ACC 113: Accounting for Business Combinations

Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

Lesson title: Business Combination (Part 3) Materials:

Lesson Targets: Student Activity Sheet, Columnar
At the end of the learning session, notebook; calculator; textbook
1. I can apply the methods of estimating goodwill. References:
2. I can account for reverse acquisitions. Millan, Zeus Vernon B.; Accounting
for Business Combinations; 2020
Edition;
Dayag, Antonio J.; Advanced
Financial Accounting and
Reporting, 2016 Edition

Productivity Tip:
Keep away anything that might be a possible source of distraction. You can also go to a quiet and comfortable
place to keep our concentration focused.

A. LESSON PREVIEW/REVIEW
Introduction (5 min.)
Welcome back to ACC 113.

Let’s continue our 7th day in Accounting for Business Combination by activating your prior knowledge
through answering the What I know Chart, part 1 in Activity 1. Do not worry if you answer the questions
incorrectly that only means you do not have prior knowledge of the subject.

1) Activity 1: What I Know Chart, part 1

Before proceeding with our main lesson, let us first answer the first column of the chart below:

What I Know Questions: What I Learned (Activity 4)

1. What are the methods of

estimating goodwill?

2. What are the special

accountings topics for business
combination?

3 How are reverse acquisitions

done?

B.MAIN LESSON

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

1) Activity 2: Content Notes (15 mins)

Special Accounting Topics for Business Combination:

Methods of Estimating Goodwill

- this is the method required by PFRS 3 and it is the method illustrated in the
preceding discussions.

- under this method, goodwill is measured on the basis of expected future

earnings from the business to be acquired.

Direct valuation method

The direct valuation method may require the determination of one or more of the following information:
a. Normal rate of return in the industry where the acquiree belongs (e.g., industry average)
b. Normal earnings = Normal rate of return x Acquiree’s net assets
c. Estimated future earnings of the acquiree.
• The earnings of the acquiree are “normalized,” i.e., adjusted for non-recurring income and
expenses.
• The excess of the acquiree’s normalized earnings over the average return in the industry
represents the “excess earnings” to which goodwill is attributed.
d. Discount rate to be applied to “excess earnings”
e. Probable duration of “excess earnings”

Reverse acquisitions

In a business combination accomplished through exchange of equity interests, the acquirer is usually the
entity that issues its equity interests. However, the opposite is true for reverse acquisitions.

In a reverse acquisition, the entity that issues securities (the legal acquirer) is identified as the acquiree
for accounting purposes while the entity whose equity interests are acquired (the legal acquiree) is the
acquirer for accounting purposes

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

Solve the following problems.

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

Use the following information for the next four items:

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

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

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

3. Goodwill is measured at the undiscounted amount of total excess earnings expected to be earned from
the combination. How much is the goodwill?

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

4. Goodwill is measured by discounting the average excess earnings at 9%. How much is the goodwill?

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

3) Activity 4: What I Know Chart, part 2

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

This time, let us go back to Activity 1 and fill out the third column for what we now know about the
lesson.

4) Activity 5: Check for Understanding (5 mins)

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

Use the following information for the next three questions:

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

Gamer Co. Player Co.

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

Fair value of net identifiable assets 500,000 380,000

Average annual earnings 40,000 39,000

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

2. How many shares will be issued to Gamer and Player, respectively?

Gamer Co. Player Co.
a. 45,500 54,500
b. 64,500 35,500
c. 25,500 74,500
d. 54,500 45,500

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

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

C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning
Congratulations for finishing this module! You can now tract your progress by shading the number of
the module that you finished. It’s just the start but by being consistent, you’ll be shading Day 31 as
scheduled.

Did you have challenges learning the concepts in this module? If none, which parts of the module

helped you learn the concepts?

__________________________________________________________________________________
__________________________________________________________________________________

FAQs
1. What happens subsequent to a reverse acquisition?
Subsequent to the reverse acquisition, the management of the formerly private company takes over the
combined business, and issues all public filings expected of a publicly-held entity.
2. When does the need to determine goodwill usually arise?
The need for determining goodwill often arises when one company buys another firm.

KEY TO CORRECTIONS

Activity 3

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

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

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

3. Solution:
Average annual earnings 1,000,000
Normal earnings (8M x 12%) (960,000)
Excess earnings 40,000
Multiply by: Probable duration 5
Goodwill 200,000

4. Solution:
Average annual earnings 1,000,000
Normal earnings (8M x 12%) (960,000)
Excess earnings 40,000
Multiply by: PV of ord. annuity of 1 @ 9%, n=5 3.88965
Goodwill 155,586

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

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 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________
Substance: Reverse – Entity B issues shares to Entity A
Entity B’s currently issued shares 3,000 75%
Shares issued to Entity A (3,000 ÷ 75%) x 25% 1,000 25%
Total shares after the combination 4,000

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

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

Activity 5
MULTIPLE CHOICE - THEORY

1. B
2. A
3. B
4. D
5. D

MULTIPLE CHOICE – COMPUTATIONAL

1. A
Solution:

Gamer Co. Player Co. Total

Average annual earnings 40,000 39,000
Normal earnings (500K x 5%); (380K x 5%) 25,000 19,000
Excess earnings 15,000 20,000
Divide by: Capitalization rate 20% 20%
Goodwill 75,000 100,000 175,000

2. D
Solution:

Gamer Co. Player Co. Total

Total contribution (squeeze) 575,000 480,000 1,055,000
Fair value of net assets 500,000 380,000
Goodwill 75,000 100,000 175,000

This document is the property of PHINMA EDUCATION

 ACC 113: Accounting for Business Combinations
Student Activity Sheet #7

Name: ______________________________________________________ Class number: ______

Section: ____________ Schedule: _______________________________ Date: ____________

Gamer Co. Player Co. Total

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

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

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

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