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Business Combination Millan
Business Combination Millan
2. Learning Outcomes
1. Define a business combination.
2. Identify a business combination transaction.
3. Explain briefly the accounting requirements for a business combination.
4. Apply the proper accounting principle for business combination transaction.
5. Compute for goodwill.
6. Compare the difference between the full PFRS and PFRS for SMEs.
the transaction or other events in which an acquirer obtains control of one or more
businesses
B. 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
C. Acquisition Date
E. Acquiree
The business or businesses that the acquirer obtains control of in a business combination
o Acquirer purchases assets and assumes liabilities in exchange for cash or non-
cash consideration
o Under the Revised Corporation Code of the Philippines, a business combination
effected through asset acquisition may be either:
1. Merger
Occurs when two or more companies merge into a single entity which shall be
one of the combining companies.
A Co. + B Co. = A Co. or B Co.
2. Consolidation
occurs when two or more companies consolidate into a single entity which shall
be the consolidated company
A Co. + B Co. = C Co.
B. Stock acquisition
1. Horizontal combination
3. Conglomerate
B. Synergy
o Synergy occurs when the collaboration of two or more entities results in greater
productivity than the sum of the productivity of each constituent working
independently. It can be simplified by the expression 1 + 1 = 3
1. The business combination brings a monopoly in the market which may have a negative
impact on society. This could result in an impediment to healthy competition between
market participants.
2. The identity of one or both of the combining constituents may cease, leading to loss of
sense of identity for existing employees and loss of goodwill.
3. Management of the combined entity may become difficult due to incompatible internal
cultures, systems, and policies.
4. The business combination may result in over-capitalization which may result in diffusion
in market price per share and attractiveness of the combined entity’s equity instruments to
potential investors.
5. The combined entity maybe subjected to stricter regulation and scrutiny by the
government, most especially if the business combination poses threat to consumers’
interests.
As defined in PFRS 3, the business combination is a transaction or other event in which the
acquirer obtains control of one or more businesses.
A. Control
1. The acquirer has the power to appoint or remove the majority of the board of
directors of the acquiree; or
2. The acquirer has the power to cast the majority of votes at board meetings or
equivalent bodies within the acquiree; or
3. The acquirer has power over more than half of the voting rights of the acquiree
because of an agreement with other investors; or
4. The acquirer controls the acquiree’s operating and financial policies because of a
law or an agreement.
B. Business
2. Process
3. Output
the result of input and process that provides investment returns to the
stakeholders of the business
Any investor who acquires some investment needs to determine whether this transaction or event
is a business combination or not.
PFRS 3 requires that assets and liabilities acquired need to constitute a business, otherwise it’s
not a business combination and an investor needs to account for the transaction as a regular asset
acquisition in line with other PFRS.
the acquirer usually the entity that transfers the cash or other assets or
incurs liabilities.
the acquirer is usually the entity that issues its equity interests.
if it is a reverse acquisition, the issuing the entity is the acquiree.
Other pertinent facts and circumstances shall also be considered in
identifying the acquirer in a business combination effected by exchanging
equity interests including the following:
a. Whose owner, as a group, have the largest portion of the voting rights of the combined entity.
b. Whose a single owner or organized group of owners holds the largest minority voting
interest in the combined entity.
c. Whose owners have the ability to appoint or remove a majority of the members of the
governing body of the combined entity
e. That pays a premium over the pre-combination fair value of the equity interests of the other
combining entity or entities.
3. As to size
a. If a new entity is formed to issue equity interests to effect a business combination, one of
the combining entities that existed before the business combination shall be identified as the
acquirer by applying the guidance provided above.
b. In contrast, a new entity that transfers cash or other assets or incurs liabilities as
consideration may be the acquirer
The acquirer shall identify the acquisition date, which is the date on which it obtains
control of the acquiree.
The date on which the acquirer obtains control of the acquiree is generally the date on
which the acquirer legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree—the closing date.
However, the acquirer might obtain control on a date that is either earlier or later than the
closing date. For example, the acquisition date precedes the closing date if a written
agreement provides that the acquirer obtains control of the acquiree on a date before the
closing date. An acquirer shall consider all pertinent facts and circumstances in
identifying the acquisition date.
Recognition Principle
Recognition Conditions
a. Identifiable assets acquired and liabilities assumed must meet the definitions of assets and
liabilities provided under the Conceptual Framework at the acquisition date.
b. It must be part of what the acquirer and acquiree exchanged in the business combination
transaction rather than the result of separate transactions.
c. Applying the recognition principle may result to the acquirer recognizing assets and
liabilities that the acquiree had not previously recognized in its financial statements
Measurement Principle
The acquirer shall measure the identifiable assets acquired and the
liabilities assumed at their acquisition-date fair values.
Separate valuation allowances are not recognized at the acquisition date
because the effects of uncertainty about future cash flows are included in
the fair value measurement.
All acquired assets are recognized regardless of whether the acquirer
intends to use them.
1. Fair value; or
Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that is not individually identified and separately
recognized.
On acquisition date, the acquirer computes and recognizes goodwill or gain on a bargain
purchase using the following formula:
A negative amount resulting from the formula is called “gain on a bargain purchase”
(also
referred to as “negative goodwill”)
On the acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
A. Consideration Transferred
o The consideration transferred is measured at fair value, which is the sum of the
acquisition-date fair values of the assets transferred by the acquirer, the liabilities
incurred by the acquirer to former owners of the acquiree and the equity interests
issued by the acquirer.
1. Cash
2. other assets
3. a business or a subsidiary of the acquirer
4. contingent consideration
5. ordinary or preference equity instruments, options, warrants
6. member interests of mutual entities.
B. Acquisition-related costs
Examples:
1. Finder’s fees
2. Professional fees, such as advisory, legal, accounting, valuation and consulting fees
3. General administrative costs, including the costs of maintaining an internal
acquisitions department
4. Costs of registering and issuing debt and equity securities
1. Costs to issue debt securities measured at amortized costs are included in the initial
measurement of the resulting financial liability.
2. Costs to issue equity securities are deducted from share premium. If the share premium is
insufficient, the issue costs are deducted from retained earnings.
o This pertains to any interest held by the acquirer before the business combination.
This affects the computation of goodwill only in a business combination
achieved in stages (discussed in the next module)
As of January 1, 2020
Assets Carrying amounts Fair values
Cash in bank 20,000 20,000
Receivables 220,000 150,000
Allowance for doubtful accounts (50,000) -
Inventory 510,000 430,000
Building – net 1,500,000 1,200,000
Goodwill 100,000 50,000
Total Assets 2,300,000 1,850,000
Liabilities
500,000 300,000
Accounts Payable
Total Liabilities
500,000 300,000
Assumption #1:
Popoy Co. paid ₱2,000,000 cash as consideration for acquiring the net assets of Basha,
how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Total 2,000,000
Fair value of net identifiable assets acquired (1,500,000)
Goodwill 500,000
Building 1,200,000
Goodwill 500,000
Accounts Payable
Cash in bank
To record the assets
acquired and liabilities
assumed on a business
combination
Assumption #2:
If Popoy Co. paid ₱1,300,000 cash as consideration for the net assets of Basha Co., how much
is the goodwill (gain on bargain purchase) on the business combination? Solution:
Total 1,300,000
Fair value of net identifiable assets acquired (1,500,000)
Assumption #1:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option
to measure non-controlling interest at fair value. The independent consultant
engaged by Popoy Co. determined that the fair value of the 25% non-controlling
interest in Basha Co. is ₱200,000. How much is the goodwill or gain in bargain
purchase on the business combination?
Solution:
Consideration transferred 1,300,000
Non-controlling interest in the acquiree 200,000
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 500,000
Entries are as follows:
To record the acquisition in Popoy’s separate books of accounts:
Jan. 1, Investment in subsidiary 1,300,000
2020 Cash 1,300,000
To include Basha in Popoy’s consolidated financial statements:
Jan. 1, Identifiable assets acquired 1,400,000
20x1 Goodwill 500,000
Liabilities assumed 400,000
Investment in subsidiary 1,300,000
Non-controlling interest Basha 200,000
Co.
Assumption #2:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option
to
measure non-controlling interest at the non-controlling interest’s proportionate share
of Basha’s net identifiable assets.
How much is the goodwill or gain on bargain purchase on the business combination?
Solution:
Consideration transferred 1,300,000
Non-controlling interest in the acquiree 250,000
Previously held equity interest in the acquiree -
Total 1,550,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 550,000
Assumption #1
As consideration for the business combination, Popoy transferred 10,000 of its own
equity instruments with par value per share of ₱100 and fair value per share of ₱120
to Basha’s former owners. Costs of registering the shares amounted to ₱50,000.
How much is the goodwill or gain on bargain purchase on the business combination?
Total 1,200,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 200,000
Note:
The acquisition-related costs are expensed, except for the costs to issue equity
securities which are deducted from share premium.
Solution:
Total 1,200,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 200,000
Entries in the books of the acquirer:
Jan. 1, Identifiable assets acquired 1,600,000
2020 Goodwill 200,000 600,000
Liabilities assumed 1,200,000
Bonds payable
To record the issuance of
bonds as consideration for the
business combination
Solution:
Consideration transferred 1,210,461
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,210,461
Notes:
Basha’s liabilities include ₱100,000 cash dividends declared on December 28, 2019,
to shareholders of record on January 15, 2020, and payable on January 31, 2020.
Total 1,400,000
Fair value of net identifiable assets acquired (900,000)
Goodwill 500,000
For purposes of computing the goodwill, the ₱100,000 payment is excluded from the
consideration transferred because this is not a payment for the business combination,
but rather for the purchased dividends.
Journal entries:
Jan. 1, Identifiable assets acquired 1,500,000
2020 Goodwill 500,000
600,000
Liabilities assumed (including
dividends) 1,400,000
Cash
The costs above are sometimes referred to as “liquidation costs”. However, a restructuring
provision does not include such costs as:
2. Marketing, or
I. Operating Leases
General rule:
The acquirer shall not recognize any assets or liabilities related to an operating lease in which
the acquiree is the lessee.
Exception:
The acquirer shall determine whether the terms of each operating lease in which the acquiree is
the lessee are favorable or unfavorable.
If the acquiree is the lessor, the acquirer shall not recognize any separate intangible asset or
liability regardless of whether the terms of the operating lease are favorable or unfavorable when
compared with market terms.
Assumption #1:
Popoy is renting out a building to Basha under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
estimated at ₱50,000.
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 (1,050,000)
Goodwill 450,000
The fair value of the net identifiable assets acquired is computed as follows:
FV of identifiable assets acquired, including intangible asset on the operating
lease with favorable terms 1,650,000
FV of liabilities assumed (600,000)
Fair value of net identifiable assets acquired 1,050,000
Assumption #2:
Popoy is renting out a patent to Basha under operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential is
estimated at ₱50,000.
How much is the goodwill or gain on bargain purchase?
Total 1,500,000
Fair value of net identifiable assets acquired (950,000)
Goodwill 550,000
Assumption #3:
Popoy is renting a building from Basha under operating leases. The terms of the
operating lease compared with market terms are favorable. The fair value of the
differential is estimated at ₱50,000.
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 (1,000,000)
Goodwill 500,000
No intangible asset or liability is recognized, regardless of the terms, because the
acquiree is the lessor.
The acquirer recognizes, separately from goodwill, the identifiable intangible assets acquired in a
business combination. An intangible asset is identifiable if it is either (a) separable or (b) arises
from contractual or other legal rights
A. Separability criterion
An intangible asset is separable if it is capable of being separated from the acquiree and sold,
transferred, licensed, rented or exchanged, either individually or together with a related contract,
identifiable asset or liability.
1. The exchange transactions are infrequent and regardless of whether the acquirer is
involved in them, as long as there is evidence of exchange transaction for that type of
asset or similar type; or
2. The acquirer does not intend to sell, license or otherwise exchange the identifiable
intangible asset
B. Contractual-legal criterion
An intangible asset that is not separable is nonetheless identifiable if it arises from contractual or
other legal rights
Example:
Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity B’s
license to operate the nuclear power plant. However, the terms of the license prohibit Entity A
from selling or transferring the license to another party.
Analysis: The license is an identifiable intangible asset because, although it is not separable, it
meets the contractual-legal criterion.
Additional information:
The computer software is considered obsolete
The patent has a remaining useful life of 10 years and a remaining legal life
of 12 years.
Basha Co. has research and development (R&D) projects with fair value of
₱50,000. However, Basha recognized the R&D costs as expenses when they
were incurred.
Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (830,000)
Goodwill 170,000
An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree has
already expensed the related costs.
Additional information:
Customer contract #1 refers to an agreement between Basha and a customer,
wherein Basha is to supply goods to customer for a period of 5 years. The
remaining period of the contract is 3 years. The agreement is expected to be
renewed at the contract-end but is not separable.
Total 1,500,000
Fair value of net identifiable assets acquired (1,200,000)
Goodwill 300,000
The requirements of PAS 37 do not apply when accounting for contingent liabilities
related to the business combination as of the acquisition date.
Under PFRS 3, a contingent liability assumed in a business combination is recognized if:
Therefore, contrary to PAS 37, the acquirer recognizes a contingent liability assumed in
business combination at the acquisition date even if it is NOT probable that an outflow of
resources embodying economic benefits will be required to settle the obligation. As long
as both the conditions above are satisfied, a contingent liability will be recognized.
Basha has a pending litigation, for which no provision was recognized because Basha
strongly believes that it will win the case. The fair value of settling the litigation is ₱50,000.
Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree 100,000
Previously held equity interest in the acquiree -
Total 1,100,000
Fair value of net identifiable assets acquired (950,000)
Goodwill 150,000
The adjusted fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired 1,600,000
Total fair value of liabilities assumed:
Fair value of liabilities assumed 600,000
Contingent liability (pending litigation) 50,000 (650,000)
Fair value of net identifiable assets acquired 950,000
The contingent liability is recognized even if it is NOT probable because it (a) represents a
present obligation and (b) has fair value.
The following items shall be recognized and measured as at acquisition date under other
applicable standards:
1. Income taxes
are accounted for using PAS 12 Income Taxes. For example, deferred taxes are measured
based on temporary differences arising from the measurement of identifiable assets and
liabilities assumed by the acquirer at the acquisition date.
Deferred taxes affect the amount of goodwill or gain on bargain purchase recognized at
the acquisition date. However, PAS 12 prohibits the recognition of deferred tax liabilities
arising from the initial recognition of goodwill.
are accounted for using PAS 19 Employee benefits. For example, defined benefit
obligations are measured through actuarial valuations.
3. Indemnification assets
arises when the former owners of the acquiree agree to reimburse the acquirer for any
payments the acquirer eventually makes upon settlement of liability.
The acquirer shall recognize an indemnification asset at the same time and on the same
basis as the indemnified item.
Accordingly, if the indemnified item is measured at fair value, the indemnification asset
is also measured at fair value. If the indemnified item is measured at other than fair value,
the indemnification asset is measured using assumptions consistent with those used to
measure the indemnified item.
Example:
Entity A acquires Entity B. At the acquisition date, the taxing authority is disputing Entity B’s
tax returns in prior years. The former owners of Entity B agree to reimburse Entity A in case
Entity A will be held liable to pay Entity B’s tax deficiencies in the prior years.
At the acquisition date, Entity A recognizes a tax liability to the taxing authority and an
indemnification asset for the reimbursement due from the former owners of Entity B
A. Reacquired rights
Reacquired rights are measured based on the remaining term of the related contract. (Discussed
in the next chapter)
Liabilities and equity instruments related to the acquiree’s share-based payment transactions are
accounted for using the PFRS 2 Share-based payment.
A non-current asset (or disposal group) that is classified as held for sale at the acquisition date
at fair value less costs to sell in accordance with PFRS 5 Non-current Assets Held for sale and
Discontinued Operations, rather than at fair value under PFRS 3.