SCHOOL OF ACCOUNTANCY

ACCT 4111 ADVANCED FINANCIAL ACCOUNTING

LECTURE 1 – BUSINESS COMBINATIONS I (SUPPLEMENTARY)

Readings: McGraw Hill Appendix 3C, pages 121 – 145

TOPIC IIC ACQUISITION METHOD – RECOGNISE AND MEASURE ASSETS ACQUIRED AND
LIABILITIES ASSUMED: PRINCIPLE 2

General rule for recognition:

Acquirer recognises the identifiable assets acquired, the liabilities assumed and any
non-controlling interest (to be discussed in Lecture 6) in the acquiree as of the acquisition date if:
(1) the assets and liabilities recognised by the acquirer must meet the definitions in the
Framework (refer to Lecture 1); AND
(2) the item acquired or assumed must be part of the business acquired rather than the result
of a separate transaction (see below for the application of this principle)
l May link another transaction with the business combination but in substance it is a
separate transaction (substance over form)

Settlement of Pre-existing Relationship

Settlement of a pre-existing relationship between acquirer and acquiree:
Amount paid to settle the pre-existing relationship does NOT form part of the consideration
paid

Settlement of Pre-existing Relationship

唔考
NON-CONTRACTUAL Relationship CONTRACTUAL Relationship
(e.g. lawsuit) (e.g. supply agreement/reacquired right)

Recognise a gain or loss (in profit or loss) Recognise a gain or loss (in profit or loss)
measured at FAIR VALUE measured at the LOWER of the following:

(i) the amount by which the contract is (ii) the amount of any stated settlement
favourable or unfavourable when provisions in the contract available to the
compared with the terms for current market counterparty to whom the contract is
transactions unfavourable

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 SCHOOL OF ACCOUNTANCY
ACCT 4111 ADVANCED FINANCIAL ACCOUNTING
LECTURE 1 – BUSINESS COMBINATIONS I (SUPPLEMENTARY)

Comparison of supply agreement and reacquired rights:

Supply agreement Reacquired rights
“Off market” Accounted for as an effective settlement of a pre-existing relationship (see
component above)
“At market” Part of goodwill (i.e. not a Forms the fair value of the reacquired
component separate intangible asset rights (which is identifiable and can be
acquired) recognised separately from goodwill)

Illustration: Entity A is a defendant in litigation relating to a patent infringement claim brought by Entity B.
Entity A pays $500,000 to acquire all of Entity B’s assets and liabilities and effectively settles the lawsuit.
The fair value of the settlement of the lawsuit is estimated to be $50,000. The fair value of Entity B’s
identifiable net assets is $400,000.

Exclude the settlement of pre-existing lawsuit Dr. Loss on settlement of lawsuit $50,000
Actual consideration: $500,000 - $50,000 =$450,000 NA acquired $400,000
FV of NA: $400,000 Goodwill $50,000

Goodwill: $450,000 - $400,000 = $50,000 Cr. Cash $500,000

else, the GW will be overstated

If Entity A had recorded a $30,000 provision in its financial statement prior to the acquisition,
Prior: At Acq.date:
Dr. Loss on settlement of lawsuit $30,000 Dr. Provision $30,000
Cr. Provision $30,000 Loss on settlement of lawsuit $20,000
NA acquired $400,000
Goodwill $50,000

Cr. Cash $500,000

Illustration: Franchiser P acquires the business of operating Franchisee S for $30,000. In connection with
the acquisition, P reacquires previously granted franchise rights. The following facts at the date of
acquisition are relevant for this case:
Fair value of the identifiable net assets of S, excluding the franchise right $17,000
Reacquired franchise rights:
- Value of the right measured in accordance with HKFRS 3 $3,000
- Cancellation penalty in the franchise contract $5,000
- Amount by which the contract is unfavourable for P relative to the terms of
current market transactions for similar items $4,000

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 SCHOOL OF ACCOUNTANCY
ACCT 4111 ADVANCED FINANCIAL ACCOUNTING
LECTURE 1 – BUSINESS COMBINATIONS I (SUPPLEMENTARY)

Compensation to Employees or Former Owners of the Acquiree for Future Services

The selling shareholders may also be key employees in the acquired business (e.g. owner-managers)
Investigate the purpose of the potential payment: e.g. paying to extra $ to force acquiree to stay

Potenital payment

Contingent consideration? Remuneration expense? As Future Service provided will

not benefit the acquiree

Part of the business Not part of the business

Affect Goodwill combination accounting (Refer X Affect Goodwill
combination
to Lecture 2, page 3)

Reimbursement of Acquisition-related Costs of the Acquirer

In most situations, the acquirer pays its own acquisition-related costs
A purchase agreement may specify that the acquisition-related costs are paid by the vendor
Such costs may or may not be reimbursed by the acquirer
Under any circumstance (whether reimbursed by the acquirer or not), the acquirer cannot avoid
the costs of the business combination being charged to its income statement by having those costs
incurred by another party
Compared with this situation: The vendor (former owners of the acquiree) and the acquirer agree, for
tax reason, that the acquirer will pay directly to third parties the selling expenses incurred by the
vendor in the sale and purchase transaction.

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© Prepared by Eric Leung, The Chinese University of Hong Kong
Do not redistribute or post