Module 2 - Specific Cases PDF

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MODULE 2 – BUSINESS COMBINATION(SPECIFIC CASES)Introduction This module aims to provide students additional guidance for applying the acquisition method to particular types of business combinations.Learning Outcomes: a. Account for business combinations (a) accomplished through share-for-share excha...

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Week 2

MODULE 2 – BUSINESS COMBINATION (SPECIFIC CASES) Introduction This module aims to provide students additional guidance for applying the acquisition method to particular types of business combinations. Learning Outcomes: a. Account for business combinations (a) accomplished through share-for-share exchanges, (b) achieved in stages, and (c) achieved without transfer of consideration b. Explain the “measurement period” in relation to business combinations c. Distinguish what is part of a business combination and what is part of a “separate transaction” d. Account for settlement of pre-existing relationship between an acquirer and an acquiree

Lesson 1 – Specific Cases on Business Combination Business Combination can also be accomplished through share-for-share exchanges, achieved in stages and achieved without transfer of consideration.

Specific cases in Business Combination I.

Share-for-share exchanges ➢ Business combination accomplished through a mere exchange of equity interests between the acquirer and the acquiree. ➢ The general principle is that the consideration transferred is measured at fair value. ➢ However, there may be cases where the fair value of the acquiree’s equity interests may be more reliably measurable than the acquirer’s. In such cases, the acquirer computes for goodwill using the fair value of the acquiree’s equity interests instead of its own.

Illustration 1: On January 1, 2020, Popoy Co. and Basha Co. combined their businesses through exchange of equity instruments, which resulted to Popoy obtaining 100% interest in Basha. At the acquisition date , Popoy’s shares are quoted at

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Week 2 ₱100 per share. Popoy Co. recognized goodwill of ₱300,000 on the business combination. No acquisition-related costs were incurred. Additional information follows: Popoy Co.

Combined entity

(before acquisition)

(after acquisition)

Share capital

700,000

850,000

Share premium

300,000

1,150,000

1,000,000

2,000,000

Totals

Requirements: Compute for the following: a. Number of shares issued by Popoy Co. b. Par value per share of the shares issued c. Acquisition-date fair value of the net identifiable assets of Basha Solutions: Requirement (a): Number of shares issued The consideration transferred is in the form of shares. Accordingly, this is reflected on the increase in share capital and share premium: Popoy Co.

Combined entity

(before

(after acquisition)

Increase

acquisition) Share capital

700,000

850,000

150,000

Share premium

300,000

1,150,000

850,000

1,000,000

2,000,000

1,000,000

Totals

The fair value of the shares issued as consideration for the business combination is ₱1,000,000. Fair value of shares transferred Divided by: Popoy’s fair value per share Number of shares issued

1,000,000 100 10,000

Requirement (b): Par value per share Increase in share capital account Divided by: Number of shares issued Par value per share

150,000 10,000 15

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Requirement (c): Fair value of net assets acquired Consideration transferred

1,000,000

Non-controlling interest in the acquiree

-

Previously held equity interest in the acquiree

-

Total

1,000,000

Fair value of net identifiable assets acquired

(700,000)

Goodwill

II.

300,000

Business combination achieved in stages ➢ A business combination achieved in stages occurs when the acquirer obtains control of an acquiree in more than one transaction. Business combination achieved in stages is also called “step acquisition”. ➢ In business combination achieved in stages, the acquirer shall: A. Remeasure the previously held equity interest in the acquiree at its acquisition-date fair value; and B. Recognize the gain or loss on the remeasurement in: 1. Profit or loss – if the previously held equity interest was classified as FVPL, Investment in Associate, or Investment in Joint Venture. 2. Other comprehensive income – if the previously held equity interest was classified as FVOCI

Illustration: Business combination achieved in stages On January 1, 2016, Popoy Co. acquired 20% ownership interest in Basha Co. for ₱150,000. Popoy Co. classified the investment as “held for trading securities” (FVPL) in accordance with PFRS 9. On January 1, 2020, Popoy acquired additional 60% ownership interest in Basha for ₱950,000. Relevant information follows: a. The previously held 20% interest has a carrying amount of ₱190,000 on December 31, 2019 and fair value of ₱200,000 on January 1, 2020. b. Basha’s net identifiable assets have a fair value of ₱ 1,000,000. c. Popoy elected to measure NCI at proportionate share.

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Week 2 Requirement: Compute for the goodwill under each of the scenarios below. Solution: Consideration transferred

950,000

Non-controlling interest in the acquiree

200,000

Previously held equity interest in the acquiree

200,000

Total

1,350,000

Fair value of net identifiable assets acquired

(1,000,000)

Goodwill

350,000

Entries are as follows: Jan. 1, Held for trading securities 2020

10,000

Unrealized gain – P/L

10,000

To remeasure previously held equity interest to acquisition-date fair value Jan. 1, Investment in subsidiary 2020

950,000

Cash

950,000 To

recognize

the

newly acquired

shares Jan. 1, Investment in subsidiary 2020

200,000

Held for trading securities

200,000

To reclassify previously held equity interest

III.

Business combination achieved without transfer of consideration ➢ The acquisition method also applies to business combinations in which the acquirer obtains control without transferring any consideration. ➢ Examples of circumstances where the acquirer obtains control without transferring consideration: a. The acquiree repurchases a sufficient number of its own shares from other investors so that the acquirer will be able to obtain control. b. Minority veto rights lapse that previously kept the acquirer from controlling an acquiree in which the acquirer held the majority voting rights. 65 | P a g e

Week 2 c. The acquirer and acquiree agree to combine their businesses by contract alone. The acquirer neither transfers consideration nor holds equity interests in the acquiree. ➢ In business combination achieved without transfer of consideration, the acquisition-date fair value of the acquirer’s interest in the acquiree is substituted for the consideration transferred in computing for goodwill. ➢ In business combination achieved by contract alone, the interest held by parties other than the acquirer are attributed to NCI, even if the result is that NCI represents 100% interest in the acquiree.

Illustration 1: Without transfer of consideration As of December 31, 2019, Popoy Co. owns 40,000 shares out of the 100,000 outstanding ordinary shares of Basha Co. Popoy accounts for the investment under the equity method. On January 1, 2020, Basha reacquires 50,000 shares from other investors. Information on the acquisition date is as follows: a. The previously held 40% interest has a fair value of ₱200,000 b. Basha’s net identifiable assets have a fair value of ₱ 1,000,000 c. Popoy elects to measure NCI at proportionate share.

How much is the goodwill or gain on bargain purchase? Solution: Consideration transferred (1M x 80%)

800,000

Non-controlling interest in the acquiree (1M x 20%)

200,000

Previously held equity interest in the acquiree Total Fair value of net identifiable assets acquired Goodwill

1,000,000 (1,000,000) -

Illustration 2: By contract alone On January 1, 2020, Popoy Co. and Basha Co. enter into a contract whereby Popoy obtains control of Basha without any consideration to be transferred between the parties. The fair value of Basha’s net identifiable assets at acquisition date is ₱1,000,000. Popoy chose to measure NCI at proportionate share. How much is the goodwill or gain on bargain purchase? 66 | P a g e

Week 2 Solution: Consideration transferred Non-controlling interest in the acquiree Previously held equity interest in the acquiree Total Fair value of net identifiable assets acquired Goodwill

1,000,000 1,000,000 (1,000,000) -

Lesson 2 – Measurement Period ➢ If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the acquirer shall report in its financial statements provisional amounts for the items for which the accounting is incomplete. ➢ Measurement period is the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination. ➢ The measurement period provides the acquirer with a reasonable time to obtain the information necessary to identify and measure the following as of the acquisition date in accordance with the requirements of PFRS 3: a. The identifiable assets acquired and liabilities assumed b. Non-controlling interest in the acquiree c. Consideration transferred d. Previously held equity interest in the acquiree e. The resulting goodwill or gain on a bargain purchase A. During measurement period ➢ Should NOT exceed 1 year from the acquisition date ➢ the acquirer retrospectively adjusts the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date and, if known, would have affected the measurement of the amounts recognized as of that date. ➢ Any adjustments to a provisional amount is recognized as an adjustment to goodwill or gain on a bargain purchase.

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Week 2 ➢ measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable. B. After the measurement period ends ➢ Beyond the 12-month measurement period. ➢ Any information obtained after the measurement period ends, the acquirer shall revise the accounting for a business combination only to correct an error in accordance with PAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Illustration 1: Provisional amounts – identifiable assets acquired On September 30, 2019, Popoy Co. acquired the net identifiable assets of Basha Co. for ₱1,000,000. On this date, the fair values of Basha’s the identifiable assets and liabilities are ₱1,500,000 and ₱600,000, respectively. Assumption #1: Information obtained during the measurement period The assets acquired include a building was assigned a provisional amount of ₱500,000 because the appraisal is not yet complete by the time Popoy authorized for issue its December 31, 2019 financial statements. The building was tentatively assigned 5 years useful and was depreciated for 3 months in 2019 using the straight-line method.

On July 1, 2020, Popoy received the valuation report for the building. The building has a fair value on September 30, 2020 is ₱300,000 and its remaining useful life from that date is 5 years. Requirements: a. What is the measurement period? b. How should Popoy account for the new information obtained on July 1, 2020? c. How much is the adjusted goodwill? d. What are the adjusting entries?

Solution: Requirement (a): Measurement period The measurement period is from September 30, 2019 to September 29, 20 20, or if earlier, (i) the date Popoy Co. obtains the information it was seeking about the facts and circumstances that existed as of the acquisition date or (ii) the date Popoy Co. learns that more information is not obtainable.

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Week 2 Requirement (b): Accounting The provisional amount assigned to the building is retrospectively adjusted with a corresponding adjustment to goodwill. The 2019 financial statements are restated, including a retrospective adjustment to depreciation expense. Requirement (c): Adjusted goodwill Provisional Consideration transferred

Adjusted

1,000,000

1,000,000

Non-controlling interest in the acquiree

-

-

Previously held equity interest in the acquiree

-

-

Total

1,000,000

1,000,000

Fair value of net identifiable assets acquired

(900,000)

(700,000)

100,000

300,000

Goodwill

Requirement (d): Adjusting entries July 1, Goodwill 2020

200,000

Building

200,000

To record the adjustment to the provisional amount assigned to the building July 1, Accumulated depreciation 2020

10,000

Retained Earnings

10,000

To record the adjustment to 20 19 depreciation

Depreciation recognized (500K ÷ 5 years) x (3/12)

25,000

‘Should-be’ depreciation (300K ÷ 5 years) x (3/12)

15,000

Adjustment to depreciation expense for 2019

10,000

If monthly depreciation expenses were recognized during January to June 30, 2020, those shall be adjusted accordingly. Assumption #2: Information obtained beyond the measurement period On October 30, 2020, Popoy’s auditors discovered a patent with fair value of ₱50,000 was erroneously omitted from the valuation listing on September 30, 2019. The remaining useful life of the patent as of the acquisition date was 4 years.

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Week 2 How should Popoy account for the new information obtained on October 30, 2020? Solution: Because the new information is obtained after the measurement period, it will be accounted for under PAS 8 as correction of a prior period error. A correction of a prior period error is accounted for by retrospective restatement. Therefore, the adjusted amounts and correcting entries would be similar to those in Assumption #1 above. However, the note disclosures will vary because PAS 8 will be applied instead of PFRS 3. The correcting entries on the 2019 financial statements are as follows: Oct 30, Patent 2020

50,000 Goodwill

Oct 30, Retained earnings (50K ÷ 4yrs) X (3/12) 2020

50,000 3,125

Accumulated amortization

3,125

The omitted patent is recognized with a corresponding charge to goodwill because if Popoy had not committed the error, the correct amount of goodwill that should have been recognized on acquisition date is ₱50,000.

Illustration 2: Provisional amounts – consideration transferred On October 1, 20 19, Popoy Co., an unlisted entity, issued 10,000, ₱10 par value, shares in exchange for the net identifiable assets of Basha Co. Information on acquisition date: ➢ The shares issued were assigned a provisional amount of ₱100 per share ➢ The fair values of some of the assets acquired are not readily determinable. Accordingly, a provisional amount of ₱900,000 was assigned to Basha’s net identifiable assets. Information after the acquisition date: ➢ On March 1, 2020, new information was obtained indicating that, on October 1, 2019, ▪

The fair value of the shares issued was ₱120 per share; and

▪

The fair value of Basha’s net identifiable assets was ₱950,000

➢ On July 1, 2020 , two competitors of Popoy have also merged. This led Popoy to believe that the merger with Basha is not as profitable as expected. Popoy estimates that the valuations of the consideration transferred and Basha’s net identifiable assets should have been ₱500,000. 70 | P a g e

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How much is the goodwill or the gain on bargain purchase? Solution: Provisional Consideration transferred

Adjusted

1,000,000

1,200,000

Non-controlling interest in the acquiree

-

-

Previously held equity interest in the acquiree

-

-

Total

1,000,000

1,200,000

Fair value of net identifiable assets acquired

(900,000)

(950,000)

100,000

250,000

Goodwill

The new information obtained on July 1, 2020 is not a measurement period adjustment because it does not relate to facts and circumstances that have existed as at the acquisition date. However, this may indicate an impairment of goodwill.

Lesson 3 – Determine what is part of the business combination transaction ➢ The acquirer and the acquiree may have a pre‑existing relationship or other arrangement before negotiations for the business combination began, or they may enter into an arrangement during the negotiations that is separate from the business combination. In either situation, the acquirer shall identify any amounts that are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination. ➢ The acquirer shall recognize as part of applying the acquisition method only the consideration transferred for the acquiree and the assets acquired and liabilities assumed in the exchange for the acquiree. Separate transactions shall be accounted for in accordance with the relevant PFRSs. ➢ The acquirer considers the following when determining whether a transaction is part of a business combination or a separate transaction: a. The reasons for the transaction ➢ Understanding the reasons why the parties to the combination entered into a particular transaction or arrangement may provide insight into whether it is part of the consideration transferred and the assets acquired or liabilities assumed. ➢ For example, if a transaction is arranged primarily for the benefit of the acquirer or the combined entity rather than primarily for the 71 | P a g e

Week 2 benefit of the acquiree or its former owners is likely to be a separate transaction. The transaction price shall be excluded from the consideration transferred when computing for goodwill. b. Who initiated the transaction ➢ A transaction or other event that is initiated by the acquirer is likely for the benefit of the acquirer or the combined entity and, therefore, a separate transaction. c. The timing of the transaction ➢ A transaction between the acquirer and the acquiree that takes place during the negotiations of the terms of a business combination is more likely to be part of the business combination.

➢ The following are examples of separate transactions that are not to be included in applying the acquisition method: 1. Settlement of pre-existing relationships between the acquirer and acquiree; 2. Remuneration to employees or former owners of the acquiree for future services; and 3. Reimbursement to the acquiree or its former owners for paying the acquirer’s acquisition-related costs. Illustration: Popoy Co. acquired all the assets and liabilities of Basha Co. for ₱1,000,000. Basha’s assets and liabilities have fair values of ₱1,500,000 and ₱600,000, respectively. Additional information: a. Basha incurred ₱25,000 legal fees in processing the regulatory requirements for the combination. Popoy agreed to reimburse the said amount. b. Basha will terminate...