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Chapter 1: Business Combinations (Part 1)

Business Combination
One company acquires another company

Two or more companies merge into one company

After the combination, one company gains control over the other

The company that obtains control over the other is the parent (acquirer)

The company that is controlled is the subsidiary (acquiree)

Methods of Business Combinations

Asset acquisition Stock acquisition
Acquirer purchases the assets and assumes the Acquirer acquires a majority ownership interest (more
liabilities of the acquiree in exchange for cash or other than 50%) in the voting rights of the acquiree
non-cash considerations
Acquirer is known as the parent
After acquisition, the acquired entity ceases to exist as
Acquiree is known as the subsidiary
a separate legal or accounting entity
After business combination, the parent and subsidiary
Acquirer records the assets acquired and liabilities
retain their separate legal entity
assumed in its book of accounts
Both the parent and subsidiary are views as a single
Results of asset acquisition
reporting entity for financial reporting purposes
1. Merger
The parent and subsidiary continue to maintain their
a. Two or more companies merge into a single separate books of accounts, recording their assets,
entity which shall be one of the combining liabilities and the transactions they enter separately.
companies
Parent records the acquired ownership interest as
b. A Co. + B Co. = A Co. or B Co. “Investment in subsidiary” in its separate books of
accounts
2. Consolidation
The investment is eliminated when the group
a. Two or more companies consolidate into a
prepares consolidated financial statements
single entity which shall be the consolidated
company

b. A Co. + B. Co = C. Co

Types of Business Combinations

1. Horizontal Combination

a. Two or more entities with similar businesses combine

b. Example: A bank acquiring another bank

2. Vertical combination

a. Two or more entities operating at different levels in a marketing chain combines

b. Example: Manufacturer acquiring its supplier of raw materials

3. Conglomerate

a. Two or more entities with dissimilar businesses combines

b. Example: Real estate developer acquiring a bank

Chapter 1: Business Combinations (Part 1) 1

 Advantages of Business Combinations
Advantage Explanation
Disadvantages of a Business
Competition between the combining
Combination
constituents with similar businesses Business combination brings monopoly in the market
Competition is is eliminated which may have a negative impact on society
eliminated or lessened
The threat of competition from other Could result to impediment to healthy competition
market participants is lessened between market participants
Greater productivity between two or The identity of one or both the combining constituents
Synergy
entities collaborating
may cease, leading to loss of sense of identity for
An increased variety of products or existing employees and loss of goodwill
services available and a decreased
dependency on limited number of Management of the combined entity may become
products and services difficult due to incompatible internal cultures, systems
and policies
Widened dispersion of products or
services and better access to new Business combination may result in overcapitalization
markets which may result to diffusion in market price per share
and attractiveness of the combined entity’s equity
Increased business
Access to either of the acquirer’s or instruments to potential investors
opportunities and
acquiree’s technological know-hows,
earnings potential The combined entity may be subjected to stricter
research and development, secret
processes and other information regulations and scrutiny by the government

Most especially if the business combination poses

Increased investment opportunities
due to increased capital
threats to consumers’ interests

Appreciation in with due to an

established trade name by either one
of the combining constituents

Horizontal combination
> Elimination of unnecessary
duplication of costs
Reduction of operating
costs Vertical combination
> Elimination of costs of negotiation
and coordination between companies
and mark-ups on purchases

Economies of scale refer to the

increase in productive efficiency
resulting from the increase in
production scale.
Combinations utilize
economies of scale An entity that achieves economies of
scale decreases its average cost per
unit as production is increased due to
fixed costs being allocated over an
increased number of units produced.

An entity can save on start-up costs,

research and development costs, cost
of regulations and licenses, and other
similar costs by acquiring another
Cost savings on company
business expansion
Business combination may be
effected through exchange of equity
instruments rather than the transfer of
cash or other resources

Favorable tax Deferred tax assets may be

implications transferred in a business
combinations

Chapter 1: Business Combinations (Part 1) 2

 Advantage Explanation

Business combinations effected

without transfers of considerations
may not be subjected to taxation

Essential Elements of a Business Combinations

Control
An investor controls an investee when the investor has the power to direct the investee’s relevant activities

Which affects the variability of the investor’s investment returns from the investee

Normally presumed to exist when the acquirer holds more than 50% (51% or more) interest in the acquiree’s voting
rights

Control can be obtained in some other ways such as

the acquirer has the power to appoint or remove the majority of the board of directors of the acquiree

the acquirer has the power to case the majority of votes at board meetings or equivalent bodies within the acquiree

the acquirer has power over more than half of the voting rights of the acquiree because of an agreement with other
investors

the acquirer controls the acquiree’s operating and financial policies because of a law or an agreement

Ways an acquirer may obtain control of an acquiree

by transferring cash or other assets

by incurring liabilities

by issuing equity interests

by providing more than one type of consideration

without transferring consideration, including by contract alone

Business
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 (such as dividends or interest) or generating other
income form ordinary activities

Elements of a Business
1. Input

a. Any economic resources resulting to an output when one or more processes are applied to it

2. Process

a. Any system, standard, protocol, convention or rule that, when applied to an input, creates an output

b. Administrative systems (accounting, billing, payroll and the like systems) are not processes used to create outputs

3. Output

a. The result of 1 and 2 above that provides goods or services to customers, investment income or other income from
activities

Identifying a Business Combination

An entity determines whether a transaction is a business combination or not in relation the the definition provided
under FPRS 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

Accounting for Business Combination

Chapter 1: Business Combinations (Part 1) 3

 Using the acquisition method

Requirements for the acquisition method

1. Identifying the acquirer

2. Determining the acquisition date

3. Recognizing and measuring goodwill which requires recognizing and measuring

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 the Acquirer

The entity that transfers the cash or other assets or incurs the liabilities

The entity that issues its equity interests

In reverse acquisitions where the issuing entity of shares is the acquiree, the acquirer is the entity

Whose owners, as a group, have the largest portion of the voting rights of the combined entity

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 f the other combining entity or
entities

The larger one between the combining entities in terms of assets, revenues or profits

The entity that initiated the combination

If a new entity is formed to effect the business combination, the acquirer is

If new entity is formed to issue equity interest to effect the business combination, one of the combining entities that
exists prior the business combination is the acquirer

If 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

Determining the Acquisition Date

The date on which the acquirer obtains control of the acquiree

The closing date on which the acquirer legal transfers the consideration, acquires the assets and assumes the liabilities
of the acquiree

Recognizing and Measuring Goodwill

Acquirer computes and recognizes goodwill (or gain on a bargain purchase) on acquisition date

Consideration transferred + Noncontrolling interest in the acquiree + Previously held equity in the acquiree = Total
consideration - Fair value of net identifiable assets acquired = Goodwill/Gain on a bargain purchase

A negative amount resulting from the formula is called “gain on a bargain purchase” (also referred to as “negative
goodwill”)

Gain on a bargain purchase occurs when

A business combination that is a forced sale in which the acquiree is acting under compulsion

Application of PFRS 3’s recognition and measurement exceptions for particular items

On acquisition date, the acquirer recognizes a resulting

Goodwill as an asset

Gain on a bargain purchase as gain in profit or loss

Chapter 1: Business Combinations (Part 1) 4

 PFRS 3 requires the acquirer to assess whether it has correctly identified all the assets acquired and all the liabilities
assumed and recognize any additional assets or liabilities that are identification in that review before recognizing a gain
on bargain purchase

Application of the conservatism concept

Acquisition-related costs
Consideration transferred
Costs that the acquirer incurs to effect a business
Measured at fair value
combination
Examples of potential forms of consideration include
Examples
Cash
Finder’s fees
Non-cash assets
Professional fees such as advisory, legal,
Equity instruments (shares, options and warrants) accounting, valuation and consulting gees
A business or a subsidiary of an acquirer General administrative costs including costs if
Contingent consideration maintaining an internal acquisitions department

Costs of registering and issuing debt and equity

securities

Expensed when incurred except for the following

Costs to issue debt securities measured at

amortized costs are included int he initial
measurement of the securities

Costs to issue equity securities are deducted from

share premium.

Insufficient share premium = issue costs are

deducted from retained earnings

Non-Controlling Interest
Equity in a subsidiary that is not attributable, directly or indirectly, to a parent

Also called minority interest

Measurement is either at

Fair value

the NCI’s proportionate share in the acquiree’s net identifiable assets

Percentage of NCI share * FV of identifiable assets

Previously Held Equity Interest in the Acquiree

Any interest held by the acquirer before the business combination

Affects the computation of goodwill only in business combinations achieved in stages

Net Identifiable Assets Acquired

Recognition Principle Recognition Conditions

Recognizes identifiable assets acquired, the liabilities Acquired identifiable assets and liabilities assumed
assumed and any NCI in the acquiree separately from must meet the definition of assets and liabilities
goodwill provided under Conceptual Framework at acquisition
date
Acquirer does not recognize unidentifiable assets such
as The identifiable assets acquired and liabilities assumed
must be part of what the acquirer and acquiree
Goodwill recorded by acquiree prior to business
exchanged in the business combination transaction
combination
Application of the principle may result in the acquirer
Assembled workforce of the acquiree
recognizing assets and liabilities that the acquiree had
not previously recognized in its financial statements

Chapter 1: Business Combinations (Part 1) 5

 Potential contracts that the acquiree is negotiating Classifying identifiable assets acquired and liabilities
with prospective new customers at acquisition date assumed

Measurement Principle Classified at acquisition date in accordance with other

PFRS that are to be applied subsequently
Measured at their fair values at the acquisition date

Separation valuation allowances not recognized at

acquisition date

All acquired assets are recognized regardless of

whether the acquirer intends to use them or not

Restructuring Provisions
Restructuring is a program that is planned and controlled by management

Restructuring materially changes either

The scope of a business undertaken by an entity

The manner in which that business is conducted

May include the costs of an entity’s plan

To exit an activity of the acquiree

To involuntarily terminate employees of the acquiree

To relocate non-continuing employees of the acquiree

The costs mentioned above is referred to liquidation costs

Does not include costs such as

Retraining or relocating continuing staff

Marketing

Investment in new systems and distribution networks

Generally not recognized as part of business combination unless acquiree has an existing liability for restructuring at
the acquisition date

Meets the definition of a liability at the acquisition date

Acquirer incurs a present obligation to settle the restructure costs assumed

Acquiree developed a formal plan for the restructuring

Raised valid expectation in those affected by publicly announcing the details of the plan on or before the
acquisition date

Provisions that do not meet the definitions of a liability at acquisition date are recognized as post-combination
expenses of the combined entity when costs are incurred

Specific Recognition Principles

Operating Leases Intangible Assets
Identifiable intangible assets are recognized separately
Acquiree is the lessee
from goodwill
General rule
Intangible assets are identifiable if it is either
Acquirer does not recognize any assets or liabilities
Separable
related to an operating lease in which the acquiree is
the lessee Arises from contractual or other legal rights

Exceptions
Separability Criterion
Acquirer determines whether the terms of the
Separable if it can be operated from acquiree
operating lease lease are favorable or unfavorable

Chapter 1: Business Combinations (Part 1) 6

 Favorable = acquirer recognizes an intangible Sold, transferred, licensed, rented or exchanged either
assets individually or together with a related contact,
identifiable asset or liability
Unfavorable = acquirer recognizes a liability
If there is evidence of exchange transactions for that
Acquiree is the lessor type of asset or similar asset even if transactions are
Acquirer does not recognize any separate intangible infrequent and acquirer is not involved
asset or liability regardless of whether the terms of the Even if the acquirer does not intent to sell, license or
operating lease is favorable or unfavorable exchange an intangible asset

Lists are not separable if confidentiality terms or other

agreements prohibit the entity from selling, leasing or
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

Exception to the Recognition Principles - Contingent Liabilities

Under PFRS 3, a contingent liability assumed in a business combination is recognized if

It is a present obligation that arises from past events

Its fair value can be measured reliably

Contingent liabilities with improbable outflow may nevertheless be recognized when applying the ‘acquisition method’
if both of the conditions above are satisfied

Exception to Both the Recognition and Measurement Principles

Income Taxes Employee Benefits Indemnification Assets
Accounted for using PAS 12 Accounted for using the PSA 19 Arises when the former owners of
Income Taxes Employee Benefits the acquiree agree to reimburse
the acquirer for any payments the
E.g. deferred taxes are measured E.g. defined benefit obligations
acquirer eventually makes upon
based on temporary differences are measured using actuarial
settlement of a particular liability
arising from measurement of valuations
identifiable assets and liabilities acquirer recognizes and measures
acquired at acquisition date. the indemnification asset at the
same time and on the same basis
Deferred taxes affect the
of the indemnified item
amount of goodwill or fain on
bargain purchased recognized If indemnified item is
at acquisition date measured at fair value, the
indemnification asset is also
PAS 12 prohibits the
measured at fair value
recognition of deferred tax
liabilities arising from the initial
recognition of goodwill

Additional Concepts on Consideration Transferred

Includes only those that are transferred to the former owners of the acquiree

Excludes those that remain within the combined entity

Assets and liabilities transferred to the former owners of the acquiree are measured to acquisition-date fair values

Any re-measurement gain or loss is recognized in profit or loss

Chapter 1: Business Combinations (Part 1) 7

 Assets and liabilities remaining within the combined entity are not remeasured but rather ignored when applying the
acquisition method

Exceptions to the Measurement Principle

Reacquired Rights Share-based payment Assets held for sale
Measured based on the remaining transactions Measured at fair value less costs
term of the related contract Liabilities and equity instruments to sell
related to the acquiree’s share
based payment transacted are
accounted for using PFRS 2
Share-based Payment

General Recognition and Measurement Principles

Net identifiable asses 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

Exception to the recognition principle

Contingent liabilities are recognized when they represent a present obligation and their fair value is determinable
even if the outflow is improbable

Exceptions to both the recognition and measurement principles

1. Deferred taxes in which PAS 12 is applied

2. Employee benefits in which PAS 19 is applied

3. Indemnification assets are recognized and measured on the same basis as the indemnified item

Exceptions to the measurement principle

1. Reacquired rights measured based on the remaining terms of the related contract

2. Share based payment in which PAS 2 is applied

3. Held for sale assets are measured at fair value less costs of sell

Chapter 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 which requires the following

1. Identifying the acquirer

2. Determining the acquisition date

3. Recognizing and measuring goodwill which requires accounting for the following

a. Consideration transferred

b. Non-controlling interest

c. Previously held equity interest

d. 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

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

Chapter 1: Business Combinations (Part 1) 8

 A “gain on bargain purchase” is recognized in profit or loss int he acquisition year only after reassessment of the assets
acquired and liabilities assumed in the business combination

Only identifiable assets acquired are recognized while 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 recognized as post-combination expenses of the combined entity when the costs are
incurred

Chapter 1: Business Combinations (Part 1) 9