ACCOUNTING FOR BUSINESS COMBINATIONS

Business Combination Acquirer / Parent - the entity that obtains control of the acquiree
- transaction or event in which an acquirer obtains control of one or more businesses (PFRS 3)
a. Transfers cash or other assets and incurs liabilities
 one company acquires another
b. Issues its equity interests (except in reverse acquisitions where acquiree issues equity)
 two or more companies merge into one
c. Receives the largest portion of the voting rights
Kinds of Business Combinations d. Has the ability to elect or appoint or to remove a majority
e. Dominates the management of the combined entity
1. Horizontal Combination – similar businesses (ex: bank acquires another bank) f. Significantly larger of the combining entities
2. Vertical Combination – different levels in a marketing chain (ex: a manufacturer acquires its g. Initiated the combination
supplier of raw materials)
Acquiree / Subsidiary - the business that the acquirer obtains control of
3. Conglomerate – different businesses (ex: real estate developer acquires a bank)
Substance Over Form
Acquisition Methods
New entity is formed to: Acquirer Illustration: A + B = C
1. Asset Acquisition one of the combining entities, A or B, whichever group of
issue equity interests
- acquirer purchases the assets and assumes liabilities in exchange for cash or non-cash whichever gain control owners gain control over C
considerations transfer cash or other assets or
new entity C transfers cash to A and B
- acquiree ceases to exist incur liabilities as consideration
 Merger: A Co. + B Co. = A Co. / B Co. 2. Determining the Acquisition Date
 Consolidation: A Co. + B Co. = C Co. - date on which the acquirer obtains control of the acquiree
2. Stock Acquisition - normally the closing date (date on which the acquirer legally transfers, acquires, and assumes)
- acquirer obtains control over the acquiree by acquiring a majority ownership interest in the - can be either earlier or later than closing date when there is a written agreement
voting rights of the acquiree 3. Recognizing and Measuring Goodwill
- acquiree still exist, however, for financial reporting viewed as a single reporting entity with
Consideration transferred xx
the acquirer (uses the name of the acquirer) Non-controlling interest in the acquiree xx
 Parent – acquirer in a stock acquisition Previously held equity interest in the acquiree xx
 Subsidiary – acquiree in as stock acquisition Total xx
Less: FV of Net Identifiable Assets Acquired (xx)
 Investment in Subsidiary Goodwill / (Gain on a Bargain Purchase) xx
– parent’s ownership interest recorded in its separate accounting book
– eliminated when consolidated financial statement is prepared On acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
PART 1: RECOGNITION AND MEASUREMENT b. Gain on a bargain purchase as gain in profit or loss (negative goodwill)
Control * Before recognizing a gain on bargain purchase, the acquirer shall reassess whether it has
- presumed to exist when the ownership interest acquired in the voting rights of the acquiree is correctly identified all assets acquired and liabilities assumed and shall recognize additional
more than 50% (51% or more) assets and liabilities identified in that reassessment (conservatism).
* An investor controls an investee when the investor is exposed, or has rights, to variable returns from its
 Consideration Transferred - measured at fair value
involvement with the investee and has the ability to affect those returns through its power over the investee.
 Cash
An acquirer may obtain control of an acquiree in a variety of ways:  Other assets
 by transferring cash or other assets  A business or a subsidiary of the acquirer
 by incurring liabilities  Contingent consideration
 by issuing equity interests  Ordinary or preference equity instruments, options, warrants, and member interests of mutual
 by providing more than one type of consideration entities
 without transferring consideration, including by contract alone
Acquisition-Related Costs
If the acquirer holds less than 50% interest in the voting rights of acquiree, control may - costs the acquirer incurs to effect a business combination
exist: - recognized as expenses in the periods in which they are incurred
 Acquirer has the power to appoint or remove the majority of the board of directors of the acquiree Exception:
 Acquirer has the power to cast majority of votes at board meetings or equivalent bodies within the a. Costs to issue Debt Securities
acquiree
- measured at amortized cost
 Acquirer has power over more thank half of the voting right of the acquiree because of an agreement
with other investors - included in the initial measurement of the resulting financial liability
 Acquirer has power to control the financial and operating policies of the acquiree because of a law or
b. Costs to issue Equity Securities
an agreement
- accounted for as deduction from share premium
Accounting for Business Combination: Acquisition Method - if share premium is insufficient, the issue costs are deducted from
1. Identifying the Acquirer retained earnings
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 Non-Controlling Interest (NCI)

- the equity in a subsidiary not attributable, directly or indirectly, to a parent
- minority interest Specific Recognition Principles
- measured at either: 1. Operating Leases
 Fair value
Acquiree is the lessee
 The NCI’s proportionate share of the acquiree’s identifiable net assets
- acquirer does not recognize any, unless terms are determined:
\
 Previously Held Equity Interest in the Acquiree a. Favorable – the acquirer shall recognize an intangible asset
- any interest held by the acquirer before the business combination
- only affects computation of goodwill in business combinations achieved in stages b. Unfavorable – the acquirer shall recognize a liability

 Net Identifiable Assets Acquired Acquiree is the lessor

- measured at acquisition-date fair value - does not recognize any, regardless
- shall be recognized separately from goodwill on acquisition date
2. Intangible Assets
- any unidentifiable asset shall not be recognized:
- the acquirer recognizes the identifiable intangible assets acquired in a business combination
 any recorded goodwill by the acquiree prior to business combination
 assembled workforce if they meet either the:
 potential contracts that the acquiree is negotiating with prospective new customers at the a. Separability Criterion
acquisition date - can be separated from the acquiree
Recognition Conditions: - if there is evidence of exchange transactions, even if infrequent or without
a. Must meet the definitions of assets and liabilities provided under the Conceptual acquirer
Framework at the acquisition date involvement
b. Must be part of the exchange in the business combination transaction rather than the - even if acquirer does not intend to sell, license, or otherwise exchange
result of separate transactions
c. Previously unrecognized from the acquiree’s financial statements b. Contractual-Legal Criterion
* All acquired assets are recognized regardless of whether the acquirer intends to use them. - not separable
- arises from contractual or other legal rights
* Separate valuation allowances are not recognized at the acquisition date because the effects of uncertainty
about
Exceptions
future cash flows are included in the fair value measurement.
Both Recognition and Measurement
Recognition Principle Measurement Principle
Restructuring Provisions Principles
- 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: Contingent Liabilities Deferred Taxes – PAS 12
such would be the case when the entity has a present obligation as of the acquisition date evidenced Reacquired Rights
by a detailed formal plan developed by the acquiree that has been announced publicly on or before Recognized if: - deferred taxes affect the amount of
the acquisition date - a present obligation that goodwill but the standard prohibits the
arises from past events recognition - measured based on the
* However, if restructuring plan is conditional, provision does not represent a present obligation nor it remaining term of the
- fair value can be
is a contingent liability and shall be recognized as post-combination expenses of the combined related contract
measured reliably
entity  CA > TB = TTD = DTL
when the costs are incurred.
* Recognized if the criteria
- may include the costs (liquidation cost) of an entity’s plan: above are met, even if the  CA < TB = DTD = DTA
a. to exit an activity of the acquiree contingent liability has an
b. to involuntarily terminate employees of the acquiree improbable outflow. Share-Based Payment
c. to relocate non-continuing employees of the acquiree
Employee Benefits – PAS 19
Transactions
- do not include such costs as:
- defined benefit obligations are measured
a. retraining or relocating continuing staff - accounted for using
using actuarial valuations
b. marketing PFRS 2
c. investment in new systems and distribution networks
Assets Held for Sale
Restructuring
- program that is planned and controlled by management, and materially changes either: Indemnification of Assets
- measured at fair value less
a. the scope of a business undertaken by an entity
cost to sell
b. the manner in which that business is conducted - arises when former owners of the acquiree
agree to reimburse the acquirer for any
payments the acquirer eventually make
upon settlement of a particular liability
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Measurement Period
- same basis as the indemnified item Provisional Amounts
(fair value) - may be used if the accounting is incomplete by the end of the business combination year
- adjusted retrospectively for information obtained during the measurement period (maximum of 12
- if measurement is other than FV, months from acquisition date) that provides evidence of facts and circumstances that existed as of
assumptions consistent with measurement
of indemnified item is used the acquisition date
* beyond 12-month measurement period = corrections of error (PAS 8)
Additional Concepts on Considerations Transferred - any adjustment is recognized as an adjustment to goodwill or gain on a bargain purchase
Includes: transferred to the former owners of the acquiree
Determining What is Part of the Business Combination Transaction
- remeasured to acquisition-date FV
- any remeasurement gain or loss is recognized as profit or loss The consideration transferred
Includes: part of business combination transaction
Excludes: remain within the combined entity
- not remeasured but rather ignored Excludes: separate transactions

PART 2: SPECIFIC CASES Business Combination Transaction Separate Transaction

Arranged primarily for the benefit of the acquirer or
Share-for-Share Exchanges Arranged primarily for the benefit of the acquiree
the combined entity
- combination is accomplished through exchange of equity interest
Initiated by the acquiree Initiated by the acquirer
General Rule for Measurement: fair value of acquirer’s equity interest Settlement of pre-existing relationship between
Exception: cases where acquiree’s equity interest is more reliably measurable than acquirer and acquiree
acquirer’s (in such case, use acquiree’s) Transaction between acquirer and acquiree during Remuneration to employees or former owners of the
the negotiations of a business combination acquiree for future services
Business Combination Achieved in Stages Reimbursement to the acquiree or its former owners
- step acquisition for paying the acquirer’s acquisition-related costs
- obtains control in more than one transaction
Reacquired Rights
Accounting for this specific case: - previously granted right to acquiree, reacquired as a result of a business combination
The acquirer: - recognized as intangible asset separately from goodwill
a. Remeasures the previously held equity interest in the acquiree at acquisition-date - measured at the “at-market” value (value derived from market participation assumptions)
fair value
ex: right to use the acquirer’s intangible asset, such as trade name under a franchise agreement
b. Recognizes the gain or loss on the remeasurement in: right to use the acquirer’s technology under a technology licensing agreement
 Profit or Loss
– if the previously held equity interest was classified as FVPL, Investment in “Off-Market” Value
Associate, or Investment in Joint Venture
- used to determine settlement of gain or loss from
 Other Comprehensive Income the acquirer’s perspective
Total Fair - excluded from ‘consideration transferred’ and
– if the previously held equity interest was classified as FVOCI
Value of treated as separate transaction
Business Combination Without the Transfer of Consideration Reacquired
Right
The acquisition method applies to all business combinations, including those that do not involve a
Consisting of:
purchase transaction. “At-Market” Value
 Acquiree repurchases a sufficient number of its own share from other investors so that the acquirer - recognized as intangible asset if it relates to a
will be able to obtain control reacquired right
 Minority veto rights – previously kept the acquirer from controlling the acquiree have lapse
 Acquirer and acquiree agreed to combine their businesses by contract alone

If a business combination is achieved: Settlement of Pre-Existing Relationship

a. Without transfer of consideration - transactions or agreement prior to business combination
- the fair value of the acquirer’s interest in the acquiree is substituted for the
consideration transferred in computing for goodwill Contractual Non-Contractual
b. By contract alone Definition Vendor – Customer Plaintiff – Defendant
- all interests not held by the acquirer are attributed to NCI, even if the resulting NCI is
100% Licensor – Licensee (on a pending lawsuit)
 ACCOUNTING FOR BUSINESS COMBINATIONS
the cash inflows from other assets or groups of assets
Franchisor – Franchisee - impaired if its recoverable amount is less than its carrying amount including the allocated goodwill
- upon disposal, goodwill is also derecognized and included in the determination of gain/loss from
(contract recognized as reacquired right)
disposal
at the lower: Due Diligence Audit
Measurement - off-market value, favorable/unfavorable
determined based on the acquirer’s perspective - initiated before negotiation take place to determine the appropriate amount of consideration to be
in gain or transferred to the acquiree
Fair value
loss on - investigation of all areas of a potential acquiree’s business before an investor agrees to a
settlement - any settlement stated in the contract
business combination transaction
Due Diligence - exercise of care that a reasonable and prudent person should take entering a
Subsequent Measurement and Accounting contract with another party

Reacquired Rights amortized over the remaining term of related contract Potential Risks Potential Rewards

Indemnification of Assets same basis as indemnified item, subject to assessments of collectability

 Possibility of future losses due to the  Unrecorded assets (trade secrets, trade
higher of:
acquiree’s pending litigations and other name, customer list, etc.)
unrecorded contingencies
- amount recognized through PAS 37
Contingent Liabilities
 Overstatement in the consideration for the  Understatement in the consideration for the
- amount initially recognized less, if appropriate, cumulative amount of business combination due to the business combination due to the acquiree’s
income recognized through PFRS 15 acquiree’s overstated assets and understated assets and overstated liabilities
Contingent Consideration understated liabilities
- additional consideration that the acquirer agreed to provide the acquiree upon the happening of a
contingency (an existing, unresolved condition that will be resolved by the occurrence/non-occurrence of a possible future event)  Incompatibility of internal cultures,
systems, and policies
Initial Measurement: Methods of Estimating Goodwill
 acquisition-date fair value
Indirect Valuation
 included in the consideration transferred
- method required by PFRS 3
Subsequent Measurement: - residual approach
 change in fair value is accounted for as a retrospective adjustment to - excess of the sum of CT, NCI, and PHEI over FV of NIAA
provisional amount
Direct Valuation
Not measurement period adjustments: - based on expected future earnings
 meeting an earnings target a. Normal Rate of Return
 reaching a specified share price - industry average from examining annual reports of similar entities or from published
 reaching a milestone on R&D project
statistical data
Accounted based on classification: Normal Earnings - normal rate of return multiplied by the acquirer’s net assets
 Equity – not remeasured, subsequently accounted for within equity b. Estimated Future Earnings of the acquiree
 Asset or Liability – fair value, any changes recognize in profit or less
 Normalized - earnings are adjusted for non-recurring income and expenses
PART 3: SPECIAL ACCOUNTING TOPICS  Excess / Superior - excess of the acquiree’s normalized earnings over
Goodwill average return in the industry
- only recognized when arising from business combinations c. Discount Rate to be applied to excess earnings
- measured and recognized on acquisition date d. Probable Duration of excess earnings
- subsequent expenditures on its maintenance are expensed immediately
- not amortized, rather, tested for impairment at least annually Application of Direct Valuation Method
* can only be tested in conjunction with groups of assets that generate independent cash inflows due to its Method #1: Multiple of Average Excess Earnings
unidentifiability
- Goodwill is measured at the average excess earnings multiplied by the probable duration of excess earnings.
- allocated to each of the acquirer’s CGU in the year of business combination
* If allocation is not completed by the end of that year, it must be completed before the end of the Method #2: Capitalization of Average Excess Earnings
immediately following year. - Goodwill is measured at the average excess earnings divided by a pre-determined capitalization rate.

Cash Generating Unit (CGU) Method #3: Capitalization of Average Earning

- smallest identifiable group of assets that generates cash inflows that are largely independent of - Average earnings are divided by a pre-determined capitalization rate to estimate purchase price of the business
combination. The excess of the estimated purchase price over the fair value of the acquirer’s net assets
 ACCOUNTING FOR BUSINESS COMBINATIONS
represents the goodwill.

Method #4: Present Value of Average Excess Earnings

- Goodwill is measured at the present value of average excess earnings discounted at a pre-determined discount
rate over the probable duration of excess earnings.

Reverse Acquisition
- reverse of the acquisition method, in which case:
Acquiree (legal acquirer) – entity that issues securities
Acquirer (legal acquiree) – entity whose equity interest are acquired
* For accounting purposes – reversed to the original application of acquisition method

Conventional Acquisition Reverse Acquisition

Issuer of Shares
as Consideration accounting acquirer accounting acquiree
Transferred
Reference to
Accounting acquirer = legal parent Accounting acquirer = legal subsidiary
Combining Accounting acquiree = legal subsidiary Accounting acquiree = legal parent
Constituents
Fair value of the notional number of equity
instruments that the accounting acquirer
Measurement of (legal subsidiary) would have had to issue
Fair value of consideration transferred
Consideration by the accounting acquirer
to the accounting acquiree (legal parent) to
Transferred give the owners of the accounting acquiree
(legal parent) the same percentage
ownership in the combined entity