POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

College of Accountancy and Finance

BUSINESS COMBINATION

PFRS 3 - Business Combinations outlines the accounting when an acquirer obtains control of a business (e.g. an
acquisition or merger). Such business combinations are accounted for using the acquisition method, which generally
requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date. It seeks to
enhance the relevance, reliability and comparability of information provided about business combinations (e.g.
acquisitions and mergers) and their effects. It sets out the principles on the recognition and measurement of acquired
assets and liabilities, the determination of goodwill and the necessary disclosures.

Definition of Terms

• 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.
• Business - An integrated set of activities and assets that is capable of being conducted and managed for the
purpose of providing goods or services to customers, generating investment income (such as dividends or interest)
or generating other income from ordinary activities.
• Acquisition Date - The date on which the acquirer obtains control of the acquiree.
• Acquirer - The entity that obtains control of the acquiree.
• Acquiree - The business or businesses that the acquirer obtains control of in a business combination.

IFRS 3 must be applied when accounting for business combinations, but does not apply to:
• The formation of a joint venture
• The acquisition of an asset or group of assets that is not a business
• Combinations of entities or businesses under common control
• Acquisitions by an investment entity of a subsidiary that is required to be measured at fair value through profit
or loss under IFRS 10 Consolidated Financial Statements.

Determining whether a transaction is a business combination

IFRS 3 provides additional guidance on determining whether a transaction meets the definition of a business
combination, and so accounted for in accordance with its requirements. This guidance includes:
• Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing
equity instruments (or any combination thereof), or by not issuing consideration at all.
• Business combinations can be structured in various ways to satisfy legal, taxation or other objectives, including
one entity becoming a subsidiary of another, the transfer of net assets from one entity to another or to a new
entity.
• The business combination must involve the acquisition of a business.

Acquisition method

The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3) is used for all business
combinations.

Steps in applying the acquisition method are:

• Identification of the 'acquirer'.
• Determination of the 'acquisition date'.
• Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-
controlling interest (NCI, formerly called minority interest) in the acquire.
• Recognition and measurement of goodwill or a gain from a bargain purchase.

Goodwill

Goodwill is measured as the difference between:

• the aggregate of (i) the value of the consideration transferred (generally at fair value), (ii) the amount of any
non-controlling interest (NCI), and (iii) in a business combination achieved in stages , the acquisition-date fair
value of the acquirer's previously-held equity interest in the acquiree, and
• the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed
(measured in accordance with IFRS 3).

This can be written in simplified equation form as follows:

Goodwill = Consideration transferred + Amount of non-controlling interests + Fair value of previous equity interests +
Net assets recognised

If the difference above is negative, the resulting gain is a bargain purchase in profit or loss, which may arise in
circumstances such as a forced seller acting under compulsion. However, before any bargain purchase gain is
recognized in profit or loss, the acquirer is required to undertake a review to ensure the identification of assets and
liabilities is complete, and that measurements appropriately reflect consideration of all available information.
Measurement of non-controlling interests (NCI)

IFRS 3 allows an accounting policy choice, available on a transaction by transaction basis, to measure non-controlling
interests (NCI) either at:
• fair value (sometimes called the full goodwill method), or
• the NCI's proportionate share of net assets of the acquiree.

The choice in accounting policy applies only to present ownership interests in the acquiree that entitle holders to a
proportionate share of the entity's net assets in the event of a liquidation (e.g. outside holdings of an acquiree's
ordinary shares). Other components of non-controlling interests at must be measured at acquisition date fair values or
in accordance with other applicable IFRSs (e.g. share-based payment transactions accounted for under IFRS 2 Share-
based Payment).

Business combination achieved in stages (step acquisitions)

Prior to control being obtained, an acquirer accounts for its investment in the equity interests of an acquiree in
accordance with the nature of the investment by applying the relevant standard, e.g. IAS 28 Investments in Associates
and Joint Ventures (2011), IFRS 11 Joint Arrangements, IAS 39 Financial Instruments: Recognition and Measurement or
IFRS 9 Financial Instruments. As part of accounting for the business combination, the acquirer remeasures any
previously held interest at fair value and takes this amount into account in the determination of goodwill as noted
above Any resultant gain or loss is recognized in profit or loss or other comprehensive income as appropriate.

The accounting treatment of an entity's pre-combination interest in an acquiree is consistent with the view that the
obtaining of control is a significant economic event that triggers a remeasurement. Consistent with this view, all of the
assets and liabilities of the acquiree are fully remeasured in accordance with the requirements of IFRS 3 (generally at
fair value). Accordingly, the determination of goodwill occurs only at the acquisition date.

Measurement period

If the initial accounting for a business combination can be determined only provisionally by the end of the first
reporting period, the business combination is accounted for using provisional amounts. Adjustments to provisional
amounts, and the recognition of newly identified asset and liabilities, must be made within the 'measurement period'
where they reflect new information obtained about facts and circumstances that were in existence at the acquisition
date. The measurement period cannot exceed one year from the acquisition date and no adjustments are permitted
after one year except to correct an error in accordance with IAS 8.

Related transactions and subsequent accounting

• Transactions that are not part of what the acquirer and acquiree (or its former owners) exchanged in the business
combination are identified and accounted for separately from business combination.
• The recognition and measurement of assets and liabilities arising in a business combination after the initial
accounting for the business combination is dealt with under other relevant standards, e.g. acquired inventory is
subsequently accounted under IAS 2 Inventories.

When determining whether a particular item is part of the exchange for the acquiree or whether it is separate from the
business combination, an acquirer considers the reason for the transaction, who initiated the transaction and the
timing of the transaction.

Contingent consideration

Contingent consideration must be measured at fair value at the time of the business combination and is taken into
account in the determination of goodwill. If the amount of contingent consideration changes as a result of a post-
acquisition event (such as meeting an earnings target), accounting for the change in consideration depends on whether
the additional consideration is classified as an equity instrument or an asset or liability:

• If the contingent consideration is classified as an equity instrument, the original amount is not remeasured
• If the additional consideration is classified as an asset or liability that is a financial instrument, the contingent
consideration is measured at fair value and gains and losses are recognised in either profit or loss or other
comprehensive income in accordance with IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Recognition
and Measurement
• If the additional consideration is not within the scope of IFRS 9 (or IAS 39), it is accounted for in accordance with
IAS 37 Provisions, Contingent Liabilities and Contingent Assets or other IFRSs as appropriate

Where a change in the fair value of contingent consideration is the result of additional information about facts and
circumstances that existed at the acquisition date, these changes are accounted for as measurement period
adjustments if they arise during the measurement period (see above).

Acquisition costs

Costs of issuing debt or equity instruments are accounted for under IAS 32 Financial Instruments: Presentation and IAS
39 Financial Instruments: Recognition and Measurement/IFRS 9 Financial Instruments. All other costs associated with an
acquisition must be expensed, including reimbursements to the acquiree for bearing some of the acquisition costs.
Examples of costs to be expensed include finder's fees; advisory, legal, accounting, valuation and other professional or
consulting fees; and general administrative costs, including the costs of maintaining an internal acquisitions
department.

Disclosure of information about current business combinations

An acquirer is required to disclose information that enables users of its financial statements to evaluate the nature and
financial effect of a business combination that occurs either during the current reporting period or after the end of the
period but before the financial statements are authorized for issue.
Among the disclosures required to meet the foregoing objective are the following:
• name and a description of the acquire
• acquisition date
• percentage of voting equity interests acquired
• primary reasons for the business combination and a description of how the acquirer obtained control of the acquire
• description of the factors that make up the goodwill recognized
• qualitative description of the factors that make up the goodwill recognized, such as expected synergies from
combining operations, intangible assets that do not qualify for separate recognition
• acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of each major
class of consideration
• details of contingent consideration arrangements and indemnification assets
• details of acquired receivables
• the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed
• details of contingent liabilities recognized
• total amount of goodwill that is expected to be deductible for tax purposes
• details about any transactions that are recognized separately from the acquisition of assets and assumption of
liabilities in the business combination
• information about a bargain purchase
• information about the measurement of non-controlling interests
• details about a business combination achieved in stages
• information about the acquiree's revenue and profit or loss
• information about a business combination whose acquisition date is after the end of the reporting period but before
the financial statements are authorized for issue

PROBBLEM 1. MERGER (A + B = A or B) - Goodwill

S Corporation acquired the net assets of M Corporation for Php 1,100,000 and incurred Php 50,000 for direct costs
related to business combination. On the date of acquisition, the assets and liabilities of M Corporation are:
Cash 120,000
Inventory 360,000
PPE 720,000
Liabilities 270,000

The inventory’s market value was established at Php 285,000 and the PPE at Php 840,000.

Required: Determine the amount of goodwill then give the entries to record the business combination in the books of
the acquirer.

PROBLEM 2. MERGER (A + B = A or B) – Gain on Bargain Purchase

S Corporation merged with M Corporation on January 2, 2017 by issuing 7,000 shares of its Php 50 par ordinary shares,
Php 100 fair value, to the stockholders of M Corporation. The Statement of Financial Position of S Corporation and M
Corporation on this date are as follows:

S Corporation M Corporation Fair Value

Current Assets 750,000 380,000 390,000
PPE 592,000 280,000 300,000
Other Assets 100,000 125,000 140,000
Total Assets 1,442,000 785,000 830,000

Liabilities 175,000 115,000

Ordinary Share, P50 400,000
Ordinary Share, P10 200,000
Share Premium 200,000
Retained Earnings 667,000 470,000
Total Liabilities and Equity 1,442,000 785,000

In connection with the merger, S Corporation incurred the following costs:

Finder’s Fee 20,000
Professional Fee 60,000
Other Indirect Cost 10,000
Printing and Registration of Shares 5,000

Required:
1. Determine the following:
 a. Gain on Bargain Purchase
b. Total Assets after business combination
c. Total Shareholder’s Equity after business combination
2. Entries to record the business combination on the books of the acquirer

PROBLEM 3. ROLL UP or PUT TOGETHER (A + B = C)

Statement of Financial Position of S Corporation and M Corporation on December 31, 2016 were as follows:

S Corporation M Corporation
Total Assets 1,400,000 1,340,000

Total Liabilities 600,000 600,000

Ordinary Shares, P25 400,000 500,000
Share Premium 160,000 260,000
Retained Earnings (Deficit) 240,000 (20,000)
Total Liabilities and Equity 1,400,000 1,340,000

On January 2, 2017, SM Corporation was formed to take over the business of S Corporation and M Corporation. The new
company will issue 15,000 shares of Php 50 par for all the outstanding shares of S Corporation and 15,000 shares to M
Corporation. On this date, an independent appraiser was commissioned to value the assets of S Corporation – Php
1,600,000 and M Corporation – Php 1,400,000. SM Corporation paid Php 80,000 direct costs, Php 40,000 for indirect
costs and Php 25,000 for printing and registration of shares. The shares of SM Corporation are currently traded at Php
80 per share.

Required:
1. Determine the amount of goodwill.
2. Entries to record the business combination on the books of the acquirer.
3. If you are a stockholder of S Corporation holding 3,000 shares, how many shares of SM Corporation will you
receive?

PROBLEM 4. SHARE CAPITAL DISTRIBUTION (SINGLE CLASS)

The following information for S Corporation and M Corporation are as follows:

S Corporation M Corporation
Assets 1,800,000 3,100,000
Liabilities 800,000 1,100,000
Equity 1,000,000 2,000,000

Est. Annual Earnings 90,000 200,000

The parties agreed that a single class of share capital with par value of Php 10 is to be issued by the new corporation,
SM Corporation in exchange for the net assets plus goodwill. Goodwill is determined by capitalizing excess earnings at
20%. Normal earnings is 8% of net assets. The two corporations have 10,000 shares outstanding.

Required:
1. How much is the goodwill and the share capital distribution of each corporation?
2. Entries to record the business combination on the books of the acquirer.

PROBLEM 5. SHARE CAPITAL DISTRIBUTION (TWO CLASSES)

Using the same information in Problem D. SM Corporation issues 5% fully participating preference share capital with a
par value of Php 100 and ordinary share capital with a par value of Php 10. PFC is to be issued in an amount equal to
the net asset contribution of each company. Earnings are capitalized at 8% determining the total share capital to be
issued. OSC is to be issued in an amount equal to the difference between the total share capital and the PSC to be
issued.

Required:
1. How much is the goodwill and the share capital distribution of each corporation (both ordinary and preference)?
2. Entries to record the business combination on the books of the acquirer.

PROBLEM 6. MEASUREMENT PERIOD

On July 1, 2015, S Corporation acquired the net assets of M Corporation for a consideration of Php 3,200,000. At the
acquisition date, the carrying value of M Corporation’s net assets was Php 2,000,000 and a temporary appraisal of Php
2,800,000 was attributed to the net assets. At December 31, 2015, a provisional fair value of Php 2,600,000 was
attributed to the net assets. An additional valuation received on March 31, 2016 increased the provisional fair value by
Php 200,000 and on July 30, 2016, the fair value was finalized with a decreased by Php 400,000 from the last valuation
date.

Required:
1. Determine the amount of goodwill to be reported in the Financial Statements of the acquirer at December 31,
2015 and 2016.
2. Entries to record the business combination in the books of the acquirer.

PROBLEM 7. ACQUISITION OF CONTROL (Full Goodwill)

On June 30, 2017, S Corporation acquired 80% interest in M Corporation by issuing 850,000 shares, 8 par value. The
market value of the share is Php 10. S Corporation incurred direct costs of Php 120,000 which includes cost of issuing
and registering shares of Php 20,000. On this date, the carrying value and fair value of M Corporation’s assets and
liabilities are:

CV FV
Current Assets 2,000,000 2,000,000
PPE 9,000,000 11,000,000
Total Assets 11,000,000 13,000,000

Liabilities 3,000,000
Ordinary Share (1M shares) 5,000,000
Retained Earnings 3,000,000
Total Liabilities and Equity 11,000,000

Required: Determine the amount of goodwill then give the entries to record the business combination in the books of
the acquirer.

PROBLEM 8. ACQUISITION OF CONTROL (Partial Goodwill)

On June 30, 2017, S Corporation acquired 80% interest in M Corporation by issuing 850,000 shares, 8 par value. The
market value of the share is Php 10. S Corporation incurred direct costs of Php 120,000 which includes cost of
issuing and registering shares of Php 20,000. On this date, the carrying value and fair value of M Corporation’s assets
and liabilities are:

CV FV
Current Assets 2,000,000 2,000,000
PPE 9,000,000 11,000,000
Total Assets 11,000,000 13,000,000

Liabilities 3,000,000
Ordinary Share (1M shares) 5,000,000
Retained Earnings 3,000,000
Total Liabilities and Equity 11,000,000

Required: Determine the amount of goodwill then give the entries to record the business combination in the books of
the acquirer.

PROBLEM 9. CONSIDERATION WITH PREMIUM

On June 30, 2017, S Corporation acquired 80% interest in M Corporation for Php 12 per share. S Corporation estimated
that the price paid include Php 2 premium in order to gain control over M Corporation. On this date, the carrying value
and fair value of M Corporation’s assets and liabilities are:

CV FV
Current Assets 2,000,000 2,000,000
PPE 9,000,000 11,000,000
Total Assets 11,000,000 13,000,000

Liabilities 3,000,000
Ordinary Share (1M shares) 5,000,000
Retained Earnings 3,000,000
Total Liabilities and Equity 11,000,000

The NCI is measured at fair value.

Required: Determine the amount of goodwill then give the entries to record the business combination in the books of
the acquirer.

PROBLEM 10. CONTINGENT CONSIDERATION

S Corporation acquired the net assets of M Corporation by paying cash of Php 500,000 and issuing 6,500 shares of its
Php 30 par value ordinary shares with FV of Php 50 per share. S Corporation also paid Php 25,000 for audit fees and Php
10,000 for legal fees. It also paid Php 15,000 for the printing and registration of shares. S Corporation also agreed to
pay Php 500,000 one year after the acquisition date if the net income of M Corporation will exceed Php 1,000,000. The
fair value of the contingent consideration is Php 200,000. The Financial Statement of S Corporation and M Corporation
are:
 S Corporation M Corporation
CV FV CV FV
Current Assets 200,000 200,000 75,000 75,000
PPE 2,000,000 2,500,000 600,000 667,500
Other Assets 12,500 12,500 25,000 25,000
Total Assets 2,212,500 2,712,500 700,000 767,500

Liabilities 937,500 875,000 250,000 280,000

Share Capital, P30 525,000
Share Capital, P20 125,000
Retained Earnings 750,000 325,000
Total Liabilities and Equity 2,112,500 700,000

Required:
1. Determine the amount of consideration transferred.
2. Determine the amount of goodwill.
3. Entries to record the business combination on the books of the acquirer.

PROBLEM 11. STEP ACQUISITION (Financial Asset becomes a subsidiary)

On January 1, 2017, S Corporation acquired a 15% interest in M Corporation for cash consideration of Php 1,000,000. S
Corporation classified the interest as equity investment at fair value through P&L. On June 1, 2017, S Corporation
acquired another 60% of the equity interest for cash consideration of Php 6,000,000. The identifiable net assets of M
Corporation had a fair value of Php 8,000,000. S Corporation elected to measure the NCI at their share of the net
identifiable net assets. On the date of acquisition, the previously held 15% interest had a fair value of Php 1,250,000.

Required:
1. Determine the amount of goodwill or gain on bargain purchase.
2. Entries to record the business combination on the books of the acquirer.

PROBLEM 12. STEP ACQUISITION (Associate becomes a subsidiary)

On January 1, 2017, S Corporation acquired 40% of M Corporation’s ordinary shares for cash consideration of Php
4,000,000. S Corporation classified it as an investment in associate. On June 1, 2017, M Corporation reported a profit of
Php 2,500,000 and declared dividends of Php 500,000. On June 30, 2017, S Corporation acquired another 35% equity
interest for cash consideration of Php 4,950,000. The identifiable net assets of M Corporation on this date had a fair
value of Php 12,000,000. S Corporation elected to measure NCI at fair value.

Required:
1. Determine the amount of goodwill or gain on bargain purchase.
2. Entries to record the business combination on the books of the acquirer.

PROBLEM 13. REVERSE ACQUISITION

On June 30, 2017, S Corporation acquired 100% of M Corporation by issuing 2.5 shares for every ordinary share of M
Corporation. On this date, the Financial Statements of s Corporation and M Corporation were:

S Corporation M Corporation
Current Assets 500,000 700,000
PPE 1,300,000 3,000,000
Total Assets 1,800,000 3,700,000

Current Liabilities 300,000 600,000

Non-Current Liabilities 400,000 1,100,000
Ordinary Shares (100,000) 300,000
Ordinary Shares (60,000) 600,000
Retained Earnings 800,000 1,400,000
Total Liabilities and Equity 1,800,000 3,700,000

The fair value of each ordinary share of M Corporation was Php 40. The quoted market price of S Corporation was Php
12. The fair value of S Corporation’s net assets was the same as its carrying value except non-current assets which had
fair value of Php 1,500,000. The fair value of the net assets of M Corporation was the same as its carrying value.

Required:
1. Determine the following:
a. Consideration transferred
b. Goodwill or Gain on Bargain Purchase
2. Entries to record the business combination on the books of the acquirer.

PROBLEM 14. PFRS FOR SMES

On June 30, 2017, S Corporation acquired 80% interest in M Corporation by issuing 850,000 shares, 8 par value. The
market value of the share is Php 10. S Corporation incurred direct costs of Php 120,000 which includes cost of issuing
and registering shares of Php 20,000. On this date, the carrying value and fair value of M Corporation’s assets and
liabilities are:

CV FV
Current Assets 2,000,000 2,000,000
PPE 9,000,000 11,000,000
Total Assets 11,000,000 13,000,000

Liabilities 3,000,000
Ordinary Share (1M shares) 5,000,000
Retained Earnings 3,000,000
Total Liabilities and Equity 11,000,000

Assuming that they are both SME.

Required: Determine the amount of goodwill then give the entries to record the business combination in the books of
the acquirer.

PROBLEM 15

The elimination entries on January 1, 2016 (date of acquisition) in the working paper of Golden and State Company are
shown below:

Share Capital 1,000,000

Share Premium 350,000
Retained Earnings 525,000
Investment in Subsidiary 1,500,000
Non-Controlling Interest 375,000

Inventory 80,000
Equipment 120,000
Goodwill 40,000
Investment in Subsidiary 200,000
Non-Controlling Interest 40,000

Required. The amount paid by Golden and the % of interest acquired.

PROBLEM 16

PIC Company, a private limited company, has arranged for PA Company, a public limited company, to acquire it as a
means of obtaining a stock exchange listing. PA issued 15,000,000 shares to acquire all the outstanding shares of PIC
(6,000,000 shares). The fair value of the net assets of PIC and PA were P30,000,000 and P18,000,000 respectively. The
fair value of each of the shares of PIC was P6 and the quoted market price of PA’s shares is P2. The share capital of PA
is 25,000,000 shares after the acquisition.

Required. The amount of goodwill or gain on bargain purchase.

PROBLEM 17

BOA Company has 100,000 outstanding shares with a par value of P2 per share. PRC Company acquired 30,000 shares of
BOA’s shares on January 2, 2016 for P120,000 when BOA’s net assets had a total fair value of P350,000. On July 1,
2016, PRC agreed to buy an additional 60,000 shares of BOA for P6 per share. Although BOA’s shares were selling at P5
per share, PRC forecasted that obtaining control of BOA would produce significant revenue synergies to justify the
premium price paid. The net identifiable assets of BOA had a fair value of P500,000 on July 1, 2016.

Required. The amount of goodwill or gain on bargain purchase.