Since 1977
PRACTICAL ACCOUNTING 2 P2.707- Business Combination
DE LEON/DE LEON OCTOBER 2009
LECTURE NOTES THE NATURE OF BUSINESS COMBINATIONS Occurs when one entity gains control over another entity either through the acquisition of net assets (must be 100%), or the acquisition of common shares (more than 50% of outstanding). Business combination requires the bringing together of businesses into a reporting entity. A reporting entity can be a single entity (acquisition of net assets), or a group comprising a parent and all of its subsidiaries (acquisition of shares). The business combination occurs from the stand point of the acquirer. All business combinations must use the purchase method. Pooling of interest method is no longer permitted. GENERAL STEPS UNDER THE PURCHASE METHOD OF ACCOUNTING FOR THE BUSINESS COMBINATION 1. Identify an acquirer 2. Measure the cost of the business combination at fair value. 3. Measure the fair values of the net assets acquired/assumed together with contingent liabilities that qualify for recognition. 4. Allocate the cost of business combination to the net assets (including contingent liabilities) acquired and assumed. 5. These steps result in determining the existence of any goodwill and excess on combination which must be accounted for. These are the required procedures under IFRS 3, the standard that governs all business combinations. SPECIFIC REQUIREMENTS OF IFRS 3 a. The use of the purchase method b. An acquirer to be identified c. The measurement of the cost of a combination d. The allocation of the cost of combination to the acquired assets and assumed liabilities and contingent liabilities. e. The assets, liabilities and contingent liabilities to be measured initially at fair value. f. Goodwill acquired to be recognized g. That goodwill not to be amortized but tested for impairment annually h. That any excess on combination be accounted for by a reassessment of the assets and liabilities acquired and, where appropriate, by recognizing any excess immediately in profit and loss. i. Disclosures of information that enable users to evaluate the nature and effect of business combinations effected in the current period and previous periods, as well as post balance-sheet dates. j. Disclosure of information that enable users to evaluate changes in the carrying amount of goodwill. ACCOUNTING FOR COST OF BUSINESS COMBINATION The acquirer shall measure the cost of business combination as the aggregate of a. The fair values at the date of exchange of assets given, liabilities incurred or assumed and equity
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b.
instruments issued by the acquirer in exchange for control of the acquiree; plus Contingent costs of guarantees made, if measurable and probable at the date of acquisition on: (1) market value of the shares issued; and/or (2) amount of net income sustained over a specified period.
ACCOUNTING TREATMENT ON SOME SPECIFIC COST ITEMS 1. Cash or other monetary assets. The fair value of the cash and cash equivalents dispersed is usually readily determinable. But if the settlement is deferred to a time subsequent to the exchange date the fair value of that deferred component shall be the present value at the date of exchange. 2. Non- monetary assets. These consist of assets such as property, plant and equipment, investments, licenses and patents. The acquirer is effectively selling the non-monetary asset to the acquiree. Hence it is earning revenue equal to the fair value on the sale of the assets and realizing a gain or incurring a loss if the carrying amount differs from the fair value. 3. 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. 4. Liabilities undertaken – the fair value of the liabilities undertaken are best measured by the present value of future cash flows. Note that expected future losses and cost, as a result of the combination are not liabilities of the acquirer and therefore not included in the calculation of the fair value of consideration paid. 5. Contingencies - Where the business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the acquirer shall include the amount of that adjustment in the cost of the combination at the acquisition date if the adjustment is probable and can be measured reliably. 6. Directly attributable costs; it includes costs such as professional fees paid to accountants, legal advisers, valuers and other consultants to effect the combination. Also included in the cost category are finders fees and brokerage fees. These costs are now no longer capitalized and are treated as expenses similar to indirect costs. 7. Other cost that are not directly attributable to the business combination are a. Cost to issue and register the shares issued by the acquirer are treated as a reduction in the total fair value of the shares issued and are recognized in equity and b. In direct acquisition costs are recognized as expenses. ALLOCATING THE COST OF BUSINESS COMBINATION: 1. Identifiable tangible assets: are recognized if it is probable that any associated future economic benefits will flow to the acquirer; and its fair value can be measured reliably 2. Intangible assets: are recognized if it’s fair value can be measured reliably. Note that, unlike tangible
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P2.707
EXCEL PROFESSIONAL SERVICES, INC.
3.
4.
assets there is no probability test only a reliability test. Liabilities – are recognized if it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and its fair value can be measured reliably. Contingent assets and liabilities Contingent assets – not yet recognized under phase I of IFRS 3
Contingent liabilities – the only test for recognition of contingent liabilities is the reliability test, the probability test is assumed to be met because the fair value measurement takes the probability factors into consideration. Hence, contingent liabilities not recognized in the records of the acquiree may be recognized in the records of the acquirer as a result of the business combination. - done -
STRAIGHT PROBLEMS PRTC Company acquired the net assets of CARD Enterprises on August 1, 2009. The carrying and fair values of Card Enterprises at the date of acquisition date follows:
Cash Accounts receivable Merchandise Inventory Land Plant and Property Patent Total assets Accounts Payable Bank Loan Payable Long-term-debt Capital Stock APIC Retained Earnings Total Equities
Carrying Value P207000 40,000 60,000 150,000 300,000 60,000 P 630,000 P30,000 220,000 180,000 120,000 20,000 60,000 P630f000
Fair Value P20,000 35,000 65,000 170,000 280,000 65.000 P 635,000 P30,000 220,000 150,000
PRTC issued the following considerations in exchange for the net assets of CARD. 1. 50,000, P1 par shares of PRTC Company. Fair value P1.50 at August 1, 2009. 2. PRTC agreed to pay additional cash consideration for the value of any decrease in the share price below P1.50 for the 50,000 shares issued. The guarantee is for 90 days and is to expire on October 30, 2009. PRTC believes there was only a 15% chance the price of the shares would fall to P1.45 during the guarantee period. 3. Cash of P80,000; P30,000 to be paid on date of exchange and the balance in one year's time. The incremental borrowing rate of PRTC is 10% per annum. 4. CARD Enterprises was currently being sued by an enraged client; the company's lawyers believe there's an 90% chance it will win the case. The expected damages in the event CARD lost the case is P30,000. 5. An old-model Toyota delivery van carried in the books of PRTC at P150,000, net of P30,000 accumulated depreciation. The fair value at the date of the exchange is P100,000. In addition to the purchase consideration PRTC had an out-of-pocket costs of P8,520 for direct acquisition cost; P2,000 for issuing and registering the shares; and P1,500 indirect cost. Required: 1. Prepare a schedule for the determination of the cost of combination. 2. Prepare a schedule for the computation of the fair value of the net assets. 3. Determine goodwill or excess from the business combination, and
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4. Prepare journal entries to record the acquisition of the net assets in the books of PRTC. Problem 2 (Purchase method) The P Company purchased the net assets of S Company which has the following balance sheet on the purchase date: S Company Balance Sheet December 31, 2009 Cash P100,000 Accounts payable P85,000 Accounts Bonds payable 200,000 receivable 155,000 Inventory Capital stock, 390,000 P 10 par 300,000 Building, net 750,000 APIC 480,000 Equipment, net 360,000 Retained earnings 735,000 Goodwill 45,000 _________ Total P1,800,000 Total P1,800,000 The following market values have been secured for the assets and liabilities of S Company: Inventory Building Equipment Bonds payable P Company incurred the following expenses: Direct acquisition costs (legal fees for business combination and brokerage fees) Indirect costs and general expenses
P 425,000 600,000 300,000 225,000 costs and
45,000 15,000
Required: On P's books (acquiring company) record the purchase of the net assets of S Company: a. Assume the purchase price: is P 1,500,000 b. Assume that P Company issued 10,000 of its own shares, P100 par value stock with market value of P124.50. In addition to the costs and expenses incurred above, the company incurred the following out-of-pocket costs for stock issuance and registration, P 20,500 Problem 3 The following summarized balance sheets were prepared for the Gold and Diamond Corporation on December 31, 2009. Assets Current Assets Land Buildings (net) Goodwill TOTAL Liabilities & Equity Accounts payable Bonds payable
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Gold P350,000 80,000 325,000 120,000 P875,000 P 115,000 170,000
Diamond P185,000 25,000 250,000 100,000 P560,000 P
85,000 150,000
P2.707
EXCEL PROFESSIONAL SERVICES, INC. Common stock, P 10 par Paid-in Capital in excess of par Retained earnings TOTAL
150,000 200,000 240,000 P 875,000
75,000 40,000 210,000 P 560,000
Gross profit Expenses Net income
1,100,000 400,000 P700,000
The appraised values of the Diamond Corporation land and buildings are P50,000 and P350,000 respectively. Gold will issue 15,250 shares of its P10 par common stock with a market value of P20 each for the net assets of Diamond Corporation. Gold will also pay P5,000 in cash for direct acquisition costs.
Cash Inventories Plant and (net) Goodwill Total Assets
Balance Sheet P220,000 380,000 equipment 800,000 200,000 P1,600,000
Required: 1. Entries on the books of Gold Corporation 2. Balance sheet of Gold Corporation immediately after the combination
Accounts payable Common stock (P12 par) Common stock (P 4 par) Additional paid-in capital Retained earnings Total liabilities and stockholders' equity
Problem 4 Acquirer Company issued 9000 shares of its P12 par common stock (P50 market value) in exchange for the net assets of Acquiree Company on December 31, 2009. In addition, Acquirer Company paid cash for the costs below relating to the acquisition of Acquiree Company (costs have not been recorded by Acquirer Company). Registration and issue costs of securities Fees of outside accountants
P 50,000 30,000
Financial statements for Acquirer Company and Acquiree Company just prior to the combination on December 31, 2009 (fiscal year-end), are as follows:
Sales Cost of goods sold
Income Statement Acquirer Acquiree Company Company P1,900,000 P500,000 800,000 300,000
P100,000 900,000
200,000 80,000 P120,000 P80,000 30,000 220,000 50,000 P380,000 P120,000
100,000 500,000
80,000 20,000 160,000
P1,600,000
P380,000
Additional information: The combination is to be treated as a merger with Acquiree Company liquidating and Acquiree assuming all assets and liabilities of Acquiree Company. All of the assets and liabilities of Acquiree Company were fairly valued except for plant and equipment, which had a fair value of P300,000. Required: a. Prepare the entries on the books of Acquirer Company to record the acquisition of the net assets of Acquiree Company. b. Prepare the December 31, 2009 income statement and balance sheet for Acquirer Company after the merger.
MULTIPLE CHOICE Ang Company issued 120,000 shares of its P25 par common stock for the net assets of Chan Corporation in a business combination completed on March 1, 2010. Chan Corporation’s net assets are worth P3,800,000 at FMV. Out of pocket costs of the combination were as follows:
Total P 97,000 2. If the business combination is treated as a purchase, the acquisition cost of the combination will be: a. P3,097,000 c. P3,017,000 b. P3,080,000 d. P3,000,000
Legal fees Contingent consideration (highly probable & measurable) Printing costs of stock certificates Finder’s fees Professional fees paid to a CPA Fees paid to company lawyers Fees paid to company accountants
Motolite Corporation issues 500,000 shares of its own P1 par common stock for the net assets of Oriental Enterprises in a merger consummated on July 1, 2009. On this date, Motolite stock is quoted at P10 per share. Balance sheet data for the two companies at July 1, 2009, just before combination, are as follows:
26,000 18,000 8,500 27,000 21,000 23,450 38,900
The goodwill from the business combination is P418,000. 1. How much is the FMV per share of Ang Company at March 1, 2010? a. P 25 c. P 30 b. P 40 d. P 35 FEU Corporation issued 100,000 shares of P20 par common stock for all the outstanding stock of UE Enterprises in a business combination consummated on August 1, 2009. FEU Corporation common stock was selling at P30 per share at the time the business combination was consummated. Out-of-pocket costs of the business combination were as follows: Finder's fee Accountant's fee (advisory) Legal fees (advisory) Printing costs SEC registration costs and fees
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P 50,000 10,000 20,000 5,000 12,000
Current Assets Plant Assets Total Assets
Motolite P18,000,000 22,000,000 P40,000,000
Oriental P1,500,000 6,500,000 P8,000,000
Liabilities Common stock, P10 par Additional paid-in capital Retained earnings Total equities
P12,000,000 20,000,000 3,000,000 5,000,000 P40,000,000
P2,000,000 3,000,000 1,000,000 2,000,000 P8,000,000
Motolite also paid finder’s fees of P50,000 and legal fees of P10,000; as well as indirect costs of 40,000. 3.
The retained earnings on the combined balance sheet after the combination will be: a. P4,960,000 c. P4,900,000 b. P5,000,000 d. P7,000,000
NOP Corp. is to acquire QRS Co. by absorbing all the assets and assuming all the liabilities of the latter
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P2.707
EXCEL PROFESSIONAL SERVICES, INC. company, in exchange for shares of stocks of the former. Below are the balance sheets of the two companies with the corresponding appraised value increment for QRS. Parties agree to use the appraised values against which the fair market value of the shares will be matched. Assets per books Asset increase per appraisal Liabilities Capital stock APIC Retained earnings (deficit) Total Equities
4.
NOP P4,000,000 1,500,000 (no par) 2,000,000 700,000 (200,000) P4,000,000
QRS P2,500,000 300,000 800,000 (P100 par) 1,000,000 300,000 400,000 P2,500,000
The stocks of NOP Corp. is currently selling at P100 per share. The number of shares to be issued to QRS by NOP is a. 20,000 c. 13,000 b. 17,000 d. 10,000
The following balance sheets were prepared for ABC Company and DEF Company on January 1, 2009, just before the entered into a business combination. Cash Accounts receivable Merchandise inventory Building and equipment Accumulated
ABC Company Book Value Fair Value 150,000 150,000
DEF Company Book Value Fair Value 10,000 10,000
150,000
150,000
40,000
40,000
400,000
600,000
100,000
245,000
800,000
870,000
200,000
250,000
depreciation Goodwill Total assets Accounts payable Bonds payable Common stock – P 10 par Additional paidin capital Retained earnings Total Liab. & SE
(200,000) ________ P1,300,000
_______ P1,770,000
( 50,000) 100,000 P400,000
_______ P545,000
100,000
100,000
140,000
140,000
400,000
440,000
60,000
85,000
300,000
P5 par 100,000
100,000
20,000
400,000
80,000
P 400,000
P1,300,000
ABC Company acquired the net assets of DEF Company by issuing 10,000 shares of stocks. Additional cash payments made by ABC Company in completing the acquisition were: Broker’s fee paid to firm that located DEF Company Cost to register and issue stocks Professional fees paid to accountants Professional fees paid to lawyers Professional fees paid to official valuers Indirect acquisition cost 5.
P10,000 40,000 20,000 20,000 20,000 15,000
Assuming the stocks issued by ABC Company has a market price of P40, how much is the total assets after the business combination? a. P 1,720,000 c. P 1,870000 b. P 1,800,000 d. P 1,145,000
- end of P2.707 - - now do the classroom drill -
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P2.707
