ACCOUNTING FOR BUSINESS COMBINATION

BUSINESS COMBINATION- DATE OF ACQUISITION

Introduction
As defined by PFRS 3, a business combination is a transaction or event in which an acquirer
obtains control of one or more businesses. In a business combination, one of the parties can always be
identified as the acquirer, being the entity that obtains control of the other business (the acquiree). The
core principle of PFRS 3 sets out that an acquirer of a business recognizes the asset acquired and
liabilities assumed at their acquisition-date fair values and discloses information that enable users to
evaluate the nature and financial effects of the acquisition.

THE SCOPE OF PFRS 3 (Use your textbook as a reference – CH1 and CH2)

Within the Scope Outside the Scope

a. _______________________________________ a. __________________________________
b. _______________________________________
b. __________________________________

c. __________________________________

IDENTIFYING A BUSINESS COMBINATION

As defined by PFRS 3 a _____________is an integrated set of activities and assets that is

capable of being conducted and managed for the purpose of providing a return in the form of dividends,
lower cost or other economic benefits directly to investors or other owners, members or participants.
An entity shall assess whether the group of assets acquired constitute a business. Applying the
guidance of PFRS 3 a business consists of inputs and processes applied to those inputs that have the
ability to create outputs. It have to be noted that output is not necessary for an integrated set to qualify
as business but the mere ability to produce outputs out of the existing processes and inputs.
These elements are defined as follows:
1. __________________________________________________________________________

2. __________________________________________________________________________

3. __________________________________________________________________________

Defensive Techniques. Enumerate. (9)

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A. Structure of Business Combination (4)
1. _________________________________________________________________________
2. _________________________________________________________________________
3. _________________________________________________________________________
4. _________________________________________________________________________

B. Method to Accomplish the Combination (3)

1. ________________________________________________________________________
2. ________________________________________________________________________
3. ________________________________________________________________________
a. X + Y = X _____________________________
b. X + Y = Z ______________________________
C. Accounting Method Used
I. ______________________________________________________________________
______________________________________________________________________

D. Five Step Process in Acquisition Method

1. _________________________________________________________________________
2. _________________________________________________________________________
3. _________________________________________________________________________
4. _________________________________________________________________________
5. _________________________________________________________________________

E. Control. An investor controls an investee if and only if the investor has all the following:
1. _________________________________________________________________________
2. _________________________________________________________________________
3. _________________________________________________________________________

F. Acquisition Date._____________________________________________________________

G. Identifiable when: (1)___________________________________________________________

(2)___________________________________________________________

H. Fair Value.___________________________________________________________________

I. Non-controlling Interest.
____________________________________________________________________________
____________________________________________________________________________

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Exceptions to Recognition Principle
Contingent Liabilities
In a business combination where the acquired entity has contingent liabilities the recognition
principle of PAS 37 _________apply. Instead, the acquirer shall recognize contingent liabilities
assumed as of the acquisition date if it arises from past events and it has a fair value that can be
measured reliably, regardless of whether it is probable or not that an outflow of resources embodying
economic benefits will be required to settle the obligation.

J. Formula to Compute Goodwill/ Gain from Bargain Purchase

K. Contingent Consideration.
____________________________________________________________________________
____________________________________________________________________________

The acquirer is required to measure the assets acquired and liabilities assumed in a business
combination at its acquisition-date fair values, however, such information is not always available at that date
and the entity measures identifiable items at provisional amounts. Therefore, PFRS 3 allows a
measurement period which is a period after the acquisition date during which the acquirer may adjust the
provisional amounts recognized for a business combination.

L. How to Identify Measurement Period Adjustments?

a. ____________________________________________________________________________
b. ____________________________________________________________________________

M. Business Combination Achieved in Stages. _____________________________________

____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________

N. Acquisition Costs. ___________________________________________________________

____________________________________________________________________________

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 COSTS TREATMENT
a. Direct and Indirect
Ex.

b. Share Issuance Cost

Ex.

c. Bond Issue Cost

Ex.

O. Measurement of Consideration
Consideration Measured at
1. Cash/Monetary

2. Non-Monetary

3. Issuance of Stocks

4. Assume Liabilities

5. Contingent Consideration

6. Share-Based Payment

P. Levels of Ownership
a. _________________
b. _________________ 1. _______________
2. _______________

Q. PAS 27 is entitled
______________________________________________________________
R. PFRS 10 is entitled ____________________________________________________________
S. Consolidation ________________________________________________________________
____________________________________________________________________________

T. Two Methods of Consolidation. Differentiate. Write the corresponding formula.

a. b.

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U. Theory in Consolidation
1. _____________________________
2. _____________________________
3. _____________________________

V. RmEAR stands for?

____________________________________________________________

W. Push-down Accounting. _______________________________________________________

____________________________________________________________________________
____________________________________________________________________________

X. Reverse Acquisition. __________________________________________________________

____________________________________________________________________________
____________________________________________________________________________

Y. Define.
a. Investment Entities. ________________________________________________________
_________________________________________________________________________

b. Variable Interest Entities. ___________________________________________________

_________________________________________________________________________

Z. Useful Computational Formulas

NON-CONTROLLING INTEREST
At Fair Value
1) Given in the problem
2) Not given, then estimate the Fair Value

I. Consideration paid includes premium II. Consideration paid includes premium

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 III. Proportionate Share in Identifiable CONSOLIDATED TOTAL ASSETS
Net Assets of the Subsidiary

CONSOLIDATED TOTAL LIABILITIES CONSOLIDATED RETAINED EARNINGS

CONSOLIDATED SHAREHOLDER’S EQUITY NOTES:

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PROBLEM-SOLVING

I – Statutory Merger versus Stock Acquisition

Valuation of assets and liabilities acquired, stock acquisition, goodwill, stock price contingency

Below is the condensed balance sheet of Sons, Inc., along with estimates of fair values. Pop, Inc. is
planning to acquire Sons by issuing 100,000 shares of its P1 par value common stock (market value P8/share) in
exchange for all the outstanding common stock of Sons. Pop also guarantees the value of its shares issued. The
expected present value of this stock price contingency is P200,000.

Pre-Combination Condensed Balance Sheet

Book value Fair value

Current assets P 380,000 P 350,000
Plant assets ___740,000 810,000
Total assets P1,120,000
Liabilities P 500,000 450,000
Common stock 50,000
Additional paid-in capital 170,000
Retained earnings ___400,000
Total liabilities and equity P1,120,000

Required:

1. Statutory Merger: Prepare Pops’ (acquirer/acquiring) entry(ies) to record the acquisition.

2. Stock Acquisition: Prepare Pops’ (parent/acquirer/acquiring) entry to record the acquisition.

1. Statutory Merger

2. Stock Acquisition

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II - Assets and Liabilities Acquired, Goodwill and Bargain Purchase Gain, Contingent Consideration,
Changes in Contingent Consideration

1Here are the pre-acquisition balance sheets of Pop Company and Sicle Company on December 31, 20x5:

Pop Co. Sicle Co.

Book value Book value Market value
Current assets P 5,000,000 P 2,000,000 P 1,500,000
Investments 1,000,000 500,000 500,000
Land 10,000,000 5,000,000 6,000,000
Buildings (net) 40,000,000 25,000,000 16,000,000
Equipment (net) 25,000,000 10,000,000 2,000,000
Total assets P81,000,000 P42,500,000
Current liabilities P 4,000,000 P 1,500,000 1,500,000
Long-term liabilities 20,000,000 10,000,000 12,000,000
Common stock, P10 par 5,000,000 1,000,000
Additional paid-in capital 40,000,000 20,000,000
Retained earnings 12,000,000 10,000,000
Total liabilities & equity P81,000,000 P42,500,000

In addition to the above, Sicle Co. has identifiable intangibles with a fair value of P5,000,000, not
recognized on its books but appropriately capitalized by Pop.
On January 1, 20x6, Pop issues 400,000 shares of its stock, with a par value of P10/share and a market
value of P100/share, to acquire Sicle Company’s assets and liabilities. SEC registration fees are P1,100,000, paid
in cash.

Required:
1. Determine the following:
(a) Total assets;
(b) Total liabilities;
(c) Additional paid-in capital (share premium);
(d) Retained earnings (accumulated profit or loss); and
(e) Stockholders’/Shareholders’ equity;

2. Assume Pop issued 90,000 shares of stock at a market value of P100 per share with contingent cash
consideration amounted to P500,000 that is present obligation and reliably measureable, expected
present value of earnout agreement of P200,000 and probability present value of stock price contingency
agreement of P300,000. The following out-of-pocket costs in relation to acquisition are as follows:

Legal fees for the contract of business combination P 80,000

Broker’s fee 40,000

Accountant’s fee for pre-acquisition audit 100,000

Other direct cost of acquisition 70,000

Internal secretarial, general and allocated expenses 60,000

Documentary stamp tax on the new shares 20,000

SEC registration fee of issued shares 90,000

Printing costs of share certificates. 50,000

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 Stock exchange listing fee 30,000

Determine the following:

(a) Total assets;
(b) Total liabilities;
(c) Additional paid-in capital (share premium);
(d) Retained earnings (accumulated profit or loss); and
(e) Stockholders’/Shareholders’ equity;
3. Now assume that Pop issues 100,000 shares for all of Sicle’s shares, as in requirement (1) above, and
Pop agrees to pay cash to Salt’s previous owners if the combined earnings of Pop and Sicle exceed a
certain threshold over the next two years. The expected present value of the earnings contingency is
P8,000,000. Determine the amount of goodwill (bargain purchase gain or gain on acquisition).
4. Assume the same facts as in requirement (3). Before the contingency period is over, the estimated value
of the earnings contingency declines to P7,800,000. Prepare Pop’s entry to reflect the change in
value of the earnings contingency, if
(a) the value decline occurs within the measurement period, or
(b) the value decline is due to events occurring subsequent to acquisition.

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III –Valuation of Assets acquired and Liabilities assumed, Measurement of Consideration Transferred,
Change in value of Assets acquired, Pre-acquisition Contingency, In-process R&D

1Sandy Corporation’s balance sheet at January 2, 20x5 is as follows:

Sandy-Dr(Cr)
Cash and receivables………………………………………………………….. P200,000,000
Inventories………………………………………………………………………… 600,000,000
Property, plant and equipment, net…………………………………………. 7,500,000,000
Current liabilities………………………………………………………………….. (400,000,000)
Long-term debt…………………………………………………………………… (7,200,000,000)
Capital stock………………………………………………………………………. (7,200,000)
Retained earnings……………………………………………………………….. ( 25,000,000)
Accumulated other comprehensive income……………………………… (5,000,000)

An analysis of Sandy’s assets and liabilities reveals that book values of some reported items do not reflect their
market values at the date of acquisition:
 Inventories are overvalued by P200,000,000
 Property, plant and equipment is overvalued by P2,000,000,000
 Long-term debt is undervalued by P100,000,000
In addition, the following items are not currently reported on Sandy’s balance sheet:
 Customer contracts, valued at P25,000,000
 Skilled work force, valued at P45,000,000
 In-process research and development, valued at P300,000,000
 Potential contracts with prospective customers, valued at P15,000,000
 Sandy has not recorded expected future warranty liabilities with a present value of
P10,000,000

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 On January 2, 20x5, Velasco issues new stock with a market value of P700,000,000 to acquire the assets
and liabilities of Sandy. Stock registration fees are P100,000,000, paid in cash. Consulting, accounting, and legal
fees connected with the merger are P150,000,000, paid in cash. In addition, Velasco enters into an earnings
contingency agreement, whereby Velasco will pay the former shareholders of Sandy an additional amount if
Sandy’s performance meets certain minimum levels. The present value of the contingency is estimated at
P50,000,000.

Required:
1. Determine the amount of goodwill.
2. Assume that during March, 20x5, new information comes in regarding the value of Sandy’s property, plant
and equipment at the date of acquisition. It is determined that the property was actually worth P1,500,000
less than previously estimated. Make the entry to record this new information.

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