ACCOUNTING FOR BUSINESS COMBINATION 1

TOPIC: BUSINESS COMBINATION LYNDON P. REGODON, CPA, MIA

BUSINESS COMBINATION
Business combination is a transaction or event in which an acquirer obtains “control” of one or
more businesses. (IFRS 3)
Types of Business Combination
1. Net Asset Acquisition – acquisition of assets and assumption of liabilities
a. Statutory Merger: A + B = A or B
b. Statutory Consolidation: A + B = C

2. Stock Acquisition – a controlling interest (typically more than 50%) of another company’s
voting common stock is acquired.
- Parent and Subsidiary relationship

Structures of Business of Combination

1. Horizontal Integration – one that involves companies within the same industry that have
been previously competitors
2. Vertical Integration – takes places between two companies involved in the same industry
but at different levels.
3. Conglomerate Combination – one involving companies in unrelated industries having
little, if any, production or market similarities for the purpose of entering into new
markets or industries.

Method of accounting for business combinations

Acquisition method

The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3) is used for
all business combinations. [IFRS 3.4] Under this method, all assets and liabilities of the acquired
company are usually recorder at fair value.

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 2

Steps in applying the acquisition method are: [IFRS 3.5]

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

1. Identifying an acquirer
✓ The acquirer is usually the entity that transfers cash or other assets where the business
combination is effected in this manner
✓ The acquirer is usually, but not always, the entity issuing equity interests where the
transaction is effected in this manner, however the entity also considers other pertinent
facts and circumstances
✓ The acquirer is usually the entity with the largest relative size (assets, revenues or profit)
✓ For business combinations involving multiple entities, consideration is given to the entity
initiating the combination, and the relative sizes of the combining entities.
2. Acquisition date
An acquirer considers all pertinent facts and circumstances when determining the acquisition
date, i.e. the date on which it obtains control of the acquiree. The acquisition date may be a date
that is earlier or later than the closing date. [IFRS 3.8-9]
Closing date – date which the acquirer legally transfers the consideration, acquires the assets and
assumes the liabilities of the acquiree.
The acquisition date is critical because it is the date used to establish the fair value of the
company acquired.
3. Determine the Consideration Given
Generally, consideration given (price paid) by the acquirer is assumed to be the fair value of the
acquiree as an entity. IFRS 3 requires these considerations to be measured at fair values on the
date of acquisition. This is calculated as the sum of:

• Assets transferred by the acquirer

• The liabilities incurred by the acquirer
• The equity interest issued by the acquirer
*Acquisition Related Costs – costs the acquirer incurs to effect a business combination, such as
broker’s fee, accounting, legal and other professional fees, general and admin costs. In general
costs incurred in relation to business combination are expensed outright (whether direct or
indirect) except for stock issuance costs which are debited to share premium.

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 3

4. Recognition and measurement of the identifiable assets acquired, the liabilities assumed and
any non-controlling interest (NCI) in the acquiree
Recognition principle. Identifiable assets acquired, liabilities assumed, and non-controlling
interests in the acquiree, are recognized separately from goodwill [IFRS 3.10]
Measurement principle. All assets acquired and liabilities assumed in a business combination are
measured at acquisition-date fair value. [IFRS 3.18]
The following exceptions to the above principles apply:

• Liabilities and contingent liabilities within the scope of IAS 37 or IFRIC 21 – for transactions and
other events within the scope of IAS 37 or IFRIC 21, an acquirer applies IAS 37 or IFRIC 21 (instead
of the Conceptual Framework) to identify the liabilities it has assumed in a business combination
[IFRS 3.21A-21B]

• Contingent liabilities and contingent assets – the requirements of IAS 37 Provisions, Contingent
Liabilities and Contingent Assets do not apply to the recognition of contingent liabilities arising in
a business combination; an acquirer does not recognize contingent assets acquired in a business
combination [IFRS 3.22-23A]

• Income taxes – the recognition and measurement of income taxes is in accordance with IAS
12 Income Taxes [IFRS 3.24-25]

• Employee benefits – assets and liabilities arising from an acquiree's employee benefits
arrangements are recognized and measured in accordance with IAS 19 Employee Benefits (2011)
[IFRS 2.26]

• Indemnification assets - an acquirer recognizes indemnification assets at the same time and on
the same basis as the indemnified item [IFRS 3.27-28]

• Reacquired rights – the measurement of reacquired rights is by reference to the remaining

contractual term without renewals [IFRS 3.29]

• Share-based payment transactions - these are measured by reference to the method in IFRS
2 Share-based Payment

• Assets held for sale – IFRS 5 Non-current Assets Held for Sale and Discontinued Operations is
applied in measuring acquired non-current assets and disposal groups classified as held for sale
at the acquisition date.

5. Recognition and measurement of goodwill or a gain from a bargain purchase

Goodwill is measured as the difference between:

• the aggregate of (i) the value of the consideration transferred (generally at fair value), (ii)
the amount of any non-controlling interest and (iii) in a business combination achieved in
stages (see below), the acquisition-date fair value of the acquirer's previously-held equity
interest in the acquiree, and

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 4

• the net of the acquisition-date amounts of the identifiable assets acquired and the
liabilities assumed (measured in accordance with IFRS 3). [IFRS 3.32]
Considerations Paid P xx
Fair Value of the Net Assets of Acquiree (xx)
Goodwill (Gain on Bargain Purchase ) xx/ (xx)

Sample Problems:
Problem 1. The condensed balance sheet of LYLIA Corporation as of December 31, 2007 is shown below:

Book Values Fair Values

Current assets P200,000 P225,000
Plant assets 300,000 400,000
Total assets P500,000

Liabilities P150,000
Capital stock, P10 par 50,000
Additional paid in capital 100,000
Retained earnings 200,000
Total equities P500,000

On January 1, 2008, ATLAS Company paid P500,000 for the net assets of LYLIA Corporation. How much is
the goodwill as a result of the merger?

Problem 2. The condensed balance sheet of LYLIA Corporation as of December 31, 2007 is shown below:

Book Values Fair Values

Current assets P200,000 P225,000
Plant assets 300,000 400,000
Total assets P500,000

Liabilities P150,000
Capital stock, P10 par 50,000
Additional paid in capital 100,000
Retained earnings 200,000
Total equities P500,000

On January 1, 2008, ATLAS Company issues 10,000 shares of its P10 par value with a market value of P40
per share for the net assets of LYLIA Corporation. How much is the goodwill as a result of the merger?

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 5

Problem 3. On January 1, 2009, Lance Corporation acquired the net assets of Odette Corp. by
paying P500,000 cash and also issuing 60,000 of its own shares. In addition, Lance will pay
additional P60,000 cash if the average earnings of Odette Corp. for two years will exceed
P500,000. The fair value of this contingent consideration is P25,000. The following balance sheet
of Lance Corporation and Odette Corporation before they entered into a business combination:
Lance Corp Odette Corp
Book value Fair value Book value Fair value
Cash P 550,000 P 550,000 P 150,000 P 150,000
Accounts receivable 50,000 50,000 40,000 40,000
Inventory 150,000 280,000 350,000 500,000
Land 5,000,000 5,500,000 1,000,000 ?
Building 3,000,000 3,500,000 1,800,000 1,780,000
Acc. Depreciation (800,000) (250,000)
Goodwill 100,000 120,000 80,000 90,000
Total assets P 8,050,000 P 3,170,000

Accounts payable P 450,000 P 430,000 P 380,000 P 380,000

Bonds payable 500,000 530,000 400,000 420,000
Common stock
P20 par value 2,000,000
P40 par value 1,200,000
Share premium 1,500,000 550,000
Retained earnings 3,600,000 640,000
Total Liabilities & SHE P 8,050,000 P 3,170,000

Lance shares were selling at P45 and Odette shares were selling at P58. Additional cash payment
made by Lance Corp. in completing the acquisition were:

Stock registration fee for new shares of Lance P13,000

Professional fees paid to accountant 25,000
Cost issuance of Lance shares 15,000
Payment to brokers and consultants 30,000
Additional information:

• On January 1, 2009, the fair value of the land was not yet determinable thereby it
was assigned by a provisional amount of P1,100,000. It was only on December 31,
2009 that the fair value of land was finalized at P1,200,000.
• The fair value of the contingent consideration on December 31, 2009 and July 1,
2010 was P30,000 and P40,000, respectively.

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 6

Requirements:
I. Prepare the necessary entries in the books of the acquirer.

II. Prepare the balance sheet of Lance Corporation immediately after the business
combination on January 1, 2009.

Lance Corp
Balance Sheet
As of January 1, 2009
Cash
Accounts receivable
Inventory
Land
Building
Acc. Depreciation
Goodwill
Total assets

Accounts payable
Bonds payable

Common stock P20 par value

Share premium
Retained earnings
Total Liabilities & SHE

SIR DON, CPA

 ACCOUNTING FOR BUSINESS COMBINATION 7

III. Compute for the following

1. On January 1, 2009, Lance Corporation recognized a goodwill or gain on bargain
purchase as a result of business combination amounting to:

2. The cash balance in the books of Lance on January 1 is:

3. On January 1, 2009, total assets amounted to:

4. How much is the stockholders’ equity right after the business combination?

5. What is the balance of additional paid in capital on January 1, 2009?

6. On its December 31, 2009 Balance sheet, Lance will report a goodwill amounting to:

SIR DON, CPA