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FINANCIAL ACCOUNTING Business combinations: purchase method of accounting Chapter 25 Unit 71 Copyright © 2010 MDIS. All rights reserved.

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Presentation on theme: "FINANCIAL ACCOUNTING Business combinations: purchase method of accounting Chapter 25 Unit 71 Copyright © 2010 MDIS. All rights reserved."— Presentation transcript:

1 FINANCIAL ACCOUNTING Business combinations: purchase method of accounting Chapter 25 Unit 71 Copyright © 2010 MDIS. All rights reserved.

2 Learning Objectives explain how to apply purchase method of accounting; explain the difference between purchase method of accounting and equity method of accounting; Unit 72Copyright © 2010 MDIS. All rights reserved.

3 Introduction When two companies join together to form new organization, the shares of both companies come under common ownership; IAS 27 “Consolidated and separate financial statements”; IFRS 3 “Business combinations”

4 A business combination A business combination is bringing together of separate entities or businesses into one reporting entity; When two or more businesses are joined, one entity (the acquirer) controls another or other entities (the acquiree);

5 All business combinations must be accounted for by applying the “purchase method”; The purchase method views a business combination from the perspective of the combining entity identified as the acquirer;

6 The acquirer must allocate the cost of a business combination by recognizing the acquiree’s identifiable assets, liabilities and contingent liabilities at their fair values. Any differences between the cost of the business combination is goodwill;

7 Goodwill Goodwill is an asset; It is an excess amount over identifiable assets, liabilities and contingent liabilities; It represents the fair value of the acquired company; It is measured at cost less any accumulated impairment losses;

8 Negative goodwill The acquirer must: reassess assets, liabilities and contingent liabilities; recognize in profit or loss any excess (i.e. negative goodwill) remaining after reassessment;

9 Positive goodwill It is not amortized; It is tested annually for impairment; If there is certain evidence that positive goodwill can be impaired, more tested might be required;

10 Purchase method of accounting A Ltd made an offer of $270,000 for the whole of the share capital of B Ltd and it was accepted; The fair value placed on the tangible assets of B Ltd for the purposes of the merger was 148,000;

11 Before the acquisition A LtdB Ltd Tangible non-current assets Current assets Current liabilities(130)(90) Ordinary shares $ Revenue reserves

12 After the acquisition Non-current assetsA LtdGroup Intangible (goodwill)-12 (W2) Tangible ( ) (W3) Current assets Investments Current assets ( )180 (W1) 380 (W4) ( ) Total assets Current liabilities(130)(220) Net assets720 Share capital500 Revenue reserves

13 Workings W1Original current account 450 – cash paid 270 = 180 W2Paid for shares Less Net assets of B at takeover date 230 Add increase on value of non-current assets of B to a “fair value” 148 – 120 = 28 Goodwill (intangible non-current asset) 270 (258) W3Non-current assets A Ltd 400+ B Ltd 148=54812 W4A Ltd (after payment) B Ltd 200 = 380

14 Summary IFRS 3 requires that all business combinations must be accounted for using purchase method of accounting; Under this method, assets and liabilities are restated to their fair values; Positive goodwill is recognized as an asset and is tested annually for impairment; Positive goodwill is not amortized; Negative goodwill is recognized in P&L and is eliminated; Any minority interest is stated at the minority interest’s proportion of the fair value of the net assets required;


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