BUSINESS COMBINATIONS

based on PFRS 3, PFRS 10

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Exceptions to the Recognition or Measurement Principle
PFRS 3 provides exceptions to its recognition and measurement principles which will result in some items being
recognized differently by applying the requirement of other PFRS and measured at an amount other than their
acquisition-date fair values.
These exceptions are summarized in the figure shown below.

RECOGNITION RECOGNITION AND MEASUREMENT

MEASUREMENT
1. Contingent 1. Income Taxes (PAS 1. Non-Current Assets
Liabilities (PAS 37) 12) Held for Sale (PFRS 5)
2. Employee Benefits 2. Share-based
(PAS 19) Payments (PFRS 2)
3. Indemnification 3. Reacquired Rights
Assets

Exceptions to Recognition Principle

Contingent Liabilities
In a business combination where the acquired entity has contingent liabilities the recognition principle of PAS 37
does not apply. Instead, the acquirer shall recognize contingent liabilities assumed as of the acquisition date if it
arises from past events and it has a fair value that can be measured reliably, regardless of whether it is probable
or not that an outflow of resources embodying economic benefits will be required to settle the obligation.

Exceptions to Recognition and Measurement Principle

Income Taxes
The acquirer shall recognize an measure deferred tax asset or liability arising from the assets acquired and liabilities
assumed as a result of the business combination in accordance with PAS 12 Income Taxes.

Employee Benefits
The acquirer shall recognize and measure a liability (or asset, if any) related to the acquiree’s employee benefit
arrangement in accordance with PAS 19 Employee Benefits.

Indemnification Assets
The acquirer shall recognize an indemnification asset at the same time that it recognize the indemnified item
measured on the same basis as the indemnified item, subject to the need for a valuation allowance for
uncollectible amounts. Thus, for an indemnification asset measured at fair value, the effects of uncertainty about
future cash flows because of collectibility considerations are included in the fair value measure and a separate
valueation allowance therefore is not necessary.

Leases
The acquirer shall recognize the right-of-use assets and lease liabilities for leases identified in accordance with PFRS
16 Leases in which the acquiree is the lessee. The acquirer shall measure the lease liability at the present value of
the remaining lease payments as if the acquired lease were new lease at the acquisition date adjusted to reflect
favorable or unfavorable terms of the lease when compared with market terms. However, the acquirer is not
required to recognize right-of-use assets and liabilities for:
a) leases for which the lease term ends within 12 months from the acquisition date; or
b) leases for which the underlying assets is of low value. Examples of low-value underlying assets can include
tablet and personal computers, small items of office furniture and telephones.

Exceptions to the Measurement Principle

Non-Current Assets Held for Sale
The acquired non-current asset that is classified as held for sale shall be measured at fair value less cost of disposal
which is the requirement in accordance with PFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

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Share-based Payment Transactions
The acquirer shall measure a liability or an equity instrument related to share-based payment transactions of the
acquiree or the replacement if an acquiree’s share-based payment transactions with share-based payment of the
acquirer in accordance with the method in PFRS 12 Share-based Payment.

Reacquired Rights
Reacquired rights are rights that the acquirer has previously granted to an acquiree and as a part of business
combination it has reacquired the right, such as franchise or a license to use the acquirer’s technology. The
reacquired rights shall be measured on the basis of the remaining contractual term of the related contract
regardless of whether market participants would consider potential contract renewals when measuring its fair
value.

Step 4
RECOGNIZING AND MEASURING GOODWILL OR GAIN FROM A BARGAIN PURCHASE

The acquirer shall recognise goodwil of gain from bargain purchase as of the acquisition date measured as the
excess of the consideration transferred, the amount of non-controlling interest in the acquiree and the
acquisition-fate fair value of the acquirer’s previously held interest in the acquiree over the acquisition-date fair
value of the identifiable assets acquired and the liabilities assumed. Thus, goodwill or gain from bargain purchase
can be computed as follows:

Consideration transferred
Cash xxxxx
Fair value of non-cash assets transferred xxxxx
Fair value of equity instrument issued xxxxx
Fair value of financial liabilities incured xxxxx
Fair value of the contingent consideration xxxxx xxxxx
Fair value of previously held investment1 xxxxx
Fair value of non-controlling interest2 xxxxx
Total xxxxx
Fair value of net assets of the acquiree (xxxxx)
Goodwill/(Gain from bargain purchase) xxxxx
1
in case of business combination achieved in stages
2
applicable only for business combination through acquisition of control

It has to be noted that before recognizing a gain from burgain purchase, the acquirer shall reassess whether it
has correctly identified all of the assets acquired and all the liabilities assumed and shall recognize any additional
assets or liabilities that are identified in that review. The acquirer shall then review the procedures used to measure
the amounts that PFRS 3 requires to be recognized at the acquisition date for all of the following:

a) the identifiable assets acquired and liabilities assumed;

b) the non-controlling interest in the acquiree, if any;
c) for a business combination achieved in stages, the acquirer’s previously held equity interest in the acquiree;
and
d) the consideration transferred .

Because PFRS 3 belives that bargain purchase would be rare to happen, the objective of the review is to
ensure that the measurements appropriately reflect consideration of all available information as of the acquisition
date. If after the review, the measurement still results to bargain purchase it shall be recognized to profit or less in
the period when the acquistion occured.

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What is contingent consideration?
Often times when the acquirer and acquiree cannot agree on the total purchase price in a business combination,
the two parties agree to an additional payment termed as ‘contingent consideration,’ based on the outcome of
future events. These payments are typically based on revenue or earnings targets that the acquired company must
meet after the acquisition date.

What is the proper treatment for contingent consideration?

The acquirer shall recognized the acquisition-date fair value as part of the consideration transferred in exchange
for the acquiree.

Initial Classification and Subsequent Measurement

On the date of acquisition the acquirer classifies the contingent consideration in one of the following:

Classification Nature Subsequent Measurement

Liability The acquirer agrees to pay cash or At fair value, with the changes it fair
transfer other assets to the acquiree, value taken to profit or loss in
after future conditions are met. accordance with PFRS 9

Equity The acquirer agrees to issue its owns Not remeasured

shares of stock to the acquiree, after
future conditions are met.

Special Consideration for Share-based Payments

Although the acquirer may settle the contingent consideration by issuing equity shares, the arrangement is not
necessarily an equity classified contingent consideration for accounting purposes. Instances that will lead the
acquirer classifying such contingent consideration as liability is when there is an arrangement between the parties
that is settled with a variable number of the acquirer’s equity shares and that creates
(i) a fixed obligation known at inception;
(ii)an obligation, the amount of which varies inversely to changes in the fair value
of the acquirer’s equity shares; or
(iii) an obligation, the amount of which varies based on something other than the
fair value of the acquirer’s equity shares.

Example 1 | Equity-Settled (Liability Classified)

Veloce Inc., acquires Push N’ Pull a major line of business from Ayala Corporation by
transferring cash amounting to P500 million and Investment in Equity Securities from
StorePrise Inc., amounting to P200 million. At the acquisition date, Veloce agrees to
issue its own shares to the shareholders of Ayala if Push N’ Pull would meet certain
target earnings. The numbers of shares that will be issued would be equivalent to 30%
of the earnings for the first year of operation. However it was further agreed that if
earnings would not exceed P60 million, Veloce is not under obligation to issue shares
of stock to Ayala.

The arrangement creates an obligation that Veloce Inc., would be required to settle
with a variable number of its own equity shares, the amount of which varies with the
expected outcome of the operations of the business acquired. Therefore, the
arrangement between Veloce and Ayala would require liability classification on the
acquisition date. Further, changes in the fair value of the contingent consideration
classified as liability will be recognized in Veloce’s profit or loss until such time it is
settled or when the obligation to transfer contingent consideration ceases.

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 Example 2 | Equity-Settled (Equity Classified)
Assume the same facts in Example 1 except that, Veloce Inc., agrees to issue 100,000
shares of stock if the earnings of the business acquired exceeds P100 million

The arrangement creates an obligation that Veloce is required to settle with a fixed
number of Veloce’s equity shares. Therefore, the equity share settled contingent
consideration could be classified as an equity arrangement.

In contrast as illustrated in Example 1, if the performance target was based on

increases of the Push N’ Pull’s earnings, and it would be settled with variable number
of share the arrangement would lead to contingent consideration classified as liability.

What is provisional amounts and measurement period?

The acquirer is required to measure the assets acquired and liabilities assumed in a business combination at its
acquisition-date fair values, however, such information is not always available at that date and the entity measures
identifiable items at provisional amounts. Therefore, PFRS 3 allows a measurement period which is a period after
the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business
combination.

How to identify measurement period adjustments?

Not all adjustments made during the measurement period to amounts recorded in the accounting for a business
combination should be treated as measurement period adjustments. Only an adjustment made during the
measurement period that possesses both of the following characteristics is considered a measurement period
adjustment and, accordingly, is reflected in the accounting for the business combination (adjustment to
goodwill/gain from bargain purchase):

a) Results from the acquirer obtaining additional information about the facts and circumstances that existed as
of the acquisition date
b) Results from the buyer determining that if this additional information had been known, it would have affected
the accounting for the business combination (e.g., recognition or measurement of an acquired asset,
assumed liability or any NCI) as of the acquisition date.

The accounting for an adjustment made during the measurement period that does not possess both of these
characteristics depends on the facts and circumstances; however, such accounting will often affect the buyer’s
operating income

When does measurement period ends?

The measurement periods ends when the entity obtains facts and information regarding circumstances that exist at
the acquisition-date or but such period must not exceed 12 months from the acquisition-date.

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Appendix A
ADDITIONAL GUIDELINES FOR SPECIFIC TRANSACTIONS

Business Combinations Achieved in Stages

The acquirer shall re-measure 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 or other comprehensive income, as
appropriate. This amount is considered in measuring goodwill or gain from bargain purchase as discussed
earlier.

Acquisition Costs
Costs Treatment
Direct and Indirect Expensed during the period incurred, such cost
Cost include but are not limited to:
- finder’s fee
- advisory, legal, accounting, valuation, and other
professional or consulting fees
- general and administrative cost, such as cost of
maintaining an internal acquisition departments

Share Issue Cost Deduction from the share premium that pertains to
(PAS 32, PFRS 9) that issue. If there is no resulting share premium
pertaining to that issue, share issue costs are
recorded as expense. These costs includes but are not
limited to:
- registration and other regulatory fees
- legal and printing costs
- stamp duties

Bond Issue Cost Deduction from the carrying value of the financial
(PAS 32, PFRS 9) liability. These costs includes but are not limited to:
- legal fees
- printing and engraving of bond certificates
- taxes
- commissions and similar charges

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Appendix B
FULL PFRS vs. PFRS FOR SMEs
Full PFRS PFRS for SMEs
Direct Costs Expensed in the period incurred Treated as part of the consideration
Indirect Costs Expensed in the period incurred Expensed in the period incurred
Share Issue Deducion from Share Premium Deducion from Share Premium
Costs
Bond Issue Deducion from Carrying Value of Deducion from Carrying Value of
Costs Financial Liability Financial Liability
Non-Controlling Can be measured using Measured ONLY using the proprotionate
Interest 1) Fair Value share in the net assets of the acquiree
2) Proportionate share in net assets of
acquiree
Goodwill Tested for impairment at least annually Amortize over the estimated life but not
or when there is indication for to exceed 10 years or when it cannot be
impairment estimated.
Contingent Recognized at acquisition-date fair value Must meet the conditions of PAS 37:
Liabilities even if not probable (exception to PAS  probable
37)  measureable

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Appendix C
USEFUL COMPUTATIONAL FORMULAS

Set A
DATE OF ACQUISITION

Non-Controlling Interest
At Fair Value
1) Given in the problem
2) Not given, then estimate the Fair Value

The consideration paid includes premium

Acquistion cost xxx
Less: Control premium % (xxx)
Consideration paid, excluding control premium xxx
Divided by: Controlling interest x%
Total fair value of business xxx
Multiply by: Non-controlling interest % x%
Fair value of Non-controlling interest xxx

The consideration paid includes no premium

Acquistion cost xxx
Divided by: Controlling interest % x%
Total fair value of business xxx
Multiply by: Non-controlling interest % x%
Fair value of Non-controlling interest xxx

At Proportionate Share in Identifaible Net Assets of the Subsidiary

Subsidiary net assets at Fair Value xxx

Multiply by: Noncontrolling interest x%
Fair value of NCI proportionate share in subsidiary
identifiable net assets xxx

Goodwill or Gain from Bargain Purchase

Consideration transferred
Cash xxx
Fair value of non-cash assets transferred xxx
Fair value of equity instrument issued xxx
Fair value of financial liabilities incured xxx
Fair value of the contingent consideration xxx xxx
Fair value of previously held investment xxx
Fair value of non-controlling interest xxx
Total xxx
Fair value of net assets of the acquiree (xxx)
Goodwill/(Gain from bargain purchase) xxx/(xxx)

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Consolidated Total Assets
Parent total assets (book value) xxx
Subsidairy total assets (fair value) exclusive of goodwill, if any xxx
Goodwill - result from acquisition xxx
Payments - made for expenses incurred in the acquisition by the acquirer (xxx)
Payments - made to the acquiree (xxx)
Consolidated total assets xxxx

Consolidated Total Liabilities

Parent total liabilities (book value) xxx
Subsidairy total liabilities (fair value) xxx
Contingent consideration - classified as liability xxx
Unpaid costs for effecting business combinations xxx
Financial Liability as Consideration (net of bond issue costs) xxx
Consolidated total liabilities xxxx

Consolidated Retained Earnings

Parent retained earnings before acquisition xxx
Gain from acquistion, if any xxx
Expenses (Direct and indirect cost, share issue costs in excess of premium) (xxx)
Consolidated retained earnings xxx

Consolidated Shareholders’ Equity

Parent common shares, before acquisition xxx
Newly issued shares at fair value (net of share issue costs) xxx
Additional paid in capital, before acquisition xxx
Consolidated retained earnings xxx
Non-controlling interest xxx
Consolidated stockholders' equity xxx

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Set B
SUBSEQUENT TO DATE OF ACQUISITION

Consolidated Net Income

Assume that the parent owns 80% ownership while the NCI is 20%

Parent NCI Consolidate

NI
Net income of parent from own 100% -- 100%
operations
Net income of subsidiary 80% 20% 100%
Dividend income from subsidiary 80% - 100%
Amortization of Excess:
Inventories - Sold1 (80%)/80% (20%)/20% (100%)/100%
Inventories - Unsold - - -
PPE/Intangible Assets2 (80%)/80% (20%)/20% (100%)/100%
Impairment of Goodwill3 (80%) (20%) (100%)
Gain on Bargain Purchase 100% - 100%
Allicated Net Income/Consolidated NI xxx xxx xxx

Notes:
1. If fair value > book value = (deduct), add otherwise. If not indicated whether sold or unsold assume SOLD.
2. If fair value > book value = (deduct), add otherwise. Establish the amount of excess in your computation of
goodwill
3. Based on PAS 36 impairment loss is always based on full goodwill (fair value).

Net Income from Subsidiary

Subsidiary reported net income xxx
+/- Amortization of Excess xxx
- impairment loss on goodwill, if any xxx
Subsidiary adjusted net income xxx
Multiply: Controlling interest x%
Net Income from subsidiary xxx

Consolidated Retained Earnings

Parent retained earnings - beg., current year xxx
Gain from bargain purchase, if any xxx
Consolidated net income attributable to parent xxx
Dividends declared - parent only (xxx)
Consolidated retained earnings - end., current year xxx

Non-Controlling Interest
Noncontrolling interest, date of acquisition xxx
Consolidated net income attributable to NCI (NCINIS) xxx
Dividends declared attributable to NCI (xxx)
Noncontrolling interest - December 31 current year xxx

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REFERENCES:

PFRS 3 Business Combinations.Financial Reporting Standards Council

PFRS 10 Consolidated Financial Statements. Financial Reporting Standards Council

Conceptual Framework For Financial Reporting. Financial Reporting Standards Council

Marshall, Brian H., Dimattia, Teresit, (2016). A Guide to Accounting For Business Combinations(Third Edition).
Financial Accounting Foundation.

Accounting for Contingent Consideration — Don’t let Earnouts Lead to Earnings Surprises (October 1, 2015).
PwC.

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