Chapter 16

Business Combinations (Part 3)

PROBLEM 16-1: THEORY

1. D
2. C
3. B
4. A
5. A
6. B
7. C
8. C
9. D
10. A

PROBLEM 16-2: THEORY & COMPUTATIONAL

1. C

2. D

3. A

4. Solution:
Gamer Player
Co. Co. Total
Fair value of net identifiable assets 500,000 380,000
Average annual earnings 40,000 39,000
Industry normal earnings (5% of net
assets) 25,000 19,000
Excess earnings 15,000 20,000
Divide by: Capitalization rate 20% 20%

Estimated goodwill 75,000 100,000 175,000

5. Solution:
Gamer Player
Co. Co. Total
Fair value of net identifiable assets 500,000 380,000
Estimated goodwill 75,000 100,000
Total contributions 575,000 480,000 1,055,000

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Distribution ratio
(575/1,055); (480/1,055) 54.50% 45.50%
Total no. of shares to be distributed 100,000 100,000
Shares to be distributed 54,500 45,500 100,000

6. Answer: Gamer Co.

Since the new entity, App Corporation, will issue equity interests to both
Gamer and Player, the acquirer is most likely the entity that receives the
most voting rights after the business combination (i.e., Gamer Co. –
54,500 shares or 54.50% interest).

However, if the newly created entity will transfer cash and other
considerations and assume liabilities to acquire both Gamer and Player, the
acquirer would be the newly created entity.

7. Solution:
Accounting acquiree (CBA Co.) issues shares – Legal form:
Actual %
CBA's currently issued shares 10,000 20%
Shares to be issued to ZYX (5 sh. x 8,000 sh.) 40,000 80%
Total shares of CBA Co. after the combination 50,000

Accounting acquirer (ZYX, Inc.) issues shares – Substance:

Reverse %
ZYX's currently issued shares 8,000 80%
Shares to be issued to CBA's shareholders to enable
them to have the same interest in ZYX, Inc.
[(8,000 ÷ 80%) x 20%] 2,000 20%
Total 10,000

As a result, the fair value of the consideration effectively transferred

by ZYX and the group’s interest in CBA is ₱800,000 (2,000 shares of
ZYX, Inc. with a fair value per share of ₱400).

Goodwill (gain on bargain purchase) is computed as follows:

Consideration transferred (2,000 x ₱400) 800,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 800,000
Fair value of net identifiable assets acquired (600,000)
Goodwill 200,000

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PROBLEM 16-3: MULTIPLE CHOICE: COMPUTATIONAL
1. A
Solution:
King Kong
Co. Co. Total
Fair value of net identifiable assets 600,000 800,000
Average annual earnings 100,000 160,000
Normal earnings (10% of net assets) 60,000 80,000
Excess earnings 40,000 80,000
Divide by: Capitalization rate 20% 20%
Estimated goodwill 200,000 400,000 600,000
Fair value of net identifiable assets 600,000 800,000
Total contributions 800,000 1,200,000 2,000,000
Distribution ratio 40.00% 60.00%
Total number of shares to be distributed 40,000 40,000
Shares to be distributed 16,000 24,000 40,000

2. A
Solution:
Da Co. De Co. Di Co. Total
Net identifiable assets 320,000 480,000 800,000
Average annual earnings 48,000 48,000 64,000
Normal earnings
(6% of Net assets) 19,200 28,800 48,000
Excess earnings 28,800 19,200 16,000
Divide by: Cap. rate 20% 20% 20%
Estimated goodwill 144,000 96,000 80,000 240,000
Net identifiable assets 320,000 480,000 800,000
Total contributions 464,000 576,000 880,000 1,920,000
Distribution ratio 24.17% 30.00% 45.83% 100%

3. C
Solution:
Gamer Co. Player Co.
Fair value of net identifiable assets 500,000 380,000
Divide by: Par value per preference share 20 20
Number of preference shares to be issued 25,000 19,000

4. A
Solution:
Gamer Co. Player Co.
Average actual earnings 40,000 39,000
Divide by: Capitalization rate 5% 5%
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Total par value of shares to be issued 800,000 780,000
Fair value of net identifiable assets 500,000 380,000
Excess 300,000 400,000
Divide by: Par value per ordinary share 10 10
Number of ordinary shares to be issued 30,000 40,000

5. A
Solution:
Gamer Co. Player Co. Total
Average actual earnings 40,000 39,000 79,000
Divide by: Capitalization rate 5% 5% 5%
Consideration transferred 800,000 780,000 1,580,000
Fair value of net identifiable assets 500,000 380,000 880,000
Goodwill 300,000 400,000 700,000

6. A
Solution:
Gamer Co. Player Co. Total
No. of ordinary shares to be issued 30,000 40,000 70,000
Interest in voting rights 42.86% 57.14% 100%

Since the new entity, App Corporation, will issue equity interests to both
Gamer and Player, the acquirer is most likely the entity that receives the
most voting rights after the business combination (i.e., Gamer Co.).

However, if the newly created entity will transfer cash and other
considerations and assume liabilities to acquire both Gamer and Player, the
acquirer would be the newly created entity.

7. B
Solution:
Analyses:
 ZYX, Inc. lets itself be acquired (legal form) for it to gain control
over the legal acquirer (substance).

Legal form of the agreement: (ZYX lets itself be acquired)

CBA Co. issues 40,000 ordinary shares to ZYX, Inc.’s shareholders in
exchange for all of ZYX, Inc.’s 8,000 shares outstanding.

Substance of the agreement: (ZYX gains control over legal acquirer)

After the combination, ZYX, Inc. gains control because it now owns
80% of CBA Co.

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Accounting acquiree (CBA Co.) issues shares – Actual:
CBA's currently issued shares 10,000 20%
Shares to be issued to ZYX (5 sh. x 8,000 sh.) 40,000 80%
Total shares of CBA Co. after the combination 50,000

Accounting acquirer (ZYX, Inc.) issues shares – Reverse:

ZYX's currently issued shares 8,000 80%
Shares to be issued to CBA's shareholders to enable
them to have the same interest in ZYX, Inc.
[(8,000 ÷ 80%) x 20%] 2,000 20%
Total 10,000

The consideration transferred is computed as follows:

Shares of ZYX effectively transferred to CBA 2,000
Multiply by: Fair value per share of ZYX’s shares 800
Fair value of consideration effectively transferred 1,600,000

Goodwill (gain on bargain purchase) is computed as follows:

Consideration transferred 1,600,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,600,000
Fair value of net identifiable assets acquired (6.4M –
5.2M) (1,200,000)
Goodwill 400,000