CONTIN ONS (Advanced Accounting 2) YA AO bo Mah oh SANE Gh) Ney s 08 Per WhACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) 2020 Edition IN PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRSs) in, Nation’s Foremost cee Review Inc. (NCPAR) 4F Pelizloy Cen mit Leer 1d, Baguio City 2600, Philippines Mobile Nui mber rete 8706962 a Like us Facebook Nation's Foremost CPARALL RIGHTS RESERVED 2020 No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means - electronic or mechanical, including photocopying - without the written permission of the author. ISBN 978-621-8029-11-8 Any copy of this book not bearing the signature of the author shall be considered as proceeding froman illegal source. Perms eee Published and Distributed by: BANDOLIN ENTERPRISE (Publishing and Printing) #21 PARAMOUNT VILL., STO. TOMAS, BAGUIO CITY CONTACT NOS. SMART (0928) 374 7571; GLOBE (0817) 813 6037; AUTHOR: (0917) 870 6962 Fine: Facebook https:/www. facebook.com/bandolin.enterprisDear Reader, This book is intended for students taking up the CHED- required subject “Accounting for Business Combinations” (formerly Advanced Accounting 2). This book is based on current Philippine Financial Reporting Standards (PFRSs). It is a labor of love and it is dedicated to you, my reader. | have written this book with the following goals in mind: completeness, conciseness, simplicity, fun to learn and practical application. Complex accounting concepts are not eliminated simply because they are too difficult to comprehend but rather they are simplified to the highest possible extent. Your thoughts about this book are important to me. If later on you have queries, comments, or suggestions on how I can improve my work, I would be glad if you inform me. Here are my contact details: zeusvernonmillan@gmail.com and (0917) 870 6962. Good luck in your learning and best wishes in your journey through life......thank you for making mea part of it #© Sincerely, Zeus vernon B. MillanAcknowledgementy y sincere gratitude to my family and relatives for their support all throughout the writing of this book; to my wife Eureka, my son Devin Joshua, and my daughter ‘Athena for their sacrifices; to my Dad and Mom for the source of to my in-laws Engr. John L. Socalo, Sr. and Dominga d trust; to my sister Donna Pamela for the extra help; to my college instructors who have taught me most of the techniques I have incorporated in this book; to Mr. Darrell Joe Asuncion, Dean Renante D. Balocating, Mr. Rex B. Banggawan, Mr. Christopher U. Ismael, Mr. John Carlo G. Bandolin, and Mr. Einroul Aljohnza A. Bandolin for the much needed encouragement and support; to my fellow instructors at NCPAR; colleagues in the profession; previous clients; previous students; to the staff of the Bandolin Enterprise; and friends who in one way or another have contributed, directly or indirectly, to the completion of this book. I would like to extend m inspiration, §, Socalo* for the assistance an: BORE IP ID PD NSP About the Author The author is a 6" Placer in the October 2006 CPA board examinations. He is a co-founder of, and a CPA reviewer at, Nation's Foremost CPA Review Inc. (NCPAR), a teacher, and an entrepreneur.Tipy ow using thix book To get the most out of this book, I strongly suggest you do the following: 1. Re-solve the illustrations independently. After reading a chapter, re-solve the _ illustrations independently by covering the suggested solutions with a piece of paper. 2. Read and reread the chapter summaries Be sure to read the summary after reading each chapter. This will reinforce what you have just learned. It is also advisable to reread the chapter summaries from time to time to ensure that you are not forgetting the concepts you have learned as you learn additional concepts. Long-term memory is invaluable in passing the board exams (as well as making professional judgments in the exercise of the profession). However, the human memory is not without limit. The human brain tends to forget information as new information is learned. To avoid this, one will need to recall information previously learned repeatedly as many times as needed. Studies show that when one forgets information previously learned, he will need to spend the same effort in learning that information again! 3. Enjoy learning. Nothing is difficult if you have the passion in doing it.TABLE OF CONTENTS | CHAPTER 1 BUSINESS COMBINATIONS (PART 1).... BUSINESS COMBINATION. | ACCOUNTING FOR BUSINESS COMBINATIO! | Identifying the acquirer i Determining the acquisition date. Recognizing and measuring goodwill .. Consideration transferred... Acquisition-related costs. Non-controlling interes Previously held equity interest in the acquiree...... Net identifiable assets acquired RESTRUCTURING PROVISIONS .... ‘SPECIFIC RECOGNITION PRINCIPLES 1. Operating leases...... 2. Intangible assets... EXCEPTION TO THE RECOGNITION PRINCIPLE — CONTINGENT LIABILITIES EXCEPTIONS TO BOTH THE RECOGNITION AND MEASUREMENT PRINCIPLES ... 34 Additional concepts on Consideration transferred....... EXCEPTIONS TO THE MEASUREMENT PRINCIPLE CHAPTER 1: SUMMARY... RELEVANT PROVISIONS OF THE PFRS FOR SMES . Business combination... Accounting... Identifying the acquirer Cost of a business combination ........ Allocating the cost of a business combination Provisional amounts... Goodwill and Negative goodwill PROBLEMSvii CHAPTER 2 BUSINESS COMBINATIONS (PART 2)..... 64 SHARE-FOR-SHARE EXCHANGES 64 68 BUSINESS COMBINATION ACHIEVED IN STAGES . BUSINESS COMBINATION WITHOUT TRANSFER OF CONSIDERATION MEASUREMENT PERIOD .. DETERMINING WHAT IS PART OF THE BUSINESS COMBINATION N-TRANSACTION 78 Reacquired rights....... Settlement of pre- existing palationships ‘SUBSEQUENT MEASUREMENT AND ACCOUNTING Contingent liabilities... Contingent consideration CHAPTER 2: SUMMAR) PROBLEMS: .. CHAPTER 3 BUSINESS COMBINATIONS (PART 3)... SPECIAL ACCOUNTING TOPICS FOR BUSINESS COMBINATION Methods of estimating goodwill REVERSE ACQUISITIONS CHAPTER 3: SUMMARY PROBLEMS: CHAPTER 4 CONSOLIDATED FINANCIAL STATEMENTS (PART 1).........129 Administrative right Unilateral rights Protective rights Substantive rights Voting rights...Potential voting rights... wo 137 Substantive removal and other rights held by other partiesi3g Exposure or rights to variable returns... Ability to use power to affect investor's return: ACCOUNTING REQUIREMENTS . Reporting dates... Uniform accounting policies Consolidation perio Measurement... Income and expenses. Investment in subsidiary .. NON-CONTROLLING INTERESTS (NCI) . PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS. CONSOLIDATION AT DATE OF ACQUISITION ..... CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION . Step 1: Analysis of subsidiary’s net asset: Step 2: Goodwill computation... Step 3: Non-controlling interest in net assets ‘Step 4: Consolidated retained earnings.. Step 5: Consolidated profit or loss. SUBSIDIARY’S CUMULATIVE PREFERENCE SHARES . CHAPTER 4: SUMMARY RELEVANT PROVISIONS OF THE PFRS FOR SMES Consolidation procedures. intragroup balances and transactions .. Uniform reporting date. Uniform accounting policies Acquisition and disposal of subsidiarie: PROBLEMS: CHAPTER 5 CONSOLIDATED FINANCIAL STATEMENTS (PART 2)... INTERCOMPANY TRANSACTIONS. intercompany sale of invento intercompany sale of property, plant and equipment intercompany dividends...Intercompany bond transaction CHAPTER S: SUMMARY... PROBLEMS:.. CHAPTER 6 CONSOLIDATED FINANCIAL STATEMENTS (PART 3) IMPAIRMENT OF GOODWILL. INTERCOMPANY ITEMS IN-TRANSIT AND RESTATEMENTS . CHANGES IN OWNERSHIP INTEREST NOT RESULTING TO LOSS OF CONTROL . 258 LOSS OF CONTROL... Derecognition of other comprehensive incom Sale of a subsidiary to an associate or joint venture IMPORTANCE OF CONSOLIDATION THEORIES OF CONSOLIDATION . Historical background... Advantages and disadvantages of the entity theory ADDITIONAL ILLUSTRATIONS: CONSOLIDATION OF A REVERSE ACQUISITION SPECIAL PURPOSE ENTITIES... CHAPTER 6: SUMMARY PROBLEMS: CHAPTER 7 CONSOLIDATED FINANCIAL STATEMENTS (PART 4).........318 INVESTMENT IN SUBSIDIARY MEASURED AT OTHER THAN COST.. COMPLEX GROUP STRUCTURES Identifying the acquisition date Consolidation of a vertical group.. Consolidation of a D-shaped (mixed) group. Complex group structure with Associate... PUSH-DOWN ACCOUNTING. CHAPTER 7: SUMMARY .. PROBLEMS: .CHAPTER 8 SEPARATE FINANCIAL STATEMENTS .... PREPARATION OF SEPARATE FINANCIAL STATEMENTS 372 COST METHOD... FAIR VALUE METHOD .. 372 Equity METHOD 373 DIVIDENDS... 373 RELEVANT PROVISIONS OF THE PFRS FOR SMES .. 375 SECTION 9 CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS 375 Separate financial statements... Accounting policy election... Combined financial statement: PROBLEM: CHAPTER 9 FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES... 381 PRICE LEVEL CHANGES AND PURCHASING POWER... HYPERINFLATION... IDENTIFVING HYPERINFLATION .. Indicators of hyperinflation .. CORE PRINCIPLE .. RESTATEMENT OF FINANCIAL STATEMENTS ..... HISTORICAL COST (NOMINAL COST) TO CONSTANT PESO . Non-monetary items carried at cost. Non-monetary items carried at other than cost Non-monetary items carried at NRV or Fair valu Revalued non-monetary items Impairment after restatement Investment in associate Borrowing COStS wees Index-linked assets and liabilities Assets acquired through issuance of noninterest-bearing liabilities... First period application of PAS 2! Statement of profit of loss and other comprehensive income3% asFormula for restatement ......... Gain or loss on net monetary position Statement of cash flows Corresponding figures. Summary of restatement procedures — Historical to Constant peso.. CURRENT COST ACCOUNTING ... CURRENT COST To CONSTANT PESO TAXES «0.0... DEFERRED TAXES CONSOLIDATED FINANCIAL STATEMENTS DIFFERENT ENDS OF REPORTING PERIODS ECONOMIES CEASING TO BE HYPERINFLATIONARY CHAPTER 9: SUMMARY... PROBLEMS. CHAPTER 10 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES TWO WAYS OF CONDUCTING FOREIGN ACTIVITIES essssoses FUNCTIONAL CURRENCY .. FOREIGN CURRENCY TRANSACTIONS Initial Recognition .. Spot exchange rate vs. Closing rat Direct vs. Indirect quotation Exchange Differences. Items measured at other than historical cost....... Several exchange rates. Exchange differences recognized in OCI. Translation of Financial Statements. FOREIGN OPERATION... Net investment in a foreign operation Disposal or partial disposal of a foreign operation. ‘TRANSLATION PROCEDURES — HYPERINFLATIONARY ECONOMY CHAPTER 10: SUMMARY...» RELEVANT PROVISIONS OF THE PFRS FOR SMES: SECTION 30 FOREIGN CURRENCY TRANSLATION. ,..xii ee Two ways of conducting foreign activities... S18 Functional currency ... 518 Factors in determining: functional currency 518 Reporting foreign currency transactions in the fu netional currency... Initial recognition.. Reporting at the end of the subsequent reporting periods . Net investment ina foreign operation Change in functional currency..... Use of a presentation currency other than the functional currency... Translation to the presentation currency. PROBLEMS: ssssssssssseesevee CHAPTER 11 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 1).... _ 53! PURPOSE OF DERIVATIVES. RISKS ... DEFINITION OF A DERIVATIVE... COMMON TYPES OF DERIVATIVE [MEASUREMENT OF DERIVATIVES. INO HEDGING DESIGNATION... HEDGING... HEDGING INSTRUMENT HEDGED ITEMS .. HEDGE ACCOUNTING HEDGING RELATIONSHIPS Fair value hedges Cash flow hedges Hedges of a net investment in a foreign operation CuapTER 11: SUMMARY... RELEVANT PROVISIONS OF THE PFRS FOR SMES .... SECTION 12 OTHER FINANCIAL INSTRUMENTS ISSUES Difference in scopes of Sections 11 and 12. Scope of Section 12. Initial recognition of financial assets and liabilitiesxiii Initial measurement... Subsequent measurement Hedge accounting PROBLEMS: CHAPTER 12 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 2).. ACCOUNTING FOR FORWARD CONTRACTS.... illustration 1: Fair value hedge of a recognized asset . Illustration 2: No hedging designation (Held for speculation). 579 illustration 3: Fair value hedge of a recognized liability 581 Illustration 4: No hedging designation (Held for speculation). 584 FAIR VALUE HEDGE OF AN UNRECOGNIZED FIRM COMMITMENT. 585 Illustration 5: Fair value hedge of a firm sale commitment ....585 Illustration 6: Fair value hedge of a firm purchase commitment Illustration 7: FV hedge - firm purchase commitment (Present value)... 593 Example of formal hedge designation documentation — Fair Value hedge .......s.sssessseear ore insaanceneein OMe Illustration 8: FV hedge - firm purchase commitment (Present value) ... 597 FAIR VALUE HEDGE VS. CASH FLOW HEDG! FIRM COMMITMENT VS. FORECAST TRANSACTION ... CHOICE TO DESIGNATE AS EITHER FAIR VALUE HEDGE OR CASH FLOW HEDGE sussequent ACCOUNTING FOR ACCUMULATED Doc! IN CASH FLOW HEDGE6O2 illustration 9: Cash flow hedge — forecasted purchase transaction J Illustration 10: Cash flow hedge of a forecasted sale transaction — Present value (Indirect quotation) 608 Iustration 11: CF hedge of a recognized liability — Present value 610 + 601 PROBLEM:CHAPTER 13 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 3)..... ACCOUNTING FOR FUTURES CONTRACT... Illustration 1: No hedging designatiot Illustration 2: FV hedge of a recognized asset measured at fair 629 value... illustration 3: FV hedge of a recognized asset measured at LOCON.. Ulustration 4: Fair value hedge of a firm sale commitment ....633 CASH FLOW HEDGE — SPECIFIC ACCOUNTING.. Illustration 5: CF hedge — Assessment of Hedge effectiveness637 ACCOUNTING FOR OPTIONS «ssssesssessessesssserssesrsnsssererssesenietecessecessesseness 642 Illustration 1: Fair value hedge of a recognized asset — ~Put option. Illustration 2: No hedging designation ~ Call option .. Ilustration 3: CF hedge - forecasted transaction (Indirect quotation)... ACCOUNTING FOR SWAPS... Illustration 1: CF hedge - variable-rate debt (Payment at maturity)... Illustration arene +650 : CF hedge - variable-rate debt (Periodic payments) 653 657 658 664 FAIR VALUE HEDGE — HEDGED ITEM IS MEASURED AT AMORTIZED CO! Illustration 3: Fair value hedge of a fixed-rate debt PROBLEMS... CHAPTER 14 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 4)... 2675 ACCOUNTING FOR NET INVESTMENT HEDGES .... 675, Illustration: Hedge of a net investment in foreign operation..675 Case#1: No hedging instrument ... 676 Case #2: With hedging instrument 679 EMBEDDED DERIVATIVES ... 681 Hybrid contracts with financial asset hosts , 682XV Separation of embedded derivative from host contract... Inability to measure fair value of embedded derivativ ADDITIONAL ILLUSTRATIONS: CHAPTER 14: Summary ..Business Combinations (Part 1) 1 Chapter 1 Business Combinations (Part 1) Related standards: PERS 3 Business Combinations Section 19 of the PFRS for SMEs Overview on the topic Our discussion on business combination is subdivided into the following chapters: Chapter Title Coverage 1 Business Combinations (Part 1) Recognition & measurement 2 Business Combinations (Part 2) Specific cases 3 Business Combinations (Part 3) Special accounting topics Learning Objectives L._ Define a business combination. 2. Explain briefly the accounting requirements for a business combination. 3. Compute for goodwill. Introduction A business combination occurs when one company acquires another or when two or more companies merge into one. After the combination, one company gains control over the other. The company that obtains control over the other is referred to as the parent or acquirer. The other company that is controlled is the subsidiary or acquiree. Business combinations are carried out either through: 1. Asset acquisition; or 2. Stock acquisitionChapter | > Asset acquisition - the acquirer purchases the assets assumes the liabilities of the acquiree in exchange for cast other non-cash consideration (which may be the acquire own shares). After the acquisition, the acquired normally ceases to exist as a separate legal or accou entity. The acquirer records the assets acquired and liabiliti assumed in the business combination in its books of accour Under the Corporation Code of the Philippines, business combination effected through asset acquisition may be either: a. Merger - occurs when two or more companies merge into a single entity which shall be one of the combining companies. For example: A Co. + BCo. =A Co. or B Co. b. Consolidation - occurs when two or more companies consolidate into a single entity which shall be the consolidated company. For example: A Co. + B Co. = C Co. Stock acquisition - instead of acquiring the assets and assuming the liabilities of the acquiree, the acquirer obtains control over the acquiree by acquiring a majority ownership interest (e.g, more than 50%) in the voting rights of the acquiree. In a stock acquisition, the acquirer is known as the parent while the acquiree is known as the subsidiary. After the business combination, the parent and the subsidiary retain their separate legal existence. However, for financial reporting purposes, both the parent and the subsidiary are viewed as a single reporting entity. After the business combination, the parent and subsidiary continue to maintain their own separate accounting books, recording separately their assets, liabilities and the transactions they enter into. The parent records the ownership interest acquired as “investment in subsidiary” in its separate accounting books. However, the investment is eliminated when the group Prepares consolidated financial statements.Business Combinations (Part 1) 3 A business combination may also be described as: 1 Horizontal combination — a business combination of two or more entities with similar businesses, e.g., a bank acquires another bank. Vertical combination — a business combination of two or more entities operating at different levels in a marketing chain, eg., a manufacturer acquires its supplier of raw materials. Conglomerate — a business combination of two or more entities with dissimilar businesses, e.g., a real estate developer acquires a bank. Advantages of a business combination a. iti, Competition is eliminated or lessened — competition between the combining constituents with similar businesses is eliminated while the threat of competition from other market participants is lessened. Synergy — synergy occurs when the collaboration of two or more entities results to greater productivity than the sum of the productivity of each constituent working independently. Synergy is most commonly described as “the whole is greater than the sum of its parts.” It can be simplified by the expression “I plus 1=3.” Increased business opportunities and earnings potential — business opportunity and earnings potential may be increased through: an increased variety of products or services available and a decreased dependency on limited number of products and services; widened dispersion of products or services and better access to new markets; access to either of the acquirer's or acquiree’s technological know-hows, research and development, secret processes, and other information;4 Chapter 1 iv. increased investment opportunities due to increased capital; or Vv. appreciation in worth due to an established trade name by either one of the combining constituents. d. Reduction of operating costs - operating costs of the combined entity may be reduced. i, Under a horizontal combination, operating costs may be reduced by the elimination of unnecessary duplication of costs (e.g., cost of information systems, registration and licenses, some employee benefits and costs of outsourced services). ii, Under a vertical combination, operating costs may be reduced by the elimination of costs of negotiation and coordination between the companies and mark-ups on purchases. e. Combinations utilize economies of scale - economies of scale refer to the increase in productive efficiency resulting from the increase in the scale of production. An entity that achieves economies of scale decreases its average cost per unit as production is increased because fixed costs are allocated over an increased number of units produced. f. Cost savings on business expansion - by acquiring another company rather that creating a new one, an entity can save on start-up costs, research and development costs, cost of regulation and licenses, and other similar costs. Moreover, a business combination may be effected through exchange of equity instruments rather than the transfer of cash or other Fesources. g- Favorable tax implications - deferred tax assets may be transferred in a business combination. Also, business combinations effected without transfers of considerations may not be subjected to taxation.w Business Combinations (Part 1) Disadvantages of a business combination a. Business combination brings monopoly in the market which may have a negative impact to the society. This could result to impediment to healthy competition between market participants. b. The identity of one or both of the combining constituents may cease, leading to loss of sense of identity for existing employees and loss of goodwill. c. Management of the combined entity may become difficult due to incompatible internal cultures, systems, and policies. d. Business combination may result in overcapitalization, which, in turn, may result to diffusion in market price per share and attractiveness of the combined entity’s equity instruments to potential investors. e. The combined entity may be subjected to stricter regulation and scrutiny by the government, most especially if the business combination poses threat to consumers’ interests. Business combinations are accounted for under PFRS 3 Business Combinations. Business Combination A business combination is “a transaction or other event in which an acquirer obtains control of one or more businesses.” Transactions referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations under PFRS 3. (prrs3.Appendix 4) Essential elements in the definition of a business combination 1. Control 2, Business Control An investor controls an investee when the investor has the power to direct the investee’s relevant activities (i.e., operating and financing policies), thereby affecting the variability of the investor's investment returns from the investee.ae __ Chapter 1 Control is normally presumed to exist when the acquire; holds more than 50% (or 51% or more) interest in the acquiree’, voting rights. However, this is only a presumption because can be obtained in some other ways, such as when: a. the acquirer has the power to appoint or remove of the board of directors of the acquiree; or contro] the majority b. the acquirer has the power to cast the Majority of votes at board meetings or equivalent bodies within the acquiree; or c. the acquirer has power over more than half of the voting Tights of the acquiree because of an agreement with other investors; or d. the acquirer controls the acquiree’s operating and financial policies because of a law or an agreement. An acquirer ma of ways, for example: by transferring cash or other assets; by incurring liabilities; by issuing equity interests; - . by providing more than one type of consideration; or without transferring consideration, including by contract alone. y obtain control of an acquiree in a variety pao Illustration: Determining the existence of control Example #1 ABC Co. acquires 51% ownership interest in XYZ, Inc's ordinary shares. Analysis: ABC is presumed to have obtained control over XYZ because of the ownership interest acquired in the voting rights of XYZis more than 50%. Example #2 | ABC Co. acquires 100% of XYZ, Inc.’s preference shares.Business Combinations (Part 1) a Analysis: ABC does not obtain control over XYZ because preference shares do not give the holder voting rights over the financial and operating policies of the investee. Example #3 ABC Co. acquires 40% ownership interest in XYZ, Inc. There is an agreement with the shareholders of XYZ that ABC will control the appointment of the majority of the board of directors of XYZ. Analysis: ABC has control over XYZ because, even though the ownership interest is only 40%, ABC has the power to appoint the majority of the board of directors of XYZ. Example t4 ABC Co. acquires 45% ownership interest in XYZ, Inc. ABC has an agreement with EFG Co., which owns 10% of XYZ, whereby EFG will always vote in the same way as ABC. Analysis: ABC has control over XYZ because it controls more than 50% of the voting rights over XYZ (Le, 45% plus 10%, per agreement with EFG). Example #5 ABC Co. acquires 50% of XYZ, Inc.’s voting shares. The board of directors of XYZ consists of 8 members. ABC appoints 4 of them and XYZ appoints the other 4. When there are deadlocks in casting votes at meetings, the decision always lies with the directors appointed by ABC. Analysis: ABC has control over XYZ because it controls more than 50% of the voting rights over XYZ in the event there is no majority decision.Chapter | 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.” (PERS 3.Appendix A) A business has the following three elements: 1. Input - any economic resource that results to an output when one or more processes are applied to it, e.g, nom-current assets, intellectual property, the ability to obtain access to necessary materials or rights and employees. 2. Process - any system, standard, protocol, convention or rule that when applied to an input, creates an output, e.g., strategic management processes, operational processes and. resource management processes. Administrative systems, e.g, accounting, billing, payroll, and the like, are not processes used to create outputs. 3. Output — the result of 1 and 2 above that provides goods or services to customers, investment income or other income from ordinary activities. Identifying a business combination An entity determines whether a transaction is a business combination in relation to the definition provided under PFRS 3. If the assets acquired (and related liabilities assumed) do not constitute a business, the entity accounts for the transaction as a regular asset acquisition and not a business combination. Accordingly, the entity applies other applicable Standards (e.g., PAS 2 for inventories acquired, PAS 16 for PPE acquired, etc.) Accounting for business combination Business combinations are accounted for using the acquisition method. This method requires the following: a. Identifying the acquirer;Business Combinations (Part 1) 9 b. Determining the acquisition date; and c. Recognizing and measuring goodwill. This requires recognizing and measuring the following: i Consideration transferred Non-controlling interest in the acquire Previously held equity interest in the acquiree Identifiable assets acquired and liabilities assumed on the business combination. Identifying the acquirer For each business combination, one of the combining entities is identified as the acquirer. The acquirer is the entity that obtains control of the acquiree. The acquiree is the business that the acquirer obtains control of in a business combination. PERS 3 provides the following guidance in identifying the acquirer: a. Who is the transferor of cash or other resources or assumes liabilities? * Ina business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities. Who is the issuer of shares? In a business combination effected primarily by exchanging equity interests, the acquirer is usually the entity that issues its equity interests. However, in some business combinations, called “reverse acquisitions,” the issuing entity is the acquiree. Other pertinent facts and circumstances shall also be considered in identifying the acquirer. The acquirer is usually the entity: » whose owners, as a group, have the largest portion of the voting rights of the combined entity. oFtapi > whose owners have the ability to appoint or remove « majority of the members of the governing body of hg combined entity. > whose (former) management dominates the management of the combined entity. > that pays a premium over the pre-combination fair value of the equity interests of the other combining entity or entities. 9 Who is larger? *» The acquirer is usually the larger between the combining entities, measured in, for example, assets, revenues or profit, d. Who is the initiator of the combination? ‘The acquirer is usually the one who initiated the combination o Substance over form > If an new entity is formed to effect the business combination, the acquirer is identified as follows: > if the new entity is formed to issue equity interests to effect the business combination, one of the combining entities that existed before the business combination is the acquirer. » if the new entity is formed to transfer cash or other assets or incur liabilities as consideration for the business combination, the new entity is the acquirer. Example: A Co. + B Co. =C Co. (new entity) > I£C Co. is formed to issue equity interests to A Co. andB Co., the acquirer is either A Co. or B Co., whichever company whose former owners, as a group, gain contrdl over CCo. » If C Co. is formed to transfer cash to A Co, and B Co,, the acquirer is C Co,Business Combinations (Part 1) ul Illustration: Identifying the acquirer ABC Co. and XYZ, Inc., both listed entities, agreed to combine their businesses. The terms of the business combination is that ABC will offer 5 shares for every share of XYZ. There is no cash consideration. ABC’s market capitalization is P900 million and XYZ’s is P100 million. After the combination, the board of directors of XYZ shall comprise only directors from ABC. Three months after the acquisition, 20% of XYZ is sold. Analysis: ABC is the acquirer based on the following indicators: ¥ ABC is the issuer of shares and the initiator of the business combination. ¥ ABC is the larger entity of the two combining constituents. Y ABC's (former) management dominates the management of the combined entity Y Part of XYZ is sold after the acquisition. This provides additional indicator that ABC is the acquirer. Determining the acquisition date The acquisition date is the date on which the acquirer obtains control of the acquiree. This is normally the closing date (ie., the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree). However, the acquirer might obtain control on a date that js either earlier or later than the closing date, for example, when there is a written agreement to that effect. Recognizing and measuring goodwill On acquisition date,’ the acquirer computes and recognizes goodwill (or gain on a bargain purchase) using the following formula:12 Chapter | Consideration transferred Non-controlling interest (NCI) in the acquiree xx Previously held equity interest in the acquiree Xx ‘Total xx Less: Fair value of net identifiable assets acquired (xx) Goodwill | (Gain on a bargain purchase) xx la is called A negative amount resulting from the formul, “gain on a bargain purchase” (also referred to as “negative goodwill). A bargain purchase may occur, for example, in a business combination that is a forced sale in which the acquiree is acting under compulsion. However, a bargain purchase may also occur in other instances such as when the application of the recognition and measurement exceptions for particular items provided under PERS 3 results in a gain on bargain purchase. On acquisition date, the acquirer recognizes a resulting: a. Goodwill as an asset. b. Gain on a bargain purchase as gain in profit or loss. However, before recognizing a gain on a bargain purchase, the acquirer shall. reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and shall recognize any additional assets or liabilities that are identified in that review. This is an application of the concept of conservatism. Consideration transferred The consideration transferred in a business combination is measured at fair value, which is the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree and the equity interests issued by the acquirer.ness Combinations (Part 1) ne 2 13 Examples of potential forms of consideration inc lude: a. Cash b. Non-cash assets c, Equity instruments, e.g,, shares, options and warrants d, A business or a subsidiary of the acquirer e. Contingent consideration ition-related costs Acquisition-related costs are costs that the acquirer incurs to effect a business combination. Examples: a. Finder’s fees b. Professional fees, such as advisory, legal, accounting, valuation and consulting fees c. General administrative costs, including the costs of maintaining an internal acquisitions department d. Costs of registering and issuing debt and equity securities Acquisition-related costs are expensed when incurred, except for the following: a. Costs to issue debt securities measured at amortized cost are included in the initial measurement of the securities, eg, bond issue costs are included (as deduction) in the carrying amount of bonds payable. b. Costs to issue equity securities are deducted from share premium. If share premium is insufficient, the issue costs are deducted from retained earnings. Non-controlling interest Non-controlling interest (NCI) is the “equity in a subsidiary not attributable, directly or indirectly, to a parent.” (PFRS 3.Appendix A) Non-controlling interest is also called “minority interest.” For example, ABC Co. acquires 80% interest in XYZ, Inc. The controlling interest is 80%, while the non-controlling interest is 20% (100% - 80%). If ABC Co. acquires 100% interest in XYZ, Inc, the non-controlling interest is zero.i4 Chapter 1 For each business combination, the acquirer measures an) non-controlling interest in the acquire either at: a. fair value; or b._ the NCI’s proportionate share in the acquiree's net identifiab| assets. Previously held equity interest in the acquiree Previously held equity interest in the acquiree pertains to any interest held by the acquirer before the business combination. This affects the computation of goodwill only in business combinations achieved in stages. Net identifiable assets acquired Recognition principle On acquisition date, the acquirer recognizes the identifiable assets acquired, the liabilities assumed and any NCI in the acquiree separately from goodwill. Unidentifiable assets are not recognized. Examples of unidentifiable assets: a. Goodwill recorded by the aequiree prior to the business combination. Assembled workforce Potential contracts that the acquiree is negotiating with prospective new customers at the acquisition date Recognition conditions a. To qualify for recognition, identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities provided under the Conceptual Framework at the acquisition date. For example, costs that the acquirer expects but is not obliged to incur in the future to effect its plan to exit the acquiree’s activity or to terminate or relocate the acquiree’s employees are sot liabilities at the acquisition date. Hence, these are not recognized when applying the acquisitionusiness Combinations (Part 1) 15 TT TE = method. but rather treated as post-combination costs in accordance with other applicable Standards. b. The identifiable assets acquired and liabilities assumed must be part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination transaction rather than the result of separate transactions, c. Applying the recognition Principle May result to the acquirer recognizing assets and liabilities that the acquiree had not previously recognized in its financial statements. For example, the acquirer may recognize an acquired intangible asset, such as a brand name, a patent or a customer relationship, that the acquiree did not recognize as an asset in its financial statements because it has developed the intangible asset internally and charged the related costs as expense. Classifying identifiable assets acquired and liabilities assumed Identifiable assets acquired and liabilities assumed are classified at the acquisition date in accordance with other PFRSs that are to be applied subsequently. For example, PPE acquired in a business combination are classified at the acquisition date in accordance with PAS 16 if the assets are to be used as PPE subsequent to the acquisition date. Measurement principle Identifiable assets acquired and liabilities assumed are measured at their acquisition-date fair values. Separate valuation allowances are not recognized at the acquisition date because the effects of uncertainty about future cash flows are included in the fair value measurement. For example, the acquirer does not recognize an “allowance for doubtful accounts” on accounts receivable acquired on a business combination. Instead, the acquired accounts receivable are Tecognized at their acquisition-date fair values.All acquired assets are recognized regardless of whether the acquirer intends to use them. For example, the acquirer recognizes the acquiree’s research and development (R&D) costs as intangible asset even if it does not intend to use them or intends to use them in some other way. The acquisition-date fair value oj such assets is determined in accordance with their use by other market participants. Illustration 1: Measuring goodwill / gain on bargain purchase Fact pattern On January 1, 20x1, ABC Co. acquired all of the assets and assumed all of the liabilities of XYZ, Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of XYZ acquired by ABC are shown below: Assets Carrying amounts Fair values Petty cash fund 10,000 10,000 Receivables 200,000 120,000 Allowance for doubtful accounts (30,000) Inventory 520,000 350,000 Building - net 1,000,000 1,100,000 Goodwill 100,000 20,000, Total assets 1,800,000 1,600,000 Liabilities Payables 400,000 400,000 —_—_—- On the negotiation for the business combination, ABC Co. incurred transaction costs amounting to P100,000 for legal, accounting, and consultancy fees. Case #1: If ABC Co. paid P1,500,000 cash as consideration for the assets and liabilities of XYZ, Inc., how much is the goodwill (gait on bargain purchase) on the business combination? Solution:Business Combinations (Part 1) > Consideration transferred 1,500,000 Non-controlling interest in the acquiree oS previously held equity interest in the acquiree Total 10,000 Fair value of net identifiable assets acquired (1,180,000) Goodwill 320,000 & Noles: = The consideration transferred refers to the cash paid as consideration for the assets and liabilities of XYZ, Inc. © There is no non-controlling interest in the acquiree because ABC Co. acquired all of XYZ's assets and liabilities. = Previously held equity interest in the acquiree affects the computation of goodwill only in business combinations achieved in stages. This is discussed in the next chapter. ©@ The fair value of the net identifiable assets of the acquiree is computed as follows: Fair value of identifiable assets acquired excluding goodwill (1.6M -20K)* 1,580,000 Fair value of liabilities assumed (400,000) Fair value of net identifiable assets acquired 1,180,000 * The goodwill recorded by the acquiree is excluded from the identifiable assets acquired because goodwill is unidentifiable. Only identifiable assets acquired are recognized. The entries in the books of the acquirer are as follows: Jan. 1, | Petty cash fund 10,000 7051 | Receivables 120,000 Inventory 350,000 Building 1,100,000 Goodwill 320,000 Payables 400,000 Cash 1,500,000 fo record the assets acquired and liabilities assumed on a business combination18 Chapter 1 jan. 1, | Professional fees expense 700,000 | 201 Cash | 100,000 to record the acquisition-related costs _| tes & Notes: © Noallowance is recorded for the acquired receivables because the receivables are recognized at acquisition-date fair value © The acquisition-related costs are expensed. @ The illustration above is an example of a business combination effected through “asset acquisition.” XYZ, Inc. (the acquiree) shall account for the business combination as a liquidation of a business. Accordingly, all of the assets, liabilities, and equity are derecognized and the difference between the carrying amount of the items derecognized and the disposal proceeds (amount received from the business combination) is treated as a gain or loss on disposal of business XYZ shall recognize a gain on disposal of business of 100,000 (P1.5M proceeds minus P1.4M carrying amount of net assets). The entries in XYZ's books are as follows: Jont, | Cash 1,500,000 20:1 | allowance for doubtful accounts 30,000 Payables 400,000 Petty cash fund 10,000 Receivables 200,000 Inventory 520,000 Building 1,000,000 Goodwill 100,000 Gain on disposal of business 100,000 to record the liquidation of the business Jan. 1, | Share capital (& other accounts) (18M-.4M) | 1,400,000 20x1 | Gain on disposal of business 100,000 Cash 1,500,000 to record the settlement of owners’ equityBusiness Combinations (Part 1) 9 Case #2: If ABC Co. paid 1,000,000 cash as consideration for the | assets and liabilities of XYZ, Inc, how much is the goodwill (gain | on bargain purchase) on the business combination? Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree e Total 7,000,000 Fair value of net identifiable assets acquired (1,180,000) Gain on a bargain purchase (180,000) ABC Co. reassesses first whether it has correctly identified all of the assets (liabilities) acquired (assumed). If after the reassessment a negative amount still exists, ABC Co. recognizes that amount as gain in its 20x1 profit or loss. The entries are as follows: Jan.1. | Petty cash fund 10,000 201 | Receivables 120,000 Inventory 350,000 Building 1,100,000 Payables 400,000 Cash 1,000,000 Gain on bargain purchase 180,000 Jen. 1, | Professional fees expense 100,000 az Cash 100,000 Illustration 2: Non-controlling interests Fact pattern On January 1, 20x1, ABC acquired 80% of the voting shares of XYZ, Inc. On this date, XYZ’s identifiable assets and liabilities have fair values of P1,200,000 and P400,000, respectively.20 Chapter 1 Case #1: Non-controlling interest measured at fair value ABC Co. elects the option to measure non-controlling interest at fair value. The independent consultant engaged by ABC Co determined that the fair value of the 20% non-controlling interest in XYZ, Inc. is P155,000. ABC Co. paid 1,000,000 for the 80% interest in XYZ, Inc. How much is the goodwill? Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquire (fair value) 1 Previously held equity interest in the acquire my Total 1,155,000 Fair value of net identifiable assets acquired (800,000) Goodwill 355,000 The entries are as follows: > To record the acquisition in ABC’s separate books of accounts: [Jen] Investment in subsidiary 1,000,000 ] 20H Cash 1,000,000 _| > Toindude XYZ in ABC's consolidated financial statements: jan. 1,] Tdentifiable assets acquired 1,200,000 | 2011 | Goodwill 355,000 | Liabilities assumed 400,000 | Investment in subsidiary 1,000,000 Non-controlling interest in XYZ, Inc. 155,000 | & Notes: @ The non-controlling interest is presented in the consolidated statement of financial position within equity but separately from the equity of the owners of ABC Co. (parent). ®@ The illustration above is an example of a business combination effected through “stock acquisition.”Business Combinations (Part 1) a Se Case #2: Non-controlling interest measured at fair value ABC Co. elects to measure non-controlling interest at fair value. A value of P250,000 is assigned to the non-controlling interest in | XYZ, Inc. [(PIM + 80%) x 20% = P250,000]. The consideration | transferred is P1,000,000. How much is the goodwill? Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree (fair value) 250,000 Previously held equity interest in the acquiree 5: Total 1,250,000 Fair value of net identifiable assets acquired (800,000) _ Goodwill 450,000 Case #3: NCI’s proportionate share in net assets ABC Co. elects the option to measure the non-controlling interest at the non-controlling interest’s proportionate share of XYZ, Inc.'s net identifiable assets. ABC Co. paid P1,000,000 for the interest acquired in XYZ, Inc. How muchis the goodwill? Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree ® 160,000 Previously held equity interest in the acquiree : Total 1,160,000 Fair value of net identifiable assets acquired (1.2M - 400K) (800,000) Goodwill 360,000 “ The NCI’s proportionate share in XYZ’s net assets is computed as follows: Fair value of net identifiable assets acquired (2M - 400K) 800,000 Multiply by: Non-controlling interest 20% NCI’s proportionate share in net identifiable assets 160,000Illustration 3: Transaction costs Fact pattern On January 1, 20x1, ABC acquired all the assets and assumed |] the liabilities of XYZ, Inc. On this date, XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000, respectivel) ly. ABC incurred the following acquisition-related costs: legal fees, P10,000, due diligence costs, P 100,000, and general administrative costs of maintaining an internal acquisitions department, P20,000, Case #1: As consideration for the business combination, ABC Co transferred 8,000 of its own equity instruments with par value per share of P100 and fair value per share of P125 to XYZ’s former owners. Costs of registering the shares amounted to 40,000. How | much is the goodwill? | Solution: Consideration transferred (8,000 sh. x 7125) 1,000,000 Non-controlling interest in the acquiree = Previously held equity interest in the acquiree “ Total 1,000,000 Fair value of net identifiable assets acquired (1.6M -.9M) (700,000) Goodwill 300,000 The entries are as follows: Tan. 1, | Identifiable assets acquired 1,600,000 ] 20x1 | Goodwill 300,000 | Liabilities assumed 900,000 Share capital (8,000 x P100 par) 800,000 Share premium 200,000 | fo record the issuance of shares as | consideration for the business combination / Jan. 1, | Share premium 40,000 | 20x1 Cash in bank 40,000 to record thi: Costs of equily transactionBusiness Combinations (Part 1) 23 Jan. 1, | Professional fees expense (10K + 100k) 110,000 | 20x1 | General and administrative costs 20,000 | Cash in bank 130,000 to record the acquisition-releted costs The acquisition-related costs are expensed, except for the stock issuance costs which are deducted from share premium. Case #2: As consideration for the business combination, ABC Co. issued bonds with face amount and fair value of P 1,000,000. Transaction costs incurred in issuing the bonds amounted to 50,000. How much is the goodwill? Solution: Consideration transferred (fair value of bonds) 1,000,000 Non-controlling interest in the acquiree * Previously held equity interest in the acquiree z Total 1,000,000 Fair value of net identifiable assets acquired (1.6M - 9M) (700,000) Goodwill 300,000 The entries are: Jan. 1, | Identifiable assets acquired 1,600,000 20x1 | Goodwill 300,000 Liabilities assumed 900,000 Bonds payable 1,000,000 to record the issuance of bonds as consideration for the business combination Bond issue costs 50,000 Cash 50,000 to record the bond issue costs Jan. 1, | Professional fees expense (10K + 100K) 110,000 20x1_| General and administrative costs 20,000 Cash 130,000Chapter 1 & Notes: @ The bond issue costs are deducted when determining tr carrying amount of the bonds. ‘The carrying amount of th: bonds payable is P950,000 (1M — 50K). @ When computing for goodwill, the consideration transferred measured at the fair value of the securities issued without deduction for the transaction costs. @ In both cases above, the acquisition-related costs, includiny costs of issuing equity and debt securities, do_not affect the computation of goodwill. Restructuring provisions Restructuring is a program that is planned and controlled by management, and materially changes either: a. the scope of a business undertaken by an entity; or b. the manner in which that business is conducted. Restructuring provisions may include the costs of an entity’s plan a. To exit an activity of the acquire, b. To involuntarily terminate employees of the acquiree, or c. To relocate non-continuing employees of the acquiree. The costs above are sometimes referred to as “liquidation costs.” Restructuring provisions do not include such costs as (a) retraining or relocating continuing staff, (b) marketing; or (¢) investment in new systems and distribution networks. Restructuring provisions are generally not recognized as part of business combination unless the acquiree has, at the acquisition date, an existing liability for restructuring that has been recognized in accordance with PAS 37 Provisions, Contingent Liabilities and Contingent Assets. A restructuring provision meets the definition of a liability at the acquisition date if the acquirer incurs a present obligation to settle the restructuring costs assumed, such as when the acquiree developed a detailed formal plan for the restructuring and raised eiws n Business Combinations (Part 1) ee a valid expectation in those affected that the restructuring will be carried out by publicly announcing the details of the plan or has begun implementing the plan on or before the acquisition date. If the acquiree’s re: ructuring plan is conditional on it being acquired, the provision does not represent a present obligation, nor is it a contingent liability, at acquisition date Restructuring provisions that do not meet the definition of a liability at the acquisition date are recognized as post- combination expenses of the combined entity when the costs are incurred. Illustration: Restructuring provisions On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. On this date, XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000, respectively. ABC Co. has estimated restructuring provisions of P200,000 representing costs of exiting the activity of XYZ, induding costs of terminating and relocating the employees of XYZ. Requirement; Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree - Total 1,000,000 Fair value of net identifiable assets acquired (1.6M -.9M) (700,000) Goodwill 300,000 The restructuring provisions are simply ignored in the computation of goodwill. These are considered only when they qualify for recognition under PAS 37 as at the acquisition date (see discussion above). Restructuring provisions that do not meet the Tecognition criteria as at the acquisition date are recognized as Post-combination expenses (i.c., expenses after the business combination).26 Chapter | Specific recognition principles PERS 3 provides the following sp ¢ recognition principles 4. Operating leases Acquiree is the lessee General rule: The acquirer does not recognize any assets or liabilities related t an operating lease in which the acquiree is the lessee. Exception: The acquirer determines whether the terms of each operating, leas in which the acquire is the lessee are favorable or unfavorable, If the terms of an operating lease relative to market terms is: 1. Favorable - the acquirer recognizes an intangible asset. 2. Unfavorable - the acquirer recognizes a liability For example, an identifiable asset (favorable) may arise when market participants are willing to pay rent at above-market rates because the leased property is located at a prime spot. Acquire is the lessor If the acquiree is the lessor, the acquirer does not recognize any separate intangible asset or liability regardless of whether the terms of the operating lease are favorable or unfavorable when compared with market terms, Illustration: Specific recognition principles - Operating leases Fact pattern On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc, for P1,000,000. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and 900,000, respectively:Business Combinations (Part 1) me Buss 27 Case #1: Acquiree is the lessee ~ terms are favorable | ABC is renting out a building to XYZ, Inc. under an operating, | lease. The terms of the lease compared with market terms are | favorable. The fair value of the differential is 20,000. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree < Total 1,000,000 Fair value of net identifiable assets acquired © (720,000) Goodwill 280,000 — Fair value of identifiable assets acquired, including intangible asset on the operating lease with favorable 1,620,000 terms (P1.6M + P20K) Fair value of liabilities assumed (900,000) Fair value of net identifiable assets acquired 720,000. Case #2: Acquire is the lessee - terms are unfavorable ABC is renting out a patent to XYZ, Inc. under an operating lease. The terms of the lease compared with market terms are unfavorable. The fair value of the differential is 20,000. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree pai i, Total 1,000,000 Fair value of net identifiable assets acquired (680,000) _ Goodwill seen 20,000Chapter 1 28 Se () Fair value of identifiable assets acquired 1,600,0¢ Fair value of liabilities assumed, including liability on the operating lease with unfavorable terms (PS00K + 20K) Fair value of net identifiable assets acquired __ (920,000, ee Case #3: Acquire is the lessor 7 ABC is renting a building from XYZ, Inc. under an operating, lease, The terms of the operating lease compared with market terms are favorable. The fair value of the differential is P20,000. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree z Previously held equity interest in the acquiree : Total 1,000,000 Fair value of net identifiable assets acquired (1.6M-.9M) (700,000) Goodwill 300,000 © No intangible asset or liability is recognized, regardless of terms of the operating lease, because the acquiree is the lessor. & Note that the basis for determining which party is the lessee or the lessor in an operating lease is the acquiree. If the acquitee is the lessee, an asset or liability is recognized depending on the terms of the lease. If the acquiree is the lessor, no asset or liability is recognized. 2. Intangible assets Identifiable intangible assets acquired in a business combination are recognized separately from goodwill. An intangible asset is identifiable if it is either (a) separable or (b) arises from contractual ot other legal rights.usiness Combinations (Part 1) - Separability criterion ‘An intangible asset is separable if it can be separated from the acquiree and sold, wansferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability. An intangible asset is also separable if there is evidence of exchange transactions for that type of asset or similar asset, even if those transactions are infrequent and the acquirer is not involved in them. An intangible asset is separable even if the acquirer does not intend to sell, license or otherwise exchange it. For example, the fact that customer and subscriber lists are frequently licensed makes such lists separable. However, such lists would not be separable if the terms of confidentiality or other agreements prohibit the entity from selling, leasing or otherwise exchanging information about its customers. Contractual-legal criterion An intangible asset that is not separable is nonetheless identifiable if it arises from contractual or other legal rights. Example: Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity B’s license to operate the nuclear power plant. However, the terms of the license prohibit Entity A from selling or transferring the license to another party. Analysis: The license is an identifiable intangible asset because, although it is not separable, it meets the contractual-legal criterion. Illustration 1: Intangible assets ABC Co, acquired all the assets and liabilities of XYZ, Inc. for P1,500,000. Relevant information follows:30 Chapter 1 Carrying amounts Fair values Other assets 1,600,000 1,480,000 Computer software 100,000 oe Patent . 50,000 Goodwill 100,000 20,000 A 1,800,000 1,550,000 Liabilities 400,000 450,000 Additional information: ¢ The computer software is considered obsolete. © The patent has a remaining useful life of 10 years and « remaining legal life of 12 years. © XYZ has research and development (R&D) projects with fair value of ®50,000. However, XYZ, Inc. recognized the R&D costs as expenses when they were incurred. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,500,000 Non-controlling interest in the acquiree Previously held equity interest in the acquiree - Total 1,500,000 Fair value of net identifiable assets acquired (1,130,000) Goodwill 370,000 —— Fair value of identifiable assets acquired, excluding computer software and recorded goodwill but including 1,580,000 patent and R&D (P1.55M - P20K goodwill + P50K R&D) Fair value of liabilities assumed (450,000) Fair value of net identifiable it of net identifiable assets acquired 1,130,000 An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree has already expensed the related costs.Business Combinations (Part 1) e he Illustration 2: Intangible assets ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities have fair values of 71,600,000 and P900,000, respectively. Not included in the fair value of assets are the following unrecorded intangible assets: Type of intangible asset Fair value Customer list 40,000 Customer contract #1 30,000 Customer contract #2 20,000 Order (production) backlog 10,000 Internet domain name 15,000 Trademark 25,000 Trade secret processes 35,000 Mask works 45,000 Total 220,000 Additional information: ¢ Customer contract #1 refers to an agreement between XYZ, Inc. and a customer, wherein XYZ, Inc. is to supply goods to the customer over a period of 5 years. The remaining term of the contract is 3 years. The agreement is expected to be renewed at contract-end, but is not separable. © Customer contract #2 refers to XYZ's insurance segment’s portfolio of one-year motor insurance contracts that are cancellable by policyholders. * XYZ, Inc. transacts with its customers solely through purchase and sales orders. As of acquisition date, XYZ has a backlog of customer purchase orders from 60% of its customers, all of whom are recurring customers. The other 40% are also recurring customers but XYZ has no open purchase orders with these customers. * The intemet domain name is registered. Requirement: Compute for the goodwill.32 Solution: Consideration transferred 1,000, Non-controlling interest in the acquiree Previously held equity interest in the acquiree Total Fair value of net identifiable assets acquired ® Goodwill ‘Fair value of identifiable assets acquired, including 1,820,00( all of the unrecorded intangible assets (P1.6M + P220K) Fair value of liabilities assumed (900,000) Fair value of net identifiable assets acquired 920,000 & Notes: * Unless restricted by confidentiality, customer lists are normally separable because they are often leased or exchanged. @ Because XYZ establishes its relationship with its customers through contracts, customer contract #s 1 and 2 and the order (production) backlog meet the contractual-legal criterion. This is regardless of whether those contracts are cancellable or not, and in the case of the order backlog, even if there were no open purchase orders as at the acquisition date. @ A registered internet domain name meets the contractual-legal criterion. @ Trademarks, trade secret processes, and mask works acquired in a business combination normally meet the contractual-legal criterion. Exception to the recognition principle — Contingent liabilities The acquirer applies PFRS 3, rather than PAS 37, when accounting for contingent liabilities related to business combinations. Under PFRS 3, a contingent liability assumed in a busine’ combination is recognized if: a. itis a present obligation that arises from past events; and b. its fair value can be measured reliably.So, contrary to PAS 37, a contingent liability with improbable outflow may nevertheless be recognized if both the conditions above are satisfied. Illustration: Contingent liability ABC Co. acquires 90% interest in XYZ, Inc. for P1,000,000. XYZ’s recognized assets and liabilities have fair values of P1,600,000 and 900,000, respectively. ABC opts to measure the non-controlling interest at fair value. The NCI’s fair value is P80,000. XYZ is a defendant in a pending litigation, for which 0 provision was recognized because XYZ strongly believes that it will win the case. The fair value of settling the litigation is P50,000. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree 80,000 Previously held equity interest in the acquire : Total 1,080,000 Fair value of net identifiable assets acquired ® (650,000) Goodwill 430,000 © Fair value of identifiable assets acquired 1,600,000 Fair value of liabilities assumed 900,000 Contingent liability (pending litigation) 50,000 _ (950,000) Fair value of net identifiable assets acquired —-650,000_ ‘lity is recognized even if it is The contingent liab nt obligation and (b) improbable because it (a) represents a prese has a fair value.Yy 34 Chapter 1 Exceptions to both the recognition and measurement principles The following items are recognized and measured as at the acquisition date under other applicable standards rather then PERS 3: a. Income taxes are accounted for using PAS 12 Income Taxes. For example, deferred taxes are measured based on temporary differences arising from the measurement of identifiable assets and liabilities acquired at the acquisition date. Deferred taxes affect the amount of goodwill or gain on bargain purchase recognized at the acquisition date. However, PAS 12 prohibits the recognition of deferred tax liabilities arising from the initial recognition of goodwill. (The accounting for deferred taxes is discussed in detail in Intermediate Accounting Part 2.) b. Employee benefits are accounted for using PAS 19 Employee Benefits. For example, defined benefit obligations are measured using actuarial valuations. (The accounting for employee benefits is discussed in detail in Intermediate Accounting Parl 2.) c. Indemnification assets - An indemnification asset arises when the former owners of the acquire agree to reimburse the acquirer for any payments the acquirer eventually makes upon settlement of a particular liability. The acquirer recognizes and measures _ the indemnification asset at the same time and on the same basis as the indemnified item. Accordingly, if the indemnified item is measured at fait value, the indemnification asset is also measured at fair value. If the indemnified item is measured at other than fair value, the indemnification asset is measured using assumptions consistent with those used to measure the indemnified item. Example: Entity A acquires Entity B. At the acquisition date, the taxing authority is disputing Entity B’s tax returns in prior years. The former owners of Entity B agree-to reimburse Entity Ain ca® =eBusiness Comtbinations (Part 1) 35 Entity A will be held liable to pay Entity B’s tax deficiencies in the prior years. At the acquisition date, Entity A recognizes a tax liability to the taxing authority and an indemnification asset for the reimbursement due from the former owners of Entity B. Illustration: Deferred taxes ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P 1,500,000. Relevant information follows: Assets Carrying amounts Fair values Cash 10,000 10,000 Receivables 200,000 120,000 Allowance for doubtful accounts (30,000) Inventory 520,000 350,000 Building net 1,000,000 1,100,000 Goodwill __ 100,000 20,000 Total assets 1,800,000 1,600,000 Liabilities Payables 400,000, 400,000 * XYZ, Inc, has unrecorded patent with fair value of P30,000 and contingent liability with fair value of P20,000. The contingent liability is a present obligation but its outflow is improbable. « Fair value adjustments to the carrying amounts of assets and liabilities do not affect their tax bases. All adjustments result to temporary differences. ABC's tax rate is 30%. Requirement: Compute for the goodwill. Solution: {2 Recall the following concept from PAS 12: © If the carrying amount of an asset exceeds its tax base, the difference is a taxable temporary difference, which, if multiplied by the tax rate, results to deferred tax liability. % For an asset: CA> TB=TTD or FI>TI; TID x tax rate = DTL (Refer to Intermediate Accounting Part 2 for detailed discussion on deferred taxes.)36 Chapter 1 > The deferred taxes are computed as follows Z Fair Previous - values Carrying reads (CA for amounts financial (TB for reporting) taxation) Cal 10,000 10,000 : Receivables — net 120,000 170,000 (50,000) Inventory 350,000 520,000 (170,000) Building ~ net 1,100,000 1,000,000 100,000 Patent 30,000 - 30,000 Payables 400,000 400,000 - Contingent liability 20,000 ss (20,000) Taxable temporary difference (TTD) (100K +30k) 130,000 Multiply by: Tax rate 30% 39,000 Deferred tax liability Deductible temporary difference (DTD) (50K + 170K + 20k) 240,000 Multiply by: Tax rate Deferred tax asset Consideration transferred Non-controlling interest in the acquire Previously held equity interest in the acquiree Total Fair value of net identifiable assets acquired Goodwill ©) Fair value of identifiable assets acquired excluding recorded goodwill (1.6M-20K goodwill + 30K unrecorded patent + 72K deferred tax asset) Fair value of liabilities assumed (400K + 20K contingent liability + 39K deferred tax liability) Fair value of net identifiable assets acquired 30% 72,000. —_—_ 1,500,000 1,500,000 (1,223,000) 277,000 —— 1,682,000 (459,000) ame 1,223: oriain=' ;Business Combinations (Part 1) 7 ee 3 Additional concepts on Consideration transferred The consideration transferred in a business combination includes only those that are transferred to the former owners of the acquiree. It excludes those that remain within the combined entity. Assets and liabilities transferred to the former owners of the acquiree are remeasured to acquisition-date fair values. Any remeasurement gain or loss is recognized in profit or loss. Assets and liabilities that remain within the combined entity (for example, because the assets or liabilities were transferred to the acquiree rather than to its former owners) are not remeasured but rather ignored when applying the acquisition method. Illustration 1: Consideration transferred On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. The assets and liabilities have fair values of P1,600,000 and P900,000, respectively. As consideration: ° ABC agrees to pay P1,000,000 cash, of which half is payable on January 1, 20x1 and the other half on December 31, 20x5. The prevailing market rate of interest on January 1, 20x1 is 10%. ¢ In addition, ABC agrees to transfer a piece of land with carrying amount of ?500,000 and fair value of P300,000 to the former owners of XYZ. * After the combination, ABC will continue the activities of XYZ. ABC agrees to provide a patented technology with carrying amount of P60,000 and fair value of P80,000 for use in XYZ's activities. Requirement: Compute for the goodwill. Solution: Consideration transferred ® | 1,110,461 Non-controlling interest in the acquiree 3 Previously held equity interest in the acquiree on Tot! 1,110,461 Fair value of net identifiable assets acquired (1.6M- 9M) 700,000) Goodwill 410,46138 * Chapter 1 “Cash payment (P1M x 50%) 500,000 PV of future cash payment (P1M x 50% x PV of Pl @10%, n=5) 310,461 Land transferred to former owners of XYZ (at fair value) Fair value of consideration transferred & Notes: @ The land is remeasured to acquisition-date fair value before it is transferred. The 200,000 adjustment is recognized as impairment loss. @ The patented technology is not included in the consideration transferred because it remains within the combined entity. The patented technology continues to be measured at carrying amount. | Illustration 2: Consideration transferred - Dividends on | On January 1, 20x1, ABC Co. acquired all the assets and liabilities | of XYZ, Inc. for #1,000,000. The assets and liabilities have fair values of P1,600,000 and 900,000, respectively. } XYZ’s liabilities include ?100,000 cash dividends declared on December 28, 20x0, to shareholders of record on January 15, 20x1, and payable on January 31, 20x1. Requirement: Compute for the goodwill. Solution: Consideration transferred (1M - 100K dividends on) 900,000 Non-controlling interest in the acquire - Previously held equity interest in the acquiree : Total 900,000 FV of net identifiable assets acquired (16M -.9M) (700,000) Goodwill A 200,000 For purposes of computing the goodwill, the 100,000 payment is excluded from the consideration transferred becaus¢ iBusiness Combinations (Part 1) a this is not a payment for the business combination, but rather for the purchased dividends. Journal entries: Jan. | Identifiable assets acquired 1,600,000 1, | Goodwill 200,000 20x1 Liabilities assumed (incldg. dividends) 900,000 Cash 900,000 Jan. | Dividends payable 100,000 1, Cash 100,000 20x1 to record the extinguishment of the purchased dividends Exceptions to the measurement principle a. Reacquired rights Reacquired rights are measured based on the remaining term of the related contract. Reacquired rights are discussed in the next chapter. b. Share-based payment transactions Liabilities and equity instruments related to the acquiree’s share- based payment transactions are accounted for using PFRS 2 Share- based Payment. (Share-based payment transactions are discussed in detail in Intermediate Accounting Part 2.) c. Assets held for sale ‘A non-current asset (or disposal group) that is classified as ‘held for sale’ at the acquisition date is measured at fair value less costs to sell in accordance with PERS 5 Non-current Assets Held for Sale and Discontinued Operations, rather than at fair value under PFRS 3. Illustration: Held for sale assets ABC Co, acquired all the assets and liabilities of XYZ, Inc. for 1,000,000. The assets and liabilities have fair values of P1,600,000 and P900,000, respectively.| 40 Chapter 1 Additional information: © XYZ’s:assets include a factory plant that ABC intends to sei immediately. The criteria for “held for sale” classification under PERS 5 are met. Costs to sell the factory plant are 20,000. © Not included in XYZ’s assets is a research and development project that ABC does not intend to use. The R&D’s fair value is P50,000. « Also not included in the assets is a customer list with an estimated value of P10,000. However, confidentiality prohibits Entity A from selling, leasing or otherwise exchanging information about the customers in the list. Requirement: Compute for the goodwill. Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree z Total 1,000,000 Fair value of net identifiable assets acquired (1.6M - 20K costs to sell + 50K RécD - 9M liabilities) 730,000) Goodwill 270,000 & Notes: © The “held for sale” factory plant is measured at fair value less costs to sell. Because the fair value is already included in the total, the costs to sell are simply deducted. @ An identifiable asset acquired (e.g., the Ré&D) is recognized regardless of whether the acquirer intends to use it. * The customer list is not recognized because it is not identifiable. See previous discussion.Business Combinations (Part 1) a [@D General recognition and measurement principles: The net identifiable assets acquired in a business combination are recognized when they meet the recognition criteria under the Conceptual Framework and are measured at acquisition-date fair values in accordance with PFRS 3, Exception to the Exceptions to both Exceptions to the recognition the recognition and measurement principle measurement principle principles 1. Contingent 1. Deferred taxes - 1. Reacquired liabilities - (PAS 12is applied). rights - measured recognized when based on the they representa | 2 Employee benefits remaining term of present obligation — (PAS 19 is applied) the related ae ea | 3. Indemnification os even ifthe outflow assets — recognized | 2. Share-based isimprobable, and measured on the payment - (PERS same basis as the 2 is applied) indemnified item. 3. “Held for sale” assets ~ measured at fair value less costs to sell Chapter 1: Summary ® A business combination is one in which an acquirer obtains control of one or more businesses. * Control is presumed to exist when an investor holds more than 50% interest in the acquiree‘s voting rights. © Business combinations are accounted for using the acquisition method. This method requires the following: a. Identifying the acquirer; b. Determining the acquisition date; c. Recognizing and measuring goodwill) - this requires accoun i Consideration transferred, Non-controlling interest: goodwill (or negative ting for the following:42 Chapter 1 iii, Previously held equity interest, and iv. _ Identifiable assets acquired and liabilities assumed. The acquirer (parent) is the entity that obtains control after the business combination. The controlled entity is the acquiree (subsidiary). The acquisition date is the date on which the acquirer obtains control of the acquiree (e.g,, the closing date). Goodwill is computed using the following formula: Consideration transferred xx Non-controlling interest in the acquiree x, Previously held equity interest in the acquiree Xx Total XX Less: Fair value of net identifiable assets acquired _(xx) Goodwill / (Gain on a bargain purchase) xx The consideration transferred is measured at fair value. NCI is measured either at fair value or the NCIs proportionate share in the acquiree’s net identifiable assets. A “gain on a bargain purchase” is recognized in profit or loss in i the year of acquisition only after reassessment of the assets | acquired and liabilities assumed in the business combination. | Only identifiable assets acquired are recognized. Unidentifiabe assets are not recognized. Acquisition-related costs are expensed, except costs of issuing 1 equity and debt instruments. Acquisition-related costs do not | affect the measurement of goodwill. } Restructuring provisions are generally not recognized as pat | of business combination, but rather as post- combination expenses of the combined entity when the costs are incurred._— pusiness Combinations (Part 1) 43 Relevant provisions of the PFRS for SMEs Section 19 Business Combinations and Goodwill section 19 of the PFRS for SMEs applies to all business combinations, including the accounting for goodwill. It does not apply to the following: a. Combinations of businesses under common control (i.e., entities having the same parent). 'p, The formation of a joint venture. c. Acquisition of a group of assets that do not constitute a business. Business combination Business combination is “the bringing together of separate entities or businesses into one reporting entity.” (PFRS for SMEs) AS a result, one entity (the acquirer) obtains control over the other business (the acquiree). A business combination may involve the purchase, by the acquirer, of some or all of the acquiree’s (a) assets and liabilities or (b) equity, in exchange for cash, non-cash assets, or the acquirer’s equity instruments. Accounting Business combinations are accounted for using the purchase method. This method involves the following: a. Identifying the acquirer b. Measuring the cost of the business combination. ©. Allocating the cost of the business combination to the assets acquired and liabilities assumed. The purchase method is applied as at the acquisition date, which is the date on which the acquirer obtains control over the Acquiree,"a 44 Chapter 1 ator Identifying the acquirer The acquirer is identified in all business combinations, The acquirer is the one that obtains control over the other combining business. - Control is “the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities.” (PERs for sMes) When the acquirer is not clearly identifiable, the acquirer is usually: a. the business with the greater fair value; b. the transferor of cash or other assets; or ¢. the business whose management dominates the management of the combined entity. Cost of a business combination The cost of a business combination is the sum of: a. The acquisition-date fair values of the assets given, liabilities incurred, and equity instruments issued by the acquirer in exchange for control over the acquire; and b. Any costs directly attributable to the business combination. Adjustments to the cost of a business combination | If the business combination agreement provides for a contingent consideration, such is included in the cost of the business combination at the acquisition date if it is probable and can be measured reliably. If the contingent consideration is not recognized at the acquisition date but subsequently becomes probable and reliably ' measurable, the additional consideration is treated as an adjustment to the cost of the combination. | Allocating the cost of a business combination | At the acquisition date, the acquirer allocates the cost of tht | business combination by recognizing the acquiree’s identifiable assets and liabilities, including contingent liabilities, at their fai | values (except for deferred taxes and employee benefits which a | | |Business Combinations (Part 1) 7 recognized and measured using the other sections of the PERS for SMES). The difference between (a) the cost of the business combination and (b) the acquirer’s interest in the fair value of the acquiree’s net identifiable assets represents goodwill or negative goodwill. Recognition and measurement The acquirer recognizes the acquiree’s identifiable assets and liabilities at the acquisition date if they satisfy the following criteria: a. Assets other than intangible assets — it is probable that any associated future economic benefits will flow to the acquirer, and its fair value can be measured reliably. b. Liabilities other than contingent liabilities — it is probable that an outflow of resources will be required to settle the obligation, and its fair value can be measured reliably. . c. Intangible assets and Contingent liabilities — its fair value can be measured reliably. Restructuring and Future losses Restructuring provisions (e.g., liabilities for terminating or reducing the acquiree’s activities) are recognized only if the acquiree has an existing liability for the restructuring as at the acquisition date. The acquirer does not recognize liabilities for future losses expected to result from the business combination. Provisional amounts wien ; Provisional amounts may be recognized if the initial accounting for a business combination is incomplete by the end of the Teporting period in which the business combination occurs. Changes to the provisional amounts within 12 months re accounted for retrospectively. from the acquisition date a ; Changes beyond the 12-month period are treated as corrections of ettors,46 Chapter 1 Fa Goodwill and Negative goodwill Goodwill is recognized as an asset and subsequently amortizeg over a useful life determined based on management's bes estimate not exceeding 10 years. For purposes of impairment testing, goodwill is allocated to individual cash generating units (CGU). The CGUs are thon tested for impairment and any impairment Joss is charged first tg | the CGU’s allocated goodwill. Any excess is charged to the other | assets of the CGU. Negative goodwill is recognized as gain in profit or loss in the year of business combination, but only after reassessments of | the assets and liabilities acquired and the cost of the business | combination. {l Notable differences between the full PFRSs and the PERS for SMEs: Full PFRSs PERS for SMEs 1._Accounting method and computation of goodwill PERS 3 requires the use ofthe | PFRS for SMEs requires the use of acquisition method. the purchase method Goodwill is computed as follows: | Goodvwill is computed as follows: Consideration transferred 7 Fair value of assets given, liabilities | NCI = incurred, and equity instruments x | Previously held equity interest a Acquisition-related costs ss Towel xx Cost of business combination = Less: Fait value of net identifiable 60) Leas: Acquires’s interest in the fair assets acquired value of the acquiree’s net ‘Goodwill (Negative goodwill) =. identifiable assets bo) Goodwill (Negative goodwill) = > — Acquisition-related costs are expensed, except costs of issuing equity or debt securities. > —Acquisition-related costs are included in the cost of the business combination, excep! costs of issuing equity or debt securities,Business Combinations (Part 1) 47 2. Non-controlling interests NCI is included in the measurement of goodwill. NCI is measured either at: a. fair value; or NCI is not included in the measurement of goodwill. NCI in the consolidated financial statements is measured at the 1. Favorable - the acquirer recognizes an intangible asset. Unfavorable — the acquirer recognizes a liability. bp. the NCI’s proportionate NCTI's proportionate share in the share in the acquiree’s net acquiree’s net assets. assets. 3._ Operating lease — Reacquired right If the terms of an operating lease | No equivalent provision under relative to market terms is: PERS for SMEs. 4, Intangible assets acquired ina business combination Recognized if the intangible asset meets either the (a) separability criterion or the (b) contractual-legal criterion. Recognized if its fair value can be measured reliably. 5._Contingent liabilities | Recognized if it is a present obligation and its fair value can be measured reliably. Recognized if its fair value can be measured reliably.Chapter 1 PROBLEMS PROBLEM 1: TRUE OR FALSE 1. The two important elements in the definition of business combination under PERS 3 are “business” and “combination 2. PFRS 3 requires the use of the purchase method in accounting for business combinations. 3. The entity that obtains control in a business combination is called the acquiree. 4, The acquisition date in a business combination is normally the dosing date. 5, Non-controlling interests are measured at fair value only. 6. Ifthe controlling interest is 80%, the non-controlling interest is 20%. 7. A gain on a bargain purchase (negative goodwill) is recognized as an allocated deduction to the net identifiable assets acquired in the year of business combination. 8. An intangible asset that is unrecorded by the acquiree may nevertheless be recognized by the acquirer in a business combination. 9. Anoncurrent asset acquired in a business combination that is classified as held for sale is measured at fair value. 10. If the consideration transferred in a business combination is deferred, the consideration may be measured at present value PROBLEM 2: TRUE OR FALSE 1. Entity A acquires 100% interest in the voting shares of Entity 8 for #100. Entity B’s identifiable assets and liabilities have fail | values of ®200 and 9120, respectively. The goodwill is #80. | Use the following information for the next two items: Entity A acquires 90% interest in the voting shares of Entity B fo" | 100. Entity B’s identifiable assets and liabilities have fair value“! | 200 and #120, respectively. |Business Combinations (Part 1) 49 8 ‘ie NCI at measured at its Proportionate share in the acquiree’s net identifiable assets, the goodwill would be #28. 3. If the NCI is measured at a fair value 10, the goodwill would be P18. Use the following information for the next seven items: Entity A acquires all the identifiable assets and assumes all the liabilities of Entity B for ®100. Entity B's identifiable assets and liabilities have fair values of ®200 and P120, respectively. 4. Entity A incurred legal fees of ®20 in negotiating the business combination. The goodwill is #40. 5. Entity A estimates liquidation costs of #10 in exiting the business activities of Entity B, The goodwill is #20. 6. Entity A is renting out a license to Entity B under an operating lease. The terms of the lease compared with market terms are favorable. The fair value of the differential is ®5. The goodwill is P25. 7. Entity B has an unrecorded patent with fair value of #30. The gain on bargain purchase is 10. 8. Entity B has an unrecognized contingent liability with fair value of #30. The contingent liability is a present obligation but has an improbable outflow of economic resources. The goodwill is #50. 9. Entity B’s assets and liabilities have carrying amounts of ®150 and ? 120, respectively. Fair value adjustments to the acquired assets and liabilities have deferred tax consequences but do not affect their tax bases. The income tax rate is 30%. The goodwill is P53. 7 5 10. Entity A agreed to share its trade secret processes with Entity B after the business combination. The trade secret processes have a fair value of #25. The goodwill is #20.E 50 Chapter 1 PROBLEM 3: FOR CLASSROOM DISCUSSION Business combination Ki In which of the following instances is a business combination least likely to occur? a. Entity A acquires all the assets and assumes all the liabilities of Entity B-in exchange for Entity A’s shares of stocks. b. Entity A purchases 80% of Entity B’s outstanding voting shares. c. Entity A acquires 30% interest in Entity B’s voting shares. All the other’ shares of Entity B are held by various shareholders in very small denominations. Accordingly, Entity A has the power to appoint the majority of the board of directors of Entity B. d. Entity A acquires a group of assets from Entity B that does not constitute a business. Acquisition method 2. PFRS 3 requires the use of the acquisition method in accounting for all business combinations. Which of the as * is not an application of the acquisition method? . Identifying the acquirer which is the entity that obtains control over another business in a business combination. . Determining the acquisition date which is the date the acquirer obtains control over the acquire. Measuring the consideration transferred at fair value. |. Measuring the non-controlling interest at the NCI’s proportionate share in the acquiree’s net identifiable assets or fair value, whichever is higher. Goodwill 3. Entity A acquired all the assets and assumed all the liabilities of Entity B for 1,800,000. Information on Entity B's assets and liabilities as at the acquisition date is shown below:Business Combinations (Part 1) 51 Assets Carrying amounts Fair values Receivables — net 200,000 100,000 Inventory 600,000 450,000 Building - net 1,200,000 1,800,000 Goodwill 100,000 ____20,000_ Total assets 2,100,000 2,370,000 Liabilities Payables 900,000 700,000 Requirement: Compute for the goodwill (gain on bargain purchase). Non-controlling interest Use the following information for the next two items: Entity A acquired 75% of the outstanding voting shares of Entity B for 2,000,000. On acquisition date, Entity B’s identifiable assets and liabilities have fair values of 4,000,000 and 1,600,000, respectively. 4. How much is the goodwill if Entity A opts to measure the non-controlling interest at the NCI’s proportionate’ share in Entity B’s net identifiable assets? 5. Entity A opts to measure the non-controlling interest at fair value. An independent valuer assessed the NCI’s fair value to be ®540,000. How much is the goodwill? Acquisition-related costs and Restructuring provisions 6. Entity A acquired all the assets and liabilities of Entity B by issuing 18,000 shares with par value of P10 per share and fair value of P100 per share. On acquisition date, Entity B's identifiable assets and liabilities have fair values of ®3,800,000 and #1,900,000, respectively. Entity A incurred stock issuance costs of ®36,000 and finder's fees related to the business-combination of ?60,000. Moreover,52 Chapter 1 Entity A expects to incur liquidation costs of ®280,000 in terminating Entity B’s activities. Requirement: Compute for the goodwill (gain on bargain purchase), erating leases and Intangible assets 8 gil 7 Entity A acquired all the assets and assumed all the liabilities of Entity B for ®2,800,000. On acquisition date, Entity B’s identifiable assets and liabilities have fair values of 4,000,000 and 1,600,000, respectively. Additional information: Entity B has an unrecorded patent with fair value of 100,000. Entity B has research and development (R&D) projects with fair value of 160,000. Entity B charged the R&D costs as expenses when they were incurred. Entity A is renting out a property to Entity B under an operating lease. The terms of the lease compared with market terms are favorable. The fair value of the differential is 40,000. Requirement: Compute for the goodwill. Contingent liabilities 8. Entity A acquired 75% of the outstanding voting shares of Entity B for 1,800,000. On acquisition date, Entity Bs identifiable assets and liabilities have fair values of #4,000,000 and 1,600,000, respectively. Additional information: Entity A replaces Entity B as a guarantor on a loan of a third party. As at the acquisition date, the third party has defaulted on the Ioan. However, because negotiations for det! restructuring are ongoing with the lender and Entity 8 strongly believes that the lender will agree on the propeBusiness Combinations (Part 1) 53 terms, no provision was recognized. The fair value of the guarantee is P200,000. « Entity A chose to measure the non-controlling interest at the NCI’s proportionate share in the acquiree’s net identifiable assets. Requirement: Compute for the goodwill. Deferred taxes 9. Entity A acquired all the assets and assumed all the liabilities of Entity B for 4,000,000. Information on Entity B’s identifiable assets and liabilities as at the acquisition date is shown below: Canyingamounts —_—‘Fair values Assets 5,800,000 6,100,000 Liabilities 2,100,000 2,300,000 All fair value adjustments to the identifiable assets acquired and liabilities assumed have deferred tax consequences, but do not affect their tax bases. The income tax rate is 30%. Requirement: Compute for the goodwill. Consideration transferred 10. On October 26, 20x1, Entity A acquired 100% interest in Entity B for ®2,800,000. On this date, Entity B's identifiable assets and liabilities have fair values of 4,000,000 and #1,600,000, respectively. Included in Entity B's liabilities are cash dividends of 280,000 declared on October 1, 20x1, to shareholders of record on November 1, 20x1, and payable on December 1, 20x1. Requirement: Compute for the goodwill.54 Chapter 1 PROBLEM 4: EXERCISES 1. ACo. issued bonds with face amount of #1M and fair value of 1.2M in exchange for all the assets and liabilities of B Co. 4 Co. incurred bond issue costs of *30,000 and legal fees of 10,000 in negotiating the business combination. The carrying amounts and fair values of B’s assets and liabilities at the acquisition date are shown below: Assets “Carrying amounts Fair values Receivables — net 300,000 200,000 Inventory 600,000 450,000 Land 800,000 1,000,000 Goodwill 80,000 50,000 Total assets 1,780,000 1,700,000 Liabilities Payables 320,000 390,000 Requirement: Compute for the goodwill (gain on bargain purchase). Use the following information for the next two requirements: A Co. acquired 80% interest in B Co. for #1,200,000. On acquisition date, B’s identifiable assets and liabilities have fair values oi 1,700,000 and ®400,000, respectively. 2. How much is the goodwill if A Co. opts to measure the non- controlling interest at the NCI’s proportionate share in B Co.'s net identifiable assets? 3. How much is the goodwill if A Co. opts to measure the nor controlling interest at fair value? (An independent appraise! valued the NCI at ®300,000.) 4. A Co. acquired all the assets and liabilities of B Co. by issui" 10,000 shares with par value of ®20 per share and fair value a 100 per share. A Co. incurred 40,000 in issuing the shareBusiness Combinations (Part 1) ut and 60,000 in professional fees and administrative costs in effecting the business combination. On acquisition date, B’s identifiable assets and liabilities have fair values of 1,800,000 and 900,000, respectively. After the business combination, A Co. will close some of the operating segments of B Co. The closure costs are estimated at #400,000. Requirement; Compute for the goodwill (gain on bargain purchase). 5, A Co. acquired 60% interest in the net assets of B Co. for 1,500,000. On acquisition date, B Co.’s identifiable assets and liabilities have fair values of 5,000,000 and 2,800,000, respectively. Additional information: B Co. has an unrecorded customer list with fair value of 80,000. The customer list is separable. A Co. is renting out a license to B Co. under an operating lease. The terms of the lease compared with market terms are unfavorable. The fair value of the differential is 30,000. A Co. opted to measure the NCI at fair value. An independent valuer assessed the fair value of the NCI to be ®800,000. Requirement: Compute for the goodwill. 6. A Co. acquired all the assets and liabilities of B Co. for 1,600,000. Information on B’s identifiable assets and liabilities as at the acquisition date is as follows: Carrying amounts Fair values Assets 3,800,000 3,500,000 Liabilities 2,000,000 1,900,000 As at the acquisition date, B Co. has breached a contract witha customer. The customer is seeking damages amounting to 250,000. However, B Co. is currently disputing the56 Chapter 1 | customer's dlaim and B Cos legal counsel believes they wi win the case. Accordingly, B Co. did not recognize provision. The fair value of settling the claim is ®100,000, Fair value adjustments to the assets acquired and liabilities | assumed have deferred tax consequences, but do not affect the tax bases of the assets and liabilities. The tax rate is 30%, Requirement: Compute for the goodwill. PROBLEM 5: MULTIPLE CHOICE - THEORY | 1. This distinguishes a business combination from other types of investment transactions. a. acquisition of assets c. obtaining of control b. acquisition of stocks d. all of these The entity that obtains control over another business in a | business combination is called the | a. controller. c. acquirer. b. acquire. d. controllee. PFRS 3 requires all business combinations to be accounted for using the a. purchase method. ¢. goodwill method. | b. acquisition method. d. control method. According to PERS 3, the acquisition date is normally the a. control date. c. closing date. | b. purchase date. d. valentine's date. in the business combination is not clearly identifiable. Which of the following in not an indicator that Entity A is the | acquirer? a. Entity A is the initiator of the business combination. Entity A and Entity B combined their businesses. The acquire |