Business Combination - Millan PDF

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Summary

1. Introduction/OverviewThis module aims to provide students a comprehensive understanding and application of the proper accounting principles for the recognition and measurement relating to a business combination. It also provides the students with the comparison between the full Philippine Financi...

Description

1. Introduction/Overview This module aims to provide students a comprehensive understanding and application of the proper accounting principles for the recognition and measurement relating to a business combination. It also provides the students with the comparison between the full Philippine Financial Reporting Standard (PFRS) and the Philippine Financial Reporting Standard for Small and Medium-sized Entities (PFRS for SMEs).

2. Learning Outcomes 1. 2. 3. 4. 5. 6.

Define a business combination. Identify a business combination transaction. Explain briefly the accounting requirements for a business combination. Apply the proper accounting principle for business combination transaction. Compute for goodwill. Compare the difference between the full PFRS and PFRS for SMEs.

3. Business Combination (Recognition & Measurement) A business combination occurs when one company acquires another or when two or more companies merge into one. After the combination, one company gains control over the other. The company that obtains control over the other is referred to as the parent or acquirer. The other company that is controlled is the subsidiary or acquiree. PFRS 3 Business Combinations is the standard to be applied for business combination transactions to improve the relevance, reliability, and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. 3.1. PFRS 3 defines the following: A. Business combination •

the transaction or other events in which an acquirer obtains control of one or more businesses

B. Business •

An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities

C. Acquisition Date • •

The date on which the acquirer obtains control of the acquire

D. Acquirer •

The entity that obtains control of the acquiree

E. Acquiree •

The business or businesses that the acquirer obtains control of in a business combination

3.2. Business Combination is carried out either through: A. Asset acquisition o o

1.

Merger ▪ ▪

2.

Acquirer purchases assets and assumes liabilities in exchange for cash or non-cash consideration Under the Revised Corporation Code of the Philippines, a business combination effected through asset acquisition may be either:

Occurs when two or more companies merge into a single entity which shall be one of the combining companies. A Co. + B Co. = A Co. or B Co.

Consolidation occurs when two or more companies consolidate into a single entity which shall be the consolidated company ▪ A Co. + B Co. = C Co. ▪

B. Stock acquisition o o o o

Acquirer obtains control over the acquire by acquiring a majority ownership interest in the voting rights of the acquire (generally more than 50%). Acquirer is known as the parent while the acquiree is known as the subsidiary. After the business combination, both companies retain their separate legal existence and continue to maintain their own separate accounting books. For financial reporting purposes, both the parent and subsidiary are viewed as a single reporting entity.

C. A business combination may also be described as: 1.

Horizontal combination ▪ ▪

A business combination of two or more entities with similar businesses (e.g., a bank acquires another bank).

2.

Vertical combination ▪

3.

A business combination of two or more entities operating at a different level in a marketing chain (e.g., a manufacturer acquires its supplier of raw materials)

Conglomerate ▪

A business combination of two or more entities with dissimilar businesses (e.g., a real estate developer acquires a bank)

3.3. Advantages and Disadvantages of a Business Combination Advantages of a business combination A. Competition is eliminated or lessened o

A competition between the combining constituents with similar business is eliminated while the threat of competition from other market participants is lessened

B. Synergy o

C.

Synergy occurs when the collaboration of two or more entities results in greater productivity than the sum of the productivity of each constituent working independently. It can be simplified by the expression 1 + 1 = 3

Increased business opportunities and earnings potential o

Business opportunity and earnings potential may be increased through:

1. An increased variety of products or services available and a decreased dependency on a limited number of products and services; 2. Widened dispersion of products or devices and better access to new markets; 3. Access to either of the acquirer’s or acquiree’s technological know-how, research and development, secret processes, and other information. 4. Increased investment opportunities due to increased capital; or 5. Appreciation in worth due to an established trade name by either one of the combining constituents D. Reduction of operating costs o

Operating costs of the combined entity may be reduced.

1. Under a horizontal combination, operating costs may be reduced by the elimination of unnecessary duplication of costs

2. Under a vertical combination, operating costs may be reduced by the elimination of costs of negotiation and coordination between the companies and mark-ups on purchases. E. Combinations utilize economies of scale o o

Economies of scale refer to the increase in productive efficiency resulting from the increase in the scale of production. An entity that achieves economies of scale decreases its average cost per unit as production is increased because fixed costs are allocated over an increased number of units produced.

F. Cost savings on business expansion o

The cost of business expansion may be lessened when a company acquires another company instead of putting up a branch.

G. Favorable tax implications o o

Deferred tax assets may be transferred in a business combination. Business combinations effected without transfers of considerations may not be subjected to taxation.

Disadvantages of a business combination 1. The business combination brings a monopoly in the market which may have a negative impact on society. This could result in an impediment to healthy competition between market participants. 2. The identity of one or both of the combining constituents may cease, leading to loss of sense of identity for existing employees and loss of goodwill. 3. Management of the combined entity may become difficult due to incompatible internal cultures, systems, and policies. 4. The business combination may result in over-capitalization which may result in diffusion in market price per share and attractiveness of the combined entity’s equity instruments to potential investors. 5. The combined entity maybe subjected to stricter regulation and scrutiny by the government, most especially if the business combination poses threat to consumers’ interests.

3.4. PFRS 3 Business Combinations PFRS 3 outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition or merger). Such business combinations are accounted for using the ‘acquisition method’, which generally requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date. As defined in PFRS 3, the business combination is a transaction or other event in which the acquirer obtains control of one or more businesses. Essential Elements in the definition of Business Combination: A. Control o

o o

As provided in PFRS 10, “an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.” Control is normally presumed to exist when the acquirer holds more than 50% interest in the acquiree’s voting interest. Control can also be obtained when:

1. The acquirer has the power to appoint or remove the majority of the board of directors of the acquiree; or 2. The acquirer has the power to cast the majority of votes at board meetings or equivalent bodies within the acquiree; or 3. The acquirer has power over more than half of the voting rights of the acquiree because of an agreement with other investors; or 4. The acquirer controls the acquiree’s operating and financial policies because of a law or an agreement. o

An acquirer may obtain control of an acquiree in a variety of ways, for example: 1. By transferring cash or other assets; 2. By incurring liabilities; 3. By issuing equity interests; 4. By providing more than one type of consideration; or 5. Without transferring consideration, including by contract alone.

B. Business o

o

As defined by PFRS 3, 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. A business has the following three elements:

1.

2.

3.

Input ▪

any economic resource that results to an output when one or more processes are applied to it

▪

any system, standard, protocol, convention or rule that when applied to an input, creates an output

▪

the result of input and process that provides investment returns to the stakeholders of the business

Process

Output

3.5. Determining whether a transaction is a business combination (Is it a business combination or not?) Any investor who acquires some investment needs to determine whether this transaction or event is a business combination or not. PFRS 3 requires that assets and liabilities acquired need to constitute a business, otherwise it’s not a business combination and an investor needs to account for the transaction as a regular asset acquisition in line with other PFRS.

The three elements of a business should be considered to determine if the transaction is a business combination.

4. Accounting for Business Combination

Business combinations are accounted for using the acquisition method. PFRS 3 provides that, applying this method requires the following steps: 1. Identifying the acquirer; 2. Determining the acquisition date; 3. Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and 4. Recognizing and measuring goodwill or a gain from a bargain purchase. 4.1. Step 1: Identifying the acquirer • •

The acquirer is the entity that obtains control of the acquiree. PFRS 3 provides the following guidance in identifying the acquirer:

1. In a business combination effected primarily by transferring cash or other assets or by incurring liabilities ▪

2.

the acquirer usually the entity that transfers the cash or other assets or incurs liabilities.

In a business combination effected primarily by exchanging equity interests ▪ ▪ ▪

the acquirer is usually the entity that issues its equity interests. if it is a reverse acquisition, the issuing the entity is the acquiree. Other pertinent facts and circumstances shall also be considered in identifying the acquirer in a business combination effected by exchanging equity interests including the following:

a. Whose owner, as a group, have the largest portion of the voting rights of the combined entity. b. Whose a single owner or organized group of owners holds the largest minority voting interest in the combined entity. c. Whose owners have the ability to appoint or remove a majority of the members of the governing body of the combined entity d.

Whose (former) management dominates the management of the combined entity

e. That pays a premium over the pre-combination fair value of the equity interests of the other combining entity or entities. 3.

As to size ▪

The acquirer is usually the combining entity whose relative size is significantly greater than that of the other combining entity or entities

4.

In a business combination involving more than two entities ▪

5.

The acquirer is usually the one who initiated the combination.

In a business combination wherein a new entity is formed ▪

The acquirer is identified as follows:

a. If a new entity is formed to issue equity interests to effect a business combination, one of the combining entities that existed before the business combination shall be identified as the acquirer by applying the guidance provided above. b. In contrast, a new entity that transfers cash or other assets or incurs liabilities as consideration may be the acquirer

4.2. Step 2: Determining the Acquisition Date • •

•

The acquirer shall identify the acquisition date, which 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 acquirer might obtain control on a date that is either earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. An acquirer shall consider all pertinent facts and circumstances in identifying the acquisition date.

4.3. Step 3: Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree A. Acquired assets and liabilities Recognition Principle ▪

On acquisition date, the acquirer recognizes, separately from goodwill the identifiable assets acquired, the liabilities assumed and any non-controlling interest (NCI) in the acquiree.

Recognition Conditions a. Identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities provided under the Conceptual Framework at the acquisition date. b. It must be part of what the acquirer and acquiree exchanged in the business combination transaction rather than the result of separate transactions. c. Applying the recognition principle may result to the acquirer recognizing assets and liabilities that the acquiree had not previously recognized in its financial statements

Classifying identifiable assets acquired and liabilities assumed ▪

Identifiable assets acquired and liabilities assumed are classified at the acquisition date in accordance with other PFRSs that are to be applied subsequently

Measurement Principle The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values. ▪ Separate valuation allowances are not recognized at the acquisition date because the effects of uncertainty about future cash flows are included in the fair value measurement. ▪ All acquired assets are recognized regardless of whether the acquirer intends to use them. ▪

B. Non-controlling Interest o o

o

1.

As provided in PFRS 3, non-controlling interest (NCI) or “minority interest” is the equity in a subsidiary not attributable, directly or indirectly, to a parent. For example, there is no NCI when an investor acquires 100% share in a company because the investor owns the subsidiary’s equity in full. But, when an investor acquires 75% (less than 100%), then 25% is NCI. For each business combination, the acquirer measures any non-controlling interest in the acquiree either at:

Fair value; or

2. The NCI’s proportionate share of the acquiree’s identifiable net assets. 4.4. Step 4: Recognizing and measuring the goodwill •

•

• •

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that is not individually identified and separately recognized. On acquisition date, the acquirer computes and recognizes goodwill or gain on a bargain purchase using the following formula:

A negative amount resulting from the formula is called “gain on a bargain purchase” (also referred to as “negative goodwill”) On the acquisition date, the acquirer recognizes a resulting:

a. Goodwill as an asset b.

Gain on bargain purchase as gain in profit or loss ▪

Before recognizing, the acquirer shall reassess to ensure that the measurements appropriately reflect consideration of all available information as of the acquisition date. (Application of the concept of conservatism)

▪

If the gain on a bargain purchase remains after reassessment, the acquirer shall recognize the resulting gain in profit or loss on the acquisition date. The gain shall be attributed to the acquirer.

A. Consideration Transferred o

The consideration transferred is measured at fair value, which is the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree and the equity interests issued by the acquirer.

Examples of potential forms of consideration include: 1. 2. 3. 4. 5. 6.

Cash other assets a business or a subsidiary of the acquirer contingent consideration ordinary or preference equity instruments, options, warrants member interests of mutual entities.

Additional concepts on consideration transferred ▪

▪

▪

The consideration transferred in a business combination includes only those that are transferred to the former owners of the acquiree. It excludes those that remain within the combined entity. Assets and liabilities transferred to the former owners of the acquiree are remeasured to acquisition-date fair values. Any remeasurement gain or loss is recognized in profit or loss. Assets and liabilities remain within the combined entity are not remeasured but rather ignored when applying the acquisition method.

B. Acquisition-related costs o

These are costs the acquirer incurs to effect a business combination.

Examples: 1. Finder’s fees 2. Professional fees, such as advisory, legal, accounting, valuation and consulting fees 3. General administrative costs, including the costs of maintaining an internal acquisitions department 4. Costs of registering and issuing debt and equity securities

o

Acquisition-related costs are expenses when they are incurred, except the cost to issue debts or equity securities which shall be recognized in accordance with PAS 32 and PFRS 9:

1. Costs to issue debt securities measured at amortized costs are included in the initial measurement of the resulting financial liability. 2. Costs to issue equity securities are deducted from share premium. If the share premium is insufficient, the issue costs are deducted from retained earnings. C. Previously held equity interest in the acquiree o

This pertains to any interest held by the acquirer before the business combination. This affects the computation of goodwill only in a business combination achieved in stages (discussed in the next module)

4.5. Illustration

4.5. Illustrations<...