Accounting for Business Combination Reviewer

Business Combination 1. Friendly – the board of directors of the

-operations of 2 or more companies are
brought under common control
Scope of Business Combination (PFRS 3)
1. Combinations involving mutual entities
2. Combinations achieved by contract alone
Not Within the Scope:
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 itself and not the accounting for the
interest in a joint arrangement in the financial
statements of a party to the joint arrangement
2. Where the business combination involves
entities or businesses under common control
3. Where the acquisition of an asset or a group
of assets does not constitute a business
-the term used to indicate this
transaction is “asset acquisition”. In such
circumstances, the acquirer:
1. 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
2. Allocates 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
3. Such transaction or event does not give rise
to goodwill
A Business Combination may be:
potential combining companies negotiate
mutually agreeable terms of a proposed
combination
2. Unfriendly (hostile) – results when the board
of directors of a company targeted for
acquisition resists the combination
Defense Tactics:
1. Poison Pill – issuing stock rights to existing
shareholders
2. Greenmail – purchase of shares held by
acquiring company at a price substantially in
excess of fair value
3. White Knight – encouraging a third firm to
acquire
4. Pac-man Defense – attempting an unfriendly
takeover of the would-be acquired company
5. Selling the Crown Jewels – sale of valuable
assets to make the firm less-attractive to the
would-be acquirer
6. Leveraged Buyouts – purchase of a
controlling interest in the target firm by its
managers and third party investors, who usually
incur substantial debt
7. 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
8. The Mudslinging Defense – when the
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 is the
prospective acquiring (acquirer) company’s
favorable cash position, the prospective
acquiring (acquirer) company my try to rid itself
of this excess cash by attempting to takeover of
its own
Reasons for Business Combination:
1. Cost Advantage
2. Lower Risk
3. Avoidance of Takeovers
4. Acquisition of Intangible Assets
5. Other Reasons
3 Schemes of Business Combination:
1. One based on the structure of the
combination
2. One based on the method used to accomplish
the combination
3. One based on the accounting method used
Structure of Business Combination:
1. Horizontal Integration – when the combining
companies are competitors
2. Vertical Integration – when the combining
companies are in the same industry or when the
combination is between an entity and its
supplier
3. Conglomerate Combination – when the
combining companies are of different industries
or are unrelated
4. Circular Combination
Methods of Effecting Business Combination:
1. Acquisition of net assets
-in statutory merger, when the acquirer
and acquired company enters into a statutory
merger, the acquirer keeps its legal entity and
the acquired one loses its identity
-in a statutory consolidation, both the
companies are dissolved and the assets and
liabilities of both companies are transferred to a
newly created corporation
2. Acquisition of common stock
-both company survives
3. Asset acquisition
Accounting Methods Used for Business
Combination
1. Acquisition Method
2. Purchase Method
Meaning of Control
-having more than 50% of the voting
stocks of a company or have expressly stated
control or influence over the decisions of the
company
-preference shares have no voting rights
-control is present when there is control
over the majority of the BOD even though
interest in the company did not exceed 50%
-when the interest is exactly 50% and
the investor appoints half of the BOD, and
decisions always lie at the directors appointed
by the investor in cases of deadlocks, control is
present
Accounting Concept for Business Combination:
-PFRS 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 true mergers or mergers of equals also are
business combinations
Elements of a Business:
-business is an integrated set of
activities and assets that is capable of being
conducted and managed for the purpose of
providing goods or services to customers,
generating investment income (such as
dividends or interest) or generating other
income from ordinary activities
1. Input
2. Process
3. Output
Accounting for Business Combination:
(acquisition method)
1. Identify the acquirer
2. Determine the acquisition date
3. Calculate the fair value of the purchase
consideration transferred
Acquisition Related Costs
-these are accounted for separately and
excluded from the measurement of the
consideration paid, because such costs are not
part of their fair value of the acquire and are
not assets:
These are expensed when incurred except for
the following:
1. Share issuance costs – deducted from the
share premium/APIC from the related issuance
or debited to “share issuance costs” (a contra
SHE account)
2. Costs to issue debt instrument – included in
the initial measurement of the liability as bond
issue costs and subject to amortization
4. Recognize and measure the identifiable
assets and liabilities of the business
-acquirer should recognize separately
from goodwill, the identifiable assets acquired,
the liabilities assumed and any non-controlling
interests in the acquirer
-identifiable assets acquired and the
liabilities assumed are measured at their
acquisition date fair values; separate valuation
allowances are not recognized
Identifiable Tangible Assets – recognize if:
-it is probable that any associated
future economic benefits will flow to the
acquirer (probability test)
-its fair value can be measured reliably
(reliability test)
1. Current asset – record at estimated FV and
valuation accounts are not used
2. Assets held for sale – record at FV less cost to
sell (PFRS 5)
3. Property, plant and equipment – record at FV
with no valuation account
4. Investments in equity – accounted entities at
FV
Identifiable Intangible Assets – an intangible
asset is identifiable if it:
-can be separated; or
-meets the contractual-legal criterion
(ex. Trademarks, licensing royalties, patents,
copyrights)
1. Existing intangible assets – at estimated FV,
typically uses discounted cash flow analysis
2. Intangible assets not currently recorded by
the acquiree – at estimated FV (ex. Customer
list, in-process research and development
acquired in business combination)
3. Acquiree is a lessee with respect to assets in
use – general rule is assets/liabilities in
operating lease not recognized except when the
terms of the operating lease compared to the
current market rates is: favorable (recognize
intangible asset at discounted present value of
the savings) or unfavorable (recognize
estimated liability at discounted present value
in excess of fair rental rates)
Liabilities – recognize at FV acquired in a business combination that are not
individually identified and separately
1. Current liabilities – FV may likely be equal to
recognized-goodwill acquired in a purchase of
existing recorded values
net assets is recorded on the acquirer’s books
2. Long term liabilities – FV may likely be not as asset, along with the FV of the other assets
equal to existing recorded values if interest and liabilities acquired
changes are material
Items Included in Goodwill:
3. Estimated liability and deferred revenue – FV
1. Acquired intangible assets that is not
at acquisition date may differ from the recorded
identifiable as of acquisition date such as
values
assembled workforce of the acquire
4. Contingent liability –recognize only if: it is a
2. Items that do not qualify as assets at the
present obligation that arises from past events
acquisition date such as potential contracts,
and its fair value can be measured reliably
contingent assets, future contracts renewal
Other Assets/Liabilities:
Gain on Bargain Purchase
1. Employee benefit plans – record liability if the
-this is considered by the members of
projected benefit obligation (PBO) exceeds the
the board (IASB) as an irregular transaction or
plan assets; record asset when the plan asset
rare/unusual event as parties to the business
exceeds the PBO
combination do not deliberately sell assets at
2. Indemnification assets – the acquiree may amount lower that their FV
contractually indemnify the acquirer for the
-the gain is attributable to the acquirer
outcome of a contingency or uncertainty
only and is recognized in its statement of
related to all or part of the specific
comprehensive income or income statement
asset/liability; the effects of uncertainty about
future cash flows due to collectability Before this is recognized, an entity should first
considerations are included in the FV measure; reassess whether:
no separate valuation allowance
1. It has correctly identified all the assets
3. Income taxes – deferred tax assets or acquired and liabilities assumed
liabilities are measured at undiscounted
2. It has correctly measured at FV all the assets
amounts
acquired and liabilities assumed
4. Employee benefits – liabilities/assets
3. It has correctly measured the consideration
referring to all types of employee benefit
transferred
arrangement shall be in accordance with PAS 19
requirements Formula:
5. Recognize and measure either goodwill or a =consideration transferred + non-
gain from a bargain purchase, if either exists in controlling interest in the acquiree + previously
the transaction held equity interest in the acquire (for business
combination achieved in stages less FV of the
Goodwill
identifiable net assets acquired = goodwill or
-this is an asset representing the future gain on bargain purchase
economic benefits arising from other assets as
Use of Provisional Values
-if the initial accounting for a business
combination is incomplete by the end of the
reporting period in which the combination
occurs, the financial statements should be
prepared using provisional amounts for the
items for which the accounting is incomplete
-PFRS 3 permits adjustments to items
recognized in the original accounting for a
business combination as long as it is within the
measurement period
Contingent Consideration
-PFRS 3 requires that all contractual
contingencies, as well as non-contractual
liabilities for which it is more likely than not that
an asset of liability exists, be measured and
recognized at fair value on the acquisition date.
This includes contingencies based on earnings,
guarantees of future security prices, and
contingent payouts based on the outcome of a
lawsuit
-the contingency’s fair value on
acquisition date is recognized as part of the
acquisition regardless of whether based on
future performance of the target firm or the
future stock prices of the acquirer. These two
contingencies will result to two contingent
considerations either as equity or cash/liability
1. Future Performance
2. Future Stock Prices
Measurement Period
-is the period after the initial acquisition
date during which the acquirer may adjust the
provisional amounts recognized at the
acquisition date. This period allows a
reasonable time to obtain the information
necessary to identify and measure the fair value
of the acquiree’s assets and liabilities, as well as
the fair value of the consideration transferred
Measurement Period ends at the earlier of:
1. One year from the acquisition date, or
2. The date when the acquirer receives needed
information about facts and circumstances
-adjustments to provisional amounts
that are made during the measurement period
are recognized as if the accounting for business
combination had been completed at the
acquisition date
Retrospective Adjustment
-the adjustments to provisional
amounts should be recognized as if the
accounting for business combination had been
completed on the acquisition date. Therefore,
comparative information for prior periods
presented in the financial statements is revised,
including making any change in depreciation,
amortization or other income effects recognized
in completing the initial accounting
1. Adjustments to recognized items
2. Adjustments to unrecognized items
3. Information to be considered
4. Revising goodwill
Adjustments after the Measurement Period:
-after the measurement period, any
correction of errors will be deemed as a prior-
period adjustment in accordance with PAS 8:
Accounting Policies, Changes in Accounting
Estimates and Errors
-subsequent to the business
combination, PFRS 3 provides guidance on the
measures to be used
-where the contingent consideration
the acquirer measures the fair value of the
contingency at each reporting date until the
contingency is resolved, it is within the scope of
PFRS 3
 -it should be noted that the subsequent
accounting for contingent consideration is to
treat it as a post-acquisition event that is not
affecting the measurements made on
acquisition date. Hence, any subsequent
adjustments do not affect the goodwill
calculated on acquisition date
To the Liquidation Account are transferred:
1. All assets taken over by the acquirer,
including cash if relevant, as well as any asset
not taken over and which have a zero value
including goodwill
2. All liabilities taken over
3. The expenses of liquidation if paid by the
acquire
4. Additional expenses to be paid by the acquire
but not previously recognized by the acquire
5. Consideration from the acquirer as proceeds
on sale of net assets
6. All reserves including retained earnings
To the Shareholders’ Distribution Account are
transferred:
1. The balance of share capital
2. The balance of the liquidation account
3. The portion of the consideration received
from the acquirer that is distributed to the
shareholders. Some of the consideration
received by the acquire may be used to pay for
liabilities not assumed by the acquirer and for
liquidation expenses
Business Combinations with no transfer of
consideration
-PFRS 3 requires an acquirer to be
identifies, and acquisition method to be
applied. Examples include such circumstances
as:
1. When the acquirer repurchases a sufficient
quantity of its shares from other shareholders
such that the acquirer, who previously was a
minority owner of the acquire, now is the
majority shareholder of the acquire and control
it
2. When the acquirer owns the majority of the
acquiree’s voting shares but had previously
been prevented from exercising control by
regulation or by contract – if that restriction
lapses or is removed, the acquirer now gains
control over the acquire
3. By contract alone
Combinations by Contract Alone
-such structures may involve a stapling
or formation of a dual listed corporation
(example: operation under a single
management and equalization of voting power
and earnings attributable to both entities’
equity investors)
Chapter 2: Separate and Consolidated Financial
Statements – Date of Acquisition
-in acquiring a company, an acquirer
must allocate its purchase price to the fair value
of the underlying assets and liabilities acquired.
The acquiring company is generally referred to
as the parent and the acquired company as a
subsidiary
-that holding any remaining stock in a
subsidiary is referred to as the non-controlling
interest. Any joint relationship is termed an
affiliation, and the related companies are called
affiliated companies
-each of the affiliated companies
continues its separate legal existence, and the
investing company carries its interest as an
investment
-the affiliated companies continue to
account individually for their own assets and
liabilities, with the parent company reflecting
the investment on its books in a single account,
investment in subsidiary. This account will
ultimately be eliminated in the consolidation
process to produce a set of consolidated
financial statements. However, the investment
account will be maintained in the parent
records.
The Levels of Investment
-the acquisition of common stock of
another company receives different accounting
treatments depending on the level of ownership
and the amount of influence or control caused
by the stock ownership
1. Passive Investment (generally under 20%
ownership)
-initial recording: at cost including
broker’s fees
-recording of income: dividends as
declared, except stock dividends (using cost
model)
2. Strategic (Active) Investment
2.1. Influential (generally 20% to 50%
ownership)
-initial recording: at cost including
broker’s fees
-recording of income: ownership share
of income (or loss) is reported. Shown as
investment income on financial statements.
Dividends declared are distributions of income
already recorded; they reduce the investment
account (equity method)
2.2. Controlling (generally over 50% ownership)
-initial recording: at cost
-recording of income: ownership share
of income (or loss). Accomplished by
consolidating the subsidiary income statement
accounts with those of the parent in the
consolidation process (cost model, equity
method, and fair value option)
Note: the term “investor” is used when
ownership in common stock is 50% or less,
“acquirer” is more than 50% or 51% or more
-under passive investment, the investor
included only its share of the dividends declared
by the investee as its income
-under influential ownership interest,
the investor reported portion of the investee
income as a separate source of income
-with a controlling interest, the investor
(now termed the parent) merges the investee’s
(now a subsidiary) nominal accounts with its
own amounts. Dividend and investment income
no longer exist
-a single set of financial statements
replaces the separate statements of the
entities. If the parent owned 100% interest, net
income would simply be reported as a
consolidated net income. If the parent owned
less than 100% interest, the net income must be
shown as distributed between the controlling
interest is the parent income plus portion of the
subsidiary income, and the non-controlling
interest is the portion of the subsidiary not
owned by the parent
Acquisition of Net Assets versus Acquisition of
Stock (voting)/Equity
Group
-which comprises a parent and its
subsidiaries, is a type of business combination
-a group is a business combination in
which the acquirer is a parent and the acquire is
a subsidiary
-business combination results from the
parent acquiring a controlling interest in the
equity (not net assets) of the subsidiary
 -in this business combination, both
parent and subsidiary retain their status as
separate legal entities. However, from an
economic perspective, they are a single
reporting entity
2 Financial Statements to be prepared:
1. Separate Financial Statements
2. Consolidated Financial Statements
Consolidation – business combination that
results to a parent-subsidiary relationship
Classification of Intercorporate Investment
-an intercorporate investment is any
purchase by one corporation of the securities of
another corporation. The investment may be
either debt securities or equity securities
(preferred or common shares)
Classification of investment in equity of another
corporation:
1. Passive Investment
2. Strategic (active) Investment
1. Passive Investment
-made to earn dividends or to earn
profits by actively trading the investment for
short-term profit
-initially recorded at cost
-reported at fair market value on each
period’s statement of financial position or
balance sheet
-the treatment of gains or losses
depends on how the company has elected to
classify the investment – a choice that the
reporting entity makes for each separate
passive equity investments when the
investments is first made
Choices of reporting an investment:
1. Fair Value Through Profit or Loss (FVTPL) –
both dividends and changes in fair value from
one period to another are reported in the net
income section of the statement of
comprehensive income (SCI)
2. Fair Value Through Other Comprehensive
Income (FVTOCI) – dividends from that
investment are recognized in net income.
Changes in the fair value of the investment are
reported as other comprehensive income (OCI).
The accumulated gains and losses are reported
as a separate component of stockholders’
equity. The choice to classify an equity
investment as FVTOCI is irrevocable – the choice
cannot be changed subsequently
2. Strategic (active) Investment
-provide a strategic or long-term
advantage by giving the investor the ability to
either significantly influence or control the
operating or financial decisions of an investee
-investments are considered strategic if
a company owns, directly or indirectly, 20% or
more of the voting shares of the investee,
unless it can be clearly demonstrated that the
investments are passive
Equity Investments and Reporting Methods
under PFRS
-sole control, subsidiary/structured
entity = consolidate (PFRS 10) and disclose
(PFRS 12)
-joint control, rights over individual
assets and liabilities of joint arrangement, joint
operation = report share of assets, liabilities,
revenues and expenses and disclose (PFRS 12)
-joint control, joint venture = equity
method (PAS 28) and disclose (PFRS 12)
-significant influence, associate = equity
method (PAS 28) and disclose (PFRS 12)
 -passive investment = FVTPL or FVTOCI
(PFRS 9)
-reporting is not the same as recording.
Consolidated amounts never appear on the
parent company’s book, reported numbers are
the results of spreadsheet analysis, either
computer-based or manual
2 General Types of Controlled Entities
1. Subsidiaries
2. Structured entities or variable interest
entities (VIE)
Subsidiary
-the most common type of controlled
entity
-a corporation (or an unincorporated
entity such as a partnership or trust company)
that is controlled by a parent company that
owns, usually, a majority of the voting shares or
rights of the subsidiary. Since stockholders elect
a corporation’s board of directors, holding most
of the shares enables a parent company to
control the composition of the subsidiary’s
board
Consolidation
-is the process of combining the assets,
liabilities, earnings and cash flows of a parent
and its subsidiaries as If they were one
economic entity
-a parent is an entity that controls one
or more subsidiaries. A group is a parent and all
its subsidiaries
3 Elements of Control
-an investor determines whether it is a
parent or when it controls one or more
investees
-PFRS 10 uses control as the single basis
for consolidation. All elements have to be
present
1. Power over the investee – power is the ability
to direct those activities which significantly
affect the investee’s returns. It arises from
rights, which may be straightforward (such as
through voting rights) or complex (such as
through one or more contractual arrangements)
2. Exposure, or rights, to variable returns – from
involvement with the investee. Return must
have the potential to vary as a result of the
investee’s performance and can be positive,
negative or both
3. The ability to use power over the investee –
to affect the amount of the investor’s returns
Power arises from rights
-such rights can be straightforward
(such as through voting rights)
-an investor that holds only protective
rights cannot have power over an investee and
so cannot control an investee
-power can be obtained directly from
ownership of the majority of the voting rights or
can be derived from other rights, such as rights
to appoint, reassign or remove key
management personnel who can direct the
relevant activities, rights to appoint or remove
another entity that directs relevant activities,
rights to direct the investee to enter into or
veto changes to, transactions for the benefit of
the investor and other rights, such as those
specified in a management control
-in assessing whether control exists, an
investor with decision making rights should
establish whether it is acting as a principal or
agent of other parties
 -an investor that is an agent does not
control an investee when it exercises decision-
making rights delegated to it
The Default Presumption
-the presumption is that ownership of
more than 50% of voting power constitutes
control, in the absence of any evidence to the
contrary
-however, control also arises from many
other sources such as statute, contractual
arrangements and implicit or explicit control
over the board of directors among others
-an investor’s separate financial
statements reflect the legal interest in the
investment and its direct benefits (dividends)
rather than the larger economic entitlements
(share of profits) that is brought by control or
significant influence or contractual arrangement
or joint control
-as economic entities are enlarged
through control or significant influence or
contractual arrangement or joint control that an
investor possesses over the financial and
operating policies of subsidiaries and associates
respectively, another level of reporting is
required. This level of reporting is described as
the consolidated financial statements that
present the financial statements of a group as
those of a single economic entity
-when the parent acquires a controlling
interest in the subsidiary, the parent makes an
entry debiting investment in subsidiary and
crediting cash or other considerations
The Parent’s Investment Account
-represents the parent’s investment in
the different asset and liability accounts of the
subsidiary and often includes a significant
amount of goodwill. However, it is recorded in a
single account entitled investment
-the subsidiary, in contrast, continues to
keep its detailed books based on historical book
values. These values are not as current as the
market value assessed by the parent at the date
of acquisition, but they are detailed as to
classification
-the purpose of consolidated
statements is to present, primarily for the
benefit of the owners and creditors of the
parent, the results of operations and the
financial position of a parent company and all
its subsidiaries as if the consolidated group
were a single economic entity
-consolidated statements ignore the
legal aspects of the separate entities but focus
instead on the economic entity under the
control of management. The presumption is
that most users of financial statements prefer
to evaluate the economic entity rather than the
legal entity. It is an example of focusing on
substance rather than form
Investments at the Date of Acquisition
-under the acquisition method, the
stock investment is recorded at its cost as
measured by the fair value of the consideration
given or the consideration received, whichever
is more clearly evident
-recall that the consideration given may
be in form of cash, other assets, debt securities,
stock of the acquiring company, any form of
asset or a combination of those items
Treatment of Acquisition-related Direct Costs in
the Separate Financial Statements (or Parent’s
Books)
-in acquisition of net assets, acquisition-
related direct costs are treated as expenses
-treatment of acquisition-related direct
costs in the books of parent entity, does not
affect the computation of goodwill, only the
manner of recording such costs in the books of
the parent entity
-after the separation of PAS 27
(Separate Financial Statements) and PFRS 10
(Consolidated Financial Statements), there is an
argument that the basis of PAS 27 is not
anymore PFRS 3 and the basis for determination
of costs will now be under the general rule of
recording costs, which includes direct
acquisition costs as part of the investment
acquired
-in the process of preparing the
consolidated statement, the acquisition-related
direct costs become consolidated expense
through working paper eliminating entries
-acquisition-related direct costs are not
capitalizable
-the original treatment of acquisition-
related direct costs whether for business
combination or separate or consolidated
financial statements will still be treated as
expenses in the books of the parent entity for
the following reasons:
1. To capitalize the acquisition-related direct
costs as part of investment seems to defeat the
purpose or substance of the standard which
serves as a guide for consolidation procedures
(even in some cases, stand-alone financial
statement would be possible)
-acquisition fee would be recorded in a
separate entry as an expense or retained
earnings (since only balance sheet accounts are
being examined)
2. If the parent records the direct costs as part
of investment in subsidiary, it may be a problem
when there will be an impairment test which
will reveal the costs (wherein the direct costs
are already included and will be included in the
impairment) and in fact unrecoverable, and
there must be an impairment charge at the
parent level (in which the direct costs is
included as part of the investment to be
impaired when in the consolidated statements
they are not impaired since they will be set-up
as an expense), which would have the effect of
bringing the parent’s accounting (with the
impairment of the investment including direct
costs) in line with what would later appear on
the consolidated financial statements
-it should be noted that the
computation of goodwill (or bargain purchase
gain) under the 2 assumptions are still the same
The Acquisition Analysis (Schedule of
Determination and Allocation of Expenses)
-as noted in paragraph 33 of PFRS 3,
where the business combination occurs by the
parent exchanging its equity interests for the
equity of the former owners of the subsidiary,
the acquisition-date fair values of the acquiree’s
interests may be more reliably measurable than
that of the acquirer’s interests
-at acquisition date, an acquisition
analysis is undertaken to determine if there has
been any goodwill acquired or a bargain
purchase has occurred
-acquirer shall measure goodwill as
excess of the aggregate of the consideration
transferred (at acquisition date fair value),
amount of any non-controlling interest in the
acquire and acquirer’s previously held equity
interest in the acquire (at acquisition date fair
value in case of business combination achieved
in stages), and the net of the acquisition date
mounts of the identifiable assets acquired and
the liabilities assumed
-where the latter exceeds the former, it
gives rise to a gain from a bargain purchase
Consolidation of wholly-owned subsidiary
-when one company acquires another,
the acquirer’s fair value is based on the
consideration given may be equal, more than or
less than book value
-in case there will be a difference
between the fair value of the subsidiary and the
book value of the acquiree’s net identifiable
assets, this is referred to as allocated excess
Consolidation of partially-owned subsidiary
-problem here arises as to the
determination and recognition of goodwill and
non-controlling interests
Methods of Measuring Goodwill and Non-
Controlling Interests:
1. Full-Goodwill Approach or Fair Value Basis
2. Partial-Goodwill Approach or Proportional
Basis
Full-Goodwill Approach/Fair Value Basis
-non-controlling interests are measured
at fair value, goodwill attributable to non-
controlling interests will be recognized in the
consolidated financial statements
3 Components of Non-Controlling Interests
under Fair Value Basis:
1. Share of book value of identifiable net assets
of subsidiary
2. Share (fair value – book value) of identifiable
net assets of subsidiary at acquisition date
3. Share of goodwill in subsidiary at acquisition
date
-under the fair value basis, non-
controlling interests are determined with
reference to either active market price of equity
shares of the subsidiary at acquisition date or
other valuation techniques
-fair value per share of non-controlling
interests may differ from fair value per share of
the acquirer because a control premium may be
paid by the acquirer
Partial-Goodwill Approach/Proportional Basis
-non-controlling interests are measured
as a portion of the acquiree’s identifiable net
assets
Components of Non-Controlling Interests under
Proportional Basis:
1. Share of book value of identifiable net assets
of subsidiary
2. Share (fair value – book value) of identifiable
net assets of subsidiary at acquisition date
-non-controlling interests’ share of
goodwill (NCI-goodwill) is not recognized under
proportional basis
Goodwill
-an unidentifiable asset in which its
existence is an important motivation for a
parent to acquire a subsidiary
-is the premium that a parent pays to
acquire the subsidiary and should be separately
recognized as an asset in the consolidated
financial statements
2 Methods of measuring Goodwill:
1. Full-Goodwill Approach
-if non-controlling interests are
measured at full-fair value, goodwill recognized
in the consolidated financial statements will
include non-controlling interest’s share of
goodwill
2. Partial-Goodwill Approach
-if non-controlling interests are
measured at the proportionate share of the
value of the net identifiable assets acquired,
non-controlling interests’ share of goodwill is
not recognized under this second option
Entity (Economic Unit) Theory
 -under the entity theory, non-
controlling interests are deemed to be as
important as a stakeholder of the combined
entity similar to the majority shareholders
-the distinction between parent and the
non-controlling interests are both included in
equity
-entity theory requires a consistent
accounting treatment for both parent and non-
controlling interests
Under the Entity Theory:
1. The consolidated financial statements should
be prepared and presented for the benefit of
both groups of equity holders
2. Non-controlling interests are shown as equity
in the balance sheet
3. The accounting equation will be controlling
and non-controlling interests equals
consolidated assets less consolidated liabilities
-the implicit consolidation theory
underlying PFRS 3
-PFRS 3 permits the recognition of non-
controlling interest’s share of goodwill
-the fair value of assets and liabilities of
subsidiaries at the date of acquisition should be
reported in full to reflect the stakes of both
parent company and non-controlling
shareholders’ interests in the net assets of the
subsidiaries
-a consistent accounting treatment is
applied to both parent’s and non-controlling
shareholders’ interests in the net assets of a
subsidiary
-hence, if the assets and liabilities of an
acquired subsidiary are shown at fair values at
the date of acquisition, non-controlling interests
are also deemed to have a share of the fair
value increment arising from the revaluation of
net assets to fair value
-goodwill is an asset of the economic
unit, and should be reflected in full. Internally
generated goodwill that is not evidenced by an
exchange transaction is recognized in full as of
the date of acquisition
-net profit of the subsidiary should be
reported in full as accruing to both majority and
non-controlling shareholders. Non-controlling
interests’ share of current profit is not shown as
a deduction of profit
Differences between Parent Theory and Entity
Theory
-fair value differences in relation to
identifiable assets and liabilities at the date of
acquisition are recognized only in respect of
parent’s share under parent theory. Under
entity theory, it is recognized in full, reflecting
both parent’s and non-controlling interests
share of the fair value adjustments
-under parent theory, non-controlling
interests are presented neither as equity nor
debt while in entity theory, it is presented as
part of equity
-under parent theory, goodwill is a
parent’s asset. Under entity theory, goodwill is
an entity asset and should be recognized in full
as at date of acquisition
Control Premium/Control Discount
Control Premium
-is an amount that a buyer is usually
willing to pay over the current market price of a
publicly traded company
-is usually justified by the expected
synergies, such as the expected increase in cash
flow resulting from cost savings and revenue
enhancements achievable in the merger or
consolidation
Control Discount
-often arises in a fire sale
-discount for lack of control
-sometimes called a non-controlling
interest discount
Control achieved in 2 or more transactions
(Step Acquisition)
-business combination achieved in
stages
Nature and Presentation of Non-Controlling
Interest (NCI)
-non-controlling interests are the
ownership interests in a subsidiary other than a
parent
-NCI is the equity in a subsidiary not
attributable, directly or indirectly, to a parent
-NCI is to be identified and presented
within equity, separately from the stockholders’
equity. It is regarded as an equity contributor to
the group (a parent and all its subsidiaries)
rather than a liability. This is because NCI does
not meet the definition of a liability as
contained in the framework, because the group
has no present obligation to provide economic
outflows to the NCI
-the NCI receives a share of
consolidated equity, and is therefore a
participant in the residual equity of the group
-the fair value option permitted for
non-controlling interests brings revised PFRS 3
closer to the entity theory. The entity theory
upholds consistency in accounting
measurements of the assets and liabilities of
the combined entity, regardless of who the
stakeholders are
-the entity theory does not support a
fragmented valuation model as embodied in the
parent theory, which focuses on information
primarily for the shareholders of the parent
company
-however, the second alternative
permitted by PFRS 3 with respect to recognizing
non-controlling interests as a proportion of fair
value of identifiable net assets and not full fair
value is a move away from the entity theory
-although the entity theory is not
without its critics, it provides a conceptual basis
to recognize, measure and present non-
controlling interests in a consistent framework
-non-controlling interests share of
losses in a subsidiary may exceed their share of
the subsidiary’s share capital, retained earnings
and other equity items. PFRS 10 requires the
non-controlling interests to have a deficit
balance under such circumstances
Other Applications of the Entity Theory to Non-
Controlling Interests
1. Non-controlling interests shall be presented
in the consolidated statement of financial
position within equity separate from the equity
of the owners of the parent
2. Profit or loss and each components of other
comprehensive income are attributed to the
owners of the parent and to the non-controlling
interests. Total comprehensive income is
attributed to the owners of the parent and to
the non-controlling interests even if this results
in the non-controlling interests having a deficit
balance
-under the entity theory, the
depreciation and amortization of fair value
differentials that affect the majority interests
also apply to the non-controlling interests
Consolidated Financial Statements
-the concept that drives all
consolidation procedures is that the
consolidated financial statements should show
only the results of transactions with outsiders
-the effects on the accounts of
transactions between the parent company and
its subsidiaries or between subsidiaries should
always be eliminated
-these are the statements prepared for
a parent company and its subsidiaries
-they include the full complement of
statements normally prepared for a separate
entity and represent essentially the sum of the
assets, liabilities, revenues and expenses of the
affiliated after eliminating the effect of any
transaction among the affiliated companies
Consolidation Procedures using the Acquisition
Method: General Approach
2 Sets of Accounts that has to be prepared:
1. The investor’s separate financial statements
2. Consolidated or group financial statements
(only one set of books or ledgers has to be kept
by the legal entity)
-there are no ledgers kept for the group
entity. Instead, consolidation worksheets are
prepared at the end of each reporting period,
which combine the separate financial
statements of a parent and its subsidiaries and
include consolidation elimination entries and
adjustments to remove the results of
intercompany transactions
-consolidated statements are prepared
from the point of view of the shareholders of
the parent company
Items to be noted in preparing consolidated
financial statements:
1. Consolidation adds the elements of the
financial statements of subsidiaries and
structured entities to those of the parent
2. On the balance sheet/statement of financial
position (SFP), there will be no investment
account for the controlled subsidiaries and
structured entities (SEs). Instead, the assets and
liabilities of the controlled entities will be added
to those of the parent to show the economic
resources of the entity
3. On the statement of comprehensive income
(SCI), the revenues and expenses will be the
totals for each item for the parent plus the
controlled entities
4. The effects of any and all intercompany
transactions will be eliminated to avoid double-
counting
RmEAR (steps for consolidation)
-the RmEAR steps to consolidation at
the end of the first year following acquisition
and end of the second year or later years
following acquisition
-Rm (reliability measurement), E
(eliminate), A (amortize), R (recognize)
1. The Reliability measurement steps to:
a. Calculate cost and fair value adjustments
(FVA)
b. Allocate FVA through over/undervaluation of
assets and liabilities
-this step involves determination of the
fair value of the subsidiary and
over/undervaluation of identifiable assets and
liabilities in the schedule of determination and
allocation of excess
-in theory, acquisition method of
accounting combines the carrying values of the
parent with the fair values (at date of
acquisition) of the purchased subsidiaries
-the FVA is first allocated to the various
identifiable assets and liabilities of the acquiree
to the full extent of their fair value increments
(or decrements). Any excess of the FVA after
the allocation process is allocated to goodwill
2. The eliminate step requires to:
a. Identify and eliminate all intercompany
transactions and balances
b. Calculate and eliminate any unrealized profits
(or loss) relating to the intercompany sale of
inventory and fixed assets in the current period
c. Calculate and recognize the profit (or loss) in
the current year on the sale of inventory and
fixed assets in previous periods
3. The amortize step requires to:
a. Amortize the FVA allocated various
identifiable assets and liabilities (such that the
over/undervaluation relating to those assets
and liabilities) in the current and previous
periods
b. Write-off any impairment of goodwill and
other intangible assets with indeterminate
useful lives in the current and previous periods
c. Find the balance of the allocated FVA
remaining unamortized and unimpaired at the
end of the current period
4. Recognize non-controlling interests’ (NCI)
share of earnings
a. Recognize NCI share of earnings
b. Calculate NCI for balance sheet purposes
c. Calculate consolidated retained earnings
Direct Approach vs Workpaper Approach to
Consolidation
Direct Approach
-prepares the consolidated statements
be setting up the income statement/statement
of comprehensive income SCI and SFP formats
and computing each consolidated balance
directly. Each asset, liability, revenue and
expense is separately calculated and entered
into the consolidated statement. The direct
approach works from the separate entity
financial statements of the parent and the
subsidiary
Workpaper Approach
-an alternative method
-the worksheet (or spreadsheet)
approach uses a multi-columnar worksheet to
enter the trial balances of the parent and each
subsidiary. Then eliminations and adjustments
are entered onto the worksheet, and the
accounts are cross-added to determine the
consolidated trial balance
Which approach to use?
-the direct approach is spontaneously
because we are working directly with the
statements and can see clearly what is
happening to the consolidated statements as
eliminations and adjustments are posted. When
the statements to be consolidated are fairly
simple, it is quite feasible to compile the
consolidated statements by the direct method
-the workpaper approach is less
spontaneous
-both approaches yield the same result
Consolidated Balance Sheet: The Use of
Workpapers (Wholly-Owned)
-assets and liabilities are summed in
their entirety, regardless of whether the parent
owns 100% or a smaller controlling interest
-the non-controlling interests are
reflected as a component of owner’s equity.
This interest may be referred to as either the
non-controlling interest in net assets or as the
non-controlling interest in equity (these terms
are identical) and is abbreviated as NCI
 -in as much as the parent and its
subsidiaries are being treated as a single entity,
eliminations must be made to cancel the effects
of transactions among them. Intercompany
receivables and payables
-any intercompany profits in assets
arising from subsequent transactions must be
eliminated, because an entity cannot profit on
transactions with itself. A workpaper is
frequently used to summarize the effects of the
various additions, eliminations and so forth
Intercompany Accounts to be eliminated:
(Parent)
1. Investment in subsidiary
2. Intercompany receivable (payable)
3. Advances to subsidiary (from subsidiary)
4. Interest income (expense)
5. Dividend income (dividends declared)
6. Management fee received from subsidiary
Intercompany Accounts to be eliminated:
(subsidiary)
1. Book value of stockholder’s equity and
over/under valuation of assets and liabilities
2. Intercompany payable (receivable)
3. Advances from parent (to parent)
4. Interest expense (income)
5. Dividends declared (dividend income)
6. Management fee paid to parent
-eliminating entries are made to cancel
the effects of intercompany transactions and
are made on the workpaper only
1. The first entry eliminates the book value of
the stockholders’ equity accounts of the
subsidiary with its equivalent amount against
Investment is subsidiary
2. The balances in the investment account will
be attributable to allocated excess (excess of
cost over book value) that must be assigned to
other subsidiary accounts in the consolidation
-the allocated excess represents the
total amount of additional net upward
valuations that must be made in the subsidiary’s
net assets upon consolidation
When Subsidiary has a recorded goodwill at
acquisition date
-from the perspective of its new parent,
the goodwill is not considered to be an
identifiable asset at the time of the business
combination. The adjusted allocated excess or
the acquisition differential is calculated as if the
goodwill had been written off by the subsidiary,
even though in fact this is not the case
-the adjusted allocated excess or the
acquisition differential is allocated first to the
fair value excess for identifiable net assets, and
then the remaining balance goes to goodwill. In
effect, the old goodwill is ignored and the
acquisition cost determines the value, if any, of
new goodwill at the date of acquisition
Partial-goodwill approach
-under the partial-goodwill approach,
the NCI is measured at the NCI’s proportionate
share of the acquiree’s identifiable net assets
-the NCI therefore does not get a share
of any equity relating to goodwill. The only
goodwill recognized is that acquired by the
parent in the business combination – hence, the
term partial goodwill
Full-goodwill approach
-under the full-goodwill method, at
acquisition date, the NCI in the subsidiary is
measured at fair value. The fair value is
determined on the basis of the market prices
for shares not acquired by the parent, or, if
these are not available, a valuation technique is Items to be noted when preparing the balance
used. It is not sufficient to use the consideration sheet?
paid by the acquirer to measure the fair value of
1. The balance sheet of the consolidated
the NCI
company immediately after the business
Subsidiary’s Treasury Stock combination is prepared by combining the fair
value of the net assets of legal parent or the
-a subsidiary may hold some of its own
acquire, including the goodwill from the
shares as treasury stock at the time the parent
combination, with the carrying amount of the
company acquires its interest
net assets of the legal subsidiary or the acquirer
-recall that treasury stock is a contra-
2. The stockholders’ equity of the legal
equity account, which has a debit balance on
subsidiary or the acquirer becomes the
the books of the subsidiary
combined stockholders’ equity of the company
-the computation of the percentage
3. The number of shares shown as issued is the
interest acquired, as well as the total equity
number of outstanding shares of the legal
acquired, is based on shares outstanding and
parent or the acquire
should, therefore, exclude treasury shares
Are there non-controlling interests in a reverse
Reverse Acquisition (Takeovers)
acquisition?
-occurs when an enterprise obtains
-non-controlling interests is zero, if all
ownership of the shares of another enterprise
of the legal subsidiary’s stockholders accept the
but, as part of the transaction, issues enough
offer to exchange their shares
voting shares as consideration that control of
the combined enterprise passes to the -if not all the legal subsidiary’s
shareholders of the acquired enterprise stockholders agree to exchange their shares,
there will be non-controlling interests
-although, legally, the enterprise that
issues the shares is regarded as the parent or Fair Value Adjustment Calculations
continuing enterprise, the enterprise whose
-fair value is defined under PFRS 13 as
former shareholders now control the combined
the price that would be received to sell an asset
enterprise is treated as the acquirer for
or paid to transfer a liability in an orderly
reporting purposes
transaction between markets at the
-as a result, the issuing enterprise (the measurement date
legal parent) is deemed to be the acquire and
-goodwill was calculated as the
the company being acquired in appearance (the
difference between the cost of investment and
legal subsidiary) is deemed to have acquired
the book value of the net assets acquired by the
control of the assets and business of the issuing
group
enterprise (the legal parent is effectively the
acquire while the legal subsidiary is effectively 2 Ways of Proper Fair Value Calculation:
the acquirer, although the legal parent is the
entity that issues shares to acquire a legal 1. No push-down accounting
subsidiary, a reverse acquisition is often -the revaluation may be made as a
initiated by the legal subsidiary) consolidation adjustment without being
incorporated in the subsidiary company’s books
 -there is a need to make necessary
adjustments to the subsidiary’s balance sheet as
eliminating entries
2. Push-down accounting
-the subsidiary company might
incorporate necessary revaluations in its own
books of account
-in this case, we can proceed directly to
the consolidation, taking asset values and
equity accounts figures straight from the
subsidiary company’s balance sheet
-fair values are pushed-down to the
acquiree’s books
-this is not in compliance with PFRS 10
Exclusion of a Subsidiary from Consolidation
-where a parent controls one or more
subsidiaries, PFRS 10 requires that consolidated
financial statements are prepared to include all
subsidiaries, both foreign and domestic other
than those held for sale in accordance with
PFRS 5 and those held under such long-term
restrictions that control cannot be operated
-the rules on exclusion of subsidiaries
from consolidation is strict, because this is a
common method used by entities to manipulate
their results
-if a subsidiary that carries a large
amount of debt can be excluded, then the
gearing of the group as a whole will be
improved. In other words, this is a way of taking
debt out of the consolidated balance sheet
-PFRS 10 is clear that a subsidiary
should not be excluded from consolidation
simply because it is a loss making or its business
activities are dissimilar from those of the group
as a whole
-exclusion on these grounds is not
justified because better information can be
provided about such subsidiaries by
consolidating their results and then giving
additional information about the different
business activities of the subsidiary
Different Reporting Dates
-in most cases, all consolidated
companies will prepare accounts to the same
reporting date
-however, on or more subsidiaries may
prepare accounts to a different reporting date
from the parent and a bulk of other subsidiaries
in the group
-in such cases, the subsidiary may
prepare additional statements to the reporting
date of the rest of the group, for consolidation
purposes
-if this is not possible, the subsidiary’s
account may still be used for the consolidation
provided that the gap between the reporting
dates is 3 month or less
Uniform Accounting Policies
-consolidated financial statements
should be prepared using uniform accounting
policies for the transactions and other events in
similar circumstances
-adjustments must be made where
members of a group use different accounting
policies, so that their financial statements are
suitable for consolidation
Date of Inclusion/Exclusion
-from the date of acquisition (the date
on which the investor obtains control) to the
date of disposal (the date when the investor
loses control)
-once an investment is no longer a
subsidiary, it should be treated as an associate
under PAS 28 (if applicable), or joint venture
under PFRS 11 or as an investment under PFRS
9
Investment Entity
-an entity that obtains funds from one
or more investors for the purpose of providing
those investors with investment management
services
-commits to its investors that its
business purpose is to invest funds solely for
returns from capital appreciation, investment
income or both
-measures and evaluates the
performance of substantially all of its
investments on a fair value basis
Investment Entities Consolidation Exemption
-PFRS 10 contains special accounting
requirement for investment entities
-where the entity meets the definition
of an investment entity, it does not consolidate
its subsidiaries or applied PFRS 3 Business
Combinations when it obtains control of
another entity
-an entity is required to consider all
facts and circumstances when assessing
whether it is an investment entity, including its
purpose and design:
Typical Characteristics of an Investment Entity:
1. It has more than one investment
2. It has more than one investor
3. It has investors that are not related parties of
the entity
4. It has ownership interests in the form of
equity or similar interests
-the absence of any of these typical
characteristics does not necessarily disqualify
an entity from being classified as an investment
entity
-an investment entity is required to
measure an investment in a subsidiary at fair
value through profit or loss in accordance with
PFRS 9 Financial Instruments
-however, an investment entity is still
required to consolidate a subsidiary where that
subsidiary provides services that relate to the
investment entity’s investment activities
-because an investment entity is not
required to consolidate its subsidiaries, intra-
group related party transactions and
outstanding balances are not eliminated
-special requirements apply when an
entity becomes, or ceases to be, an investment
entity
-the exemption from consolidation only
applied to the investment entity itself.
Accordingly, a parent of an investment entity is
required to consolidate all entities that it
controls, including those controlled through an
investment entity subsidiary, unless the parent
itself is an investment entity
Variable Interest Entities (VIEs) or Structured
Entities
-second type of controlled enterprise
-also known as special purpose entity
-PFRS 10 provides guidance on when a
structured entity (SE) should be consolidated
-an SE is set up by the reporting
enterprise (or sponsor) to perform a very
specific and narrow function
-the difference between a subsidiary
and an SE is that an SE is not controlled through
voting power
-an SE may not even be a corporation
but could be instead a partnership
-an SE also can be created simply by
delegating specific powers to certain individuals
to act on behalf of the sponsoring corporation –
in effect, by creating sort of agency relationship
with individuals instead of corporate entities