LECPA

MINDTECH REVIEW AND LEARNING CENTER

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ADVANCED FINANCIAL ACCOUNTING AND REPORTING

Lec. 5 – Business Combination

BUSINESS COMBINATIONS market price per share

A business combination occurs when one company acquires 5. May be subjected to stricter regulation and scrutiny by the
another or when two or more companies merge into one. After the government.
combination, one company gains control over the other.
ACCOUNTING FOR BUSINESS COMBINATION
The company that obtains control over the other is referred to as Business combinations are accounted for using the acquisition
the parent and acquirer. The other company that is controlled is method. This method requires:
the subsidiary or acquiree. a) Identifying the acquirer;
b) Determining the acquisition date; and
Business combinations are carried out either through: c) Recognizing and measuring goodwill. This requires
1. Asset acquisition recognizing and measuring the following:
The acquirer purchases the assets and assumes the liabilities 1) Consideration transferred
of the acquiree in exchange for cash or other noncash 2) Non-controlling interest in the acquiree
consideration. 3) Previously held equity interest in the acquiree
4) Identifiable assets acquired and liabilities assumed on
After the acquisition, the acquired entity normally ceases to the business combination
exist as a separate legal or accounting entity. The acquirer
records the assets acquired and liabilities assumed in the Identifying the Acquirer
business combination in its books of accounts. The acquirer is the entity that obtains control of the acquiree. The
acquiree is the business that the acquirer obtains control of in a
A business combination effected through asset acquisition business combination.
may be either:
a. Merger – occurs when two or more companies merge PFRS 3 provides the following guidance in identifying the acquirer:
into a single entity which shall be one of the combining 1. In a business combination effected through asset acquisition,
companies. the acquirer is usually the entity that transfers the cash or
b. Consolidation – occurs when two or more companies other assets or incurs the liabilities.
consolidate into a single entity which will be the 2. In a business combination effected through stock acquisition,
consolidated company. the acquirer is usually the entity that issues its equity
interests. Other pertinent facts and circumstances in
2. Stock acquisition identifying the acquirer:
The acquirer obtains control over the acquiree by acquiring a a) Whose owners, as a group, have the largest portion of the
majority ownership interest in the voting rights of the voting rights of the combined entity.
acquiree. b) Whose owners have the ability to appoint or remove a
majority of the members of the governing body of the
The acquirer is known as the parent while the acquiree is combined entity.
known as the subsidiary. After the business combination, the c) Whose management dominates the management of the
parent and subsidiary retain their separate legal existence. combined entity.
However, for financial reporting purposes, both the parent d) That pays a premium over the pre-combination fair value
and the subsidiary are viewed as a single reporting entity. of the equity interests of the other combining entity or
entities.
The parent records the ownership acquired as investment in 3. The acquirer is usually the larger between the combining
subsidiary in its separate accounting books. However, the entities.
investment is eliminated when the group prepares 4. The acquirer is usually the one who initiated the combination.
consolidated financial statements. 5. If the new entity is formed to effect the business combination,
the acquirer is identified as follows:
A business combination may also be described as: a) If the new entity is formed to issue equity interests to
1. Horizontal combination – a business combination of two or effect the business combination, one of the combining
more entities with similar businesses. entities that existed before the business combination is
2. Vertical combination - a business combination of two or the acquirer.
more entities operating at different levels in a marketing b) If the new entity is formed to transfer cash or other
chain. assets to incur liabilities as consideration for the
3. Conglomerate – a business combination of two or more business combination, the new entity is the acquirer.
entities with dissimilar businesses.
Determining the Acquisition Date
Advantages of Business Combination The acquisition date is the date on which the acquirer obtains
1. Competition is eliminated or lessened control of the acquiree. This is normally the closing date – the date
2. Synergy the acquirer legally transfers the consideration, acquires assets
3. Increased business opportunities and earnings potential and assumes the liabilities of the acquiree.
4. Reduction of operating costs
5. Combination utilize economies of scale However, the acquirer might obtain control on a date that is either
6. Cost savings on business expansion earlier or later than the closing date.
7. Favorable tax implications
Recognizing and Measuring Goodwill
Disadvantages of a Business Combination On acquisition date, the acquirer recognizes a resulting:
1. Business combination brings monopoly in the market a. Goodwill as an asset
2. Loss of identity of one or both of the combining constituents b. Gain on bargain purchase as gain in profit or loss
3. Incompatible internal cultures, systems, and policies Note: Before recognizing a gain on bargain purchase, the acquirer
4. May cause overcapitalization that may result to diffusion in shall reassess whether it has correctly identified all of the assets

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 LECPA
MINDTECH REVIEW AND LEARNING CENTER
I-LINK CST UPTOWN CROSSING, POB.8, MIDSAYAP, NORTH COTABATO REVIEW

acquired and all of the liabilities assumed and shall recognize any Classifying identifiable assets acquired and liabilities assumed
additional assets or liabilities that are identified in the review. Identifiable assets acquired and liabilities assumed are classified
at the acquisition date in accordance with other PFRSs that are to
Formula: be applied subsequently.
Consideration transferred xx
Non-controlling interest (NCI) in the acquiree xx Measurement principle
Previously held equity interest in the acquiree xx Identifiable assets acquired and liabilities assumed are measured
Total xx at their acquisition-date fair values.
Les: Fair value of net identifiable assets acquired xx
Goodwill (Gain on a bargain purchase) xx 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.
Consideration Transferred
The consideration transferred in the business combination is All acquired assets are recognized regardless of whether the
measured at fair value, which is the sum of the acquisition-date fair acquirer intends to use them or not. The acquisition-date fair
values of the assets transferred by the acquirer, the liabilities values of such assets is determined in accordance with their use
incurred by the acquirer to former owners of the acquiree and the by other market participants.
equity interests issued by the acquirer.
Restructuring Provisions
A consideration transferred in a business combination includes Restructuring is a program that is planned and controlled by
only those that are transferred to the former owners of the management, and materially changes either:
acquiree. It excludes those that remain within the combined entity. a. A scope of a business undertaken by an entity; or
b. The manner in which that business is conducted.
Assets and liabilities transferred to the former owners of the
acquiree are remeasured to acquisition-date fair values. Any Restructuring provisions may include the costs of an entity’s plan
remeasurement gain or loss is recognized in profit or loss. a. To exit an activity of the acquiree,
b. To involuntarily terminate employees of the acquiree, or
Assets and liabilities that remain within the combined entity are c. To relocate non-continuing employees of the acquiree.
not remeasured but rather ignore when applying the acquisition
method. Restructuring provisions are generally not recognized as part of
business combination unless the acquiree has, at the acquisition
Acquisition-related Costs date, an existing liability for restructuring that has been
Acquisition-related costs are costs that the acquirer incurs to recognized in accordance with PAS 37 Provisions, Contingent
effect a business combination. These costs are expensed when Liabilities and Contingent Assets.
incurred, except for the following:
a. Costs to issue debt securities measured at amortized costs are Specific Recognition Principles
included in the initial measurement of the securities. PFRS 3 provides the following specific recognition principles:
b. Costs to issue equity securities are deducted from share 1. Operating leases
premium. If share premium is insufficient, the issue costs are Acquiree is the lessee
deducted from retained earnings. General rule: The acquirer does not recognize any assets or
liabilities related to an operating lease in which the acquiree
Non-controlling Interest (NCI) is the lessee.
The NCI is the equity in a subsidiary not attributable, directly or
indirectly, to a parent. It is also referred to as minority interest. Exception: The acquirer determines whether the terms of
each operating lease in which the acquiree is the lessee are
For each business combination, the acquirer measures any non- favorable or unfavorable.
controlling interest in the acquirer either at: a) Favorable – the acquirer recognizes an intangible asset.
1. Fair value; or b) Unfavorable – the acquirer recognizes liability.
2. The NCI’s proportionate share in the acquiree’s net
identifiable assets. Acquiree is the lessor
If the acquiree is the lessor, the acquirer does not recognize
Previously Held Equity Interest in the Acquiree any separate intangible asset or liability regardless of
Previously held equity interest in the acquiree pertains to any whether the terms of the operating lease are favorable or
interest held by the acquirer before the business combination. unfavorable when compared with market terms.
This affects the computation of goodwill only in business
combination achieved in stages. 2. Intangible assets
Identifiable intangible assets acquired in business
Net Identifiable Assets Acquired combination are recognized separately from goodwill. An
Recognition principle intangible asset is identifiable if it is either (a) separable or
On acquisition date, the acquirer recognizes the identifiable assets (b) arises from contractual or other legal rights.
acquired, the liabilities assumed and any NCI in the acquiree
separately from goodwill. “Separable” criterion
An intangible asset is separable if it can be separated from the
Recognition conditions acquiree and sold, transferred, licensed, rented or exchange,
a. To qualify for recognition, identifiable assets acquired and either individually or together with a related contract,
liabilities assumed must meet the definitions of assets and identifiable asset or liability.
liabilities provided under the conceptual framework.
b. The identifiable assets acquired and liabilities assumed must An intangible asset is also separable if there is evidence of
be part of what the acquirer and the acquiree exchanged in exchange transactions for that type of asset or similar asset,
the business combination transaction rather than the result even if those transactions are infrequent and the acquirer is
of separate transactions. not involved in them.
c. Applying the recognition principle may result to the acquirer
recognizing assets and liabilities that the acquiree had not An intangible asset is separable even if the acquirer does not
previously recognized in its financial statements. intend to sell, license, or otherwise exchange it.

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MINDTECH REVIEW AND LEARNING CENTER
I-LINK CST UPTOWN CROSSING, POB.8, MIDSAYAP, NORTH COTABATO REVIEW

Contractual-legal criterion classified as FVPL, investment in associate, or

An intangible asset that is not separable is nonetheless investment in joint venture; or
identifiable it is arises from contractual or other legal rights. b. Other comprehensive income – if the previously held
equity interest was classified as FVOCI.
Exception to the Recognition Principle – Contingent
Liabilities Business Combination without Transfer of Consideration
The acquirer applies PFRS 3, rather than PAS 37, when accounting The acquisition method also applies to business combinations in
for contingent liabilities related to business combinations. which the acquirer obtains control without transferring any
consideration.
Under PFRS 3, a contingent liability assumed in a business
combination is recognized if: Examples of circumstances where the acquiree obtains control
a. It is a present obligation that arises from past events; and without transferring consideration:
b. Its fair value can be measured reliably. a. The acquiree repurchases a sufficient number of its own
shares from other investors so that the acquirer will be able
Exception to both the Recognition and Measurement to obtain control.
Principles b. Minority veto rights that previously kept the acquirer from
The following items are recognized and measured as at the controlling the acquiree have lapsed.
acquisition date under other applicable standards rather than c. The acquirer and acquiree agree to combine their businesses
PFRS 3: by contact alone. The acquirer neither transfers
1. Income taxes are accounting for using PAS 12 Income taxes. consideration nor holds equity interests in the acquiree.
Deferred taxes affect the amount of goodwill or gain on
bargain purchase recognized at the acquisition date. In a business combination achieved without transfer of
However, PAS 12 prohibits the recognition of deferred tax consideration, the acquisition-date fair value of the acquirer’s
liabilities arising from the initial recognition of goodwill. interest in the acquiree is substituted for the consideration
2. Employee benefits are accounted for suing PAS 19 Employee transferred in computing for goodwill.
Benefits.
3. Indemnification asset – asset arises when the former owners In a business combination achieved by contract alone, the
of the acquiree agree to reimburse the acquirer for any interests held by parties other than the acquirer are attributed to
payments the acquirer eventually makes upon settlement of NCI, even if the result is that NCI represents 100% interest in the
a particular liability. The acquirer recognizes and measures acquiree.
the indemnification asset at the same time and on the same
basis as the indemnified item. Measurement Period
If the initial accounting for a business combination is incomplete
Exception to the Measurement Principle by the end of the reporting period in which the combination
1. Reacquired rights occurred, the acquirer can use provisional amounts to measure
A right that an acquirer has previously granted to the any of the following for which the accounting is incomplete:
acquiree that is reacquired as a result of a business a. Consideration transferred
combination is recognized as an intangible asset separately b. Non-controlling interest in the acquiree
from goodwill. c. Previously held equity interest in the acquiree
d. Identifiable assets acquired and liabilities assumed
Reacquired rights are measured based on the remaining
terms of the related contract. Within 12 months from the acquisition date, the acquirer
retrospectively adjusts the provisional amounts for any new
2. Share-based payment transactions information obtained that provides evidence of facts and
Liabilities and equity instruments related to the acquiree’s circumstances that existed as of the acquisition date, which if
share-based payment transactions are accounted for using known would have affected the measurement of the amounts
PFRS 2 Share-based Payment. recognized on that date. Any adjustment to the provisional amount
is recognized as an adjustment to goodwill or gain on a bargain
3. Assets held for sale purchase.
A noncurrent asset that is classified as held for sale at the
acquisition date is measured at fair value less costs to sell in Adjustments for new information obtained beyond the 12-month
accordance with PFRS 5 Noncurrent Assets Held for Sale and measurement period are accounted for as corrections of error in
Discontinued Operations. accordance with PAS 8 Accounting Policies, Changes on
Accounting Estimates and Errors.
SHARE-FOR-SHARE EXCHANGES
A business combination may be accomplished through exchange Determination of the Part of the Business Combination
of equity interest between the acquirer and the acquiree. The The acquirer considers the following when determining whether
general principle is that the consideration transferred is measured a transaction is part of a business combination or a separate
at fair value. transaction:
a. A transaction that is arranged primarily for the benefit of the
However, there may be cases where the fair value of the acquiree’s acquirer or combined entity rather than the acquiree or its
equity interests may be more reliably measurable than the former owners is likely to be a separate transaction. The
acquirer’s. in such cases, the acquirer computed for goodwill using transaction price shall be excluded from the consideration
the fair value of the acquiree’s equity interests instead of its own. transferred when computing for goodwill.

Business Combination achieved in Stages (Step Acquisition) Hence, a transaction that is arranged primarily for the benefit
A business combination is achieved in stages when the acquirer of the acquiree or its former owners is more likely to be a part
obtains control of an acquiree in more than one transaction. of the business combination transaction.

In accounting for a business combination achieved in stages, the b. A transaction initiated by the acquirer is likely for the benefit
acquirer: of the acquirer or the combined entity and, therefore, a
1. Remeasures the previously held equity interest in the separate transaction.
acquiree at acquisition-date fair values; and
2. Recognizes the gain or loss on the remeasurement in: Hence, a transaction initiated by the acquiree or its former
a. Profit or loss – if the previously held equity interest was owners is more likely to be a part of the business combination

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MINDTECH REVIEW AND LEARNING CENTER
I-LINK CST UPTOWN CROSSING, POB.8, MIDSAYAP, NORTH COTABATO REVIEW

transaction. A change in the fair value of a contingent consideration

resulting from additional information obtained during the
c. A transaction between the acquirer and acquiree during the measurement period is accounted for as a retrospective
negotiations of a business combination is more likely to be adjustment to provisional amount. However, changes
part of the business combination. resulting from meeting an earnings target, reaching a
However, the following are separate transactions that are specified share price or reaching a milestone on a research
excluded when applying the acquisition method: and development project are not measurement period
1) Settlement of pre-existing relationship between the adjustments.
acquirer and acquiree;
2) Remuneration to employees or former owners of the Changes in the fair value that are not measurement period
acquiree for future services; and adjustments are accounted for depending on the
3) Reimbursement to the acquiree or its former owners for classification of the contingent consideration:
paying the acquirer’s acquisition-related costs. a. A contingent consideration classified as equity is not
remeasured and its subsequent settlement is accounted
Settlement of Pre-existing Relationship for within equity.
If the pre-existing relationship is settled due to the business b. A contingent consideration classified as an asset or a
combination, the acquirer recognizes a settlement gain or loss liability is measured at fair value at each reporting date.
measured as follows: Changes in fair value are recognized in profit or loss.
a. At the lower of (1) and (2) provided below, if the pre-existing
relationship is contractual. GOODWILL
1. The amount by which the contract is favorable or Goodwill is measured and recognized on acquisition date.
unfavorable, from the acquirer’s perspective, when Subsequent expenditures on maintaining goodwill are expensed
compared with market terms. immediately.
2. Any settlement amount stated in the contract that is
available to the counterparty to which the contract is After initial recognition, goodwill is not amortized but rather
unfavorable. If this is less than the amount in (1), the tested for impairment at least annually. For this purpose, goodwill
difference is included as part of the business is allocated to each of the acquirer’s cash-generating units (CGU)
combination accounting. in the year of business combination. If the allocation is not
completed by the end of that year, it must be completed before the
b. At fair value, if the pre-existing relationship is non- end of the immediately following year.
contractual.
Goodwill is unidentifiable, therefore, it cannot be tested for
The settlement gain or loss is adjusted for the derecognition impairment separately but only in conjunction with groups of
of any related asset or liability that the acquirer has assets that generate independent cash inflows - CGUs.
previously recognized.
A CGU is impaired it is recoverable amount is less than its carrying
Subsequent Measurement and Accounting amount including the allocated goodwill. Impairment loss is
Subsequent to acquisition date, the acquirer accounts for assets charged first to the CGU’s goodwill and any excess is charged to the
acquired, liabilities assumed and equity instruments issued in a other assets in the CGU. Impairment of goodwill is not reversed in
business combination in accordance with other PFRSs applicable subsequent period.
for those items. However, the following are subsequently
measured under PFRS 3: Methods of Estimating Goodwill
1. Reacquired rights Before actual business combination transaction takes place, the
Reacquired rights recognized as intangible assets are amount of goodwill may be estimated using any of the following
amortized over the remaining terms of the related contract. methods:
1. Indirect valuation – a residual approach wherein goodwill is
2. Indemnification assets measured as the excess of the sum of a consideration
Indemnification assets are measured on the same basis as the transferred, non-controlling interest in the acquiree, and
indemnified item, subject to assessments of collectability for previously held equity interest in the acquiree over the fair
indemnification assets not measured at fair value. value of net identifiable assets acquired (method required by
PFRS 3).
3. Contingent liabilities recognized as of the acquisition date 2. Direct valuation – goodwill is measured based on expected
Contingent liabilities recognized in a business combination future earnings from the business to be acquired. The
are measured at the higher of: application of this method may require the determination of
a. The amount that would be recognized by applying PAS the following:
37; and a. Normal rate of return in the industry where the acquiree
b. The amount initially recognized less, if appropriate, belongs.
cumulative amount of income recognized in accordance b. Estimated future earnings of the acquiree. The excess of
with PFRS 15 Revenue from Contracts with Customers. the acquiree’s normalized earnings over the average
return in the industry represents the excess earnings to
4. Contingent Consideration which goodwill is attributed.
Contingent consideration is additional for a business c. Discount rate to be applied to excess earnings.
combination that the acquirer agrees to provide to the d. Probable duration of excess earnings.
acquiree upon the happening of a contingency.
REVERSE ACQUISITION
Initial recognition and measurement In a reverse acquisition, the entity that issues securities (the legal
A contingent consideration is measured at acquisition-date acquirer) is identified as the acquiree for accounting purposes,
fair value and included in the consideration transferred. while the entity whose equity interests are acquired (the legal
acquiree) is the acquirer for accounting purposes.
An obligation to pay the contingent consideration is classified
either as liability or equity. A right to recover a previously Measuring the Consideration Transferred
transferred consideration if specified conditions are met is The acquisition-date fair value of the consideration transferred by
classified as an asset. the accounting acquirer is measured as an amount based on the
number of equity interests the legal subsidiary (legal acquirer)
Subsequent measurement would have had to issue to give the owners of the legal parent

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(accounting acquiree) the same percentage of equity interest in

the combined entity that results from the reverse acquisition.

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