Business

Combinations:
Statutory Merger
and
Statutory
Consolidation
Chapter 1
 Introduction
• Accounting for business combinations is one of the most significant and interesting topics of accounting
theory and practice. Simultaneously, it is multifaceted and divisive. Business combinations involve financial
transactions of immeasurable magnitudes, business empires, triumphant stories and individual fortunes,
managerial genius, and management debacles. By their nature, they affect the destiny of entire companies.
Each is exceptional and must be evaluated in terms of its economic substance, regardless of its legal form.

• Why do business entities enter into a business combination? Although a number of reasons have been cited,
the overriding reason is probably growth. Growth is a major objective of many business organizations. A
company may grow slowly, may gradually expand its product lines, facilities, or services, or may skyrocket
almost overnight

• This chapter presents reasons for the popularity of business combination, the methods and techniques in
dealing with them
 The Nature of a Business Combination

A business combination may be friendly or unfriendly (hostile takeovers):

• In a friendly combination, the board of directors of the potential combining companies negotiates mutually
agreeable terms of a proposed combination.
• An unfriendly (hostile) combination results when the board of directors of a company targeted for
acquisition resists the combination
Because they are relatively quick and easily executed (often in about a month), tender offers are the preferred
means of acquiring public companies
 Reasons for Business Combinations
There are several ways of business expansion; it may either be through acquisition or
construction of new amenities or through business combination. Following are the reasons why
business combination may be preferred as compared to other means.
1. Cost Advantage
2. Lower Risk
3. Avoidance of Takeovers
4. Acquisition of Intangible Assets
5. Other Reasons
Types of Business Combinations
Business combinations may be classified under three schemes:
1. One based on the structure of the combination
2. One based on the method used to accomplish the combination, and
3. One based on the accounting method used

Structure of Business Combination

In general terms, business combinations unite previously separate business entities. Because of this reason,
combinations are classified by structure into four types – horizontal, vertical, conglomerate, and circular.
• Horizontal Integration
• Vertical Integration
• Conglomerate Combination
• Circular Combination
 Possible Structures
The structure of a business combination may be determined by a variety of factors, including legal and tax
strategies. Other factors might include market considerations and regulatory considerations include:
• one business becomes a subsidiary of another;
• two entities are legally merged into one entity;
• one entity transfers its net assets to another entity;
• an entity’s owners transfer their equity interests to the owners of another entity;
• two or more entities transfer their net assets, or the owners transfer their equity interests, to a newly-formed
entity (sometimes termed a “roll-up or ‘put-together’ transaction); and
• a group of former owners of one entity obtains control of a combined entity.
 Methods/Types of Combinations /
Legal Forms of Effecting Business Combinations
There are four types of combination which can be identified from legal and organizational
perspectives.
From legal perspective, accounting and organizational perspective, the specific procedures to be
used in accounting for a business combination is affected through:
I. Acquisition of Net Assets (Assets less Liabilities).
II. Acquisition of Common Stock (Stock Acquisition)
III. Asset Acquisition
 Acquisition of Net Assets (Assets less Liabilities). The books of the acquired (acquiree) company are
closed out, and its assets and liabilities are transferred to the books of the acquirer (or the acquiring
/surviving company).
Following are the features of an asset and liabilities acquisition:
• The acquirer acquires from another enterprise all or most of the net assets of the other enterprise for cash
or other property, debt instruments, and equity instruments (common or preferred stock), or a combination
thereof
• The acquirer must acquire 100% of the net assets of the acquiree (acquired) company.
• It involves only when the acquirer (acquiring) company survives.
Acquisitions of Net Assets (assets less liabilities) are classified into:
A. Statutory merger
B. Statutory consolidation

In this chapter, we focus on the acquisition of net assets of the acquired company.
 Acquisition of Common Stock (Stock Acquisition)

• The books of the acquirer (acquiring) company and acquiree (acquired) company
• the acquirer (acquiring) company debits an account “Investment in Subsidiary
A business combination effected through a stock acquisition does not necessarily have
to involve the acquisition of all of a company’s outstanding voting (common) shares.
Following are the features of a stock acquisition:
a. The acquirer acquires voting (common) stock from another enterprise for cash or other
property, debt instruments, and equity instruments (common or preferred stock), or a combination
thereof
b. The acquirer must obtain control by purchasing 50% or more of the voting common stock
or possibly less when other factors are present that lead to the acquirer gaining control.
c. The acquired company need not be dissolved; that is, the acquired company does not have to go
out of existence. Both the acquirer (acquiring) company and the acquiree (acquired) company
remain as separate legal entity.
Further discussions and illustration for the topic “stock acquisition” will be discussed in the
succeeding chapters.
Asset Acquisition
• It reflects the acquisition by one firm of assets (and possibly liabilities) of another firm, but not its
shares.
• The selling firm may continue to survive as a legal entity, or it may liquidate entirely. The acquirer
typically targets key assets for acquisition, or buys the acquiree’s assets but does not assume its
liabilities.
• Often the assets acquired are in the form of a division or product line. The acquirer may not buy
the entire entity.
It should be noted that asset acquisition is not within the scope of business combination under
PFRS 3.
 There are two independent issues related to the consummation of a combination:
• what is acquired (net assets, stock or assets) and
• what is given up (the consideration for the combination).

Acquisition of Net Assets (Assets less Liabilities)

The terms merger and consolidation are often used synonymously for acquisitions.
However, legally and in accounting, there is a difference. The distinction between these
categories is largely a technicality, and the terms mergers, consolidations, and acquisitions
are popularly used interchangeably.
Statutory Merger
A statutory merger entails that acquiring (acquirer) company survives, whereas the acquired (acquire)
company (or companies) ceases to exist as a separate legal entity, although it may be continued as a separate
division of the acquiring company. Thus, if A Company acquires B Company in a statutory merger, the
combination is often expressed as:
X Company + Y Company = X Company or Y Company

Statutory Consolidation
A statutory consolidation results when a new corporation is formed to acquire two or more other
corporations; the acquired corporations then cease to exist (dissolve) as separate legal entities. For example, if
C Company is formed to consolidate A Company and B Company, the combination is generally expressed as:
X Company + Y Company = Z Company
Future references in this chapter:
• The term merger in the technical sense of a business combination in which all but one of the combining
companies go out of existence.
• Similarly, the term consolidation will be used in its technical sense to refer to a business combination in
which all the combining companies are dissolved and a new corporation is formed to take over their net
assets.
• Consolidation is also used in accounting which refers to the accounting process or procedures of combining
parent and subsidiary financial statements, such as in the expressions “principles of consolidation”,
“consolidation procedures,” and “consolidated financial statements.”
• In succeeding chapters, the meaning of the term “consolidation” refers to stock acquisition. As a matter of
procedure to prepare consolidated financial statements, the business combination defined as stock
acquisition is expressed as:

Financial Financial
Consolidated Financial Statements of X
Statements of X + Statements of Y =
Company and Y Company
Company Company
Accounting Concept of Business Combination
The accounting standard relevant for accounting for business combinations is PFRS 3
(Business Combinations) issued by the International Accounting Standards Board (IASB).
Definition
• PFRS 3 defines “business combination” as a transaction or other event in which an
acquirer obtains control of one or more businesses.
• Transactions sometimes referred to as “true mergers” or “mergers of equals” also are
business combinations.
 A first key aspect in this definition is “control”. This means that there must be a
triggering economic event or transaction and not, for example, merely a decision to start
preparing combined or consolidated financial statements for an existing group. Control can
usually be obtained either by:
1. Buying the assets or
2. Buying enough shares
Economic events that might result in an entity obtaining control include:
• transferring cash or other assets (including net assets that constitute a business);
• incurring liabilities;
• issuing equity instruments;
• a combination of the above; and
• a transaction not involving consideration, such as combination by contract alone (e.g. a
dual listed structure)
The meaning of “control” will be discussed later in Chapter 2 and the accounting
procedures are thoroughly discussed in succeeding chapters.
The second key aspect of the definition is that the acquirer obtains control of a
“business”.
Identifying a Business
PFRS 3 defines the term “business” as “an integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing goods or services to customers, generating investment
income (such as dividends or interest) or generating other income from ordinary activities.”
• The definition of business was narrowed by:
• focusing on providing goods and services to customers
• removing the emphasis from providing a return to shareholders
• removing the reference to ‘lower costs or other economics benefits
The business combination must involve the acquisition of a business, which generally has three elements:
• Inputs
• Process
• Output
 The purpose of defining a business is to distinguish between the acquisitions of a group of assets such as a number
of chairs, bookshelves and filing cabinets ­– and the acquisition of an entity that is capable of producing some form of
output. Accounting for a group of assets is based on standards such as PAS 16 Property, Plant and Equipment rather than
PFRS 3.

Scope of Business Combination

The following transactions are within the scope of PFRS 3:

1. Combinations involving mutual entities.

2. Combinations achieved by contract alone (dual listing stapling).

On the other hand, the following transactions are not within the scope of PFRS 3:

3. Where the business combination results in the formation of all types of joint arrangements (joint ventures and joint
operations) and the scope exception only applies to the financial statements of the joint venture or the joint operation
itself and not the accounting for the interest in a joint arrangement in the financial statements of a party to the joint
arrangement.

4. Where the business combination involves entities or businesses under common control.

5. Where the acquisition of an asset or a group of assets does not constitute a business.
The Acquisition Method
The acquisition method is applied on the acquisition date which is the date
the acquirer obtains control of the acquiree. The acquisition method
approaches a business combination from the perspective of the acquirer (not
the acquiree), the entity that obtains control of the other entity(ies) in the
business combination.
Under the acquisition method, all assets and liabilities are identified and
reported at their fair values.
Accounting Procedures for a Business Combination
The required method of accounting for a business combination under paragraph 4 of PFRS 3 is the
acquisition method. Under the acquisition method, the general approach to accounting business
combinations is a five step process:
1. Identify the acquirer;
2. Determine the acquisition date;
3. Calculate the fair value of the purchase consideration transferred (i.e., the cost of purchase)
4. Recognize and measure the identifiable assets and liabilities of the business, and
5. Recognize and measure either goodwill or a gain from a bargain purchase, if either exists in the
transaction.
If an acquirer gains control by purchasing less than 100% of the acquired entity, then the fourth step
includes measuring and recognizing the non-controlling interests (NCI). Discussion of NCI will be in
Chapter 2.
Identifying the Acquirer
PFRS 3 paragraph 7 states that “the acquirer is the entity that obtains
control of the acquiree". Paragraph 6 requires that in each business
combination, one of the combining entities should be identified as the
acquirer.
The concept of control under PFRS 3 will be discussed methodically in
Chapter 2. PFRS 3, however, recognizes that it may be difficult to identify
which entity has control over other combining entities. In the event that the
overriding principle of "control” in PFRS 3 does not conclusively determine the
identity of the acquirer, PFRS 3 provides additional guidance.
Determining the Acquisition Date
PFRS 3 defines “acquisition date” as the date on which the acquirer obtains control of the acquiree
A business combination involves the joining together of assets under the control of a specific entity.
Therefore, the business combination occurs at the date of the assets or net assets are under the control of the
acquirer. This date is the acquisition date.
• Other dates that are important during the process of business combination may be:
– The date the contract is signed;
– The date the consideration is paid;
– A date nominated in the contract;
– The date on which assets acquired are delivered to the acquirer; and
– The date on which an offer becomes unconditional.

• The definition of acquisition date then relates to the point in time when the net assets of the acquiree
become the net assets of the acquirer – in essence the date on which the acquirer can recognize the net assets
acquired in its own records
 There are four main areas where the selection of the date affects the accounting for a business
combination:
1. The identifiable assets acquired and liabilities assumed by the acquirer
2. The consideration paid by the acquirer
3. The acquirer may acquire only some of the shares of the acquiree
4. The acquirer may have previously held an equity interest in the acquiree prior to obtaining control of
the acquiree
The effect of determining the acquisition date is that the financial position of the combined entity on
acquisition date should report the assets and liabilities of the acquiree on that date and any profits reports as
a result of the acquiree’s operation within the business combination should reflect profits earned after the
acquisition date.
Calculating the Fair Value of the Consideration Transferred:
Accounting Records of the Acquirer
According to PFRS 3 paragraph 37, the consideration transferred:
• is measured at fair value at acquisition date
• is calculated as the sum of the acquisition date fair values of:
1. the assets transferred by the acquirer;
2. the liabilities incurred by the acquirer to former owners of the acquiree; and
3. the equity interest issued by the acquirer.
 In a specific exchange, the consideration transferred to the acquirer could include just one form of
consideration, such as cash, but could equally well consist of a number of forms such as cash, other assets, a
business or a subsidiary of the acquirer, contingent consideration, equity instruments (common or preferred
stock) and debt instruments, options, warrants and member interests of mutual entities.
The consideration transferred includes the following items:
1. Cash or Other Monetary Assets.
For deferred payment, the fair value to the acquirer
2. Non-monetary Assets.
3. Equity Instruments.
4. Liabilities Undertaken.
5. Contingent Consideration.
6. Share-based payment awards.
Acquisition-Related Costs
In addition to the consideration transferred by the acquirer to the acquiree, a further item to be considered
in determining the cost of the business combination is the acquisition-related costs.
Acquisition-related costs are excluded from the measurement of the consideration paid, because such
costs are not part of the fair value of the acquiree and are not assets. They are as follows:
1. Costs directly attributable to the combination which includes costs such as legal fees, finder’s and
brokerage fee, advisory, accounting, valuation and other professional or consulting fees.
2. Indirect, ongoing costs, general costs including the cost to maintain an internal acquisition department
(mergers and acquisitions department), as well as general and administrative costs such as managerial
(including the costs of maintaining an internal acquisitions department (management salaries,
depreciation, rent, and costs incurred to duplicate facilities), overhead that are allocated to the merger but
would have existed in its absence and other costs of which cannot be directly attributed to the particular
acquisition.
 The PFRS 3 accounting for these outlays is a result of the decision to record the identifiable
assets acquired and liabilities assumed at fair value.
The acquisition-related costs associated with a business combination are accounted for as
expenses in the periods in which they are incurred and the services are received.
The key reasons given for this approach are:
• Acquisition-related costs are not part of the fair value exchange between the buyer and seller.
• They are separate transactions for which the buyer pays the fair value for the services received.
• These amounts do not generally represent assets of the acquirer at acquisition date because the
benefits obtained are consumed as the services are received.
Costs of Issuing Equity Instruments / Share Issuance Costs
The costs of issuing equity instruments is also excluded from the consideration and
accounted for separately.
In issuing equity instruments such as shares as part of the consideration paid, transaction
costs such as documentary stamp duties on new shares, professional adviser’s fees,
underwriting costs and brokerage fees may be incurred.
Costs of Issuing Debt Instruments
Similarly with equity instruments, the costs of arranging and issuing debt instruments
or financial liabilities in accordance with PFRS 9), are an integral part of the liability
issue transaction. They are deemed as yield adjustments to the cost of borrowing. These
costs are included in the initial measurement of the liability as bond issue costs and
amortized the life of the debt.
Table 1 – 1: Summary of Acquisition-related Costs:
Acquisition-related costs
1. Directly attributable costs
2. Indirect acquisition costs
3. Costs of issuing securities (issue and
register stocks)* - refer to discussion
above
4. Cost of arranging (registering) and
issuing debt securities or financial
liabilities
Examples Treatment
Legal fees, finders and brokerage fee, Expenses
advisory, accounting, valuation (valuers)
and other professional or consulting fees
to effect the combination.
General and administrative costs such as Expenses
managerial (including the costs of
maintaining an internal acquisitions
department (management salaries,
depreciation, rent, and costs incurred to
duplicate facilities), overhead that are
allocated to the merger but would have
existed in its absence and other costs of
which cannot be directly attributed to the
particular acquisition
Transaction costs such as stamp duties on Debit to “Share Premium” or “Additional
new shares, professional adviser’s fees, paid-in capital” account.
underwriting costs and brokerage fees
may be incurred
Professional adviser’s fees, underwriting Bond issue costs
costs and brokerage fees may be incurred.
 Principles in Assessing What is Part of the Business Combination

PFRS 3 requires that:

• an acquirer shall assess whether any portion of the transaction price (payments or other arrangements) and any
assets acquired or liabilities assumed or incurred are not a part or a component of the exchange for the acquiree
• Only the consideration transferred and the assets acquired or liabilities assumed or incurred that are part of the
exchange for the acquiree shall be included in the business combination accounting
• Any portion of the transaction price or any assets acquired or liabilities assumed or incurred that are not parts or
components of the exchange for the acquiree shall be accounted for separately from the business combination
 Recognition and Measurement of Assets Acquired and Liabilities Assumed:
Accounting Records of the Acquirer

PFRS 3 sets out basic principles for the recognition and measurement of identifiable assets acquired, liabilities
assumed and non-controlling interests. Having established those principles, the PFRS 3 provides detailed application for
specific assets and liabilities and a number of limited exceptions to the general principles.

Under the acquisition method, the acquirer is required to:

1. Recognize identifiable assets and liabilities separately from goodwill; and

2. Measure such assets and liabilities at their fair values on the date of acquisition.
 Recognition Principle for Assets and Liabilities

A key word is identifiable. The acquirer may be able to identify many more assets and liabilities than those
shown in the acquiree’s balance sheet
PFRS 3 paragraph 10 requires that, as of the acquisition date, the acquirer should recognize, separately from
goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interests in the
acquirer.
Paragraph 83 of the Framework for the preparation and presentation of Financial Statements specifies two
recognition criteria for assets and liabilities stating that the recognition occurs if:
• It is probable that any future economic benefit will flow to or from the entity; and
• The item has a cost or value that can be reliably measured.
 Conditions for Recognition Principle

In paragraphs 11 and 12 of PFRS 3, there are two conditions that have to be met prior to the recognition of
assets and liabilities acquired in the business combination:
1. At the acquisition date, the assets and liabilities recognized by the acquirer must meet the definitions of
assets and liabilities in the Framework. Any expected future costs cannot be included in the calculation
of assets and liabilities acquired and liabilities assumed
The following are outcomes as a result of applying this recognition condition:
• Post-acquisition reorganization
• Unrecognized assets and liabilities
 Exception to the Recognition Principle

One area affected by this condition is the accounting for contingent liabilities. PAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
2. The item acquired or assumed must be part of the business acquired rather than the result of a separate
transaction.
As noted in Paragraph 13 of PFRS 3, a possible result of applying the principles of PFRS 3 is that there may
be assets and liabilities recognized as a result of the business combination that were not recognized by the
acquiree.
One example of this is internally generated intangibles that were not recognized by the acquiree on the
application of PAS 38 Intangible Assets; for example, internally generated brands would not be recognized
by an acquire but would be recognized by the acquirer. The acquirer would measure these at fair value.
 Measurement Principle for Assets and Liabilities

Identifiable assets acquired and the liabilities assumed are measured at their fair values on
acquisition date fair values.
PFRS 13 defines “fair value” as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement
date (i.e., an exit price).
That definition of fair value emphasizes that fair value is a market-based measurement,
not an entity-specific measurement.
Fair value is basically a market-based measure in a transaction between unrelated parties. However, the
process of determining fair value necessarily involves judgment and estimation. The acquiring entity is not
actually trading the items in the marketplace for cash, but is trying to estimate what the exchange price would
be if it did so. Hence, the determination of fair value involves estimation.
To assist in the determination of fair value, the standard setters have developed a fair value hierarchy. The
hierarchy categorizes the inputs used in valuation techniques into three levels.
The hierarchy gives the highest priority to (unadjusted) quoted prices in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs
Measurement under the fair value hierarchy is as follows (it should be noted that inputs
are being prioritized):

• Level 1 Inputs – are fully observable and are unadjusted quoted prices in an active market for identical
assets and liabilities.
• Level 2 Inputs - are directly or indirectly observable inputs other than Level 1 inputs.
• Level 3 Inputs - unobservable inputs for the asset or liability (not based on observable market data).
 Valuation of Identifiable Assets and Liabilities

The above discussion on recognition and measurement principles serves as guidelines as to the proper
recording and valuation of identifiable assets and liabilities
• The first step in recording an acquisition is to record the existing assets and liabilities accounts (except
goodwill). As a general rule, assets and liabilities are to be recorded at their individually determined fair
values.
• The preferred method is quoted market value, where an active market for the item exists. Where there is
not an active market, independent appraisals, discounted cash flow analysis, and other types of analysis
are used to estimate fair values. There are some exceptions to the use of fair value that apply to accounts
such as assets for resale and deferred taxes (see below for discussion).
• The acquirer is not required to establish values immediately on the acquisition date.
In summary, the procedures for recording the assets and liabilities of the acquiree are as
follows:
1. Identifiable Tangible Assets
A. Current Assets
B. Assets held for sale (assets that are going to be sold rather than to be used in
operations).
C. Property, plant and equipment
D. Investments in equity-accounted entities
2. Identifiable Intangible Assets
An intangible asset is identifiable if, it:
• can be separated; or
• meets the contractual-legal criterion e.g., license to operate a nuclear power plant is an
intangible asset, even though the acquirer cannot sell or transfer the license separately
from the acquired power plant
PFRS 3 presumes that where an intangible asset satisfies either of the criteria above,
sufficient information should exist to measure reliably its fair value.
However, it emphasizes that separability is not a necessary condition for an asset to meet
the contractual-legal criterion.
The table below summarizes the items mentioned above in their classification as an
intangible asset and are therefore to be recognized separately from goodwill.
• Marketing-related Intangible Assets
• Customer-related Intangible Assets
• Artistic-related Intangible Assets
• Contract-based Intangible Assets
• Technological-based Intangible Assets
Other intangible assets being acquired as part of business combinations with their proper
valuation are:

1. Emission rights.
2. Reacquired rights. A reacquired right is an intangible that the acquirer recognizes
separately from goodwill.
1. Relative to the above discussions and examples, care should be considered to as
recognition of intangible assets:

A. Existing intangible assets

B. Intangible assets not currently recorded by the acquiree
C. When the acquiree is a lessee with respect to assets in use
2. Existing Liabilities
Long-term liabilities
In cases of deferred revenue,
The measurement of the deferred revenue should be based on the fair value of the
obligation at the date of acquisition, which will not be necessarily the same as the
amount of deferred revenue recognized by the acquiree.
3. Contingent liabilities
In a business combination, the requirements of PAS 37 are not applied in determining
which contingent liabilities should be recognized as of the acquisition date
Instead, PFRS 3 requires that the acquirer should recognize a contingent liability
assumed in a business combination as of the acquisition date if:
• It is a present obligation that arises from past events; and
• Its fair value can be measured reliably.
The acquirer recognizes the liability even if it is not probable that an outflow of resources
embodying economic benefits will be required to settle the obligation
4. Liabilities associated with restructuring or exit activities
To record a liability, there must be an existing obligation to other entities. The possible
future costs connected with restructuring or exit activities that may be planned by the
acquirer are not part of the acquisition and are expensed in future periods.
5. Other Assets/Liabilities
a. Employee benefit plans
b. Indemnification assets
c. Income Taxes
d. Employee benefits
 Measuring and Recognizing Goodwill or a Gain from Bargain Purchase:
Accounting Records of the Acquirer

• The price paid for the entity will be determined in part by its earnings ability. The acquirer may or may not
choose to operate the entity in the same manner; but regardless of the acquirer’s plans, the price to be paid
will take into account the acquiree’s future earnings potential,
• If the entity has been successful and has demonstrated an ability to generate above-earnings, then the
acquirer may have to pay a price that is higher the aggregate fair value of the identifiable net assets. On the
other hand, if the entity has not been successful, the price may be less than the fair value of the net
identifiable assets (but not normally less than the liquidating value of the net assets including tax effects)
 Goodwill

PFRS 3 states that “the acquirer shall recognize goodwill as of the acquisition date, measured as the excess
of (I) over (II) below”:
I. the aggregate of:
a. the consideration transferred measured in accordance with this Standard, which generally requires
acquisition date fair value;
b. the amount of any non-controlling interest in the acquiree measured in accordance with this standard;
and
c. in a business combination achieved in stages, the acquisition date fair value of the acquirer’s previously
held equity interest in the acquire.
II. the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed
measured in accordance with this Standard
In relation to parts (I) (b) and (c) in paragraph 32, these will affect calculations only where the acquirer
obtains control by acquiring shares in the acquiree, this topic on the calculation of goodwill will be discussed
in Chapter 2.

In this chapter discussion, the business combinations defined as statutory merger and statutory
consolidation, goodwill is determined to be as the excess of the consideration transferred over the net fair
value of the identifiable assets and liabilities assumed. Thus:

Goodwill = Consideration transferred less Acquirer’s interests net fair value of the acquiree’s identifiable
assets and liabilities
Goodwill is accounted for as an asset and is defined in PFRS 3

The criterion of being individually identified relates to the characteristics of “identifiability”

In order to be identifiable, an asset must be capable of being separated or divided from the entity, or arise
from contractual or other legal rights.

Goodwill acquired in a purchase of net assets is recorded on the acquirer’s books, along with the fair values
of the other assets and liabilities acquired.
Items Included In Goodwill
The acquirer subsumes (includes) into goodwill the following:
• Acquired intangible asset that is not identifiable (unidentifiable) as of the acquisition date:
1. Assembled workforce of the acquiree
• Items that do not qualify as assets at the acquisition date:
2. Potential contracts
3. Contingent assets
4. Future contracts renewal
Bargain Purchase Gain
When the acquirer’s interest in the net fair value of the acquiree’s identifiable assets and liabilities is greater
than the consideration transferred, the difference is called a bargain purchase gain, thus:
Bargain purchase gain = Acquirer’s interests net fair value of the acquiree’s identifiable assets and
liabilities less
Consideration transferred
PFRS 3 requires that before a “bargain purchase gain” is recognized:
1. An entity should first reassess whether:
a. it has correctly identified all the assets acquired and liabilities assumed;
b. it has correctly measured at fair value all the assets acquired and liabilities assumed; and
c. it has correctly measured the consideration transferred.
2. Any remaining excess should be recognized immediately in profit or loss
Note that one effect of recognizing a bargain purchase is that there is no recognition of goodwill. A gain on
bargain purchase and goodwill cannot be recognized in the same business combination. Gain on
acquisition is never netted off simultaneously with positive goodwill.
Assignment:

Michael issues 25,000 shares of its P1` par value Common stock
shares with market value of P20 each for Johnson Company.
Michael pays related acquisition costs of P35,000

How much is the Gain or goodwill to be recognized by Michael?

What is the journal entries in the books of Michael?

Accounting Procedures for a Business Combination
The required method of accounting for a business combination under paragraph 4 of PFRS 3 is the
acquisition method. Under the acquisition method, the general approach to accounting business
combinations is a five step process:
1. Identify the acquirer;
2. Determine the acquisition date;
3. Calculate the fair value of the purchase consideration transferred (i.e., the cost of purchase)
4. Recognize and measure the identifiable assets and liabilities of the business, and
5. Recognize and measure either goodwill or a gain from a bargain purchase, if either exists in the
transaction.
If an acquirer gains control by purchasing less than 100% of the acquired entity, then the fourth step
includes measuring and recognizing the non-controlling interests (NCI). Discussion of NCI will be in
Chapter 2.
I. CONSIDERATION TRANSFERRED: 12/31
40,000 shares x P20.00 P800,000.00
LESS: II. FV OF NET ASSETS ACQUIRED:
ASSETS ACQUIRED @ FV P846,000.00
LIABILITIES ACQUIRED @ FV P(141,000.00)
NET ASSETS ACQUIRED AT FV P705,000.00
GOODWILL / (GAIN) P95,000.00

SOLUTION GUIDE
 DEBIT CREDIT DEBIT CREDIT
Cash 40,000 ACQUISITION 35,000
Investment 66,000 EXPENSE
Inventory 110,000 CASH 35,000
Land 72,000
Building 288,000
DEBIT CREDIT
Equipment 145,000
APIC/SP 12,000
Customer List 125,000
CASH 12,000
Goodwill 95,000
Current Liab 25,000
Bonds Payable 104,000
Warranty Liab 12,000
Capital Shares 40,000
Share Premium 760,000

ENTRIES IN THE BOOKS OF THE ACQUIRER:

Contingent Consideration
PFRS 3 requires that all contractual contingencies, as well as non-contractual liabilities for which it is more
likely than not that an asset or liability exists, be measured and recognized at fair value on the acquisition
date. This includes contingencies based on earnings, guarantees of future security prices, and contingent
payouts based on the outcome of a lawsuit
The contingency’s fair value on acquisition date is recognized as part of the acquisition regardless of whether
based on future performance of the target firm or the future stock prices of the acquirer. These two examples
of contingencies will result to two contingent considerations either as equity or cash/liability:
• Future Performance
• Future Stock Prices
Contingent consideration will be classified as either a liability or equity depending on its
nature:
• As a liability – if the contingent consideration will be paid in the form of cash or another
asset
• As equity – if issuing additional shares will satisfy the contingent consideration. After the
initial recognition, the contingent consideration will not be remeasured
Measurement Period
The measurement period is the period after the initial acquisition date during which the acquirer may adjust
the “provisional amounts” recognized at the acquisition date. This period allows a reasonable time to
obtain the information necessary to identify and measure the fair value of the acquiree’s assets and liabilities,
as well as the fair value of the consideration transferred.
If some of the measurements can only be determined provisionally by the end of the period in which the
business combination occurs, the acquirer should report those provisional determinations in the financial
statements.
The one-year period is known as the “measurement period”. However, it is necessary to note that
information that relates to events and circumstances arising after the measurement date do not lead to
measurement adjustments. For example loss of an acquiree’s intangible arising from technological changes
after the acquisition date is not a measurement adjustment.
Therefore, measurement period ends at the earlier of:
a. one year from the acquisition date, or
b. the date when the acquirer receives needed information about facts and circumstances.
The rule on “changes of fair value of contingent consideration normally will change as the future unfolds
due to gathering of new information revealed in a  piece-meal or installment fashion about facts and
circumstances that existed at (on or as of) the acquisition date and within a maximum of one year
subsequent to the acquisition date.”
Adjustments to provisional amount that are made during the measurement period are recognized as if the
accounting for business combination had been completed at the acquisition date.
Hindsight correction is allowed only because of incorrect or incomplete information available as at
acquisition date. For example, the acquirer may have failed to obtain information on all contracts at the
acquisition date.
It should be noted carefully that the choice between reporting value changes as
corrections of the acquisition entry or as gains or losses as prior-period adjustments
under PAS 8 (refer to discussion below) depends on whether the changes affect value as of
the acquisition date, or value changes caused by subsequent events.
Therefore, as a reminder, accountants cannot assume that all changes within the first
year are corrections of the original acquisition entry.
PFRS 3 par. 46 requires adjustments may be made in the measurement period to the following components:
a. the identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree;
b. the consideration transferred for the acquiree (or the other amount used in measuring goodwill);
c. in a business combination achieved in stages (to be discussed in Chapter 2), the equity interest in the
acquiree previously held by the acquirer; and
d. the resulting goodwill or gain on bargain purchase.
After the measurement period, any correction of errors will be deemed as a prior-period adjustment in
accordance with PAS 8.
 Post-combination Accounting-Guidance on Subsequent Measurement and Accounting
In general, assets acquired, liabilities assumed or incurred, and equity instruments issued in a business
combination are subsequently measured and accounted for in accordance with other applicable PFRSs,
according to their nature.
Examples of other PFRSs that provide guidance on subsequently measuring and accounting for assets
acquired and liabilities assumed or incurred in a business combination include:
• PAS 38 Intangible Assets
• PAS 36 Impairment of Assets;
• PAS 12 Income Taxes;
• PFRS 2 Share-based Payment; and
• PFRS 10 Consolidated Financial Statements
• PFRS 17 Insurance Contracts (effective January 1, 2023)
Business Combinations with No Transfer of Consideration
PFRS 3 paragraph 33 also deals a business combination without the transfer of any consideration by the
acquirer. In such cases, PFRS 3 requires an acquirer to be identified, and the acquisition method to be applied.
Examples include such circumstances as:
• when the acquire repurchases a sufficient quantity of its shares from other shareholders such that the
acquirer, who previously was a minority owner of the acquire, now is the majority shareholder of the
acquire and controls it;
• when the acquirer owns the majority of the acquiree’s voting shares but had previously been prevented from
exercising control by regulation or by contract – if that restriction lapses or is removed, the acquirer now
gains control over the acquire; and
• by contract alone
Combinations by Contract Alone
In a business combination achieved by contract alone, two entities enter into a contractual arrangement which
covers, for example, operation under a single management and equalization of voting power and earnings
attributable to both entities’ equity investors. Such structures may involve a ‘stapling’ or formation of a dual
listed corporation.
Accounting for a Combination by Contract
PFRS 3 requires one of the combining entities to be identified as the acquirer, and one to be identified as the
acquiree. In reaching the conclusion that combinations achieved by contract alone should not be excluded
from the scope of PFRS 3, the Board noted that:
a. such business combinations do not involve the payment of readily measurable consideration and, in rare
circumstances, it might be difficult to identify the acquirer;
b. difficulties in identifying the acquirer are not a sufficient reason to justify a different accounting
treatment, and no further guidance is necessary for identifying the acquirer; and
c. the acquisition method is already being applied for such combinations in the United States and
insurmountable issues have not been encountered.
 PFRS/IFRS for Small and Medium-Sized Entities (SMEs) – Business Combination and Goodwill
Areas covered in PFRS 3 but not in PFRS for SMEs include:
• Subsequent adjustments to assets and liabilities (re-measurement period).
• Deferred tax recognized after initial purchase accounting.
• Non-controlling interests
• Step acquisitions.
• A business combination achieved without the transfer of consideration.
• Indemnification assets.
• Re-acquired rights.
• Shared-based payments.
• Employee benefits.
 DEBIT CREDIT
12.31.11
 DATE ACCOUNT DEBIT CREDIT
8.31.2012

DATE ACCOUNT DEBIT CREDIT

1.1.2014
 DATE ACCOUNT DEBIT CREDIT
2.1.2013

DATE ACCOUNT DEBIT CREDIT

1.1.2014
 DATE ACCOUNT DEBIT CREDIT
12.31.11

DATE ACCOUNT DEBIT CREDIT

1.1.2013
 DATE ACCOUNT DEBIT CREDIT
12.31.11

DATE ACCOUNT DEBIT CREDIT

1.1.2014