Chapter 1

Overview of Business Combination

Introduction:

BUSINESS COMBINATION DEFINED

A business combination occurs when one company acquires another company or when two or
more companies merge into one. After the combination, one company gains CONTROL over
the other.

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

Specific Objectives:
At the end of the lesson, the students should be able to:

• Define a business combination.

• Explain the accounting requirements for a business combination.
• Be able to compute for goodwill.

Duration: 3 hours (Lecture/Discussion/Problem Solving)

LESSON PROPER

TYPES OF BUSINESS COMBINATION

1. Horizontal combination- a business combination of two or more entities with
SIMILAR BUSINESSES.

2. Vertical combination- A business combination of two or more entities operating at

different levels in a marketing chain.

3. Conglomerate- a business combination of two or more entities with DISSIMILAR

businesses.

ADVANTAGES OF A BUSINESS COMBINATION

1. Competition is eliminated or lessened

2. Synergy
3. Increased business opportunities and earnings potential
4. Reduction of operating costs
5. Combinations utilize economies of scale
6. Cost savings on business expansion
7. Favorable tax implications
DISADVANTAGES OF A BUSINESS COMBINATION

1. Monopoly in the market

2. Loss of identity of one or both of the combining entities
3. Incompatibility of internal cultures of the management
4. Overcapitalization
5. Stricter regulation by the government.

MODES of EFFECTING BUSINESS COMBINATION

Business combinations are carried out either through:
1. Asset acquisition; or
2. Stock acquisition

ASSET ACQUISITION –
The acquirer purchases ALL the net assets and of the acquiree in exchange for cash or other
noncash consideration (which may be the acquirer’s own shares). - A business combination
effected through asset acquisition may be either:
1. STATUTORY MERGER - Occurs when two or more companies combine into a single entity
and one remains while the other is absorbed. - A + B = A/B

2. STATUTORY CONSOLIDATION - Occurs when two or more companies consolidate into a

single entity which shall be the consolidated company. Both the combining entities are dissolved
and a new entity is formed. - A + B = C

STOCK ACQUISITION –
• The acquirer obtains control over the acquiree by acquiring a majority ownership interest
(more than 50% or the CONTROLLING INTEREST) in the voting rights of the
acquiree.
• Parent-subsidiary relation is created - The parent and the subsidiary RETAIN their
separate legal existence. However, for financial reporting purposes, both the parent and
the subsidiary ae viewed as a SINGLE REPORTING ENTITY. CONSOLIDATED
FINANCIAL STATEMENTS are prepared.

ACCOUNTING FOR BUSINESS COMBINATION

A business combination is accounted for using acquisition method under PFRS 3. The
acquisition method requires the following steps:
• Identifying the acquirer;
• Determining the acquisition date;
• Recognizing and measuring goodwill.

IDENTIFYING THE ACQUIRER –

• The entity that obtains control of the acquiree
• The acquirer is usually the entity that transfers the cash or other assets or incurs the
liabilities
ACQUISITION DATE –
The date on which the acquirer obtains control of the acquiree. This is normally the closing date
(date on which the acquirer legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree).

RECOGNIZING and MEASURING GOODWILL –

Goodwill is determined as follows:
FAIR VALUE OF CONSIDERATION GIVEN xx
Cash paid (./)
Shares issued (./)
Contingent consideration (./)
Noncontrolling interest (./)
Previously held equity interest(./)
FAIR VALUE OF NET ASSETS ACQUIRED (xx)
GOODWILL (or GAIN on BARGAIN PURCHASE) xx
===

Consideration transferred is measured at ACQUISITION-DATE FAIR VALUES (provisional

amounts) - Measurement period ends as soon as the acquirer obtains enough information to finalize
the provisional amounts, but in any event does not exceed one year from the date of acquisition.

Activity Sheet
ACTIVITY 1

Name: ______________________Course/Year/Section: ___________ Score: ______

Direction: Multiple Choice

1) This distinguishes a business combination from other types of investment transactions:
a) Acquisition of assets c) obtaining of control
b) Acquisition of stocks d) all of these

2) The entity that obtains control over another business in a business combination is called
the:
a) Controller c) acquirer
b) Acquiree d) controllee

3) PFRS 3 requires all business combinations to be accounted for using the:

a) Purchase method c) goodwill method
b) Acquisition method d) control method

4) According to PFRS 3, the acquisition date is normally the

a) Control date c) closing date
b) Purchase date d) Valentine’s date

5) Direct costs incurred in a business combination are:

 a) Capitalized
b) Expensed
c) Capitalized, except for costs of issuing equity and debt instruments
d) Expensed, except for costs of issuing equity and debt instruments

Additional Activity: Discussion of exercises/problems I Chapter 1, Accounting for Business

Combinations, 2020 Ed., Zeus Vernon B. Millan