Colegio de San Gabriel Arcangel

Area E, City of San Jose del Monte, Bulacan

Unit Title: Business Combination

Title of the Lesson: Acquisition of Control
Duration: 3 hours

Objectives:

At the end of this Module, the student will be able to:

1. Define Business Combination and Acquisition of Control;
2. Identify the different methods of Business Combination;
3. Journalize the required entries in Acquisition Method of Accounting for
Business Combinations (Acquirer and Acquiree);
;

Subject Matter: Business Combinations

Procedures:

A. Lesson Presentation

• A business combination is the term applied to external expansion in which

separate enterprises are bought together into one economic entity as a
result of one enterprise obtaining control over the net assets and
operations of another enterprise.

• IFRS 3 defines business combination as a transaction or event in which an

acquirer obtains control of one or more businesses.
• A business is defined as an integrated set of activities and assets that is
capable of being conducted and managed for the purpose of providing a return
directly to investors or other owners, members or participants.
• An acquirer must be identified for all business combinations
• There are increasing trend to expand operations through business combinations
rather than through internal expansions. The development is largely due to the
effects of recession, inflation, and continued uncertainty over the ability of the
government to control economic ills. With business combination, both
companies will utilize common facilities and share fixed costs. In addition, a
business combination may be undertaken for the possible tax advantages
available to one or more parties to the combination
• STATUTORY CONSOLIDATION
 Refers to the combining of two or more existing legal entities into one new legal
entity. The previous companies are dissolved and are then replaced by new
continuing company.

• STATUTORY MERGER
> Refers to the absorption of one or more existing legal entities by another
existing company that continues as the sole surviving legal entity. The absorbed
company ceases to exist but may continue as a division of the surviving
company

• Only those companies which have the same or compatible sets of objectives
should combine.

• On the other hand, successful firms are usually not willing to combine. The
acquiring enterprise may also inherit the acquired firm’s inefficiencies and
problems together with its inadequate resources.

ACQUISITION OF CONTROL
 Control of another company may be achieved by either acquiring the assets of
the target company or acquiring a controlling interest (usually over 50%) in the
target company’s voting common stock.
1. ACQUISITION OF NET ASSETS
 In an acquisition of assets, all of the company’s assets are acquired directly from
the company. In most cases, existing liabilities of the acquired company also are
assumed. This is also called acquisition of net assets.
 Payment may be made in cash, exchanged property or issuance of debt or
equity securities

2. STOCK ACQUISITION
 In a stock acquisition, a controlling interest of another company’s voting stock is
acquired. The acquiring company is termed as the PARENT (acquirer), and the
acquired company is termed as SUBSIDIARY (acquiree).
 Both the parent and the subsidiary remain separate legal entities and maintain
their own financial records and statements.
 However, for external financial reporting purposes, the companies will usually
combine their individual financial statements into a single set of consolidated
statements.

METHODS OF BUSINESS COMBINATIONS

 Prior to the issuance of IFRS 3, two methods were used to account for business
combinations.
 PURCHASE METHOD
Under purchase method, all assets and liabilities of the acquired company are
usually recorded at fair value. This is the primary method in use, in some cases,
pooling of interest method was allowed.
 POOLING OF INTEREST METHOD
The pooling of interest method recorded the assets and liabilities of the acquired
company at their book values
IFRS 3 eliminated the use of pooling of interest method.

4 STEPS IN THE APPLICATION OF ACQUISITION METHOD

1. Identify the acquirer
2. Determine the acquisition date
3. Determine the consideration given (price paid) by the acquiree
4. Recognize and measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree. Any resulting goodwill or gain
from a bargain purchases should be recognized

ACQUISITION RELATED COSTS

 The costs of the acquirer incurs to effect a business combination, such as
broker’s fees, accounting and legal fees, and other professional fees, general
administrative costs, including the costs of maintaining an internal acquisition
department are NOT included in the price of the company acquired and are
expensed.
> Where the consideration given is the stock of the acquirer, the issue costs are
usually deducted from the value assigned to paid in capital in excess of par.
If the stock issue costs exceed the additional paid in capital recorded at
acquisition, the excess should be treated as expense

Price paid exceeds the fair value assigned to net assets

The excess of the price paid over the value assigned to net assets is
“new” goodwill. The goodwill recorded is not amortized, but is
impairment tested in future accounting periods
Price paid is less than the fair value assigned to net assets
Where the price paid is actually less than the fair value assigned to
the net assets, a “bargain purchase option” has occurred. The
excess of the fair value assigned to the net assets over the price
paid is recorded as gain on the acquisition by the acquirer.

VALUATION OF IDENTIFIABLE ASSETS AND LIABILITIES

As a general rule, assets and liabilities acquired are recorded at their individually
determined values. The preferred method is quoted market value, where an
active market for the item exists. Where there is no active market, independent
appraisals, discounted cash flow analysis, and other types of analysis are used
to estimate fair values.

The acquiring company is not required to establish values immediately on the

acquisition date. A measurement period of up to one year is allowed for
measurement. Temporary values would be used in financial statements prepared
prior to the end of the measurement period. A note to financial statements would
 explain the use of temporary values. Any change in the recorded values is
adjusted retroactively to the date of acquisition. Prior-period statements are
revised to reflect the final values and any related amortizations.

Assets with uncertain cash flows (valuation allowance)

An acquirer is not permitted to recognize a separate valuation allowance as of

the acquisition date for assets acquired in business combination that are
measured at their acquisition-date fair values because the effects of uncertainty
about future cash flows are included in the fair value measured.

Illustration
Let us assume that the Salve Company (acquiree) to be acquired by Pablo
(acquirer) has the following Statement of financial position with corresponding
fair values on June 30, 2019:

Salve Company
Statement of financial position
June 30, 2019

Book value Fair value

Cash 200,000 200,000
Marketable securities 300,000 330,000
Inventory 500,000 550,000
Land 150,000 360,000
Building (net) 750,000 900,000
Equipment (net) 400,000 700,000
Unrecognized receivables 225,000
Total assets 2,300,000 3,265,000

Current liabilities 125,000 125,000

Bonds payable 500,000 500,000
Premium on bonds
payable 20,000
Common stock (P1 par) 50,000
Additional paid in capital 700,000
Retained earnings 925,000
Totals liabilities & equity 2,300,000

Case 1: Price paid exceeds the fair of net identifiable assets acquired

Pablo Company issues 80,000 share of its P10 par value common stock with a
market value of P40 each for Salve Company’s net assets. Pablo pays
professional fees of P50,000 to accomplish the acquisition and stock issuance
costs of P30,000.
Suggested solution:

Price paid (80,000 x P40 (market value) 3,200,000

Fair value of net identifiable assets acquired
Cash 200,000
Marketable securities 330,000
Inventory 550,000
Land 360,000
Building (net) 900,000
Equipment (net) 700,000
Unrecognized receivables 225,000
Current liabilities (125,000)
Bonds payable (500,000)
Premium on bonds payable (20,000) 2,620,000
Goodwill 580,000

Professional fee (expense) 50,000

Stock issue costs (reduction from additional paid in capital) 30,000

Entries recorded by Pablo Company are as follows:

#1
Cash 200,000
Marketable securities 330,000
Inventory 550,000
Land 360,000
Building (net) 900,000
Equipment (net) 700,000
Trade receivables 225,000
Goodwill 580,000
Current liabilities 125,000
Bonds payable 500,000

Premium on bonds payable 20,000

Common Stock (80,000 x 10) 800,000
Additional paid-in capital (80,000 x 30) 2,400,000
To record net assets acquired including the new goodwill

#2
Acquisition expense 50,000
Additional paid-in capital 30,000
Cash 80,000
To record acquisition related costs
Entries recorded by Salve Company are as follows:
#1
3,200,00
Investment in Pablo Company (80,000 x 40) 0
Current liabilities 125,000
Bonds payable 500,000
Cash 200,000
Marketable securities 300,000
Inventory 500,000
Land 150,000
Building (net) 750,000
Equipment (net) 400,000
Gain on sale of business 1,525,000
To record sale of business

Consideration received 3,200,000

Book Value of NA acquired 1,675,000
Gain on sale of business 1,525,000

#2
Common stock 50,000
Additional paid in capital 700,000
Retained earnings 925,000
1,525,00
Gain on sale of business 0
Investment in Pablo Company 3,200,000
To record the distribution of shares by Pablo & liquidation of Salve

Case 2: Price paid is less than the fair of net identifiable assets acquired
Pablo Company issues 60,000 share of its P10 par value common stock with a market
value of P40 each for Salve Company’s net assets. Pablo pays professional fees of
P50,000 to accomplish the acquisition and stock issuance costs of P30,000.

Suggested solution:

Price paid (60,000 x P40 market value) 2,400,000

Fair value of net identifiable assets acquired
Cash 200,000
Marketable securities 330,000
Inventory 550,000
Land 360,000
Building (net) 900,000
Equipment (net) 700,000
Unrecognized receivables 225,000
Current liabilities (125,000)
Bonds payable (500,000)
 Premium on bonds payable (20,000) 2,620,000
Gain on acquisition (220,000)

Professional fee (expense) 50,000

Stock issue costs (reduction from additional paid in capital) 30,000
Entries recorded by Pablo Company are as follows:
#1
Cash 200,000
Marketable securities 330,000
Inventory 550,000
Land 360,000
Building (net) 900,000
Equipment (net) 700,000
Trade receivables 225,000
Current liabilities 125,000
Bonds payable 500,000
Premium on bonds payable 20,000
Common Stock (60,000 x 10) 600,000
Additional paid-in capital (60,000 x 30) 1,800,000
Gain on acquisition 220,000
To record net assets acquired

#2
Acquisition expense 50,000
Additional paid-in capital 30,000
Cash 80,000
To record acquisition related costs

Entries recorded by Salve Company are as follows:

#1
Investment in Pablo Company (60,000 x 40) 2,400,000
Current liabilities 125,000
Bonds payable 500,000
Cash 200,000
Marketable securities 300,000
Inventory 500,000
Land 150,000
Building (net) 750,000
Equipment (net) 400,000
Gain on sale of business 725,000
To record sale of business

#2
Common stock 50,000
Additional paid in capital 700,000
Retained earnings 925,000
Gain on sale of business 725,000
Investment in Pablo Company 2,400,000
To record the distribution of shares by Pablo & liquidation of Salve
B. Application
ACTIVITY 1
On January 1, 2019, Tienes Corporation issued 6,000 shares of its P10 par value
common stock to acquire the net assets of Chukchak Corporation. Tienes
Corporation shares were selling at P90 on that date. Carrying value and fair value
data for Chukchak Corporation at the time of acquisition were as follows:

Carrying value Fair value

Cash 50,000 50,000
Inventory 120,000 200,000
Building and equipment (net) 250,000 300,000
Total assets 420,000 550,000

Current liabilities 50,000 50,000

Common stock (P1 par) 200,000
Retained earnings 170,000
Totals liabilities & equity 420,000

Tienes Corporation paid P25,000 in issuing its new shares and paid
professional fees of P15,000 in locating the merger candidate.
Required:
Record the journal entries for the acquisition in the books of Tienes Corporation and
the sale on the books of Chukchak Corporation and the subsequent total liquidation
of the corporation.
ACTIVITY 2
On January 1, 2019, Prezi Corporation issues 12,000 shares of its P10 par value
stock to acquire the net assets of Stanley Company. Underlying book value and fair
value information for the statement of financial position of Stanley Company at the
time of acquisition are as follows:
Carrying value Fair value
Cash 60,000 60,000
Accounts receivable 100,000 100,000
Inventory 60,000 115,000
Land 50,000 70,000
Building and equipment 400,000 350,000
Accumulated depreciation (150,000)
Total assets 520,000 695,000

Accounts payable 10,000 10,000

Bonds payable 200,000 180,000
Common stock (P5 par) 150,000
Additional paid-in capital 70,000
Retained earnings 90,000
 Totals liabilities & equity 520,000

Stanley’s shares were selling at P18 and Prezi’s shares were selling at P50 just
before the merger announcement. Additional cash payments made by Prezi in
completing the acquisition were: Broker’s fee paid to firm that located Stanley –
P10,000, Audit fee for stock issued by Prezi – P12,000, and cost of SEC registration
of Prezi shares – P6,000
Required:
1. Record the acquisition in the books of Prezi Corporation.
2. Record the sale on the books of Stanley and the subsequent total liquidation of
the corporation.