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Business Combinations
A business combination is the term applied to external expansion in which separate
enterprises are brought together into one economic entity as a result of one enterprise
obtaining control over the net assets and operations of another enterprise. However,
business combinations involve certain limitations and risks. Corporate objectives must be
taken into consideration. Only those companies which have the same or compatible sets of
objectives should combine. The acquiring enterprise may also inherit the acquired firm’s
inefficiencies and problems together with its inadequate resources.

Learning Objectives
1. Define a business combination
2. Enumerate the different classifications of business combinations
3. Define acquisition of Net Assets
4. Compute for Goodwill or Gain on Acquisition
5. Identify accounting treatment of expenses related to acquisition
6. Account for contingent considerations
7. Explain the measurement period
8. Prepare entries on the books of the acquired company.
9. Define acquisition of Stocks
10. Compute for the Non-controlling Interest

Business Combinations Defined

The term business combination refers in general to any set of conditions in which two or
more organizations are joined together through common ownership. As defined by IFRS 3,
business combination is a transaction or event in which an acquirer obtains control of one or
more businesses. For each business combination, one of the combining entities shall be
identified as the acquirer.

Some Reasons for Business Combinations

● Cost Advantage
● Lower Risk
● Avoidance of Takeovers
● Acquisition of Intangible Assets
 ACCT 108 Accounting for Business Combinations (Apostol, P.A.)
College of Business Studies, Don Honorio Ventura State University
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Classification of Business Combinations

I. Structure of the Combination (Business Point of View)
A. Horizontal Integration
B. Vertical Integration
C. Conglomerate Combination
D. Circular Combination

II. Method of Combination (Legal Point of View)

A. Net Asset Acquisition. The books of the acquired company are closed out and its
assets and liabilities are transferred to the books of the acquiring company. 1.
Statutory Merger
2. Statutory Consolidation
B. Stock Acquisition.
C. Asset Acquisition (NOTE: not within the scope of IFRS 3)

III. Accounting Method Used

A. Acquisition or Purchase Method. All assets and liabilities of the acquired
company are usually recorded at Fair Values. Under the acquisition method,
the general approach to accounting business combinations is a five-step
process
1. Identify the acquirer. Acquirer is the entity that obtains control of the
acquired company.
2. Determine the acquisition date. This is the date on which the entity
obtains control of the acquired business. This is critical because it is the
date used to establish the fair value of the company acquired.
3. Calculate the fair value of the purchase consideration transferred.
Generally, the consideration is assumed to be the fair value of the
acquired entity.
4. Recognize and measure the identifiable assets and liabilities of the
business at fair value.
5. Recognize and measure either goodwill or a gain from bargain purchase.
B. Pooling of Interest Method. All assets and liabilities of the acquired company are
recorded at Book Values. (NOTE: not permitted in IFRS 3)
 ACCT 108 Accounting for Business Combinations (Apostol, P.A.)
College of Business Studies, Don Honorio Ventura State University
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Acquisition of Net Assets (Asset less Liabilities)

The following are the features of a net acquisition:
➔ An acquirer acquires 100% of the net assets of the acquired company. ➔ An acquirer
acquires from enterprise for cash, other property, debt instruments, and equity
instruments, or a combination thereof.
➔ The acquiring company usually survives and the acquired company is dissolved

Statutory Merger
A type of net asset acquisition where the acquiring company survives (remains in existence),
whereas the acquired company ceases to exist as a separate legal entity. It may be expressed
as:
A Company + B Company = A Company or B Company

Statutory Consolidation
A type of net asset acquisition where a new corporation is formed as a result of one company
acquiring another. It may be express as:
A Company + B Company = C Company

Problem I
On June 30, 2021, A Company decided to purchase all the net assets of B Company. The
acquiring company issued 80,000 shares of its P10 par value common stock with a market
value of P40 each. The acquirer pays professional fees of 50,000 to accomplish the acquisition
and incurs 30,000 stock issuance costs. The following are the records of the companies at the
date of acquisition:

A Company B Company

Book Value Fair Value Book Value Fair Value

Cash 1,000,000 1,000,000 200,000 200,000

Marketable Securities 400,000 380,000 300,000 330,000

 Inventory 800,000 750,000 500,000 550,000

Land 500,000 550,000 150,000 360,000

Buildings (net) 1,200,000 1,100,000 750,000 900,000

Equipments (net) 480,000 500,000 400,000 700,000

Unrecognized --- 225,000

Receivables Current 600,000 600,000 125,000 125,000

Liabilities

Bonds Payable 1,100,000 1,100,000 500,000 500,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Premium on Bonds 40,000 40,000 - 20,000

Common Stock 1,000,000 50,000

APIC 20,000 700,000

Retained Earnings 1,620,,000 925,000

Requirement: Applying the 5-step process, record the necessary entries on the date of
acquisition and determine the amounts to be reported in the Financial Position of the
acquiring company following the business combination.

Step 1: The acquirer in this business combination is A company.

Step 2: The date of acquisition is June 30, 2021.
Step 3: The price paid is 3,200,000 (80,000 share x P40)
Step 4: The fair value of net assets of the acquired company is 2,620,000 computed as follows:
Fair Value of Identifiable Assets 3,265,000
Less: FV of Liabilities 645,000
FV of Net Assets 2,620,000

Another method of determining the fair value of the net assets acquired is to effect
the changes in fair values of accounts to the sum on their book values.
Book Value of Net Assets 1,675,000
Plus: Increase in Asset 965,000
Less: Decrease in Asset 0
Less: Increase in Liabilities 20,000
Plus: Decrease in Liabilities 0
FV of Net Assets 2,620,000
Step 5: The difference between the price paid and the FV of the net assets acquired results to
a Goodwill of 580,000 computed as follows:
Price Paid 3,200,000
FV of Net Assets 2,620,000
Goodwill 580,000

Journal Entries
1. To record the net assets acquired
Cash 200,000
Trade Receivables 225,000
Marketable Securities 330,000
Inventory 550,000
Land 360,000
Building 900,000
Equipment 700,000
Goodwill 580,000
Current Liabilities 125,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Bonds Payable 500,000

Premium on Bonds Payable 20,000
Common Stock 800,000
Additional Paid in Capital 2,400,000

Goodwill is accounted for as a non-current asset separate from Intangible assets and is
defined in PFRS 3 as an asset representing the future economic benefits arising from other
assets as acquired in a business combination that are not individually identified and
separately recognized. In order to be identifiable, an asset must be capable of being
separated or divided from the entity. Goodwill acquired in a purchase of net assets is recorded
on the acquirer’s books, along with the fair values of other assets and liabilities.
Acquired Assets xx
Goodwill xx
Assumed Liabilities xx
Price Paid xx

2. To record acquisition-related costs

Acquisition Expense 50,000
Additional Paid in Capital 30,000
Cash 80,000

Expenses of Business Combination

Acquisition-related costs are incurred when effecting a business combination such as broker’s
fee, accounting, legal, and other professional fee; general administrative costs, including
maintaining an internal acquisition department. These are expenses when incurred and are
not part of the purchase price.
Acquisition Expense xx
Cash xx

Stock issuance costs are incurred when an acquirer issues shares of stock such as SEC
registration fees, documentary stamp tax, and newspaper publication fees treated as a
deduction from additional paid in capital (APIC) from precious share issuance. In case APIC is
reduced to zero, the remaining costs will be charged to the Stock Issuance Cost account,
treated as a contra equity account presented as a separate line item.
Share Premium (Additional Paid in Capital) xx
Share (Stock) Issuance Cost xx
Cash xx

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Financial Position After Acquisition (of Acquiring/Surviving Company)

COMMON STOCK
- Ordinary (Common) Shares of the Surviving Company xx - Ordinary
(Common) Shares issued during combination xx APIC
- Share Premium (APIC) of the Surviving Company xx - Share Premium
(APIC) from issuance xx - Share Issuance Cost (xx) RETAINED EARNINGS
- Retained Earnings of the Surviving Company xx - Gain on Acquisition
xx - Acquisition-related Expense (xx) LIABILITIES
- Book Value of the Surviving Company xx - Fair Value of the Dissolved
Company xx - Liabilities arising from the acquisition xx ASSETS
- Book Value of the Surviving Company xx - Fair Value of the Dissolved
Company xx - Goodwill from acquisition xx - Cash paid (xx)

BV of A FV of B Adjustments New BV

Cash (A) 1,000,000 200,000 (80,000) 1,120,000

Trade Receivables - 225,000 225,000

Marketable Securities 400,000 330,000 730,000

Inventory 800,000 550,000 1,350,000

Land 500,000 360,000 860,000

 Buildings (net) 1,200,000 900,000 2,100,00

Equipments (net) 480,000 700,000 1,180,000

Goodwill 580,000 580,000

Current Liabilities (L) 600,000 125,000 725,000

Bonds Payable 1,100,000 500,000 1,600,000 Premium on Bonds 40,000 20,000 60,000 Common

Stock (C) 1,000,000 800,000 1,800,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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APIC (A) 20,000 2,370,000 2,390,000

Retained Earnings (R) 1,620,000 (50,000) 1,570,000

Problem II
Using the same problem above, record the necessary entries on the date of acquisition if the
acquirer issues 20,000 shares of its P115 par value ordinary shares with a market value of P120
each. Company A pays professional fees of 50,000 and stock issuance cost of 130,000.

Journal Entries
3. To record the net assets acquired
Cash 200,000
Trade Receivables 225,000
Marketable Securities 330,000
Inventory 550,000
Land 360,000
Building 900,000
Equipment 700,000
Current Liabilities 125,000
Bonds Payable 500,000
Premium on Bonds Payable 20,000
Common Stock 2,300,000
Additional Paid in Capital 100,000
Gain on Acquisition 220,000

A Bargain Purchase Gain (Gain on Acquisition) results when the acquirer’s interest in the
net fair value of the acquiree’s identifiable assets and liabilities is greater than the
consideration transferred. This account is to be reported as a separate line item in the
statement of comprehensive income of the acquirer in the period of the acquisition
Acquired Assets xx
Assumed Liabilities xx
 Price Paid xx
Gain on Acquisition xx

4. To record acquisition-related costs

Acquisition Expense 50,000
Additional Paid in Capital 120,000
Share Issuance Cost 10,000
Cash 180,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

College of Business Studies, Don Honorio Ventura State University
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Contingent Consideration
As defined in the standards, a contingent consideration is an obligation of the acquirer to
transfer additional assets or equity interests to the former owners of an acquired company as
part of the exchange for control of the acquired if specified future events occur or
considerattions are met.
● Meeting a specified level of earnings
● Reaching a specified share price
● Reaching a certain milestone in development projects

Problem III
Using the same problem above, record the entries on the date of acquisition if the acquirer
issued 80,000 shares of its P10 par value ordinary shares with a market value of 3,200,000. In
addition to the stock issues, the acquirer agreed to pay an additional 200,000 on January 1,
2022 if the average income for the 2-year period of 2020 and 2021 exceeds 160,000 per year.
The expected probability of achieving the target average income is set at 50%.

Step 5: The difference between the price paid and the FV of the net assets acquired results to
a Goodwill of 680,000 computed as follows:
Shares Issued 3,200,000
Contingent Consideration 100,000
FV of Net Assets (2,620,000)
Goodwill 680,000

Journal Entries
1. To record the net assets acquired
Cash 200,000
Trade Receivables 225,000
Marketable Securities 330,000
Inventory 550,000
Land 360,000
 Building 900,000
Equipment 700,000
Goodwill 680,000
Current Liabilities 125,000
Bonds Payable 500,000
Premium on Bonds Payable 20,000
Contingent Consideration Payable 100,000
Common Stock 800,000
Additional Paid in Capital 2,400,000

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2. To record acquisition-related costs

Acquisition Expense 50,000
Additional Paid in Capital 30,000
Cash 80,000

Changes in Contingent Consideration

Changes resulting from obtaining additional information about facts and circumstances that
existed at the acquisition date, and that occur within the measurement period are
recognized as adjustments against the original accounting for the acquisition, thus may
affect Goodwill.
Goodwill xx
Contingent Consideration Payable xx

NOTE: ↑ CCP - ↑ GW; ↓ CCP - ↓ GW

↑ CCP - ↓ BPG; ↓ CCP - ↑ BPG

Changes resulting from events after the acquisition date are not measurement period
adjustments. Accounting for such depends on whether the instrument is an equity, cash, or
other asset.
● For equity instruments, the original amount is not re-measured, thus the APIC and
Ordinary Shares accounts are only adjusted.
Additional Paid in Capital xx
Ordinary Shares xx
● For cash or other assets, the amount is recognized in profit or loss.
Loss on Contingent Consideration Payable xx
Contingent Consideration Payable xx

Problem IV
Using the same problem above, record the changes on the Contingent Consideration if
 Case 1: The probability of achieving the target average income is revised to 80%.
Goodwill 160,000
Contingent Consideration Payable 160,000

Case 2: In addition to the 80,000 shares, the acquirer agrees to issue another 20,000 of
If the target average income is met. Assuming the contingent event occurs, the
following entry is to be made:
Additional Paid in Capital 200,000
Ordinary Shares 200,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

College of Business Studies, Don Honorio Ventura State University
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Measurement Period
The measurement period is a one-year period after the initial acquisition date during which
the acquirer may adjust the provisional amounts recognized at the acquisition date. This
period allows a reasonable time to obtain the information necessary to identify and measure
the fair value of the acquiree's assets and liabilities, as well as the fair value of the
consideration transferred. The values recorded on the acquisition date are considered
Provisional Fair Values. They are used in financial statements prior to the end of the
measurement period. NOTE: ↑ PFV - ↑ BGP; ↓ PFV - ↓ BGP

↑ PFV - ↓ GW; ↓ PFV - ↑ GW

Problem V
Case 1: Using the same data in the problem above, except that the value assigned to the
Building is only provisional. The said provisional value and received value are illustrated below:

Provisional (2021) Revised (2022)

Fair Value 900,000 950,000

Depreciation Method 20-yr SLM 20-yr SLM

Residual Value 660,000 590,000

Annual Depreciation 12,000 18,000

Requirement: Record all necessary entries to reflect the revised value of the
Building. 1. To adjust the Book Value of the Building
Building 50,000
Goodwill 50,000
2. To record the retroactive depreciation in 2022
 ` Retained Earnings 3,000
Accumulated Depreciation 3,000

Case 2: Assume that there had been a gain on acquisition on the original acquisition date.
Record all the necessary adjustments.
1. To adjust the Book Value of the Building
Building 50,000
Retained Earnings 50,000

Adjustment was made directly to the Retained Earnings account because the gain on
acquisition was recorded in the prior period which is 2021.

2. To record the retroactive depreciation in 2022

` Retained Earnings 3,000
Accumulated Depreciation 3,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Entries on the Books of the Acquired Company

Pro-forma Journal Entries
1. To record the sale of Net Assets
Investment in Acquirer Company xx
Liabilities xx
Assets xx
Gain on Sale of Business xx

2. To record the liquidation of the Dissolved Company

Ordinary Shares xx
APIC xx
Retained Earnings xx
Gain on Sale of Business xx
Investment in Acquirer Company xx

Problem VI
Using the same data in the problem above, record the entries of the business combinations
on the books of B Company

1. To record the sale of Net Assets

Investment in A Company 3,200,000
Current Liabilities 125,000
Bonds Payable 500,000
Cash 200,000
Marketable Securities 300,000
Inventory 500,000
Land 150,000
Building 750,000
Equipment 400,000
 Gain on Sale of Business 1,525,000

Gain on Sale of Business is computed as the difference between the purchase price received
and the Book Values of the net assets of the acquired company.
BV of Assets 2,300,000
Less: BV of Liabilities 625,000
BV of Net Assets 1,675,000
Less: Price Received 3,200,000
Gain on Sale of Business 1,525,000

2. To record the liquidation of B Company

Ordinary Shares 50,000
APIC 700,000
Retained Earnings 925,000
Gain on Sale of Business 1,525,000
Investment in A Company 3,200,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Acquisition of Stocks
The following are the features of a net acquisition:
➔ An acquirer acquires voting (ordinary) shares from another company. ➔ An acquirer
obtains control by purchasing more than 50% of the voting stocks. ➔ An acquired
company need not be dissolved. Both the acquiring and acquired company remain as
separate legal entities.

Pro-forma Journal Entries

1. To record the acquisition of stock
Investment in Subsidiary xx
Cash xx

2. To record the acquisition-related costs

Acquisition Expense xx
Cash xx

➢ In the above entries, the acquirer does not record the underlying assets and liabilities.
Instead the acquisition is recorded in an Investment account that represents the
controlling interest in the net assets of the subsidiary.
➢ No Goodwill or gain on acquisition is recorded on the date of acquisition. These will
only be recognized in the consolidated financial statements.
➢ The business combination does not dissolve the acquired company. ➢ A new
relationship is being formed which is a Parent-Subsidiary relationship.

Investment in Subsidiary Account

➔ Appears as a long-term investment of the parent company in its separate Statement of
Financial Position
 ➔ If control exists (>50%), preparation of the Consolidated Financial Statements will be
required on the date of acquisition and on a date subsequent to acquisition.

Problem VII
On December 31, 2021, P Company acquired all 10,000 issued and outstanding shares of S
Company’s P100 par value ordinary shares for 2,000,000 cash. In addition, P Company paid
professional fees to accomplish the combination of 100,000. Prepare the journal entries upon
acquisition.

1. To record the acquisition

Investment in Subsidiary - S Company 2,000,000
Cash 2,000,000

2. To record the acquisition-related costs

Acquisition Expense 100,000
Cash 100,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Non-Controlling Interest
When a subsidiary is less than 100% owned or partially-owned, a problem arises as to the
determination and recognition of Goodwill and the Non-controlling Interests. Thus, the NCI is
to be measured whichever is higher between these two methods:
1. Partial-goodwill approach or Proportional Basis
This the the minimum value of NCI computed as a proportionate share in the fair
value of the net assets of the acquired company
★ FV of NA xx
NCI% %
NCI xxx

2. Full-goodwill approach or Fair Value Basis

The fair value of the non-controlling interest must be given. If not, use an implied FV
★ (Purchase Price / CI%) x NCI% = NCI

There is no requirement in IFRS 3 to measure the non-controlling interest on a consistent

basis for similar types of business combinations and therefore, an entity has a free choice
between the two options, except that there is a minimum value to be considered.

Goodwill or Gain is then computed using this formula:

★ Purchase Price xx
NCI xx
Company Fair Value xxx
FV of Net Assets (xx)
Goodwill/Gain xxx
The Goodwill shall be measured at cost less impairment losses. There will be no amortization
of Goodwill but it must be tested for impairment annually, or more frequently if events or
changes in circumstances indicate a possible impairment.

Problem VIII
Case 1: On January 01, 2021, P company acquired a 75% equity interest in S company, paying
cash consideration of 50,000 and issuing 50,000, P1.00 par value new ordinary shares valued
at P2.00 each. On this date, the net fair value of the identifiable assets and liabilities of S
Company is 100,000,000. Determine the non-controlling interest and the goodwill (gain) as a
result of the business combination.

1. Partial-goodwill Approach
FV of NA 100,000,000
NCI % 25%
NCI 25,000,000

2. Full-goodwill Approach
Purchase Price 150,000,000
Divide: CI % 75%
Multiply: NCI % 25%
NCI 50,000,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Thus,
Purchase Price 150,000,000
NCI 50,000,000
FV of Net Assets (100,000,000)
Goodwill 100,000,000

Case 2: Using the same data above, except that the fair value of the non-controlling interest is
determined to be 30,000,000.

1. Partial-goodwill Approach
FV of NA 100,000,000
NCI % 25%
NCI 25,000,000

2. Full-goodwill Approach
FV of NCI 30,000,000

Thus,
Purchase Price 150,000,000
NCI 30,000,000
FVof Net Assets (100,000,000)
Goodwill 80,000,000
Case 3: Using the same data above, except that the fair value of the non-controlling interest is
determined to be 20,000,000.

1. Partial-goodwill Approach
FV of NA 100,000,000
NCI% 25%
NCI 25,000,000

2. Full-goodwill Approach
FV of NCI 20,000,000

Thus,
Purchase Price 150,000,000
NCI 25,000,000
FVof Net Assets (100,000,000)
Goodwill 75,000,000

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Contingent Consideration
When a contingent consideration is based on a specified level of future earning and the
specified level is
➔ Achieved, there is no adjustment to the cost of combination
➔ Not achieved, there will be adjustments on the amount of Goodwill initially computed if
within the measurement period.

Problem IX
On January 1, 2021, P Company acquired 75% interest in the equity of S Company. On this date,
the identifiable assets and liabilities of S Company are valued at 200,000,000. The
maintainable profits of S Company are estimated at 40,000,000 per year. On the basis of a
price-earnings ratio of 10 times, the fair value of the ordinary shares of S Company is
estimated as 400,000,000.

The purchase consideration consists of the following terms:

1. An initial payment of 100,000,000;
2. An amount of 110,000,000 payable on January 01, 2022 contingent on the achievement
of maintainable profit of 40,000,000 in the first year; and 3. An amount of 121,000,000
payable on January 1, 2023 contingent on the achievement of the maintenance profit of
40,000,000 in the second year.
S Company’s profits have been averaging 40,000,000 per year in the past 5 year and it's
probable that this level of profits would be maintained in the foreseeable future. At the
acquisition date, P Company’s borrowing rate is 10%.

Requirement: Determine the cost of combination and Goodwill (Gain) resulting from the
combination; and prepare entries to record the transactions.

Problem X
P Company acquired 100% interest in the equity capital of S Company on January 01, 2017. On
this date, the fair value of the identifiable net assets of S Company is 30,000,000. The
consideration is agreed at 50,000,000 and this is based on capitalization of a 5,000,000
maintainable profits of S Company with a price-earnings ratio of 10x. The terms of payment
are as follows:
● 30,000,000 upfront fee
● 11,000,000 at the end of first year, if the profit of S Company is at least 5,000,000 for that
year.
● 12,100,000 at the end of second year, if the profit of the S company is at least 5,000,000
for that year.
● In the event that the profit level is below 5,000,000. The amount payable is reduced
accordingly by the shortfall multiplied by the factor of 5.

Requirement: Determine the cost of combination and Goodwill (Gain) resulting from the
combination; and prepare the entries to record the transactions:
1. Assuming the target profits for years 1 and 2 are both achieved.
2. Assuming the profit in year 1 is only 4,000,000.

ACCT 108 Accounting for Business Combinations (Apostol, P.A.)

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Reference/s
● Millan, Z.V. (2021). Accounting for Business Combinations (Advanced Accounting 2).
● Dayag, A.J. (2021). Advanced Financial Accounting. Good Dreams Publishing. ●
Guerrero, P., Peralta, J.. (2017). Volume 2 Advanced Financial Accounting.
 ACCT 108 Accounting for Business Combinations (Apostol, P.A.)
College of Business Studies, Don Honorio Ventura State University