SCHOOL OF ACCOUNTANCY

ACCT 4011 FINANCIAL ACCOUNTING STUDIES

LECTURE 3 BUSINESS COMBINATIONS III: SPECIAL TOPICS
TOPIC III

BUSINESS COMBINATION ACHIEVED IN STAGES (OR STEP ACQUISITION)

Acquirer may achieve control in acquiree only after acquiring additional block(s) of shares to
complement its existing holdings
Financial assets Investment in equity instruments (HKFRS 9)
Measured at fair value
(i) through profit or loss (default; the only choice for shares held for trading and derivatives)
(ii) through other comprehensive income (irrevocable initial designation)
Measurement procedures:
Previously held equity interest in the acquiree must be REMEASURED to fair value at
acquisition date when control is achieved
RECOGNISE GAIN/LOSS arising from remeasurement to fair value of previously held equity
interest in profit or loss or other comprehensive income, as appropriate
If the acquirer has, in prior periods, recognised changes in value of its equity interest in the
acquiree directly in equity, the cumulative amount that was recognised directly in equity will be
accounted for in a manner as if the acquirer had disposed of the previously held equity interests
No recycling to profit or loss
Can choose to transfer balance in other comprehensive income to retained earnings (within
equity)
Recognise goodwill upon obtaining control and starts consolidation subsidiary since then:
(Note: This formula is a revision to the formula in the notes of Lecture 2.

This applies to business

combination achieved in stages in which the acquirer subsequently acquires 100% of equity interests of the
acquiree.

If the step acquisition results in a partially-owned subsidiary, i.e. involving non-controlling

interest calculation, the formula below requires further revision.

Fair value of consideration

transferred
Goodwill

Fair value of acquirers
previously held equity
interest in acquiree

We will discuss that in Lecture 6.)

Acquirers interest in the

net fair value of the
acquirees identifiable
assets and liabilities

Illustration: On 1 November 2010, Entity A acquired 5% of the 30,000 outstanding common shares of Entity
B at consideration $10 per share.

On Entity As 31 December 2010 statement of financial position, it

designated its investment in Entity B to be measured at fair value through other comprehensive income.
On 31 December 2010, the fair value of Entity Bs share spurred to $16 per share.

On 31 March 2011,

Entity A acquired the remaining equity shares at market price $20 per share in Entity B so that Entity B
becomes a wholly-owned subsidiary of Entity A.

On 31 March 2011, the fair value of identifiable net

assets of Entity B was valued at $590,000.

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SCHOOL OF ACCOUNTANCY
ACCT 4011 FINANCIAL ACCOUNTING STUDIES
LECTURE 3 BUSINESS COMBINATIONS III: SPECIAL TOPICS

TOPIC IV

REVERSE ACQUISITION

An entity (legal parent: issue equity interests) obtains ownership of the equity of another entity (legal
subsidiary: equity interests being acquired)
As part of the exchange transaction, legal parent issues enough voting equity as consideration for
control of the combined entity to pass to the owners of the legal subsidiary
Referring to the definition of acquirer in HKFRS 3 (Revised),
Legal parent becomes the accounting acquiree
Legal subsidiary becomes the accounting acquirer who obtains control of the combined entity
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SCHOOL OF ACCOUNTANCY
ACCT 4011 FINANCIAL ACCOUNTING STUDIES
LECTURE 3 BUSINESS COMBINATIONS III: SPECIAL TOPICS

LSs shareholders

100%

LSs shareholders

LPs
shareholders

80%
(control)

100%

LPs
shareholders
20%
(100%
20%)

Legal Parent/Acquirer
(Accounting Acquiree)
Legal
Subsidiary/Acquiree
(Accounting Acquirer)

Legal Parent/Acquirer
(Accounting Acquiree)

100%
Legal
Subsidiary/Acquiree
(Accounting Acquirer)

Before reverse acquisition

After reverse acquisition

Accounting implications:
Consolidated financial statement still issued under the name of the legal parent
Consideration transferred (*) = fair value of notional number of equity instruments which
would have been issued by the legal subsidiary to the legal parent to provide the resulting
percentage ownership in the combined entity
Identifiable net assets acquired = those assets of legal parent
Assets of legal parent restated to fair value
Goodwill = Consideration transferred (*) fair value of identifiable net assets of legal parent
Illustration (adapted from Tan, Lim & Lee, Appendix 3A, pages 103 107):
On 1 July 2011, Entity P, a private entity, arranged to have all its shares acquired by Entity L, a publicly
listed entity.

The arrangement required Entity L to issue 20,000,000 shares to Entity Ps shareholders in

exchange for the existing 6,000,000 shares of Entity P.

The following information relates to Entities L and

P at the date of exchange:

SCHOOL OF ACCOUNTANCY
ACCT 4011 FINANCIAL ACCOUNTING STUDIES
LECTURE 3 BUSINESS COMBINATIONS III: SPECIAL TOPICS
After the issue of an additional 20,000,000 shares by Entity L, the shareholding structure of the combined
entity should be:

Ps shareholders

Ls shareholders

0 80%

100 20%

Entity L
100%

Entity P

In substance, Entity P becomes the effective parent obtaining control of the combined entity.

Reversing

(or reinterpreting) the ownership structure, it is required to work out the number of shares that Entity P
would have issued (now, Entity L is the entity issuing the shares to Entity P) to Entity Ls shareholders for
Entity Ps shareholders to own the same percentage in the combined entity (i.e. 80%).

In effect, Entity P

would have to issue 1,500,000* of its own shares to Entity Ls shareholders for Entity Ps shareholders to
own 80% in the combined entity.

Consequentially, under such re-interpretation, Entity P would own

100% of Entity L and Entity Ls shareholders would own 20% of Entity P as follows:

Ps shareholders

Ls shareholders

80%

20%

Entity P
100%

Entity L

* Calculation of the number of shares Entity P would have to issue to own 80% in the combined entity:
6,000,000 (original issued shares of Entity P) / (6,000,000 + hypothetical newly issued shares) = 80%
30,000,000 = 4x + 24,000,000
4x = 6,000,000
Solving for x yields 1,500,000
If Entity P had been the acquirer, the consideration transferred would be:
1,500,000 (hypothetical newly issued shares by Entity P) x $10 (share price of Entity P) = $15,000,000
The goodwill arising from the business combination would be:
Consideration Fair value of identifiable net assets acquired = $15,000,000 - $12,000,000 (Entity Ls fair value) =
$3,000,000
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