MODULE 12 Accounting For Business Combination PART 2

MODULE ACCOUNTING FOR BUSINESS COMBINATION PART II
12
INTRODUCTION
This module aims to provide students additional guidance for applying the
acquisition method to types of business combinations. This module also deals with
accounting treatment for business combination in relation to goodwill, reverse
acquisitions, and combination of mutual entities.
INTENDED LEARNING OUTCOMES
1. Account for business combinations (a) accomplished through share-for-share

exchanges, (b) achieved in stages, and (c) achieved without transfer of
consideration
2. Explain the “measurement period” in relation to business combinations
3. Distinguish what is part of a business combination and what is part of a
“separate transaction”
4. Account for settlement of pre-existing relationship between an acquirer and an
acquiree
5. Apply the methods of estimating goodwill
6. Account for reverse acquisitions.
LEARNING CONTENT
Lesson 1: Business Combination (Specific Cases)

Business Combination can also be accomplished through share-for-share
exchanges, achieved in stages and achieved without transfer of consideration.
Specific cases in Business Combination

I. Share-for-share exchanges
 In a business combination accomplished through a mere exchange of
equity interests between the acquirer and the acquiree.
 The general principle is that the consideration transferred is measured
at fair value.
 However, there may be cases where the fair value of the acquiree’s
equity interests may be more reliably measurable than the acquirer’s.
In such cases, the acquirer computes for goodwill using the fair value
of the acquiree’s equity interests instead of its own.
Illustration 1:
ABC Co. and XYZ, Inc. combined their businesses through exchange of equity instruments,
which resulted to ABC obtaining 100% interest in XYZ. Both entities are publicly listed. At
the acquisition date, ABC’s shares are quoted at ₱100 per share. ABC Co. recognized goodwill
of ₱300,000 on the business combination. No acquisition-related costs were incurred.
Additional information follows:
ABC Co. Combined entity

(before acquisition) (after acquisition)
Share capital 600,000 700,000
Share premium 300,000 1,200,000
Totals 900,000 1,900,000
Requirements:
Compute for the following:
a. Number of shares issued by ABC Co.
b. Par value per share of the shares issued
c. Acquisition-date fair value of the net identifiable assets of XYZ
Solutions:
Requirement (a): Number of shares issued
The consideration transferred is in the form of shares. Accordingly, this is reflected on
the increase in share capital and share premium:
ABC Co. Combined entity Increase

(before (after acquisition)
acquisition)
Share capital 600,000 700,000 100,000
Share premium 300,000 1,200,000 900,000
Totals 900,000 1,900,000 1,000,000
The fair value of the shares issued as consideration for the business combination is
₱1,000,000.
Fair value of shares transferred 1,000,000
Divided by: ABC’s fair value per share 100
Number of shares issued 10,000
Requirement (b): Par value per share

Increase in share capital account 100,000
Divided by: Number of shares issued
10,000
Par value per share 10
Requirement (c): Fair value of net assets acquired

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 (700,000)
Goodwill 300,000
Illustration 2:
ABC Co. issued shares in exchange for 100% interest in XYZ, Inc. Relevant information
follows:
ABC Co. XYZ, Inc. Combined

(carrying (fair values) entity
amount)
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 and
equity 2,400,000 1,600,000 ?
Additional information:
 ABC’s share capital consists of 60,000 ordinary shares with par value of ₱10 per share
 XYZ’s share capital consists of 3,000 ordinary shares with par value of ₱100 per share.
Requirements:
Compute for the following:
a. Number of shares issued by ABC Co.
b. Fair value per share of the shares issued
c. Goodwill recognized on acquisition date
d. Retained earnings of the combined entity immediately after the business combination
Solutions:
Requirement (a): Number of shares issued
Share capital 600,000 700,000 100,000
Increase in ABC’s share capital account

100,000
Divided by: ABC’s par value per share
10
Number of shares issued
10,000
Requirement (b): Fair value per share

Share capital 600,000 700,000 100,000
Share premium 300,000 1,200,000 900,000
Totals 900,000 1,900,000 1,000,000
Fair value of consideration transferred 1,000,000

Divided by: Number of shares issued 10,000
Acquisition-date fair value per share 100
XYZ’s equity accounts are ignored in the computations above because an acquiree’s
(subsidiary) equity accounts are eliminated in the consolidated financial statements
and replaced by non-controlling interest.
Requirement (c): Goodwill
Total 1,000,000
Goodwill 300,000
Requirement (d): Retained earnings of the combined entity

Because XYZ’s retained earnings are eliminated in the consolidated financial
statements, the combined entity’s retained earnings are equal to ABC’s retained
earnings of ₱800,000.
The statement of financial position of the combined entity immediately after the
business combination is shown below:
Combined entity
Identifiable asset 4,000,000
Goodwill 300,000
Total Assets 4,300,000
Liabilities 1,600,000
Share capital 700,000
Share premium 1,200,000
Retained earnings 800,000
Total Liabilities and equity 4,300,000
II. Business combination achieved in stages

 A business combination achieved in stages occurs when the acquirer
obtains control of an acquiree in more than one transaction. Business
combination achieved in stages is also called “step acquisition”.
In accounting for a business combination achieved in stages, the acquirer:

A. Remeasure the previously held equity interest in the acquiree at its
acquisition-date fair value; and
B. Recognize the gain or loss on the remeasurement in:
1. Profit or loss – if the previously held equity interest was
classified as FVPL, Investment in Associate, or Investment in
Joint Venture.
2. Other comprehensive income – if the previously held equity
interest was classified as FVOCI
Illustration: Business combination achieved in stages

On January 1, 20x1, ABC Co. acquired 15% ownership interest in XYZ, Inc. for ₱100,000.
ABC Co. classified the investment as “held for trading securities” (FVPL) in accordance
with PFRS 9.
On January 1, 20x4, ABC acquired additional 60% ownership interest in XYZ for
₱800,000. Relevant information follows:
a. The previously held 15% interest has a carrying amount of ₱170,000 on
December 31, 20x3 and fair value of ₱180,000 on January 1, 20x4.
b. XYZ’s net identifiable assets have a fair value of ₱1,000,000.
c. ABC elected to measure NCI at proportionate share.
Requirement:
Compute for the goodwill under each of the scenarios below.
Solution:
Consideration transferred
800,000
Non-controlling interest in the acquiree 250,000
Previously held equity interest in the acquiree
180,000
Total 1,230,000
Fair value of net identifiable assets acquired
(1,000,000)
Goodwill 230,000
Entries are as follows:

Jan. 1, Held for trading securities 30,000
20x4 Unrealized gain – P/L 30,000
To remeasure previously held equity
interest to acquisition-date fair value
Jan. 1, Investment in subsidiary 800,000
20x4 Cash 800,000
To recognize the newly acquired shares
Jan. 1, Investment in subsidiary 180,000
20x4 Held for trading securities 180,000
To reclassify previously held equity
interest
III. Business combination achieved without transfer of consideration

 The acquisition method also applies to business combinations in which
the acquirer obtains control without transferring any consideration.
 Examples of circumstances where the acquirer obtains control without
transferring consideration:
a. The acquiree repurchases a sufficient number of its own
shares from other investors so that the acquirer will be able
to obtain control.
b. Minority veto rights lapse that previously kept the acquirer
from controlling an acquiree in which the acquirer held the
majority voting rights.
c. The acquirer and acquiree agree to combine their businesses
by contract alone. The acquirer neither transfers
consideration nor holds equity interests in the acquiree.
 In business combination achieved without transfer of consideration,

the acquisition-date fair value of the acquirer’s interest in the acquiree
is substituted for the consideration transferred in computing for
goodwill.
 In business combination achieved by contract alone, the interest held
by parties other than the acquirer are attributed to NCI, even if the
result is that NCI represents 100% interest in the acquiree.
Illustration 1: Without transfer of consideration

ABC Co. owns 36,000 shares out of the 90,000 outstanding ordinary shares of
XYZ, Inc. ABC accounts for the investment under the equity method. XYZ
subsequently reacquires 30,000 shares from other investors. Information on
the acquisition date is as follows:
a. The previously held 40% interest has a fair value of ₱180,000
b. XYZ’s net identifiable assets have a fair value of ₱1,000,000
c. ABC elects to measure NCI at proportionate share.
Requirement: Compute for goodwill.
Solution:
Consideration transferred -
Previously held equity interest in the acquiree 600,000
Total 1,000,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill -
Illustration 2: By contract alone

ABC Co. and XYZ, Inc. enter into a contract whereby ABC obtains control of XYZ.
No consideration is transferred between the parties. The fair value of XYZ’s net
identifiable assets at acquisition date is ₱1,000,000. ABC chose to measure NCI
at proportionate share.
Requirement: Compute for goodwill
Solution:
Consideration transferred
-
Non-controlling interest in the acquiree
1,000,000
-
Total
1,000,000
(1,000,000)
Goodwill
-
Measurement Period
 If the initial accounting for a business combination is incomplete by the end of
the reporting period in which the combination occurs, the acquirer can use
provisional amounts to measure any of the following for which the accounting
is incomplete:
a. Consideration transferred
b. Non-controlling interest in the acquiree
c. Previously held equity interest in the acquiree
d. The identifiable assets acquired and liabilities assumed
A. During measurement period

 Within 12 months from the acquisition date
 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 adjustments to a provisional amount is recognized as an
adjustment to goodwill or gain on a bargain purchase.
B. After the measurement period ends
 Beyond the 12-month measurement period.
 Any information obtained after the measurement period are accounted
for as correction of errors in accordance with PAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors, rather than PFRS 3.
Illustration 1: Provisional amounts – identifiable assets acquired
Fact Pattern
On October 1, 20x1, ABC Co. acquired all the identifiable assets and assumed all of
the liabilities of XYZ, Inc. for ₱1,000,000. On this date, XYZ’s the identifiable assets
and liabilities have fair values of ₱1,600,000 and ₱900,000, respectively.
Case #1: Identifiable assets recognized at provisional amount

The assets acquired include a building was assigned a provisional amount of
₱700,000 because the appraisal is not yet complete by the time ABC authorized for
issue its December 31, 20x1 financial statements. The building was tentatively
assigned a 10-year useful and was depreciated for three months in 20x1 using the
straight-line method.
On July 1, 20x2, ABC received the valuation report for the building. The buildings
fair value on October 1, 20x1 is ₱500,000 and its remaining useful life from that
date is 5 years.
Requirements:
a. What is the measurement period?
b. How should ABC account for the new information obtained on July 1, 20x2?
c. How much is the adjusted goodwill?
d. What are the adjusting entries?
Solution:
Requirement (a): Measurement period
The measurement period is from October 1, 20x1 to September 30, 20x2, or if
earlier, (i) the date ABC Co. obtains the information it was seeking about the
facts and circumstances that existed as of the acquisition date or (ii) the date
ABC Co. learns that more information is not obtainable.
Requirement (b): Accounting

The provisional amount assigned to the building is retrospectively adjusted
with a corresponding adjustment to goodwill. The 20x1 financial statements
are restated, including a retrospective adjustment to depreciation expense.
Requirement (c): Adjusted goodwill

Provisiona Adjusted
l
Consideration transferred 1,000,000 1,000,000
Non-controlling interest in the acquiree - -
Previously held equity interest in the
acquiree - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets acquired (700,000) (500,000)
Goodwill 300,000 500,000
Requirement (d): Adjusting entries
July 1, Goodwill 200,000
20x2 Building 200,000
To record the adjustment to the
provisional amount assigned to
the building
July 1, Retained earnings 7,500
20x2 Accumulated depreciation 7,500
To record the adjustment to 20x1
depreciation
Depreciation recognized (700K ÷ 10 years x 3/12)

17,500
‘Should-be’ depreciation (500K ÷ 5 years x 3/12) 25,000
Additional depreciation expense for 20x1 7,500
If monthly depreciation expenses were recognized during January to June 30, 20x2,
those shall be adjusted accordingly.
Case #2: Unrecorded identifiable asset acquired

On July 1, 20x2, ABC obtained new information that XYZ has an unrecorded patent
which was not known on October 1, 20x1. The patent has a fair value of ₱100,000
and a remaining useful life of 4 years as of October 1, 20x1.
Requirement:
Compute for the adjusted goodwill and provide the adjusting entries.
Solutions:
Provisional Adjusted
acquiree - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets
acquired (700,000) (800,000)
Goodwill 300,000 200,000
The measurement period adjusting entries are as follows:

July 1, Patent 100,000
20x2 Goodwill 100,000
July 1, Retained earnings 6,250
20x2 Accumulated depreciation 6,250
Case #3: Information obtained beyond the measurement period

On November 1, 20x2, ABC’s auditors discovered a patent with fair value of
₱100,000 was erroneously omitted from the valuation listing on October 1, 20x1.
Requirement:
How should ABC account for the new information obtained on November 1, 20x2?
Solution:
Because the new information is obtained after the measurement period, it
will be accounted for under PAS 8 as correction of a prior period error. A
correction of a prior period error is accounted for by retrospective restatement.
Therefore, the adjusted amounts and correcting entries would be similar to those in
Case #2 above. However, the note disclosures will vary because PAS 8 will be
applied instead of PFRS 3.
The correcting entries on the 20x1 financial statements are as follows:
Nov 1, Patent 100,000
Nov 1, Retained earnings 6,250
20x2 Accumulated amortization 6,250
The omitted patent is recognized with a corresponding charge to goodwill because

if ABC had not committed the error, the correct amount of goodwill that should have
been recognized on acquisition date is ₱200,000.
Illustration 2: Provisional amounts – consideration transferred

On October 1, 20x1, ABC Co., an unlisted entity, issued 10,000, ₱5 par value, shares
in exchange for all the identifiable assets and liabilities of XYZ, Inc.
Information on acquisition date:

 The shares issued were assigned a provisional amount of ₱100 per share
 The fair values of some of the assets acquired are not readily determinable.
Accordingly, a provisional amount of ₱700,000 was assigned to XYZ’s net
identifiable assets.
Information after the acquisition date:

 On April 1, 20x2, new information was obtained indicating that, on October
1, 20x1,
 The fair value of the shares issued was ₱110 per share; and
 The fair value of XYZ’s net identifiable assets was ₱900,000
 On July 1, 20x2, two competitors of ABC have also merged. This led ABC to
believe that the merger with XYZ is not as profitable as expected. ABC
estimates that the valuations of the consideration transferred and XYZ’s net
identifiable assets should have been ₱900,000 and ₱400,000, respectively.
Requirement:
Compute for the adjusted goodwill.
Solution:
Provisiona Adjusted
l
acquiree - -
Total 1,000,000 1,100,000
Fair value of net identifiable assets
acquired (700,000) (900,000)
Goodwill 300,000 200,000
The new information obtained on July 1, 20x2 is not a measurement period

adjustment because it does not relate to facts and circumstances that have existed
as at the acquisition date. However, this may indicate an impairment of goodwill.
Determine what is part of the business combination transaction

 The acquirer identifies and excludes amounts that are not part of the
consideration transferred on the business combination and accounts for them
using other relevant PFRSs.
 The acquirer considers the following when determining whether a transaction
is part of a business combination or a separate transaction:
a. The reasons for the transaction
 Understanding the reasons why the parties to the combination
entered into a particular transaction or arrangement may
provide insight into whether it is part of the consideration
transferred and the assets acquired or liabilities assumed.
 For example, if a transaction is arranged primarily for the
benefit of the acquirer or the combined entity rather than
primarily for the benefit of the acquiree or its former owners is
likely to be a separate transaction. The transaction price shall
be excluded from the consideration transferred when computing
for goodwill.
b. Who initiated the transaction
 A transaction or other event that is initiated by the acquirer is
likely for the benefit of the acquirer or the combined entity and,
therefore, a separate transaction.
c. The timing of the transaction
 A transaction between the acquirer and the acquiree that takes
place during the negotiations of the terms of a business
combination is more likely to be part of the business
combination.
However, the following are separate transactions that are excluded

when applying the acquisition method:
1. Settlement of pre-existing relationships between the acquirer and
acquiree;
2. Remuneration to employees or former owners of the acquiree for
future services; and
3. Reimbursement to the acquiree or its former owners for paying the
acquirer’s acquisition-related costs.
Illustration:
ABC Co. acquired all the assets and liabilities of XYZ, Inc. for ₱1,000,000. XYZ’s
assets and liabilities have fair values of ₱1,600,000 and ₱900,000, respectively.
a. XYZ incurred ₱10,000 legal fees in processing the regulatory requirements
for the combination. ABC agreed to reimburse the said amount.
b. XYZ will terminate its activities after the business combination. ABC agreed
to reimburse XYZ’s estimated liquidation costs of ₱200,000.
c. ABC will retain XYZ’s former key employees. ABC agreed to pay the key
employees ₱100,000 as signing bonuses.
d. ABC agreed to pay additional ₱50,000 directly to Mr. Numerix, the previous
major shareholder of XYZ, to persuade him in selling his shareholdings to
ABC.
e. Ms. Vital Statistix, a former major shareholder of XYZ, will acquire title to the
inventories with fair value of P90,000 that were included in the asset
valuation.
Requirement:
Compute for the goodwill or gain on bargain purchase.
Solution:
Total 1,050,000
Goodwill 440,000
The fair value of net identifiable assets acquired is computed as follows:

Fair value of identifiable assets acquired
1,600,000
Fair value of inventory not transferred to ABC (90,000)
Adjusted fair value of identifiable assets acquired 1,510,000
Fair value of liabilities assumed (900,000)
Adjusted fair value of net identifiable assets acquired 610,000
Reacquired rights
 A right that an acquirer has previously granted to the acquiree, that is
reacquired as a result of the business combination is recognized as an
intangible asset separately from goodwill.
Examples of reacquired rights:
1. Right to use the acquirer’s intangible assets such as trade name
under a franchise agreement.
2. Right to use the acquirer’s technology under a technology
licensing agreement.
Settlement of pre-existing relationships between the acquirer and acquiree

 Prior to business combination, the acquirer and acquiree may have pre-existing
relationship. Such relationship may be:
1. Contractual – such as vendor and customer, licensor and licensee, or
franchisor and franchisee. A pre-existing relationship may be a contract
that the acquirer recognizes as a reacquired right.
2. Non-contractual – such as plaintiff and defendant on a pending lawsuit
 If the pre-existing relationship is settled due to the business combination, the

acquirer recognizes a settlement gain or loss measured as follows:
1. At the lower of (i) and (ii) below, if the pre-existing relationship is
contractual
a. The amount by which the contract is favorable or unfavorable from
the perspective of the acquirer when compared with pricing for
current market transactions for the same or similar items.
b. The amount of any stated settlement provisions in the contract
available to the counterparty to whom the contract is unfavorable. If
this amount is less than the amount in (i), the difference should be
included as part of the business combination accounting.
2. At fair value, if the pre-existing relationship is non-contractual.
The settlement gain or loss is adjusted for the derecognition of any related
asset or liability that the acquirer has previously recognized.
Illustration 1: Reacquired right

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
₱1,000,000. XYZ’s assets and liabilities have fair values of ₱1,600,000 and ₱900,000,
respectively.
 Prior to business combination, ABC granted XYZ the right to use ABC’s
patented technology over a 5-year period in exchange for ₱100,000 cash
(payable on grant date) and royalty fees based on XYZ’s sales over the 5-year
period.
 ABC recognized the ₱100,000 license fee as deferred liability (unearned
income) and amortized it over 5 years. The carrying amount of the deferred
liability on January 1, 20x1 is ₱60,000.
 On the other hand, XYZ recognized the license fee as prepayment (prepaid
asset) and amortized it based on the number of products sold. The carrying
amount of the prepayment on January 1, 20x1 is ₱50,000.
 On acquisition date, the fair value of the license agreement is ₱120,000. This
consists of the following components:
 ₱40,000 “at-market” (based on market participants’ estimates); and
 ₱80,000 “off-market” (the excess of ₱120,000 fair value from cash
flow estimates over ₱40,000 ‘at-market’ value).
 The off-market component is favorable to XYZ and unfavorable to
ABC, as royalty rates have increased considerably in comparable
markets since the initiation of the contract. The contract does not
have any cancellation clause or any minimum royalty payment
requirements.
Requirement:
Compute for goodwill or gain on bargain purchase.
Solution:
As mentioned in the previous chapter, a reacquired right is measured based on the
remaining term of the related contract. This is in contrast with other assets which
are measured based on market participation.
The measurement of a reacquired right could result to a difference between the

value derived from market participation assumptions (“at-market” value) and fair
value based on cash flow estimates. The difference (“off-market” value) makes a
reacquired right favorable or unfavorable from the acquirer’s perspective.
In the illustration above, the ₱80,000 “off-market” value is unfavorable from the
perspective of ABC Co. (because the royalty fees that XYZ is paying ABC are below-
market rate). Accordingly, ABC recognizes a settlement loss.
The pre-existing relationship is contractual. Therefore, the settlement loss is

measured at the lower of (i) the unfavorable amount and (ii) the settlement in the
contract. However, because the contract does not have a cancellation clause or
minimum royalty payment requirement, the settlement loss is measured based on
(i), after adjustment for the recognized deferred liability. This is computed as
follows:
Settlement loss before adjustment (“off-market” value) 80,000

Carrying amount of the deferred liability (60,000)
Adjusted settlement loss 20,000
The settlement of the pre-existing relationship is a separate transaction.

Therefore, the ₱80,000 “off-market” value is excluded from the consideration
transferred on the business combination and treated as payment for the settlement
of the pre-existing relationship.
ABC recognizes the ₱40,000 “at-market” value component of the reacquired right as
an intangible asset, separate from goodwill, to be amortized over the remaining
term of the agreement.
The ₱50,000 prepayment recognized by XYZ is excluded from the identifiable assets
acquired and replaced by the intangible asset on the reacquired right.
The goodwill is computed as follows:

Consideration transferred (1M-80K)
920,000
-
Total 920,000
(1.6M + 40K intangible asset – 50K prepayment– 900K)
(690,000)
Goodwill 230,000
Journal entries:
Jan 1, Identifiable assets acquired 1,590,000
Liabilities assumed 900,000
Cash 920,000
To record the business
combination
Jan 1, Settlement loss 20,000
20x1 Deferred liability 60,000
Cash 80,000
To record the effective settlement
of pre-existing relationship as a
separate transaction from business
combination transaction
Notes:
Illustration 2: Contractual pre-existing relationship

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
respectively.
 ABC and XYZ have a pre-existing supply contract under which ABC could
purchase raw materials from XYZ at discounted rates. The contract has a
remaining term of three years, which ABC can terminate by paying ₱100,000
penalty.
 The supply contract has a fair value of ₱160,000, of which ₱70,000 is “at-
market”. The “off-market” component is unfavorable to ABC because it
exceeds the price of current market transactions for similar items.
 No assets or liabilities related to the contract were recognized in either of
ABC’s or XYZ’s books as at the acquisition date.
Requirement: Compute for the goodwill.
Solution:
The ₱90,000 “off-market” value is unfavorable from the perspective of ABC Co.
Accordingly, ABC recognizes a settlement loss.
The pre-existing relationship is contractual. Therefore, the settlement loss is

measured at the lower of (i) the unfavorable amount and (ii) the settlement amount
in the contract. This is computed as follows:
Settlement loss (lower of 90K off-market and 100K

settlement) 90,000
Carrying amount of the deferred liability -
Adjusted settlement loss 90,000
The ₱90,000 “off-market” value is excluded from the consideration transferred on

the business combination and treated as payment for the settlement of the pre-
existing relationship (separate transaction).
The ₱70,000 “at-market” value is subsumed in goodwill and not recognized as

intangible asset because there is no reacquired right. Contrast this with illustration
1 above:
 In Illustration 1, ABC (acquirer) granted the license to XYZ (acquiree). There

is reacquired right because ABC (supplier) takes back the license form XYZ
(customer) as a result of the business combination.
 In Illustration 2, XYZ(acquiree) granted the supply contract to ABC
(acquirer). There is no reacquired right because ABC (customer) gives back
the supply contract to XYZ (supplier) as a result of the business combination.

Consideration transferred (1M-90K ‘off-market’ value) 910,000
Total 910,000
Goodwill 210,000
Journal entries:
Cash 910,000
Jan 1, Settlement loss 90,000
20x1 Cash 90,000
Illustration 3: Non-contractual pre-existing relationship

On January 1, 20x1, ABC Co. acquired all assets and liabilities of XYZ, Inc. for
respectively.
ABC is the defendant on a pending patent infringement suit filed by XYZ. ABC
recognized a provision of ₱130,000 on the lawsuit. After the business combination,
the disputed patent will be transferred to ABC. The fair value of settling the pending
lawsuit is ₱100,000.
Requirement:
Compute for the goodwill.
Solution:
The ₱100,000 fair value is excluded from the consideration transferred on the
business combination and treated as payment for the settlement of the pre-exiting
relationship (separate transaction).
The pre-existing relationship is non-contractual. Therefore, the settlement gain or

loss is measured at fair value. This is computed as follows:
Payment for settlement of pre-existing relationship 100,000

Carrying amount of related provision (liability) (130,000)
Settlement gain 30,000

Consideration transferred (1M-100K settlement amt.)
900,000
Non-controlling interest in the acquiree
-
-
Total
900,000
(700,000)
Goodwill
200,000
Journal entries:
Cash 900,000
Jan 1, Estimated liability on a pending lawsuit 130,000
20x1 Cash 100,000
Settlement gain 30,000
Subsequent Measurement and Accounting
 Subsequent to acquisition date, the acquirer accounts for assets acquired,
liabilities assumed and equity instruments issued in a business combination in
accordance with other PFRSs applicable to those items. However, the following
are subsequently accounted for under PFRS 3:
a. Reacquired rights
b. Indemnification assets
c. Contingent liabilities recognized as of the acquisition date
d. Contingent Consideration
I. Reacquired Rights
 Reacquired rights recognized as intangible assets are amortized over
the term of the related contract
II. Indemnification Assets

 Indemnification assets are measured on the same basis as the
indemnified item, subject to assessment of collectability for
indemnification assets not measured at fair value.
III. Contingent Liabilities

 Contingent liabilities recognized in a business combination are
measured at the higher of:
a. The amount that would be recognized by applying PAS 37; and
b. The amount initially recognized less, if appropriate, cumulative
amount of income recognized in accordance with PFRS 15
Revenue from Contracts with Customers.
IV. Contingent Consideration

 Contingent consideration is additional consideration for a business
combination that the acquirer agrees to provide to the acquiree upon
the happening of a contingency.
 A contingency is an existing, unresolved condition that will be resolved
by the occurrence or non-occurrence of a possible future event.
A. Initial recognition and measurement

 A contingent consideration is measured at acquisition-date fair
value and included in the consideration transferred.
 The obligation to pay the contingent consideration is classified
either as a liability or equity. A right to recover a previously
transferred consideration if specified conditions are met is classified
as an asset.
B. Subsequent measurement
 A change in fair value of a contingent consideration resulting from
additional information obtained during the measurement period is
accounted for as a retrospective adjustment to provisional amount.
 Changes in fair value that are not measurement period adjustments
are accounted for depending on the classification of the contingent
consideration:
a. A contingent consideration classified as equity is not
remeasured and its subsequent settlement is accounted for
within equity.
b. A contingent consideration classified as an asset or a
liability is measured at fair value at each reporting date.
Changes in fair value are recognized in profit or loss.
Illustration 1: Contingent consideration classified as equity
On January 1, 20x1, ABC Co. issued 10,000 shares with par value of ₱10 per share and fair value
of ₱100 per share in exchange for all the assets and liabilities of XYZ. XYZ’s assets and liabilities
have fair values of ₱1,600,000 and ₱900,000, respectively.
In addition, ABC agrees to issue additional 1,000 shares to the former owners of XYZ if the
market price of ABC’s shares increases to ₱120 per share by December 31, 20x1. The fair value
of the contingent consideration as of January 1, 20x1 is ₱90,000, based on consideration of the
vesting conditions.
Requirement:
Compute for the goodwill.
Solution:
Consideration transferred (1M+90K contingent
consideration) 1,090,000
Total 1,090,000
Goodwill 390,000
Journal entries:
Share capital 100,000
Share premium 900,000
Share premium-contingent 90,000
consideration
Case #1 Continuation of Illustration 1 - Subsequent Measurement

The market price of ABC’s share on December 31, 20x1 is ₱120. The contingent consideration is
settled on January 15, 20x2.
Requirement: Provide the journal entries.
Solution:
Dec 31,
No Entry
20x1
Jan 15, Share premium-contingent consideration 90,000
20x2 Share capital 10,000
Share premium 80,000
To record the issuance of 1,000
additional shares
A contingent consideration that is classified as equity is not remeasured and its subsequent
settlement is accounted for within equity.
Case #2
The market price of ABC’s share on December 31, 20x is ₱90.
Requirement: Provide the journal entries.

Solution:
Dec 31, Share premium – contingent consideration 90,000
20x1 Share premium 90,000
Regardless of whether the vesting condition is met, the amount recognized in equity for a
contingent consideration remain in equity. This, however, does not preclude an entity from
transferring amounts within equity (reclassification between equity accounts).
Illustration 2: Contingent consideration classified as liability

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for ₱1,000,000.
XYZ’s asset and liabilities have fair values of ₱1,600,000 and ₱900,000, respectively.
ABC agrees to pay additional cash equal to 10% of the 20x1 year-end profit that exceeds
₱400,000. XYZ historically has reported profits of ₱300,000 to ₱400,000 each year. The fair
value of the contingent consideration as of January 1, 20x1 is ₱10,000, based on assessments of
the expected level of profits for the year, as well as, forecasts, plans and industry trends.
Requirement: Compute for the goodwill
Solution:
Consideration transferred (1M+10K contingent
consideration) 1,010,000
Total 1,010,000
Goodwill 310,000
Journal entries:
Liability for contingent consideration 10,000
Cash 1,000,000
A contingent consideration representing an obligation to pay cash or other non-cash assets is

classified as liability, and measured at acquisition-date fair value, even if payment is not
probable.
Case #1
The profit for the year is ₱550,000. The contingent consideration is settled on January 15,20x2.
Requirement:
Provide the journal entries.
Solution:
Dec 31, Unrealized loss – P/L 5,000
20x1 Liability for contingent consideration 5,0000
To recognize loss on change in fair
value of contingent consideration
classified as liability
Jan 15, Liability for contingent consideration 15,000
20x2 Cash 15,000
Carrying amount of contingent consideration-

12/31/20x1
10,000
Fair value-12/31/20x1 [(550K-400K) x 10%]
15,000
Increase in fair value of liability (loss)
(5,000)
A contingent consideration that is classified as liability is remeasured to fair value at each

reporting date. Changes in fair value are recognized in profit or loss.
Case #2
The profit for the year is ₱300,000.
Requirement: Provide the journal entry.
Solution:
Dec 31, Liability for contingent consideration 10,000
20x1 Gain on extinguishment of liability - P/L 10,000
The liability is extinguished because the earning target is not met.
In Case 1 & 2 above, the fair value changes relate to the meeting and non-meeting of the
earnings target, which are not measurement period adjustments. Accordingly, these are
recognized in profit or loss. The recognized goodwill is not affected regardless of the outcome
of the contingency.
Illustration 3: Contingent payments to employees

ABC Co. acquired 90% interest in XYZ, Inc. for ₱1,000,000. XYZ’s assets and liabilities have fair
values of ₱1,600,000 and ₱900,000, respectively. ABC measured the NCI at a fair value of
₱80,000.
Five years ago, XYZ appointed Mr. Boss as the CEO under a ten-year contract which requires
XYZ to pay Mr. Boss ₱100,000 if XYZ is acquired before the contract expires. ABC assumes the
obligation to pay Mr. Boss the contracted amount.
Requirement: Compute for the goodwill.
Solution:
Total 1,080,000
Goodwill 480,000
The employment contract existed long before the business combination, and for the purpose of
obtaining the services of the CEO. There is no evidence that the agreement was arranged
primarily for the benefit of ABC or the combined entity. Therefore, the ₱100,000 obligation is
treated as an additional liability assumed rather than an adjustment to the consideration
transferred.
DIFFERENCES BETWEEN THE PROVISIONS OF THE FULL PFRS AND THE PFRS
FOR SMEs
Full PFRS PFRS for SMEs

6. Previously held equity interest in the acquiree
In a business combination achieved in No equivalent provision under PFRS
stages, the acquirer’s previously held of SMEs.
equity interest in the acquiree is
remeasured to fair value and included
in the computation of goodwill.
7. Contingent consideration
Initial measurement Initial measurement
 Included in the consideration  Included in the cost of business
transferred at acquisition-date combination if it is probable
fair value and can be measured reliably.
Subsequent measurement Subsequent measurement

 Change in fair value that is:  Change in fair value is treated
a. A measurement period as an adjustment to the cost of
adjustment is adjusted to business combination
goodwill. (adjusted to goodwill)
b. Not a measurement period
adjustment:
i. Remains in equity, if
contingent
consideration is
classified as equity
ii. Is recognized in profit
or loss, if the
contingent
consideration is
classified as liability
or asset.
Lesson 2: – Business Combination (Special Accounting Topics)
Special accounting topics for business combination are estimation of goodwill,
reverse acquisitions, and combination of mutual agencies.
Goodwill
 Only a goodwill that arises from a business combination is recognized as an
asset.
 Goodwill is measured and recognized on acquisition date. Subsequent
expenditures on maintaining goodwill are expensed already.
 After initial recognition, goodwill is not amortized but rather tested for
impairment at least annually. For this purpose, goodwill is allocated to each
of the acquirer’s cash-generating unit (CGU) in the year of the business
combination. If the allocation is not completed by the end of that year, it must
be completed before the end of the immediately following year.
Cash-Generating Unit
 Is the “smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or group of
assets” (PAS 36.6)
 Because goodwill is unidentifiable, it cannot be tested for impairment

separately but only in conjunction with groups of assets that generate
independent cash inflows (CGUs). Goodwill does not generate cash flows on its
own but contributes on the cash flows of CGUs.
Due Diligence
 Due diligence audit refers to the investigation of all areas if a potential
acquiree’s business before an investor agrees to a business combination
transaction. The term “due diligence” may refer to the exercise of care that a
reasonable and prudent person should take before entering a contract with
another party. Due diligence audit is a service most commonly performed by
CPAs or external auditing firms.
 Due diligence audit helps investor evaluate the possible risks and rewards of
the potential investment and determine whether it would be a good decision to
pursue it.
 Examples of potential risks which may be determined through a diligence

audit:
1. Possibility of future losses due to the acquiree’s pending litigations
and other unrecorded contingencies.
2. Overstatement in the consideration for the business combination
due to the acquiree’s due to the overstated assets and understated
liabilities.
3. Incompatibility of internal cultures, systems, and policies.
 Examples of potential rewards which may be determined through a due

diligence audit:
1. Unrecorded assets, such as trade secrets. Trade names, customer
lists, and the like.
2. Understatement in the consideration for the business combination
due to the acquiree’s understated assets and overstated liabilities.
Methods of Estimating Goodwill
Before the actual business combination transaction takes place, the amount of
goodwill may be estimated using any of the following methods:
A. Indirect valuation
 this is a residual approach wherein goodwill is measured as the excess
of the sum of consideration transferred, non-controlling interest in the
acquiree, and previously held equity interest in the acquiree over the
fair value of net identifiable assets acquired. PFRS 3 requires this
method and it is the method illustrated in the [receding discussions.
B. Direct valuation
 Under this method, goodwill is measured based on expected future
earnings from the business to be acquired.
 The application of the direct valuation method may require the
determination of the following information:
1. Normal rate of return in the industry where the acquiree
belongs. The normal rate of return may be the industry
average determined from examination of annual reports of
similar entities or from published statistical data.
“Normal earnings” = (normal rate of return) x (acquiree’s net

assets)
2. Estimated future earnings of the acquiree.

a. For purposes of goodwill measurement, the earnings
of the acquiree are “normalized,” meaning earnings are
adjusted for non-recurring income and expenses (e.g.,
expropriation gains or losses).
b. The excess of the acquiree's normalized earnings over
the average return in the industry represents the
“excess earnings” to which goodwill is attributed.
Excess earnings are sometimes referred to as
“superior earnings.”
3. Discount rate to be applied to "excess earnings”
4. Probable duration of “excess earnings”
Illustration 1: Applications of the Direct valuation method

ABC Co. is contemplating on acquiring XYZ, Inc. The following information
was gathered through a due diligence audit:
 The actual earnings of XYZ, Inc. for the past 5 years are shown below:
Year Earnings
20x1 1,200,000
20x2 1,300,000
20x3 1,350,000
20x4 1,250,000
20x5 1,800,000
Total 6,900,000
 Earnings in 20x5 include an expropriation gain of ₱400,000.

 The fair value of XYZ’s net assets as of the end of 20x5 is ₱10,000,000.
 The industry average rate of return is 12%.
 Probable duration of “excess earnings” is 5 years.
Method #1: Multiples of average excess earnings
Under this method, goodwill is measured at the average excess earnings
multiplied by the probable duration of excess earnings.
Total earnings for the last 5 years 6,900,000
Less: Expropriation gain (400,000)
Normalized earnings for the last 5
6,500,000
years
Divided by: 5
(a) Average annual earnings 1,300,000
Fair value of acquiree’s net assets 10,000,000

Multiply by: Normal rate of return 12%
(b) Normal earnings 1,200,000
Excess earnings (a) – (b) 100,000

Multiply by: Probable duration of excess earnings 5
Goodwill 500,000
Method #2: Capitalization of average excess earnings

Under this method, goodwill is measured at the average excess earnings
divided by a pre-determined capitalization rate. (Assume a capitalization rate
of 25%).
Average earnings [(6.9M – 0.4M expropriation gain)
1,300,000
÷ 5yrs]
Normal Earnings (10M x 12%) (1,200,000)
Excess earnings 100,000
Divided by: Capitalization rate 25%
Goodwill 400,000
Method #3: Capitalization of average earnings

Under this method, the average earnings are divided by a pre-determined
capitalization rate to estimate the purchase price of the business
combination. The excess of the estimated purchase price over the fair value
of the acquiree’s net assets represents the goodwill. (Assume a capitalization
rate of 12.50%).

1,300,000
÷ 5yrs]
Divided by: Capitalization rate 12.50%
Estimated purchase price 10,400,000
Fair value of XYZ’s net assets (10,000,000)
Goodwill 400,000
Method #4: Present value of average excess earnings
Under this method, 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. (Assume a discount rate of 10%).

1,300,000
÷ 5yrs]
Normal Earnings in the industry (10M x 12%) (1,200,000)
Multiply by: PV of an ordinary annuity @10%, n=5 3.79079
Goodwill 379,079
ABC Co. is estimating the goodwill in the expected purchase of XYZ, Inc. in
January 20x6. The following information was determined.
Year Earnings Year-end net assets
20x1 120,000 480,000
20x2 130,000 580,000
20x3 135,000 540,000
20x4 125,000 560,000
20x5 140,000 590,000
Total 650,000 2,750,000
Case #1: Excess Earnings

Goodwill shall be measured by capitalizing excess earnings at 30%, with
normal return on average net assets at 10%. The year-end net assets in 20x5
approximate fair value.
Requirement: Compute for the estimated purchase price in the contemplated

business combination.
Solution:
Average earnings (650,000 ÷ 5yrs) 130,000
Normal Earnings on average net assets [10% x (2.75M ÷
(55,000)
5)]
Goodwill 250,000
Add: Fair value of net identifiable assets acquired 590,000
Estimated purchase price 840,000
Case #2: Average earnings

Goodwill shall be measured by capitalizing average earnings at 16%. The
year-end net assets in 20x5 approximate fair value.
Requirement: Compute for the estimated purchase price and goodwill in the
contemplated business combination.
Solution:
Average earnings (650,000 ÷ 5yrs) 130,000
Estimated purchase price 812,500
Fair value of net identifiable assets acquired 590,000
Goodwill 222,500

ABC Co. plans to acquire the net assets of XYZ, Inc. with carrying amount of
₱9,000,000. This amount approximates fair value, except for one asset whose
fair value exceeds its carrying amount by ₱1,000,000. XYZ's average earnings
are ₱1,300,000. The industry average rate of return is 12% of the fair value
of net assets. XYZ’s excess earnings are expected to last for 5 years. The
expected return on the investment is 10%.
Requirement: Compute for the estimated purchase price using the "present
value of average excess earnings" approach.
Solution:
Average earnings 1,300,000
Normal earnings in the industry (12% x 10M*) (1,200,000)
Multiply by: PV of an ordinary annuity @10%, n=5 3.79079
Goodwill 379,079
* Carrying amount of equity 9,000,000

Excess of fair value of one asset over its carrying
1,000,000
amount
Fair value of XYZ’s net assets 10,000,000
Estimated purchase price (squeeze) 10,379,079

Less: Fair value of XYZ’s net assets (10,000,000)
Goodwill 379,079

ABC Co. acquired the net assets of XYZ, Inc. for ₱10.4M. The acquisition
resulted to goodwill of ₱400,000 measured by capitalizing the annual
superior earnings of XYZ at 25%. The normal rate of return is 12% on net
assets before recognition of goodwill.
Requirement: Compute for the average earnings of XYZ.
Solution:
Average earnings (squeeze) 1,300,000
Normal earnings in the industry (12% x 10M*) (1,200,000)
Excess earnings or Superior earnings 100,000
Goodwill 400,000
* Purchase price 10,400,000

Less: Fair value of net assets acquired (squeeze) (10,000,000
)
Goodwill 400,000
Illustration 5: Applications of the Direct Valuation method

ABC Co. and XYZ, Inc. decided to combine and set up a new entity –
Alphabets Corporation. The individual records of the combining constituents
show the following:
ABC Co. XYZ, Inc.
Net assets (at fair values 400,000 600,000
Average annual earnings 80,000 120,000
Alphabets Corporation issues 10% preference shares with par value per
share of P100 for the net assets contributions of the combining constituents
and ordinary shares with par value per share of ₱50 for the excess of total
contributions (net assets contribution plus goodwill) over net assets
contributions.
The normal rate of return is 10% of net assets. Excess earnings will be
capitalized at 20%.
Requirements: Compute for the following:

a. Goodwill
b. Total contributions of ABC Co. and XYZ, Inc.
c. The ratio of total shares (preference and ordinary) issued to ABC Co.
and XYZ, Inc.
Solutions:
Requirement (a):
ABC Co. XYZ, Inc. Total
Average annual earnings 80,000 120,000
Normal earnings on net
assets (40,000) (60,000)
Excess earnings 40,000 60,000
Divide by: Capitalization rate 20% 20%
Goodwill 200,000 300,000 500,000
Requirement (b):
Total contribution
(squeeze) 600,000 900,000 1,500,000
Fair value of net assets (400,000) (600,000)
Goodwill 200,000 300,000
Requirement (c):
Net assets contributions 400,000 600,000 1,000,000
Divide by: Par value per share of PS 100 100 100
Number of preference shares
issued 4,000 6,000 10,000
Total contribution 600,000 900,000 1,500,000

Net asset contribution (400,000) (600,000) (1,000,000)
Excess of total contribution 200,000 300,000 500,000
Divide by: Par value per share of
OS 50 50 50
Number of preference shares
issued 4,000 6,000 10,000
Total PS and OS issued 8,000 12,000 20,000
Ratio of shares issued 40% 60% 100%
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.
 For example, ABC Co., a private entity, wants to become a public entity but does
not want to register its shares. To accomplish this, ABC will arrange for a public
entity to acquire its equity interests in exchange for the public entity’s equity
interests.
 In here, the public entity is the legal acquirer because it issued its equity
interests, and ABC Co. is the legal acquiree because its equity interests were
acquired. However, when applying the acquisition method:
a. the public entity is identified as the acquiree for accounting purposes
(accounting acquiree); and
b. ABC Co. is identified as the as the accounting acquirer.
Measuring the consideration transferred

 The acquisition-date fair value of the consideration transferred by the
accounting acquirer is measured 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 acquiree) the same percentage
of equity interest in the combined entity that results from the reverse acquisition.
Conventional Acquisition vs. Reverse Acquisition
Conventional Acquisition Reverse Acquisition

Issuer of shares as  Accounting acquirer  Accounting acquiree
consideration
transferred
Reference to combining  Accounting acquirer /  Accounting acquirer /
constituents Legal parent Legal subsidiary
 Accounting acquiree /  Accounting acquiree /
Legal subsidiary Legal parent
Measurement of  Fair value of  Fair value of the
consideration consideration notional number of
transferred transferred by the equity instruments
accounting acquirer that the accounting
acquirer (legal
subsidiary) would have
to issue to the
accounting acquiree
(legal parent) to give
the owners of the
accounting acquiree
(legal parent) the
same percentage
ownership in the
combined entity.
Illustration: Reverse acquisition

ABC Co., a publicly listed entity, and XYZ, Inc., an unlisted company, exchange equity
interests.
 ABC Co. issues 5 shares in exchange for all the outstanding shares of XYZ, Inc.
 ABC’s shares are quoted at ₱40 per share, while XYZ’s shares have a fair
value of ₱200 per share.
 The statements of financial position immediately before the combination are
shown below:
ABC Co. XYZ, Inc.
Identifiable assets 1,600,000 2,400,000
Total assets 1,600,000 2,400,000
Liabilities 1,300,000 700,000

Share capital
10,000 ordinary shares, ₱10 par 100,000
8,000 ordinary shares, ₱100
par 800,000
Retained earnings 200,000 900,000
Total liabilities and equity 1,600,000 2,400,000
 The assets and liabilities approximate their fair values.
Requirements:
a. Identify the accounting acquirer
b. Compute for the goodwill
Solution:
Requirement (a):
Legal form of the contract: ABC issues 5 shares for each of the 8,000 outstanding
shares of XYZ. After the issuance, ABC’s equity will have the following structure:
ABC’s currently issued shares 10,000 20%

Shares issued to XYZ (5 x 8,000) 40,000 80%
Total shares after the combination 50,000
Analysis:
The business combination is a reverse acquisition because XYZ obtains control
over ABC despite the fact that ABC is the issuer of shares. In other words, XYZ let
itself be acquired (legal form) in order to gain control over ABC (substance).
 XYZ, Inc., the legal acquiree, is the accounting acquirer.

 ABC Co., the legal acquirer, is the accounting acquiree.
Requirement (b):
Substance of the contract: XYZ obtains control over ABC in a reverse acquisition.
Accordingly, the consideration transferred is computed based on the number of
shares XYZ (accounting acquirer) would have had to issue to give ABC (accounting
acquiree) the same percentage of equity interest in the combined entity.
Reverse – XYZ (accounting acquirer) issues shares to ABC

Shares %
XYZ’s currently issued shares 8,000 80%
Shares issued to ABC [(8,000÷80%) x 20%] 2,000 20%
Total shares after the combination 10,000
If the business combination had taken the form of XYZ issuing additional ordinary
shares to ABC’s shareholders, XYZ would have had to issue 2,000 shares for the
ratio of ownership interest in the combined entity to be the same. XYZ’s
shareholders would then own 8,000 of the 10,000 issued shares of XYZ (80% of the
combined entity), while ABC’s shareholders own 2,000 (20% of the combined
entity).
Consideration transferred (2,000sh x 200) 400,000

Total 400,000
Fair value of ABC’s net assets (300,000)
Goodwill 100,000
MODULE SUMAMRY
Accounting for Business Combinations (Part 2)
 The acquisition method applies to all business combination, including those

that do not involve a purchase transaction. If a business combination is
achieved.
a) without transfer of consideration, the fair value of acquirer's interest in the

acquiree is substituted for the consideration transferred in computing for goodwill.
b) by contact alone, all interest not held by the acquirer are attributed to NCI, even if
the resulting NCI is 100%.
 Provisional amounts may be used if accounting is incomplete by the end of the
business combination year. The provisional amounts are adjusted
retrospectively for information obtained during the measurement period. (i.e.,
maximum of 12 months from acquisition date) that provides evidence of facts
and circumstances that existed as of the acquisition date.
 The consideration transferred includes only those that are transferred to the
previous owners of the acquiree. It excludes those that are retained by the
combined entity after the combination and those that are in effect used to
settle a pre-existing relationship.
 A reacquired right in a business combination is recognized as an intangible

asset measured at the "at-market" value.
 The gain or loss on settlement of a pre-existing relationship is measured as

follow:
a) If contractual- at the lower of (i) "off-market" value, favorable/unfavorable

determined based on the acquirer’s perspective; and (ii) any settlement amount
stated in the contract.
b) If non-contractual - at fair value
 A contingent consideration is measured at acquisition-date fair value and
included in the consideration transferred.
Notable differences between the provision of the full PFRSs and the PFRS for SMEs:
Full PFRSs PFRS for SMEs
6. Previously held equity interest in the acquiree
In a business combination achieved in No equivalent provision under PFRS for
stages, the acquirer's previously held SMEs.
equity interest in the acquiree is
remeasured to fair value and included in
the computation of goodwill
7. Contingent consideration
Initial measurement: initial measurement:
Included in the consideration Included in the cost of business
transferred at acquisition-date fair combination if it is probable and can be
value. measured reliably.
Subsequent measurement: Subsequent measurement:
a) a measurement period adjustment is Change in fair value is treated as an
adjusted to goodwill. adjustment to the cost of business
combination (i.e., adjustment to
b) not a measurement period
goodwill).
adjustment:
i. remains in equity, if the contingent
consideration is classified as equity
ii. is recognized in profit or loss, if the
contingent consideration is classified as
liability or asset.
MODULE SUMMARY
 Goodwill arising from a business combination is not amortized but tested for
impairement at least annually.
 In a reverse acquisition, the issuer of shares ( the legal acquirer) is the
accounting acquiree.
 The consideration transferred in a reverse acquisition is measured based on
the number of equity interest the legal subsidiary (accounting acquirer)
would have had to issue to give the owner of the legal parent (accounting
acquiree) the same percentage of equity interest in the combined entity that
results fron the reverse acquisition.
REFERENCES:
BOOKS:
Millan, Zeus Vernon B. (2020).Accounting for Special Transactions and

Business Combinations , Bandolin Enterprise ,Baguio City.
Dayag, Antonio J. (2019).Advanced Financial Accounting and Reporting

Part I and II , GIC Enterprise, Claro M. Recto Manila, Philippines.
De Jesus, Paul Anthony (2019). Advanced Financial Accounting and

Reporting , GIC Enterprise, Claro M. Recto Manila, Philippines.
Guerrero, Pedro (2019). Advanced Financial Accounting and Reporting ,

GIC Enterprise, Claro M. Recto Manila, Philippines.
Philippine Financial Reporting Standards (PFRSs), Philippines: Financial Reporting

Standards Council (FRSC
WEBSITE REFERENCES:
http://www.iasplus.com/
http://www.picpa.com.ph/
MODULE ACTIVTY/ASSESSMENT
ACTIVITY 1:
1. Which of the following factors is used as multiplier of super profits in valuation of

goodwill of a business?
a. Average capital employed in the business d. Normal rate of return
b. Simple profits e. Normal profits.
c. Number of years’ purchase
2. This type of business combination occurs when, for example, a private entity
decides to have itself “acquired” by a smaller public entity in order to obtain a
stock exchange listing.
a. Step acquisition c. Reverse acquisition
b. Rewind acquisition d. Stock acquisition
3. UNFLEDGED Co. is contemplating on acquiring IMMATURE, Inc. The following

information was gathered through a diligence audit:
 The actual earnings of IMMATURE, Inc. for the past 5 years are shown below:
Year Earnings
20x1 2,400,000
20x2 2,600,000
20x3 2,700,000
20x4 2,500,000
20x5 3,600,000
13,800,00
Total 0
 Earnings in 20x5 included an expropriation gain of ₱800,000.

 The fair value of IMMATURE’s net assets as of the end of 20x5 is ₱20,000,000.
 The industry average rate of return is 12%.
 Probable duration of “excess earnings” is 5 years.
Requirements:
a. How much is the estimated goodwill under the multiples of average excess earnings
method?
b. How much is the estimated goodwill under the capitalization of average excess
earnings method? Use a capitalization rate of 25%.
c. How much is the estimated goodwill under the capitalization of average earnings
method? Use a capitalization rate of 12.5%.
d. How much is the estimated goodwill under the present value of average excess
earnings method? Use a discount rate of 10%.

MODULE 12 Accounting For Business Combination PART 2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

MODULE 12 Accounting For Business Combination PART 2

Uploaded by

Copyright:

Available Formats

MODULE ACCOUNTING FOR BUSINESS COMBINATION PART II

INTENDED LEARNING OUTCOMES

1. Account for business combinations (a) accomplished through share-for-share

Lesson 1: Business Combination (Specific Cases)

Specific cases in Business Combination

ABC Co. Combined entity

ABC Co. Combined entity Increase

Requirement (b): Par value per share

Requirement (c): Fair value of net assets acquired

ABC Co. XYZ, Inc. Combined

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

Increase in ABC’s share capital account

Requirement (b): Fair value per share

Fair value of consideration transferred 1,000,000

Requirement (d): Retained earnings of the combined entity

II. Business combination achieved in stages

In accounting for a business combination achieved in stages, the acquirer:

Illustration: Business combination achieved in stages

Entries are as follows:

III. Business combination achieved without transfer of consideration

 In business combination achieved without transfer of consideration,

Illustration 1: Without transfer of consideration

Requirement: Compute for goodwill.

Illustration 2: By contract alone

Requirement: Compute for goodwill

A. During measurement period

Illustration 1: Provisional amounts – identifiable assets acquired

Case #1: Identifiable assets recognized at provisional amount

Requirement (b): Accounting

Requirement (c): Adjusted goodwill

Depreciation recognized (700K ÷ 10 years x 3/12)

Case #2: Unrecorded identifiable asset acquired

The measurement period adjusting entries are as follows:

Case #3: Information obtained beyond the measurement period

The omitted patent is recognized with a corresponding charge to goodwill because

Illustration 2: Provisional amounts – consideration transferred

Information on acquisition date:

Information after the acquisition date:

The new information obtained on July 1, 20x2 is not a measurement period

Determine what is part of the business combination transaction

However, the following are separate transactions that are excluded

The fair value of net identifiable assets acquired is computed as follows:

Settlement of pre-existing relationships between the acquirer and acquiree

 If the pre-existing relationship is settled due to the business combination, the

Illustration 1: Reacquired right

The measurement of a reacquired right could result to a difference between the

The pre-existing relationship is contractual. Therefore, the settlement loss is

Settlement loss before adjustment (“off-market” value) 80,000

The settlement of the pre-existing relationship is a separate transaction.

The goodwill is computed as follows:

Illustration 2: Contractual pre-existing relationship

Requirement: Compute for the goodwill.

The pre-existing relationship is contractual. Therefore, the settlement loss is

Settlement loss (lower of 90K off-market and 100K

The ₱90,000 “off-market” value is excluded from the consideration transferred on

The ₱70,000 “at-market” value is subsumed in goodwill and not recognized as

 In Illustration 1, ABC (acquirer) granted the license to XYZ (acquiree). There

The goodwill is computed as follows:

Illustration 3: Non-contractual pre-existing relationship

The pre-existing relationship is non-contractual. Therefore, the settlement gain or

Payment for settlement of pre-existing relationship 100,000

The goodwill is computed as follows:

II. Indemnification Assets