International Financial Reporting Standards

Business Combinations
(IFRS 3)
 2

Business Combination
A business combination is the term applied to
external expansion in which separate enterprises are
brought together into one economic entity as a
result of one enterprise obtaining control over the
net assets and operations of another enterprise.
 3

There are increasing trend to expand operations

through business combinations rather than through
internal external expansion. This development is
largely due to the effects of recession, inflation, and
continued uncertainty over the ability of the
government to control economic ills. With business
combination, both companies will utilize common
facilities and share fixed costs. In addition, a business
combination maybe undertake for the possible tax
advantages available to one or more parties to the
combination.
 4
However, business combinations involve certain
limitations and risks. Corporate objectives must be
taken into consideration. Only those companies
which have the same or compatible sets of
objectives should combine. On the other hand,
successful firms are usually not willing to combine.
The acquiring enterprise may also inherit the
acquired firm’s inefficiencies and problems together
with its inadequate resources.
 Business Combination Defined 5

IFRS 3 defines Business Combination as a transaction or

event in which an acquirer obtains control of one or more
businesses (the acquiree). For each business combination,
one of the combining entities shall be identified as the
acquirer.
 6

Identifying a Business

A business is defined as an integrated set of

activities and assets that is capable of being
conducted and managed for the purpose of
providing a return directly to investors or other
owners, members, or participants.
• The standard clarifies that a business consists of
inputs and processes applied to those inputs that
have the ability to create outputs.

• Input is any economic resource that creates or has

the ability to create outputs when on or more
processes are applied to it. These may include
intangible assets or rights to use non-current assets,
intellectual property, the ability to obtain access to
necessary materials or rights and employees.
• Process is the system, standard, protocol,
convention, or rule that when applied to an
input or inputs, creates or has the ability to
create outputs. Example include strategic
management processes.

• Output is the result of inputs and process or

processes applied to those inputs that will
provide or have the ability to provide a return in
the form of dividends, lower costs or other
economic benefits directly to investors or other
owners, members or participants.
• Although business usually have outputs, outputs are not
required for an integrated set to qualify as a business.
For example, an integrated set of activities and assets
in the development stage might not have outputs. In
such cases, the acquirer should consider other factors
to determine whether the set of activities is a business.
These include whether the set of activities:

(a) has begun planned principal activities

(b) has employees, intellectual property and other inputs
and processes that could be applied to those inputs.
(c) is pursuing a plan to produce outputs; and
(d) will be able to obtain access to customers that will
purchase the outputs.
• Not all of these factors need to be present for a
particular integrated set of activities and assets in
the development stage to qualify as a business.
Also, although most businesses usually have
liabilities, a set of integrated activities need not
have liabilities to qualify as a business.

• The standard takes the view that “in the absence

of evidence to the contrary, a particular set of
assets and activities in which goodwill is present
shall be presumed to be a business. However, a
business need not have a good will.
 Illustration 13-1
On January 1, 2017, Entity X purchases two separate sets of assets and
activities from 3rd parties, as follows:
(i) A manufacturing plant of A company. The set of assets acquired, and
liability assumed are as follows:
P’Million
Plant premise 100
Machinery 50
Equipment 20
Mortgage loan secured on the plant premise (90)
Entity X will continue to employ the existing employees of the
manufacturing that paying them the same salaries as before. The plant is
a cash-generating unit which generate outputs that are sold to outside
customers. Entity X pays a cash consideration of P100million to the
vendor.
(ii) A set of assets and liability of B Company, as follows:
P’Million
Factory premise 60
Machinery 20
Equipment 20
Loan secured on the factory premise (50)
The vendor will retrench the existing employees of the factory and pay
their termination benefits. The set of asset is not capable of generating
independent cash flows. However, Entity X believes it can use this set of
assets to obtain economies of scale with its existing facilities. It pays a
consideration of P55 million to the vendor.
As at the end of the prior financial year, December 31, 2016, the summarized
statement of financial position of Entity X is as follows;
P’Million
Plant and factory premise 200
Machinery 100
Equipment 50
Current assets 250
600
Current Liabilities 100
Long-term loans 200
Total Liabilities 300
Share Capital 100
Retained Earnings 200
Equity attributable to owners 300
600
• Required:
(a)Explain how entity X shall account for the
purchases of the two assets and activities; and

(b)Prepare the statement of financial position of

Entity X as of January 1, 2017 immediately after
the acquisition of the two sets of assets and
activities.
The set of assets and liability of manufacturing plant shall
continue a business as all the three elements of inputs,
processes and outputs are evident. The plant was a separate
cash-generating unit of the vendor and it was acquired as a
business with an element of goodwill. Therefore, Entity X
shall apply IFRS 3 and account for the acquisition of the
manufacturing plants as a business combination with
goodwill being measured at P20 million (P100 million less
the net assets of P80 million).

The set of assets and liabilities in the second acquisition

cannot be identified as a business because none of the three
elements of inputs, processes and outputs are evident.
Entity X will only use them together with its existing facilities
to achieve the cost paid for this set of assets exceeds net
carrying amount, Entity |X allocated the cost as follows:
 P’Million
Factory premise (60+ .6*5) 63
Machinery (20+.2*5) 21
Equipment (20+.2*5) 21
Mortgage Loan (50)
Cost of purchase 55
(b) Statement of financial position- As of January 1, 2017
P’Million
Current assets (250-155) 95
Plant and factory premise (200+100+63) 363
Machinery (100+50+21) 171
Equipment (50+20+21) 91
Goodwill on combination 20
Total Assets 740
Current Liabilities 100
Long-term loans (200+90+50) 340
Share Capital 100
Retained Earnings 200
Total Liabilities and Equity 740
 ACQUISITION OF CONTROL
Control of another company
may be achieved by either acquiring the assets of the target
company or acquiring a controlling interest (usually over
50%) in the target company’s voting common stock.

18
 19
In an acquisition of assets, all of the company’s
assets are acquired directly from the company. In most
cases, existing liabilities of the acquired company also
are assumed. When assets are acquired and liabilities
are assumed, the transaction referred to as an
acquisition of “net assets”. Payment may be made in
cash, exchanged property, or issuance of either debt or
equity securities. Business combinations may be
achieved legally either by statutory consolidation or
statutory merger.
 20

Statutory consolidation refers to the combining of two or

more existing entities into one new legal entity. The
previous companies are dissolved and are then replaced
by the new continuing company.
Statutory merger refers to the absorption of one or more
existing legal entities by another existing company that
continues as a sole surviving legal entity. The absorbed
company ceases to exist but may continue as a division
of the surviving company.
 21
In a stock acquisition, a controlling interest (typically, more
than 50%) of another company’s voting common stock is
required. The acquiring company is termed as the parent (also
the acquirer), and the acquired company is termed as a
subsidiary (also the acquiree). Both the parent and the
subsidiary remain separate legal entities and maintain their own
financial records and statements. However, for external financial
reporting purposes, the companies will usually combine their
individual financial statements into a single set of consolidated
statements.
 METHODS OF BUSINESS 22

COMBINATIONS
Prior to the issuance of IFRS 3, two methods are used to
account for business combinations. These were the
purchase method and the pooling of interest method.
Under the purchase method, all assets and liabilities of the
acquired company are usually recorded at fair value. The
purchase method was the primary method in use. However,
under some cases, the pooling of interest method is
allowed. The pooling of interest recorded the assets and
liabilities of the acquired company at their book values.
IFRS 3 eliminated the pooling of interest method.

22
 ACQUISITION METHOD ACCOUNTING 23
FOR BUSINESS COMBINATIONS
IFRS 3 requires that all business combinations be
accounted for by applying the acquisition method
(called the purchase method in the 2004 version of
IFRS 3). To determine whether a transaction or other
event is a business combination, four steps in the
application of the acquisition method are to be used as
follows:
1. Identify the acquirer.
2. Determine the acquisition date.
3. Determine the consideration given (price paid) by the
acquirer.
4. Recognize and measure the identifiable assets
acquired, the liabilities, assumed any non-controlling
interest (formerly called minority interest) in the
acquiree. Any resulting goodwill or gain from a
bargain purchase should be recognized.
 1. Identify the Acquirer
In an asset acquisition, the company transferring cash or other assets
and/or assuming liabilities is the acquiring company. In a stock
acquisition, the acquirer is, in most cases, the company transferring cash
or other assets for a controlling interest in the voting common stock of
the acquiree (company being acquired). Some stock acquisitions may be
accomplished by exchanging the voting common stock. Usually, the
issuing the voting common stock is the acquirer. In some cases, the
acquiree may issue the stock in the acquisition. This “reverse
acquisition” may occur when a publicly traded company is acquired by
a privately traded company. The appendix at the end of Chapter 15
considers this case and provides the applicable accounting procedures.

25
 2. Determine the Acquisition Date

This is the date on which the acquirer obtains control of the acquiree.
IFRS 3 explains that 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
should consider all pertinent facts and circumstances in identifying
the acquisition date, and it might be that control is achieved on a date
that is earlier or later than the closing date. For example, the
acquisition date precedes the closing date if a written agreement
provides that the acquirer obtain control of the acquiree on a date
before the closing date.

26
The acquisition date is critical because it is the date used
to establish the fair value of the company acquired, and it
is usually the date that the fair values are established for
the accounts of the acquired company.

27
 3. Determine the Consideration Given 28

Generally, the consideration given (price paid) by the acquirer is

assumed to be the fair value of the acquiree as an entity. IFRS 3
requires the consideration given in a business combination to be
measured at fair value. This is calculated as 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
acquire; and
∙The equity interests issued by the acquirer.

Usual forms of consideration include cash, other assets,

contingent consideration, ordinary or preference equity
instruments, options, warrants and member interests of mutual
entities.
 4. Contingent Consideration 29

The consideration the acquirer transfers in exchange

for the acquiree includes any asset or liability
resulting from a contingent consideration
arrangement. Contingent consideration is an
agreement to issue additional consideration (asset or
stock) at a later date if specified events occur. The
most common agreements focus on a targeted sales or
income performance of the acquiree company.
Contingent consideration is measured at its
acquisition date fair value.
Changes that are the result of the acquirer to obtain additional information about
facts and circumstances that existed at the acquisition date, and that occur within
the measurement period (which may be a maximum of one year from the
acquisition date), are recognized as adjustments against the original accounting
for the acquisition (and so may affect goodwill).
Changes resulting from events after the acquisition date (e.g. meeting an
earnings target) are not measurement period adjustments. Accounting for such
change depends on whether the additional consideration is an equity instrument
or cash, or other assets paid or owed. If it is equity, the original amount is not
measured. If the additional consideration is cash or other assets paid or owed,
the changed amount is recognized in profit or loss.

30
 Acquisition-related Costs

The cost the acquirer incurs to effect a business

combination, such as broker’s fee; accounting, legal,
and other fees; general administrative costs,
including the cost of maintaining an internal
acquisition department, are not included in the price
of the company acquired and are expensed.

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 Stock Issuance Costs

When the acquirer issued shares of stock for the net

assets acquired, the stock issuance costs such as SEC
registration fees, documentary stamp tax and
newspaper publication fees are treated as a deduction
from additional paid in capital (APIC) from previous
share issuance. In case the APIC is reduced to zero,
the remaining stock issuance costs is treated as a
contra account from retained earnings presented as a
separate line item. (Philippine Interpretation
Committee).

32
 Record and Measure the Acquirer’s Assets and
Liability that are Assumed.
The fair values of all identifiable assets and liabilities of the
acquiree are measured and recorded. Fair value is the amount that
the asset or liability would be bought or sold for in a current,
normal sale between willing parties.
The total of all identifiable assets, less liabilities recorded, is
referred to as the fair value of the net assets. The identifiable
assets should never include goodwill that may exist in the
acquiree’s books. The only goodwill recorded in an acquisition is
“new” goodwill based on the price paid by the acquirer.

33
 34

Price paid exceeds the fair values assigned to net assets. The excess of
the price paid over the values assigned to net assets is “new” goodwill.
The goodwill recorded is not amortized but is impairment tested in future
accounting periods.

Price paid less than the fair values assigned to net assets. Where the
price paid is actually less than the fair value assigned to the net assets, a
“bargain purchase” has occurred. The excess of the fair value assigned to
the net assets over the price paid is recorded as a “gain” on the
acquisition by the acquirer.
 Valuation Of Identifiable Assets And Liabilities 35

• As a general rule, assets and liabilities acquired are

recorded at their individually determined values. The
preferred method is quoted market value, when an
active market for the item exists. Where there is no
active market, independent appraisals, discounted cash
flow analysis, and other types of analysis are used to
estimate fair values.
The acquiring company is not required to establish
values immediately on the acquisition date. A
measurement period of up to one year is allowed for
measurement. Temporary values would be used in
financial statements prepared prior to the end of the
measurement period. A note to the financial statements
would explain the use of temporary values. Any change in
the recorded values is adjusted retroactively to the date of
acquisition. Prior-period statements are revised to reflect
the final values and any related amortizations.

• Show guidance on the measurement of fair value as provided in the

IFRS, are explained below:

36
 Equity Instrument Transferred
Equity instruments issued are measured at their
fair value. For quoted equity instruments issued,
the published price at the date or exchange
(which is the acquisition date) of a quoted equity
instrument provides the best evidence of the
instrument’s fair value and shall be used.
If the published price at the date of exchange is
an unreliable indicator or if a published price
does not exist for equity instruments (for
example unquoted equity shares) issued by the
acquirer, the fair value of those instruments
could, for example, be estimated by reference to
their proportional interest in the fair value of the
acquirer or by reference to the proportional
interest in the fair value of the acquirer or by
reference to the proportional interest in the fair
value of the acquire obtained, whichever is the
more clearly evident.
 Non-Financial Assets Transferred
Non-financial assets given shall be measured by
reference to their market prices, estimated realizable
values, independent valuations or other available
information relevant to the valuation. For example, a
landed property transferred to the former owners of a
newly acquired company as part of the purchase
consideration shall be measured at its market value at
the acquisition date. If the fair value differs from the
carrying amount as at the acquisition date, the acquirer
remeasures the carrying amount to fair value and
recognizes the resulting gain or loan in profit or loss (IFRS
3.38).
The cost of a business combination includes
liabilities incurred or assumed by the acquirer in
exchange for control of the acquiree. Future
losses or other costs expected to be incurred as
a result of a combination are not liabilities
incurred or assumed by the acquirer in exchange
for control of the acquiree, and are not,
therefore, included as part of the cost of
combination.
When a property is transferred to the acquire
rather than to its former shareholders, the
acquirer shall measure the non-monetary assets
transferred at their carrying amounts rather
than at their fair value, so that it does not
recognize a gain or loss in profit or loss, both
before and after the business combination. (IFRS
3.38).
Illustration 13-3
P Ltd acquires 1 100% interest in the equity shares of S Ltd
from two controlling shareholders on January 1, 2017. the
terms of the business combination include:

(i) P Ltd shall pay an amount of P10 million to the two

controlling shareholders of S Ltd;
(ii) P Ltd shall inject a property into S Ltd. The carrying
amount of the property in the accounts of P Ltd at
acquisition date is P20 million. The fair market value of the
property at acquisition date is P30 million:
(iii) P Ltd shall assume the bank loans of P5 millions taken
by the two controlling shareholders when they invested in
S Ltd; and
(iv) P Ltd shall bear the future losses and future
restructuring costs of S Ltd, estimated at P6 million.
The cost of combination is computed as follows:
Cash consideration P10 million
Liabilities assumed 5 million
Property transferred at carrying amount 20 million
Cost of combination 35 million

The property transferred is measured at the carrying

amount not at their fair value at the acquisition date
because it remains within the combined entity after the
business combination. The future losses and
restructuring costs are not included in the cost of the
business combination but shall be accounted for as
losses and expenses in the post combination period
when they are incurred.
 Assets with Uncertain Cash Flows
(valuation allowances)
An acquirer is not permitted to recognize a separate valuation
allowance as of the acquisition date for assets acquired in a
business combination that are measured at their acquisition-date
fair values because the effects of uncertainty about future cash
flows are included in the fair value measured. For example,
because IFRS 3 requires the acquirer to measure acquired
receivables, including loans, at their acquisition-date fair values,
the acquirer does not recognize a separate valuation allowance for
the contractual cash flows that are deemed to be uncollectable at
that date. {IFRS 3 (2008)}

44
• The principle of “no valuation allowance” also applies to
property, plant and equipment such that, following a business
combination, such assets are stated at a single fair value amount,
and not in a gross “deemed cost” and accumulated depreciation.

Unrecognized Assets and Liabilities

The acquirer may recognize some assets and liabilities that the
acquiree had not previously recognized in its financial
statements.

45
APPLYING THE ACQUISITION
METHOD
• As mentioned earlier, control of another company
may be achieved either by the acquisition of net
assets or by acquisition of stock.

46
 Illustration 14-1 Acquisition of Net Assets

Let us assume that the company to be acquired by Acquirer, Inc., has the following
Statement of Financial Position on June 30, 2017:

J & J Company
Statement of Financial Position
June 30, 2017
Cash P 200, 000 Current Liabilities P 125, 000
Marketable Securities 300, 000 Bonds Payable 500,000
Inventory 500, 000
Land 150, 000 Common Stock( P1 par) 50, 000
Building (net) 750, 000 Add. Paid in Capital 700, 000
Equipment (net) 400, 000 Retained Earnings 925, 000

Total assets P 2, 300, 000 Total Liability & Equity P 2, 300,

000

47
 Fair values for all accounts have been measured as of June
30, 2017 as follows:
International Financial Reporting Standards
• Cash P200, 000
Marketable Securities 330, 000
Inventory 550, 000
Land 360, 000
Building 900, 000
Equipment 700, 000
Unrecognized Receivables 225, 000 P 3, 265, 000

• Current Liabilities P125, 000

Bonds Payable 500, 000
Premium on Bonds Payable 20, 000 645, 000
Fair Value of net identifiable assets P 2, 620, 000

48
 Accounting Procedures in
Recording the Acquisitions 49

The basic accounting procedures to record the acquisition of net

assets are as follows:

∙All accounts identified are measured at estimated fair value. This

is always the case even if the consideration given for a company is
less than the sum of the fair values of the net assets acquired
(assets less liabilities assumed, P 2, 620, 000 in the illustration).
∙If the total consideration given for a company exceeds the fair
value of its net identifiable assets (P 2, 620, 000), the excess price
paid is recorded as goodwill.

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∙ If the total consideration given for a company is less than the fair 50
value
of its net identifiable assets
(P 2, 620, 000), the excess of the net assets over the price paid is
recorded as gain on acquisition (bargain purchase) in the period of the
purchase.
∙ All acquisition-related costs are expensed in the period in which the
costs are incurred, with one exception. The cost to issue equity
securities are recognized as a reduction from the value assigned to the
additional paid in capital account.

Before recording the acquisition, the acquirer should calculate the

difference between the price paid and the fair value of the net assets
acquired.

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Case 1: Price paid exceeds the fair value of the net
identifiable assets acquired.

Acquirer, Inc., issues 80, 000 shares of its P10 par

value common stock with a market value of P40
each for J & J Company’s net assets. Acquirer, Inc.
pays professional fees of P50, 000 to accomplish
the acquisition and stock issuance costs of P30,
000.

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• Analysis
Price paid (consideration given),

80, 000 shares x P40 market value P 3, 200, 000

Fair value of net identifiable assets

acquired from J & J (2, 620, 000)
Goodwill P 580, 000

Professional fees (expense) P 50, 000

Stock issue costs (reduction from
additional paid in capital) 30, 000

52
Entries recorded by the Acquirer, Inc. are as follows: 53

1.To record the net assets acquired including the new goodwill:

Cash P 200, 000

Marketable Securities 330, 000
Inventory 550, 000
Land 360, 000
Building 900, 000
Equipment 700, 000
Receivables – Trade 225, 000
Goodwill 580, 000
Current Liabilities P 125, 000
Bonds Payable 500, 000 Premium
on Bonds Payable 20, 000 Common stock
(P10 par, 80, 000 shares issued) 800, 000
Additional paid in capital
(P30 x 80, 000 shares) 2, 400, 000
 54

2. To record acquisition-related costs;

Acquisition expense 50, 000
Additional paid in capital 30, 000
Cash 80, 000
 55

Case 2: Price paid is less than the fair value of the net
identifiable assets acquired.
Acquirer, Inc., issues 20, 000 shares of its P115 par value
common stock with a market value of P120 each for J & J
Company’s net assets. Acquirer, Inc. pays professional fees of P50,
000 to accomplish the acquisition and stock issuance costs of P130,
000.
 56

Analysis
Price paid (consideration given),
20,000shares x P120 market value P 2, 400, 000
Fair value of net identifiable assets
acquired from J & J (2, 620, 000)
Gain on acquisition(bargain purchase) P( 220, 000)

Professional fees (expense) P 50, 000

Stock issue costs (reduction from
additional paid in capital) 130, 000
Entries recorded by the Acquirer, Inc. to record the acquisition and
related costs are as follows: 57

1.To record the acquisition of net assets:

Cash P 200, 000
Marketable Securities 330, 000
Inventory 550, 000
Land 360, 000
Building 900, 000
Equipment 700, 000
Receivables – Trade 225, 000
Current Liabilities P 125, 000
Bonds Payable 500, 000
Premium on Bonds Payable 20, 000
Common stock
(20, 000 shares x P115 par) 2, 300, 000
Additional paid in capital
(20, 000 shares x P5) 100, 000
Gain on acquisition 220, 000
 58

2. To record acquisition-related costs:

Acquisition expense 50, 000
Additional paid in capital 100, 000
Stock Issuance costs 30, 000
Cash 180, 000
The following should be noted from the entries of the acquirer.

∙ The stock issuance costs exceeds the additional paid in capital recorded at
acquisition, the excess is debited to “stock issuance costs”. This account
should be treated as a contra account from retained earnings under the equity
section of the statement of financial position.
∙ The gain must be reported as a separate line item in the statement of
comprehensive income of the acquirer in the period of acquisition.
 Recording Contingent Consideration
59

Using the data in J & J Company (Case 1), assume that Acquirer,
Inc., issued 80, 000 shares with a market value of P3, 200, 000. In
addition to the stock issued, the acquirer agreed to pay an additional
P200, 000 on January 1, 2018, if the average income for the 2-year
period of 2016 and 2017 exceeds P160, 000 per year. The expected
value is estimated as P100, 000 based on the 50% probability of
achieving the target average income.

The revised analysis of the difference between the price paid and
the fair value of the net assets acquired and the entries to record the
acquisition are presented below and on the next page.
 60

Analysis

Total price paid:

Stock issued at market value P3, 200, 000

Estimated value of contingent

consideration 100, 000 P3, 300, 000

Fair value of the net assets acquired

from J & J Company (2, 620, 000)

Goodwill P 680, 000

Acquisition-related costs:

Professional fees (expense) P 50, 000

Stock issue costs (reduction from APIC) 30, 000

Entries to record the acquisition of net assets and the acquisition-
related costs are as follows: 61

1.To record the net assets acquired at fair value including the new goodwill:

Cash P 200, 000

Marketable Securities 330, 000
Inventory 550, 000
Land 360, 000
Building 900, 000
Equipment 700, 000
Receivables – trade 225, 000
Goodwill 680, 000
Current Liabilities P 125, 000
Bonds Payable 500, 000
Premium on Bonds Payable 20, 000
Common stock, P10 par 800, 000
Additional paid in capital 2, 400, 000
 62

2. To record acquisition-related costs:

Acquisition expense 50, 000
Additional paid in capital 30, 000
Cash 80, 000
Recording Change in Contingent Consideration

If during the measurement period, the contingent consideration was revalued

based on additional information, the estimated liability and the goodwill (or gain
on acquisition) would be adjusted. For example, if within the measurement
period, the estimate was revised to P160, 000, the P60, 000 increase would be
adjusted as follows:

Goodwill 60, 000

Contingent Consideration Payable 60, 000

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If the estimate is again revised after the measurement period, the adjustment is
included in profit or loss of the later period. For example, if the estimate was
revised to P200, 000 after the measurement period, the P40, 000 increase would be
recorded as follows:

Loss on contingent consideration payable 40, 000

Contingent consideration payable 40, 000

The illustrated procedures applies to any contingent consideration payable in cash

or other assets other than issuing additional shares of stocks. An agreement to issue
additional stock upon the occurrence of future event is treated to be a change in the
estimated value of the shares issued. No liability is recorded at the acquisition date.
The only entry made is at the date when additional shares are issued.

[[[
The views expressed in this presentation are those of the presenter,
not necessarily those of the IASB or IFRS Foundation

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 65

Using the example of the acquisition of J & J Company for P3, 200, 000,
assume that there was an agreement to issue 20, 000 additional shares if
the average income during the 2-year period of 2012 and 2013 exceed
P160, 000 per year. There would be no change in the entry in Case 1 to
record the acquisition on June 30, 2013.

Assuming the contingent event occurs, the following entry would be made
after December 2015, to issue additional 20, 000 shares.

Additional paid in capital 200, 000

Common stock, P10 par 200, 000

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 Recording Changes in Value During
Measurement Period 66

During the measurement period, values assigned to accounts recorded as a

part of the acquisition may be adjusted to better reflect the value of the
accounts as of the acquisition date. Changes in value caused by events that
occur after the acquisition date are not a part of this adjustments. They
would be adjusted to income in the period they occur.

The values recorded on the acquisition date are considered “provisional”.

They must be used in financial statements with dates prior to the end of the
measurement period. The measurement period ends when the improved
information is available, or it is obvious that no better information is
available. In no case can the measurement period exceed one year from the
acquisition date.

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 67

Illustration:

Let us return to the acquisition of J & J Company for P3, 200,

000 in Case 1. Assume now that the values assigned to the
buildings is provisional. The 2013 financial year will include
the statement of comprehensive income accounts for the
acquired, J & J Company, starting as of the acquisition date,
June 30. The values assigned to the buildings and resulting
adjustments to income for 2013 and projected for 2014 are as
follows:

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Provisional Value P 900, 000
Depreciation Method:
20-year straight line with P660, 000
Residual value.
P240, 000/20 years = P12, 000 per year,
P1, 000 per month.

Recorded in 2013 (6 months) 6, 000

Projected in 2014 12, 000

Better estimates of values for the building become available in early

2014. The new values and revised depreciation are as follows:

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Revised Value P 950, 000

Depreciation Method:
20-year straight line with P590, 000
Residual value.
P360, 000/20 years = P18, 000 per year,
P1, 500 per month.

Adjusted amount for 2013 (6 months) 9, 000

Amount to be recorded in 2014 18, 000

­The recorded values are adjusted during 2014 as follows:

Buildings (P950, 000 – P900, 000) 50, 000

Goodwill 50,000

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Goodwill would absorb the impact of the adjustment. Had there
been a gain on the original acquisition date, the gain would be
adjusted at the end of the measurement period. Since the gain was
recorded in the prior periods, the entry to adjust the gain would be
made to retained earnings.

The depreciation for the period must also be adjusted retroactively.

The entry made in 2014 would be as follows:

Retained earning 3,000

Accumulated depreciation–buildings 3, 000

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Books of the Acquiree

Using the example of the acquisition of J & J

Company for P3, 200, 000 in Case 1. The excess of
the price received by the acquiree (P3, 200, 000) over
the sum of the book value of the net assets of P1, 675,
000 (2, 300, 000 assets – P625, 000) is recorded as a
gain on the sale. In this case, the gain is P1, 525, 000.
The entries recorded by J & J Company are as follows:

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1. To record the sale of the net assets:
Investment in Acquirer, Inc. 3, 200, 000
Current liabilities 125, 000
Bonds payable 500, 000
Cash 200,000
Marketable securities 300, 000
Inventory 500, 000
Land 150, 000
Building (net) 750, 000
Equipment (net) 400, 000
Gain on sale of Business 1, 525, 000
2. To record the distribution of Acquirer, Inc. shares received to its shareholders and the
liquidation of J & J Company.
Common stock 50, 000
Additional paid in capital 700, 000
Retained earnings 925, 000
Gain on sale of business 1, 525, 000
Investment in Acquirer, Inc. 3, 200, 000

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 Financial Statements Following the Acquisition of Net
Assets.

Statement of Financial Position. Under the acquisition method, the

Statement of Financial Position of Acquirer, Inc. after the
combination includes all the assets and liabilities of J & J
Company at fair values.

Statement of Comprehensive Income. The Statement of

Comprehensive Income of the acquirer for the accounting period
in which the business combination occurred includes the operating
results of the acquiree after the date of acquisition only.

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 Illustration 14-2

Acquisition of Stock

In a stock acquisition, the acquiring company deals only with

existing shareholders of the acquired company not the company
itself. To illustrate, assume that on December 31, 2013, P Company
acquired all 10, 000 issued and outstanding shares of S Company’s
P100 par value common stock for P2, 000, 000 cash. In addition, P
Company paid professional fees to accomplish the combination of
P100, 000. The journal entries to record the acquisition of stock and
the acquisition-related costs in the books of P Company on
December 31, 2013 are as follows:

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1. To record the acquisition of stock from S Company:

Investment in subsidiary S Company 2, 000, 000

Cash 2, 000, 000
2. To record the acquisition-related costs:
Acquisition expense 100, 000
Cash 100, 000
The above entries do not record the individual underlying assets and liabilities over
which control is achieved. Instead, the acquisition is recorded in an Investment
account that represents the controlling interest in the net assets of the subsidiary.
On the date of acquisition of stock no goodwill or income from acquisition is
recorded by the acquirer. After the acquisition S Company will not be dissolved. A
relationship now exists that of parent/subsidiary relationship. P Company is now
the parent and S Company is now the subsidiary.

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If no further action is taken, the Investment in Subsidiary account
would appear as a long- term investment on P Company’s statement of
financial position. However, such presentation is permitted only if
consolidation were not required (i, e., when control does not exist).

Assuming consolidated statements are required (i, e., when control

does exist), the statement of financial position of the two companies
must be combined into a single Consolidated Statement of Financial
Position. The accounting process in the preparation of consolidation
statements will be discussed in the chapters that follows.

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 IMPAIRMENT OF ASSETS
The following key terms are used in the impairment of assets (IAS
36):

∙Impairment. An asset is impaired when its carrying amount

exceeds its recoverable amount.
∙Carrying amount. The amount at which an asset is recognized in
the balance sheet after deducting accumulated depreciation and
accumulated impairment loss.
∙Recoverable amount. The higher of an asset’s fair value less costs
to sell (net selling price) and its value in use.

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∙ Fair value. The amount obtainable from the sale of an asset in a bargained
transaction between knowledgeable, willing parties.
∙ Value in use. The discounted present value of estimated future cash flows
expected to arise from:
a. The continuing use of an asset, and from

b. Its disposal at the end of its useful life.

∙ Cash generating unit. The smallest identifiable group of assets:

a. That generates cash inflows from continuing use, and

b. That are largely independent of the cash inflows from other assets
or group of assets.

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 IMPAIRMENT OF GOODWILL
Goodwill should be tested for impairment annually. The test of
impairment to each of the acquirer’s cash generating unit, or groups of
cash generating units, that are expected to benefit from the synergies
of the combination, irrespective of whether other assets or liabilities
of the acquiree are assigned to those units or groups of units.

A cash generating unit to which goodwill has been allocated shall be

tested for impairment at least annually by comparing the carrying
amount of the unit, including the goodwill, with the recoverable
amount of the unit.

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 Impairment Testing in Later
Periods
Goodwill is considered to be impaired if the carrying amount of
the unit’s net assets (including goodwill) exceeds the recoverable
amount of the unit.

To illustrate, assume the following estimates were made at the end

of the first year:

Estimated recoverable amount of the cash

generating unit, based on projected
cash flows (value in use) P 650, 000

Carrying amount of the cash generating unit

(including goodwill) 680, 000

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Since the recorded carrying amount of the cash generating unit exceeds its
recoverable amount, goodwill is considered to be impaired. If the
recoverable amount exceeds the carrying amount, there is no impairment,
and there is no need to proceed to calculate a goodwill impairment loss.
Goodwill Impairment Loss in Later Periods

If the above test indicates impairment, the impairment loss must be estimated.
The impairment loss for goodwill is the excess of the carrying amount of the
cash generating unit’s net assets (including goodwill) over the recoverable
amount of the cash generating unit. These are the values that would be assigned
to those account if the cash generating unit were purchased on the date of
impairment measurement.

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The following are the calculation of the impairment loss:

Carrying amount of the net assets on the

date on measurement,(including goodwill of P90, 000) P 690,000
Estimated recoverable amount of the
cash generating unit, based on project
cash flows (value in use) 650, 000
Estimated impairment loss P 40, 000

The following entry would be made:

Goodwill impairment loss 40, 000

Goodwill 40, 000

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 Disclosure of Business Combinations in a Note to
Financial Statements
Because of the complex nature of the business combination and their effects
in the financial position and operating results of the combined companies,
extensive disclosure is required for the period in which they occur.

Following are the extensive disclosure requirements for business combination

established by IFRS 3:

a. The names and description of the combining entities.

b. Method for accounting business combination.

c. The effective date of combination for accounting purposes.

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k. Provisions for terminating or reducing activities of acquiree.
l. Effects of acquisition on the financial position at the balance sheet date
and on the results since the acquisition.
m. More details for negative goodwill (income from acquisition). The
reason why the acquisition price was higher than the fair value of the net
assets acquired, leading to the recognition of goodwill.
n. Details of the annual impairment test (key assumption used to
determine recoverable amount, a sensitivity analysis on the key
assumptions).

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o. Disclosure of information for evaluation of the nature and/or
financial effect of business combinations occurred during the
reporting period, those occurred after the balance sheet date but
before the financial statements are authorized for issue; (certain
business combinations that occurred in previous reporting periods).
p. Information for evaluating changes in the carrying amount of
goodwill during the reporting period.

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