BUSINESS

COMBINATION
S PART 2
Learning Objectives
• Account for business combinations
a) accomplished through share-for-share exchanges
b) Achieve stages
c) Achieve without transfer of consideration
• Explain the “measurement period” in relation to business combinations
• Distinguish what is part of business combination and what is part of a “separate transaction”
• Account for settlement of pre-existing relationship between an acquirer and acquiree
Share-for-Share Exchanges
A business combination may be accomplished through an exchange of equity interest between the acquirer and
the acquiree.

However, there are cases where the fair value of the acquiree’s equity interest may be more reliably measured
than the acquirer. In such cases, the acquirer computes for goodwill using the fair value of the acquiree’s equity
interest instead of its own.
Example
ABC Co. and XZY Inc. combined their business through exchange of equity instruments, which resulted to
ABC obtaining 100% interest in XYZ Inc. Both entities are publicly listed. At the acquisition date, ABC’s share
are quoted at P100 per share. ABC Co. recognized goodwill of P300,000 on the business combination.
Additional information are as follows:

Requirements:
a. Number of shares issued by ABC Co.
b. Par value per share of the shared issued
c. Acquisition date fair value of the net identifiable assets of XYZ
Solution
  ABC Co. Combined Entity Increase
Share Capital 600,000 700,000 100,000
Share Premium 300,000 1,200,000 900,000
Total 900,000 1,900,000 1,000,000
Fair Value per Share     100
Shares (a)
 
 
 
 
   
10,000
Increase in Capital     100,000
Number of Shares     10,000
Par value per Share (b)   10
       

Consideration     1,000,000
NCI     -
Previously held equity interest in the acquiree -
Total     1,000,000
Fair value of identifiable asset ( c ) (squeez) 700,000
Goodwill     300,000
Example
Requirements:
a) Number of shares issued by ABC Co.
b) Fair value per share of the shares issued
c) Goodwill recognized at acquisition date
d) Retained Earnings of the combined
entity immediately after business
combination
Solution
ABC Co. Combined EntityIncrease
Share Capital 600,000 700,000 100,000
Par value per share 10
Shares Issued (a) 10,000
(d) Combined Entity
Share Capital 600,000 700,000 100,000 Identifiable Assets 4,000,000
Share Premium 300,000 1,200,000 900,000 Goodwill 300,000
Total 900,000 1,900,000 1,000,000 Total Assets 4,300,000
Shares issued 10,000
Fair value per share (b) 100 Liabilities 1,600,000
Share Capital 700,000
Consideration 1,000,000 Share Premium 1,200,000
NCI - Retained Earnings 800,000
Previously held equity interest in the acquiree - 4,300,000
Total 1,000,000
Fair value of identifiable asset (1.6M-.9M) 700,000
Goodwill ( c) 300,000
Business Combination in Stages
Business combination achieved in stages is also called “step acquisition”. The acquirer…
1. Remeasures previously held equity interest in the acquiree at acquisition date fair value and.
2. Recognized the gain or loss on remeasurement in:
a) Profit or loss – if the previously held equity interest was classified as FVPL, Investment in associate,
of investment in Joint Venture; or
b) Other Comprehensive income – if previously held equity interest was classified as FVOCI.
Example
Consideration Transferred 800,000
Non- Controlling Interest in the acquiree (1Mx25%) 250,000
Previously Held equity interest in the acquiree 180,000
Total 1,230,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 230,000
Business Combination Without transfer of Consideration
Circumstances where the acquirer obtains control without transferring consideration.

1. The acquiree repurchases a sufficient number of its own shares from other investors so that the acquirer will be
able to control.
Example:
ABC Co. holds 40,000 shares out of the 100,000 shares of XYZ, Inc. Subsequently, XYZ repurchases 25,000
shares from other investors. After the treasury share transaction, ABC’s ownership interest increased to
53.333% (40,000 / 75,000)
2. Minority veto rights that previously kept the acquirer from controlling the acquiree have lapsed.
3. The acquirer and the acquiree agree to combine their businesses by contract alone. The acquirer neither
transfers consideration nor holds equity interest in the acquiree.

Consideration on business combination without transfer of consideration:

A. In a business combination achieved without transfer of consideration, the acquisition-date fair value of the
acquirer’s interest in the acquiree is substituted for the consideration transferred in computing goodwill.
B. In a business combination achieved by contract alone, the interest held by parties other than the acquirer are
attributed to NCI, even if the result is that NCI represents 100% interest in the acquiree.
Example – Without transfer of consideration

ABC Co. owns 36,000 out of the 90,000 Solution:

outstanding shares of XYZ Inc. ABC account for
the investment under the equity method. XYZ Consideration Transferred (1M x 60%) 600,000
subsequently reacquires 30,000 shares from other Non- Controlling Interest in the acquiree (1Mx40%) 400,000
investors. Information on the acquisition date is Previously Held equity interest in the acquiree -
as follows:
Total 1,000,000
a. The previously held 40% interest has a fair Fair value of net identifiable assets acquired (1,000,000)
value of P180,000.00
Goodwill -
b. XYZ’s net identifiable assets have a fair value
of P1,000,000.00
c. ABC elects to measure NCI’s at proportionate
shares.
Requirement: Compute the goodwill
Example – by contract alone

ABC Co. and XYZ Inc. enter into a contract Solution:

whereby ABC obtains control of XYZ Co. No Consideration Transferred -
consideration is transferred between the parties.
The fair value of XYZ’s net identifiable assets at Non- Controlling Interest in the acquiree (1M x 100%) 1,000,000
the acquisition date is P1,000,000.00. ABC chose Previously Held equity interest in the acquiree -
to measure NCI at ‘Proportionate shares” Total 1,000,000
Requirement: Compute for goodwill. Fair value of net identifiable assets acquired (1,000,000)
Goodwill -
Measurement Period
• Acquirer can use provisional amounts for initial accounting of business combination
• Measurement period is within 12 months from the acquisition date.
• Within the measurement period the acquirer con retrospectively adjust the provisional amounts
• Any adjustment to provisional amounts will be considered as adjustment to goodwill.
• Corrections beyond 12 months are accounted for as correction of error.
•
Example
On October 1, 20x1, ABC Co. acquires all the identifiable assets and all the liabilities of XYZ, Inc. for P1,000,000. On
this date XYZ’s assets and liabilities have fair values of P1,600,000and P900,000respectively
The assets acquired include a building which was assigned a provisional amount of P700,000 because the appraisal is
not yet complete by the time ABC authorized for issue its December 31,020x1 financial statements. The building was
tentatively assigned a 10-year useful life and was depreciated for three months in 20x1 using the straight line method.

On July 1,20x2, ABC received valuation report for the building. The building’s fair value on October 1,20x1 is
P500,000 and its remaining useful life from that date is 5 years.

Requirements:
a. What is the measurement period?
b. How should ABC account for the new information obtained in July 1, 20x2?
c. How much is the goodwill?
d. What are the adjusting entries?
Solution:
a. October 1,20x1 to September 30,20x2 or earlier
b. The provisional amount assigned to the building is retrospectively adjusted with a corresponding adjustment to
goodwill. The 20x1 financial statements are stated, including a retrospective adjustment to depreciation
expenses.
c. Adjusted goodwill: Provisional Adjusted
Consideration Transferred 1,000,000 1,000,000
Non- Controlling Interest in the acquiree (1M x 100%) - -
Previously Held equity interest in the acquiree - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets acquired (700,000) (500,000)
Goodwill 300,000 500,000
Journal Entries
Goodwill 200,000
d. Building 200,000
To record adjustment to provisional amount assigned to building

Retained Earnings 7,500

Accumulated depreciation 7,500
To record the adjustment to 20x1 depreciation

20x1 Depreciation (700,000/10*3/12) 17,500

20x2 Depreciation (500,000/5 x 3/12) 25,000
Additional Depreciation 7,500
Example
On October 1, 20x1, ABC Co. acquires all the identifiable assets and all the liabilities of XYZ, Inc. for P1,000,000.
On this date XYZ’s assets and liabilities have fair values of P1,600,000and P900,000respectively
The assets acquired include a building which was assigned a provisional amount of P700,000 because the appraisal is
not yet complete by the time ABC authorized for issue its December 31,020x1 financial statements. The building was
tentatively assigned a 10-year useful life and was depreciated for three months in 20x1 using the straight line method.
On July 1,20x2, ABC obtained new information that XYZ has unrecorded patent which was not known on October 1,
20x1. The patent has a fair value of P100,000 and a remaining useful life of 4 years as of October 1, 20x1.

Requirement: Compute for the adjusted goodwill and provide the adjusting entries.
Solution
Provisional Adjusted
Consideration Transferred 1,000,000 1,000,000
Non- Controlling Interest in the acquiree (1M x 100%) - -
Previously Held equity interest in the acquiree - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets acquired (700,000) (800,000)
Goodwill 300,000 200,000

Journal Entries
Patent 100,000
Building 100,000

Retained Earnings 6,250

Accumulated Amortization 6,250
Example
On October 1, 20x1, ABC Co. acquires all the identifiable assets and all the liabilities of XYZ, Inc. for P1,000,000.
On this date XYZ’s assets and liabilities have fair values of P1,600,000and P900,000respectively
The assets acquired include a building which was assigned a provisional amount of P700,000 because the appraisal
is not yet complete by the time ABC authorized for issue its December 31,020x1 financial statements. The building
was tentatively assigned a 10-year useful life and was depreciated for three months in 20x1 using the straight line
method.
On November 1, 20x2 ABC’s auditors discovered that a patent with fair value of P100,000 was erroneously omitted
from the valuation listing on October 1, 20x1. The patent has a fair value of P100,000 and remaining useful life of 4
years as of October 1, 20x1.

Requirement: How should ABC account for the new information obtained on November 1, 20x2?

Answer:
New information was obtained after the measurement period, thus, it will be accounted for under PAS 8 as
correction of error.
Same adjustments as above but with different disclosures.
Example
On October 1, 20x1 ABC Co. as unlisted entity issued 10,000 shares with a par value of P5 in exchange for all
the identifiable assets and liabilities of XYZ Co.
Information at acquisition date are as follows:
• The shares issued were assigned a provisional amount of P100.00 per share
• The fair value of some of the assets acquired are not readily determinable. Accordingly, a provisional amount
of P700,000 were assigned to XYZ’s net identifiable assets
Information after the acquisition date are as follows:
• On April 1, 20x2, new information was obtained indicating that on October 1, 20x1
- the fair value of issued shares was P110
- the fair value of XYZ’s net identifiable assets was P900,000
• On July 2, 20x2 two competitors of ABC also merged. This led ABC to believe that the merger with XYZ is
not as profitable as expected. ABC estimates that the valuations of the consideration transferred and XYZ’s
net identifiable assets should have been P900,000 and 400,000 respectively

• Requirement: Compute for the adjusted goodwill

Solution
Provisional Adjusted
Consideration Transferred 1,000,000 1,100,000
Non- Controlling Interest in the acquiree (1M x 100%) - -
Previously Held equity interest in the acquiree - -
Total 1,000,000 1,100,000
Fair value of net identifiable assets acquired (700,000) (900,000)
Goodwill 300,000 200,000
Determining what is part of the business combination transaction
Included
For the benefit of the acquiree
For the benefit of the former owners
Transaction initiated by acquiree
Excluded
For the benefit of the acquirer
For the benefit of the combined entity
Transaction initiated by acquirer or combined entity
Settlement of pre-existing relationship between
acquirer and acquiree
Enumeration to employees or former owners of the
acquiree for future services
Reimbursement to the acquiree or its former owners
for paying the acquirer’s acquisition-related cost
Example

Requirement: compute goodwill

Solution

Consideration(1M + 50k) 1,050,000

NCI -
Previously held equity interest in the acquiree -
Total 1,050,000
Fair value of identifiable asset (1.6M-90k-0.9M) (610,000)
Goodwill 440,000
Reacquired Right
Reacquired Right – a right that an acquirer has previously granted to the acquiree that is reacquired as a result of
a business combination is recognized as an intangible assets separate from goodwill
Examples of Reacquired Right
• Right to use the acquirer’s intangible assets, such as trade name under a franchise agreement.
• Right to use acquirer’s technology under a technology licensing agreement.
Settlement of pre-existing relationship
a) Contractual – as vendor and customer, licensor and licensee, franchisor or franchisee. A pre-existing relationship
may be a contract that the acquirer recognizes as reacquired right
b) Non-contractual – as plaintiff and defendant on a pending lawsuit
If the pre-existing relationship is settled due to the business combination, the acquirer recognizes a settlement gain
or loss measured as follows:
a. At the lower of the items below, if the pre-existing agreement is contractual.
i. The amount by which the contract is favorable or unfavorable, from the acquirer’s perspective, when
compared to market terms.
ii. Any settlement amount stated in the contract that is available to the counterparty to which the contract is
unfavorable. If this is less than the amount in (i), the difference is included as part of the business
combination accounting.
b. At fair value, if the pre-existing relationship is non-contractual.
Example
On January 1 20x1, ABC Co. acquired all the assets and liabilities of XYZ Inc. for P1,000,000. XYZ’s assets and
liabilities have fair values of P1,600,000 and P900,000 respectively.
Additional Information:
• Prior to the business combination, ABC granted XYZ the right to use ABC’s patented technology over a 5-year period
in exchange for P100,000 cash (payable at grant date) and royalty fees based on XYZ’s sales over the 5-year period
• ABC recognized the P100,000 license fee as deferred liability (unearned income) and amortized it over 5 years. The
carrying amount of the deferred liability on January 1, 20x1 is P60,000
• On the other hand, XYZ recognized the license fee as prepayment (prepaid asset) and amortized it based on the
number of products sold. The carrying amount of the prepayment on January 1, 20x1 is P50,000
• On acquisition date, the fair value of the license agreement is P120,000. this consists of the following components:
• P40,000 “at-market” (based on market participants’ estimates) and
• P80,000”off-market”(the excess of P120,000 fair value derived from cashflow estimated over P40,000 at-market
value)
• The off-market component is favorable to XYZ and unfavorable to ABC, as royalty rates have increased
considerably in comparable markets since the initiation of the contract. The contract does not have any cancellation
clause or any minimum royalty payment requirements.
Requirement: compute goodwill
 Solution

Consideration(1M + 80k off market value) 920,000 Identifiable assets acquired (1.6M+40K-50K) 1,590,000
Goodwill 230,000
NCI - Liabilities assumed 900,000
Previously held equity interest in the acquiree - Cash 920,000
To record business combination
Total 920,000
Fair value of identifiable asset (1.6M+40kintangible asset-50kprepayment-0.9M) (690,000) Settlement loss 20,000
Deferred Liability 60,000
Goodwil 230,000 Cash 80,000
To record the effective settlement of pre-existing relationship as a separate
Settlement loss before Adjustment (off-market value) 80,000 transaction from business combination transaction
Carrying amount of deferred liability (60,000)
Adjusted Settlement Cost 20,000
Example
On January 1 20x1, ABC Co. acquired all the assets and liabilities of XYZ Inc. for P1,000,000. XYZ’s assets and
liabilities have fair values of P1,600,000 and P900,000 respectively.
Additional Information:
• ABC and XYZ have pre-existing supply contract under which ABC could purchase raw materials from XYZ at
discounted rates. The contract has a remaining term of three years which ABC can terminate by paying P100,000
penalty.
• The supply contract has a fair value of P160,000 of which P70,000 is “at-market”. The “off-market” component is
unfavorable to ABC because it exceeds the price of current market transactions for similar items
• No assets or liabilities related to the contract were recognized in either of ABC’s or xyz’s books as at the acquisition
date.

Requirement: compute goodwill

Solution
Consideration(1M - 90k off market value) 910,000 Identifiable assets acquired 1,600,000
NCI - Goodwill 210,000
Previously held equity interest in the acquiree - Liabilities assumed 900,000
Cash 910,000
Total 910,000
To record business combination
Fair value of identifiable asset (1.6M-0.9M) (700,000)
Goodwill 210,000 Settlement loss 90,000
Cash 90,000
To record the effective settlement of pre-existing relationship as a separate
transaction from business combination transaction
Example
Solution
Consideration(1M - 90k off market value) 900,000 Identifiable assets acquired 1,600,000
NCI - Goodwill 200,000
Previously held equity interest in the acquiree - Liabilities assumed 900,000
Total 900,000 Cash (1M -100K) 900,000
Fair value of identifiable asset (1.6M-0.9M) (700,000) To record business combination
Goodwill 200,000
Estimated Liability 130,000
Payment for the settlement of pre-existing relationship 100,000 Cash 100,000
Carrying amount of related provision(liability) 130,000 Settlement gain 30,000
Settlement gain (30,000)
Subsequent Measurement and Accounting
• Reacquired Rights – recognized as intangible assets are amortized over the remaining term of the related
contract
• Indemnification assets – are measured on the same basis as the indemnified item, subject to an assessment of
collectability for indemnification assets not measured as fair value.
• Contingent liability – recognized in a business combination are measured at higher of:
a) The amount that would be recognized by applying PAS 37; and
b) The amount initially recognized less, if appropriate, the cumulative amount of income recognized in
accordance with PFRS 15.
• Contingent consideration – is an additional consideration for a business combination that the acquirer agrees
to provide to the acquiree upon the happening of a contingency
A contingency is an existing, unresolved condition that will be resolved by the occurrence or non-
occurrence of a possible future event.
Example

Requirement: Compute the goodwill

Solution
Consideration(1M + 90k contingent consideration ) 1,090,000
Identifiable assets acquired 1,600,000
NCI -
Previously held equity interest in the acquiree -
Goodwill 390,000
Total 1,090,000 Liabilities assumed 900,000
Fair value of identifiable asset (1.6M-0.9M) (700,000) Share Capital (10,000 x P10) 100,000
Goodwill 390,000 Share Premium (10,000 x (100-10) 900,000
Share Premium - contingent consideration 90,000
Example Continuation
Market price of ABC’s share on December 31,20x1 is P120. the contingent consideration is settled on January
15, 20x2.
Requirement: Journal Entries
Share Premium - contingent consideration 90,000
Share Capital (1,000 x P10) 10,000
Share Premium (squeeze) 80,000

Market price of ABC’s share on December 31,20x1 is P90.

Requirement: Journal Entries
Share Premium - contingent consideration 90,000
Share Premium (squeeze) 90,000
Example

Requirement: Compute for goodwill

Solution
Consideration(1M + 10k contingent consideration ) 1,010,000
NCI -
Previously held equity interest in the acquiree -
Total 1,010,000
Fair value of identifiable asset (1.6M-0.9M) (700,000)
Goodwill 310,000

Identifiable assets acquired 1,600,000

Goodwill 310,000
Liabilities assumed 900,000
Liability for contingent consideration 10,000
Cash 1,000,000
Example Continuation
Profit for the year is P550,000. the contingent consideration is settled on January 15, 20x2
Provide journal Entries
Unrealized Loss P/L 5,000
Liability for contingent consideration 5,000

Liability for contingent consideration 15,000

Cash 15,000

Profit for the year is P300,000

Provide journal Entry
Liability for contingent consideration 10,000
Gain on extinguishment of Liability P/L 10,000
Example

Requirement: Compute for goodwill

Example
Consideration 1,000,000
NCI 80,000
Previously held equity interest in the acquiree -
Total 1,080,000
Fair value of identifiable asset (1.6M-0.9M-100k) (600,000)
Goodwill 480,000
• Fin