MODULE 29 Business Combinations

LEARNING OBJECTIVES:
1. Define a business combination.
2. Explain briefly the accounting requirements for a business combination.
3. Compute for goodwill related to acquisition.

OVERVIEW
PFRS 3 Business Combinations 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.

Acquiring new knowledge

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A synchronous discussion for this lesson will be scheduled on October 13, 2020 (Tuesday 9:00
– 10:00 AM)

Business combination
A transaction or other event in which an acquirer obtains control of one or more businesses.
Transactions sometimes referred to as 'true mergers' or 'mergers of equals' are also business
combinations as that term is used in [PFRS 3]

The company that obtains control over the other is referred to as parent or acquirer. The other
company that is controlled is the subsidiary or acquiree.

The objective of PFRS 3 it to enhance the relevance, reliability and comparability of the
acquirer’s financial reporting by establishing the recognition and measurement principles and
disclosure requirements for a business combination

Essential elements in the definition of a business combination:

1. Control
2. Business

Control is the power of the investor to direct the investee’s relevant activities (i,e., operating
and financing policies), thereby affecting the variability 0f the investor’s investment returns from
the investee. Control normally exist when the acquirer holds 50% or more interest in the
acquiree’s voting rights.

Business is “an integrated set of activities and assets that is capable of being conducted and
manage for the purpose of providing goods or services to customers, generating investment
income from ordinary activities.” (PFRS 3 Appendix A)

Determining whether a transaction is a business combination

PFRS 3 provides additional guidance on determining whether a transaction meets the definition
of a business combination, and so accounted for in accordance with its requirements.

This guidance includes:

 o Business combinations can occur in various ways, such as by transferring cash,
incurring liabilities, issuing equity instruments (or any combination thereof), or by not
issuing consideration at all (i.e. by contract alone)
o Business combinations can be structured in various ways to satisfy legal, taxation or
other objectives, including one entity becoming a subsidiary of another, the transfer of
net assets from one entity to another or to a new entity.
o The business combination must involve the acquisition of a business, which generally
has three elements:
o Inputs – an economic resource (e.g. non-current assets, intellectual property)
that creates outputs when one or more processes are applied to it
o Process – a system, standard, protocol, convention or rule that when applied to
an input or inputs, creates outputs (e.g. strategic management, operational
processes, resource management)
o Output – the result of inputs and processes applied to those inputs.

Method of accounting for business combinations

Acquisition method
The acquisition method (called the 'purchase method' in the 2004 version of PFRS 3) is used
for all business combinations.

Steps in applying the acquisition method are:

1. Identification of the 'acquirer'
2. Determination of the 'acquisition date'
3. Recognition and measurement of the identifiable assets acquired, the liabilities
assumed and any non-controlling interest (NCI, formerly called minority interest) in the
acquiree
4. Recognition and measurement of goodwill or a gain from a bargain purchase

Measurement principle
All assets acquired and liabilities assumed in a business combination are measured at acquisi-
tion-date fair value.

All other costs associated with an acquisition must be expensed, including reimbursements to
the acquiree for bearing some of the acquisition costs.

Examples of costs to be expensed include finder's fees; advisory, legal, accounting, valuation
and other professional or consulting fees; and general administrative costs, including the costs
of maintaining an internal acquisitions department.

Recognizing and measuring Goodwill

On acquisition date, the acquirer computes and recognizes goodwill (or gain on bargain
purchase) using the following formula:
Consideration transferred xx
Non-controlling interest in the acquire xx
Previously held interest in the acquire xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill (gain on bargain purchase) xx
If the difference above is negative, the resulting gain is a bargain purchase in profit or loss,

Non- controlling interest

Non-controlling interest is the “equity in a subsidiary not attributable, directly or indirectly, to a
parent.” (PFRS 3 Appendix A)

Non- controlling interest is also called “minority interest.” For example, ABC Co. acquires 80%
interest in XYZ Co. the controlling interest is 80%, while the non-controlling interest is 20%.

The acquirer measures any non-controlling interest (NCI) in the acquire either at:
A. fair value; or
B. the NCI’s proportionate share of the acquiree’s identifiable net assets.

Previously held equity interest in the acquire

Previously held equity pertains to any interest held by the acquirer before the business
combination. This affects the computation of goodwill only in business combinations achieved
in stages.

Net identifiable assets acquired – Recognition principle

To qualify for recognition, identifiable assets acquired and liabilities assumed must meet the
definition of assets and liabilities provided under the conceptual framework at the acquisition
date.

The identifiable assets and liabilities assumed must be part of what the acquirer and acquire (or
its former owners) exchange in the business combination transaction rather than the result of
separate transactions.

Applying the recognition principle may result to the acquirer recognizing assets and liabilities
that the acquiree had not previously recognized in its financial statements.

Unidentifiable assets are not recognized. Examples of unidentifiable assets:

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.

Illustration:
On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. for 1,000,000 cash. ABC
incurred transaction cost of 100,000 for legal, accounting and consultancy fees in negotiating
the business combination.

ABC Co. elected to measure NCI at the proportionate share in XYZ, Inc.” identifiable assets.
The carrying amounts and fair values of XYZ’s assets and liabilities at the acquisition date were
as follows:
Assets Carrying Amounts Fair value
Cash 10,000 10,000
Receivables 200,000 120,000
Allowance for bad debts (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 400,000 400,000

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

Fair value of identifiable assets acquired
Excluding goodwill(1,600,000 – 20,000) 1,580,000
Less: Fair value of liabilities assumed (400,000)
Fair value of identifiable assets 1,180,000

Goodwill is excluded because it is unidentifiable assets, only identifiable are recognized.

The NCI’s proportionate share in the identifiable net assets is computed as follows:
Fair value of identifiable net assets acquired 1,180,000
Multiply by the non-controlling interest (100% - 80%) x 20%
NCI’s proportionate share in identifiable net assets 236,000

Goodwill (gain) is computed as follows:

Consideration transferred 1,000,000
NCI in the acquire 236,000
Previously held equity interest in the acquire -
Total 1,236,000
Less: Fair value of identifiable net assets acquired (1,180,000)
Goodwill 56,000

Transaction cost of 100,000 are expense. Acquisition cost do not affect the measurement of
goodwill.

Disclosure of information about current business combinations

An acquirer is required to disclose information that enables users of its financial statements to
evaluate the nature and financial effect of a business combination that occurs either during the
current reporting period or after the end of the period but before the financial statements are au-
thorised for issue.

Among the disclosures required to meet the foregoing objective are the following:
o name and a description of the acquiree
o acquisition date
o percentage of voting equity interests acquired
o primary reasons for the business combination and a description of how the acquirer
obtained control of the acquiree
o description of the factors that make up the goodwill recognised
o qualitative description of the factors that make up the goodwill recognised, such as
expected synergies from combining operations, intangible assets that do not qualify for
separate recognition
o acquisition-date fair value of the total consideration transferred and the acquisition-date
fair value of each major class of consideration
o details of contingent consideration arrangements and indemnification assets
o details of acquired receivables
o the amounts recognised as of the acquisition date for each major class of assets
acquired and liabilities assumed
o details of contingent liabilities recognised
o total amount of goodwill that is expected to be deductible for tax purposes
o details about any transactions that are recognised separately from the acquisition of
assets and assumption of liabilities in the business combination
o information about a bargain purchase
o information about the measurement of non-controlling interests
o details about a business combination achieved in stages
o information about the acquiree's revenue and profit or loss
o information about a business combination whose acquisition date is after the end of the
reporting period but before the financial statements are authorised for issue
 MODULE # 29 Post-test
TOA – BUSINESS COMBINATIONS
Prof. U. C. Valladolid

Multiple Choice
Identify the choice that best completes the statement or answers the question.
All answers shall be submitted on or before October 16, 2020 (Friday)

1. In a business combination, an acquirer’s interest in the fair value of the net assets acquired exceeds the
consideration transferred in the combination. Under PFRS 3, the acquirer shall
a. Recognize the excess immediately in profit or loss
b. Recognize the excess immediately in other comprehensive income
c. Reassess the recognition and measurement of the net assets acquired and the
consideration transferred, then recognize any excess immediately in profit or loss
d. Reassess the recognition and measurement of the net assets acquired and the
consideration transferred, then recognize any excess immediately in other comprehensive
income.

2. What is the term for the business combination where all combining entities transfer their net assets to a
newly formed entity?
a. True merger
b. Legal merger
c. Roll up transaction
d. Spin off

3. An acquirer holds 30% equity interest in an acquiree and subsequently purchases another 25% equity
interest in order to gain control. This transaction is known as
a. Business combination of entities under common control
b. Business combination achieved in stages
c. Business combination by installment
d. Step by step acquisition

4. An acquirer shall at the acquisition date recognize goodwill acquired in a business combination as an asset.
Goodwill shall be accounted for as which of the following?
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 trigger event occurs.
d. Recognize as an intangible asset and annually impairment test or more frequently if
impairment is indicated.
 5. The acquisition-related costs in a business combination to be expensed immediately include all of the
following, except
a. Professional and consulting fees
b. Finder’s fees
c. Costs of maintaining an internal acquisition department
d. Costs of issuing debt securities

6. It is the equity in a subsidiary not attributable directly to a parent.

a. Controlling interest
b. Subsidiary interest
c. Non-controlling interest
d. Residual interest

7. In a business combination, any “gain on bargain purchase” shall

a. Be recognized in profit or loss.
b. Be recognized in other comprehensive income.
c. Be recognized in retained earnings.
d. Not be recognized.

8. In the final settlement of a contingent consideration classified as financial liability, the amount
a. Shall not be remeasured.
b. Shall be remeasured at fair value with any gain or loss included in profit or loss.
c. Shall be remeasured at fair value with any gain or loss included in other comprehensive
income.
d. Shall be remeasured at fair value with any gain or loss included in retained earnings.

9. In the final settlement of the contingent consideration classified as equity, the amount
a. Shall not be remeasured but instead recognized as part of equity.
b. Shall be remeasured at fair value with any gain or loss included in profit or loss.
c. Shall be remeasured at fair value with any gain or loss included in retained earnings.
d. Shall be remeasured at fair value with any gain or loss included in other comprehensive
income.

10. The consideration transferred in a business combination shall be measured at

a. Fair value
b. Carrying amount
c. Fair value determined by the acquirer
d. Transaction value
11. The following statements relate to recognition and measurement of a business combination. Which
statement is correct?

I. As of acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets
acquired, the liabilities assumed and any non-controlling interest in the acquiree.
II. The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their
acquisition-date fair value.

a. I only
b. II only
c. Both I and II
d. Neither I nor II

12. It is a business combination in which all of the combining entities or businesses ultimately are controlled by
the same party or parties both before and after the combination and that control is not transitory.
a. Combination of entities or businesses under common control
b. True merger
c. Merger of equals
d. Consolidation

13. It is a transaction or other event in which an acquirer obtains control of one or more businesses.
a. Business combination
b. Merger
c. Consolidation
d. Controlling interest

14. In a business combination, goodwill is measured as the excess of

a. The consideration transferred over the identifiable net assets acquired.
b. The total of the consideration transferred and the amount of any non-controlling interest in
the acquiree over the identifiable net assets acquired.
c. The total of the consideration received and the fair value of the previously held interest in
the acquiree over the identifiable net assets acquired.
d. The total of the consideration received, the amount of any non-controlling interest in the
acquiree and the fair value of previously held interest in the acquiree over the identifiable
net assets acquired.

15. If the impairment of the value of goodwill is seen to have reversed, the entity shall
a. Reverse the impairment charge and credit income for the period.
b. Reverse the impairment charge and credit retained earnings.
c. Not reverse the impairment charge.
d. Reverse the impairment charge only if the original circumstances that led to the impairment
 no longer exist and credit retained earnings.

16. An entity shall account for each business combination by applying the
a. Acquisition method only
b. Pooling method only
c. Either acquisition method or pooling method
d. Neither acquisition method nor pooling method

17. This is defined as an integrated set of activities and assets that is capable of being conducted and
managed for the purpose of providing a return directly to investors or other owners, members or
participants
a. Business
b. Transaction
c. Isolated event
d. Undertaking

18. In a business combination achieved in stages, the acquirer shall

a. Not remeasure the previously held equity interest.
b. Remeasure the previously held interest at fair value with any resulting gain or loss included
in profit or loss.
c. Remeasure the previously held interest at fair value with any resulting gain or loss included
in other comprehensive income.
d. Remeasure the previously held interest at fair value with the resulting gain or loss included
in retained earnings.

19. A parent entity is acquiring a majority holding in an entity whose shares are dealt in on a recognized
market. Under PFRS 3, which of the following measurement bases may be used in measuring the non-
controlling interest at the acquisition date?

I. Fair value
II. A proportionate share of the acquiree’s identifiable net assets.

a. I only
b. II only
c. Either I or II
d. Neither I nor II
20. Control is the

I. Power to govern the financial and operating policies of an entity so as to obtain benefits from its
activities.
II. Power to participate in the financial and operating policy decisions of the investee.

a. I only
b. II only
c. Both I and II
d. Neither I nor II