Accounting For Business Combination - Compress

PSBA: AFAR 04_BUSINESS COMBINATIONS: STATUTORY MERGERS & FULL STOCK ACQUISITION BATCH 2020
AFAR04 BUSINESS COMBINATIONS: STATUTORY MERGERS &

–
FULL STOCK ACQUISITION
RELATED STANDARDS: PFRS 3 – BUSINESS COMBINATIONS
TOPIC OUTLINE
Basic Concepts and Introduction
Accounting for Business

Combination
BUSINESS COMBINATIONS
(PFRS 3)
Accounting for Cost of Business
Combination
PFRS for SMEs
LECTURE NOTES
BASIC CONCEPTS AND INTRODUCTION
DEFINITION
A business combination is a transaction or other event in which an acquirer obtains control of one or more
businesses.
Transactions sometimes referred to as "true mergers" or "mergers of equals" are also business
combinations as that term is used in PFRS 3.
Essential elements in the definition of a business combination are:
(1) Control
Control is the power to govern the financial and operating policies of an entity so as to obtain benefits
from its activities.
Control is normally presumed to exist when the acquirer holds more than 50% interest
(QUANTITATIVE THRESHOLD) in the acquiree voting rights. However, this is only a presumption
because control can be obtained in some other ways, such as when (QUALITATIVE THRESHOLD):
(a) The acquirer has the power to appoint or remove the majority of board of directors of the
acquiree.
(b) The acquirer has the power to cast the majority of votes at board meetings or equivalent bodies
within the acquiree.
(c) The acquirer has power over more than half of the voting rights of the acquiree because of an
agreement with other investors
(d) The acquirer controls the acquiree’s operating and financial policies because of law or an
agreement.
An acquirer may obtain control of an acquiree in variety of ways, for example:
(a) by transferring cash or other assets
(b) by incurring liabilities
(c) by issuing equity securities
(d) by providing more than one type of consideration
(e) without transferring consideration, including by contract alone
(2) Business
A business is defined as "an integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing a return in the form of dividends, lower costs or other
economic benefits directly to investors or other owners, members or participants".
CLASSIFICATION OF BUSINESS COMBINATION
ACCORDING TO STRUCTURE (BUSINESS POINT OF VIEW)
(a) Horizontal Integration – this type of business combination is one that involves companies within the
same industry that have been previously competitors.
Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 1

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(b) Vertical Integration - this type of business combination take place between two companies involved in
the same industry but at different levels. It normally involves a combination of a company and its
supplier or customers.
(c) Conglomerate Combination – is one involving companies in unrelated industries having little, if any,
production or market similarities for the purpose of entering into a new market or industry.
(d) Circular Combination – entails some diversification, but does not have a drastic change in operation
as a comglomerate.
ACCORDING TO METHOD (LEGAL POINT OF VIEW)
(a) ASSET ACQUISTION – The acquirer purchases the assets and assumes liabilities of the acquiree in
exchange of cash or other non-cash consideration. Under the Corporation Code of the Philippines, a
business combination effected through asset acquisition may be either:
 Merger – occurs when two or more companies merge into a single entity which shall be one of
the combining entities. For example: A Corp. + B Corp. = A Corp. or B. Corp.
 Consolidation – occurs when two or more companies consolidate into a single entity which shall
be the consolidated entity. For example: A Corp. + B Corp. = C Corp.
(b) STOCK ACQUISITION – instead of acquiring the assets and assuming the liability of the acquiree, the
acquirer obtains control over the acquiree by acquiring majority ownership interest in the voting
rights of the acquiree. In stock acquisition, the acquirer is known as the parent while the acquiree is
known as subsidiary. After the acquisition, the entities retain their separate legal existence but for
financial reporting purposes, both entities are viewed as a single reporting entity.
ACCOUNTING FOR BUSINESS COMBINATIONS
Business combinations are accounted for using the ACQUISITION METHOD. This method requires the
following steps or procedures:
(1) IDENTIFY THE ACQUIRER
(a) In a 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.
(b) In a business combination effected primarily by exchanging equity interests, the acquirer is
usually the entity that issues its equity interests.
(c) The acquirer is usually the combining entity whose relative size measured in terms of assets ,
revenue or profit is significantly greater than that of the other combining entities.
(d) In a business combination involving more than two entities, determining the acquirer shall
include a consideration of which of the combining entities initiated the combination as well as
the relative size of the entities.
(e) If a new entity is formed to issue equity interests to effect a business combination, one of the
combining entities that existed before the combination shall be identified as the acquirer.
(f) The combining entity whose owners as a group receive the largest proportion of the voting
rights in the combined entity is likely the acquirer.
(g) Where there is a large minority interest in the combined entity and no other owner has a
significant voting interest, the holder of the large minority interest is likely the acquirer.
(h) Where one entity has the ability to select the management team or the majority of the
members of the governing body of the combined entity, such entity is likely the acquirer.
(2) DETERMINE THE ACQUISITION DATE
The acquisition date is the date on which an ACQUIRER OBTAINS CONTROL over the acquiree. The
acquisition date is normally the date on which the acquirer legally transfers the consideration,
acquires the assets and assumes the liabilities of the acquiree. The acquisition date is also known as,
the "CLOSING DATE”.
However, it is possible for control to pass to the acquirer before or after the closing date. Where
several dates are key to a business combination, it is the date on which control passes that
determines the acquisition date. For example, the acquisition date precedes the closing date if a
written agreement provides that the acquirer obtains control of the acquiree on a date before the
closing date.
(3) RECOGNIZING AND MEASURING GOODWILL
On acquisition date, the acquirer computes and recognizes goodwill (or gain or bargain purchase)
using the following formula:
Consideration transferred xxx
NCI in the acquiree xxx
Previously held equity interest in the acquiree xxx
Total xxx
Less: Fair value of net identifiable assets acquired xxx
Goodwill / (Gain on Bargain Purchase) xxx
Goodwill is recognized as an asset while gain on bargain purchase is presented as gain in profit or
loss.
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NOTE: NCI and Previously held equity interest in the acquiree are to be discussed on the next topic.
Consideration transferred
The consideration transferred may include assets or liabilities of the acquirer that have carrying amounts
that differ from their fair values at the acquisition date.
The following are the considerations that the acquirer may transfer or incur and their proper measurement:
(1) Cash or other monetary assets – The fair value is the amount of cash or cash equivalent dispersed.
(2) Deferred payment – the fair value to the acquirer is the amount the entity would have to borrow to
settle their debt immediately. Basically, the amount should be at present value.
(3) Non-monetary assets - Their fair values on acquisition date.
(4) Equity instruments – If an acquirer issues its own shares as consideration, it will need to determine
the fair value of those shares at the date of exchange.
(5) Debt instruments or liabilities undertaken – The fair values of liabilities undertaken are best measured
by the present value of future cash flows.
(6) Contingent consideration – The acquirer shall recognize the acquisition-date fair value of contingent
consideration. Changes that are result of the acquirer obtaining additional information about facts and
circumstances that existed at the acquisition date, and that occur within the measurement period
(which may be a maximum of one year from the acquisition date) are recognized as adjustments
against the original accounting for the acquisition (in other words are adjusted in goodwill). Changes
resulting from events after the acquisition date are not measurement period adjustments. Such
changes are therefore accounted for separately from the business combination.
Recognition and Measurement of Acquired Assets and Liabilities
Recognition Principle
On acquisition date, the acquirer recognizes the identifiable assets acquired and liabilities assumed. To
qualify for recognition, the identifiable assets and liabilities must meet the definition of assets and liabilities
in the Conceptual Framework for Financial Reporting.
Unidentifiable assets are NOT RECOGNIZED. Examples of which are as follows:
 Goodwill recorded by acquiree prior to the business combination
 Assembled workforce
 Potential contracts that the acquiree is negotiating with prospective mew customers at the acquisition
date.
Measurement Principle
1. The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their
acquisition-date fair value.
2. For each business combination, the acquirer shall measure any non-controlling interest in the
acquiree either at:
a. Fair value
b. The non-controlling interest's proportionate share of the acquiree's identifiable net assets.
Specific Recognition Principle
(1) Operating Leases
Acquiree is the lessee
General Rule: The acquirer does not recognize any assets or liabilities related to an operating lease in
which the acquiree is the lessee.
Exception: The acquirer determines whether the terms of each operating lease in which the acquiree
is the lessee are favorable or unfavorable
If the terms of the lease relative to market terms is:
 Favorable – the acquirer recognizes an intangible asset.
 Unfavorable – the acquirer recognizes a liability.
Acquiree is the lessor
If the acquiree is the lessor, the acquirer does not recognize any separate intangible asset or liability
regardless whether the terms of the operating lease are favorable or unfavorable when compared
with market terms.
(2) Intangible assets

PFRS 3 requires the acquirer to recognize IDENTIFIABLE ASSETS acquired regardless of the degree of
probability of an inflow of economic benefits.
An intangible asset is identifiable if it:
 can be separated or
 meets the contractual-legal criterion. (If it arises from legal or contractual right regardless of
separability.
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Exception to the Exceptions to both the Recognition Exception to the

Recognition Principle and Measurement Principle Measurement Principle
(1) Reacquired rights -
(1) Deferred Taxes - PAS 12 is measured based on the
(1) Contingent Liabilities - applied remaining terms of the
recognized when they related contract
represent a present (2) Employee Benefits - PAS 19 is
obligation and their fair applied (2) Share-based payment
value is determinable - PFRS 2 is applied
even if the outflow is (3) Indemnification assets -
improbable recognized and measured on the (3) NCA Held for Sale -
same basis as the indemnified item. measured at fair value less
costs to sell
Measurement Period
If the initial accounting for business combination is incomplete by the end of the reporting period in which
the combination occurred, the acquirer can use provisional amounts to measure any of the following for
which the accounting is incomplete:
 Consideration transferred
 NCI in the acquiree
 Previously held equity interest in the acquiree
 Identifiable assets acquired and liabilities assumed
Within 12 MONTHS FROM THE ACQUISITION DATE (the measurement period), the acquirer retrospectively
adjusts the provisional amounts for any new information obtained that provides evidence of facts and
circumstances that existed as of the acquisition date, which if known would have affected the measurement
of the amounts recognized on that date. Any adjustment to a provisional amount is recognized as an
adjustment to goodwill or gain on bargain purchase.
ACCOUNTING FOR COSTS OF BUSINESS COMBINATION
Acquisition-related Costs Examples Treatment
Professional fees paid to
accountants, legal advisors, valuers
Direct Costs and other consultants (finders and Expensed as incurred
brokerage fees) to affect the
combination
General and administrative costs,
Indirect Costs including the costs of maintaining an Expensed as incurred
internal acquisitions department
transaction costs such as stamp
duties, professional adviser's fees, Debit to APIC or Share
Cost of Issuing Equity Securities
underwriting costs and brokerage Premium Account
fees
Deducted from Carrying
Cost of Issuing Debt Securities Bond issue costs Amount of Financial
Liability
PFRS FOR SMEs
FULL PFRS PFRS for SMEs
Accounting Method
PFRS 3 requires the use of ACQUISITION PFRS for SMEs requires the use of PURCHASE
METHOD METHOD
Acquisition Related Costs
Expensed except for costs of issuing debt or Included in the cost of business combination
equity securities except for costs of issuing debt or equity securities
Operating Lease
PFRS 3 has a specific provision for operating PFRS for SMEs has no specific provision for
leases. operating leases.
Intangible Assets Acquired
Recognized if the intangible asset is either
(a) separable or (b) arises from legal or Recognized if its fair value can be measured
contractual right reliably
Contingent Liabilities
Recognized if it is a present obligation and its Recognized if its fair value can be measured
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fair value can be measured reliably reliably
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DISCUSSION EXERCISES
STRAIGHT PROBLEMS:
1. On January 1, 2019, ALABAMA CORP. acquired all the assets and assumed all of the liabilities of
ALABANG INC. As of this date, the carrying amounts and fair values of the assets and liabilities of
ALABANG acquired by ALABAMA are shown below:
Carrying amounts Fair value
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
Payables 400,000 400,000
On the negotiation for the business combination, ALABAMA incurred transaction costs amounting to
P100,000 for legal, accounting and consultancy fees.
REQUIREMENTS:
(a) If ALABAMA paid P1,500,000 cash as consideration for the assets and liabilities of ALABANG,
how much is the goodwill or gain or bargain purchase on the business combination?
Consideration transferred P1,500,000
Fair value of net identifiable assets (P1,580,000 – P400,000) (1,180,000)
Goodwill P320,000
(b) If ALABAMA paid P1,000,000 cash as consideration for the assets and liabilities of ALABANG,
how much is the goodwill or gain or bargain purchase on the business combination?
Consideration transferred P1,000,000
Goodwill P180,000
(c) If ALABAMA is an SME and paid P1,500,000 cash as consideration for the assets and liabilities of
ALABANG, how much is the goodwill or gain or bargain purchase on the business combination?
Consideration transferred (P1,500,000 + 100,000) P1,600,000
Goodwill P420,000
2. On January 1, 2020, ALASKA CORP. acquired all the assets and assumed all the liabilities of
CONDENSADA CORP for the following considerations:
 Cash of P200,000 plus an installment payment of P1,000,000 on December 31, 2020. The
incremental borrowing rate of ALASKA is 5% per annum. (Round-off present value factors in 2
decimal places)
 Bonds payable with a face value of P500,000. At the acquisition date, the bonds are trading at
110. The bonds are classified as financial liability at amortized cost.
 ALASKA agreed to pay additional P200,000 on January 1, 2022 if the average income of
CONDENSADA during the 2-year period of 2020 – 2022 exceeds P10 million per year. The
expected value is P200,000 calculated based on the 40% probability of achieving the target
average income.
As of this date, the carrying amounts and fair values of the assets and liabilities of CONDENSADA are
shown below:
Carrying amounts Fair value
Current assets 500,000 800,000
Building – net 400,000 200,000
Equipment – net 200,000 150,000
Patent - 200,000
Computer software 150,000 -
Current liabilities 300,000 350,000
Additional information:
 CONDENSADA is a defendant in a pending litigation for which no provision was recognized
because CONDENSADA believes that it will win the case. The fair value of settling the litigation
is P100,000.
 ALASKA is renting out a building to CONDENSADA under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of differential is P50,000.
 CONDENSADA has research and development projects with a fair value of P150,000. However,
CONDENSADA recognized the costs expenses.
 The assets include an equipment which was assigned a provisional amount of P150,000. This
equipment was assigned a tentative useful life of 10 years and to be depreciated using straight-
line method. The equipment’s fair value on October 1, 2020 is P300,000.
 In addition, ALASKA had an out-of-pocket costs of P10,000 for direct cost, P5,000 for indirect
costs and P20,000 for bond issuance costs.
REQUIREMENTS:
(a) Compute the amount of goodwill arising from the business combination.
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Consideration transferred:
Cash P200,000
Notes payable (1,000,000 x 0.95) 950,000
Bonds payable (500,000 x 1.10) 550,000
Contingent consideration 200,000 P1,900,000
Fair value of net identifiable assets:
Current assets 800,000
Building – net 200,000
Equipment – net 150,000
Patent 200,000
Research and development costs 150,000
Operating lease – intangible assets 50,000
Current liabilities (350,000)
Contingent liabilities (100,000) 1,100,000
Goodwill P800,000
Adjustment for provisional amounts 150,000
Adjusted amount of goodwill P950,000
(b) Assuming that the terms of the lease compared with market terms are unfavorable, compute for
the amount of goodwill arising from the business combination.
Cash P200,000
Notes payable (1,000,000 x 0.95) 950,000
Bonds payable (500,000 x 1.10) 550,000
Patent 200,000
Operating lease – liability (50,000)
Goodwill P900,000
Adjusted amount of goodwill P1,050,000
(c) Assuming that before the contingency period is over, the probability present value of the
earnings contingency declines to P150,000 and the change in value is within measurement
period, compute for the amount of goodwill arising from the business combination.
Cash P200,000
Notes payable (1,000,000 x 0.95) 950,000
Bonds payable (500,000 x 1.10) 550,000
Patent 200,000
Goodwill P800,000
Adjustment for provisional amounts (150,000 – 50,000) 100,000
(d) Assuming that before the contingency period is over, the probability present value of the
earnings contingency declines to P150,000 and the change in value is beyond measurement
period, compute for the amount of goodwill arising from the business combination.
Cash P200,000
Notes payable (1,000,000 x 0.95) 950,000
Bonds payable (500,000 x 1.10) 550,000
Patent 200,000
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Goodwill P800,000
3. The following data relates to the balance sheets of ARIZONA COMPANY and ARENA INC. on December
31, 2020 just before the business combination:
ASSETS ARIZONA ARENA
Current Assets P400,000 P500,000
Land 100,000 150,000
Buildings (net) 200,000 150,000
Total P700,000 P800,000
LIABILITIES & EQUITY
Accounts Payable P100,000 P90,000
Bonds Payable 300,000 380,000
Share Capital - Ordinary (P10 par) 100,000 120,000
APIC 50,000 80,000
Retained Earnings 150,000 130,000
Total P700,000 P800,000
On January 1, 2021, ARIZONA acquired the net assets of ARENA for the following consideration:
 Cash of P600,000.
 Issuance of 5,000 shares with a market value of P20 per share at the date of combination.
 Bonds payable with a face value of P200,000. At the acquisition date, the bonds are trading at
110. The bonds are classified as financial liability at amortized cost.
The following items have a fair value different from their book values that are relevant for business
combination:
ARIZONA ARENA
Land P150,000 P200,000
Building 150,000 250,000
Accounts Payable 120,000 150,000
The following out-of-pocket costs of the combination were as follows:
Legal fees for the contract of business combination P2,000 Direct Costs
Audit fee for SEC registration of share issue 3,000 SIC
Printing costs of share certificates 1,000 SIC
Broker’s fee 2,000 Direct Costs
Accountants fee 1,500 Direct Costs
Lawyer’s fee 3,000 Direct Costs
Other direct cost of acquisition 1,500 Direct Costs
Internal secretarial, general and allocated expense 2,500 Indirect Costs
Documentary stamp tax on new shares 1,000 SIC
Bond issue cost 5,000 BIC
REQUIREMENTS: Using the following assumption (a) Compute the amount of goodwill at the date of
acquisition; (b) The total assets after business combination; (c) Total liabilities after the business
combination; (d) Total retained earnings after business combination; (e) Total shareholders’ equity
after business combination
(1) Assume that ARIZONA acquires the net assets of ARENA.
Cash P300,000
Issuance of shares (5,000 shares x P20) 100,000
Bonds payable (200,000 x 1.10) 220,000 P620,000
Fair value of net identifiable assets: 420,000
Goodwill (a) P200,000
Current Assets (400,000 + 500,000 – 300,000 – 22,500) 577,500
Land (100,000 + 200,000) 300,000
Building (200,000 + 250,000) 450,000
Goodwill 200,000
Total assets (b) 1,527,500
Accounts payable (100,000 + 150,000) 250,000
Bonds payable (300,000 + 380,000 + 220,000 – 5,000) 895,000
Total liabilities (c) 1,145,000
Retained earnings (150,000 – 12,500) (d) P137,500
Share capital (100,000 + 50,000) 150,000
Share premium (50,000 + 50,000 – 5,000) 95,000
Total shareholder’s equity (e) 382,500
(2) Assume that ARIZONA acquires all of the outstanding shares of ARENA.
Cash P300,000
Bonds payable (200,000 x 1.10) 220,000 P620,000
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Fair value of net assets: 420,000

Current Assets (400,000– 300,000 – 22,500) 77,500
Land 100,000
Investment in subsidiary 620,000
Building 200,000
Total assets (b) 997,500
Accounts payable 100,000
Bonds payable (300,000 + 220,000 – 5,000) 515,000
Total liabilities (c) 615,000
Share capital (100,000 + 50,000) 150,000
Share premium (50,000 + 50,000 – 5,000) 95,000
(3) Assume that ARIZONA acquires the net assets of ARENA but with no cash consideration.
Bonds payable (200,000 x 1.10) 220,000 P320,000
Gain on bargain purchase (a) P100,000
Current Assets (400,000 + 500,000– 22,500) 877,500
Land (100,000 + 200,000) 300,000
Building (200,000 + 250,000) 450,000
Bonds payable (300,000 + 380,000 + 220,000 – 5,000) 895,000
Retained earnings (150,000 + 100,000 – 12,500) (d) P237,500
Share capital (100,000 + 50,000) 150,000
Share premium (50,000 + 50,000 – 5,000) 95,000
(4) Assume that ARIZONA acquires the net assets of ARENA and it is an SME.
Cash P300,000
Direct costs 10,000
Bonds payable (200,000 x 1.10) 220,000 P630,000
Current Assets (400,000 + 500,000 – 300,000 – 22,500) 577,500
Land (100,000 + 200,000) 300,000
Building (200,000 + 250,000) 450,000
Goodwill 210,000
Bonds payable (300,000 + 380,000 + 220,000 – 5,000) 895,000
Share capital (100,000 + 50,000) 150,000
Share premium (50,000 + 50,000 – 5,000) 95,000
4. ARKANSAS INC. issued shares in exchange for 100% interest in CALIFORNIA CORP. Relevant
information follows:
ARKANSAS CALIFORNIA COMBINED
(Carrying Amounts) (Fair Values) ENTITY
Identifiable Assets 2,400,000 1,600,000 4,000,000
Goodwill - - ?
Total Assets 2,400,000 1,600,000 ?
Liabilities 700,000 900,000 1,600,000

Share Capital 600,000 300,000 700,000
Share Premium 300,000 250,000 1,200,000
Retained Earnings 800,000 150,000 ?
Total Liabilities & Equity 2,400,000 1,600,000 ?
Additional Information:
 ARKANSAS’ share capital consists of 60,000 ordinary shares with par value of P10 per share.
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PSBA: AFAR 04_BUSINESS COMBINATIONS: STATUTORY MERGERS & FULL STOCK ACQUISITION BATCH 2020

AFAR04 BUSINESS COMBINATIONS: STATUTORY MERGERS &

Basic Concepts and Introduction

Accounting for Business

PFRS for SMEs

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 1

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 2

(2) Intangible assets

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 3

Exception to the Exceptions to both the Recognition Exception to the

fair value can be measured reliably reliably

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 5

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 6

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 7

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 8

Fair value of net assets: 420,000

Liabilities 700,000 900,000 1,600,000

Advanced Financial Accounting & Reporting by Karim G. Abitago, CPA Page 9

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