PFRS 3, Business Combination 2020

PFRS 3, Business Combination, establishes principles and requirements on how an

Acquirer:
a) recognizes and measures in its financial statements the identifiable assets acquired,
the liabilities assumed and any non-controlling interest in the Acquiree;
b) recognizes and measures the goodwill acquired in the business combination or a gain
from a bargain purchase; and
c) determines what information to disclose to enable users of the financial statements
to evaluate the nature and financial effects of the business combination.
*Acquirer - the entity that obtains control of the Acquiree.
*Acquiree - the business or businesses that the Acquirer obtains control of in a business combination.
*Business - an integrated set of activities and assets that is capable of being conducted and managed for the
purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to
investors or other owners, members or participants.
*Business Combination - a transaction or other event in which an Acquirer obtains control of one or more
businesses. Transactions sometimes referred to as 'true mergers' or 'mergers of equals' are also business
combinations.
*Noncontrolling interest - the equity in a subsidiary not attributable, directly or indirectly, to a parent.

OBJECTIVE:
To improve the relevance, reliability and comparability of the information that a reporting
entity provides in its financial statements about a business combination and its effects.

CORE PRINCIPLE:
An Acquirer of a business recognizes the assets acquired and liabilities assumed at their
acquisition date fair values and discloses information that enables users to evaluate the
nature and financial effects of the acquisition.

*Acquisition Date - the date on which the Acquirer obtains control of the Acquiree.
*Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (See PFRS 13.)

PFRS 3 DOES NOT APPLY TO:

a) formation of a joint venture – PFRS 11, Joint Arrangements
b) acquisition of an asset or a group of assets that does not constitute a business.
Such a transaction or event is accounted for as an asset acquisition, and does not
give rise to goodwill.
c) business combination under common control – accounted for as either ‘pooling
of interest method’ or acquisition method under PIC Q&A 2011-02

EXCEPTIONS TO THE RECOGNITION AND MEASUREMENT PRINCIPLES OF PFRS 3:

(a) Leases and insurance contracts
(b) Only those contingent liabilities assumed in a business combination that are a
present obligation and can be measured reliably are recognized.
(c) Some assets and liabilities are required to be recognized or measured in accordance
with other PFRSs, rather than at fair value. The assets and liabilities affected are
those falling within the scope of:
1) PAS 12, Income Taxes: recognize and measure a deferred tax asset or liability
arising from the assets acquired and liabilities assumed in a business
combination.
2) PAS 19 Employee Benefits: recognize and measure a liability (or asset, if any)
related to the Acquiree's employee benefit arrangements.
3) PFRS 2, Share-based Payment: measure a liability or an equity instrument
related to share-based payment transactions of the Acquiree or the
replacement of an Acquiree's share-based payment transactions with share-
based payment transactions of the Acquirer.
4) PFRS 5 Non-current Assets Held for Sale and Discontinued Operations:
measure at fair value less costs to sell.
(d) Reacquired right: measure on the basis of the remaining contractual term.
A reacquired right is an identifiable intangible asset/right that an Acquirer had
previously granted to the Acquiree for the use of one or more of the Acquirer's
assets. Examples of such rights include a right to use the Acquirer's trade name
under a franchise agreement or a right to use the Acquirer's technology under a
technology licensing agreement.
(e) Indemnification assets are recognized and measured on a basis that is consistent
with the item that is subject to the indemnification, even if that measure is not fair
value.

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 PFRS 3, Business Combination 2020

ACQUISITION METHOD

An entity shall account for each business combination by applying the acquisition method,
which requires:

(a) Identifying the Acquirer.

• In a business combination effected primarily by transferring cash or other assets

or by incurring liabilities, the acquirer is usually the entity that transfers the
cash or other assets or incurs the liabilities.

• In a business combination effected primarily by exchanging equity interests, the

Acquirer is usually the entity that issues its equity interests, except for reverse
acquisitions. Other pertinent facts and circumstances shall also be considered in
identifying the acquirer in a business combination effected by exchanging equity
interests, including:
➢ the relative voting rights in the combined entity after the business
combination
➢ the existence of a large minority voting interest in the combined entity if
no other owner or organised group of owners has a significant voting
interest
➢ the composition of the governing body of the combined entity
➢ the composition of the senior management of the combined entity
➢ the terms of the exchange of equity interests

REVERSE ACQUISITION - occurs when the entity that issues securities (the legal
Acquirer) is identified as the Acquiree for accounting purposes.

For example, reverse acquisitions sometimes occur when a private operating

entity wants to become a public entity but does not want to register its equity
shares. To accomplish that, the private entity will arrange for a public entity to
acquire its equity interests in exchange for the equity interests of the public
entity (known as “backdoor listing”).

• The Acquirer is usually the combining entity whose relative size (measured in, for
example, assets, revenues or profit) is significantly greater than that of the other
combining entity or entities.

• If a new entity is formed to issue equity interests to effect a business

combination, one of the combining entities that existed before the business
combination shall be identified as the Acquirer.

(b) Determining the acquisition date.

The date on which the Acquirer obtains control of the Acquiree is generally the date
on which the Acquirer legally transfers the consideration, acquires the assets and
assumes the liabilities of the Acquiree—the “closing date”.

However, the Acquirer might obtain control on a date that is either earlier or later
than the closing date. For example, the acquisition date precedes the closing date if a
written agreement provides that the Acquirer obtains control of the Acquiree on a
date before the closing date. An Acquirer shall consider all pertinent facts and
circumstances in identifying the acquisition date.

(c) Recognizing and measuring the identifiable assets acquired, the liabilities
assumed and any non-controlling interest in the Acquiree.

The Acquirer's application of the recognition principle and conditions may result in
recognizing some assets and liabilities that the Acquiree had not previously
recognized as assets and liabilities in its financial statements. For example, the
Acquirer recognizes the acquired identifiable intangible assets, such as a brand name,
a patent or a customer relationship, that the Acquiree did not recognize as assets in
its financial statements because it developed them internally and charged the related
costs to expense.
How to compute for “Goodwill (Gain on Bargain Purchase)”?

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 PFRS 3, Business Combination 2020

Difference between:

(a) the aggregate of the (1) consideration transferred, (2) any non-controlling interest in
the Acquiree and, (3) in a business combination achieved in stages, the acquisition-
date fair value of the Acquirer's previously held equity interest in the Acquiree; and

(b) the net identifiable assets acquired (4).

Consideration Transferred (1) ➢ at Fair Value, including Contingent

+ Non Controlling Interest (2)
+ Previously Held Equity Interest (3)
TOTAL
- Net identifiable assets acquired (4)
GOODWILL (GAIN ON BARGAIN PURCHASE)
Consideration
➢ either at (a) Fair Value/ Full Goodwill,
or at (b) Proportionate Share/ Partial
Goodwill
➢ at acquisition date Fair Value
➢ at acquisition date Fair Value

➢ If positive Recognize as asset (BS) “Goodwill”

➢ If negative Recognize as income (P&L) “Gain from Bargain

Purchase”

(1) Consideration Transferred:

The consideration transferred in a business combination shall be measured at fair

value, which shall be calculated as the sum of:
i. the acquisition-date fair values of the assets transferred by the Acquirer,
ii. the liabilities incurred by the Acquirer to former owners of the Acquiree, and
iii. the equity interests issued by the Acquirer.

NOTE ON SUBSEQUENT MEASUREMENT OF CONTINGENT CONSIDERATION:

The Acquirer shall account for changes in the fair value of contingent
consideration that are not measurement period adjustments as follows:
a. Contingent consideration classified as equity shall not be remeasured and
its subsequent settlement shall be accounted for within equity.
b. Contingent consideration classified as an asset or a liability that:
i. is a financial instrument and is within the scope of PAS 39 shall be
measured at fair value, with any resulting gain or loss recognized
either in profit or loss or in other comprehensive income in
accordance with that PFRS.
ii. is not within the scope of PAS 39 shall be accounted for in accordance
with PAS 37 or other PFRSs as appropriate.

(2) Noncontrolling Interest (NCI)

NCI shall be measured at either:

a. Fair value (previously “full goodwill” method)

NCI @ FV = Consideration Transferred ÷ %Acquirer Interest x %NCI

For example:
Consideration transferred P800,000
%Acquirer Interest 80%

NCI @ FV = P800,000 ÷ 80% x 20% = P200,000

(%NCI is computed as the percentage of interest not attributable to Acquirer/

Parent)
b. Proportionate share in the identifiable net assets acquired (previously “partial
goodwill” method).

NCI @ Proportionate = Fair Value of Net Assets of Acquiree x %NCI

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 PFRS 3, Business Combination 2020

For example:
FV of Net Assets of Acquiree P800,000
%Acquirer Interest 80%

NCI @ Proportionate = P800,000 x 20% = P160,000

(%NCI is computed as the percentage of interest not attributable to Acquirer/

Parent)

NOTES:
- If the problem is silent, measure NCI at the proportionate share (option B).
- If NCI is measured using fair value (option A) and resulted to a Gain on
Bargain Purchase, recompute instead using NCI measured at the
proportionate share (option B).
- If the Acquirer’s interest is used as the basis of determining the fair value of
NCI, include the control premium/discount on Consideration Transferred,
but exclude on computation of NCI fair value.

(3) Previously Held Equity Interests

“Business Combination Achieved in Stages” / “Step Acquisition”:

An Acquirer sometimes obtains control of an Acquiree in which it held an equity
interest immediately before the acquisition date.

For example, on 31 December 20X1, Entity A holds a 35% non-controlling equity

interest in Entity B. On that date, Entity A purchases an additional 40% interest in
Entity B, which gives it control of Entity B.

In a business combination achieved in stages, the Acquirer shall remeasure its

previously held equity interest in the Acquiree at its acquisition-date fair value
and recognize the resulting gain or loss, if any, in profit or loss.

In prior reporting periods, the Acquirer may have recognized changes in the value
of its equity interest in the Acquiree in other comprehensive income (for example,
because the investment was classified as available for sale). If so, the amount that
was recognized in other comprehensive income shall be recognized on the same
basis as would be required if the Acquirer had disposed directly of the previously
held equity interest.

*Goodwill - an asset representing the future economic benefits arising from other assets acquired in a business
combination that are not individually identified and separately recognized.

*Identifiable - an asset is identifiable if it either:

a) is separable, ie capable of being separated or divided from the entity and sold, transferred, licensed, rented
or exchanged, either individually or together with a related contract, identifiable asset or liability, regard-
less of whether the entity intends to do so; or
b) arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations.

*Contingent Consideration - usually, an obligation of the Acquirer to transfer additional assets or equity interests
to the former owners of an Acquiree as part of the exchange for control of the Acquiree if specified future events
occur or conditions are met. However, contingent consideration also may give the Acquirer the right to the return
of previously transferred consideration if specified conditions are met.

*Equity Interests - ownership interests of investor-owned entities and owner, member or participant interests of
mutual entities.

*Mutual Entity - an entity, other than an investor-owned entity, that provides dividends, lower costs or other
economic benefits directly to its owners, members or participants. For example, a mutual insurance company, a
credit union and a co-operative entity are all mutual entities.

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 PFRS 3, Business Combination 2020

Additional Notes on Goodwill Computation:

• Before recognizing a gain on a bargain purchase, the Acquirer shall reassess whether
it has correctly identified all of the assets acquired and all of the liabilities assumed
and shall recognize any additional assets or liabilities that are identified in that
review. The objective of the review is to ensure that the measurements
appropriately reflect consideration of all available information as of the acquisition
date.

• An Acquirer sometimes obtains control of an Acquiree without transferring

consideration. The acquisition method of accounting for a business combination
applies to those combinations. Such circumstances include:
➢ The Acquiree repurchases a sufficient number of its own shares for an existing
investor (the Acquirer) to obtain control.
➢ Minority veto rights lapse that previously kept the Acquirer from controlling an
Acquiree in which the Acquirer held the majority voting rights.
➢ The Acquirer and Acquiree agree to combine their businesses by contract alone.
The Acquirer transfers no consideration in exchange for control of an Acquiree
and holds no equity interests in the Acquiree, either on the acquisition date or
previously. Examples of business combinations achieved by contract alone
include bringing two businesses together in a stapling arrangement or forming
a dual listed corporation.

• MEASUREMENT PERIOD
The measurement period is the period (shall not exceed one year) after the
acquisition date during which the Acquirer may adjust the “provisional amounts”
recognized for a business combination.

During the measurement period, the Acquirer shall retrospectively adjust the
provisional amounts recognized at the acquisition date to reflect new information
obtained about facts and circumstances that existed as of the acquisition date and,
if known, would have affected the measurement of the amounts recognized as of
that date.

The measurement period ends as soon as the Acquirer receives the information it
was seeking about facts and circumstances that existed as of the acquisition date or
learns that more information is not obtainable.

After the measurement period ends, the Acquirer shall revise the accounting for a
business combination only to correct an error in accordance with PAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors.

• Acquisition-related costs are costs the Acquirer incurs to effect a business

combination. Those costs include: finder's fees; advisory, legal, accounting,
valuation and other professional or consulting fees; general administrative costs,
including the costs of maintaining an internal acquisitions department; and costs of
registering and issuing debt and equity securities.

The Acquirer shall account for acquisition related costs as expenses in the periods
in which the costs are incurred and the services are received, with one exception.
The costs to issue debt or equity securities shall be recognized in accordance with
PAS 32 and PAS 39.

• Share Issuance Costs. Transaction costs that are directly attributable to issuing new
shares be deducted from equity, net of any related income tax benefit.

The share issuance costs will be treated as a contra shareholders’ equity account as
a deduction to the following in the order of priority:
1. Share Premium from the same share issuance;
2. Share Premium from previous share issuance; or
3. Retained Earnings with appropriate disclosure.

• Costs of Public Offering (PO) of Shares (involves issuing new shares simultaneous
with listing with the stock exchange). The costs of listing shares are not considered
as costs of an “equity transaction” since no equity instrument has been issued and,
hence, such costs are recognized as an expense in profit or loss when incurred.
The offering and listing of shares are usually done simultaneously. Incremental
costs that relate jointly to more than one transaction are allocated to those

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 PFRS 3, Business Combination 2020

transactions according to the facts and circumstances using a basis that is rational
and consistent with similar transactions. The most appropriate basis of allocation is
one based on the proportion of the number of new shares sold compared to the total
number of outstanding shares immediately after the new share issuance.

The following table provides a general indication as to some of the costs incurred in
a PO that involves issuance of new shares and concurrent listing of existing shares,
and the basis on which the costs might be allocated:

Type of Cost Share Issuance/ Listing General

Taxes:
Documentary stamp tax
Other percentage tax
Professional fees on:
Underwriting
Audit and other professional
advice relating to prospectus
Opinion of Counsel
Tax Opinion
Fairness Opinion and
Valuation Report
Other costs:
Prospectus design and
printing
Road show presentation
Public relations consultant’s
fees
Newspaper publication fees
SEC registration fees for new
shares
Stock exchange listing fees
Treatment
Share issuance Deduction to equity
Share issuance – as the PO tax on Deduction to equity
primary offering3 is imposed and shall
be paid by the issuing corporation
Share issuance Deduction to equity
Joint – as it is typically required both for For allocation to
the offer of shares to the public and for equity and expense
listing procedures to comply with
requirements established by SEC and the
stock exchange
Joint – as it is typically required both for For allocation to
the offer of shares to the public and for equity and expense
listing procedures to comply with
requirements established by SEC and the
stock exchange
Joint – as it is typically required both for For allocation to
the offer of shares to the public and for equity and expense
listing procedures to comply with
requirements established by SEC and the
stock exchange
Joint – as it is typically required both for For allocation to
the offer of shares to the public and for equity and expense
listing procedures to comply with
requirements established by SEC and the
stock exchange
Joint – although in cases where most For allocation to
prospectus copies are sent to potential equity and expense
new shareholders, the majority of such
costs might relate to share issuance
Listing – although it may help to sell the Profit or loss item
offer to potential investors and hence
contributes to raising equity, it is usually
a general promotional activity
Listing – these costs generally relate to Profit or loss item
overall company promotion and are not,
therefore, incremental to the share
issuance
Share issuance – if the advertising relates Deduction to equity
directly to the share issue and is not
general advertising aimed at enhancing
the entity’s brand
Share issuance Deduction to equity
Listing Profit or loss item

Example
Go-public Company undertakes an IPO for the listing and issuance of 700,000
new shares and 300,000 existing shares. In relation to this, the company
incurred the following costs:
Documentary stamp tax P25,000
Fairness opinion and valuation 125,000
report
Tax opinion 75,000
Newspaper publication 200,000
Listing fee 300,000
Other joint costs 275,000
Go-public will recognize the listing fee of P300,000 immediately to profit or
loss.

The documentary stamp tax and newspaper publication fee amounting to

P25,000 and P200,000, respectively, will be recognized as a deduction to equity.

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 PFRS 3, Business Combination 2020

a. Issue price of shares at above par value

Share premium 225,000
Cash/ Creditor 225,000

b. Issue price of shares at par value

Share Issuance Costs 225,000****
Cash/ Creditor 225,000

****The share issuance costs will be treated as a contra shareholders’ equity account as a
deduction to the following in the order of priority:
1. Share Premium from previous share issuance; or
2. Retained Earnings with appropriate disclosure.

Joint costs, which include fee for fairness opinion and valuation report, tax
opinion cost and other joint costs, amounting to P475,000 will be allocated
using the proportion of newly sold shares to the total number of shares
outstanding immediately after the new share issuance.

Costs to be recognized as deduction to equity:

P475,000 x 700,000*****/1,000,000 = P332,500

*****Observe that 700,000 is used for the allocation as this relates to the new shares issued
considered as equity transaction. 1,000,000 shares were listed and issued but only
700,000 shares have been added to the number of shares outstanding after the listing
and issuance of shares. This means that the 300,000 shares listed and issued pertain to
those that were issued by existing shareholders, thus, not resulting to the issuance of
new shares on the part of ABC Company.

Costs to be recognized immediately in profit or loss:

P475,000 x 300,000/1,000,000 = P142,500

DISCLOSURES:

The Acquirer shall disclose information that enables users of its financial statements to
evaluate the nature and financial effect of a business combination that occurs either:
(a) during the current reporting period; or
(b) after the end of the reporting period but before the financial statements are
authorised for issue.

The Acquirer shall disclose information that enables users of its financial statements to
evaluate the financial effects of adjustments recognized in the current reporting period
that relate to business combinations that occurred in the period or previous reporting
periods.

If the specific disclosures required by this and other PFRSs do not meet the objectives
set out above, the Acquirer shall disclose whatever additional information is necessary
to meet those objectives.

LEGAL POINT OF VIEW

From the legal point of view, a business combination is classified as follows:

1. Acquisition of Assets – results in automatic consolidation, since the assets and
liabilities of both companies are recorded in the same set of books
i. Statutory Merger: A Corp + B Corp = A Corp/ B Corp
ii. Statutory Consolidation: A Corp + B Corp = C Corp

2. Stock Acquisition/ Acquisition of Common Stock – Acquirer acquires control over an

Acquiree through acquisition of common stocks, and the separate legal entities are both
preserved. In this case, Acquirer is known as the “Parent” and the Acquireee is the
“Subsidiary”.

Separate FS of Parent (PAS 27) + FS of Subsidiary = Conso FS of Parent and Subsidiary

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