PFRS 3
Business Combination
Learning Objectives:
Define abusiness combination.
Explain briefly the accounting requirements for a
business combination.
Make basic computations of 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 is the
subsidiary or acquiree.
Introduction
PFRS 3 applies to business combinations. Its
objective is to enhance the relevance, reliability, and
comparability of an acquirer’s financial reporting
by establishing the recognition and measurement
principles and disclosure requirements for a
business combination.
Introduction
PFRS 3 does not apply to the following:
a. The formation of joint venture.
b. The acquisition of an asset or a group of assets
and related liabilities that does not constitute a
business. This transaction does not give rise to
goodwill.
c. A combination of entities under common control.
Definition
A business combination is a “transaction or other
event in which an acquirer obtains control of one
or more businesses.” (PFRS 3)
Essential elements
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.
Controlis normally presumed to exist when the
ownership interest acquired in the voting rights of
the acquiree is more than 50% (or 51% or more).
Control
Control may exist even if the acquirer holds less than 50% interest in
the voting rights of acquiree, such as in the following cases:
1. The acquirer has the power to appoint or remove the majority of
the board of directors of the acquiree; or
2. The acquirer has the power to cast the majority of votes at
board meetings or equivalent bodies within the acquiree; or
3. The acquirer has power over more than half of the voting rights
of the acquiree because of an agreement with other investors; or
4. The acquirer has power to control the financial and operating
policies of the acquiree because of a law or an agreement.
Business
Businessis “an integrated set of activities and assets that
is capable of being conducted and managed for the
purpose of providing goods or services to customers,
generating investment income or generating other income
from ordinary activities.” (PFRS 3)
A business has the following three elements:
1. Input
2. Process
3. Output
Accounting for Business Combination
Business combinations are accounted for using the acquisition method.
This method requires the following:
1. Identifying the acquirer;
2. Determining the acquisition date; and
3. Recognizing and measuring goodwill. This requires recognizing and
measuring the following:
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 on the business
combination.
Identifying an acquirer
The acquirer is usually the entity that transfers cash or other assets where the business
combination is effected in this manner
The acquirer is usually, but not always, the entity issuing equity interests where the
transaction is effected in this manner, however the entity also considers other pertinent facts
and circumstances including:
relative voting rights in the combined entity after the business combination
the existence of any large minority interest if no other owner or group of owners has a
significant voting interest
the composition of the governing body and senior management of the combined entity
the terms on which equity interests are exchanged
The acquirer is usually the entity with the largest relative size (assets, revenues or profit)
For business combinations involving multiple entities, consideration is given to the entity
initiating the combination, and the relative sizes of the combining entities.
Determining the Acquisition Date
The acquisition date is the date on which the
acquirer obtains control of the acquiree.
The acquisition date may be a date that is earlier or
later than the closing date.
Recognizing and Measuring Goodwill
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.
Consideration transferred xx
Non-controlling interest in the acquiree (NCI) 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
Consideration Transferred
The consideration transferred in a business combination is
measured at fair value.
Examples of potential forms of consideration include:
1. Cash,
2. Other assets,
3. A business or a subsidiary of the acquirer,
4. Contingent consideration,
5. Ordinary or preference equity instruments, options, warrants
and member interests of mutual entities.
Acquisition-related Costs
Acquisition-related costs are costs the acquirer incurs to effect a
business combination.
Acquisition-related costs are recognized as expenses in the periods
in which they are incurred, except for the following:
a. Costs to issue debt securities measured at amortized cost –
included in the initial measurement of the resulting financial
liability.
b. Costs to issue equity securities – are accounted for as
deduction from share premium. If share premium is
insufficient, the issue costs are deducted from retained
earnings.
Non-Controlling Interest (NCI)
Non-controlling interest (NCI) is the equity in a
subsidiary not attributable, directly or indirectly, to a
parent.
NCI is measured either at:
a. Fair value, or
b. The NCI’s proportionate share of the acquiree’s
identifiable net assets.
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.
Net Identifiable Assets Acquired
On acquisition date, the acquirer shall recognize,
separately from goodwill, the identifiable assets
acquired, the liabilities assumed and any non-controlling
interest in the acquiree.
Any unidentifiable asset of the acquiree (e.g., any recorded
goodwill by the acquiree) shall not be recognized.
The identifiable assets acquired and the liabilities
assumed are measured at their acquisition-date fair
values.
Illustration
On January 1, 2021, ABC Co. acquired 80% interest in XYZ, Inc. for ₱1,000,000 cash. ABC Co.
incurred transaction costs of ₱100,000 for legal, accounting, and consultancy fees in negotiating
the business combination.
ABC Co. elected to measure NCI at the NCI’s proportionate share in XYZ, Inc.’s identifiable
net assets. The carrying amounts and fair values of XYZ’s assets and liabilities at the acquisition
date were as follows: Assets Carrying amounts Fair Values
Cash 10,000 10,000
Receivables 200,000 120,000
Allowance for bad debts (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
How much is the goodwill (gain on a bargain purchase)?
Illustration
Assets Fair Values
Cash 10,000
Receivables 120,000
Allowance for bad debts
Inventory 3350,000
Building – net 1,100,000
Goodwill 20,000
Total assets 1,600,000
Less: Goodwill (20,000)
Fair value of identifiable assets 1,580,000
Less: Fair value of liabilities assume (400,000)
Fair value of identifiable net assets acquired 1,180,000
Multiply: Non-controlling interest 20%
NCI’s proportionate share in identifiable net assets 236,000
Illustration
Parent NCI Total
Consideration transferred 1,000,000 236,000 1,236,000
Less: FV of net identifiable assets acquired *(944,000) (236,000) 1,180,000
Goodwill 56,000 0 56,000
*1,180,000 x 80% = 944,000
Application of
concepts
Problem 1: Multiple Choice
1. Which of the following methods must be applied in accounting
for business combination?
a. Pooling of interest
b. Purchase method
c. Acquirer method
d. Acquisition method
Problem 1: Multiple Choice
1. Which of the following methods must be applied in accounting
for business combination?
a. Pooling of interest
b. Purchase method
c. Acquirer method
d. Acquisition method
Problem 1: Multiple Choice
2. The company that obtains control over another company in a
business combination transaction is referred to as the _____.
a. Subsidiary
b. Acquirer
c. Parent
d. b and c
Problem 1: Multiple Choice
2. The company that obtains control over another company in a
business combination transaction is referred to as the _____.
a. Subsidiary
b. Acquirer
c. Parent
d. b and c
Problem 1: Multiple Choice
3. According to PFRS 3, which of the following transaction costs
would increase the amount of goodwill from a business
combination?
a. Legal fees, accounting fees, and similar costs
b. Issuance costs of equity securities
c. Issuance costs of debt instruments
d. None of these
Problem 1: Multiple Choice
3. According to PFRS 3, which of the following transaction costs
would increase the amount of goodwill from a business
combination?
a. Legal fees, accounting fees, and similar costs
b. Issuance costs of equity securities
c. Issuance costs of debt instruments
d. None of these
Problem 2
On January 1, 2021, ABC Co. acquired 75% interest in XYZ, Inc. for ₱2,500,000 cash. ABC Co.
incurred transaction costs of ₱250,000 for legal, accounting, and consultancy fees in negotiating
the business combination.
ABC Co. elected to measure NCI at the NCI’s proportionate share in XYZ, Inc.’s identifiable
net assets. The carrying amounts and fair values of XYZ’s assets and liabilities at the acquisition
date were as follows:
Assets Carrying amounts Fair Values
Cash in bank 25,000 25,000
Accounts receivable 425,000 300,000
Inventory 1,300,000 875,000
Equipment – net 2,500,000 2,750,000
Goodwill 250,000 50,000
Total assets 4,500,000 4,000,000
Liabilities
Payables 1,000,000 1,000,000
How much is the goodwill (gain on a bargain purchase)?
Problem 2
Assets Fair Values
Cash in bank 25,000
Accounts receivable 300,000
Inventory 875,000
Equipment – net 2,750,000
Goodwill 50,000
Total assets 4,000,000
Less: Goodwill (50,000)
Fair value of identifiable assets 3,950,000
Less: Fair value of liabilities assume (1,000,000)
Fair value of identifiable net assets acquired 2,950,000
Multiply: Non-controlling interest (100% - 75%) 25%
NCI’s proportionate share in identifiable net assets 737,500
Problem 2
Parent NCI Total
Consideration transferred 2,500,000 737,500 3,237,500
Less: FV of net identifiable assets acquired *(2,212,500) (737,500) 2,950,000
Goodwill 287,500 0 287,500
*2,950,000 x 75% = 2,212500
Thank
You!
