XADVAC2
Notes in Business Combination
Jonathan M. Tipay, CPA
BusCom may be accounted for either as:
1. Acquisition of Net Assets
2. Acquisition of Stocks
In #1, acquisition is always 100% and the acquiree is
legally dissolved. Parent records all the assets and
liabilities in its books just like an ordinary purchase.
In #2, acquisition is normally below 100% and the
acquiree remains to subsist even if it becomes a wholly-
owned subsidiary by the parent. The parent merely
records its consideration as “investment in subsidiary.”
Phase 1: Consolidation immediately after combination
During phase 1 of the business combination, the first
step is always to compute for the result of acquisition.
The result of acquisition is computed simply as:
Fair value of the Business VS. Fair value of the
indentifiable net assets of the Subsidiar, or
Parent NCI (3)
Fair value of the XX XX
business (1)
Fair value of the (XX) (XX)
identifiable net
assets of the
subsidiary (2)
Goodwill/(Gain XX XX
on Acquisition)
Rationale: if the difference is positive, the parent sees
something intangible in the subsidiary and hence the
difference is Goodwill. It follows therefore, that is the
difference is negative, the parent pays for a bargain
and consequently, Gain on acquisition is recognized.
1. FAIR VALUE OF THE BUSINESS
The fair value of the business consists of the
consideration transferred by the parent including its
previously held interest in the subsidiary if any. This also
includes the fair value of the Non-Controlling interest or
NCI as well as ay contingent consideration in which the
parent may give as incentive in the business
combination.
Fair value of the business is computed simply as:
Cash consideration XX
transferred @ Face Value
Shares transferred or XX
issued as consideration @
Fair Value
Contingent Consideration XX
@ Estimated Fair Value *
Fair Value of Previously XX
Held Interest in the
subsidiary **
Fair Value of the Non- XX
controlling interest (3)
Total Fair Value of the XX
Business
*FAIR VALUE of CONTINGENT CONSIDERATION
Contingent Consideration is normally a contingent
liability granted as an inducement or incentive for the
subsidiary to perform better. Contingent considerations
are subject to scrutiny because they are mere estimates
during the date of combination. These are subject to
the measurement period provided for in PFRS 3 which is
1 year. Thus, any change as a result of NEW
INFORMATION existing as of combination date will
affect the result of acquisition. However, POST-
COMBINATION events which are non-existent as of
combination date will be included in the PROFIT/LOSS
of the parent REGARDLESS if they fall within the
measurement period.
If the change in contingent consideration is the result of
NEW INFORMATION or ERROR, the change will affect
the result of acquisition EXCEPT if the measurement
period is not complied with. Thus, even if the change in
contingent consideration is a result of error or new
information but such change is known BEYOND or
AFTER the 1 year measurement period, then such
change in consideration will not affect the result of
acquisition but will merely be reflected in the Profit and
Loss of the parent.
If the change in contingent consideration is the result of
POST-COMBINATION EVENTS, the change will
automatically be reflected as either gain or loss in the
Profit and Loss of the parent even if the change takes
place within the 1 year measurement period.
The following are common POST-COMBINATION
EVENTS: 1.) meeting a share price target of subsidiary,
2.) meeting an earnings target of subsidiary, 3.)
milestone in research and development of subsidiary
**FAIR VALUE of PREVIOUSLY HELD INTEREST (PHI)
Normally, before a parent obtains control in its
subsidiary, the parent owns a pre-existing interest in
the subsidiary i.e. a 25% investment in associate. Such
ownership is carried in the books of the parents
normally at acquisition cost, let’s say P200,000. PFRS 3
however requires that consideration transferred
including previously held interest (PHI) be record at
their Fair Values.
The previously held interest normally has no market
value and hence its fair value is not determinable from a
market standpoint. However, there is a logical way to
compute for the fair value of the PHI.
The new consideration given by the parent may it be
cash or shares are indicative of the fair value of the
business. i.e. if the parent is willing to pay P500,000 for
50% of the shares of the business, then it is logical to say
that if he were to buy 100% of all its shares, he would be
willing to pay P1,000,000.
Tying the examples together, if suppose the parent
owns 25% interest which he acquired for P200,000
years ago and now he is paying P500,000 for another
50%, his total interest will now be equal to 75%. The
question is, how much is the fair value of its total
interest? There are two ways of looking into this.
First approach: The parent’s new interest (50%) in
relation to his total interest (75%) is 66.67%(50/75).
Hence, it follows that its total interest is P750,000
(500,000/66.67%)
Second approach: The parent’s new interest is equal to
50% of the ENTIRE BUSINESS. The total implied fair
value of the business is therefore P1,000,000. Since the
parent’s total interest is 75%, it follows that the fair
value of its interest is P750,000.
The fair value of its total interest is P750,000. P500,000
of which is the FV of its new interest and it follows that
P250,000 is the FV of its PHI.
Suppose the acquisition cost of the OLD interest is
P200,000. What will be the implication of the fair value
of the PHI of P250,000?
The parent will recognize a gain of P50,000 (250,000-
200,000). This is the consequence of the Fair Value
approach mandated by PFRS 3.
2. FAIR VALUE OF THE INDENTIFIABLE NET ASSETS OF
THE SUBSIARY
In computing the result of acquisition, we compare the
Fair Value of the business with the fair value of the
Identifiable net assets of the subsidiary. PFRS 3
mandates that all the identifiable net assets and
liabilities of the subsidiary be reflected for consolidation
purposes at Fair value.
The Measurement period of 1 year again applies to the
estimates of the Fair Value of the Identifiable Net
Assets of the Subsidiary. (See rules on the
Measurement period on the previous page.)
Query: What happens to the difference between the
book value and fair value of an identifiable asset and/or
liability?
Answer: Such difference is relevant for Phase 2 of
business combinations or on dates subsequent to the
acquisition. Example of which is the excess of the fair
value over the book value of the inventory. Such excess
will be subject to amortization/realization on
consolidation of the financial statements.
SUBSIDIARY’s Pre-existing Goodwill
OBSERVATION: the caption used is the FAIR VALUE of
the IDENTIFIABLE NET ASSETS of the Subsidiary.
Conclusion: if the subsidiary before combination has
pre-existing goodwill, such goodwill will be written off
for consolidation purposes but will continue to be
reported in the SUBSIDIARY’s SEPARATE STATEMENTS.
3. NON-CONTROLLING INTEREST (NCI)
PFRS 3 requires that Non-Controlling interest be
measured at Fair Value.
Fair value connotes either the Fair value given to the
NCI, its implied value or its Proportionate share in the
FVNA of the subsidiary.
The Fair Value attached to the NCI CANNOT BE LOWER
THAN their proportionate share in the FVNA of the
subsidiary. Thus, NCI can never recognize any gain on
acquisition and is limited to recognizing goodwill.
Reason for the rule: the owners of the NCI are mere
spectators and play a passive role in the business
combination and are therefore disallowed to recognize
gain on their interests.
There are two types of goodwill methods to be used in 3. CONSOLIDATED TOTAL SHAREHOLDERS’ EQUITY
business combinations. Either the total/full or grossed Only the parent’s equity items are included in the
up goodwill or the partial goodwill approach. computation of CSHE. The subsidiary’s equity is
eliminated against the Investment in Subsidiary account
FULL GOODWILL - under the Full Goodwill, the Fair as well as against the NCI account.
Value attached to the NCI will be either the
given/implied fair value or the Proportionate share in Parent’s This includes the XX
the FVNA, whichever is HIGHER. Common Stock newly-issued
stocks if shares
PARTIAL GOODWILL – under the partial goodwill, the were issued as
consideration
fair value of the NCI is ALWAYS equal to the
Parent’s APIC This includes the XX
proportionate share in the FVNA meaning there is NO APIC arising
GOODWILL for the NCI. from the new
issue if shares
CONSOLIDATED FINANCIAL STATETMENTS on the Date were issued as
of Acquisition (PHASE 1) consideration
(Stock issue costs
At this point, only the Consolidated Balance Sheet may
may be deducted
be prepared because there are no operations as Parent-
directly from
Subsidiary yet. Parent’s APIC)
Parent’s RE Acquisition- XX
CONSOLIDATED BALANCE SHEET related costs
(direct and
1. CONSOLIDATED TOTAL ASSTES indirect costs
may be deducted
For consolidation purposes, assets should be included in
directly from
their Book Values for Parent’s assets and Fair Value for Parent’s RE)
Subsidiary’s assets. Hence, a simple formula follows: Gain from XX
Acquisition
Parent’s Assets at Book XX Gain from XX
Value changes in Fair
Subsidiary’s Assets at Fair XX Value of PHI
Non-controlling This generally is XX
Value
interest the Fair Value of
Goodwill arising from the XX the NCI which
Combination includes both
Cash Paid as Consideration (XX) their
Cash Paid for Acquisition (XX) proportionate
Related Costs share in FVNA
and their share
Consolidated Total Assets XX
in Goodwill if
any.
2. CONSOLIDATED TOTAL LIABILITIES Acquisition For consolidated (XX)
Again, Parent’s liabilities will be included at their Book Related Costs equity, these
Values and Subsidiary’s liabilities will be included at may be lumped
their Fair Values. together and
deducted in their
entirety
Parent’s Liabilities at Book XX
PROVIDED that
Value they have not
Subsidiary’s Liabilities at XX yet been
Fair Value deducted from
Contingent Consideration XX APIC and R/E
otherwise, they
at estimated fair value
would be
Consolidated Total XX deducted twice
Liabilities Consolidated XX
Total Equity
Additional Notes in Business Combination
Dr. Rodiel C. Ferrer, CPA
AFAR Reviewer, CPAR
Business Combination – is a transaction where the
acquirer obtains control over the net assets of the
acquiree.
Notes for CONTROL PREMIUM
1. Should be included in Purchase Price
2. Excluded in Computing NCI
3. It affects Goodwill or Gain on Acquisition
COMPUTATION OF TOTAL ASSETS, LIABILITIES &
EQUITY ON DATE OF BUSINESS COMBINATION

Ownership Account Title Model Total Assets of Parent @ BV XX

>0% - <20% Financial Asset Cost / Fair Value Total Assets of Subsidiary @ FV XX
@ Fair Value Goodwill (arising from buscom) XX
Through PL / OCI (Purchase Price in Cash)* (XX)
20% - 50% Investment in Equity (Direct Cost)** (XX)
Associate *if SME, may use (Indirect Cost)** (XX)
Cost/Equity/FV (Cost to Issue and Register)** (XX)
>50% - 100% Investment in Cost / Equity / TOTAL ASSETS XX
Subsidiary Fair Value *Disregard if assets of Parent are after payment
**Only deduct IF PAID
TYPES OF BUSINESS COMBINATION
1. Asset Acquisition – 100% ownership Total Liabilities of Parent @ BV XX
1.1 Statutory Merger – A + B = A or B (one continues) Total Liabilities of Subsidiary @ FV XX
1.2 Statutory Consolidation – A + B = C FV of Contingent Consideration Payable XX
2. Stock Acquisition – A + B = A&B Purchase Price - Liabilities XX
2.1 Fully Owned Subsidiary – 100% Direct Cost* XX
2.2 Partially Owned Subsidiary - <100% Indirect Cost* XX
Cost to Issue and Register* XX
ACQUISITION RELATED EXPENSES
TOTAL LIABILITIES XX
1. Direct Cost – Expensed
*Only add IF NOT PAID
2. Indirect Cost – Expensed
3. Cost to Issue and Register (CTIR)
Shareholders’ Equity of Parent @ BV XX
These costs are treated for in the following priority:
Shareholders’ Equity of Subsidiary
3.1 Deducted from Share Premium from issuance of
(ELIMINATED)
NEW shares
Only include NCI if any XX
3.2 Deducted from other existing Share Premium
Gains
*3.3 Debited to “Stock Issuance Cost” (SIC) which is a
-Gain on Acquisition
separate line item considered as a deduction to
-Gain/Loss on PHI
SHE
-Gain/Loss on Contingent Consideration Payable* XX
*SIC is no longer deducted from R/E as per Philippine
Purchase Price (New Issuance @ FV) XX
Interpretation Committee
(Direct Cost)** (XX)
(Indirect Cost)** (XX)
PRESENTATION OF NCI
1. Fair Value of NCI (Full Goodwill) (Cost to Issue and Register)*** (XX)
If the FV is unknown, compute for the implied FV using TOTAL SHAREHOLDERS’ EQUITY XX
the following formula *Arises only beyond date of acquisition
(PP – ControlPremium) / CI% x NCI% **Deducted whether PAID OR NOT
***CTIR is considered as a Contra Equity item.
PP or Purchase Price includes:
a. FV of Consideration Transferred /ljbp
b. FV of Previously Held Interest (PHI)
c. FV of Contingent Consideration

2. Proportionate/Relevant Share (Implied Goodwill)

FVNA x NCI% = INAS (Interest in NA of Subsidiaries)

FLOOR TEST – FV of NCI should not be less than INAS