Tutorial - Chapter 25 – Business Combinations Q A PDF

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Chapter 25 – Business Combinations 1.

What is meant by a “business combination”?

AASB 3/IFRS 3 Appendix A: A business combination is defined as:  A transaction or other event in which an acquirer obtains control of one or more businesses. A business is then defined as:  “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.” Para B7 of AASB 3/IFRS 3 identifies three elements of a business being inputs, processes and outputs.

2.

Discuss the importance of identifying the acquisition date.

Acquisition date is the date on which the acquirer obtains control of the acquiree. Important because on this date:  the fair values of the identifiable assets acquired and liabilities assumed are measured.  the fair value of the consideration transferred is measured  the goodwill or gain on bargain purchase is calculated. 4.

Explain the key components of “core” goodwill.

Core goodwill has two main components: (i) Going concern goodwill: relates to the net assets of the acquiree, in that the acquiree’s net assets together are worth more than the net assets separately, caused by the synergy created by the acquiree’s net assets within the acquiree as a going concern. (ii) Combination goodwill: relates to the extra benefits accruing because of the synergy created by the acquirer and the acquiree combining together eg if the raw materials available to the acquiree are of particular use to the acquirer. These benefits could affect the recorded earnings of the acquirer or the acquiree [or both] depending on the nature of the benefits.

6.

How is an acquirer identified?

Para 6: For each business combination, one of the combining entities shall be identified as the acquirer.

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Appendix A: The acquirer is the entity that obtains control of the acquiree. Appendix A: Control is the power to govern the financial and operating policies of the acquiree so as to obtain benefits from its activities. Determination of the acquirer requires judgement. Paragraphs B13-B18 of AASB 3/IFRS 3 provides indicators/guidelines to assist in this judgement:  Form of consideration: did one entity transfer cash or other assets for the shares of the other? [para B14]; did one entity issue its own equity interests in exchange for another entity’s equity interests? [para B15] Was there a premium paid by one of the entities? [para B16(e)]  Subsequent management: which entity’s management subsequently controls the business combination? What are the relative voting rights after the business combination? [para B15(a)] What is the composition of the senior management of the combined entity? [para B15(d)]  Large minority voting interest: The acquirer normally holds the largest minority voting interest in the combined entity. [para B15(b)]  Predator or target: which entity initiated the combination? [B17]  Relative size of the businesses: is the fair value of one entity significantly greater than another? [para B16] Large entities normally takeover small entities.

8.

How is the consideration transferred calculated?

AASB 3/IFRS 3 para 37 states that the consideration transferred shall be  Measured at fair value, determined at acquisition date, and  Calculated as the sum of the fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer, and the equity interests issued by the acquirer.

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Exercise 25.1

Accounting by an acquirer

On 1 July 2020, Sonic Ltd acquired the following assets and liabilities from Screwdriver Ltd.

Land Plant (Cost $400 000) Inventories Cash

Carrying Fair value amount 300 000 350 000 280 000 290 000 80 000 85 000 15 000 15 000

Accounts payable Loans

20 000 80 000

20 000 80 000

In exchange for these assets and liabilities, Sonic Ltd issued 100 000 shares that had been issued for $1.20 per share but at 1 July 2020 had a fair value of $6.50 per share. Required 1. Prepare the journal entries in the records of Sonic Ltd to account for the acquisition of the assets and liabilities of Screwdriver Ltd. 2. Prepare the journal entries assuming that the fair value of Sonic Ltd shares was $6 per share. (LO6)

1. Acquisition analysis: Consideration transferred 100 000 shares at $6.50 each Net fair value of identifiable assets and liabilities acquired: Land Plant Inventories Cash

Accounts payable Loans Net assets Goodwill $650 000 - $640 000

$650 000

$350 000 290 000 85 000 15 000 740 000 20 000 80 000 100 000 $640 000 $10 000

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1. Journal entries: Sonic Ltd, FV of shares = $6.50: Dr Dr Dr Dr Dr Cr Cr Cr

Land Plant Inventories Cash Goodwill Accounts payable Loans Share capital

350 000 290 000 85 000 15 000 10 000 20 000 80 000 650 000

2. Journal entries: Sonic Ltd, FV of shares = $6.00: Consideration transferred: 100 000 x $6 Fair value of acquiree’s net assets (as above) Gain on bargain purchase Dr Dr Dr Dr Cr Cr Cr Cr

Land Plant Inventories Cash Accounts payable Loans Share capital Gain on bargain purchase

$600 000 $640 000 $40 000 350 000 290 000 85 000 15 000 20 000 80 000 600 000 40 000

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Exercise 25.2 Accounting by an acquirer Russell Ltd acquired all the assets and liabilities of Davies Ltd on 1 July 2021. At this date, the assets and liabilities of Davies Ltd consisted of:

In exchange for these net assets, Russell Ltd agreed to: • issue 10 Russell Ltd shares for every Davies Ltd share — Russell Ltd shares were considered to have a fair value of $10 per share; costs of share issue were $500 • transfer a patent to the former shareholders of Davies Ltd — the patent was carried in the records of Russell Ltd at $350 000 but was considered to have a fair value of $1 million • pay $5.20 per share in cash to each of the former shareholders of Davies Ltd. Russell Ltd incurred $10 000 in costs associated with the acquisition of these net assets. Required 1. Prepare an acquisition analysis in relation to this acquisition. 2. Prepare the journal entries in Russell Ltd to record the acquisition at 1 July 2021. (LO6)

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RUSSELL LTD – DAVIES LTD 1. Acquisition analysis: Consideration transferred: Shares: 100 000 x 10 x $10 Patent Cash: 100 000 x $5.20

$10 000 000 1 000 000 520 000 $11 520 000

Fair value of identifiable assets and liabilities acquired: Current assets Non-current assets

$980 000 4 220 000 5 200 000 500 000 $4 700 000

Liabilities Goodwill = $11 520 000 - $4 700 000 = $6 820 000 2. Journal entries for Russell Ltd: Patent Dr Gain Cr (Re-measurement as part of consideration transferred in a business combination) Current assets Non-current assets Goodwill Liabilities Share capital Patent Cash (Acquisition of Sound Ltd)

650 000 650 000

Dr Dr Dr Cr Cr Cr Cr

980 000 4 220 000 6 820 000

Acquisition-related expenses Dr Cash Cr (Payment of directly attributable costs)

10 000

Share capital Cash (Costs of issuing shares)

Dr Cr

500 000 10 000 000 1 000 000 520 000

10 000

500 500

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Exercise 25.7 Accounting for business combination by acquirer River Ltd and Song Ltd are two family-owned flax-producing companies in Queensland. River Ltd is owned by the Jones family and the Smith family owns Song Ltd. The Jones family has only one son and he is engaged to be married to the daughter of the Smith family. Because the son is currently managing Song Ltd, it is proposed that, after the wedding, he should manage both companies. As a result, it is agreed by the two families that River Ltd should take over the net assets of Song Ltd. The statement of financial position of Song Ltd immediately before the takeover is as follows.

The takeover agreement specified the following details. •

•

•

River Ltd is to acquire all the assets of Song Ltd except for cash, and one of the vehicles (having a carrying amount of $45 000 and a fair value of $48 000), and assume all the liabilities except for the loan from the Trevally Bank. Song Ltd is then to go into liquidation. The vehicle is to be transferred to Mr and Mrs Smith. River Ltd is to supply sufficient cash to enable the debt to the Trevally Bank to be paid off and to cover the liquidation costs of $5500. It will also give $150 000 to be distributed to Mr and Mrs Smith to help pay the costs of the wedding. River Ltd is also to give a piece of its own prime land to Song Ltd to be distributed to Mr and Mrs Smith, this eventually being available to be given to any offspring of the forthcoming marriage. The piece of land in question has a carrying amount of $80 000 and a fair value of $220 000.

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•

River Ltd is to issue 100 000 shares, these having a fair value of $14 per share, to be distributed via Song Ltd to the soon to-be-married-daughter of Mr and Mrs Smith, who is currently a shareholder in Song Ltd.

The takeover proceeded as per the agreement, with River Ltd incurring incidental costs of $25 000 and share issue costs of $18 000. Required Prepare the acquisition analysis and the journal entries to record the acquisition of Song Ltd in the records of River Ltd. (LO6)

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RIVER LTD – SONG LTD Acquisition analysis: Consideration transferred: Shares: Cash: Land:

100 000 x $14 per share $480 000 +$5500 +$150 000 - $20 000

$1 400 000 615 500 220 000 $2 235 500

Net fair value of identifiable assets and liabilities acquired: Accounts receivable Land Buildings Farm equipment Irrigation equipment Vehicles ($172 000 - $48 000)

$125 000 840 000 550 000 364 000 225 000 124 000 2 228 000 80 000 $2 148 000

Accounts payable

Goodwill:

$2 235 500 - $2 148 000 =

$87 500

The journal entries in River Ltd are: Land

Dr 140 000 Gain Cr 140 000 (Re-measurement as part of consideration transferred in a business combination) Accounts receivable Land Buildings Farm equipment Irrigation equipment Vehicles Goodwill Accounts payable Share capital Cash Land (Acquisition of net assets of Song Ltd)

Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

125 000 840 000 550 000 364 000 225 000 124 000 87 500

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

25 000

Share capital Cash (Share issue costs)

Dr Cr

18 000

80 000 1 400 000 615 500 220 000

25 000

18 000

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