Professional Documents
Culture Documents
Introduction/Overview
This module aims to provide students a comprehensive understanding and application of the proper
accounting principles for the recognition and measurement relating to a business combination. It
also provides the students with the comparison between the full Philippine Financial Reporting
Standard (PFRS) and the Philippine Financial Reporting Standard for Small and Medium-sized
Entities (PFRS for SMEs).
2. Learning Outcomes
1. Define a business combination.
2. Identify a business combination transaction.
3. Explain briefly the accounting requirements for a business combination.
4. Apply the proper accounting principle for business combination transaction.
5. Compute for goodwill.
6. Compare the difference between the full PFRS and PFRS for SMEs.
PFRS 3 Business Combinations is the standard to be applied for business combination transactions
to improve the relevance, reliability, and comparability of the information that a reporting entity
provides in its financial statements about a business combination and its effects.
• the transaction or other events in which an acquirer obtains control of one or more
businesses
B. Business
• An integrated set of activities and assets that is capable of being conducted and managed
for the purpose of providing goods or services to customers, generating investment income
(such as dividends or interest) or generating other income from ordinary activities
C. Acquisition Date
E. Acquiree
• The business or businesses that the acquirer obtains control of in a business combination
o Acquirer purchases assets and assumes liabilities in exchange for cash or non-cash
consideration
o Under the Revised Corporation Code of the Philippines, a business combination
effected through asset acquisition may be either:
1. Merger
▪ Occurs when two or more companies merge into a single entity which shall be one
of the combining companies.
▪ A Co. + B Co. = A Co. or B Co.
2. Consolidation
▪ occurs when two or more companies consolidate into a single entity which shall be
the consolidated company
▪ A Co. + B Co. = C Co.
B. Stock acquisition
o Acquirer obtains control over the acquire by acquiring a majority ownership interest
in the voting rights of the acquiree (generally more than 50%).
o Acquirer is known as the parent while the acquiree is known as the subsidiary.
o After the business combination, both companies retain their separate legal existence
and continue to maintain their own separate accounting books.
o For financial reporting purposes, both the parent and subsidiary are viewed as
a single reporting entity.
1. Horizontal combination
3. Conglomerate
B. Synergy
o Synergy occurs when the collaboration of two or more entities results in greater
productivity than the sum of the productivity of each constituent working
independently. It can be simplified by the expression 1 + 1 = 3
o Economies of scale refer to the increase in productive efficiency resulting from the
increase in the scale of production.
o An entity that achieves economies of scale decreases its average cost per unit as
production is increased because fixed costs are allocated over an increased number
of units produced.
o The cost of business expansion may be lessened when a company acquires another
company instead of putting up a branch.
1. The business combination brings a monopoly in the market which may have a negative
impact on society. This could result in an impediment to healthy competition between
market participants.
2. The identity of one or both of the combining constituents may cease, leading to loss of
sense of identity for existing employees and loss of goodwill.
3. Management of the combined entity may become difficult due to incompatible internal
cultures, systems, and policies.
4. The business combination may result in over-capitalization which may result in diffusion
in market price per share and attractiveness of the combined entity’s equity instruments to
potential investors.
5. The combined entity maybe subjected to stricter regulation and scrutiny by the government,
most especially if the business combination poses threat to consumers’ interests.
3.4. PFRS 3 Business Combinations
PFRS 3 outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition
or merger). Such business combinations are accounted for using the ‘acquisition method’, which
generally requires assets acquired and liabilities assumed to be measured at their fair values at the
acquisition date.
As defined in PFRS 3, the business combination is a transaction or other event in which the
acquirer obtains control of one or more businesses.
A. Control
1. The acquirer has the power to appoint or remove the majority of the board of
directors of the acquiree; or
2. The acquirer has the power to cast the majority of votes at board meetings or
equivalent bodies within the acquiree; or
3. The acquirer has power over more than half of the voting rights of the acquiree
because of an agreement with other investors; or
4. The acquirer controls the acquiree’s operating and financial policies because of a
law or an agreement.
B. Business
▪ any economic resource that results to an output when one or more processes
are applied to it
2. Process
3. Output
▪ the result of input and process that provides investment returns to the
stakeholders of the business
Any investor who acquires some investment needs to determine whether this transaction or event
is a business combination or not.
PFRS 3 requires that assets and liabilities acquired need to constitute a business, otherwise it’s
not a business combination and an investor needs to account for the transaction as a regular asset
acquisition in line with other PFRS.
The three elements of a business should be considered to determine if the transaction is a business
combination.
4. Accounting for Business Combination
Business combinations are accounted for using the acquisition method. PFRS 3 provides that,
applying this method requires the following steps:
▪ the acquirer usually the entity that transfers the cash or other assets or incurs
liabilities.
▪ the acquirer is usually the entity that issues its equity interests.
▪ if it is a reverse acquisition, the issuing the entity is the acquiree.
▪ Other pertinent facts and circumstances shall also be considered in
identifying the acquirer in a business combination effected by exchanging
equity interests including the following:
a. Whose owner, as a group, have the largest portion of the voting rights of the combined entity.
b. Whose a single owner or organized group of owners holds the largest minority voting interest
in the combined entity.
c. Whose owners have the ability to appoint or remove a majority of the members of the
governing body of the combined entity
e. That pays a premium over the pre-combination fair value of the equity interests of the other
combining entity or entities.
3. As to size
a. If a new entity is formed to issue equity interests to effect a business combination, one of the
combining entities that existed before the business combination shall be identified as the acquirer
by applying the guidance provided above.
b. In contrast, a new entity that transfers cash or other assets or incurs liabilities as consideration
may be the acquirer
• The acquirer shall identify the acquisition date, which is the date on which it obtains control
of the acquiree.
• The date on which the acquirer obtains control of the acquiree is generally the date on
which the acquirer legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree—the closing date.
• However, the acquirer might obtain control on a date that is either earlier or later than the
closing 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. An acquirer shall consider all pertinent facts and circumstances in identifying
the acquisition date.
4.3. Step 3: Recognizing and measuring the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree
Recognition Principle
Recognition Conditions
a. Identifiable assets acquired and liabilities assumed must meet the definitions of assets and
liabilities provided under the Conceptual Framework at the acquisition date.
b. It must be part of what the acquirer and acquiree exchanged in the business combination
transaction rather than the result of separate transactions.
c. Applying the recognition principle may result to the acquirer recognizing assets and liabilities
that the acquiree had not previously recognized in its financial statements
Measurement Principle
▪ The acquirer shall measure the identifiable assets acquired and the liabilities
assumed at their acquisition-date fair values.
▪ Separate valuation allowances are not recognized at the acquisition date
because the effects of uncertainty about future cash flows are included in the
fair value measurement.
▪ All acquired assets are recognized regardless of whether the acquirer intends
to use them.
B. Non-controlling Interest
1. Fair value; or
• Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that is not individually identified and separately
recognized.
• On acquisition date, the acquirer computes and recognizes goodwill or gain on a bargain
purchase using the following formula:
• A negative amount resulting from the formula is called “gain on a bargain purchase” (also
referred to as “negative goodwill”)
• On the acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
A. Consideration Transferred
o The consideration transferred is measured at fair value, which is the sum of the
acquisition-date fair values of the assets transferred by the acquirer, the liabilities
incurred by the acquirer to former owners of the acquiree and the equity interests
issued by the acquirer.
1. Cash
2. other assets
3. a business or a subsidiary of the acquirer
4. contingent consideration
5. ordinary or preference equity instruments, options, warrants
6. member interests of mutual entities.
B. Acquisition-related costs
Examples:
1. Finder’s fees
2. Professional fees, such as advisory, legal, accounting, valuation and consulting fees
3. General administrative costs, including the costs of maintaining an internal
acquisitions department
4. Costs of registering and issuing debt and equity securities
o Acquisition-related costs are expenses when they are incurred, except the cost to
issue debts or equity securities which shall be recognized in accordance with PAS
32 and PFRS 9:
1. Costs to issue debt securities measured at amortized costs are included in the initial
measurement of the resulting financial liability.
2. Costs to issue equity securities are deducted from share premium. If the share premium is
insufficient, the issue costs are deducted from retained earnings.
o This pertains to any interest held by the acquirer before the business combination.
This affects the computation of goodwill only in a business combination achieved
in stages (discussed in the next module)
4.5. Illustrations
As of January 1, 2020
Assets Carrying amounts Fair values
Cash in bank 20,000 20,000
Receivables 220,000 150,000
Allowance for doubtful accounts (50,000) -
Inventory 510,000 430,000
Building – net 1,500,000 1,200,000
Goodwill 100,000 50,000
Total Assets 2,300,000 1,850,000
Liabilities
500,000 300,000
Accounts Payable
Total Liabilities
500,000 300,000
Assumption #1:
Popoy Co. paid ₱2,000,000 cash as consideration for acquiring the net assets of Basha,
how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Consideration transferred 2,000,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 2,000,000
Fair value of net identifiable assets acquired (1,500,000)
Goodwill 500,000
The fair value of the net identifiable assets of the acquiree is computed as follows:
Fair value of identifiable assets acquired excluding
goodwill 1,800,000
Fair value of liabilities assumed (300,000)
Fair value of net identifiable assets acquired 1,500,000
Assumption #2:
If Popoy Co. paid ₱1,300,000 cash as consideration for the net assets of Basha Co.,
how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Consideration transferred 1,300,000
Non-controlling interest in the acquiree -
Total 1,300,000
Fair value of net identifiable assets acquired (1,500,000)
Assumption #1:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option to
measure non-controlling interest at fair value. The independent consultant engaged
by Popoy Co. determined that the fair value of the 25% non-controlling interest in
Basha Co. is ₱200,000. How much is the goodwill or gain in bargain purchase on the
business combination?
Solution:
Consideration transferred 1,300,000
Non-controlling interest in the acquiree 200,000
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 500,000
Entries are as follows:
To record the acquisition in Popoy’s separate books of accounts:
Jan. 1, Investment in subsidiary 1,300,000
2020 Cash 1,300,000
To include Basha in Popoy’s consolidated financial statements:
Jan. 1, Identifiable assets acquired 1,400,000
20x1 Goodwill 500,000
Liabilities assumed 400,000
Investment in subsidiary 1,300,000
Non-controlling interest Basha 200,000
Co.
Note:
The non-controlling interest is presented in the consolidated statement of financial
position within equity but separately from the equity of the owners of Popoy Co.
(parent).
Assumption #2:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option to
measure non-controlling interest at the non-controlling interest’s proportionate share
of Basha’s net identifiable assets.
How much is the goodwill or gain on bargain purchase on the business combination?
Solution:
Consideration transferred 1,300,000
Non-controlling interest in the acquiree 250,000
Previously held equity interest in the acquiree -
Total 1,550,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 550,000
Assumption #1
As consideration for the business combination, Popoy transferred 10,000 of its own
equity instruments with par value per share of ₱100 and fair value per share of ₱120
to Basha’s former owners. Costs of registering the shares amounted to ₱50,000. How
much is the goodwill or gain on bargain purchase on the business combination?
Solution:
Consideration transferred (10,000 sh. X 120) 1,200,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,200,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 200,000
Share Premium
To record the issuance of
shares as consideration for the
business combination
Note:
The acquisition-related costs are expensed, except for the costs to issue equity
securities which are deducted from share premium.
Assumption #2
As consideration for the business combination, Popoy Co. issued bonds with face
amount and fair value of ₱1,200,000. Transaction costs incurred in issuing the bonds
amounted to ₱50,000. How much is the goodwill or gain on bargain purchase on the
business combination?
Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,200,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 200,000
Entries in the books of the acquirer:
Jan. 1, Identifiable assets acquired 1,600,000
2020 Goodwill 200,000 600,000
Liabilities assumed 1,200,000
Bonds payable
To record the issuance of
bonds as consideration for the
business combination
Solution:
Consideration transferred 1,210,461
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,210,461
Notes:
The building is remeasured to acquisition date fair-value before it is
transferred. The ₱100,000 adjustment is recognized as impairment loss.
The patented technology is not included in the consideration transferred
because it remains within the combined entity. The patented technology
continues to be measured at carrying amount.
Basha’s liabilities include ₱100,000 cash dividends declared on December 28, 2019,
to shareholders of record on January 15, 2020, and payable on January 31, 2020.
Total 1,400,000
Fair value of net identifiable assets acquired (900,000)
Goodwill 500,000
For purposes of computing the goodwill, the ₱100,000 payment is excluded from the
consideration transferred because this is not a payment for the business combination,
but rather for the purchased dividends.
Journal entries:
Jan. 1, Identifiable assets acquired 1,500,000
2020 Goodwill 500,000
600,000
Liabilities assumed (including
dividends) 1,400,000
Cash
The costs above are sometimes referred to as “liquidation costs”. However, a restructuring
provision does not include such costs as:
2. Marketing, or
I. Operating Leases
General rule:
The acquirer shall not recognize any assets or liabilities related to an operating lease in which
the acquiree is the lessee.
Exception:
The acquirer shall determine whether the terms of each operating lease in which the acquiree is
the lessee are favorable or unfavorable.
If the acquiree is the lessor, the acquirer shall not recognize any separate intangible asset or
liability regardless of whether the terms of the operating lease are favorable or unfavorable when
compared with market terms.
llustration: Specific recognition principles – Operating leases
On January 1, 2020, Popoy Co. acquired all the identifiable assets and assumed all the
liabilities of Basha Co. for ₱1,500,000. On this date, the identifiable assets acquired
and liabilities assumed have fair values of ₱1,600,000 and ₱600,000, respectively.
Assumption #1:
Popoy is renting out a building to Basha under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
estimated at ₱50,000.
Solution:
Consideration transferred 1,500,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,050,000)
Goodwill 450,000
The fair value of the net identifiable assets acquired is computed as follows:
FV of identifiable assets acquired, including intangible asset on the operating
lease with favorable terms 1,650,000
FV of liabilities assumed (600,000)
Fair value of net identifiable assets acquired 1,050,000
Assumption #2:
Popoy is renting out a patent to Basha under operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential is
estimated at ₱50,000.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred 1,500,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (950,000)
Goodwill 550,000
Assumption #3:
Popoy is renting a building from Basha under operating leases. The terms of the
operating lease compared with market terms are favorable. The fair value of the
differential is estimated at ₱50,000.
Solution:
Consideration transferred 1,500,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 500,000
No intangible asset or liability is recognized, regardless of the terms, because the
acquiree is the lessor.
II. INTANGIBLE ASSETS
The acquirer recognizes, separately from goodwill, the identifiable intangible assets acquired in a
business combination. An intangible asset is identifiable if it is either (a) separable or (b) arises
from contractual or other legal rights
A. Separability criterion
An intangible asset is separable if it is capable of being separated from the acquiree and sold,
transferred, licensed, rented or exchanged, either individually or together with a related contract,
identifiable asset or liability.
1. The exchange transactions are infrequent and regardless of whether the acquirer is
involved in them, as long as there is evidence of exchange transaction for that type of
asset or similar type; or
2. The acquirer does not intend to sell, license or otherwise exchange the identifiable
intangible asset
B. Contractual-legal criterion
An intangible asset that is not separable is nonetheless identifiable if it arises from contractual or
other legal rights
Example:
Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity B’s license
to operate the nuclear power plant. However, the terms of the license prohibit Entity A from selling
or transferring the license to another party.
Analysis: The license is an identifiable intangible asset because, although it is not separable, it
meets the contractual-legal criterion.
llustration: Intangible assets – separability and contractual legal criteria
On January 1, 2020, Popoy Co. acquired all the assets and liabilities of Basha Co.
for ₱1,000,000. Relevant financial information of Basha are as follows:
Carrying amounts Fair values
Other assets 1,300,000 1,180,000
Computer software 100,000 -
Patent - 50,000
Goodwill 100,000 20,000
Total Assets 1,500,000 1,250,000
Liabilities
400,000 450,000
Bonds Payables
Total Liabilities
400,000 450,000
Additional information:
The computer software is considered obsolete
The patent has a remaining useful life of 10 years and a remaining legal life
of 12 years.
Basha Co. has research and development (R&D) projects with fair value of
₱50,000. However, Basha recognized the R&D costs as expenses when they
were incurred.
Solution:
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 (830,000)
Goodwill 170,000
The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired, excluding computer software and
recorded goodwill but including patent and R&D 1,280,000
Fair value of liabilities assumed (450,000)
Fair value of net identifiable assets acquired 830,000
An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree has
already expensed the related costs.
Additional information:
Customer contract #1 refers to an agreement between Basha and a customer,
wherein Basha is to supply goods to customer for a period of 5 years. The
remaining period of the contract is 3 years. The agreement is expected to be
renewed at the contract-end but is not separable.
Total 1,500,000
Fair value of net identifiable assets acquired (1,200,000)
Goodwill 300,000
• The requirements of PAS 37 do not apply when accounting for contingent liabilities related
to the business combination as of the acquisition date.
• Under PFRS 3, a contingent liability assumed in a business combination is recognized if:
• Therefore, contrary to PAS 37, the acquirer recognizes a contingent liability assumed in
business combination at the acquisition date even if it is NOT probable that an outflow of
resources embodying economic benefits will be required to settle the obligation. As long
as both the conditions above are satisfied, a contingent liability will be recognized.
Illustration: Contingent liabilities
On January 1, 2020, Popoy Co. acquires 90% interest in Basha Co. for ₱1,000,000. Basha’s
recognized assets and liabilities have fair values of ₱1,600,000 and ₱600,000, respectively.
ABC opts to measure the non-controlling interest at fair value. The NCI’s fair value is
₱100,000.
Basha has a pending litigation, for which no provision was recognized because Basha
strongly believes that it will win the case. The fair value of settling the litigation is ₱50,000.
Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree 100,000
Previously held equity interest in the acquiree -
Total 1,100,000
Fair value of net identifiable assets acquired (950,000)
Goodwill 150,000
The adjusted fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired 1,600,000
Total fair value of liabilities assumed:
Fair value of liabilities assumed 600,000
Contingent liability (pending litigation) 50,000 (650,000)
Fair value of net identifiable assets acquired 950,000
The contingent liability is recognized even if it is NOT probable because it (a) represents a
present obligation and (b) has fair value.
Exceptions to both the recognition and measurement principles
The following items shall be recognized and measured as at acquisition date under other applicable
standards:
1. Income taxes
• are accounted for using PAS 12 Income Taxes. For example, deferred taxes are measured
based on temporary differences arising from the measurement of identifiable assets and
liabilities assumed by the acquirer at the acquisition date.
• Deferred taxes affect the amount of goodwill or gain on bargain purchase recognized at the
acquisition date. However, PAS 12 prohibits the recognition of deferred tax liabilities
arising from the initial recognition of goodwill.
2. Employee benefits
• are accounted for using PAS 19 Employee benefits. For example, defined benefit
obligations are measured through actuarial valuations.
3. Indemnification assets
• arises when the former owners of the acquiree agree to reimburse the acquirer for any
payments the acquirer eventually makes upon settlement of liability.
• The acquirer shall recognize an indemnification asset at the same time and on the same
basis as the indemnified item.
• Accordingly, if the indemnified item is measured at fair value, the indemnification asset is
also measured at fair value. If the indemnified item is measured at other than fair value, the
indemnification asset is measured using assumptions consistent with those used to measure
the indemnified item.
Example:
Entity A acquires Entity B. At the acquisition date, the taxing authority is disputing Entity B’s tax
returns in prior years. The former owners of Entity B agree to reimburse Entity A in case Entity A
will be held liable to pay Entity B’s tax deficiencies in the prior years.
At the acquisition date, Entity A recognizes a tax liability to the taxing authority and an
indemnification asset for the reimbursement due from the former owners of Entity B
A. Reacquired rights
Reacquired rights are measured based on the remaining term of the related contract. (Discussed in
the next chapter)
Liabilities and equity instruments related to the acquiree’s share-based payment transactions are
accounted for using the PFRS 2 Share-based payment.
A non-current asset (or disposal group) that is classified as held for sale at the acquisition date
at fair value less costs to sell in accordance with PFRS 5 Non-current Assets Held for sale and
Discontinued Operations, rather than at fair value under PFRS 3.