Chapter 3: Business

Combination

Based on IFRS 3

PREPARED BY: HASSEN MUSTEFA

 Definition of BC
 Business combinations are events or
transactions in which two or more business
enterprises, or their net assets, are brought
under common control in a single accounting
entity.
 Identification of BC
A transaction or other event is a business
combination if: The assets acquired and liabilities
assumed constitute a business.

 Ifthe asset acquired are not a business, it must be

accounted for as an asset acquisition.
 Business
 IFRS 3 defines a business as ‘an integrated set
of activities and assets that is capable of being
conducted and managed for the purpose of
providing a return in the form of dividends,
lower costs or other economic benefits directly
to investors or other owners, members or
participants.

 Business consists of Input, process and output

 Example
 E&P Co A (an oil and gas exploration and production
company) acquires a mineral interest from E&P Co
B, on which it intends to perform exploration
activities to determine if reserves exist. The mineral
interest is an unproven property and there have been
no exploration activities performed on the property.
 It is not a BC.
 Cont…
• E&P Co A acquires a property similar to that
in Example above, except that oil and gas
production activities are in place. The target’s
employees are not part of the transferred set.
E&P Co A will take over the operations by
using its own employees.
• It is a BC.
Definition of terms under
BC
Combined Enterprise: The accounting entity that results
from a business combination.
 Constituent Companies: The business enterprises that enter
into a combination.
 Combinor : A constituent company entering into a
combination whose owners as a group ends up with control of
the ownership interests in the combined enterprise. The term
acquirer, parent and combinor can be used interchangeably.
 Combinee: a constituent company other than the combinor in
a business combination. The term acquired, acquiree,
subsidiary and combinee can be used interchangeably.
 Types of Business
Combinations
There are three types of business combinations: Horizontal Combination,
Vertical Combination, and Conglomerate Combination:
1. Horizontal Combination: is a combination involving enterprises in the
same industry. E.g. assume combination of Ethio flour and Sun flour.
2. Vertical Combination: A Combination involving an enterprise and its
customers or suppliers. It is a combination involving companies engaged in
different stages of production or distribution. It is classified into two:
Backward Vertical Combination – combination with supplier and Forward
Vertical Combination – combination with customers.
E.g.: A Tannery Company acquiring a Shoes Company - Forward
3. Conglomerate (Mixed) Combination: is a combination involving
companies that are neither horizontally nor vertically integrated. It is a
combination between enterprises in unrelated industries or markets.
Methods of Business
Combinations
 TheThree common methods for carrying out a
business combination are:
 Statutory Merger
 Statutory Consolidation, and
 Acquisition of Common Stock
 1. Statutory Merger
ABC
Company
ABC Company
XYZ
Company
2. Statutory Consolidation
ABC
Company
EFG Company
XYZ
Company
3. Acquisition of Common
Stock
ABC
ABC Company
Company
XYZ
XYZ Company
Company

ABC…….Parent
XYZ…….Subsidiary
 Reasons of Business
combination
1. Growth
2. Economies of scale
3. Better management
4. Monopolistic ambition
5. Diversification
6. Tax advantage
 Acquisition Method
 This standard requires to use the acquisition method
to account for a business combination transaction.
 It involves four steps:
 Step 1: Identify the acquirer
The guidance in IFRS 10 shall be used to identify the
acquirer—the entity that obtains control of another
entity, i.e. the acquiree.
 Cont….
In the absence of evidence to the contrary:
Example 1: Companies A and B combine businesses by
forming C. C issues 30 million and 20 million shares to A’s
& B’s shareholders in exchange for A’s and B’s businesses.
Example 2: same as Example 1, except: 20 million shares
are issued to each of A’s & B’s shareholders. C had 9 board
members, 5 appointed by A’s shareholders and 4 by B’s.
Example 3: on 31 December 2014 A has 100 million
shares in issue. On 1 January 2015 A issued 200 million
new A shares to the owners of B in exchange for all of B’s
shares.
 Cont…..
Entity A intends to acquire the voting shares
(and therefore obtain control) of Target Entity.
Entity A incorporates Newco and uses this
entity to effect the business combination.
Entity A provides a loan at commercial interest
rates to Newco. The loan funds are used by
Newco to acquire 100% of the voting shares of
Target Entity in an arm’s length transaction.
Step 2: Determine the acquisition
date: date on which the acquirer
obtains control.
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
Step 3: Recognize and measure the
identifiable assets acquired, the
liabilities assumed and any non
controlling interest in the acquiree;
The acquirer shall measure the identifiable assets acquired and the
liabilities assumed at their acquisition-date fair values. All other
components of non-controlling interests shall be measured at their
acquisition-date fair values.
1. Marketable Securities: Recorded at Fair value.
2. Receivables: Recorded at Discounted present value Amount.
3.Inventory:
I. Raw materials: Current Replacement cost
II. Work in Process: Net realizable cost-cost to complete-cost to
sale
III. Finished Goods: Net realizable cost-cost to sale
 Cont…
4. Intangible Assets: Recorded at Fair value.
5. Fixed Assets: Recorded at Fair value.
6. Liabilities: Recorded at Fair value.
 Non controlling interest
NCI is arise when one company controls
another company less than 100%. It is also
referred as Minority Interest.
IFRS 3: allows an accounting policy choice for
measuring non-controlling interest (NCI) at
the acquisition date:
1) fair value; or
2) NCI’s proportion of the group values of the
subsidiary’s net assets.
IFRS for SMEs: NCI = NCI’s proportion of the
group values of the subsidiary’s net assets.
 Cont…
 Sometimes NCI is calculated through Implied value.
Implied value = Acquisition cost / % of controlling
interest
NCI = Implied value-Acquisition cost
 For example, If Com. A acquired 80% of Com. B at Br.

800,000. Find the NCI:

Implied value= Br. 800,000/ 0.8 = Br. 1,000,000.00
NCI = Br. 1,000,000-Br. 800,000 = Br. 200,000.00
 Step 4:Recognize and measure the
goodwill or a gain from a bargain
purchase.
 If the acquisition cost(Implied value)
exceed the fair value of net identifiable
asset, then we recognize as goodwill.
 If the fair value of net identifiable asset

exceed the acquisition cost(Implied

value), then we recognize as Negative
goodwill(Gain on bargain purchase).
 Cont…
1. Determination of Cost of Acquisition – assets to be acquired
and liabilities to be assumed are identified and then, like other
exchange transactions, measured on the basis of the fair values
exchanged. The Cost of combinee includes also some other
costs as discussed below.
 The cost of a combine on a BC accounted for by Acquisition

method is the total of

a. The amount of consideration paid by the combiner,
b. Any contingent consideration that is determinable on the date
of the business combination.
Cont…
a. Amount of Consideration:
 This is the total amount of

a. Cash paid,
b. The Current fair value of other assets distributed,
c. The present value of debt securities issued &
d. The Current fair value (Market) value of equity security issued by the combiner.

Investment in Subsidiary………………….xx
Cash/other assets………………………………………………………………
xx
Bond
Payable………………………………………………………………………..xx
Common
stock……………………………………………………………………...xx
Additional paid in capital in excess of par value…………………xx
Cont…
b. Contingent Consideration: Relates to an additional
amount paid by the parent to the shareholders of
subsidiary if certain conditions are met. It recorded at
fair value.
Investment in subsidiary……………xx
Contingent
Consideration………………xx

Acquisition cost = Amount of consideration + Contingent

consideration

Implied value = Acquisition cost + Non Controlling

Interest
Other costs
1. Direct combination costs: Associated with completing the
business combination (Legal, Accounting, Consulting,
Appraisal and Finder`s fee).
Merger Expense………………xx
Cash……………………………………xx
2. Stock Issuance Cost: When the parent issues stock in
conjunction with a BC, any stock issuance costs, such as
underwriter fee and exchange fee.
Additional paid in capital in excess of
par…………….xx

Cash…………………………………………………………
……………xx
Cont…
2. Fair value of Net Identifiable Asset (FVNIA):

FVNIA = Fair value of Asset-Fair value of Liabilities

Cont…
Goodwill
The acquirer shall, at the acquisition date:
(a) Recognize goodwill acquired in a business combination as an
asset, and
(b) Initially measure that goodwill at its cost, being the excess of
the cost of the business combination over the acquirer’s interest
in the net fair value of the identifiable assets, liabilities and
contingent liabilities recognized.
(c) Subsequently, goodwill acquired in a business combination to
be tested for impairment annually. So, the company doesn`t
amortize the Goodwill.
Example 1
Entity A pays $78,000 to acquire 75% of the voting interest in
Entity B when the fair value of Entity B’s identifiable assets less
the fair value of Entity B’s liabilities and contingent liabilities is
$100,000. The fair value of NCI is Br 26,000.
Is the goodwill in the business combination an asset of the group?
Choose one of: 1) Yes; or 2) No.

If yes, what is the economic value of the goodwill to the group?

Choose one of: 1) $3,000; 2) $4,000; 3) $3,000 or $4,000 (at the
entity’s discretion); or 4) somewhere between $3,000 (if all
synergies are attributable to Entity A’s CGUs) and $4,000 (if all
synergies are attributable to Entity B’s CGUs).
 Cont…

1. Implied Value = 78,000 + 26,000 = 104,000 or

Implied Value = 78,000/0.75 = 104,000
Goodwill = 104,000-100,000 = 4,000

2. Goodwill = 78,000-(0.75*100,000)
=78,000-75,000 = 3,000
Example 2
P com acquired S com on Dec. 31/2017 with the
following balances:
 The carrying amount of Assets are Br 440,000.

 The carrying amount of liabilities are Br 140,000.

 The fair value of assets are Br 500,000.

 The fair value of liabilities are Br 170,000.

 On Dec.31/2017 P com issued 50,000 shares of its Br

5(CFV of Br 8) CS for all the net asset of S.

 Issuance and out of pocket costs are Br 40,000 and Br

25,000, respectively.
Cont…
 Journal Entries:
1. Investment in S…..(8*50,000)…...........….400,000
Common Stock…(5*50,000)…………………….
……………250,000
Additional Paid in capital in excess of par…..
………..150,000

2. Merger Expense……………………………………………………
25,000
Additional Paid in capital in excess of par…...…….40,000

Cash…………………………………………………………….65,00
0
Cont…
Goodwill Calculation
 Acquisition Cost = Br 400,000

 FVNIA = Fair Value of Asset – Fair Value of Liability

= Br 500,000 – Br 170,000 = Br 330,000

 Goodwill = AC-FVNIA = Br 400,000 – Br 330,000 = Br

70,000.
Example 3
Cont…
 Journal Entries:
1. Investment in Set…((100,000*13) + 50,000)
…….1,350,000
Common Stock…(100,000*10)
………………………………1,000,000
Additional Paid in Capital in Excess of
Par…………… 300,000

Cash…………………………………………………
…………..…………….50,000

2. Merger
Expense………………………………………………
Cont…
Goodwill calculation
 Acquisition cost = Br 1,350,000

 FVNIA = Fair Value of Asset – Fair Value of Liability

= (60,000 + 500,000 + 450,000 + 300,000 +

250,000) –
(180,000 + 240,000) = 1,560,000 – 420,000
= 1,140,000

 Goodwill= AC-FVNIA = Br 1,350,000 – Br

1,140,000 = Br 210,000.