1 - Business Combinations

Business Combinations
Prof. Ma. Rona Corda-Prado, MBA, CPA

UP in the Visayas
Business Combinations
• A transaction or other event in which

an acquirer obtains control of one or
more businesses.
• Control of an entity - one party or a
number of parties has the power over
another to govern its financial and
operating policies so as to obtain the
benefits from its activities
Reasons for Business Combinations
• Cost advantage
• Lower risk
• Fewer operating delays
• Avoidance of takeovers
• Acquisition of intangible assets
Reasons for Business Combinations
• Integration of business activities

• Acquisition or development of a stronger
organization, better production and management
talent
• Reduction of costs through economies and
efficiencies of a large scale operation
• Better access to capital for growth
Types of Business Integration
• The immediate concern of many combinations is to gain operating

efficiencies thru business integration
• Vertical integration - combination of firms with operations in different
but successive stages of production and/or distribution
 Backward vertical integration - acquisition towards the source
 Forward vertical integration - acquisition towards the market
• Horizontal integration - combination of firms in the same business
lines and markets (acquisition of competitors - direct or indirect)
• Conglomeration - combination of firms with unrelated and diverse
products and/or service functions to reduce risks of single product
lines or even out cyclical earnings (San Miguel – Bank of Commerce,
Petron)
• Circular Combination – combination of companies that operate
within the same general market but offer a different product mix (i.e
shoes and bag).
Forms of Business Combinations
Acquisition of Net Assets

Merger: One entity retains its
identity.
Consolidation: New entity
identity is created.
Stock Acquisition
Parent/Subsidiary
Relationship: All entities
maintain identity.
Merger
A+B=A
One company acquires a second company and the
second company ceases to exist.
Company A Net Assets of B Company B

(Surviving Entity) (Dissolved Entity)
e.g. HP and Compaq; Agilent-HSG and Philips

Consolidation
A+B=C
Two companies form a third company and the
original two companies cease to exist.
Company A
Company
C
Company B
Exxon and Mobil: Exxon-Mobil

Parent and Subsidiaries
A+B=A+B
One company acquires the common stock of a
second company, and after the transaction, both
companies continue to exist
Over 50% of
Company A Stock B Company B
(Parent) (Subsidiary)
Both the parent and the subsidiary maintain their own

accounting records and FS but present consolidated FS
for external reporting purposes (e.g. Panasonic and
Sanyo).
PFRS 3: Business Combinations
• Originally published in March 2004 as the outcome of

IASB‟s 1st phase of its business combination project
• Superseded in January 2008 by IFRS 3 which was a
joint output of IASB and US FASB
• Under the revised version of IFRS 3, the term purchase
method of accounting is replaced with the term
acquisition method
• Applied to business combinations with an acquisition
date on or after July 1, 2009
• Applied in the Philippines as PFRS 3
VIDEO
• IFRS 3
PFRS 3 Application
Applies to a transaction or other event that meets

the definition of a business combination.
Business combination – bringing together of
separate entities or businesses into one reporting
entity
Business – integrated set of activities and assets
that is capable of being conducted and managed
for the purpose of providing a return directly to
investors and other stakeholders
PFRS 3 Application

the definition of a business combination, including
combinations:
1. Involving mutual entities (mutual entity refers to an entity other than
an investor owned entity, that provides dividends, lower costs, or
other economic benefits directly to its owners, members or
participants i.e. mutual insurance company, credit union or a
cooperative entity)
2. Achieved by contract alone (dual listing/stapling): two entities
enter into a contractual agreement which covers matters like
operation under a single management, equalization of voting power
and earning attributable to both entities‟ equity investors
PFRS 3 Application

the definition of a business combination. This IFRS
does not apply to:
1. The formation of a joint venture.
2. The acquisition of an asset or a group of assets that does not
constitute a business. In such cases the acquirer shall identify
and recognize the individual identifiable assets acquired and
liabilities assumed. The cost of the group shall be allocated to
the individual identifiable assets and liabilities on the basis of
their relative fair values at the date of purchase. Such a
transaction or event does not give rise to goodwill.
3. A combination between entities or businesses under common
control
Illustration A
Entity A purchases all of the assets and liabilities of

the ongoing widget manufacturing operations of
Entity B. Would this transaction be considered
within the Scope of IFRS 3?
The transaction would be considered within

the scope of IFRS 3 because the activities and
assets acquired constitute a business in
accordance with IFRS3.
Illustration B
Entity B purchases all of the hardware that

comprises the computer and telephone systems of
a company that is winding up. Would this
transaction be considered within the Scope of
IFRS 3?
No, because hardware in itself is not considered
to be an integrated set of assets and activities
and without an extensive range of other assets
(software) and services (installation and ongoing
servicing) cannot be used to provide a return to
investors or to lower costs.
Illustration C
• Company S is a manufacturer of a wide range of

products. The company‟s payroll and accounting system
is managed as a separate cost centre, supporting all the
operating segments and the head office functions.
Company A agrees to acquire the trade, assets, liabilities
and workforce of the operating segments of Company S
but does not acquire the payroll and accounting cost
centre or any head office functions. Company A is a
competitor of Company S. Would IFRS 3 apply in this
case?
Illustration C
• In this example, the activities and assets within the

operating segments are capable of being managed as a
business and so Company A accounts for the acquisition
as a business combination. The payroll and accounting
cost centre and administrative head office functions are
typically not used to create outputs and so are generally
not considered an essential element in the assessment
of whether an integrated set of activities and assets is a
business.
Illustration D
Entity C and Entity D are both controlled by Entity

E. To make its operations more efficient, Entity E
reorganizes its group structure where Entity C is
purchased by Entity D. Would this transaction be
considered within the Scope of IFRS 3?
No, because Entity C and D were controlled by
Entity E both before and after the transaction. In
this case, transfer of assets and liabilities would
be recorded at carrying values but Entity D could
also opt to record the transfer at fair values.
Illustration E
• Company Q has a wholly-owned subsidiary, Company R,

and a 30% owned associate, Company S. During the
year, Company R acquired Company Q‟s shares in
Company S by issuing its own shares and purchased the
remaining shares of Company S held by other
shareholders for cash. After these transactions,
Company S became a wholly-owned subsidiary of
Company R.
Illustration E
• In this situation, Company R paid consideration to Company

Q and the other shareholders of Company S to obtain control
of Company S. The transaction meets the definition of a
business combination. Although Company S is a related party,
Company Q did not control Company S before the
transaction. Company R‟s acquisition of Company S changed
the nature of the investment from an associate to a subsidiary.
This transaction does not meet the criteria of a common
control combination and is a business combination within the
scope of IFRS 3. Company Q and Company R (if it prepares
consolidated financial statements) will apply the acquisition
method in their consolidated financial statements.
Definition of Terms
• Acquiree - The business or businesses that the acquirer

obtains control of in a business combination.
• Acquirer - The entity that obtains control of the acquiree.
• Acquisition date - The date on which the acquirer
obtains control of the acquiree.
• Non-controlling interest - The equity in a subsidiary not
attributable, directly or indirectly, to a parent
Pooling of Interest Method
• IFRS 3 eliminated „pooling of interest‟ for all

combinations
• Historically, many combinations were recorded as
pooling
 Net assets acquired recorded at their book value
 No goodwill was recognized
Acquisition Method of Accounting
• Formerly known as “purchase method”

• The transaction is recorded at the fair market
value of the consideration given by the acquiring
company
• The net assets of the acquired company are
written up or down to fair market value
• Any excess of the value paid over the sum
of the fair market values of the net assets
acquired is recorded as goodwill
Acquisition Method of Accounting
1. Identify the acquirer

2. Determine the acquisition date.
3. Recognize and measure the identifiable assets
acquired, the liabilities assumed and any non-
controlling interest in the acquiree (take note
that only the acquiree‟s net assets are restated
at FV; the acquirer‟s net assets would be
retained at book or carrying value).
4. Recognize and measure goodwill or gain from
bargain purchase.
Identifying the Acquirer
Acquirer
• Party that gains control over the other party
• Assumed to have control of another when it acquires
more than half (more than 50%) of the other entity‟s
voting rights
• Even if it has less than 50% share, an entity is still
considered as the acquirer if it has the ability to
appoint or remove majority of the members of the
board of the acquiree
Illustration F
Entity D and E enter into a business combination
transaction. The terms of the transaction are as
follows:
• A new entity, Entity F is created
• The previous shareholders of Entity D hold 55% of
the interests in entity F
• The previous CEO and CFO of Entity D hold those
respective positions in Entity F
• The fair value of the net assets of Entity D at
acquisition was CU 1m
Illustration F
• The fair value of the net assets of Entity E at
acquisition was CU 0.9m
Who is the acquirer in this scenario?
Based on these facts and the absence of other facts to

the contrary, Entity D would be considered as the
acquirer. Accordingly, the assets, liabilities and
contingent liabilities of Entity E must be measured at fair
value for their initial inclusion in the combined accounts.
Illustration G
Entity E (a listed entity) and Entity F (privately traded)
enters into a business combination transaction. The
terms of the transaction are as follows:
• Entity E acquires 100% of the ordinary share
capital of Entity F
• The previous shareholders of Entity F are issued
with new shares making up 75% of the voting
shares in Entity E
• The previous CEO and CFO of Entity F take up
those positions in Entity E
Illustration G
• The fair value of the net assets of Entity E at the
date of acquisition was CU1m
• The fair value of the net assets of Entity F at the
date of acquisition was CU3m
Who is the acquirer in this scenario?
In this example, Entity F is considered to be the acquirer

for accounting purposes, irrespective of the fact that
from a legal perspective, Entity E is considered to be the
acquirer, and the requirements for reverse acquisition are
applied.
Other Indicators of an Acquirer
• The combining entity whose owners as a group

receive the largest proportion of the voting rights in the
combined entity;
• Owner who has a large minority interest in the
combined entity and no other owner has a significant
voting interest;
Other Indicators of an Acquirer
• Entity that has the ability to select the management

team, or the majority of the members of the governing
body, of the combined entity; or
• Entity who paid a premium over the fair value of one or
more of the combining entities prior to the combination
Illustration H
• Company X, a clothing retailer acquires 40% of the

voting shares in Company Z, a major supplier. Company
Z needs to expand its production capacity to meet
Company X‟s demands but currently has limited access
to financing. Company X agrees to provide a long-term
loan to fund expansion. As part of the agreement,
Company Z‟s other shareholders agree that Company X
will be able to appoint or remove three of the five
directors of Company Z. The directors are empowered to
determine Company Z‟s financial and operating policies
by simple majority vote. Does Company X exercise
control over Company Z?
Illustration H
• Company X‟s ability to appoint or remove the majority of

the board of directors of Company Z gives it the power to
determine Company Z‟s financial and operating policies.
Its ownership of 40% of the equity gives Company X
access to benefits from Company Z‟s activities.
Accordingly, Company X has obtained control.
Illustration I
• Company Z has an existing 40% ownership interest in

Company X, a company in the technology industry. Two
private equity firms, Firm A and Firm B, own 30% each of
the remaining equity of Company X. During the year,
Firm A announced that it will concentrate its investments
in the real estate sector and is planning to divest its
investments in other sectors, including its investment in
Company X. Since Company X is cash rich and has
sufficient capital, it repurchased the shares held by Firm
A. Who has control over Company X?
Illustration I
• In this situation, Company Z was not a party to the

transaction between Company X and Firm A and
Company Z did not pay any consideration. However, the
repurchase by Company X of its shares is an economic
event that changed Company Z‟s ownership interest in
Company X from 40% to 57%. As a result, Company Z
obtained control of Company X and accordingly should
account for the event as a business combination.
Illustration J
Company W decided to spin-off two of its existing businesses

(currently housed in two separate entities, Company X and
Company Y). To facilitate the spin-off, Company W
incorporates a new entity (Company Z) with nominal equity
and appoints independent directors to the board of Company
Z. Company Z signs an agreement to purchase Companies X
and Y in cash, conditional on obtaining sufficient funding. To
fund these acquisitions, Company Z issues a prospectus
offering to issue shares for cash. At the conclusion of the
transaction, Company Z is owned 99% by the new investors
with Company W retaining only a 1% non-controlling interest.
Would IFRS 3 apply in this case?
Illustration J
• In this situation, a set of new investors paid cash to

obtain control of Company Z in an arm‟s length
transaction. Company Z is then used to effect the
acquisition of 100% ownership of Companies X and Y by
paying cash. Company W relinquishes its control of
Companies Y and Z to the new owners of Company Z.
Although Company Z is a newly formed entity, Company
Z is identified as the acquirer not only because it paid
cash but also because the new owners of Company Z
have obtained control of Companies X and Y from
Company W.
Determine the Acquisition Date
• Date on which the acquirer obtains control of the

acquiree is generally the date when the acquirer legally
transfers the consideration, acquires the assets and
assumes the liabilities of the acquiree (closing date)
• Where several dates are key to the business
combination, the date when control passes is
considered as the acquisition date
• Critical as it is the date used to establish the fair value
of the company acquired
Determine the Acquisition Date
5/2 8/10 9/30 11/30

A public offer was made for Received Acceptances received Paid cash to
100% of the equity shares shareholders‟ to date represent 95% remaining
of XYZ Company approval of XYZ Co. shares shareholders
7/1 10/10
Received Paid cash to
regulatory XYZ Company
approval accepting
3/19 8/31 shareholders
ABC Corp approached the Acceptances received
management of XYZ Corp to date represent 55%
seeking endorsement of the of XYZ Company
acquisition shares
Determine the Consideration Given
• Consideration transferred in a business combination

shall be measured at fair value
• Fair value would be the sum of the following:
• Face value of cash paid;
• Fair values of assets transferred by the acquirer at
acquisition date
• Liabilities incurred by the acquirer to former
owners of the acquiree
• Equity interests issued by the acquirer
Determine the Consideration Given
• If consideration > FV of the assets acquired

• Goodwill would be recognized subject to impairment
testing
• If consideration < FV of the assets acquired
• Gain on acquisition (bargain purchase): presented
as a separate line item in SCI
• Note: An acquirer is not permitted to recognize a separate
valuation allowance as of acquisition date. This applies to
both receivables and PPE.
Acquisition Related Costs
• Costs the acquirer incurs to effect a

business combination and includes:
• Finder‟s fees;
• Advisory, legal accounting,
valuation and other professional
and consulting fees;
• General administrative costs,
including the cost of maintaining an
internal acquisitions department;
and
• Costs of registering and issuing
debt or equity securities
Acquisition related costs are

accounted for as expenses* in
the periods in which costs are
incurred and services received
except the cost of issuing debt
or equity securities which is
usually deducted from the
carrying amount of equity or
liability.
* In the 2004 version, direct costs are part of the consideration

and only indirect costs are expensed.
• Professional fees paid to accountants for pre-acquisition audit,

legal fees/advisers and other consultants (finder‟s fees and
brokerage fees) should be directly charged to expenses.
• General and administrative costs, including the costs of
maintaining an acquisitions department and other indirect costs
should be accounted for as expenses.
• Cost of registering and issuing equity securities such as CPA
audit fee and legal fees for SEC registration and costs of printing
stock certificates should be debited to additional paid in
capital/share premium of current share issuance.
• If share premium of current issuance is reduced to zero, charge
to Stock Issuance Costs which would be presented as a contra
equity account under Share Premium of Previous Share
Issuance or Retained Earnings.
• Direct cost of issuing debt securities should be considered as

bond issue cost (lumped with discount and netted against the
premium on bonds payable) as per IFRS 9.
• BCD Corp. acquires all the outstanding share capital of

the WXY Company by issuing 100,000, P10.00 par
new ordinary shares with a fair value of P25.00 on
acquisition date. The professional fees associated with
the acquisition are P32,000 and the issue costs of the
shares are P15,000.
• How much is the consideration transferred in the
business combination?
• Consideration = P2,500,000 (100,000 x P25.00)
• Expenses = P32,000
• Deduction from APIC = P15,000
Bond Issuance
• ASDF Corp. acquires the net assets of QWER Corp. On top of

the cash and stock consideration, ASDF Corp is to provide QWER
Corp with enough cash so that it could pay its outstanding
liabilities. This would be financed thru a bond issuance which
would be redeemed at 105 per P100 bond. Total bond issued is
P50M and ASDF incurred P1M for bond issuance costs. What
would be the entry for the bond issuance?
Cash 52,500,000
Bonds Payable 50,000,000
Premium on bonds payable 2,500,000
Premium on bonds payable 1,000,000

Cash 1,000,000
Bond Issuance
• On December 31, 2011, an airplane manufacturer, Airways, issued

$1 million in bonds at 5% annual interest, due December 31,
2014, at par. Airways incurred bank fees of $100,000, legal fees
of $50,000 and salaries of $25,000 for its employees in
conjunction with issuing the bonds. What is the entry for bond
issuance?
Cash $825,000
Salary expense 25,000*
Discount on Bonds Payable 150,000
Bonds payable $1,000,000
* Airways can capitalize the $100,000 of bank fees and $50,000 of legal fees.
Salaries must be expensed as they are internal costs and are not direct and
incremental. The transaction costs directly reduce the carrying value for IFRS
Assignment
• LP 14-1
• LP 14-2
• LP 14-3
Measurement Period
Measurement Period Any change in estimates

(any change in estimates beyond the
in this period would be measurement period
treated as an adjustment would be charged to
of goodwill or gain in P&L.
acquisition)
Acquisition Maximum The measurement period ends

Date Length of when improved information is
(1/1/2014) Measurement available or its obvious that no
Period better information is available
(pp100).
(12/31/2014)
Contingent Consideration
• An agreement to issue additional consideration (asset, liability

or equity) at a later date if specified events occur.
• Two of the most common scenario where a contingent event
will lead to a contingent consideration in equity or cash/liability
are:
• Future performance – future income or cash flows of the
acquiree is regarded as uncertain and the agreement
contains a clause that requires the acquirer to provide
additional consideration to the acquiree if the income/cash
flows of the acquiree is not equal to or exceeds a specified
amount over some specified period
• Future stock prices – acquirer issues shares to the
acquiree and the acquiree is concerned about a potential
decline in the acquirer‟s shares market value over time
• Measured at its fair value at the acquisition date and

recognized by the acquirer as either a liability or as equity,
according to its nature
• As a liability – if the contingent consideration will be paid in
cash or another asset
• As equity – if issuing additional shares will satisfy the
contingent consideration. After the initial recognition, the
contingent consideration will not be remeasured.
• When there is a trading relationship between the acquiree and
acquirer, any consideration that is paid in relation to this
existing trading relationship (i.e. supply contract) should not
form part of the business combination. Proper disclosure
should be made (per PFRS 3.51).
The acquisition of VWX Co. by CDE Corp. include the following terms
and conditions:
1. If the profits of VWX Co. for the first full year following acquisition
exceeded P5,000,000 then CDE Corp will pay additional
consideration of P12,000,000 three months after the close of that
year. It is doubtful whether VWX will achieve this profit, hence the
acquisition date fair value of this consideration is P400,000.
2. A contract exists whereby CDE Corp. will buy certain components
from the VWX Co. over the next 5 years. The contract was signed
when market price for these components were higher than they are
at the acquisition date. Contract prices are expected to exceed
market prices over the next 5 years by P3,000,000.
How would you record the 2 items above assuming that consideration
other than the contingent portion resulted to goodwill?
1. Contingent consideration of P400,000 - increase in the fair value of

the consideration
Goodwill 400,000
Contingent Consideration Payable 400,000
2. CDE Corp now owns VWX and can therefore cancel the contract; it is
not part of the consideration value. The P3,000,000 of the
consideration should be recognized as an expense in profit or loss,
rather than treated as transferred in the business combination.
Subsequent Accounting for Contingent
Consideration
• If the change results from additional information about conditions at

the acquisition date and it arises within the measurement period
(maximum of 12 months from the acquisition date), the change
should be related back to the acquisition date, with a possible effect
on the goodwill acquired or gain from bargain purchase recognized.
• If the change results from events after the acquisition date or
beyond the measurement period:
• If equity: Amount should not be remeasured until the
contingency is resolved. When the contingency is settled, the
subsequent settlements change in FV is accounted for within
the equity accounts.
• If cash or other assets paid or owed: Changed amount is
recognized in P&L
Case 1: Liability Contingency based on Future
Earnings
Acquirer agreed to pay the following to the acquiree to

effect a merger on January 1, 2016:
• 25,000 shares, P10 par, P25 FMV per share
• P150,000 long term 8% notes payable; and
• P100,000 cash after two years if the average income of
the acquiree during the 2-year period exceeds 250,000
per year. Acquirer estimates that there is a 30%
probability that the P100,000 payment will be required.
What is the related entry on acquisition date assuming
that the net assets of the acquiree is P720,000?
Case 1: Liability Contingency based on Future
Earnings
Net Assets 720,000

Goodwill 85,000
Notes Payable 150,000
Common Stock (25,000 x 10) 250,000
Share Premium (25,000 x 15) 375,000
Est. Contingent Consideration Payable 30,000
To record acquisition of the acquiree by the acquirer
Case 2: Provisional Amount on Asset Acquired
Given the facts of the preceding case, assume that one of

the assets acquired was land with a provisional amount of
P300,000 on the date of acquisition. Eight months after the
acquisition date, independent appraisals indicate that the
land‟s fair value is P320,000. What would the adjustment
in the acquirer‟s books on August 31, 2016?
Net Assets 20,000

Goodwill 20,000
Adjustment to goodwill due to changes in the value of land
within the measurement period
Case 3: Cash/Liability Contingency Using the
Measurement Period Rule
Given the facts in Case 1, assume that eight months after

the acquisition date, the probability of paying the contingent
liability was changed from 30% to 50%. What would the
adjustment in the acquirer‟s books on August 31, 2016?
Goodwill 20,000
Adjustment to goodwill due to changes in the probability of
paying the contingent consideration within the
measurement period
On November 1, 2016, the probability of paying the

contingent consideration was revised to 40%. What would
be the adjusting entry in the acquirer‟s books?
Gain from Est. Contingent Consideration Payable 10,000
Adjustment to goodwill due to changes in the probability of paying the
contingent consideration beyond the measurement period
On December 15, 2016, the probability of paying the
contingent consideration was revised to 65%. What would
be the adjusting entry in the acquirer‟s books?
Loss from Est. Contingent Consideration Payable 25,000
Adjustment to goodwill due to changes in the probability of paying the
contingent consideration beyond the measurement period
On January 1, 2018, the acquiree‟s average income was

P270,000 and P260,000 for the 1st and 2nd year
respectively. What will be the adjusting entry in the
acquirer‟s books on this date?

Loss from Est. Contingent Consideration Payable 35,000
Cash 100,000
To record settlement of the contingency
Case 4: Cash/Liability with Present Value
based on Future Performance – Cash Flows
Given the facts in Case 1, except that the contingent

consideration of P100,000 cash is based on the condition
that the acquiree will generate cash flows from operations
of P300,000 or more during its first year of operations. It is
estimated that there is a 35% probability that the acquiree
will meet this target. 4% is used to incorporate the time
value of money. What would be the entry in the acquirer‟s
books as of acquisition date?
Net Assets 720,000

Goodwill 88,654
Common Stock (25,000 x 10) 250,000
Share Premium (25,000 x 15) 375,000
On December 31, 2016, the acquiree was only able to

generate operational cash flows of P280,000. What entry
would be made in the acquirer‟s books?
Gain from Est. Contingent Consideration Payable 33,654
Adjustment to close the contingent consideration liability as the payment
conditions were not met
*Note: The position taken by PFRS 3 is that the conditions that prevent the
target from being made occurred subsequently to the acquisition date and
the acquirer had the information to measure the liability upon acquisition
based on the circumstances existing during that time. Hence the
adjustment would be made to P&L.
Case 5: Cash/Liability Based on Future
Performance - Earnings
Given the facts in Case 1, except that the contingent

consideration would be an additional cash payment after
two years equal to twice the amount by which the average
annual income of the acquiree exceed P25,000 a year, for
two years. Net income was P65,000 and P70,000 in the 1 st
and 2nd year, respectively. Estimated liability for this on
acquisition date is P30,000.
Net Assets 720,000

Goodwill 85,000
Common Stock (25,000 x 10) 250,000
Share Premium (25,000 x 15) 375,000

Loss on Estimated Contingent Consideration 55,000
Cash 85,000
To record settlement of contingent consideration
Assignment
• LP 14-4
• LP 14-5
• LP 14-6
• LP 14-7
Theme of the day: Shades of Red

Case 6: Stock Contingency Based on Future
Performance – Earnings with MV of Stock Given
In addition to the facts given in Case 1, the acquirer also

agreed to issue 1,000 additional shares of common stock
to the acquiree‟s shareholders if the average post
combination earnings in the next two years equaled or
exceeded P390,000. The expected additional shares to be
issued are valued at P15,000. What would be the entry in
the acquirer‟s books on acquisition date?
Net Assets 720,000

Goodwill 100,000
Common Stock (25,000 x 10) 250,000
Share Premium (25,000 x 15) 375,000
Share Premium – Contingent Consideration 15,000
If the contingent event happens:

Common Stock 10,000
Share premium 5,000
To record settlement of contingent consideration
If the contingent event does not happen:
Share Premium – Contingent Consideration
Not Met 15,000
Reclassification between equity accounts for non
occurrence of contingent event
Performance – Earnings
In addition to the facts given in Case 1, the acquirer also

agreed to issue 5,000 additional shares if the average
income during the 2-year period after acquisition exceeded
P80,000 per year. The average income for the 2-year
period stipulated is P110,000. What would be the entry
upon settlement?
Paid in capital in excess of par 50,000
Common stock (P10 x 5,000) 50,000
Settlement of contingent consideration
*The entry on acquisition date is similar to Case 1. Prior

to the settlement, once the contingency conditions is
met, it would be described in a footnote.
Stock Prices
In addition to the facts given in Case 1, the acquirer agreed

to issue 5,000 additional shares if two years later, the fair
value of the acquirer‟s stocks fell below P25/share. Assume
that the contingent event happened, what would be the
entry upon settlement?
Common stock (P10 x 5,000) 50,000
*The entry on acquisition date is similar to Case 1. Prior
to the settlement, once the contingency conditions is
met, it would be described in a footnote.

to issue additional shares two years later, equal to twice the
amount by which average annual earnings of the acquiree
exceed P25,000 a year. Net income was P65,000 and
P70,000 in the first and second years, respectively.
Assume that the fair value of the stock after two years is
P20/share. What is the entry in the acquirer‟s books upon
settlement?
Common stock (P10 x 4,250) 42,500
*The entry on acquisition date is similar to Case 1. Prior to the settlement,
once the contingency conditions is met, it would be described in a footnote.
Stock Prices

to issue additional shares if two years later, the fair value of
the acquirer‟s stocks fell below P25/share. The acquirer
would issue added shares based on their fair value two
years after. The market price of the shares after two years
is P20. What is the entry in the acquirer‟s books upon
settlement?
Common stock (P10 x 6,250) 62,500
*The entry on acquisition date is similar to Case 1. Prior to the settlement,
once the contingency conditions is met, it would be described in a footnote.
Stock Prices
In addition to the facts given in Case 1, except that the

contingent consideration would be the acquirer agreed to
issue sufficient shares of its common stock to ensure a total
stock value of P625,000 if the fair value of the stocks would
fall below P25/share after one year. The acquirer estimates
that there is a 40% probability that the 25,000 shares
issued will have a market value of P425,000 after one year
and a 60% probability that the market value of the shares
will exceed P625,000. What will be the entry on the
acquirer‟s books at the date of acquisition?
Stock Prices
Net Assets 720,000

Goodwill 135,000
Common Stock (25,000 x 10) 250,000
Share Premium (25,000 x 15) 375,000
Share Premium – Contingent Consideration 80,000*
* (625,000-425,000)*40%
Stock Prices
After one year, the contingent event occurs and the

acquirer‟s stocks fell to P20/share. What would be the
adjusting entry needed in the books of the accquirer?

Common stock (P10 x 6,250) 62,500
Share Premium 17,500
Stock Prices
If after one year, the contingent event does not occur and
the acquirer‟s stocks were at P30/share. What would be
the adjusting entry needed in the books of the acquirer?

Share Premium - Contingent Consideration
Not Met 80,000
Reclassification between equity accounts for non
occurrence of contingent event
Assignment
• LP 14-9
• LP 14-10
• LP 14-11
Estimating the Value of Goodwill
• An acquirer may attempt to forecast the future income of a target

company in order to arrive at a logical purchase price.
• Goodwill is often, at least in part, a payment for above normal
expected future earnings.
• When forecasting future income based on past performance,
factor out “one-time” occurrences that will not likely recur on the
near future (i.e. extraordinary items, discontinued operations and
any other unusual events).
• Expected future income is then compared to normal income.
• Normal Income = Normal rate of return x FV of gross assets of
the acquired company
• Gross assets include specifically identifiable assets such as
patents and copyrights (see handout for complete list) but do not
include existing goodwill in the acquiree‟s books.
Approach 1: Based on a number of years’
excess earnings
Given: Expected annual average future income = P200,000

Normal return on assets = 10%
Fair value of total identifiable assets = P1,692,000
Acquirer would pay goodwill on excess earnings above normal
for the next five years.
Expected average future income 200,000

Less: Normal return on assets
FV of total identifiable assets 1,692,000
x Normal rate of return 10% (169,200)
Expected annual earnings in excess of normal 30,800
x Number of years' excess earnings 5
Goodwill 154,000
Approach 2: Based on excess earnings for a
perpetuity

Acquirer is very optimistic and assume that excess earnings
would continue indefinitely.
/ Normal rate of return 10%
Goodwill 308,000
Approach 3: Based on limited number of
years’ earnings capitalized at a certain rate

Acquirer assumes that excess earnings above normal would
only be for five years and capitalizable at a rate of 16%.

x PV of an annuity of P1 for five years at 16% 3.2743
Goodwill 100,848
VIDEO – IAS 36
Impairment of Assets
• Impairment. Asset is impaired when its carrying amount exceeds
its recoverable amount.
• Carrying Amount. Amount at which an asset is recognized in the
balance sheet after deducting accumulated depreciation and
accumulated impairment losses.
• Recoverable amount. The higher of an asset‟s fair value less
costs to sell (net selling price) and its value in use.
• Value in use. The discounted present value of estimated cash
flows expected to arise from:
1. The continuing use of an asset and from
2. Its disposal at the end of its useful life
• Cash Generating Unit. Smallest identifiable group of assets
that generates cash inflows from continuing use and that are
largely independent on the cash inflows from other assets or
group of assets.
Impairment Testing
• Goodwill should be tested for impairment annually.
• If the recoverable amount < carrying value of the cash generating
unit (including goodwill), then goodwill is impaired.
• If the recoverable amount > carrying value, then there is no
impairment.
Estimated recoverable amount of
Cash generating unit based on projected cash flows P150,000
Carrying amount of the cash generating unit
(inc. goodwill) 170,000
Impairment 20,000
• Entry: Goodwill impairment loss 20,000

Goodwill 20,000
Stock Exchange Ratio
• Consideration in the form of cash or liability is often expressed in
peso for the amount of consideration issued.
• When common stock is issued by the acquirer in a business
combination, the price is expressed as a number of shares of the
acquirer‟s common stock to be exchanged for each share of the
acquiree‟s common stock. This is known as “stock exchange
ratio”.
Stock Exchange Ratio – Single Class Stock
• Assume that the stockholders of Companies A, B and C agree to

consolidate and form Company D. Net assets at appraised
values and average adjusted earnings of the past five years,
which the parties believe after the most reliable estimate, follows:
A B C Total
Net asset contribution 200,000 300,000 500,000 1,000,000
% of asset contibution
to total assets 20% 30% 50%
Earnings contribution 30,000 30,000 40,000 100,000
% of earnings
contribution to total
earnings 30% 30% 40%
• To avoid inequalities resulting from the distribution of a single

class of stock either in the net assets ratio or the earnings ratio,
the parties decide that respective contributions shall be
measured by the values assigned to net assets as increased by
goodwill determined as follows: (1) a 6% return is to be regarded
as a fair return on identifiable net assets; (2) excess earnings are
to be capitalized at 20% to arrive at goodwill
A B C Total
Goodwill:
Average annual eanings 30,000 30,000 40,000
Normal return on net assets, 6% 12,000 18,000 30,000
Excess earnings 18,000 12,000 10,000
Goodwill = Excess annual earnings

capitalized at 20% (Excess
earnings/20%) 90,000 60,000 50,000
Total contributions 290,000 360,000 550,000 1,200,000
24% 30% 46%
If Company D will issue 25,000 shares of stock, then A, B, and C will

receive the following number of shares:
A 6,042
B 7,500
C 11,458
25,000
Stock Exchange Ratio – Several Classes of
Stock
1. Earnings of the constituent companies should be capitalized

but this rate must not exceed the earnings rate of any of the
constituent companies. This step determines the total stock to
be issued to each company.
2. Preferred stock should be distributed to constituent companies
in proportion to the net assets they contribute. Such stock
should be preferred as to assets upon dissolution and the
dividend rate should not exceed the rate used in capitalizing
the profits. Shares should be fully participating with common
stocks.
3. Common stock should be calculated as the difference between
total stock calculated in (1) and preferred stock allocation
calculated in (2).
Stock
• Assume that the stockholders of Companies A, B and C agree to

consolidate and form Company Q. Net assets at appraised
values and average adjusted earnings of the past five years,
which the parties believe after the most reliable estimate, follows:
A B C Total
Earnings rate on net assets 15% 10% 8%
• It is agreed that earnings would be capitalized at 8% to determine
the total stock to be issued. Fully participating 6% preferred
stock, P100 par is to be issued in exchange for net assets
transferred. Common stock, P100 par, is to be issued to each
company for the difference between total stock entitlement and
preferred stock shares received.
Stock
A B C Total
Earnings rate on net assets 15% 10% 8%
A B C Total
Total Stock to be issued 375,000 375,000 500,000 1,250,000
Preferred Stock Allocation
(equal to asset contibutions) 200,000 300,000 500,000 1,000,000
Common Stock Allocation
(represents Goodwill) 175,000 75,000 - 250,000
Net Assets 1,000,000

Goodwill 250,000
Preferred Stock, P100 par 1,000,000
Common Stock, P100 par 250,000
Stock
• The preferred stock allocation would ensure that the constituent

companies‟ claims to net assets is preserved and the total stock
issued (preferred + common) provide for a distribution of stocks
according to the earnings ratio. If amounts calculated are in
money values, divide by FV or par to get number of shares.
If Preference Shares have a FV of P125/share and Common

stock , P200/share, then entry would have been:
Net Assets 1,000,000
Goodwill 250,000
Preferred Stock, P100 par 800,000
Share Premium – P/S 200,000
Common Stock, P100 par 125,000
Share Premium – C/S 125,000
ASSIGNMENT
14-12
14-13
14-14

1 - Business Combinations

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1 - Business Combinations

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Business Combinations

Prof. Ma. Rona Corda-Prado, MBA, CPA

• A transaction or other event in which

• Integration of business activities

• The immediate concern of many combinations is to gain operating

Acquisition of Net Assets

Company A Net Assets of B Company B

e.g. HP and Compaq; Agilent-HSG and Philips

Exxon and Mobil: Exxon-Mobil

Both the parent and the subsidiary maintain their own

• Originally published in March 2004 as the outcome of

Applies to a transaction or other event that meets

Applies to a transaction or other event that meets

Applies to a transaction or other event that meets

Entity A purchases all of the assets and liabilities of

The transaction would be considered within

Entity B purchases all of the hardware that

• Company S is a manufacturer of a wide range of

• In this example, the activities and assets within the

Entity C and Entity D are both controlled by Entity

• Company Q has a wholly-owned subsidiary, Company R,

• In this situation, Company R paid consideration to Company

• Acquiree - The business or businesses that the acquirer

• IFRS 3 eliminated „pooling of interest‟ for all

• Formerly known as “purchase method”

1. Identify the acquirer

Who is the acquirer in this scenario?

Based on these facts and the absence of other facts to

Who is the acquirer in this scenario?

In this example, Entity F is considered to be the acquirer

• The combining entity whose owners as a group

• Entity that has the ability to select the management

• Company X, a clothing retailer acquires 40% of the

• Company X‟s ability to appoint or remove the majority of

• Company Z has an existing 40% ownership interest in

• In this situation, Company Z was not a party to the

Company W decided to spin-off two of its existing businesses

• In this situation, a set of new investors paid cash to

• Date on which the acquirer obtains control of the

5/2 8/10 9/30 11/30

• Consideration transferred in a business combination

• If consideration > FV of the assets acquired

• Costs the acquirer incurs to effect a

Acquisition related costs are

* In the 2004 version, direct costs are part of the consideration

• Professional fees paid to accountants for pre-acquisition audit,

• Direct cost of issuing debt securities should be considered as

• BCD Corp. acquires all the outstanding share capital of

• ASDF Corp. acquires the net assets of QWER Corp. On top of

Premium on bonds payable 1,000,000

• On December 31, 2011, an airplane manufacturer, Airways, issued

Measurement Period Any change in estimates

Acquisition Maximum The measurement period ends

• An agreement to issue additional consideration (asset, liability

• Measured at its fair value at the acquisition date and

1. Contingent consideration of P400,000 - increase in the fair value of

• If the change results from additional information about conditions at

Acquirer agreed to pay the following to the acquiree to

Net Assets 720,000

Given the facts of the preceding case, assume that one of

Net Assets 20,000

Given the facts in Case 1, assume that eight months after

On November 1, 2016, the probability of paying the

On January 1, 2018, the acquiree‟s average income was