Business combination is the t, . gaterprises are brought to ae applied to external expansion inwhich separate gnierprise obtaining contr wet er into one economic entity as a result of one a ‘ol over the net assets and operations ofanother enteprise. are increasii father than ‘rough a to expand operations through business combinations ‘gfects of recession, infl nal expansion. This development is largely due to the ee nment to control lation, and continued uncertainty over the ability of the a. ntrol economic ills. With business combination, both companies pill utilize common facilities and share fixed costs. In addition, a business ination may be undertaken for the possible tax advantages available to one “ormore parties to the combination. Ej However, business combinations involve certain limitations and risks. Corporate abjectives must be taken into consideration. Only those companies which have the ‘same or compatible sets of objectives ‘should combine. On the other hand, “successful firms are us ually not willing to combine. The acquiring enterprise may ‘also inherit the acquired firm's inefficiencies and problems together with its inadequate resources. . Business Combination Defined IFRS 3 defines business combination as a transaction or other event in which an ; e or more businesses (the acquire). For each “acquirer obtains control of on e | ss business combination, one of the combining entities shall be identified as the “Acquirer. Scanned with CamScannerc _ Sl anne # Business : Me extn the Standant a “an integrated set of activities and assets thatig A business is conducted! and managed for the purpose of pr oviding a retum inthe capable 0! ae, Jower costs or dther economic benefits directly to investors Orothep fa of vide ticular” [IFRS 3 Appostdix Al. owners, ifies that a business consists of inputs and processes applieq ie The Sunda to create outputs. Jnputis any economic resource: that cose se ability to create outputs when one or more processes are applied to it, These pice y intangible assets or rights to use non-current assets, intellectual pro fevbility to obtain access to necessary materials or rights and employees, Process ' system, standard, protocol, convention or rule that when applied to an input or inputs ereates or has the ability to create outputs. Examples include strategic process, operational processes and resource management processes, Output isthe result of inputs and process or processes applied to those inputs that will Provide og have the ability to provide a retum in the form of dividends, lowercosts or other economn benefits directly to investors or other owners, members or participants, Although businesses usually have outputs, outputs are not required for an integrated set to qualify asa business. For example, an integrated set of activities and assets in the development stage might not have outputs. In such cases, the acquirer should consider other factors to determine whether the set of activities is a business, These include whether the set of activities: (a) has begun planned principal activities; (b) has employees, intellectual property and other inputs and processes that could be applied to those inputs; : (©) ispursuinga plan to produce outputs; and (@)_ will be able to obtain access to customers that will purchase the outputs, Not all of these factors need to be present for a particular integrated set of activities and assets in the development stage to qualify as a business. Also, although most businesses sealers liabilities, a set of integrated activities need not have liabilities to qualify as abusiness, The Standard takes the view that "in the absence of evidence to the contrary, a particular rot selsand activites in which goodwill is present shall be presumed to bea bites However, a business need not have goodwill". Scanned with CamScanneranufacturi ed ne Pl; areas follows fA Com 7 Npany, The set ofassets acquired and liability -PMillion 100 60 e 20 wipment 20 secured on the factory premise . (50) -etrench the existing employees of the factory and pay their he vendor will r rmination benefits. The set of assets is not capable of generating 1 X believes it can use this set of assets to obtain deration of P55 million sh flows. However. Entity : es of scale with stsexisting facilities. Itpaysa consi Scanned with CamScanneroi al 1, 2016, the summarized a ber 3 a i inl year, Decem , a fOllOWS! — te io eh acm the end OF of Pntity X is - af financial POS . Fillion pant and fctory premises io em 250 Crete 09 100 Carrent liabilities 200 term loans oor eae 300 Total liabilities 4 att Share capital ; 100 snedearnings ; 200 Equity attributable to owners” 300 0 Required: (a) Explain how Entity X shall account for the purchases of the two sets of assets. and () Prepare the statement of financial position of Entity X as of Jan 1;2 immediately afer the acquisition of thetwo sets of assets end activities. Scanned with CamScannerp 13-1 ! : easured, Pe at P20 mili ; ie ion). 0 million (P10 million less the netassets set of assets and liabilities i pusiness because somes in the second acquisition cannot be identified 35% evident: Entity X will onk three elements of inputs, processes and outpuss economies of scale. Th y use them together with ts exist eres taal eco ores the cost paid for this quisition. allocated the cost as iene exceeds the net carrying amount, Entity X E Factory premises (60+ .6x5) Pyiicn PE Machinery (20+ .2x5) . 2 Equipment (20 +.2x5) 1 ‘Mortgage loan - : ©) Cost of purchase 5 58 (p) Statement of Financial Position —As of January 41,2017 Current assets (250+ 155) Lt Ni 95 Plant and factory premises (200+ 100+ 63) 363 Machin (101 +50+21) Vn Equipment (50+ 20+21) a Goodwill on combinat n 20 Total Assets 740. Current liabilities 100 erm | (200+90+50) ce Share capital A “Total Liabilities and Batty 740 Scanned with CamScannerChapter: 6 f F trON OF CONTROL ACQUIST c » may be achieved by cither acquirin Control of another company may quiring the assets of rarget Company OF acquiring a controting interest (usually over 50%) i 4 ing common stock 4) in the tar, n acquisition of assets, all of the company's assets are acquired di dna any. Inenost cases, existing nbs of the aequired oonpuyae When assets are acquired and liabilities are assumed, the transaction is referred tt acquisition of "met assets", Payment may be made in cash, exchanged proy oe issuance of either debt or equity securitics. Business combinations may be cad legally either by statutory consolidation or statutory merger. Statutory consi Bie refers to the combining of two or more existing legal entities into one new le; f a The previous companies are dissolved and are then replaced by the new oa f company. A statutory merger refers to the absorption of one or more existing led entities by another existing company that continues as the sole surviving legal entit a absorbed company ceases to exist but may continuc as a division of the surviving company. In astock acquisition, a controlling interest (typically, more than 50%) of another company’s voting common stock is acquired. The acquiring company is termed as the parent (also the acquirer), and the acquired company is termed as a subsidiary (also the acquire). Both the parent and the subsidiary remain separate legal entities and maintain their own financial records and statements. However, for external financial reporting! the companies will usually combine theit individual financial statements: into a single set of consolidated statements. METHODS OF BUSINESS COMBINATIONS two methods were used to account for business hase method and the pooling of interests method. ities of the acquired company are usually rimary method in use. Howevet, allowed, The pooling of interest their book values. Prior to the issuance of IFRS 3, combinations. These were the purc! Under the purchase method, all assets and liabil recorded at fair value. The purchase method was the p under some cases, the pooling of interests method was recorded the assets and liabilities of the acquired company at (FRS 3 eliminated the pooling of interest method. Scanned with CamScanner= SS a~_—_—_—_——(assss— Business Combinations 7 ACQUISITION ae MET} COMBINATIONS © THOD OF ACCOUNTING FOR BUSINESS IFRS 3 requires pea that all busi acquisition method (cal Tease combinations be accounted for by applying the determine whether a transactic purchase method" in the 2004 version of IFRS 3). To the application ofthe newton ‘other event is a business combination, four steps in equisition method are to be used as follows: (1) - Identify the acquirer, “-Q) Petermin the acquisition de. 1) Rocemnine tg consideration given (price pid) by the est any non’ Gsbfecllica tae the identifiable assets acquired, the fiabilities assumed and resulting e Ie interest (formerly called minority interest) in the: acquiree. Any goodwil or gain from a bargain purchase should be recognized. ; Identify i : assets pba rpeocs ari ie ea asset acquisition, the company transferring cash or other acquirers, Gmmnoat or ilities is the acquiring company. Ina stock acquisition, the intrest in the voti ,, the company transferring cash of other assets for! acontrolting stock accquisit ting common stock of the acquiree (company being acquired). Some the tions may be accomplished by exchanging voting common stock. Usually, e company issuing the voting common stockis the acquirer. Insome cases, theacquiree may issue the stock in the acquisition. This "reverse acquisition" may occur when a publicly traded company is acquired by aprivately traded company. The appendix at the end of Chapter 15 considers this case and provides the applicable accounting procedures. ’ e date on which the acquirer obtains Determine the Acquisition Date. This is the the date on which the acquirer obtains ~ control of the acquiree. TERS 3 explains that control of the acquiree is generally the date ‘onwhich the acquirer legally transfers the consideration, acquires the assets and assures the liabilities of the acquire —the closing, date. However, the acquirer should consider all pertinent facts and circumstances in identifying the acquisition date, and it might be that control ig achieved ona date that is earlier or later than the closing date. For example, the acquisition date precedes the closing date ifa written agreement provides that the acquirer obtain control of the acquiree ona date before the closing date. iscritical becauseitis the date used to establish the fair value of the The acquisition date , company acquired, and it is usually the date that fair values are establ accounts of the acquired company. Scanned with CamScanner ished for the¢ Chapter J Generally, the consideration given (price pai ir value of the acquiree as an ent IFRS combination to be measured at fair vz -date fair values of: 8 a —— tion Given. ine the Cee to be the fi by the acquit eration given ina business Thi es ated fas the sum of the acquisiti aoa irer. : sect trator ie ace to former owners of the aequiree; and ~ equity interests issued by the acquirer. « samation include cash, other assets, contingent consideration, ordi Usual formsof consideration in warrants and member interests of mutual entiti orproference equity instruments, ' Contingent Consideration i jderation is defined in the Standard as "usually, an obligation of eat ne Tonal assets or equity interests to the former owners of Se re ‘as part of the exchange for control of the acquire if specified future events ordonsiderationsare met”. However, contingent consideration may also give the acquit the right to the retum of previously transferred consideration if specified conditions met. The specified future events may be in the form of meeting a specified level earnings, reaching a specified share price or reaching a certain milestone in develop projects. : Contingencies in a business acquisition may take the form of an additional considerati payable by the acquirer to the former owners of the acquire, conditional upon th acquire achieving a certain maintainable profit. Another contingency is in the form of guarantee of the value of securities issued by the acquirer, who may have to issu additional securities to the former owners of the acquire if the value of the origi securities issued falls below the guaranteed value. The Standard clarifies that the consideration that the acquirer transfers in exchange fc the acquire includes any asset or liabilities resulting from a contingent considerati arrangement. The acquirer shall recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquire (without regards to the probability of contingency crystallizing in the future periods. The acquirer shall classify an obligation to pay contingent consideration as a liability or as equity on the basis of the definitions of an equity instrument and a financial liability in IAS 32 financial Instruments. For example if the contingent consideration takes the form of additional cash consideration payable, it shall be classified as a financial liability. Ifthe contingent consideration is in the form of issuing additional equity instrument, it shall be classified as an equity instrument. A contingent consideration included in the cost of combination, which relates to probable cash amount payable in the future, shall be measured at its present value \scounting the future amount at the acquirer's current borrowing cost. Scanned with CamScannerwines Combinations Jegal, and other prc ssi ita armies sto +k Issuance Costs yy acquired and are expensed. en the acquirer j issues osts suchas SEC regi shares of stock f¢ i fees are treated aeadehone fees, sock fr he 0 ae 0 issuance. In case BIC from additional paid in capital CE ns tr - as acontra account a ee ts zero, the remaining stock issuance costs is ilippine Interpretation Committee). earnings presente as a sepratline Hem Record and Ds fair v Sera the Acquiree's Assets and Liabilities that are Assumed. Ee rded Fair valuc deni — and liabilities of the acquiree are dand r e amount that the asset or Yiability would be bo Nd in acurrent, normal sale between willing patties. . Re The total of all sinisable sts ew initrd eeeOOa RCE Ty the net assets. The identifiable assets should never include go i existon he acquiree's books. The only g jwill recorded in an.acdl isitionis "new" goodwill =d on the price paid by the acquirer. The fair ‘value of the net assets recorded is not kely to be equal to the price paid by the acquirer. Price paid exceeds the, fair values assigned to net assets. The excess of the price } e assigned to netassetsis "new" goodwill. The goodwill recorded is isi pairment tested in future accounting per «1 is less than. fair yalues assigned to net assets. Where the price paid i dto the net assets, & "bargain purchase" ha is I i ‘an the fair value assigne' ‘ actually Te excess of the fair value assigned to the net assets over the price paid ain" on the acquisition by the acquirer. recorded asa"8 OF JDENTIFIABLE. ASSETS AND LIABILITIES U ATION jabiliti i jr individue Je, assets and liabilities acquired are recorded at their in Asa eet ere les. The preferred metho is quoted market ‘value, where 2” ee tbe item exists. Where there is no active market, independen pe ES market ied cash flow analysis, and other types of analysis are used to yu Scanned with CamScanner10 pieces a (occ Chapter 13. The acquiring company is not required to establish values i i ly 18) m is lues immediatel: couisit date. A measurementiparted of up to one year is allowed for Anaiemnene Toten ‘alucs would be usedin financial statements prepared prior tothe end ofthe pence note to the financial statements would explain the use of t ny change in the recorded values is adjusted retroactively to the date of, ogee sition, Prior-period statements are revised to reflect the final values and any related amortizati ; ions. Some guidance on the measurement of fait value as provided in the IFRS, are explained below: Cash and Cash Equivalents, Short-term. Monetary Assets and Deferred a Cash and cash equivalents and short-term monetary assets gi inoured = apne at peo ee which is normally equal to their icovaaned jue. Forexample, cash an equivalents gi recorded, i value of the amount transferred. : a diet Deferred consideration is measured and recorded at the present value of the considerati a Ny ‘considerati and not at the nominal value of the payable. The rate of discounting is the acqu ae current borrowing cost. 4 Mlustration 13-2 P Company acquires S Company on January 1, 2017. Included in the purchase consideration is an amount of P5 million payable on January 1, 2019. P Company's borrowing cost on acquisition date is 8% per annum. of the deferred consideration that should be included in the cost of The fair value combination is computed below: Present value = P5,000,000 /(1 +0.08)= P4,286,694 acquisitions given below: The journal entry to be recorded on the date of 286,694 ot 4,286,694 Cost of combination Deferred liability Scanned with CamScanner