College of Management

Bachelor of Science in Accountancy

PrE 314 – ACCOUNTING FOR BUSINESS COMBINATION

First Semester, A.Y. 2021-2022

BUSINESS COMBINATION - MERGER AND CONSOLIDATION

Problems to be Discussed:
- Illustration 1 – Acquisition of Net Assets (Assets less Liabilities) – Books of Acquirer
and Acquiree with Statement of Financial Position
- Illustration 2 – Goodwill Computation with Contingent Consideration Based on
Future Performance – Earnings
- Illustration 3 – Provisional Amount on Asset Acquired
- Illustration 4 – Cash/Liability Contingent applying Measurement Date Rule
- Illustration 5 – Cash/Liability Contingent with Present Value based on Future
Performance – Cash Flows
- Illustration 6 – Cash/Liability Contingent Based on future performance – Earnings)

Illustration 1

Paul Simon
Book Value Fair Value Book Value Fair Value
Assets P600,000 P650,000 P176,000 P218,000
Liabilities P240,000 P180,000 P58,000

Stockholder’s Equity: P200,000 P50,000

Common Stock/Retained (P20 par (P10 par @
Earnings/Accumulated @10,000 5,000 shares)
Shares)

Profit or Loss P160,000 P66,000

Total Liabilities and Equities P600,000 P176,000

Assume that on January 1, 20x4, Paul Company Pays P100,000 in cash and issued 3,600
shares common stock with a fair value of P25 per share to Simon Company for ALL of the
net assets of that company, and that no other direct costs are involved. Because cash and
stock are the means of payment, Paul Company is the Acquirer (Acquiring)
Required:

1. Compute for the Goodwill

2. Prepare the Entries of Paul Company and Simon Company
3. Prepare the New Statement of Financial Position of Paul Company and Simon
Company

Illustration 2

On December 31, 20x4, Peter Corporation enters into a business Combination by acquiring
the assets and assumed the liabilities of Saul Corporation in which Saul Corporation will be
dissolved. Peters’ Consideration transferred consists of the following:

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 a. 25,000 unissued shares of its P10 par common stock, with a market value of P25 per
share;
b. P150,000 in long-term 8% notes payable, and
c. A contingent payment of P100,000 cash on January 1, 20x7, if the average income
during the 2-year period of 20x5 – 20x6 exceeds P250,000 per year. Peter estimates
that there is a 30% chance or probability that the P100,000 payments will be required.

In addition, Peter pays the following at the time of the merger:

- Finder’s Fee – P10,000
- Accounting Fees – P20,000
- Legal Fees to arrange the business combination – P35,000
- Cost of SEC registration, including accounting and legal fees – P15,000
- Cost of printing and issuing stock certificates – P12,000
- Indirect Costs of combining, including allocated overhead and executive salaries
P23,000

Balance Sheet and Fair Value information for the two companies on December 31, 20x4,
immediately before the merger, are as follows:

Peter Saul
Book Value Fair Value Book Value Fair Value
Cash P230,000 P230,000 P20,000 P20,000
Receivables – Net 80,000 80,000 40,000 40,000
Inventories 240,000 300,000 100,000 60,000
Land 90,000 200,000 60,000 200,000
Buildings – net (10-year life) 400,000 600,000 200,000 300,000
Equipment – net (5-year life) 360,000 490,000 180,000 250,000
In process research and Development 0 0 0 50,000
Total Assets P1,400,000 P1,900,000 P600,000 P920,000
Accounts Payable P180,000 P180,000 P60,000 P60,000
Other Liabilities 200,000 180,000 120,000 140,000
Common stock, P10 par 600,000 200,000
Additional paid-in capital 200,000 160,000
Retained earnings 220,000 60,000
Total Liabilities and Equities P1,400,000 P600,000

Required:
1. Compute for the Goodwill
2. Prepare the Entries of Peter Company and Saul Company
3. Prepare the New Statement of Financial Position of Peter Company and Saul
Company

Notes:
1. It should be noted that under PFRS 3. In-process R&D is measured and recorded at
fair value as an asset on the acquisition date. This requirement does not extend to
R&D in contexts other than Business Combination.

2. 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 prepare using provisional amounts for the items for
which the accounting is incomplete.

Adjustments to Provisional Values – PFRS 3 permits adjustments to items recognized

in the original accounting for a business combination as long as it is within the
measurement period. FOR A MAXIMUM OF ONE YEAR after the acquisition
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 date, where new information about facts and circumstances existing on the acquisition
date is obtained. Any such adjustments are made RETROSPECTIVELY as if those
adjustments had been made on the acquisition date.

There are three areas where adjustments need to be made subsequent to the initial
accounting after acquisition date:

a. Goodwill – having recognized goodwill arising in the business

combination, the subsequent accounting is directed from other accounting
standards
b. Contingent Liabilities – Having recognized any contingent liabilities of
the acquiree as liabilities, the acquirer must then determine a subsequent
measurement for the liability. The liability is initially recognized at fair
value.
c. 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.
 Contingent Consideration will be classified as either liability or
equity depending on the nature
o As a Liability – if the contingent consideration will be
paid in the form of cash or another asset.
o As Equity – if issuing additional shares will satisfy the
contingent consideration. After the initial recognition,
the contingent consideration will not be remeasured.

Illustration 3

Assume that the value of the buildings in Illustration 2 was provisionally determined on
December 31, 20x4. On August 1, 20x5. Peter Corporation received the final value from the
independent appraisal, the fair value at acquisition date being P320,000.

The entry on August 1, 20x5 to reflect the adjustment since it is still within the measurement
period of one (1) year would be:

Buildings ----------------------------------------------------------- 20,000

Goodwill -------------------------------------------------------- 20,000
Adjustment to goodwill due to measurement date

Assets that have been provisionally recorded as of the acquisition date are retrospectively
adjusted in value during the measurement period for new information that clarifies the
acquisition-date value.

The adjustments affect goodwill since the measurement period is still within one year from
the acquisition date. Therefore, the goodwill to be reported then on the acquisition should be
P65,000 (P85,000 – P20,000).

Illustration 4

Assume from the information in the Illustration 2 and that on August 31, 20x5 because of
improved information about facts and circumstances that exist on the acquisition date, the
contingent consideration was revised to an expected /probability value of P50,000.

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Since the adjustment is still within the measurement period, the entity to adjust the liability
should be:
Goodwill ----------------------------------------------------------- 20,000
Estimated Liability for contingent consideration ------------ 20,000
Adjustment to goodwill due to measurement date

The goodwill to be reported then on the acquisition should be P105,000 (P85,000 + P20,000).

Illustration 5

Assuming the same information in Illustration 2, except that a contingent payment of

P100,000 cash, if Saul Corporation will generate cash flows from operations of P300,000 or
more 20x5. Saul estimates that there is 35% chance that the P100,000 will be required. Saul
uses an interest rate of 4% to incorporate the time value of money.

Required:
1. Compute the amount of Goodwill to be recognized
2. Prepare the journal entries

On December 31, 20x5, Saul Corporation’s Cash Flows from operations amounted to
P280,000, which means that it did not exceed the cash flows from operations threshold of
P300,000, therefore, there is no cash payment to be made to Saul Corporation. The entry for
Peter Corporation on December 31, 20x5 to record such occurrence would be:
Estimated Liability for contingent consideration ------------------ 33,654
Gain on estimated contingent consideration -------------------- 33,654
Adjustment after measurement date.

Illustration 6

Assuming the same information in Illustration 2, except that instead of contingent payment of
P100,000 cash, an additional cash payment would be made on January 1, 20x7, equal to twice
the amount by which average annual earnings of Saul Corporation exceed P25,000 per year,
prior to January 1, 20x7. Net Income was P65,000 in 20x5 and P70,000 in 20x6.

The entry by Peter Corporation on January 1, 20x7 for the payment of the contingent

Estimated Liability for contingent consideration ------------------ 30,000

Loss on Estimated Contingent Consideration ---------------------- 55,000
Cash [(65,000+70,000)/2 – 25,000] x 2 ------------------------- 85,000
Settlement of contingent consideration

consideration would be:

--- END OF DISCUSSION ---

Accredited: Accrediting Agency of Chartered Colleges and Universities of the Philippines (AACCUP)
Member: Philippine Association of State Universities and Colleges (PASUC)
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References:

Dayag, Antonio J. (2021). Advanced Financial Accounting (A comprehensive –

Conceptual & Procedural Approach). 2021 Edition. Good Dreams Publishing, Quezon City,
NCR Second District. ISBN No. 978-971-9599-7-5

Prepared by:

JOSEPH ANTHONY A. BUENVENIDA, CPA, MBA

Course Facilitator

Accredited: Accrediting Agency of Chartered Colleges and Universities of the Philippines (AACCUP)
Member: Philippine Association of State Universities and Colleges (PASUC)
Agricultural Colleges Association of the Philippines (ACAP)