Chapter 1: Business

Combination

Based on IFRS 3
Prepared By: Hassen Mustefa
 Definition of BC

 Business combinations are events or

transactions in which two or more business
enterprises, or their net assets, are brought
under common control in a single accounting
entity.
 Identification of BC
A transaction or other event is a business
combination if: The assets acquired and liabilities
assumed constitute a business.

 If the asset acquired are not a business, it must be

accounted for as an asset acquisition.
 Business
 IFRS 3 defines a business as ‘an integrated set
of activities and assets that is capable of being
conducted and managed for the purpose of
providing a return in the form of dividends,
lower costs or other economic benefits directly
to investors or other owners, members or
participants.

 Business consists of Input, process and output

 Example

 E&P Co A (an oil and gas exploration and production

company) acquires a mineral interest from E&P Co B,
on which it intends to perform exploration activities to
determine if reserves exist. The mineral interest is an
unproven property and there have been no exploration
activities performed on the property.
 It is not a BC.
 Cont…
• E&P Co A acquires a property similar to
that in Example above, except that oil and
gas production activities are in place. The
target’s employees are not part of the
transferred set. E&P Co A will take over the
operations by using its own employees.
• It is a BC.
Definition of terms under
BC
Combined Enterprise: The accounting entity that results
from a business combination.
Constituent Companies: The business enterprises that
enter into a combination.
Combinor : A constituent company entering into a
combination whose owners as a group ends up with control
of the ownership interests in the combined enterprise. The
term acquirer, parent and combinor can be used
interchangeably.
Combinee: a constituent company other than the combinor
in a business combination. The term acquired, acquiree,
subsidiary and combinee can be used interchangeably.
 Types of Business
Combinations
There are three types of business combinations: Horizontal Combination, Vertical
Combination, and Conglomerate Combination:
1. Horizontal Combination: is a combination involving enterprises in the same
industry. E.g. assume combination of Ethio flour and Sun flour.
2. Vertical Combination: A Combination involving an enterprise and its
customers or suppliers. It is a combination involving companies engaged in
different stages of production or distribution. It is classified into two: Backward
Vertical Combination – combination with supplier and Forward Vertical
Combination – combination with customers.
E.g.: A Tannery Company acquiring a Shoes Company - Forward
3. Conglomerate (Mixed) Combination: is a combination involving companies
that are neither horizontally nor vertically integrated. It is a combination between
enterprises in unrelated industries or markets.
Methods of Business
Combinations
 The Three common methods for carrying out a
business combination are:
Statutory Merger
Statutory Consolidation, and
Acquisition of Common Stock
 1. Statutory Merger
The acquired company’s assets and liabilities are
transferred to the acquiring company, and the
acquired company is dissolved, or liquidated.
The operations of the previously separate companies
are carried on in a single legal entity.
ABC
Company
ABC Company
XYZ
Company
 2. Statutory Consolidation
Both combining companies are dissolved
and the assets and liabilities of both
companies are transferred to a newly
created
ABCcorporation.
Company
EFG Company
XYZ
Company
3. Acquisition of Common

Stock
One company acquires the voting shares of another
company and the two companies continue to operate
as separate, but related, legal entities.
 The acquiring company accounts for its ownership
interest in the other company as an investment.
ABC
ABC Company
Company
XYZ
XYZ Company
Company
ABC…….Parent
XYZ…….Subsidiary
 Reasons of Business
combination
1. Growth: In recent years Growth has been main
reason for business enterprises to enter into a
business combination. Firms can achieve growth
through external and internal methods. The
external (e.g. business combination) method of
achieving growth is more rapid than growth
through internal methods, as per advocates of
external method.
2. Economies of scale: The economies of
scale will occur as a result of more intensive
utilization of production facilities, distribution
 Cont.…

3. Better management: Combinations results in better

management. Combinations result running the large scale
enterprises. A large enterprise can offer to use the service of
expertise. Various managerial functions can be efficiently
managed by those persons who are qualified for such jobs.
4. Monopolistic ambition: One of the important
reasons behind business combination is monopolistic
ambitions. The combined enterprises try to control more and
more enterprises in the same line so that they may be able to
detect their terms (E.g. set their price). But, the antitrust law is
against such type of business combination.
 Cont.…
5. Diversification: When one company involves
business combination, it can diversify risks of operations. A
Company involving business combination can minimize
risks as the enterprise is diversifying operation or line of
their activity. Since different companies are already dealing
in their respective lines, there will be risk diversification.
6. Tax advantage: When an enterprise with
accumulated losses merges with a profit making enterprise,
it is able to utilize tax shields (benefits). An enterprise
having losses will not be able to set-off losses against
future profits, because it is not a profit earning unit.
 Acquisition Method
 This standard requires to use the acquisition method
to account for a business combination transaction.
 It involves four steps:
 Step 1: Identify the acquirer
The guidance in IFRS 10 shall be used to identify
the acquirer—the entity that obtains control of
another entity, i.e. the acquiree.
In an asset acquisition, the company transferring
cash or other assets and/or assuming liabilities is
the acquiring company. In a stock acquisition, the
acquirer is, in most cases, the company transferring
cash or other assets for a controlling interest in the
voting common stock of the acquiree (company
being acquired).
 Cont.…
 When an acquisition is accomplished through an exchange
of equity interests, the factors considered in determining
the acquirer firm include the following:
1. Voting rights—The entity with the largest share of
voting rights is typically the acquirer.
2. Large minority interest—Where the company
purchases only a large minority interest (under 50%), but
no other owner or group has a significant voting interest,
the company acquiring the large minority interest is likely
the acquirer.
3. Governing body of combined entity—The entity that
has the ability to elect or appoint a majority of the
combined entity is likely the acquirer.
 Cont….
In the absence of evidence to the contrary:
Example 1: Companies A and B combine businesses by
forming C. C issues 30 million and 20 million shares to A’s
& B’s shareholders in exchange for A’s and B’s businesses.
Example 2: same as Example 1, except: 20 million shares
are issued to each of A’s & B’s shareholders. C had 9 board
members, 5 appointed by A’s shareholders and 4 by B’s.
Example 3: on 31 December 2014 A has 100 million
shares in issue. On 1 January 2015 A issued 200 million
new A shares to the owners of B in exchange for all of B’s
shares.
 Cont…..
Entity A intends to acquire the voting shares
(and therefore obtain control) of Target Entity.
Entity A incorporates Newco and uses this
entity to effect the business combination.
Entity A provides a loan at commercial interest
rates to Newco. The loan funds are used by
Newco to acquire 100% of the voting shares of
Target Entity in an arm’s length transaction.
Step 2: Determine the acquisition
date: date on which the acquirer
obtains control.
The date on which the acquirer obtains
control of the acquiree is generally the
date on which the acquirer legally
transfers the consideration, acquires the
assets and assumes the liabilities of the
acquiree—the closing date
 Step 3: Recognize and measure the
identifiable assets acquired, the liabilities
assumed and any non controlling interest in
the acquiree;
The acquirer shall measure the identifiable assets acquired and the
liabilities assumed at their acquisition-date fair values. All other
components of non-controlling interests shall be measured at their
acquisition-date fair values.
Fair value is the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between
market participants at the measurement date.
1. Marketable Securities: Recorded at Fair value.
2. Receivables: are recorded at the discounted present value of
amounts to be received using current interest rates, less
allowances for bad debts and collection costs.
 Cont…
3. Inventories:
I. Raw materials: Current Replacement cost
II. Work in Process: Net realizable value (Estimated
selling price/Fair value/Market value-cost to complete-cost
to sale)
III. Finished Goods: Net realizable cost (Estimated selling
price/Fair value/Market value-cost to sale).
4. Intangible Assets: Recorded at Fair value.
5. PPE, IP and NR: Recorded at Fair value.
6. Long term investments: Recorded at Fair value.
7. Liabilities: Recorded at Fair value.
 Cont.…
8. Research and development assets: The fair values of
both tangible and intangible research and development
assets are recorded even where the assets do not have
alternative future uses (the usual criteria for
capitalization of R&D assets).
 Non controlling interest
NCI is arise when one company controls another
company less than 100%. It is also referred as
Minority Interest.
IFRS 3: allows an accounting policy choice for
measuring non-controlling interest (NCI) at
the acquisition date:
1) fair value; or
2) NCI’s proportion of the group values of the
subsidiary’s net assets.
IFRS for SMEs: NCI = NCI’s proportion of the
Step 4: Recognize and measure the
goodwill or a gain from a bargain
purchase.
If the acquisition cost(Total Consideration)
exceed the fair value of net identifiable
asset, then we recognize a goodwill.
If the fair value of net identifiable asset
exceed the acquisition cost (Total
Consideration), then we recognize a
Negative goodwill (Gain on bargain
purchase).
 Cont…
1. Determination of Cost of Acquisition – assets to be acquired
and liabilities to be assumed are identified and then, like other
exchange transactions, measured on the basis of the fair values
exchanged. The Cost of acquiree includes also some other costs
as discussed below.
 The cost of a combine on a BC accounted for by Acquisition
method is the total of:
1. The amount of consideration paid by the combiner (Transfer of
assets, liabilities and shares),
2. Any contingent consideration that is determinable on the date of
the business combination.
 Cont…
1. Amount of Consideration (Transfer of assets, liabilities and shares):
This is the total amount of

a. Cash paid,
b. The Current fair value of other assets distributed,
c. The present value of debt securities issued &
d. The Current fair value (Market) value of equity security issued by the combiner.
Investment in Subsidiary………………….xx
Cash/other
assets………………………………………………………………xx
Bond/Notes Payable….
………………………………………………………..xx
Common
stock……………………………………………………………………...xx
Share Premium-Common Stock……………………….…………………xx
 Cont…
2. Contingent Consideration: Relates to an additional amount
paid by the parent to the shareholders of subsidiary if certain
conditions are met. It recorded at fair value.
Investment in subsidiary……………xx
Contingent Consideration………………xx
E.g.we will assume that, on Jan. 1, 2008, the acquirer issued
40,000 shares of stock with a market value of $800,000. In
addition to the stock issue, the acquirer agreed to pay an
additional $100,000 on January 1, 2010, if the average
income during the 2-year period of 2008–2009 exceeds
$80,000 per year. The expected value is calculated as $40,000
based on the 40% probability of achieving the target average
income.
 Cont.…
Summary
 Acquisition cost = Amount of consideration + Contingent
consideration
 Total Consideration = Acquisition cost + Fair value of Non
Controlling Interest +
The fair value of any interest in the acquiree already held by the
acquirer, if any.
 Other costs
1. Direct combination costs: Associated with completing the
business combination (Legal, Accounting, Consulting,
Appraisal and Finder`s fee).
Merger Expense………………xx
Cash……………………………………xx
2. Stock Issuance Cost: When the parent issues stock in
conjunction with a BC, any stock issuance costs, such as
underwriter fee and exchange fee.
Share premium-Common stock…………….xx
Cash…………………………………..
…………………xx
 Cont…
2. Fair value of Net Identifiable Asset (FVNIA):

FVNIA = Fair value of Asset-Fair value of Liabilities

 Cont…
Goodwill: is an asset representing the future economic benefits arising in a
business combination that are not individually identified and separately
recognized. Essentially, goodwill embodies the expected synergies that the
acquirer expects to achieve through control of the acquired firm’s assets.
The acquirer shall, at the acquisition date:
(a) Recognize goodwill acquired in a business combination as an asset,
(b) Initially measure that goodwill at its cost, being the excess of the cost of
the business combination over the acquirer’s interest in the net fair
value of the identifiable assets, liabilities and contingent liabilities
recognized. and
(c) Subsequently, goodwill acquired in a business combination to be tested
for impairment annually. So, the company doesn`t amortize the
Goodwill.
 Example 1
Entity A pays $78,000 to acquire 75% of the voting interest in
Entity B when the fair value of Entity B’s identifiable assets less
the fair value of Entity B’s liabilities and contingent liabilities is
$100,000. The fair value of NCI is Br 26,000.
Is the goodwill in the business combination an asset of the group?
Choose one of: 1) Yes; or 2) No.

If yes, what is the economic value of the goodwill to the group?

Choose one of: 1) $3,000; 2) $4,000; 3) $3,000 or $4,000 (at the
entity’s discretion); or 4) somewhere between $3,000 (if all synergies
are attributable to Entity A’s CGUs) and $4,000 (if all synergies are
attributable to Entity B’s CGUs).
 Cont…
1. Total Consideration= 78,000 + 26,000 =
104,000 or
Goodwill = 104,000-100,000 = 4,000…….Full
IFRS

2. Goodwill = 78,000-(0.75*100,000)
=78,000-75,000 = 3,000………IFRS
for SME
 Example 2
P com acquired S com on Dec. 31/2017 with the following
balances:
 The carrying amount of Assets are Br 440,000.
 The carrying amount of liabilities are Br 140,000.
 The fair value of assets are Br 500,000.
 The fair value of liabilities are Br 170,000.
 On Dec.31/2017 P com issued 50,000 shares of its Br
5(CFV of Br 8) CS for all the net asset of S.
 Issuance and out of pocket costs are Br 40,000 and Br
25,000, respectively.
Cont…
 Journal Entries:
1. Investment in S…..(8*50,000)…...........….400,000
Common Stock…(5*50,000)…………………………
250,000
Share premium-Common stock…………..
………..150,000

2. Merger Expense………………………………..……25,000
Share premium-Common stock……..…….40,000
Cash……………………………………..
………………….65,000
Cont…
Goodwill Calculation
 Acquisition Cost = Br 400,000
 FVNIA = Fair Value of Asset – Fair Value of Liability
= Br 500,000 – Br 170,000 = Br 330,000
 Goodwill = AC-FVNIA = Br 400,000 – Br 330,000 = Br
70,000.
Example 3
Cont…
 Journal Entries:
1. Investment in Set…((100,000*13) + 50,000)……….
….1,350,000
Common Stock…(100,000*10)
………………………1,000,000
Share premium-Common stock ……….........
…….300,000

Cash…………………………………………………………
………...50.000

2. Merger Expense…………………………………..…180,000
Cont…
Goodwill calculation
 Acquisition cost = Br 1,350,000
 FVNIA = Fair Value of Asset – Fair Value of Liability
= (60,000 + 500,000 + 450,000 + 300,000 + 250,000) –
(180,000 + 240,000) = 1,560,000 – 420,000 =
1,140,000

 Goodwill = AC-FVNIA = Br 1,350,000 – Br

1,140,000 = Br 210,000.
 Thank You for Your
Attention !

The End

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