ACC 113: Accounting for Business Combinations

Student Activity Sheet #7

Name: JOHN LORENZ M. DAYANGHIRANG Class number: 019-0059

Section: 3A-A8 Schedule: FRI 5:00-7:00 PM Date: 01/21/2022

1) Activity 3: Skill-building Activities (35 mins)

Solve the following problems.
Use the following information for the next four items:
Entity A is contemplating on acquiring Entity B. relevant information follows:
 Entity B’s average annual earnings in the past 5 years were P1,000,000.
 Entity B’s net assets as at the current year-end have a value of P8,000,000.
 The industry average rate of return on equity is 12%.
 The probable duration of Entity B’s “excess earnings” is 5 years.

1. Goodwill is equal to the average excess earnings capitalized at 25%. How much is the goodwill?

1. Solution:
Average annual earnings 1,000,000
Normal earnings (8M x
12%) (960,000)
Excess earnings 40,000
Divide by: Capitalization rate 25%
Goodwill 160,000

2. Goodwill is measured by capitalizing the average earnings at 12%. How much is the
goodwill?

2. Solution:
Average earnings 1,000,000
Divide by: Capitalization rate 12%
Estimated purchase price 8,333,333
Fair value of Entity B’s net assets (8,000,000)
Goodwill 333,333

3. Goodwill is measured at the undiscounted amount of total excess earnings expected to be

earned from the combination. How much is the goodwill?
3. Solution:
Average annual earnings 1,000,000
Normal earnings (8M x 12%) (960,000)
Excess earnings 40,000
Multiply by: Probable
duration 5
Goodwill 200,000

4. Goodwill is measured by discounting the average excess earnings at 9%. How much is the
goodwill?
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 4. Solution:
Average annual earnings 1,000,000
Normal earnings (8M x 12%) (960,000)
Excess earnings 40,000
Multiply by: PV of ord. annuity of 1 @ 9%, n=5 3.88965
Goodwill 155,586

5. Entity A and Entity B exchanged equity interests in a business combination. Relevant information
follows:
 Entity a has 2,000 issued shares. To effect the business combination, Entity A will issue 2
new shares for each of the 3,000 total outstanding shares of Entity B.
 Entity A’s shares have fair value of P100 per share, while entity B’s shares have fair value
of P300 per share.
 Entity A’s net identifiable assets have a fair value of P260,000 as at the acquisition date.
How much is the goodwill?

5. Solution:
Legal form: Entity A issues shares to Entity B.
Entity A’s currently issued shares 2,000 25%
Shares issued to Entity B (2 x
3,000) 6,000 75%
Total shares after the combination 8,000

Substance: Reverse – Entity B issues shares to Entity A

Entity B’s currently issued shares 3,000 75%
Shares issued to Entity A (3,000 ÷ 75%) x 25% 1,000 25%
Total shares after the combination 4,000

Consideration transferred (1,000 sh. x ₱300) 300,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 300,000
Fair value of Entity A’s net assets (260,000)
Goodwill 40,000

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2) Activity 5: Check for Understanding (5 mins)
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 To measure our understanding of today’s lesson, let us try answering the question below:
Encircle the letter of your choice.
1. After initial recognition, goodwill arising from a business combination is (use ‘full PFRSs’)
a. Amortized over its useful life, not exceeding 10 years
b. Not amortized but tested for impairment at least annually
c. Amortized over its useful life, not exceeding 40 years
d. Amortized and tested for impairment
2. How is goodwill tested for impairment?
a. Goodwill is allocated to CGUs. The CGUs are the ones tested for impairment. Any
impairment is charged first to the allocated goodwill, and any excess is charged to the other
assets in the CGU.
b. Goodwill is unidentifiable, i.e., cannot be seen. Therefore, to test goodwill for impairment,
the accountant must use a microscope
c. Goodwill cannot be tested for impairment on its own – the accountant smells it, if it is bad,
the goodwill is impaired!
d. Any of these as a matter of accounting policy choice.
3. The cost of internally developed goodwill and the costs of maintaining a recognized goodwill are
a. Capitalized as costs of goodwill
b. Not capitalized but rather expensed when incurred
c. Sometimes capitalized and sometimes expensed
d. Ignored for accounting purposes
4. In a reverse acquisition,
a. The issuer of shares is the accounting acquirer
b. The legal acquirer is also the accounting acquirer
c. The consideration transferred is liability rather than asset
d. The legally acquired is the accounting acquirer
5. How is the consideration transferred in a reverse acquisition is measured?
a. At nil
b. At cost rather than fair value
c. In a reverse fashion by squeezing upwards starting with goodwill
d. As an amount based on the number of equity interests the legal subsidiary (accounting
acquirer) would have had to issue to give the owners of the legal parent (accounting
acquire)( the same percentage of equity interest in the combined entity that results from the
reverse acquisition

Use the following information for the next three questions:

Gamer Co. and Player Co. are planning to combine their businesses and put up a new entity called
App Corporation.
 App will issue 100,000 ordinary shares, which are to be subdivided between Gamer and
Player based on their total contributions, including goodwill
 Goodwill is computed by capitalizing excess earnings at 20%.
 The industry normal earnings are 5% of net assets

Gamer Co. Player Co.

Fair value of net identifiable assets 500,000 380,000
Average annual earnings 40,000 39,000

1. How much is the total goodwill expected to arise from the business combination?
a. 175,000 b. 100,0000 c. 75,000 d. 0
Solution:

Gamer
Co. Player Co. Total
Average annual earnings 40,000 39,000
Normal earnings (500K x 5%); (380K x
5%) 25,000 19,000
Excess earnings 15,000 20,000
Divide
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Goodwill 75,000 100,000 175,000
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 2. How many shares will be issued to Gamer and Player, respectively?
Gamer Co. Player Co.
a. 45,500 54,500
b. 64,500 35,500
c. 25,500 74,500
d. 54,500 45,500

Solution:

Gamer
Co. Player Co. Total
Total contribution 1,055,00
(squeeze) 575,000 480,000 0
Fair value of net assets 500,000 380,000
Goodwill 75,000 100,000 175,000

Gamer
Co. Player Co. Total
Total contribution 575,000 480,000 1,055,000
Distribution ratio (575/1,055);
(480/1,055) 54.50% 45.50%
Total shares to be issued 100,000 100,000
Distribution of shares 54,500 45,500 100,000

3. Which of the combining entities is most likely the acquirer?

a. Gamer Co. b. Player Co. c. App Corporation d. Google Play

Explanation: Since the new entity, App Corporation, will issue equity interests to both Gamer and Player,
the acquirer is most likely the entity that receives the most voting rights after the business
combination (i.e., Gamer Co. – 54,500 shares or 54.50% interest).

However, if the newly created entity will transfer cash and other considerations and assume
liabilities to acquire both Gamer and Player, the acquirer would be the newly created entity.

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