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ACC203

Financial Accounting 2
Accounting for non-current assets:
Business Combinations
COMMONWEALTH OF AUSTRALIA
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Lecture Outline
• Understand the nature of a business combination
1.

• Explain the basic steps in the acquisition method of accounting for


2. business combinations

• Recognise and measure the assets acquired and liabilities assumed in


3. the business combination and the consideration transferred

• Understand the nature of and accounting for goodwill and gain from
4. bargain purchase.

• Account for subsequent adjustments to the initial accounting for a


business combination
5.

• Provide the disclosures required under AASB 3


6.

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Reference

Prescribed • Company Accounting 10 th Edition 2015, Leo, Hoggett J.,

Text and Sweeting J - Chapter 12

• AASB 3 Business Combinations


AASB

• Tutorial 6. Refer Detailed Weekly Schedule for


Tutorial question numbers

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The nature of a
business combination
AASB 3 (Appendix A) defines a business combination
as:

“A transaction or other event in which an acquirer


obtains control of one or more businesses.”

A ‘business’ is not just a group of assets, rather, it is an


entity able to produce output

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Four General Forms of
Business Combinations
• A Ltd acquires all assets and liabilities of B Ltd
• B Ltd continues as a company, holding shares in A Ltd
1.

• A Ltd acquires all assets and liabilities of B Ltd


• B Ltd liquidates
2.
• C Ltd is formed to acquire all assets and liabilities of A Ltd
and B Ltd
3. • A Ltd and B Ltd liquidate

• A Ltd acquires a group of net assets of B Ltd


• B Ltd continues to operate
4.

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Basic Principles
• AASB 3 prescribes the acquisition method in accounting
for a business combination. The key steps in this method
* are:

• Identify an acquirer
• Determine the acquisition date
*
• Recognise and measure the identifiable assets acquired,
the liabilities assumed, and any non-controlling interest in
* the acquiree

• Recognise and measure goodwill or a gain from bargain


purchase.
*

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Identifying The Acquirer
• The business combination is viewed from the perspective of
the acquirer
1. • The acquirer is the entity that obtains control of the acquiree

• In most cases this step is straight forward. In other cases


judgement may be required > e.g. where two existing entities
(A&B) combine and a new entity (C) is formed to acquire all
2. the shares of the existing entities

• Who is the acquirer? Cannot be C


3.

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Determining the
acquisition date
• Acquisition date is the date that the acquirer
obtains control of the acquiree
1.
• The correct acquisition date is important as it
will:
2. • The fair values of net assets acquired

• Consideration given, if in a non-cash form


• Measurement of the non-controlling interest
3.

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Accounting in the Records of
the Acquirer:
• Fair value allocation occurs at acquisition date and requires the
recognition of:
1.

• Identifiable tangible and intangible assets


• Liabilities
2.

• Contingent liabilities
3. • Any non-controlling interest in the acquiree

• Goodwill
• FVINA = Fair Value of Identifiable Net Assets (incl. contingent
4. liabilities)

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Accounting in the records of the
acquirer: Contingent liabilities
AASB 3 requires:
Contingent liabilities which can be measured reliably are
recognised by the acquirer

Does not consider issues of probability


Fair value of contingent liability:

The amount that a third party would charge for contingent


liabilities.
The amount reflects the expectations about possible cash
flows.

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Accounting in the records of
the acquirer: Intangible assets

• AASB 3 requires the acquirer to recognise


Recognition intangible assets where their fair value can be
measured reliably

Fair value of
an • Reflects market expectations about the probability
of future economic benefits flowing to the entity
intangible

• If the expected benefits are $1,000 and the


probability of receiving the benefits is 90%, the fair
Examples value will be $900
• Trademarks, customer lists, royalty agreements,
patented technology

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Accounting in the records of the
acquirer: Measurement
• AASB 3 requires that assets acquired and liabilities and
contingent liabilities assumed are measured at FV
1.

• Fair value is basically market value and is determined by


judgement, estimation and a three-level ‘fair value
2. hierarchy’

• Acquirer has 12 months from acquisition date to determine


fair values
• Finalisation of fair values will result in adjustments to
3. goodwill

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Accounting in the records of the
acquirer: Consideration
transferred

Assets

Consideration Contingent
Liabilities
Fair value of: Liabilities

Equity
Instruments

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Accounting in the records of the
acquirer: Consideration Transferred
• The consideration paid by the acquirer may consist
of one or a number of the following forms of
1. consideration:

• Cash
• Non-monetary assets
2. • Equity instruments

• Liabilities undertaken
• Cost of issuing debt/equity instruments
3. • Contingent consideration

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Accounting in the records of the
acquirer: Consideration
transferred
• At face value if paid now
• If deferred  must be discounted to present
Cash value as at the date of acquisition

• At the fair value of the shares as at the date of


exchange
Equity
Instruments • If listed  quoted market price

• Equity - Transaction costs – debited to share


capital
Issue costs • Debt – transaction costs are part of the liability

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Accounting in the records of the
acquirer: Consideration transferred

Contingent consideration

If the adjustment is probable and can be measured reliably, then the


amount should be included in the calculation of the cost of acquisition

Example
Where an acquirer issues shares as part of their consideration, the agreement may
require an additional payment of the value of the shares falls below a certain
amount within a specified period of time

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Calculating consideration
transferred: Example
On 1 January 2015 A Ltd acquired all the assets and liabilities of B
Ltd. Details of the consideration transferred are as follows:
 Cash of $400,000, half to be paid on 1 January 2015, the
balance due on 1 January 2016. The incremental borrowing
rate is 10%
 100,000 shares in A Ltd were issued. The share price on 1
January 2015 was $1.50 per share. Costs of issuing the shares
was $1,000.
 Due to doubts as to whether the share price would remain at or
above the $1.50 level, A Ltd agreed to supply cash to the value
of any decrease in the share price below $1.50. This guarantee
was valid for a period of 3 months (to 31 March 2015). A Ltd
believed that there was a 75% chance that the share price
would remain at or above $1.50 until 31 March 2015 (and a
25% chance that it would fall to $1.40)
 Supply of a patent to B Ltd. The fair value of the patent is
$60,000. As the patent was internally generated it has not been
recognised in A Ltd.'s books.
 Legal fees and associated with the acquisition totalled $5,000.

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Calculating consideration transferred:
example
Required:
Calculate the consideration transferred

Cash Payable now 200,000


Discounted to PV at rate of
10%
Deferred ($200,000 x 181,818
0.909091)
Based on
Shares quoted market 100,000 x $1.50 150,000
price
Guarantee 100,000 x ($1.50-$1.40) x 2,500
25%
Based on probability of share price falling below $1.50

Patent FV of patent 60,000


Total cost of acquisition 594,318
Share issue costs, legal fees and stamp duty are excluded from the
calculation

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Accounting in the records of the
acquirer: Goodwill
• When a business combination results in goodwill,
AASB 3 requires that the goodwill is:
1.

• Recognised as an asset
• Measured at its cost at the date of acquisition
2.
• Goodwill = consideration transferred - acquirer’s
interest in the FVINA
3. • Goodwill is considered to be a residual interest

• Goodwill is an unidentifiable asset which is incapable of


being individually identified and separately recognised
4.

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Accounting in the records of the
Example acquirer: Goodwill
Details of B Ltd’s assets and liabilities acquired by A Ltd are as follows:
CA FV
Plant & equipment 360,000 367,000
Land 260,000 257,000
Inventory 24,000 30,000
Accounts receivable 18,000 16,000
Accounts payable (35,000) (35,000)
Bank overdraft (55,000) (55,000)
Net assets 572,000 580,000
B Ltd is currently being sued by a previous customer. The expected
damages is $50,000. Lawyers estimate that there is a 20% chance of losing
the case. Required:
a) Calculate the FVINA acquired and determine the goodwill on acquisition.
b) Prepare the journal entry in the books of A Ltd to account for the
acquisition

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Accounting in the records of
the acquirer: Goodwill
Fair value of recorded net assets 580,000
Carrying amounts in B’s books are irrelevant
to A

Less: Contingent liability re damages (10,000)


($50,000 x 20%) Based on probability of losing the
case

FVINA 570,000
Cost of acquisition Per Slide 19 594,318
Goodwill on acquisition “Residual” interest 24,318

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Accounting in the records of the acquirer: Goodwill
Journal entries in the books of A Ltd to account for the
acquisition

Plant & equipment 367,000

Land 257,000 FV

Inventory 30,000
A/C Receivable 16,000
Residual interest FV
Goodwill 24,318
A/C Payable 35,000
Bank o/draft Contingent 55,000
liability
Provision for damages 10,000
Cash 200,000
Deferred consideration payable Components of 181,818
cost of
Share capital acquisition 150,000
Provision for loss in value of shares 2,500
Gain on sale of patent 60,000 25
Accounting in the Records of the
Acquirer: Goodwill
Journal entries in the books of A Ltd to account for the acquisition
(cont.)
Legal fee expenses 5,000
Share capital – share issue 1,000
costs
Cash 6,000

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Subsequent adjustments to the
initial accounting for business
combinations
• May be made subsequent to acquisition date in relation
to:
1.

• Goodwill - also subject to impairment on an ongoing basis


2.
• Contingent liabilities – initially recognised at FV
• Contingent consideration - Subsequent adjustments do
3. not affect the goodwill calculated at acquisition date.

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Disclosures

 AASB 3 contains extensive


disclosure requirements in relation to
business combinations – See Figure
12.23

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Lecture 08 Activity

Chapter 12 of the prescribed text:


Question 12.2

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