ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS

CHAPTER 1: BUSINESS COMBINATION - if the acquiring company offers stock instead

of cash, acquirer management try to convince
PFRS 3 BUSINESS COMBINATION that stock would be bad investment
 A transaction or other event in which an
acquirer obtains control of one or more 9. DEFENSIVE ACQUISITION TACTIC
businesses. - a defensive acquisition is a corporate finance
 It outlines the accounting when an acquirer strategy that consists of companies acquiring
obtains control of a business (e.g. an acquisition other companies and assets as a “defense”
or merger). Such business combinations are against market downturns or possible
accounted for using the ‘acquisition method’, takeovers.
which generally requires assets acquired and
liabilities assumed to be measured at their fair REASONS FOR BUSINESS COMBINATION
values at the acquisition date. 1. COST ADVANTAGE
FRIENDLY - commonly less expensive for a firm to obtain
 Board of directors of potential combining needed amenities through combination rather
companies negotiates mutually agreeable terms than through development
of proposed combination. Proposal is submitted 2. LOWER RISK
to the stockholders of the involved companies - acquisition of reputable product lines and
for approval. markets is usually less risky than developing
UNFRIENDLY/HOSTILE new products and markets
 Acquiring firm deal directly with individual 3. AVOIDANCE OF TAKEOVERS
shareholders - companies combine to evade being acquired
DEFENSIVE TACTICS OR MOVES TO RESIST PROPOSED themselves. Smaller companies tend to be more
BUSINESS COMBINATION susceptible to corporate takeovers
1. POISON PILL 4. ACQUISITION OF INTANGIBLE ASSETS
- amendment of articles of incorporation or by- - business combination bring together both
laws to make it difficult to obtain stockholder intangible and tangible resources
approval or takeover.
2. GREENMAIL STRUCTURES OF BUSINESS COMBINATION
- purchase own shares and retire or set as 1. HORIZONTAL INTEGRATION
treasury shares. However, this is large - combination of companies within the same
ineffective because it may result to an industry that have previously been competitors
expensive excise tax. 2. VERTICAL INTEGRATION
3. WHITE KNIGHT - combination of companies involved in the
- encouraging a third company more acceptable same industry but at different levels (e.g.,
to the target company to acquire their company suppliers and customers)
4. PAC-MAN DEFENSE 3. CONGLOMERATE COMBINATION
- attempting an unfriendly takeover of the - combination of companies in unrelated
would be acquiring company industries having little, if any, production or
5. SELLING THE CROWN JEWELS market similarities for purpose of entering into
- sale of valuable assets to others to make the new markets and industries
firm less attractive. However, the negative 4. CIRCULAR COMBINATION
aspect is that if the firm survives, it is left - it entails some diversification but does not
without some important assets have a drastic change in operation as a
6. SHARK REPELLANT conglomerate
- acquisition of substantial amount of
outstanding common stock to treasury or for METHODS/TYPES OF BUSINESS COMBINATION
retirement 1. ACQUISITION OF NET ASSETS
7. LEVERAGED BUYOUTS - the books of the acquired company are closed
- company buy out its stockholders using out, and its assets and liabilities are transferred
company’s assets to finance the deal to the books of the acquirer
8. MUDSLINGING DEFENSE a. STATUTORY MERGER - x company + y
company = x company or y company

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
b. STATUTORY CONSOLIDATION - x • is calculated as the sum of acquisition date for
company + y company = z company values of The consideration transferred includes
the following items:
2. ACQUISITION OF COMMON STOCKS a. Cash or other monetary assets
- the books of the acquiring company and - Fair value is the amount of cash or
acquired company remain intact and cash equivalent dispersed.
consolidated financial statements are prepared - For deferred payment, the fair value
periodically. to the acquirer is the amount the entity
- acquiring company debits an account would have to borrow to settle the debt
“Investment Subsidiary” and recorded as an immediately.
inter-company investment rather than - Hence, the discount rate used is the
transferring the underlying assets and liabilities entity's incremental borrowing rate.
onto its own books b. Non-monetary assets
- it does not necessarily have to involve the - Assets such as Property, Plant and
acquisition of all of a company’s outstanding Equipment, investments, licenses and
common shares. Only control of another patents measured at fair value. In this
company is acquired case, the acquirer is in effect selling the
3. ASSET ACQUISITION non-monetary asset to the acquiree.
- acquisition by one firm of assets of another Thus, it is earning an income equal to
firm, but not its shares. The selling firm may the fair value on the sale of asset. If the
continue to survive as a legal entity, or it may carrying amount of the asset is in the
liquidate entirely. records of acquirer is different from fair
- acquirer targets key assets for acquisition, but value, a gain or loss on the asset is
does not assume its liabilities recognized at acquisition date.
- this is not within the scope of Business c. Equity Instruments
Combination - Acquirer issues its own shares as
consideration, it needs to determine
ACCOUNTING CONCEPT OF BUSINESS COMBINATION the fair value of those shares at
1. Control acquisition date.
2. Business - For listed entities, reference is made
to the quoted prices of the shares.
ACCOUNTING PROCEDURES FOR BUSINESS d. Liabilities undertaken
COMBINATION - The fair value of liabilities are best
1. IDENTIFY THE ACQUIRER measured by the present values of
- PFRS 3 Paragraph 7 states that the acquirer is expected future cash outflows.
the entity that obtains control of the acquiree. e. Contingent consideration
- It includes distribution of cash or other
2. DETERMINE THE ACQUISITION DATE assets or the issuance of debt or equity
- PFRS 3 defines acquisition date as the date on securities if specified under future
which the acquirer obtains control of the events occur or conditions are met.
acquiree. ACQUISITION-RELATED COSTS
- Business combination occurs at the date of the - Excluded from the measurement of the consideration
assets or net assets are under the control of paid, because such costs are not part of the fair value of
acquirer. the acquiree and are not assets and accounted for as
- Financial position should report assets and expense.
liabilities on that date. • Costs directly attributable to the combination,
which includes costs such as legal fees, finder's
3. CALCULATE THE FAIR VALUE OF PURCHASE and brokerage fees, advisory, etc.
CONSIDERATION TRANSFERRED • Indirect, ongoing costs, general costs including
- According to PFRS 3 paragraph 37, the the cost to maintain an internal acquisition
consideration transferred: department.
• is measured at fair value at acquisition date COSTS OF ISSUNG EQUITY INSTRUMENTS

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
- Also excluded from the consideration and accounted - Accounts receivable and property,
for under PAS 32 Financial Instruments and should be plant and equipment are presented at
treated as reduction in the share capital of the entity net amount and no separate allowance
such costs reduce proceeds from the equity issue. or accumulated depreciation account.
• Transaction costs such as documentary stamp
duties on new shares, professional adviser's
fees, underwriting costs, etc.
4. RECOGNIZE AND MEASUREMENT OF ASSETS e. IDENTIFIABLE INTANGIBLE ASSETS
ACQUIRED AND LIABILITIES ASSUMED - An Intangible Asset is Identifiable if:
a. FAIR VALUE • can be separated; or
- Market-based measure in a • meets the contractual-legal criterion
transaction between unrelated parties. - According to PFRS 3, in-process
- Usually determined by the market and research and development, acquirer
agreed upon by a willing buyer and recognizes all tangible and intangible
seller. research and development assets
b. FAIR VALUE HIERARCHY acquired in a business combination and
• Level 1 Inputs - fully observable and recorded at fair value as an asset on the
are unadjusted quoted prices date of acquisition.
• Level 2 Inputs - directly or indirectly f. EXISTING LIABILITIES
observable inputs other than Level 1 - Recorded at fair values or present
Inputs values.
• Level 3 Inputs - unobservable inputs - In cases of deferred revenue, an
for the asset or liability acquirer should recognize a liability for
c. VALUATION TECHNIQUES deferred revenue of the acquiree only if
- Recognition and Measurement of it relates to an outstanding
Assets Acquired and Liabilities Assumed performance obligation assumed by the
The objective is to estimate the price at acquirer. It should be based on the fair
which an orderly transaction to sell the value of the obligation at the date of
asset or to transfer the liability would acquisition.
take place between market participants g. CONTINGENT LIABILITIES
and the measurement date under - Recorded at fair values or present
current market conditions. values.
 Market/Benchmark approach - h. LIABILITIES ASSOCIATED WITH
uses price and other relevant RESTRUCTURING OR EXIT ACTIVITIES
information generated by - To record a liability, there must be an
market transactions. existing obligation to other entities. The
 Income approach - based on possible future costs connected with
future economic benefit restructuring or exit activities that may
derived from owning the asset be planned by the acquirer are not part
or coverts future amounts to a of the acquisition and are expensed in
single current amount. future periods.
 Cost approach - reflects the i. OTHER ASSETS/LIABILITIES
amount that would be required  Employee benefits plans
currently to replace the service  b. Indemnification assets
capacity of an asset.  c. Income Taxes
d. IDENTIFIABLE TANGIBLE ASSETS  d. Employee benefits
- Recognized if it is probable that any 5. RECOGNIZE AND MEASURE EITHER GOODWILL
associated future economic benefits OR GAIN FROM A BARGAIN PURCHASE
will flow to the acquirer, and its fair - The acquirer may or may not choose to
value can be measured reliably. operate the entity in the same manner; but
- Assets held for sale accounted for regardless of the acquirer’s plans, the price to
under PFRS 5 - measured at FV less cost be paid will take into account the acquiree’s
to sell. future earnings potential

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
- If the entity has been successful and has occurs, the financial statements should be
demonstrated an ability to generate above- prepared using provisional amounts for the
earnings, then the acquirer may have to pay a items for which the accounting is incomplete.
price that is higher the aggregate fair value of ADJUSTMENTS TO PROVISIONAL VALUES
the identifiable net assets. On the other hand, if  PFRS 3 permits adjustments to items recognized
the entity has not been successful, the price in the original accounting for a business
may be less than the fair value of the net combination as long as it is within the
identifiable assets (but not normally less than measurement period.
the liquidating value of the net assets including
tax effects) In summary, there are normally three areas
where adjustments need to be made subsequent to the
GOODWILL initial accounting after acquisition date, they are:
 PFRS 3 states that “the acquirer shall recognize • Goodwill
goodwill as of the acquisition date, measured as the • Contingent liabilities
excess of (I) over (II) below”: • Contingent consideration
I. The aggregate of: PFRS 3 requires that all contractual
a. The consideration transferred measured which contingencies, as well as non-contractual liabilities for
generally requires acquisition date fair value; which it is more likely than not that an asset or liability
b. The amount of any non-controlling interest in exists, be measured and recognized at fair value on the
the acquiree; acquisition date.
c. In a business combination achieved in stages, MEASUREMENT PERIOD
the acquisition date fair value of the acquirer’s  The measurement period is the period after the
previously held equity interest in the acquire. initial acquisition date during which the acquirer
II. The net of the acquisition date amounts of the may adjust the “provisional amounts”
identifiable assets acquired and the liabilities recognized at the acquisition date.
assumed measured in accordance with this  The one-year period is known as the
Standard “measurement period”. However, it is
 In this chapter discussion, the business necessary to note that information that relates
combinations defined as statutory merger and to events and circumstances arising after the
statutory consolidation, goodwill is determined to measurement date do not lead to measurement
be as the excess of the consideration transferred adjustments.
over the net fair value of the identifiable assets and RETROSPECTIVE ADJUSTMENTS
liabilities assumed. Thus:  The adjustments to provisional amounts should
Goodwill = Consideration transferred - Acquirer’s be recognized as if the accounting for the
interests net fair value of the acquiree’s business combination had been completed on
identifiable assets and liabilities the acquisition date. Therefore, comparative
information for prior periods presented in the
BARGAIN PURCHASE GAIN financial statements is revised, including making
 When the acquirer’s interest in the net fair any change in depreciation, amortization or
value of the acquiree’s identifiable assets and other income effects recognized in completing
liabilities is greater than the consideration the initial accounting.
transferred, the difference is called a bargain
purchase gain, thus: NOTE: If purchase is less than 100%, then the 4th step
Bargain purchase gain = Acquirer’s interests includes measuring and recognition of NCI.
net fair value of the acquiree’s identifiable
assets and liabilities less Consideration
transferred

USE OF PROVISIONAL VALUES

 If the initial accounting for a business
combination is incomplete by the end of the
reporting period in which the combination

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
CHAPTER 2: SEPARATE AND CONSOLIDATED  Both parent and subsidiary retain their status as
FINANCIAL STATEMENTS - DATE OF ACQUISITION separate legal entities
 However, from an economic perspective, they
LEVELS OF INVESTMENT are a single reporting entity
 The acquisition of common stock of another
company receives different accounting Two sets of financial statements must be prepared —
treatments depending on the level of separate financial statements for the legal entity and
ownership and the amount of influence or consolidated financial statements for the group.
control caused by the stock ownership. The 1. Separate financial statements
ownership levels and accounting methods can 2. Consolidated financial statements
be summarized as follows:
The focus of this chapter is:
 On the business combination in general that
results to a parent-subsidiary relationship which
is properly termed as a consolidation
 PFRS 3 presumes that there is a dominant party
in a business combination, which may be
identified as an “acquirer”

CLASSIFICATION OF INTERCORPORATE INVESTMENT

 An inter-corporate investment is any purchase
by one corporation of the securities of another
corporation.
Levels of investment - sample problem  The focus of this text is on equity (ordinary
 Assume that the investee company paid P2,000 shares/common stock) investments.
in cash dividends. The investor would prepare  The investment of a corporation in the equity of
the following income statements, depending on another corporation can broadly be classified as
either passive or strategic:
a. A passive investment is made to earn
dividends or to earn profits by actively
trading the investment for short-term
profit.
b. A strategic (active) investment is made
to significantly influence or control the
operations of the investee (acquire)
corporation.

the level of ownership:

ACQUISITION OF NET ASSETS VERSUS ACQUISITION OF
STOCK (VOTING) / EQUITY
Conceptually, a “group”,
 which comprises a parent and its subsidiaries, is
a type of “business combination”.
 a group is a business combination in which the
acquirer is a “parent” and the acquiree is a
“subsidiary”,
 business combination results from the parent
acquiring a controlling interest in the equity EQUITY INVESTMENTS AND REPORTING METHODS
(not net assets) of the subsidiary. UNDER PFRS
In this business combination, THE CONCEPT OF CONTROL

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
 CONSOLIDATION IS THE PROCESS OF c. In a business combination achieved in stages,
COMBINING THE ASSETS, LIABILITIES, EARNINGS the acquisition date fair value of the acquirer’s
AND CASH FLOWS OF A PARENT AND ITS previously held equity interest in the acquiree.
SUBSIDIARIES AS IF THEY WERE ONE ECONOMIC II. The net of the acquisition date amounts of the
ENTITY. identifiable assets acquired and the liabilities
 A parent is an entity that controls one or more assumed measured in accordance with PFRS 3.
subsidiaries. A group is a parent and all its Where (II) exceeds (I), PFRS 3 regards the giving rise to a
subsidiaries. gain on a bargain purchase.
 PFRS 10 GUIDANCE ON CONTROL - An investor
determines whether it is a parent by assessing CONSOLIDATION OF PARTIALLY-OWNED SUBSIDIARIES
or it controls one or more investees. PFRS 10 When a subsidiary is less than 100% owned or
uses control as the single basis for partially-owned, problem arises as to the determination
consolidation. An investor controls an investee and recognition of goodwill and the non-controlling
if and only if the investor has all of the following interests.
three elements of control: PFRS 3 allows goodwill and non-controlling
1. Power over the investee. interests in the acquiree at acquisition date to be
2. Exposure, or rights, to variable returns measured at either:
from involvement with the investee  Full-goodwill approach or Fair Value Basis
3. The ability to use power over the (consistent with the measurement principle for
investee to affect the amount of the other components of the business
investor’s returns. combination), or
THE “DEFAULT PRESUMPTION”  Partial-goodwill approach or Proportional Basis
The presence of “control” determines the existence of a (of the acquiree’s identifiable net assets).
parent-subsidiary relationship.
 In the context of PFRS 10 the quantitative FULL-GOODWILL APPROACH (OR FAIR VALUE BASIS)
criterion of more than 50% of voting power was When non-controlling interests are measured at
not mentioned but not superseded by a new fair value, goodwill attributable to non-controlling
rule. interests will be recognized in the consolidated
 For practical reasons, the presumption is that financial statements.
ownership of more than 50% of voting power Under the fair value basis, non-controlling
constitutes control, in the absence of any interests comprise three components:
evidence to the contrary.  Share of book value of identifiable net assets of
 However, control also arises from many other subsidiary;
sources: statute, contractual arrangements,  Share (fair value - book value) of identifiable net
implicit or explicit control over the board of assets of subsidiary at acquisition date; and
directors among others.  Share of goodwill in subsidiary at acquisition
As PFRS 10 is based on principles rather than rules, the date.
use of a quantitative criterion is only a guide. This is PARTIAL-GOODWILL APPROACH (OR PROPORTIONAL
known as the “default presumption”. BASIS)
Non-controlling interests’ share of goodwill
THE ACQUISITION ANALYSIS (OR SCHEDULE OF (NCI-goodwill) is not recognized under the proportional
DETERMINATION AND ALLOCATION OF EXCESS) basis.
The acquirer obtains control by acquiring shares (stock Under the fair value basis, non-controlling
acquisition) in the acquiree. interests comprise three components:
Goodwill is the excess of (I) over (II) below.  Share of book value of identifiable net assets of
I. The aggregate of: subsidiary;
a. The consideration transferred measured in  Share (fair value - book value) of identifiable net
accordance with PFRS 3, which generally assets of subsidiary at acquisition date; and
requires acquisition date fair value  Share of goodwill in subsidiary at acquisition
b. The amount of any non-controlling interest in date.
the acquiree measured in accordance with this
PFRS 3; and ENTITY (ECONOMIC UNIT) THEORY

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 ACTG 31: ACCOUNTING FOR BUSINESS COMBINATIONS
Non-controlling interests are deemed to be as PROPORTIONATE BASIS (PARTIAL-GOODWILL
important as a stakeholder of the combined entity APPROACH)
 Partial-goodwill
 Non-controlling interest
FAIR VALUE BASIS (FULL-GOODWILL APPROACH)
 Full-goodwill

 Non-controlling interest

similar to the majority shareholders. Hence, it requires a

consistent accounting treatment for both parent and

non-controlling interests.
(Controlling and non-controlling interests) =
Consolidated assets – Consolidated liabilities

PARENT THEORY
Focuses on the information needs of the parent
company shareholders. Claims by non-controlling
interests in the net assets of a subsidiary are shown as
separate component in the balance sheet.
Consolidated equity and non-controlling interests =
Consolidated assets – Consolidated liabilities

PARENT THEORY VS. ENTITY THEORY

ILLUSTRATION 2-1: FAIR VALUE OF NON-CONTROLLING

INTEREST IN SUBSIDIARY NOT GIVEN
Par Company acquires 80% of Son Company for
P10,000,000, carrying value of Son Company’s net
assets at time of acquisition being P6,000,000 and fair
value of these net identifiable assets being P8,000,000

The following computations for goodwill and non-

controlling interest under two options are as follows:

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