er TABLE OF CONTENTS CHAPTER 1 BUSINESS CoM BUSINESS COMBINATION . Control Business « Identifying a business combinatio1 COUNTING FOR BUSINESS COMBINATION Identifying the acquirer Determining the acquisition date.. Recognizing and measuring goodwill Consideration transferred. Acquisition-related cost: Non-controlling interest... Previously held equity interest in the acquiree Net identifiable assets acquired RESTRUCTURING PROVISIONS..... SPECIFIC RECOGNITION PRINCIPLES 1, Operating leases...... 2. Intangible assets... EXCEPTION TO THE RECOGNITION PRINCIPLE — CONTINGENT LIABILITIES. 31 EXCEPTIONS TO BOTH THE RECOGNITION AND MEASUREMENT PRINCIPLES BINATIONS (PART 1) ..--:--+essevseeeesseeee 7 A Additional concepts on Consideration transferred. EXCEPTIONS TO THE MEASUREMENT PRINCIPLE, CHAPTER 1: SUMMARY FULL PFRS vs. PFRS FOR SMES Vs. PFRS FOR SES PROBLEMS...viii CHAPTER 2 BUSINESS COMBINATIONS (PART 2) ... SHARE-FOR-SHARE EXCHANGES BUSINESS COMBINATION ACHIEVED IN STAGES..... BUSINESS COMBINATION WITHOUT TRANSFER OF CONSIDERATION MEASUREMENT PERIOD... DETERMINING WHAT IS PART OF THE BUSINESS COMBINATION TRANSACTION .... Reacquired rights. Settlement of pre-existing relationship SUBSEQUENT MEASUREMENT AND ACCOUNTING . Reacquired rights... Indemnification assets. Contingent liabilitie: Contingent consideration . CHAPTER 2: SUMMARY PROBLEMS:. CHAPTER 3 BUSINESS COMBINATIONS (PART 3)......... SPECIAL ACCOUNTING TOPICS FOR BUSINESS COMBINATION . GOODWILL... Due diligence .. Methods of estimating goodwill. REVERSE ACQUISITIONS ....... te CHAPTER 3: SUMMARYCHAPTER 4 TED FINANCIAL STATEMENTS (PART 1 consoLIOAT™ im Administrative rights. Unilateral rights..... protective rights substantive rights Voting rights.. potential voting rights. Substantive removal and other rights held by other parties . Exposure or rights to variable returns..... Ability to use power to affect investor's returns .. ACCOUNTING REQUIREMENTS .. Reporting dates .. Uniform accounting policies Consolidation period.. Measurement .... Income and expenses. Investment in subsidiai NON-CONTROLLING INTERESTS (NCI PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATION AT DATE OF ACQUISITION CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION Step 1: Analysis of subsidiary’s net assets. Step 2: Goodwill computation Step 3: Non-controlling interest in net assets. Step 4: Consolidated retained earnings. Step 5: Consolidated profit or loss. Suasioiary’s CUMULATIVE PREFERENCE SHARE: Chapter 4: SUMMARY... FULL PERS vs. PFRS FoR SMES Vs. PFRS For SESess combinations (Part 1) , Chapter 1 Business Combinations (Part 1) Related standards: PERS 3 Business Combinations Section 19 of the PFRS for SMEs Overview on the topic Our discussion on business combinations is subdivided into the following chapters: Chapter Title Coverage 1 Business Combinations (Part 1) Recognition & measurement 2. Business Combinations (Part 2), Specific cases 3 Business Combinations (Part 3) Special accounting topics Learning Objectives 1. Define a business combination. 2. Explain briefly the accounting requirements for a business combination. . Compute for goodwill. Introduction A business\comibination 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 company_that_obtains control over the other is referred to aNth¢parent or acquire F oF acquirers The other company: thatiis Business combinations are Walttige aU SiNEPERFOURH: 1. Asset acquisition; or — 2 Stock acquisition2 . nthe aeauire urease THe aS q r other non-cash consideration (which may be the acquirer, own shares). After the acquisition, the acquired enti normally ceases to exist as a separate legal or accountin, entity. The acquirer records the assets acquired and liabilities assumed in the business combination in its books of accounts, Under the Corporation Code of the Philippines, a business combination effected through asset acquisition may be either: a. Merger ~ occurs when i ‘hich shall be For example(X Co, +B Co, =A Co. or-B Co. b. Consolidation — occurs when Pahies Sal aceeemmmmens consolidated company ACo.+BCo.=CCo, > Stock acquisition — instead of acquiring the assets and assuming the liabilities of the acquiree, the acquirer ; n cont: iri a wi . For examp! @ stock acquisition, the acquirer is knowr Coarent syhile the acquinee i hs the business combination the parent and th their . However, for purposes, the parent and the subsidiary are viewed as a After the business combination, the parent and subsidiary continue to maintain their separate books of accounts, recording Separately their assets, liabilities and the transactions they enter in rest as in its separate books of accounts. However, the investment is eliminated when the group Prepares consolidated financial statements,se combinations (Part D , .g., a bank acquires another business combination of two or more bal + Wet opesins at diferent levels in a marketing chan, ©, uires its supplier of raw materials. a manufacturer acq of two or more entities eg. a real estate developer acquires abank. Advantages of a business combination Competition is eliminated or lessened ~ competition between the combining constituents with similar businesses is eliminated while the threat of competition from other market participants is lessened. a. Synergy — synergy occurs when the collaboration of two or more entities results to greater productivity than the sum of the productivity of each constituent working independently. Synergy is most commonly described as “the whole is greater than the sum of its parts.” It can be simplified by. the expression “1 plus 1=3.” Increased business opportunities and earnings potential — business opportunity and earnings potential may be increased through: i. an increased variety of products or services available and a decreased dependency on limited number of products and services; widened dispersion of products or services and better access to new markets; access to either of the acquirer's or acquiree’s technological know-hows, research and development, secret processes, and other information;4 Chapter 1 $ave iv. increased investment opportunities due to increas capital; or ¥. appreciation in worth due to an established tracle name by either one of the combining constituents. d. Reduction of operating costs - operating costs of the combineg entity may be reduced. i. Under a horizontal combination, operating costs may by reduced by the elimination of unnecessary duplication of costs (e.g., cost of information systems, registration ang | licenses, some employee benefits and costs of outsourced | services). i ii, Under a vertical combination, operating costs may be reduced by the elimination of costs of negotiation and coordination between the companies and mark-ups on purchases. e, Combinations utilize economies of scale - economies of scale refer to the increase in productive efficiency resulting from the increase in the scale of production. An entity that achieves economies of scale decreases its average cost per unit as production is increased because fixed costs are allocated over an increased number of units produced. Cost savings on business expansion — by acquiring another company rather that creating a new one, an entity can save on start-up costs, research and development costs, cost of regulation and licenses, and other similar costs: Moreover, a business combination may be effected through exchange of equity instruments rather than the transfer of cash or other Tesources. 8 Favorable tax implications — deferred tax assets may be transferred in a business combination. Also, business combinations effected without transfers of considerations may not be subjected to taxation. oaEe — Combinations (Part 1) ; usin os i vantages of a business combination Disa combination brings monopoly in the market which Business © ation i ! have a negative impact to the society. This could result to may he mt to healthy competition between market impedime participants. - / The identity of one or both of the combining constituents may bane leading £0 loss of sense of identity for existing cease, employees and loss of goodwill. ; Management of the combined entity may become difficult due to incompatible internal cultures, systems and policies. d, Business combination may result in overcapitalization, which, in turn, may result to diffusion in market price per share and attractiveness of the combined entity’s equity instruments to potential investors. The combined entity may be subjected to stricter regulation and scrutiny by the government, most especially if the business combination poses threat to consumers’ interests. Business Combination Business combinations are accounted for under PFRS 3 Business Combinations. PFRS 3 defines a business combination as “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. The following are the essential elements in the definition of a business combination , 1. Control 2 Business Control a investor controls an investee when the investor has the power ° direct the investee’s relevant activities (j.e., operating and in a ae Nancing policies), thereby affecting the variability of the investor's “stor's investment returns from the investee. a6 Chapter 1 Control is normally presumed to exist when the acquire, holds more than 50% (or 51% or more) interest in the acquiree', voting rights. However, this is only a presumption because contro can be obtained in some other ways, such as when: a. the acquirer has the power to appoint or remove the majority of the board of directors of the acquiree; or b. the acquirer has the power to cast the majority of votes a board meetings or equivalent bodies within the acquire; or c. the acquirer has power over more than half of the voting rights of the acquiree because of an agreement with: other investors; or d. the acquirer controls the acquiree’s operating and financial policies because of a law or an agreement. ‘An acquirer may obtain control of an acquire in a variety of ways, for example: a. by transferring cash or other assets; b. by incurring liabilities; c. by issuing equity interests; d. by providing more than one type of consideration; or e. without transferring consideration, including by contract alone. Illustration: Determining the existence of control Example 1 ABC Co. acquires 51% ownership interest in XYZ, Inc.'s ordinary shares. Z Analysis: ABC is presumed to have obtained control over x because the ownership interest acquired in the voting rights ° XYZ is more than 50%. Example 2 ABC Co. acquires 100% of XYZ, Inc.’s preference shares.< combinations (Part D z jess Combing iOT ABC does not obtain control over XYZ because lysis’ "ares do not give the holder voting rights over the oronce ; feren cLoperating policies of the investee, ncial ane te 3 ai ‘ ; nae acquires 40% ownership interest in XYZ, Inc. There is an Co. ith the other shareholders of XYZ, that ABC will come’ appointment of the majority of the board of directors trol the XYZ. alysis; ABC has control over XYZ because, even though the ership interest is only 40%, ABC has the power to appoint the ajority of the board of directors of XYZ. ample 4 BC Co. acquires 45% ownership interest in XYZ, Inc. ABC has an eement with EEG Co., which owns 10% of XYZ, whereby EFG ill always vote in the same way as ABC. nalysis: ABC has control over XYZ because it controls more than of the voting rights over XYZ (ie, 45% plus 10%, per greement with EFG). ample 5 BC Co. acquires 50% of XYZ, Inc.'s voting shares. The board of irectors of XYZ consists of 8 members. ABC appoints 4 of them 'd XYZ appoints the other 4. When there are deadlocks in asting votes at meetings, the decision always lies with the “rectors appointed by ABC. "alysis: ABC has control over XYZ because it controls more than % Fe 3 aie Hee the voting rights over XYZ in the event there is no majority lon,Ss smwery! set of activities and assets that is Capabl, | sseery and managed for the purpose of Providing | = sees fo customers, generating investment income SS as tividends or interest) or generating other income fron eaeey activities.” (PFRS 3.Appendix A) A business has the following three elements: Input — any economic resource that results to an output when, one or more processes are applied to it, ©.g., non-current assets, intellectual property, the ability to obtain access to necessary materials or rights and employees. 2. Process - any system, standard, Protocol, convention or Tule that when applied to an input, creates an output, e.g, strategic management processes, operational Processes and resource management processes, Administrative systems, e, * accounting, _ billing, payroll, and the like, are not processes used to create outputs, Output ~ the result of 1 and 2 above th ‘at provides goods or services to customers, investment income or other income from ordinary activities, Identifying a business combination An entity determines wheth combination in relation to the If the assets not constitute cr a transaction is a business definition Provided under PERS 3, acquired (and re| 4 busines a regular asset Accordingly, the PAS 2 for inve , the e acquisition and not a business combination. entity applies other applicable Standards (eg, MOries acquired, PAS 16 for PPE acquired, etc) Accounting for bu: Business combin, method. This met a siness combination AIONS are sccounted for using the acquisition thod requir a es the following: 'dentifying the acquirer - | i. Ss, Jaled liabilities assumed) do | Nlily avcounts tor the transaction as | mere epee EREmins ess Cont Busines ning the acquisition date; and b. peter and measuring goodwill. This requires Reeve ing ‘and measuring the following: recogn'” Consideration transferred ; Non-controlling interest in the acquiree previously held equity interest in the acquiree Identifiable assets acquired and liabilities assumed on the business combination. Identifying the acquirer For each business combination, one of the combining entities is identified as the acquirer. The acquirer is the entity that obtains control of the acquiree. The acquiree is the business that the acquirer obtains control of in a business combination. PERS 3 provides the following guidance in identifying the acquirer: a, Who is the transferor of cash or other resources or assumes linbilities? + Ina business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities, . - Who is the issuer of shares? In a business combination effected primarily by exchanging “quity interests, the acquirer is usually the entity that issues is equity interests. However, in some business combinations, a “reverse acquisitions,” the issuing entity is the acquire. Pertinent facts and circumstances shall also be con ent fact tenn in identifying the acquirer. The acquirer is usually uy) * ” wh hose owners, as a group, have the largest portion of the Voting ri ting rights of the combined enti ty.a OS | 10 Chapter 1 | » whose owners have the ability to appoint or renore A majority of the members of the governing body of the combined entity. > whose (former) management dominates the management of the combined entity. nation fa > that pays a premium over the pre-combination fair value of the equity interests of the other combining entity or entities. ©. Who is larger? 7 * The acquirer is usually the larger between the combining entities, measured in, for example, assets, revenues or profit., d. Who is the initiator of the combination? The acquirer is usually the one who initiated the combination, e. Substance over form Lf a new entity is formed to effect the business combination, | the acquirer is identified as follows: i > if the new entity is formed to issue equity interests to effect thé business combination, one of the combining entities that existed before the business combination is the acquirer. » if the new entity is formed to transfer cash or other assets or incur liabilities as consideration for the business | combination, the new entity is the acquirer. Example: A Co. +B Co. =C Co, (new entity) » IEC Co. is formed to issue equity interests to A Co. and B Co. the acquirer is either A Co. or B Co., whichever company whose former owners, as a group, gain control over CCo, If C Co. is formed to transfer cash to A Co. and B Co,, the acquirer is C Co,combinations (Part 1) ess Combinations (Par pusi 11 Illustration: Identifying the acquirer ABC CO. and XYZ, Inc., both listed entities, agreed to combine their businesses: Under the terms of the agreement, ABC will offer 5 shares for every share of XYZ (there is no cash consideration) and after the combination, the board of directors of XYZ shall comprise only directors from ABC. On acquisition date, ABC’s market capitalization was P900 million and XYZ’s was P100 million. Three months after the acquisition, 20% of XYZ was sold. Analysis: ABC is the acquirer based on the following indicators: ¥ ABC is the issuer of shares and the initiator of the business combination. ¥ ABCis the larger entity of the two combining constituents. ¥ ABC's (former) management dominates the management of the combined entity. Y The fact that part of XYZ is sold after the acquisition provides an additional indicator that ABC is the acquirer. Determining the acquisition date The acquisition date is the date on which the acquirer obtains control of the acquiree. This is normally the closing date (i.e. the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquire). However, the acquirer might obtain control’ on a date that is either earlier or later than the closing date, for example, when there is a written agreement to that effect. Recognizing and measuring goodwill On acquisition date, the acquirer computes and recognizes at (or gain on a bargain purchase) using the following mula:Ss 12 Chapter 1 Consideration transferred xx Non-controlling interest (NCI) in the acquiree x Previously held equity interest in the acquiree Xx Total : 2 Less: Fair value of net identifiable assets acquired (x) Goodwill / (Gain on a bargain purchase) xx . —a A negative amount resulting from the formula is called “gain on a bargain purchase” (also referred to as “negative goodwill), ‘A bargain purchase may occur, for’ example, in a business combination that is a forced sale in which the acquiree is acting under compulsion. A negativ application of PERS 3's recognition and measurement exceptions for particular items. e amount may also result from the Gn acquisition date, the acquirer recognizes a resulting: a. Goodwill as an asset. b. Gain on a bargain purchase as gain in profit or loss. However, before recognizing a gain on a bargain purchase, PFRS 3 requires the acquirer to reassess whether it has correctly identified all the assets acquired and all the liabilities assumed and recognize any additional assets or liabilities that are identified in that review. This is an application of the concept of conservatism. Consideration transferred The consideration transferred in a business combination 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 the former owners of the acquiree and the equity interests issued by the acquirer. dlsof potential forms of consideration include: " -cash assets | Be instruments, €-B., shares, options and warrants Equity ‘A business OF asubsidiary of the acquirer Contingent consideration isition-related costs f A jsition-related costs are costs that the acquirer incurs to effect a quis business combination. Examples: Finder's fees b. professional fees, such as advisory, legal, accounting, * uation and consulting fees c General administrative costs, induding the costs of + ee aining an internal acquisitions department d. Costs of registering and issuing debt and equity securities Acquisition-related costs are expensed when incurred, except for the following: Costs to issue debt securities measured at amortized cost are induded in the initial measurement of the’ securities, e.g, bond issue costs are included (as deduction) in the carrying amount of bonds payable. b. Costs to issue equity securities are deducted from share premium. If share premium is insufficient, the issue costs are deducted from retained earnings. a Non-controlling interest Non-oontrolting interest (NCI) is the “equity in a subsidiary not attributable, directly or indirectly, to a parent.” (PFRS 3.Appendix A) Non-controlling interest is also called “minority interest.” ” For example, ABC Co. acquires 80% interest in XYZ, Inc. es interest is 80%, while the non-controlling interest tne ee % + 80%). IF ABC Co. acquires 100% interest in XYZ, “Me non-controlling interest is zero.Oo - Chapter 1 For each business combination, the acquirer measures any non-controlling interest in the acquiree either at: a. fair value; or b._ the NCI’s proporti assets. ionate share in the acquiree’s net identifiabl, Previously held equity interest in the acquiree , the acquiree pertains to any Previously held equity interest in ae interest held by the acquirer before the business combination. This affects the computation of goodwill only in business combinations achieved in stages. Net identifiable assets acquired Recognition principle On acquisition date, acquired, the liabilities assume separately from goodwill. The acquire unidentifiable assets, such as: Goodwill recorded by the acquiree pri combination. b. Assembled workforce of the acquire. Potential contracts that the acquiree is negotiating with prospective new customers at the acquisition date. the acquirer recognizes the identifiable assets d and any NCI in the acquiree r does not recognize a ior to the business © Recognition conditions a. To qualify for recognition, identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities provided under the Conceptual Framework at the acquisition date. For example, obliged to incur in the future to effect its pl acquiree’s activity or to terminate or relocate the acquiree’s employees are not liabilities at the acquisition date. Hence: these are not recognized when applying the acquisitio" method but rather treated as post-combination costs in accordance with other applicable Standards. costs that the acquirer expects but is nol jan to exit thens Part 15 shinatton able assets acquired and liabilities assumed must hat the acquirer and the acquiree (or its former d in the business combination transaction The identifi be part of W sqeners) exchange’ 1 ther than the result of separate transactions. ra b the recognition principle may result to the acquirer recognizing, assets and liabilities that the acquiree had not previously recognized in its financial statements. For example, the acquirer may recognize an acquired e asset, such as a brand name, a patent or a customer relationship, that the acquiree did not recognize as an asset in its financial statements because it has developed the intangible internally and charged the related costs as expense. Applying, intangibl asset Classifying identifiable assets acquired and liabilities assumed Identifiable assets acquired and liabilities assumed are classified at the acquisition date in accordance with other PFRSs that are to be applied subsequently. For example, PPE acquired in a business combination are dassified at the acquisition date in accordance with PAS 16 if the assets are to be used as PPE subsequent to the acquisition date. Measurement principle Identifiable assets acquired and liabilities assumed are measured at their acquisition-date fair values. Separate valuation allowances are not recognized at the acquisition date because the effects of uncertainty about future pau aa are included in the fair value measurement. For ete scquirer does not recognize - “allowance for bic a on accounts receivable acquired ona business ee eae) Instead, ; the acquired accounts receivable are at their acquisition-date fair values. he mi assets are recognized regardless of whether "ecognizes et intends to use them. For example, the acquirer le acquiree’s research and development (R&D) costsee | 16 Chapter 1 as intangible asset even if it does not intend to use them or intends to use them in some other way. The acquisition-date fair value of such assets is determined in accordance with their use by other market participants. Illustration 1: Goodwill / Gain on bargain purchase Fact pattern On January 1, 20x1, ABC Co. acquired all the assets and assumed all the liabilities of XYZ, Inc. On acquisition date, the carrying amounts and fair values of XYZ’s assets and liabilities are as follows: Assets Carrying amounts Fair values Petty cash fund P10,000 P10,000. 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 P1,800,000 - P1,600,000° Liabilities i Payables . 400,000 400,000 In negotiating the business combination, ABC Co. incurred 100,000 for legal, accounting and consultancy fees. Case L ABC Co. paid P1,500,000 as consideration for the assets and liabilities of XYZ, Inc. How much is the goodwill (gain on bargain purchase) on the business combination? Solution:17 anon transferred 1,500,000 erat ang interest (NCI) in the acquire . mi eld equity interest in the acquire a pecs 1,500,000 oll og net identifiable assets acquired (4,180,000). ae 320,000 aque of assets acquired excluding acquiree's ~ Fa ged goodwill (1,600,000 ~ 20,0000) 1,580,000 sar value of liabilities assumed (400,000) rar ao et identifiable assets acquired P1,160,000 Nir re is no NCI because ABC acquired 100% of XYZ. Previously held equity interest in the acquiree affects the computation of goodwill only in business combinations achieved in stages. This is discussed in the next chapter. ‘The entries in the books of ABC Co. (the acquirer) are as follows: [ian 1 | Petty cash fund 10,000 | 2011 | Receivables 120,000 | Payables 400,000 Cash 1,500,000 - Cash 100,000 lo record the acquisition-related costs Inventory 350,000 Building 1,100,000 | Goodwill 320,000 | to record the assets acquired and ___ lates assumed in a business combination “|. | Professional fees expense 100,000 * Notes: No allowance is recorded for the acquired receivables because the Ta Wables are recognized at acquisition-date fair value, Th, Suuisition-related costs are expensed. ‘he 'ikistration above is an example of a business combination effected , "ugh “asset acquisition.”ee oe » 18 Chapter 1 XYZ, Inc. (the acquiree) accounts for the business combination as a liquidation of its business. The entries in XYZ’, books are as follows: Jan. 1, | Cash 1,500,000 201 | Allowance for doubtful accounts 30,000 Payables 400,000 Petty cash fund 10,000 Receivables 200,000 Inventory 520,000 Building 1,000,000 Goodwill 100,000 100,000 Gain on disposal of business to record the liquidation of the business Jan.1, | Share capital (& other equity accounts) | 1,400,000 20x1 (1.8M - 4M) Gain on disposal of business 100,000 1,500,000 Cash fo record the settlement of owners’ equity Case 2: ABC Co. paid 1,000,000 as consideration for the assets and liabilities of XYZ, Inc. How much is the goodwill (gain on bargain purchase) on the business combination? Solution: Consideration transferred P1,000,000 Non-controlling interest in the acquiree : Previously held equity interest in the acquiree : 7,000,000 Total Fair value of net identifiable assets acquired Gain on a bargain purchase (1,180,000) P (180,000) — ABC Co. reassesses first whether it has correctly identified all the assets acquired and liabilities assumed. If after the Teassessment a negative amount still exists, ABC Co. recognizes that amount as gain in its 20x1 profit or loss. The entries are a3 follows: —_ |auildi's 400000 1,000,000 180,000 T | fees expense 100,000 ba |e 100,000 | Cash | | Gain on bargain purchase pilustration Fact pate 0x1, ABC acquired 80% of the voting shares of ae is this date, XYZ’s identifiable assets and liabilities ela values of PI,200,000 and P400,000, respectively. 2; Non-controlling interests (NCD Case 1.1: NCI measured at fair value ‘the consideration transferred is 1,000,000. ABC Co. elects to ineasure non-controliing interest at fair value. The independent vonsultant engaged by ABC Co. determined that the fair value of the 20% NCI is P155,000. How much is the goodwill? = Solution: Consideration transferred 1,000,000 Non-controlling interest in the acquire (fair ualue) 155,000- Previously held equity interest in the acquire - Total 1,155,000 Fair value of net identifiable assets acquired (800,000) Gooduwill 355,000 | The Entries are as follows: | ph ylozecord the acquisition in ABC’s separate books of accounts: mq | /tVestment in subsidiary a aie 1,000,000 a20 Chapter 1 BP >_ To include XYZ in ABC's consolidated financial statements; be 1] Identifiable assets acquired 1,200,000 ‘1! Goodwill 355,000 Liabilities assumed 400,009, Investment in subsidiary 1,000,009 | Non-controlling interest in XYZ, Inc. 155,009 | & Notes: © The NClis presented in the con: within equity but separately from the equity (parent), © The illustration above is an through “stack acquisition.” solidated statement of financial position of the owners of ABC Co, example of a business combination effected Case 1.2: NCI measured at fair value The consideration transferred is P1,000,000. ABC Co. elects to measure NCI at fair value. A value of P250,000 is assigned to the NCI [(P1M + 80%) x 20% = 250,000]. How much is the goodwill? | Solution: Consideration transferred ~ P1,000,000 250,000 Non-controlling interest in the acquire (fair value) Previously held equity interest in the acquire : 1,250,000 Total Fair value of net identifiable assets acquired (800,000) Goodwill P450,000 . — Case 3: NCI’s proportionate share in net assets The consideration transferred is P1,000,000. ABC Co. elects to measure NCI at the NCI’s proportionate share in XYZ’s ret | identifiable assets. How much is the goodwill? __ Solution: Consideration transferred 1,000,000 160,000 Non-controlling interest in the acquiree Previously held equity interest in the acquiree Total - 1,160;21 entifiable assets acquired (1.2M - 400k) (800,000) aque of net id pair VO" 360,000 Gooteill a jue of net identifiable assets acquired (1.2M - 400K) 800,000 Fa any: Non-controlling interest 20% em ortionate share in net identifiable assets P160,000 ncr's pilustration 3: Transaction costs act patter . On January 1, 20x1, ABC acquired all the assets and assumed a the liabilities of XYZ, Inc. On this date, XYZ’s assets and liabilities have fait values of 1,600,000 and 900,000, respectively. ABC incurred the following acquisition-related costs: legal fees, 10,000, due diligence costs, P100,000, and general administrative costs of maintaining an internal acquisitions department, P20,000. ‘As consideration for the business combination, ABC Co. transferred 8,000 of its own equity instruments with par value per share of P100 and fair value per share of P125 to XYZ’s former owners. Costs of registering the shares amounted to P40,000. How much is the goodwill? Case 1: Solution: Consideration transferred (8,000 sh. x P125) P1,000,000 Non-controlling interest in the acquiree . - Previously held equity interest in the acquiree e Total 1,000,000 Fair value of net identifiable assets acquired (1.6M-.9M) (700,000) Goodwill P300,000 Journal entries. ae Identifiable assets acquired 1,600,000 Goodwill 300,000 Liabilities assumed 900,000 Share capital (6,000 x P100 par) 800,000 Share premium 200,000 to record the issuance of shares as consideration for the business combinationJ us Chapter 1 Jan. 1, | Share premium 40,000 zeal Cash 40,0) to record the casts of equity transaction Jan. 1, | Professional fees expense (10K + 100K) 710,000 20x1 | General and administrative costs 20,000 Cash 130,00) to record the acquisition-related costs costs are expensed, except for the stock ¥ Note: The acquisition-related s issuance costs which are deducted from share premium. Case 2: As consideration for the business combination, ABC Co, d fair value of P1,000,000, issued bonds with face amount an Transaction costs incurred in issuing the bonds amounted to| | P50,000. How much is the goodwill? Solution: Consideration transferred (fair value of bonds) P 1,000,000 Non-controlling interest in the acquiree Previously held equity interest in the acquiree : 1,000,000 Total Fair value of net identifiable assets acquired (1.6M -.9M) (700,000) Goodwill P300,000 Journal entries: Jan. 1, | Identifiable assets acquired 1,600,000 20x1 | Goodwill 300,000 Liabilities assumed 900,000 Bonds payable 1,000,000 | to record the issuance of bonds as consideration for the business combination Jan. 1, | Bond issue costs 50,000 20 Cash 50,000 to record the bond issue costs Jan. 1, | Professional fees expense (10K + 100K) 110,000 20x1 | General and administrative costs 20,000 s Cash 130,000ppinations (Part usin SNE gd iseve costs. are deducted from the face amount when 6 omg the carrying amount of the bonds deteor™ omputing for goodwill, the consideration transferred is measured ‘air value of the securities issued without deduction for the at the (ar costs, Thus, in both cases above, the acquisition-related costs, the costs of issuing equity and debt securities, do not affect the tion of goodwill. when © transact including computal estructuring provisions ' “rng is a program that is planned and controlled by and materially changes either: of a business undertaken by an entity; or hich that business is conducted. Restruct management, _ the scope b, the manner in 1 Restructuring provisions may include the costs of an entity's plan to exit an activity of the acquiree, to involuntarily terminate employees of the acquiree, or to relocate non-continuing employees of the acquiree. a. b. cs The costs above are sometimes referred to as “liquidation costs.” : Restructuring provisions do not include such costs as (a) retraining or relocating continuing staff, (b) marketing; or (c) | investment in new systems and distribution networks. R is are gener not recognized as f business combination unless the ac acq MeO Sting liability for restructuring that has been recognized in accordance with PAS 37 Provisions, Contingent Liabilities and Contingent Assets. A restructuring provision meets the definition of a liability at the acquisition date if the acquirer incurs a present obligation to ima the restructuring costs assumed, such as when the acquiree a ac a detailed ‘formal plan for the restructuring and raised re Srpectation in those affected that the restructuring will be be fe by publicly announcing the details of the plan or has plementing the plan on or before the acquisition date. >24 Chapter 1 Suse If the acquiree’s restructuring plan is conditional on jt being acquired, the provision does not represent a presen; obligation, nor is it a contingent liability, at acquisition date. Restructuring provisions that do not meet the definition of a liability at the acquisition date are recognized as post. combination expenses of the combined entity when the costs are incurred. Illustration: Restructuring provisions On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. On this date, XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000, respectively, ABC Co. has estimated restructuring provisions of P200,000 representing costs of exiting the activity of XYZ, including costs of terminating and relocating the employees of XYZ. Requirement: Compute for the goodwill. Soliition: Consideration transferred 1,000,000 Non-controlling interest in the acquiree - Previously held equity interest in the acquiree 2 Total 1,000,000 Fair value of net identifiable assets acquired (1.6M - 9M) (700,000) Goodwill P300,000 % Nate: The restructuring provisions are simply ignored in the computation of goodwill. These are considered only when they qualify for recognition under PAS 37 as at the acquisition date (see discussion above). Restructuring provisions that do not meet the recognition criteria as at the acquisition date are recognized as post-combination expenses (ie., expenses after the business combination).Combinations (Part 1) s psi c recognition principles ifi des the following, specific recognition Principles 3 provi ‘ing leases 1 operating uiree is the lessee cs General rule: : / irer does not recognize any assets or liabilities related to e acqui ks as y mm perating lease in which the acquiree is the lessee, al Exception: " The acquirer determines whether the terms of each operating lease in which the acquiree is the lessee are favorable or unfavorable. If the terms of an operating lease relative to market terms is: 1, Favorable — the acquirer recognizes an intangible asset. 2. Unfavorable — the acquirer recognizes a liability. For example, an identifiable asset (favorable) may arise when market participants are willing to pay rent at above-market rates because the leased property is located at a prime spot. Acquiree is the lessor If the acquiree is the lessor, the acquirer does not recognize any separate intangible asset or liability regardless of whether the terms of the operating lease are favorable or unfavorable. Illustration: Specific recognition principles — Operating leases Fact pattern On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. On this date, XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000, respectively. pa 1: Acquire is the lessee — terms are favorable C is renting out a building to XYZ, Inc. under an operating Se. The terms of the lease compared with market terms are frorable The fair value of the differential is P20,000. How much lea the goodwill?26 Chapter 1 Solution: Consideration transferred Non-controlling interest in the acquiree Previously held equity interest in the acquiree Total Fair value of net identifiable asset: Goodwill s acquired © a (PL.6M + P20K intangible asset on operating lease with favorable terms ~ P200 liabilities) = P720,000 Case 2: Acquiree is the lessee - terms are unfavorable ABC is renting out a patent to XYZ, Inc. under an operating lease The terms of the lease compared with market terms are unfavorable. The fair value of the differential is P20,000. How | much is the goodwill? Solution: Consideration transferred P1,000,000 Non-controlling interest in the acquiree : Previously held equity interest in the acquiree ‘ Total 1,000,000 Fair value of net identifiable assets acquired © (680,000) Goodwill 320,000 Se (P1.6M — P900K liabilities ~ P20K liability on operating lease with unfavorable terms) = 680,000 Case 3: Acquiree is the lessor ABCis renting a building from XYZ, Inc. under an operating lease | The terms of the operating lease compared with market terms ae | favorable. The fair value of the differential is P20,000. How muct is the goodwill? Solution:pinations (Part 1) ae » amt pats , sferred era tion trans! d conse ting interest in the acquiree P1,000,000 Nowon held equity cei re . previo a 1,000,000 = at identifiable assets i l } i a obn= identifiable assets acquired (16M - 9m) (700,000) -podtvill = oor = or liability is recognized because the acquirce is the angible assel a No int ess" jowing: lessee, an asset or a liability is recognized depending on the s the lessor, no asset or liability is recognized. 2 Intangible assets Tientfable intangible assets acquired in a business combination are recognized separately from goodwill. An intangible asset is identifiable jf it is either (a) separable or (b) arises from contractual or other legal rights. Separability criterion ‘An intangible asset is separable if it can be separated from the acquiree and sold, transferred, licensed, rented or exchanged, cither individually or together with a related contract, identifiable asset or liability. An intangible as: exchange transactions for that type those transactions are infrequent an in them. An intangible asset is separable ev not intend to sell, license or otherwise exchange it. For example, the fact that customer and subscriber lists are frequently licensed makes such lists separable. However, such lists would not be ‘parable if the terms of confidentiality or other agreemeni® Prohibit the entity from selling, leasing or otherwise exchanging informati "mation about its customers. set is also separable if there is evidence of of asset or similar asset, even if d the acquirer is not involved en if the acquirer does28 Contractual-legal criterion An intangible asset that i if it arises from contractual or other legal rights. Example: Entity A acquires Entity B, an ow’ Entity A obtains Entity B’s license plant. However, selling or transferring the licen: Analysis: The license i although it is not separable, Illustration 1: Intangible assets ABC Co. acquired all the assets and liabilities of XYZ, Inc. for 1,500,000. Relevant information follows: Carrying amounts is not separable is nonetheless identifiabj, ner of a nuclear power Plant to operate the nuclear powe the terms of the license prohibit Entity A from se to another party. s an identifiable intangible asset because, it arises from a contractual right. Fair values Chapter 1 Other assets 1,600,000 P 1,480,000 Computer software 100,000 - Patent = 50,000 Goodwill 100,000 20,000 Assets P1,800,000 P1,550,000 Liabilities 400,000 450,000 Additional information: ¢ The computer software is considered obsolete. © The patent has a remaining useful life of 10 years and remaining legal life of 12 years. * XYZ has research and development (R&D) projects with fait value of ®50,000. However, XYZ recognized the R&D costs a expenses when they were incurred. Requirement: Compute for the goodwill. Solution:pinations (Part 1) pusiness COM ee 2 / receet consideration ansterr 1,500,000 olling interest in the acquiree on-contr" ink ‘ f No held equity interest in the acquiree previously —___ Tovtl cof net identifiable assets acquired @ #200 000 Goodwill ?370,000 wo (PSSM total assets ~ P20K recorded goodwill + P50K R&D - P&50K = P1.130M) wo (PLS «Note: An acquirer recognizes an acquiree's R&D.as intangible asset even if the acquiree has already expensed the related costs. Illustration 2: Intangible assets ABC Co. acquired all the assets and liabilities of XYZ, Inc. for 1,000,000. XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000, respectively. Not included in the fair value of assets are the following unrecorded intangible assets: Type of intangible asset Fair value Customer list ‘40,000 Customer contract #1 30,000 Customer contract #2 20,000 Order (production) backlog 10,000 Intemet domain name 15,000 Trademark 25,000 Trade secret processes 35,000 Mask works 45,000 Total 220,000 Additional information: . Customer contract #1 refers to a supply agreement between XYZ and a customer. The contract is not separable but is : aot to be renewed at the end of its remaining 3-year life. ‘stomer contract #2 refers. to XYZ’s insurance segment’s Portfolio of one-year motor insurance contracts that are Sancellable by policyholders.