Since 1977

ADVANCED FINANCIAL ACCOUNTING DE LEON/DE LEON/DE LEON/TAN

AFAR 2905 –BUSINESS COMBINATIONS – MERGERS OCTOBER, 2020

LECTURE NOTES
THE NATURE OF BUSINESS COMBINATIONS
➢ Occurs when one entity gains control over another
entity either through the acquisition of net assets
(must be 100%), or the acquisition of common
shares (more than 50% of outstanding).
➢ Business combination requires the bringing together
of businesses into a reporting entity. A reporting
entity can be a single entity (acquisition of net
assets), or a group comprising a parent and all of its
subsidiaries (acquisition of shares).
➢ The business combination occurs from the stand
point of the acquirer.
➢ All business combinations must use the purchase
method. Pooling of interest method is no longer
permitted.
ACCOUNTING TREATMENT ON SOME SPECIFIC
COST ITEMS
1. Cash or other monetary assets. The fair value of
the cash and cash equivalents dispersed is usually
readily determinable. But if the settlement is
deferred to a time subsequent to the exchange date
the fair value of that deferred component shall be
the present value at the date of exchange.
2. Non- monetary assets. These consist of assets
such as property, plant and equipment, investments,
licenses and patents. The acquirer is effectively
selling the non-monetary asset to the acquiree.
Hence it is earning revenue equal to the fair value
on the sale of the assets and realizing a gain or
incurring a loss if the carrying amount differs from
the fair value.

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GENERAL STEPS UNDER THE PURCHASE METHOD 3. Equity instruments. If an acquirer issues its own

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OF ACCOUNTING FOR THE BUSINESS shares as consideration it will need to determine the

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COMBINATION fair value of those shares at the date of exchange.

a. The use of the purchase method

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liabilities undertaken are best measured by the

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b. An acquirer to be identified present value of future cash flows. Note that
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c. The measurement of the cost of a combination expected future losses and cost, as a result of the
The allocation of the cost of combination to the combination are not liabilities of the acquirer and
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d.
acquired assets and assumed liabilities and therefore not included in the calculation of the fair
contingent liabilities. value of consideration paid.
e. The assets, liabilities and contingent liabilities to be 5. Contingencies - Where the business combination
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measured initially at fair value. agreement provides for an adjustment to the cost of
f. Goodwill acquired to be recognized the combination contingent on future events, the
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g. That goodwill upon recognition is subsequently acquirer shall include the amount of that adjustment
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accounted for as follows: in the cost of the combination at the acquisition date
ACQUIRER NON-SME SME if the adjustment is probable and can be measured
AMORTIZATION no yes reliably.
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IMPAIRMENT TEST yes yes 6. Directly attributable costs; it includes costs such
h. That any excess on combination be accounted for by as professional fees paid to accountants, legal
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a reassessment of the assets and liabilities acquired advisers, valuers and other consultants to effect the
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and, where appropriate, by recognizing any excess
immediately in profit and loss. Any such discount (or
premium) accrues only to the acquirer.
i. Disclosures of information that enable users to
evaluate the nature and effect of business
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combination. Also included in the cost category are
finders fees and brokerage fees. These are
recognized as expenses if acquirer is a non-SME.
7. Other cost that are not directly attributable to
the business combination are

combinations effected in the current period and a. Cost to issue and register the shares issued by
previous periods, as well as post balance-sheet the acquirer are treated as a reduction in the
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dates. total fair value of the shares issued and are

j. Disclosure of information that enable users to recognized in equity and
evaluate changes in the carrying amount of goodwill. b. Indirect acquisition costs are recognized as
expenses.
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ACCOUNTING FOR COST OF BUSINESS

COMBINATION
The acquirer shall measure the cost of business
combination as the aggregate of
a. The fair values at the date of exchange of assets
given, liabilities incurred or assumed and equity
instruments issued by the acquirer in exchange for
control of the acquiree; plus
b. Contingent costs of guarantees made, if measurable
and probable at the date of acquisition on: (1)
market value of the shares issued; and/or (2)
amount of net income sustained over a specified
period.
c. Direct acquisition costs, if the acquirer is an SME.
ALLOCATING THE COST OF BUSINESS
COMBINATION:
1. Identifiable tangible assets: are recognized if it is
probable that any associated future economic
benefits will flow to the acquirer; and its fair value
can be measured reliably
2. Intangible assets: are recognized if it’s fair value
can be measured reliably. Note that, unlike tangible
assets there is no probability test only a reliability
test.
3. Liabilities – are recognized if it is probable that an
outflow of resources embodying economic benefits
will be required to settle the obligation; and its fair
value can be measured reliably.
4. Unrecorded identifiable assets and liabilities

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 EXCEL PROFESSIONAL SERVICES, INC.

IFRS requires the recognition of the acquiree’s acquire exchanged in the business combination
unrecognized assets and liabilities if they meet rather than the result of separate transactions.
the following criteria: (a) they must meet the Therefore, any unrecognized assets and
definition of assets and liabilities in the IFRS liabilities that meet the above requisites but
Framework at the acquisition date and (b) they are not recognized in the acquiree’s balance
must be part of what the acquirer and the sheet should be recognized in the acquirer’s/group
balance sheet.
- done -

EXERCISES

Case 1 – Computations of GW or IFA 3. Determine goodwill or excess from the business

NORTHPOINT COMPANY acquired the net assets of combination, and
DOMINI0N ENTERPRISES on January 1, 2020 The 4. Prepare journal entries to record the acquisition of
carrying and fair values of DOMINION at the date of the net assets of DOMINION ENTERPRISES in the
acquisition follows: books of NORTHPOINT COMPANY.
Carrying
Value Fair Value Case 2 – Merger Combination
Cash P16,000 P16,000 The following balance sheets at December 31, 2020 are
Accounts receivable 32,000 32,000 for PHILRABBIT Company and SUPERLINES Enterprises,
Merchandise Inventory 48,000 56,000 respectively just before the business combination.. On
this date, PHILRABBIT acquires the net assets of
Plant and Property 360,000 368,000 SUPERLINES and issues 9,600 new shares in
Patent 48,000 44.000 consideration thereof. . The issued shares have a market
Total assets P 504,000 P 516,000 value of P35 each.

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Accounts Payable P24,000 P24,000 PHILRABBIT SUPERLINES
Long-term debt 320,000 296,000 Cash P 112,000 P 40,000

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Capital stock 96,000
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Land 176,000 40,000
Buildings, net 280,000 168,000

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APIC 16,000 Equipment, net 328,000 100,000
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Retained Earnings 48,000 Total assets P 992,000 P 376,000
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Total Equities P504f000

Accounts payable P 128,000 P 44,000
NORTHPOINT COMPANY issued the following Bonds payable 160,000 80,000
considerations in exchange for the net assets of Share capital, P10 par 320,000 144,000
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DOMINION: Share premium - 20,000

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1. 40,000, P1 par shares of NORTHPOINT. Fair value- Retained profit 384,000 88,000
P2.75 at January 1, 2020. Total liabilities and
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2. NORTHPOINT agreed to pay additional cash equity P 992,000 P 376,000

consideration for the value of any decrease in the
share price below P2.75 for the 40,000 shares issued. The following market values have been agreed upon by
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The guarantee is for 90 days and is to expire on the parties over some of SUPERLINES’s net asset items:
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March 31, 2020. NORTHPOINT believes there was

only a 20% chance the price of the shares would fall Accounts receivable, P24,000; Land, P48,000; Buildings,
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to P2.60 during the guarantee period. P200,000; Equipment, P120,000; and

3. Cash of P72,000; P24,000 to be paid on date of Bonds payable, P88,000.
exchange and the balance in one year's time. The
incremental borrowing rate of NORTHPOINT is 10% PHILRABBIT Company also paid out-of-pocket costs:
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per annum. P6,400 for direct acquisition costs; P12,000 for stock
4. DOMINION was currently being sued by an enraged issuance and registration; and P1,600 for indirect
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client; the company's lawyers believe there's an 95% acquisition expenses.

chance it will win the case. The expected damages in
the event DOMINION lost the case is P200,000. Required:
5. An old-model KIA delivery van carried in the books of (1) Prepare a schedule for the computation of goodwill or
NORTHPOINT at P40,000, net of P8,000 accumulated income from combination.
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depreciation. The fair value at the date of the

exchange is P28,000.
➢ In addition to the purchase consideration
NORTHPOINT had an out-of-pocket costs of
P6,816 for direct acquisition cost; P1,600 for
issuing and registering the shares; and P1,200
indirect cost.
(2) Prepare the necessary journal entries in the books of
PHILRABBIT Company. The journal entries in the books of
SUPERLINES Enterprises may be ignored.
(3) Prepare the balance sheet of PHILRABBIT Company
just after the merger business combination.

Required:
1. Prepare a schedule for the determination of the cost
of combination.
2. Prepare a schedule for the computation of the fair
value of the net assets.

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EXCEL PROFESSIONAL SERVICES, INC.

MULTIPLE CHOICE

RED LABELCOMPANY issued 96,000 shares of its P25 b. P4,720,000 d. P5,600,000

par common stock for the net assets of BLUEGREEN PURPLE HEART COMPANY. is to acquire BROWN
CORPORATION in a business combination completed on CORPORATION by absorbing all the assets and
March1, 2020. BLUEGREEN Corporation’s net assets assuming all the liabilities of the latter company, in
are worth P3,040,000 at FMV. Out of pocket costs of exchange for shares of stocks of the former. Below are
the combination were as follows: the balance sheets of the two companies with the
corresponding appraised value increment for Brown.
Legal fees 20,800 Parties agree to use the appraised values against which
Contingent consideration (probable & the fair market value of the shares will be matched.
measurable) 14,400
Printing costs of stock certificates 6,800 PURPLEHEART BROWN
Finder’s fees 21,600 Assets per books P3,200,000 P2,000,000
Professional fees paid to a CPA 16,800 Asset increase per 240,000
Fees paid to company lawyers 18,760 appraisal
Fees paid to company accountants 31,120 Liabilities 1,200,000 640,000
Capital stock (no par) (P100 par)
The goodwill from the business combination is 1,600,000 800,000
P334,400. APIC 560,000 240,000
1. How much is the FMV per share of RED LABEL Retained earnings (deficit) (160,000) 320,000
COMPANY at March 1, 2020? Total Equities P3,200,000 P2,000,000
a. P 20 c. P 24
b. P 32 d. P 28 4. The stocks of PURPLE COMPANY is currently selling

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at P100 per share. The number of shares to be

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WHITEBOARD COMPANY issued 80,000 shares of P20 issued to BROWN by PURPLE is

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par common stock for all the outstanding stock of a. 16,000 c. 10,400
BLACK CORPORATION in a business combination
consummated on August 1, 2020. WHITEBOARD
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COMPANY common stock was selling at P30 per share The following balance sheets were prepared for
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at the time the business combination was GREYHOUND COMPANY and VIOLET CORPORATION on
consummated. Out-of-pocket costs of the business January 1, 2020, just before they entered into a
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combination were as follows: business combination.

G/HOUND COMPANY VIOLET CORP.
Finder's fee P 40,000 Book Value Fair Value Book Value Fair
Accountant's fee (advisory) 8,000 Value
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Cash 120,000 120,000 8,000 8,000

Legal fees (advisory) 16,000
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Accounts
Printing costs of stock certificates 4,000 receivable 120,000 120,000 32,000 32,000
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SEC registration costs and fees 9,600 Merchandise

Total P 77,600 inventory 320,000 480,000 80,000 196,000
Building and
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2. The acquisition cost of the combination will be: equipment 640,000 696,000 160,000 200,000
a. P2,477,600 c. P2,413,600 Accumulated
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b. P2,464,000 d. P2,400,000 depreciation (160,000) ( 40,000)

Goodwill ________ _______ 80,000 _______
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Total assets P1,040,000 P1,416,000 P320,000 P436,000

BLACKBELT COMPANY issues 400,000 shares of its own
P1 par common stock for the net assets of Accounts
YELLOWTOWN CORPORATION in a merger payable 80,000 80,000 112,000 112,000
consummated on July 1, 2020. On this date, Bonds
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BLACKBELT stock is quoted at P10 per share. Balance payable 320,000 352,000 48,000 68,000
sheet data for the two companies at July 1, 2020, just Common
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before combination, are as follows: stock – P 10 P5 par

par 240,000 80,000
Additional
BLACKBELT YELLOWTOWN paid- in
Current Assets P14,400,000 P1,200,000 capital 80,000 16,000
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Plant Assets 17,600,000 5,200,000 Retained

Total Assets P32,000,000 P6,400,000 earnings 320,000 64,000
Total Liab. &
Liabilities P9,600,000 P1,600,000 SHE P 1,040,000 P320,000
Common stock, P10 16,000,000 2,400,000
par GREYHOUND COMPANY acquired the net assets of
Additional paid-in 2,400,000 800,000 VIOLET COMPANY by issuing 8,000 shares of stocks.
capital Additional cash payments made by GREYHOUND
Retained earnings 4,000,000 1,600,000 CORPORATION in completing the acquisition were:
Total equities P32,000,000 P6,400,000
Broker’s fee paid to firm that located
BLACKBELT COMPANY also paid finder’s fees of P40,000 VIOLET CORP. P8,000
and legal fees of P8,000; as well as indirect expenses of Cost to register and issue stocks 32,000
32,000. Professional fees paid to accountants 16,000
3. The retained earnings on the combined balance Professional fees paid to lawyers 16,000
sheet after the combination will be: Professional fees paid to official valuers 16,000
a. P3,968,000 c. P3,920,000 Indirect acquisition cost 12,000

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 EXCEL PROFESSIONAL SERVICES, INC.

6. What is the total cost of the investment?

5. Assuming the stocks issued by GREYHOUND a. P5,111,588 c. P5,586,947
COMPANY has a market price of P40, how much is b. P7,187,091 d. P6,711,718
the total assets after the business combination?
a. P 1,376,000 c. P 1,496,000 A, B, C, and D are companies to be combined just prior
b. P 1,440,000 d. P 916,000 to the combination, their individual stockholder’s equity
consists of the following balances:
KING COMPANY issued 96,000 shares of P25 par
ordinary shares for all the outstanding stock of FISHER A B C D
CORPORATION in a business combination consummated Ordinary P480,000 P96,000 P360,000 P120,000
on July 1, 2020. King’s ordinary shares were selling at shares
P40 per share at the time of consummation of the Share 120,000 48,000 36,000
combination. In addition cash payment of P160,000 was premium
made and a deferred cash payment of P1,200,000 Retained 144,000 72,000 216,000 36,000
payable on July 1, 2021. Market rate of interest is 12%. Earnings
FISHER’s net assets are P3.04 million at book value.
Out of pocket costs of the combination were as follows: Company A is the surviving entity. It issued 16,000,
Legal and accounting fees related with the issuance of P69 par value ordinary shares, with a fair value per
shares, P9,600 and printing cost of stock certificates, share of P91; dispersed to the stockholders of the
P7,520. A contingent consideration which is probable acquired companies.
and can be reasonably estimated amounted to P40,160. 7. How much goodwill is to be recognized assuming
that the net assets are fairly valued?
a. P676,000 c. P388,000
b. P438,400 d. P352,000

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Quad Corporation purchases all of the net assets of Retained earnings 200,000
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Chrome, Inc., for P320,000. Immediately prior to the

combination, Chrome’s net assets were carried on the 2. Determine the goodwill as a result of the business
books at P180,000, and Chrome had retained earnings of combination.
P24,000. The fair value of Chrome’s net assets at the date a. P614,546 c. P416,645
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of combination is P248,000. Quad Corporation had b. P654,146 d. P461,465

retained earnings of P40,000 and no goodwill immediately
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prior to the combination 3. How much is the retained earnings of Romeo Company
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1. Immediately after the combination, the combined after the business combination?
company reports goodwill and retained earnings of: a. P250,000 c. P502,000
Goodwill Retained Earnings b. P486,870 d. P468,780
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a. P 0 P 40,000
The Carl Company will issue P10 par value common stock
b. P 0 P 64,000
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for the net assets of PBA Company. The fair market value
c. P 72,000 P 40,000
per share of Carl’s common stock is P40. The following is
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d. P 72,000 P 64,000
the list of accounts of PBA Company on the date of the
acquisition.
Romeo Company issued 120,000 shares of P10 par
Book Value Fair Market Value
ordinary shares with a fair value of P3,160,000 for all the
Current assets P280,000 P 320,000
net assets of Juliet Company and a deferred cash payment
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Plant assets (net) 680,000 1,280,000

of P500,000 payable one year after the acquisition date.
Liabilities 320,000
Market rate of interest is 10%. Romeo’s retained earnings
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Common stock 64,000

prior to business combination amounted to P600,000.
Additional paid-in capital 256,000
Romeo incurred the following additional costs:
Retained earnings 320,000
Legal fees to arrange the business
4. To have an income from acquisition of P120,000, the
combination P30,000
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number of shares to be issued by Carl Company should

Accounting and consultancy fees
be”
related with the business combination 15,000
a. 30,000 shares c. 29,000 shares
Cost of printing and issuing new stock
b. 30,400 shares d. 35,000 shares
certificates 3,000
Indirect costs of combining, including 5. Same data as in No. 4, to have a goodwill of P
allocated overhead and Executive salaries 25,000 120,000, the number of shares to be issued by Carl
Broker’s and Finder’s fees related with Company should be
the business combination 28,000 a. 30,000 shares c. 29,000 shares
b. 30,400 shares d. 35,000 shares
Immediately before the business combination in which
Juliet Company was dissolved, Juliet’s assets and equities A Company issued 120,000 shares of its P25 par common
were as follows stock for all the outstanding stocks of B Corporation in a
Book Value Fair Value business combination completed on August 1, 2019. A
Current assets P1,000,000 P1,100,000 Company’s stock has a FMV of P32 per share. B
Plant assets 1,500,000 2,200,000 Corporation’s net assets are worth P3.04 million at book
Liabilities 300,000 value. Out of pocket costs of the combination were as
Ordinary shares 2,000,000 follows:
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 EXCEL PROFESSIONAL SERVICES, INC.

Legal fees P 20,800 Plant assets 20,800,000 17,600,000 20,800,000

Contingent consideration Liabilities 12,000,000 4,000,000
(reasonable & measurable) 14,400 Common stock, 16,000,000 8,000,000
Printing costs of stock certificates 6,400 P10 par
Finder’s fees 21,600 Additional paid-in
Professional fees paid to a CPA 16,800 capital 800,000 800,000
Fees paid to company lawyers 8,000 Retained earnings 11,200,000 11,200,000
Fees paid to company accountants 12,000
6. If the combination is treated as a purchase Assume that P Company issues 1,000,000 shares of its
transaction, the cost of the combination will be: own stock for the net assets of S Company on July 1,
a. P 3,840,000 c. P 3,920,000 2019, in a purchase business combination in which S
b. P 3,940,000 d. P 3,899,200 Company is dissolved.
P Company incurred the following costs:
7. The goodwill from the combination is Legal fees to arrange the business combination 20,000
a. P 800,000 c. P 880,000 Cost of SEC registration 9,600
b. P 900,000 d. P 859,200 Cost of printing and issuing new stock 2,400
certificates
On August 1, 2019, Blite Company paid P850,000 for all Indirect costs of combining 16,000
the net assets of Ong Enterprises in a transaction properly 9. The goodwill from the business combination is
recorded as a purchase. The recorded assets and liabilities a. P10,000,000 c. P10,040,000
of Ong Enterprises on August 1, 2019, follow: b. P10,025,000 d. P 8,000,000
Cash P 80,000
Inventory 240,000 10. The total RE of P Company immediately after the
Property and equipment, net 480,000 business combination
Liabilities (180,000) a. P13,980,000 c. P13,955,000

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b. P14,000,000 d. P11,164,000

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On August 1, 2019 it was determined that the inventory of
Ong had a fair market value of P190,000, and the property Jolly Corporation exchanged its common stock, worth P

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and equipment (net) had a fair market value of P560,000.
eH w 280,000 for all of the net assets of Bee Company in a
8. What is the amount of goodwill resulting from the business combination treated as a purchase. At the date
business combination? of combination, Jolly’s net assets had a book value of

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a. P 0 c. P200,000 P480,000 and a fair value of P680,000. Bee’s net assets
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b. P 20,000 d. P230,000 had a book value of P260,000 and a fair value of
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P272,000.
Summary information is given for P Company and S 11. Immediately following the combination, the net assets
Company at July 1, 2019. The quoted market price of P of the combined company should have been reported
Co.’s stock on July 1, 2019 is P 32 per share. at what amount?
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P Company S Company S Company a. P 740,000 c. P760,000

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Per books Per books Fair values b. P 752,000 d. P952,000

Current assets P19,200,000 P6,400,000 P7,200,000
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