Since 1977

ADVANCED FINANCIAL ACCOUNTING DE LEON/DE LEON

AFAR 3005 –BUSINESS COMBINATIONS – MERGERS MAY 2021

LECTURE NOTES
THE NATURE OF BUSINESS COMBINATIONS ACCOUNTING TREATMENT ON SOME SPECIFIC
➢ Occurs when one entity gains control over another COST ITEMS
entity either through the acquisition of net assets 1. Cash or other monetary assets. The fair value of
(must be 100%), or the acquisition of common the cash and cash equivalents dispersed is usually
shares (more than 50% of outstanding). readily determinable. But if the settlement is
➢ Business combination requires the bringing together deferred to a time subsequent to the exchange date
of businesses into a reporting entity. A reporting the fair value of that deferred component shall be
entity can be a single entity (acquisition of net the present value at the date of exchange.
assets), or a group comprising a parent and all of its 2. Non- monetary assets. These consist of assets
subsidiaries (acquisition of shares). such as property, plant and equipment, investments,
➢ The business combination occurs from the stand licenses and patents. The acquirer is effectively
point of the acquirer. selling the non-monetary asset to the acquiree.
➢ All business combinations must use the purchase Hence it is earning revenue equal to the fair value
method. Pooling of interest method is no longer on the sale of the assets and realizing a gain or
permitted. incurring a loss if the carrying amount differs from
the fair value.
GENERAL STEPS UNDER THE PURCHASE METHOD 3. Equity instruments. If an acquirer issues its own
OF ACCOUNTING FOR THE BUSINESS shares as consideration it will need to determine the
COMBINATION fair value of those shares at the date of exchange.
4. Liabilities undertaken – the fair value of the
a. The use of the purchase method liabilities undertaken are best measured by the
b. An acquirer to be identified present value of future cash flows. Note that
c. The measurement of the cost of a combination expected future losses and cost, as a result of the
d. The allocation of the cost of combination to the combination are not liabilities of the acquirer and
acquired assets and assumed liabilities and therefore not included in the calculation of the fair
contingent liabilities. value of consideration paid.
e. The assets, liabilities and contingent liabilities to be 5. Contingencies - Where the business combination
measured initially at fair value. agreement provides for an adjustment to the cost of
f. Goodwill acquired to be recognized the combination contingent on future events, the
g. That goodwill upon recognition is subsequently acquirer shall include the amount of that adjustment
accounted for as follows: in the cost of the combination at the acquisition date
ACQUIRER NON-SME SME if the adjustment is probable and can be measured
AMORTIZATION no yes reliably.
IMPAIRMENT TEST yes yes 6. Directly attributable costs; it includes costs such
h. That any excess on combination be accounted for by as professional fees paid to accountants, legal
a reassessment of the assets and liabilities acquired advisers, valuers and other consultants to effect the
and, where appropriate, by recognizing any excess combination. Also included in the cost category are
immediately in profit and loss. Any such discount (or finders fees and brokerage fees. These are
premium) accrues only to the acquirer. recognized as expenses if acquirer is a non-SME.
i. Disclosures of information that enable users to 7. Other cost that are not directly attributable to
evaluate the nature and effect of business the business combination are
combinations effected in the current period and a. Cost to issue and register the shares issued by
previous periods, as well as post balance-sheet the acquirer are treated as a reduction in the
dates. total fair value of the shares issued and are
j. Disclosure of information that enable users to recognized in equity and
evaluate changes in the carrying amount of goodwill. b. Indirect acquisition costs are recognized as
expenses.
ACCOUNTING FOR COST OF BUSINESS
COMBINATION ALLOCATING THE COST OF BUSINESS
The acquirer shall measure the cost of business COMBINATION:
combination as the aggregate of 1. Identifiable tangible assets: are recognized if it is
a. The fair values at the date of exchange of assets probable that any associated future economic
given, liabilities incurred or assumed and equity benefits will flow to the acquirer; and its fair value
instruments issued by the acquirer in exchange for can be measured reliably
control of the acquiree; plus 2. Intangible assets: are recognized if it’s fair value
b. Contingent costs of guarantees made, if measurable can be measured reliably. Note that, unlike tangible
and probable at the date of acquisition on: (1) assets there is no probability test only a reliability
market value of the shares issued; and/or (2) test.
amount of net income sustained over a specified 3. Liabilities – are recognized if it is probable that an
period. outflow of resources embodying economic benefits
c. Direct acquisition costs, if the acquirer is an SME. will be required to settle the obligation; and its fair
value can be measured reliably.
4. Unrecorded identifiable assets and liabilities

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IFRS requires the recognition of the acquiree’s acquire exchanged in the business combination
unrecognized assets and liabilities if they meet rather than the result of separate transactions.
the following criteria: (a) they must meet the Therefore, any unrecognized assets and
definition of assets and liabilities in the IFRS liabilities that meet the above requisites but
Framework at the acquisition date and (b) they are not recognized in the acquiree’s balance
must be part of what the acquirer and the sheet should be recognized in the acquirer’s/group
balance sheet.
- done -

EXERCISES

Case 1 – Computations of GW or IFA 3. Determine goodwill or excess from the business

NORTHPOINT COMPANY acquired the net assets of combination, and
DOMINI0N ENTERPRISES on January 1, 2020 The 4. Prepare journal entries to record the acquisition of
carrying and fair values of DOMINION at the date of the net assets of DOMINION ENTERPRISES in the
acquisition follows: books of NORTHPOINT COMPANY.
Carrying
Value Fair Value Case 2 – Merger Combination
Cash P16,000 P16,000 The following balance sheets at December 31, 2020 are
Accounts receivable 32,000 32,000 for PHILRABBIT Company and SUPERLINES Enterprises,
Merchandise Inventory 48,000 56,000 respectively just before the business combination.. On
this date, PHILRABBIT acquires the net assets of
Plant and Property 360,000 368,000 SUPERLINES and issues 9,600 new shares in
Patent 48,000 44.000 consideration thereof. . The issued shares have a market
Total assets P 504,000 P 516,000 value of P35 each.

Accounts Payable P24,000 P24,000 PHILRABBIT SUPERLINES

Long-term debt 320,000 296,000 Cash P 112,000 P 40,000
Capital stock 96,000 Accounts receivable 96,000 28,000
Land 176,000 40,000
Buildings, net 280,000 168,000
APIC 16,000 Equipment, net 328,000 100,000
Retained Earnings 48,000 Total assets P 992,000 P 376,000
Total Equities P504f000
Accounts payable P 128,000 P 44,000
NORTHPOINT COMPANY issued the following Bonds payable 160,000 80,000
considerations in exchange for the net assets of Share capital, P10 par 320,000 144,000
DOMINION: Share premium - 20,000
1. 40,000, P1 par shares of NORTHPOINT. Fair value- Retained profit 384,000 88,000
P2.75 at January 1, 2020. Total liabilities and
2. NORTHPOINT agreed to pay additional cash equity P 992,000 P 376,000
consideration for the value of any decrease in the
share price below P2.75 for the 40,000 shares issued. The following market values have been agreed upon by
The guarantee is for 90 days and is to expire on the parties over some of SUPERLINES’s net asset items:
March 31, 2020. NORTHPOINT believes there was
only a 20% chance the price of the shares would fall Accounts receivable, P24,000; Land, P48,000; Buildings,
to P2.60 during the guarantee period. P200,000; Equipment, P120,000; and
3. Cash of P72,000; P24,000 to be paid on date of Bonds payable, P88,000.
exchange and the balance in one year's time. The
incremental borrowing rate of NORTHPOINT is 10% PHILRABBIT Company also paid out-of-pocket costs:
per annum. P6,400 for direct acquisition costs; P12,000 for stock
4. DOMINION was currently being sued by an enraged issuance and registration; and P1,600 for indirect
client; the company's lawyers believe there's an 95% acquisition expenses.
chance it will win the case. The expected damages in
the event DOMINION lost the case is P200,000. Required:
5. An old-model KIA delivery van carried in the books of (1) Prepare a schedule for the computation of goodwill or
NORTHPOINT at P40,000, net of P8,000 accumulated income from combination.
depreciation. The fair value at the date of the
exchange is P28,000. (2) Prepare the necessary journal entries in the books of
➢ In addition to the purchase consideration PHILRABBIT Company. The journal entries in the books of
NORTHPOINT had an out-of-pocket costs of SUPERLINES Enterprises may be ignored.
P6,816 for direct acquisition cost; P1,600 for
issuing and registering the shares; and P1,200 (3) Prepare the balance sheet of PHILRABBIT Company
indirect cost. just after the merger business combination.

Required:
1. Prepare a schedule for the determination of the cost
of combination.
2. Prepare a schedule for the computation of the fair
value of the net assets.

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MULTIPLE CHOICE

RED LABELCOMPANY issued 96,000 shares of its P25 PURPLE HEART COMPANY. is to acquire BROWN
par common stock for the net assets of BLUEGREEN CORPORATION by absorbing all the assets and
CORPORATION in a business combination completed on assuming all the liabilities of the latter company, in
March1, 2020. BLUEGREEN Corporation’s net assets exchange for shares of stocks of the former. Below are
are worth P3,040,000 at FMV. Out of pocket costs of the balance sheets of the two companies with the
the combination were as follows: corresponding appraised value increment for Brown.
Parties agree to use the appraised values against which
Legal fees 20,800 the fair market value of the shares will be matched.
Contingent consideration (probable &
measurable) 14,400 PURPLEHEART BROWN
Printing costs of stock certificates 6,800 Assets per books P3,200,000 P2,000,000
Finder’s fees 21,600 Asset increase per 240,000
Professional fees paid to a CPA 16,800 appraisal
Fees paid to company lawyers 18,760 Liabilities 1,200,000 640,000
Fees paid to company accountants 31,120 Capital stock (no par) (P100 par)
1,600,000 800,000
The goodwill from the business combination is APIC 560,000 240,000
P334,400. Retained earnings (deficit) (160,000) 320,000
1. How much is the FMV per share of RED LABEL Total Equities P3,200,000 P2,000,000
COMPANY at March 1, 2020?
a. P 20 c. P 24 4. The stocks of PURPLE COMPANY is currently selling
b. P 32 d. P 28 at P100 per share. The number of shares to be
issued to BROWN by PURPLE is
WHITEBOARD COMPANY issued 80,000 shares of P20 a. 16,000 c. 10,400
par common stock for all the outstanding stock of b. 13,600 d. 8,000
BLACK CORPORATION in a business combination
consummated on August 1, 2020. WHITEBOARD The following balance sheets were prepared for
COMPANY common stock was selling at P30 per share GREYHOUND COMPANY and VIOLET CORPORATION on
at the time the business combination was January 1, 2020, just before they entered into a
consummated. Out-of-pocket costs of the business business combination.
combination were as follows: G/HOUND COMPANY VIOLET CORP.
Book Value Fair Value Book Value Fair
Finder's fee P 40,000 Value
Cash 120,000 120,000 8,000 8,000
Accountant's fee (advisory) 8,000
Accounts
Legal fees (advisory) 16,000 receivable 120,000 120,000 32,000 32,000
Printing costs of stock certificates 4,000 Merchandise
SEC registration costs and fees 9,600 inventory 320,000 480,000 80,000 196,000
Total P 77,600 Building and
equipment 640,000 696,000 160,000 200,000
2. The acquisition cost of the combination will be: Accumulated
a. P2,477,600 c. P2,413,600 depreciation (160,000) ( 40,000)
Goodwill ________ _______ 80,000 _______
b. P2,464,000 d. P2,400,000
Total assets P1,040,000 P1,416,000 P320,000 P436,000

BLACKBELT COMPANY issues 400,000 shares of its own Accounts

P1 par common stock for the net assets of payable 80,000 80,000 112,000 112,000
YELLOWTOWN CORPORATION in a merger Bonds
consummated on July 1, 2020. On this date, payable 320,000 352,000 48,000 68,000
BLACKBELT stock is quoted at P10 per share. Balance Common
sheet data for the two companies at July 1, 2020, just stock – P 10 P5 par
par 240,000 80,000
before combination, are as follows:
Additional
paid- in
BLACKBELT YELLOWTOWN capital 80,000 16,000
Current Assets P14,400,000 P1,200,000 Retained
Plant Assets 17,600,000 5,200,000 earnings 320,000 64,000
Total Assets P32,000,000 P6,400,000 Total Liab. &
SHE P 1,040,000 P320,000
Liabilities P9,600,000 P1,600,000
Common stock, P10 16,000,000 2,400,000 GREYHOUND COMPANY acquired the net assets of
par VIOLET COMPANY by issuing 8,000 shares of stocks.
Additional paid-in 2,400,000 800,000 Additional cash payments made by GREYHOUND
capital CORPORATION in completing the acquisition were:
Retained earnings 4,000,000 1,600,000
Total equities P32,000,000 P6,400,000 Broker’s fee paid to firm that located
VIOLET CORP. P8,000
BLACKBELT COMPANY also paid finder’s fees of P40,000 Cost to register and issue stocks 32,000
and legal fees of P8,000; as well as indirect expenses of Professional fees paid to accountants 16,000
32,000. Professional fees paid to lawyers 16,000
3. The retained earnings on the combined balance Professional fees paid to official valuers 16,000
sheet after the combination will be: Indirect acquisition cost 12,000
a. P3,968,000 c. P3,920,000
b. P4,720,000 d. P5,600,000

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5. Assuming the stocks issued by GREYHOUND 6. What is the total cost of the investment?
COMPANY has a market price of P40, how much is a. P5,111,588 c. P5,586,947
the total assets after the business combination? b. P7,187,091 d. P6,711,718
a. P 1,376,000 c. P 1,496,000
b. P 1,440,000 d. P 916,000 A, B, C, and D are companies to be combined just prior
to the combination, their individual stockholder’s equity
KING COMPANY issued 96,000 shares of P25 par consists of the following balances:
ordinary shares for all the outstanding stock of FISHER
CORPORATION in a business combination consummated A B C D
on July 1, 2020. King’s ordinary shares were selling at Ordinary P480,000 P96,000 P360,000 P120,000
P40 per share at the time of consummation of the shares
combination. In addition cash payment of P160,000 was Share 120,000 48,000 36,000
made and a deferred cash payment of P1,200,000 premium
payable on July 1, 2021. Market rate of interest is 12%. Retained 144,000 72,000 216,000 36,000
FISHER’s net assets are P3.04 million at book value. Earnings
Out of pocket costs of the combination were as follows:
Legal and accounting fees related with the issuance of Company A is the surviving entity. It issued 16,000,
shares, P9,600 and printing cost of stock certificates, P69 par value ordinary shares, with a fair value per
P7,520. A contingent consideration which is probable share of P91; dispersed to the stockholders of the
and can be reasonably estimated amounted to P40,160. acquired companies.
7. How much goodwill is to be recognized assuming
that the net assets are fairly valued?
a. P676,000 c. P388,000
b. P438,400 d. P352,000

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