BUSINESS COMBINATION

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MODULE 1: STATUTORY MERGER AND STATUTORY

CONSOLIDATION
I. ACQUISITION OF NET ASSETS (assets – liabilities)
 Acquiree books – transferred to the books of the acquirer
 Acquirer acquires cash and other property, debt instruments, and equity
instruments (common or preferred stock)
 Must acquire 100% of the net assets
a. Statutory merger – one of the entities are cease to exist as a legal entity (A + B
= A or B)
b. Statutory consolidation – results in a new corporation; all combining partners
are dissolved (A + B = C)

II. ACQUISITION OF COMMON STOCKS (Stock Acquisition) – Consolidation

 Books of the acquirer and acquiree are kept and consolidated financial statements
are periodically prepared.
 Acquirer: Debit “Investment in Subsidiary” – intercorporate investment

FEATURES OF STOCK ACQUISITION

 Voting rights (common stocks)
 Control -> 50% or MORE on the voting rights
NCI – total of the shares of an acquired company not held by the controlling
shareholder
 Separate legal entity

III. ASSET ACQUISITION

- NOT within the scope of business combination (PFRS 3)
- Acquisition by one firm of assets, NOT shares

ACCOUNTING CONCEPT – PFRS (IASB)

Business Combination – an event in which the acquirer gains control; “true mergers” or
“merger equal”
CONTROL
 Transferring cash or other assets, incurring liabilities, issuing equity instruments,
transaction not including consideration

BUSINESS
 an integrated set of activities and assets; providing goods and services to
customers
 Input (economic resource); process (system, standard, protocol, or rule); output
(results)

SCOPE OF BUSINESS COMBINATION

WITHIN NOT WITHIN
1. Mutual agency 1. Joint arrangements (ventures and
2. Contractual agreement (dual listing operations) – PAS 31
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stapling) 2. Common control – controlled by the
same party (lack of transitory control)
3. Acquisition of assets/group of assets
that DOES NOT constitute a business;
DOES NOT RISE TO GOODWILL
(asset acquisition)
a. Identify and recognize the
individual assets acquired and
liabilities assumed
b. Allocation of individual assets –
FV

ACQUISITION METHOD (perspective of the acquirer) – assets and liabilities at FV*

*Fair value measurement already reflects expectations about uncollectible balances
Exception: indemnification assets, income taxes, employee benefits, reacquired
rights, share-based payment awards, assets held for sale, and certain assets and
liabilities related to contingencies – measured according to the specific rules
provided in the standard.

1. Identify the acquirer – an entity that obtains control over the acquiree.
2. Determine the acquisition date.
3. Recognize the consideration transferred
4. Recognize and measure the net assets acquired (NAA) and non-controlling interest (NCI) if
any
5. Recognize or measure goodwill or a gain from a bargain purchase.

Identify the acquirer – entity obtains control of the acquiree on the acquisition date
 Who pays cash or other assets as part of the acquisition transaction 
 Who has more voting rights in the combined entity following the acquisition 
 Who holds the largest minority voting interest in the combined entity 
 Who is able to elect, appoint or remove members from the governing body of the
combined entity 
 Who takes the lead in managing the combined entity 
 Who is larger (in terms of assets, revenues, earnings, or some other measure) 
 Who initiated the acquisition

Acquisition date – the date where the acquirer obtains control OR when the net assets of the
acquiree become the net assets of the acquirer. It also might be the closing date for the contract
or another date
KEY CRITERION: CONTROL which ensures the substance of the transaction

FOUR MAIN AREAS MEASUREMENT

Identifiable assets and liabilities assumed FV on the acquisition date
by the acquirer
Consideration paid by the acquirer Sum of the FV of assets, equity issued,
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liabilities
Non-controlling interest (NCI) Either at:
a. Fair value (if using the FV leads to a
recognition of GBP, re-measure it
using the proportionate share to
eliminate the negative balance)
b. NCI’s proportionate share in the
acquiree’s identifiable net assets
Previously Held Equity Interests (PHEI)

Calculate the FV of the purchase consideration transferred – the sum of the FV of assets
transferred, liabilities incurred, and equity interest.
Consideration transferred Measurement
Cash or other monetary assets Fair Value
For deferred payment: FV to the acquirer (or FV of the
obligation)
 Discount rate is used
Nonmonetary assets – PPE, investments, Carrying amount equal to the FV on the
patents sale of the asset
 Gain/loss is recognized (if CA is
not equal to FC)
Equity instruments – shares/stocks Fair value
Listed entities Quoted prices
Liabilities* Present values of expected future cash
outflows
Contingent consideration – distribution Measurable fair value
of cash or other assets, or the issuance of
debt or debt securities
Share-based payment awards Market based measure
*Future losses or other costs expected to be incurred as a result of the combination is NOT
included in the calculation of the FV of consideration paid; are not liabilities of the acquirer.
**An acquirer should recognize a liability for deferred revenue of the acquiree only if it relates
to an outstanding performance obligation assumed by the acquirer.

ACCOUNTED FOR SEPARATELY FROM THE BUSINESS COMBINATION:

Acquisition- Examples Treatment
related costs
1. Directly Legal fees, finder’s and brokerage fee, Expenses
attributable advisory, accounting, valuation (valuers),
costs and other professional or consulting fees
 Directly attributable costs – part
of the cost of acquisition and
capitalized into the cost of the
asset acquired
 Listing fee – outright expense
 Additional acquisition-related
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restricting costs – expensed and
do not affect acquisition cost
2. Indirect General and administrative costs Expenses
acquisition  Managerial including the costs of
costs 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
3. Costs to Transaction costs such as stamp duties on  Debit to “Share Premium” or
issue equity new shares, professional adviser’s fees, “Additional paid-in capital”
securities underwriting costs, and brokerage fees  If share premium is not
(issue and may be incurred sufficient:
register o Such excess shall be
stocks) debited to “Share
Issuance Costs” (contra
shareholders’ equity
account); or
o Retained earnings with
appropriate disclosure
4. Costs to Professional adviser’s fees, underwriting  Bond issue costs included in the
issue debt costs, and brokerage fees may be initial measurement of the
securities incurred resulting financial liability
Amortized the life of the debt
The following are also accounted for separately:
 Effective settlement of a pre-existing relationship between the acquirer and acquiree
 Contingent payments are compensation for future services
 Contingency
 Intangible assets – MUST be amortized and recognized separately from goodwill; failing
to identify and measure them can result in an overstatement of goodwill.

Intangible assets Measurement Example/Treatment

A. Existing intangible Estimated fair value Patent and copyrights – the
assets use of discounted cash flow
analysis
B. Intangible assets not  In-process research and  Must be recorded
currently recorded by development (IPRD) – all separately
the acquiree tangible and intangible  Identifiable if it arises
acquired at FAIR from contractual or other
VALUE legal rights (even if it is
not separable)
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IPRD – considered
separable on occasion that
they are bought and sold
C. When the acquiree is a General rule: Operating  If terms are favorable:
lessee with respect to leases are not recognized o Recorded equal to
assets in use the discounted
present value of
the SAVINGS
 If terms are unfavorable:
o Estimated liability
is recorded to the
discounted
present value of
the rent in
EXCESS of fair
rental rates.

D. When the acquiree acted Fair value at the acquisition  Acquirer does not
as the/is the lessor date in the books of Acquirer recognize separately an
intangible asset or
liability
 Terms are favorable –
rental rate exceeds fair
rental value
 Terms are unfavorable –
fair rental value exceeds
the contract rate
EXCEPTION TO THE FAIR VALUE PRINCIPLE
Liabilities Present values of expected
future cash outflows
Current contractual Existing recorded value
liabilities
Estimated liabilities A new fair value
Deferred revenue* Acquisition-date fair value of
the obligation
Contingent liabilities** Acquisition-date fair value  Record even if it is not
probable that an outflow
of resources
Liabilities associated with Separate liability  There must be an existing
restricting or exit activities obligation to other entities
Other assets/Liabilities
a. Employee benefits  Liability – recorded if the
plans projected benefit
obligation exceeds the
plan assets
 Assets – recorded if the
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plan assets exceed the
projected benefit
obligation
b. Indemnified assets Measured on the same basis  IF measured at FV –
as the indemnified item separate valuation
allowance is not
necessary; effects of
uncertainty about future
cash flows
c. Income taxes Deferred tax assets/liabilities
– undiscounted amount
d. Employee benefits
*An acquirer should recognize a liability for deferred revenue of the acquiree only if it relates to
an outstanding performance obligation assumed by the acquirer.
**Recognition of contingent liabilities:
 Present obligation
 Fair value can be measured reliably

Recognize and measure the net realizable assets and liabilities

 If the acquirer gains control of less than 100%, THIS step includes the measurement of
non-controlling interest (NCI) -> stock acquisition (not always 100%)

Non-controlling interest (NCI) is the equity in a subsidiary not attributable, directly or

indirectly, to a parent. It is measured at:
a. Fair value; or
b. The NCI’s proportionate share of the acquiree’s identifiable net assets

Net Identifiable Assets acquired – acquisition-date fair values

 Recognized separately from goodwill, the identifiable assets acquired, the liabilities
assumed and any non-controlling interest in the acquiree
 Unidentifiable assets (e.g., any recorded goodwill by the acquiree) shall not be
recognized

Measurement Rule
Identifiable tangible assets – probable and reliably measured
1. Current Assets Estimated fair value  A/R and N/R – recorded in
a net account; a separate
valuation account for
uncollectible accounts is
not allowed
 All accounts are recorded
at net fair value and
valuation accounts are
not used.
2. Assets held for sale Fair value less cost to sell at  Acquired non-current
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the acquisition date assets (disposal group)
that is classified as held
for sale
3. Property, plant, and Estimate of fair value that  “No valuation allowance”
equipment will be recorded at the net also extends to PPE stated
amount with no separate at a single fair value
accumulated depreciation amount and not at a gross
account “deemed cost” and
accumulated depreciation
4. Investments in Fair value of the associate  No difference between an
equity-accounted investment that is an
entities associate or an investment
that is a trade investment
Identifiable intangible assets
1. Separate criterion  Capable of separated or
divided from the entity
sold, transferred, licensed,
rented, or exchanged
2. Contractual-legal  Contractual or legal rights
criterion whether those rights are
transferable or separable

Contingent Consideration – additional consideration for a business combination that the

acquirer agrees to provide to the acquiree upon the happening of a contingency
 Contingency – an existing, unresolved condition that will be resolved by the
occurrence or non-occurrence of a possible future event
 Changes in the FV are reported as a gain or loss in earnings, and the liability is also
adjusted

Contingent consideration Recognition

Initial measurement Acquisition-date fair value  Included in the
consideration transferred
 Obligation to pay –
classified either as liability
or equity.
Subsequent Retrospective adjustment to  Additional information
measurement the provisional amount obtained during the
measurement period is
accounted for as a
retrospective adjustment to
provisional amount.
NOT measurement period adjustments:
o Changes result from meeting an earning target, reaching a specified share price, or
reaching a milestone on a research and development project. These are accounted
for as:
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 Classified as equity – not remeasured and its subsequent settlement is
accounted for within equity.
 Classified as an asset or a liability – measured at fair value at each
reporting date. Changes in FV are recognized in profit or loss

NOT to be included in applying the acquisition method:

 Pre-existing relationships – contractual and non-contractual relationships
 Compensation to employees or former owners of the acquiree – contingent
payments (depending on the nature of the arrangement)

Use of Provisional Values

 If the initial accounting for a business combination is incomplete by the end of the
reporting period in which the combination occurs, the financial statements should
be prepared using provisional amounts

Adjustments:
Measurement Period
 If the initial accounting for a business combination is incomplete by the end
of the reporting period –> report financial statements in provisional amounts
 If new information is obtained during the measurement period which provides
evidence of facts and circumstances that existed as of the acquisition date, if
known, would have affected the measurement of the amounts recognized as of
that date, the acquirer shall retrospectively adjust the provisional amounts
recognized at the acquisition date.
 Shall NOT exceed one year from the acquisition date; the measurement
period ends when the acquirer obtains the information necessary for an error
 Events that happened after the acquisition date

Recognize and measure either goodwill/gain from a bargain purchase, if any

- At the acquisition date measured as the excess of (I) over (II) below (Total Consideration
Transferred vs. Net Assets Acquired):
I. the aggregate of:
1. The consideration transferred measured at acquisition-date fair value
2. Non-controlling interest in the acquiree
3. The acquisition-date fair value of the acquirer’s previously held equity
interest (PHEI) in the acquiree in a business combination achieved in stages
II. the net acquisition date amounts of the identifiable assets acquired and the
liabilities assumed are measured in accordance with the standards

Where (II) exceeds (I), PFRS 3 regards the giving rise to a gain on a bargain
purchase.

Full Goodwill
Consideration transferred xxx
Non-controlling interest in the acquiree (NCI) xxx
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Previously held equity interest in the acquiree (PHEI) xxx
Total xxx
Less: FV of net identifiable assets acquired (xxx)

Goodwill/(Gain on a bargain purchase) xxx

On the acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
b. Gain on a bargain purchase as gain in profit or loss

Goodwill
 an asset representing future economic benefits arising from other assets acquired in a
business combination that are not individually identified and separately recognized.
 An unidentifiable asset in which its existence is an important motivation for a parent to
acquire a subsidiary
 It is the premium that a parent pays to acquire the subsidiary and should be
separately recognized as an asset in the consolidated financial statements
 Goodwill = consideration transferred LESS Acquirer’s interests net fair value of the
acquiree’s identifiable assets and liabilities

Items included in Goodwill:

Acquired intangible asset (unidentifiable) NOT qualified as assets:
1. assembled workforce of the acquiree 1. potential contracts
– do not rise from contractual or 2. contingent assets -
legal rights 3. future contracts renewal
Note: Intangible assets must be identifiable to record separately from goodwill.

Bargain Purchase Gain (attributable to the acquirer only -> statement of comprehensive
income or income statement)
 Acquirer’s interest in the net FV of the acquiree’s identifiable asset and liabilities >
consideration transferred
 Bargain purchase gain = Acquirer’s interests net FV of the acquiree’s identifiable assets
and liabilities LESS consideration transferred
 An irregular transaction; unusual or rare event
 No recognition of goodwill in recognizing a bargain purchase; NEGATIVE goodwill

Reverse acquisition
 Exchange of equity interests (in a business combination) – the acquirer is usually the
entity that issues its equity interests.
 In a reverse acquisition, the entity that issues securities (the legal acquirer) is
identified as the acquiree for accounting purposes; the entity whose equity interests
are acquired (the legal acquiree) is the acquirer for accounting purposes.

Conventional acquisition Reverse acquisition

Issuer of shares as Acquirer Acquiree
consideration
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transferred
Reference to combining - Accounting - Accounting
constituents acquirer/legal parent acquirer/legal
- Accounting subsidiary
acquiree/legal - Accounting
subsidiary acquiree/legal parent
Measurement of Fair value of Fair value of the notional
consideration consideration transferred number of equity
transferred by the accounting acquirer instruments that the
accounting acquirer (legal
subsidiary) would have
has 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
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MODULE 2: SEPARATE AND CONSOLIDATED FINANCIAL

STATEMENTS – Date of Acquisition
BASIS: PAS 27 (2014)
Level of Interest of Initial Recording Recording of Income
Ownership Ownership
Passive Under 20% At COST Dividends as declared, except stock
Investment including dividends (using COST MODEL)
brokers’ fees

Strategic (Active)
Investment:
a. Influential 20% to 50% At COST - Ownership share of income (or loss) is
ownership including reported.
brokers’ fee - Dividends declared are distributions of
income already recorded; they reduce
the investment account (EQUITY
METHOD)
b. Controllin Over 50% At COST - Ownership shares of income (or loss)
g ownership - Accomplished by consolidating the
subsidiary income statement accounts
with those of the parent in the
consolidation process (COST MODEL,
EQUITY METHOD, AND FAIR
VALUE OPTION)

PASSIVE INVESTMENTS – to earn dividends or to earn profits

 Measurement: Initially reported AT COST and are reported at FAIR MARKET VALUE
on each period’s FS or balance sheet.
 Under PFRS 9:
o FVTPL
- Dividends;
- Change in FV from one period to another is reported in the statement of
comprehensive income.
o FVTOCI
- Dividends are recognized as net income;
- Changes in the FV is reported in OCI; the accumulated gains and losses
are reported as a separate component of stockholder’s equity.
- Choice to classify as FVTOCI is irrevocable – cannot be changed
subsequently.

STRATEGIC (ACTIVE) INVESTMENTS – significantly influence or control

 Controlled entities:
o Subsidiaries (PAS 27 and PFRS 10)
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o Structured entities (or variable interest entities)
o Associated companies (PAS 28)
o Joint ventures (PFRS 11)

The preparation of Consolidated Statements is an example of focusing on substance rather

than form

JOURNAL ENTRIES:
When the parent acquires a controlling interest in the subsidiary:
Investment in Subsidiary xxx
Cash/Debt/Stock xxx

INVESTMENTS AT THE DATE OF ACQUISITION

Recording Investments at Cost (Parent’s Books)
 Acquisition Method: Stock Investment is recorded at its cost as measured by the FAIR
VALUE OF THE CONSIDERATION GIVEN or the consideration received,
whichever is more clearly evident.

Treatment of Acquisition-related Direct Costs in the Separate Financial Statements (or Parent’s
Books)
 DOES NOT affect the computation of goodwill, only the manner of recording such
costs in the books of the parent entity

CONSOLIDATION OF WHOLLY OWNED SUBSIDIARIES

ALLOCATED EXCESS = difference between the FV of the subsidiary and the BV of the
acquiree’s net identifiable assets (100%)

CONSOLIDATION OF PARTIALLY-OWNED SUBSIDIARIES

 A problem arises as to the determination and recognition of goodwill and the non-
controlling interests

Two measurement bases for non-controlling interest:

1. Full-goodwill Approach (or Fair Value Basis)
- Share of BV of identifiable net assets of subsidiary;
- Share (FV – BV) of identifiable net assets of subsidiary at acquisition dates; and
- Share of goodwill in subsidiary at acquisition date
2. Partial-goodwill approach (or Proportional Basis of the Acquiree’s Identifiable Net
Assets)
- Share of BV of identifiable net assets of subsidiary; and
- Share (FV – BV) of identifiable net assets of subsidiary at acquisition date
o FV of the net identifiable assets x NCI percentage
o NCI share of goodwill (NCI-goodwill) is NOT recognized (because it is
attributed to the parent only)

Where goodwill is measured as a residual, it should in substance be:

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 An expectation of future economic benefits arising from the acquisition; and
 An asset that is integral to the entity as a whole, which is not individually identifiable or
severable as a stand-alone asset.

THE ACQUISITION ANALYSIS (or Schedule of Determination and Allocation of Excess)

Full Goodwill Approach (or Fair Value Proportionate Basis (Partial-goodwill
Basis) Approach)
Consideration transferred xxx Consideration transferred xxx
Non-controlling interest in xxx Non-controlling interest in the xxx
the acquiree (NCI) acquiree (NCI)
Previously held equity xxx Total Value of Subsidiary xxx
interest in the acquiree
(PHEI)
Total xxx Less: BV of Subsidiary (xxx)
Less: FV of net identifiable (xxx) Allocated excess xxx
assets acquired
+/- Adjustment (FV – BV) over xxx
or understatement
Goodwill/(Gain on a xxx Goodwill/(Gain on a bargain xxx
bargain purchase) purchase)

Attributes Parent Theory Entity Theory (PFRS 3)

FV differences in relation to Recognized only in respect of Recognized in full, reflecting
identifiable assets and parent’s share both parent’s and NCI’s share
liabilities at the date of of the FV adjustments
acquisition
Presentation of NCI Neither as equity nor debt Part of equity
Goodwill Goodwill is parent’s asset Should be recognized in full
as date of acquisition

Summary of NCI Determination

 If method is given:
o Full Goodwill Approach: Recognize NCI @ FV Given
If FV is not given, compute it by dividing the
Contribution Transferred to the Controlling Interest,
CT
then multiply it by the NCI = (FV = x % NCI )
% CI

o Partial Goodwill: Recognize NCI @ Proportionate Basis

PSB = FVNA of Subsidiary x % NCI
 If silent as to method:
o NCI is recognized as higher of FV Assessed/FV Implied OR PSB
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NON-CONTROLLING INTEREST
BV of stockholders’ equity of subsidiary xxx
Adjustments to reflect FV (over/undervaluation of assets and xxx
liabilities)
FV of stockholders’ equity of subsidiary xxx
Multiplied by: NCI percentage (%) xxx
Non-controlling interest (partial) xxx
BV of share of NCI xxx
Allocated Excess NCI xxx
Total Allocated Excess (parent + NCI) xxx

CONTROL PREMIUM / CONTROL DISCOUNT

 An amount that a buyer is usually willing to pay over the current market price of a
publicly traded company
 Usually justified by the expected synergies, such as the expected increase in cash flow
resulting from cost savings and revenue enhancements achievable in the merger or
consolidation
 Control premium – if the consideration transferred is proportionally more than the fair
value of non-controlling interests;
 Control discount (often arises in a fire sale) – discount for lack of control (non-
controlling interest discount) rates.

CONTROL ACHIEVED IN TWO OR MORE TRANSACTIONS – STEP ACQUISITION

(or BUSINESS COMBINATIONS ACHIEVED IN STAGES)
Step Acquisition – date of the second acquisition of shares that the business combination occurs

Principles to be applied:
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• A business combination occurs only in respect of the transaction that gives one entity
control to another;
• The identifiable net assets of the acquisition are remeasured to their fair value on the date
of acquisition (i.e. the date that control passes)
• NCI is measured on the date of acquisition under one of the Full Goodwill or Partial
Goodwill approach.

BUSINESS COMBINATION ACHIEVED IN STAGES

• A business combination achieved in stages occurs when an investor acquires additional
shares from an investee in which it had previously held equity interest and the additional
shares purchased result in the investor obtaining control over the investee.
• Accounting for a business combination achieved in stages:
1. Remeasure the previously held equity interest in the acquiree at its acquisition-
date fair value; and
2. Recognize the gain or loss on the remeasurement in:
• Profit or loss – if the previously held equity interest was classified as
FVPL, Investment in Associate, or Investment in Joint Venture.
• Other comprehensive income – if the previously held equity interest was
classified as FVOCI.
• NCI is to be identified and presented within equity, separately from the parent
stockholders’ equity.

Preparing the Consolidated Financial Statements

• Consolidated financial statements are prepared by combining the financial statements of
the parent and its subsidiaries line by line by adding together similar items of assets,
liabilities, equity, income, and expenses.

CONSOLIDATED FINANCIAL STATEMENTS (PFRS 10)

The concept that drives all consolidation procedures is that the consolidated financial
statements should show only the results of transactions with outsiders. The effects on the
accounts of transactions between the parent company and its subsidiaries or between
subsidiaries should always be eliminated.

1. Eliminate the “Investment in subsidiary” account. This requires:

a. Measuring the identifiable assets acquired and liabilities assumed in the business
combination at their acquisition-date fair values.
b. Recognizing the goodwill from the business combination.
c. Eliminating the subsidiary’s pre-combination equity accounts and replacing them
with non-controlling interest.
2. Add, line by line, similar items of assets and liabilities of the combining constituents.

Direct Approach versus Workpaper Approach to Consolidation

Direct Approach
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The direct approach prepares the consolidated statements by setting up the income
statement/statement of comprehensive income SCI and SFP formats and computing each
consolidated balance directly. Each asset, liability, revenue, and expense are separately
calculated and entered into the consolidated statement. The direct approach works from the
separate entity financial statements of the parent and the subsidiary.

Workpaper Approach. The alternative method is the work paper approach. The worksheet (or
spreadsheet) approach uses a multi-columnar worksheet to enter the trial balances of the parent
and each subsidiary. Then eliminations and adjustments are entered onto the worksheet, and the
accounts are cross-added to determine the consolidated trial balance

• Which Approach to Use?

• The direct approach is spontaneously appealing because we are working directly with
the statements and can see clearly what is happening to the consolidated statements as
eliminations and adjustments are posted. When the statements to be consolidated are
fairly simple, it is quite feasible to compile the consolidated statements by the direct
method
• The workpaper approach is less spontaneous