Business Combination (IFRS 3) - General Discussion

Business Combination (IFRS 3)

I. DISCUSSION

IFRS 3, Business Combinations outlines the accounting when an acquirer obtains

control of a business thus there are two different companies with separate operations and
books before the combination. Being in the corporate world, continuous improvement is a
must and one way of improving a business is to expand. Expansion is similar to
diversification whereas a company aims to provide new products and services to a new
market, hence the business combination. Another reason for business combination is; a) to
reduce the potential competitors who are planning to target the same market as yours in
the same area where your business is, so instead of having to maintain a competitive
advantage against the said competitor, one can always acquire the business. b) obtaining
new management strength or better use of existing management. c) for the income tax
advantages.

Business combination could be a net asset acquisition or a stock acquisition;

Net asset acquisition is the acquisition of the total assets and assuming the entire liabilities
of a certain entity that the company wishes to acquire, thus the acquiree is required to be
dissolved. In net asset acquisition, business combination may be achieved legally by
statutory merger where one company dissolves and the other survives (A + B = A or B) or
by statutory consolidation is somewhat similar to partnership where the two companies are
dissolved and a new book of operations is required (A + B = C). Percentage of acquisition
is always 100% and acquisition or purchase method is used.

Stock acquisition is as simple as investing or the acquisition of the shares of stocks which
means there is no transfer of assets and liabilities and each company’s books will continue
to operate separately (A + B = A&B). With that being said, the two entities are required to
prepare a combining worksheet every year end. Percentage of acquisition is 51% and above
which implies that the companies may use any of the three models namely cost model, fair
value model, equity model or the acquisition method.

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 Business Combination (IFRS 3) - General Discussion

ACQUISITION METHOD REQUIRES:

 Identifying The Acquirer

In net asset acquisition, the company transferring cash or other assets and/or
assuming liabilities is the acquirer. In stock acquisition, the acquirer is the company
transferring cash or other assets for a controlling interest in the voting common stock of the
acquiree.

 Determining The Acquisition Date

Acquisition date is the date on which the acquirer obtains control of the acquiree.
It is important because on this date:

 the fair values of the identifiable assets acquired and liabilities assumed are
measured.

 the fair value of the consideration transferred is measured

 the goodwill or gain on bargain purchase is calculated

 Determining The Consideration Given or The Price Paid by The Acquirer

The consideration given is generally assumed to be the fair value of the acquiree as
an entity. IFRS 3 requires the consideration given 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 acquiree; and

 The equity interests issued by the acquirer

Contingent Consideration

Usually, an obligation of the acquirer to transfer additional assets or equity

interests to the former owners of an acquiree as part of the exchange for control of
the acquiree if specified future events occur or conditions are met. However,

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contingent consideration also may give the acquirer the right to the return of
previously transferred consideration if specified conditions are met. The acquirer
shall classify an obligation to pay contingent consideration as a liability or as equity
on the basis of the definitions of an equity instrument and a financial liability in IAS
32 Financial Instruments. For example, if the contingent consideration takes the
form of additional cash consideration payable, it shall be classified as a financial
liability. If the contingent consideration is in the form of issuing additional equity
instrument, it shall be classified as an equity instrument. A contingent consideration
included in the cost of combination, which relates to a probable cash amount
payable in the future, shall be measured at its present value by discounting the future
amount at the acquirer’s current borrowing cost.

Acquistion-related Costs

The costs the acquirer incurs to effect a business combination, such as

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

Stock Issuance Cost

When the acquirer issues 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 APIC is reduced to zero, the remaining stock
issuance costs is treated as a contra account from retained earnings presented in as
a separate line item.

 Recognizing and Measuring the Identifiable Assets Acquired, The Liabilities

Assumed and Any Non-Controlling Interest in The Acquiree

The fair values of all identifiable assets and liabilities of the acquiree are measured
and recorded. The total of all identifiable assets less liabilities recorded is

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referred to as the fair value of the net assets. The identifiable assets should never include
goodwill that may exist on the acquiree’s books. The only goodwill recorded in an
acquisition is “new“ goodwill based on the price paid by the acquirer. The fair value of the
net assets recorded is not likely to be equal to the price paid by the acquirer.

When the price paid exceeds the fair values assigned to net assets, the excess is said
to be the “new“ goodwill and it is not amortized but is impairment tested in future
accounting periods. When the price paid is less than the fair values assigned to the net
assets, a “bargain purchase” has occurred and a gain on the acquisition is recorded by the
acquirer.

There are also assets and liabilities that are not recorded at fair market value which
are;

 Contingent Liabilities
 Income Taxes (IAS 12)
 Employee Benefits (IAS 19)
 Indemnification Assets/Liabilities
 Reacquired Rights

 Share-based payment awards (IFRS 2)

 Non-current Assets held for sale (IFRS 5)

 Recognizing and Measuring Goodwill Or A Gain From A Bargain Purchase

Goodwill is the excess of the fair value of the investment in the acquiree (including
the fair value of the claim of the non-controlling interest) over the fair value of the
identifiable net assets of the acquired business. At the acquisition date, the acquirer must
recognize and measure any goodwill or gain from a bargain purchase that resulted from the
business combination. The amount of that goodwill or bargain purchase gain, if any is
determined using the "Investment Value" of the acquired business or the fair value of the
net of identifiable assets acquired and liabilities assumed in the business combination.

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Conforming to the IFRS 3, the acquirer recognizes the consideration transferred

(including contingent consideration) at its acquisition-date fair value. The acquirer
expenses all acquisition-related costs associated with the business combination. The
acquirer recognizes, as of the acquisition date, separately from goodwill, the identifiable
assets acquired and liabilities assumed and any non-controlling interest in the acquiree. The
acquirer measures the identifiable assets acquired and liabilities assumed at their
acquisition-date fair values (unless another measurement basis is required by IFRS 3). The
acquirer recognizes as goodwill the excess of:

A. The consideration transferred, any non-controlling interest and the fair value of
any previously held equity interest in the acquiree over.

B. The net identifiable assets acquired. Where this amount results in a deficiency, it
is considered to be a bargain purchase gain and is recognized in profit or loss. In
general, an acquirer measures and accounts for assets acquired and liabilities
assumed in a business combination after it has been completed in accordance with
other applicable IFRSs. However, IFRS 3 provides accounting requirements for
reacquired rights, contingent liabilities, contingent consideration and
indemnification assets.

APPLYING THE ACQUISITION METHOD

ACQUISITION OF THE NET ASSETS

BOOKS OF THE ACQUIRER

Recording Guidelines:

 Record assets acquired and liabilities assumed using fair value principle.
 If equity securities are issued by the acquirer, charge registration and issue cost against
the fair value of the securities issued, usually a reduction in additional paid- in-capital.
 Charge other direct combination cost and indirect combination cost to expense.

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 When the acquiring firm transfers its assets other than cash as part of the combination,
any gai or loss on the disposal of those assets is recorded in current income.
 The excess of cash, other assets and equity securities transferred over the fair value of
the net assets (price paid- fair value of net assets acquired) is recorded as goodwill.
 If the net asset acquired exceeds cash, other assets and equity securities transferred, a
gain on the bargain purchase is recorded in current income.

Example: Poppy Corporation

Poppy Corporation issues 100,000 shares of its P10 par value common stock for
Sunny Corporation. Poppy’s stock is valued at P16 per share.

Investment in Sunny Corporation 1,600

Common Stock 1,000
Additional paid-in-capital 600
Example: Poppy Corporation

Poppy Corporation pays cash for P80,000 in finder’s fees and consulting fees for
P0,000 to register and issue its common stock.

Investment Expense 80
Additional paid-in-capital 40
Cash 120
Example: Poppy Corporation

Sunny Corporation is assumed to have been dissolved. So, Poppy Corporation will
allocate the investment’s cost to the fair value of the identifiable assets acquired and
liabilities assumed. Excess cost id goodwill.

Cash and Receivables xxx

Inventories Xxx
Plant Assets Xxx
Goodwill Xxx

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Accounts Payable xxx

Notes Payable xxx
Investment in Sunny Corporation 1,600
Cost Allocation Using the Acquisition Method

Identify the:

 Tangible assets acquired

 Intangible assets acquired
 Liabilities Assumed

Include:

 Identifiable intangibles resulting from legal of contractual rights, or separate from the
entity
 Research and development in process
 Contractual contingencies
 Some non-contractual contingencies

Use fair values determined, in preferential order, by:

 Established market prices

 Present value of estimated future cash flows, discounted based on observable
measures
 Other internally derived estimations

Exceptions to Fair Value Rule:

 Deferred tax assets and liabilities

 Pensions and other benefits
 Operating and capital leases
 Goodwill on the books of the acquired firm is assigned no value

Goodwill, the excess of the sum of:

 Fair value of the consideration transferred
 Fair value of any non-controlling interest in the acquiree

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 Fair value of any previously held interest in the acquiree over the net assets acquired.

Contingent Consideration:

 If the fair value of the contingent consideration is determinable t the acquisition date,
it is included in the cost of combination.
 If the fair value of the contingent consideration is not determinable at that date, it is
recognized when the contingency is resolves.
 Types of consideration contingencies.
 Future earnings levels.
 Future security prices.
 Contingencies based on future earnings increase the cost of investment.
 Contingencies based on future security prices do not change the cost of the investment.
Additional consideration distributed is recorded at its fair value with an offsetting
write-down of the equity or debt securities issued.

Illustration: For cases 1 and 2

Joseph Company
Statement of Financial Position
January 1 2016
Book Value Fair Value
Cash P 300,000 300,000
Marketable Securities 200,000 230,000
Inventory 300,000 350,000
Land 250,000 400,000
Building (net) 800,000 900,000
Equipment (net) 500,000 600,000
Unrecognized Receivables 220,000
Total Assets 2,350,000 3,000,000

Current liabilities P 200,000 150,000

Bonds payable 600,000 500,000
Premium on bonds payable 20,000

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Common Stock (P10 par) 600,000

APIC 500,000
Retained earnings 450,000
Total Liab and Equity 2,350,000
FV of net assets: P2,330,000
Case 1: Price Paid exceeds the fair value of net identifiable assets acquired

Karina Inc., issues 100,000 shares of its 10 par value common stock with a market
value of P40 each for joseph’s net assets. Karina Inc. pays professional fees of P50, 000 to
accomplish the acquisition and stock issuance cost of P30,000

Price paid P 4,000,000

Fair value of net identifiable assets acquired (2,330,000)
Goodwill P 1,670,000

Professional fees P 50,000

Stock Issuance Cost 30,000

(1) To record the net assets acquired including goodwill

Cash 300,000
Marketable Securities 230,000
Inventory 350,000
Land 400,000
Building (net) 900,000
Equipment (net) 600,000
Unrecognized Receivables 220,000
Goodwill 1,670,000
Current liabilities 150,000
Bonds payable 500,000
Premium on bonds payable 20,000
Common stock 1,000,000

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APIC 3,000,000
(2) To record acquisition related cost

Acquisition Expense 50,000

APIC 30,000
Cash 80,000

Case 2: Price paid id less than fair value of net identifiable assets acquired.

Karina Inc., issues 15,000 shares of its P10 par value common stock with a market
value of P120 each for Joseph Company’s net assets. Joseph pays P50,000 for professional
fees and P130,000 for stock issuance cost.

Price paid P1,800,000

Fair value of net identifiable assets acquired (2,330,000)

Gain on acquisition( Bargain Purchase) P(530,000)

Professional fees P 50,000

Stock Issuance Cost 30,000

(1) To record the net assets acquired including goodwill

Cash 300,000
Marketable Securities 230,000
Inventory 350,000
Land 400,000
Building (net) 900,000
Equipment (net) 600,000
Unrecognized Receivables 220,000
Current liabilities 150,000
Bonds payable 500,000

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Premium on bonds payable 20,000

Common stock 150,000
APIC 1,650,000
Gain on acquisition 530,000
(1) To record acquisition related cost

Acquisition Expense 50,000

APIC 30,000
Cash 80,000
Recording Contingent Consideration in Acquisition of Net Assets

Using the data of case 1, assume that aside from the 100,000 shares issued, Karina
also agreed to pay an additional P200,000 on Jan 1, 2019 if the average income for the 2
year period of 2016 and 2017 exceeds P160,000 per year. The expected value is estimated
at P100,000.

Total price paid:

Stock Issued P4,000,000

Estimated value of contingent consideration P100,000

Fair value of net assets acquired P(2,330,000)

Goodwill P1,770,000

(1) To record the net assets acquired including goodwill

Cash 300,000
Marketable Securities 230,000
Inventory 350,000
Land 400,000
Building (net) 900,000
Equipment (net) 600,000
Unrecognized Receivables 220,000

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Goodwill 1,770,000
Current liabilities 150,000
Bonds payable 500,000
Contingent consideration Payable 100,000
Premium on bonds payable 20,000
Common stock 1,000,000
APIC 3,000,000
(2) To record acquisition related cost

Acquisition Expense 50,000

APIC 30,000
Cash 80,000
Recording Changes in Contingent Consideration (maybe maximum of 1 year)

 If during the measurement period and the contingent consideration is valued from
P100,000 to 150,000

Goodwill 50,000
Contingent consideration payable 50,000
 If the estimate is revised after the measurement period from P150,000 to P230,000

Loss on contingent consideration payable 80,000

Contingent consideration payable 80,000
 If the contingent event occurs and there is an agreement to issue 10,000 additional
shares if it exceeds 160,000 per year of income

APIC 100,000
Common Stock, P10 par 100,000
Recording Changes in Value during Measurement Period

During the measurement period, provisional values are sometimes recorded to other
accounts and then adjusted to the amount that may better reflect the value and must be
adjusted retroactively.

Illustration:

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Provisional Value of building P1,000,000

Depreciation Method:

20 year straight line (P50,000/yr)

Recorded for 6 months P25,000

Revised value of building P1,200,000

Depreciation Method:

15 year straight line method(P80,000/yr)

Adjusted Amount for 6 months P40,000

To record adjusting entries

(1) Building 200,000

Goodwill 200,000
(2) Retained Earnings 15,000
Accumulated Depreciation-Building 15,000
BOOKS OF THE ACQUIREE

Using the example in case 1, the excess of the price received by the acquiree over
the sum of the book value of the net assets is recorded as a gain on the sale.

(1) To record the sale of net assets

Investment in Karina 4,000,000

Current Liabilities 200,000
Bonds payable 600,000
Cash 300,000
Marketable securities 200,000
Inventory 300,000
Land 250,000
Building 800,000
Equipment 500,000

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Gain on sale of business 2,450,000

(2) To record distribution of Karina Inc., shares received by its shareholders and
the liquidation of Joseph Company

Common Stock 600,000

APIC 500,000
Retained Earnings 450,000
Gain on Sale of Business 2,450,000
Investment in Karina Inc., 4,000,000
ACQUISITION OF STOCK

 The acquiring company deals only with existing shareholders of the acquired company
and not the company itself

 On the date of the acquisition of stock, no goodwill or income from acquisition is

recorded by the acquirer. These are to be recognized only in the consolidated financial
statements

 After acquisition, subsidiary will not be dissolved, and it will form a parent/subsidiary
relationship

Illustration:

Patricia Company acquired 20,000 issued and outstanding shares of Solenn Company's
P100 par for P4,000,000 cash. Patricia Company also paid professional fees of P50,000 to
accomplish the combination
(1) to record the acquisition of stock
Investment in Solenn 4,000,000
Cash 4,000,000
(2) to record acquisition related cost
Acquisition Expense 50,000
Cash 50,000

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II. REFERENCE

IASB (2008, January). IFRS 3 Business Combination. Retrieved from

https://www.iasplus.com/en-ca/standards/part-i-ifrs/international-financial-
reporting- standards/ifrs3

DrRockSheep (2015). Chapter 14 Business Combination Discussion. Retrieved from

https://www.coursehero.com/file/10588168/tut-8-ss/

Howarth, Jeff M. Recognizing or Measuring Goodwill or Bargain Purchase. Retrieved

from https://quizlet.com/35586474/recognizingmeasuring-goodwill-or-bargain-
purchase-a- flash-cards/

Pearson Education Inc (2012). Chapter 1 Business Combination. Retrieved from

http://deltauniv.edu.eg/new/businessadministration/wp-
content/uploads/beams11_ppt01.pptx

Wiley, John (2018). Ch25: Business Combination Test Bank. Retrieved from
https://www.studocu.com/en/document/university-of-western-australia/corporate-
accounting/other/ch25-business-combination-test-bank/1633326/view

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