Mill a n Ch a pter-1-Business-Combin a tion-P a rt-3

Accountancy (a)

BSA III – DILIGENCE

UMLAS, RIASOL JANE D. 2019 - 0238
DABU, ANNE SHANNEN B. 2019 – 0240

Problem 1: Methods of estimating goodwill

Use the following information for the next four items:

Entity A is contemplating on acquiring Entity B. Relevant information follows:

● Entity B’s average annual earnings in the past 5 years were ₱1,000,000.
● Entity B’s net assets as at the current year-end have a fair value of ₱8,000,000.
● The industry average rate of return on equity is 12%.
● The probable duration of Entity B’s “excess earnings” is 5 years.

1. Goodwill is equal to the average excess earnings capitalized at 25%. How much is the goodwill?

Average Annual Earnings 1,000,000

Normal Earnings (8,000,000 x 12%) (960,000)
Excess Earnings 40,000
Divide: Capitalization Rate 25%
GOODWILL ₱ 160, 000

2. Goodwill is measured by capitalizing the average earnings at 12%. How much is he goodwill?

Average Annual Earnings 1,000,000

Divide: Capitalization Rate 12%
Estimated Purchase Price 8,333,333
FV of entity B’s Asset (8,000,000)
GOODWILL ₱ 333,333

3. Goodwill is measured at the undiscounted amount of total excess earnings expected to be earned from the
combination. How much is the goodwill?

Average Annual Earnings 1,000,000

Normal Earnings (8,000,000 x 12%) (960,000)
Excess Earnings 40,000
Multiply: Probable duration of excess earnings 5
GOODWILL ₱ 200,000

4. Goodwill is measured by discounting the average excess earnings at 9%. How much is the goodwill?

Average Annual Earnings 1,000,000

Normal Earnings (8,000,000 x 12%) (960,000)
Excess Earnings 40,000
Multiply: N of an ordinary annuity @ 10%, N=5 3.88965
GOODWILL ₱ 155, 586

REVERSE ACQUISITION
5. Entity A and B exchange equity interests in a business combination. Relevant information follows:
● Entity A has 2,000 issued shares. To effect the business combination, Entity A will issue 2 new shares
for each of the 3,000 total outstanding shares of Entity B.
● Entity A’s share have fair value of ₱ 100 per share, while entity B’s share have fair value of ₱300 per
share.
● Entity A’s net identifiable assets have a fair value of ₱ 260,000 as at the acquisition date.

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Legal form: Entity A issues share to entity B.
Entity A’s currently issued shares 2000 25%
Shared issued to entity B (2 x 3,000) 6000 75%
Total shares after the combination 8,000

Reverse: En琀椀ty B issues share to en琀椀ty A.

Entity B’s currently issued shares 3000 75%
Shared issued to entity A [(3,000/75%) x 25%] 1000 25%
Total shares after the combination 4,000

Consideration transferred (1000 shares x 300) 300,000

Non – controlling interest in the acquiree -
Previously held equity interest in the acquiree -____
Total 300,000
PV of entity A’s net assets (260 000)
GOODWILL 40,000

Problem 2:
1. After initial recognition, goodwill arising from business combination is (use ‘full PFRS’s’)
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.

Answer: B

2. How is goodwill tested for impairment?

A. Goodwill is allocated for CGU’s. The CGU’s are the ones tested for impairment. Any impairment is charged
first to the allocated goodwill, and any excess is charged to the other assents 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.

Answer: A

3. The cost of internally developed goodwill and the cost of maintaining a recognized goodwill are
A. Capitalized as cost of goodwill.
B. Not capitalized but rather expensed when incurred.
C. Sometimes capitalized and sometimes expensed.
D. Ignored for accounting purposes.

Answer: B

4. In 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.

Answer: D

5. How is the consideration transferred in a reverse acquisition measured?

A. At nil.
B. At cost rather that fair value.
C. In a reverse fashion by squeezing upwards starting wih goodwill.

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 D. 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 percent ( accounting acquiree) the same percentage of
equal interest in the combined equity that results from the reverse acquisition.

Answer: D

Problem 3:
Use the following information for the next three questions:

Gamer Co. and Player Co. are planning to combine their businesses and put up a new entity called App Corporation.

● App will issue 100,000 ordinary shares, which are to be subdivided between gamer and player 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.

Gamer Co. Player Co.

Fair value of net identifiable assets 500,000 380,000
Average annual Earnings 40,000 39,000

1. How much is the total goodwill expected to arise from the business combination?
A. 175,000
B. 100,000
C. 75,000
D. 0

Answer: A

Gamer Co. Player Co. Total

Average Annual Earnings 40,000 39,000
(500,000 x (380,000 x
Normal Earnings on net Assets 5%) -25,000 5%) -19000
Excess Earnings 15,000 20,000
Divide: Capitalization Rate 20% 20%
Goodwill 75,000 100,000 175,000

2. How many shares will be issued to Gamer and player, respectively?

Gamer Co. Player Co.

A. 45,500 54,500
B. 64,500 35,500
C. 25,500 74,500
D. 54,500 45,500

Answer: D
Gamer Co. Player Co.
(500,000 +
Contributions 75,000) 575,000 (380,000 + 100,000) 480,000
(575,000 +
Divide: Total Contributions 480,000) 1,055,000 (575,000 + 480,000) 1,055,000
Percentage 54.50% 45.50%
Multiply: Total number of shares to be
issued 100,000 100,000
Shared to be issued 54,500 45,500

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 3. Which of the combining entities is most likely the acquirer?
A. Gamer Co.
B. Player Co.
C. App Corporation
D. Google Play

Answer: A
Gamer Co. Player Co.
(380,000 +
Contributions (500,000 + 75,000) 575,000 100,000) 480,000
(575,000 + (575,000 +
Divide: Total Contributions 480,000) 1,055,000 480,000) 1,055,000
Percentage 54.50% 45.50%

4. Cloudy Co. plans to acquire all the assets and liabilities of Day Co. Cloudy expects that it will need to pay a
premium equal to the discounted amount of Day’s excess average annual earnings in order to effect the
transaction. The appropriate discount rate is 10%.
● Day’s earnings in the past 5 years:
Year Earnings
20x1 120,000
20x2 130,000
20x3 135,000
20x4 125,000
20x5 140,000____
Total _______650,000_____

● The 20x4 earnings include an expropriation loss of ₱40,000.

● Day’s net assets have a current fair value of ₱590,000.
● The industry average rate of return on net assets is 12%
● The probable duration of “excess earnings” is 5 years.

How much is the estimated price?

A. 932,432
B. 844,741
C. 817,447
D. 798,324

Answer: B

Average Earnings 138,000

Normal Earnings -70,800
Excess Earnings 67,200
Multiply: PV ordinary anuity for 5 periods @10, n=5
3.790786
[-((1.10)^-5)/.10]
Goodwill 254,741
FV of net Assets 590,000
Estimated Purchase Price 844,741

5. Sunday Co. a publicly listed entity, and Monday Co., a private company, exchange equity interests in a business
combination.

● Sunday Co. issues 12 shares for all the outstanding shares of Monday.

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 ● Sunday’s shares are quoted at₱ 60 per share, while Monday’s shares have a fair value of ₱200 per
share.
● The net assets of the entities immediately before the combination are shown below: (The amounts
approximate the acquisition-date fair values)

Equity Sunday Co. Monday Co.

Share Capital:
12,000 ordinary shares, ₱10 par 120, 000
9,000 ordinary shares, ₱100 par 900,000
Retained Earnings 10,000 800,000
Total Equity 130,000 1,700,000

How much is the goodwill?

A. 50,000
B. 60,000
C. 70,000
D. 90,000

Answer: C

Legal Form: Sunday Co issues shares to Monday

Co.
Sunday Co. currently issued shares 12,000 10%
Shares issued to Monday Co. 108,000 90%
Total shares of combination 120,000

Reverse: Moday Co. issues shares to Sunday Co.

Monday Co. currently issued shares 9,000 90%
Shared issued to Sunday Co. 1,000 10%
Total shares of combination 10,000

Consideration transferred 200,000

Total Equity Sunday Co. -130,000
Goodwill 70,000

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