ACCT 113: HO# 01

(PFRS 3: Statutory Merger and Statutory Consolidation)

BUSINESS COMBINATION- Creating a Single Economic Entity
The term business combination refers in general to any set of conditions in which two or more organizations are joined together
through common ownership.
PFRS 3 Revised
Business combination is a transaction or event in which an acquirer obtains control of one or more businesses. A business is
defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing
a return directly to investors or other owners, members or participants.
Scope of PFRS 3 Revised Formation of all type of joint arrangements (joint venture x
and joint operations)*
Acquisition of an asset (a group of assets) that is not a business x
Entities under common control x
Combinations involving mutual entities √
By contract alone (dual listing, stapling) √

x = not within the scope

√ = within the scope
*the scope exception only applies to the financial statements of the joint venture or joint operation itself and not the accounting
for the interest in a joint arrangement in the financial statements of a party to the joint arrangement.
Classification of BUSINESS COMBINATIONS
Business Combinations may be classified into three schemes:
1. Based on the structure of the combination.
2. Based on the method used to accomplish the combination.
3. Based on the accounting method used.
Structure of the Combination (Business Point of View)
Combinations are classified into four types:
1. Horizontal Integration – this type of combination is one that involves companies within the same industry that have been
previously competitors. A horizontal integration would occur if Shell Company and Petron Company, both integrated oil
companies, were to combine.

2. Vertical Integration – this type of combination take place between two companies involved in the same industry but at different
levels. It normally involves a combination of a company and its suppliers or customers. For example – a tire manufacturer and a
tire distributor; Bally Shoe Company (a manufacturer of shoes and Rustans Department Store)

3. Conglomerate Combination – is one involving companies in unrelated industries having little, if any, production or market
similarities for the purpose of entering into new markets or industries - such as a tire manufacturer and an insurance company.
3

4. Circular Combination - entails some diversification, but does not have a drastic change in operation as a conglomerate. For
example – San Miguel Corporation accomplished when they diversify their activities by putting up Magnolia Products.
Method of Combination (Legal Point of View)
Business combinations are also classified by method of combination into three types – statutory mergers, statutory
consolidations, and stock acquisition.
A Statutory Merger results when one company acquires all the net assets (assets and liabilities) of one or more other companies
through an exchange of stock, payment of cash or other property, or the issue of debt instruments (or a combination of these
methods). The acquiring company survives (remains in existence), whereas the acquired company (or companies) ceases to
exist as a separate legal entity, although it may be continued as a separate division of the acquiring company.

Thus, if A Company acquires B Company in a statutory merger, the combination is often expressed as:
A Company + B Company = A Company
Or, if B Company acquires A Company:
A Company + B Company = B Company
The Board of Directors of the companies involved, normally negotiate the terms of a plan of merger, which must be approved by
the stockholders of each company involved.
A Statutory Consolidation results when a new corporation is formed to acquire the net assets (assets and liabilities) two or more
other corporations. The acquired company, then cease to exist as separate legal entities. For example, if C Company is formed
to consolidate A Company and B Company, then the combination is generally expressed as follows:
A Company + B Company = C Company
Stockholders of the acquired companies (A and B) become stockholders in the new entity (C). The acquired companies may be
operated as separate divisions of the new corporation, just as they may under a statutory merger. Statutory consolidation
requires the same type of stockholders approval as in statutory mergers.
The use of the term consolidation should not be confused with the accounting usage of the same word . In accounting,
consolidation refers to the mechanical process of bringing together the financial records of two or more organizations to form a
single set of statements. Statutory consolidation is a legal term used to denote a specific type of business combination in which
two or more existing companies are united under the ownership of a newly created company.
A Stock Acquisition occurs when one corporation pays cash or issues stock or debt for all part of the voting stock of another
company, and the acquired companies remained intact as a separate legal entity. If the acquiring company acquires more than
50% of the voting stock of the acquired company, for example, if A Company acquires 75% of the voting stock of B Company, a
parent-subsidiary relationship results. Consolidated financial statements (explained in later topics) are prepared and the business
combination is often expressed as:
Financial Statements of A Co. + Financial Statements of B. Co.
=
Consolidated Financial Statements of A Co. and B Co.
The stock may be acquired through market purchases or through direct purchase from, or exchange with, individual stockholders
of the subsidiary company. Sometimes stock is acquired through a tender offer, which is an open offer to purchase up to a stated
number of shares of a given corporation at a stipulated price per share . The offering price is generally set somewhat above the
current market price of the shares in order to provide an additional incentive to prospective sellers. The investee or subsidiary
company continues its legal existence and the investor or parent company records its acquisition in its records as a long-term
investment.
Although business combination is a broad term encompassing all forms of combination and the terms merger and consolidation
and stock acquisition have technical, legal definitions, the three terms are often used interchangeably in practice . Thus, one
cannot always rely on the accuracy of the term used to identify the type of combination, but, must look to the facts of the situation
to determine its accounting treatment.
Method of Accounting for Business Combinations
The acquisition method is used for all business combinations. The pooling of interests method is prohibited.
Acquirer must be identified. Under PFRS No. 3, an acquirer must be identified for all business combinations.
Identification of an Acquirer
Control. The acquirer is the combining entity that obtains control of the other combining entities or businesses. PFRS No. 3
provides considerable guidance for identifying the acquirer.
Other indicators of which party was the acquirer in any given business combinations are as follows (these are suggestive only,
not conclusive):
1. The fair value of one entity is significantly greater than that of the other combining enterprises; in such a case, the larger entity
would be deemed the acquirer.
2. The combination is effected by an exchange of voting stock for cash; the entity paying the cash would be deemed to be the
acquirer.
3. Management of one enterprise is able to dominate selection of management of the combined entity; the dominant entity would
be deemed to be the acquirer.

Recognizing and Measuring Goodwill and Gain from a Bargain Purchase

As a result of the PFRS 3 Revised, the way in which goodwill or a gain on a bargain purchase is calculated has changed, being
the difference between:
I. The sum of:
 the fair value of the consideration transferred
 the recognized amount of any non-controlling interest in the acquire
 for a business combination achieved in stages, the fair value of any previously held equity interest in the acquiree; and

II. The acquisition-date recognized fair value amount of the identifiable assets acquired and liabilities assumed.
Goodwill arises when I exceed II, under:
 Option 1: “Full” Goodwill Method – there is a non-controlling interest share in the goodwill.
 Option 2: “Partial/Proportionate Basis” Goodwill Method – there is no non-controlling interest share in the goodwill.

Bargain purchase arises when II exceeds I. When a bargain purchase (as previously defined) occurs, a gain on acquisition is
recognized in the profit or loss. While this is consistent with the pronouncement of PFRS 3 (old) under Option 2, the amount
recognized may differ, due to the other changes in the PFRS 3 Revised (new) which may also allow Option 1. It is under Option
(1) where there is an inconsistency of recognition of gain, wherein any excess that remains is recognized as a gain, which is
attributable only to the acquirer (or parent company).
Before concluding that bargain purchase (or discount on acquisition) has arisen, however, PFRS No. 3 requires that the acquirer
shall:
1. reassess the identification and measurement of the acquiree's identifiable assets, liabilities, and contingent liabilities and the
measurement of the cost of the combination; and
2. recognize immediately in profit or loss any excess remaining after that reassessment.

Consideration transferred
For the purposes of applying the acquisition method, the fair value of the consideration transferred in exchange for the acquirer’s
interest in the acquiree is calculated as the sum of:
a. the acquisition-date fair values of the assets transferred by the acquirer, liabilities assumed or incurred by the acquirer, and
equity interests issued by the acquirer. Examples include cash, other assets, contingent consideration, a business or a
subsidiary of the acquirer, common or preferred equity instruments, options, warrants, and member interests of mutual entities;
and

b. the acquisition-date fair value of any non-controlling equity investment in the acquiree that the acquirer owned immediately
before the acquisition date.

The consideration transferred may include assets or liabilities of the acquirer that have carrying amounts that differ from their fair
values at the acquisition date (for example, non-monetary assets or a business of the acquirer). In that case, the acquirer shall
remeasure those transferred assets or liabilities to their fair values as of the acquisition date and recognize any gains or losses in
profit or loss. However, if those assets or liabilities are transferred to the acquiree and, therefore, remain within the combined
entity after the business combination, the acquirer shall eliminate any gains or losses on those transferred assets or liabilities in
the consolidated financial statements.
The acquisition-date fair value of the consideration transferred , including the fair value of each major class of consideration, such
as:
1. Cash or other monetary assets. The fair value is the amount of cash or cash equivalent dispersed. The amount is usually
readily available.
2. For deferred payment, the fair value to the acquirer is the amount the entity would have to borrow to settle their debt
immediately. Hence, the discount rate used is the entity’s incremental borrowing rate.
3. Non-monetary assets. These consist of assets such as property, plant and equipment, investments, licenses and patents. If
active second-hand market price exists, fair values can be obtained by reference to those markets. Where active markets do not
exist, other means of valuation, including the use of expert valuers, may be used.
4. 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.

5. Debt instruments/Liabilities undertaken. The fair values of liabilities undertaken are best measured by the present value of
future cash outflows. As noted in PFRS 3, future losses or other costs expected to be incurred as a result of the business
combination are not liabilities of the acquirer and are therefore not included in the calculation of the fair value of consideration
paid. These must be treated as post-combination expenses.
6. Contingent consideration. The acquirer shall recognize the acquisition-date fair value of contingent consideration. PFRS 3
Revised has formally defined contingent consideration as additional consideration by the acquirer to the former owners (or return
of consideration from the former owners). Changes that are the result of the acquirer obtaining additional information about facts
and circumstances that existed at the acquisition date, and that occur within the measurement period (which may be a maximum
of one year from the acquisition date), are recognized as adjustments against the original accounting for the acquisition (and so
may impact goodwill). Changes resulting from events after the acquisition date are not measurement period adjustments. Such
changes are therefore accounted for separately from the business combination.
Costs and Expenses of Business Combination
The PFRS 3 Revised states that Examples Treatment
acquisition-related costs are costs
incurred by the acquirer to effect a
business combination, including
reimbursements to the acquiree for
bearing some of the acquisition costs,
except costs of issuing debt
instruments are accounted for under
PFRS 9, and costs of issuing equity
instruments are accounted for under
PAS 32, shall be accounted for as
expenses in the periods in which they
are incurred. They are summarize as
follows: Acquisition-related costs
1. Directly attributable costs professional fees paid to accountants, legal Expenses
advisers, valuers, and other consultants
(finders and brokerage fees) to effect the
combination.
2. Indirect acquisition costs general and administrative costs, including Expenses
the costs of maintaining an internal
acquisitions department (management
salaries, depreciation, rent, and costs
incurred to duplicate facilities) and other
costs of which cannot be directly attributed
to the particular acquisition
3. Costs of issuing securities (issue and transaction costs such as stamp duties, Debit to APIC/Share Premium Account
register stocks)* professional adviser’s fees, underwriting
costs and brokerage fees may be incurred
*Similarly, the cost of arranging (registering) and issuing debt securities or financial liabilities are an integral part of the liability
issue transaction (Bond Issue Costs).
Allocating the cost of the business combination
Par. 36 of PFRS 3 includes the following statements:
“The acquirer shall measure and recognize as of the acquisition date the assets acquired and liabilities assumed as part of the
business combination. The identifiable assets acquired and liabilities assumed shall be measured at fair value and recognized
separately from goodwill.”
Recognition of Acquired Assets and Liabilities
The allocation of acquired assets and liabilities measurement which is at fair value occurs at acquisition date. The allocation
requires the recognition of:
1. Identifiable Tangible Assets. An asset other than an intangible asset is recognized if it is probable (probability test) that any
associated future economic benefits will flow to the acquirer, and its fair value can be measured reliably (reliability test).
2. Identifiable Intangible Assets. PFRS 3 Revised requires the acquirer to recognize identifiable assets acquired regardless of the
degree of probability of an inflow of economic benefits. This change emphasizes the expectation that all intangible assets that
satisfy the definition criteria in PAS 38, if acquired as part of a business combination, must be recognized.

An intangible asset is identifiable if it:

 can be separated; or
 meets the contractual-legal criterion e.g. license to operate a nuclear power plant is an intangible asset, even though the
acquirer cannot sell or transfer the license separately from the acquired power plant.

The acquirer shall recognize, separately from goodwill, the acquisition-date fair value of intangible assets acquired in a business
combination that meet the definition of an intangible asset in PAS 38.

Examples that would meet the definition of Intangible Assets:

a. Marketing-related intangible assets:
- trademarks, trade names, service marks, collective marks and certification marks
- internet domain names
- trade dress – unique color, share or package design
- newspaper mastheads
- non-competition assets
b. Customer-related intangible assets:
- customer lists
- order or production backlog
- customer contracts and the related customer relationships
- non-contractual customer relationships
c. Artistic-related intangible assets:
- plays, operas and ballets
- books, magazines, newspapers and other literary works
- musical works such as compositions, song lyrics, and advertising jingles
- pictures and photographs
- video and audiovisual material, including films, music videos, and television programs
d. Contract-based intangible assets
- licensing, royalty, and standstill agreements
- advertising, construction, management, service or supply contracts
- lease agreements
- construction permits
- franchise agreements
- operating and broadcasting rights
- use rights such as drilling, water, timber-getting and route authorities
- servicing contracts such as mortgage servicing contracts
- employment contracts priced below their market value
e. Technology-based intangible contracts
- Patented and unpatented technology
- computer software and mask works
- databases
- trade secrets such as secret formulas, processes or recipes
3. Liabilities. A liability other than a contingent liability is recognized if it is probable that an outflow of resources will be required
to settle the obligation, and its fair value can be measured reliably.
4. Contingent Liabilities. PFRS No. 3 Revised requires recognition of a contingent liability (of the acquiree) assumed in a
business combination will be recognize at their fair values if it is a present obligation that arises from past events and its fair
value can be measured reliably, regardless of the probability of a cash flow arising.