Example 1

AU Advanced Financial Accounting II Lecture Note 2023
CHAPTER THREE BUSINESS COMBINATIONS

3.1 DEFINITION
 A business combination refers to a transaction or other event in which an acquirer obtains control over
one or more businesses. i.e. Creating a Single Economic Entity
 A business combination is the bringing together of separate entities or businesses into one reporting
entity. The result of nearly all business combinations is that one entity, the acquirer, obtains control of
one or more other businesses, the acquiree.
 Business combinations represent accounting transactions in which two or more accounting entities (or
companies or groups of net assets that constitute a going concern) are brought together under common
control in a single accounting entity. In common word; business combination is often referred to as
Mergers and Acquisitions.
The following definition for terms used in business combination
 Combined enterprise: the accounting entity that results from business combination.
 Constituent companies: the business enterprises that enter into a business combination.
 Combinor a constituent company entering into a purchase type business combination whose owners as
a group end up with control of the ownership interest in the combined enterprise.
 Combinee: a constituent company other than the combinor in a business combination
TYPES OF BUSINESS COMBINATION
1. Vertical integration is the combination of firms with operations indifferent, but successive, stages of
production or distribution, or both.
 A vertical merger joins two companies that may not compete with each other, but exist in the same
supply chain.
 A vertically integrated business refers to a business that has expanded into different steps along
production, manufacturing, and supply.
 In other words, a vertically integrated business controls some aspect of the supply chain, which
means that it not only distributes the product it sells, it is also involved in the creation and
development of that product before it reaches the consumer
Example1
Mountain Mist,’ a packaged water manufacturer, combines with a PET bottle manufacturer ‘Beige
Plasto.’ This type of combination will bring two different processes under single management. In addition,
the inclusion of the bottle manufacturing unit under the same management will reduce per-unit cost.
Example2
A firm that operates retail clothing stores can vertically integrated by acquiring the factory that
manufacturing clothes. The firm now controls both production and distribution, giving greater control over
the supply chain and greater share of profit margin.
Prepared by Lemessa N Page 1
TYPES OF VERTICAL INTEGRATION
i. Backward Integration
A company that chooses backward integration moves the ownership control of its products to a point earlier
in the supply chain or the production process.
An example of backward integration is store of retail chains acquiring a milk plant to produce its own-brand
milk, or a shirt-maker acquiring cotton fields.
ii. Forward Integration
A company that decides on forward integration expands by gaining control of the distribution process and
sale of its finished products.
An example of forward integration is if a farmer purchases a trucking company that transports milk (a
downstream distributor) to distribute produce to retail stores.
Balanced Integration: This occurs when a firm takes control over both earlier and later stages. Such a firm
must be a “middleman”, which until now took raw materials from someone and also worked with retailers. If
a mobile company decides to manufacture its microchips and retail its products, it would be a balanced
integration.
2. Horizontal Combination is the combination of firms in the same business lines and markets. A horizontal
combination comes into being when units carrying on the same trade or pursuing the same productive
activity join together with a common end in view.
For example,
The business combinations of CBE and CBB
Coca-Cola and the Pepsi beverage division,
Integration of Face book, Whatsapp, Instagram & Messenger
3. Lateral integration refers to the combination of those firms which manufacture different kinds of products
though they are ‘allied in some way. It is a form of material integration.
For example, printing press unit may integrate with the unit’s dealings in machinery, types, papers and
ink. Different material of these units converges on the same product.
It can be classified as
A. Convergent lateral integration, a convergent combination is the combination of different business units,
say suppliers of raw materials to a major firm. In this type of combination, the larger firm benefits from
supplying raw materials and its inventory under its control.
Example Supplier A deals in printer ink, papers, and folders, and Supplier B deals in the same business.
‘Pressfit’ is a leading printing press. Supplier A and B with Press Fit will be a concurrent combination.
B. Divergent lateral integration. The convergent lateral combination comes into existence when different
forms join together to supply goods and services to help the functioning of major undertakings. Example:

For instance, a book publishing may join with other units producing paper, doing printing work, and
providing bookbinding services.
The example of divergent lateral integration is provided by a flourmill supplying flour to a number of
units like bakery, confectionary, and hotel. The main benefit of lateral integration is that both the
supply of raw materials and availability and existence of demand are ensured to the new combination
C. Mixed (Conglomeration) is the combination of firms with unrelated and diverse products or services
functions or both. When firms belonging to different industries and producing altogether different
products and combine under the banner of a central agency, it is called a mixed or circular combination
For example, if a cell phone company bought a car manufacturing company that would be an example of a
circular combination.
D. Diagonal Combination It is also called ‘Service’ integration - Diagonal integration comes into existence
when a unit providing auxiliary goods and services to industry is combined with a unit engaged in the
mainline of production, within the organization
For example, an iron and steel company may require power and the same may be supplied by another
unit and if both of them combine, it would be called diagonal combinations. It helps in achieving self-
sufficiency in operations. It ensures regular and uninterrupted service to the manufacturing industry.
Forms of Business combination
A) Friendly take over
 A friendly takeover occurs when one corporation acquires another with both boards of directors
approving the transaction.
 A friendly takeover is where the target company agrees to the acquisition offer peacefully. In this case,
the takeover is subject to the approval of the shareholders of the target company and that of the
regulators to check if the deal complies with the antitrust laws.
 A friendly Takeover is a type of takeover that is very friendly as the management of the acquired
company and the management of the target company agrees to the terms and conditions of
the takeover. A takeover is done without any difficulty, arguments, etc., and fights. An acquirer
doesn’t have to plot or make any strategies against the target company to acquire the same.
 A friendly takeover happens when one company is willingly acquired by another. In a friendly
takeover, the management and board of directors consent to or approve the takeover. It’s important to
note that the target company’s shareholders will still need to agree to the takeover. In a friendly
takeover, both shareholders and management are in agreement on both sides of the deal.
 In a friendly takeover, the management and board of directors approve of the takeover and advises
shareholders to vote in favor of the deal

EXAMPLE OF FRIENDLY TAKEOVER
Let’s assume there is a company called XYZ interested in buying a majority in company ABC. Company
XYZ makes a plan to approach company ABC’s board of directors with a potential bid. Company ABC’s
board of directors would then discuss the bid or vote on the bid. If the company ABC management evaluates
that the deal is beneficial to the company, they will accept the offer and recommend the deal to shareholders.
After all the approvals from a board of directors, shareholders, and other regulatory authorities are involved,
the deal will be finalized.
B) Defensive strategies to counter Hostile tender offer.
A hostile takeover occurs when one corporation, the acquiring corporation, attempts to take over another
corporation, the target corporation, without the agreement of the target corporation’s board of directors.
Unlike a Friendly Takeover, In a Hostile takeover, the target company doesn’t want the acquirer to acquire it.
When the takeover is without the consent of the board of directors of the target company, it is hostile on the
board of the directors of the target company; then, the takeover is called a “Hostile Takeover.”
In a friendly takeover, the target company's management and board of directors approve the takeover proposal
and help to implement it. However, in a hostile takeover, the management and board of directors of the
targeted company oppose the intended takeover
What’s the difference between a friendly and a hostile takeover?
A friendly takeover is one where the company’s management and board of directors approve of the takeover
instead of opposing it. It might even be something they’ve deliberately sought out, perhaps as an exit strategy.
A hostile takeover is one where the company’s management does not want the takeover to take place. The
acquiring company can push through a hostile takeover by going directly to the target company’s
shareholders.
A friendly takeover is far better than a hostile takeover for all involved. It tends to mean:
 The deal is better for both the acquiring and target companies.
 The target company doesn’t need to spend money (or lose value) to fight an unwanted takeover
attempt.
 The acquiring company doesn’t need to pay an excessive amount to force through the takeover.
 Shareholders will often get a better price per share in a friendly takeover.
Example of a Hostile Takeover
For example, Company A is looking to pursue a corporate-level strategy and expand into a new geographical
market.
1. Company A approaches Company B with a bid offer to purchase Company B.
2. The board of directors of Company B concludes that this would not be in the best interest of
shareholders in Company B and rejects the bid offer.

3. Despite seeing the bid offer denied, Company A continues to push for an attempted acquisition of
Company B.
In the scenario above, despite the rejection of its bid, Company A is still attempting an acquisition of
Company B. This situation would then be referred to as a hostile takeover attempt.
Hostile Takeover Strategies
In a hostile takeover, the target management and board of directors reject the takeover and advise shareholders
to vote against the takeover. The acquirer company, in a hostile takeover, can employ strategies such as the
following:
1. Tender offer
A tender offer is a direct offer to shareholders to purchase their shares at a premium to the current market
price of the stock.
For example, if the target company’s share price is $20, the acquirer company could make a tender offer to
purchase shares of the target company at $30 per(a 50% premium). The rationale behind a tender offer is to
acquire enough shares to obtain a majority stake in the target company.
2. Proxy fight
A proxy fight is where the acquirer company persuades shareholders of the target company to band together
and vote out the board of directors, and then subsequently approve the takeover.
For example, the acquirer company can reach out to shareholders of the target company to vote out certain
directors during the annual general meeting (AGM) and reinstall a new board. The rationale behind a proxy
fight is to replace the current board of directors with a new board that is more receptive to a takeover by the
acquiring company.
3.Poison Pill
This defense tactic is officially known as a shareholder rights plan. It allows existing shareholders to buy
newly issued stock at a discount if one shareholder has bought more than a stipulated percentage of the stock,
resulting in a dilution of the ownership interest of the acquiring company. The buyer who triggered the
defense, usually the acquiring company, is excluded from the discount.
Reasons for Business Combinations
 For growth i.e. external method of achieving growth.
 To achieving manufacturing or other operating economies and,
 Better Management
 The income tax advantages.
 Diversification of Business risk
 Cost advantage
 Fewer operating delays , etc
5.3 Methods/ legal form of Business Combinations
The four common methods for carrying out a business combination are statutory merger, statutory
consolidation, common stock, and acquisition of assets.
1. Statutory Merger
A statutory merger refers to the absorption of one or more former legal entities by another company that
continues as the sole surviving legal entity. The absorbed company ceases to exist as a legal entity but may
continue as a division of the surviving company.
One company acquires all the net assets of another company. The acquiring company survives, whereas the
acquired company ceases to exist as a separate legal entity.
A + B = A
Procedures in a statutory merger
 The boards of directors of the constituent companies work out the terms of the merger
 Stockholders of the constituent companies approve the terms of the merger, in accordance with
applicable corporate bylaws and state laws
 The survivor dissolves and liquidates the other constituent companies, receiving in exchange for its
common stock investments the net assets of those companies.
 Activities of the constituent companies are often continued as divisions of the survivor
2. Statutory Consolidation
Legally, a statutory consolidation refers to the combining of two or more previously independent legal entities
into one new legal entity. The previous companies are dissolved and are then replaced by a single continuing
company
A new corporation is formed to acquire two or more other corporations through an exchange of voting stock;
the acquired corporations then cease to exist as separate legal entities.
A + B = C
Procedures in a statutory consolidation
 The boards of directors of the constituent companies work out the terms of the merger
 Stockholders of the constituent companies approve the terms of the merger, in accordance with
applicable corporate bylaws and state laws
 A new corporation is formed to issue common stock to the stockholders of the constituent companies
in exchange for all their outstanding voting common stock of those companies.
 The new corporation dissolves and liquidates the other constituent companies, receiving in exchange
for its common stock investments the net assets of those companies.
3. Acquisition of Common Stock
One corporation, the investor, may issue preferred or common stock, cash, debt or a combination thereof to
acquire from present stockholders a controlling interest in the voting common stock of another corporation,
the investee. Stock acquisition may be accomplished through:
 Direct acquisition in the stock market
 Negotiation with the principal stockholders of a closely held corporation

 Through a tender offer to stockholders of a publicly owned corporation. The price per share state in
the tender offer usually is well above the prevailing market price
A + B = AB
If a controlling interest in the combinee’s common stock is acquired, that corporation becomes affiliated with
the combinor parent company as a subsidiary, but is not dissolved and liquidated and remains a separate legal
entity. Combinations arranged in this manner require authorization by the combinor’s board of directors and
require ratification by the combinee’s stockholders. Most hostile takeovers are accomplished by this means.
In a stock acquisition, a controlling interest (typically, more than 50%) of another company’s voting common
stock is acquired. The company making the acquisition is termed the parent, and the company acquired is
termed a subsidiary. Both the parent and the subsidiary remain separate legal entities and maintain their own
financial records and statements. However, for external financial reporting purposes, the companies usually
will combine their individual financial statements into a single set of consolidated statements. Thus, a
consolidation may refer to a statutory combination or, more commonly, to the consolidated statements of a
parent and its subsidiary
4. Acquisition of Assets
A business enterprise may acquire from another enterprise all or most of its gross assets or net assets for cash
debt, preferred or common stock, or a combination thereof. The transaction generally must be approved by the
boards of the constituent companies. The selling enterprise may continue its existence as a separate or it may
be dissolved and liquidated; it does not become an affiliate of the combinor.
Note -The term merger applies when an existing company acquires another company and combines that
company’s operations with its own. The term consolidation applies when two or more previously separate
firms merge into one new, continuing company
Combination Pur Acqu. New company Operation control Legal owner ship
company company
Acquisition A B A&B A, control operation A, has no legal owner ship
existed or not activities of B over company B
dissolved
Merger A B A ( B, out of A, control all over the A, has a legal owner ship over
existence or operation activities of company B.
dissolved) B
Combination A B C( A&B out of C, take over asset and C, has a legal owner ship over
existence or both control operation of company A&B.
dissolved). A&B.
METHOD OF ACCOUNTING FOR BUSINESS COMBINATIONS

Under IFRS 3, a business combination, an entity shall account for each business combination by applying the
acquisition method (which is replaced instead of purchase method).
Acquisition method differs is differ from purchase method in the following ways
 The acquisition method differs in that it views the purchase as the whole firm, not just the sum of its parts.
 The acquisition method requires accountants to disclose contingencies -- potential assets or liabilities that
the company may or may not recognize in the future. The purchase method did not require these to be
disclosed at the time of the acquisition
 Under the purchase method, the difference between the acquired company's fair value and its purchase
price would be accounted for as negative goodwill on the balance sheet. That amount would then be
amortized over time, trickling through to the income statement with minimal impact. Under the
acquisition method, however, the negative goodwill is treated as a gain on the income statement
immediately with the acquisition.
 The purchase method requires no acknowledgment of contingencies arising from a merger or
acquisition. In contrast, the acquisition method obliges the acquirer to recognize contingencies, whether
contractual or otherwise, at fair value
Thus, an entity shall account for each business combination by applying the acquisition method. Applying
the acquisition method requires the following steps
1) Identifying the acquirer- the entity that obtains control of another entity.
2) Determining the acquisition date- is the date on which it obtains control of the acquiree.
The date on which the acquirer obtains control of the acquiree is generally the date on which the acquirer
legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree—the closing
date. However, the acquisition date is not necessarily the closing date; it may be before or after the closing
date. The acquisition date is the date on which the acquirer effectively obtains control of the acquire
3. Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non-
controlling interest in the acquire.
Recognition conditions
 To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired
and liabilities assumed must meet the definitions of assets and liabilities in the Conceptual Framework
for Financial Reporting at the acquisition date
 To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired
and liabilities assumed must be part of what the acquirer and the acquiree (or its former owners)
exchanged in the business combination transaction rather than the result of separate transactions
4. Recognizing and measuring goodwill or a gain from a bargain purchase.
Measurement principle
The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date
fair values.

TREATMENT OF COST RELATED TO BUSINESS COMBINATION
In accordance with the revised IFRS 3(as issued 2009), because acquisition- related costs are not part of the
exchange transaction between the acquirer and the acquiree (or its former owners), they are not considered
part of the business combination. Therefore, except for costs to issue debt or equity securities that are
recognized in accordance with IAS 32 and IAS 39, the revised IFRS 3 requires an entity to account for
acquisition-related costs as expenses in the periods in which the costs are incurred and the services are
received. In contrast, IFRS 3 (as issued in 2004) required the acquisition-related costs to be included in the
cost of a business combination.
Reason not to add
The IFRIC noted that more than one interpretation of how the requirements of the two IFRSs interact is
possible. Accordingly, the IFRIC concluded that an entity should disclose its accounting policy for such costs
and the amount recognized in the financial statements. Because this is a transitional issue that will not arise
for accounting periods beginning on after 1 July 2009, the IFRIC decided not to add the issue to its agenda.
All acquisition costs, even those directly related to the acquisition such as professional fees (legal, accounting,
valuation, etc), must be expensed. The costs of issuing debt or equity are to be accounted for under the rules
of IFRS 9®, Financial Instruments and IAS 32® Financial Instruments: Presentation.
In an acquisition of a business, transaction costs are expensed on, or prior to, the acquisition date. In an
asset acquisition, transaction costs are a cost of acquiring the assets, and therefore initially capitalized and
then subsequently depreciated
Procedures under Acquisition Method of Accounting for Business Combinations
1. Determination of the Combinor or the Acquiring Company – this steps deals with identification of the
combinor.
2. Determination of Cost of Acquisition – assets to be acquired and liabilities to be assumed are identified
and then, like other exchange transactions, measured on the basis of the fair values exchanged. The Cost
of combinee includes also some other costs as discussed below.
The cost of a combine on a BC accounted for by Acquisition method is the total of
(1) The amount of consideration paid by the combinor- Capitalized
(2) The combiners DIRECT “out of pocket” costs of the combination-expense as incurred
(3) Any contingent consideration that is determinable on the date of the business combination.
1) Amount of Consideration. This is:
 The total amount of cash paid,
 The current fair value of other assets distributed,
 The present value of debt securities issued, and,
 The current fair (or market) value of equity securities issued by the combinor.
2) Direct Out-of-Pocket Costs. These categories are includes:
 Legal fees,
 Accounting fees and,

 Finder's fees.
Indirect out of pocket cost
 Cost of registering with SEC & issuing equity securities
 Printing cost
 Financing costs: costs of issuing debt or equity securities to finance the acquisition
INDIRECT OUT-OF-POCKET COSTS OF THE COMBINATION, such as salaries of officers of
constituent companies involved in negotiation and completion of the combination, are recognized as expenses
incurred by the constituent companies.
1) Contingent Considerations-
 IFRS 3 defines contingent consideration as: ‘Usually, 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.
 Contingent consideration must be recorded on the acquisition date at its fair value either
as equity or a liability. It is recorded as equity when it is expected to be settled in a fixed number
of the acquirer’s shares. In all other cases, recognition as financial liability is better.
 Contingent consideration recognized as a liability is periodically adjusted to its updated fair value
and the associated gain or loss is recognized in income, but the contingent consideration
recognized as equity is not adjusted for changes in fair value
Accounting treatment for contingent consideration:
a. Contingent consideration which is determinable on the combination date: recorded as part of
the cost of the combination.
b. Contingent consideration that is not determinable on the combination date: the contingent amount
is recorded as goodwill when the contingency is resolved.
Example1: Acquisition of Accounting for Merger, with Goodwill

On December 31, 2005, Mason Company was merged into Saxon Corporations. Both companies used the
same accounting principles for assets, liabilities, revenue, and expenses and both had a December 31 fiscal
year.
Saxon issued 150,000 shares of its Br. 10 par common stock (current fair value Br. 25 a share) to Mason's
stockholders for all 100,000 issued and outstanding shares of Mason's no-Par Br. 10 stated value common
stock.
Saxon paid the following direct cost attributable to the business combination:
Accounting fee Br 5,000
Legal fee 10,000
Finder's fee 51,250
Saxon paid the following financing cost:
Printing charges 23,000
Registration fee 110750
There was no contingent consideration in the merger contract. Immediately prior to the merger, Mason
Company's condensed balance sheet was as follows:

There was no contingent consideration in the merger contract. Immediately prior to the merger, Mason
Company's condensed balance sheet was as follows:
MASON COMPANY (Combinee)
Balance Sheet (prior to business combination)
December 31, 2005
Book value Fair value

Current assets …………………….. .. 1,000,000 ……………1, 150,000
Plant assets (net) 3,000,000……………3,400,000
Other assets 600,000 ……………600, 000
Total assets 4,600,000 …………5,150, 0000
Liability and SHE
Current liabilities 500,000……………… 500,000
Long term debt 1,000,000…………… 950,000
Common stock, no par, $10 stated value 1,000,000
Additional paid in capital 700,000
Retained earnings 1,400,000
Total liabilities and capital 4,600,000……………1450, 000
Required
a. Pass entry to record merger with Mason Company as a purchase
b. Compute good will
c. Prepare liquidation/closing entry
Note that no adjustments
Saxon Corporation
Journal Entries in the books of Saxon
December 31, 2005
1. To record merger with Mason Company as a purchase.
Investment in Mason Company Common Stock (150,000 × Br. 25)…… 3,750,000
Common Stock (150,000 × Br. 10) ……………………………… 1,500,000
Paid-in Capital in Excess of Par…………………………………… 2,250,000
To record merger with Mason Company.
2. To record direct and indirect attributable to the business combination
Professional services expense. 66,250
Paid-in Capital in Excess of Par (Br. 110750+ 23,000 ) 133,750
Cash……………………………………………………………… 200,000
3. Recognising identifiable assets and liabilities and goodwill.
Current Assets………………………………………………… 1,150,000
Plant Assets……………………………………………………… 3,400,000
Other Assets…………………………………………………… 600,000
Discount on long-Term Debt………………………………… 50,000
Goodwill……………………………………………………… 50,000
Current Liabilities………………………………… 500,000
Long-Term Debt………………………………………………… 1,000,000
Investment in Mason Comp Common Stock(Br.3,750,000) 3,750,000

Amount of goodwill is computed as follows:
Total cost of Mason Company (Br. 3,750,000 + Br. 66,250) Br. 3,750,000
Less: Carrying amount of Mason’s identifiable net Assets 3,700,000
Amount of goodwill………………………………… Br. 50,000
Goodwill computation under Acquisition accounting:
Goodwill:
GW = Total cost (purchase price + contingent consideration) - CFV of net asset.
NB CFv of net asset= CFV of total asset-CFV of total liability.
Note that no adjustments are made in the foregoing journal entries to reflect the current fair values of Saxon's
identifiable net assets or goodwill, because Saxon is the combinor in the business combination. The
combinee on the other hand has to record the above transaction in a way that reflects the liquidation.
Mason Company
Journal Entries
December 31, 2005
Current Liabilities……………………………… 500,000
Long-Term Debt……………………………… 1,000,000
Common Stock, Br. 10 stated value ……………… 1,000,000
Paid-in Capital in Excess of Stated Value…… 700,000
Retained Earnings………………………………… 1,400,000
Current Assets…………………………………… 1,000,000
Plant Assets (net)………………………………… 3,000,000
Other Assets……………………………………… 600,000
The above entry wipes out the records of Mason Company (the acquiree) as posting the above entry to the
respective accounts makes their balances zero.
Example 2: Acquisition Accounting for Acquisition of Net Assets, with “Negative Goodwill” (Bargain-
Purchase Excess)
On December 31, 2005, Davis Corporation acquired all the net assets of Fairmont Corporation directly from
Fairmont for Br. 400,000 cash, in a business combination. Davis paid legal fees of Br. 40,000 in connection
with the combination. The condensed balance sheet of Fairmont prior to the business combination, with
related current fair value data, is presented below:
Fairmont Corporation
Balance Sheet (Prior To Business Combination)
December 31, 2005
Carrying Current
Amounts Fair Values
Assets
Current Assets: Br. 190,000 Br. 200,000
Inv’t Marketable Debt Securities(Held To Maturity) 50,000 60,000
Plant Assets (Net) 870,000 900,000
Intangible assets(net) 90,000 100,000
Total assets Br. 1,200,000 Br. 1,260,000

Liabilities and Stockholders' Equity
Current liabilities Br. 240,000 Br. 240,000
Long-term debt 500,000 520,000
Total liabilities Br. 740,000 Br. 760,000
Common stock, Br.1 par Br. 600,000
Deficit (140,000)
Total stockholders’ equity Br. 460,000
Total liabilities and stockholders’ equity Br. 1,200,000
Total cost of Mason Company ………………………………Br400,000

Less: Carrying amount of Mason’s identifiable net Assets. 500,000
Negative goodwill……………………………………………100,000
This negative goodwill is prorated to the plant assets and intangible assets in the ratio of their respective
current fair values, as follows:
To plant assets: Br. 100, 000 × (Br. 900,000 ÷ Br. 1,000, 000) = Br. 90,000
To Intangible assets: Br. 100, 000 × (Br. 100,000 ÷ Br. 1,000, 000) = 10,000
Total excess of current fair value of identifiable net assets over acquirer cost Br. 100,000
Remember that no part of the Br. 100, 000 bargain-purchase excess is allocated to current assets or to the
investment in marketable securities.
The journal entries below record Davis Corporation's acquisition of the net assets of Fairmont Corporation
and payment of Br. 40,000 legal fees are shown below:
Davis Corporation
Journal Entries
December 31, 2005
Investment in Net Assets of Fairmont corporation ………………… 400,000
Cash …………………………………………………..………… 400,000
To record acquisition of net assets of Fairmont Corporation.
Professional services expense. 40,000
Cash………………………………………………………………… 40,000
To record payment of legal fees incurred in acquisition of net assets of Fairmont corporation.
Recognising identifiable assets and liabilities

Current Assets………………………………………………….………… 200,000
Investments in marketable Debt securities……………………………. 60,000
Plant Assets (Br. 900,000 – Br. 90,000)……………………….………… 810,000
Intangible Assets (Br. 100,000 – Br. 10,000)……..……………………… 90,000
Current Liabilities ……………………………..……………………… 240,000
Long-Term Debt ……………………………….……………………… 500,000

Premium on long-Term Debt (Br. 520,000 – Br. 500,000)……..…… 20,000
Inv’t in net Assets of Fairmont Corporation (Br. 400,000). 400,000
Acquisition Accounting for Consolidation
Because a new corporation issues common stock to effect a consolidation, one of the combined companies
must be identified as the acquirer, under the criteria described to identify acquirer. Once the acquirer has been
identified, the new corporation recognizes net assets acquired from the acquirer at their carrying amount in the
acquirer’s accounting records; however, net assets acquired from the acquiree are recorded by the new
corporation at their current fair values.
To illustrate, assume the following condensed balance sheets of the constituent companies involved in a
purchase-type statutory consolidation on December 31, Year 2022:
Lamson Corporation & Donald Company
Balance Sheet (prior business combination)
December 31, 2022
Asset Lamson Co. Donald Co.
Current assets.......................................................... Br.600,000 Br. 400,000
Plant asset (net) ......................................................... 1,800,000 1,200,000
Other assets ...................................................................400,000 300,000
Total assets ...........................................................Br.2,800,000 Br. 1,900,000
Liabilities & Shareholders’ Equity
Current liabilities ......................................................... 400,000 300,000
Long-term debt ............................................................ 500,000 200,000
Common stock, Br.10.................................................. 430,000 620,000
Paid in capital ............................................................... 300,000 400,000
Retained Earnings ........................................................1,170,000 380,000
Total ........................................................................Br.2,800,000 1,900,000
The current fair values of both companies’ liabilities were equal to carrying amounts. Current fair values of
identifiable assets were as follows;
Lamson company fair value
Current assets, Br 800,000
Plant assets, 2,000,000
Other assets, 500,000
Donaldcompany fair value
Current assets, Br 500,000
Plant assets, 1,400,000
Other assets, 400,000.
On December 31, Year 2022, in a consolidation approved by shareholders of both combined companies, a
new corporation, LamDon Corporation, issued 74,000 shares of no stated value common stock with an
agreed value of Br 60 a share.
Assuming that LamDonpaid Br 200,000 costs which comprise Br 110,000 direct cost and Br 90,000
financing cost for the consolidation after it was consummated on December 31, Year 2022; LamDon’s journal
entries would be as follows:
To record consolidation of Lamson corporation and Donald company as a purchase

Investment in Lamson and Donald Co Common Stock (74,000 x 60)... 4,440,000

Common stock, no par ........................................................................................ 4,440,000
(To record payment of costs incurred in consolidation of Lamson Corporation and Donald Company).
Accounting legal and finder’s fee in connection with the consolidation are recorded as service expenses; other
financing costs are recorded as a reduction in the proceeds received from the issuance of common stock.
Professional services expense……………………………........................... 110,000

Common stock, no par ........................................................................... ……..90,000
Cash ........................................................................................................................ 200,000
Recognizing identifiable net asset and liabilities
Assume Lamson Corporation was identified as acquirer and valued Current Assets at Br 500,000;Plant assets
at Br 1,400,000; and Other assets at Br 400,000 of Donald Company:
Current assets (600,000 + 500,000) ..........................................Br. 1,100,000

Plant assets (1,800,000 +1,400,000) .............................................. 3,200,000
Other assets ((400,000 +400,000) .....................................................800,000
Goodwill .......................................................................................740,000
Current liabilities (400,000 +300,000) .............................................................700,000
Long-term Debt (500,000+ 200,000) ...............................................................700,000
Investment in Lamson and Donald Co common stock (4,440,000)…………4,440,000
Fair value of net of assets of Lamson Br 2, 800,000-900,000=1,900,000

Fair value of net assets of Donald Br 2,300,000-500,00= 1,800,000
Fair value of net assets of both company (1,900,000+1,800,000) = 3,700,000
Total cost of investment ( ………….............................................. ……….Br 4,440,000

Less: Fair value of net assets of both company (1,900,000+1,800,000) = 3,700,000
Amount of Goodwill ............................................................................... Br 740,000
Comparisons across the Purchase and Acquisition Methods

To illustrate some of the differences across the purchase, and acquisition methods, assume that on January 1,
Archer, Inc., acquired Baker Company in exchange for 10,000 shares of its $1.00 par common stock having a
fair value of $1,200,000 in a transaction structured as a merger. In connection with the acquisition, Archer
paid $25,000 in legal and accounting fees. Also, Archer agreed to pay the former owners additional cash
consideration contingent upon the completion of Baker’s existing contracts at specified profit margins. The
current fair value of the contingent obligation was estimated to be $150,000.
Purchase Method Applied
Archer’s valuation basis for its purchase of Baker is computed and allocated as follows:
Fair value of shares issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,200,000

Direct combination costs (legal and accounting fees) . . . . . . . . . . . . 25,000
Cost of the Baker purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,225,000
Cost allocation:
Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,000
Internet domain name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Licensing agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Research and development expense . . . . . . . . . . . . . . . . . . . . . . . 200,000
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,000)
Total net fair value of items acquired . . . . . . . . . . . . . . . . . . . . . 1,005,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 220,000
Note the following characteristics of the purchase method from the above schedule.
 The valuation basis is cost and includes direct combination costs, but excludes the contingent
consideration.
 The cost is allocated to the assets acquired and liabilities assumed based on their individual fair values
(unless a bargain purchase occurs and then the long-term items may be recorded as amounts less than their
fair values).
 Goodwill is the excess of cost of the fair values of the net assets purchase.
 Acquired in-process research and development is expensed immediately at the purchase date.
Acquisition Method Applied

According to the acquisition method, Archer’s valuation basis for its acquisition of Baker is
computed as follows:
Fair value of shares issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,200,000
Fair value of contingent performance obligation . . . . . . . . . . . . . . . . 150,000
Total consideration transferred for the Baker acquisition . . . . . . . . . . $1,350,000
Cost allocation:
Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,000
Internet domain name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Licensing agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Research and development asset . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,000)
Total net fair value of items acquired . . . . . . . . . . . . . . . . . . . . . 1,005,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 345,000
Note the following characteristics of the acquisition method from the above entry.
• The valuation basis is fair value of consideration transferred and includes the contingent consideration, but
excludes direct combination costs.
• The assets acquired and liabilities assumed are recorded at their individual fair values.
• Goodwill is the excess of the consideration transferred over the fair values of the net assets acquired.
• Acquired in-process research and development is recognized as an asset.
• Professional service fees to help accomplish the acquisition are expensed.
The following table compares the amounts from Baker that Archer would include in its combination-date
consolidated financial statements under the pooling of interests method, the purchase method, and the
acquisition method.
EXERCISE
Problem 1:
Tweedy Corporation is contemplating the purchase of the net assets of Sylvester Corporation in
anticipation of expanding its operations. The balance sheet of Sylvester Corporation on December 31, 20X1,
is as follows:
Sylvester Corporation
Balance Sheet
December 31, 20X1
Current assets: Current liabilities:
Notes receivable Br.24,000 Accounts payable Br.45,000
Accounts receivable 56,000 Accrued liabilities 12,500
Inventory 31,000 Debt maturing in one year 10,000
Other current assets 18,000 Total current liabilities Br. 67,500
Total current assets Br.129,000
Investments 65,000
Fixed assets: Other liabilities:
Land Br.32,000 Long-term debt Br.248,000
Building. 245,000 Payroll & related liabilities 156,000
Equipment. 387,000
Total fixed assets 664,000 Total other liabilities 404,000
Intangibles: Stockholders’ equity:
Goodwill Br.45,000 Common stock Br.100,000
Patents 23,000 Paid-in capital in excess of 250,000
par
Trade names 10,000 Retained earnings 114,500
Total intangibles 78,000 Total equity 464,500
Total assets Br.936,000 Total liabilities and equity Br.936,00
0
An appraiser for Tweedy determined the fair values of the assets and liabilities to be as follows:
ASSETS LIABILITIES
Notes receivable Br. 24,000 Accounts payable Br. 45,000
Accounts 56,000 Accrued liabilities 12,500
receivable
Inventory 30,000 Debt maturing in one year 10,000
Other current assets 15,000 Long-term debt 248,000

Investments 63,000 Payroll and related 156,000
liabilities
Land 55,000
Building. 275,000
Equipment. 426,000
Goodwill —
Patents 20,000
Trade names 15,000
The agreed-upon purchase price was Br. 580,000 in cash. Direct acquisition costs paid in cash totaled Br.
20,000.
Required:
Using the above information, prepare the entry on the books of Tweedy Corporation to purchase the net
assets of Sylvester Corporation on December 31, 20X1, using purchase method and acquisition method
Problem 2:
HT Corporation is contemplating the acquisition of the net assets of Smith Company on
December 31, 20X1. It is considering making an offer, which would include a cash payout of
Br.290,000 along with giving 10,000 shares of its Br. 2 par value common stock that is currently
selling for Br. 20 per share. The balance sheet of Smith Company is given below, along with
estimated fair values of the net assets to be acquired.
Smith Company
Balance Sheet
December 31, 20X1
Book Value Fair Liabilities and Stockholders’ Book Value Fair Value
Assets Value equity
Current assets: Current liabilities:
Notes receivable Br. 33,000 Br. 33,000 Accounts payable Br. 63,000 Br. 63,000
Inventory 89,000 80,000 Taxes payable 15,000 15,000
Prepaid expenses 15,000 15,000 Interest payable 3,000 3,000
Totalcurrent assets Br. 137,000 Br.128,000 Totalcurrent liabilities Br. 81,000 Br. 81,000
Investments Br. 36,000 Br. 55,000
Fixed assets: Other liabilities:
Land Br. 15,000 Br. 90,000 Bonds payable Br. 250,000 Br.250,000
Building. 115,000 170,000 Discount on bonds payable (18,000) (30,000)
Equipment. 256,000 250,000
Vehicles 32,000 25,000
Total fixed assets Br. 418,000 Br.535,000 Total other liabilities Br. 232,000 Br.220,000
Intangibles: Stockholders’ equity:

Franchise Br. 56,000 Br. 70,000 Common stock Br. 50,000
Paid-in capital in excess of par 200,000
Retained earnings 84,000
Total equity Br. 334,000
Total assets Br. 647,000 Br.788,000 Total liabilities and equity Br. 647,000
Required:

Prepare the entry on the books of HT Corporation to record the acquisition of Smith Company using
acquisition method.

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AU Advanced Financial Accounting II Lecture Note 2023

CHAPTER THREE BUSINESS COMBINATIONS

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METHOD OF ACCOUNTING FOR BUSINESS COMBINATIONS

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Example1: Acquisition of Accounting for Merger, with Goodwill

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Book value Fair value

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Total cost of Mason Company ………………………………Br400,000

Recognising identifiable assets and liabilities

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To record consolidation of Lamson corporation and Donald company as a purchase

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Professional services expense……………………………........................... 110,000

Current assets (600,000 + 500,000) ..........................................Br. 1,100,000

Fair value of net of assets of Lamson Br 2, 800,000-900,000=1,900,000

Total cost of investment ( ………….............................................. ……….Br 4,440,000

Comparisons across the Purchase and Acquisition Methods

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Acquisition Method Applied

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Intangibles: Stockholders’ equity:

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