ADVANCED FINANCIAL ACCOUNTING AND REPORTING
BUSINESS COMBINATIONS – MERGERS
LECTURE NOTES
THE NATURE OF BUSINESS COMBINATIONS
➢ Occurs when one entity gains control over another
entity either through the acquisition of net assets
(must be 100%), or the acquisition of common shares
(more than 50% of outstanding).
➢ Business combination requires the bringing together
of businesses into a reporting entity. A reporting
entity can be a single entity (acquisition of net
assets), or a group comprising a parent and all of its
subsidiaries (acquisition of shares).
➢ The business combination occurs from the stand point
of the acquirer.
➢ All business combinations must use the purchase
method. Pooling of interest method is no longer
permitted.
GENERAL STEPS UNDER THE PURCHASE METHOD
OF ACCOUNTING FOR THE BUSINESS
COMBINATION
a. The use of the purchase method
b. An acquirer to be identified
c. The measurement of the cost of a combination
d. The allocation of the cost of combination to the
acquired assets and assumed liabilities and
contingent liabilities.
e. The assets, liabilities and contingent liabilities to be
measured initially at fair value.
f. Goodwill acquired to be recognized
g. That goodwill upon recognition is subsequently
accounted for as follows:
ACQUIRER NON-SME SME
AMORTIZATION no yes
IMPAIRMENT TEST yes yes
h. That any excess on combination be accounted for by
a reassessment of the assets and liabilities acquired
and, where appropriate, by recognizing any excess
immediately in profit and loss. Any such discount (or
premium) accrues only to the acquirer.
i. Disclosures of information that enable users to
evaluate the nature and effect of business
combinations effected in the current period and
previous periods, as well as post balance-sheet dates.
j. Disclosure of information that enable users to
evaluate changes in the carrying amount of goodwill.
ACCOUNTING FOR COST OF BUSINESS
COMBINATION
The acquirer shall measure the cost of business
combination as the aggregate of
a. The fair values at the date of exchange of assets
given, liabilities incurred or assumed and equity
instruments issued by the acquirer in exchange for
control of the acquiree; plus
b. Contingent costs of guarantees made, if measurable
and probable at the date of acquisition on: (1) market
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value of the shares issued; and/or (2) amount of net
income sustained over a specified period.
c. Direct acquisition costs, if the acquirer is an SME.
ACCOUNTING TREATMENT ON SOME SPECIFIC COST
ITEMS
1. Cash or other monetary assets. The fair value of
the cash and cash equivalents dispersed is usually
readily determinable. But if the settlement is
deferred to a time subsequent to the exchange date
the fair value of that deferred component shall be
the present value at the date of exchange.
2. Non- monetary assets. These consist of assets
such as property, plant and equipment, investments,
licenses and patents. The acquirer is effectively
selling the non-monetary asset to the acquiree.
Hence it is earning revenue equal to the fair value on
the sale of the assets and realizing a gain or
incurring a loss if the carrying amount differs from
the fair value.
3. Equity instruments. If an acquirer issues its own
shares as consideration it will need to determine the
fair value of those shares at the date of exchange.
4. Liabilities undertaken – the fair value of the
liabilities undertaken are best measured by the
present value of future cash flows. Note that
expected future losses and cost, as a result of the
combination are not liabilities of the acquirer and
therefore not included in the calculation of the fair
value of consideration paid.
5. Contingencies - Where the business combination
agreement provides for an adjustment to the cost of
the combination contingent on future events, the
acquirer shall include the amount of that adjustment
in the cost of the combination at the acquisition date
if the adjustment is probable and can be measured
reliably.
6. Directly attributable costs; it includes costs such
as professional fees paid to accountants, legal
advisers, valuers and other consultants to effect the
combination. Also included in the cost category are
finders fees and brokerage fees. These are
recognized as expenses if acquirer is a non-SME.
7. Other cost that are not directly attributable to
the business combination are
a. Cost to issue and register the shares issued by
the acquirer are treated as a reduction in the total
fair value of the shares issued and are recognized
in equity and
b. Indirect acquisition costs are recognized as
expenses.
 EXERCISES

Case 1 – Computations of GW or IFA 2. Prepare a schedule for the computation of the fair
NORTHPOINT COMPANY acquired the net assets of value of the net assets.
DOMINI0N ENTERPRISES on January 1, 2020 The 3. Determine goodwill or excess from the business
carrying and fair values of DOMINION at the date of combination, and
acquisition follows: 4. Prepare journal entries to record the acquisition of
Carrying the net assets of DOMINION ENTERPRISES in the
Value Fair Value books of NORTHPOINT COMPANY.
Cash P16,000 P16,000
Accounts receivable 32,000 32,000 Case 2 – Merger Combination
Merchandise Inventory 48,000 56,000 The following balance sheets at December 31, 2020 are
for PHILRABBIT Company and SUPERLINES Enterprises,
Plant and Property 360,000 368,000 respectively just before the business combination.. On
Patent 48,000 44.000 this date, PHILRABBIT acquires the net assets of
Total assets P 504,000 P 516,000 SUPERLINES and issues 9,600 new shares in
consideration thereof. . The issued shares have a market
Accounts Payable P24,000 P24,000 value of P35 each.
Long-term debt 320,000 296,000
Capital stock 96,000 PHILRABBIT SUPERLINES
Cash P 112,000 P 40,000
Accounts receivable 96,000 28,000
APIC 16,000 Land 176,000 40,000
Retained Earnings 48,000 Buildings, net 280,000 168,000
Total Equities P504f000 Equipment, net 328,000 100,000
Total assets P 992,000 P 376,000
NORTHPOINT COMPANY issued the following
considerations in exchange for the net assets of Accounts payable P 128,000 P 44,000
DOMINION: Bonds payable 160,000 80,000
1. 40,000, P1 par shares of NORTHPOINT. Fair value- Share capital, P10 par 320,000 144,000
P2.75 at January 1, 2020. Share premium - 20,000
2. NORTHPOINT agreed to pay additional cash Retained profit 384,000 88,000
consideration for the value of any decrease in the Total liabilities and
share price below P2.75 for the 40,000 shares issued. equity P 992,000 P 376,000
The guarantee is for 90 days and is to expire on
March 31, 2020. NORTHPOINT believes there was The following market values have been agreed upon by
only a 20% chance the price of the shares would fall the parties over some of SUPERLINES’s net asset items:
to P2.60 during the guarantee period.
3. Cash of P72,000; P24,000 to be paid on date of Accounts receivable, P24,000; Land, P48,000; Buildings,
exchange and the balance in one year's time. The P200,000; Equipment, P120,000; and
incremental borrowing rate of NORTHPOINT is 10% Bonds payable, P88,000.
per annum.
4. DOMINION was currently being sued by an enraged PHILRABBIT Company also paid out-of-pocket costs:
client; the company's lawyers believe there's an 95% P6,400 for direct acquisition costs; P12,000 for stock
chance it will win the case. The expected damages in issuance and registration; and P1,600 for indirect
the event DOMINION lost the case is P200,000. acquisition expenses.
5. An old-model KIA delivery van carried in the books of
NORTHPOINT at P40,000, net of P8,000 accumulated Required:
depreciation. The fair value at the date of the (1) Prepare a schedule for the computation of goodwill or
exchange is P28,000. income from combination.
➢ In addition to the purchase consideration
NORTHPOINT had an out-of-pocket costs of (2) Prepare the necessary journal entries in the books of
P6,816 for direct acquisition cost; P1,600 for PHILRABBIT Company. The journal entries in the books of
issuing and registering the shares; and P1,200 SUPERLINES Enterprises may be ignored.
indirect cost.
(3) Prepare the balance sheet of PHILRABBIT Company
Required: just after the merger business combination.
1. Prepare a schedule for the determination of the cost
of combination.
MULTIPLE CHOICE

RED LABELCOMPANY issued 96,000 shares of its P25

par common stock for the net assets of BLUEGREEN The goodwill from the business combination is
CORPORATION in a business combination completed on P334,400.
March1, 2020. BLUEGREEN Corporation’s net assets 1. How much is the FMV per share of RED LABEL
are worth P3,040,000 at FMV. Out of pocket costs of COMPANY at March 1, 2020?
the combination were as follows: a. P 34 c. P 30
b. P 32 d. P 35
Legal fees 46,000
Contingent consideration (probable & WHITEBOARD COMPANY issued 80,000 shares of P20
measurable) 14,400 par common stock for all the outstanding stock of
Printing costs of stock certificates 6,800 BLACK CORPORATION in a business combination
Finder’s fees 50,000 consummated on August 1, 2020. WHITEBOARD

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COMPANY common stock was selling at P30 per share G/HOUND COMPANY VIOLET CORP.
at the time the business combination was Book Value Fair Value Book Value Fair
consummated. Out-of-pocket costs of the business Value
Cash 120,000 120,000 8,000 8,000
combination were as follows:
Accounts
receivable 120,000 120,000 32,000 32,000
Finder's fee P 40,000 Merchandise
Accountant's fee (advisory) 8,000 inventory 320,000 480,000 80,000 196,000
Legal fees (advisory) 16,000 Building and
Printing costs of stock certificates 4,000 equipment 640,000 696,000 160,000 200,000
SEC registration costs and fees 9,600 Accumulated
Total P 77,600 depreciation (160,000) ( 40,000)
Goodwill ________ _______ 80,000 _______
Total assets P1,040,000 P1,416,000 P320,000 P436,000
2. The acquisition cost of the combination will be:
a. P2,477,600 c. P2,413,600 Accounts
b. P2,464,000 d. P2,400,000 payable 80,000 80,000 112,000 112,000
Bonds
BLACKBELT COMPANY issues 400,000 shares of its own payable 320,000 352,000 48,000 68,000
P1 par common stock for the net assets of Common
YELLOWTOWN CORPORATION in a merger stock – P 10 P5 par
par 240,000 80,000
consummated on July 1, 2020. On this date,
Additional
BLACKBELT stock is quoted at P10 per share. Balance paid- in
sheet data for the two companies at July 1, 2020, just capital 80,000 16,000
before combination, are as follows: Retained
earnings 320,000 64,000
BLACKBELT YELLOWTOWN Total Liab. &
Current Assets P14,400,000 P1,200,000 SHE P 1,040,000 P320,000
Plant Assets 17,600,000 5,200,000
Total Assets P32,000,000 P6,400,000 GREYHOUND COMPANY acquired the net assets of
VIOLET COMPANY by issuing 8,000 shares of stocks.
Liabilities P9,600,000 P1,600,000 Additional cash payments made by GREYHOUND
Common stock, P10 16,000,000 2,400,000 CORPORATION in completing the acquisition were:
par
Additional paid-in 2,400,000 800,000 Broker’s fee paid to firm that located
capital VIOLET CORP. P8,000
Retained earnings 4,000,000 1,600,000 Cost to register and issue stocks 32,000
Total equities P32,000,000 P6,400,000 Professional fees paid to accountants 16,000
Professional fees paid to lawyers 16,000
BLACKBELT COMPANY also paid finder’s fees of P40,000 Professional fees paid to official valuers 16,000
and legal fees of P8,000; as well as indirect expenses of Indirect acquisition cost 12,000
32,000.
3. The retained earnings on the combined balance 5. Assuming the stocks issued by GREYHOUND
sheet after the combination will be: COMPANY has a market price of P40, how much is
a. P3,968,000 c. P3,920,000 the total assets after the business combination?
b. P4,720,000 d. P5,600,000 a. P 1,376,000 c. P 1,496,000
PURPLE HEART COMPANY. is to acquire BROWN b. P 1,440,000 d. P 916,000
CORPORATION by absorbing all the assets and
assuming all the liabilities of the latter company, in KING COMPANY issued 96,000 shares of P25 par
exchange for shares of stocks of the former. Below are ordinary shares for all the outstanding stock of FISHER
the balance sheets of the two companies with the CORPORATION in a business combination consummated
corresponding appraised value increment for Brown. on July 1, 2020. King’s ordinary shares were selling at
Parties agree to use the appraised values against which P40 per share at the time of consummation of the
the fair market value of the shares will be matched. combination. In addition cash payment of P160,000 was
made and a deferred cash payment of P1,200,000
PURPLEHEART BROWN payable on July 1, 2021. Market rate of interest is 12%.
Assets per books P3,200,000 P2,000,000 FISHER’s net assets are P3.04 million at book value.
Asset increase per 240,000 Out of pocket costs of the combination were as follows:
appraisal Legal and accounting fees related with the issuance of
Liabilities 1,200,000 640,000 shares, P9,600 and printing cost of stock certificates,
Capital stock (no par) (P100 par) P7,520. A contingent consideration which is probable
1,600,000 800,000 and can be reasonably estimated amounted to P40,160.
APIC 560,000 240,000
Retained earnings (deficit) (160,000) 320,000 6. What is the total cost of the investment?
Total Equities P3,200,000 P2,000,000 a. P5,111,588 c. P5,586,947
b. P7,187,091 d. P6,711,718
4. The stocks of PURPLE COMPANY is currently selling
at P100 per share. The number of shares to be A, B, C, and D are companies to be combined just prior
issued to BROWN by PURPLE is to the combination, their individual stockholder’s equity
a. 16,000 c. 10,400 consists of the following balances:
b. 13,600 d. 8,000
A B C D
The following balance sheets were prepared for Ordinary P480,000 P96,000 P360,000 P120,000
GREYHOUND COMPANY and VIOLET CORPORATION on shares
January 1, 2020, just before they entered into a Share 120,000 48,000 36,000
business combination. premium

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Retained 144,000 72,000 216,000 36,000 share of P91; dispersed to the stockholders of the
Earnings acquired companies.
7. How much goodwill is to be recognized assuming
Company A is the surviving entity. It issued 16,000, that the net assets are fairly valued?
P69 par value ordinary shares, with a fair value per a. P676,000 c. P388,000
b. P438,400 d. P352,000

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