Chapter 3 BUSINESS COMBINATIONS (Part 3)

 
Learning Objectives
• Apply the methods of estimating goodwill.
• Account for reverse acquisitions.

ACCOUNTING FOR BUSINESS

COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
Methods of estimating goodwill

1. Indirect valuation – this is the method required by

PFRS 3 and it is the method illustrated in the preceding
discussions.
2.Direct valuation – under this method, goodwill is
measured on the basis of expected future earnings from
the business to be acquired.

ACCOUNTING FOR BUSINESS

COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
Direct valuation method

The direct valuation method may require the determination of one or more of
the following information:

a. Normal rate of return in the industry where the acquiree

belongs (e.g., industry average)

b. Normal earnings = Normal rate of return x Acquiree’s net assets

c. Estimated future earnings of the acquiree.

•The earnings of the acquiree are “normalized,” i.e., adjusted for non-
recurring income and expenses.
•The excess of the acquiree’s normalized earnings over the average return in the
industry represents the “excess earnings” to which goodwill is attributed.

d. Discount rate to be applied to “excess earnings”

e. Probable duration of “excess earnings”

ACCOUNTING FOR BUSINESS
COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
Reverse acquisitions

• In a business combination accomplished through exchange of

equity interests, the acquirer is usually the entity that issues its
equity interests. However, the opposite is true for reverse
acquisitions.

• In a reverse acquisition, the entity that issues securities (the

legal acquirer) is identified as the acquiree for accounting
purposes while the entity whose equity interests are
acquired (the legal acquiree) is the acquirer for accounting
purposes ACCOUNTING FOR BUSINESS
COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
  Conventional acquisition vs. Reverse acquisition:
Conventional
  Reverse acquisition
acquisition
Issuer of shares as The issuer of shares is The issuer of shares is
consideration the accounting the accounting
transferred acquirer. acquiree.
   

Reference to ˗ Accounting ˗ Accounting

combining acquirer/ Legal acquirer/ Legal
constituents parent subsidiary
˗ Accounting ˗ Accounting
acquiree/ Legal acquiree/ Legal
subsidiary parent
 
ACCOUNTING FOR BUSINESS
COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
 Conventional
  Reverse acquisition
acquisition
Measurement of Fair value of Fair value of the
consideration consideration notional number of
transferred transferred by the equity instruments
accounting acquirer. that the accounting
acquirer (legal
subsidiary) would
have had to issue to
the accounting
acquiree (legal
parent) to give the
owners of the
accounting acquiree
(legal parent) the
same percentage
ownership in the
combined entity.
 
ACCOUNTING FOR BUSINESS
COMBINATIONS (Advanced
Accounting 2) - (by: MILLAN)
 END
ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by:
MILLAN)