remaining useful life of 4 years as of October 1, 20, Requirement: How should ABC account for the new informaiz: | obtained on November 1, 20x2? Answer: Because the new information is obtained after t measurement period, it will be accounted for under PAS $ 5 correction of prior period error. A correction of prior period en is accounted for by retrospective restatement. Therefore. adjusted amounts and correcting entries would be similar to thes in ‘Case #2’ above. However, the note disclosures will * because PAS 8 will be applied instead of PFRS 3. Correcting entries to restate the 20x1 financial stateme |‘ | Patent 100,000 Goodwill ea ; Accumulated amortization . sind The omitted patent is recognized with a comes?” charge to goodwill because if ABC had mot committed ty ap ect amount of goodwill that should have bee" 1000! On acquisition date is P200,000. 1” Susi 5 the Tor the ose ion 2: Provisional ilustration amounts — considerati erat: on October 1, abo Co, an unlisted entity, io Mansferred pat value, shar As xchange for all the identifiable ass, 100, PS, fiabilities of XYZ, Inc. le assets and Information on acquisition date: The shares issued were assigned a ° € provisi per share. Provisional amount of P100 « The fair values of some of the assets ac; ui i ired are not i determinable. Accordingly, q e not readily : a provisional amount of 700,000 was assigned to XYZ’s net identifiable assets, Information after the acquisition date: « On April 1, 20x2, new information was obtained indicating that, on October 1, 20x1, - the fair value of the shares issued was P110 per share; and + the fair value of XYZ’s net identifiable assets was P900,000. © On July 1, 20x2, two competitors of ABC have also merged. . This led ABC to believe that the merger with XYZ is not as profitable as expected. ABC estimates that the valuations of the consideration transferred and XYZ’s net identifiable assets should have been P900,000 and P400,000, respectively. Requirement: Compute for the adjusted goodwill. Solution: Provisional Ad usted . i us ee ideration transferred 1,000,000 1100000 Prey lous! e = Tota ly held equity interest [000,000 1,100,000 Riry, 000) 900,000) alue of net i ts 7004 604 net identifiable asse! 300,000 200,000, will w 20x1) - ined on Apr. 1, is sh. x10 fair value based on new information ae ; 1.1, "alue based on new information obtained oF AP The new information obtained on July 1, 20x2 is ny measurement period adjustment because it does not relate to he aA and circumstances that have existed as at the acquisition ne However, this may indicate an impairment of goodwill, ® p? Determining what is part of the business Combinatic, ar transaction 3 . Before the business combination, the acquirer and acquiree Thay have pre-existing relationship or they may enter into transactcs, during the negotiation period that are separate from the busine, combination. : In applying the acquisition method, the acquirer identifi. and excludes amounts that are not part of the considerat, transferred on the business combination and accounts for the: ee using other relevant PFRSs. 71,00 The acquirer considers the following when determirir: 1,60 whether a transaction is part of a business combination or : separate transaction: ; Addit a. A transaction that is arranged primarily for. the benefit of te a X acquirer or the combined entity rather than the acquiree or = former owners is likely to be a separate transaction Tx th transaction price shall be excluded from the considerat" b. Xx transferred when computing for goodwill. ne ss Contrarily, a transaction that is arranged primarily . - hi the benefit of the acquire or its former owners is more Lee A to be a part of the business combination transaction a i, transaction price is appropriately included ™ i consideration transferred. g P ef eM b. A transaction initiated by the acquirer is likely for the a i ti of the acquirer or the combined entity and, ther in separate transaction. ott Contrarily, a transaction initiated by the acquis Requi former owners is more likely to be a part of the combination transaction. aaa LE a A transaction between the acquirer negotiations of a business cc ae during the part of the business combination, more likely to be t However, the followin, : are excluded when applying the sequana Becleeiales that t 10n : \ i. Settlement of pre-existing er a . , acquirer and acquiree; P Detween the t 5 ii. Remuneration to employees or former owners of the : acquiree for future services; and iii, Reimbursement to the acquire or its former owners for t 5 paying the acquirer's acquisition-related costs. ’ 7 Ilustration: 2 ABC Co. acquired all the assets and liabilities of XYZ, Inc. for 1,000,000. XYZ’s assets and liabilities have fair values of B P1,600,000 and P900,000, respectively. I a : Additional information: he a. XYZ incurred P10,000 legal fees in processing the regulatory its requirements for the combination. ABC agreed to reimburse he the said amount. : . . on b. XYZ will terminate its activities after the business combination. ABC agreed to reimburse XYZ’s estimated for liquidation costs of P200,000. oly ¢. ABC will retain XYZ’s former key employees. ABC agreed fo he pay the key employees 7100,000 as Sign ae Mr. Five- the a. ABC agreed to pay an additional 950/900 ae y of XYZ, to six Numerix, the previous ro a ABC po . ings 7 : persuade him in selling he Oh polder of XYZ, will acquire efit ® Ms. Vital Statistix, a former ShaFl + sooo that were , 3 title to inventories with fair va us included in the asset valuation. 8 will Requirement; Compute for the good! Solution:.. i i sferred 1 0659, Consideration trans! d , 150m Non-controlling interest in the acquires : . i ity interest in the acquiree i Previously held equity in\ 2 Total : i aaron Fair value of net identifiable assets acquired 61009 440, Goodwill anon ©) (1M +50K additional payment to Mr, Numerix) = 1,050,000 ©) (16M - 90K inventories taken by Ms. Statistix - .9M) = 610,000 § Notes: @ The reimbursement for the legal fees is an acqiusisition-related cost. This is expensed. © The reimbursement for liquidation costs is a restructuring provision. This is a post-combination expense. @ The payment to key employees is a separate transaction because _itis remuneration to employees for future services. 7 The additional 50,000 payment is included in the consideration transferred because it is for the benefit of the acquiree's former owner. "© The inventories are excluded because these are not asse!s acquired in the business combination. Reacquired rights A right that an acquirer has previously granted to the acquire® that is reacquired as a result of a business combination recognized as an intangible asset separately from goodwill. Examples of reacquired rights; e a. Right to use the acquirer's intangible asset, such as trade “ b under a franchise agreement, : BY . Right : to use the acquirer's technology under a technolo licensing agreement. ‘tae faint per © ng se he ets jree 1 is ame 108Y =_ 7 tlement of pre-existing relationship prior 10 business ane the acquirer and acquiree m have re-existing re lationship. Such a relationship may ber ay Contractual ~ C8 as vendor and customer, licensor and jicensee, OF franchisor and franchisee. A pre-existin relationship may be a contract that the acquirer recognizes ee reacquired right. b. Non-contractual - e.g., as plaintiff and defendant on a pending lawsuit. If the pre-existing relationship is settled due to the pusiness combination, the acquirer recognizes a settlement gain or Joss measured as follows: a. At the lower of (i) and (ji) below, if the pre-existing relationship is contractual. i. The amount by which the contract is favorable or unfavorable, from the acquirer's perspective, when compared with market terms. ii, Any settlement amount stated in the contract that is available to the counterparty to which the contract is unfavorable. If this is less than the amount in (j), the difference is included as part of the business combination accounting. b. At fair value, if the pre-existing relationship is mon- contractual. or loss is adjusted for the The settlement gain ¢ at the acquirer has Aetecognition of any related asset oF liability th Previously recognized. Wustrat on 1; Reacquired right nee January 1, 2rd, ABC ex acquired all the assets and liabilities XYZ, Ine, for PL 000,000. XYZ’s assets and liabilities have fair 7 a lus ofP1600,000 and 900,000, respectively Additional information: a «Prior to the business combination, ABC granted Xyz, they, to use ABC’s patented technology over a 5-year pejj,, 000 cash (payable at grant date) ang ;,, s sales over the 5-year period. * ABC recognized the P100,000 license fee as deferred jig} (unearned income) and amortized it over 5 years. The carry amount of the deferred liability on January 1, 20x1 is P60 ,y, * On the other hand, XYZ recognized the license {,, prepayment (prepaid asset) and amortized it based on number of products sold. The carrying amount of :, prepayment on January 1, 20x1 is 50,000. * On acquisition date, the fair value of the license agreement |; P120,000. This consists of the following components: = 40,000 “at-market” (based on market participants’ estimates); anc = 80,000 “off-market” (the excess of P120,000 fair value derived fro: cash flow estimates over P40,000 ‘at-market’ value). ¢ The off-market component is favorable to XYZ z unfavorable to ABC, as royalty rates have incr considerably in comparable markets since the initiation of te contract. The contract does not have any cancellation dause ot any minimum royalty payment requirements. exchange for P1 00, yal fees based on XYZ' uy 4 N. Requirement: Compute for the goodwill. Solution: As mentioned in the previous chapter (‘Exceptions ' w measurement principle’), a reacquired right is measured based °’ the remaining term of the related contract, This is in contrast ¥!" other assets which are measured based on market participatio" io of a reacquired right could result Pa aun een the Value derived from market participa estimates. Th ie value) and fair value based on cast a Tight favonatie erence off-market” value) makes a reac or unfavorable from the acquirer's perspective Bust — aa B® Jn the illustration above, 4 sje from the oe a ote marie” value is foes that XYZ is paying ABC are below-market oy: ae ‘ABC recognizes @ settlement loss. ate). Accordingly The pre-existing relationship i settlement loss is measured at ne eee eae we amount and (ii) the settlement amount in the eee pecause the contract does not have a cancellation clause on minimum royalty payment requirement, the settlement loss is measured based on (i), after adjustment for the recognized deferred liability. This is computed as follows: Settlement loss before adjustment (“off-market” value) 80,000 Carrying amount of deferred liability (60,000) Adjusted settlement loss 20,000 — The settlement’ of the pre-existing relationship is a separate transaction. Therefore, the 780,000 “off-market” value is excluded from the consideration transferred on the business combination and treated as payment for the settlement of the pre- existing relationship. ABC recognizes the 40,000 “at-market” value component of the reacquired right as an intangible asset, separate from goodwill, to be amortized over the remaining term of the agreement. The P50,000 prepayment recognized by XYZ is excluded from the identifiable assets acquired and replaced by the intangible asset on the reacquired right. The goodwill follows: is computed as follow®: 7 Consideration transferred (1M 80K ‘off-market value) 920,000 Nor-controlling interest in the acquiree Previ cae jree —_———- ee held equity interest in the acquir 920,000 Fair valu a uired ( a i ssets acd . 690,000 Goodwill / — Journal entries: Jan. | Ydentifiable assets acquired (1.6M +40K~50k) 1,590,000 | ---— aia] Goodwill 230,000 Liabilities assumed 900 69 Cash (1M - 80K) 920, ‘ng | to record the business combination " Jan. | Settlement loss 20,000 ~ agia| Deferred liability 60,000 | Cash 80,069) to record the effective settlement of pre~ | «| existing relationship as a separate transaction from | business combination transaction. | ® Notes: “Off-market” value = used to determine settlement gain or loss from the acquirer's perspective. - excluded from’‘consideration transferred’ and treated as a separate transaction. Total fair value of reacquired right consisting of: “Atmarket” value ~ recognized as intangible asset if it relates toa reacquired right. Ilustration 2: Contractual pre-existing relationship On January 1, 20x1, ABC Co, acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. X¥Z’s assets and liabilities have fait values of P1,600,000 and ?900,000, respectively. Additional information: * ABC and XYZ have a pre-existing supply contract under which ABC could purchase raw’ materials from XYZ 7 discounted rates, The contract has a remaining term of years, which ABC can terminate by paying P100,000 penalty: h The ‘supply contract has a fair value of 160,000, of whi P70,000 is “at-market.” The “off-market” componet * Reguir solutio The PS is unfa recogr settlen amour compt Ss 00 ities fait nder Zz at three ty: 8 ints Combinations (Part 2) unfavorable to ABC because it exceeds the price of of current market transactions for similar items, 19 assets oF liabilities related to the contract were recognized ecognize jneither of ABC’s or XYZ’s books as at the acquisition date. quirement Compute for the goodwill. olution: The 790,000 off-market” value (160K total fair value ~70K ‘at-market value) is unfavorable from the perspective of ABC Co. Accordingly, ABC recognizes a settlement loss. if The pre-existing relationship is contractual. Therefore, the settlement loss is measured at the lower of (i) the unfavorable amount and (ii) the settlement amount in the contract. This is computed as follows: settlement loss (lower of 990K. off-market and ®100K settlement amt) 90,000 Carrying amount of related asset or liability recognized ‘Adjusted settlement loss — The 90,000. “off-market” value is excluded from the don the business combination and treated consideration transferre e-existing relationship (i.e., as payment for the settlement of the pr a separate transaction). The P70,000 “at-markel and not recognized as intany reacquired right. Contrast this with Illustration 7 above. * In Illustration 1, ABC (acquirer) granted the license to XYZ (acquiree). There is reacquived right because ABC (supplier) takes back the license from XYZ (customer) a8 @ result of the o business combination. 4 In Illustration 2, XYZ (acquire) granted the supply contract to ABC (acquirer), There is 110 reacquired right because ABC (customer) gives back the supply contract to XYZ (supplier) as a Tesult of the business combination. 1” value is subsumed in goodwill gible asset because there is 10 cae rr “SS at emi Cade be? Chapter 2 The goodwill is computed as follows: Consideration transferred (IM-90K ‘off-market’ value) 510.5 Non-controlling interest in the acquiree : Previously held equity interest in the acquire ——o Total , 2005 Fair value of net identifiable assets acquired (16M -.9M) (700,0%9) will 2u Goodwi 0,009 Journal entries: Jen. | Identifiable assets acquired 1,600,000 a Goodwill 210,000 Liabilities assumed 900,000 | Cash (1M -90K) 910,000 Jen. | Settlement loss 90,000 ] L Cash 20x1 90,000 Illustration 3: Non-contractual pre-existing relationship On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities have fait values of P1,600,000 and P900,000, respectively. ABC is the defendant on a pending patent infringement suit filed by XYZ. ABC recognized a provision of P130,000 on the lawsuit After the business combination, the disputed patent will be transferred to ABC. The fair value of settling the pending lawsu!t is 100,000. Requirement: Compute for the goodwill, Solution: The 100,000 fair value is excluded from the consideratio® transferred on the business combination and treated as pay™=" for the settlement of the pre-existing relationship (ie, 2 8°P™ transaction). The goo Conside! Nor-con Previous Total Fair valt Goodwi Journal ness combination (Part 2) —~ B 87 The _ pre-existing relationship j : . is non- erefore, the settlement gain or loss i contractual. a) ws ;scomputed as follows: S measured at fair value. for the settlement of pre-exi: a payment Pre-existing relationshi 000 paying amount of related provision Gis Pe | 2 . eee ee There is gain because the liability is settled for a lower amount. the goodwill is computed as follows: Consideration transferred (1M - 100K settlement amt.) 900,000 Nor-controlling interest in the acquiree _ Previously held equity interest in the acquiree - Total et 900,000 Fair value of net identifiable assets acquired (16M -.9M) (700,000) Goodwill ~ 200,000 lities Journal entries: e fair jen, | Identifiable assets acquired 1,600,000 20d | Goodwill 200,000 : Liabilities assumed 900,000 ee = Cash (iM - 100K) ie 900,000 } wsuit in.1, | Estimated liability on pending lawsuit 130,000 : 2x1 : ; ill be Cash 100,000 wsuit L_|___ Settlement gain" Subsequent measurement and accounting the acquirer accown’ Subsequent to acquisition date, anh Acquired, liabilities assumed and equity instruments issued in 2 business combination in accordance with other PERSs rele quently ts for assets lowing are subse aration 7 those items, However, the ‘ol ymens sounted for under PFRS 3: yparate 3 peseauired rights Mnnochieier the acquisition date tingent liabilities recognized of ” be resolved by the occur d. Contingent consideration Reacquired rights , Reacquired rights recognize over the remaining term of the relate d as intangible assets are g Moy d contract. "tag Indemnification assets ; i Indemnification assets are measured on the same basis 4, . indemnified item, subject to assessments of collectability, fa indemnification assets not measured at fair value. Contingent liabilities Contingent liabilities recognized in a business combination 2. measured at the higher of: a. The amount that would be recognized by applying PAs x. and i b. The amount initially recognized less, if appropriate, cumulative amount of income recognized in accordance wit: PERS 15 Revenue from Contracts with Customers. Contingent consideration Contingent consideration is additional consideration for a busines combination that the. acquirer agrees to provide to the acquitt upon the happening of a contingency. A contingency is an existing, unresolved condition that v2 rence or non-occurrence of a possit® future event, ¥ s pean example of a contingent consideration is whe" ® seauirer agrees to issue additional shares to the acquire ®™" Specified conditions are met, such as meeting an earnings tag reaching a specified share Price or reaching a milestone °° research and development Project. Initial recognition and measurement A contingent i it cons: ion j Ve je value and i ideration ig measured at acquisition-date included in the consideration transferred. Busines ea classifi previo met is Subseqi A char from ¢ period | amoun target, a resea adjustr adjustr the con a A Ten wit b. Ac ist fair lustra On Jan of P19 ; all the have fa: In addi former Ncreas¢ the con based o; Requires 1 ie t, pjusiness Combinations (Part 2) 89 The obligation to pay the contr classified either as liability. or e reviously transferred consider met is classified as an asset. “ontingent consideration is equity. A right to recover a ation if specified conditions are Subsequent measurement ‘A change in the fair value of a contingent consideration resulting from additional information obtained during the measurement period is accounted for as a retrospective adjustment to provisional amount. However, changes Tesulting from meeting an earnings target, reaching a specified share price or reaching a milestone on a research and development project are not measurement period adjustments. Changes in fair value that are not measurement period adjustments are accounted for depending on the classification of the contingent consideration: a. A contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity. b. Acontingent consideration classified as an asset or a liability is measured at fair value at each reporting date. Changes in fair value are recognized in profit or loss. Ilustration 1: Contingent consideration classified as equity On January 1, 20x1, ABC Co. issued 10,000 shares with par value of P10 per share and fair value of P100 per share in exchange for all the assets and liabilities of XYZ. XYZ's assets and liabilities have fair values of P1,600,000 and £900,000, respectively. 'n addition, ABC agrees to issue additional 1,000 shares to the former owners of XYZ. if the market price of ABC's shares creases to P120 per share by December 31, 20x1. The fair value of contingent consideration as of January 1, 20x1 is. P90,000, sed on consideration of the vesting conditions. Reauirement; Compute for the goodwill. Chapter 2 Solution: tion transferred (IM +90K contingent consideration) 1090 (44 iderat rans con satroling interest in the a a 7 2 i quire . i 1d equity interest in the a ee ed held eq ‘ai ‘otal . a Fair value of net identifiable assets acquired (6M-9M) —__ (200,19, Goodwill ‘ 390,00 journal entry: = fen. 1] Identifiable assets acquired 1,600,000 20:1) Goodwill 390,000 Liabilities assumed 900,001 Share capital (10,000 x P10 par) 100,000 Share premium [10,000 x (P100-P10)] 900,000 90,000 Share premium - contingent consideration Case #1: The market price of ABC’s shares on December 31, 20x1 is P120. The contingent consideration is settled on January 15, 20x2. Requirement: Provide the journal entries. as __ Solution: Share premium ~ contingent consideration Share capital (1,000 x p10 Par) Share premium (squeeze) 40 record the issuance of 1,000 additional So shares A contingent considerati eration th fi ity i ae Sete hat is classified as equity equity. no sequent settlement is accounted for with pusiness Combinations (art 2) 1 00 case 42: a _ 0 ket price of ABC’s share: The market P 8 shares on December 31, 20x1 is P90. — Require | 009 ea J 200) | galulion: 4000 hare premium - contingent consideration | 90,000 eae Share premium ‘ 20x1 90,000 —, | Regardless of whether the vesting condition is met, the \ amount recognized in equity for a contingent consideration 9,000 | remains in equity. This, however, does not preclude an entity 0,000 | from transferring amounts within equity (i.e., reclassification 0,000 | between equity accounts). 10,000 | Illustration 2: Contingent consideration classified as liability On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities have fair 120. | values of P1,600,000 and P900,000, respectively. | \ ABC agrees to pay additional cash equal to 10% of the 20x1 year- _ end profit that exceeds P400,000. XYZ historically has reported Profits of P300,000 to P400,000 each year. The fair value of the — contingent consideration as of January 1, 20x1 is P10,000, based on assessments of the expected level of profits for the year, as well as, forecasts, plans and industry trends. Requirement: Compute for the goodwill. 30,000 0 30,00 Solution: ide i 010,000 - Consideration transferred (IM + 10K contingent consideration) 10 Q Pprcontrolling, interest in the acquiree . is 101 Tong Us held equity interest in the acquire a wi 700,000) i Ba et 6M- 9M) ,{ Ai value of net identifiable assets acquired Se ond ELS Oodwill 2 Chapter ge Se Journal ent Identifiable assets acquired ] 1,600,000 | 310,000 Goodwill Liabilities assumed ; 0 Liability for contingent consideration 10.609 1,000 r¢¢ Cash A contingent consideration representing an obligation , pay cash or other non-cash assets is classified as liability, ar measured at acquisition-date fair value, even if payment is nc; probable. Continuation of Illustration 2 - Subsequent measurement: | Case #1: | ‘The profit for the year is P550,000. The contingent consideration s | settled on January 15, 20x2. | Requirement: Provide the journal entries. a Solution: Dec. | Unrealized loss - P/L 5,000 ay Liability for contingent consideration 5 | to recognize loss on change in fair value of contingent consideration classified as liability (ee Liability for contingent consideration an es ts. “Carrying amount of contingent consideration « 12/31/20s1 oe Fair value ~ 12/31/20x1 [(550K - 400K) x 10%) a Increase in fair value of liability (loss). a ility” 7 A contingent consideration that is classified as diab! A remeasured to fair value at each reporting date. Change " value are recognized in profit or loss. » QM to and 5 Not 5,000 usiness Combinations (Part 2) (Case #2: ‘the profit for the year is P3009, 099, Solution: Dee. Liability for contingent consideration Gain on extinguishment of liability ~ py 10,000 10,000 The liability is extinguished because th not met. In Cases 1 & 2 above, the fair value changes relate to the meeting and non-meeting of the earnings target, which are not measurement - period adjustments. Accordingly, these are recognized in profit or loss, The recognized goodwill is not affected regardless of the outcome of the contingency. le earnings target is Illustration 3: Contingent payments to employees ABC Co. acquired 90% interest in XYZ, Inc. for P1,000,000. XYZ's assets and liabilities have fair values of P1,600,000 and 900,000, Tespectively. ABC measured the NCI at a fair value of P80,000. Five years ago, XYZ appointed Mr. Boss as the CEO under te Year contract which requires XYZ to pay Mr. Boss P100,000 i u2 is acquired before the -contract expires. ABC assumes Sbligation to pay Mr. Boss the contracted amount. Requirement: Compute for the goodwill. Solutions 94 Chapter 2 My Consideration transferred 1000 Non-controlling interest in the acquiree 80.04 Previously held equity interest in the acquiree ea Total Ts Fair value of net identifiable assets acquired ~ (1.6M - 9M ~ 100K payable to Mr. Boss) (600.0 Goodwill ee — The employment contract existed long before the business combination, and for the purpose of obtaining the services of the CEO. There is no evidence that the agreement was arranged primarily for the benefit of ABC or the combined entity. Therefore the P100,000 obligation is treated as an additional liabiliy assumed rather than an adjustment to the consideration transferred. \ yr 009 chaptel 2: Summa > The acquisition method applies to all business combinations, i including those that do not in 009 inetpees combination is re & Purchase transaction. If a 000 a) with jout transfer of consideration, the fair value of 000 acquirer's interest in the acquiree is substituted for the — consideration transferred in computing for goodwill. — b) by ‘contract alone, all interests not held by the acquirer are the attributed to NCI, even if the resulting NCI is 100%. \ iged « Provisional amounts may be used if accounting is incomplete fore by the end of me business combination year. The provisional sility amounts are adjusted retrospectively for information obtained > during the measurement period (i.e., maximum of 12 months ation from acquisition date) that provides evidence of facts and circumstances that existed as of the acquisition date. « The consideration transferred includes only those that are transferred to the previous owners of the acquire. It excludes those that are retained by the combined entity after the combination and those that are in effect used to settle a pre- existing relationship. : * Areacquired right in a business combination is recognized as an intangible asset measured at the “at-market” value. © The gain or loss on settlement of a pre-existing relationship is measured as follows: 2) If contractual - at the lower of (i) “off-market” value, favorable/unfavorable determined based on the aod s perspective; and (ii) any settlement amount stated in the 6) eae ae non-contractual - at fair valu Retin A contingent consideration is messed ele it fair value and included in the conside Chapter 96 Sota (Notable differences between. and the PFRS for SMEs: the provisions of the fut ppp RS, Full PERSs PERS for SMEs ~~ 6._Previonsly held equity interest in the acquiree In a business combination achieved in stages, the acquirer's previously held equity interest in the acquiree is remeasured to fair value and included in the computation of goodwill. ——— 7._Contingent consideration: Initial measurement: > Included in the consideration transferred at acquisition- ° date fair value. Subsequent measurement: ° > Change in fair value that is: a) a ‘measurement period adjustment’ is adjusted to goodwill. b) not a measurement period adjustment: i. remains in equity, if the contingent consideration is classified as equity ii. is recognized in profit or loss, if the contingent «Consideration is classified as Hability Or asset, No equivalent provision ungo~ PERS for SMEs. IP Initial measurement: > “Included in the cost of business combination if itis probable and can be measured reliably. Subsequent measurement: > Change in fair value is treated as an adjustment to the cost of business combination (i.e, adjusted to goodwill). net id busin increa Rs, LL ito susiness Combinations (wart 2) a pROBLEMS: pROBLEM 1: TRUE OR FALSE 1, Entity A issues 1,000 shares in exchan, shares of Entity B. After the transacti Entity B become owners of 1,000 shares out of the 10,000 outstanding shares of Entity A. Entity A will own all the shares of Entity B. This transaction is not a business combination that is accounted for under PERS 3. Be for all the outstanding ion, the former owners of Use the following information for the next three items: Entity A issues shares in exchange for 100% interest in Entity B’s net identifiable assets with fair value of 80. As a result of the business combination, Entity A’s share capital and share premium increased by 30 and ®70, respectively. 2, The aggregate par value of the shares issued is #30. ' 3. The fair value of the consideration transferred is ®70. 4. The business combination resulted to goodwill of #10. Use the following information for the next four items: Once upon a’ time, Entity A acquired 20% interest in Entity B. After sometime, Entity A acquired additional 50% interest for 9100, at which time, Entity B’s net identifiable assets have a fair value of ®180, the previous investment of Entity A has a carrying amount of ®30 and fair value of 40, and the NCI has a fair value of P60. fo 5. The transaction described above is a ‘business combination achieved in stages’ or ‘step acquisition’. | 6 The 20% pevions eae is ignored when computing for goodwill, . i i * Entity A recognizes a remeasurement gain of #10 in profit or lo 8 The goodwill is #20. «

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