UNIVERSITY OF SANTO TOMAS – LEGAZPI

COLLEGE OF BUSINESS, MANAGEMENT, AND ACCOUNTANCY

ADVANCED ACCOUNTING PART II MARK FRANCIS G. NG, CPA, MBA

LECTURE

6 BUSINESS COMBINATION – STATUTORY MERGER

BUSINESS COMBINATIONS

POINTERS:

Introduction
A business combination occurs when a corporation and one or more other businesses are brought together as a single entity
to carry on the activities of the previously separated enterprises.
It is the result of the acquiring of control of one or more enterprise by another enterprise, or the union of ownership
interests of two or more entities.
Definition of Business Combination (IFRS 3)
A business combination is the bringing together of separate entities or businesses into one reporting entity.
Legal Point of View
From the legal point of view, business combinations are classified as follows:
1. Acquisition of Assets – The acquiring corporation must negotiate with management to obtain the assets (and assume the
liabilities) of the company being acquired in exchange for cash, securities, or other consideration. Upon consummation, the
acquired company ceases to exist as a separate economic, legal and accounting entity. The surviving corporation records in
its books the assets and liabilities of the acquired company. Note that this results in automatic consolidation for the current
and subsequent periods, since the assets and liabilities of both companies are recorded in the same set of books.
Acquisition of assets and assumption of liabilities may either be:
a. Statutory Merger – when two or more corporation merge into a single entity which shall be one of the constituent
corporation. In other words, one constituent corporation acquires the other constituent corporations and retains
their original identity, while the acquired corporations are automatically dissolved. It may be expressed as follows:
A Corp. + B Corp. = A Corp. or B Corp.
b. Statutory Consolidation – when two or more consolidate and form a new corporation from then on. It may be
expressed as follows:
A Corp. + B Corp. = Z Corp.
2. Stock Acquisition or Acquisition of Common Stock – an acquiring corporation may acquire majority ownership interest
of outstanding common stock or control of a corporation and the separate legal entities of each enterprise are preserved or
they both continue their legal existence. In this case, the acquiring corporation is known as the parent and the acquired
corporation as subsidiary.
For financial reporting purposes, however, the two companies may be viewed as a single reporting entity, in accordance
with PAS no. 27; this created the need for consolidated financial statements.
It may be expressed as follows:
Financial Statement of P Corp. + Financial Statement of S Corp.
= Consolidated Financial Statement of P Corp. and S Corp.
Cost and Expenses
The consideration transferred in a business combination is the total fair values at the acquisition date of the consideration given by
the acquirer. The consideration transferred may take a number of forms, such as:
§ Cash or other asset given up
§ Liabilities assumed
§ Issuance of equity instruments (common shares)
Any costs incurred by the acquirer to achieve the business combination, such as legal and professional fees, should not form part of
the consideration transferred: instead should be recognized in profit or loss in the period in which they are incurred.
Costs which have been incurred in issuing debt or equity securities should be deducted from the carrying amount of the equity or
liability.
Steps in recording Business Combination
1. Determine the difference between the total acquisition costs and the fair value of the net identifiable assets acquired
(excluding goodwill)

a. If total acquisition cost is greater than the net identifiable assets acquired, the excess is recognized as goodwill (to
undergo test of impairment periodically)

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 b. It total acquisition costs is less than the net identifiable assets acquired, income from acquisition is recognized
2. Record assets and liabilities acquired at fair market value
3. Record acquisition costs
4. Record cost to issue and register, if equity securities were issued by debiting the amount to APIC

IFRS 3 – EVOLUTION OF ACCOUNTING TREATMENTS

ACCOUNTING TREATEMENT OLD/OLD OLD/NEW NEW

(PRIOR TO 2008) (2008-2010 VERSION) (CURRENT VERSION)
COST OF INVESTMENT Cash paid Cash paid Cash paid
FV of shares FV of shares FV of shares
Contingent consideration Contingent consideration Contingent consideration
Direct costs Direct costs DC – expensed outright
MODE OF ACQUISITION Purchase of Interest Purchase of Interest ONLY Purchase of Interest ONLY
Pooling of Interest
ACCOUNTING METHOD Cost Method Cost Method Cost Method
Equity Method
STOCK ISSUANCE COSTS CHARGED AGAINST APIC CHARGED AGAINST APIC CHARGED AGAINST APIC
INDIRECT COSTS EXPENSED EXPENSED EXPENSED

SHORTCUT PROCEDURES:
NOTES:
Cost of Investment (COI) xx
Consideration given: shares at FV
§ always determine first if there is
cash paid
any goodwill or income from
contingent consideration
acquisition
Fair value of Net Assets xx
Goodwill (Income from Acquisition) xx
§ other acquisition-related costs,
whether direct or indirect, are
CS – acquirer xx expensed, except stock issuance
Additional issuance – at par xx costs
TOTAL CS AFTER BUSINESS COMBINATION xx
NEW UPDATE ON
STOCK ISSUANCE COSTS
APIC – acquirer xx
APIC from additional issuance xx § stock issuance costs are deducted
Stock issuance costs (xx) following the new order of priority:
TOTAL APIC AFTER BUSINESS COMBINATION xx
(1) APIC from additional issuance;
(2) APIC – original; and
RE - acquirer xx (3) RE (for the portion that cannot
Income from acquisition xx be absorbed in full by APIC)
Stock issuance costs (not absorbed by APIC) (xx)
All expenses (xx) § for purposes of problem solving, all
TOTAL RE AFTER BUSINESS COMBINATION xx expenses including stock issuance
cost are assumed to be paid in
BV - acquirer xx cash
FV - acquiree xx
Contingent consideration xx § contingent consideration is only
recognized when it is probable and
TOTAL LIABILITIES AFTER BUSINESS COMBINATION xx
measurable
BV - acquirer xx
FV - acquiree xx
Goodwill xx
All cash paid (xx)
TOTAL ASSETS AFTER BUSINESS COMBINATION xx

CS after combination xx
APIC after combination xx
RE after combination xx
TOTAL SE AFTER BUSINESS COMBINATION xx

or:

SE of acquirer before combination xx

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Issuance of CS at FV xx
Stock issuance costs (xx)
Income from acquisition xx
All expenses (xx)
TOTAL SE AFTER BUSINESS COMBINATION xx

ILLUSTRATIVE PROBLEMS:

Problem 1
A condensed balance sheet on August 31, 20Y1 and related current fair value data for ABC Company are presented below:

ABC Company
Balance Sheet
August 31, 20Y1

Carrying Amount Fair Value

Assets:
Current assets P736,000 P809,000
Plant assets 1,185,000 1,380,000
Patent (net) 117,000 96,000
Total Assets P2,038,000
Liabilities and Stockholders’ Equity:
Current Liabilities P215,000 P215,000
Long-term debt 560,000 595,000
Capital sock, P20 par 420,000
Retained earnings 843,000
Total Liabilities and Stockholders’ Equity P2,038,000

Case I: Assume the following:

On September 1, 20Y1, XYZ Corporation issued 17,800 shares of its P29 par value common stock (current fair value P45 per share) and
P502,000 cash for the net assets of ABC Company. Of the P385,000 out-of-pocket costs paid by XYZ on September 1, 20Y1, P163,000
were indirect cost and the remainder were legal fees and finders' fees related to the business combination. Stock issuance cost
amount to P80,000. Assume the following data for XYZ Company:
Book Value Fair Value
Total Assets P5,000,000 P7,000,000
Total Liabilities 3,000,000 3,000,000
CS (P29 par) 290,000
APIC 910,000
RE 800,000
Compute the following:
§ Goodwill/ Income from acquisition
§ Total CS after combination
§ Total APIC after combination
§ Total RE after combination
§ Total Liabilities after combination
§ Total Assets after combination
§ Total SE after combination

Case II: Assume the following:

On September 1, 20Y1, XYZ Corporation issued 20,000 shares of its P29 par value common stock (current fair value P45 per share) and
P502,000 cash for the net assets of ABC Company. Of the P385,000 out-of-pocket costs paid by XYZ on September 1, 20Y1, P163,000
were indirect cost and the remainder were legal fees and finders' fees related to the business combination. Stock issuance cost
amount to P400,000. Also, there was a contingent consideration of P100,000. Assume the following data for XYZ Company:
Book Value Fair Value
Total Assets P5,000,000 P7,000,000
Total Liabilities 3,000,000 3,000,000
CS (P29 par) 290,000
APIC 910,000
RE 800,000

Compute the following:

§ Goodwill/ Income from acquisition
§ Total CS after combination
§ Total APIC after combination
§ Total RE after combination
§ Total Liabilities after combination
§ Total Assets after combination
§ Total SE after combination

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SOLUTIONS – Case I

Cost of Investment P1,303,000

(17,800 shs. X P45 fair value) + P502,000 cash
FV of NA acquired (1,475,000)
Income from acquisition (P172,000)

CS – acquirer P290,000
Additional issuance – at par 516,200
(17,800 shs. X P29)
TOTAL CS AFTER BUSINESS COMBINATION P806,200

APIC – acquirer P910,000

APIC from additional issuance 284,800
17,800 shs. X (P45 – P29)
Stock issuance costs (80,000)
TOTAL APIC AFTER BUSINESS COMBINATION P1,114,800

RE - acquirer P800,000
Income from acquisition 172,000
Stock issuance costs (not absorbed by APIC) -
All expenses (385,000)
TOTAL RE AFTER BUSINESS COMBINATION P587,000

BV - acquirer P3,000,000
FV - acquiree 810,000
Contingent consideration -
TOTAL LIABILITIES AFTER BUSINESS COMBINATION P3,810,000

BV - acquirer P5,000,000
FV - acquiree 2,285,000
Goodwill -
All cash paid (967,000)
(P502,000 + P385,000 + P80,000)
TOTAL ASSETS AFTER BUSINESS COMBINATION P6,318,000

CS after combination P806,200

APIC after combination 1,114,800
RE after combination 587,000
TOTAL SE AFTER BUSINESS COMBINATION P2,508,000

Total Assets after Business Combination P6,318,000

Total Liabilities after Business Combination 3,810,000
TOTAL SE AFTER BUSINESS COMBINATION P2,508,000

SE of acquirer before combination P2,000,000

(P290,000 + P910,000 + P800,000)
Issuance of CS at FV 801,000
(17,800 shs. X P45 FV)
Stock issuance costs (80,000)
Income from acquisition 172,000
All expenses (385,000)
TOTAL SE AFTER BUSINESS COMBINATION P2,508,000

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SOLUTIONS – Case II

Cost of Investment P1,502,000

(20,000 shs. X P45 fair value) + P502,000 cash + P100,000 contingent consideration
FV of NA acquired (1,475,000)
Goodwill P27,000

CS – acquirer P290,000
Additional issuance – at par 580,000
(20,000 shs. X P29)
TOTAL CS AFTER BUSINESS COMBINATION P870,000

APIC – acquirer P910,000

APIC from additional issuance 320,000
20,000 shs. X (P45 – P29)
Stock issuance costs (400,000)
TOTAL APIC AFTER BUSINESS COMBINATION P830,000

RE - acquirer P800,000
Income from acquisition -
Stock issuance costs (not absorbed by APIC) -
All expenses (385,000)
TOTAL RE AFTER BUSINESS COMBINATION P415,000

BV - acquirer P3,000,000
FV - acquiree 810,000
Contingent consideration 100,000
TOTAL LIABILITIES AFTER BUSINESS COMBINATION P3,910,000

BV - acquirer P5,000,000
FV - acquiree 2,285,000
Goodwill 27,000
All cash paid (1,287,000)
(P502,000 + P385,000 + P400,000)
TOTAL ASSETS AFTER BUSINESS COMBINATION P6,025,000

CS after combination P870,000

APIC after combination 830,000
RE after combination 415,000
TOTAL SE AFTER BUSINESS COMBINATION P2,115,000

Total Assets after Business Combination P6,025,000

Total Liabilities after Business Combination 3,910,000
TOTAL SE AFTER BUSINESS COMBINATION P2,115,000

SE of acquirer before combination P2,000,000

(P290,000 + P910,000 + P800,000)
Issuance of CS at FV 900,000
(20,000 shs. X P45 FV)
Stock issuance costs (400,000)
Income from acquisition -
All expenses (385,000)
TOTAL SE AFTER BUSINESS COMBINATION P2,115,000

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Problem 2 – Multiple Acquirees
Balance Sheets reflecting uniform accounting procedures, as well as fair values, that are to be used as a basis for the combination are
prepared on September 1, 2007 as follows:

A B C
Assets P5,250,000 P6,800,000 P900,000

Liabilities P3,950,000 P2,650,000 P530,000

Capital stock (all P10 par) 1,700,000 1,200,000 275,000
Additional paid-in capital 500,000 140,000
Retained earnings (deficit) (400,000) 2,450,000 (45,000)

Total Liabilities and Stockholders’ Equity P5,250,000 P6,800,000 P900,000

A Company shares have a market price of P16. A market price is not available for shares of B Company and C Company since stocks of
these companies are closely held. A Company acquires all of the assets and assumes all of the liabilities of B Company and C Company
by issuing in exchange 265,000 shares of its stock to B Company and 17,000 shares of its stock to C Company.

How much is the increase in capital stock as a result of the business combination?
How much is the retained earnings (deficit) immediately after the business combination?

SOLUTIONS – Multiple Acquirees

* for multiple acquirees, compute good will or income from acquisition SEPARATELY per acquiree

INCREASE IN CS (282,000 shs. X P10 par) P2,820,000

FOR ACQUIREE B
Cost of Investment (265,000 shs. X P16) P4,240,000
FV of NA acquired (4,150,000)
Goodwill P90,000

FOR ACQUIREE C
Cost of Investment (17,000 shs. X P16) P272,000
FV of NA acquired (370,000)
Income from acquisition (P98,000)

RE before combination (P400,000)

Income from acquisition 98,000
RE after combination (P302,000)

Problem 3
JKL Co. merged into LMN Co. on June 30, 2007. In exchange for the net assets at fair market value of JKL Co. amounting to P7,487,200, LMN
issued 172, 000 common shares at P29 par value, then going at a market price of P43 per share. Relevant data on stockholders' equity
immediately before the combination show:
LMN JKL
Common stock P9,350,000 P3,580,000
APIC 4,022,000 1,624,000
Retained earnings/ (deficit) (1,016,000) 859,000

Out of pocket costs of the combination were as follows:

Legal fees:
For contract of business combination P49,000
For SEC registration 32,500
Accounting fees for SEC registration 20,200
Printing costs of stock certificates 11,100
Finder’s fee 29,000
CPA audit fees for SEC registration 36,400
Accountant’s fee for pre-acquisition audit 22,000
Other indirect cost 7,800
Contingent consideration (probable and can be reasonably estimated) 10,600
General and allocated expenses 13,900
Listing fees in issuing new shares 16,000

What amount should LMN capitalize as the cost of acquiring JKL's net assets?
How much is the stockholders' equity immediately following the business combination?
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SOLUTIONS:

Identify first the treatment of costs as to whether they are:

- Expensed
- Stock Issuance Cost
- Capitalized as COI

Legal fees:
For contract of business combination P49,000 EXPENSED
For SEC registration 32,500 STOCK ISSUANCE COST
Accounting fees for SEC registration 20,200 STOCK ISSUANCE COST
Printing costs of stock certificates 11,100 STOCK ISSUANCE COST
Finder’s fee 29,000 EXPENSED
CPA audit fees for SEC registration 36,400 STOCK ISSUANCE COST
Accountant’s fee for pre-acquisition audit 22,000 EXPENSED
Other indirect cost 7,800 EXPENSED
Contingent consideration (probable and can be reasonably estimated) 10,600 CAPITALIZED AS COI
General and allocated expenses 13,900 EXPENSED
Listing fees in issuing new shares 16,000 STOCK ISSUANCE COST

TOTAL EXPENSES P121,700

TOTAL STOCK ISSUANCE COST P116,200

172,000 shs. X P43 P7,396,000

Contingent consideration 10,600
Cost of Investment P7,406,600

Cost of Investment P7,406,600

FV of NA (given in the problem) (7,487,200)
Income from acquisition (P80,600)

SE of acquirer before combination P12,356,000

Issuance of CS at FV 7,396,000
(172,000 shs. X P43 FV)
Stock issuance costs (116,200)
Income from acquisition 80,600
All expenses (121,700)
TOTAL SE AFTER BUSINESS COMBINATION P19,594,700

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