CHAPTER 1: BUSINESS COMBINATION

Business combination (PFRS 3) - is a transaction or other event in which an acquirer obtains

control of one or more businesses.
True mergers or mergers of equals are also business combination.
First phase (IASB project) - IFRS 3 was originally published in March 2004.
All business combination are acquisitions and required the use of one method of accounting for
business combination - acquisition method.
Second phase (US Standard setter, FASB) - Second edition was in January 2008. It supersedes
IFRS 3 issued on March 2004.
Revised version - applicable for acquisition date on or after July 1, 2009. But permitted to adopt
on or after June 30, 2007 provided that IAS 27, is applied at the same time.
Objectives and Scope of PFRS 3
The objective of PFRS 3 is to set out the accounting and disclosure requirements for a business
combination, to enhance the RELEVANCE, RELIABILITY and COMPARABILITY of the information
presented in the financial statements.
ACQUIRER - the entity that obtains control of the acquiree.
ACQUIREE - business or businesses that the acquirer obtains control of in a business
combination.
Exceptions under the provisions PFRS 3
1. Where to or more separate business are bought together to operate as one entity in the
form of joint venture
2. Where an asset or a group of assets have been acquired and they do not constitute a
business.
3. Where a number of entities that under common control are recognized as part of a
business combination.
IDENTIYING A BUSINESS COMBINATION
BUSINESS - is an integrated set of activities and assets that is capable of being conducted and
managed for the purpose of providing a return in the form of DIVIDENDS, LOWER COSTS or
OTHER ECONOMIC BENEFITS directly to investors or other owners, members or participants.
Three Elements of Business
1. INPUT - any economic resource that creates, or has the ability to create, outputs when one
or more processes are applied to it.
2. PROCESS - any system, standard, protocol, convention or rule that when applied to an
input or inputs, creates or has the ability to create outputs.
3. OUTPUT - the result of inputs and process applied to those inputs that provide or have the
ability to provide a return in the form of dividends.
A business combination may be structured in a variety of ways which are determined for legal,
taxation or other reasons. It may include:
1. one or more businesses become subsidiaries or the net assets of one or more businesses
are legally merged into the acquiree
2. one combining entity transfers its net assets, or its owners transfer their equity interests,
to another combining entity or its owners
 3. all of the combining entities transfer their net assets, or the owners of those entities
thansfer their equity interests to a newly formed entity (ROLL UP or PUT TOGETHER
TRANSACTION)
4. a group of former owners of one of the combining entities obtains control of the combined
entity
OWNERS - include HOLDERS OF EQUITY INTERESTS of investor-owned entities and owners or
members of, or particpants in mutual entities.
EQUITY INTERESTS - OWNERSHIP INTERESTS OF INVESTOR-OWNED ENTITIES and owner,
member or participant interests of mutual entities.
MUTUAL ENTITY - an entity OTHER THAN AN OWNER-OWNED ENTITY, that provides dividends,
lower costs or other economic benefiots directly to its owners, members or participants. (mutual
insurance companies, credit unions, cooperative entities)
IDENTIFICATION OF BUSINESS COMBINATION MAY BE GROUPED INTO:
1. the acquisition of all net assets of a business enterprise
2. the acquisition by enterprise of all or part of the equity shares of another enterprise or
enterprises wherein one or more businesses become subsidiaries of an entity called
PARENT COMPANY
The business combination may give rise to a TRUE MERGER or MERGER OF EQUALS which is
usually a merger between two or more businesses
1. MERGER - the assets and liabilities of one or more entities are transferred to another
surviving entity DISSOLVING the acquired entity or entities.
2. CONSOLIDATION - the assets and liabilities of two or more entities are transferred to a
NEWLY FORMED entity and both the combined entities are dissolved. A business
combination may involve the ACQUISITION OF STOCK in exchange for CASH or OTHER
ASSETS, DEBT INSTRUMENTS, OR EQUITY SECURITIES or a COMBINATION thereof resulting
in a PARENT-SUBSIDIARY RELATIONSHIP.
The ACQUIRER is called the PARENT and the ACQUIREE becomes a SUBSIDIARY of the acquirer.
The acquirer includes its interest in the acquiree in its SEPARATE FINANCIAL STATEMENTS as an
INVESTMENT IN SUBSIDIARY.
AN ACQUIRER MIGHT OBTAIN CONTROL OF AN ACQUIREE THROUGH ANY OF THE
FOLLOWING WAYS:
1. transferring CASH, CASH EQUIVALENTS or OTHER ASSETS
2. incurring LIABILITIES
3. issuing EQUITY INTERESTS
4. proving MORE THAN ONE TYPE OF CONSIDERATION
5. WITHOUT TRANSFERRING CONSIDERATION, including CONTRACT ALONE
REASONS FOR BUSINESS COMBINATION
1. COST ADVANTAGE
2. LOWER RISK 3.
1. FEWER OPERATING DELAYS
3. AVOIDANCE OF TAKEOVERS
4. ACQUISITION OF INTANGIBLE ASSETS
5. OTHER REASONS
The immediate concern of many combinations is to gain operating efficiences through
HORIZONTAL and VERTICAL INTEGRATION of operations or to diversify risks through
CONGLOMERATE business operations. VERTICAL INTEGRATION (also called SEQUENCE OR
INDUSTRY INTEGRATION) - combination of firms with operation in DIFFERENT BUT SUCCESIVE,
stages of production or distribution. HORIZONTAL INTEGRATION - combination of firms in the
SAME BUSINESS LINES and markets. CONGLOMERATION - combination of firms with UNRELATED
AND DIVERSE PRODUCTS / SERVICE functions. TWO KINDS OF ACQUISITION 1. ACQUISITION OF
NET ASSETS - an entity acquires the net assets including goodwill, of another entity or entities 2.
ACQUSITION OF EQUITY SHARES - an entity acquires equity shares to control another entity or
entities resulting in a parent-subsidiary relationship. ACQUISITION METHOD OF ACCOUNTING
(The application of acquistion method) All bsuiness combination should be accounted for by the
ACQUISITION METHOD. 1. Identifying the acquirer. 2. Determining the acquisition date. 3.
Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non
controlling interests in the acquiree. 4. Recognizing and measuring goodwill or a gain from a
bargain purchase. IDENTIYING THE ACQUIRER (PFRS 10, Consolidated Financial Statements)
ACQUIRER - the party to the transaction that gains control over the other party. DETERMINING
THE ACQUISITION DATE ACQUISITION DATE - the date on which the acquirer obtains control of the
acquiree. CLOSING DATE - the date on which the acquirer legally transfers the consideration,
acquires the assets and assumes the liabilities of the acquiree. CONSIDERTION TRANSFERRED IN
A BUSINESS COMBINATION The consideration transferred in a business combination shall be
measured at FAIR VALUE. List of Potential Forms of Consideration 1. Cash or other asset given up
2. liabilities assumed 3. the issue of equity instruments 4. the transfer of a business or a
subsidiary of the acquirer 5. contingent considerations 6. option, warrants and member interests
of mutual entities FAIR VALUE - the price that would be received to sell as asset or paied to
transfer a liability in an orderly transaction between market participants at measurement date.
ACQUISITION-RELATED COSTS - costs that acquirer incurs to effect a business combination.
(finder's fee, general administrative costs, cost of registering and issuing debt and equity
securities) The acquirer shall account for acquisition-related costs as expenses in the periods in
which the costs are incurred and the services received. RECOGNITION AND MEASUREMENT OF
THE IDENTIFIABLE ASSET ACQUIRED Asset id identifiable if it either: 1. is SEPARABLE 2. arises
from CONTRACTUAL or OTHER LEGAL RIGHTS CLASSIFYING AND MEASURING THE IDENTIFIABLE
NET ASSET ACQUIRED The classification or designation is made on the basis of the
CONTRACTUAL TERM, ECONOMIC CONDITIONS, OPERATING or ACCOUNTING POLICIES and OTHER
PERTINENT CONDITIONS as they exist at the acquisition date. Examples of classifications or
designations: 1. Classification of particular financial assets and liabilities as measured at fair
value or at amortized cost in accordance with PFRS 9 Financial Instruments 2. deisgnation of a
derivative instrument as a hedging instrument in accordance with PAS 39 3. Assessment of
whether an embedded derivative should be separated from a host contract in accordance with
PFRS 9 The acquirer shal measure the identifiable assets acquired and liabilities assumed at their
ACQUISTION-DATE FAIR VALUE. RECOGNITION AND MEASUREMENT OF NON-CONTROLLING
INTEREST The acquirer shall recognize, for each business combination, any non-controlling
interest in the acquiree at either 1. fair value 2. at the present ownership instruments'
proportionate share in the recognized amounts of the acquiree's identifiable net assets NON-
CONTROLLING INTEREST - the equity in a subsidiary not attributable, directly or indirectly to a
parent. EXCEPTIONS TO THE RECOGNITION AND/OR MEASUREMENT IN RELATION TO: 1.
Contingent liabilities 2. Income Taxes 3. Employee Benefits 4. Indemnification assets 5.
Reacquired rights 6. Share-based payments 7. Assets held for sale GOODWILL AND GAIN FROM A
BARGAIN PURCHASE GOODWILL - is the amount paid to gain access to the future economic
benefits anticipated to be generated from the assets not specifically identified and separately
recognized. - an asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately recognized.
FORMULA FOR GOODWILL: The sum of; 1. the consideration transferred measured at acquisition-
date fair value 2. the amount of any non-controlling interest in the acquiree 3. the acquisition-
date fair value of the acquirer's previously held equity interest in the acquiree, in a business
combination achieved in stages. less 1. the net of the acquisition date amounts of the
identifiable assets acquired and the liabilities assumed GOODWILL arising from a business
combination is to be recognized as an ASSET of the acquiring entity. When there is NO
consideration is transferred, the amount of goodwill is determined on the basis of the acquisition
date FAIR VALE OF THE ACQUIRER'S INTEREST in the acquiree instead of the acquisition date fair
value of the consideration transferred. Goodwill shall be carried in the statement of financial
position at COST LESS ACCUMULATED IMPAIRMENT LOSSES. GAIN ON BARGAIN PURCHASE
BARGAIN PURCHASE (NEGATIVE GOODWILL) - the excess of the identifiable net assets recognized
in a business combination over the consideration transferred and the non-controlling interest in
the acquiree. Such situation may arise where the seller has to raise funds urgently as in a
FORCED SALE. INITIAL RECOGNITION AND SUBSEQUENT ADJUSTMENTS It is sometimes not
practicable for the assessment to be finished in this time scale especially when the valuation of
non-current assets inluding intangibles is required or the transaction occured near the end of the
acquirer's reporting period. ADJUSTMENT FOR PROVISIONAL AMOUNTS If the initial accounting for
a business combination is incomplete by the end of the reporting period in which the
combination occurs, the acquirer shall report in its financial statements PROVISIONAL AMOUNTS
for the items for which the accounting is incomplete. The acquirer shall RESTROSPECTIVELY
adjust the provisional amounts recognized at the acquisition date to reflect new iformation
obtained about facts circumstance that existed as of the acquisition date. The provisional
amounts should subsequently be finalized within the measurement period and adjustments
should be made to the IDENTIFIABLE NET ASSETS, the CONSIDERATION TRANSFERRED and hence
to GOODWILL. Adjustments shall also be made to the EQUITY INTEREST in the acquiree
previously held by the acquirer in a business combination achieved in stages. MEASUREMENT
PERIOD The measurement period ends as soon as the acquirer obtains information to finalize the
provisional amounts, but in any event does not exceed ONE YEAR from the date of acquisition.
During the measurement period, the acquirer shall recognize adjustments to the provisional
amounts as if the accounting for the business combination had been completed at the
acquisition date. CONTINGENT CONSIDERATION - an obligation of the acquirer to transfer
additional assets or equity interests to the former owners of an acquiree as part of the exchange
for control of the acquiree if specified future events occur or conditions are met. DETERMINING
WHAT IS PART OF BUSINESS COMBINATION The following are examples of separate transactions
that are NOT to be included in applying the acquisition method. 1. a transaction that in effect
settles pre-existing relationships between the acquirer and the acquiree 2. a transaction that
remunerates employees or former owners of the acquiree for future services 3. a transaction that
reimburses the acquiree or its former owners for paying the acquirer's acquisition-related costs.
ENTRIES REQUIRED ON THE SEPARATE BOOKS OF THE ACQUIREE The following are the
procedures to be followed to record the merger on the books of an acquiree. 1. Adjust and close
the nominal accounts and transfer the profit to date of merger to Retained Earnings. 2. Revalue
the assets to conform to fair values in accordance with the merger agreement. 3. Close the asset
and liability account and record the account with the acquirer for the claim resulting from the
transfer of net assets. 4. Record the distributin of cash or equity shares of the acquirer in
payment for the claim. 5. Record the distribution of cash or equity shares of the acquirer to the
shareholders in final settlement. BUSINESS COMBINATION ACHIEVED IN STAGES (STEP
ACQUISITION) A business combination may be achieved in stages such as where a 35% equity
interest in an acquiree was held and the acquirer subsequently purchases another 40% equity
interest to gain control. REVERSE ACQUISITION - occurs when the entity that issues securities
(the LEGAL ACQUIRER) is identified as the acquiree for accounting purposes and the entity whose
equity interests are acquired (the LEGAL ACQUIREE) must be the acquirer for accounting
purposes. The ACCOUNTING ACQUIRER usually issues no consideration. It is the ACCOUNTING
ACQUIREE whoo issues it equity shares to the owners of the ACCOUNTING ACQUIRER. Owners of
the legal acquiree (the ACCOUNTING ACQUIRER) who do not exchange their equity interests for
equity interests of the legal parent (the ACCOUNTING ACQUIREE) are treated as a non-controlling
interest after the reverse acquisition. SHARE CAPITAL DISTRIBUTION A satisfactory recognition of
individual contributions of each of the constituent companies mey be through: 1. ISSUANCE OF A
SINGLE CLASS OF SHARE CAPITAL 2. ISSUANCE OF TWO CLASSES OF SHARE CAPITAL SHARE
CAPITAL EXCHAGE RATIO (STOCK EXCHANGE RATIO) - when share capital is isuued by an acquirer
in exchange for the share capital of the acquired company, the price is expressed as a ration of
the number of shares of the acquiring company's share capital to be exchanged for each share of
the acquired company's share capital. ISSUANCE OF A SINGLE CLASS OF SHARE CAPITAL 1.
Determine the net asset contribution.(Assets - Liabilities) 2. Determine goodwill contribution.
(Estimated earnings - Normal earnings = Excess Earnings * Capitalization rate = Goodwill
Contribution) GOODWILL CONTRIBUTION - computed by capitalizing excess earnings at a certain
rate. NORMAL EARNINGS - percentage of net asset contribution at appraised value. EXCESS
EARNINGS - est. earnings less normal earnings 3. Determine total contribution. (Net asset
contribution + Goodwill Contribution) 4. Determine share capital distribution. - (total contribution
/ outstanding share) ***SHARE CAPITAL EXCHANGE RATIO = share capital distribution /
outstanding share ISSUANCE OF TWO CLASSES OF SHARE CAPITAL 1. Estimated earnings in the
acquiree enterprises are capitalize at a certain rate to determine the total share capital to be
issued to each enterprise. 2. Preference Share Capital is distributed equal to the net assets
contribution of each of the acquiree enterprises. 3. Ordinary Share Capital is issued to each
comapny for the difference between the total contribution and the amount of Preference Share
Capital and it shall represent payment for goodwill. DISCLOSURES UNDER PFRS 3 The acquirer
shall disclose the following information for each business combination that occurs during the
reporting period: 1. the name or a description of the acquiree 2. the acqusition date 3. the
percentage of voting equity interest acquired 4. the primary reason for business combination and
a description of how the acquirer obtained control of the acquiree 5. a qualitative description of
the factors that make up the goodwill recognized 9. the amounts recognized as of the acquisition
date for each major class of assets acquired and liabilities assumed 11. the total amount of
goodwill that is expected to be deductible for tax purposes