Accounting For Business Combinations

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) LECTURE AID 2018 ZEUS VERNON B. MILLAN

BUSINESS COMBINATIONS Overview on the topic: Chapter Title topics___ 1 Bus. Com. (Part 1) measurement 2 Bus. Com. (Part 2) 3 Bus. Com. (Part 3)

SubRecognition and Specific cases Special accounting topics

Related standard:

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PFRS 3: Business Combinations

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Chapter 1 BUSINESS COMBINATIONS (Part 1)

Learning Objectives

 

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Define a business combination. Explain briefly the accounting requirements for a business combination. Compute for goodwill.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Definition of a Business Combination

A business combination is “a transaction or other event in which an acquirer obtains control of one or more businesses.” (PFRS 3)

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Control

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An investor controls an investee when the investor 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.

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Control is normally presumed to exist when the ownership interest acquired in the voting rights of the acquiree is more than 50% (or 51% or more). ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Control - continuation •

Control may exist even if the acquirer holds less than 50% interest in the voting rights of acquiree, such as in the following cases: 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 has power to control the financial and operating policies of the acquiree because of a law or an agreement.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Accounting for business combinations • Business combinations are accounted for using the acquisition method. This method requires the following: 1. Identifying the acquirer; 2. Determining the acquisition date; and 3. Recognizing and measuring goodwill. This requires recognizing and measuring the following: a. Consideration transferred b. Non-controlling interest in the acquiree c. Previously held equity interest in the acquiree d. Identifiable assets acquired and liabilities assumed on the business combination. ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Identifying the acquirer • The acquirer is the entity that obtains control of the acquiree. The acquiree is the business that the acquirer obtains control of in a business combination.

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The acquirer is normally the entity that: a. b. c. d. e. f. g.

Transfers cash or other assets and incurs liabilities; Issues its equity interests (except in reverse acquisitions); Receives the largest portion of the voting rights; Has the ability to elect or appoint or to remove a majority ; Dominates the management of the combined entity; Significantly larger of the combining entities; Initiated the combination

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Determining the acquisition date

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The acquisition date is the date on which the acquirer obtains control of the acquiree.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Recognizing and measuring goodwill Consideration transferred Non-controlling interest in the acquiree

xx

(NCI) Previously held equity interest in the

xx

acquiree Total Less: Fair value of net identifiable assets

xx xx

acquired (xx) On acquisition date, the recognizes a resulting: xx Goodwill / (Gain onacquirer a bargain purchase) a. Goodwill as an asset. b. Gain on a bargain purchase as gain in profit or loss. ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Consideration transferred •

The consideration transferred in a business combination is measured at fair value.

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Examples of potential forms of consideration include: 1. Cash, 2. Other assets, 3. A business or a subsidiary of the acquirer, 4. Contingent consideration, 5. Ordinary or preference equity instruments, options, warrants and member interests of mutual entities.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Non-controlling interest (NCI)

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Non-controlling interest (NCI) is the equity in a subsidiary not attributable, directly or indirectly, to a parent.

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NCI is measured either at: a. Fair value, or b. The NCI’s proportionate share of the acquiree’s identifiable net assets.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Previously held equity interest in the acquiree

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Previously held equity interest in the acquiree pertains to any interest held by the acquirer before the business combination.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Net identifiable assets acquired •

On acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree.

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Any unidentifiable asset of the acquiree (e.g., any recorded goodwill by the acquiree) shall not be recognized.

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The identifiable assets acquired and the liabilities assumed are measured at their acquisition-date fair values. ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Calculating goodwill Illustration 1

On January 1, 2018, AKO Company acquired SIYA Co. On this date the AKO’s assets & liabilities have the following values: CA 10,000 200,000

FV 10,000 120,000

400,000

400,000

Cash Accounts Receivable Allowance for bad debts -30,000 Inventory 520,000 350,000 Building-net 1,000,000 1,100,000 AKO Co. Goodwill incurred P100,000 for legal, accounting & consultancy cost. 100,000 20,000 How muchTotal is theassets goodwill? 1,800,000 1,600,000 Liabilities

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Calculating goodwill illustration 1 CASE 1: AKO paid P1.5M as consideration for assets & liabilities, how much is the goodwill? Did SIYA gain or loss on the disposal? HM? Note: The goodwill of P20k will not be considered in calculating the fair value of net assets in calculating the goodwill. The acquisition related cost in not capitalized or made part of the FV of consideration transferred but the same is expensed. This illustration is business combination thru asset acquisition

Consideration transferred NCI Previously held equity Total FV of net assets (P1.6M-20k400k) Goodwill Journal entry: (AKO book, if Cash Accounts Receivable Inventory Building-net Goodwill Payables Cash Professional fees Cash

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

1,500,000 0 0 1,500,000 -1,180,000 320,000

10,000 120,000 350,000 1,100,000 320,000 400,000 1,500,000 100,000 100,000

Calculating goodwill (consolidation illustration If the parent company, wants the newly acquired company (named Kayo Co.) to operate separately, journal entry will be (see right side):

Ako book Investment in subsidiary

1,500,000

Cash

Professional fees

1,500,000

100,000

Cash

100,000

Kayo book

When the parent company and subsidiary company are consolidated the working paper will be as per next slides.

Cash Accounts Receivable

120,000

Inventory

350,000

Building-net Goodwill Payables Share capital

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

10,000

1,100,000 320,000 400,000 1,500,000

Calculating goodwill (Consolidated F/S) When Ako group prepare consolidated FS , the reciprocal account, Investment in Ako (subsidy) & Share capital (Kayo’s book) are just eliminated. On consolidation, there will be elimination entry that is: Dr Share Capital P1.5M and Cr Investment in KAYO P 1.5M Particulars Cash Accounts Receivable Allowance for bad debts Inventory Investment in KAYO Building-net Goodwill Accounts payable Bonds Payable Share capital

AKO book Debit Credit 100,000 200,000

KAYO book Debit Credit 10,000 130,000

30,000 520,000 1,500,000 910,000 100,000 100,000 1,800,000 1,400,000 3,330,00 3,330,000 0

Consolidated (A+K) Debit Credit 110,000 330,000

10,000

40,000

350,000

870,000

1,100,000 320,000

2,010,000 420,000 100,000 300,000 1,500,000

200,000 2,100,000 1,400,000

1,910,000 1,910,000 3,740,000 3,740,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Calculation of goodwillIllustration 1 Note:

SIYA shall account the business as liquidation of business. All assets & liabilities will be derecognized. The excess amount over the net assets is treated as gain on disposal of business, in this case P100k (P1.5M proceeds vs P1.4M carrying amount

Journal entry: (SIYA's book) 1,500,00 Cash 0 Allowance for B/D 30,000 Payables 400,000 Cash 10,000 Accounts Receivable 200,000 Inventory 520,000 1,000,00 Building-net 0 Goodwill 100,000 Gain on disposal of business 100,000

Share capital Gain on disposal of business Cash

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

1,400,00 0 100,000 1,500,00 0

Calculating goodwill illustration 1 CASE 2: AKO paid P1M as consideration for assets & liabilities, how much is the goodwill/gain on purchase bargain? Note: AKO Co need to reassess first whether it has correctly identified all the net assets acquired. If after assessment, a negative amount still exists, then AKO recognizes the amount as gain in its 2018 profit or loss

Consideration transferred NCI Previously held equity Total FV of net assets (P1.6M-20k- 400k) Gain on purchase bargain

Cash Accounts Receivable Inventory Building-net Payables Cash Gain on purchase bargain Professional fees Cash ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

1,000,000 0 0 1,000,000 -1,180,000 -180,000

10,000 120,000 350,000 1,100,000 400,000 1,000,000 180,000 100,000 100,000

Calculating goodwill Illustration 2 (w/NCI) Consideration transferred

On January 1, 2018, AKO acquired 80% of NCI the voting share of SIYA Co. On this Previously held equity date, SIYA’s identifiable assets and liabilities have a fair value of P1.2M and Total P400k respectively. FV of net assets (P1.2M-20k- 400k) Goodwill

CASE 1: AKO P1M as consideration for assets & liabilities. An independent consultant engaged by AKO determined Journal entry: (AKO's book) that the fair value of the 20% NCI is Investment in subsidiary P175k, how much is the goodwill? Cash

1,000,000 175,000 0 1,175,000 -800,000 375,000

1,000,000 1,000,000

Note: The NCI is presented in the consolidated Consolidation entry will be as follows: Identifiable assets 1,200,000 SFP within equity, but separate fm equity Goodwill 375,000 of AKO Co. This illustration is an example of business combination affected by Stock acquisition.

Payables Investment in subsidiary Non controlling interest

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

400,000 1,000,000 175,000

Calculating goodwill Illustration 2 (w/NCI) CASE 2: AKO Co elects to measure NCI at fair value. An amount will be assigned to NCI, 20% of Ako’s consideration paid. AKO Co. paid P1,000,000 , how much is the goodwill? Note: To calculate value of NCI (20%) amount can be derived as: Since P1M, represents 80%, then the total fair value is P1,250,000 (1M ÷ 80%), thus NCI will have a fair value P250,000 (P1.25M-1M).

Consideration transferred NCI Previously held equity Total FV of net assets (P1.2M-400k) Goodwill Journal entry: (AKO's book) Investment in subsidiary Cash

1,000,000 250,000 0 1,250,000 -800,000 450,000

1,000,000 1,000,000

Consolidation entry will be as follows: Identifiable assets 1,200,000 Goodwill 450,000 Payables 400,000 Investment in subsidiary 1,000,000 Non controlling interest 250,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Calculating goodwill Illustration 2 (w/NCI) CASE 3: AKO Co elects to measure NCI at fair value at the NCI’s proportionate share of SIYA Co’s identifiable net assets. AKO Co. paid P1,000,000 , how much is the goodwill? Note: Since the computation of NCI is ref to the net identifiable assets of SIYA, to compute the NCI’s FV is to get 20% of P800k

Consideration transferred NCI (800k × 20%) Previously held equity Total FV of net assets (P1.2M-400k) Goodwill Journal entry: (AKO's book) Investment in subsidiary Cash

1,000,000 160,000 0 1,160,000 -800,000 360,000

1,000,000 1,000,000

Consolidation entry will be as follows: Identifiable assets 1,200,000 Goodwill 360,000 Payables 400,000 Investment in subsidiary 1,000,000 Non controlling interest 160,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Acquisition-related costs

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Acquisition-related costs are cost the acquirer incurs to effect a business combination.

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Acquisition-related costs are recognized as expenses in the periods in which they are incurred, except for the following: a. Costs to issue debt securities measured at amortized cost – included in the initial measurement of the resulting financial liability. b. Costs to issue equity securities – are accounted for as deduction from share premium. If share premium is insufficient, the issue costs are deducted from retained earnings. ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration (Transaction /Stock related cost) On Jan 1, 2018, AKO Inc. acquired all the assets and assumed all the liabilities of SIYA Inc. On this date SIYA’s net assets and liabilities have a fair value of P1.6M and P900k respectively. AKO incurred the ffg acquisition related costs; legal feesP10k, due diligence costs-P100k & gen. admin cost-P20k

Case 1 As consideration, AKO Inc

transferred 8,000 of its equity instrument, par P100 & FV/share of P130 to SIYA Inc’s former owner. Cost of registering the shares amounted to P40k. How much is the goodwill? Note: The acquisition cost of P120k is immediately expense, whereas the stock issuance cost of P40k is adjusted against premium.

Consideration transferred (8k × P130) NCI Previously held equity

1,040,00 0 0

0 1,040,00 Total 0 FV of net assets (P1.6M-900k) -700,000 Goodwill 340,000

Identifiable assets Goodwill Payables Share capital Share premium Share premium Cash in bank

1,600,00 0 340,000 900,000 800,000 240,000 40,000 40,000

Professional fees exp 110,000 Gen & admin exp 20,000 Cash in bank 130,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration (Transaction /Bond issue costs)

Case 2. As consideration, AKO Inc issued bonds with face amount of P1M but with a fair value of P1.1 M. Transaction cost of incurred in issuing bonds amounted to P60k. How much is the goodwill? Note: The transaction costs of P130k is immediately expense, whereas bond issue cost of P60k is debited, which will be adjustment against the carrying amount of the bond.

Consideration transferred NCI Previously held equity Total FV of net assets (P1.6M-900k) Goodwill

1,100,000 0 0 1,100,000 -700,000 400,000

Identifiable assets 1,600,000 Goodwill 400,000 Payables Bonds payable Premium on bonds payable

900,000 1,000,000 100,000

Bond issue costs Cash in bank

Professional fees exp Gen & admin exp Cash in bank

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

60,000 60,000

110,000 20,000 130,000

Restructuring provisions •

Restructuring is a program that is planned and controlled by management, and materially changes either:

a. b.

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the scope of a business undertaken by an entity; or the manner in which that business is conducted.

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.

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Such would be the case when the entity has a present obligation as of the acquisition date evidenced by a detailed formal plan developed by the acquiree that has been announced publicly on or before the acquisition date.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Specific recognition principles 1. Operating leases (whereby the acquiree is the lessee) - 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.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration -Lease-favorable (unfavorable) On Jan 1, 2018, AKO Inc. acquired all the assets and assumed all the liabilities of SIYA Inc for P1.1M. On this date SIYA’s net assets and liabilities have a fair value of P1.6M and P900k respectively. Case 1: AKO is renting out space to SIYA under operating lease. The term compare to market is favorable with fair value of differential amount of P30k. Note: Intangible asset is recognized Case 2. AKO is renting out space to SIYA under operating lease. The term compare to market is unfavorable with fair value of differential amount of P30k. Note: Liability is recognized

Case 1 Consideration trfd NCI Previously held equity Total FV of net assets (P1.6M+30-900k) Goodwill

Case 2 Consideration trfd NCI Previously held

1,100,000 0 0 1,100,000 -730,000 370,000

1,100,00 0 0 0 1,100,00 0

Total FV of net assets (P1.6M900k-30k) -670,000 Goodwill 430,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Specific recognition principles 2. Intangible assets – The acquirer recognizes the identifiable intangible assets acquired in a business combination if they meet either the (a) separability criterion or the (b) contractual-legal criterion.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration 1 -Intangibles AKO Inc. acquired all the assets & liabilities of SIYA Inc. for P1.7M. Relevant information are as per details on the right side: Additional information:  The computer software is considered obsolete.  The patent has remaining useful life of 10 years and a remaining legal life of 12 years  SIYA Inc has research & Development (R&D) project with a fair value of P60k, however AKO Inc. recognized R&D costs as expenses when they were incurred

CA

FV

Other assets 1,600,000 1,480,000 Compute r software 100,000 Patent 50,000 Goodwill 100,000 20,000 Total assets 1,800,000 1,550,000 Liabilitie s

How much is the goodwill?

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

400,000

450,000

Illustration 1 -Intangibles Notes: Again goodwill need to always be adjusted. The acquirer recognizes acquiree’s R&D as intangible even if the acquiree has already expensed the related cost.

Consideration transferred NCI Previously held equity Total

1,700,000 0 0 1,700,000

FV of net assets (P1.6M-30k+50k-450k) -1,170,000 Goodwill

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

530,000

Illustration 2 -Intangibles AKO Inc. acquired all the assets & liabilities of SIYA Inc. for P1.1M. SIYA’s assets & liabilities have fair value of P1.7M and P1M respectively. Not included in the fair value of assets are the following unrecorded intangibles on your left: How much is the goodwill? ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration 2 -Intangibles All the intangible assets need to be considered as per notes on the right side Goodwill is computed as follows: Consideration transferred NCI Previously held equity Total FV of net assets (P1.7M+220k-1M) Goodwill

1,100,000 0 0 1,100,000 -920,000 180,000

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Exception to the recognition principle – Contingent liabilities

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A contingent liability assumed in a business combination is recognized if: 1. it is a present obligation that arises from past events and 2. its fair value can be measured reliably.

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A contingent liability assumed in a business combination is recognized if the criteria above are met even if the contingent liability has an improbable outflow.

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

Illustration – Contingent liabilities On Jan 1, 2018, AKO Inc. acquired 90% interest of SIYA Inc for P1.3M. On this date SIYA’s net assets and liabilities have a fair value of P1.7M and P800k respectively. AKO opts to measure the NCI at fair value, which has a FV of P90k. SIYA is defendant in a pending litigation for which no provision was recognized because SIYA strongly believes that it will win the case. The FV of settling litigation is P60k. How much is the goodwill? Note: The contingent liability of P60k is recognized even if it is improbable.

Consideratio n transferred NCI Previously held equity

1,300,000 90,000 0

Total 1,390,000 FV of net assets (P1.7M-800k60k) -840,000 Goodwill

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

550,000

 full PFRSs vs. the PFRS for SMEs:

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

 full PFRSs vs. the PFRS for SMEs:

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

 full PFRSs vs. the PFRS for SMEs:

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

APPLICATION OF CONCEPTS  

PROBLEM 2: FOR CLASSROOM DISCUSSION

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

OPEN FORUM QUESTIONS???? REACTIONS!!!!!

ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)

END ACCOUNTING FOR BUSINESS COMBINATIONS (Advanced Accounting 2) - (by: MILLAN)