ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION

MODULE 2

BUSINESS COMBINATIONS II. Method of Combination (Legal Point of View)

A. Net Asset Acquisition. The books of the
A business combination is the term applied to external expansion
acquired company are closed out and its
in which separate enterprises are brought together into one
economic entity as a result of one enterprise obtaining control assets and liabilities are transferred to
over the net assets and operations of another enterprise. the books of the acquiring company.
However, business combinations involve certain limitations and
risks. Corporate objectives must be taken into consideration. Only 1. Statutory Merger
those companies which have the same or compatible sets of
objectives should combine. The acquiring enterprise may also 2. Statutory Consolidation
inherit the acquired firm’s inefficiencies and problems together
with its inadequate resources.
B. Stock Acquisition.

LEARNING OBJECTIVES C. Asset Acquisition (NOTE: not within the

scope of IFRS 3)
1. Define a business combination
2. Enumerate the different classifications of business
combinations
3. Define acquisition of Net Assets III. Accounting Method Used
4. Compute for Goodwill or Gain on Acquisition A. Acquisition or Purchase Method. All
5. Identify accounting treatment of expenses related to assets and liabilities of the acquired
acquisition company are usually recorded at Fair
6. Account for contingent considerations Values. Under the acquisition method,
7. Explain the measurement period the general approach to accounting
8. Prepare entries on the books of the acquired company business combinations is a five-step
9. Define acquisition of Stocks process
10. Compute for the Non-controlling Interest

1. Identify the acquirer. Acquirer

is the entity that obtains
BUSINESS COMBINATIONS DEFINED
control of the acquired
The term business combination refers in general to any set of company.
conditions in which two or more organizations are joined
together through common ownership. As defined by IFRS 3, 2. Determine the acquisition date.
business combination is a transaction or event in which an This is the date on which the
acquirer obtains control of one or more businesses. For each entity obtains control of the
business combination, one of the combining entities shall be acquired business. This is
identified as the acquirer. critical because it is the date
used to establish the fair value
of the company acquired.
Some Reasons for Business Combinations

• Cost Advantage 3. Calculate the fair value of the

• Lower Risk purchase consideration
• Avoidance of Takeovers transferred. Generally, the
• Acquisition of Intangible Assets consideration is assumed to be
the fair value of the acquired
entity.
CLASSIFICATION OF BUSINESS COMBINATIONS
4. Recognize and measure the
I. Structure of the Combination (Business Point of
identifiable assets and
View)
liabilities of the business at fair
A. Horizontal Integration
value.

B. Vertical Integration
5. Recognize and measure either
C. Conglomerate Combination goodwill or a gain from bargain
purchase.
D. Circular Combination
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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B. Pooling of Interest Method. All assets and PROBLEM I

liabilities of the acquired company are
On June 30, 2021, A Company decided to purchase all the net
recorded at Book Values. (NOTE: not
assets of B Company. The acquiring company issued 80,000
permitted in IFRS 3)
shares of its P10 par value common stock with a market value of
P40 each. The acquirer pays professional fees of 50,000 to
accomplish the acquisition and incurs 30,000 stock issuance costs.
ACQUISITION OF NET ASSETS The following are the records of the companies at the date of
The following are the features of a net acquisition: acquisition:
➔ An acquirer acquires 100% of the net assets of the
acquired company.

➔ An acquirer acquires from enterprise for cash, A Company B Company

other property, debt instruments, and equity
instruments, or a combination thereof. Book Value Fair Value Book Value Fair Value

Cash 1,000,000 1,000,000 200,000 200,000

➔ The acquiring company usually survives and the
acquired company is dissolved Marketable Securities 400,000 380,000 300,000 330,000

Inventory 800,000 750,000 500,000 550,000

SATUTORY MERGER Land 500,000 550,000 150,000 360,000

A type of net asset acquisition where the acquiring company Buildings (net) 1,200,000 1,100,000 750,000 900,000
survives (remains in existence), whereas the acquired company
ceases to exist as a separate legal entity. It may be expressed as: Equipments (net) 480,000 500,000 400,000 700,000

A Company + B Company = A Company or B Company Unrecognized Receivables - - - 225,000

Current Liabilities 600,000 600,000 125,000 125,000

Bonds Payable 1,100,000 1,100,000 500,000 500,000

SATUTORY CONSOLIDATION Premium on Bonds 40,000 40,000 - 20,000

A type of net asset acquisition where a new corporation is Common Stock 1,000,000 50,000
formed as a result of one company acquiring another. It may be
express as: APIC 20,000 700,000

A Company + B Company = C Company Retained Earnings 1,620,000 925,000

Requirement: Applying the 5-step process, record the necessary

entries on the date of acquisition and determine the amounts to
be reported in the Financial Position of the acquiring company
following the business combination.

Step 1: The acquirer in this business combination is A company.

Step 2: The date of acquisition is June 30, 2021.

Step 3: The price paid is 3,200,000 (80,000 share x P40)

Step 4: The fair value of net assets of the acquired company is

2,620,000 computed as follows: Fair Value of Identifiable

Assets 3,265,000
Less: FV of Liabilities 645,000
FV of Net Assets 2,620,000
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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Another method of determining the fair value of the net assets EXPENSES OF BUSINESS COMBINATION
acquired is to effect the changes in fair values of accounts to the
sum on their book values. Acquisition-related costs are incurred when effecting a business
combination such as broker’s fee, accounting, legal, and other
Book Value of Net Assets 1,675,000 professional fee; general administrative costs, including
Plus: Increase in Asset 965,000 maintaining an internal acquisition department. These are
Less: Decrease in Asset 0 expenses when incurred and are not part of the purchase price.
Less: Increase in Liabilities 20,000 Acquisition Expense xx
Plus: Decrease in Liabilities 0 Cash xx
FV of Net Assets 2,620,000

Step 5: The difference between the price paid and the FV of the
net assets acquired results to a Goodwill of 580,000 computed as Stock issuance costs are incurred when an acquirer issue share of
follows: stock such as SEC registration fees, documentary stamp tax, and
newspaper publication fees treated as a deduction from
Price Paid 3,200,000 additional paid in capital (APIC) from previous share issuances. In
FV of Net Assets 2,620,000 case APIC is reduced to zero, the remaining costs will be charged
Goodwill 580,000 to the Stock Issuance Cost account, treated as a contra retained
earnings account presented as a separate line item.

JOURNAL ENTRIES Share Premium (Additional Paid in Capital) xx

1. To record the net assets acquired Share (Stock) Issuance Cost / RE xx
Cash 200,000 Cash xx
Trade Receivables 225,000
Marketable Securities 330,000
Inventory 550,000 FINANCIAL POSITION AFTER ACQUISITION (OF ACQUIRING/
Land 360,000 SURVIVING COMPANY)
Building 900,000
Equipment 700,000
Goodwill 580,000 COMMON STOCK
Current Liabilities 125,000
- Ordinary (Common) Shares of the Surviving Company xx
- Ordinary (Common) Shares issued during combination xx
Bonds Payable 500,000
Premium on Bonds Payable 20,000
APIC
Common Stock 800,000
- Share Premium (APIC) of the Surviving Company xx
Additional Paid in Capital 2,400,000
- Share Premium (APIC) from issuance xx
- Share Issuance Cost (xx)
Goodwill is accounted for as a non-current asset separate from
Intangible assets and is defined in PFRS 3 as an asset representing
the future economic benefits arising from other assets as RETAINED EARNINGS
acquired in a business combination that are not individually - Retained Earnings of the Surviving Company xx
identified and separately recognized. In order to be identifiable, - Gain on Acquisition xx
an asset must be capable of being separated or divided from the - Acquisition-related Expense (xx)
entity. Goodwill acquired in a purchase of net assets is recorded
on the acquirer’s books, along with the fair values of other assets
and liabilities. LIABILITIES
- Book Value of the Surviving Company xx
Acquired Assets xx - Fair Value of the Dissolved Company xx
Goodwill xx - Liabilities arising from the acquisition xx
Assumed Liabilities xx
Price Paid xx
ASSETS
- Book Value of the Surviving Company xx
2. To record acquisition-related costs - Fair Value of the Dissolved Company xx
Acquisition Expense 50,000 - Goodwill from acquisition xx
Additional Paid in Capital 30,000 - Cash paid (xx)
Cash 80,000
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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BV of A FV of B Adjustments New BV

Cash (A) 1,000,000 200,000 (80,000) 1,120,000

Trade Receivables - 225,000 225,000

Marketable Securities 400,000 330,000 730,000

Inventory 800,000 550,000 1,350,000

Land 500,000 360,000 860,000

Buildings (net) 1,200,000 900,000 2,100,00

Equipments (net) 480,000 700,000 1,180,000

Goodwill 580,000 580,000
Current Liabilities (L) 600,000 125,000 725,000
Bonds Payable 1,100,000 500,000 1,600,000

Premium on Bonds 40,000 20,000 60,000

800,000
Common Stock (C) 1,000,000 1,800,000
2,370,000
APIC (A) 20,000 2,390,000
(50,000)
Retained Earnings (R) 1,620,000 1,570,000

Problem II
A Bargain Purchase Gain (Gain on Acquisition) results when the
Using the same problem above, record the necessary entries on acquirer’s interest in the net fair value of the acquiree’s
the date of acquisition if the acquirer issues 20,000 shares of its identifiable assets and liabilities is greater than the consideration
P115 par value ordinary shares with a market value of P120 each. transferred. This account is to be reported as a separate line item
Company A pays professional fees of 50,000 and stock issuance in the statement of comprehensive income of the acquirer in the
cost of 130,000. period of the acquisition

Acquired Assets xx
Journal Entries Assumed Liabilities xx
Price Paid xx
1. To record the net assets acquired Gain on Acquisition xx
Cash 200,000
Trade Receivables 225,000
Marketable Securities 330,000
Inventory 550,000 2. To record acquisition-related costs
Land 360,000 Acquisition Expense 50,000
Building 900,000 Additional Paid in Capital 120,000
Equipment 700,000 Share (Stock) Issuance Cost / RE 10,000
Current Liabilities 125,000
Cash 180,000
Bonds Payable 500,000
Premium on Bonds Payable 20,000
Common Stock 2,300,000
Additional Paid in Capital 100,000
Gain on Acquisition 220,000
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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CONTINGENT CONSIDERATION Changes resulting from obtaining additional information about

facts and circumstances that existed at the acquisition date, and
As defined in the standards, a contingent consideration is an that occur within the measurement period are recognized as
obligation of the acquirer to transfer additional assets or adjustments against the original accounting for the acquisition,
equity interests to the former owners of an acquired company thus may affect Goodwill.
as part of the exchange for control of the acquired if specified
future events occur or considerations are met. Goodwill xx
● Meeting a specified level of earnings Contingent Consideration Payable xx
● Reaching a specified share price
● Reaching a certain milestone in development projects
NOTE: ↑ CCP - ↑ GW; ↓ CCP - ↓ GW

↑ CCP - ↓ BPG; ↓ CCP - ↑ BPG

Problem III
Using the same problem above, record the entries on the
date of acquisition if the acquirer issued 80,000 shares of its
Changes resulting from events after the acquisition date are not
P10 par value ordinary shares with a market value of 3,200,000.
measurement period adjustments. Accounting for such depends
In addition to the stock issues, the acquirer agreed to pay an on whether the instrument is an equity, cash, or other asset.
additional 200,000 on January 1, 2022 if the average income
for the 2-year period of 2020 and 2021 exceeds 160,000 per • For equity instruments, the original amount is not re-
year. The expected probability of achieving the target average measured, thus the APIC and Ordinary Shares accounts
income is set at 50%. are only adjusted.

Additional Paid in Capital xx

Ordinary Shares xx
Step 5: The difference between the price paid and the FV of
the net assets acquired results to a Goodwill of 680,000
computed as follows: • For cash or other assets, the amount is recognized in
Shares Issued 3,200,000 profit or loss.
Contingent Consideration 100,000
FV of Net Assets (2,620,000)
Loss on Contingent Consideration Payable xx
Goodwill 680,000
Contingent Consideration Payable xx
Journal Entries

Problem IV
1.To record the net assets acquired Using the same problem above, record the changes on the
Contingent Consideration if
Cash 200,000
Trade Receivables 225,000 Case 1: The probability of achieving the target average income is
Marketable Securities 330,000 revised to 80%.
Inventory 550,000
Land 360,000 Goodwill 60,000
Building 900,000
Contingent Consideration Payable 60,000
Equipment 700,000
Goodwill 680,000
Current Liabilities 125,000
Bonds Payable 500,000 Case 2: In addition to the 80,000 shares, the acquirer agrees to
Premium on Bonds Payable 20,000 issue another 20,000 shares if the target average income is met.
Contingent Consideration Payable 100,000 Assuming the contingent event occurs, the following entry is to
Common Stock 800,000 be made:
Additional Paid in Capital 2,400,000
Additional Paid in Capital 200,000

Ordinary Shares 200,000

2. To record acquisition-related costs
Acquisition Expense 50,000
Additional Paid in Capital 30,000
Cash 80,000

CHANGES IN CONTINGENT CONSIDEARTION

ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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MEASUREMENT PERIOD 2.To record the retroactive depreciation in 2022

The measurement period is a one-year period after the initial Retained Earnings 3,000
acquisition date during which the acquirer may adjust the
provisional amounts recognized at the acquisition date. This Accumulated Depreciation 3,000
period allows a reasonable time to obtain the information
necessary to identify and measure the fair value of the acquiree's
assets and liabilities, as well as the fair value of the consideration
transferred. The values recorded on the acquisition date are
considered Provisional Fair Values. They are used in financial ENTRIES ON THE BOOKS OF THE ACQUIRED COMPANY
statements prior to the end of the measurement period. Pro-forma Journal Entries

1. To record the sale of Net Assets

NOTE: ↑ PFV - ↑ BGP; ↓ PFV - ↓ BGP Investment in Acquirer Company xx
Liabilities xx
↑ PFV - ↓ GW; ↓ PFV - ↑ GW
Assets xx
Gain on Sale of Business xx
Problem V

Case 1: Using the same data in the problem above, except that
2. To record the liquidation of the Dissolved Company
Ordinary Shares xx
the value assigned to the Building is only provisional. The said
provisional value and received value are illustrated below: APIC xx
Retained Earnings xx
Gain on Sale of Business xx
Provisional (2021) Revised (2022)
Investment in Acquirer Company xx

Fair Value 900,000 950,000

Depreciation Method 20-yr SLM 20-yr SLM

Problem VI
Using the same data in the problem above, record the entries of
Residual Value 660,000 590,000
the business combinations on the books of B Company
Annual Depreciation 12,000 18,000
1. To record the sale of Net Assets
Investment in A Company 3,200,000
Requirement: Record all necessary entries to reflect the revised Current Liabilities 125,000
value of the building. Bonds Payable 500,00
Cash 200,000
1.To adjust the Book Value of the Building Marketable Securities 300,000
Building 50,000 Inventory 500,000
Land 150,000
Goodwill 50,000 Building 750,000
Equipment 400,000
Gain on Sale of Business 1,525,000
2.To record the retroactive depreciation in 2022

Retained Earnings 3,000

Accumulated Depreciation 3,000 Gain on Sale of Business is computed as the difference between
the purchase price received and the Book Values of the net assets
of the acquired company.
Case 2: Assume that there had been a gain on acquisition on the BV of Assets 2,300,000
original acquisition date. Record all the necessary adjustments. Less: BV of Liabilities 625,000
BV of Net Assets 1,675,000
1.To adjust the Book Value of the Building
Less: Price Received 3,200,000
Building 50,000
Gain on Sale of Business 1,525,000
Retained Earnings 50,000
2. To record the liquidation of B Company
Ordinary Shares 50,000
Adjustment was made directly to the Retained Earnings account APIC 700,000
because the gain on acquisition was recorded in the prior period Retained Earnings 925,000
which is 2021.
Gain on Sale of Business 1,525,000
Investment in A Company 3,200,000
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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ACQUISITION OF STOCKS Problem VII

The following are the features of a stock acquisition: On December 31, 2021, P Company acquired all 10,000 issued and
➔ An acquirer acquires voting (ordinary) shares from outstanding shares of S Company’s P100 par value ordinary
another company. shares for 2,000,000 cash. In addition, P Company paid
➔ An acquirer obtains control by purchasing more than professional fees to accomplish the combination of 100,000.
50% of the voting stocks. Prepare the journal entries upon acquisition.
➔ An acquired company need not be dissolved.
Both the acquiring and acquired company
remain as separate legal entities. 1.To record the acquisition

Investment in Subsidiary -S Company 2,000,000

Pro-forma Journal Entries
Cash 2,000,000
1. To record the acquisition of stock Investment in

Subsidiary xx
2.To record the acquisition-related costs
Cash xx
Acquisition Expense 100,000
2. To record the acquisition-related costs Acquisition
Cash 100,000
Expense xx

Cash xx
NON-CONTROLLING INTEREST

When a subsidiary is less than 100% owned or partially-owned, a

➢ In the above entries, the acquirer does not record the problem arises as to the
underlying assets and liabilities. Instead, the
determination and recognition of Goodwill and the Non-
acquisition is recorded in an investment account that
controlling Interests. Thus, the NCI is to be measured whichever
represents the controlling interest in the net assets of
is higher between these two methods:
the subsidiary.

➢ No Goodwill or gain on acquisition is recorded on the

date of acquisition. These will only be recognized in 1. Partial-goodwill approach or Proportional Basis
the consolidated financial statements. This the the minimum value of NCI computed as a
proportionate share in the fair value of the net assets
➢ The business combination does not dissolve the of the acquired company
acquired company.
★ FV of NA xx
➢ A new relationship is being formed which is a Parent-
Subsidiary relationship. NCI% %

NCI xxx

INVESTMENT IN SUBSIDIARY ACCOUNT

➔ Appears as a long-term investment of the parent 2. Full-goodwill approach or Fair Value Basis
company in its separate Statement of Financial The fair value of the non-controlling interest must be
Position given. If not, use an implied FV

➔ If control exists (>50%), preparation of the ★ (Purchase Price / CI%) x NCI% = NCI
Consolidated Financial Statements will be required
on the date of acquisition and on a date subsequent There is no requirement in IFRS 3 to measure the non-
to acquisition. controlling interest on a consistent basis for similar
types of business combinations and therefore, an entity
has a free choice between the two options, except that
there is a minimum value to be considered.
Goodwill or Gain is then computed using this formula:
★ Purchase Price xx
NCI xx
Company Fair Value xxx
FV of Net Assets (xx)
Goodwill/Gain xxx
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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The Goodwill shall be measured at cost less impairment losses. Thus,

There will be no amortization of Goodwill but it must be tested Purchase Price 150,000,000
for impairment annually, or more frequently if events or changes NCI 30,000,000
in circumstances indicate a possible impairment.
FV of Net Assets (100,000,000)
Goodwill 80,000,000

Problem VIII

Case 1: On January 01, 2021, P company acquired a 75% equity

interest in S company, paying cash consideration of 50,000,000
and issuing 50,000, P1,000.00 par value new ordinary shares
valued at P2,000.00 each. On this date, the net fair value of the Case 3: Using the same data above, except that the fair value of
identifiable assets and liabilities of S Company is 100,000,000. the non-controlling interest is determined to be 20,000,000.
Determine the non-controlling interest and the goodwill (gain) as
1. Partial-goodwill Approach
a result of the business combination.
FV of NA 100,000,000
1. Partial-goodwill Approach NCI% 25%
FV of NA 100,000,000 NCI 25,000,000
NCI % 25%
NCI 25,000,000
2. Full-goodwill Approach

FV of NCI 20,000,000
2. Full-goodwill Approach

Purchase Price 150,000,000

Divide: CI % 75% Thus,
Multiply: NCI % 25% Purchase Price 150,000,000
NCI 25,000,000
FV of Net Assets (100,000,000)
Goodwill 75,000,000
NCI 50,000,000
Thus,
Purchase Price 150,000,000
NCI 50,000,000
FV of Net Assets (100,000,000)
Goodwill 100,000,000

CONTINGENT CONSIDERATION

When a contingent consideration is based on a specified level of future

earning and the specified level is

Case 2: Using the same data above, except that the fair value of ➔ Achieved, there is no adjustment to the cost of combination
the non-controlling interest is determined to be 30,000,000.
➔ Not achieved, there will be adjustments on the amount of
Goodwill initially computed if within the measurement
period.
1. Partial-goodwill Approach
FV of NA 100,000,000
NCI % 25%
NCI 25,000,000

2. Full-goodwill Approach
FV of NCI 30,000,000
ACCTG 108 ACCOUNTING FOR BUSINESS COMBINATION
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Problem IX Problem X

On January 1, 2021, P Company acquired 75% interest in the equity of S P Company acquired 100% interest in the equity capital of S Company on
Company. On this date, the identifiable assets and liabilities of S Company January 01, 2017. On this date, the fair value of the identifiable net assets
are valued at 200,000,000. The maintainable profits of S Company are of S Company is 30,000,000. The consideration is agreed at 50,000,000
estimated at 40,000,000 per year. On the basis of a price-earnings ratio of and this is based on capitalization of a 5,000,000 maintainable profits of S
10 times, the fair value of the ordinary shares of S Company is estimated Company with a price-earnings ratio of 10x. The terms of payment are as
as 400,000,000. follows:

● 30,000,000 upfront fee

The purchase consideration consists of the following terms: ● 11,000,000 at the end of first year, if the profit of S Company
is at least 5,000,000 for that year; and 12,100,000 at the end
1. An initial payment of 100,000,000; of second year, if the profit of the S company is at least
5,000,000 for that year.
2. An amount of 110,000,000 payable on January 01, 2022
contingent on the achievement of maintainable profit of ● In the event that the profit level is below 5,000,000. The
40,000,000 in the first year; and amount payable is reduced accordingly by the shortfall
multiplied by the factor of 5. At the acquisition date, P
3. An amount of 121,000,000 payable on January 1, 2023 Company’s borrowing rate is 10%.
contingent on the achievement of the maintainable profit of
40,000,000 in the second year. Requirement: Determine the cost of combination and Goodwill (Gain)
resulting from the combination; and prepare the entries to record the
transactions:
S Company’s profits have been averaging 40,000,000 per year in the past 1. Assuming the target proffits for years 1 and 2 are both
5 years and it's probable that this level of profits would be maintained in achieved.
the foreseeable future. At the acquisition date, P Company’s borrowing 2. Assuming the proffit in year 1 is only 4,000,000.
rate is 10%.

Requirement: Determine the cost of combination and Goodwill (Gain)

resulting from the combination; and prepare entries to record the
transactions.