ACCOUNTING FOR BUSINESS COMBINATION

MODULE CONTENT:

2. Acquisition of assets and assumption of liabilities (Statutory Merger / Acquisitions)

2.1 Goodwill Computation with Contingent Consideration based on Future Performance – Earnings

2.2 Provisional Amount on Asset Acquired

2.3 Cash / Liability Contingency applying measurement date rule

2.4 Cash / Liability Contingency with Present Value based on Future Performance – Cash Flows

2.5 Cash / Liability Contingency based on Future Performance – Earnings

2.6 Stock Contingency based on Future Performance – Earnings with Market Value of Stock Given

2.7 Stock Contingency based on Future Performance – Earnings

2.8 Stock Contingency based on Future Stock prices

INTENDED LEARNING OUTCOMES:

ILO1 Recognize the accounts affected in each situation under Statutory Merger of Acquisition

ILO2 Demonstrate competency in computing for Goodwill Computation with Contingent Consideration
based on Future Performance – Earnings

ILO3 Indicate the accounting requirements for provisional amounts on Asset Acquired

ILO4 Identify the accounting requirements for Cash / Liability Contingency

ILO5 Recognize the accounting requirements for Stock Contingency

INSTRUCTORE’S NOTE: Always prepare for a graded recitation: past and current week’s topic
 ACCOUNTING FOR BUSINESS COMBINATION

Illustration 14-1: Goodwill Computation with Contingent Consideration based on Future

Performance - Earnings

On December 31, 20x4, Peter Corporation enters into a business combination by acquiring the
assets and assumed the liabilities of Saul Corporation in which Saul Corporation will be
dissolved. Peter’s consideration transferred consists of the following:

a. 25,000 unissued shares of its P10 par common stock, with a market value of P25 per share;
b. P150,000 in long-term 8% notes payable, and
c. A contingent payment of 100 cash on January 1, 20x7, if the average income of during the
two-year period of 20x5-20x6 exceeds P 250,000 per year. Peter estimates that there is a 30%
chance or probability that the 100,000 payment will be required.

In addition, Peter pays the following at the time of the merger:

• Finder’s fee- P10,000
• Accounting fees-P20,000
• Legal fees to arrange the business combination-P35,000
• Cost of SEC registration, including accounting and legal fees- P15,000
• Cost of printing and issuing stock certificates- P12,000
• Indirect cost of combining, including allocated overhead and executive salaries- P23,000

Balance sheet and fair value information for the two companies on December 31, 20x4,
immediately before the merger, are as follows:

Peter Saul
Book Value Fair Value Book Value Fair Value

Cash . . . . . . . . . . . . . . . . . . . . . . . . . P 230,000 P 230,000 P 20,000 P 20,000

Receivables- net . . . . . . . . . . . . . . . . 80,000 80,000 40,000 40,000
Inventories . . . . . . . . . . . . . . . . . . . . 240,000 300,000 100,000 60,000
Land . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 200,000 60,000 200,000
Buildings- net (10-year life) . . . . . . 400,000 600,000 200,000 300,000
Equipment- net (5- year life) . . . . . . 360,000 490,000 180,000 250,000
In-process research and
Development . . . . . . . . . . . . . . . . . . 0 0 0 50,000
Total Assets . . . . . . . . . . . . . . . . P 1,400,000 P 1,900,000 P 600,000 P 920,000
Accounts Payable . . . . . . . . . . . . . . P 180,000 P 180,000 P 60,000 P 60,000
Other liabilities . . . . . . . . . . . . . . . . 200,000 180,000 120,000 140,000
Common stock, P10 par . . . . . . . . . 600,000 200,000
Additional paid-in capital . . . . . . . . 200,000 160,000
Retained earnings . . . . . . . . . . . . . . 220,000 60,000
Total Liabilities and Equities . . . P 1,400,000 P 600,000
 ACCOUNTING FOR BUSINESS COMBINATION

The computation of goodwill is as follows:

Consideration transferred:
Common shares: 25,000 shares x P25. . . . . . . . . . . . . P 625,000
Notes Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Contingent consideration (cash contingency):
P100,000 x 30% probability. . . . . . . . . . . . . . . . . . . 30,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 805,000
Less: Fair value of identifiable assets acquired and
liabilities assumed:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 20,000
Receivables- net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Buildings- net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Equipment- net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
In-process research and development . . . . . . . . . . . . . . . 50,000
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60,000)
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (140,000) 720,000
Positive Excess – Goodwill . . . . . . . . . . . . . . . . . . . . . . P 85,000
The journal entries by Peter Corporation to record the acquisition are as follows:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Receivables – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Building – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Equipment – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
In-process research and development . . . . . . . . . . . . . . . . 50,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Estimated Liability for Contingent Consideration . . . . . 30,000
Common Stock (P10 par x 25, 000 shares) . . . . . . . . . . 250,000
Paid-in capital excess of par
[(P25 – P10) x 25, 000 shares] . . . . . . . . . . . . . . . . . . 375,000
Acquisition of Saul Company.

Acquisition-related expenses . . . . . . . . . . . . . . . . . . . . . . . . 65,000

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65,000
Acquisition related costs – direct costs.

Paid-in capital excess of par . . . . . . . . . . . . . . . . . . . . . . . . . 27,000

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,000
Acquisition related costs – costs to issue and register stocks.

Acquisition –related expenses . . . . . . . . . . . . . . . . . . . . . . 23,000

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,000
Acquisition related costs – indirect costs.
 ACCOUNTING FOR BUSINESS COMBINATION

Illustration 14-2: Provisional Amount on Asset Acquired

Assume that the value of the buildings in Illustration 14-1 was provisionally determined on
December 31 20x4, Peter Corporation received the final value from the independent appraisal,
the fair value at acquisition date being P 320,000.

The entry on august 1, 20x4 to reflect the adjustment since it is still within the measurement
period of one (1) year would be:

Buildings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Adjustment to goodwill due to measurement date.

The following illustrations are the different situations regarding contingent consideration.

Illustration 14-3: Cash / Liability Contingency applying Measurement Date Rule

Assume the information and Illustration 14-1 and that on August 31, 20x5 because of
improved information about facts and circumstances that existed on the acquisition date, the
contingent consideration was revised to an expected value of P50,000.

Since the adjustment is still within the measurement period, the entry to adjust the liability would
be:

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Estimated liability for contingent consideration. . . . . . . . . . 20,000
Adjustment after measurement date.

The goodwill to be reported then on the acquisition should be P105,000 (P85,000 + P20,000)
On November 1, 20x5, the probability value of the contingent consideration amounted to P40,
000, the entry to adjust the liability would be:
Estimated liability for contingent consideration . . . . . . . . . . . . . 10,000
Gain on estimated contingent consideration. . . . . . . . . . . . . . 10,000
Adjustment after measurement date.

Further, on December 15, 20x5, the expected value of the contingent consideration amounted to
P65,000, the entry would be:
Loss on estimated liability contingent consideration . . . . . . . . . . . . . 25,000
Estimated liability for contingent consideration. . . . . . . . . . . . . . . 25,000
Adjustment after measurement date.
 ACCOUNTING FOR BUSINESS COMBINATION

On January 1, 20x7, Saul’s average income in 20x5 is P270,000 and 20x6 is P260,000, which
means that the target is met, Peter Corporation will make the following entry:
Estimated liability for contingent consideration . . . . . . . . . . . . . 65,000
Loss on estimated contingent consideration . . . . . . . . . . . . . . . . 35,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Settlement of contingent consideration.

Illustration 14-4: Cash/Liability Contingency with Present Value based on Future

Performance – Cash Flows
Assuming the same information in Illustration 14-1, except that a contingent payment of
P100,000 cash if Saul Corporation will generate cash flows from operations of P300,000 or more
in 20x5. Saul estimates that there is a 35% chance that the P100,000 will be required. Saul uses
an interest rate of 4 percent to incorporate the time value of money.
The amount of goodwill will be recomputed as follows:
Consideration transferred
Common shares: 25, 000 shares x P25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 625,000
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Contingent consideration (Cash contingency):
P100,000 x 35% probability x (1/[1 + .04]*). . . . . . . . . . . . . . . . . . . . . . . . 33,654
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 808,654
Less: Fair value of identifiable assets acquired and
Liabilities assumed (refer to Illustrative Problem 14-1). . . . . . . . . . . . . . . . 720,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 88,654
* present value of P1 @ 4% for one period.

The journal entries by Peter Corporation to record the acquisition are as follows:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Receivables – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Buildings – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Equipment – net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
In-process research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,654
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Estimated Liability for Contingent Consideration . . . . . . . . . . . . . . . 33,654
Common stock (P10 par x 25, 0000 shares) . . . . . . . . . . . . . . . . . . . . 250,000
Paid-in capital excess of par
[(P25 – P10) x 25, 000 shares] . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375,000
Acquisition of Saul Company.
On December 31, 20x5, Saul Corporation’s cash flows from operations amounted to P280,000,
which means that it did not exceed the cash flows from operations threshold of P300,000,
 ACCOUNTING FOR BUSINESS COMBINATION

therefore, there is no cash payment to be made to Saul Corporation. The entry for Peter
Corporation on December 31, 20x5 to record such occurrence would be:
Estimated liability for contingent consideration . . . . . . . . . . . . . . . . . . . . . . . 33,654
Gain on estimated contingent consideration . . . . . . . . . . . . . . . . . . . . . . . . 33,654
Adjustment after measurement date.

Illustration 14-5: Cash/Liability Contingency based on Future Performance – Earnings

Assuming the same information in Illustration 14-1, except that instead of contingent payment
of P100,000 cash, an additional cash payment would be made on January 1, 20x7, equal to twice
the amount by which average annual earnings of Saul Corporation exceed P25,000 per year, prior
to January 1, 20x7. Net income was P65,000 in 20x5 and P70,000 in 20x6.
The entry by Peter Corporation on January 1, 20x7 for the payment of the contingent consideration
would be:
Estimated liability for contingent consideration. . . . . . . . . . . . . . . . . . . 30,000
Loss on estimated contingent consideration. . . . . . . . . . . . . . . . . . . . . . 55,000
Cash ((P65,000 + P70,000)/2- P25,000] x 2 . . . . . . . . . . . . . . . . . . . 85,000
Settlement of contingent consideration.

Illustration14-6: Stock Contingency based on Future Performance – Earnings with Market

Value of Stock Given
Assuming the same information in Illustration 14-1, in addition to the stock issue, Peter
Corporation also agreed to issue additional shares of common stock to the former stockholders of
Saul Corporation if the average post-combination earnings over next two years (i.e., 20x5 and
20x6) equaled or exceeded P390,000. The additional 1,000 shares expected to be issued are valued
at P15,000.
 ACCOUNTING FOR BUSINESS COMBINATION

The amount of goodwill on acquisition will be recomputed as follows:

Consideration transferred;
Common shares: 25,000 shares x P25. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 625,000
Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Contingent consideration (cash contingency):
P100,000 x 30% probability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Contingent consideration (stock contingency) . . . . . . . . . . . . . . . . . . . . . . . . 15,000
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 820,000
Less: Fair value of identifiable assets acquired and
liabilities assumed (refer to Illustrative Problem 14-1). . . . . . . . . . . . . . . . 720, 000
Positive Excess – Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P100,000

The journal entries by Peter Corporation to record the acquisition are as follows:
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Receivables- net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Buildings – net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Equipment – net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
In-process research and development . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Goodwill. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000
Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000
Estimated Liability for Contingent Consideration. . . . . . . . . . . . . 30,000
Paid-in capital for Contingent Consideration. . . . . . . . . . . . . . . . . 15,000
Common stock (P10 par x 25,000 shares). . . . . . . . . . . . . . . . . . . 250,000
Additional paid-in capital [(P25 – P10) x 25,000 shares]. . . . . . . . 375,000
Acquisition of Saul Company.
On January 1, 20x7, the target is met or contingent event happens, ie., average post- combination
earnings over the next two years amounted to P410.000. Thus, Peter Corporation will make the
following entry for the issuance of 1,000 additional shares:
Paid-in capital for Contingent Consideration. . . . . . . . . . . . . . . . . . . 15,000
Common stock (P10 par x 1.000 shares) . . . . . . . . . . . . . . . . . . . 10,000
Paid-in capital in excess of par. . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000
Settlement of contingent consideration.

In the event, that the contingent does not met, then, the account "Paid-in capital for Contingent
Consideration" will be closed to account, "Paid-in capital from net meeting the contingent event"
 ACCOUNTING FOR BUSINESS COMBINATION

Illustration 14-7: Stock Contingency based on Future Performance –Earnings

Assuming the same information in Illustration 14-1, in addition to the stock issue, Peter
Corporation agreed to issue 5,000 additional shares if the average income during the 2- year period
of 20x5-20x6 exceeded P80,000 per year.
Thus, the above transaction requires the same entry with Illustration 14-1 on December 31, 20x4.
Prior to the termination of the contingency, it would be described in a footnote.
On January 1, 20x7, the average income amounted to P110,000 (the contingent event occurs).
Thus, the entry record the occurrence of such event to reassign the P625,000 original consideration
to 30,000 shares (25,000 original shares issued + 5,000 additional shares due to contingency)
would be:
Paid-in capital in excess of par . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Common stock (P10 par x 5,000 shares) . . . . . . . . . . . . . . . . . . . . . . 50,000
Settlement of contingent consideration.

Illustration 14-8: Stock Contingency based on Future Stock Prices

Assuming the same information in Illustration 14-1, in addition to the stock issue, Peter
Corporation agreed to issue 5,000 additional shares if two years later, the fair value of acquirer fell
below P25 per share.
Thus, the above transaction requires the same entry with Illustration 14-1 on December 31, 20x4.
Prior to the termination of the contingency, it would be described in a footnote.
On January 1, 20x7, the contingent event happens and the stock had a fair value below P25. Thus,
the entry record the occurrence of such event to reassign the P625,000 original consideration to
30,000 shares (25,000 original shares issued + 5,000 additional shares due to contingency) would
be:
Paid-in capital in excess of par . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Common stock (P10 par x 5,000 shares) . . . . . . . . . . . . . . . . . . . . . . 50,000
Settlement of contingent consideration.

Illustration 14-9: Stock Contingency based on Future Performance -Earnings

Assuming the same information in Illustration 14-1, in addition to the stock issue, Peter
Corporation agreed to issue additional shares on January 1, 20x7, equal in value to twice the
amount by which average annual earnings of the Saul Corporation exceed P25,000 per year, prior
to January 1, 20x7. Net income was P65,000 in 20x5 and P70,000 in 20x6.
Thus, the above transaction requires the same entry with Illustration 14-1 on December 31, 20x4.
Prior to the termination of the contingency, it would be' described in a footnote.
On January 1, 20x7, the contingent event happens since the average annual earnings for 20x5 and
P20x6 is in excess of P25,000 and stock had a fair value P20 per share. Thus, the entry record the
 ACCOUNTING FOR BUSINESS COMBINATION

occurrence of such event to reassign the P625,000 original consideration to 29,450 shares (25,000
original shares issued + 4,250* additional shares due to contingency)would be:
Paid-in capital in excess of par . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,500
Common stock (P10 par x 4,250 shares) . . . . . . . . . . . . . . . . . . . . . . 42,500
Settlement of contingent consideration.
*{(P65,000 + P70,000)/2 - P25,000) x 2}/ P20
Illustration 14-10: Stock Contingency based on Future Stock Prices
Assuming the same information in Illustration 14-1, in addition to the stock issue, Peter
Corporation agreed to issue additional shares on January 1, 20x7, to compensate for any fall in the
value of Peter common stock below P25 per share. The settlement would be to cure the deficiency
by issuing added shares based on their fair value on January 1, 20x7. The market price of the shares
on January 1, 20x7, was P20.
Thus, the above transaction requires the same entry with Illustration 14-1 on December 31. 20x4.
Prior to the termination of the contingency, it would be described in a footnote. On January 1,
20x7, the contingent event happens since the fair value per share fall below P25. Thus, the entry
record the occurrence of such event to reassign the P625,000 original consideration to 31,250
shares (25,000 original shares issued + 6,250* additional shares due to contingency) would be:
Paid-in capital in excess of par . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,500
Common stock (P10 par x 6,250 shares) . . . . . . . . . . . . . . . . . . . . . . . 62,500
Settlement of contingent consideration.
*Deficiency: (P25 – P20) x 25,000 shares issued to acquire....P125,000
Divide by fair value per share on January 1, 20x7……… P 20
Added number of shares to issue........................................ 6,250

*** END OF LESSON ***

REFERENCES

Books:
Dayag, A.J. (2020). Advanced Financial Accounting vol. 2. Lajara Publishing House
De Jesus, P.A.D.F. (2020) Advanced Financial Accounting and Reporting Reviewer. New Omori Printing
Press
Millan, Z.V.B. (2020). Accounting for Business Combinations. Bandolin Enterprise

Internet References:
https://www.iasplus.com/en/standards/ifrs/ifrs3
https://www.iasplus.com/en/standards/ias/ias21
https://www.iasplus.com/en/standards/ias/ias27-2011
https://www.academia.edu/25847527/Chapter_1_Business_Combinations
http://www.accountingdose.com/2015/07/journal-entry-for-difference-in-foreign.html
https://frv.kpmg.us/content/dam/frv/en/pdfs/2016/accounting-for-business-combinations.pdf
 ACCOUNTING FOR BUSINESS COMBINATION

https://www.grantthornton.com.au/insights/technical-publications--ifrs/navigating-the-accounting-for-
business-combinations/
https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/ASC/Roadmaps/us-aers-a-roadmap-
to-consolidation-identifying-a-controlling-financial-interest.pdf
https://www.accaglobal.com/hk/en/student/exam-support-resources/professional-exams-study-
resources/strategic-business reporting/technical-articles/business-combinations.html