Accounting For Business Combinations

Accounting for Business
Combinations
(Business Combination
Part 1, 2 & 3)
Table of Contents
Table of Contents......................................................................................................................... 1
ACCOUNTING FOR BUSINESS COMBINATIONS ................................................................................ 2
Business Combination (Part 1) ................................................................................................... 3
Learning Objectives:.............................................................................................................................. 3
Advantages of a business combination ................................................................................................ 4
Disadvantages of a business combination ............................................................................................ 4
Essential elements in the definition of a business combination .......................................................... 5
Restructuring Provisions ....................................................................................................................... 8
Specific Recognition Principles ............................................................................................................. 9
Business Combination (Part 2) ..................................................................................................11
Learning Objectives:............................................................................................................................ 11
Share-for-Share exchanges ................................................................................................................. 12
Business Combination achieved in stages .......................................................................................... 14
Business combination without transfer of consideration................................................................... 15
Measurement Period .......................................................................................................................... 17
Subsequent Measurement and Accounting ....................................................................................... 24
Business Combination (Part 3) ..................................................................................................26
Learning Objectives:............................................................................................................................ 26
Goodwill .............................................................................................................................................. 26
Due Diligence ...................................................................................................................................... 27
Methods of Estimating Goodwill ........................................................................................................ 27
Reverse acquisitions............................................................................................................................ 30
Measuring the consideration transferred........................................................................................... 30
Questions: ..............................................................................................................................34
Answer Key.............................................................................................................................44
Reference: ..............................................................................................................................52
ACCOUNTING FOR BUSINESS COMBINATIONS

(Advanced Accounting 2)
Business Combination (Part 1)
Recognition & Measurement
Learning Objectives:
At the end of this lesson, you will be able
● To define a business combination
● To explain briefly the accounting requirements for a business combination.
● To compute for goodwill.
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 acquirer (parent) is the entity that obtains control after the business combination.
The controlled entity is the acquiree (subsidiary)
Business combinations are carried out either through asset acquisition or stock acquisition
❖ Asset Acquisition- the acquirer purchases the assets and assumes the liabilities of the
acquiree in exchange for cash or other non-cash consideration (which may be the
acquirer’s own shares).
Under the Corporation Code of the Philippines, a business combination affected
through asset acquisition may be either;
a. Merger- occurs when two or more companies merge into a single entity which
shall be one of the combining companies.
For example: A Co. + B Co. = A Co. or B Co.
b. Consolidation- occurs when two or more companies consolidate into a single
entity which shall be consolidated into a single entity which shall be the
consolidated company.
For example: A Co. + B Co. = C Co.
❖ Stock acquisition- instead of acquiring the assets and assuming the liabilities of the
acquiree, 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.
The parent and subsidiary retain their separate legal existence. However, for
financial reporting purposes, both the parent and the subsidiary are viewed as a single
reporting entity.
A business combination may also be described as:
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, 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- competition between the combining constituents with similar
businesses is eliminated while the threat of competition from other market participants
is lessened
b. Synergy- it occurs when the collaboration of two or more entities results in greater
productivity than the sum of the productivity of each constituent working independently
c. Increased business opportunities and earnings potential
d. Reduction of operating costs- a) Horizontal (unnecessary duplication of costs); b) Vertical
(elimination of costs of negotiation)
e. Combinations utilize economies of scale- increase in productive efficiency and decrease
its average cost per unit
f. Cost savings on business expansion- expansion may be lessened if we do this instead of
putting up a branch
g. Favorable tax implications- deferred tax assets may be transferred in a business
combination.
Disadvantages of a business combination

1. Brings monopoly that has a negative impact to society
2. Leads to loss of sense of identity of one of them
3. Management may become difficult due to differences internally
4. Overcapitalization, diffusion in market price per share
5. May be subjected to stricter regulation and scrutiny by the government especially if
against consumer’s interest.
A business combination is “a transaction or other event in which an acquirer obtains
control of one or more businesses''. Transactions referred to as ‘true mergers or mergers of
equals are also business combinations under PFRS 3. (PFRS 3. Appendix A)
Essential elements in the definition of a business combination

1. Control- normally presumed to exist when the acquirer holds more than 50% (or 51%
more) interest in the acquiree’s voting rights.
Illustration: Determining the existence of control
Example 1:
2. 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.” (PFRS3: Appendix A)
3 elements
a. Input (economic resource)
b. Process
c. Output (the result of A and B)
Business combinations are accounted for using the acquisition method. This method requires
the following:
a. Identifying the acquirer
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 is the entity that obtains control of the acquiree. It is the business that the
acquirer obtains control of in a business combination.
The acquisition date is the date on which the acquirer obtains control of the acquiree
(e.g., the closing date).
Recognizing and measuring goodwill
Good will 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
*Goodwill recognizes as an asset

*Gain on a bargain purchase as gain in profit or loss
The consideration transferred is measured at fair value, which is the sum of the
acquisition-date fair value.
Examples of potential forms of consideration include:
a. Cash
b. Non-cash assets
c. Equity instruments, e.g., shares, options and warrants
d. A business or a subsidiary of the acquirer
e. Contingent considerations
Non-controlling interest is measured either at fair value or the NCI’s proportionate share
in the acquiree’s net identifiable assets.
For example, OPQ Co. acquires 80% interest in RST Inc. The controlling interest is 80%,
while the non-controlling interest is 20% (100%- 80%). If OPQ Co. acquires 100% interest in RST
Inc., the non-controlling interest is zero.
Previously held equity interest in the acquiree pertains to any interest held by the
acquirer before the business combination.
Illustration 1: Measuring goodwill / gain on bargain purchase

On January 1, 2022, BTS Co. acquired all of the assets and assumed all of the liabilities of
EXO, Inc. As of this date, the carrying amounts and liabilities of EXO, Inc. acquired by BTS are
shown below:
Assets Carrying amounts Fair values
Petty cash fund 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 400,000 400,000
If BTS Co. paid P1,500,000 cash as consideration for the assets and liabilities of EXO, 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
Fair value of identifiable assets

acquired excluding goodwill (1.6M-20K) 1,580,000
Fair value of liabilities assumed (400,000)
Fair value of net identifiable assets acquired 1,180,000
Illustration 2: Non-controlling
On January 1,2021, BTS acquired 80% of the voting shares of EXO, Inc. On this date, EXO’s
identifiable assets and liabilities have fair values of P1,200,000 and P400,000, respectively.
Non-controlling interest measured at fair value.
BTS Co. elects the option to measure non-controlling interest at fair value. The
independent consultant engaged by BTS Co. determined that the fair value of the 20% non-
controlling interest in EXO, Inc. is P155,000. BTS Co. paid P1,000,000 for the 80% interest in EXO,
Inc. How much is the goodwill?
Solution:
Non-controlling interest in the acquiree 155,000
Previously held equity interest in the acquiree ____-____
Total 1,155,000
Fair value of net identifiable assets acquired (800,000)
Goodwill 355,000
Restructuring Provisions
● A program that is planned and controlled by management and materially changes either
1) The scope of business undertaken by entity
2) Manner in how the business is conducted
● May include the liquidation costs of an entity’s plan
1) To exit an activity of an acquiree
2) To involuntarily terminate acquiree’s employees
3) To relocate non continuing acquiree’s employees
● Does not include costs such as
1) Retraining or relocating continuing staff
2) Marketing
3) Investments in new systems and distribution networks
Note:
1) This is not generally 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 IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
2) If it does not meet the definition of a liability at acquisition date, then it is recognized as
post combination expenses of the combined entity when the costs are incurred.
Illustration: Restructuring provisions
On January 1, 20x1, BTS Co. acquired all the assets and liabilities of RST, Inc. for
P1,000,000. On this date, EXO’s assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.
BTS Co. has estimated restructuring provisions of P200,000 representing costs of exiting
the activity of EXO, including costs of terminating and relocating the employees of BTS.
Solution:
Total 1,000,000
Fair value of net identifiable assets acquired (1.6M-9M) (700,000)
Goodwill 300,000
Specific Recognition Principles

1) Operating leases
➢ Acquiree is the lessee (if acquirer is lessee, he shall not recognize anything)
A) Favorable- acquirer shall recognize an intangible asset.
B) Unfavorable-recognize a liability.
2) Intangible Assets
➢ Acquirer recognized separately from goodwill; intangible assets acquired in the comb
meets either:
A) Separability criterion- it can be separated from the acquiree and sold, transferred,
licensed, rented or exchanged, either individually or together with a related
contract, identifiable asset or liability.
B) Contractual-legal criterion- an intangible asset that is not separable
Examples
1) Market -Related
2) Customer -Related
3) Artistic -Related
4) Contract -Based
Contingent Liability is not recognized if it does not meet all requirements of a liability
Under PFRS, 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 reliability
➔ Examples of it that assumed in bus comb and is recognized

1) Present obligation from past events
2) Fair value can be measured reliably
➔ If it is with improbable outflow of resources embodying eco benefits may nevertheless be
recognized if both conditions above were satisfied.
Illustration: Contingent liability

BTS Co. acquired 90% interest in EXO, Inc. for P1,000,000. EXO’s recognized assets and liabilities
have fair values of P1.600,000 and P900,000, respectively. BTS opts to measure the non-
controlling interest at fair value. The NCI’s fair value is P80,000.
EXO is a defendant in a pending litigation, for which no provision was recognized because EXO
strongly believes that it will win the case. The fair value of settling the litigation is P50,000.
Solution:
Non-controlling interest in the acquiree 80,000
Total 1,080,000
Goodwill 430,000
Fair value of identifiable assets acquired 1,600,000
Fair value of liabilities assumed 900,000
Contingent liability (pending litigation) 50,000 (950,000)

Fair value of net identifiable assets acquired 650,000

Specific Cases
1. Account for business combinations:
a. Accomplished through share-for-share exchanges,
b. Achieved in stages, and
c. Achieved without transfer of consideration.
2. Explain the “measurement period” in relation to business combinations.
3. Distinguish what is part of a business combination and what is part of a separate
transaction.
4. Account for settlement of pre-existing relationships between an acquirer and an
acquiree.
Share-for-Share exchanges
A business combination may be accomplished through exchange of equity interests between the
acquirer and the acquiree (former owners). The general principle is that the consideration
transferred is measured at fair value.
However, there may be cases where the fair value of the acquiree’s equity interests may
be more reliably measurable than the acquirers. In such cases, the acquirer computes for
goodwill using the fair value of the acquiree’s equity interests instead of its own.
Example:
AY, Inc., an unlisted company, acquires AU Co., a publicly listed entity, through an
exchange of equity instruments.
The fair value of AU’s (acquiree) shares may be more reliably measurable than AY’s
(acquirer) because AU’s shares are quoted, while AY’s are not.
Illustration:
AU Co. and AY Inc. combined their businesses through exchange of equity instruments, which
resulted to AU obtaining 100% interest in AY. Both entities are publicly listed. At the acquisition
date, AU’s shares are quoted at P100 per share. AU Co. recognized goodwill of P300,000 on the
business combination. Additional information follows
AU Co. Combined entity

(before acquisition) (after acquisition)
Share capital 600,000 700,000
Share premium 300,000 1,200,00
Totals 900,000 1,900,000
Requirements: Compute for the following:

a. Number of shares issued by AU Co.
b. Par value per share of the shares issued.
c. Acquisition-date fair value of the net identifiable assets of AY.
Solution:
Requirement (a): Number of shares issued
The consideration transferred is in the form of shares. Accordingly, this is reflected on the
increase in share capital and share premium:
AU Co. Combined entity Increase
Share capital 600,000 700,000 100,000
Share premium 300,000 1,200,00 900,000
Totals 900,000 1,900,000 1,000,000
The fair value of the shares issued as consideration for the business combination is
P1,000,000.
Fair value of shares issued P1,000,000
Divide by: Fair value per AU’s share P100
Number of shares issued 10,000
Requirement (b): Par value per share

Increase in share capital account (see table above P100,000
Divide by: Number of shares issued 10,000
Par value per share P10
Requirement (c): Fair value of the net assets acquired

Consideration transferred (see requirement a) 1,000,000
Total 1,000,00
Fair value of net identifiable assets acquired (squeeze) (700,000)
Goodwill (given information) 300,000
Business Combination achieved in stages
A business combination is ‘achieved in stages’ when the acquirer obtains control of an acquiree
in more than one transaction.
Business combination achieved in stages is also called “step acquisition”.

In accounting for a business combination achieved in stages, the acquirer:
1. Remeasures the previously held equity interest in the acquiree at acquisition date
fair value; and
2. Recognizes the gain or loss on the remeasurement in:
a) Profit or loss – if the previously held equity interest was classified as FVPL,
Investment in Associate, or Investment in Joint Venture; or
b) Other comprehensive income – if the previously held equity interest was
classified as FVOCI
Illustration: Business combination achieved in stages

On January 1, 20x1, ATAY Co. acquired 15% ownership interest in XIN, Inc. for P100,000. ATAY
Co. classified the investment as ‘held for trading securities’ (i.e.,FVPL) in accordance with PFRS 9.
On January 1, 20x4, ATAY Co., acquired additional 60% interest in XIN, Inc. for P800,000. Relevant
information follows:
a. The previously held 15% interest has a carrying amount of P170,000 on December 31,
20x3 and fair value of P180,000 on January 1, 20x4.
b. XIN’s net identifiable assets have a fair value of P1,000,000.
c. ATAY elected to measure the NCI at ‘proportionate share’.
Requirement: Compute for goodwill.
Solution:
Consideration transferred 800,000
Non-controlling interest in the acquiree (1M x 25%*) 250,000
Previously held equity interest in the acquiree 180,000

Total 1,230,00
Goodwill 230,000
*100% - (15%+60%) = 25%
Business combination without transfer of consideration
The acquisition method also applied to business combinations in which the acquirer
obtains control without transferring any consideration. The reason why the “purchase method”
previously used for the business combinations has been replaced with the “acquisition method”
is to emphasize that a business combination may occur even when a purchase transaction is not
involved.
Examples of circumstances where the acquirer obtains control without transferring

consideration:
a. The acquiree repurchases a sufficient number of its own shares from other investors so
that the acquirer will be able to obtain control.
For example, AU Co. holds 40,000 out of the 100,000 outstanding ordinary shares
of AY, Inc. Subsequently, AY repurchases 25,000 shares from other investors. After the
treasury share transaction, AU’s ownership interest is increased to 53.33%
(40,000/75,000)
b. Minority veto rights that previously kept the acquirer from controlling the acquiree have
lapsed
c. The acquirer and acquiree agree to combine their businesses by contract alone. The
acquirer neither transfers consideration nor holds equity interests in the acquiree.
Note:
• In a business combination achieved without transfer of consideration, the acquisition-
date fair value of the acquirer’s interest in the acquiree is substituted for the
consideration transferred in computing for goodwill.
• In a business combination achieved by contract alone, the interests held by parties other
than acquirer are attributed to NCI represents 100% interests in the acquiree.
Illustration 1: Without transfer of consideration

ATAY Co. owns 36,000 out of the 90,000 outstanding shares of XIN, Inc. ATAY accounts
for the investment under the equity method. XIN subsequently reacquires 30,000 shares from
other investors. Information on the acquisition date is as follows:
a. The previously held 40% interest has a fair value of P180,000.
b. XIN’s net identifiable assets have a fair value of P1,000,000.
c. ATAY elects to measure NCI at ‘proportionate share’.
Solution:
Consideration transferred (1M x 60%) 600,000
Non-controlling interest in the acquiree (1M x 40%) 400,000
Total 1,000,00
Goodwill -
Illustration 2: By contract alone

ATAY Co. and XIN, Inc. enter into a contract whereby ATAY obtains control of XIN. No
consideration is transferred between the parties. The fair value of XIN’s net identifiable assets at
acquisition date is P1,000,000. ATAY chose to measure NCI at ‘proportionate share’.
Solution:
Consideration transferred -
Non-controlling interest in the acquiree (1M x 100%) 1,000,000
Total 1,000,00
Goodwill -
Measurement Period
If the initial accounting for a business combination is incomplete by the end of the reporting
period in which the combinations occurred, the acquirer can use provisional amounts to measure
any of the following for which the accounting is incomplete:
a) Consideration transferred
b) Non-controlling interest in the acquiree
c) Previously held equity interest in the acquiree
d) Identifiable assets acquired and liabilities assumed
Within 12 months from the acquisition date, the acquirer retrospectively adjusts the
provisional amounts for any new information obtained that provides evidence of facts and
circumstances that existed as if the acquisition date, which if known would have affected the
measurement of the amounts recognized on that date. Any adjustment to a provisional amount
is recognized as an adjustment to goodwill or gain on a bargain purchase.
Adjustments for new information obtained beyond the 12-month measurement period
are accounted for as corrections of error in accordance with PAS 8 Accounting Policies, Changes
in Accounting Estimates and Errors, rather than PFRS 3.
Illustration 1: Provisional amounts - identifiable assets acquired
On October 1, 20x1, ATAY Co. acquired all the identifiable assets and assumed all the
liabilities of AKO, Inc. for P1,000,000. On this date, AKO’s assets and liabilities have fair values of
P1,600,000 and P900,000, respectively.
Case #1: Identifiable asset recognized at provisional amount

The assets acquired include a building which was assigned a provisional amount of P700,000
because the appraisal is not yet complete by the time ATAY is authorized to issue its December
31, 20x1 financial statements. The building was tentatively assigned a 10-year useful life and was
depreciated for three months in 20x1 using the straight-line method.
On July 1, 20x2 ATAY received the valuation report for the building. The building’s fair
value on October 1, 20x1 is P500,000 and its remaining useful life from that date is 5 years.
Requirements:
a. What is the measurement period?
b. How should ATAY account for the new information obtained on July 1, 20x2?
c. How much is the adjusted goodwill?
d. What are the adjusting entries?
Solutions:
Requirement (a): Measurement period

The measurement period is from October 1, 20x1 to September 30, 20x2, or if earlier, (i)
the date ATAY Co. obtains the information it was seeking about facts and circumstances that
existed as of the acquisition date or (ii) the date ATAY Co. learns that more information is not
obtainable.
Requirement (b): Accounting

The provisional amount assigned to the building is retrospectively adjusted with a
corresponding adjustment to goodwill. The 20x1 adjustment to depreciation expense.
Requirement (c): Adjusted goodwill

Provisional Adjusted
Consideration transferred 1,000,000 1,000,000
NCI - -
Previously held equity interest - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets (700,000) (a) (500,000) (b)
Goodwill 300,000 500,000

(a) (1.6M - .9M) = 700,000
(b) (1.6M - 700,000 PA + 500,00 FV - .9M) = 500,000
Requirement (d): Adjusting entries
July 1, Goodwill (500K-300K) 200,000

20x1
Building 200,000
To record the adjustment to the provisional amount assigned
to the building
July 1, Retained earnings 7,500
20x2
Accumulated Depreciation (c) 7,500
To record the adjustment to 20x1 depreciation
(c) Depreciation recognized (700,000/10 years x 3/12) 17,500
‘Should-be’ depreciation (500,000/ 5 years x 3/12) 25,000
Additional depreciation expense for 20x1 7,500
Illustration 2: Provisional amounts - consideration transferred

On October 1, 20x1, ATAY Co., an unlisted entity, issued 10,000, P5 par value, shares in exchange
for all the identifiable assets and liabilities of XIN, Inc.
Information on acquisition date:

● The shares issued were assigned a provisional amount of P100 per share.
● The fair values of some of the assets acquired are not readily determinable. Accordingly,
a provisional amount of P700,000 was assigned to XIN’s net identifiable assets.
Information after the acquisition date

● On April 1, 20x2, new information was obtained indicating that, on October 1, 20x1,
- The fair value of the shares issued was P110 per share; and
- The fair value of XIN’s net identifiable assets was P900,000.
● On July 1, 20x2, two competitors of ATAY have also merged. This led ATAY to believe that
the merger with XIN is not as profitable as expected. ATAY estimates that the valuations
of consideration transferred and XIN’s net identifiable assets should have been P900,000
and P400,000 respectively.
Requirement: Compute for the adjusted goodwill
Solution:
Consideration transferred 1,000,000 1,000,000(a)
NCI - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets (700,000) (900,000)(b)

Goodwill 300,000 200,000
(a) (10,000 sh. X P110 fair value based on new information obtained on Apr. 1, 20x1)
(b) (fair value based on new information obtained on Apr. 1, 20x1)
Determining what is part of the business combination transaction
The acquirer considers the following when determining whether a transaction is part of a
business combination or a separate transaction:
a) A transaction that is arranged primarily for the benefit of the acquirer or combined entity
rather than the acquiree or its former owners is likely to be a separate transaction. The
transaction price shall be excluded from the consideration transferred when computing
for goodwill.
Contrarily, a transaction that is arranged primarily for the benefit of the acquiree
or its former owners is more likely to be a part of the business combination
transaction. The transaction price is appropriately included in the consideration
transferred.
b) A transaction initiated by the acquirer is likely for the benefit of the acquirer or the
combined entity and, therefore, a separate transaction.
Contrarily, a transaction initiated by the acquiree or its former owners is more
likely to be a part of the business combination transaction.
c) A transaction between the acquirer and acquiree during the negotiations of a business
combination is more likely to be part of the business combination.
However, the following are separate transactions that are excluded when applying
the acquisition method:
i. Settlement of pre-existing relationship between the acquirer and acquiree;
ii. Remuneration to employees or former owners of the acquiree for future
services; and
iii. Reimbursement to the acquiree or its former owners for paying the
acquirer’s acquisition-related costs.
Illustration:
ATAY Co. acquired all the assets and liabilities of XIN, Inc. for P1,000,000. XIN’s assets and
liabilities have fair values of P1,600,000 and P900,000, respectively.
Additional information:
a. XIN incurred P10,000 legal fees in processing the regulatory requirements for the
combination. ATAY agreed to reimburse the said amount.
b. XIN will terminate its activities after the business combination. ATAY agreed to reimburse
XIN’s estimated liquidation costs of P200,000.
c. ATAY will retain XIN’s former key employees. ATAY agreed to pay the key employees
P100,000 as signing bonuses.
d. ATAY agreed to pay an additional P50,000 directly to Mr. ABC Xyz, the previous major
shareholder of XIN, to persuade him in selling his shareholdings to ATAY.
e. Ms. Thirty Six, a former shareholder of XIN, will acquire title to inventories with fair value
of P90,000 that were included in the asset valuation.
Solution:
Non-controlling interest in the acquiree (1M x 100%) -
Total 1,050,00
Goodwill 440,000
(a) (1M + 50K additional payment to Mr. Xyz) = 1,050,000
(b) (1.6M - 90K inventories taken by Ms. Six - .9M) = 610,000
Reacquired Rights
A right that an acquirer has previously granted to the acquiree that is re-acquired as a result of a
business combination is recognized as an intangible asset separately from goodwill.
Example of reacquired rights:
a. Right to use the acquirer’s intangible asset, such as trade name under a franchise
agreement.
b. Right to use the acquirer’s technology under a technology licensing agreement.
Settlement of pre-existing relationship

Prior to business combination, the acquirer and acquiree may have a pre-existing relationship.
Such a relation may be:
a. Contractual – e.g., as vendor and customer, licensor and licensee, or franchisor and
franchisee. A pre-existing relationship may be a contract that the acquirer recognizes as
a reacquired right.
b. Non-contractual – e.g., as plaintiff and defendant on a pending lawsuit.
If the pre-existing relationship is settled due to the business combination, the acquirer recognizes
a settlement gain or loss measured as follows:
a. At the lower of (i) and (ii) below, if the pre-existing relationship is contractual.
i. The amount by which the contract is favorable or unfavorable, from the acquirer’s
perspective, when compared with market terms.
ii. Any settlement amount stated in the contract that is available to the counterparty
to which the contract is unfavorable. If this is less than the amount in (i), the
difference is included as part of the business combination accounting.
b. At fair value, if the pre-existing relationship is non-contractual.

The settlement gain or loss is adjusted for the derecognition of any related asset
or liability that the acquirer has previously recognized.
Illustration 1: Contractual pre-existing relationship

On January 1, 20x1, ATAY Co. acquired all the assets and liabilities of XIN, Inc. for P1,000,000.
XIN’s assets and liabilities have fair values of P1,600,000 and P900,000 respectively.
● ATAY and XIN have a pre-existing supply contract under which ATAY could purchase raw
materials from XIN at discounted rates. The contract has a remaining term of three years,
which ATAY can terminate by paying a P100,000 penalty.
● The supply contract has a fair value of P160,000 of which P70,000 is “at-market”. The “off-
market” component is unfavorable to ATAY because it exceeds the price of current
market transactions for similar items.
● No assets or liabilities related to the contract were recognized in either of ATAY’s or XIN’s
books as at the acquisition date.
Solution:
The P90,000 “off-market” value (160K total fair value - 70K ‘at-market’ value) is unfavorable from
the perspective of ATAY Co. Accordingly, ATAY recognizes a settlement loss
Settlement loss (lower of (90K off-market and 100K settlement amt.) 90,000
Carrying amount of related asset or liability recognized -
Adjusted settlement loss 90,000
The P90,000 “off-market” value is excluded from the consideration transferred on the business
combination and treated as payment for the settlement of the pre-existing relationship (i.e., a
separate transaction).
The P70,000 “at-market” value is subsumed in goodwill and not recognized as intangible asset
because there is no reacquired right.
The goodwill is computed as follows:

Consideration transferred (1M-90K ‘off-market’ value) 910,000
Total 910,00
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 210,000
Illustration 3: Non-Contractual pre-existing relationship

On January 1, 20x1, ATAY Co. acquired all the assets and liabilities of XIN, Inc. for P1,000,000.
XIN’s assets and liabilities have fair values of P1,600,000 and P900,000 respectively.
ATAY is the defendant in a pending patent infringement suit filed by XIN. ATAY recognized a
provision of P130,000 on the lawsuit. After the business combination, the disputed patent will
be transferred to ATAY. The fair value of settling the pending lawsuit is P100,000.

Solution:
The P100,000 fair value is excluded from the consideration transferred on the business
combination and treated as payment for the settlement of the pre-existing relationship (i.e., a
separate transaction).
Payment for the settlement of pre-existing relationship 100,000
Carrying amount of related provision (liability) (130,000)
Settlement gain 30,000
There is a gain because the liability is settled for a lower amount.
The goodwill is computed as follows:

Consideration transferred (1M-100K settlement amt.) 900,000
Total 900,00
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 200,000
Subsequent Measurement and Accounting
Subsequent to acquisition date, the acquirer accounts for assets acquired, liabilities
assumed and equity instruments issued in a business combination in accordance with other
PFRSs applicable for those items. However, the following are subsequently accounted for under
PFRS 3:
1. Reacquired rights – recognized as intangible assets are amortized over the remaining term
of the related contract.
2. Indemnification assets – measured on the same basis as the indemnified item, subject to
assessments of collectability for indemnification assets not measured at fair value.
3. Contingent liabilities recognized as of the acquisition date – recognized in a business
combination are measured at the higher of:
a. The amount that would be recognized by applying PAS 37; and
b. The amount initially recognized is less, if appropriate, cumulative amount of
income recognized in accordance with PFRS 15 Revenue from Contracts with
Customers.
4. Contingent Considerations – an additional consideration for a business combination that
the acquirer agrees to provide to the acquiree upon the happening of a contingency.
Example: The acquirer agrees to issue additional shares to the acquiree when
specified conditions are met, such as meeting an earnings target, reaching a
specified share price or reaching a milestone on a research and development
project.
Initial recognition and measurement

A contingent consideration is measured at acquisition-date fair value and included in the
consideration transferred.
The obligation to pay the contingent consideration is classified either as liability or equity.
A right to recover a previously transferred consideration if specified conditions are met is
classified as an asset.
Subsequent measurement
A change in the fair value of a contingent consideration resulting from additional
information obtained during the measurement period is accounted for as a retrospective
adjustment to the provisional amount. However, changes resulting from meeting an earnings
target, reaching a specified share price or reaching a milestone on a research and development
project are not measurement period adjustments.
Changes in fair value that are not measurement period adjustments are accounted for
depending on the classification of the contingent consideration:
a. A contingent consideration classified as equity is not remeasured and its subsequent
settlement is accounted for within equity.
b. A contingent consideration classified as an asset or a liability is measured at fair value at
each reporting date. Changes in fair value are recognized in profit and loss.

Special Accounting Topics
1. Apply the methods of estimating goodwill
2. Account for reverse acquisition
Special accounting topics for business combination
This chapter discusses accounting for business combination in relation to the following:
1. Goodwill
2. Reverse acquisitions
3. Combination of mutual entities
Goodwill
Only goodwill that arises from a business combination is recognized as an asset. Goodwill
arising from other sources (e.g., internally generated) is not recognized. Goodwill is measured
and recognized on acquisition date. Subsequent expenditures on maintaining goodwill are
expensed immediately.
After initial recognition, goodwill is not amortized but rather tested for impairment at
least annually. For this purpose, goodwill is allocated to each of the acquirer’s cash-generated
units (GCU) in the year of business combination. If the allocation is not completed by the end of
that year, it must be completed before the end of the immediately following year.
Cash-generating unit (GCU) is the smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or groups of assets.
(PAS 36.6)
Goodwill is allocated to the GCUs expected to benefit from the synergies of the business
combination using a methodology that is reasonable, supportable, and applied in a consistent
manner. For example, goodwill may be allocated based on the relative fair values of the GCUs.
Due Diligence
Before negotiations take place for a business combination, the acquirer normally initiates a due
diligence audit for the purpose of determining the appropriate amount of consideration to be
transferred to the acquiree.
Due diligence audit refers to the investigation of all areas of a potential acquiree’s
business before an investor agrees to a business combination transaction. Due diligence audit is
a service most commonly performed by CPAs or external auditing firms.
Methods of Estimating Goodwill

Before the actual business combination transaction takes place amount of goodwill may be
estimated using any of the following methods:
1. Indirect valuation - this is a residual approach wherein goodwill is measured as the excess
of the sum of consideration transferred, non-controlling interest in the acquiree, and
previously held equity interest in the acquiree over the fair value of net identifiable assets
acquired. PFRS 3 requires this method.
2. Direct valuation - under this method, goodwill is measured based on expected future
earnings from the business acquired.
The application of the direct valuation method may require the determination of the
following information:
a. Normal rate of return in the industry where the acquiree belongs. The normal rate
of return may be the industry average determined from examination of annual
reports of similar entities or from published statistical data.
“Normal earnings” is equal to the normal rate of return multiplied by the
acquiree’s net assets.
b. Estimated future earnings of the acquiree.
i. For purposes of goodwill measurement, the earnings of the acquiree are
normalized, meaning earnings are adjusted for non-recurring income and
expenses
ii. The excess of the acquiree’s normalized earnings over the average return
in the industry represents the excess earnings to which goodwill is
attributed. Excess earnings are sometimes referred to as superior
earnings.
c. Discount rate to be applied to “excess earnings”
d. Probable duration of “excess earnings”
Illustration 1: Applications of the Direct valuation method

BTS Co. is contemplating on acquiring EX0, Inc. The following information was gathered through
a due diligence audit:
● The actual earnings of EXO, Inc. for the past 5 years are shown below:
Year Earnings
20x1 1,200,000
20x2 1,300,000
20x3 1,350,000
20x4 1,250,000
20x5 1,800,000
Total 6,900,000
● Earnings in 20x5 include an expropriation gain P400,000

● The fair value of EXO’s net assets as of the end of 20x5 is P10,000.
● The industry average rate of return is 12%.
● Probable duration of “excess earnings” is 5 years.
Method #1: Multiples of average excess earnings

Total earnings for the last 5 years 6,900,000
Less: Expropriation gain (400,000)
Normalized earnings for the last 5 years 6,500,000
Divide by: 5
(a) Average annual earnings 1,300,000
Fair value of acquiree’s net assets 10,000,000

Multiply by: Normal rate of return 12%
(b) Normal earnings 1,200,000
Excess earnings (a)-(b) 100,000

Multiply by: Probable duration of excess earnings 5
Goodwill 500,000
Method #2: Capitalization of average excess earnings (assume 25% Capitalization rate)
Average earnings [(6.9M - 4M expropriation gain) / 5 yrs.] 1,300,000
Normal earnings (10M x 12%) (1,200,000)
Excess earnings 100,000
Divided by: Capitalization rate 25%
Goodwill 400,000
Method #3: Capitalization of average earnings

Divided by: Capitalization rate 12.50%
Excess earnings 10,400,000
Fair value of EXO’s net assets (10,000,000)
Goodwill 400,000
Method #4: Present value of average

Normal earnings in the industry (10M x 12%) (1,200,000)
Excess earnings 100,000
Divided by: Capitalization rate 3.79079
Goodwill 379,079
Reverse acquisitions
In a business combination accomplished through exchange of equity interests, the
acquirer is usually the entity that issues its equity interests. However, the opposite is true for
reverse acquisitions.
In a reverse acquisition, the entity that issues securities (the legal acquirer) is identified
as the acquiree for accounting purposes, while the entity whose equity interests are acquired
(the legal acquiree) is the acquirer for accounting purposes.
For example, ATIN Co., a private entity, wants to become a public entity but does not
want to register its shares. To accomplish this, ATIN will arrange for a public entity to acquire its
equity interests in exchange for the public entity’s equity interests.
In the example above, the public entity is the legal acquirer because it issued its equity
interests, and ATIN Co. is the legal acquiree because its equity interests were acquired. However,
when applying the acquisition method:
a. The public entity is identified as the acquiree for accounting purposes (accounting
acquiree); and
b. ATIN Co. is identified as the accounting acquirer.
Measuring the consideration transferred

In substance, the accounting acquirer issues no consideration to the acquiree. Instead, the
accounting acquiree issues equity interests to the owners of the accounting acquirer for them to
obtain control over the accounting acquiree.
As such, the acquisition-date fair value of the consideration transferred by the accounting
acquirer is measured as an amount based on the number of equity interests the legal subsidiary
(accounting acquirer) would have had to issue to give the owners of the legal parent (accounting
acquiree) the same percentage of equity interest in the combined entity that results from the
reverse acquisition.
Conventional acquisition vs. Reverse acquisition:

Conventional acquisition Reverse acquisition
Issuer of shares as - Accounting acquirer. - Accounting acquiree

consideration
transferred
Reference to combining - Accounting - Accounting

constituents acquirer/Legal parent acquirer/Legal subsidiary
- Accounting - Accounting
acquiree/Legal subsidiary acquiree/Legal parent
Measurement of Fair value of consideration Fair value of the notional number

consideration transferred by the accounting of equity instruments that the
transferred acquirer. accounting acquirer (legal
subsidiary) would have had to
issue to the accounting acquiree
(legal parent) to give the owners
of the accounting acquiree (legal
parent) the same percentage
ownership in the combined
entity.
Illustration: Reverse acquisition

BTS Co., a publicly listed entity, and EXO, Inc., an unlisted company, exchange equity interests.
● BTS Co. issues 5 shares in exchange for all the outstanding shares of EXO, Inc.
● BTS’s shares are quoted at P40 per share, while EXO’s shares have a fair value of P200,000
per share.
● The statements of financial position immediately before the combination are shown
below:
BTS Co. EXO, Inc.

Identifiable assets 1,600,000 2,400,000
Total assets 1,600,000 2,400,000
Liabilities 1,300,000 700,000
Share capital:
10,000 ordinary shares, P10 par 100,000
8,000 ordinary shares, P100 par 800,000

Retained earnings 200,000 900,000
Total liabilities and equity 1,600,000
Requirements:
a. Identify the accounting acquirer.
Legal form of the contract: BTS issues 5 shares for each of the 8,000 outstanding shares
of XYZ. After the issuance, BTS’s equity will have the following structure:
BTS’s currently issued shares 10,000 20%

Shares issued to XYZ (5 x 8,000) 40,000 80%
Total shares after the combination 50,000
Analysis: The business combination is a reverse acquisition because EXO obtains control over BTS
despite the fact that BTS is the issuer of shares. In other words, EXO let itself be acquired (legal
form) in order to gain control over BTS (substance).
➢ EXO, Inc., the legal acquiree, is the accounting acquirer.
➢ BTS, Co., the legal acquirer is the accounting acquiree.
b. Compute for goodwill.

Substance of the contract: EXO obtains control over BTS in a reverse acquisition.
Accordingly, the consideration transferred is computed based on the number of shares
EXO (accounting acquirer) would have had to issue to give ABC (accounting acquiree) the
same percentage of equity interest in the combined entity.
Reverse- EXO (accounting acquirer) issues share to BTS
Shares %
EXO’s currently issued shares 8,000 80%
Shares issued to BTS [(8,000/ 80%) x 20%] 2,000 20%
Total shares after the combination 10,000
If the business combination had taken the form of EXO issuing additional ordinary shares
to BTS’s shareholders, EXO would have had to issue 2,000 shares for the ratio of ownership
interest in the combined entity to be the same. EXO’s shareholders would then own 8,000 of the
10,000 issued shares of EXO (80% of the combined entity), while BTS’s shareholders own 2,000
(20% of the combined entity).
Consideration transferred (2,000 sh. X P200)

400,000
Total 400,000
Fair value of ABC’s net assets (1.6M - 1.3M) 300,000

Goodwill 100,000
Questions:
Part I. Multiple Choice - Theory
1. In which of the following instances is a business combination least likely to occur?

a. Entity A acquires all the assets and assumes all the liabilities of Entity B in exchange
for Entity A’s shares of stock
b. Entity A purchases 80% of Entity B’s outstanding voting shares
c. Entity A acquires the 30% interest in Entity B’s voting shares. All the other shares
of Entity B are held by various shareholders in very small denominations.
Accordingly, Entity A has the power to appoint the majority of the board of
directors of Entity B.
d. Entity A acquires a group of assets from Entity B that does not constitute a
business.
2. PFRS 3 acquires the use of the acquisition method in accounting for all business
combinations. Which of the following is not an application of the acquisition method?
a. Identifying the acquirer which is the entity that obtains control over another
business in a business combination.
b. Determining the acquisition date which is the date the acquirer obtains control
over the acquiree.
c. Measuring the consideration transferred at fair value.
d. Measuring the non-controlling interest at the NCI’s proportionate share in the
acquiree’s net identifiable assets or fair value, whichever is higher.
3. 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
4. The identifiable assets acquired and liabilities assumed in a business combination are
generally measured at
a. acquisition-date fair values.
b. previous carrying amounts.
c. fair value less costs to sell.
d. Cost
5. Which of the following transactions will most likely increase the share premium of the
acquirer?
a. A business combination achieved in stages
b. A business combination involving a contingent consideration that is classified as a
liability.
c. A business combination where the acquirer reacquires a right that it has
previously granted to the acquiree
d. A business combination accomplished through a mere exchange of equity
interests between the acquirer and the acquiree’s former owners.
6. It is a type of business combination wherein an investor, having an existing investment in

the investee, acquires additional interest in order to obtain control over contract alone
a. Business combination achieved in stage
b. Baby step combination
c. Business combination achieved by contract alone
d. Business combination achieved by mere exchange of equity interests
7. Business combination achieved in stages are accounted for
a. Retrospectively, as if the acquired entity has been a subsidiary all along
b. Prospectively.
c. Retrospectively, if the previously held equity interest was classified as investment
in associate.
d. a and c
8. After initial recognition, goodwill arising from a business combination is (use ‘full PFRSs’)
a. amortized over its useful life, not exceeding 10 years.
b. not amortized but tested for impairment at least annually.
c. amortized over its useful life, not exceeding 40 years.
d. amortized and tested for impairment.
9. How is goodwill tested for impairment?

a. Goodwill is allocated to CGU. The CGUs are the ones tested for impairment. Any
impairment is charged first to the allocated goodwill, and any excess is charged to
the other assets in the CGU.
b. Goodwill is unidentifiable, i.e., cannot be seen. Therefore, to test goodwill for
impairment, the accountant must use a microscope.
c. Goodwill can be tested for impairment on its own- the accountant smells it, if it is
bad, the goodwill is impaired.
d. Any of these as a matter of accounting policy choice.
10. In a reverse acquisition,

a. the issuer of shares is the accounting acquirer.
b. the legal acquirer is also the accounting acquirer.
c. the consideration transferred is liability rather than asset.
d. the legally acquired is the accounting acquirer.
Part II. Multiple Choice - Computational
1. BTS Co. acquired all the assets and liabilities of EXO Co. for P2,600,000. On acquisition
date, EXO’s identifiable assets and liabilities have fair values of P5,900,000 and
P3,500,000, respectively. Relevant information follows:
● BTS is renting out a building to EXO Co. on an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential
is P90,000.
● EXO is a defendant in a pending lawsuit. No provision was recognized because
EXO’s legal counsel believes they will successfully defend the case. The fair value
of settling the lawsuit is P10,000.
How much is the goodwill (gain on bargain purchase)?

a. 120,000 c. 200,000
b. 140,000 d. 180,000
2. TWICE Co. acquires 100% controlling interest in EXID Co. by issuing 2,000 shares with par
value per share of P100 and fair value per share of P500. TWICE Co. incurs stock issuance
costs of P10 per share. On acquisition date, EXID Co.’s identifiable assets and liabilities
have fair values of P2,800,000 and P1,600,000, respectively. TWICE Co. incurred P40,000
in hiring an independent appraiser to value EXID’s assets and liabilities. After the
combination, TWICE intends to eliminate some of EXID’s activities. The estimated costs
are P20,000. In addition, TWICE Co. expects to incur losses of P80,000 during the first year
after the business combination. How much is the goodwill (gain on bargain purchase)?
a. (260,000) c. (200,000)
b. 24,000 d. 280,000
3. Aespa Co. acquires 80% controlling interest in Wonder Co. for P1,200,000. Wonder Co’s
identifiable assets and liabilities have fair value of P3,300,000 and P1,700,000,
respectively. Included in Wonder’s assets is a web press machine with fair value of
P900,000 which Aespa Co. intends to sell immediately. The machine qualifies for
classification as ‘held for sale’. The cost to sell are P150,000. Wonder Co. opts to measure
the non-controlling interest at fair value. How much is the goodwill? (Assume the fair
value of the NCI is equal to the grossed-up value of the consideration transferred
multiplied by the NCI percentage.)
i. 600,000 c. 50,000
b. 40,000 d. 20,000
4. On January 1, 20x1, Momoland Co. acquires 80% of the outstanding voting shares of
Blackpink Co. Blackpink’s identifiable assets and liabilities have fair values of P3,400,000
and P1,700,000, respectively. Relevant information follows:
● Momoland Co. agrees to pay Blackpink’s former owners P2,000,000 cash, half of
which is to be paid on January 1, 20x1, while the other half will be paid in five
equal annual instalments starting December 31, 20x1. The current market rate of
interest on January 1, 20x1 is 12%.
● Momoland also agrees to provide a technical know-how to be used in Blackpink’s
operations after the business combination. The technical know-how has a fair
value of P200,000.
● Saturday opts to measure the non-controlling interest at the NCI’s proportionate
share in Blackpink’s net identifiable assets.
How much is the goodwill (gain on bargain purchase)?

a. 360,955 c. (220,045)
b. 340,955 d. 280,955
Use the following information for the next two questions:

Baba Co. issued 20,000 ordinary shares in exchange for all the outstanding shares of Chin, Inc. On
acquisition date, Chin’s net identifiable assets have a carrying amount of P4,000,000 and a fair
value of P2,000,000. The transaction increased in Babas’ share premium by P400,000; however,
no goodwill resulted from the business combination.
5. How much is acquisition-date fair value per share of the ordinary shares issued by Babas?
a. 20 c. 80
b. 40 d. 100
6. How much is par value per share of Baba’s ordinary shares?
a. 20 c. 80
b. 40 d. 100
7. Papa Co. issued shares in exchange for all the outstanding shares of Mama Co. The
business combination did not result to any goodwill. The share exchange ratio was 2:1.
Mama’s share capital has a carrying amount of P40,000. The par value per share is P4.
Mama’s net identifiable assets have a carrying amount of P400,000 and a fair value of
P800,000. Papa’s shares have par value per share of P10. How much is the acquisition-
date fair value per share of Papa’s shares?
a. 20 c. 80
b. 40 d. 100
Use the following information for the next three questions:

Keyboard Co. and Mouse Co. are planning to combine their businesses and put up a new entity
called PC Corporation.
● PC will issue 100,000 ordinary shares, which are to be subdivided between Keyboard and
Mouse based on their total contributions, including goodwill.
● Goodwill is computed by capitalizing excess earnings at 20%.
● The industry normal earnings are 5% of net assets.
Keyboard Co. Mouse Co.
Fair value of net identifiable assets 500,000 380,000
Average annual earnings 40,000 39,000
How much is the total goodwill expected to arise from the business combination?
8. How much is the total goodwill expected to arise from the business combination?
a. 175,000 c. 75,000
b. 100,000 d. 0
9. How many shares will be issued to Keyboard and Mouse, respectively?

Keyboard Co. Mouse Co.
a. 45,500 54,500
b. 64,500 35,500
c. 25,500 74,500
d. 54,500 45,500
10. Which of the combining entities is most likely the acquirer?
a. Keyboard Co. c. PC Corporation
b. Mouse Co. d. Play store
Problem
Goodwill
1. Entity X acquired all the assets and assumed all the liabilities of Entity Y for P1,800,000.
Information on Entity B’s assets and liabilities as at the acquisition date is shown below:
Assets Carrying amounts Fair values
Receivables-net 200,000 100,000

Inventory 600,000 450,000
Building- net 1,200,000 1,800,000
Goodwill 100,000 20,000
Total assets 2,100,000 2,370,000
Liabilities
Payables 900,000 700,000
Requirement: Compute the goodwill (gain on bargain purchase).
Non-controlling interest
Use the following information for the next two items:
Entity X acquired 75% of the outstanding voting shares of Entity Y for P2,000,000. On
acquisition date, Entity X’s identifiable assets and liabilities have fair values of P4,000,000
and P1,600,000, respectively.
2. How much is the goodwill if Entity X opts to measure the non-controlling interest at the
NCI’s proportionate share in Entity Y’s net identifiable assets?
3. Entity X opts to measure the non-controlling interest at fair value. An independent valuer
assessed the NCI’s fair value to be P540,000. How is the goodwill?
Operating leases and Intangible assets

4. Entity X acquired all the assets and assumed all the liabilities of Entity Y for P2,800,000.
On acquisition date, Entity Y’s identifiable assets and liabilities have fair values of
P4,000,000 and P1,600,000, respectively.
● Entity Y has an unrecorded patent with fair value of P100,000.
● Entity Y has research and development (R&D) projects with fair value of P1,600,00.
Entity Y charged the R&D costs as expenses when they were incurred.
● Entity X is renting out a property to Entity B under an operating lease. The terms
of the lease compared with market terms are favorable. The fair value of the
differential is P40,000.
Requirement: Compute for the goodwill.
Contingent liabilities
5. Entity X acquired 75% of the outstanding voting shares of Entity Y for P1,800,000. On
acquisition date, Entity Y’s identifiable assets and liabilities have fair values of P4,000,000
and P1,600,000 respectively.
● Entity X replaces Entity Y as a guarantor on a loan of a third party. As at the
acquisition date, the third party has defaulted on the loan. However, because
negotiations for debt restructuring are ongoing with the lender and Entity Y
strongly believes that the lender will agree on the proposed terms, no provision
was recognized. The fair value of the guarantee is P200,000.
● Entity X chose to measure the non-controlling interest at the NCI’s proportionate
share in the acquiree’s net identifiable assets.
Share-for-share exchanges
6. One Co. issued shares in exchange for all the outstanding shares of Two Co. One’s shares
have par value of P20 per share and fair value per value of P100. On acquisition date,
Two’s net identifiable assets have a fair value of P4,000,000. One recognized goodwill of
P200,00 from the business combination. How many shares did One issue on the business
combination?
Business combination achieved in stages

7. Three Co. acquired 20% interest in Four Co. many years ago. On January 1, 20x1, Three
acquired additional 40% interest in Four for P300,000. On this date, Four’s net identifiable
assets have a fair value of P690,000, and Three’s previous investment in Four has a
carrying amount of P128,000 and fair value of P138,000. Three opted to measure the NCI
at ‘proportionate share’. How much is the goodwill?
Business combination without transfer of consideration

8. X Co. acquired 100% voting rights in Y Co. by contract alone. No consideration was
transferred on the arrangement. Y’s net identifiable assets have a fair value of P1,800,000.
X measured the NCI at ‘proportionate share’. How much is the goodwill?
Measurement period
9. On November 2, 20x1 APO Co. acquired all the identifiable assets and liabilities of ANAK,
Inc. for P2,000,000.
Information on acquisition date:
● ANAK’s net identifiable assets were valued at P1,980,000. The amount included a
provisional amount of P220,000 assigned to a specialized machine for which the
fair value is not readily determinable. APO tentatively depreciated the machine
over 6 years using the straight-line method in 20x1.
Information after the acquisition date:

● On April 1, 20x2, an independent consultant determined that the machine’s fair
value on acquisition date was P140,000 and the remaining useful life as of that
date was 4 years.
● On July 1, 20x2, the stock market crashed. Various held for trading securities
acquired from ANAK, Inc. with acquisition date fair value of P500,000 now have a
fair value of only P20,000.
Requirement: Provide the adjusting entry to restate the goodwill.
Determining what is part of the business combination

10. SUN Co. acquired 100% interest in MOON, Inc.’s net identifiable assets with fair value of
P600,000 for P800,00. The valuation of the consideration transferred includes the
following:
a. P30,000 reimbursements for appraisal fees incurred by MOON in valuing a patent.
b. P50,000 fair value of a trade secret that SUN will grant MOON after business
combination. The trade secret has a carrying amount of P40,000 in SUN’s books.
Requirement: Compute for goodwill

Answer Key
Multiple Choice - Theory

1. D
2. D
3. D
4. A
5. D
6. A
7. B
8. B
9. A
10. D
Multiple Choice - Computational

1. A
Solution:
NCI -
Total 2,600,000
(5.9M + 90K int. Asset on optg. Lease - 3.5M - 10K cont. liab.)
Goodwill 120,000
2. C
Solution:
Consideration transferred (2,000 sh. X P500) 1,000,000
NCI -
Total 1,000,000

Goodwill (200,000)
3. C
Solution:
NCI (1.2M - 80%) x 20% 300,000
Total 1,500,000

(3.3M + 150K costs to sell - 1.7M)
Goodwill 50,000
4. A
Solution:
Consideration transferred 1M + (200K x PV of ordinary annuity of 1 @ 12%, n=5) 1,720,955
NCI (3.4M - 1.7M) x 20% 340,000

Total 2,060,955

Goodwill 120,000
5. D
Solution:
Consideration transferred (squeeze) 2,000,000
NCI in the acquiree -
Total 2,000,000
Goodwill -
(2,000,000 ÷ 20,000 shares) = 100 per share
6. C
Solution:
2M consideration transferred - 400K increase in share premium = 1.6M increase in share
capital;
(1.6M ÷ 20,000 shares) = 80 par value per share
7. B
Solution:
Outstanding share of MAMA (P40,000 ÷ P4 par) 10,000
Ratio 2:1
No. of shares issued by PAPA (10,000 sh. x 2) 20,000
Consideration transferred (squeeze) 800,000
Total 800,000
Goodwill -
(800,000 consideration transferred ÷ 20,000 sh. Issued by PAPA) = 40
8. A
Keyboard Mouse Co. Total
Co.
Average annual earnings 40,000 39,000 79,000
Normal earnings 25,000 19,000 44,000
Excess earnings 15,000 20,000 35,000
Divide by capitalization rate 20% 20% 20%
Goodwill 75,000 100,000 175,000
9. D
Keyboard Mouse Co. Total
Co.
Fair value of net identifiable assets 500,000 380,000
Estimated goodwill 75,000 100,000
Total distributions 575,000 480,000 1,055,000
Distribution ratio (575/1,055);(480/1,055) 54.50% 45.50%

Total number of shares to be distributed 100,000 100,000
Goodwill 54,500 45,500 100,000
10. A
Since the new entity, PC corporation, will issue interests to both Keyboard and Mouse,
the acquirer is most likely the entity that receives the most voting rights after the business
combination (i.e., Keyboard Co. - 54,500 shares or 54.5% interest)
However, if the newly acquired entity transfers cash and other considerations and
assumes liabilities to acquire both Keyboard and Mouse, the acquirer would be the newly
created entity.
Problem
1. Solution:
Total 1,800,000

(2.37M - 20K goodwill - 700K liabilities)
Goodwill 150,000
2. Solution:
NCI [(4M - 1.6M) x 25%] 600,000
Total 2,600,000
Fair value of net identifiable assets acquired (4M - 1.6M) (2,400,000)
Goodwill 200,000
3. Solution:
NCI [(4M - 1.6M) x 25%] 540,000
Total 2,540,000
Fair value of net identifiable assets acquired (4M - 1.6M) (2,400,000)
Goodwill 140,000
4. Solution:
Non-controlling interest in the acquire -
Total 2,800,000

(4M + 100K patent + 160k R&D + 40K intangible asset on
operating lease w/ favorable terms)
Goodwill 100,000
5. Solution:
NCI (2.2M ‘see below’ x 25%) 550,000
Total 2,350,000
Fair value of net identifiable assets acquired (4M - 1.6M - 200K contingent liability) (2,200,000)
Goodwill 150,000
6. Solution:
Step 1
Consideration transferred (squeeze) 4,200,000
Total 4,200,000

Goodwill 200,000
Step 2
(P4.2M consideration transferred ÷ P100 fair value per sh.) = 42,000 shares issued
7. Solution:
Consideration transferred 300,000
NCI in the acquiree (690K x 40%*) 276,000
Previously held equity interest in the acquiree 138,000
Total 714,000
Goodwill 24,000
*100% - (20% + 40%) = 40%

8. Solution:
Consideration transferred -
NCI in the acquiree (1.8M x 100%) 1,800,000
Total 1,800,000
Goodwill -
9. Solution:
Consideration transferred 2,000,000 2,000,000
NCI - -

Total 2,000,000 2,000,000
Fair value of net identifiable assets (1,980,000) (1,900,000(a))
Goodwill 20,000 100,000

(a) (1.980M - 220K provisional amount + 140K fair value)
Apr. 1, Goodwill 80,000

20x2 Machine 80,000
Apr. 1, Accumulated Depreciation (b) 278

20x2 Retained earnings 278
(b) Depreciation based on:
Provisional amount: (220K ÷ 6) x 2/12 = 6,111
Fair value: (140K ÷ 4) x 2/12 = 5,833
Decrease in accumulated depreciation: (6,111 - 5,833) = 278
10. Solution:
Consideration transferred (800K - 30K - 50K) 720,000
Total 720,000
Goodwill 120,000
Reference:
• Accounting for Business Combinations by Zeus B. Millan (Book)

Accounting For Business Combinations

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Accounting For Business Combinations

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Accounting for Business

ACCOUNTING FOR BUSINESS COMBINATIONS

Advantages of a business combination

Disadvantages of a business combination

Essential elements in the definition of a business combination

*Goodwill recognizes as an asset

Illustration 1: Measuring goodwill / gain on bargain purchase

Fair value of identifiable assets

Specific Recognition Principles

➔ Examples of it that assumed in bus comb and is recognized

Illustration: Contingent liability

Fair value of identifiable assets acquired 1,600,000

Fair value of liabilities assumed 900,000

Contingent liability (pending litigation) 50,000 (950,000)

Business Combination (Part 2)

AU Co. Combined entity

Share capital 600,000 700,000

Share premium 300,000 1,200,00

Totals 900,000 1,900,000

Requirements: Compute for the following:

AU Co. Combined entity Increase

Share capital 600,000 700,000 100,000

Share premium 300,000 1,200,00 900,000

Totals 900,000 1,900,000 1,000,000

Fair value of shares issued P1,000,000

Divide by: Fair value per AU’s share P100

Number of shares issued 10,000

Requirement (b): Par value per share

Divide by: Number of shares issued 10,000

Par value per share P10

Requirement (c): Fair value of the net assets acquired

Non-controlling interest in the acquiree -

Previously held equity interest in the acquiree -

Goodwill (given information) 300,000

Business Combination achieved in stages

Business combination achieved in stages is also called “step acquisition”.

Illustration: Business combination achieved in stages

Requirement: Compute for goodwill.

Non-controlling interest in the acquiree (1M x 25%*) 250,000

Previously held equity interest in the acquiree 180,000

Fair value of net identifiable assets acquired (1,000,000)

Business combination without transfer of consideration

Examples of circumstances where the acquirer obtains control without transferring

Illustration 1: Without transfer of consideration

Requirement: Compute for goodwill.

Non-controlling interest in the acquiree (1M x 40%) 400,000

Previously held equity interest in the acquiree -

Fair value of net identifiable assets acquired (1,000,000)

Illustration 2: By contract alone

Requirement: Compute for goodwill.

Non-controlling interest in the acquiree (1M x 100%) 1,000,000

Previously held equity interest in the acquiree -

Fair value of net identifiable assets acquired (1,000,000)

Illustration 1: Provisional amounts - identifiable assets acquired

Case #1: Identifiable asset recognized at provisional amount

Requirement (a): Measurement period

Requirement (b): Accounting

Requirement (c): Adjusted goodwill

Consideration transferred 1,000,000 1,000,000

Previously held equity interest - -

Total 1,000,000 1,000,000

Fair value of net identifiable assets (700,000) (a) (500,000) (b)