Business Combinations (Part 1) 1

Chapter 1
Business Combinations (Part 1)

Related standards:
PFRS3 Business Combinations
Section 19 of the PFRS for SMEs

Overview on the topic

Our discussion on business combination is subdivided into the following chapters:

Chapter Title Coverage

1 Business Combinations (Part 1) Recognition & measurement
2 Business Combinations (Part 2) Specific cases
3 Business Combinations (Part 3) Special accounting topics

Learning Objectives
1. Define a busines8 combination.
2. Explain briefly the accounting requirements for a business combination.
3. Compute for goodwill.

Introduction
A business combination occurs when one company acquires another or when two or more
companies merge into one. After the combination, one company gains control over the
other.
The company that obtains control over the other is referred to as the parent or
acquirer. The other company that is controlled s the subsidiary or acquire.

Business combinations are carried out either through:

1. Asset acquisition; or
2. Stock acquisition
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 Asset acquisition - the acquirer purchases the assets and assumes the liabilities of
the acquire in exchange for cash other non-cash consideration (which may be the
acquirer’s own shares). After the acquisition, the acquired entity normally ceases
to exist as a separate legal or accounting entity. The acquirer records the assets
acquired and liabilities assumed in the business combination in its books of
accounts
Under the Corporation Code of the Philippines, a business combination
effected through asset acquisition may
be either:
a. Merger - occurs when two or more companies merge into a single entity which
shall be one of the combining companies. For example: A Co, + B Co. = A Co. or
B Co.
b. Consolidation - occurs when two or more companies consolidate into a single
entity which shall be the consolidated company. For example: A Co. + B Co. -C
Co.

 Stock acquisition - instead of acquiring the assets and assuming the liabilities of
the acquiree, the acquirer obtains
control over the acquiree by acquiring a majority ownership interest (e.g., more
than 50%) in the voting rights of the acquiree.
In a stock acquisition, the acquirer is known as the parent while the
acquiree is known as the subsidiary. After the business combination, the parent
and the subsidiary retain their separate legal existence. However, for financial
reporting purposes, both the parent and the subsidiary are viewed as a single
reporting entity.
After the business combination, the parent and subsidiary continue to
maintain their own separate accounting books, recording separately their assets,
liabilities and the transactions they enter into.
The parent records the ownership interest acquired as "investment in subsidiary"
in its separate accounting books.
However, the investment is eliminated when the group prepares consolidated
financial statements.
Business Combinations (Part 1) 3
4 Chapter 1

A business combination may also be described as:

1. Horizontal combination -a business combination of two or more entities with

similar businesses, e.g.-, a bank acquires another bank.
2. Vertical combination -a business combination of two or more entities operating at
different levels in a marketing chain, e.g., a manufacturer acquires its supplier of
raw materials.
3. Conglomerate - a business combination of two or more entitles with dissimilar
businesses, e.g. a real estate developer acquires a bank.

Advantages of a business combination

a. Competition is eliminated or lessened - competition between the combining

constituents with similar businesses is eliminated while the threat of competition
from other market participants is lessened.

b. Synergy - synergy occurs when the collaboration of two or more entities results to
greater productivity than the sum of the productivity of each constituent working
independently.
Synergy is most commonly described as "the whole is greater than the sum of its
parts." It can be simplified by the expression "l plus 1=3."

c. Increased business opportunities and earnings potential - business opportunity

and earrings potential may be increased through:
i. an increased variety of products or services available and a decreased
dependency on limited number of products and services;
ii. widened dispersion of products or services and better access to new markets;
iii. access to either of the acquirer's or acquiree's technological know-hows,
research and development, secret processes, and other information;
Business Combinations (Part 1) 5

iv. increased investment opportunities due to increased capital; or appreciation

in worth due to an established trade name by either one of the combining
constituents.
d. Reduction of operating costs - operating costs of the combined entity may be
reduced.
i. Under a horizontal combination, operating costs may be reduced by the
elimination of unnecessary duplication of costs (e.g. cost of information
systems, registration and licenses, some employee benefits and costs of
outsourced services).
ii. Under a vertical combination, operating costs may be reduced by the
elimination of costs of negotiation and coordination between the companies
and mark-ups on purchases.
e. Combinations utilize economies of scale - economies of scale refer to the increase
in productive efficiency resulting from the increase in the scale of production.
An entity that achieves economies of scale decreases its average cost per nit as
production is increased because fixed costs are allocated over an increased
number of units produced.
f. Cost savings on business expansion - by acquiring another company rather that
creating a new one, an entity can save on start-up costs, research and
development costs, cost of regulation and licenses, and other similar costs.
Moreover, a business combination may be effected through exchange of equity
instruments rather than the transfer of cash or other resources.
g. Favorable tax implications - deferred tax assets may be transferred in a business
combination. Also, business combinations effected without transfers of
considerations may not be subjected to taxation.
6 Chapter 1

Disadvantages of a business combination

a. Business combination brings monopoly in the market which may have a negative
impact to the society. This could result to impediment to healthy competition
between market participants.
b. The identity of one or both of the combining constituent’s may ease, leading to loss
of sense of identity for existing employees and loss of goodwill.
c. Management of the combined entity may become difficult due to incompatible
internal cultures, systems, and policies.
d. Business combination may result in overcapitalization, which, in turn, may result to
diffusion in market price per share and attractiveness of the combined entity's
equity instruments to potential investors.
e. The combined entity may be subjected to stricter regulation and scrutiny by the
government, most especially if the business combination poses threat to consumers'
interests.

Business combinations are accounted for under PFRS 3 Business

Combinations.

Business Combination

A business combination is "a transaction or other event in which an acquirer obtains

control of one or more businesses." Transactions referred to as 'true mergers or 'mergers
of equals are also business combinations under PFRS 3. (PFRS Appendix A)

Essential elements in the definition of a business combination

1. Control
2. Business

Control
An investor controls an investee when the investor has the power to direct the investee's
relevant activities (i.e., operating and financing policies), thereby affecting the variability
of the investor's investment returns from the investee.
Business Combinations (Part 1) 7

Control is normally presumed to exist when the acquirer holds more than 50% (or
51% t more) interest in the acquiree's voting rights. However, this is only a presumption
because control can be obtained in some other ways, such as when:

a. the acquirer has the power to appoint or remove the majority of the board of
directors of the acquiree; or
b. the acquirer has the power to cast the majority of votes at board meetings or
equivalent bodies within the acquiree, or
c. the acquirer has power over more than half of the voting rights of the acquiree
because of an agreement with other investors; or
d. the acquirer controls the acquiree's operating and financial policies because of a
law or an agreement.

An acquirer may obtain control of an acquiree in a variety of ways, for

example:
a. by transferring cash or other assets;
b. by incurring liabilities;
c. by issuing equity interests;
d. by providing more than one type of consideration; or
e. without transferring consideration, including by contract alone.

Illustration: Determining the existence of control

Example #1
ABC Co. acquires 51% ownership interest in XYZ, Inc.'s ordinary shares.

Analysts: ABC is presumed to have obtained control over XYZ because of the ownership
interest acquired in the voting rights of XYZ is more than 50%

Example #2
ABC Co. acquires 100% of XYZ, Inc's preference shares.
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Analysis: ABC does not obtain control over XYZ because preference shares do not give
the holder voting rights over the financial and operating policies of the investee.

Example #3

ABC Co, acquires 40% ownership interest in XYZ, Inc. There is an agreement with the
shareholders of XYZ that ABC will control the appointment of the majority of the board
of directors of XYZ.

Analysis: ABC has control over XYZ because, even though the ownership interest is only
40%, ABC has the power to appoint the majority of the board of directors of XYZ.

Example #4

ABC Co. acquires 45% ownership interest in XYZ, Inc. ABC has an agreement with
EFG Co, which owns 10% of XYZ, whereby EFG will always vote in the same way as
ABC.

Analysis: ABC has control over XYZ because it controls more than 50% of the voting
rights over XYZ Ge, 45% plus 10%, per agreement with EFG).

Example #5

ABC Co. acquires 50% of XYZ, Inc.’s voting shares. The board of directors of XYZ
consists of 8 members. ABC appoints 4 of them and XYZ appoints the other 4. When
there are deadlocks in casting votes at meetings, the decision always lies with the
directors appointed by ABC.

Analysis: ABC has control over XYZ because it controls more than 50% of the voting
rights over XYZ in the event there is no majority decision.
Business Combinations (Part 1) 9

Business
Business is "an integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing goods or 5ervices to customers, generating
investment income (such as dividends or interest) or generating other income from
ordinary activities." FFRS 3. Appendix A)
A business has the following three elements:
a. Input - any economic resource that results to an output when one or more processes
are applied to it, e.g., non-current assets, intellectual property, the ability to obtain
access to necessary materials or rights and employees.
b. Process - any system, standard, protocol, convention or rule that when applied to an
input, creates an output, e.g., strategic management processes, operational processes
and resource management processes.
Administrative systems, e.g. accounting billing payroll, and the like, are not
processes used to create outputs.
c. Output - the result of 1 and 2 above that provides goods or services to customers,
investment income or other income from ordinary activities.

Identifying a business combination

An entity determines whether a transaction is a business combination in relation to the
definition provided under PERS 3.
If the assets acquired (and related liabilities assumed) do not constitute a business,
the entity accounts for the transaction as a regular asset acquisition and mot a business
combination. Accordingly, the entity applies other applicable Standards (e.g. PAS2 for
inventories acquired, PAS16 for PPE acquired, etc.)

Accounting for business combination

Business combinations are accounted for using the acquisition method. This method
requires the following:
a. identifying the acquirer,
10 Chapter 1

b. Determining the acquisition date; and

c. Recognizing and measuring goodwill. This requires recognizing and measuring the
following:
i. Consideration transferred
ii. Non-controlling interest in the acquiree
iii. Previously held equity interest in the acquiree
iv. identifiable assets acquired and liabilities assumed on the business combination.

Identifying the acquirer

For each business combination, one of the combining entities is identified as the acquirer.
The acquirer is the entity that obtains control of the acquiree. The acquiree is the
business that the acquirer obtains control of in a business combination.
PFRS 3 provides the following guidance in identifying the acquirer:
a. Who’s the transferor of cash or other resources or assumes liabilities?
 In a business combination effected primarily by transferring cash or other assets or
by incurring liabilities, the acquirer is usually the entity that transfers the cash or
other assets or incurs the liabilities.

b. Who is the issuer of shares?

 In a business combination effected primarily by exchanging equity interests, the
acquirer is usually the entity that issues its equity interests. However, in some
business combinations, called "reverse acquisitions," the issuing entity is the
acquiree. Other pertinent facts and circumstances shall also be considered in
identifying the acquirer. The acquirer is usually the entity:
 whose owners, as a group, have the largest portion of the voting rights of the
combined entity.
Business Combinations (Part 1) 11

 whose owners have the ability to appoint or remove a majority of the members
of the governing body of the combined entity.
 whose (former) management dominates the management of the combined entity.
 that pays a premium over the pre-combination fair value of the equity interests of
the other combining entity or entities.

c. Who is larger?
 The acquirer is usually the larger between the combining entities, measured in, for
example, assets, revenues or profit.

d. Who is the initiator of the combination?

 The acquirer is usually the one who initiated the combination.

e. Substance over form

 If an new entity is formed to effect the business Combination, the acquirer is
identified as follows:
 if the new entity is formed to issue equity interests to effect the business
combination, one of the combining entities that existed before the business
combination is the acquirer.
 if the new entity is formed to transfer cash or other assets or incur liabilities as
consideration for the business combination, the new entity is the acquirer.

Example: A Co. +B Co. =C Co. (new entity)

 If C Co. is formed to issue equity interests to A Co. and B Co, the acquirer is either A
Co. or B Co, whichever company whose former owners, as a group. gain control over
C Co.
 If C Co. is formed to transfer cash to A Co. and B Co, the acquirer is C Co.
12 Chapter 1

Illustration: identifying the acquirer

ABC Co. and XYZ, Inc., both listed entities, agreed to combine their businesses. The
terms of the business combination is that ABC will offer 5 shares for every share of
XYZ. There is no cash consideration, ABC's market capitalization is P00 million and
XYZ's İs PI00 million. After the combination, the board of directors of XYZ shall
comprise only directors from ABC. Three months after the acquisition, 20% of XYZ is
sold.

Analysis: ABC is the acquirer based on the following indicators:

 ÄBC is the issuer of shares and the initiator of the business combination.
 ABC is the larger entity of the two combining constituents.
 ABC's (former) management dominates the management of the combined entity.
 Part of XYZ is sold after the acquisition. This provides additional indicator that ABC
is the acquirer.

Determining the acquisition date

The acquisition date is the date on which the acquirer obtains control of the acquiree.
This is normally the closing date (i.e., the date on which the acquirer legally transfers the
consideration, acquires the assets and assumes the liabilities of the acquiree).
However, the acquirer might obtain control on a date that is either earlier or later
than the closing date, for example, when there is a written agreement to that effect.

Recognizing and measuring goodwill

On acquisition date, the acquirer computes and recognizes goodwill (or gain on a bargain
purchase) using the following formula:
Business Combinations (Part 1) 13

Consideration transferred xx
Non-controlling interest (NCI) in the acquiree xx
Previously held equity interest in the acquiree xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill/ (Gain on a bargain purchase) xx

A negative amount resulting from the formula is called "gain on a bargain

purchase" (also referred to as "negative goodwill).
A bargain purchase may occur, for example, in a business combination that is a
forced sale which the acquiree is acting under compulsion. However, a bargain purchase
may also occur other instances such as when the application of the recognition and
measurement exceptions for particular items provided under PFRS 3 results in a gain on
bargain purchase.

On acquisition date, the acquirer recognizes a resulting:

a. Goodwill as an asset.
b. Gain on a bargain purchase as gain in profit or loss.

However, before recognizing a gain on a bargain purchase, the acquirer shall

reassess whether it has correctly identified all of the assets acquired and all of the
liabilities assumed and shall recognize any additional assets or liabilities that are
identified in that review. This is an application of the concept of conservatism.

Consideration transferred
The consideration transferred in a business Combination is measured at fair value, which
is 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.
14 Chapter 1

Examples of potential forms of consideration include:

a. Cash
b. Non-cash assets
c. Equity instruments, e.g., shares, options and warrants
d. A business or a subsidiary of the acquirer
e. Contingent consideration

Acquisition-related costs
Acquisition-related costs are costs that the acquirer incurs to effect a business
combination. Examples:
a. Finder's fees
b. Professional fees, such as advisory, legal, accounting, valuation and consulting fees
c. General administrative costs, including the costs of maintaining an internal
acquisitions department
d. Costs of registering and issuing debt and equity securities

Acquisition-related costs are expensed when incurred, except for the following:
a. Costs to issue debt securities measured at amortized cost are included the initial
measurement of the securities, e.g., bond issue costs are included (as deduction) in the
carrying amount of bonds payable.
b. Costs to issue equity securities are deducted from share premium. If share premium
is insufficient, the issue costs are deducted from retained earnings.

Non-controlling interest
Non-controlling interest (NCI) is the "equity in a subsidiary not attributable, directly or
indirectly, to a parent." (PFRS 3Appendix A) Non-controlling interest is also called
"minority interest."
For example, ABC Co. acquires 80% interest in XYZ, Inc. The controlling interest is
80%, while the non-controlling interest is 20% (100% - 80%). If ABC Co. acquires
100% interest in XYZ, Inc., the non-controlling interest is zero.
Business Combinations (Part 1) 15

For each business combination, the acquirer measures any non-controlling

interest in the acquiree either at:
a. fair value; or
b. the NCI's proportionate share in the acquiree's net identifiable assets.
c.
Previously held equity interest in the acquiree
Previously held equity interest in the acquiree pertains to any interest held by the acquirer
before the business combination. This affects the computation of goodwill only in
business combinations achieved in stages.

Net identifiable assets acquired

Recognition principle
On acquisition date, the acquirer recognizes the identifiable assets acquired, the liabilities
assumed and any NCI in the acquiree separately from goodwill.
Unidentifiable assets are not recognized. Examples of unidentifiable assets:
a. Goodwill recorded by the acquiree prior to the business combination.
b. Assembled workforce
c. C. Potential contracts that the acquiree is negotiating with prospective new customers
at the acquisition date

Recognition conditions
a. To qualify for recognition, identifiable assets acquired and liabilities assumed must
meet the definitions of assets and liabilities provided under the Conceptual
Framework at the
acquisition date.
For example, costs that the acquirer expects but is not obliged to incur in the
future to effect its plan to exit the acquiree's activity or to terminate or relocate the
acquiree's employees are not liabilities at the acquisition date. Hence, these are not
recognized when applying the acquisition
16 Chapter 1

method but rather treated as post-combination costs in accordance with other applicable
Standards.

b. The identifiable assets acquired and liabilities assumed must be part of what the
acquirer and the acquiree (or its former owners) exchanged in the business
combination transaction rather than the result of separate transactions.

c. Applying the recognition principle may result to the acquirer recognizing assets and
liabilities that the acquiree had not previously recognized in its financial statements.
For example, the acquirer may recognize an acquired intangible asset, such as a
brand name, a patent or a customer relationship, that the acquiree did not recognize as an
asset in its financial statements because it has developed the intangible asset internally
and charged the related costs as expense.

Classifying identifiable assets acquired and liabilities assumed

Identifiable assets acquired and liabilities assumed are classified at the acquisition date
in accordance with other PFRSs that are to be applied subsequently.
For example, PPE acquired in a business combination are classified at the
acquisition date in accordance with PAS 16 if the assets are to be used as PPE subsequent
to the acquisition date.

Measurement principle
Identifiable assets acquired and liabilities assumed are measured at their acquisition-date
fair vales.
Separate valuation allowances are not recognized at the acquisition date because
the effects of uncertainty about future cash flows are included in the fair value
measurement. For example, the acquirer does not recognize an "allowance for
doubtful accounts" on accounts receivable acquired on a business Combination. Instead,
the acquired accounts receivable are recognized at their acquisition-date fair values.
Business Combinations (Part 1) 17

All acquired assets are recognized regardless of whether the acquirer intends to
use them. For example, the acquirer recognizes the acquiree's research and development
(R&D) costs as intangible asset even if it does not intend to use them or intends to use
them in some other way. The acquisition-date fair value of such assets is determined in
accordance with their use by other market participants.

Illustration 1: Measuring goodwill / gain on bargain purchase

Fact pattern
On January 1, 20x1, ABC Co. acquired all of the assets and assumed all of the liabilities
of XYZ, Inc. As of this date, the carrying amounts and fair values of the assets and
liabilities of XYZ acquired by ABC are shown below:

Assets Carrying Amounts Fair values

Petty cash fund 10,000 10,000
Receivables 200,000 120,000
Allowance for doubtful accounts -30,000
Inventory 520,000 350,000
Building - net 1,000,000 1,100,000
Goodwill 100,000 20,000
Total assets 1,800,000 1,600,000
Liabilities
Payables 400,000 400,000

On the negotiation for the business combination, ABC Co. incurred transaction costs
amounting to P100,000 for legal, accounting, and consultancy fees.

Case #1: If ABC Co. paid ₱1,500,000 cash as consideration for the assets and liabilities
of XYZ, Inc., how much is the goodwill (gain on bargain purchase) on the business
combination?

Solution:
18 Chapter 1

Consideration transferred 1,500,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired 1,180,000
Goodwill 320,000

Notes:
 The consideration transferred refers to the cash paid as consideration for the assets
and liabilities of XYZ, Inc.
 There is no non-controlling interest in the acquiree because ABC Co. acquired all of
XYZ's assets and liabilities.
 Previously held equity interest in the acquiree affects the computation of goodwill
ony in business combinations achieved in stages. This is discussed in the next
chapter.
 The fair value of the net identifiable assets of the acquiree is computed as follows:

Fair value of identifiable assets acquired excluding

goodwill (1.6M - 20K) 1,580,000
Fair value of liabilities assumed (400,000)
Fair value of net identifiable assets acquired 1,180,000

 The goodwill recorded by the acquiree is excluded from the identifiable assets
acquired
because goodwill is unidentifiable. Only identifiable assets acquired are recognized.

The entries in the books of the acquirer are as follows:

Jan. 1 Petty cash fund 10,000
20x1 Receivables 120,000
Inventory 350,000
Building 1,100,000
Goodwill 320,000
Payables 400,000
Cash 1 1,500,000
Business Combinations (Part 1) 19

to record the assets acquired and liabilities

assumed on a business combination

Jan. 1
Professional fees expense
20x1 100,000
Cash 100,000
to record the acquisition-related costs

Notes:
 No allowance is recorded for the acquired receivables because the receivables are
recognized at acquisition-date fair value.
 The acquisition-related costs are expensed.
 The illustration above is an example of a business combination effected through
"asset acquisition."

XYZ, Inc. (the acquiree) shall account for the business combination as a
liquidation of a business. Accordingly, all of the assets, liabilities, and equity are
derecognized and the difference between the carrying amount of the items derecognized
and the disposal proceeds (amount received from the business combination) is treated as
a gain or loss on disposal of business.
XYZ shall recognize a gain on disposal of business of P100,000 (P1.5M
proceeds minus P1.4M carrying amount of net assets). The entries in XYZ's books are as
follows:
Jan. 1 Cash 1,500,000
20x1 Allowance for doubtful accounts 30,000
Payables 400,000
Petty cash fund 10,000
Receivables 200,000
Inventory 520,000
Building 1,000,000
Goodwill 100,000
Gain on disposal of business 100,000
to record the liquidation of the business
Jan. 1 Share capital (& other accounts) (1.8M-4M) 1,400,000
20x1
20 Chapter 1

Gain on disposal of business 100,000

Cash 1,500,000
to record the settlement of owners' equity

Case #2: If ABC Co. paid P1,000,000 cash as consideration for the assets and liabilities
of XYZ, Inc., how much is the goodwill (gain on bargain purchase) on the business
combination?
Requirement: Compute for goodwill

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired 1,180,000
Gain on a bargain purchase 180,000

ABC Co. reassesses first whether it has correctly identified all of the assets (liabilities)
acquired (assumed). If after the reassessment a negative amount still exists, ABC Co.
recognizes that amount as gain in its 20x1 profit or loss.

The entries are as follows:

Jan. 1 Petty cash fund 10,000
20x1 Receivables 120,000
Inventory 350,000
Building 1,100,000
Payables 400,000
Cash 1,000,000
Gain on bargain purchase 180,000
Jan. 1
20x1 Professional fees expense 100,000
Cash 100,000

Illustration 2: Non-controlling interests

Business Combinations (Part 1) 21

Fact pattern
On January 1, 20x1, ABC acquired 80% of the voting shares of XYZ, Inc. On this date,
XYZ's identifiable assets and liabilities have fair values of P1,200,000 and P400,000,
respectively.
Case #1: Non-controlling interest measured at fair value
ABC Co. elects the option to measure non-controlling interest at fair value. The
independent consultant engaged by ABC Co. determined that the fair value of the 20%
non-controlling interest in XYZ, Inc. is P155,000. ABC Co. paid P1,000,000 for the 80%
interest in XYZ, Inc. How much is the goodwill?

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) 155,00
Previously held equity interest in the acquiree -
Total 1,155,000
Fair value of net identifiable assets acquired (800,000)
Goodwill 180,000

The entries are follows:

 To record the acquisition in ABC's separate books of accounts:
Jan. 1
20x1 1,000,000
Investment in subsidiary
Cash 1,000,000

 To include XYZ in ABC's consolidated financial statements:

Jan. 1 Identifiable assets acquired 1,200,000
20x1
Goodwill 355,000
Liabilities assumed 400000
Investment in subsidiary 1,000,000
Non-controlling interest in XYZ, Inc. 155,000

Notes:
22 Chapter 1

 The non-controlling interest is presented in the consolidated statement of financial

position within equity but separately from the equity of the owners of ABC Co.
(parent).
 The illustration above is an example of a business combination effected through
"stock acquisition."
Case #2: Non-controlling interest measured at fair value
ABC Co. elects to measure non-controlling interest at fair value. A value of P250,000 is
assigned to the non-controlling interest in XYZ, Inc. [(PIM + 80%) x 20% = P250,000].
The consideration transferred is P1,000,000. How much is the goodwill?

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) 250,00
Previously held equity interest in the acquiree -
Total 1,250,000
Fair value of net identifiable assets acquired (800,000)
Goodwill 450,000

Case #3: NCI's proportionate share in net assets

ABC Co. elects the option to measure the non-controlling interest at the non-controlling
interest's proportionate share of XYZ, Inc.'s
net identifiable assets. ABC Co. paid P1,000,000 for the interest acquired in XYZ, Inc.
How much is the goodwill?

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) 160,00
Previously held equity interest in the acquiree -
Total 1,160,000
Fair value of net identifiable assets acquired (1.2M-
400K) (800,000)
Goodwill 360,000

(a)
The NCI's proportionate share in XYZ's net assets is computed
Business Combinations (Part 1) 23

as follows:

Fair value of net identifiable assets acquired (1.2M-400K) 800,000

Multiply by: Non-controlling interest 20%
NCI's proportionate share in net identifiable assets 160,000

Illustration 3: Transaction costs

Fact pattern
On January 1, 20x1, ABC acquired all the assets and assumed all the liabilities of XYZ,
Inc. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and
P900,000, respectively.

ABC incurred the following acquisition-related costs: legal fees, P10,000, due diligence
costs, P100,000, and general administrative costs of maintaining an internal acquisitions
department, P20,000.

Case #1: As consideration for the business combination, ABC Co. transferred 8,000 of its
own equity instruments with par value per share of P100 and fair value per share of P125
to XYZ's former owners. Costs of registering the shares amounted to P40,000. How
much is the goodwill?

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (1.2M-
400K) (700,000)
Goodwill 300,000

The entries as follows:

Jan. 1 Identifiable assets acquired 1,600,000
20x1 Goodwill 300,000
Liabilities assumed 900,000
Share Capital (8,00xp100 par) 800,000
24 Chapter 1

Share premium 200,000

to record the issuance of shares as consideration for
business combination
Jan. 1 Share premium
40,000
20x1
Cash in bank 40,000
To record cost of transactions

Jan. 1 Professional fees expense (10K + 100K) 110,000

20x1
General and administrative costs 20,000
Cash in bank 130,000
to record the acquisition-related costs

The acquisition-related costs are expensed, except for the stock issuance costs
which are deducted from share premium.

Case #2: As consideration for the business combination, ABC Co. issued bonds with face
amount and fair value of P1,000,000. Transaction costs incurred in issuing the bonds
amounted to P50,000. How much is the goodwill?

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (1.2M-
400K) (700,000)
Goodwill 300,000

The entries are:

Jan. 1 Identifiable assets acquired 1,600,000
20x1 Goodwill 300,000
Liabilities assumed 900,000
Bonds payable 1,000,000
to record the issuance of shares as consideration for
business combination
Bond issue costs 50,00
Business Combinations (Part 1) 25

Cash
To record the bond issue cost
Jan. 1 Professional fees expense (10K + 100K)
110,000
20x1
General and administrative cost 20,000
Cash 130,000

Notes:
 The bond issue costs are deducted when determining the carrying amount of the
bonds.
 The carrying amount of the bonds payable is P950,000 (1M-50K).
 When computing for goodwill, the consideration transferred is measured at the fair
value of the securities issued without deduction for the transaction costs.
 In both cases above, the acquisition-related costs, including costs of issuing equity
and debt securities, do not affect the computation of goodwill.

Restructuring provisions
Restructuring is a program that is planned and controlled by management, and materially
changes either:
a. the scope of a business undertaken by an entity; or
b. the manner in which that business is conducted.

Restructuring provisions may include the costs of an entity's plan

a. To exit an activity of the acquiree,
b. To involuntarily terminate employees of the acquiree, or
c. To relocate non-continuing employees of the acquiree.
The cost above are sometimes referred as “liquidation costs.”
Restructuring provisions do not include such costs as (a) retraining or relocating
continuing staff, (b) marketing; or (c) investment in new systems and distribution
networks.
Restructuring provisions are generally not recognized as part of business
combination unless the acquiree has, at the acquisition date, an existing liability for
26 Chapter 1

restructuring that has been recognized in accordance with PAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
A restructuring provision meets the definition of a liability at the acquisition date
if the acquirer incurs a present obligation to settle the restructuring costs assumed, such
as when the acquiree developed a detailed formal plan for the restructuring and raised

a valid expectation in those affected that the restructuring will be carried out by publicly
announcing the details of the plan or has begun implementing the plan on or before the
acquisition date.
If the acquiree's restructuring plan is conditional on it being acquired, the
provision does not represent a present obligation, nor is it a contingent liability, at
acquisition date.
Restructuring provisions that do not met the definition of a liability at the
acquisition date are recognized as post- combination expenses of the combined entity
when the costs are incurred.

Illustration: Restructuring provisions

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and
P900,000, respectively.

ABC Co. has estimated restructuring provisions of 200,000 representing costs of exiting
the activity of XYZ, including costs of terminating and relocating the employees of XYZ.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) -
Business Combinations (Part 1) 27

Previously held equity interest in the acquiree -

Total 1,000,000
Fair value of net identifiable assets acquired (1.2M-
400K) (700,000)
Goodwill 300,000

The restructuring provisions are simply ignored in the computation of goodwill.

These are considered only when they qualify for recognition under PAS 37 as at the
acquisition date (see discussion above). Restructuring provisions that do not meet the
recognition criteria as at the acquisition date are recognized as post-combination
expenses (i.e., expenses after the business combination).
Specific recognition principles
PFRS 3 provides the following specific recognition principles:

1. Operating leases
Acquiree is the lessee
General rule:
The acquirer does not recognize any assets or liabilities related to an operating lease in
which the acquiree is the lessee.

Exception:
The acquirer determines whether the terms of each operating lease in which the acquiree
is the lessee are favorable or unfavorable.

If the terms of an operating lease relative to market terms is:

1. Favorable - the acquirer recognizes an intangible asset.
2. Unfavorable - the acquirer recognizes a liability.
For example, an identifiable asset (favorable) may arise when market participants are
willing to pay rent at above-market rates because the leased property is located at a prime
spot.

Acquiree is the lessor

28 Chapter 1

If the acquiree is the lessor, the acquirer does not recognize any separate intangible asset
or liability regardless of whether the terms of the operating lease are favorable or
unfavorable when compared with market terms.

Illustration: Specific recognition principles - Operating leases

Fact pattern
On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. On this date, XYZ's assets and liabilities have fair values of P1,600,000 and
P900,000, respectively.
Case #1: Acquiree is the lessee - terms are favorable
ABC is renting out a building to XYZ, Inc. under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
P20,000.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (a) (720,000)
Goodwill 280,000

Fair value of identifiable assets acquired, including

(a)

intangible asset on the operating lease with favorable 1,620,000

terms (P1.6M + P20K)
Fair value of liabilities assumed (900,000)
Fair value of net identifiable assets acquired 720,000

Case #2: Acquiree is the lessee - terms are unfavorable

Business Combinations (Part 1) 29

ABC is renting out a patent to XYZ, Inc. under an operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential is
P20,000.

Requirement: Compute for the goodwill.

Solution:

Consideration transferred 1,000,000

Non-controlling interest in the acquiree (fair value) -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (a)
(680,000)
Goodwill 320,000
Fair value of identifiable assets acquired, including
(b)

intangible asset on the operating lease with favorable 1,600,000

terms (P1.6M + P20K)
Fair value of liabilities assumed (920,000)
Fair value of net identifiable assets acquired 680,000

Case #3: Acquiree is the lessor

ABC is renting a building from XYZ, Inc. under an operating lease. The terms of the
operating lease compared with market terms are favorable. The fair value of the
differential is P20,000.
Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree (fair value) -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (a) (700,000)
Goodwill 300,000
30 Chapter 1

(c)
No intangible asset or liability is recognized, regardless of terms of the operating lease,
because the acquiree is the lessor.

Note that the basis for determining which party is the lessee or the lessor in an
operating lease is the acquiree. If the acquiree is the lessee, an asset or liability is
recognized depending on the terms of the lease. If the acquiree is the lessor, no asset or
liability is recognized.

2. Intangible assets
Identifiable intangible assets acquired in a business combination are recognized
separately from goodwill. An intangible asset is identifiable if it is either (a) separable or
(b) arises from contractual or other legal rights.

Separability criterion
An intangible asset is separable if it can be separated from the acquiree and sold,
transferred, licensed, rented or exchanged, either individually or together with a related
contract, identifiable asset or liability.

An intangible asset is also separable if there is evidence of exchange transactions for that
type of asset or similar asset, even if those transactions are infrequent and the acquirer is
not involved in them.

An intangible asset is separable even if the acquirer does not intend to sell, license or
otherwise exchange it. For example, the fact that customer and subscriber lists are
frequently licensed makes such lists separable. However, such lists would not be
separable if the terms of confidentiality or other agreements prohibit the entity from
selling, leasing or otherwise exchanging information about its customers.

Contractual-legal criterion
An intangible asset that is not separable is nonetheless identifiable if it arises from
contractual or other legal rights.
Business Combinations (Part 1) 31

Example:
Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity
B's license to operate the nuclear power plant. However, the terms of the license prohibit
Entity A from selling or transferring the license to another party.

Analysis: The license is an identifiable intangible asset because, although it is not

separable, it meets the contractual-legal criterion.

Illustration 1: Intangible assets

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,500,000. Relevant
information follows:

Carrying Amounts Fair values

Others assets 1,600,000 1,480,000
Computer software 100,000 -
Patent - 50,000
Goodwill 100,000 20,000
Assets 1,800,000 1,550,000

Liabilities 400,000 450,000

Additional information:
The computer software is considered obsolete.
The patent has a remaining useful life of 10 years and a remaining legal life of 12 years.
XYZ has research and development (R&D) projects with fair value of 50,000. However,
XYZ, Inc. recognized the R&D costs as expenses when they were incurred.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,500,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
32 Chapter 1

Total 1,500,000
Fair value of net identifiable assets acquired (a) (1,1300,000)
Goodwill 370,000

Fair value of identifiable assets acquired, excluding

(a)

computer software and recorded goodwill but

1,620,000
including patent and R&D (P155M-P20K goodwill +
P50K R&D))
Fair value of liabilities assumed (900,000)
Fair value of net identifiable assets acquired 720,000

An acquirer recognizes an acquiree's R&D as intangible asset even if the acquiree

has already expensed the related costs.

Illustration 2: Intangible assets

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ's assets
and liabilities have fair values of P1,600,000 and P900,000, respectively. Not included in
the fair value of assets are the following unrecorded intangible assets:

Type of intangible asset Fair value

Customer list 40,000
Customer contract #1 30,000
Customer contract #2 20,000
Order (production) backlog 10,000
Internet domain name 15,000
Trademark 25,000
Trade secret processes 35,000
Mask works 45,000
Total 220,000

Additional information:
Business Combinations (Part 1) 33

 Customer contract #1 refers to an agreement between XYZ, Inc. and a customer,

wherein XYZ, Inc. is to supply goods to the customer over a period of 5 years. The
remaining term of the contract is 3 years. The agreement is expected to be renewed at
contract-end, but is not separable.
 Customer contract #2 refers to XYZ's insurance segment's portfolio of one-year motor
insurance contracts that are cancellable by policyholders.
 XYZ, Inc. transacts with its customers solely through purchase and sales orders. As of
acquisition date, XYZ has a backlog of customer purchase orders from 60% of its
customers, all of whom are recurring customers. The other 40% are also recurring
customers but XYZ has no open purchase orders with these customers.
 The internet domain name is registered.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (a) (920,000)
Goodwill 80,000

Fair value of identifiable assets acquired, including

(a)
1,820,000
all of the unrecorded intangible assets (P1.6M-P220K)

Fair value of liabilities assumed (900,000)

Fair value of net identifiable assets acquired 920,000

Notes:
 Unless restricted by confidentiality, customer lists are normally separable because
they are often leased or exchanged.
 Because XYZ establishes its relationship with its customers through contracts,
customer contract #s 1 and 2 and the order (production) backlog meet the contractual-
legal criterion. This is regardless of whether those contracts are cancellable or not,
34 Chapter 1

and in the case of the order backlog, even if there were no open purchase orders as at
the acquisition date.
 A registered internet domain name meets the contractual-legal criterion.
 Trademarks, trade secret processes, and mask works acquired in a business
combination normally meet the contractual-legal criterion.

Exception to the recognition principle - Contingent liabilities

The acquirer applies PFRS 3, rather than PAS 37, when accounting for contingent
liabilities related to business combinations.
Under PFRS 3, a contingent liability assumed in a business combination is
recognized if:
a. it is a present obligation that arises from past events; and
b. its fair value can be measured reliably.
So, contrary to PAS 37, a contingent liability with improbable outflow may nevertheless
be recognized if both the conditions above are satisfied.

Illustration: Contingent liability

ABC Co. acquires 90% interest in XYZ, Inc. for P1,000,000. XYZ's recognized assets
and liabilities have fair values of P1,600,000 and P900,000, respectively. ABC opts to
measure the non-controlling interest at fair value. The NCI's fair value is P80,000.

XYZ is a defendant in a pending litigation, for which no provision was recognized

because XYZ strongly believes that it will win the case. The fair value of settling the
litigation is P50,000.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree 80,000
Previously held equity interest in the acquiree -
Total 1,080,000
Business Combinations (Part 1) 35

Fair value of net identifiable assets acquired (a) (650,000)

Goodwill 430,000

Fair value of identifiable assets acquired

(a)
1,600,000

Fair value of liabilities assumed 900,000

Contingent liability (pending litigation) 50,000 (950,000)
Fair value of net identifiable assets acquired 650,000

The contingent liability is recognized even if it is improbable because it (a)

represents a present obligation and (b) has a fair value.

Exceptions to both the recognition and measurement principles

The following items are recognized and measured as at the acquisition date under other
applicable standards rather than PFRS 3:
a. Income taxes are accounted for using PAS 12 Income Taxes. For example, deferred
taxes are measured based on temporary differences arising from the measurement of
identifiable assets and liabilities acquired at the acquisition date.
Deferred taxes affect the amount of goodwill or gain on bargain purchase
recognized at the acquisition date. However, PAS 12 prohibits the recognition of
deferred tax liabilities arising from the initial recognition of goodwill. (The
accounting for deferred taxes is discussed in detail in Intermediate Accounting Part
2.)

b. Employee benefits are accounted for using PAS 19 Employee Benefits. For example,
defined benefit obligations are measured using actuarial valuations. (The accounting
for employee benefits is discussed in detail in Intermediate Accounting Part 2.)

c. Indemnification assets - An indemnification asset arises when the former owners of

the acquiree agree to reimburse the acquirer for any payments the acquirer eventually
makes upon settlement of a particular liability.
36 Chapter 1

The acquirer recognizes and measures the indemnification asset at the same time
and on the same basis as the indemnified item.
Accordingly, if the indemnified item is measured at fair value, the
indemnification asset is also measured at fair value. If the indemnified item is
measured at other than fair value, the indemnification asset is measured using
assumptions consistent with those used to measure the indemnified item.

Example:
Entity A acquires Entity B. At the acquisition date, the taxing authority is disputing
Entity B's tax returns in prior years. former owners of Entity B agree to reimburse Entity
A in case

Entity A will be held liable to pay Entity B's tax deficiencies in the prior years.
At the acquisition date, Entity A recognizes a tax liability to the taxing authority
and an indemnification asset for the reimbursement due from the former owners of Entity
B.

Illustration: Deferred taxes

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,500,000. Relevant
information follows:
Carrying
Assets
Amounts Fair values
Petty cash fund 10,000 10,000
Receivables 200,000 120,000
Allowance for doubtful accounts (30,000)
Inventory 520,000.00 350,000
Building - net 1,000,000 1,100,000
Goodwill 100,000 20,000
Total assets 1,800,000 1,600,000
Liabilities
Payables 400,000 400,000
 Business Combinations (Part 1) 37

 XYZ, Inc. has unrecorded patent with fair value of P30,000 and contingent liability
with fair value of P20,000. The contingent liability is a present obligation but its
outflow is improbable.
 Fair value adjustments to the carrying amounts of assets and liabilities do not affect
their tax bases. All adjustments result to temporary differences. ABC's tax rate is
30%.
Requirement: Compute for the goodwill.

Solution:
 Recall the following concept from PAS 12:
 If the carrying amount of an asset exceeds its tax base, the difference is a taxable
temporary difference, which, if multiplied by the tax rate, results to deferred tax
liability.
 For an asset: CA > TB = TTD or FI>TI; TTD x tax rate = DTL
 The deferred taxes are computed as follows:
Fair Previous
Values Carrying TTD (DTD)
CA for amounts
financial (TB for
reporting taxation)
Cash 10,000 10,000 -
Receivables - net 120,000 170,000 50,000
Inventory 350,000 520,000 170,000
Building - net 1,100,000 1,000,000 100,000
Patent 30,000 - 30,000
Payables 400,000 400,000 -
Contingent liability 20,000 - 20,000

Taxable temporary difference (TTD) (100K+ 30K)

130,000
Multiply by: Tax rate 30%
Deferred tax liability 39,000

Deductible temporary difference (DTD) (50K+ 170K+20K) 240,000

 38 Chapter 1

Multiply by: Tax rate 30%

Deferred tax asset 720,000

Consideration transferred 1,500,000

Non-controlling interest in the acquire -
Previously held equity interest in the acquiree -
Total 1,500,000
Fair value of net identifiable assets acquired (a) 1,223,000
Goodwill 277,000

(a) Fair value of identifiable assets acquired excluding recorded goodwill (1.6M-20K
goodwill + 30K unrecorded patent + 72K deferred tax asset) 1,682,000
Fair value of liabilities assumed (400K + 20K contingent
liability +39K deferred tax liability) 459,000
Fair value of net identifiable assets acquired 1,223,000

Additional concepts on Consideration transferred

The consideration transferred in a business combination includes only those that are
transferred to the former owners of the acquiree. It excludes those that remain within the
combined entity.
Assets and liabilities transferred to the former owners of the acquiree are
remeasured to acquisition-date fair values. Any remeasurement gain or loss is
recognized in profit or loss.
Assets and liabilities that remain within the combined entity (for example,
because the assets or liabilities were transferred to the acquiree rather than to its former
owners) are not remeasured but rather ignored when applying the acquisition method.

Illustration 1: Consideration transferred

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. The
assets and liabilities have fair values of P1,600,000 and P900,000, respectively. As
consideration:
Business Combinations (Part 1) 39

 ABC agrees to pay P1,000,000 cash, of which half is payable on January 1, 20x1 and
the other half on December 31, 20x5. The prevailing market rate of interest on
January 1, 20x1 is 10%.
 In addition, ABC agrees to transfer a piece of land with carrying amount of P500,000
and fair value of P300,000 to the former owners of XYZ.
 After the combination, ABC will continue the activities of XYZ. ABC agrees to
provide a patented technology with carrying amount of P60,000 and fair value of
P80,000 for use in XYZ's activities.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,110,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,110,000
Fair value of net identifiable assets acquired (a) (700,000)
Goodwill 410,461
(a)
Cash payment (PIM x 50%) 500,000

PV of future cash payment (PIM x 50 % x PV of P1 @10%, n=5) 310,46

Land transferred to former owners of XYZ (at fair value) 300,000

Fair value of consideration transferred 1,110,461

 Notes:
 The land is remeasured to acquisition-date fair value before it is transferred. The
$200,000 adjustment is recognized as impairment loss.
 The patented technology is not included in the consideration transferred because it
remains within the combined entity.
 The patented technology continues to be measured at carrying amount.

Illustration 2: Consideration transferred - Dividends on

40 Chapter 1

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. The assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.

XYZ's liabilities include P100,000 cash dividends declared on December 28, 20x0, to
shareholders of record on January 15, 20x1, and payable on January 31, 20x1.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred (1M-100K dividends on) 900,000
Non-controlling interest in the acquire -
Previously held equity interest in the acquiree -
Total 900,00
FV of net identifiable assets acquired (1.6M-9M) 700,000
Goodwill 200,000

For purposes of computing the goodwill, the 100,000 payment is excluded from the
consideration transferred because
this is not a payment for the business combination, but rather for the purchased
dividends.

Journal entries:
Jan. 1
20x1 Identifiable assets acquired 1,600,000

Goodwill 200,000
Liabilities assumed (incldg. Dividends) 900,000
Cash 900,000
Dividends payable 100,000
Jan. 1 Cash 100,000
20x1 to record the extinguishment of the purchased

Exceptions to the measurement principle

a. Reacquired rights
Business Combinations (Part 1) 41

Reacquired rights are measured based on the remaining term of the related contract.
Reacquired rights are discussed in the next chapter.

b. Share-based payment transactions

Liabilities and equity instruments related to the acquiree's share- based payment
transactions are accounted for using PFRS 2 Share- based Payment. (Share-based payment
transactions are discussed in detail in Intermediate Accounting Part 2.)

c. Assets held for sale

A non-current asset (or disposal group) that is classified as 'held for sale' at the
acquisition date is measured at fair value less costs to sell in accordance with PFRS 5
Non-current Assets Held for Sale and Discontinued Operations, rather than at fair value
under PFRS 3.

Illustration: Held for sale assets

ABC Co. acquired all the assets and liabilities of XYZ, Inc. for $1,000,000. The assets
and liabilities have fair values of P1,600,000 and P900,000, respectively.

Additional information:
 XYZ's assets include a factory plant that ABC intends to sell immediately. The
criteria for "held for sale" classification under PFRS 5 are met. Costs to sell the
factory plant are P20,000.
 Not included in XYZ's assets is a research and development project that ABC
does not intend to use. The R&D's fair value is P50,000.
 Also not included in the assets is a customer list with an estimated value of
P10,000. However, confidentiality prohibits Entity A from selling, leasing or
otherwise exchanging information about the customers in the list.

Requirement: Compute for the goodwill.

42 Chapter 1

Solution:

Consideration transferred 1,000,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (1.6M-20K
costs to sell + 50K R&D-9M liabilities) 730,000
Goodwill 270,000

 Notes:
 The "held for sale" factory plant is measured at fair value less costs to sell. Because
the fair value is already included in the total, the costs to sell are simply deducted.
 An identifiable asset acquired (e.g., the R&D) is recognized regardless of whether the
acquirer intends to use it.
 The customer list is not recognized because it is not identifiable. See previous
discussion.

 General recognition and measurement principles: The net identifiable assets

acquired in a business combination are recognized when they meet the recognition
criteria under the Conceptual Framework and are measured at acquisition-date fair
values in accordance with PFRS 3.
Exceptions to both the
Exception to the Exceptions to the measurement
recognition and
recognition principle principle
measurement principles
1. Contingent liabilities - 1. Reacquired. rights – measured
1. Deferred taxes - (PAS
recognized when they based on the remaining term of
12 is applied).
represent a present the related contract.
obligation and their fair 2. Employee benefits - 2. Share-based payment - (PFRS
value is determinable, (PAS 19 is applied) 2 is applied)
even if the outflow is
3. Indemnification - 3. "Held for sale" assets –
Business Combinations (Part 1) 43

assets - recognized and

measured on the same measured at fair value less costs
improbable. basis as the indemnified to sell
item.
Chapter 1: Summary
 A business combination is one in which an acquirer obtains control of one or more
businesses.
 Control is presumed to exist when an investor holds more than 50% interest in the
acquiree's voting rights.
 Business combinations are accounted for using the acquisition method. This method
requires the following:
a. Identifying the acquirer;
b. Determining the acquisition date;
c. Recognizing and measuring goodwill (or negative goodwill) - this requires
accounting for the following:
i. Consideration transferred,
ii. Non-controlling interest,

i. Previously held equity interest, and

ii. Identifiable assets acquired and liabilities assumed.
 The acquirer (parent) is the entity that obtains control after the business combination.
The controlled entity is the acquiree (subsidiary).
 The acquisition date is the date on which the acquirer obtains control of the acquiree
(e.g., the closing date). Goodwill is computed using the following formula:

Consideration transferred xx
Non-controlling interest (NCI) in the acquiree xx
Previously held equity interest in the acquiree xx
Total xx
Less: Fair value of net identifiable assets acquired (xx)
Goodwill/ (Gain on a bargain purchase) xx
44 Chapter 1

 The consideration transferred is measured at fair value. NCI is measured either at fair
value or the NCI's proportionate share in the acquiree's net identifiable assets.
 A "gain on a bargain purchase" is recognized in profit or loss in the year of
acquisition only after reassessment of the assets acquired and liabilities assumed in
the business combination.
 Only identifiable assets acquired are recognized. Unidentifiable assets are not
recognized.
 Acquisition-related costs are expensed, except costs of issuing equity and debt
instruments. Acquisition-related costs do not affect the measurement of goodwill.
 Restructuring provisions are generally not recognized as part of business
combination, but rather as post-combination expenses of the combined entity when
the costs are incurred.

Relevant provisions of the PFRS for SMEs

Section 19 Business Combinations and Goodwill

Section 19 of the PFRS for SMEs applies to all business combinations, including the
accounting for goodwill. It does not apply to the following:
a. Combinations of businesses under common control (i.e., entities having the same
parent).
b. The formation of a joint venture.
c. Acquisition of a group of assets that do not constitute a business.

Business combination
Business Combinations (Part 1) 45

Business combination is "the bringing together of separate entities or businesses into one
reporting entity." (PFRS for SMEs) As a result, one entity (the acquirer) obtains control
over the other business (the acquiree).
A business combination may involve the purchase, by the acquirer, of some or all
of the acquiree's (a) assets and liabilities or (b) equity, in exchange for cash, non-cash
assets, or the acquirer's equity instruments.

Accounting
Business combinations are accounted for using the purchase method. This method
involves the following:
a. Identifying the acquirer
b. Measuring the cost of the business combination.
c. Allocating the cost of the business combination to the assets acquired and liabilities
assumed.

The purchase method is applied as at the acquisition date, which is the date on which
the acquirer obtains control over the acquiree.

Identifying the acquirer

The acquirer is identified in all business combinations. The acquirer is the one that
obtains control over the other combining business.
Control is "the power to govern the financial and operating policies of an entity or
business so as to obtain benefits from its activities." (PFRS for SMEs)
When the acquirer is not clearly identifiable, the acquirer is usually:
a. the business with the greater fair value;
b. the transferor of cash or other assets; or
c. the business whose management dominates the management of the combined entity.

Cost of a business combination

The cost of a business combination is the sum of:
46 Chapter 1

a. The acquisition-date fair values of the assets given, liabilities incurred, and equity
instruments issued by the acquirer in exchange for control over the acquiree; and
b. Any costs directly attributable to the business combination.

Adjustments to the cost of a business combination

If the business combination agreement provides for a contingent consideration, such is
included in the cost of the business combination at the acquisition date if it is probable
and can be measured reliably.
If the contingent consideration is not recognized at the acquisition date but
subsequently becomes probable and reliably measurable, the additional consideration is
treated as an adjustment to the cost of the combination.

Allocating the cost of a business combination

At the acquisition date, the acquirer allocates the cost of the business combination by
recognizing the acquiree's identifiable assets and liabilities, including contingent
liabilities, at their fair values (except for deferred taxes and employee benefits which are

recognized and measured using the other sections of the PFRS for SMEs).
The difference between (a) the cost of the business combination and (b) the
acquirer's interest in the fair value of the acquiree's net identifiable assets represents
goodwill or negative goodwill.

Recognition and measurement

The acquirer recognizes the acquiree's identifiable assets and liabilities at the acquisition
date if they satisfy the following criteria:
a. Assets other than intangible assets it is probable that any associated future economic
benefits will flow to the acquirer, and its fair value can be measured reliably.
b. Liabilities other than contingent liabilities - it is probable that an outflow of resources
will be required to settle the obligation, nd its fair value can be measured reliably.
Business Combinations (Part 1) 47

c. Intangible assets and Contingent liabilities - its fair value can be measured reliably.

Restructuring and Future losses

Restructuring provisions (e.g., liabilities for terminating or reducing the acquiree's
activities) are recognized only if the acquiree has an existing liability for the restructuring
as at the acquisition date.
The acquirer does not recognize liabilities for future losses expected to result from
the business combination.

Provisional amounts
Provisional amounts may be recognized if the initial accounting for a business
combination is incomplete by the end of the reporting period in which the business
combination occurs.

Changes to the provisional amounts within 12 months from the acquisition date
are accounted for retrospectively. Changes beyond the 12-month period are treated as
corrections of errors.

Goodwill and Negative goodwill

Goodwill is recognized as an asset and subsequently amortized over a useful life
determined based on management's best estimate not exceeding 10 years.
For purposes of impairment testing, goodwill is allocated to individual cash
generating units (CGU). The CGUs are then tested for impairment and any impairment
loss is charged first to the CGU's allocated goodwill. Any excess is charged to the other
assets of the CGU.
Negative goodwill is recognized as gain in profit or loss in the year of business
combination, but only after reassessments of the assets and liabilities acquired and the
cost of the business combination.
48 Chapter 1

 Notable differences between the full PFRSS and the PFRS for SMES:

Full PFRSs PFRS for SME’s

1. Accounting method and computation of goodwill

PFRS 3 requires the use of the PFRS for SMEs requires the use of the
acquisition method. purchase method
Goodwill is computed as follows: Goodwill is computed as follows:
Fair value of assets given liabilities
Consideration transferred xx incurred and quality instruments xx
NCI xx Acquisition-related cost xx
Previously hold equity interest xx Cost of business combination xx
Less: Acquirer's interest in the fair
cost of business combination of
the acquiree's net identifiable
total xx assets xx
Less: Fair value of net (xx
identifiable ) Goodwill (Negative goodwill) xx
Goodwill(Negative goodwill) xx

 Acquisition-related costs are  Acquisition-related costs are included

expensed, except costs of in the cost of the business
issuing equity or debt combination, except costs of issuing
securities. equity or debt securities.

2. Non-controlling interests
NCI is not included in the measurement of goodwill.
the consolidated financial statement is measured at
NCI is included in the NCI is
the NCI’s proportionate share in the acquiree’s net
measurement of goodwill. NCI
assets.
in measured either at:

a. fair value; or

b. the NCI's proportionate share

in the acquiree's net assets.
Business Combinations (Part 1) 49

3. Operating lease - Reacquired right

No equivalent provision under PFRS for SMEs.
If the terms of an operating lease
relative to market terms is:

1. Favorable - the acquirer

recognizes an intangible asset.

2. Unfavorable - the acquirer

recognizes a liability.

4. Intangible assets acquired in a business combination

Recognized if its fair value can be measured reliability
Recognized if the intangible
asset meets either the (a)
Separability criterion or the (b)
contractual-legal criterion.

5. Contingent liabilities
Recognized if it is a present
obligation and its fair value can Recognized if its fair value can be measured reliably.
be measured reliably.

PROBLEMS

PROBLEM 1: TRUE OR FALSE

1. The two important elements in the definition of business combination under PFRS 3
are "business" and "combination."
2. PFRS 3 requires the use of the purchase method in accounting for business
combinations.
3. The entity that obtains control in a business combination is called the acquiree.
4. The acquisition date in a business combination is normally the closing date.
5. Non-controlling interests are measured at fair value only.
50 Chapter 1

6. If the controlling interest is 80%, the non-controlling interest is 20%.

7. A gain on a bargain purchase (negative goodwill) is recognized as an allocated
deduction to the net identifiable assets acquired in the year of business combination.
8. An intangible asset that is unrecorded by the acquiree may nevertheless, be
recognized by the acquirer in a business combination.
9. A noncurrent asset acquired in a business combination that is classified as held for
sale is measured at fair value.
10. If the consideration transferred in a business combination is deferred, the
consideration may be measured at present value.

PROBLEM 2: TRUE OR FALSE

1. Entity A acquires 100% interest in the voting shares of Entity B for 100. Entity B's
identifiable assets and liabilities have fair values of $200 and 120, respectively. The
goodwill is P80.

Use the following information for the next two items:

Entity A acquires 90% interest in the voting shares of Entity B for 100. Entity B's
identifiable assets and liabilities have fair value of $200 and 120, respectively.

2. If the NCI is measured at its proportionate share in the acquiree's net identifiable
assets, the goodwill would be 28.
3. If the NCI is measured at a fair value 10, the goodwill would be $18.

Use the following information for the next seven items:

Entity A acquires all the identifiable assets and assumes all the liabilities of Entity B for
P100. Entity B's identifiable assets and liabilities have fair values of $200 and 120,
respectively.
Business Combinations (Part 1) 51

4. Entity A incurred legal fees of $20 in negotiating the business combination. The
goodwill is $40.
5. Entity A estimates liquidation costs of 10 in exiting the business activities of Entity
B. The goodwill is $20.
6. Entity A is renting out a license to Entity B under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is 5.
The goodwill is $25.
7. Entity B has an unrecorded patent with fair value of $30. The gain on bargain
purchase is $10.
8. Entity B has an unrecognized contingent liability with fair value of P30. The
contingent liability is a present obligation but has an improbable outflow of economic
resources. The goodwill is $50.
9. Entity B's assets and liabilities have carrying amounts of $150 and P120, respectively.
Fair value adjustments to the acquired assets and liabilities have deferred tax
consequences but do not affect their tax bases. The income tax rate is 30%. The
goodwill is P53.
10. Entity A agreed to share its trade secret processes with Entity B after the business
combination. The trade secret processes have a fair value of $25. The goodwill is $20.

PROBLEM 3: FOR CLASSROOM DISCUSSION

Business combination
1. In which of the following instances is a business combination least likely to occur?
a. Entity A acquires all the assets and assumes all the liabilities of Entity B in
exchange for Entity A's shares of stocks.
b. Entity A purchases 80% of Entity B's outstanding voting shares.
c. Entity A acquires 30% interest in Entity B's voting shares. All the other shares of
Entity B are held by various shareholders in very small denominations.
52 Chapter 1

Accordingly, Entity A has the power to appoint the majority of the board of
directors of Entity B.
d. Entity A acquires a group of assets from Entity B that does not constitute a
business.

Acquisition method
2. PFRS 3 requires the use of the acquisition method in accounting for all business
combinations. Which of the following is not an application of the acquisition method?
a. Identifying the acquirer which is the entity that obtains control over another business
in a business combination.
b. Determining the acquisition date which is the date the acquirer obtains control over
the acquiree.
c. Measuring the consideration transferred at fair value.
d. Measuring the non-controlling interest at the NCI's proportionate share in the
acquiree's net identifiable assets or fair value, whichever is higher.

Goodwill
3. Entity A acquired all the assets and assumed all the liabilities of Entity B for
$1,800,000. Information on Entity B's assets and liabilities as at the acquisition date is
shown below:

Assets Carrying Amounts Fair values

Receivables - net 20,000 10,000
Inventory 600,000 120,000
Building - net 1,200,000
Goodwill 100,000 350,000
Total assets 2,100,000 1,100,000
Liabilities
Business Combinations (Part 1) 53

Payables 900,000 700,000

Requirement: Compute for the goodwill (gain on bargain purchase).

Non-controlling interest
Use the following information for the next two items:
Entity A acquired 75% of the outstanding voting shares of Entity B for $2,000,000. On
acquisition date, Entity B's identifiable assets and liabilities have fair values of
$4,000,000 and $1,600,000, respectively.

4. How much is the goodwill if Entity A opts to measure the non-controlling interest at
the NCI's proportionate share in Entity B's net identifiable assets?
5. Entity A opts to measure the non-controlling interest at fair value. An independent
valuer assessed the NCI's fair value to be $540,000. How much is the goodwill?

Acquisition-related costs and Restructuring provisions

6. Entity A acquired all the assets and liabilities of Entity B by issuing 18,000 shares
with par value of 10 per share and fair value of 100 per share. On acquisition date,
Entity B's identifiable assets and liabilities have fair values of $3,800,000 and
1,900,000, respectively.

Entity A incurred stock issuance costs of 36,000 and finder's fees related to the business
combination of P60,000. Moreover,

Entity A expects to incur liquidation costs of $280,000 in terminating Entity B's

activities.

Requirement: Compute for the goodwill (gain on bargain purchase)

Operating leases and Intangible assets

54 Chapter 1

7. Entity A acquired all the assets and assumed all the liabilities of Entity B for
P2,800,000. On acquisition date, Entity B's identifiable assets and liabilities have fair
values of $4,000,000 and 1,600,000, respectively.

Additional information:
Entity B has an unrecorded patent with fair value of 100,000. Entity B has research and
development (R&D) projects with fair value of 160,000. Entity B charged the R&D costs
as expenses when they were incurred.
Entity A is renting out a property to Entity B under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
$40,000.

Requirement: Compute for the goodwill.

Contingent liabilities
8. Entity A acquired 75% of the outstanding voting shares of Entity B for 1,800,000. On
acquisition date, Entity B's identifiable assets and liabilities have fair values of
$4,000,000 and 1,600,000, respectively.

Additional information:
 Entity A replaces Entity B as a guarantor on a loan of a third party. As at the
acquisition date, the third party has defaulted on the loan. However, because
negotiations for debt restructuring are ongoing with the lender and Entity B strongly
believes that the lender will agree on the proposed
terms, no provision was recognized. The fair value of the guarantee is $200,000.
 Entity A chose to measure the non-controlling interest at the NCI's proportionate
share in the acquiree's net identifiable assets.
Requirement: Compute for the goodwill.

Deferred taxes
Business Combinations (Part 1) 55

9. Entity A acquired all the assets and assumed all the liabilities of Entity B for
$4,000,000. Information on Entity B's identifiable assets and liabilities as at the
acquisition date is
shown below:
Carrying Amounts Fair values
Liabilities 5,800,000 6,100,000
230,000,00
Payables 2,100,000
0

All fair value adjustments to the identifiable assets acquired and liabilities assumed have
deferred tax consequences, but do not affect their tax bases. The income tax rate is 30%.

Requirement: Compute for the goodwill.

Consideration transferred
10. On October 26, 20x1, Entity A acquired 100% interest in Entity B for $2,800,000.
On this date, Entity B's identifiable assets and liabilities have fair values of
4,000,000 and 1,600,000, respectively. Included in Entity B's liabilities are cash
dividends of $280,000 declared on October 1, 20x1, to shareholders of record on
November 1, 20x1, and payable on December 1, 20x1.

Requirement: Compute for the goodwill.

PROBLEM 4: EXERCISES

1. A Co. issued bonds with face amount of 1M and fair value of 1.2M in exchange for
all the assets and liabilities of B Co. A Co. incurred bond issue costs of 30,000 and
56 Chapter 1

legal fees of P10,000 in negotiating the business combination. The carrying amounts
and fair values of B's assets and liabilities at the acquisition date are shown below:

Assets Carrying Amounts Fair values

Receivables - net 300,000 200,000
Inventory 600,000 450,000
Building - net 800,000 1,000,000
Goodwill 80,000 50,000
Total assets 1,780,000 1,700,000
Liabilities
Payables 320,000 390,000

Requirement: Compute for the goodwill (gain on bargain purchase).

Use the following information for the next two requirements:

A Co. acquired 80% interest in B Co. for $1,200,000. On acquisition date, B's identifiable
assets and liabilities have fair values of $1,700,000 and $400,000, respectively.

2. How much is the goodwill if A Co. opts to measure the non- controlling interest at
the NCI's proportionate share in B Co.'s net identifiable assets?

3. How much is the goodwill if A Co. opts to measure the non- controlling interest at
fair value? (An independent appraiser valued the NCI at P300,000.)

4. A Co. acquired all the assets and liabilities of B Co. by issuing 10,000 shares with
par value of $20 per share and fair value of $100 per share. A Co. incurred
$40,000 in issuing the shares
and P60,000 in professional fees and administrative costs in effecting the business
combination. On acquisition date, B's identifiable assets and liabilities have fair
values of 1,800,000 and $900,000, respectively. After the business combination,
Business Combinations (Part 1) 57

A Co. will close some of the operating segments of B Co. The closure costs are
estimated at $400,000.

Requirement: Compute for the goodwill (gain on bargain purchase).

5. A Co. acquired 60% interest in the net assets of B Co. for $1,500,000. On acquisition
date, B Co.'s identifiable assets and liabilities have fair values of $5,000,000 and
$2,800,000, respectively.

Additional information:
 B Co. has an unrecorded customer list with fair value of $80,000. The customer list is
separable.
 A Co. is renting out a license to B Co. under an operating lease. The terms of the
lease compared with market terms are unfavorable. The fair value of the differential is
$30,000.
 A Co. opted to measure the NCI at fair value. An independent valuer assessed the fair
value of the NCI to be P800,000.

Requirement: Compute for the goodwill.

6. A Co. acquired all the assets and liabilities of B Co. for $1,600,000. Information
on B's identifiable assets and liabilitie as at the acquisition date is as follows:
Carrying Amounts Fair values
Liabilities 5,800,000 3,500,000
Payables 2,000,000 1,900,000

 As at the acquisition date, B Co. has breached a contract with a customer. The
customer is seeking damages amounting to $250,000. However, B Co. is currently
disputing the

customer's claim and B Co.'s legal counsel believes they will win the case. Accordingly,
B Co. did not recognize provision. The fair value of settling the claim is $100,000.
58 Chapter 1

 Fair value adjustments to the assets acquired and liabilities assumed have deferred tax
consequences, but do not affect the tax bases of the assets and liabilities. The tax rate
is 30%.

Requirement: Compute for the goodwill.

PROBLEM 5: MULTIPLE CHOICE-THEORY

1. This distinguishes a business combination from other types of investment transactions.
a. acquisition of assets c. obtaining of control
b. acquisition of stocks d. all of these
2. The entity that obtains control over another business in a business combination is
called the
a. controller. c. acquirer.
b. acquiree. d. controllee.
3. PFRS 3 requires all business combinations to be accounted for using the
a. purchase method. c. goodwill method.
b. acquisition method. a. d. control method.

4. According to PFRS 3, the acquisition date is normally the

a. control date.
b. closing date.
c. purchase date.
d. valentine's date.
5. Entity A and Entity B combined their businesses. The acquirer in the business
combination is not clearly identifiable. Which of the following in not an indicator that
Entity A is the acquirer?
a. Entity A is the initiator of the business combination.

b. Entity A's former owners receive the largest portion of the voting rights in the
combined entity.
Business Combinations (Part 1) 59

c. Entity A's former management team dominates the management of the combined
entity.
d. Entity C, a new entity, is formed and Entity C transfers cash to Entity A and
Entity B.
6. Which of the following statements is incorrect regarding the consideration transferred
in a business combination?
a. It includes only those that are transferred to the former owners of the acquiree.
b. It includes those that are retained in the combined entity.
c. It can be in the form of cash, non-cash assets, the acquirer's own equity
instruments, or a mixture of these.
d. It is measured at fair value.
7. Direct costs incurred in a business combination are
a. capitalized
b. expensed
c. capitalized, except for costs of issuing equity and debt instruments
d. expensed, except for costs of issuing equity and debt instruments
8. According to PFRS 3, the acquirer measures non-controlling interest in the acquiree
a. at fair value.
b. at the non-controlling interest's proportionate share in the acquiree's net
identifiable assets.
c. either a or b, whichever is higher
d. either a or b, as an accounting policy choice
9. The identifiable assets acquired and liabilities assumed in a business combination are
generally measured at
a. acquisition-date fair values.
b. previous carrying amounts.

c. fair value less costs to sell.

d. cost.
60 Chapter 1

10. Which of the following assets of an acquiree may not be included when computing
for the goodwill arising from a business combination?
a. capitalized kitchen utensils and equipment
b. intangible assets not previously recorde
c. research and development costs charged as expenses
d. goodwill

11. A noncurrent asset (or disposal group) acquired in a business combination that is
classified as held for sale is measured at
a. acquisition-date fair values.
b. previous carrying amounts
c. fair value less costs to sell.
d. cost.

12. Restructuring provisions

a. are generally not recognized as part of business combination unless the acquiree
has, at the acquisition date, an existing liability for restructuring that has been
recognized in accordance with PAS 37.
b. that do not meet the definition of a liability at the acquisition date are recognized
as post-combination expenses of the combined entity when the costs are incurred.
c. generally increases goodwill
d. a and b

13. A contingent liability assumed in a business combination

a. is not accounted for by the acquirer if the contingent liability has an improbable
outflow of economic resources.
b. is recognized even if it has an improbable outflow of economic resources for as
long as there is present
obligation and the fair value of the obligation can be measured reliably.
Business Combinations (Part 1) 61

c. is recognized only if there is present obligation, probable outflow of economic

resources, and can be measured reliably.
d. a and c

14. Entity A obtained control of Entity B in a business combination. When computing for
goodwill, Entity A would least likely account for which of the following?
a. Entity B's research and development projects that were already charged as
expenses, but have a fair value as at the acquisition date.
b. Entity B's unrecorded identifiable intangible assets.
c. Operating lease between Entity A and Entity B, wherein Entity B is the lessee.
d. Entity A's expected costs of exiting or terminating some or all of Entity B's
activities after the combination.

15. According to PFRS 3, a 'gain on a bargain purchase' is

a. recognized in profit or loss in the year of acquisition.
b. amortized in profit or loss over the lower of its legal life and estimated useful life.
c. recognized in profit or loss in the year of acquisition but only after reassessment
of the assets acquired and liabilities assumed in the business combination.
d. any of these

PROBLEM 6: MULTIPLE CHOICE-COMPUTATIONAL

1. On January 1, 20x1, Saturday Co. acquires 80% of the outstanding voting shares of
Sunny Co. Sunny's identifiable assets and liabilities have fair values of P3,400,000
and P1,700,000, respectively. Relevant information follows:
 Saturday Co. agrees to pay Sunny's former owners $2,000,000 cash, half of which
is to be paid on January 1,
62 Chapter 1

20x1, while the other half will be paid in five equal annual installments starting
December 31, 20x1. The current market rate of interest on January 1, 20x1 is
12%.
 Saturday also agrees to provide a technical know-how to be used in Sunny's
operations after the business combination. The technical know-how has a fair
value of $200,000.
 Saturday opts to measure the non-controlling interest at the NCI's proportionate
share in Sunny's net identifiable assets.

How much is the goodwill (gain on bargain purchase)?

a. (220,045) c. 360,955
b. 280,955 d. 340,955

2. Silent Co. acquires 80% controlling interest in Peaceful Co. for 1,200,000. Peaceful
Co.'s identifiable assets and liabilities have fair values of P3,300,000 and P1,700,000,
respectively. Included in Peaceful's assets is a web press machine with fair value of
$900,000 which Silent Co. intends to sell immediately. The machine qualifies for
classification as 'held for sale'. The costs to sell are $150,000. Silent Co. opts to
measure the non- controlling interest at fair value. How much is the goodwill?
(Assume the fair value of the NCI is equal to the grossed-up value of the
consideration transferred multiplied by the NCI percentage.)
a. 60,000 c. 50,000
b. 40,000 d. 20,000

3. Carpenter Co. acquires 100% controlling interest in Wood Co. by issuing 2,000 shares
with par value per share of P100 and fair value per share of 500. Carpenter Co. incurs
stock issuance costs of 10 per share. On acquisition date, Wood Co.'s identifiable
assets and liabilities have fair values of $2,800,000 and 1,600,000, respectively.
Carpenter Co incurred $40,000 in hiring an independent appraiser to value
Business Combinations (Part 1) 63

Wood's assets and liabilities. After the combination, Carpenter intends to eliminate
some of Wood's activities. The estimated costs are $20,000. In addition, Carpenter Co.
expects to incur losses of $80,000 during the first year after the business combination.
How much is the goodwill (gain on bargain purchase)?
a. (260,000) c. (200,00)
b. 240,000 d. 280,000

4. Mason Co. acquired all the assets and liabilities of Hammer Co. for $2,600,000. On
acquisition date, Hammer's identifiable assets and liabilities have fair values of 5,900,000
and $3,500,000, respectively. Relevant information follows:
 Mason is renting out a building to Hammer Co. on an operating lease. The terms
of the lease compared with market terms are favorable. The fair value of the
differential is $90,000.
 Hammer is a defendant on a pending lawsuit. No provision was recognized
because Hammer's legal counsel believes they will successfully defend the case.
The fair value of settling the lawsuit is $10,000.

How much is the goodwill (gain on bargain purchase)?

3. 140,000
1. 120,000 4. 180,000
2. 200,000

5. On January 1, 20x1, Creek Co. acquired all the assets and assumed all the liabilities
of Bamboo Co. for $2,400,000. Relevant information follows:
Carrying
Assets
Amounts Fair values
Receivables - net 10,000 10,000
Inventory 400,000 280,000
Land 480,000 350,000
Goodwill 2,000,000 2,200,000
64 Chapter 1

Total assets 110,000 20,000

Liabilities
Payables 400,000 480,000

 Bamboo Co. has research and development projects with fair value of $60,000. Creek
Co. does not intend to use those R&Ds. However, there have been exchange
transactions involving the information generated from Bamboo's R&D, but those
transactions are infrequent.
 All fair value adjustments result to temporary differences but do not affect the tax
bases of the assets and liabilities. The tax rate is 30%.
 Creek incurred P100,000 on general administrative costs of maintaining an internal
acquisitions department.

How much is the goodwill (gain on bargain purchase)?

a. 12,000 c. 20,000
b. (41,000) d. 19,000

PROBLEM 7: MULTIPLE CHOICE - PFRS for SMEs

1. Which of the following statements is correct?
a. The PFRS for SMEs does not address the accounting for business combinations.
b. An SME cannot recognize any goodwill.
c. The PFRS for SMEs requires the use of the purchase method in accounting for
business combinations.
d. Control is not an essential criterion in identifying a business combination between
SMEs.

Use the following information for the next two questions:

On January 1, 20x1, Sit Co. acquired 75% controlling interest in Stand Co. for
P1,000,000. On this date, the fair value of Stand's net identifiable assets is P800,000. Sit
Co. incurred transaction costs of P100,000 on the acquisition.
Business Combinations (Part 1) 65

2. How much is the goodwill if Sit Co. uses the full PFRSs and Sit opts to measure NCI
using proportionate share method?
a. 380,000 c. 400,000
b. 460,000 d. 500,000

3. How much is the goodwill if Sit Co. uses the PFRS for SMEs?
a. 380,000 c. 460,000
b. 400,000 d. 500,000

4. The PFRS for SMEs differs from PFRS 3 in all of the following respects, except
a. the measurement of the consideration transferred
b. the treatment of NCI in the computation of goodwill
c. the treatment of acquisition-related costs
d. the recognition criteria for contingent liabilities
e.
5. Which of the following statements is incorrect regarding the provisions of the PFRS
for SMEs?
a. NCI is not included in computing for goodwill.
b. NCI is measured in the consolidated financial statements at the NCI's
proportionate share in the acquiree's net identifiable assets; fair value
measurement is not an option.
c. The PFRS for SMEs specifically requires the acquirer to recognize an intangible
asset or a liability from an operating lease wherein the acquiree is the lessee.
d. Direct costs of a business combination, other than issue. costs of equity and debt
securities, are capitalized under the PFRS for SMEs as part of goodwill, whereas
these are expensed under PFRS 3.
66 Chapter 1

Chapter 2

Business Combinations (Part 2)

Related standard: PFRS 3 Business Combinations

Learning Objectives

1. Account for business combinations (a) accomplished through share-for-share

exchanges, (b) achieved in stages, and (c) achieved without transfer of consideration.
2. Explain the "measurement period" in relation to business combinations.
3. Distinguish what is part of a business combination and what is part of a "separate
transaction."
4. Account for settlement of pre-existing relationship between an acquirer and an
acquiree.

Share-for-share exchanges

A business combination may be accomplished through exchange of equity interests

between the acquirer and the acquiree (or its former owners). The general principle is that
the consideration transferred (in this case, the shares issued by the acquirer) is measured
at fair value.
However, there may be cases where the fair value of the acquiree's equity interests
may be more reliably measurable than the acquirer's. In such cases, the acquirer computes
for goodwill using the fair value of the acquiree's equity interests instead of its own.

Example:
XYZ, Inc., an unlisted company, acquires ABC Co., a publicly listed entity, through an
exchange of equity instruments.
 The fair value of ABC's (acquiree) shares may be more reliably measurable than
XYZ's (acquirer) because ABC's shares are quoted, while XYZ's are not. (See
Business Combinations (Part 1) 67

additional illustrations in discussion of reverse acquisition and combination of mutual

entities in Chapter 3).
Illustration 1:
ABC Co. and XYZ, Inc. combined their businesses through exchange of equity
instruments, which resulted to ABC obtaining 100% interest in XYZ. Both entities are
publicly listed. At the acquisition date, ABC's shares are quoted at P100 per share. ABC
Co. recognized goodwill of P300,000 on the business combination.
Additional information follows:

ABC Co. Combined entity

(before acquisition) (after acquisition)
Share capital 600,000 700,000
Share premium 300,000 1,200,000
Totals 900,000 1,900,000
Requirements: Compute for the following:
a. Number of shares issued by ABC Co.
b. Par value per share of the shares issued.
c. Acquisition-date fair value of the net identifiable assets of XYZ.
Solution:
Requirement (a): Number of shares issued
The consideration transferred is in the form of shares. Accordingly, this is reflected on
the increase in share capital and share premium:
ABC Co. Combined entity Increase
Share capital 600,000 700,000 100,000
Share premium 300,000 1,200,000 900,000
Totals 900,000 1,900,000 1,000,000

The fair value of the shares issued as consideration for the issued business
combination is P1,000,000.
Fair value of shares ₱1,000,000
Divide by: Fair value per ABC's share ₱100
68 Chapter 1

Number of shares issued 10,000

Requirement (b): Par value per share

Increase in share capital account (see table above) 100,000
Divide by: Number of shares issued 10,000
Par value per share P10

Requirement (c): Fair value of the net assets acquired

Consideration transferred (see Requirement a) 1,000,000

Non-controlling interest in the acquiree -

Previously held equity interest in the acquiree -

Total 1,000,000
Fair value of net identifiable assets acquired (squeeze) 700,000

Goodwill (given information) 300,000

Illustration 2:
ABC Co. issued shares in exchange for 100% interest in XYZ, Inc. Relevant information
follows:
ABC Co. XYZ. Inc.
 
(Carrying amounts)
Combined entity
(Fair values)
Identifiable assets 2,400,000 1,600,000 4,000,000
Goodwill - - ?
Total assets 2,400,000 1,600,000 ?
1,600,
Liabilities 700,000 900,000
000
400
Share capital 600,000 300,000
,000
1,200,
Share premium 300,000 250,000
000
Retained earnings 800,000 150,000 ?
Total liabilities and equity 2,400,000 1,600,000 ?

Additional information:
Business Combinations (Part 1) 69

 ABC's share capital consists of 60,000 ordinary shares with par value of P10 per
share.
 XYZ's share capital consists of 3,000 ordinary shares with par value of P100 per
share.
Requirements: Compute for the following:
a. Number of shares issued by ABC Co.
b. Fair value per share of the shares issued
c. Goodwill recognized on acquisition date
d. Retained earnings of the combined entity immediately after the business combination
Solutions:

Requirement (a): Number of shares issued

ABC Co. Combined entity Increase

10
Share capital 700,000
600,000 0,000

Increase in ABC's share

capital ₱100,000
Divide by: ABC's par value
per share 10
Number of shares issued ₱10,000

Requirement (b): Fair value per share

ABC Co. Combined entity Increase

Share capital 600,000 700,000 100,000
Share premium 300,000 1,200,000 900,00
Totals 900,000 1,900,000 1,000,000

Fair value of consideration transferred ₱1,000,000

Divide by: Number of shares issued ₱100
Acquisition-date fair value per share 10,000
70 Chapter 1

XYZ's equity accounts are ignored in the computations above because an acquiree's
(subsidiary) equity accounts are eliminated in the consolidated financial statements and
replaced by 'non-controlling interest'. Consolidation is discussed in the succeeding
chapters.

Requirement (c): Goodwill

Consideration transferred (see Requirement a) 1,000,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,000,000
Fair value of net identifiable assets acquired (squeeze) 700,000
Goodwill (given information) 300,000

Requirement (d): Retained earnings of the combined entity

Because XYZ's retained earnings are eliminated in the consolidated financial statements,
the combined entity's retained earnings are equal to ABC Co.'s retained earnings of
P800,000.
The statement of financial position of the combined entity immediately after the
business combination is shown below:
Combined entity
Identifiable assets 4,000,000
Goodwill 300,000
Total assets 4,300,000

Liabilities 1,600,000
Share capital 700,000
Share premium 1,200,000
Retained earnings
800,000
Total liabilities and equity 4,300,000

Business combination achieved in stages

Business Combinations (Part 1) 71

A business combination is achieved in stages' when the acquirer obtains control of an

acquiree in more than one transaction. For example, Entity A acquires 20% interest in
Entity B in Year 1. This transaction is not a business combination because Entity A has
not yet obtained control of Entity B. In Year 2, Entity A acquires additional 40% interest
in Entity B, thereby bringing its interest to a total of 60%. The second acquisition
qualifies as a business combination because Entity A has obtained control of Entity B.
Business combination achieved in stages is also called "step acquisition."
In accounting for a business combination achieved in stages, the acquirer:
1. Remeasures the previously held equity interest in the acquiree at acquisition-date fair
value; and
2. Recognizes the gain or loss on the remeasurement in:
a. Profit or loss - if the previously held equity interest was classified as FVPL,
Investment in Associate, or Investment in Joint Venture; or
b. Other comprehensive income if the previously held equity interest was classified
as FVOCI.
Illustration: Business combination achieved in stages
On January 1, 20x1, ABC Co. acquired 15% ownership interest in XYZ, Inc. for
P100,000. ABC Co. classified the investment as 'held for trading securities' (i.e., FVPL)
in accordance with PFRS 9.

On January 1, 20x4, ABC Co. acquired additional 60% ownership interest in XYZ, Inc.
for P800,000. Relevant information follows:
a. The previously held 15% interest has a carrying amount of P170,000 on December
31, 20x3 and fair value of P180,000 on January 1, 20x4.
b. XYZ's net identifiable assets have a fair value of P1,000,000.
c. ABC elected to measure the NCI at 'proportionate share".

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 800,000
Non-controlling interest in the acquire (1M x 25% ) 250,000
Previously held equity interest in the acquiree 180,000
72 Chapter 1

Total 1,230,000
(1,000,000
Fair value of net identifiable assets acquired
)
(Goodwill 230,000
*100 %-(15%+60%)-25%

Journal entries:
Jan. 1
20x4 Held for trading securities 30,000
Unrealized gain - P/L (180K-150K)
30,000
to remeasure the previously held equity interest to
acquisition-date fair value
Jan. 1
Investment in subsidiary
20x4 80,000
Cash
80,000
to recognize the newly acquired shares
Jan. 1
Investment in subsidiary
20x5 180,000
Held for trading securities
180,000
to reclassify the previously held equity interest

 Notes:
 The business combination is effected through stock acquisition. Accordingly, the
acquisition is recorded in the parent's separate accounting records through the
investment in subsidiary account. The carrying amount of this account immediately
after the combination is 980,000 (800K consideration transferred + 180K acquisition-
date fair value of the previously held equity interest).
 When consolidated financial statements are prepared, the investment in subsidiary is
eliminated and the goodwill and NCI are recognized.
 The same accounting procedures apply if the previously held equity interest was
classified as FVOCI, investment in associate, or investment in joint venture.
However, if the previous classification was FVOCI, the remeasurement gain or loss is
recognized in other comprehensive income. If the previous classification was
Business Combinations (Part 1) 73

investment in associate or joint venture, the remeasurement gain or loss is also

recognized in profit or loss.

Business combination without transfer of consideration

The acquisition method also applies to business combinations in which the acquirer
obtains control without transferring any consideration. The reason why the "purchase
method" previously used for business combinations has been replaced with the

"acquisition method" is to emphasize that a business combination may occur even when a
purchase transaction is not involved.
Examples of circumstances where the acquirer obtains control without
transferring consideration:
a. The acquiree repurchases a sufficient number of its own shares from other investors
so that the acquirer will be able to obtain control.
For example, ABC Co. holds 40,000 out of the 100,000 outstanding ordinary
shares of XYZ, Inc. Subsequently, XYZ repurchases 25,000 shares from other
investors. After the treasury share transaction, ABC's ownership interest is increased
to 53.33% (40,000+ 75,000).

b. Minority veto rights that previously kept the acquirer from controlling the acquiree
have lapsed.

c. The acquirer and acquiree agree to combine their businesses by contract alone. The
acquirer neither transfers consideration nor holds equity interests in the acquiree.

 In a business combination achieved without transfer o consideration, the acquisition-

date fair value of the acquirer' interest in the acquiree is substituted for the
consideration transferred in computing for goodwill.
 In a business combination achieved by contract alone, the interests held by parties
other than the acquirer are attributed to NCI, even if the result is that NCI represents
100% interest in the acquiree.
74 Chapter 1

Illustration 1: Without transfer of consideration

ABC Co. owns 36,000 out of the 90,000 outstanding shares of XYZ, Inc. ABC accounts
for the investment under the equity method. XYZ subsequently reacquires 30,000 shares
from other investors. Information on the acquisition date is as follows:
a. The previously held 40% interest has a fair value of P180,000.
b. XYZ's net identifiable assets have a fair value of P1,000,000.
c. ABC elects to measure NCI at 'proportionate share'.

Requirement: Compute for the goodwill.

Solution:

Consideration transferred (1M x 60% ) 600,000

Non-controlling interest in the acquire (1M x 40% ) 400,000
Previously held equity interest in the acquiree -
Total 1,000,000
(1,000,000
Fair value of net identifiable assets acquired
)
Goodwill -

Notes:
 XYZ's treasury share transaction increased ABC's interest to 60% [i.e., 36,000+
(90,000-30,000)]. Consequently, the NCI is 40%.
 The acquisition-date fair value of ABC's interest in XYZ is substituted for the
consideration transferred (instead of attributing an amount to the 'previously held
equity interest') because there is no consideration transferred and there is no change in
the number of shares held by ABC.

Illustration 2: By contract alone

ABC Co. and XYZ, Inc. enter into a contract whereby ABC obtains control of XYZ. No
consideration is transferred between the parties. The fair value of XYZ's net identifiable
assets at acquisition date is P1,000,000. ABC chose to measure NCI at 'proportionate
share'. Requirement: Compute for the goodwill.
Business Combinations (Part 1) 75

Solution:
Consideration transferred -
Non-controlling interest in the acquire (1M x 100% ) 1,000,000
Previously held equity interest in the acquiree -
Total 1,000,000
(1,000,000
Fair value of net identifiable assets acquired
)
(Goodwill -

Measurement period
If the initial accounting for a business combination is incomplete by the end of the
reporting period in which the combination occurred, the acquirer can use provisional
amounts to measure any of the following for which the accounting is incomplete:
a. Consideration transferred
b. Non-controlling interest in the acquiree
c. Previously held equity interest in the acquiree
d. Identifiable assets acquired and liabilities assumed

Within 12 months from the acquisition date (i.e., the 'measurement period'), the
acquirer retrospectively adjusts the provisional amounts for any new information
obtained that provides evidence of facts and circumstances that existed as of the
acquisition date, which if known would have affected the measurement of the amounts
recognized on that date. Any adjustment to a provisional amount is recognized as an
adjustment to goodwill or gain on a bargain purchase.

Adjustments for new information obtained beyond the 12- month measurement period
are accounted for as corrections of error in accordance with PAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors, rather than PFRS 3.

Illustration 1: Provisional amounts - identifiable assets acquired

Fact pattern
76 Chapter 1

On October 1, 20x1, ABC Co. acquired all the identifiable assets and assumed all the
liabilities of XYZ, Inc. for P1,000,000. On this date, XYZ's assets and liabilities have fair
values of P1,600,000 and P900,000, respectively.

Case #1: Identifiable asset recognized at provisional amount

The assets acquired include a building which was assigned a provisional amount of
P700,000 because the appraisal is not yet complete by the time ABC authorized for issue
its December 31, 20x1 financial statements. The building was tentatively assigned a

10-year useful life and was depreciated for using the straight-line method.

On July 1, 20x2, ABC received the valuation report for the building. The building's fair
value on October 1, 20x1 is P500,000 and its remaining useful life from that date is 5
years.

Requirements:
a. What is the measurement period?
b. How should ABC account for the new information obtained on July 1, 20x2?
c. How much is the adjusted goodwill?
d. What are the adjusting entries?

Solutions:
Requirement (a): Measurement period
The measurement period is from October 1, 20x1 to September 30, 20x2, or if earlier, (i)
the date ABC Co. obtains the information it was seeking about facts and circumstances
that existed as of the acquisition date or (ii) the date ABC Co. learns that more
information is not obtainable.

Requirement (b): Accounting

Business Combinations (Part 1) 77

The provisional amount assigned to the building is retrospectively adjusted with a

corresponding adjustment to goodwill. The 20x1 financial statements are restated,
including a retrospective adjustment to depreciation expense.
Requirement (c): Adjusted goodwill
Provisional Adjusted
Consideration transferred 1,000,000 1,000,000
NCI
Previously held equity interest
Total 1,000,000 1,000,000
Fair value of net identifiable
(700,000)(a) -500,000
assets
Goodwill 300,000 500,000

(a)
(1.6M-.9M)-700,000
(b)
(1.6M-700,000 provisional amount +500,000 fair value - .9M) = 500,000

Requirement (d): Adjusting entries

July. 1
Goodwill (500K-300K)
20x2 200,000
Building
200,000
to record the adjustment to the provisional
amount assigned to the building
July. 1 Retained earnings 7,500
20x2 Accumulated depreciation (c)
7,5000

to record the adjustment to 20x1 depreciation

(c)
Depreciation recognized (P700,000+ 10 years’ x 3/12) 17,500
Should-be' depreciation (P500,000+ 5 years’ x 3/12) 25,000
Additional depreciation expense for 20x1 7,500

If monthly depreciation expenses were recognized during January to June 30,

20x2, those shall also be adjusted accordingly.
Case #2: Unrecorded identifiable asset acquired
78 Chapter 1

On July 1, 20x2, ABC obtained new information that XYZ has an unrecorded patent
which was not known on October 1, 20x1. The patent has a fair value of P100,000 and
remaining useful life of 4 years as of October 1, 20x1.

Requirement: Compute for the adjusted goodwill and provide the adjusting entries.

Unadjusted Adjusted

Consideration transferred 1,000,000 1,000,000

NC - -
Previously held equity interest - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets 700,000 800,000
Goodwill 300,000 200,000
(a)
(1.6M-9M)-700,000
(b)
(1.6M.100,000 patent- .9M) = 800,000

Adjusting entries:
July 1, Patent 100,000
20x2
Goodwill
100,000
July 1,
20x2 Retained earnings (100K+ 4 x 3/12)
6,250
Accumulated amortization 6,250

Case #3: Information obtained beyond the measurement period

On November 1, 20x2, ABC's auditors discovered that a patent with fair value of
P100,000 was erroneously omitted from the valuation listing on October 1, 20x1. The
patent has a fair value of P100,000 and remaining useful life of 4 years as of October 1,
20x1.

Requirement: How should ABC account for the new information obtained on November
1, 20x2?

Answer: Because the new information is obtained after the measurement period, it will
be accounted for under PAS 8 as correction of prior period error. A correction of prior
Business Combinations (Part 1) 79

period error is accounted for by retrospective restatement. Therefore, the adjusted

amounts and correcting entries would be similar to those in 'Case #2' above. However,
the note disclosures will vary because PAS 8 will be applied instead of PFRS 3.

Correcting entries to restate the 20x1 financial statement

Nov 1, Patent 100,000
20x2
Goodwill
100,000
Nov 1,
20x2 Retained earnings (100K+ 4 x 3/12)
6,250
Accumulated amortization 6,250

The omitted patent is recognized with a corresponding charge to goodwill because

if ABC had not committed the error, the correct amount of goodwill that should have
been recognized on acquisition date is P200,000.
Illustration 2: Provisional amounts - consideration transferred
On October 1, 20x1, ABC Co., an unlisted entity, issued 10,000, P5 par value, shares in
exchange for all the identifiable assets and liabilities of XYZ, Inc.

Information on acquisition date:

 The shares issued were assigned a provisional amount of P100 per share.
 The fair values of some of the assets acquired are not readily determinable.
Accordingly, a provisional amount of P700,000 was assigned to XYZ's net
identifiable assets.

Information after the acquisition date:

 On April 1, 20x2, new information was obtained indicating that, on October 1, 20x1,
 the fair value of the shares issued was P110 per share; and
 the fair value of XYZ's net identifiable assets was P900,000.
 On July 1, 20x2, two competitors of ABC have also merged. This led ABC to believe
that the merger with XYZ is not as profitable as expected. ABC estimates that the
valuations of the consideration transferred and XYZ's net identifiable assets should
have been P900,000 and P400,000, respectively.
80 Chapter 1

Requirement: Compute for the adjusted goodwill.

Solution:
Provisional Adjusted
Consideration transferred 1,000,000 1,000,000(a)
NC - -
Previously held equity interest - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets (700,000) (9,000,000)(b)
Goodwill 300,000 200,000

(a)
(10,000 sh. x 110 fair value based on new information obtained on Apr. 1, 20x1)
(b)
(fair value based on new information obtained on Apr. 1, 20x1)

The new information obtained on July 1, 20x2 is not a measurement period

adjustment because it does not relate to facts and circumstances that have existed as at the
acquisition date. However, this may indicate an impairment of goodwill.

Determining what is part of the business combination transaction

Before the business combination, the acquirer and acquiree may have pre-existing
relationship or they may enter into transactions during the negotiation period that are
separate from the business combination.
In applying the acquisition method, the acquirer identifies and excludes amounts
that are not part of the consideration transferred on the business combination and
accounts for them using other relevant PFRSs.
The acquirer considers the following when determining whether a transaction is
part of a business combination or a separate transaction:
a. A transaction that is arranged primarily for the benefit of the acquirer or the combined
entity rather than the acquiree or its former owners is likely to be a separate
transaction. The transaction price shall be excluded from the consideration transferred
when computing for goodwill.
Business Combinations (Part 1) 81

Contrarily, a transaction that is arranged primarily for the benefit of the acquiree
or its former owners is more likely to be a part of the business combination
transaction. The transaction price is appropriately included in the consideration
transferred.

b. A transaction initiated by the acquirer is likely for the benefit of the acquirer or the
combined entity and, therefore, a separate transaction.
Contrarily, a transaction initiated by the acquiree or its former owners is more
likely to be a part of the business combination transaction.

c. A transaction between the acquirer and acquiree during the negotiations of a business
combination is more likely to be part of the business combination.
However, the following are separate transactions that are excluded when applying
the acquisition method:
i. Settlement of pre-existing relationship between the acquirer and acquiree;
ii. Remuneration to employees or former owners of the acquiree for future services;
and
iii. Reimbursement to the acquiree or its former owners for paying the acquirer's
acquisition-related costs.

Illustration:
ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ's assets
and liabilities have fair values of P1,600,000 and P900,000, respectively.

Additional information:
82 Chapter 1

a. XYZ incurred P10,000 legal fees in processing the regulatory requirements for the
combination. ABC agreed to reimburse the said amount.
b. XYZ will terminate its activities after the business combination. ABC agreed to
reimburse XYZ's estimated liquidation costs of P200,000.
c. ABC will retain XYZ's former key employees. ABC agreed to pay the key employees
P100,000 as signing bonuses.
d. ABC agreed to pay an additional $50,000 directly to Mr. Five-six Numerix, the
previous major shareholder of XYZ, to persuade him in selling his shareholdings to
ABC.
e. Ms. Vital Statistix, a former shareholder of XYZ, will acquire title to inventories with
fair value of P90,000 that were included in the asset valuation.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,050,000
Non-controlling interest in the acquire (1M x 100% ) -
Previously held equity interest in the acquiree -
Total 1,050,000
Fair value of net identifiable assets acquired (610,000)
(Goodwill 440

(a)
(1M + 50K additional payment to Mr. Numerix) = 1,050,000
(b)
(1.6M-90K inventories taken by Ms. Statistix - .9M) = 610,000

 Notes:
 The reimbursement for the legal fees is an acquisition-related cost. This is expensed.
 The reimbursement for liquidation costs is a restructuring provision. This is a post-
combination expense.
 The payment to key employees is a separate transaction because it is remuneration to
employees for future services.
Business Combinations (Part 1) 83

 The additional $50,000 payment is included in the consideration transferred because

it is for the benefit of the acquiree's former owner.
 The inventories are excluded because these are not assets acquired in the business
combination.

Reacquired rights
A right that an acquirer has previously granted to the acquiree that is reacquired as a
result of a business combination is recognized as an intangible asset separately from
goodwill.

Examples of reacquired rights:

a. Right to use the acquirer's intangible asset, such as trade name under a franchise
agreement.
b. Right to use the acquirer's technology under a technology licensing agreement.

Settlement of pre-existing relationship

Prior to business combination, the acquirer and acquiree may have pre-existing
relationship. Such a relationship may be:

a. Contractual - e.g., as vendor and customer, licensor and licensee, or franchisor and
franchisee. A pre-existing relationship may be a contract that the acquirer recognizes
as a reacquired right.
b. Non-contractual - e.g., as plaintiff and defendant on a pending lawsuit.

If the pre-existing relationship is settled due to the business combination, the

acquirer recognizes a settlement gain or loss measured as follows:
a. At the lower of (i) and (ii) below, if the pre-existing relationship is contractual.
i. The amount by which the contract is favorable or unfavorable, from the acquirer's
perspective, when compared with market terms.
84 Chapter 1

ii. Any settlement amount stated in the contract that is available to the counterparty
to which the contract is unfavorable. If this is less than the amount in (i), the
difference is included as part of the business combination accounting.

b. At fair value, if the pre-existing relationship is non- contractual.

The settlement gain or loss is adjusted for the derecognition of any related asset or
liability that the acquirer has previously recognized.

Illustration 1: Reacquired right

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. XYZ's assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.

Additional information:
 Prior to the business combination, ABC granted XYZ the right to use ABC's patented
technology over a 5-year period in exchange for P100,000 cash (payable at grant
date) and royalty fees based on XYZ's sales over the 5-year period.
 ABC recognized the P100,000 license fee as deferred liability (unearned income) and
amortized it over 5 years. The carrying amount of the deferred liability on January 1,
20x1 is P60,000.
 On the other hand, XYZ recognized the license fee as prepayment (prepaid asset) and
amortized it based on the number of products sold. The carrying amount of the
prepayment on January 1, 20x1 is P50,000.
 On acquisition date, the fair value of the license agreement is P120,000. This consists
of the following components:
 P40,000 "at-market" (based on market participants' estimates); and
Business Combinations (Part 1) 85

 P80,000 "off-market" (the excess of P120,000 fair value derived from cash
flow estimates over P40,000 'at-market value).
 The off-market component is favorable to XYZ and unfavorable to ABC, as royalty
rates have increased considerably in comparable markets since the initiation of the
contract. The contract does not have any cancellation clause or any minimum royalty
payment requirements.

Requirement: Compute for the goodwill.

Solution:
As mentioned in the previous chapter ('Exceptions to the measurement principle), a
reacquired right is measured based on the remaining term of the related contract. This is
in contrast with other assets which are measured based on market participation.
The measurement of a reacquired right could result to a difference between the
value derived from market participation assumptions ("at-market" value) and fair value
based on cash flow estimates. The difference ("off-market" value) makes a reacquired
right favorable or unfavorable from the acquirer's perspective.

In the illustration above, the P80,000 "off-market" value is unfavorable from the
perspective of ABC Co. (because the royalty fees that XYZ is paying ABC are below-
market rate). Accordingly, ABC recognizes a settlement loss.
The pre-existing relationship is contractual. Therefore, the settlement loss is
measured at the lower of (i) the unfavorable amount and (ii) the settlement amount in the
contract. However, because the contract does not have a cancellation clause or minimum
royalty payment requirement, the settlement loss is measured based on (i), after
adjustment for the recognized deferred liability. This is computed as follows:

Settlement loss before adjustment ("off-market" value) 80,000

Carrying amount of deferred liability 60,000
Adjusted settlement loss 20,000
86 Chapter 1

The settlement of the pre-existing relationship is a separate transaction. Therefore,

the P80,000 "off-market" value is excluded from the consideration transferred on the
business combination and treated as payment for the settlement of the pre-existing
relationship.
ABC recognizes the P40,000 "at-market" value component of the reacquired right
as an intangible asset, separate from goodwill, to be amortized over the remaining term of
the agreement.
The P50,000 prepayment recognized by XYZ is excluded from the identifiable
assets acquired and replaced by the intangible asset on the reacquired right.

The goodwill is computed as follows:

Consideration transferred (IM-80K 'off-market' value) 920,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 920,000
Fair value of net identifiable assets acquired (1.6M + 40K intangible asset on
reacquired rt. -50K prepayment - .9M)
-690,000
Goodwill 230,000

Journal entries:
Jan. 1 1,590,00
20x1 Identifiable assets acquired
0
230,00
Goodwill
0
Liabilities assumed 900,000
Cash (1M-80K) to records the business
combination 920,000
Jan. 1 Settlement loss 20,000
20x1 Deferred liability 60,000
Cash 80,000
to record the effective settlement of pre-
existing relationship as a separate
transaction from business combination
transaction
 Business Combinations (Part 1) 87

 Notes:
"Off-market" value
- used to determine settlement gain or loss
from the acquirer's perspective.
- excluded from 'consideration transferred'
Total fair value of and treated as a separate transaction.
reacquired right
consisting of:
"At-market" value
- recognized as intangible asset if it relates
to a reacquired right.

Illustration 2: Contractual pre-existing relationship

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for
P1,000,000. XYZ's assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.
Additional information:
 ABC and XYZ have a pre-existing supply contract under which ABC could purchase
raw materials from XYZ at discounted rates. The contract has a remaining term of
three years, which ABC can terminate by paying P100,000 penalties.
 The supply contract has a fair value of P160,000, of which P70,000 is "at-market."
The off-market" component is
unfavorable to ABC because it exceeds the price of current market transactions for
similar items.
 No assets or liabilities related to the contract were recognized in either of ABC's or
XYZ's books as at the acquisition date.

Requirement: Compute for the goodwill.

Solution:
The P90,000 "off-market" value (160K total fair value -70K 'at-market value) is
unfavorable from the perspective of ABC Co. Accordingly, ABC
recognizes a settlement loss.
88 Chapter 1

The pre-existing relationship is contractual. Therefore, the settlement loss is

measured at the lower of (i) the unfavorable amount and (ii) the settlement amount in the
contract. This is computed as follows:

Settlement loss (lower of 90K off-market and 100K settlement amt.) 90,000
Carrying amount of related asset or liability recognized -
Adjusted settlement loss 90,000

The P90,000 "off-market" value is excluded from the consideration transferred on

the business combination and treated as payment for the settlement of the pre-existing
relationship (i.e., a separate transaction).
The P70,000 "at-market" value is subsumed in goodwill and not recognized as
intangible asset because there is no reacquired right. Contrast this with Illustration 1
above.
 In Illustration 1, ABC (acquirer) granted the license to XYZ (acquiree). There is
reacquired right because ABC (supplier) takes back the license from XYZ (customer)
as a result of the business combination.
 In Illustration 2, XYZ (acquiree) granted the supply contract to ABC (acquirer).
There is no reacquired right because ABC (customer) gives back the supply contract
to XYZ (supplier) as a result of the business combination.

The goodwill is computed as follows:

Consideration transferred (IM-90K 'off-market' value) 910,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 910,000
Fair value of net identifiable assets acquired (1.6M - 9M) (700,000)
Goodwill 210,000

Journal entries:
Jan. Identifiable assets acquired
Business Combinations (Part 1) 89

1,
Goodwill
20x1
Jan.
1,
20x1
Liabilities assumed
Cash (1M-90K)
Settlement loss
Cash
1,600,000
210,000
90,000
Requirement: Compute for the goodwill.
910,000
-
-
910,000
(700,000)
210,000
900,000
910,000
90,000
Illustration 3: Non-contractual pre-existing relationship
On January 1, 20x1, ABC Co. acquired all the assets and liabilities
of XYZ, Inc. for P1,000,000. XYZ's assets and liabilities have fair
values of P1,600,000 and P900,000, respectively.
ABC is the defendant on a pending patent infringement suit filed
by XYZ. ABC recognized a provision of P130,000 on the lawsuit.
After the business combination, the disputed patent will be
transferred to ABC. The fair value of settling the pending lawsuit
90 Chapter 1

is P100,000.
Solution:
The P100,000 fair value is excluded from the consideration
transferred on the business combination and treated as payment
for the settlement of the pre-existing relationship (i.e., a separate
transaction).
The pre-existing relationship is non-contractual.

Therefore, the settlement gain or loss is measured at fair value.

This is computed as follows:

Payment for the settlement of pre-existing relationship

Carrying amount of related provision (liability)

Settlement gain

There is gain because the liability is settled for a lower

amount.

The goodwill is computed as follows:

Consideration transferred (1M-100K settlement amt.)

Non-controlling interest in the acquiree

Previously held equity interest in the acquiree

Total

Fair value of net identifiable assets acquired (1.6M - 9M)

Goodwill

Journal entries:

Jan. 1, Identifiable assets acquired

20x1
Business Combinations (Part 1) 91

Goodwill

Liabilities assumed

Cash (1M-100K)

Jan. 1, Estimated liability on pending lawsuit

20x1

Cash

Settlement gain

1,600,000

200,000

100,000

(130,000)

30,000

130,000

900,000

900,000

(700,000)

200,000

900,000

900,000

100,000

30,000

Subsequent measurement and accounting

Subsequent to acquisition date, the acquirer accounts for assets

92 Chapter 1

acquired, liabilities assumed and equity instruments issued in a

business combination in accordance with other PFRSs applicable

for those items. However, the following are subsequently

accounted for under PFRS 3:

a. Reacquired rights

b. Indemnification assets

c. Contingent liabilities recognized as of the acquisition date

d. Contingent consideration
Reacquired rights
Reacquired rights recognized as intangible assets are amortized
over the remaining term of the related contract.
Indemnification
assets
Indemnification assets are measured on the same basis as the
indemnified item, subject to assessments of collectability for
indemnification assets not measured at fair value.
Contingent liabilities
Contingent liabilities recognized in a business combination are
measured at the higher of:
a. The amount that would be recognized by applying PAS 37;
and
b. The amount initially recognized less, if appropriate,
cumulative amount of income recognized in accordance with
PFRS 15 Revenue from Contracts with Customers.
Contingent consideration
Contingent consideration is additional consideration for a business
combination that the acquirer agrees to provide to the acquiree
upon the happening of a contingency.
A contingency is an existing, unresolved condition that will
be resolved by the occurrence or non-occurrence of a possible
future event.
An example of a contingent consideration is when the
acquirer agrees to issue additional shares to the acquiree when
specified conditions are met, such as meeting an earnings target,
reaching a specified share price or reaching a milestone on a
research and development project.
Initial recognition and measurement
A contingent consideration is measured at acquisition-date fair
value and included in the consideration transferred.
Business Combinations (Part 1) 93

=
The obligation to pay the contingent consideration is
classified either as liability or equity. A right to recover a
previously transferred consideration if specified conditions are
met is classified as an asset.
Subsequent measurement
A change in the fair value of a contingent consideration resulting
from additional information obtained during the measurement
period is accounted for as a retrospective adjustment to provisional
amount. However, changes resulting from meeting an earnings
target, reaching a specified share price or reaching a milestone on
a research and development project are not measurement period
adjustments.
Changes in fair value that are not measurement period
adjustments are accounted for depending on the classification of
the contingent consideration:
a. A contingent consideration classified as equity is not
remeasured and its subsequent settlement is accounted for
within equity.
b. A contingent consideration classified as an asset or a liability
is measured at fair value at each reporting date. Changes in
fair value are recognized in profit or loss.
Illustration 1: Contingent consideration classified as equity
On January 1, 20x1, ABC Co. issued 10,000 shares with par value
of P10 per share and fair value of P100 per share in exchange for
all the assets and liabilities of XYZ. XYZ's assets and liabilities
have fair values of P1,600,000 and P900,000, respectively.
K
In addition, ABC agrees to issue additional 1,000 shares to the
1 former owners of XYZ if the market price of ABC's shares
increases to P120 per share by December 31, 20x1. The fair value of
the contingent consideration as of January 1, 20x1 is P90,000,
based on consideration of the vesting conditions.
Requirement: Compute for the goodwill.
Solution:

Consideration transferred (1M +90K contingent consideration)

Non-controlling interest in the acquiree

Previously held equity interest in the acquiree

Total

Fair value of net identifiable assets acquired (1.6M - .9M)

94 Chapter 1

Goodwill

Journal entry:

Jan. 1. Identifiable assets acquired

20x1 Goodwill

Liabilities assumed

Share capital (10,000 x P10 par)

Share premium [10,000 x (P100 - P10)]

Share premium-contingent consideration

Solution:

Dec.

31,

20x1

No entry (a)

Jan. 15, Share premium - contingent consideration

20x2

shares

1,600,000

390,000

Continuation of Illustration 1 - Subsequent measurement:

Case #1:

The market price of ABC's shares on December 31, 20x1 is P120.

The contingent consideration is settled on January 15, 20x2.

Requirement: Provide the journal entries.

Business Combinations (Part 1) 95

Share capital (1,000 x P10 par)

Share premium (squeeze)

to record the issuance of 1,000 additional

1,090,000

90,000

1,090,000

(700,000)

390,000

900,000

100,000

900,000

90,000

10,000

80,000

(a) A contingent consideration that is classified as equity is not

remeasured and its subsequent settlement is accounted for within

equity.

NOT FOR SALE!

Case #2:
The market price of ABC's shares on December 31, 20x1 is P90.
Requirement: Provide the journal entries.
Solution:
Dec.
31,
20x1
Share premium - contingent consideration 90,000
Share premium
Regardless of whether the vesting condition is met, the
amount recognized in equity for a contingent consideration
96 Chapter 1

remains in equity. This, however, does not preclude an entity

from transferring amounts within equity (i.e., reclassification
between equity accounts).
90,000
Illustration 2: Contingent consideration classified as liability
On January 1, 20x1, ABC Co, acquired all the assets and liabilities
of XYZ, Inc. for P1,000,000. XYZ's assets and liabilities have fair
values of P1,600,000 and P900,000, respectively.
ABC agrees to pay additional cash equal to 10% of the 20x1 year-
end profit that exceeds P400,000. XYZ historically has reported
profits of P300,000 to P400,000 each year. The fair value of the
contingent consideration as of January 1, 20x1 is P10,000, based on
assessments of the expected level of profits for the year, as well as,
forecasts, plans and industry trends.
Requirement: Compute for the goodwill.
Solution:
Consideration transferred (1M+10K contingent consideration)
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired (1.6M -.9M)
Goodwill
NOT FOR SALE!
1,010,000
1,010,000
(700,000)
310,000
Journal entry:
Jan. Identifiable assets acquired
1, Goodwill
20x1
Liabilities assumed
Liability for contingent consideration
Cash
1,600,000
310,000
A contingent consideration representing an obligation to
pay cash or other non-cash assets is classified as liability, and
measured at acquisition-date fair value, even if payment is not
probable.
Continuation of Illustration 2 - Subsequent measurement:
Case #1:
The profit for the year is P550,000. The contingent consideration is
settled on January 15, 20x2.
Requirement: Provide the journal entries.
Solution:
Business Combinations (Part 1) 97

Dec. Unrealized loss - P/L (2)

31,
20x1
Liability for contingent consideration
to recognize loss on change in fair value of
contingent consideration classified as liability
Jan. Liability for contingent consideration
Cash
15,
20x2
5,000
900,000
10,000
1,000,000
15,000
(a) Carrying amount of contingent consideration - 12/31/20x1
Fair value-12/31/20x1 [(550K-400K) x 10%]
Increase in fair value of liability (loss)
5,000
15,000
10,000
15,000
(5,000)
A contingent consideration that is classified as liability is
remeasured to fair value at each reporting date. Changes in fair
value are recognized in profit or loss.
от г
Case #2:

The profit for the year is P300,000.

Requirement: Provide the journal entry.

Solution:

31,

20x1

Liability for contingent consideration

Gain on extinguishment of liability - P/L

10,000

10,000
98 Chapter 1

The liability is extinguished because the earnings target is

not met.

In Cases 1 & 2 above, the fair value changes relate to the

meeting and non-meeting of the earnings target, which are not

measurement period adjustments. Accordingly, these are

recognized in profit or loss. The recognized goodwill is not

affected regardless of the outcome of the contingency.

Illustration 3: Contingent payments to employees

ABC Co. acquired 90% interest in XYZ, Inc. for P1,000,000. XYZ's

assets and liabilities have fair values of P1,600,000 and P900,000,

respectively. ABC measured the NCI at a fair value of P80,000.

Five years ago, XYZ appointed Mr. Boss as the CEO under a ten-

year contract which requires XYZ to pay Mr. Boss P100,000 if XYZ

is acquired before the contract expires. ABC assumes the

obligation to pay Mr. Boss the contracted amount.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired
(1.6M-9M-100K payable to Mr. Boss)
Goodwill
1,000,000
80,000
1,080,000
(600,000)
480,000
Business Combinations (Part 1) 99

The employment contract existed long before the business

combination, and for the purpose of obtaining the services of the
CEO. There is no evidence that the agreement was arranged
primarily for the benefit of ABC or the combined entity. Therefore,
the P100,000 obligation is treated as an additional liability
assumed rather than an adjustment to the consideration
transferred.
Consideration transferred
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired
(1.6M-9M-100K payable to Mr. Boss)
Goodwill
1,000,000
80,000
1,080,000
(600,000)
480,000
The employment contract existed long before the business
combination, and for the purpose of obtaining the services of the
CEO. There is no evidence that the agreement was arranged
primarily for the benefit of ABC or the combined entity. Therefore,
the P100,000 obligation is treated as an additional liability
assumed rather than an adjustment to the consideration
transferred.
Chapter 2: Summary
The acquisition method applies to all business combinations,
including those that do not involve a purchase transaction. If a
business combination is achieved:
●
a) without transfer of consideration, the fair value of
acquirer's interest in the acquiree is substituted for the
consideration transferred in computing for goodwill.
b) by contract alone, all interests not held by the acquirer are
attributed to NCI, even if the resulting NCI is 100%.
Provisional amounts may be used if accounting is incomplete
by the end of the business combination year. The provisional
amounts are adjusted retrospectively for information obtained
during the measurement period (i.e., maximum of 12 months
from acquisition date) that provides evidence of facts and
circumstances that existed as of the acquisition date.
The consideration transferred includes only those that are
transferred to the previous owners of the acquiree. It excludes
those that are retained by the combined entity after the
combination and those that are in effect used to settle a pre-
100 Chapter 1

existing relationship.
A reacquired right in a business combination is recognized as
an intangible asset measured at the "at-market" value.
The gain or loss on settlement of a pre-existing relationship is
measured as follows:
a) If contractual - at the lower of (i) "off-market" value,
favorable/unfavorable determined based on the acquirer's
perspective; and (ii) any settlement amount stated in the
contract.
b) If non-contractual - at fair value
A contingent consideration is measured at acquisition-date
fair value and included in the consideration transferred.
Notable differences between the provisions of the full PFRSS

and the PFRS for SMEs:

Full PFRSs

6. Previously held equity interest in the acquiree

In a business combination

achieved in stages, the acquirer's

previously held equity interest in the

acquiree is remeasured to fair

value and included in the

computation of goodwill.

7. Contingent consideration

Initial measurement:

Included in the consideration

transferred at acquisition-

date fair value.

Subsequent measurement:

> Change in fair value that is:

Business Combinations (Part 1) 101

a) a 'measurement period

adjustment' is adjusted to

goodwill.

b) not a measurement

PFRS for SMEs

period adjustment:

i. remains in equity, if

the contingent

consideration is

classified as equity

ii. is recognized in profit

or loss, if the

contingent

consideration is

classified as liability

or asset.

No equivalent provision under

PFRS for SMEs.

Initial measurement:

Included in the cost of

business combination if it is

probable and can be

measured reliably.
102 Chapter 1

Subsequent measurement:

> Change in fair value is

treated as an adjustment to

the cost of business

combination (i.e., adjusted to

goodwill).
PROBLEMS:
PROBLEM 1: TRUE OR FALSE
1. Entity A issues 1,000 shares in exchange for all the outstanding
shares of Entity B. After the transaction, the former owners of
Entity B become owners of 1,000 shares out of the 10,000
outstanding shares of Entity A. Entity A will own all the
shares of Entity B. This transaction is not a business
combination that is accounted for under PFRS 3.
Use the following information for the next three items:
Entity A issues shares in exchange for 100% interest in Entity B's
net identifiable assets with fair value of P80. As a result of the
business combination, Entity A's share capital and share premium
increased by #30 and 70, respectively.
2. The aggregate par value of the shares issued is $30.
3. The fair value of the consideration transferred is $70.
4. The business combination resulted to goodwill of $10.
Use the following information for the next four items:
Once upon a time, Entity A acquired 20% interest in Entity B.
After sometime, Entity A acquired additional 50% interest for
$100, at which time, Entity B's net identifiable assets have a fair
value of 180, the previous investment of Entity A has a carrying
amount of 30 and fair value of $40, and the NCI has a fair value
of $60.
5. The transaction described above is a business combination
achieved in stages' or 'step acquisition'.
6. The 20% previous interest is ignored when computing for
goodwill.
7. Entity A recognizes a remeasurement gain of 10 in profit or
loss.
8. The goodwill is $20.
9. Entity A owns 40% interest in Entity B. Entity A enters into an
agreement with Entity C, owner of 20% interest in Entity B,
whereby Entity A will exercise all of Entity C's voting interests
in Entity B for a period of 25 years. The agreement between
Entity A and Entity C cannot result to a business combination
Business Combinations (Part 1) 103

between Entity A and Entity B, according to PFRS 3.

10. There can be a business combination that results to a 100%
non-controlling interest.
PROBLEM 2: TRUE OR FALSE
1. The measurement period under PFRS 3 is a maximum of 12
months after the end of the business combination year.
Use the following information for the next two items:
On November 1, 20x1, Entity A acquires all the assets and
liabilities of Entity B for 100. Entity B's assets and liabilities have
fair values of P170 and 80, respectively. Entity B assigns a
provisional amount of 70 for a certain asset for which the
accounting is incomplete. On February 1, 20x2, Entity A obtains
the information it is seeking and confirms that the acquisition-date
fair value of asset is $60.
2. Entity A should restate its 20x1 financial statements to
incorporate the effects of the new information obtained on
February 1, 20x2.
3. The goodwill that is presented in the 20x1 restated financial
statements is P10.
4. A transaction that is arranged primarily for the benefit of the
acquirer or the combined entity rather than the acquiree or its
former owners is likely to be a separate transaction. The
transaction price is excluded from the consideration
transferred when computing for goodwill.
5. The acquirer recognizes a reacquired right in a business
combination as an intangible asset.
6. The acquirer recognizes a settlement gain or loss if a pre-

existing relationship with the acquiree is settled due to the

business combination.

7.

A contingent consideration is measured at acquisition-date

fair value and included in the consideration transferred.

8.

A contingent consideration that is classified as equity is not

adjusted for changes in fair value subsequent to initial

recognition, except for changes in fair value that are

104 Chapter 1

measurement period adjustments.

Use the following information for the next two questions:

On January 1, 20x1, Entity A issues shares with total fair value of

100 in exchange for all the assets and liabilities of Entity B with

fair values of P170 and $80, respectively. Entity A agrees to issue

additional shares if Entity A reaches a milestone on the acquired

R&D project by December 31, 20x1. The fair value of the

additional consideration on January 1, 20x1 is $20.

9. Entity A reaches a milestone on the R&D project on December

31, 20x1, and therefore issues the additional shares. Entity A

reports goodwill of P30 in its December 31, 20x1 financial

statements.

10. Entity A does not reach a milestone on the R&D project on

December 31, 20x1, and therefore the contingent consideration

is cancelled. Entity A reports goodwill of 30 in its December

31, 20x1 financial statements.

PROBLEM 3: FOR CLASSROOM DISCUSSION

Share-for-share exchanges

1. Frown Co. issued shares in exchange for all the outstanding

shares of Long Co. Frown's shares have par value of P20 per

share and fair value per value of P100. On acquisition date,

Long's net identifiable assets have fair value of P4,000,000.

Frown recognized goodwill of P200,000 from the business

Business Combinations (Part 1) 105

combination. How many shares did Frown issue on the

business combination?OT FOR SALE!

Business combination achieved in stages
2. Angry Co. acquired 20% interest in Misery Co. many years
ago. On January 1, 20x1, Angry acquired additional 40%
interest in Misery for $300,000. On this date, Misery's net
identifiable assets have a fair value of $690,000, and Angry's
previous investment in Misery has a carrying amount of
P128,000 and fair value of 138,000. Angry opted to measure
the NCI at 'proportionate share'. How much is the goodwill?
Business combination without transfer of consideration
3. Nag Co. acquired 100% voting rights in Sag Co. by contract
alone. No consideration was transferred on the arrangement.
Sag's net identifiable assets have fair value of 1,800,000. Nag
measured the NCI at 'proportionate share'. How much is the
goodwill?
Measurement period
4. On November 2, 20x1, ABC Co. acquired all the identifiable
assets and liabilities of XYZ, Inc. for P2,000,000.
Information on acquisition date:
• XYZ's net identifiable assets were valued at $1,980,000. This
amount included a provisional amount of $220,000 assigned to
a specialized machine for which the fair value is not readily
determinable. ABC tentatively depreciated the machine over 6
years using the straight line method in 20x1.
Information after the acquisition date:
On April 1, 20x2, an independent consultant determined that
the machine's fair value on acquisition date was $140,000 and
the remaining useful life as of that date was 4 years.
• On July 1, 20x2, the stock market crashed. Various held for
trading securities acquired from XYZ, Inc. with acquisition-
date fair value of P500,000 now have a fair value of only
$20,000.
●
Requirement: Provide the adjusting entry to restate the goodwill.
Determining what is part of the business combination
5. Sky Co. acquired 100% interest in Star, Inc.'s net identifiable
assets with fair value of P600,000 for P800,000. The valuation
of the consideration transferred includes the following:
a. P30,000 reimbursement for appraisal fees incurred by Star
in valuing a patent.
b.
P50,000 fair value of a trade secret that Sky will grant Star
after the business combination. The trade secret has a
carrying amount of P40,000 in Sky's books
106 Chapter 1

Requirement: Compute for the goodwill.

Reacquired rights & Settlement of pre-existing relationship
6. On January 1, 20x1, Entity A acquires all the assets and
liabilities of Entity B for $2,000,000. Entity B's identifiable
assets and liabilities have fair values of $4,000,000 and
$2,200,000, respectively.
Additional information:
. Prior to the business combination, Entity B is a franchisee of
Entity A. The franchise agreement has a remaining term of 5
years, which either party can terminate without any penalty.
• The franchise agreement has a fair value of $300,000, of which
$100,000 is "at-market" value. The "off-market" value is
favorable to Entity A, but unfavorable to Entity B.
Entity A's related 'contract liability' account has a carrying
amount of 230,000, while Entity B's related 'franchise'
account has a carrying amount of $150,000.
Requirement: Compute for the goodwill.
●
Contingent consideration

7. On January 1, 20x1, Entity A acquires 100% interest in Entity B

value per

in exchange for Entity A's 10,000 shares with par

share of P20 and fair value per share of $200. Entity B's net

identifiable assets have a fair value of $1,900,000. In addition,

Entity A agrees to issue additional 2,000 shares if Entity B's

20x1 profit will exceed 3,600,000. The fair value of the

contingent consideration is $280,000.

Requirements:

a. How much is the goodwill recognized on acquisition date?

b. Entity B's 20x1 profit is $3,800,000. Entity A issues the

additional shares on January 14, 20x2. Provide the journal

entries.
Business Combinations (Part 1) 107

c. Entity B's 20x1 profit is $2,800,000. Provide the journal entries.

PROBLEM 4: EXERCISES

1. Entity A and Entity B exchanged equity interests resulting to

Entity A obtaining control over Entity B. Relevant information

follows:

Identifiable assets

Goodwill

Total assets

Liabilities

Share capital (20 par)

Share premium

Retained earnings

Total liabilities and equity

ABC Co.

(before combination)

2,200,000

2,200,000

700,000

800,000

300,000

400,000

2,200,000

Requirements: Compute for the following:

108 Chapter 1

a. Number of shares issued by Entity A

b. Goodwill

Combined entity

3,600,000

1,300,000

976,000

1,092,000

?
c. Retained earnings of the combined entity immediately after
the business combination
2. On January 1, 20x1, Row Co. acquired 10,000 out of the
100,000 outstanding shares of Boat Co. for P30,000. Row Co.
classified the shares as financial asset measured at fair value
through profit or loss. The shares were trading at P5 on
December 31, 20x1.
On July 1, 20x2, Row Co. acquired additional 80,000 shares of
Boat Co. at P8 per share, the quoted price on that date. The
outstanding shares of Boat Co. remained at 100,000 shares.
Boat Co.'s net identifiable assets have a fair value of $665,000.
Row Co. elected to measure NCI at 'proportionate share'.
Requirements:
a. Compute for the goodwill.
b. Provide all the journal entries on July 1, 20x2.
3. On November 1, 20x1, Entity A acquired all the assets and
liabilities of Entity B for P1,800,000. On this date, Entity B's
assets and liabilities were valued at P2,600,000 and P900,000,
respectively. The assets acquired include a trademark which
was assigned a provisional amount of P300,000 because the
fair value was not readily obtainable at acquisition date. The
trademark has an indefinite useful life. On August 31, 20x2,
Entity A confirmed that the acquisition-date fair value of the
trademark was P200,000.
Requirements:
Business Combinations (Part 1) 109

a. Compute for the unadjusted and adjusted goodwill.

b. Provide the adjusting entry.
4. On January 1, 20x1, Entity A acquired all the assets and
liabilities of Entity B for P2,200,000, XYZ's assets and liabilities
have fair values of P3,600,000 and P1,800,000, respectively.
Additional information:
• Entity A is the exclusive distributor of Entity B's products. The
distributorship agreement has a remaining term of five years.
The contract does not have any cancellation clause.
The distributorship contract has a fair value of P360,000, of
which P170,000 is "at-market." The "off-market" component is
unfavorable to Entity A, but favorable to Entity B.
No assets or liabilities related to the contract were recognized
in either of Entity A's or Entity B's books as at the acquisition
date.
Requirements:
a.
Compute for the gain or loss on the settlement of the pre-
existing relationship. Provide the journal entry.
b. Compute for the goodwill.
5. On January 1, 20x1, Entity A acquires 100% interest in Entity B
in exchange for Entity A's 10,000 shares with par value per
share of 20 and fair value per share of $200. Entity B's net
identifiable assets have fair value of $1,920,000. In addition,
Entity A agrees to provide an additional payment of $400,000
if Entity B's 20x1 profit will exceed $3,600,000. The fair value
of the contingent consideration is $280,000.
Requirements:
How much is the goodwill recognized on acquisition date?
b. Entity B's 20x1 profit is 3,800,000. Entity A pays
additional $400,000 on January 14, 20x2. Provide the journal
entries.
c. Entity B's 20x1 profit is $2,800,000. Provide the journal entries.
PROBLEM 5: MULTIPLE CHOICE-THEORY

1. Which of the following transactions will most likely increase

the share premium of the acquirer?

a. A business combination achieved in stages.

b. A business combination accomplished through a mere

exchange of equity interests between the acquirer and the

acquiree's former owners.

110 Chapter 1

c. A

business combination involving a contingent

consideration that is classified as a liability.

d. A business combination where the acquirer reacquires a

right that it has previously granted to the acquiree.

2. It is a type of business combination wherein an investor,

having an existing investment in the investee, acquires

additional interest in order to obtain control over the investee.

a. business combination achieved by contract alone

b. business combination achieved by mere exchanges of

equity interests

c. business combination achieved in stages

d. baby step combination

3. Business combinations achieved in stages are accounted for

a. prospectively.

b. retrospectively, as if the acquired entity has been a

subsidiary all along.

c. retrospectively if the previously held equity interest was

classified as investment in associate.

d. b and d

4. How does an acquirer account for a business combination that

is achieved in stages?

The acquirer substitutes the acquisition-date fair value of

Business Combinations (Part 1) 111

its interest in the acquiree for the acquisition-date fair

value of the consideration transferred to measure

goodwill.
b. The acquirer remeasures its previously held equity interest
in the acquiree at acquisition-date fair value and includes
that amount in computing for the goodwill.
c.
The acquirer attributes to the non-controlling interest all of
the acquiree's net identifiable assets.
d. The acquirer accounts for the business combination step
by step, beginning with step one.
5. In a business combination achieved in stages, the acquisition-
date remeasurement gain or loss of an acquirer's previously
held interest in the acquiree is recognized
a. in profit or loss.
b. in other comprehensive income.
c. directly in equity.
d. a or b
6. The acquisition method of PFRS 3 does not apply to which of
the following?
a. Entity A obtains control of Entity B without transferring
any consideration.
b.
Entity A obtains control of Entity B through series of
acquisitions of voting interests.
c.
Entity A exchanges some of its shares for all the shares of
Entity B.
d. Entity A acquires a building, three trucks, and one stapler
from Entity B. The assets acquired do not constitute a
business.
7. If the initial accounting for a business combination is
incomplete by the end of the reporting period in which the
combination has occurred, the acquirer
a. shall report in its financial statements provisional amounts
for the items for which the accounting is incomplete.
b. shall be exempted from preparing consolidated financial
statements until the accounting for the business
C.
combination is completed.
shall prepare financial statements as if the business
combination did not take place.
d. and the acquiree shall be divorced. The acquiree is entitled
112 Chapter 1

to one-half of the acquirer's net assets and alimony until

their children reach the age of eighteen.
8. Provisional amounts recognized in a business combination are
adjusted
a. prospectively for information obtained during the
measurement period.
b. retrospectively for information obtained during the
measurement period.
C. not adjusted for any information obtained during the
measurement period.
d. PFRS 3 (revised) outlawed the use of provisional amounts.
9. The consideration transferred in a business combination will
most likely include which of the following?
a. The transaction price in an arrangement that is primarily
for the benefit of the acquirer or the combined entity.
b. A contingent liability with an acquisition-date fair value
but imposes an improbable outflow that the acquirer
assumes in a business combination.
c. The "off-market" value of a reacquired right.
d. The acquisition-date fair value of a contingent
consideration that is dependent upon the occurrence of a
possible, but not probable, future event.
10. Entity A obtains control over Entity B in a business
combination. As a result, Entity A reacquires a right that it has
previously granted to Entity B. Which of the following is
correct?
a. Entity A subsumes to goodwill the intangible asset for the
reacquired right.
b. Entity A recognizes an intangible asset for the reacquired
right at the "off-market" value of the reacquired right.
Entity A recognizes a settlement gain or loss depending on
whether the terms of the contract is favorable or
c.
unfavorable, determined based on Entity B's perspective,

when compared with market terms.

at

d. Entity A recognizes a settlement gain or loss measured

the lower of the settlement amount in the contract and the

"off-market" value of the reacquired right.

PROBLEM 6: MULTIPLE CHOICE-COMPUTATIONAL

Business Combinations (Part 1) 113

Use the following information for the next two questions:

Burns Co. issued 20,000 ordinary shares in exchange for all the

outstanding shares of Sighing, Inc. On acquisition date, Sighing's

net identifiable assets have a carrying amount of P4,000,000 and a

fair value of P2,000,000. The transaction increased Burns' share

premium by P400,000; however, no goodwill resulted from the

business combination.

1. How much is acquisition-date fair value per share of the

ordinary shares issued by Burns?

a. 20

b. 40

c. 80

d. 100

2. How much is par value per share of Burn's ordinary shares?

a. 20

b. 40

c. 80

d. 100

3. Point Co. issued shares in exchange for all the outstanding

shares of Finger Co. The business combination did not result

to any goodwill. The share exchange ratio was 2:1. Finger's

share capital has a carrying amount of P40,000. The par

value
114 Chapter 1

per share is P4. Finger's net identifiable assets have a carrying

amount of P400,000 and a fair value of P800,000. Point's shares

have par value per share of P10. How much is the acquisition-

date fair value per share of Point's shares?

c. 80

d. 100

a. 20

b. 40
4. On January 1, 20x1, Over Co. acquired 10,000 out of the
100,000 outstanding shares of Seas Co. for P30,000. Transaction
costs on the acquisition amounted to P2,000. Over Co.
classified the shares as held for trading. The shares were
trading at P5 on December 31, 20x1. On July 1, 20x2, Over Co.
acquired additional 50,000 shares of Seas Co. at P7 per share,
the quoted price on that date. The outstanding shares of Seas
Co. remained at 100,000 shares. Seas Co.'s net identifiable
assets have a fair value of P665,000 as of this date. Over Co.
elected to measure NCI using the proportionate share method.
How much is the goodwill?
a. 12,000
b. 18,000
c. 21,000
d. 31,000
5. On July 1, 20x1, SUV Co. acquired all the identifiable assets
and assumed all the liabilities of Pickup, Inc. for P800,000. At
acquisition date, Pickup's identifiable assets and liabilities
have fair values of P1,200,000 and P300,000, respectively.
Additional information:
Pickup has an unrecognized intangible asset for secret
processes. SUV Co. assigned a provisional amount of P200,000
for this asset because its fair value is not readily determinable
on acquisition date. The provisional amount is included in the
total valuation of the assets acquired. SUV amortized the
intangible asset over an estimated useful life of 10 years using
the straight line method.
On February 1, 20x2, an independent consultant determined
that the intangible asset's fair value on acquisition date was
P20,000 and that the useful life was 4 years.
Business Combinations (Part 1) 115

The entry to restate the goodwill includes which of the following?

a. debit to goodwill for $180,000
b. debit to intangible asset for $180,000
c. debit to retained earnings for 100,000
d. credit to goodwill for $80,000
NOT FOR SALE!
Chapter 3
Business Combinations (Part 3)
Related standard: PFRS 3 Business Combinations
Learning Objectives
1. Apply the methods of estimating goodwill.
2. Account for reverse acquisitions.
Special accounting topics for business combination
This chapter discusses accounting for business combination in
relation to the following:
1. Goodwill
2. Reverse acquisitions
3. Combination of mutual entities
Goodwill
Only a goodwill that arises from a business combination is
recognized as an asset. Goodwill arising from other sources (e.g.,
internally generated) is not recognized. Goodwill is measured and
recognized on acquisition date. Subsequent expenditures on
maintaining goodwill are expensed immediately.
After initial recognition, goodwill is not amortized but
rather tested for impairment at least annually. For this purpose,
goodwill is allocated to each of the acquirer's cash-generating
units (CGU) in the year of business combination. If the allocation
is not completed by the end of that year, it must be completed before
the end of the immediately following year.
> Cash-generating unit (CGU) is "the smallest identifiable group
of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or groups of
assets." (PAS 36.6)
Goodwill is allocated to the CCUs expected to benefit
from the synergies of the business combination using
thors
All rights
methodology that is reasonable, supportable, and applied in a

consistent manner. For example, goodwill may be allocated based

on the relative fair values of the CGUS.

Because goodwill is unidentifiable, it cannot be tested for

116 Chapter 1

impairment separately but only in conjunction with groups of

assets that generate independent cash inflows (i.e., CGUS).

Goodwill does not generate cash flows on its own but contributes

on the cash flows of CGUS.

A CGU to which goodwill has been allocated is tested for

impairment annually. A CGU is impaired if its recoverable

amount is less than its carrying amount including the allocated

goodwill. Impairment loss is charged first to the CGU's goodwill

and any excess is charged to the other assets in the CGU.

Impairment of goodwill is not reversed in a subsequent period.

If the CGU is disposed, the goodwill allocated to it is also

derecognized and included in the determination of gain or loss

from the disposal.

The subsequent accounting for goodwill is discussed extensively

in Intermediate Accounting Part 1B. The accounting for impairment

loss on goodwill in the consolidated financial statements is

discussed in Chapter 6.

Due diligence

Before negotiations take place for a business combination, the

acquirer normally initiates a due diligence audit for the purpose of

determining the appropriate amount of consideration to be

transferred to the acquiree.

Due diligence audit refers to the investigation of all areas of

Business Combinations (Part 1) 117

a potential acquiree's business before an investor agrees to a

business combination transaction. The term "due diligence" may

refer to the exercise of care that a reasonable and prudent person

should take before entering a contract with another party. Due

diligence audit is a service most commonly performed by CPAs or

external auditing firms.

Due diligence audit helps an investor evaluate the possible
risks and rewards of the potential investment and determine
whether it would be a good decision to pursue it.
Examples of potential risks which may be determined
through a due diligence audit:
1. Possibility of future losses due to the acquiree's pending
litigations and other unrecorded contingencies.
2. Overstatement in the consideration for the business
combination due to the acquiree's overstated assets and
understated liabilities.
3. Incompatibility of internal cultures, systems, and policies.
Examples of potential rewards which may be determined
through a due diligence audit:
1. Unrecorded assets, such as trade secrets, trade name, customer
lists, and the like.
2. Understatement in the consideration for the business
combination due to the acquiree's understated assets and
overstated liabilities.
Methods of estimating goodwill
Before the actual business combination transaction takes place, the
amount of goodwill may be estimated using any of the following
methods:
1. Indirect valuation - this is a residual approach wherein
goodwill is measured as the excess of the sum of consideration
transferred, non-controlling interest in the acquiree, and
previously held equity interest in the acquiree over the fair
value of net identifiable assets acquired. PFRS 3 requires this
method and it is the method illustrated in the preceding
discussions.
2. Direct valuation - under this method, goodwill is measured
based on expected future earnings from the business to be
acquired.
The application of the direct valuation method may
require the determination of the following information:
a. Normal rate of return in the industry where the acquiree
118 Chapter 1

belongs. The normal rate of return may be the industry

average determined from examination of annual reports
of similar entities or from published statistical data.
> "Normal earnings" is equal to normal rate of return
multiplied by the acquiree's net assets.
b. Estimated future earnings of the acquiree.
i. For purposes of goodwill measurement, the earnings of
the acquiree are "normalized," meaning earnings are
adjusted for non-recurring income and expenses (e.g.,
expropriation gains or losses).
ii. The excess of the acquiree's normalized earnings over
the average return in the industry represents the
"excess earnings" to which goodwill is attributed.
Excess earnings are sometimes referred to as "superior
earnings."
C.
Discount rate to be applied to "excess earnings"
d. Probable duration of "excess earnings"
Illustration 1: Applications of the Direct valuation method
ABC Co. is contemplating on acquiring XYZ, Inc. The following
information was gathered through a due diligence audit:
• The actual earnings of XYZ, Inc. for the past 5 years are shown
below:
Year
20x1
20x2
20x3
20x4
20x5
Total
Earnings
1,200,000
1,300,000
1,350,000
1,250,000
1,800,000
6,900,000
Earnings in 20x5 include an expropriation gain of P400,000.
The fair value of XYZ's net assets as of the end of 20x5 is
NOT FOR SALE!
P10,000,000.
All right.●

The industry average rate of return is 12%.

Probable duration of "excess earnings" is 5 years.

Business Combinations (Part 1) 119

Method #1: Multiples of average excess earnings

Under this method, goodwill is measured at the average excess

earnings multiplied by the probable duration of excess earnings.

Total earnings for the last 5 years

Less: Expropriation gain

Normalized earnings for the last 5 years

Divide by:

(a) Average annual earnings

Fair value of acquiree's net assets

Multiply by: Normal rate of return

(b) Normal earnings

6,900,000

(400,000)

6,500,000

10,000,000

12%

Excess earnings (a) - (b)

Multiply by: Probable duration of excess earnings

Goodwill

Excess earnings

Divide by: Capitalization rate

Goodwill
120 Chapter 1

Average earnings [(6.9M-AM expropriation gain) + 5 yrs.]

Normal earnings (10M x 12%)

1,300,000

1,200,000

Method #2: Capitalization of average excess earnings

Under this method, goodwill is measured at the average excess

earnings divided by a pre-determined capitalization rate. (Assume

a capitalization rate of 25%).

100,000

500,000

1,300,000

(1,200,000)

100,000

25%

400,000

Method #3: Capitalization of average earnings

Under this method, the average earnings are divided by a pre

determined capitalization rate to estimate the purchase price of

the business combination. The excess of the estimated purchase/

price over the fair value of the acquiree's net assets represents the
goodwill. (Assume a capitalization rate of 12.5%).
Average earnings [(6.9M-AM expropriation gain) +5 yrs.]
Divide by: Capitalization rate
Estimated purchase price
Fair value of XYZ's net assets
Business Combinations (Part 1) 121

Goodwill
Notice that if the "excess earnings" is used in the
computations, the amount directly computed is goodwill. On the
other hand, if the "average earnings" is used, the amount directly
computed is the estimated purchase price.
Average earnings (6.9M-AM expropriation gain) + 5 years
Normal earnings in the industry (10M x 12%)
Method #4: Present value of average excess earnings
Under this method, goodwill is measured at the present value of
average excess earnings discounted at a pre-determined discount
rate over the probable duration of excess earnings. (Assume a
discount rate of 10%).
Excess earnings
Multiply by: PV of an ordinary annuity @10%, n=5
Goodwill
1,300,000
12.50%
Year
20x1
20x2
20x3
20x4
20x5
Total
10,400,000
(10,000,000)
400,000
Year-end net assets
480,000
580,000
540,000
560,000
590,000
Earnings
120,000
130,000
135,000
125,000
140,000
650,000 NOT FOR 2,750,000
Illustration 2: Applications of the Direct valuation method
ABC Co. is estimating the goodwill in the expected purchase of
XYZ, Inc. in January 20x6. The following information was
determined.
1,300,000
(1,200,000)
122 Chapter 1

100,000
3.79079
379,079
Case #1: Excess earnings
Goodwill shall be measured by capitalizing excess earnings at
30%, with normal return on average net assets at 10%. The year-
end net assets in 20x5 approximate fair value.
Requirement: Compute for the estimated purchase price in the
contemplated business combination.
Solution:
Average earnings (650,000+ 5 years)
Normal earnings on average net assets [10% x (2.75M+5)]
Excess earnings
Divide by: Capitalization rate
Goodwill
Add: Fair value of net identifiable assets acquired
Estimated purchase price
130,000
(55,000)
75,000
30%
Case #2: Average earnings
Goodwill shall be measured by capitalizing average earnings at
16%. The year-end net assets in 20x5 approximate fair value.
Solution:
Average earnings (650,000+ 5 years)
Divide by: Capitalization rate
250,000
590,000
840,000
Requirement: Compute for the estimated purchase price and
goodwill in the contemplated business combination.
Estimated purchase price
Fair value of net identifiable assets acquired
Goodwill
130,000
16%
812,500
(590,000)
222,500
Illustration 3: Applications of the Direct valuation method
ABC Co. plans to acquire the net assets of XYZ, Inc. with carrying
amount of P9,000,000. This amount approximates fair value,
except for one asset whose fair value exceeds its carrying amount
right
authors
Business Combinations (Part 1) 123

by P1,000,000. XYZ's average earnings are P1,300,000. The industry

average rate of return is 12% of the fair value of net assets. XYZ's

excess earnings are expected to last for 5 years. The expected

return on the investment is 10%.

Requirement: Compute for the estimated purchase price using the

"present value of average excess earnings" approach.

Solution:

Average earnings

Normal earnings in the industry ( 12% x 10M*)

Excess earnings

Multiply by: PV of an ordinary annuity @10%, n=5

Goodwill

* Carrying amount of equity

Excess of fair value of one asset over its carrying amount

Fair value of XYZ's net assets

Estimated purchase price (squeeze)

Less: Fair value of XYZ's net assets

Goodwill

1,300,000

(1,200,000)

100,000

3.79079

379,079
124 Chapter 1

9,000,000

1,000,000

10,000,000

10,379,079

(10,000,000)

379,079

Illustration 4: Applications of the Direct valuation method

ABC Co. acquired the net assets of XYZ, Inc. for P10.4M. The

acquisition resulted to goodwill of P400,000 measured by

capitalizing the annual superior earnings of XYZ at 25%. The

normal rate of return is 12% on net assets before recognition of

goodwill.

Requirement: Compute for the average earnings of XYZ.

Solution:
Average earnings
Normal earnings (12% x 10M*)
Excess earnings or Superior earnings (given)
Divide by: Capitalization rate
Goodwill (given)
1,300,000
(1,200,000)
100,000
25%
Net assets (at fair values)
Average annual earnings
400,000
*Purchase price (given)
10,400,000
Less: Fair value of net assets acquired (squeeze) (10,000,000)
Goodwill (given)
400,000
(squeeze)
(start)
Business Combinations (Part 1) 125

Illustration 5: Applications of the Direct valuation method

ABC Co. and XYZ, Inc. decided to combine and set up a new
entity Alphabets Corporation. The individual records of the
combining constituents show the following:
ABC Co.
400,000
80,000
XYZ, Inc.
600,000
120,000
Alphabets Corporation issues 10% preference shares with par
value per share of P100 for the net assets contributions of the
combining constituents and ordinary shares with par value per
share of P50 for the excess of total contributions (net asset
contribution plus goodwill) over net assets contributions.
The normal rate of return is 10% of net assets. Excess earnings will
be capitalized at 20%.
Requirements: Compute for the following:
a. Goodwill.
b. Total contributions of ABC Co. and XYZ, Inc.
c. The ratio of total shares (preference and ordinary) issued to
ABC Co. and XYZ, Inc.
Solutions:
Requirement (a):
Average annual earnings
Normal earnings on net assets
Excess earnings
Divide by: Capitalization rate
Goodwill
Requirement (b):
Total contribution (squeeze)
Fair value of net assets
Goodwill
Requirement (c):
ABC Co.
Net asset contributions
Divide by: Par value per share of PS
Number of preference shares issued
Ratio of shares issued
Total contribution
Net asset contribution
Excess of total contribution
Divide by: Par value per share of OS
Number of ordinary shares issued
Total PS and OS issued
80,000
126 Chapter 1

(40,000)
40,000
20%
200,000
ABC Co.
XYZ, Inc.
600,000 900,000
(400,000)
(600,000)
200,000 300,000
ABC Co. XYZ, Inc.
400,000 600,000
100
100
4,000
6,000
XYZ, Inc.
120,000
(60,000)
60,000
20%
300,000
50
4,000
8,000
40%
50
6,000
600,000 900,000 1,500,000
(400,000) (600,000) (1,000,000)
200,000
300,000
500,000
50
10,000
12,000
Total
60%
500,000
Total
1,500,000
Totals
1,000,000
100
10,000
20,000
Business Combinations (Part 1) 127

100%
Reverse acquisitions

In a business combination accomplished through exchange of equity

interests, the acquirer is usually the entity that issues its equity

interests. However, the opposite is true for reverse acquisitions.

In a reverse acquisition, the entity that issues securities

(the legal acquirer) is identified as the acquiree for accounting

purposes, while the entity whose equity interests are acquired (the

legal acquiree) is the acquirer for accounting purposes

For example, ABC Co., a private entity, wants to become a

public entity but does not want to register its shares. To

accomplish this, ABC will arrange for a public entity to acquire its

equity interests in exchange for the public entity's equity interests.

In here, the public entity is the legal acquirer because it

issued its equity interests, and ABC Co. is the legal acquiree

because its equity interests were acquired. However, when

applying the acquisition method:

a. the public entity is identified as the acquiree for accounting

purposes (accounting acquiree); and

b. ABC Co. is identified as the as the accounting acquirer.

Measuring the consideration transferred

In substance, the accounting acquirer issues no consideration to

the acquiree. Instead, the accounting acquiree issues equity

interests to the owners of the accounting acquirer for them to

128 Chapter 1

obtain control over the accounting acquiree.

As such, the acquisition-date fair value of the

consideration transferred by the accounting acquirer is measured

as an amount based on the number of equity interests the legal

subsidiary (accounting acquirer) would have had to issue to give the

owners of the legal parent (accounting acquiree) the same

equity interest in the combined entity that results from the reverse

e percentage of

acquisition.
Conventional acquisition vs. Reverse acquisition:
Conventional
Reverse acquisition
acquisition
Accounting acquirer.- Accounting acquiree.
Issuer of shares as
consideration
transferred
Reference to
combining
constituents
Measurement of
consideration
transferred
Accounting acquirer/
Legal parent
Accounting acquiree/
Legal subsidiary
Identifiable assets
Total assets
Fair value of
consideration
transferred by the
accounting acquirer.
Accounting
acquirer/ Legal
subsidiary
Accounting
Business Combinations (Part 1) 129

acquiree/ Legal
parent
Illustration: Reverse acquisition
ABC Co., a publicly listed entity, and XYZ, Inc., an unlisted
company, exchange equity interests.
• ABC Co. issues 5 shares in exchange for all the outstanding
shares of XYZ, Inc.
• ABC's shares are quoted at P40 per share, while XYZ's shares
have a fair value of P200 per share.
• The statements of financial position immediately before the
combination are shown below:
ABC Co.
1,600,000
- 1,600,000
Fair value of the
notional number of
equity instruments that
the accounting acquirer
(legal subsidiary)
would have had 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.
XYZ, Inc.
2,400,000
2,400,000
Liabilities
Share capital:
10,000 ordinary shares, P10 par
8,000 ordinary shares, P100 par
Retained earnings
Total liabilities and equity
●
1,300,000
Solution:
Requirements:
a. Identify the accounting acquirer.
b. Compute for the goodwill.
100,000
200,000
1,600,000
ABC's currently issued shares
130 Chapter 1

Shares issued to XYZ (5 x 8,000)

Total shares after the combination
The assets and liabilities approximate their fair values.
700,000
800,000
900,000
2,400,000
Requirement (a):
Legal form of the contract: ABC issues 5 shares for each of the 8,000
outstanding shares of XYZ. After the issuance, ABC's equity will
have the following structure:
10,000
40,000
50,000
20%
80%
Analysis: The business combination is a reverse acquisition
because XYZ obtains control over ABC despite the fact that ABC
is the issuer of shares. In other words, XYZ let itself be acquired
(legal form) in order to gain control over ABC (substance).
> XYZ, Inc., the legal acquiree, is the accounting acquirer.
> ABC, Co..., the legal acquirer, is the accounting acquiree.Requirement (b):

Substance of the contract: XYZ obtains control over ABC in a reverse

acquisition. Accordingly, the consideration transferred is

computed based on the number of shares XYZ (accounting acquirer)

would have had to issue to give ABC (accounting acquiree) the same

percentage of equity interest in the combined entity.

Reverse - XYZ (accounting acquirer) issues shares to ABC

Shares

8,000

XYZ's currently issued shares

Shares issued to ABC [(8,000 + 80%) x 20%]

Total shares after the combination

Consideration transferred (2,000 sh. x 1200)

Business Combinations (Part 1) 131

Non-controlling interest in the acquiree

Previously held equity interest in the acquiree

2,000

10,000

If the business combination had taken the form of XYZ

issuing additional ordinary shares to ABC's shareholders, XYZ

would have had to issue 2,000 shares for the ratio of ownership

interest in the combined entity to be the same. XYZ's shareholders

would then own 8,000 of the 10,000 issued shares of XYZ (80% of

the combined entity), while ABC's shareholders own 2,000 (20% of

the combined entity).

Total

Fair value of ABC's net assets (1.6M-1.3M)

Goodwill

80%

20%

400,000

400,000

(300,000)

100,000
3
Chapter 3: Summary
Goodwill arising from a business combination is not
amortized but tested for impairment at least annually.
In a reverse acquisition, the issuer of shares (the legal acquirer)
is the accounting acquiree.
132 Chapter 1

The consideration transferred in a reverse acquisition is

measured based on the number of equity interests the legal
subsidiary (accounting acquirer) would have had to issue to give the
owners of the legal parent (accounting acquiree) the same
percentage of equity interest in the combined entity that results from
the reverse acquisition.
PROBLEMS:
PROBLEM 1: FOR CLASSROOM DISCUSSION
Methods of estimating goodwill
Use the following information for the next four items:
Entity A is contemplating on acquiring Entity B. Relevant
information follows:
• Entity B's average annual earnings in the past 5 years were
$1,000,000.
Entity B's net assets as at the current year-end have a fair
value of P8,000,000.
●
The industry average rate of return on equity is 12%.
The probable duration of Entity B's "excess earnings" is 5
years.
1. Goodwill is equal to the average excess earnings capitalized at
25%. How much is the goodwill?
2. Goodwill is measured by capitalizing the average earnings at
12%. How much is the goodwill?
4
3. Goodwill is measured at the undiscounted amount of total
excess earnings expected to be earned from the combination.
How much is the goodwill?
4. Goodwill is measured by discounting the average excess
earnings at 9%. How much is the goodwill?
Reverse acquisition
5. Entity A and Entity B exchanged equity interests in a business
combination. Relevant information follows:
• Entity A has 2,000 issued shares. To effect the business
combination, Entity A will issue 2 new shares for each of
the 3,000 total outstanding shares of Entity B.
• Entity A's shares have fair value of P100 per share, while
Entity B's shares have fair value of P300 per share.
Entity A's net identifiable assets have a fair value of
$260,000 as at the acquisition date.
How much is the goodwill?
●
PROBLEM 2: MULTIPLE CHOICE-THEORY
1. After initial recognition, goodwill arising from a business
combination is (use 'full PFRSs')
a. amortized over its useful life, not exceeding 10 years.
Business Combinations (Part 1) 133

b. not amortized but tested for impairment at least annually.

c. amortized over its useful life, not exceeding 40 years.
d. amortized and tested for impairment.
2. How is goodwill tested for impairment?
a. Goodwill is allocated to CGUs. The CGUS are the ones
tested for impairment. Any impairment is charged first to
the allocated goodwill, and any excess is charged to the
other assets in the CGU.
b. Goodwill is unidentifiable, i.e., cannot be seen. Therefore,

to test goodwill for impairment, the accountant must use a

microscope.

c. Goodwill can be tested for impairment on its own the

accountant smells it, if it is bad, the goodwill is impaired!

d. Any of these as a matter of accounting policy choice.

3. The costs of internally developed goodwill and the costs of

maintaining a recognized goodwill are

a. capitalized as costs of goodwill.

b. not capitalized but rather expensed when incurred.

c. sometimes capitalized and sometimes expensed.

d. ignored for accounting purposes.

4. In a reverse acquisition,

a. the issuer of shares is the accounting acquirer.

b. the legal acquirer is also the accounting acquirer.

c. the consideration transferred is liability rather than asset.

d. the legally acquired is the accounting acquirer.

5. How is the consideration transferred in a reverse acquisition

measured?
134 Chapter 1

a. at nil.

b. at cost rather than fair value.

in a reverse fashion by squeezing upwards starting with

goodwill.

d. as an amount based on the number of equity interests the

legal subsidiary (accounting acquirer) would have had to

issue to give the owners of the legal parent (accounting

acquiree) the same percentage of equity interest in the

combined entity that results from the reverse acquisition.

PROBLEM 3: MULTIPLE CHOICE-COMPUTATIONAL
Use the following information for the next three questions:
Gamer Co. and Player Co. are planning to combine their
businesses and put up a new entity called App Corporation.
. App will issue 100,000 ordinary shares, which are to be
subdivided between Gamer and Player based on their total
contributions, including goodwill.
Goodwill is computed by capitalizing excess earnings at 20%.
• The industry normal earnings are 5% of net assets.
Fair value of net identifiable assets
Average annual earnings
a. 175,000
b. 100,000
Gamer Co.
500,000
40,000
a. 45,500
b. 64,500
c. 25,500
d. 54,500
1. How much is the total goodwill expected to arise from the
business combination?
c. 75,000
d. 0
Player Co.
2. How many shares will be issued to Gamer and Player,
respectively?
Gamer Co.
Player Co.
Business Combinations (Part 1) 135

54,500
380,000
39,000
35,500
74,500
45,500
3. Which of the combining entities is most likely the acquirer?
a. Gamer Co.
c. App Corporation
d. Google Play
b. Player Co.
4. Cloudy Co. plans to acquire all the assets and liabilities of Day
Co. Cloudy expects that it will need to pay a premium equal to
the discounted amount of Day's excess average annual
earnings in order to effect the transaction. The appropriate
discount rate is 10%. NOT FOR SALE!
.
•
•
Day's earnings in the past 5 years:
Year
20x1
20x2
20x3
20x4
20x5
Total
Earnings
120,000
130,000
135,000
125,000
140,000
650,000
The 20x4 earnings include an expropriation loss of
P40,000.
Day's net assets have a current fair value of P590,000.
The industry average rate of return on net assets is 12%.
The probable duration of "excess earnings" is 5 years.
How much is the estimated purchase price?
a. 932,432
b. 844,741
d. 798,324
5. Sunday Co., a publicly listed entity, and Monday Co., a
private company, exchange equity interests in a business
combination.
136 Chapter 1

• Sunday Co. issues 12 shares for all the outstanding shares

of Monday.
•
•
Sunday's shares are quoted at P60 per share, while
Monday's shares have a fair value of P200 per share.
The net assets of the entities immediately before the
combination are shown below: (The amounts approximate
the acquisition-date fair values)
Sunday Co.
EQUITY
Share capital:
12,000 ordinary shares, P10 par
9,000 ordinary shares, P100 par
Retained earnings
Total equity
How much is the goodwill?
a. 50,000
c. 817,447
120,000
10,000
130,000
b. 60,000OR SA. 70,000
Monday Co.
900,000
800,000
1,700,000
d. 90,000Chapter 4

Consolidated Financial Statements (Part 1)

Related standards:

PFRS 10 Consolidated Financial Statements

Section 9 of the PFRS for SMEs

Overview on the topic

Our discussion on business combination is subdivided into the

following chapters:

Chapter

Title
Business Combinations (Part 1) 137

Consolidated FS (Part 1)

Consolidated FS (Part 2)

Consolidated FS (Part 3)

7 Consolidated FS (Part 4)

45

Coverage

Basic consolidation procedures

Intercompany transactions

Miscellaneous topics

Measurement at other than cost

Learning Objectives

1. State the elements of control.

2. Prepare consolidated financial statements at the acquisition

date.

3. Prepare consolidated financial statements at a subsequent

date.

Introduction

PFRS 3 deals with the accounting for a business combination at

the acquisition date, while PFRS 10 deals with the preparation

and presentation of consolidated financial statements after the

business combination.
138 Chapter 1

> Consolidated financial statements - "the financial statements

of a group in which the assets, liabilities, equity, income,

expenses and cash flows of the parent and its subsidiaries are

presented as those of a single economic entity."

> Group - "a parent and its subsidiaries."

Parent - "an entity that controls one or more entities."

Subsidiary "an entity that is controlled by another entity."

(PFRS 10. Appendix A)

NOT FOR SALE!

All parent entities are required to prepare consolidated
financial statements, except as follows:
1. A parent is exempt from presenting consolidated financial
statements if:
a. it is a subsidiary of another entity (whether wholly-owned
or partially-owned) and all its other owners do not object
to its non-presentation of consolidated financial
statements;
b. its debt or equity instruments are not traded in a public
market (or being processed for such purpose); and
c. its ultimate or any intermediate parent produces
consolidated financial statements that are available for
public use and comply with PFRSs.
2. Post-employment benefit plans or other long-term employee
benefit plans to which PAS 19 applies.
.
Control
Control is the basis for consolidation. PFRS 10 requires an investor
to determine whether it is a parent by assessing whether it
controls the investee.
Control of an investee - "an investor controls an investee when
the investor is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to affect
those returns through its power over the investee."
(PFRS 10.Appdendix A)
Control exists if the investor has all of the following:
a. Power over the investee;
b. Exposure, or rights, to variable returns from the investee; and
Business Combinations (Part 1) 139

c. Ability to the affect returns through use of power.

Only one entity is identified to have control over an
investee. If two or more investors collectively control an investee,
such as when they must act together to direct the investee's
relevant activities, none of them individually controls the investee.
All rights
Accordingly, each investor accounts for its interest in the investee
in accordance with PFRS 11 Joint Arrangements, PAS 28 Investments
in Associates and Joint Ventures or PFRS 9 Financial Instruments, as
appropriate.
Example:
ABC Co. holds 70% of the voting shares of Alphabets, Inc. XYZ,
Inc., the former majority owner of Alphabets, holds 10% of the
voting shares of Alphabets but retains its power to appoint the
majority of the board of directors of Alphabets. The other 20% is
held by various shareholders holding shares of 1% or less.
Decisions about the relevant activities of Alphabets require the
approval of a majority of votes cast at relevant shareholders'
meetings - 75% of the voting rights of the investee have been cast
at recent relevant shareholders' meetings.
Analysis:
Neither ABC Co. nor XYZ, Inc. has control over Alphabets Co.
Power
An investor has power over an investee when the investor has
existing rights that give it the current ability to direct the
investee's relevant activities.
Relevant activities - "activities of the investee that significantly
affect the investee's returns." (PFRS 10. Appendix A)
An investor's current ability to direct the investee's
relevant activities is often evidenced by the investor's ability to
establish and direct the investee's operating and financing
policies, e.g., making operating and capital decisions, and
appointing, remunerating, and terminating key management
personnel.
Power arises from rights and it may be obtained directly
from the voting rights conferred by shareholdings. However,
power may also arise from other sources, such as contractual
arrangements. Examples of rights that can give an investor power:
a. Voting rights (or potential voting rights);

b. Rights to appoint or remove members of the investee's key

management personnel or another entity that directs the

relevant activities of the investee;

140 Chapter 1

c. Rights to direct the investee to enter into transactions for the

benefit of the investor; and

d. Other decision-making rights that give the investor the ability

to direct the investee's relevant activities. (PFRS 10.B15)

Administrative rights

When voting rights do not have a significant effect on an

investee's returns, such as when voting rights relate to

administrative tasks only and contractual arrangements

determine the direction of the relevant activities, the investor

needs to assess those contractual arrangements in order to

determine whether it has rights sufficient to give it power over the

investee.

Unilateral rights

If two or more investors individually (unilaterally) have the ability

to direct different relevant activities, the investor that has the

current ability to direct the activities that most significantly affect

the returns of the investee has power over the investee.

Protective rights

An investor can have power over an investee even if other entities

have existing rights that give them the current ability to

participate in the direction of the relevant activities, for example

when another entity has significant influence.

However, an investor that holds only protective rights

Business Combinations (Part 1) 141

does not have power over an investee, and consequently does not

control the investee.

> Protective rights are "rights designed to protect the interest of

the party holding those rights without giving that party power

over the entity to which those rights relate." (PFRS 10.Appendix A)

NOT FOR SALE!

Examples of protective rights:
a. A lender's right to seize the assets of the borrower if the
borrower defaults on a loan, or to restrict the borrower from
undertaking activities that are detrimental to the lender.
b. The right of holders of non-controlling interests to approve
capital expenditure above a specified amount, or the issue of
equity or debt instruments.
Example: Unilateral right and Protective right
Entity A holds 10% voting rights in Entity B. Entity A is also the
franchisor of Entity B. The franchise agreement confers Entity A
some decision-making rights regarding the operations of Entity B.
Analysis:
The franchise agreement provides both Entity A
(investor/franchisor) and Entity B (investee/franchisee) unilateral
rights in directing the relevant activities of Entity B. In assessing
the existence of power, the entity with the ability to direct the
activities that most significantly affect the returns of Entity B has
power over Entity B.
If the decision-making rights granted to Entity A are
designed solely to protect the franchise brand (protective right)
and the unilateral right of Entity B is to operate the franchise in
accordance with the franchise agreement but for its own account,
Entity A does not have power over Entity B.
Substantive rights
In assessing whether it has a power, an investor considers only
substantive rights, i.e., rights which the investor has the ability to
exercise.
Application examples - Substantive rights
Fact pattern (This applies to each of the independent cases below)
An investee's policies over relevant activities can be changed only
at scheduled shareholder's meetings or at special meetings.
The next scheduled shareholders' meeting is in 8 months.
Shareholders that individually or collectively hold at least 5%

of the voting rights can call a special meeting to change the

142 Chapter 1

existing policies over the relevant activities. This requires

giving notice to the other shareholders, which means that a

special meeting cannot be held for at least 30 days.

Case #1

An investor holds a majority of the voting rights in the investee.

Analysis:

The investor's voting rights are substantive because the investor is

able to direct the investee's relevant activities in both a scheduled

shareholder's meeting and a special meeting.

Case #2 (PFRS 10.B24)

An investor owns a forward contract (or an option contract that is

'in the money') to purchase a majority of the investee's shares. The

contract's settlement date is in 25 days.

Analysis:

The investor's voting rights are substantive. The existing

shareholders are unable to change the existing policies over the

relevant activities because a special meeting cannot be held for at

least 30 days, at which point the contract will have been settled.

Case #3

The settlement date of the forward contract (or the option

contract) in Case #2 is in 6 months.

Analysis:

The investor's voting rights are not substantive. The existing

Business Combinations (Part 1) 143

shareholders can change the existing policies over the relevant

activities through a special meeting.

Voting rights

The investor's ability to direct the relevant activities of an investee

is normally obtained through voting or similar rights.ective autho

Power with a majority of the voting rights
An investor that holds more than half (51% or more) of the voting
rights of an investee is presumed to have power over the investee,
except when this is clearly not the case.
Holding more than half of the voting rights results to
power when:
a. The relevant activities are directed through majority vote; or
b. A majority of the members of the governing body that directs
the relevant activities are appointed through majority vote.
Majority of the voting rights but no power
An investor does not have power over an investee, even if he
holds more than half of the voting rights, if:
a. The right to direct the investee's relevant activities is conferred
to a third party who is not an agent of the investor. For
example, the investee's relevant activities are subject to
direction by a government, court, administrator, receiver,
liquidator or regulator.
b. The investor's voting rights are not substantive.
Power without a majority of the voting rights
An investor can have power even if he holds less than a majority
of the voting rights of an investee. For example, through:
a. A contractual arrangement between the investor and other
vote holders;
b. Rights arising from other contractual arrangements;
c. The investor's voting rights;
d. Potential voting rights; or
e. A combination of (a)-(d).
Contractual arrangement with other vote holders
A contractual arrangement between an investor and other vote
holders can give the investor power if the contractual
arrangement gives the investor:
NOT FOR SALE!
a. The right to exercise the voting rights of other vote holders
sufficient to give the investor power; or
b. The right to direct how other vote holders vote to enable the
investor to make decisions about the relevant activities.
144 Chapter 1

Under the Corporation Code of the Philippines, an example of a contractual

arrangement described above is referred to as "proxy."
Example: (PFRS 10.B43-B45)
Investor A holds 40% of the voting rights of an investee. The other
60% is held by 12 other investors, each holding 5%. A shareholder
agreement grants Investor A the right to appoint, remove and set
the remuneration of management responsible for directing the
relevant activities. To change the agreement, a two-thirds vote of
the shareholders is required.
Analysis:
Investor A has power over the investee because of his contractual
right to appoint, remove and set the remuneration of
management.
Rights from other contractual arrangements
Rights from other contractual arrangements may give an investor
the current ability to direct an investee's relevant activities, for
example, the investee's manufacturing processes or other
operating or financing activities that significantly affect the
investee's returns. However, in the absence of any other rights,
economic dependence of an investee on the investor (such
customer-supplier relationship) does not result to power.
as
The investor's voting rights
An investor with less than a majority of the voting rights has
power when he has the practical ability to direct the relevant
activities unilaterally.
Example 1

Entity A holds 40% of the voting rights of Entity B. The remaining

60% is held by numerous shareholders in very small

denominations. None of the shareholders make collective

decisions.

Analysis:

Entity A has power over Entity B because the other shareholdings

are widely dispersed and are not being exercised collectively.

Example 2

Entity A holds 30% of the voting rights of Entity B. Four other

Business Combinations (Part 1) 145

investors hold 5% each. The remainder is widely dispersed. None

of the shareholders make collective decisions. Decisions about

Entity B's relevant activities require a majority of vote. Seventy-

five percent of the voting rights have been cast in previous

shareholders' meetings.

Analysis:

Entity A has no power over Entity B because it does not have the

ability to unilaterally direct Entity B's relevant activities. This

requires the active participation of the other shareholders.

Example 3

Entity A holds 40% of the voting rights of Entity B. Two other

investors hold 28% each. The remaining 4% is held by numerous

other investors.

Analysis:

Entity A has no power over Entity B because the two other

investors have the ability to cooperate and prevent Entity A from

directing the relevant activities of Entity B.

Potenti
Potential voting rights include share warrants, share call
options, debt or equity instruments that are convertible into
ordinary shares, or other similar instruments that, if exercised,
have the potential to give the entity voting power or reduce
another party's voting power over an investee.
Potential voting rights are not currently exercisable if they
cannot be exercised until a future date or until the occurrence of a
future event.
However, during consolidation, non-controlling interests
are determined on the basis of present ownership interests and do
not reflect the effect of potential voting rights. Potential voting
146 Chapter 1

rights are considered only for purposes of determining the

existence of control, which in turn determines whether an investee
should be consolidated.
Example:
Entity A owns 40% of the voting rights in Entity B. Entity A also
holds bonds that are currently convertible into Entity B's ordinary
shares. If the bonds were converted, Entity A's voting rights
would be increased to 60%.
Analysis:
Entity A has power over Entity B. The existing voting rights plus
the substantive potential voting rights result to a majority of the
voting rights in Entity B.
Substantive removal and other rights held by other parties
Substantive removal and other rights held by other parties may
affect the decision maker's ability to direct the relevant activities
of an investee.
➤ Removal rights are "rights to deprive the decision maker of its
decision-making authority." (PFRS 10.Appendix A)
Such rights are considered when evaluating whether the
decision maker is a principal or an agent for other parties. An
investor acting as an agent de
does not co
control an investee. For
Ал
example, a decision maker that is required to obtain approval
from a small number of other parties for its actions is generally an
agent.
Exposure or rights to variable returns
An investor is exposed, or has a right, to variable returns if its
returns from its involvement with the investee vary depending on
the investee's performance.
Ability to use power to affect investor's returns
The investor's ability to use its power to affect its returns from the
investee provides the link between power and variable returns.
Only if this ability exists along with power and exposure or right
to variable returns does the investor obtain control over the
investee.
Power
Elements of Control
Ability to affect returns
Control
Variable
returns
Accounting requirements
Reporting dates
The financial statements of the parent and its subsidiaries used in
Business Combinations (Part 1) 147

preparing consolidated financial statements shall have the same

reporting date.
If the parent's and its subsidiary's reporting periods do
not coincide, the subsidiary shall prepare financial statements that
coincide with the parent's reporting period before consolidation.
If this is impracticable, the subsidiary's financial
statements shall be adjusted for significant transactions and events
that occur between the end of the subsidiary's reporting period
and that of the parent's. The difference between the parent's and
subsidiary's end of reporting periods shall not exceed three

months.

Uniform accounting policies

Uniform accounting policies shall be used. If the subsidiary uses

different accounting policies, its financial statements need to be

adjusted to conform to the parent's accounting policies before they

are consolidated.

Example:

A British parent entity uses the revaluation model to measure its

property, but a Philippine subsidiary uses the cost model. The

Philippine subsidiary's directors find the revaluation model too

costly to implement.

Question: In the consolidated financial statements, is the group

allowed to measure the Philippine subsidiary's property under

the cost model?

Answer: No, the Philippine subsidiary's property shall be adjusted

to conform to the group's accounting policy of revaluation model.

Consolidation period

Consolidation begins from the date the investor obtains control of

148 Chapter 1

the investee and ceases when the investor loses control of the

investee.

For example, if an investor obtains control of an investee

on July 1, 20x1, the group's consolidated financial statements for

the

year ended December 31, 20x1 shall include only the

results of operations from July 1 to December 31, 20x1.

investee's

On the other hand, if a parent loses control over its

subsidiary on September 30, 20x2, the group's consolidated

financial statements for the year ended December 31, 20x2 shall

include only the investee's results of operations from January 1 to

September 30, 20x2.

Measurement
Income and expenses
Income and expenses of the subsidiary are based on the amounts
of the assets and liabilities recognized in the consolidated financial
statements at the acquisition date.
For example, depreciation expense in the consolidated
financial statements is based on the related asset's acquisition-date
fair value, rather than its carrying amount in the subsidiary's
accounting records.
Investment in subsidiary
Investments in subsidiaries are accounted for in the parent's
separate financial statements either:
a. at cost;
b. in accordance with PFRS 9; or
c. using the equity method.
Measurement at cost
The investment in subsidiary is initially measured equal to the
value assigned to the consideration transferred at the acquisition
date and subsequently measured at that amount, unless the
investment becomes impaired.
Business Combinations (Part 1) 149

Measurement in accordance with PFRS 9

The investment in subsidiary is initially measured equal to the
value assigned to the consideration transferred at the acquisition
date and subsequently measured at fair value.
Measurement using the equity method
The investment in subsidiary is initially measured equal to the
value assigned to the consideration transferred at the acquisition
date and subsequently increased or decreased for the investor's
share in the changes in the investee's equity.
Non-controlling interests (NCI)
NCI in the net assets of the subsidiary
NCI in net assets is presented in the consolidated statement of
financial position within equity, separately from the equity of the
owners of the parent.
NCI in the net assets of the subsidiary consists of:
a. The amount determined at the acquisition date using PFRS 3,
and
b. The NCI's share of changes in equity since the acquisition
date.
NCI in profit or loss and comprehensive income
The profit or loss and each component of other comprehensive
income in the consolidated statement of profit or loss and other
comprehensive income are attributed to the following:
1. Owners of the parent
2. Non-controlling interests
Total comprehensive income is attributed to the owners of
the parent and to the NCI even if this results in the non-
controlling interests having a deficit balance.
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.
Consolidation at date of acquisition
The consolidation procedures at the acquisition date are simple
because only the statements of financial position of the combining
entities are consolidated. The consolidation involves the following
steps:
1. Eliminate the "Investment in subsidiary" account. This
requires:
NOT EOD CAI EL
a. Measuring the identifiable assets acquired and liabilities

assumed in the business combination at their acquisition-

date fair values.

150 Chapter 1

b. Recognizing the goodwill from the business combination.

c. Eliminating the subsidiary's pre-combination equity

accounts and replacing them with the non-controlling

interest.

2. Add, line by line, similar items of assets and liabilities of the

combining entities. The subsidiary's assets and liabilities are

included in the consolidated financial statements at 100% of

their amounts irrespective of the interest acquired by the

parent.

Illustration: Consolidation at acquisition date

On January 1, 20x1, ABC Co. (parent) acquires 80% interest in

XYZ, Inc. (subsidiary). The financial statements of the combining

entities immediately after the business combination are shown

below:

Cash

Accounts receivable

Inventory

Investment in subsidiary

Equipment, net

Total assets

Accounts payable

Share capital

Share premium
Business Combinations (Part 1) 151

Retained earnings

Total liabilities and equity

Parent

10,000

30,000

40,000

75,000

180,000

335,000

50,000

170,000

65,000

50,000

335,000

Subsidiary

5,000

12,000

23,000

40,000

80,000

6,000

50,000
152 Chapter 1

24,000

80,000

Additional information:

The subsidiary's assets and liabilities are stated at their

acquisition-date fair values, except for the following:

- Inventory, 31,000
Equipment, net, 48,000
The goodwill determined using PFRS 3 is $3,000.
The NCI in the net assets of the subsidiary, also determined
using PFRS 3, is $18,000.
Requirement: Prepare the consolidated statement of financial
position.
Solution:
Step 1: Eliminate the "Investment in subsidiary" account and:
a. Measure the subsidiary's assets and liabilities at their
acquisition-date fair values;
Recognize the goodwill; and
Replace the subsidiary's pre-combination equity accounts
with the NCI in net assets.
b.
c.
Cash
Accounts receivable
Inventory
Investment in subsidiary
Equipment, net
Goodwill
Accounts payable
Share capital
Share premium
Retained earnings
NCI in net assets
Step 1- Eliminate "Investment in
subsidiary" account.
Parent Subsidiary
10,000
5,000
30,000
40,000
75,000
180,000
Business Combinations (Part 1) 153

50,000
170,000
65,000
50,000
12,000
31,000
48,000
3,000
6,000
50,000
24,000
18,000
Step 1(a)- Measure
subsidiary's assets and
liabilities at
acquisition-date fair
values.
Step 1(b) - Recognize
goodwill.
Step 1(c)-Replace the
subsidiary's pre-
combination equity
accounts with the NCI
in net assets.
Step 2: Add, line by line, similar items of assets and liabilities of
the combining constituents.
Cash
Accounts receivable
Inventory
Investment in subsidiary
Equipment, net
Goodwill
Total assets
Accounts payable
Share capital
Share premium
Retained earnings
NCI in net assets
Total liabilities & equity
Parent Subsidiary Consolidated
10,000
30,000
40,000
180,000
50,000
170,000
154 Chapter 1

65,000
50,000
5,000
12,000
31,000
48,000
3,000
-
6,000
18,000
15,000
42,000
71,000
228,000
3,000
359,000
56,000
170,000
65,000
50,000
18,000
359,000
Notes:
✔100% of the assets and liabilities of the subsidiary are included
in the consolidated financial statement even though the parent
holds only 80% interest. This is an application of the following
concepts:
the consolidated financial
a. "Substance over form"
statements report the parent's ability to control the whole
of the subsidiary and not just only up to the extent of the
legal percentage acquired.
b. "Entity theory" - the parent and subsidiary is viewed as a
single reporting entity.
The subsidiary's pre-combination equity accounts (i.e., share
capital and retained earnings) are eliminated in full and
replaced with the non-controlling interest account.
The share capital, share premium, and retained earnings
accounts in the consolidated financial statements pertain to
NOT FOR SALE!
the owners of the parent, while the non-controlling interest

account pertains to the other owners of the subsidiary.

✓ The equity structure appearing in the consolidated financial

Business Combinations (Part 1) 155

statements reflects that of a "legal entity." The "group" is not

a legal entity, although each member of the group is a separate

legal entity. Thus, the consolidated financial statement reflects

the equity structure of the legal parent. The equity of the other

members of the group is presented in a single line item

described as non-controlling interests.

The consolidated statement of financial position is shown below:

ABC Group

Consolidated statement of financial position

As of January 1, 20x1

ASSETS

Cash

Accounts receivable

Inventory

Equipment, net

Goodwill

TOTAL ASSETS

LIABILITIES AND EQUITY

Accounts payable

Total liabilities

Share capital

Share premium

Retained earnings
156 Chapter 1

Owners of parent

Non-controlling interest

Total equity

15,000

42,000

71,000

228,000

3,000

359,000

56,000

56,000

170,000

65,000

50,000

285,000

18,000

303,000

TOTAL LIABILITIES AND EQUITY

Observe that the non-controlling interest is presented

within equity but separately from the equity of the owners of the

NOT FOR SALE!

parent.

359,000
Traditional Accounting Method
Business Combinations (Part 1) 157

The consolidated financial statements can also be prepared by

using (a) consolidation journal entries and (b) consolidation
worksheet.
CJE #1: To eliminate investment in subsidiary and recognize goodwill
Jan. 1, Inventory
8,000
20x1
Equipment
8,000
Share capital - XYZ, Inc.
Retained earnings - XYZ, Inc.
Goodwill
Investment in subsidiary
Non-controlling interest
to adjust the subsidiary's assets to
acquisition-date fair values, to eliminate the
investment in subsidiary and subsidiary's pre-
combination equity, and to recognize goodwill
and non-controlling interest in the consolidated
financial statements
50,000
24,000
3,000
75,000
18,000
148
ASSETS
Cash
Accounts receivable
Inventory
Investment in subsidiary
Equipment, net
Goodwill
TOTAL ASSETS
로 회의
LIABILITIES AND EQUITY
Accounts payable
Total liabilities
Share capital
Share premjum
Retained earnings
Non-controlling interest
Total equity
TOTAL LIABILITES & EQUITY
ABC Co.
Chapter 4
158 Chapter 1

ABC Group
Consolidation Worksheet
January 1, 20x1
XYZ, Inc. CJE ref. # Consolidation adjustments CJE ref. # Consolidated
Dr.
50,000
50,000
10,000
30,000
40,000 23,000
75,000
180,000
40,000
335,000
80,000
5,000
12,000
6,000
6,000
170,000
50,000
65,000
50,000 24,000
285,000 74,000
335,000
80,000
8,000
8,000
3,000
50,000
24,000
93,000
Cr.
75,000 1
18,000 1
93,000
15,000
42,000
71,000
228,000
3,000
359,000
56,000
56,000
170,000
65,000
Business Combinations (Part 1) 159

50,000
18,000
303,000
359,000
Note: Consolidation journal entries are not recorded in either of the parent's or the
subsidiary's books of accounts.
These are prepared only for the purpose of preparing the consolidated financial
statements. Consolidation
worksheets are also prepared for the same purpose, rather than as formal reports.
Consolidation subsequent to date of acquisition

The consolidation procedures subsequent to the acquisition date

involve the same procedures of (a) eliminating the investment in

subsidiary account and (b) adding, line by line, similar items of

assets, liabilities, income and expenses of the parent and the

subsidiary. However, this time, changes in the subsidiary's net

assets since the acquisition date are considered.

Illustration 1: Consolidation - Subsequent to date of acquisition

On January 1, 20x1, ABC acquired 80% interest in XYZ, Inc. for

P75,000.

Information on acquisition date (Jan. 1, 20x1):

• XYZ's net identifiable assets have a carrying amount of

P74,000 and fair value of P90,000. The difference is due to the

following:

Inventory

Equipment, net

Totals

Carrying

amount
160 Chapter 1

20,000

40,000

60,000

ASSETS

Cash

Fair

value

24,000

52,000

76,000

Fair value

adjustment (FVA)

The remaining useful life of the equipment is 6 years.

ABC measured the NCI at 'proportionate share'.

Information on subsequent reporting date (Dec. 31, 20x1):

Statements of financial position

As at December 31, 20x1

Accounts receivable

Inventory

Investment in subsidiary (at cost)

Equipment, net

TOTAL ASSETS

4,000
Business Combinations (Part 1) 161

12,000

16,000

ABC Co.

XYZ, Inc.

23,000

75,000

105,000

75,000

140,000

NOT FOR SAL 418,000

All rights belongs to respective author

57,000

22,000

15,000

30,000

124,000
LIABILITIES AND EQUITY
Accounts payable
Total liabilities
Share capital
Share premium
Retained earnings
Total equity
TOTAL LIABILITIES AND EQUITY
Statements of profit or loss
For the year ended December 31, 20x1
Sales
Cost of goods sold
Gross profit
Depreciation expense
162 Chapter 1

Distribution costs
Profit for the year
●
73,000
73,000
170,000
65,000
110,000
345,000
418,000
ABC Co.
300,000
(165,000)
30,000
Jan. 1, 20x1
74,000
16,000(a)
30,000
40,000
10,000
44,000
94,000
124,000
XYZ, Inc.
120,000
(72,000)
135,000
48,000
(40,000) (10,000)
(35,000)
(18,000)
60,000
20,000
There were no dividends declared, no intercompany
transactions and no impairment of goodwill in 20x1.
Requirement: Prepare the December 31, 20x1 consolidated financial
statements.
Solutions:
The first thing that we should do is to analyze the changes in the
subsidiary's net assets since the acquisition date. We will use the
formulas below to simplify this process.
Step 1: Analysis of subsidiary's net assets
XYZ, Inc.
Net assets at carrying amount
Fair value adjustments (FVA)
Net assets at fair valueT FOR $90,000
Business Combinations (Part 1) 163

Dec. 31, 20x1

94,000
10,000(b)
Net
change
1
9.5
All rights belongs to respective authors
104,000
14,000
!
(a) FVA at acquisition date.
(b) FVA at acquisition date less subsequent depreciation.
FVA, 1/1/x1
4,000
Useful life Depreciation FVA, 12/31/x1(b)
N/A *
Inventory
4,000
Equipment
12,000
6 yrs.
2,000
Totals
16,000
6,000
* The entire inventory is assumed to have been sold during the year.
Step 2: Goodwill computation
The goodwill that is reported in the post-combination financial
statements is the amount determined at the acquisition date less
accumulated impairment losses.
Consideration transferred
Non-controlling interest in the acquiree (90K x 20%) - Step 1
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired (see Step 1)
Goodwill - Jan. 1, 20x1
Less: Accumulated impairment losses
Goodwill-Dec. 31, 20x1
10,000
10,000
Step 3: Non-controlling interest in net assets
Subsidiary's net assets at fair value - Dec. 31, 20x1 (see Step 1)
Multiply by: NCI percentage
Non-controlling interest in net assets - Dec. 31, 20x1
Step 4: Consolidated retained earnings
164 Chapter 1

Parent's retained earnings - Dec. 31, 20x1

Parent's share in the net change in subsidiary's net assets (d)
Consolidated retained earnings - Dec. 31, 20x1
(d) Net change in XYZ's net assets (see Step 1)
Multiply by: ABC's interest in XYZ
ABC's share in the net change in XYZ's net assets
NOT FOR SALE!
75,000
18,000
93,000
(90,000)
3,000
3,000
104,000
20%
20,800
110,000
11,200
121,200
14,000
80%
11,200
The NCI computed in Step 3 can also be reconciled as follows:

NCI at acquisition date

NCI's share in net change in subsidiary's net assets (14K x 20%)

NCI - Dec. 31,20x1

Step 5: Consolidated profit or loss

Profits of ABC & XYZ (60K+20K)

Depreciation of FVA (see Step 1)

Consolidated profit

Both the parent and NCI share in the post-combination

change in the subsidiary's net assets. The parent's share is

included in retained earnings, while the NCI's share is included in

NCI.
Business Combinations (Part 1) 165

parent and NCI as follows:

80,000

(6,000)

74,000

18,000

2,800

The consolidated profit is attributed to the owners of the

Parent's profit before FVA

Share in XYZ's profit before FVA (e)

Depreciation of FVA ()

Totals

20,800

Owners of parent NCI Consolidated

60,000 N/A

60,000

16,000

4,000

20,000

(4,800) (1,200)

71,200 2,800

(6,000)

74,000
166 Chapter 1

(e) (20,000 profit of XYZ x 80% = 16,000 share of ABC); (20K x 20% = 4,000

share of XYZ). This allocation is like the parent saying, "what is yours is ours,

what is mine is mine alone." Ⓒ

(n (P6,000 depreciation of FVA x 80% = 4,800 share of ABC); (6K x 20% = 1,200

share of XYZ).

We now have all the information we need to draft the

consolidated financial statements. Recall the following

consolidation procedures:
1. Eliminate the "Investment in subsidiary" account.
a. Measure the subsidiary's assets and liabilities at their
acquisition-date fair values, net of depreciation.
b. Recognize the goodwill.
c. Replace the subsidiary's equity accounts with NCI in net
assets.
2. Add, line by line, similar items of assets and liabilities.
ABC Group
Consolidated statement of financial position
As of December 31, 20x1
ASSETS
Cash (23,000+57,000)
Accounts receivable (75,000+22,000)
Inventory (105,000 + 15,000+ 0 FVA net, Step 1)
Investment in subsidiary (Eliminated)
Equipment, net (140,000+ 30,000+ 10,000 FVA net, Step 1)
Goodwill (Step 2)
TOTAL ASSETS
LIABILITIES AND EQUITY
Accounts payable (73,000+30,000)
Total liabilities
Share capital (Parent only)
Share premium (Parent only)
Retained earnings (Parent only-Step 4)
Owners of parent
Non-controlling interest (Step 3)
Total equity
TOTAL LIABILITIES AND EQUITY
80,000
97,000
120,000
Business Combinations (Part 1) 167

180,000
3,000
480,000
103,000
103,000
170,000
65,000
121,200
356,200
20,800
377,000
480,000
ABC Group

Statement of profit or loss

For the year ended December 31, 20x1

Sales (300,000+120,000)

Cost of goods sold (165K+ 72K+ 4K dep'n. of FVA on inventory)

Gross profit

Depreciation expense (40K + 10K + 2K dep'n. of FVA on equipt.)

Distribution costs (35,000+ 18,000)

Profit for the year

Profit attributable to:

Owners of the parent (Step 5)

Non-controlling interests (Step 5)

CJE #1: To eliminate investment in subsidiary

Dec. Inventory

31,

Equipment

20x1
168 Chapter 1

Traditional accounting method

The consolidated financial statements can also be prepared by

using (a) consolidation journal entries and (b) consolidation

worksheet.

Share capital (same as year-end)

Share premium (same as year-end)

Retained earnings (74K-40K - 10K)

Goodwill

Investment in subsidiary

NCI (90K x 20%)

420,000

(241,000)

179,000

(52,000)

(53,000)

74,000

4,000

12,000

40,000

10,000

24,000

3,000

71,200
Business Combinations (Part 1) 169

2,800

74,000

75,000

18,000

The entry above is exactly the same consolidation journal

entry that was made at the acquisition-date consolidation. Notice

that all amounts pertain to the acquisition date.

CJE #2: To recognize depreciation of fair value adjustments
Dec.
Cost of sales (dep'n. of FVA on inventory)
Depreciation expense (on equipment)
Inventory
Accumulated depreciation
31,
20x1
Dec.
31,
20x2
Subsequent to 20x1, the accounts debited for the depreciation
of FVA in preceding years are the "retained earnings" of both
the parent and the subsidiary for their respective shares. For
example, in the December 31, 20x2 consolidation, the
depreciation of FVA is recorded as follows:
Retained earnings - ABC (6K* x 80%)
Retained earnings - XYZ (6K* x 20%)
Depreciation expense
Dec.
31,
20x1
Inventory
Accumulated depreciation
*This amount pertains to the depreciation of FVA recognized in 20x1.
4,000
2,000
31,
20x1
Retained earnings - ABC [(4K + 2K) x 80%]
Retained earnings - XYZ [(4K + 2K) x 20%]
Income summary - working paper
4,800
170 Chapter 1

1,200
2,000
CJE #3: To adjust the Parent's and Subsidiary's retained earnings for the
depreciation of FVA during the year
Retained earnings - ABC (d)
NCI (post-acquisition) (e)
4,000
2,000
4,800
1,200
4,000
4,000
CJE #4: To recognize NCI in post-acquisition change in XYZ's net assets
Dec. Retained earnings - XYZ
18,800
6,000
16,000
2,800
(d) This represents the parent's share in the profit or loss of the subsidiary
before FVA ("Step 5').
(e) This represents the profit or loss attributable to NCI ("Step 5').
The sum of NCI's in CJE's #1 and #4 represents the Dec. 31, 20x1 NCI.
NCI in acquisition-date net assets (CJE #1)
NCI in post-acquisition net assets (CJE #4)
Non-controlling interest in net assets - Dec. 31, 20x1
18,000
2,800
20,800
156
ASSETS
Cash
respective authors.
Accounts receivable
Inventory
Investment in subsidiary
Equipment, net
Goodwill
TOTAL ASSETS
LIABILITIES AND EQUITY
Accounts payable
Total liabilities
Share capital
Share premium
Retained earnings
Non-controlling interest
Total equity
Business Combinations (Part 1) 171

TOTAL LIAB. & EQTY.

Sales
Cost of goods sold
Gross profit
Depreciation expense
Distribution costs
Profit for the year
ABC Co.
23,000
75,000
105,000
75,000
140,000
418,000
73,000
73,000
170,000
65,000
110,000
345,000
418,000
300,000
(165,000)
135,000
(40,000)
(35,000)
60,000
XYZ, Inc.
57,000
22,000
15,000
30,000
124,000
30,000
30,000
40,000
10,000
44,000
94,000
124,000
120,000
(72,000)
48,000
(10,000)
(18,000)
20,000
172 Chapter 1

Chapter 4
CJE ref. # Consolidation adjustments CJE ref. # Consolidated
Dr.
Cr.
1
1
1
1, 3,& 4
2
2
4,000
12,000
3,000
40,000
10,000
48,800
117,800
4,000
2,000
4,000
75,000
2,000
16,000
20,800
117,800
2
2
4
1&4
80,000
97,000
120,000
180,000
3,000
480,000
103,000
103,000
170,000
65,000
121,200
20,800
377,000
480,000
420,000
(241,000)
179,000
Business Combinations (Part 1) 173

(52,000)
(53,000)
74,000
Whether the contemporary method (i.e., the first method

illustrated) or the traditional method is used in preparing

consolidated financial statements, the concepts applied are the

same. Analyze the summary below:

ASSETS

Cash

Accounts receivable

Inventory

Investment in subsidiary

Equipment, net

Goodwill

TOTAL ASSETS

LIABILITIES AND EQUITY

Accounts payable

Total liabilities

Share capital

Share premium

Retained earnings

Sales

Cost of goods sold

Gross profit

ABC Co. XYZ, Inc. Consolidated

174 Chapter 1

23,000 57,000 80,000

75,000

22,000

97,000

105,000

15,000

120,000/

75,000

140,000 30,000

Depreciation expense

Distribution costs

Profit for the year

418,000 124,000

NCI

Total equity

345,000 94,000

TOTAL LIABILITIES & EQUITY 418,000 124,000

73,000 30,000

73,000 30,000

170,000 40,000

65,000 10,000

110,000 44,000

180,000
Business Combinations (Part 1) 175

3,000

480,000

103,000

103,000

Total assets of parent

Total assets of subsidiary

Investment in subsidiary

Fair value adjustments - net

Goodwill-net

Consolidated total assets

170,000

65,000

121,200

20,800

377,000

480,000

300,000 120,000 420,000

(165,000) (72,000) (241,000)

135,000 48,000

179,000

(40,000) (10,000)

(52,000)

(35,000) (18,000) (53,000)

176 Chapter 1

74,000

60,000 20,000

Eliminate the "Investment in

Subsidiary account.

Measure assets and liabilities at

acquisition-date fair values, net of

depreciation

-Invty: (105K+15K+0FVA, net)

-Equipt: (140K+ 30K+10K FVA, net)

Recognize the goodwill.

These pertain to the parent only.

Retained earnings include parent's

share in the change in subsidiary's

net assets since acquisiton date.

Replace the subsidiary's equity

accounts with the NCI in net assets.

Recognize depreciation of FVA:

-COGS: (165K+72K+4K invty.);

-Depreciation expense (40K+10K+2K

equipt.)

The formulas below may provide additional guidance in

solving CPA board questions. Analyze how the formulas are

derived from the summary above.

Business Combinations (Part 1) 177

418,000

124,000

(75,000)

10,000

3,000

480,000
Total liabilities of parent
Total liabilities of subsidiary
Fair value adjustments - net
Consolidated total liabilities
Share capital of parent
Share premium of parent
Retained earnings (ABC's plus sh. in the change in XYZ's net assets)
Equity attributable to owners of the parent
Non-controlling interests (XYZ's net assets at fair value, net x 20%)
Consolidated total equity
Information on subsequent reporting date (Dec. 31, 20x1):
ABC Co.
Other assets
Investment in subsidiary (at cost)
Equipment, net
TOTAL ASSETS
Illustration 2: NCI measured at Fair Value
On January 1, 20x1, ABC acquired 80% interest in XYZ, Inc. for
P80,000.
Total liabilities
Share capital
Retained earnings
Total equity
TOTAL LIABILITIES AND EQUITY
Information on acquisition date (Jan. 1, 20x1):
.XYZ's net identifiable assets have a carrying amount of
P74,000 and fair value of P90,000. The difference is due to
piece of equipment with a carrying amount of $60,000 and fair
value of $76,000. The equipment's remaining useful life is 4
years.
ABC measured the NCI at a fair value of $20,000.
178,000
80,000
160,000
178 Chapter 1

418,000
.
73,000
30,000
73,000
235,000
110,000
345,000
418,000
103,000
NOT FOR SALE!
170,000
65,000
121,200
356,200
20,800
377,000
XYZ, Inc.
44,000
90,000
134,000
30,000
50,000
54,000
104,000
134,000
Income
Expenses
PROFIT FOR THE YEAR
There were no dividends declared, no intercompany
transactions and no impairment of goodwill in 20x1.
Requirement: Prepare the consolidated financial information on
December 31, 20x1.
Solutions:
300,000
130,000
(240,000) (100,000)
60,000
30,000
Step 1: Analysis of subsidiary's net assets
XYZ, Inc.
Net assets at carrying amount
Fair value adjustments (FVA)
Net assets at fair value
(a)
FVA, 1/1/x1
Business Combinations (Part 1) 179

Equipment 16,000*
Totals
16,000
* (76,000 fair value - 60,000 carrying amount)
Useful life
4 yrs.
Jan. 1, 20x1 Dec. 31, 20x1
74,000
104,000
16,000(a)
12,000(a)
90,000
116,000 26,000
Net
change
Depreciation FVA, 12/31/x1
4,000
4,000
12,000
12,000
Step 2: Goodwill computation
If NCI is measured at 'proportionate share', the goodwill is
attributable only to the owners of the parent. However, if NCI is
measured at fair value, the goodwill is attributable to both the
owners of the parent and NCI. To compute for the attributed
amounts, we will modify our previous formula for goodwill as
follows:Consideration transferred

Previously held equity interest in the acquiree

Total

Less: Parent's proportionate share in the net assets

of subsidiary (90,000 x 80%) - Step 1

Goodwill attributable to owners of the parent

Fair value of NCI

Less: NCI's proportionate share in the net assets

of subsidiary (90,000 x 20%) - Step 1

Goodwill attributable to NCI

180 Chapter 1

Goodwill-Dec. 31, 20x1

previous formula:

Consideration transferred

Non-controlling interest in the acquiree (fair value)

Previously held equity interest in the acquiree

Total

Fair value of net identifiable assets acquired (Step 1)

Goodwill-Dec. 31, 20x1

We can reconcile the computed amount using our

Subsidiary's net assets at fair value - Dec. 31, 20x1 (Step 1)

Multiply by: NCI percentage

80,000

Total

Add: Goodwill attributable to NCI (Step 2)

Non-controlling interest in net assets - Dec. 31, 20x1

80,000

Step 4: Consolidated retained earnings

Parent's retained earnings - Dec. 31, 20x1

Parent's share in the net change in subsidiary's net assets (d)

Consolidated retained earnings - Dec. 31, 20x1

(72,000)

8,000

20,000
Business Combinations (Part 1) 181

(18,000)

2,000

10,000

Step 3: Non-controlling interest in net assets

The amount of goodwill attributable to NCI is included in the NCI in

net assets as follows:

80,000

20,000

100,000

(90,000)

10,000

116,000

20%

23,200

2,000

25,200

110,000

20,800

130,800
(d) Net change in XYZ's net assets (Step 1)
Multiply by: ABC's interest in XYZ
ABC's share in the net change in XYZ's net assets
Step 5: Consolidated profit or loss
Profits of ABC & XYZ (60K+ 30K)
Depreciation of FVA (Step 1)
Consolidated profit
Parent's profit before FVA
Share in XYZ's profit before FVA (e)
182 Chapter 1

Depreciation of FVA
Owners of parent NCI Consolidated
60,000 N/A
60,000
24,000 6,000
(3,200) (800)
80,800 5,200
90,000
(4,000)
86,000
Totals
(e) (30K profit of XYZ x 80% = 24,000); (30K x 20%= 6,000)
(0 (4K depreciation of FVA x 80% = 3,200); (4K x 20%= 800)
Consolidated financial information - December 31, 20x1
Other assets (178,000+ 44,000)
Investment in subsidiary (Eliminated)
Equipment, net (160,000+90,000+12,000 FVA net, Step 1)
Goodwill (Step 2)
TOTAL ASSETS
LIABILITIES AND EQUITY
Total liabilities (73,000 + 30,000)
Share capital (Parent only)
Retained earnings (Parent only-Step 4)
Owners of parent
Non-controlling interest (Step 3)
Total equity
TOTAL LIABILITIES AND EQUITY
Income (300,000+ 130,000)
Expenses (240,000+ 100,000 +4,000 dep'n of FVA, Step 1)
PROFIT FOR THE YEAR
26,000
80%
20,800
All rights belon
30,000
(4,000)
86,000
222,000
262,000
10,000
494,000
103,000
235,000
130,800
356,800
25,200
Business Combinations (Part 1) 183

391,000
494,000
430,000
(344,000)
86,000
When NCI is measured at fair value, the computations for goodwill and NCI in net
assets (i.e., Steps 2 and 3) are modified. The other steps remain the same.
Subsidiary's cumulative preference shares
If the subsidiary has outstanding cumulative preference shares
that are classified as equity and held by non-controlling interests,
one-year preferred dividends, whether declared or not, are
deducted from the subsidiary's profit before computing for the
parent's share.
Illustration: Subsidiary's cumulative preference shares
Bear Co. owns 75% of Cub Co.'s ordinary shares. Cub Co. has
P100,000 outstanding 12% cumulative preference shares, none of
which are held by Bear Co. Bear and Cub reported individual
profits of P234,000 and P175,000, respectively, in 20x1. Neither
company declared dividends. The preference shares have
dividends in arrears of 3 years.
Requirement: Compute for the profit attributable to the owners of
the parent and NCI.
Solution:
Bear's profit
Share in Cub's profit (2)
Totals
Owners of parent
234,000
122,250
356,250
NCI
N/A
52,750(b)
52,750
> Bear's share (163,000 x 75%)
>NCI's share (163,000 x 25%)
Consolidated
234,000
175,000
409,000
(a) Profit of Cub. Co.
175,000
One-year dividends on cumulative preference sh. (100K x 12%) (12,000)
Profit of Cub Co. attributable to ordinary shareholders
163,000
(b) Profit of Cub. Co. attributable to preference shareholders
184 Chapter 1

NCI's share in profit attributable to ordinary shareholders

Total NCI's share in Cub's profit
NOT FOR SALE!
122,250
40,750
12,000
40,750
52,750
Chapter 4: Summary

A parent is required to prepare consolidated financial

statements except in limited cases mentioned in PFRS 10.

Consolidated financial statements provide information on a

parent and its subsidiaries viewed as a single reporting entity.

The basis for consolidation is control. Control exists if an

investor has the following over an investee: (1) power; (2)

exposure, or rights, to variable returns, and (b) ability to affect

returns.

• Consolidation starts when control is obtained and ceases when

control is lost. Both cases are accounted for prospectively.

• Consolidated financial statements are prepared using uniform

accounting policies and same reporting date.

Consolidation involves the following:

1. Eliminate the "Investment in subsidiary" account.

a. Measure the subsidiary's assets and liabilities at their

acquisition-date fair values, net of depreciation.

b. Recognize the goodwill.

c. Replace the subsidiary's equity accounts with NCI in net

Business Combinations (Part 1) 185

assets.

2. Add, line by line, similar items of assets and liabilities.

Consolidated retained earnings include the retained earnings

of the parent plus the parent's share in the change in net assets

of the subsidiary since acquisition date.

NCI in net assets includes the NCI at acquisition date plus the

NCI's share in the change in net assets of the subsidiary since

acquisition date.

NCI in net assets is presented within equity but separate from

the equity of the owners of the parent.

• The consolidated profit or loss is attributed to the (a) owners

of the parent and (b) NCI.

Relevant provisions of the PFRS for SMES
Section 9 Consolidated and Separate Financial Statements
A parent is required to prepare consolidated financial statements
except if:
a. the parent is itself a subsidiary and its ultimate or
intermediate parent produces consolidated
financial
statements that comply with full PFRSs or the PFRS for SMEs.
b. the subsidiary is acquired with the intention of selling it
within one year from the acquisition date.
If the subsidiary is not sold within one year, it must be
consolidated by restating all prior period financial statements,
except when the failure to sell is beyond the parent's control
and the parent remains committed to sell the subsidiary.
A subsidiary is not excluded from consolidation simply
because
a. the investor is a venture capital organization or similar entity,
or
b. the subsidiary's business activities are dissimilar to those of
the other entities within the group, or
c. the subsidiary operates in a jurisdiction that imposes
restrictions on transferring cash or other assets out of the
jurisdiction.
186 Chapter 1

A parent that does not have public accountability may

present its separate financial statements in accordance with the
PFRS for SMEs, even if it presents its consolidated financial
statements in accordance with full PFRSs.
Special purpose entities (SPE)
a narrow
An SPE is an entity that is created to accomplish
objective (e.g., to effect a lease, undertake R&D activities of
securitize financial assets). An SPE may take the form of a
corporation, trust, partnership or unincorporated entity.
SPEs that are controlled by an entity are included in the
entity's consolidated financial statements, to respective authors.
> Control is "the power to govern the financial and operating
policies of an entity so as to obtain benefits from its activities."
"Control is presumed to exist when the parent owns, directly
or indirectly through subsidiaries, more than half of the
voting power of an entity." (PFRS for SMES 9.4 & 9.5)
Consolidation procedures
a. Eliminate the investment in subsidiary.
b. Measure the NCI in net assets and NCI in profit or loss and
present them separately from those of the owners of the
parent.
c. Add, line by line, similar items of assets, liabilities, equity,
income and expenses of the combining entities.
The parent's and NCI's shares in the subsidiary's changes
in equity and profit or loss are computed based on existing
ownership interests and do not reflect the possible exercise or
conversion of options or convertible instruments
Intragroup balances and transactions
Intragroup balances and transactions, including income, expenses
and dividends, are eliminated in full.
Uniform reporting date
The parent's and the subsidiary's financial statements used in
consolidation shall be prepared as of the same reporting date. If
not, the subsidiary's financial statements are adjusted first before
they are consolidated.
Uniform accounting policies
Consolidated financial statements are prepared using uniform
accounting policies. If a subsidiary uses accounting policies that
are different from those of the group's, the subsidiary's financial
statements are adjusted first before they are consolidated.
Acquisition and disposal of subsidiaries

The subsidiary's income and expenses are consolidated from the

acquisition date to the date the parent ceases to control the

Business Combinations (Part 1) 187

subsidiary.

When control ceases, the difference between the disposal

proceeds and the subsidiary's carrying amount at disposal date is

recognized as gain or loss.

The cumulative amount of any exchange differences that

relate to a foreign subsidiary recognized in other comprehensive

income is not reclassified to profit or loss on disposal of the

subsidiary.

If control ceases but the investor (former parent) continues

to hold investment in the former subsidiary, the investment is

accounted for

a. at fair value, with changes in fair value recognized in profit or

loss, or

b. at cost less accumulated impairment losses.

Investments in quoted shares and investments for which

the fair value can be measured reliably are measured at fair value.

Measurement at cost is appropriate only when fair value cannot

be measured reliably. The carrying amount of the investment at

the date control ceases is the investment's deemed cost for

measurement purposes.

If the investment retained in the former subsidiary

qualifies as an investment in associate or an interest in a jointly

controlled entity, the investment is accounted for

188 Chapter 1

a. at fair value, with changes in fair value recognized in profit or

loss, or

b. at cost less accumulated impairment losses, or

c. using the equity method.

PROBLEMS:
PROBLEM 1: TRUE OR FALSE
1. The basis for consolidation is power.
2. Entity A acquires Entity B on November 1, 20x1. The 20x1
consolidated profit includes Entity B's profit from January 1 to
December 31, 20x1 - it is as if control had existed for the entire
year.
3. Goodwill is remeasured to fair value at each reporting date.
Use the following information for the next two items:
Entity A acquired 90% interest in Entity B on January 1, 20x1
when Entity B's net assets had a fair value of 100. On December
31, 20x2, Entity B's net assets increased to $200 after adjustments
for acquisition-date fair values, net of depreciation.
4. The NCI on December 31, 20x2 is $20.
5.
Before consolidation, Entity A's retained earnings balance is
$1,000. The consolidated retained earnings is $1,090.
6.
7.
NCI in the net assets of a subsidiary is presented in the
consolidated financial statements as a mezzanine item.
Goodwill is attributed both to the owners of the parent and
non-controlling interests only if the non-controlling interests
are measured at fair value.
8. The amount of goodwill attributed to non-controlling interests
is included in the measurement of non-controlling interests in
the subsidiary's net assets.
Use the following information for the next two items:
Day Co. owns 80% of Night Co. Day and Night reported profits of
$200 and 100, respectively, in 20x1. There is no depreciation of
fair value adjustment.
9. The consolidated profit is $300.
10. The profit attributable to the owners of Day Co. is $280.
PROBLEM 2: FOR CLASSROOM DISCUSSION
Consolidation at acquisition date
1. On January 1, 20x1, Health Co. acquired 70% interest in
Wealth Co. The financial statements of the combining entities
right after the business combination are as follows:
Business Combinations (Part 1) 189

Health Co.
Cash
Accounts receivable
Inventory
Investment in subsidiary
Prepaid assets
Building, net
Total assets
Accounts payable
Share capital
Share premium
Retained earnings
Total liabilities and equity
100,000
120,000
400,000
560,000
30,000
1,200,000
2,410,000
70,000
1,000,000
350,000
990,000
2,410,000
Wealth Co.
20,000
40,000
100,000
10,000
400,000
570,000
90,000
200,000
50,000
230,000
570,000
The carrying amounts of Wealth's assets and liabilities
approximate the acquisition-date fair values, except as follows:
Fair value
Carrying amount
40,000
20,000
400,000
540,000
Accounts receivable
190 Chapter 1

Building, net
Health measured the NCI at 'proportionate share'.
Requirement: Prepare the consolidated statement of financial
position.
Consolidation subsequent to acquisition date - 'proportionate
2. Pink Co. acquired 90% interest in Floyd, Inc. on January 1,
20x1.
Information on Jan. 1, 20x1:

Floyd's net identifiable assets have a carrying amount of

P480,000 and fair value of P600,000. The difference is due to

the following:

Inventory

Building, net

Carrying amount Fair value

110,000

510,000

• The remaining useful life of the building is 5 years.

• Pink measured the NCI at 'proportionate share'.

ASSETS

Cash

100,000

400,000

Information on Dec. 31, 20x1:

Statements of financial position

As at December 31, 20x1

Prepaid assets

Building, net
Business Combinations (Part 1) 191

Total assets

Accounts receivable

Inventory

Investment in subsidiary (at cost)

Accounts payable

Share capital

Share premium

Retained earnings

Total liabilities and equity

Statements of profit or loss

For the year ended December 31, 20x1

Sales

Cost of goods sold

Gross profit

Depreciation expense

Pink Co.

620,000

170,000

200,000

560,000

10,000

1,100,000

2,660,000
192 Chapter 1

50,000

1,000,000

350,000

1,260,000

2,660,000

Pink Co.

600,000

(200,000)

400,000

NOT FO(100,000) E!

Floyd Co..

120,000

100,000

80,000

8,000

350,000

658,000

90,000

200,000

50,000

318,000

658,000

Floyd Co.
Business Combinations (Part 1) 193

200,000

(60,000)

140,000

(50,000)
Distribution costs
Profit for the year
Solution:
• There were no dividends declared, no intercompany
transactions and no impairment of goodwill in 20x1.
Requirement: Prepare the December 31, 20x1 consolidated financial
statements.
Consolidation subsequent to acquisition date - "fair value'
3. Use the information in the preceding problem except that Pink
measured the NCI at a fair value of $65,000.
Cash
Inventory
Investment in subsidiary
(30,000)
270,000
Requirement: Prepare the December 31, 20x1 consolidated financial
statements.
Land
Total assets
PROBLEM 3: EXERCISES
1. On January 1, 20x1, Sunny Co. acquired 60% interest in Rainy
Co. for P300,000. The financial statements of Sunny Co. and
Rainy Co. right after the business combination follows:
Rainy Co.
Accounts payable
Share capital
Retained earnings
Total liabilities & equity
Sunny Co.
Carrying
amt.
80,000
400,000
300,000
600,000
1,380,000
200,000
1,000,000
194 Chapter 1

180,000
1,380,000
(2,000)
88,000
Carrying
amt.
50,000
120,000
200,000
370,000
80,000
250,000
40,000
370,000
Rainy Co.
Fair value
50,000
80,000
250,000
380,000
80,000
250,000
50,000
380,000
NCI is measured under the proportionate share method.
Requirement: Prepare the consolidated statement of financial
position on January 1, 20x1.
2. On January 1, 20x1, Hammer Co. acquired 80% interest in Folk
Co. The financial statements of the combining entities right
after the business combination are as follows:
Cash
Accounts receivable
Inventory
Investment in subsidiary
Building, net
Total assets
Accounts payable
Share capital
Share premium
Retained earnings
Total liabilities and equity
Hammer Co.
160,000
200,000
400,000
520,000
Business Combinations (Part 1) 195

1,000,000
2,280,000
100,000
1,000,000
300,000
880,000
2,280,000
Folk Co.
10,000
110,000
80,000
300,000
500,000
20,000
200,000
100,000
180,000
500,000
• Folk's assets and liabilities approximate their fair values,
except inventory (fair value is 100,000) and building (fair
value is $400,000).
• Hammer measured the NCI at 'proportionate share'.
Requirement: Prepare the consolidated statement of financial
position.
3. On January 1, 20x1, Run Co. acquired 80% interest in Walk Co.
Information on Jan. 1, 20x1:
Walk's net identifiable assets have a carrying amount of
P480,000 and fair value of P600,000. The difference is due to
NOT FOR SALE!
172

Information on Dec. 31, 20x1:

Statements of financial position

the following: inventory (carrying amount, P80,000; fair value,

P100,000) and building (carrying amount, 300,000; fair value,

$400,000).

The remaining useful life of the building is 10 years.

Run measured the NCI at 'proportionate share'.

196 Chapter 1

As at December 31, 20x1

ASSETS

Cash

Accounts receivable

Inventory

Investment in subsidiary (at cost)

Building, net

Total assets

Accounts payable

Share capital

Share premium

Retained earnings

Total liabilities and equity

Statements of profit or loss

For the year ended December 31, 20x1

Sales

Cost of goods sold

Gross profit

Depreciation expense

Distribution costs

Profit for the year

Run Co.
Business Combinations (Part 1) 197

750,000

260,000

200,000

520,000

950,000

2,680,000

80,000

1,000,000

300,000

1,300,000

2,680,000

Chapter 4

Run Co.

800,000

(200,000)

600,000

(50,000)

(130,000)

420,000

Walk Co.

258,000

50,000

20,000
198 Chapter 1

250,000

578,000

10,000

200,000

100,000

268,000

578,000

Walk Co.

200,000

(60,000)

140,000

(50,000)

(2,000)

88,000

There were no dividends declared, no intercompany

transactions and no impairment of goodwill in 20x1.

Consolidated Financial Statements (Part 1)
Requirement: Prepare the December 31, 20x1 consolidated financial
statements.
4. Use the same information in #3 above except that Run Co.
measured the NCI at a fair value of $130,000.
Requirement: Prepare the December 31, 20x1 consolidated financial
statements.
5. On January 1, 20x1, Joy Co. acquired 60% interest in Axion,
Inc. for P300,000. Information on Axion's financial position on
this date follows:
. The identifiable assets and liabilities approximated their
fair values except for inventories with carrying amount of
P120,000 and fair value of P80,000 and building with
carrying amount of P200,000 and fair value of $250,000.
Business Combinations (Part 1) 199

The building has a remaining useful life of 5 years.

Axion's equity comprises only share capital and retained
earnings with carrying amounts of P250,000 and P40,000,
respectively.
NCI is measured at 'proportionate share'.
●
173
All the inventories on January 1, 20x1 were sold during 20x1. No
dividends were declared by either entity during 20x1. There were
also no intercompany transactions and no impairment of
goodwill. The individual financial statements of the entities on
December 31, 20x1 are shown below:
Statements of financial position
As at December 31, 20x1
ASSETS
Cash
Joy Co.
143,000
440,000
300,000
560,000
NOT FOR 1,443,000
Inventory
Investment in subsidiary (at cost)
Building-net
TOTAL ASSETS
Axion Co.
60,000
160,000
160,000
380,000
LIABILITIES AND EQUITY
Accounts payable
Share capital
Retained earnings
Total equity
TOTAL LIABILITIES AND EQUITY
Statements of profit or loss
For the year ended December 31, 20x1
Sales
Cost of goods sold
Gross profit
Depreciation expense
Distribution costs
Profit for the year
200,000
200 Chapter 1

1,000,000
243,000
1,243,000
1,443,000
Joy Co.
300,000
(165,000)
135,000
(40,000)
(32,000)
63,000
70,000
250,000
60,000
310,000
380,000
Axion Co.
120,000
(72,000)
48,000
(10,000)
(18,000)
20,000
Requirement: Prepare the consolidated financial statements as at
December 31, 20x1.
6. Use the same information in #5 except that Joy Co. measured
the NCI at fair value of $132,000.
Requirement: Prepare the consolidated financial statements as at
December 31, 20x1.
PROBLEM 4: MICROSOFT EXCEL

NOTE: This activity is OPTIONAL as the learner will need to

have access to a COMPUTER with a Microsoft Excel

application installed in it.

1. Open a Microsoft Excel® Worksheet and copy the following:

2
Business Combinations (Part 1) 201

Cash

3 Accounts receivable

4 Inventory

5 Investment in subsidiary

6 Land

8 Accounts payable

9 Share capital

10 Share premium

11 Retained earnings

Paste

Home

Cut

la Copy-

Insert

Format Painter

Clipboard

To place commas on the amounts or increase/decrease

decimal places, use these buttons.

.C.A.

Page Layout

Calibri

Formulas Data
202 Chapter 1

Parent Subsidiary

40,000

50,000

10,000

180,000

800,000

90,000

500,000

100,000

390,000

2. Make your table look like this:

Review View

Acrobat

5,000

20,000

25,000

Alignment

250,000

130,000

80,000

90,000

Wrap Text

Merge & Center.

Business Combinations (Part 1) 203

Number
1
2
Cash
3 Accounts receivable
4 Inventory
5 Investment in subsidiary
6 Land
7
8
Goodwill
Totals
A
9
10 Accounts payable
11 Share capital
12
13 Retained earnings
14 NCI
15 Totals
AC
Paste
Share premium
cut
Copy-
Format Painter
Clipboard
B
Parent
40,000
50,000
10,000
180,000
800,000
Salibri
VN
1,080,000
90,000
500,000
100,000
390,000
1,080,000
-11
с
Subsidiary Consolidated
204 Chapter 1

5,000
20,000
25,000
To format words or amounts into 'bold', 'italic, or 'bold italic,
use these:
BIUBI
Font
250,000
Home Insert Page Layout Formulas Dats
300,000
130,000
80,000
90,000
300,000
Chapter 4
AA
A
To make lines or double-rules, use this:
*The shortcut for bold is CTRL+B, while the shortcut for italic is CTRL+1.
To insert rows, place your cursor on a row (like this)......
A
B
D
Parent Subsidiary Consolidated
40,000
50,000
10,000
180,000
800,000 250,000
...right click, a dropdown list appears, select 'Insert' from that list.
1
2 Cash
3 Accounts receivable
4 Inventory
5 Investment in subsidiary
Land
To get the total of Parent's assets, you can do any of the
following:
a. Select cell B8 then left click "AutoSum" (located on the
"Home" tab, "Editing" menu bar) - this one; or
Σ Autosum "
Fill-
Q Clear
-
Sort & Find &
Filter Select.
Business Combinations (Part 1) 205

Editing
5,000
20,000
25,000
O
b. Select cell B8 then type the following formula =sum(B2:B7)
> To check a formula, select the cell with the formula (e.g., cell
B8) then press the 'F2' key on the keyboard.
>
To get the total of Subsidiary's assets, you can copy the
formula in cell B8 and paste it on cell C8, for example, select
cell B8 then press CTRL+C (shortcut for copy), select cell C8
then press CTRL+V (shortcut for paste).
Get the totals of Parent's and Subsidiary's liabilities and
equity.
CONSOLIDATION PROCEDURES
Step 1: Eliminate the investment in subsidiary account by:
a. Measuring the subsidiary's assets and liabilities at their
acquisition-date fair values;FOR SALE!
b. Recognizing the goodwill; and

c. Replacing the subsidiary's equity accounts with the NCI in

net assets.

Additional information:

• Subsidiary's assets and liabilities approximate their

acquisition-date fair values, except for the following:

- Inventory, $5,000

- Land, $300,000

The goodwill is $30,000.

The NCI is $50,000.

Step 1: Type zero for investment in subsidiary in the 'Consolidated

column.

Step 1(a):

> Select cell D4 then type =B4+5000. Press enter.

206 Chapter 1

Select cell D6 then type =B6+300000. Press enter.

Step 1(b): Type 30000 for goodwill in the 'Consolidated' column.

Step 1(c): Type 50000 for NCI in the 'Consolidated' column.

At this point, your table should look like this:

A
1
2
Cash
3 Accounts receivable
4 Inventory
5 Investment in subsidiary
6 Land
7 Goodwill
8
Totals
9
10 Accounts payable
11 Share capital
12 Share premium
13 Retained earnings
14 NCI
15 Totals
B
Parent
40,000
50,000
10,000
1,080,000
180,000
800,000 250,000
90,000
500,000
100,000
390,000
с
Subsidiary Consolidated
1,080,000
5,000
20,000
25,000
300,000
130,000
Business Combinations (Part 1) 207

80,000
90,000
300,000
15,000
1,100,000
30,000
50,000
Step 2: Add, line by line, similar items of assets and liabilities of
the combining entities.
▸ Select cell D2 then type =B2+C2. Press enter.
> Copy the formula in cell D2 (select cell D2 then press CTRL+C
on your keyboard).
Go to cell D3 and paste the formula (CTRL+V).
‣ Go to cell D10 and press CTRL+V.
Select cell D11 then type =B11. Press enter.
> Copy the formula in cell D11 and paste it on cell D12 and cell
D13.
Get the totals of assets and liabilities and equity in the
'Consolidated' columns. These should be equal.
Your table should look like this:
1
2
Cash
3 Accounts receivable
4 Inventory
5 Investment in subsidiary
6 Land
7
8
Goodwill
Totals
9
10 Accounts payable
11 Share capital
12 Share premium
13 Retained earnings
14 NCI
15 Totals
B
Parent
40,000
50,000
10,000
180,000
800,000
1,080,000
208 Chapter 1

90,000
500,000
100,000
390,000
C
Subsidiary Consolidated
5,000
20,000
25,000
250,000
300,000
130,000
80,000
90,000
1,080,000 300,000
Print the file and submit it to your teacher for grading.
45,000
70,000
15,000
1,100,000
30,000
1,260,000
PROBLEM 5: MULTIPLE CHOICE-THEORY
1. According to PFRS 10
a. a parent entity is required to consolidate its subsidiaries.
b. a parent entity is encouraged but not required to
consolidate its subsidiaries.
2. Which of the following is not an element of control?
a. Power
b. Exposure, or rights, to variable returns
c. Major holdings
d. Ability to affect return
220,000
500,000
100,000
390,000
50,000
1,260,000
C.
a parent need not consolidate a subsidiary if the
subsidiary's business is different from that of the parent.
d. a parent entity is required to consolidate its subsidiaries
only for internal reporting purposes.
3. One of the essential elements of control is power. According to

PFRS 10, an investor has power if

Business Combinations (Part 1) 209

a. the investor holds more than half of the outstanding

shares of the investee.

b.

the investor has existing rights that give it the current

ability to direct the investee's relevant activities.

c.

the investor's interest in the earnings of the investee is not

fixed but rather varies depending on the level of the

earnings.

d. the investor's Kelly is bad.

4. In which of the following instances does Entity A have control

over Entity B?

a. Entity A holds a majority of the shares of Entity B. The

major holdings entitle Entity A to voting rights that relate

solely to administrative tasks.

b. Entity A holds 90% interest in Entity B. Entity A's interest

in the earnings of Entity B is fixed at 10% of the aggregate

par value of Entity A's shareholdings.

c. Entity A holds a majority of the shares of Entity B and is

entitled to a variable return on Entity B's shares. The

relevant activities of Entity B are directed by a third party

unrelated to Entity A.

d. Entity A is the ultimate boss of Entity B. Entity A makes all

210 Chapter 1

the major decisions and earns profit the most if Entity B

earns profit, but suffers the most if Entity B incurs loss.

5. In which of the following instances does Entity A have control

over Entity B?

a. Entity A and Entity B both have unilateral rights in

directing the relevant activities of Entity B. Entity A's

rights are considered protective rights.

b. Entity A has the right to direct the relevant activities of

Entity B but only in accordance with the directives of

Entity C.
c. Entity A's right to direct Entity B's relevant activities is

exercisable only upon the occurrence of a contingency.

d. Entity A holds a 30-day forward contract to buy a majority

of Entity B's voting rights. The contract can be cancelled in

a shareholders meeting. A shareholders meeting will be

held in 3 months' time.

6. Entity A acquired 80% interest in Entity B on December 31,

20x1. How much of Entity B's profit will be included in the

December 31, 20x1 consolidated statement of profit or loss?

a. None

b. 80%

c. 100%

d. b or c
Business Combinations (Part 1) 211

7. Goodwill is attributed to both the owners of the parent and

non-controlling interests (NCI) if

a. the NCI is measured at 'proportionate share'.

b. the NCI is measured at 'fair value'.

c. in both a and b.

d. the goodwill is big.

8. Which of the following is incorrect regarding consolidated

financial statements?

a. A parent is exempt from consolidation if it is in itself a

subsidiary, its securities are not traded, and its parent

produces PFRS consolidated financial statements.

b. Consolidation involves adding similar assets, liabilities,

income and expenses of the parent and its subsidiaries.

C. The subsidiary's equity is eliminated and replaced with

non-controlling interest.

d. The consolidated profit pertains only to the parent.

9. How is the non-controlling interest in the subsidiary's net

assets presented in the consolidated statement of financial

position?

a. As a mezzanine item between liabilities and equity

NOT FOR SALE!

b. Within equity but separately from the equity of the owners
of the parent.
c. Within equity as part of retained earnings
d. Any of these as a matter of accounting policy choice
10. How is the non-controlling interest (NCI) in the subsidiary's
212 Chapter 1

profit or loss presented in the consolidated statement of profit

or loss?
a. As part of the group's profit or loss. The group's profit or
loss is then attributed to both the owners of the parent and
NCI.
b. Not presented but disclosed either as a footnote or in the
notes. The consolidated profit or loss pertains to the parent
only.
c. The consolidated profit or loss pertains to the parent only.
The NCI in profit is presented separately.
d. Any of these as a matter of accounting policy choice
PROBLEM 6: MULTIPLE CHOICE-COMPUTATIONAL
1. Jeep Co. acquired 60% interest in Taxi Co. on January 1, 20x1.
Information on the combining entities' accounts right after the
business combination follows:
Other assets
Investment in subsidiary
Liabilities
Net assets
Jeep Co.
Taxi Co.
(carrying amount) (carrying amount)
1,296,000
444,000
360,000
(240,000)
1,416,000
Taxi's net assets have a fair value of $310,000.
The NCI is measured at a fair value of $240,000.
a. 1,954,000
b. 1,992,000
How much is the consolidated total assets?
c. 1,965,000
(96,000)
348,000
NOT FOR. 1,972,000
All rights belongs to respective authors
Use the following information for the next two questions:
Strings Corp. acquired 80% of Wind Corp.'s voting rights. The
statements of financial position of both entities immediately after
the acquisition are shown below:
Investment in subsidiary (at cost)
Other assets
Assets
Liabilities
Ordinary share capital
Business Combinations (Part 1) 213

Retained earnings
Liabilities and stockholders' equity
Strings Co.
430,000
1,570,000
2,000,000
750,000
1,000,000
250,000
2,000,000
2. How much is the consolidated total assets?
a. 2,910,000
b. 2,480,000
a. 1,310,000
b. 1,250,000
c. 1,250,000
d. 1,250,000
The fair value of Wind's assets is P50,000 more than the aggregate
carrying amounts. Non-controlling interest is measured under the
proportionate share method.
c. 2,430,000
d. 2,370,000
Wind Co.
750,000
750,000
40,000
80,000
350,000
40,000
400,000
310,000
40,000
750,000
3. What is the breakdown of the consolidated total equity?
Owners of the parent
NCI
Use the following information for the next nine questions:
On January 1, 20x1, Square Co. acquired 80% interest in Circle Co.
On acquisition date, Circle's net identifiable assets have a carrying
amount of P296,000. Circle's identifiable assets approximated their
fair values except for inventory with carrying amount of P92,000
and fair value of P124,000 and equipment with carrying amount ofP160,000 and fair
value of P192,000. The remaining useful life of

the equipment is 4 years. Non-controlling interest was measured

214 Chapter 1

using the proportionate share method. Information on December

31, 20x1 is as follows:

ASSETS

Cash

Inventory

Investment in subsidiary (at cost)

Equipment, net

TOTAL ASSETS

LIABILITIES AND EQUITY

Trade and other payables

Share capital

Retained earnings

Total equity

TOTAL LIABILITIES AND EQUITY

Income

Expenses

PROFIT FOR THE YEAR

Square Co.

392,000

420,000

300,000

560,000

1,672,000
Business Combinations (Part 1) 215

a. 100,000 increase

b. 60,000 increase

292,000

940,000

440,000

1,380,000

1,672,000

1,000,000

(400,000)

600,000

Circle Co.

316,000

60,000

c. 100,000 decrease

d. 40,000 increase

120,000

496,000

No dividends were declared by either entity during 20x1. There

were also no intercompany transactions and no impairment of

goodwill.

c. 48,000

NOT FOR SALE!

d. 84,000
216 Chapter 1

120,000

200,000

176,000

376,000

496,000

4. How much is the net change in the fair value of the

subsidiary's net assets since the acquisition date?

200,000

(120,000)

80,000

5. What amount of goodwill is reported in the December 31, 20x1

consolidated financial statements?

a. 12,000

b. 42,000186
6. What amount of goodwill is attributed to non-controlling
interests on December 31, 20x1?
a. 12,000
b. 2,400
c. 2,000
d. 0
a. 1,867,000
b. 1,894,000
7. How much is the consolidated total assets on December 31,
20x1?
c. 1,904,000
d. 1,907,000
8. How much is the non-controlling interest in the net assets of
the subsidiary on December 31, 20x1?
a. 40,000
c. 120,000
b. 80,000
d. 160,000
9. How much is the consolidated retained earnings on December
Business Combinations (Part 1) 217

31, 20x1?
a. 378,000
b. 392,000
c. 472,000
d. 522,000
Chapter 4
10. How is the consolidated total equity on December 31, 20x1
attributed to the following?
Owners of the parent
a. 1,417,000
b. 1,328,000
c. 1,412,000
d. 1,492,000
NCI
80,000
72,000
80,000
80,000
11. How much is the consolidated profit in 20x1?
a. 720,000
b. 680,000
c. 640,000
d. 568,000
12. How is the consolidated profit attributed to the following?
Owners of the parent
a. 544,000
NCI
NOT FOR SA136.000
b. 632,000
c. 454,400
d. 600,000
Use the following information for the next eight questions:
On January 1, 20x1, Original Co. acquired 60% interest in Pirated,
Inc. for P360,000. Information on Pirated's financial position on
acquisition date follows:
. The identifiable assets and liabilities approximated their fair
values except for inventories with carrying amount of
P144,000 and fair value of P96,000, and building with carrying
amount of P240,000 and fair value of P250,000. The building
has a remaining useful life of 8 years.
• Pirated's retained earnings was P48,000.
•
Non-controlling interest is measured at a fair value of
P240,000.
Additional information for 20x1:
• The investment in subsidiary is measured at cost.
218 Chapter 1

• Pirated Co. did not issue additional shares.

8,000
113,600
80,000
• All the inventories on January 1, 20x1 were sold.
• No dividends, intercompany transactions or impairment of
goodwill.
A summary of the individual financial information of the entities
on December 31, 20x1 is shown below:
Total assets
Total liabilities
Share capital
Retained earnings
Total equity
Sales
Cost of sales
Other operating expenses
Profit for the year
Original Co.
1,550,000
34,000
1,200,000
316,000
1,516,000
700,000
(200,000)
(400,00)
NOT FOR SA 100,000
All rights belongs
Pirated Co.
550,000
132,000
300,000
118,000
418,000
350,000
(80,000)
(200,000)
70,000
authors
13. How much is the goodwill attributable to non-controlling

interests as of December 31, 20x1?

a. 124,000
Business Combinations (Part 1) 219

b. 116,000

14. How much is the consolidated total assets?

a. 1,982,750

b. 2,083,750

15. How much is the NCI in net assets as of December 31, 20x1?

a. 286,700

c. 132,700

b. 170,700

d. 118,700

a. 1,586,050

b. 1,606,750

c. 98,000

d. 0

16. How much is the equity attributable to the owners of the

parent?

a. 280,000

b. 232,000

c. 2,038,750

d. 2,350,450

17. How much is the consolidated cost of sales?

c. 328,000

d. 322,000

c. 1,582,650
220 Chapter 1

d. 1,592,050

18. How much is the consolidated other operating expenses?

a. 601,250

c. 604,750

b. 598,750

d. 581,250

a. 103,950

b. 138,650

19. How much is the consolidated profit?

a. 216,750

b. 123,250

c. 108,050

d. 170,050

20. How is the consolidated profit attributed to the following?

Owners of the parent

NCI

c. 173,150

d. 124,750

19,300

34,500

16,700

46,700