Since 1977
PRACTICAL ACCOUNTING 2
P2.707- Business Combination
LECTURE NOTES
THE NATURE OF BUSINESS COMBINATIONS
Occurs when one entity gains control over another
entity either through the acquisition of net assets
(must be 100%), or the acquisition of common
shares (more than 50% of outstanding).
Business combination requires the bringing together
of businesses into a reporting entity. A reporting
entity can be a single entity (acquisition of net
assets), or a group comprising a parent and all of its
subsidiaries (acquisition of shares).
The business combination occurs from the stand
point of the acquirer.
All business combinations must use the purchase
method. Pooling of interest method is no longer
permitted.
GENERAL STEPS UNDER THE PURCHASE METHOD
OF ACCOUNTING FOR THE BUSINESS
COMBINATION
1. Identify an acquirer
2. Measure the cost of the business combination at fair
value.
3. Measure the fair values of the net assets
acquired/assumed together with contingent liabilities
that qualify for recognition.
4. Allocate the cost of business combination to the net
assets (including contingent liabilities) acquired and
assumed.
5. These steps result in determining the existence of
any goodwill and excess on combination which must
be accounted for.
These are the required procedures under IFRS 3, the
standard that governs all business combinations.
SPECIFIC REQUIREMENTS OF IFRS 3
a. The use of the purchase method
b. An acquirer to be identified
c. The measurement of the cost of a combination
d. The allocation of the cost of combination to the
acquired assets and assumed liabilities and
contingent liabilities.
e. The assets, liabilities and contingent liabilities to be
measured initially at fair value.
f. Goodwill acquired to be recognized
g. That goodwill not to be amortized but tested for
impairment annually
h. That any excess on combination be accounted for by
a reassessment of the assets and liabilities acquired
and, where appropriate, by recognizing any excess
immediately in profit and loss.
i. Disclosures of information that enable users to
evaluate the nature and effect of business
combinations effected in the current period and
previous periods, as well as post balance-sheet
dates.
j. Disclosure of information that enable users to
evaluate changes in the carrying amount of goodwill.
ACCOUNTING FOR COST OF BUSINESS
COMBINATION
The acquirer shall measure the cost of business
combination as the aggregate of
a. The fair values at the date of exchange of assets
given, liabilities incurred or assumed and equity
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DE LEON/DE LEON
OCTOBER 2009
instruments issued by the acquirer in exchange for
control of the acquiree; plus
b. Contingent costs of guarantees made, if measurable
and probable at the date of acquisition on: (1)
market value of the shares issued; and/or (2)
amount of net income sustained over a specified
period.
ACCOUNTING TREATMENT ON SOME SPECIFIC
COST ITEMS
1. Cash or other monetary assets. The fair value of
the cash and cash equivalents dispersed is usually
readily determinable. But if the settlement is
deferred to a time subsequent to the exchange date
the fair value of that deferred component shall be
the present value at the date of exchange.
2. Non- monetary assets. These consist of assets
such as property, plant and equipment, investments,
licenses and patents. The acquirer is effectively
selling the non-monetary asset to the acquiree.
Hence it is earning revenue equal to the fair value
on the sale of the assets and realizing a gain or
incurring a loss if the carrying amount differs from
the fair value.
3. Equity instruments. If an acquirer issues its own
shares as consideration it will need to determine the
fair value of those shares at the date of exchange.
4. Liabilities undertaken the fair value of the
liabilities undertaken are best measured by the
present value of future cash flows. Note that
expected future losses and cost, as a result of the
combination are not liabilities of the acquirer and
therefore not included in the calculation of the fair
value of consideration paid.
5. Contingencies - Where the business combination
agreement provides for an adjustment to the cost of
the combination contingent on future events, the
acquirer shall include the amount of that adjustment
in the cost of the combination at the acquisition date
if the adjustment is probable and can be measured
reliably.
6. Directly attributable costs; it includes costs such
as professional fees paid to accountants, legal
advisers, valuers and other consultants to effect the
combination. Also included in the cost category are
finders fees and brokerage fees. These costs are
now no longer capitalized and are treated as
expenses similar to indirect costs.
7. Other cost that are not directly attributable to
the business combination are
a. Cost to issue and register the shares issued by
the acquirer are treated as a reduction in the
total fair value of the shares issued and are
recognized in equity and
b. In direct acquisition costs are recognized as
expenses.
ALLOCATING THE COST OF BUSINESS
COMBINATION:
1. Identifiable tangible assets: are recognized if it is
probable that any associated future economic
benefits will flow to the acquirer; and its fair value
can be measured reliably
2. Intangible assets: are recognized if its fair value
can be measured reliably. Note that, unlike tangible
P2.707
EXCEL PROFESSIONAL SERVICES, INC.

assets there is no probability test only a reliability
test.
3. Liabilities are recognized if it is probable that an
outflow of resources embodying economic benefits
will be required to settle the obligation; and its fair
value can be measured reliably.
4. Contingent assets and liabilities
Contingent assets not yet recognized under
phase I of IFRS 3
Contingent liabilities the only test for recognition
of contingent liabilities is the reliability test, the
probability test is assumed to be met because the
fair value measurement takes the probability factors
into consideration. Hence, contingent liabilities not
recognized in the records of the acquiree may be
recognized in the records of the acquirer as a result
of the business combination.

- done -

STRAIGHT PROBLEMS

PRTC Company acquired the net assets of CARD 4. Prepare journal entries to record the acquisition of the
Enterprises on August 1, 2009. The carrying and fair net assets in the books of PRTC.
values of Card Enterprises at the date of acquisition date
follows: Problem 2 (Purchase method)
The P Company purchased the net assets of S Company
Carrying which has the following balance sheet on the purchase
Value Fair Value date:
Cash P207000 P20,000 S Company
Accounts receivable 40,000 35,000 Balance Sheet
Merchandise Inventory 60,000 65,000 December 31, 2009
Land 150,000 170,000 Cash P100,000 Accounts
Plant and Property 300,000 280,000 payable P85,000
Patent 60,000 65.000 Accounts Bonds payable 200,000
Total assets P 630,000 P 635,000 receivable 155,000
Inventory Capital stock,
Accounts Payable P30,000 P30,000 390,000 P 10 par 300,000
Bank Loan Payable 220,000 220,000 Building, net 750,000 APIC 480,000
Long-term-debt 180,000 150,000 Equipment, net 360,000 Retained
Capital Stock 120,000 earnings 735,000
APIC 20,000 Goodwill 45,000 _________
Retained Earnings 60,000 Total P1,800,000 Total P1,800,000
Total Equities P630f000 The following market values have been secured for the
assets and liabilities of S Company:
PRTC issued the following considerations in exchange for
the net assets of CARD. Inventory P 425,000
1. 50,000, P1 par shares of PRTC Company. Fair value - Building 600,000
P1.50 at August 1, 2009. Equipment 300,000
2. PRTC agreed to pay additional cash consideration for Bonds payable 225,000
the value of any decrease in the share price below P Company incurred the following costs and
P1.50 for the 50,000 shares issued. The guarantee is expenses:
for 90 days and is to expire on October 30, 2009. Direct acquisition costs (legal fees for
PRTC believes there was only a 15% chance the price business combination and brokerage
of the shares would fall to P1.45 during the guarantee fees) 45,000
period. Indirect costs and general expenses 15,000
3. Cash of P80,000; P30,000 to be paid on date of
exchange and the balance in one year's time. The Required: On P's books (acquiring company) record the
incremental borrowing rate of PRTC is 10% per purchase of the net assets of S Company:
annum. a. Assume the purchase price: is P 1,500,000
4. CARD Enterprises was currently being sued by an b. Assume that P Company issued 10,000 of its own
enraged client; the company's lawyers believe there's shares, P100 par value stock with market value of
an 90% chance it will win the case. The expected P124.50. In addition to the costs and expenses
damages in the event CARD lost the case is P30,000. incurred above, the company incurred the following
5. An old-model Toyota delivery van carried in the books out-of-pocket costs for stock issuance and
of PRTC at P150,000, net of P30,000 accumulated registration, P 20,500
depreciation. The fair value at the date of the
exchange is P100,000. Problem 3
In addition to the purchase consideration PRTC The following summarized balance sheets were prepared
had an out-of-pocket costs of P8,520 for direct for the Gold and Diamond Corporation on December 31,
acquisition cost; P2,000 for issuing and 2009.
registering the shares; and P1,500 indirect cost.
Assets Gold Diamond
Required: Current Assets P350,000 P185,000
1. Prepare a schedule for the determination of the cost Land 80,000 25,000
of combination. Buildings (net) 325,000 250,000
2. Prepare a schedule for the computation of the fair Goodwill 120,000 100,000
value of the net assets. TOTAL P875,000 P560,000
3. Determine goodwill or excess from the business Liabilities & Equity
combination, and Accounts payable P 115,000 P 85,000
Bonds payable 170,000 150,000

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EXCEL PROFESSIONAL SERVICES, INC.

Common stock, P 10 par 150,000 75,000 Gross profit 1,100,000 200,000

Paid-in Capital in excess of par 200,000 40,000 Expenses 400,000 80,000
Retained earnings 240,000 210,000 Net income P700,000 P120,000
TOTAL P 875,000 P 560,000
Balance Sheet
The appraised values of the Diamond Corporation land Cash P220,000 P80,000
and buildings are P50,000 and P350,000 respectively. Inventories 380,000 30,000
Gold will issue 15,250 shares of its P10 par common Plant and equipment
stock with a market value of P20 each for the net assets (net) 800,000 220,000
of Diamond Corporation. Gold will also pay P5,000 in cash Goodwill 200,000 50,000
for direct acquisition costs. Total Assets P1,600,000 P380,000

Required: Accounts payable P100,000 P120,000

1. Entries on the books of Gold Corporation Common stock (P12 par) 900,000
2. Balance sheet of Gold Corporation immediately after Common stock (P 4 par) 80,000
the combination Additional paid-in capital 100,000 20,000
Retained earnings 500,000 160,000
Problem 4 Total liabilities and
Acquirer Company issued 9000 shares of its P12 par stockholders' equity P1,600,000 P380,000
common stock (P50 market value) in exchange for the
net assets of Acquiree Company on December 31, 2009. Additional information:
In addition, Acquirer Company paid cash for the costs The combination is to be treated as a merger with
below relating to the acquisition of Acquiree Company Acquiree Company liquidating and Acquiree assuming all
(costs have not been recorded by Acquirer Company). assets and liabilities of Acquiree Company.

All of the assets and liabilities of Acquiree Company were

Registration and issue costs of securities P 50,000 fairly valued except for plant and equipment, which had a
Fees of outside accountants 30,000 fair value of P300,000.

Required:
Financial statements for Acquirer Company and Acquiree a. Prepare the entries on the books of Acquirer
Company just prior to the combination on December 31, Company to record the acquisition of the net assets
2009 (fiscal year-end), are as follows: of Acquiree Company.
Income Statement b. Prepare the December 31, 2009 income statement
Acquirer Acquiree and balance sheet for Acquirer Company after the
Company Company merger.
Sales P1,900,000 P500,000
Cost of goods sold 800,000 300,000

MULTIPLE CHOICE

Ang Company issued 120,000 shares of its P25 par Total P 97,000
common stock for the net assets of Chan Corporation in 2. If the business combination is treated as a
a business combination completed on March 1, 2010. purchase, the acquisition cost of the combination
Chan Corporations net assets are worth P3,800,000 at will be:
FMV. Out of pocket costs of the combination were as a. P3,097,000 c. P3,017,000
follows: b. P3,080,000 d. P3,000,000
Legal fees 26,000 Motolite Corporation issues 500,000 shares of its own
Contingent consideration (highly probable P1 par common stock for the net assets of Oriental
& measurable) 18,000 Enterprises in a merger consummated on July 1, 2009.
Printing costs of stock certificates 8,500 On this date, Motolite stock is quoted at P10 per share.
Finders fees 27,000 Balance sheet data for the two companies at July 1,
Professional fees paid to a CPA 21,000 2009, just before combination, are as follows:
Fees paid to company lawyers 23,450
Fees paid to company accountants 38,900 Motolite Oriental
The goodwill from the business combination is Current Assets P18,000,000 P1,500,000
Plant Assets 22,000,000 6,500,000
P418,000.
Total Assets P40,000,000 P8,000,000
1. How much is the FMV per share of Ang Company at
March 1, 2010? Liabilities P12,000,000 P2,000,000
a. P 25 c. P 30 Common stock, P10 par 20,000,000 3,000,000
b. P 40 d. P 35 Additional paid-in capital 3,000,000 1,000,000
Retained earnings 5,000,000 2,000,000
FEU Corporation issued 100,000 shares of P20 par Total equities P40,000,000 P8,000,000
common stock for all the outstanding stock of UE
Enterprises in a business combination consummated on Motolite also paid finders fees of P50,000 and legal fees
August 1, 2009. FEU Corporation common stock was of P10,000; as well as indirect costs of 40,000.
selling at P30 per share at the time the business
combination was consummated. Out-of-pocket costs of 3. The retained earnings on the combined balance
the business combination were as follows: sheet after the combination will be:
a. P4,960,000 c. P4,900,000
Finder's fee P 50,000
b. P5,000,000 d. P7,000,000
Accountant's fee (advisory) 10,000
Legal fees (advisory) 20,000
NOP Corp. is to acquire QRS Co. by absorbing all the
Printing costs 5,000
assets and assuming all the liabilities of the latter
SEC registration costs and fees 12,000

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EXCEL PROFESSIONAL SERVICES, INC.

company, in exchange for shares of stocks of the depreciation (200,000) ( 50,000)

former. Below are the balance sheets of the two Goodwill ________ _______ 100,000 _______
Total assets P1,300,000 P1,770,000 P400,000 P545,000
companies with the corresponding appraised value
increment for QRS. Parties agree to use the appraised Accounts
values against which the fair market value of the shares payable 100,000 100,000 140,000 140,000
will be matched. Bonds
payable 400,000 440,000 60,000 85,000
Common
NOP QRS
stock P 10 P5 par
Assets per books P4,000,000 P2,500,000 par 300,000 100,000
Asset increase per appraisal 300,000 Additional
Liabilities 1,500,000 800,000 paid- in
Capital stock (no par) (P100 par) capital 100,000 20,000
2,000,000 1,000,000 Retained
APIC 700,000 300,000 earnings 400,000 80,000
Total Liab. &
Retained earnings (deficit) (200,000) 400,000
SE P 400,000 P1,300,000
Total Equities P4,000,000 P2,500,000

ABC Company acquired the net assets of DEF Company

4. The stocks of NOP Corp. is currently selling at P100 by issuing 10,000 shares of stocks. Additional cash
per share. The number of shares to be issued to payments made by ABC Company in completing the
QRS by NOP is acquisition were:
a. 20,000 c. 13,000
b. 17,000 d. 10,000 Brokers fee paid to firm that located DEF
Company P10,000
The following balance sheets were prepared for ABC Cost to register and issue stocks 40,000
Company and DEF Company on January 1, 2009, just Professional fees paid to accountants 20,000
before the entered into a business combination. Professional fees paid to lawyers 20,000
ABC Company DEF Company Professional fees paid to official valuers 20,000
Book Value Fair Value Book Value Fair Value
Indirect acquisition cost 15,000
Cash 150,000 150,000 10,000 10,000
Accounts 5. Assuming the stocks issued by ABC Company has a
receivable 150,000 150,000 40,000 40,000
market price of P40, how much is the total assets
Merchandise
inventory 400,000 600,000 100,000 245,000 after the business combination?
Building and a. P 1,720,000 c. P 1,870000
equipment 800,000 870,000 200,000 250,000 b. P 1,800,000 d. P 1,145,000
Accumulated

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