INTEGRATED ACCOUNTING REVIEW CLASS IN ADVANCED FINANCIAL ACCOUNTING AND REPORTING (AFAR)

AFAR 09 – Business Combinations

BUSINESS COMBINATION
A business combination occurs when one company acquires another or when two or more companies merge into one.
The company that obtains control over the other is the parent or acquirer. The other company that is controlled is
the subsidiary or acquiree.

Business combinations may be achieved either by:

1. Net asset acquisition; or
2. Stock acquisition

NET ASSET ACQUISITION

Ø The acquirer purchases the assets and assumes the liabilities of the acquiree in exchange for cash or non-cash
consideration.
Ø A business combination achieved through net asset acquisition may be either:
a. Statutory Merger – A business combination that absorbs one or more existing legal entities by another
existing entity that continues as the sole surviving legal entity.
b. Statutory Consolidation – A business combination that combines two or more existing legal entities
into one new legal entity.

STOCK ACQUISITION
Ø A controlling interest of another company’s voting common stock is acquired. A controlling interest is more
than 50% of a company’s voting common stock.
Ø The acquiring company is called the parent (or the acquirer) and the acquired company is called the
subsidiary (or the acquiree). Both of them remain separate legal entities and maintain their own accounting
books. However, they are required for external financial accounting purposes to combine their separate
financial statements into a single set of consolidated financial statements.

ACCOUNTING FOR BUSINESS COMBINATIONS

Ø Business combinations are accounted for under IFRS 3 Business Combinations.

METHOD OF BUSINESS COMBINATION

IFRS 3 par. 4 states that an entity shall account for each business combination by applying the acquisition method.

APPLYING THE ACQUISITION METHOD

Ø Procedures in applying the acquisition method of business combination are as follows:
1. Identifying the acquirer
2. Determining the acquisition date
3. Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling
interest in the acquiree; and
4. Recognizing and measuring goodwill or gain from bargain purchase.

IDENTIFYING THE ACQUIRER

Ø The company transferring cash or other assets and/or assuming liabilities is the acquirer.

DETERMINING THE ACQUISITION DATE

Ø The acquisition date is generally the date on which the acquirer legally transfers the consideration, acquires
the assets and assumes the liabilities of the acquiree.
Ø The acquisition date is the date used to establish the fair value of the entity acquired.

RECOGNIZING AND MEASURING IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES ASSUMED

Ø All identifiable assets and liabilities of the acquiree shall be recognized and measured at fair value.

RECOGNIZING AND MEASURING GOODWILL OR GAIN FROM BARGAIN PURCHASE

Ø This step requires the recognition and measurement of the following:
a. Identifiable assets acquired and liabilities assumed
b. Consideration transferred
c. Non-controlling interest in the acquiree
d. Previously held equity interest in the acquiree

MEASURING THE CONSIDERATION TRANSFERRED

Ø Consideration transferred is computed as follows:
Assets transferred by the acquirer XX
Liabilities incurred by the acquirer to the former owners of the acquiree XX
Equity interests issued by the acquirer XX
Consideration transferred (or price paid) XX

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 Special Considerations:
(a) Acquisition-related costs
Ø Acquisition-related costs such as general administrative costs, broker’s fees, accounting, legal, and other
professional fees are not included in the consideration transferred and are expensed immediately.

(b) Stock issuance costs

Ø Stock issuance costs (SIC) such as SEC registration fees, documentary stamp tax and newspaper publication
shall be treated as a direct charge to share premium arising from related share issuance.
v In case the said share premium is insufficient to absorb such SIC, the excess shall be debited to
SIC account. The SIC shall be reported as a contra-equity account as a deduction from the following
in the order of priority:
1. Share premium from previous share issuance
2. Retained earnings

VALUATION OF IDENTIFIABLE ASSETS AND LIABILITIES OF THE ACQUIREE

IFRS 3 par. 45 states that if the initial accounting for a business combination is incomplete by the end of the reporting
period in which the combination occurs, the acquirer shall report in its financial statements provisional amounts for
the items for which the accounting is incomplete.

During the measurement period, the acquirer shall retrospectively adjust the provisional amounts recognized at the
acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition
date and, if known, would have affected the measurement of the amounts recognized as of that date. During the
measurement period, the acquirer shall also recognize additional assets or liabilities if new information is obtained
about facts and circumstances that existed as of the acquisition date and, if known, would have resulted in the
recognition of those assets and liabilities as of that date. The measurement period ends as soon as the acquirer receives
the information it was seeking about facts and circumstances that existed as of the acquisition date However, the
measurement period shall not exceed one year from the acquisition date.

ACCOUNTING FOR CHANGES IN VALUE

Ø During the measurement period, values assigned to accounts recorded as part of acquisition may be adjusted
to better reflect the value of the accounts as of the date of acquisition. Values assigned to accounts as part
of acquisition are considered “provisional”.
Ø Changes that relate to facts and circumstances that existed at the acquisition date and that occur within the
one-year measurement period shall be recognized as retroactive adjustments against the result of the business
combination at the acquisition date.
Ø Changes that result from events after the acquisition date are not measurement period adjustments. These
changes are recognized in profit or loss.

ACCOUNTING FOR CHANGES IN CONTINGENT CONSIDERATION

Ø Changes that relate to facts and circumstances that existed at the acquisition date and that occur within the
one-year measurement period shall be recognized as retroactive adjustments against the result of the
business combination at the acquisition date. However, changes resulting from events after the acquisition
date, such as meeting an earnings target, reaching a specified share price or reaching a milestone on a research
and development project, are not measurement period adjustments.

DISCUSSION PROBLEMS
Problem 1:
The following Statement of Financial Position were prepared for Beshy Co. and Wap Inc. on January 1, 2023, just before
they entered business combination:
Beshy Co. Wap Inc.
Book Value Fair Value Book Value Fair Value
Cash 200,000 200,000 30,000 30,000
Accounts receivable 140,000 25,000
Allowance for doubtful accounts (40,000) 80,000 (5,000) 18,000
Inventory 400,000 350,000 100,000 120,000
Buildings and Equipment 800,000 300,000
Accumulated Depreciation (200,000) 700,000 (150,000) 160,000
Accounts payable 100,000 100,000 40,000 35,000
Bonds payable 400,000 440,000 60,000 75,000
Ordinary share capital
P10 par value 300,000
P5 par value 100,000
Share premium 100,000 20,000
Retained earnings 400,000 80,000

Beshy Co. acquired the net assets of Wap Inc. by issuing 12,000 shares of its common stocks and paying cash amounting
to P75,000. In addition, the following costs were incurred and paid for by Beshy Co.:
• Legal fees for effecting the combination, P5,000
• Costs of SEC registration for authorization of share issuance, P12,000
BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA
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 • Broker’s fee, P3,000
• Accountant’s fee for pre-acquisition audit, P10,000
• Other direct cost of acquisition, P4,000
• Cost of printing share certificates, P20,000
• General administrative costs, P12,500
• Documentary stamp tax on the new shares issued, P3,000

CASE 1: The stock market price of the Beshy Co. and Wap Inc. are P13.50 and P7.20, respectively at the time of
acquisition. Determine the following:
1. Goodwill or Gain on bargain purchase.
A. 13,400 goodwill C. 19,000 goodwill
B. 13,400 gain on bargain purchase D. 19,000 gain on bargain purchase

2. Combined Common Stock after acquisition.

A. 300,000 C. 420,000
B. 400,000 D. 520,000

3. Combined Share Premium after acquisition.

A. 74,600 C. 107,000
B. 94,600 D. 127,000

4. Combined Retained Earnings after acquisition.

A. 365,500 C. 400,000
B. 378,900 D. 480,000

5. Combined Total Liabilities after acquisition.

A. 500,000 C. 644,500
B. 610,000 D. 679,500

6. Combined Total Assets after acquisition.

A. 1,174,500 C. 1,502,500
B. 1,483,500 D. 1,572,000

CASE 2: The stock market price of the Beshy Co. and Wap Inc. are P10.80 and P6.60, respectively at the time of
acquisition. Determine the following:
1. Goodwill or Gain on bargain purchase.
A. 13,400 goodwill C. 19,000 goodwill
B. 13,400 gain on bargain purchase D. 19,000 gain on bargain purchase

2. Combined Common Stock after acquisition.

A. 300,000 C. 420,000
B. 400,000 D. 520,000

3. Combined Share Premium after acquisition.

A. 74,600 C. 107,000
B. 94,600 D. 127,000

4. Combined Retained Earnings after acquisition.

A. 365,500 C. 400,000
B. 378,900 D. 480,000

5. Combined Total Liabilities after acquisition.

A. 500,000 C. 644,500
B. 610,000 D. 679,500

6. Combined Total Assets after acquisition.

A. 1,174,500 C. 1,502,500
B. 1,483,500 D. 1,572,000

BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA

CPA Reviewer, Pinnacle CPA Review School
YouTube Content Creator, Accounting Lessons with BCV
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Problem 2:
On January 1, 2023, X Company and Y Company decided to enter a business combination. The balance sheets of X
Company and Y Company prior to business combination are shown below:
X Company Y Company
Book Value Fair Value Book Value Fair Value
Cash and receivables P560,000 P560,000 P100,000 P100,000
Inventory 200,000 230,000 100,000 120,000
Land 325,000 445,000 200,000 230,000*
Accounts Payable 460,000 460,000 50,000 50,000
Notes payable 100,000 50,000 50,000 30,000
Ordinary share capital
P10 par 200,000
P5 par 100,000
Share Premium 105,000 50,000
Retained Earnings 220,000 150,000
*provisional

X Company acquired the net assets of Y Company by paying cash of P350,000. The direct and indirect cost paid by X
Company to effect the combination amounted to P45,000 and P15,000, respectively.

1. How much is the result of the business combination on January 1, 2023?

A. 20,000 goodwill C. 25,000 goodwill
B. 20,000 gain on acquisition D. 25,000 gain on acquisition

2. How much is the combined retained earnings on January 1, 2023?

A. 160,000 C. 225,000
B. 180,000 D. 330,000

3. How much is the combined inventory on January 1, 2023?

A. 300,000 C. 330,000
B. 320,000 D. 350,000

4. How much is the combined land on January 1, 2023?

A. 525,000 C. 645,000
B. 555,000 D. 675,000

5. How much is the combined notes payable on January 1, 2023?

A. 80,000 C. 130,000
B. 100,000 D. 150,000

CASE 1: On June 30, 2023, the fair value of Y Company’s land increased to P250,000 due to facts existing at the date of
acquisition.
1. How much is the result of the combination to be reported in 2023?
A. 20,000 goodwill C. 40,000 goodwill
B. 20,000 gain on acquisition D. 40,000 gain on acquisition

2. How much is the combined land to be reported in 2023?

A. 525,000 C. 575,000
B. 555,000 D. 675,000

CASE 2: On March 1, 2023, the fair value of Y Company’s land decreased to P200,000 due to facts existing at the date
of acquisition but increased to P250,000 on June 30, 2023, due to facts existing subsequent to the date of acquisition.
1. How much is the result of the combination to be reported in 2023?
A. 10,000 goodwill C. 40,000 goodwill
B. 10,000 gain on acquisition D. 40,000 gain on acquisition

2. How much shall be reported as the gain due to change in fair value in 2023?
A. 0 C. 30,000
B. 20,000 D. 50,000

3. How much is the combined land to be reported in 2023?

A. 525,000 C. 575,000
B. 555,000 D. 675,000

BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA

CPA Reviewer, Pinnacle CPA Review School
YouTube Content Creator, Accounting Lessons with BCV
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Problem 3:
ABC Company acquired the assets (except cash) and assumed the liabilities of XYZ Company on January 1, 2023, paying
P720,000 cash. XYZ Company’s December 31, 2022, balance sheet, reflecting both book values and fair values, showed:

Book Value Fair Value

Accounts receivable, net 72,000 65,000
Inventory 86,000 99,000
Land 110,000 162,000
Buildings, net 369,000 450,000
Equipment, net 237,000 288,000
Accounts payable 83,000 83,000
Notes payable 180,000 180,000
Common stock, P2 par value 153,000
Share premium 229,000
Retained earnings 229,000

As part of negotiations, ABC Company agreed to pay the former shareholders of XYZ Company P300,000 cash on December
31, 2023, if the post-combination earnings of the combined company will reach a certain level during 2023. ABC estimates
that there is a 40% chance that the P300,000 will be paid. Because of improved information about facts and circumstances
that existed at date of acquisition, ABC increased its estimate to 75% on August 1, 2023.

REQUIRED:
1. How much is the initial consideration transferred on January 1, 2023?
A. 720,000 C. 945,000
B. 840,000 D. 1,020,000

2. What is the initial result of the business combination on January 1, 2023?

A. 39,000 goodwill C. 144,000 goodwill
B. 39,000 gain on acquisition D. 144,000 gain on acquisition

3. What is the revised result of the business combination on January 1, 2023 due to change in estimate on
August 1, 2023?
A. 39,000 goodwill C. 144,000 goodwill
B. 39,000 gain on acquisition D. 144,000 gain on acquisition

4. Assuming the earnings target is met, how much is the gain or loss on the settlement of contingent
consideration?
5. Assuming the earnings target is not met, how much is the gain or loss on the settlement of contingent
consideration?

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BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA

CPA Reviewer, Pinnacle CPA Review School
YouTube Content Creator, Accounting Lessons with BCV
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