Tutorial - Week5

Chapter 10 – Business Combinations

1. What is meant by a “business combination”?

AASB 3 Appendix A:

Business:
“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”

Business combination:
A transaction or other event in which an acquirer obtains control of one or more businesses”

Consider inputs, processes and outputs

Only in a business combination can goodwill be present.

4. Explain the key components of “core” goodwill.

Core goodwill has two main components:

(i) Going concern goodwill: relates to the net assets of the acquiree, in that the acquiree’s net assets
together are worth more than the net assets separately, caused by the synergy created by the
acquiree’s net assets within the acquiree as a going concern.
(ii) Combination goodwill: relates to the extra benefits accruing because of the synergy created by
the acquirer and the acquiree combining together eg if the raw materials available to the
acquiree are of particular use to the acquirer. These benefits could affect the recorded earnings
of the acquirer or the acquiree [or both] depending on the nature of the benefits.

7. Explain the key steps in the acquisition method.

AASB 3 para 5:

1. identify the acquirer

2. determine the acquisition date
3. recognise and measure the identifiable assets acquired, the liabilities assumed and any non-
controlling interest in the acquiree
4. recognise and measure goodwill or a gain from a bargain purchase.

8. How is the consideration transferred calculated?

AASB 3 para 37 states that the consideration transferred shall be

- measured at fair value, determined at acquisition date, and
- calculated as the sum of the fair values of the assets transferred by the acquirer, the
liabilities incurred by the acquirer, and the equity interests issued by the acquirer.

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11. Why is it important to identify an acquirer in a business combination?

Consider the example in para B18 in Appendix B to AASB 3. Assume A Ltd and B Ltd combine
together by creating C Ltd which acquires all the shares in A Ltd and B Ltd and issues its own shares
in exchange. As noted in para B18, C Ltd is not necessarily the acquirer.

What differences occur if either A Ltd or B Ltd is identified as the acquirer?

2 effects:
(i) the consideration transferred is based on what the acquirer gives up; and
(ii) the acquiree’s net assets are measured at fair value.

In relation to point (ii), if A Ltd is the acquirer then in the consolidated financial statements B Ltd’s
net assets are adjusted to fair value while A Ltd’s net assets are at the carrying amounts in A Ltd. If B
Ltd is the acquirer, A Ltd’s net assets are adjusted to fair value while B Ltd’s net assets are at the
carrying amounts in B Ltd.

Case Study 2: Accounting for goodwill

SILVER LTD

Nature of goodwill

 Is it an asset?
 2 types: Internal vs external/acquired goodwill
 Nature of internal goodwill: undervalued/unrecorded assets, core goodwill
 Nature of acquired goodwill? Core goodwill: going concern & combination
 Why did acquirer pay for goodwill? Synergy – extra benefits

How to account for it

 Internal goodwill IAS 38: not recognised as cannot determine a cost

 Acquired goodwill
 Recognised only in a business combination
 Measured as a residual under para 32
 Subject to annual impairment test
 If allocated to CGU, write off first if impairment loss
 If reversal of impairment loss, no reinstatement of goodwill
 Future effects on Statement of Comprehensive Income
 No cause for concern
 No annual amortisation
 Only expense if impairment loss
 Impairment loss cushioned by various accounting treatments such as use of cost method
for PPE, non-recognition of internally generated goodwill & internally generated
intangibles

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PRACTICE QUESTIONS

Question 10.1
NEW LTD – DAY LTD

Acquisition analysis:
Net fair value of identifiable assets and liabilities acquired:

Land $350 000

Plant 290 000
Inventory 85 000
Cash 15 000
740 000

Accounts payable 20 000

Loans 80 000
100 000
Net assets $640 000

Consideration transferred:

100 000 shares at $6.50 each $650 000

Goodwill = $650 000 - $640 000 = $10 000

A. Journal entries: New Ltd, FV of shares = $6.50

Land Dr 350 000

Plant Dr 290 000
Inventory Dr 85 000
Cash Dr 15 000
Goodwill Dr 10 000
Accounts payable Cr 20 000
Loans Cr 80 000
Share capital Cr 650 000

B. Journal entries: New Ltd, FV of shares = $6.00

Fair value of acquiree’s net assets $640 000

Consideration transferred: 100 000 x $6 $600 000
Gain on bargain purchase $40 000

Land Dr 350 000

Plant Dr 290 000
Inventory Dr 85 000
Cash Dr 15 000
Accounts payable Cr 20 000
Loans Cr 80 000
Share capital Cr 600 000
Gain on bargain purchase Cr 40 000

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QUESTION 10.2
LIGHT LTD – SOUND LTD

A. Acquisition analysis:

Fair value of identifiable assets and liabilities acquired:

Current assets $980 000

Non-current assets 4 220 000
5 200 000
Liabilities 500 000
$4 700 000

Consideration transferred:

Shares: 100 000 x 10 x $10 $10 000 000

Patent 1 000 000
Cash: 100 000 x $5.20 520 000
$11 520 000

Goodwill = $11 520 000 - $4 700 000 = $6 820 000

B. Journal entries: Light Ltd

Patent Dr 650 000

Gain Cr 650 000
(Re-measurement as part of consideration
transferred in a business combination)

Current assets Dr 980 000

Non-current assets Dr 4 220 000
Goodwill Dr 6 820 000
Liabilities Cr 500 000
Share capital Cr 10 000 000
Patent Cr 1 000 000
Cash Cr 520 000
(Acquisition of Sound Ltd)

Acquisition-related expenses Dr 10 000

Cash Cr 10 000
(Payment of directly attributable costs)

Share capital Dr 500

Cash Cr 500
(Costs of issuing shares)

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QUESTION 10.3
DESERT LTD – ISLAND LTD

Consideration transferred:

Shares: 2 x 100 000 x $4 $800 000

Cash: $1.50 x 100 000 150 000
$950 000

Journal entries: Desert Ltd

Shares in Island Ltd Dr 950 000

Share capital Cr 800 000
Cash Cr 150 000
(Acquisition of shares in Island Ltd)

Share capital Dr 800

Cash Cr 800
(Share issue costs)

QUESTION 10.4
LOWER LTD – HIGHER LTD

(A) FV of shares is $1.80 per share

Net fair value of identifiable assets, liabilities and contingent liabilities acquired:

Equipment $50 000

Land 80 000
Trucks 40 000
Current assets 10 000
180 000
Current liabilities 16 000
$164 000

Consideration transferred
Shares: 100 000 x $1.80 $180 000

Goodwill = $180 000 - $164 000 $16 000

Journal entries: Lower Ltd

Equipment Dr 50 000
Land Dr 80 000
Trucks Dr 40 000
Current assets Dr 10 000
Goodwill Dr 16 000
Current liabilities Cr 16 000
Share capital Cr 180 000
(Acquisition of assets and liabilities
of Higher Ltd)

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(B) FV of shares is $1.60 per share

Net fair value of net assets acquired $164 000

Consideration transferred
Shares: 100 000 x $1.60 $160 000
Gain on bargain purchase = $164 000 - $160 000 $4 000

Journal entries: Lower Ltd

Equipment Dr 50 000
Land Dr 80 000
Trucks Dr 40 000
Current assets Dr 10 000
Current liabilities Cr 16 000
Gain on bargain purchase Cr 4 000
Share capital Cr 160 000
(Acquisition of assets & liabilities of Higher Ltd)