1/11/2018

Week 1
Introduction to business combinations and
accounting for goodwill
(HKFRS 3 (Revised)) – revised Nov 2014

Textbook: Chapter 1

Intended Learning Outcomes

APPLY the appropriate accounting
concepts and policies and relevant Hong
Kong Financial Reporting Standards
(HKFRSs) to the preparation of financial
statements for a Group which is
composed of parent company, subsidiaries,
and associated companies.

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Learning Objectives
1. Define “business combination” and discuss the
causes for business combinations.
2. Explain the nature and various forms of business
combination and its accounting issues.
3. Understand the nature and characteristics of
goodwill.
4. Distinguish between purchased goodwill and non-
purchased goodwill.
5. Define “goodwill.”
6. Recognize and measure goodwill or gain from a
bargain purchase.
7. Account for non-controlling interests under the
two options available in HKFRS3(revised).
8. Explain accounting treatment for goodwill or gain
from a bargain purchase in the business
combination.
3

Background
Good businesses => expansion
◦ Internal growth – expand
expand existing
existing settings
settings
◦ External growth – buy
buy established
established businesses
business
External growth may give rise to complex
complex
organizational and
organizational and ownership
ownership structures e.g.
structures
subsidiaries, associates,
subsidiaries, associates and
and joint
joint ventures
ventures
Issues for accountants - How to present the
performance and financial position of a
group
Accounting for a group – difficult and
complex (mainly covered in advanced level)
HKFRS3 deals with the accounting for
business combination 4

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Part I. Business Combinations

1. Introduction (LO1)
Business combination: ‘a transaction or other
event in which an acquirer obtains control of one
or more businesses’ -- HKFRS 3(revised)
◦ Two or more companies combining together
Directly by
bytaking
takingover
overthe
theoperations
operationsof the other
of the company
other companies
or
Indirectly by
by acquiring
acquiringcontrolling
controllingstake of of
stake voting shares
voting shares
◦ Must have an acquirer and acquiree(s)
For settlement of purchase price, cash, shares or
a combination of cash and shares (or even
debentures)

Part I. Business Combinations

Reasons for business combinations
◦ of expertiseof scale
Economics
Examples:
- Facebook bought WhatsApp in 2014
- Foxconn’s takeover Sharp in 2016
- Nissan acquired Mitsubishi in 2016

Elimination of competition
- Youku acquired Tudou in 2012
- Nissan acquired Mitsubishi

Diversification of risk
Acquisition of expertise
- FB 6
- Foxconn's

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Part I. Business Combinations

2. Common forms (LO2)
A. Absorption
Acquirer takes
Acquirer takes over
over alloperations
all the the operations of
of acquiree
acquiree. Purchase of assets

Acquiree will
Acquiree will cease
cease to exist
to exist after
after absorption
absorption.
A + B = A

Part I. Business Combinations

B. Amalgamation (or Merger)
A newcompany
A new company is formed
is formed i.e. acquirer.
e.g. acquirer
Twocompanies
Two companiese.g.i.e. acquirees
acquirees will cease
will cease to existto
after combination
exist after combination.
A + B = C

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Part I. Business Combinations

C. Acquisition (or Takeover)
An
Anyacquirer
acquireracquires
acquires all
all or
or aa majority
majority(e.g.
(i.e.more
morethan 50%) of
than 50%) shares
the voting of the voting shares of acquiree(s).
of acquirees.
AA takeover resultsininaaparent/
takeover results parent/subsidiary
subsidiary relationship
relationship => group structure.
=> group structure

A + B = A + B

There’re still 2 companies, but they become a group

Part I. Business Combinations

C. Acquisition (or Takeover)
A takeover can be friendly or hostile.
Both acquirer and acquiree(s) continue to operate
as before.
According to Companies Ordinance, they are
separate legal entities although they have close
relationship.

Notes: Acquiring company = Acquirer

Acquirer
Acquired company = Acquiree

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Part I. Business Combinations

Thinking question: Purchase of assets like A.
Absorption or acquisition of shares like C.
Takeover, which form is better?

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Part I. Business Combinations

Thinking question: Purchase of assets like A.
Absorption or acquisition of shares like C.
Takeover, which form is better?
Answer: Which form is better depends on the scenario
Factors Assets Shares
Time Longer Shorter
Cost Higher More efficient
Risk Lower Higher for hidden liabilities

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Example 1
To buy a property, which is held by a
corporation.
2 options:
◦ Buy property directly (i.e. change of legal title)
or
◦ Buy all the shares of the corporation so as to
control the use of property indirectly

Which option would you choose?

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Example 1 (answer)
Since thereis is
Since there only
only oneone
assetasset
in thisin this
transaction,
transaction, it would be safer andtheeasier
it would be safer and easier to transfer legal title

to transfer the legal title.

Acquiring
Acquiring thethe shares,
shares, shareholders
shareholders may bemay
liablebe
to
hidden liabilities of the corporation
liable to hidden liabilities of the
corporation.

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Part II. Background of Goodwill

(positive or negative)
1. What is goodwill? (LO3)
In a business combination, the acquirer may offer a price
that is different from the total value of the identifiable net
assets of the acquiree.

In general,
Value of business as a whole
(i.e. purchase price) xxx
Less: Fair value of separate net assets (xxx)
Goodwill xxx

NOT carrying amount/book value

Goodwill represents premium paid to acquire control.

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Part II. Background of Goodwill

(positive or negative)
Case 1 Case 2
$million $million
Value of business as a whole 300 250
FV of net assets
Land and building 220 220
Other assets 150 150
Liabilities (90) (90)
280 280
Goodwill 20 (30)
Positive Negative
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Part II. Background of Goodwill

(positive or negative)
1. What is goodwill? (LO3)
Goodwill is an unidentifiable intangible asset
(no physical existence), which is expected to
benefit the company for more than one year.
It is an intrinsic part of the business and
cannot be sold separately.

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Part II. Background of Goodwill

(positive or negative)
2. Why does goodwill exist? (LO3)
Intangible factors:
◦ Commercial connections
Commercial connections
◦ Good reputation
Good reputation
◦ Trained skilled
Trained skilled workforce
workforce
◦ Efficient
Efficient management
management The acquirer is paying the fair value
So, successful business should worth more
than the sum of the net assets they control.
Going-concern goodwill (i.e. enhance earning
capability on combination of assets) and
Combination goodwill (i.e. achieve synergy
by combining with competitors)
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Example 2
To start a business as a property
developer like Sun Hung Kai Properties
(FV of $240 billion, which represents the
FV of net assets)
Instead of setting up a new company to
save time => make a direct offer to buy
all the shares of SHK
What price will you offer for all the
shares of SHK?
- Subjective to different buyers
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Example 2 (answer)
Fact of SHK
◦ Incorporated on 14 July and went public on 23 Aug
1972
◦ One of the blue chips in HKSE
◦ Credit rating is A+ (S&P) and A1(Moody)
◦ Award of best company in HK
So, the price you offer must be higher than its FV
of net assets as there are many intangible factors
e.g. reputation, quality of properties developed by
SHK
How much it should be higher depends on
buyers’ point of view i.e. how to assess the value
of the company.
Going-concern goodwill
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Example 3
Firm A and Firm B are two similar CPA
firms
◦ Setting up offices in China
◦ Providing similar services to clients
Firm A to expand business by acquiring all
the business of Firm B (FV of net assets
$30m today)
What price will Firm A offer?

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Example 3 (answer)
goodwill
Synergy effect in the business combination as it
- eliminate competitions
- shares common resources

Firm A should offer price higher than the FV of net assets of Firm B

How much it should be depends on impact of the synergy

from the acquisition (e.g. how to measure the economic benefit)

Combination goodwill

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Part II. Background of Goodwill

(positive or negative)
Thinking questions:
What intangible factors in Cathay Pacific Airline
(“CPA”) are and which can enable the company to
charge a higher air ticket fare than other airlines?

What is the goodwill of TVB?

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Part II. Background of Goodwill

(positive or negative)
Thinking questions:
What intangible factors in Cathay Pacific Airline
(“CPA”) are and which can enable the company to
charge a higher air ticket fare than other airlines?
Answer:

What is the goodwill of TVB?

Answer:

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Part II. Background of Goodwill

(positive or negative)
3. Characteristics of goodwill (LO3)
a. Intangible factors can’t be valued

b. Assessment of value of goodwill is highly

subjective and unique at a particular point in
time i.e. assessment from the viewpoint of the
buyer

c. Value of goodwill may fluctuate

d. Goodwill is incapable of realization separately

from the business as a whole

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Part II. Background of Goodwill

(positive or negative)
3. Characteristics of goodwill (LO3)
a. Intangible factors can’t be valued e.g.

b. Assessment of value of goodwill is highly

subjective and unique at a particular point in
time i.e. assessment from the viewpoint of the
buyer e.g.

c. Value of goodwill may fluctuate e.g.

d. Goodwill is incapable of realization separately

from the business as a whole e.g.

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Part II. Background of Goodwill

(positive or negative)
4. Classification of goodwill (LO4)
a. Purchased goodwill (positive or negative)
◦ As a result of purchasing a business (i.e. a buyer is
willing to pay for it and so, value can be realized in
the business combination).
◦ Also called goodwill arising on business combination
/ goodwill on consolidation.

b. Non-purchased goodwill
◦ Any goodwill other than purchased goodwill
mentioned above (i.e. only subjective measurement
by the company itself and so, not realized).
◦ Also called inherent / internally generated goodwill.
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Classification of goodwill
Thinking Question: What are the main differences
between purchased goodwill and non-purchased
goodwill, which may lead to different accounting
treatments?
Purchased goodwill –

Non-purchased goodwill –

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Classification of goodwill
Thinking Question:What are the main differences
between purchased goodwill and non-purchased
goodwill, which may lead to different accounting
treatments?
Answer:
Purchased goodwill –

Non-purchased goodwill -

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Part II. Background of Goodwill

(positive or negative)
5. Main issue: Should goodwill be
recognized as an asset in the statement of
financial position (i.e. balance sheet)? (LO3)
i. Permanent asset
ii. Amortization
iii. Write-off
iv. Revaluation
v. Impairment

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Part II. Background of Goodwill

(positive or negative)
Thinking Question: Discuss the issues of
each view above.

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Part II. Background of Goodwill

(positive or negative)
Thinking Question: Discuss the issues of each
view above.
Answer:
Refer to the characteristics of goodwill:

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
1. Definition of goodwill (HKFRS 3 (revised))
(LO5)
Goodwill – Future economic benefits
arising from assets acquired in a business
combination that are not individually
identified and separately recognized.

◦ Can’t be identified individually, but, it could

be identified as a whole.
◦ Measured as a residual value.

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
1. Definition of goodwill (HKFRS 3 (revised))
(LO5)
Do not mix up Goodwill and Intangible
assets from accounting standards’ point of
view.
◦ Goodwill will be accounted for under HKFRS
3 (Revised) whereas
◦ Intangible assets will be recognized under
HKAS 38 (e.g. patent, copyright, trademark,
royalty).

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
2. Recognition and measurement of goodwill or a Gain from a
Bargain Purchase (LO6, LO7)
Goodwill is recognized on acquisition date measured as a) – b) below.
a)i. Fair Value of Consideration transferred (slide 33 for details)
3. equity interest 4. contingent
1. assets transferred 2. liabilities incurred
issued by acquirer consideration

+ a)ii. Amount of NCI

1) if present ownership interests => Net
2) if other components => only FV
assets OR FV

+ a)iii. Fair Value of any previously held equity interest in the acquiree

- b) Amount of identifiable assets and liabilities acquired

= Goodwill arising from combination

Refer to next slide for details. 35

Part III. Accounting practice: HKFRS3

(revised) Business combinations
The acquirer shall recognize goodwill as of the acquisition date
measured as the excess of a) over b) below:
a) The aggregate of:
i. The consideration transferred measured in accordance with the HKFRS, which
generally requires acquisition-date fair value;
ii. The amount of any non-controlling interest (“NCI”) in the acquiree measured in
accordance with the HKFRS:
1) NCI that are present ownership interests and entitle their holders to a
proportionate share of the entity’s net assets in the event of liquidation (two
options – measurement choice net assets excluding goodwill OR fair value
including goodwill).
2) Any other components of NCI: fair value including goodwill (one option only);
and
iii. A business combination achieved in stages; the acquisition-date fair value of the
acquirer’s previously held equity interest in the acquiree.

b) The net of the acquisition-date amounts of the identifiable assets

acquired and the liabilities assumed measured in accordance with
the HKFRS.

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
2. Recognition and measurement of goodwill or
a Gain from a Bargain Purchase (LO6, LO7)

This new model measures the goodwill of the entity as a

whole:
$
Total value of the business of the acquiree, – a) above xxx
The amount of fair value of net assets, – b) above xxx
Goodwill xxx

This model differs from old accounting standards.

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
2. Recognition and measurement of goodwill
or a Gain from a Bargain Purchase (LO6, LO7)
a)i. Fair value of consideration given from the
acquirer to the acquiree:
1. Fair value of assets transferred e.g. cash given
2. Fair value of liabilities incurred
3. Fair value of equity interest issued by the acquirer
4. Fair value of contingent consideration
Fair value of consideration transferred

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Example 4
H purchased 100% of shares of S for
$1,200.
FV of S’s net assets was $900.

Compute the amount of goodwill.

39

Example 4 (answer)
$
The consideration transferred
The fair value of net assets gg

Goodwill

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
2.1 Accounting issues in identifying the goodwill of the
company as a whole
If the acquirer purchases 80% of the shares of
acquiree, should goodwill be calculated for 80%
only or for the whole company (i.e. acquiree)?
Entity theory and Parent theory

2.1.1. Two bases on NCI measurement

NCI at fair value at acquisition date (i.e. FV
option)
NCI as a proportion of net assets at acquisition
date (i.e. net assets option)
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Example 5
H purchased 80% of S for $1,000.
FV of S’s net assets was $900.
FV of NCI $230.

Compute goodwill and further analyze

goodwill for acquirer and NCI.

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Example 5 (answer)
Old method: no longer applicable

Consideration transferred $1,000

FV of net assets 900*80% 720
Goodwill (H only) 280

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Example 5 (answer)
New practice NCI at NA NCI at FV

Consideration
transferred
Amount of NCI

FV of S’s net
assets
Goodwill
Goodwill attributable to:
H
NCI
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Part III. Accounting practice: HKFRS3

(revised) Business combinations
3. Accounting treatment for (positive) goodwill
(LO8)
i. Recognition: as an asset
ii. Initial measurement: shall be at cost
(amount computed on slide 30)
iii. Subsequent measurement: no amortization,
carried at
Cost less any accumulated impairment losses
iv. Presentation: as a non-current asset

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Part III. Accounting practice: HKFRS3

(revised) Business combinations
3.1 Impairment test
Goodwill will be reviewed annually for
impairment loss.
Impairment loss, once made, can’t be
reversed even if subsequent information
reveals that impairment no longer exists.
Impairment loss of goodwill will be borne by parent or shared
by both parent and NCI depends on options to measure NCI
Options Parent NCI
Fair value option √ √
Net assets option √ X
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Example 6
Data about acquiree on 1.1.x6 was:
Cost of acquisition (100%) $400
FV of net assets $250
The total value of goodwill at 31.12
◦ 20x6 $70
◦ 20x7 $100
◦ 20x8 $50
Prepare accounting entries for goodwill
adjustment for the years from 20x6 to 20x8
assuming year-end at 31.12.
Show extract of statement of financial position.

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Example 6 (answer)
1.1.x6 $
Cost of acquisition 400
FV of net assets (250)
Goodwill 150

Goodwill at 31.12.x6 Statement of financial

position at 31.12.x6
Goodwill 70
Goodwill, at cost $150
Goodwill on acquisition 150
Goodwill impairment for 20x6 80 Less: Accumulated
impairment loss 80
70
Accounting entries at 31.12.x6:

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Example 6 (answer)
Goodwill at 31.12.x7 $
Goodwill 100
Goodwill on 1.1.x7 70
Goodwill impairment for 20x7 Nil
Action:

Statement of financial
position at 31.12.x7
Goodwill, at cost $150
Less: Accumulated
impairment loss 80
70
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Example 6 (answer)
Goodwill at 31.12.x8 $
Goodwill 50
Goodwill on 1.1.x8 70
Goodwill impairment for 20x8 20

Accounting entries at 31.12.x8:

Statement of financial position at 31.12.x8

Goodwill, at cost $150

Less: Accumulated impairment loss (80+20)
100
50
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Part III. Accounting practice: HKFRS3

(revised) Business combinations
4. The nature of the ‘Negative goodwill’ – a gain?
(LO8)
HKFRS 3 (Revised), gain from a bargain
purchase can comprise of the following
components:
a) Errors in measurement
b) According to standards, the amount used is not
fair value
c) A bargain purchase (i.e. gain) (e.g. seller to sell
business at a price lower than its fair value
maybe due to shortage of money or other
reasons.)
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Part III. Accounting practice: HKFRS3

(revised) Business combinations
4.1 Accounting treatment for (negative)
goodwill – a gain from a bargain purchase
i.e. net asset in excess of cost (i.e.
Negative goodwill):
◦ a reassessment of the fair value of both
cost of the combination and acquiree’s net
assets.
◦ any excess remaining after reassessment is
recognized immediately in profit or loss (i.e.
income statement as a gain).

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Example 7
Acquisition of businesses by H as follows:
A Ltd B Ltd
$000 $000
Property, plant and equipment 1,000 5,000
Inventories 1,300 3,700
Bills and debtors 4,400 2,600
Cash at bank 2,000 1,200
Current liabilities (1,000) (3,000)
FV of net assets 7,700 9,500
FV of consideration 5,000 8,500
Negative goodwill 2,700 1,000

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Example 7
Required:
a. Discuss accounting treatment of
negative goodwill in respect of A and B
from H’s point of view.
b. After reassessment, “Bills and debtors”
in A should be $2,100. Provide the
journal to recognize negative goodwill.
c. If recoverable amount of business
significantly increases next year, what
could H Ltd do?
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Example 7 (answer)
a.
b.

c. .

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Example 8
On 1.7.x1, H purchased 1,500 shares
from S’s existing shareholders at $3/share
by cash.
Total number of shares issued by S was
2,000.
H will pay additional $900 to existing
shareholders of S in 20x4 if S can sustain
existing profitability for 2 years from
1.7.x1. It is likely S could achieve this.
FV of NCI on 1.7.x1 was $1,700.
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Example 8
Financial position of S at 1.7.x1 BV $ FV $ FV adj $
Property, plant and equipment 3,000 2,800 (200)
Development cost 0 1,000 1,000
Investment properties 1,200 2,600 1,400
Inventory 1,500 600 (900)
Accounts receivable 1,400 1,300 (100)
Cash 300 300 0
Total assets 7,400 8,600 1,200
Total recognized liabilities 2,500 2,500 0
Contingent liabilities recognized 0 500 500
Total liabilities 2,500 3,000 500
Net Assets 4,900 5,600 700
Share capital 2,000
Retained profit 2,900
4,900 57

Example 8
Required:
a. Compute percentage of shareholding.
b. Compute the consideration transferred.
c. Determine the goodwill and analyze the
goodwill for H and NCI respectively.

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Example 8 (answer)
a. % of shareholding

b. Consideration transferred

c. Goodwill =

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End of Lecture

You may do the exercise questions

in the textbook.

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