1. Introduction/Overview
This module aims to provide students a comprehensive understanding and application of the proper
accounting principles for the recognition and measurement relating to a business combination. It
also provides the students with the comparison between the full Philippine Financial Reporting
Standard (PFRS) and the Philippine Financial Reporting Standard for Small and Medium-sized
Entities (PFRS for SMEs).
2. Learning Outcomes
1.
2.
3.
4.
5.
6.
Define a business combination.
Identify a business combination transaction.
Explain briefly the accounting requirements for a business combination.
Apply the proper accounting principle for business combination transaction.
Compute for goodwill.
Compare the difference between the full PFRS and PFRS for SMEs.
3. Business Combination (Recognition & Measurement)
A business combination occurs when one company acquires another or when two or more
companies merge into one. After the combination, one company gains control over the other. The
company that obtains control over the other is referred to as the parent or acquirer. The other
company that is controlled is the subsidiary or acquiree.
PFRS 3 Business Combinations is the standard to be applied for business combination transactions
to improve the relevance, reliability, and comparability of the information that a reporting entity
provides in its financial statements about a business combination and its effects.
3.1. PFRS 3 defines the following:
A. Business combination
•
the transaction or other events in which an acquirer obtains control of one or more
businesses
B. 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
C. Acquisition Date
•
•
The date on which the acquirer obtains control of the acquire
D. Acquirer
•
The entity that obtains control of the acquiree
E. Acquiree
•
The business or businesses that the acquirer obtains control of in a business combination
3.2. Business Combination is carried out either through:
A. Asset acquisition
o
o
1.
Merger
▪
▪
2.
Acquirer purchases assets and assumes liabilities in exchange for cash or non-cash
consideration
Under the Revised Corporation Code of the Philippines, a business combination
effected through asset acquisition may be either:
Occurs when two or more companies merge into a single entity which shall be one
of the combining companies.
A Co. + B Co. = A Co. or B Co.
Consolidation
occurs when two or more companies consolidate into a single entity which shall be
the consolidated company
▪ A Co. + B Co. = C Co.
▪
B. Stock acquisition
o
o
o
o
Acquirer obtains control over the acquire by acquiring a majority ownership interest
in the voting rights of the acquire (generally more than 50%).
Acquirer is known as the parent while the acquiree is known as the subsidiary.
After the business combination, both companies retain their separate legal existence
and continue to maintain their own separate accounting books.
For financial reporting purposes, both the parent and subsidiary are viewed as
a single reporting entity.
C. A business combination may also be described as:
1.
Horizontal combination
▪
▪
A business combination of two or more entities with similar businesses (e.g., a
bank acquires another bank).
2.
Vertical combination
▪
3.
A business combination of two or more entities operating at a different level in a
marketing chain (e.g., a manufacturer acquires its supplier of raw materials)
Conglomerate
▪
A business combination of two or more entities with dissimilar businesses (e.g., a
real estate developer acquires a bank)
3.3. Advantages and Disadvantages of a Business Combination
Advantages of a business combination
A. Competition is eliminated or lessened
o
A competition between the combining constituents with similar business is
eliminated while the threat of competition from other market participants is
lessened
B. Synergy
o
C.
Synergy occurs when the collaboration of two or more entities results in greater
productivity than the sum of the productivity of each constituent working
independently. It can be simplified by the expression 1 + 1 = 3
Increased business opportunities and earnings potential
o
Business opportunity and earnings potential may be increased through:
1. An increased variety of products or services available and a decreased dependency
on a limited number of products and services;
2. Widened dispersion of products or devices and better access to new markets;
3. Access to either of the acquirer’s or acquiree’s technological know-how, research
and development, secret processes, and other information.
4. Increased investment opportunities due to increased capital; or
5. Appreciation in worth due to an established trade name by either one of the
combining constituents
D. Reduction of operating costs
o
Operating costs of the combined entity may be reduced.
1. Under a horizontal combination, operating costs may be reduced by the elimination
of unnecessary duplication of costs
2. Under a vertical combination, operating costs may be reduced by the elimination
of costs of negotiation and coordination between the companies and mark-ups on
purchases.
E. Combinations utilize economies of scale
o
o
Economies of scale refer to the increase in productive efficiency resulting from the
increase in the scale of production.
An entity that achieves economies of scale decreases its average cost per unit as
production is increased because fixed costs are allocated over an increased number
of units produced.
F. Cost savings on business expansion
o
The cost of business expansion may be lessened when a company acquires another
company instead of putting up a branch.
G. Favorable tax implications
o
o
Deferred tax assets may be transferred in a business combination.
Business combinations effected without transfers of considerations may not be
subjected to taxation.
Disadvantages of a business combination
1. The business combination brings a monopoly in the market which may have a negative
impact on society. This could result in an impediment to healthy competition between
market participants.
2. The identity of one or both of the combining constituents may cease, leading to loss of
sense of identity for existing employees and loss of goodwill.
3. Management of the combined entity may become difficult due to incompatible internal
cultures, systems, and policies.
4. The business combination may result in over-capitalization which may result in diffusion
in market price per share and attractiveness of the combined entity’s equity instruments to
potential investors.
5. The combined entity maybe subjected to stricter regulation and scrutiny by the government,
most especially if the business combination poses threat to consumers’ interests.
3.4. PFRS 3 Business Combinations
PFRS 3 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.
As defined in PFRS 3, the business combination is a transaction or other event in which the
acquirer obtains control of one or more businesses.
Essential Elements in the definition of Business Combination:
A. Control
o
o
o
As provided in PFRS 10, “an investor controls an investee when it is exposed, or
has rights, to variable returns from its involvement with the investee and has the
ability to affect those returns through its power over the investee.”
Control is normally presumed to exist when the acquirer holds more than 50%
interest in the acquiree’s voting interest.
Control can also be obtained when:
1. The acquirer has the power to appoint or remove the majority of the board of
directors of the acquiree; or
2. The acquirer has the power to cast the majority of votes at board meetings or
equivalent bodies within the acquiree; or
3. The acquirer has power over more than half of the voting rights of the acquiree
because of an agreement with other investors; or
4. The acquirer controls the acquiree’s operating and financial policies because of a
law or an agreement.
o
An acquirer may obtain control of an acquiree in a variety of ways, for example:
1. By transferring cash or other assets;
2. By incurring liabilities;
3. By issuing equity interests;
4. By providing more than one type of consideration; or
5. Without transferring consideration, including by contract alone.
B. Business
o
o
As defined by PFRS 3, business is an integrated set of activities and assets that is
capable of being conducted and managed for the purpose of providing a return in
the form of dividends, lower costs or other economic benefits directly to investors
or other owners, members, or participants.
A business has the following three elements:
1.
2.
3.
Input
▪
any economic resource that results to an output when one or more processes
are applied to it
▪
any system, standard, protocol, convention or rule that when applied to an
input, creates an output
▪
the result of input and process that provides investment returns to the
stakeholders of the business
Process
Output
3.5. Determining whether a transaction is a business combination
(Is it a business combination or not?)
Any investor who acquires some investment needs to determine whether this transaction or event
is a business combination or not.
PFRS 3 requires that assets and liabilities acquired need to constitute a business, otherwise it’s
not a business combination and an investor needs to account for the transaction as a regular asset
acquisition in line with other PFRS.
The three elements of a business should be considered to determine if the transaction is a business
combination.
4. Accounting for Business Combination
Business combinations are accounted for using the acquisition method. PFRS 3 provides that,
applying this method requires the following steps:
1. Identifying the acquirer;
2. Determining the acquisition date;
3. Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any
non-controlling interest in the acquiree; and
4. Recognizing and measuring goodwill or a gain from a bargain purchase.
4.1. Step 1: Identifying the acquirer
•
•
The acquirer is the entity that obtains control of the acquiree.
PFRS 3 provides the following guidance in identifying the acquirer:
1. In a business combination effected primarily by transferring cash or other assets or by
incurring liabilities
▪
2.
the acquirer usually the entity that transfers the cash or other assets or incurs
liabilities.
In a business combination effected primarily by exchanging equity interests
▪
▪
▪
the acquirer is usually the entity that issues its equity interests.
if it is a reverse acquisition, the issuing the entity is the acquiree.
Other pertinent facts and circumstances shall also be considered in
identifying the acquirer in a business combination effected by exchanging
equity interests including the following:
a. Whose owner, as a group, have the largest portion of the voting rights of the combined entity.
b. Whose a single owner or organized group of owners holds the largest minority voting interest
in the combined entity.
c. Whose owners have the ability to appoint or remove a majority of the members of the
governing body of the combined entity
d.
Whose (former) management dominates the management of the combined entity
e. That pays a premium over the pre-combination fair value of the equity interests of the other
combining entity or entities.
3.
As to size
▪
The acquirer is usually the combining entity whose relative size
is significantly greater than that of the other combining entity or entities
4.
In a business combination involving more than two entities
▪
5.
The acquirer is usually the one who initiated the combination.
In a business combination wherein a new entity is formed
▪
The acquirer is identified as follows:
a. If a new entity is formed to issue equity interests to effect a business combination, one of the
combining entities that existed before the business combination shall be identified as the acquirer
by applying the guidance provided above.
b. In contrast, a new entity that transfers cash or other assets or incurs liabilities as consideration
may be the acquirer
4.2. Step 2: Determining the Acquisition Date
•
•
•
The acquirer shall identify the acquisition date, which is the date on which it obtains control
of the acquiree.
The date on which the acquirer obtains control of the acquiree is generally the date on
which the acquirer legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree—the closing date.
However, the acquirer might obtain control on a date that is either earlier or later than the
closing date. For example, the acquisition date precedes the closing date if a written
agreement provides that the acquirer obtains control of the acquiree on a date before the
closing date. An acquirer shall consider all pertinent facts and circumstances in identifying
the acquisition date.
4.3. Step 3: Recognizing and measuring the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree
A. Acquired assets and liabilities
Recognition Principle
▪
On acquisition date, the acquirer recognizes, separately from goodwill
the identifiable assets acquired, the liabilities assumed and any
non-controlling interest (NCI) in the acquiree.
Recognition Conditions
a. Identifiable assets acquired and liabilities assumed must meet the definitions of assets and
liabilities provided under the Conceptual Framework at the acquisition date.
b. It must be part of what the acquirer and acquiree exchanged in the business combination
transaction rather than the result of separate transactions.
c. Applying the recognition principle may result to the acquirer recognizing assets and liabilities
that the acquiree had not previously recognized in its financial statements
Classifying identifiable assets acquired and liabilities assumed
▪
Identifiable assets acquired and liabilities assumed are classified at the
acquisition date in accordance with other PFRSs that are to be applied
subsequently
Measurement Principle
The acquirer shall measure the identifiable assets acquired and the liabilities
assumed at their acquisition-date fair values.
▪ Separate valuation allowances are not recognized at the acquisition date
because the effects of uncertainty about future cash flows are included in the
fair value measurement.
▪ All acquired assets are recognized regardless of whether the acquirer intends
to use them.
▪
B. Non-controlling Interest
o
o
o
1.
As provided in PFRS 3, non-controlling interest (NCI) or “minority interest” is the
equity in a subsidiary not attributable, directly or indirectly, to a parent.
For example, there is no NCI when an investor acquires 100% share in a company
because the investor owns the subsidiary’s equity in full. But, when an investor
acquires 75% (less than 100%), then 25% is NCI.
For each business combination, the acquirer measures any non-controlling interest
in the acquiree either at:
Fair value; or
2. The NCI’s proportionate share of the acquiree’s identifiable net assets.
4.4. Step 4: Recognizing and measuring the goodwill
•
•
•
•
Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that is not individually identified and separately
recognized.
On acquisition date, the acquirer computes and recognizes goodwill or gain on a bargain
purchase using the following formula:
A negative amount resulting from the formula is called “gain on a bargain purchase” (also
referred to as “negative goodwill”)
On the acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
b.
Gain on bargain purchase as gain in profit or loss
▪
Before recognizing, the acquirer shall reassess to ensure that the
measurements appropriately reflect consideration of all available
information as of the acquisition date. (Application of the concept of
conservatism)
▪
If the gain on a bargain purchase remains after reassessment, the acquirer
shall recognize the resulting gain in profit or loss on the acquisition date.
The gain shall be attributed to the acquirer.
A. Consideration Transferred
o
The consideration transferred is measured at fair value, which is the sum of the
acquisition-date fair values of the assets transferred by the acquirer, the liabilities
incurred by the acquirer to former owners of the acquiree and the equity interests
issued by the acquirer.
Examples of potential forms of consideration include:
1.
2.
3.
4.
5.
6.
Cash
other assets
a business or a subsidiary of the acquirer
contingent consideration
ordinary or preference equity instruments, options, warrants
member interests of mutual entities.
Additional concepts on consideration transferred
▪
▪
▪
The consideration
transferred in
a
business
combination includes only those that are transferred to the former
owners of the acquiree. It excludes those that remain within the
combined entity.
Assets and liabilities transferred to the former owners of the
acquiree are remeasured to acquisition-date fair values. Any
remeasurement gain or loss is recognized in profit or loss.
Assets and liabilities remain within the combined entity are not
remeasured but rather ignored when applying the acquisition
method.
B. Acquisition-related costs
o
These are costs the acquirer incurs to effect a business combination.
Examples:
1. Finder’s fees
2. Professional fees, such as advisory, legal, accounting, valuation and consulting fees
3. General administrative costs, including the costs of maintaining an internal
acquisitions department
4. Costs of registering and issuing debt and equity securities
o
Acquisition-related costs are expenses when they are incurred, except the cost to
issue debts or equity securities which shall be recognized in accordance with PAS
32 and PFRS 9:
1. Costs to issue debt securities measured at amortized costs are included in the initial
measurement of the resulting financial liability.
2. Costs to issue equity securities are deducted from share premium. If the share premium is
insufficient, the issue costs are deducted from retained earnings.
C. Previously held equity interest in the acquiree
o
This pertains to any interest held by the acquirer before the business combination.
This affects the computation of goodwill only in a business combination achieved
in stages (discussed in the next module)
4.5. Illustration
4.5. Illustrations
Illustration 1: Asset Acquisition
On January 1, 2020, Popoy Co. acquired all assets and assumed all liabilities of the
Basha Co. Due to the business combination Popoy Co. incurred transaction costs for
accounting and legal fees amounting to ₱100,000. The carrying amounts and fair
values of the assets and liabilities of Basha acquired by Popoy are shown below:
As of January 1, 2020
Assets
Carrying amounts
Cash in bank
Fair values
20,000
20,000
Receivables
220,000
150,000
Allowance for doubtful accounts
(50,000)
-
510,000
430,000
1,500,000
100,000
1,200,000
50,000
Inventory
Building – net
Goodwill
Total Assets
Liabilities
2,300,000
1,850,000
500,000
300,000
500,000
300,000
Accounts Payable
Total Liabilities
Assumption #1:
Popoy Co. paid ₱2,000,000 cash as consideration for acquiring the net assets of Basha,
how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Consideration transferred
2,000,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
Goodwill
2,000,000
(1,500,000)
500,000
The fair value of the net identifiable assets of the acquiree is computed as follows:
Fair value of identifiable assets acquired excluding
goodwill
1,800,000
Fair value of liabilities assumed
(300,000)
Fair value of net identifiable assets acquired
1,500,000
The goodwill recorded by the acquiree is unidentifiable, thus, it should be excluded
from the identifiable assets acquired. Only identifiable assets are recognized.
Entries in the books of the Popoy (acquirer):
Jan. 1,
Cash in bank
2020
20,000
Receivables
150,000
Inventory
430,000
Building
1,200,000
500,000
Goodwill
300,000
2,000,000
Accounts Payable
Cash in bank
To record the assets
acquired and liabilities
assumed on a business
combination
Jan. 1,
2020
Professional fees expense
100,000
Cash in bank
100,000
To record the acquisition
related costs
Basha Co. should account the business combination as a liquidation of a business.
Such that, all the assets, liabilities, and equity are derecognized and the difference
between the carrying amount of the items derecognized and the proceeds of the
disposal is treated as a gain or loss on disposal of business.
The entries in Basha’s books are as follows:
Jan. 1,
Cash on hand
2020
2,000,000
Allowance for doubtful account
50,000
Accounts payable
500,000
20,000
Cash in bank
220,000
Receivables
510,000
Inventory
1,500,000
Building
100,000
200,000
Goodwill
Gain on disposal of business To
record the liquidation of
the business
Jan. 1,
Share capital (& other accounts in equity)
2020
Gain on disposal of business
1,800,000
200,000
2,000,000
Cash on hand
To record the settlement of
owner’s equity
Assumption #2:
If Popoy Co. paid ₱1,300,000 cash as consideration for the net assets of Basha Co.,
how much is the goodwill (gain on bargain purchase) on the business combination?
Solution:
Consideration transferred
1,300,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
Gain on a bargain purchase
1,300,000
(1,500,000)
(200,000)
Entries in the books of the Popoy (acquirer):
Jan. 1,
Cash in bank
20,000
2020
Receivables
150,000
Inventory
430,000
Building
1,200,000
Accounts Payable
300,000
1,300,000
200,000
Cash in bank
Gain on bargain purchase
To record the assets
acquired and liabilities
assumed on a business
combination
Jan. 1,
2020
Professional fees expense
100,000
Cash in bank
To
acquisition-related costs
100,000
record
the
Illustration 2: Stock acquisition with NCI
Popoy Co. acquired 75% of the voting shares of Basha Co. on January 1, 2020. On
this date, Basha’s identifiable assets and liabilities have fair values of ₱1,400,000 and
₱400,000, respectively.
Assumption #1:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option to
measure non-controlling interest at fair value. The independent consultant engaged
by Popoy Co. determined that the fair value of the 25% non-controlling interest in
Basha Co. is ₱200,000. How much is the goodwill or gain in bargain purchase on the
business combination?
Solution:
Consideration transferred
1,300,000
Non-controlling interest in the acquiree
200,000
Previously held equity interest in the acquiree
-
Total
1,500,000
Fair value of net identifiable assets acquired
(1,000,000)
Goodwill
500,000
Entries are as follows:
To record the acquisition in Popoy’s separate books of accounts:
Jan. 1,
Investment in subsidiary
1,300,000
2020
Cash
1,300,000
To include Basha in Popoy’s consolidated financial statements:
Jan. 1,
Identifiable assets acquired
20x1
Goodwill
Liabilities assumed
Investment in subsidiary
Non-controlling interest Basha
Co.
1,400,000
500,000
400,000
1,300,000
200,000
Note:
The non-controlling interest is presented in the consolidated statement of financial
position within equity but separately from the equity of the owners of Popoy Co.
(parent).
Assumption #2:
Popoy Co. paid ₱1,300,000 for the 75% interest in Basha Co. and elects the option to
measure non-controlling interest at the non-controlling interest’s proportionate share
of Basha’s net identifiable assets.
How much is the goodwill or gain on bargain purchase on the business combination?
Solution:
Consideration transferred
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired
Goodwill
1,300,000
250,000
1,550,000
(1,000,000)
550,000
The NCI’s proportionate share of Basha’s identifiable assets is computed as follows:
Fair value of net identifiable assets acquired
Multiply by: Non-controlling interest
NCI’s proportionate share in net identifiable assets
1,000,000
25%
250,000
Illustration 3: Transaction costs
On January 1, 2020, Popoy Co. acquired all the identifiable assets and assumed all the
liabilities of Basha Co. On this date, the identifiable assets acquired and liabilities
assumed have fair values of ₱1,600,000 and ₱600,000, respectively. Popoy incurred
the following acquisition-related costs: legal fees ₱20,000, due diligence costs
₱100,000, and general administrative costs of maintaining an internal acquisition
department ₱30,000.
Assumption #1
As consideration for the business combination, Popoy transferred 10,000 of its own
equity instruments with par value per share of ₱100 and fair value per share of ₱120
to Basha’s former owners. Costs of registering the shares amounted to ₱50,000. How
much is the goodwill or gain on bargain purchase on the business combination?
Solution:
Consideration transferred (10,000 sh. X 120)
1,200,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
1,200,000
Fair value of net identifiable assets acquired
(1,000,000)
Goodwill
200,000
Entries in the books of the acquirer:
Jan. 1,
Identifiable assets acquired
2020
Goodwill
1,600,000
200,000
Liabilities assumed
600,000
1,000,000
200,000
Share capital
Share Premium
To record the issuance of
shares as consideration for the
business combination
Jan. 1,
2020
Share Premium
50,000
50,000
Cash in bank
To record the costs of equity
transaction
Jan. 1,
Professional fees expense
2020
General and administrative costs
Cash in bank
120,000
30,000
150,000
To record the acquisition
related costs
Note:
The acquisition-related costs are expensed, except for the costs to issue equity
securities which are deducted from share premium.
Assumption #2
As consideration for the business combination, Popoy Co. issued bonds with face
amount and fair value of ₱1,200,000. Transaction costs incurred in issuing the bonds
amounted to ₱50,000. How much is the goodwill or gain on bargain purchase on the
business combination?
Solution:
Consideration transferred
1,000,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
1,200,000
Fair value of net identifiable assets acquired
(1,000,000)
Goodwill
200,000
Entries in the books of the acquirer:
Jan. 1,
Identifiable assets acquired
2020
Goodwill
1,600,000
200,000
Liabilities assumed
600,000
1,200,000
Bonds payable
To record the issuance of
bonds as consideration for the
business combination
Jan. 1,
2020
Bond issue costs
50,000
50,000
Cash
To record the bond issue costs
Jan. 1,
Professional fees expense
2020
General and administrative costs
Cash in bank
To record the acquisition
related costs
120,000
30,000
150,000
Notes:
The bond issue costs are deducted when determining the carrying amount of
the bonds. The carrying amount of the bonds payable is P1,150,000.
For goodwill computation:
a. the consideration transferred is measured at the fair value of the debt
securities issued without deduction for the transaction costs.
b. the acquisition-related costs, including costs of issuing debt and
equity securities, do not affect the computation of goodwill.
Illustration 4: Consideration transferred
On January 1, 2020, Popoy acquired all the identifiable assets and assumed all the
liabilities of Basha Co.. The assets and liabilities have fair values of ₱1,500,000 and
₱600,000, respectively. As consideration:
Popoy agrees to pay ₱1,000,000 cash, of which half is payable on January 1,
2020 and the other half on December 1, 2024. The prevailing market rate as
of January 1, 2020 is 10%.
In additions, Popoy agrees to transfer a building with a carrying amount of
₱500,000 and fair value of ₱400,000 shall be transferred to the former owners
of Basha.
After the combination, Popoy will continue the activities of Basha. Popoy
agrees to provide a patented technology with a carrying amount of ₱60,000 in
the books of Popoy and a fair value of ₱80,000 for use in Basha’s activities.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,210,461
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
1,210,461
Fair value of net identifiable assets acquired
(900,000)
Goodwill
310,461
The fair value of the consideration transferred is determined as follows:
Cash payment
500,000
Present value of future cash payment
310,461
(1M x 50% X PV of ₱1 @ 10%, n=5)
Land transferred to former owners of XYZ (at fair value)
Fair value of consideration transferred
400,000
1,210,461
Notes:
The building is remeasured to acquisition date fair-value before it is
transferred. The ₱100,000 adjustment is recognized as impairment loss.
The patented technology is not included in the consideration transferred
because it remains within the combined entity. The patented technology
continues to be measured at carrying amount.
Illustration 2: Consideration transferred – Dividends on
On January 1, 2020, Popoy Co. acquired all the assets and assumes all the liabilities of
Basha Co. for ₱1,500,000. The assets and liabilities have fair values of ₱1,500,000 and
₱600,000, respectively.
Basha’s liabilities include ₱100,000 cash dividends declared on December 28, 2019,
to shareholders of record on January 15, 2020, and payable on January 31, 2020.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,400,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
1,400,000
Fair value of net identifiable assets acquired
(900,000)
Goodwill
500,000
For purposes of computing the goodwill, the ₱100,000 payment is excluded from the
consideration transferred because this is not a payment for the business combination,
but rather for the purchased dividends.
Journal entries:
Jan. 1,
Identifiable assets acquired
2020
1,500,000
500,000
Goodwill
Liabilities
assumed
600,000
(including
1,400,000
dividends)
Cash
Jan. 1,
Dividends payable
2020
Cash
100,000
100,000
5. Restructuring provisions
•
PAS 37 provides that restructuring is a program that is planned and controlled by
management and materially changes either:
1.
The scope of a business undertaken by an entity; or
2.
The manner in which that business is conducted
Restructuring provisions may include the costs of an entity’s plan
1.
To exit the activity of the acquiree.
2.
To involuntarily terminate employees of the acquiree, or
3.
To relocate non-continuing employees of the acquiree.
The costs above are sometimes referred to as “liquidation costs”. However, a restructuring
provision does not include such costs as:
1.
Retraining or relocating continuing staff,
2.
Marketing, or
3.
Investment in new systems and distribution networks.
•
Restructuring provisions are generally not recognized as part of business
combination unless the acquiree has at the acquisition date an existing liability for
restructuring that has been recognized in accordance with PAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
A restructuring provision will be recognized as:
1.
Liability if it meets the definition of liability as to the acquisition date:
▪
Acquirer incurs a present obligation to settle the restructuring costs
assumed, such as when the acquiree developed a detailed formal plan for
the restructuring and raised a valid expectation in those affected that the
restructuring will be carried out by publicly announcing the details of the
plan or has begun implementing the plan on or before the acquisition date.
2.
Post-combination expenses of the combined entity when incurred:
Acquiree’s restructuring plan is conditional on it being acquired (not the
present obligation nor contingent liability)
▪ Restructuring provisions that do not meet the definition of a liability at the
acquisition date
▪
6. Specific Recognition Principles
PFRS 3 provides the following specific recognition principles:
I.
Operating Leases
A. Acquiree is the lessee
General rule:
The acquirer shall not recognize any assets or liabilities related to an operating lease in which
the acquiree is the lessee.
Exception:
The acquirer shall determine whether the terms of each operating lease in which the acquiree is
the lessee are favorable or unfavorable.
If the terms of an operating lease relative to market terms is:
1.
Favorable – the acquirer shall recognize an intangible asset
2.
Unfavorable – the acquirer shall recognize a liability
B. Acquiree is the lessor
If the acquiree is the lessor, the acquirer shall not recognize any separate intangible asset or
liability regardless of whether the terms of the operating lease are favorable or unfavorable when
compared with market terms.
llustration: Specific recognition principles – Operating leases
On January 1, 2020, Popoy Co. acquired all the identifiable assets and assumed all the
liabilities of Basha Co. for ₱1,500,000. On this date, the identifiable assets acquired
and liabilities assumed have fair values of ₱1,600,000 and ₱600,000, respectively.
Assumption #1:
Popoy is renting out a building to Basha under an operating lease. The terms of the
lease compared with market terms are favorable. The fair value of the differential is
estimated at ₱50,000.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,500,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
1,500,000
(1,050,000)
Goodwill
450,000
The fair value of the net identifiable assets acquired is computed as follows:
FV of identifiable assets acquired, including intangible asset on the operating
lease with favorable terms 1,650,000
FV of liabilities assumed
Fair value of net identifiable assets acquired
(600,000)
1,050,000
Assumption #2:
Popoy is renting out a patent to Basha under operating lease. The terms of the lease
compared with market terms are unfavorable. The fair value of the differential is
estimated at ₱50,000.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,500,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
Goodwill
1,500,000
(950,000)
550,000
The fair value of net identifiable assets acquired is computed as follows:
FV of identifiable assets acquired
1,600,000
FV of liabilities assumed, including liability on the
operating lease with favorable terms
Fair value of net identifiable assets acquired
(650,000)
950,000
Assumption #3:
Popoy is renting a building from Basha under operating leases. The terms of the
operating lease compared with market terms are favorable. The fair value of the
differential is estimated at ₱50,000.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,500,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
Goodwill
1,500,000
(1,000,000)
500,000
No intangible asset or liability is recognized, regardless of the terms, because the
acquiree is the lessor.
II.
INTANGIBLE ASSETS
The acquirer recognizes, separately from goodwill, the identifiable intangible assets acquired in a
business combination. An intangible asset is identifiable if it is either (a) separable or (b) arises
from contractual or other legal rights
A. Separability criterion
An intangible asset is separable if it is capable of being separated from the acquiree and sold,
transferred, licensed, rented or exchanged, either individually or together with a related contract,
identifiable asset or liability.
The separability criterion is met even if:
1.
The exchange transactions are infrequent and regardless of whether the acquirer is
involved in them, as long as there is evidence of exchange transaction for that type of
asset or similar type; or
2.
The acquirer does not intend to sell, license or otherwise exchange the identifiable
intangible asset
B. Contractual-legal criterion
An intangible asset that is not separable is nonetheless identifiable if it arises from contractual or
other legal rights
Example:
Entity A acquires Entity B, an owner of a nuclear power plant. Entity A obtains Entity B’s license
to operate the nuclear power plant. However, the terms of the license prohibit Entity A from selling
or transferring the license to another party.
Analysis: The license is an identifiable intangible asset because, although it is not separable, it
meets the contractual-legal criterion.
llustration: Intangible assets – separability and contractual legal criteria
On January 1, 2020, Popoy Co. acquired all the assets and liabilities of Basha Co.
for ₱1,000,000. Relevant financial information of Basha are as follows:
Carrying amounts
Other assets
1,300,000
1,180,000
100,000
-
-
50,000
100,000
20,000
1,500,000
1,250,000
400,000
450,000
400,000
450,000
Computer software
Patent
Goodwill
Total Assets
Fair values
Liabilities
Bonds Payables
Total Liabilities
Additional information:
The computer software is considered obsolete
The patent has a remaining useful life of 10 years and a remaining legal life
of 12 years.
Basha Co. has research and development (R&D) projects with fair value of
₱50,000. However, Basha recognized the R&D costs as expenses when they
were incurred.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,000,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
Goodwill
1,000,000
(830,000)
170,000
The fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired, excluding computer software and
recorded goodwill but including patent and R&D
1,280,000
Fair value of liabilities assumed
(450,000)
Fair value of net identifiable assets acquired
830,000
An acquirer recognizes an acquiree’s R&D as intangible asset even if the acquiree has
already expensed the related costs.
Illustration 2: Intangible assets
On January 1, 2020, Popoy Co. acquired all the assets and liabilities of XYZ, Inc. for
₱1,500,000. XYZ’s assets and liabilities have fair values of ₱1,600,000 and ₱600,000,
respectively. Not included in the fair of assets are the following unrecorded intangible
assets:
Type of intangible asset
Fair value
Customer list
Customer contract #1
50,000
20,000 Customer contract #2 10,000
Order (production) backlog
20,000
Internet domain name
25,000
Trademark
35,000
Trade secret processes
25,000
Mask words
15,000
Total
200,000
Additional information:
Customer contract #1 refers to an agreement between Basha and a customer,
wherein Basha is to supply goods to customer for a period of 5 years. The
remaining period of the contract is 3 years. The agreement is expected to be
renewed at the contract-end but is not separable.
Customer contract #2 refers to Basha’s insurance segment’s portfolio of oneyear motor insurance contracts that are cancellable by policy holders.
Basha transacts with its customers solely through purchase and sales orders.
As of acquisition date, has a backlog of customer purchase orders from 60%
of its customers, all of whom are recurring customers. The other 40% are also
recurring customers but Basha has no open purchase orders or other contracts
with those customers.
The internet domain name is registered.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,500,000
Non-controlling interest in the acquiree
-
Previously held equity interest in the acquiree
-
Total
Fair value of net identifiable assets acquired
1,500,000
(1,200,000)
Goodwill
300,000
7. Exceptions to the recognition or measurement principles
PFRS 3 provides limited exceptions to its recognition and measurement principles.
Exception to the recognition principle – Contingent liabilities
•
•
The requirements of PAS 37 do not apply when accounting for contingent liabilities related
to the business combination as of the acquisition date.
Under PFRS 3, a contingent liability assumed in a business combination is recognized if:
a. It is a present obligation that arises from past events and
b.
Its fair value can be measured reliably.
•
Therefore, contrary to PAS 37, the acquirer recognizes a contingent liability assumed in
business combination at the acquisition date even if it is NOT probable that an outflow of
resources embodying economic benefits will be required to settle the obligation. As long
as both the conditions above are satisfied, a contingent liability will be recognized.
Illustration: Contingent liabilities
On January 1, 2020, Popoy Co. acquires 90% interest in Basha Co. for ₱1,000,000. Basha’s
recognized assets and liabilities have fair values of ₱1,600,000 and ₱600,000, respectively.
ABC opts to measure the non-controlling interest at fair value. The NCI’s fair value is
₱100,000.
Basha has a pending litigation, for which no provision was recognized because Basha
strongly believes that it will win the case. The fair value of settling the litigation is ₱50,000.
How much is the goodwill or gain on bargain purchase?
Solution:
Consideration transferred
1,000,000
Non-controlling interest in the acquiree
100,000
Previously held equity interest in the acquiree
-
Total
1,100,000
Fair value of net identifiable assets acquired
(950,000)
Goodwill
150,000
The adjusted fair value of net identifiable assets acquired is computed as follows:
Fair value of identifiable assets acquired
1,600,000
Total fair value of liabilities assumed:
Fair value of liabilities assumed
Contingent liability (pending litigation)
Fair value of net identifiable assets acquired
600,000
50,000
(650,000)
950,000
The contingent liability is recognized even if it is NOT probable because it (a) represents a
present obligation and (b) has fair value.
Exceptions to both the recognition and measurement principles
The following items shall be recognized and measured as at acquisition date under other applicable
standards:
1.
Income taxes
•
•
are accounted for using PAS 12 Income Taxes. For example, deferred taxes are measured
based on temporary differences arising from the measurement of identifiable assets and
liabilities assumed by the acquirer at the acquisition date.
Deferred taxes affect the amount of goodwill or gain on bargain purchase recognized at the
acquisition date. However, PAS 12 prohibits the recognition of deferred tax liabilities
arising from the initial recognition of goodwill.
2.
Employee benefits
•
3.
are accounted for using PAS 19 Employee benefits. For example, defined benefit
obligations are measured through actuarial valuations.
Indemnification assets
•
•
•
arises when the former owners of the acquiree agree to reimburse the acquirer for any
payments the acquirer eventually makes upon settlement of liability.
The acquirer shall recognize an indemnification asset at the same time and on the same
basis as the indemnified item.
Accordingly, if the indemnified item is measured at fair value, the indemnification asset is
also measured at fair value. If the indemnified item is measured at other than fair value, the
indemnification asset is measured using assumptions consistent with those used to measure
the indemnified item.
Example:
Entity A acquires Entity B. At the acquisition date, the taxing authority is disputing Entity B’s tax
returns in prior years. The former owners of Entity B agree to reimburse Entity A in case Entity A
will be held liable to pay Entity B’s tax deficiencies in the prior years.
At the acquisition date, Entity A recognizes a tax liability to the taxing authority and an
indemnification asset for the reimbursement due from the former owners of Entity B
Exceptions to the measurement principle
A. Reacquired rights
Reacquired rights are measured based on the remaining term of the related contract. (Discussed in
the next chapter)
B. Share-based payment transactions
Liabilities and equity instruments related to the acquiree’s share-based payment transactions are
accounted for using the PFRS 2 Share-based payment.
C. Assets held for sale
A non-current asset (or disposal group) that is classified as held for sale at the acquisition date
at fair value less costs to sell in accordance with PFRS 5 Non-current Assets Held for sale and
Discontinued Operations, rather than at fair value under PFRS 3.
8. Differences between the provisions of the full PFRS and the PFRS
for SMEs
IFRS for SMEs - Section 19