MODULE 11 Accounting For Business Combination PART 1

MODULE ACCOUNTING FOR BUSINESS COMBINATION PART I
11
Week 9-10
INTRODUCTION
This module aims to provide students a comprehensive understanding and

application of the proper accounting principles for the recognition and measurement
relating to business combination. It also provides the students 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).
INTENDED 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.
7. Account for business combinations (a) accomplished through share-for-share
exchanges, (b) achieved in stages, and (c) achieved without transfer of
consideration
8. Explain the “measurement period” in relation to business combinations
9. Distinguish what is part of a business combination and what is part of a
“separate transaction”
10. Account for settlement of pre-existing relationship between an acquirer and an
acquiree
LEARNING CONTENT
Introduction
A business combination occurs when one company acquires another or when
two or more companies merge into one. After the combination, one company gains
control over the other. The company that obtains control over the other is referred to
as the parent or acquirer. The other company that is controlled is the subsidiary or
acquiree.
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.
PFRS 3 defines the following:
A. Business combination
 transaction or other event 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
 The date on which the acquirer obtains control of the acquire
D. Acquirer
 The entity that obtains control of the acquiree
E. Acquiree
 The business or businesses that the acquirer obtains control of in a
business combination
Business Combination are carried out either through:

A. Asset acquisition
 Acquirer purchases assets and assumes liabilities in exchange of cash or
non-cash consideration
 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
 Acquirer obtains control over the acquire by acquiring a majority
ownership interest in the voting rights of the acquire (generally more
than 50%).
 Acquirer is known as the parent while the acquire is known as the
subsidiary.
 After the business combination, both companies retain their separate
legal existence and continue to maintain their own separate accounting
books, recording separately their assets, liabilities, and transactions
they enter into.
 For financial reporting purposes, both the parent and subsidiary are
viewed as a single reporting entity.
 The parent company records the ownership interest acquired as
“investment in subsidiary” in its separate accounting books. However,
the investment is eliminated when the group prepares consolidated
financial statements.
C. A business combination may also be described as:

1. Horizontal combination
 A business combination of two or more entities with similar
businesses (e.g., a bank acquires another bank).
2. Vertical combination
 A business combination of two or more entities operating at a
different level in a marketing chain (e.g., a manufacturer acquires its
supplier of raw materials)
3. Conglomerate
 A business combination of two or more entities with dissimilar
businesses (e.g., a real estate developer acquires a bank)
Advantages of a business combination

A. Competition is eliminated or lessened
 A competition between the combining constituents with similar business
is eliminated while the threat of competition from other market
participants is lessened
B. Synergy
 Synergy occurs when the collaboration of two or more entities results to
greater productivity than the sum of the productivity of each constituent
working independently.
 Synergy is most commonly describes as “the whole is greater than the
sum of its parts.” It can be simplified by the expression 1 + 1 = 3
C. Increased business opportunities and earnings potential
 Business opportunity and earnings potential may be increased through:
1. An increased variety of products or services available and a
decreased dependency on limited number of products and
services;
2. Widened dispersion of products or devices and better access to
new markets;
3. Access to either of the acquirer’s or acquiree’s technological
know-hows, research and development, secret processes, and
other information.
4. Increased investment opportunities due to increased capital; or
5. Appreciation in worth due to an established trade name by either
one of the combining constituents
D. Reduction of operating costs
 Operating costs of the combined entity may be reduced.
1. Under a horizonal combination, operating costs may be reduced
by the elimination of unnecessary duplication of costs
2. Under a vertical combination, operating costs may be reduced by
the elimination of costs of negotiation and coordination between
the companies and mark-ups on purchases.
E. Combinations utilize economies of scale
 Economies of scale refer to the increase in productive efficiency
resulting from the increase in the scale of production.
 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.
F. Cost savings on business expansion
 The cost of business expansion may be lessened when a company
acquires another company instead of putting up a branch.
 There may be various regulations which may restrict a company from
branching out such as minimum capitalization, level of liquidity and
other requirements.
G. Favorable tax implications
 Deferred tax assets may be transferred in a business combination.
 Business combinations effected without transfers of considerations may
not be subjected to taxation.
Disadvantages of a business combination
A. Business combination brings monopoly in the market which may have a
negative impact to the society. This could result to impediment to a healthy
competition between market participants.
B. 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.
C. Management of the combined entity may become difficult due to incompatible
internal cultures, systems, and policies.
D. Business combination may result in over-capitalization which may result to
diffusion in market price per share and attractiveness of the combined entity’s
equity instruments to potential investors.
E. The combined entity may be subjected to stricter regulation and scrutiny by
the government, most especially if the business combination poses threat to
consumers’ interests.
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, business combination is a transaction or other event in
which the acquirer obtains control of one or more businesses.
Essential Elements in the definition of Business Combination:

A. Control
 An investor controls an investee when the investor has the power to
direct the investee’s relevant activities
 Control is normally presumed to exist when the acquirer holds more
than 50% interest in the acquiree’s voting interest; exact determination
is based on the facts of the relationship between shareholders and the
company
 Control can also be obtained when:
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.
 An acquirer may obtain control of an acquiree in a variety of ways, for
example:
1. By transferring cash or other assets;
2. By incurring liabilities;
3. By issuing equity interests;
4. By providing more than one type of consideration; or
5. Without transferring consideration, including by contract alone.
Illustration: Determining the existence of control
Example #1
ABC Co. acquires 51% ownership interest of XYZ, Inc.’s ordinary shares.
Analysis:
ABC is presumed to have obtained control over XYZ because of the ownership
interest acquired in the voting rights of XYZ is more than 50%.
Example #2
ABC Co. acquires 100% of XYZ, Inc.’s preference shares.
Analysis:
ABC does not obtain control over XYZ because preference shares do not give
the holder voting rights over the financial and operating policies of the
investee.
Example #3
ABC Co. acquires 40% ownership interest in XYZ, Inc. There is an agreement
with the shareholders of XYZ that ABC will control the appointment of the
majority of the board of directors of XYZ.
Analysis:
ABC has control over XYZ because, even though the ownership interest is only
40%, ABC has the power to appoint the majority of the board of directors of
XYZ.
Example #4
ABC Co. acquires 45% ownership interest in XYZ, Inc. ABC has an agreement
with EFG Co., which owns 10% of XYZ, whereby EFG will always vote in the
same way as ABC.
Analysis:
ABC has control over XYZ because it controls more than 50% of the voting
rights of XYZ (45% plus 10%, per agreement with EFG, Co)
Example #5
ABC Co. acquires 50% of XYZ, Inc.’s voting shares. The board of directors of XYZ
consists of 8 members. ABC appoints 4 of them and XYZ appoints the other 4.
When there are deadlocks in casting votes at meetings, the decision always lies
with the directors appointed by ABC.
Analysis:
ABC has control over XYZ because it controls more than 50% of the voting
rights over XYZ in the event there is no majority decision.
B. Business
 As defined by PFRS 3, business is an integrated set of activities and
assets that is capable of being conducted and managed for the purpose
of providing a return in the form of dividends, lower costs or other
economic benefits directly to investors or other owners, members or
participants.
 A business has the following three elements:
1. Input
 any economic resource that results to an output when one or
more processes are applied to it
2. Process
 any system, standard, protocol, convention or rule that when
applied to an input, creates an output
3. Output
 the result of input and process that provides investment
returns to the stakeholders of the business
Determining whether a transaction is a business combination

(Is it a business combination or not?)
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.
Accounting for Business Combination

Business combinations are accounted for using the acquisition method. PFRS
3 provides that, applying this method requires the following steps:
1. Identifying the acquirer;
2. Determining the acquisition date;
3. Recognizing and measuring the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree;
and
4. Recognizing and measuring goodwill or a gain from a bargain
purchase.
I. Step 1: Identifying the acquirer
The acquirer is the entity that obtains control of the acquiree. The
acquiree is the business that the acquirer obtains control of in a business
combination. PFRS 3 provides the following guidance in identifying the
acquirer:
1. Who is the transferor of cash and other resources and assumes
liabilities?
 In a business combination effected primarily by transferring
cash or other assets or by incurring liabilities, the acquirer
usually the entity that transfers the cash or other assets or
incurs liabilities.
2. Who is the issuer of shares?
 In a business combination effected primarily by exchanging
equity interests, the acquirer is usually the entity that issues
its equity interests.
 However, if it is a reverse acquisition, the issuing 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 owners have the ability to appoint or remove a
majority of the members of the governing body of the
combined entity
c. Whose (former) management dominates the
management of the combined entity
d. That pays a premium over the pre-combination fair
value of the equity interests of the other combining
entity or entities.
3. Who is larger?
 The acquirer is usually the combining entity whose relative
size is significantly greater than that of the other combining
entity or entities
4. Who is the initiator of the combination?
 The acquirer is usually the one who initiated the
combination.
5. Substance over form
 If a new entity is formed to effect the business combination,
the acquirer is identified as follows:
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
 Example: A Co. + B Co. = C. Co.
a. If C Co. if formed to issue equity interest to A Co. and B
Co., the acquirer is either A Co. or B Co., whichever
company whose former owners, as a group, gain
control over C Co.
b. If C Co. is formed to transfer cash to A Co. and B Co., the
acquirer is C Co.
Illustration: Identifying the acquirer
Example #1
ABC Co. and XYZ, Inc., both listed entities, agreed to combine their
businesses. The terms of the business combination is that ABC will offer 5
shares for every share of XYZ. There is no cash consideration. ABC’s market
capitalization is ₱900 million and XYZ’s is ₱100 million. After the
combination, the board of directors of XYZ shall comprise only directors
from ABC. Three months after the acquisition, 20% of XYZ is sold.
Analysis:
ABC is the acquirer based on the following indicators:
 ABC is the issuer of shares and the initiator of the business
combination
 ABC is the larger entity of the two combining constituents
 The board of directors of XYZ after the combination comprises only
directors from ABC. This gives ABC the ability to dominate the
management of XYZ
 Part of XYZ is sold after the acquisition. This provides additional
indicator that ABC is the acquirer
II. Step 2: Determining the Acquisition Date

The acquisition date is the date on which the acquirer obtains control of
the acquiree. This is normally the closing date (the date on which the
acquirer legally transfers the consideration, acquires the assets and
assumes the liabilities of the acquiree).
However, the acquirer might obtain control on a date that is either
earlier or later than the closing date. The acquirer should consider all
pertinent facts and circumstances in identifying the acquisition date.
III. Step 3: Recognize and measure the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree
A. Acquired assets and liabilities
Recognition Principle
On acquisition date, the acquirer recognizes the identifiable assets
acquired, the liabilities assumed and any NCI in the acquiree separately
from goodwill.
Unidentifiable assets are not recognized. Example are:
a. Goodwill recorded by the acquiree prior to the business
combination
b. Assembled workforce
c. Potential contracts that the acquiree is negotiating with
prospective new customers at the acquisition date.
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
Classifying identifiable assets acquired and liabilities assumed

Identifiable assets acquired and liabilities assumed are classified
at the acquisition date in accordance with other PFRSs that are to be
applied subsequently
Measurement Principle
Identifiable assets acquired and liabilities assumed are measured
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
As provided in PFRS 3, non-controlling interest (NCI) or “minority
interest” is the equity in a subsidiary not attributable, directly or
indirectly, to a parent.
For example, when an investor acquires 100% share in a company,
then there’s no non-controlling interest, because the investor owns
subsidiary’s equity in full.
However, when an investor acquires less than 100%, let’s say 80%,
then there’s non-controlling interest of 20%, as the 20% of subsidiary’s
net assets belong to someone else.
For each business combination, the acquirer measures any non-
controlling interest in the acquiree either at:
1. Fair value; or
2. The NCI’s proportionate share of the acquiree’s
identifiable net assets.
IV. Step 4: Recognizing and measuring the goodwill

Goodwill is an asset representing the future economic benefits arising
from other assets acquired in a business combination that are 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:
Consideration transferred xx
Non-controlling interest (NCI) in the acquiree xx
Previously held equity interest in the acquiree xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill / (Gain on a bargain purchase) xx
A negative amount resulting from the formula is called “gain on a

bargain purchase” (also referred as “negative goodwill”)
On the acquisition date, the acquirer recognizes a resulting:

a. Goodwill as an asset
b. Gain on a bargain purchase as gain in profit or loss
 Before recognizing, the acquirer shall reassess
 Application of the concept of conservatism
A. Consideration Transferred
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.
Examples of potential forms of consideration include:

1. Cash
2. Non-cash assets
3. Equity instruments
4. A business or subsidiary of the acquirer
5. Contingent consideration
B. Acquisition-related costs
These are costs the acquirer incurs to effect a business combination.
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
Acquisition costs are recognized as expenses when they are

incurred, except for the following:
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 share premium is insufficient, the issue costs
are deducted from retained earnings.
C. Previously held equity interest in the acquiree
This pertains to any interest held by the acquirer before the
business combination. This affects the computation of goodwill
only in business combination achieved in stages.
Illustration 1: Measuring goodwill/ gain on bargain purchase
Fact Pattern:
On January 1, 20x1, ABC Co. acquired all assets and assumed all liabilities of
the XYZ, Inc. As of this date, the carrying amounts and fair values of the
assets and liabilities of XYZ acquired by ABC are shown below:
Assets Carrying amounts Fair values

Cash in bank
10,000 10,000
Receivables
200,000 120,000
Allowance for doubtful
accounts (30,000) -
Inventory
520,000 350,000
Building – net
1,000,000 1,100,000
Goodwill
100,000 20,000
Total Assets 1,800,000 1,600,000
Liabilities
Accounts Payable
400,000 400,000
Total Liabilities
400,000 400,000
On the negotiation for the business combination, ABC Co. incurred

transaction costs amounting to ₱100,000 for legal, accounting, consultancy
fees.
Case #1:
ABC Co. paid ₱1,500,000 cash as consideration for the assets and liabilities
of XYZ, Inc., how much is the goodwill (gain on bargain purchase) on the
business combination?
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
(1,180,000)
Goodwill
320,000
The fair value of the net identifiable assets of the acquiree is computed as
follows:
Fair value of identifiable assets acquired excluding

goodwill
1,580,000
Fair value of liabilities assumed
(400,000)
1,180,000
The goodwill recorded by the acquiree is excluded from the identifiable

assets acquired because goodwill is unidentifiable. Only identifiable assets
are recognized.
Entries in the books of the acquirer:

Jan. 1, Cash in bank 10,000
20x1 Receivables 120,000
Inventory 350,000
Building 1,100,000
Goodwill 320,000
Accounts Payable 400,000
Cash in bank 1,500,000
To record the assets
acquired and liabilities
assumed on a business
combination
Jan. 1, Professional fees expense 100,000
20x1 Cash in bank 100,000
To record the
acquisition-related costs
XYZ, Inc. shall account for the business combination as a liquidation of a

business. Accordingly, all the assets, liabilities, and equity are derecognized
and the difference between the carrying amount of the items derecognized
and the disposal proceeds (amount received from the business combination)
is treated as a gain or loss on disposal of business.
XYZ shall recognized a gain on disposal of business of ₱100,000. The entries

in XYZ’s books are as follows:
Jan. 1, Cash on hand 1,500,000
20x1 Allowance for doubtful account 30,000
Accounts payable 400,000
Cash in bank 10,000
Receivables 200,000
Inventory 520,000
Building 1,000,000
Goodwill 100,000
Gain on disposal of business 100,000
To record the
liquidation of the
business
Jan. 1, Share capital (& other accounts in 1,400,000
20x1 equity)
Gain on disposal of business 100,000
Cash on hand 1,500,000
To record the
settlement of owner’s
equity
Case #2:
If ABC Co. paid ₱1,000,000 cash as consideration for the assets and liabilities
of XYZ, Inc., how much is the goodwill (gain on bargain purchase) on the
business combination?
Solution:
1,000,000
-
-
Total
1,000,000
(1,180,000)
Gain on a bargain purchase
(180,000)
Jan. 1, Cash in bank 10,000
20x1 Receivables 120,000
Inventory 350,000
Building 1,100,000
Accounts Payable 400,000
Cash in bank 1,000,000
Gain on bargain purchase 180,000
To record the assets
acquired and liabilities
assumed on a business
combination
To record the
acquisition-related
costs
Illustration 2: Non-controlling interests

Fact Pattern:
On January 1, 20x1, ABC acquired 80% of the voting shares of XYZ, Inc. On
this date, XYZ’s identifiable assets and liabilities have fair values of
₱1,200,000 and ₱400,000, respectively.
Case #1 – Non-controlling interest measured at fair value

ABC Co. elects the option to measure non-controlling interest at fair value.
The independent consultant engaged by ABC Co. determined that the fair
value of the 20% non-controlling interest in XYZ, Inc. is ₱155,000.
ABC paid ₱1,000,000 for the 80% interest in XYZ. How much is the goodwill
or gain in bargain purchase on the business combination?
Solution:
1,000,000
155,000
-
Total
1,155,000
(800,000)
Goodwill 355,000
Entries are as follows:

To record the acquisition in ABC’s separate books of accounts:
Jan. 1, Investment in subsidiary 1,000,000
20x1 Cash 1,000,000
To include XYZ in ABC’s consolidated financial statements:

Jan. 1, Identifiable assets acquired- XYZ 1,200,000
20x1 Goodwill 355,000
Liabilities assumed 400,000
Investment in subsidiary 1,000,000
Non-controlling interest in 155,000
XYZ, Inc.
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 ABC Co. (parent).
Case #2 – Non-controlling interest measured at fair value

ABC Co. elects the option to measure non-controlling interest at fair value. A
value of ₱250,000 is assigned to the non-controlling interest in XYZ, Inc.
The consideration transferred is ₱1,000,000. 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 250,000
Previously held equity interest in the acquiree -
Total 1,250,000
Fair value of net identifiable assets acquired (800,000)
Goodwill 450,000
Case #3 – NCI’s proportionate share in net assets

ABC Co. elects the option to measure non-controlling interest at the non-
controlling interest’s proportionate share of XYZ’s net identifiable assets.
ABC paid ₱1,000,000 for the interest acquired in XYZ. How much is the
goodwill or gain on bargain purchase on the business combination?
Solution:
1,000,000
160,000
-
Total
1,160,000
(800,000)
Goodwill
360,000
The NCI’s proportionate share of XYZ’s identifiable assets is computed as

follows:
Fair value of net identifiable assets acquired 800,000
Multiply by: Non-controlling interest 20%
NCI’s proportionate share in net identifiable assets 160,000
Illustration 3: Transaction costs

Fact Pattern:
On January 1, 20x1, ABC Co. acquired all of the identifiable assets and
assumed all of the liabilities of XYZ, Inc. On this date, the identifiable assets
acquired and liabilities assumed have fair values of ₱1,600,000 and
₱900,000, respectively.
ABC incurred the following acquisition-related costs: legal fees ₱10,000, due
diligence costs ₱100,000, and general administrative costs of maintaining an
internal acquisition department ₱20,000.
Case #1
As consideration for the business combination, ABC transferred 8,000 of its
own equity instruments with par value per share of ₱100 and fair value per
share of ₱125 to XYZ’s former owners. Costs of registering the shares
amounted to ₱40,000. How much is the goodwill or gain on bargain
purchase on the business combination?
Solution:
1,000,000
-
-
Total
1,000,000
(700,000)
Goodwill
300,000

Jan. 1, Identifiable assets acquired 1,600,000
Share capital 800,000
Share Premium 200,000
To record the issuance of
shares as consideration
for the business
combination
Jan. 1, Share Premium 40,000
To record the costs of
equity transaction

20x1 General and administrative costs 20,000
Cash in bank 130,000
To record the acquisition-
related costs
Note:
The acquisition-related costs are expensed, except for the costs to issue
equity securities which are deducted from share premium.
Case #2
As consideration for the business combination, ABC Co. issued bonds with
face amount and fair value of ₱1,000,000. 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:
-
Total 1,000,000
Goodwill 300,000

Bonds payable 1,000,000
To record the issuance of
bonds as consideration
for the business
combination
Jan. 1, Bond issue costs 50,000
20x1 Cash 50,000
To record the bond issue
costs
20x1 General and administrative costs 20,000
Cash in bank 130,000
To record the acquisition-
related costs
Notes:
 The bond issue costs are deducted when determining the carrying
amount of the bonds. The carrying amount of the bonds payable is
P950,000.
 For goodwill computation, the consideration transferred is measured
at the fair value of the debt securities issued without deduction for
the transaction costs.
 In both cases above, the acquisition-related costs, including costs of
issuing debt and equity securities, do not affect the computation of
goodwill.
Restructuring provisions
Restructuring is a program that is planned and controlled by management and
materially changes either:
1. The scope of a business undertaken by an entity; or
2. The manner in which that business is conducted
Restructuring provisions may include the costs of an entity’s plan

1. To exit an activity of the acquiree.
2. To involuntarily terminate employees of the acquiree, or
3. To relocate non-continuing employees of the acquiree.
The costs above are sometimes referred to as “liquidation costs”. However, a

restructuring provision do not include such costs as:
1. Retraining or relocating continuing staff,
2. Marketing, or
3. Investment in new systems and distribution networks.
Restructuring provisions are generally not recognized as part of business

combination unless the acquiree has at the acquisition date an existing liability for
restructuring that has been recognized in accordance with PAS 37 Provisions,
Contingent Liabilities and Contingent Assets.
A restructuring provision will be recognized as:

1. Liability if it meets the definition of liability as the acquisition date:
 Acquirer incurs a present obligation to settle the restructuring costs
assumed, such as when the acquiree developed a detailed formal
plan for the restructuring and raised a valid expectation in those
affected that the restructuring will be carried out by publicly
announcing the details of the plan or has begun implementing the
plan on or before the acquisition date.
2. Post-combination expenses of the combined entity when incurred:
 Acquiree’s restructuring plan is conditional on it being acquired (not
present obligation nor contingent liability)
 Restructuring provisions that do not meet the definition of a liability
at the acquisition date
Illustration: Restructuring provisions

On January 1, 20x1, ABC Co. acquired all of the identifiable assets and assumed all of
the liabilities of XYZ, Inc. by paying cash of ₱1,000,000. On this date, the identifiable
assets acquired and liabilities assumed have fair values of ₱1,600,000 and ₱900,000,
respectively.
ABC Co. has estimated restructuring provisions of ₱200,000 representing costs of

exiting the activity of XYZ, including costs of terminating and relocating employees of
XYZ.
Requirement:
Compute for the goodwill or gain on bargain purchase
Solution:
1,000,000
-
-
Total
1,000,000
(700,000)
Goodwill
300,000
Note:
 Restructuring provisions are simply ignored in the computation of goodwill.
 Restructuring provisions may form part of business combination only if they
meet the definition of liability as of the acquisition date
Specific Recognition Principles
PFRS 3 provides the following specific recognition principles:
I. Operating Leases
A. Acquiree is the lessee
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 terms of an operating lease relative to market terms is:

1. Favorable – the acquirer shall recognize an intangible asset
2. Unfavorable – the acquirer shall recognize a liability
B. Acquiree is the lessor

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.
Illustration: Specific recognition principles – Operating leases

Facts Pattern:
On January 1, 20x1, BAC Co. acquired all of the identifiable assets and assumed
all of the liabilities of XYZ, Inc. for ₱1,000,000. On this date, the identifiable
assets acquired and liabilities assumed have fair values of ₱1,600,000 and
Case #1: Acquiree is the lessee – terms are favorable

ABC is renting out a building to XYZ, Inc. under an operating lease. The terms of
the lease compared with market terms are favorable. The fair value of the
differential is estimated at ₱20,000.
Requirement:
Compute for the goodwill or gain on bargain purchase.
Solution:
1,000,000
-
-
Total
1,000,000
(720,000)
Goodwill 280,000
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
1,620,000
FV of liabilities assumed (900,000)
Case #2: Acquiree is the lessee – terms are unfavorable

ABC is renting out a patent to XYZ under operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential
is estimated at ₱20,000.
Requirement:
Solution:
Goodwill is computed as follows:
1,000,000
-
-
Total
1,000,000
(680,000)
Goodwill 320,000
The fair value of net identifiable assets acquired is computed as follows:

FV of identifiable assets acquired
1,600,000
FV of liabilities assumed, including liability on the
operating lease with favorable terms
(920,000)
680,000
Case #3: Acquiree is the lessor

ABC is renting a building from XYZ under operating leases. The terms of the
operating lease compared with market terms are favorable. The fair value of the
differential is estimated at ₱20,000.
Requirement:
Solution:
Non-controlling interest in the acquiree -
Total 1,000,000
Goodwill 300,000
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.
The separability criterion is met even if:

1. The exchange transactions are infrequent and regardless of
whether the acquirer is involved in them, as long as there is
an 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.
Illustration: Intangible assets – separability and contractual legal criteria
ABC Co. acquired all the assets and liabilities of XYZ, Inc. for ₱1,500,000. Relevant
information follows:
Carrying amounts Fair values

Other assets 1,600,000 1,480,000
Computer software 100,000 -
Patent - 50,000
Goodwill 100,000 20,000
Total Assets 1,800,000 1,550,000
Liabilities
Bonds Payables 400,000 450,000
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.
 XYZ, Inc. has research and development (R&D) projects with fair value of
₱50,000. However, XYZ, Inc. recognized the R&D costs as expenses when
they were incurred.
Requirement:
Compute for goodwill or gain on bargain purchase
Solution:
1,500,000
-
-
Total
1,500,000
(1,130,000)
Goodwill
150,000

Fair value of identifiable assets acquired, excluding
computer software and recorded goodwill but
including patent and R&D
1,580,000
(450,000)
1,130,000
An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree

has already expensed the related costs.
Illustration 2: Intangible assets

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.
Not included in the fair of assets are the following unrecorded intangible assets:
Type of intangible asset Fair value

Customer list 40,000
Customer contract #1 30,000
Customer contract #2 20,000
Order (production) backlog 10,000
Internet domain name 15,000
Trademark 25,000
Trade secret processes 35,000
Mask words 45,000
Total 220,000
 Customer contract #1 refers to an agreement between XYZ and a customer,
wherein XYZ 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.
 Customer contract #2 refers to XYZ’s insurance segment’s portfolio of one-
year motor insurance contracts that are cancellable by policy holders.
 XYZ transacts with its customers solely through purchase and sales orders.
As of acquisition date, has a backlog of customer purchase orders from
60% of its customers, all of whom are recurring customers. The other 40%
are also recurring customers but XYZ has no open purchase orders or
other contracts with those customers.
 The internet domain name is registered.
Requirement:
Compute for goodwill or gain on bargain purchase
Solution:
1,000,000
-
-
Total 1,000,000
(920,000)
Goodwill 80,000

Fair value of identifiable assets acquired, including all of
the unrecorded intangible assets 1,820,000
Fair value of liabilities assumed (900,000)
Exception to the recognition principle – Contingent liabilities

The acquirer shall apply PFRS 3, rather that PAS 37 when accounting for
contingent liabilities related to business combination.
Under PFRS 3, a contingent liability assumed in a business combination is
recognized if:
a. It is a present obligation that arises from past events and
b. Its fair value can be measured reliably.
So, contrary to PAS 37, a contingent liability with improbable outflow of

resources embodying economic benefits may nevertheless be recognized if both the
conditions above are satisfied.
Illustration: Contingent liabilities

ABC Co. acquires 90% interest in XYZ, Inc. for ₱1,000,000. XYZ’s recognized assets and
liabilities have fair values of ₱1,600,000 and ₱900,000, respectively. ABC opts to
measure the non-controlling interest at fair value. The NCI’s fair value is ₱80,000
XYZ id a defendant in a pending litigation, for which no provision was recognized

because XYZ strongly believes that it will win the case. The fair value of settling the
litigation is ₱50,000.
Requirement:
Compute for goodwill or gain on bargain purchase.
Solution:
Non-controlling interest in the acquiree 80,000
Total 1,080,000
Goodwill 430,000
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 900,000
Contingent liability (pending litigation) 50,000 (950,000)
The contingent liability is recognized even if it is improbable 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 rather that PFRS 3:
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
acquisition date.
Deferred taxes affects the amount of goodwill or gain on bargain
purchase recognized at 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 a particular liability.
The acquirer recognizes and measures the 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
Illustration 1: Deferred taxes

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for ₱1,500,000.
Relevant information follows:
Cash in bank 10,000 10,000
Receivables 200,000 120,000
Allowance for doubtful
accounts (30,000) -
Inventory 520,000 350,000
Building – net 1,000,000 1,100,000
Goodwill 100,000 20,000
Total Assets 1,800,000 1,600,000
Liabilities
Payables 400,000 450,000
XYZ, Inc. has an unrecorded patent with a fair value of ₱30,000 and a
contingent liability with fair value of ₱20,000. The contingent liability is a
present obligation but its outflow is improbable.
Fair value adjustments to the carrying amounts of assets and liabilities do not
affect their tax bases. All adjustments result to temporary differences. ABC’s tax
rate is 30%
Requirement:
Compute for the goodwill
Solution:
RECALL: (PAS 12 INCOME TAXES):

 If the carrying amount of an asset exceeds its tax base,
the difference is a taxable temporary difference, which, if
multiplied by the tax rate represents a deferred tax
liability.
 For asset: CA>TB = TTD or FI>TI; TTD x tax rate = DTL
The deferred taxes are computed as follows:
Fair values (CA Previous carrying Taxable /

for financial amounts (TB for (deductible)
reporting) taxation) temporary
difference
Cash in bank
10,000 10,000 -
Receivables – net 120,000 170,000 (50,000)
Inventory
350,000 520,000 (350,000)
Building – net
1,100,00 1,000,000 100,000
Patent
30,000 - 30,000
Payables
400,000 400,000 -
Contingent liability 20,000 - (20,000)
Taxable temporary difference (TTD) 130,000

Multiply by: Tax rate 30%
Deferred tax liability 39,000
Deductible temporary difference (DTD) 240,000
Multiply by: Tax rate 30%
Deferred tax asset 72,000
Goodwill is computed as follows:

Non-controlling interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,223,000)
Goodwill 277,000
The fair value of the net identifiable assets of the acquiree is computed as
follows:
Fair value of identifiable assets acquired excluding
recorded goodwill
1,682,000
(459,000)
1,223,000
Additional concepts on consideration transferred

 The consideration transferred in a business combination includes only those
that are transferred to the former owners of the acquiree. It excludes those that
remain within the combined entity.
 Assets and liabilities transferred to the former owners of the acquiree are
remeasured to acquisition-date fair values. Any remeasurement gain or loss
is recognized in profit or loss.
 Assets and liabilities remain within the combined entity are not remeasured
but rather ignored when applying the acquisition method.
Illustration 1: Consideration transferred
On January 1, 20x1, ABC acquired all the identifiable assets and assumed all of the
liabilities of XYZ, Inc. The assets and liabilities have fair values of ₱1,600,000 and
₱900,000, respectively. As consideration:
 ABC agrees to pay ₱1,000,000 cash, of which half is payable on January 1, 20x1
and the other half on December 1, 20x5. The prevailing market rate as of
January 1, 20x1 is 10%.
 In additions, ABC agrees to transfer a piece of land with a carrying amount of
₱500,000 and fair value of ₱300,000 shall be transferred to the former owners
of XYZ.
 After the combination, ABC will continue the activities of XYZ. ABC agrees to
provide a patented technology with a carrying amount of ₱60,000 in the books
of ABC and a fair value of ₱80,000 for use in XYZ’s activities.
Requirement:
Compute for the goodwill.
Solution:
-
Total 1,110,461
(700,000)
Goodwill 410,461
The fair value of the consideration transferred is determined as follows:

Cash payment
500,000
Present value of future cash payment
310,461
Land transferred to former owners of XYZ (at fair value)
300,000
Fair value of consideration transferred 1,110,461
Notes:
 The land is remeasured to acquisition date fair-value before it is
transferred. The ₱200,000 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.
Illustration 2: Consideration transferred – Dividends on

On January 1, 20x1, ABC Co. acquired all the assets and assumes all the liabilities of
XYZ, Inc. for ₱1,000,000. The assets and liabilities have fair values of ₱1,600,000 and
XYZ’s liabilities include ₱100,000 cash dividends declared on December 28, 20x0, to
shareholders of record on January 15, 20x1, and payable on January 31, 20x1.
Requirement:
Solution:
900,000
-
-
Total
900,000
(700,000)
Goodwill
200,000
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:
Liabilities assumed (including dividends) 900,000
Cash 900,000
Jan. 1, Dividends payable 100,000
20x1 Cash 100,000
Exceptions to the measurement principle

A. Reacquired rights
Reacquired rights are measured based on the remaining term of the
related contract. (Discussed in the next chapter)
B. Share-based payment transactions

Liabilities and equity instruments related to the acquiree’s share-based
payment transactions are accounted for using the PFRS 2 Share-based
payment.
C. Assets held for sale

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.
Illustration: Held for sale assets

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for ₱1,000,000. The assets
and liabilities assumed have fair values of ₱1,600,000 and ₱900,000, respectively.
 XYZ’s assets include a factory plant that ABC intends to sell immediately. The
criteria for “held for sale” classification criteria under PFRS 5 are met. Costs to
sell the factory plant are ₱20,000.
 Not included in XYZ’s asset is a research and development project that ABC
does not intend to use. The fair value of this asset is ₱50,000
 Also, not included in the asset of XYZ is a customer list with an estimated value
of ₱10,000. However, confidentiality prohibits Entity A from selling, leasing or
otherwise exchanging information about the customers in the list.
Requirement:
Solution:
-
Total 1,000,000
(730,000)
Goodwill 270,000
The fair value of the net identifiable assets is computed as follows:

Fair value of identifiable assets 1,600,000
Costs to sell of the “held for sale” asset
(20,000)
Fair value of unrecognized research and development 50,000
Adjusted value of identifiable assets 1,630,000
(900,000)
Notes:
 The “held for sale” factory plant is measured at fair value less cost to sell.
Because the fair value is already included in the total, the costs to sell are
simply deducted.
 An identifiable asset acquired (R&D) is recognized regardless of whether the
acquirer intends to use it.
 The customer list is not recognized because it is not identifiable.
DIFFERENCES BETWEEN THE PROVISIONS OF THE FULL PFRS AND THE PFRS
FOR SMEs
Full PFRS PFRS for SMEs

1. Accounting method and computation of goodwill
PFRS 3 Business Combinations requires The PFRS for SMEs requires a business
a business combination to be accounted combination to be accounted for under
for using the acquisition method. the purchase method
Goodwill is computed as follows: Goodwill is computed as follows:
Consideration transferred xx Fair vales of assets given,

Non-controlling interest xx liabilities incurred, and
Previously held equity interest xx equity instruments xx
Total xx Acquisition-related costs xx
Less: Fair value of net Cost of business combination xx
identifiable assets Less: Acquirer’s interest in the
acquired (xx) fair value of the acquiree’s
Goodwill (Negative goodwill) xx net identifiable assets (xx)
Goodwill (Negative goodwill) xx
 Acquisition-related costs are
expensed, except for costs of  Acquisition-related costs are
issuing equity and debt included in the cost of the
securities. business combination, except
for costs of issuing equity and
debt securities.
2. Non-controlling interests
NCI is included in the measurement of NCI is not included in the measurement
goodwill and is measured either: of goodwill. NCI in the consolidated
a. At fair value; or financial statements is measured at the
b. At the NCI’s proportionate share NCI’s proportionate share in the
in the acquiree’s net assets. acquiree’s net assets.
3. Operating lease – Reacquired right

If the terms of an operating lease No equivalent provision under PFRS for
relative to market terms is: SMEs.
a. Favorable – the acquirer shall
recognize an intangible asset
b. Unfavorable – the acquirer shall
recognize a liability
4. Intangible assets acquired in a business combination

Recognized if the intangible asset meets Recognized if the fair value can be
either (a) separability criterion or the measured reliably.
(b) contractual-legal criterion.
5. Contingent liabilities
Recognized if it is a present obligation Recognized if fair value can be
and fair value can be measured reliably. measured reliably.
MODULE SUMMARY
 A business combination is one in which an acquirer obtains control of one or

more businesses.
 Control is presumed to exist when an investor holds more than 50% interest in
the acquiree’s voting rights.
 Business combinations are accounted for using the acquisition method. This
method requires the following:
a. Identifying the acquire;
b. Determining the acquisition date;
c. Recognizing and measuring goodwill (or negative goodwill) – this
requires accounting for the following:
i. Consideration transferred,
ii. Non-controlling interest,
iii. Previously held equity interest, and
iv. Identifiable assets acquired and liabilities assumed.
 The acquirer (parent) is the entity that obtains control after the business
combination. The controlled entity is the acquiree (subsidiary)
 The acquisition date is the date on which the acquirer obtains control of the
acquiree (e.g., the closing date).
 Goodwill is computed using the following formula
Consideration transferred xx
Non-controlling interest in the acquiree xx
Previously held equity interest in the acquiree xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill/ (Gain on a bargain purchase) xx
 The consideration transferred is measured at fair value.
 NCI is measured either at fair value or the NCI’s proportionate share in the
acquiree’s net identifiable assets.
 A “gain on a bargain purchase” is recognized in profit or loss in the year of
acquisition only after reassessment of the assets acquired and liabilities
assumed in the business combination.
 Only identifiable assets acquired are recognized. Unidentifiable assets are not
recognized.
 Acquisition-related costs are expensed, except costs of issuing equity and debt
instruments. Acquisition-related costs do not affect the measurement of
goodwill.
 Restricting provisions are generally not recognized as part of business
combination, but rather as post-combination expenses of the combined entity
when the costs are incurred.
Relevant provision of the PFRS for SMEs
Section 19 Business Combinations and Goodwill

Section 19 of the PFRS for SMEs applies to all business combinations, including the
accounting for goodwill. It does not apply to the following:
a. Combination of businesses under common control (i.e., entities having the
same parent).
b. The formation of a joint venture
c. Acquisition of a group of assets that do not constitute a business.
Business combination
Business combination is “the bringing together of separate entities or business into
one reporting entity”. (PFRS for SMEs) As a result, one entity (the acquirer) obtains
control over the other business (the acquiree).
A business combination may involve the purchase, by the acquirer, of some or all
of the acquiree’s (a) assets and liabilities or (b) equity, in exchange for cash, non-cash
assets, or the acquirer’s equity instrument.
Accounting
Business combination are accounted for using the purchase method. This method
involves the following:
a. Identifying the acquirer
b. Measuring the costs of the business combination.
c. Allocating the costs of the business combination of the assets acquired and
liabilities assumed.
The purchased method is applied as at the acquisition date, which is the date
on which the acquirer obtains control over the acquiree.
Identifying the acquirer

The acquirer is identified in all business combinations. The acquirer is the one that
obtain control over the other combining business.
Control is “the power to govern the financial and operating policies of an entity
or business so as to obtain benefits from its activities.” (PFRS for SMEs)
When the acquirer is not clearly identifiable, the acquirer is usually:
a. The business with greater fair value;
b. The transferor of cash or other assets; or
c. The business whose management dominate the management of the combine
entity.
Cost of a business combination

The cost of a business combination is the sum of:
a. The acquisition- date fair values of the assets given, liabilities incurred, and
equity instrument measured issued by the enquirer in exchange for control
over the acquiree; and
b. Any costs directly attributable to the business combination.
Adjustment to the cost of a business combination
If the business combination agreement provides for a contingent
consideration, such is included in the cost of the business combination at the
acquisition date if it is probable and can be measured reliably.
If the contingent consideration is not recognized at the acquisition date
but subsequently becomes probable and reliably measurable, the additional
consideration is treated as an adjustment to the cost of the combination.
Allocating the cost of a business combination

At the acquisition date, the acquirer allocates the cost of the business
combination by recognizing the acquiree’s identifiable assets and liabilities,
including contingent liabilities, at their fair value (except for deferred taxes and
employee benefits which are recognized and measured using the other
sections of the PFRS for SMEs).
The difference between (a) the cost of the business combination and (b) the
acquirer’s interest in the fair value of the acquiree’s net identifiable assets
represents goodwill or negative goodwill.
Recognition and measurement

The acquirer recognizes the acquiree’s identifiable assets and liabilities at the
acquisition date if they satisfy the following criteria:
a. Assets other than intangible assets- it is probable that any associated future
economic benefits will flow to the acquirer, and its fair value can be
measured reliably.
b. Liabilities other than contingent liabilities- it is probable that an outflow of
resources will be required to settle the obligation, and its fair value can be
measured reliably.
c. Intangible assets and Contingent liabilities- its fair value can be measured
reliably.
Restructuring and future losses

Restructuring provisions (e.g., liabilities for terminating or reducing the acquiree’s
activities) are recognized only if the acquire has an existing liability for the
restructuring as at the acquisition date.
The acquirer does not recognize liabilities for future losses expected to result from
the business combination.
Provisional amounts
Provisional amounts may be recognized if the initial accounting for a business
combination is incomplete by the end of the reporting period in which the business
combination occurs.
Changes to the provisional amount within 12 months from the acquisition date are
accounted for retrospectively. Changes beyond the 12-months period are treated as
correction of errors
Goodwill and Negative goodwill
Goodwill is recognized as an asset and subsequently amortized over a useful life
determined based on management’s best estimated not exceeding 10 years.
For purpose of impairment testing, goodwill is allocated to individual cash
generating units (CGU). The CGUs are then tested for impairment and any impairment
loss is charged first to the CGU’s allocated goodwill. Any excess is charged to the other
assets of the CGU.
Negative goodwill is recognized as gain in profit or loss in the year of business
combination, but only after reassessments the assets and liabilities acquired and the
cost of the business combination.
Notable differences between the full PFRSs and the PFRS for SMEs
FULL PFRSs PFRS for SMEs
1.Accounting method and computation of goodwill
PFRS 3 required the use of the acquisition PFRS for SMEs required the use of the
method. purchased method.
Goodwill is computed as follow : Goodwill is computed as follow :

Consideration transferred xx Fair value of assets given, liabilities
NCI xx incurred and equity instrument xx
Previously held equity interest xx Acquisition- related costs xx
Total xx Cost of business combination xx
Less: Fair value of net Less: Acquirer’s interest in the fair
Identifiable assets acquired (xx) value of the acquirer’s net
Goodwill (Negative goodwill) xx Identifiable assets (xx)
Goodwill (Negative goodwill) xx
 Acquisition- related cost are  Acquisition-related cost are
expensed, except costs of issuing included in the cost of the business
equity or debt securities. combination, except costs of
issuing equity or debt securities.
2. Non-controlling interest
NCI is included in the measurement of NCI is not included in the measurement of
goodwill. NCI is measured either at: goodwill. NCI in the consolidated financial
a. Fair value; or statements is measured at the NCI’s
b. The NCI’s proportionate share in proportionate share in the acquiree’s net
the acquiree’s net assets. assets
3. Operating lease- Reacquired right
If the terms of an operating lease relative No equivalent provision under PFRS for
to market terms is: SMEs.
1. Favorable- the acquirer recognizes
an intangible asset.
2. Unfavorable- the acquirer
recognizes a liability.
4. Intagible assets acquired in a business combination
Recognized if the intangible asset meets Recognized if its fair value can be
either the (a) separability criterion or the measured reliably.
(b) contractual – legal criterion.
5. Contingent liabilities
Recognized if it is a present obligation Recognized if its fair value can be
and its fair value can be measured measured reliably.
reliably.
 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 acquurer'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 transferred Included in the cost of business
at acquisition-date fair value. combination if it is probable and can be
Subsequent measurement: measured reliably.
a) a measurement period adjustment is Subsequent measurement:
adjusted to goodwill. Change in fair value is treated as an
b) not a measurement period adjustment: adjustment to the cost of business
i. remains in equity, if the contingent combination (i.e., adjustment to
consideration is classified as equity goodwill).
ii. is recognized in profit or loss, if the
contingent consideration is classified as
liability or asset.
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. In a business combination, how should long-term debt of the acquired company generally
be recognized on acquisition date?
a. Fair value
b. Amortized cost
c. Carrying amount
d. Fair value less costs to sell
2. In a business combination accounted for under the acquisition method, the fair value of
the net identifiable assets acquired exceeded the consideration transferred. How should
the excess fair value be reported?
a. As negative goodwill, recognized in profit or loss in the period the business
combination occurred.
b. As an extraordinary gain.
c. As a reduction of the values assigned to noncurrent assets and an extraordinary gain
for any unallocated portion.
d. As positive goodwill.
3. The costs of issuing equity securities in a business combination are

a. expensed
b. treated as direct reduction in equity
c. included in the initial measurement of the credit to share capital account
d. b and c
4. The costs of issuing debt securities in a business combination are

a. expensed
b. included in the initial measurement of the debt securities issued
c. accounted for like a “discount” on liability
d. b and c
5. A business combination is accounted for properly as an acquisition. Direct costs of

combination, other than registration and issuance costs of equity securities, should be:
a. Capitalized as a deferred charge and amortized.
b. Deducted directly from the retained earnings of the combined corporation.
c. Deducted in determining the net income of the combined corporation for the period in
which the costs were incurred.
d. Included in the acquisition cost to be allocated to identifiable assets according to their
fair values.
6. PDX Corp. acquired 100% of the outstanding common stock of Sea Corp. in an acquisition
transaction. The cost of the acquisition exceeded the fair value of the identifiable assets
and assumed liabilities. The general guidelines for assigning amounts to the inventories
acquired provide for:
a. Raw materials to be valued at original cost.
b. Work in process to be valued at the estimated selling prices of finished goods, less
both costs to complete and costs of disposal.
c. Finished goods to be valued at replacement cost.
d. Inventories to be valued at acquisition-date fair values.
7. A business combination is accounted for as an acquisition. Which of the following

expenses related to the business combination should be included, in total, in the
determination of net income of the combined corporation for the period in which the
expenses are incurred?
Fees of finders and Registration fees
consultants for equity securities issued
a. Yes Yes
b. Yes No
c. No Yes
d. No No
8. Easton Company acquired Lofton Company in a business combination. Easton was able to
acquire Lofton at a bargain price. The fair value of the net identifiable assets acquired
exceeded the consideration transferred to Lofton. After revaluing noncurrent assets to
zero, there was still some "negative goodwill." Proper accounting treatment by Easton is
to report the amount as
a. an extraordinary gain.
b. part of current income in the year of combination.
c. a deferred credit and amortize it.
d. paid-in capital.
9. Goodwill may be capitalized

a. only when it arises in a business combination.
b. only when it is created internally.
c. only when it is purchased
d. on any of these cases.
10. A contingent liability assumed in a business combination is recognized

a. if it is a present obligation that arises from past events and
b. if its fair value can be measured reliably.
c. even if it has an improbable outflow of resources embodying economic benefits.
d. All of these
ACTIVITY 2:
1. On January 1, 20x1, DIMINUTIVE Co. acquired all of the assets and assumed all of the
liabilities of SMALL, Inc. As of this date, the carrying amounts and fair values of the assets
and liabilities of SMALL acquired by DIMINUTIVE are shown below:
Cash in bank 20,000 20,000
Receivables 400,000 240,000
Allowance for probable losses on
(60,000)
receivables
Inventory 1,040,000 700,000
Building – net 2,000,000 2,200,000
Goodwill 200,000 40,000
Total assets 3,600,000 3,200,000
Liabilities
Payables 800,000 800,000
On the negotiation for the business combination, DIMINUTIVE Co. incurred transaction costs
amounting to ₱200,000 for legal, accounting, and consultancy fees.
Case #1: If DIMINUTIVE Co. paid ₱3,000,000 cash as consideration for the assets and
liabilities of SMALL, Inc., how much is the goodwill (gain on bargain purchase) on the business
combination?
Case #2: If DIMINUTIVE Co. paid ₱2,000,000 cash as consideration for the assets and
liabilities of SMALL, Inc., how much is the goodwill (gain on bargain purchase) on the business
combination?
Fact pattern
2. On January 1, 20x1, KNAVE acquired 80% of the equity interests of RASCAL, Inc. in
exchange for cash. Because the former owners of RASCAL needed to dispose of their
investments in RASCAL by a specified date, they did not have sufficient time to market
RASCAL to multiple potential buyers.
As January 1, 20x1, RASCAL’s identifiable assets and liabilities have fair values of ₱2,400,000
and ₱800,000, respectively.
Case #1:
KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent
consultant was engaged who determined that the fair value of the 20% non-controlling
interest in RASCAL, Inc. is ₱310,000.
If KNAVE Co. paid ₱2,000,000 cash as consideration for the 80% interest in RASCAL, Inc., how
much is the goodwill (gain on bargain purchase) on the business combination?
Case #2:
KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent
consultant was engaged who determined that the fair value of the 20% non-controlling
interest in RASCAL, Inc. is ₱310,000.
Case #3:
KNAVE Co. elects the option to measure non-controlling interest at fair value. A value of
₱250,000 is assigned to the 20% non-controlling interest in RASCAL, Inc. [(₱2M ÷ 80%) x 20%
= 500,000].
Case #4:
KNAVE Co. elects the option to measure the non-controlling interest at the non-controlling
interest’s proportionate share of RASCAL, Inc.’s net identifiable assets
If KNAVE Co. paid ₱2,000,000 cash as consideration for the 80% interest in RASCAL, Inc. and,
how much is the goodwill (gain on bargain purchase) on the business combination?
ACTIVITY 3:
Fact pattern
1. On January 1, 20x1, SMUTTY acquired all of the identifiable assets and assumed all of the
liabilities of OBSCENE, Inc. On this date, the identifiable assets acquired and liabilities
assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.
SMUTTY incurred the following acquisition-related costs: legal fees, ₱20,000, due diligence
costs, ₱200,000, and general administrative costs of maintaining an internal acquisitions
department, ₱40,000.
Case #1: As consideration for the business combination, SMUTTY Co. transferred 8,000 of its
own equity instruments with par value per share of ₱200 and fair value per share of ₱250 to
OBSCENE’s former owners. Costs of registering the shares amounted to ₱80,000. How much is
the goodwill (gain on bargain purchase) on the business combination?
Case #2: As consideration for the business combination, SMUTTY Co. issued bonds with face
amount and fair value of ₱2,000,000. Transaction costs incurred in issuing the bonds
amounted to ₱100,000. How much is the goodwill (gain on bargain purchase) on the business
combination?
2. On January 1, 20x1, ENTREAT Co. acquired all of the identifiable assets and assumed all of
the liabilities of BEG, Inc. by paying cash of ₱2,000,000. On this date, the identifiable assets
acquired and liabilities assumed have fair values of ₱3,200,000 and ₱1,800,000,
respectively.
ENTREAT Co. has estimated restructuring provisions of ₱400,000 representing costs of

exiting the activity of BEG, costs of terminating employees of BEG, and costs of relocating the
terminated employees.
Requirement: Compute for the goodwill (gain on bargain purchase).
Fact pattern
3. On January 1, 20x1, HISTRIONAL Co. acquired all of the identifiable assets and assumed all
of the liabilities of THEATRICAL, Inc. by paying cash of ₱2,000,000. On this date, the
identifiable assets acquired and liabilities assumed have fair values of ₱3,200,000 and
₱1,800,000, respectively.
Case #1:
As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out
to THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of
the operating lease on the building compared with market terms are favorable. The fair value
of the differential is estimated at ₱40,000.
Case #2:
As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out
to THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of
the operating lease on the patent compared with market terms are unfavorable. The fair
value of the differential is estimated at ₱40,000.

Case #3:
As of January 1, 20x1, HISTRIONAL is renting a building and a patent from THEATRICAL, Inc.
under operating leases. HISTRIONAL has determined that the terms of the operating lease on
the building compared with market terms are favorable. The fair value of the differential is
estimated at ₱40,000.
ACTIVITY 4:
1. Given the following information, how is goodwill from a business combination
computed under PFRS 3?
A = Consideration transferred
B = Non-controlling interest in net assets of subsidiary
C = Previously held equity interest
D = Fair value of net identifiable assets of subsidiary
% = Percentage of ownership acquired by the parent in the subsidiary
a. A+B+C-D c. (A+C) – (D x %)
b. A – (D x %) d. (A+B) – [(D x %) – B]
2. PFRS 3 requires that the contingent liabilities of the acquired entity should be
recognized in the balance sheet at fair value. The existence of contingent liabilities
is often reflected in a lower purchase price. Recognition of such contingent
liabilities will
a. Decrease the value attributed to goodwill, thus decreasing the risk of
impairment of goodwill.
b. Decrease the value attributed to goodwill, thus increasing the risk of
c. Increase the value attributed to goodwill, thus decreasing the risk of
d. Increase the value attributed to goodwill, thus increasing the risk of
3. Are the following statements about an acquisition true or false, according to PFRS
3 Business combinations?
I. The acquirer should recognize the acquiree's contingent liabilities if certain
conditions are met.
II. The acquirer should recognize the acquiree's contingent assets if certain
conditions are met.
a. False, False b. False, True c. True, False d. True, True
4. An acquirer should at the acquisition date recognize goodwill acquired in a

business combination as an asset. Goodwill should be accounted for as follows:
a. Recognize as an intangible asset and amortize over its useful life.
b. Write off against retained earnings.
c. Recognize as an intangible asset and impairment test when a trigger event
occurs.
d. Recognize as an intangible asset and annually impairment test (or more
frequently if impairment is indicated).
5. On September 1, 20x1, TEPID Co. acquired LUKEWARM Co. in a business

combination that resulted to goodwill. By December 31, 20x1, the initial allocation
of goodwill is not yet completed. According to PAS 36, TEPID should
a. complete the initial allocation before the end of December 31, 20x1.
b. complete the initial allocation before the end of December 31, 20x2.
c. complete the initial allocation before the end of November 30, 20x1.
d. complete the initial allocation before the end of September 1, 20x2.
6. On September 1, 20x1, TEPID Co. acquired LUKEWARM Co. in a business

combination that resulted to goodwill. By December 31, 20x1, the initial allocation
of goodwill is not yet completed. According to PAS 36, TEPID should
a. complete the initial allocation before the end of December 31, 20x1.
b. complete the initial allocation before the end of December 31, 20x2.
c. complete the initial allocation before the end of November 30, 20x1.
d. complete the initial allocation before the end of September 1, 20x2.
7. Which of the following methods must be applied in accounting for business

combinations under PFRS 3?
a. acquirer method c. purchase method
b. acquisition method d. pooling of interest
8. The company that obtains control over another company in a business

combination transaction is referred to as the
a. acquirer c. subsidiary
b. parent d. a and b
9. According to PFRS 3, which of the following transaction costs would increase the
amount of goodwill from a business combination?
a. legal fees, accounting fees and similar costs
b. issuance costs of equity securities
c. issuance costs of debt instruments
d. none of these
10. This refers to the additional consideration for a business combination to be given
to the acquiree upon the happening of a contingency which is pre-agreed at the
acquisition date.
a. Contingent liability
b. Contingent asset
c. Contingent consideration
d. Additional compensation
ACTIVITY 5:
1. On January 1, 20x1, CONJUNCTION Co., and UNION, Inc. entered into a business
combination effected through exchange of equity instruments. The combination
resulted to CONJUNCTION obtaining 100% interest in UNION. Both of the
combining entities are publicly listed. As of this date, CONJUNCTION’s shares have
a quoted price of ₱200 per share. CONJUNCTION Co. recognized goodwill of
₱600,000 on the business combination. No acquisition-related costs were
incurred. Additional selected information at acquisition date is shown below:
CONJUNCTION Co. Combined entity

(before acquisition) (after acquisition)
Share capital 1,200,000 1,400,000
Share premium 600,000 2,400,000
Totals 1,800,000 3,800,000
Requirements: Compute for the following:

a. Number of shares issued by CONJUNCTION Co. in the business combination.
b. Par value per share of the shares issued.
c. Acquisition-date fair value of the net identifiable assets of UNION.
2. On January 1, 20x1, OBDURATE Co. acquired 30% ownership interest in

STUBBORN, Inc. for ₱200,000. Because the investment gave OBDURATE significant
influence over STUBBORN, the investment was accounted for under the equity
method in accordance with PAS 28.
From 20x1 to the end of 20x3, OBDURATE recognized ₱100,000 net share in the
profits of the associate and ₱20,000 share in dividends. Therefore, the carrying
amount of the investment in associate account on January 1, 20x3, is ₱280,000.
On January 1, 20x4, OBDURATE acquired additional 60% ownership interest in

STUBBORN, Inc. for ₱1,600,000. As of this date, OBDURATE has identified the
following:
a. The previously held 30% interest has a fair value of ₱360,000.
b. STUBBORN’s net identifiable assets have a fair value of ₱2,000,000.
c. OBDURATE elected to measure non-controlling interests at the non-controlling
interest’s proportionate share of STUBBORN’s identifiable net assets.
Requirement: Compute for the goodwill.
3. OBSTREPEROUS Co. and NOISY, Inc. both engage in the same business. On January
1, 20x1, OBSTREPEROUS and NOISY signed a contract, the terms of which resulted
in OBSTREPEROUS obtaining control over NOISY without any transfer of
consideration between the parties.
The fair value of the identifiable net assets of NOISY, Inc. on January 1, 20x1 is
₱2,000,000. NOISY chose to measure non-controlling interest at the non-controlling
interest’s proportionate share of the acquiree’s identifiable net assets.
Requirement: Compute for the goodwill.
4. On January 1, 20x1, DIAPHANOUS Co. acquired all of the identifiable assets and
assumed all of the liabilities of TRANSPARENT, Inc. by paying cash of ₱2,000,000.
On this date, the identifiable assets acquired and liabilities assumed have fair
values of ₱3,200,000 and ₱1,800,000, respectively.
In addition to the business combination transaction, the following have also
transcribed during the negotiation period:
a. After the business combination, TRANSPARENT will enter into liquidation and
DIAPHANOUS agreed to reimburse TRANSPARENT for liquidation costs estimated
at ₱40,000.
b. DIAPHANOUS agreed to reimburse TRANSPARENT for the appraisal fee of a
building included in the identifiable assets acquired. The agreed reimbursement is
₱20,000.
c. DIAPHANOUS entered into an agreement to retain the top management of
TRANSPARENT for continuing employment. On acquisition date, DIAPHANOUS
agreed to pay the key employees signing bonuses totaling ₱200,000.
d. To persuade, Mr. Five-six Numerix, the previous major shareholder of
TRANSPARENT, to sell his major holdings to DIAPHANOUS, DIAPHANOUS agreed
to pay an additional ₱100,000 directly to Mr. Numerix.
e. Included in the valuation of identifiable assets are inventories with fair value of
₱180,000. Ms. Vital Statistix, a former major shareholder of TRANSPARENT, shall
acquire title to the goods.

MODULE 11 Accounting For Business Combination PART 1

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MODULE 11 Accounting For Business Combination PART 1

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MODULE ACCOUNTING FOR BUSINESS COMBINATION PART I

This module aims to provide students a comprehensive understanding and

INTENDED LEARNING OUTCOMES

1. Define a business combination.

Business Combination are carried out either through:

C. A business combination may also be described as:

Advantages of a business combination

PFRS 3 Business Combinations

Essential Elements in the definition of Business Combination:

Determining whether a transaction is a business combination

Accounting for Business Combination

II. Step 2: Determining the Acquisition Date

Classifying identifiable assets acquired and liabilities assumed

IV. Step 4: Recognizing and measuring the goodwill

A negative amount resulting from the formula is called “gain on a

On the acquisition date, the acquirer recognizes a resulting:

Examples of potential forms of consideration include:

Acquisition costs are recognized as expenses when they are

Illustration 1: Measuring goodwill/ gain on bargain purchase

Assets Carrying amounts Fair values

On the negotiation for the business combination, ABC Co. incurred

Fair value of identifiable assets acquired excluding

The goodwill recorded by the acquiree is excluded from the identifiable

Entries in the books of the acquirer:

XYZ, Inc. shall account for the business combination as a liquidation of a

XYZ shall recognized a gain on disposal of business of ₱100,000. The entries

Illustration 2: Non-controlling interests

Case #1 – Non-controlling interest measured at fair value

Entries are as follows:

To include XYZ in ABC’s consolidated financial statements:

Case #2 – Non-controlling interest measured at fair value

The consideration transferred is ₱1,000,000. How much is the goodwill or

Case #3 – NCI’s proportionate share in net assets

The NCI’s proportionate share of XYZ’s identifiable assets is computed as

Illustration 3: Transaction costs

Entries in the books of the acquirer:

Jan. 1, Professional fees expense 110,000

Entries in the books of the acquirer:

Restructuring provisions may include the costs of an entity’s plan

The costs above are sometimes referred to as “liquidation costs”. However, a

Restructuring provisions are generally not recognized as part of business

A restructuring provision will be recognized as:

Illustration: Restructuring provisions

ABC Co. has estimated restructuring provisions of ₱200,000 representing costs of

If the terms of an operating lease relative to market terms is:

B. Acquiree is the lessor

Illustration: Specific recognition principles – Operating leases

Case #1: Acquiree is the lessee – terms are favorable

Case #2: Acquiree is the lessee – terms are unfavorable

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

Case #3: Acquiree is the lessor

No intangible asset or liability is recognized, regardless of the terms, because the

II. INTANGIBLE ASSETS

The separability criterion is met even if:

Illustration: Intangible assets – separability and contractual legal criteria

Carrying amounts Fair values

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

An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree

Illustration 2: Intangible assets

Type of intangible asset Fair value

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

Exception to the recognition principle – Contingent liabilities

So, contrary to PAS 37, a contingent liability with improbable outflow of