BUSINESS COMBINATIONS

May 19, 2020

I. Choose the correct answer:

1. In a business combination, how should long-term debt of the acquired company generally be recognized
on acquisition date?
a. Fair value
b. Amortized cost
c. Carrying amount
d. Fair value less costs to sell

2. In a business combination accounted for under the acquisition method, the fair value of the net
identifiable assets acquired exceeded the consideration transferred. How should the excess fair value be
reported?
a. As negative goodwill, recognized in profit or loss in the period the business combination occurred.
b. As an extraordinary gain.
c. As a reduction of the values assigned to noncurrent assets and an extraordinary gain for any
unallocated portion.
d. As positive goodwill.

3. The costs of issuing equity securities in a business combination are

a. expensed
b. treated as direct reduction in equity
c. included in the initial measurement of the credit to share capital account
d. b and c

4. The costs of issuing debt securities in a business combination are

a. expensed
b. included in the initial measurement of the debt securities issued
c. accounted for like a “discount” on liability
d. b and c

5. A business combination is accounted for properly as an acquisition. Direct costs of combination, other
than registration and issuance costs of equity securities, should be:
a. Capitalized as a deferred charge and amortized.
b. Deducted directly from the retained earnings of the combined corporation.
c. Deducted in determining the net income of the combined corporation for the period in which the
costs were incurred.
d. Included in the acquisition cost to be allocated to identifiable assets according to their fair values.

6. PDX Corp. acquired 100% of the outstanding common stock of Sea Corp. in an acquisition transaction.
The cost of the acquisition exceeded the fair value of the identifiable assets and assumed liabilities. The
general guidelines for assigning amounts to the inventories acquired provide for:
a. Raw materials to be valued at original cost.
b. Work in process to be valued at the estimated selling prices of finished goods, less both costs to
complete and costs of disposal.
c. Finished goods to be valued at replacement cost.
d. Inventories to be valued at acquisition-date fair values.

7. A business combination is accounted for as an acquisition. Which of the following expenses related to
the business combination should be included, in total, in the determination of net income of the combined
corporation for the period in which the expenses are incurred?
Fees of finders and Registration fees
consultants for equity securities issued
a. Yes Yes
 b. Yes No
c. No Yes
d. No No

8. Easton Company acquired Lofton Company in a business combination. Easton was able to acquire Lofton
at a bargain price. The fair value of the net identifiable assets acquired exceeded the consideration
transferred to Lofton. After revaluing noncurrent assets to zero, there was still some "negative goodwill."
Proper accounting treatment by Easton is to report the amount as
a. an extraordinary gain.
b. part of current income in the year of combination.
c. a deferred credit and amortize it.
d. paid-in capital.

9. Goodwill may be capitalized

a. only when it arises in a business combination.
b. only when it is created internally.
c. only when it is purchased
d. on any of these cases.

10. A contingent liability assumed in a business combination is recognized

a. if it is a present obligation that arises from past events and
b. if its fair value can be measured reliably.
c. even if it has an improbable outflow of resources embodying economic benefits.
d. All of these

II. Solve the following problems with appropriate solutions:

1. On January 1, 20x1, DIMINUTIVE Co. acquired all of the assets and assumed all of the liabilities of
SMALL, Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of SMALL
acquired by DIMINUTIVE are shown below:
Assets Carrying amounts Fair values
Cash in bank 20,000 20,000
Receivables 400,000 240,000
Allowance for probable losses on
(60,000)
receivables
Inventory 1,040,000 700,000
Building – net 2,000,000 2,200,000
Goodwill 200,000 40,000
Total assets 3,600,000 3,200,000

Liabilities
Payables 800,000 800,000

On the negotiation for the business combination, DIMINUTIVE Co. incurred transaction costs amounting to
₱200,000 for legal, accounting, and consultancy fees.

Case #1: If DIMINUTIVE Co. paid ₱3,000,000 cash as consideration for the assets and liabilities of SMALL,
Inc., how much is the goodwill (gain on bargain purchase) on the business combination?

Case #2: If DIMINUTIVE Co. paid ₱2,000,000 cash as consideration for the assets and liabilities of SMALL,
Inc., how much is the goodwill (gain on bargain purchase) on the business combination?
2. On January 1, 20x1, KNAVE acquired 80% of the equity interests of RASCAL, Inc. in exchange for
cash. Because the former owners of RASCAL needed to dispose of their investments in RASCAL by a
specified date, they did not have sufficient time to market RASCAL to multiple potential buyers.

As January 1, 20x1, RASCAL’s identifiable assets and liabilities have fair values of ₱2,400,000 and ₱800,000,
respectively.

Case #1:
KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent consultant
was engaged who determined that the fair value of the 20% non-controlling interest in RASCAL, Inc. is
₱310,000.

If KNAVE Co. paid ₱2,000,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the
goodwill (gain on bargain purchase) on the business combination?

Case #2:
KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent consultant
was engaged who determined that the fair value of the 20% non-controlling interest in RASCAL, Inc. is
₱310,000.

If KNAVE Co. paid ₱1,200,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the
goodwill (gain on bargain purchase) on the business combination?

Case #3:
KNAVE Co. elects the option to measure non-controlling interest at fair value. A value of ₱250,000 is
assigned to the 20% non-controlling interest in RASCAL, Inc. [(₱2M ÷ 80%) x 20% = 500,000].

If KNAVE Co. paid ₱2,000,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the
goodwill (gain on bargain purchase) on the business combination?

Case #4:
KNAVE Co. elects the option to measure the non-controlling interest at the non-controlling interest’s
proportionate share of RASCAL, Inc.’s net identifiable assets

If KNAVE Co. paid ₱2,000,000 cash as consideration for the 80% interest in RASCAL, Inc. and, how much
is the goodwill (gain on bargain purchase) on the business combination?

3. On January 1, 20x1, SMUTTY acquired all of the identifiable assets and assumed all of the liabilities of
OBSCENE, Inc. On this date, the identifiable assets acquired and liabilities assumed have fair values of
₱3,200,000 and ₱1,800,000, respectively.

SMUTTY incurred the following acquisition-related costs: legal fees, ₱20,000, due diligence costs, ₱200,000,
and general administrative costs of maintaining an internal acquisitions department, ₱40,000.

Case #1: As consideration for the business combination, SMUTTY Co. transferred 8,000 of its own equity
instruments with par value per share of ₱200 and fair value per share of ₱250 to OBSCENE’s former owners.
Costs of registering the shares amounted to ₱80,000. How much is the goodwill (gain on bargain purchase)
on the business combination?

Case #2: As consideration for the business combination, SMUTTY Co. issued bonds with face amount and
fair value of ₱2,000,000. Transaction costs incurred in issuing the bonds amounted to ₱100,000. How much
is the goodwill (gain on bargain purchase) on the business combination?
4. On January 1, 20x1, ENTREAT Co. acquired all of the identifiable assets and assumed all of the liabilities
of BEG, Inc. by paying cash of ₱2,000,000. On this date, the identifiable assets acquired and liabilities
assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.

ENTREAT Co. has estimated restructuring provisions of ₱400,000 representing costs of exiting the activity
of BEG, costs of terminating employees of BEG, and costs of relocating the terminated employees.

Requirement: Compute for the goodwill (gain on bargain purchase).

5. On January 1, 20x1, HISTRIONAL Co. acquired all of the identifiable assets and assumed all of the
liabilities of THEATRICAL, Inc. by paying cash of ₱2,000,000. On this date, the identifiable assets
acquired and liabilities assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.

Case #1:
As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out to
THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of the operating
lease on the building compared with market terms are favorable. The fair value of the differential is
estimated at ₱40,000.

Requirement: Compute for the goodwill (gain on bargain purchase).

Case #2:
As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out to
THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of the operating
lease on the patent compared with market terms are unfavorable. The fair value of the differential is
estimated at ₱40,000.

Requirement: Compute for the goodwill (gain on bargain purchase).

Case #3:
As of January 1, 20x1, HISTRIONAL is renting a building and a patent from THEATRICAL, Inc. under
operating leases. HISTRIONAL has determined that the terms of the operating lease on the building
compared with market terms are favorable. The fair value of the differential is estimated at ₱40,000.

Requirement: Compute for the goodwill (gain on bargain purchase).

6. On January 1, 20x1, CONJUNCTION Co., and UNION, Inc. entered into a business combination effected
through exchange of equity instruments. The combination resulted to CONJUNCTION obtaining 100%
interest in UNION. Both of the combining entities are publicly listed. As of this date, CONJUNCTION’s
shares have a quoted price of ₱200 per share. CONJUNCTION Co. recognized goodwill of ₱600,000 on
the business combination. No acquisition-related costs were incurred. Additional selected information at
acquisition date is shown below:

CONJUNCTION Co. Combined entity

(before acquisition) (after acquisition)
Share capital 1,200,000 1,400,000
Share premium 600,000 2,400,000
Totals 1,800,000 3,800,000

Requirements: Compute for the following:

a. Number of shares issued by CONJUNCTION Co. in the business combination.
b. Par value per share of the shares issued.
c. Acquisition-date fair value of the net identifiable assets of UNION.
7. On January 1, 20x1, OBDURATE Co. acquired 30% ownership interest in STUBBORN, Inc. for ₱200,000.
Because the investment gave OBDURATE significant influence over STUBBORN, the investment was
accounted for under the equity method in accordance with PAS 28.

From 20x1 to the end of 20x3, OBDURATE recognized ₱100,000 net share in the profits of the associate and
₱20,000 share in dividends. Therefore, the carrying amount of the investment in associate account on
January 1, 20x3, is ₱280,000.

On January 1, 20x4, OBDURATE acquired additional 60% ownership interest in STUBBORN, Inc. for
₱1,600,000. As of this date, OBDURATE has identified the following:
a. The previously held 30% interest has a fair value of ₱360,000.
b. STUBBORN’s net identifiable assets have a fair value of ₱2,000,000.
c. OBDURATE elected to measure non-controlling interests at the non-controlling interest’s proportionate
share of STUBBORN’s identifiable net assets.

Requirement: Compute for the goodwill.

8. OBSTREPEROUS Co. and NOISY, Inc. both engage in the same business. On January 1, 20x1,
OBSTREPEROUS and NOISY signed a contract, the terms of which resulted in OBSTREPEROUS obtaining
control over NOISY without any transfer of consideration between the parties.

The fair value of the identifiable net assets of NOISY, Inc. on January 1, 20x1 is ₱2,000,000. NOISY chose
to measure non-controlling interest at the non-controlling interest’s proportionate share of the acquiree’s
identifiable net assets.

Requirement: Compute for the goodwill.

9. On January 1, 20x1, DIAPHANOUS Co. acquired all of the identifiable assets and assumed all of the
liabilities of TRANSPARENT, Inc. by paying cash of ₱2,000,000. On this date, the identifiable assets
acquired and liabilities assumed have fair values of ₱3,200,000 and ₱1,800,000, respectively.

Additional information:
In addition to the business combination transaction, the following have also transcribed during the
negotiation period:
a. After the business combination, TRANSPARENT will enter into liquidation and DIAPHANOUS agreed to
reimburse TRANSPARENT for liquidation costs estimated at ₱40,000.
b. DIAPHANOUS agreed to reimburse TRANSPARENT for the appraisal fee of a building included in the
identifiable assets acquired. The agreed reimbursement is ₱20,000.
c. DIAPHANOUS entered into an agreement to retain the top management of TRANSPARENT for continuing
employment. On acquisition date, DIAPHANOUS agreed to pay the key employees signing bonuses
totaling ₱200,000.
d. To persuade, Mr. Five-six Numerix, the previous major shareholder of TRANSPARENT, to sell his major
holdings to DIAPHANOUS, DIAPHANOUS agreed to pay an additional ₱100,000 directly to Mr. Numerix.
e. Included in the valuation of identifiable assets are inventories with fair value of ₱180,000. Ms. Vital
Statistix, a former major shareholder of TRANSPARENT, shall acquire title to the goods.

Requirement: Compute for the goodwill (gain on bargain purchase).