2. Business combinations
Lecture 4
Business combinations

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4. Objectives Understand the nature and form of business combinations.
Acquisition method of accounting for business combination.
Determine how to measure goodwill or a gain from a bargain purchase.
Explain an excess on acquisition and how to account for it.
Account for business combinations in the records of the acquiree.

5. Business combinations
IFRS 3 Business Combinations (Appendix A) defines a ‘business combination’ as “a transaction or other event in which an acquirer obtains control of one or more businesses”.
A ‘business’ is an integrated set of activities and assets for the purpose of providing a return, lower costs or other economic benefits.
Accounting for a group of non-current assets is accounted for under IAS 16 Property, Plant and Equipment rather than IFRS 3.
If goodwill is acquired, a group of assets acquired must constitute a business and accounted for under IFRS 3.

6. Business combinations - example
ENTITY A
ACQUIRER
ENTITY B
AQUIREE
Sale of mining division to entity A
Issue of shares to entity B
Entity A acquires a mining division from entity B and selling shares in itself to entity B.
Entity B is acquiring shares from entity A and selling a mining division to entity A.
Entity A is undertaking a business combination.
Entity B is not undertaking a business combination: it is acquiring shares in entity A only.
Entity A is the acquirer as it obtains control of the mining division from Entity B.

7. Business combination - example
Various business combinations are possible using the previous example:
A Ltd acquires all net assets of B Ltd – B Ltd continues to operate as a company.
A Ltd acquires net assets of B Ltd – B liquidates.
C Ltd is formed to acquire net assets of A Ltd and B Ltd – A Ltd and B Ltd liquidate.
A Ltd acquires a division, branch or segment (a business) of B Ltd – B Ltd continues to operate as a company.

8. Accounting by an acquirer
IFRS 3 (Para. 4) prescribes the acquisition method in accounting for business combinations.
This method involves:
Identifying an acquirer.
Determine the acquisition date.
Recognise and measure the identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree.
Recognise and measure goodwill or a gain from a bargain purchase.
Acquisition method is applied on the acquisition date, the date the acquirer obtains control of acquiree.

9. Identification of an acquirer
The key criterion in identifying an acquirer is control.
Control is the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities.
A combining entity shall be presumed to have obtained control of another entity when it acquires more than 50% of that entity’s voting rights.
Other factors such as power to appoint or remove the majority of members of board of directors that indicate control.

10. Determining the acquisition date
Acquisition date: Date on which the acquirer effectively gains control of the acquiree (i.e. acquiree’s assets or net assets are under control of the acquirer).
Acquisition date may not necessarily be the date when the acquirer receives physical possession of the assets acquired or the date when acquirer pays the acquiree.
Assets may be acquired in stages without control being achieved by the acquirer.

11. Importance of acquisition date
Identifiable assets acquired and liabilities assumed by the acquirer are measured at fair value at acquisition date. The choice of fair value is affected by choice of acquisition date.
Consideration paid by acquirer is determined by the sum of the fair values of assets given, equity issued and/or liabilities undertaken in exchange for the net assets or shares of the acquiree. Choice of acquisition date determines fair value of consideration paid.
Acquirer may only acquire some of the shares in acquiree. The non-controlling interest (what the acquirer does not own) is also measured at fair value at acquisition date.

12. Consideration transferred
The objective is to measure the consideration transferred to the acquiree.
The acquirer shall recognise goodwill at acquisition date as the excess of (a) over (b): (Para 32):
a) the aggregate of:
- the consideration transferred
- amount of any non-controlling interest
- in a business combination achieved in stages, the fair value of previously held equity interest in acquiree.
b) net fair value of identifiable assets and liabilities acquired at acquisition date.
Consideration paid may include cash, non-monetary assets, equity instruments, liabilities undertaken, directly attributable costs, cost of issuing debt/equity instruments.

13. Consideration transferred
Use of cash, non-monetary assets and share capital to acquire assets would result in the acquirer recording this entry at acquisition date:
DR Net assets X
CR Payable to acquiree X
CR Proceeds on disposal of asset X
CR Share Capital X
On payment of the purchase consideration, the acquirer records:
DR Payable to acquiree X
CR Cash X

14. Consideration transferred
Sale of non-cash assets (e.g. plant) as part of the consideration results in acquirer recording:
DR Accumulated Depreciation – Plant X
CR Plant X
CR Gain X
e.g. If plant costs $180, carrying amount is $150 & fair value is $155, the acquirer records:
DR Accumulated Deprec. – Plant 30
CR Plant
CR Gain

15. Consideration transferred
Payment of acquisition related costs by acquirer:
DR Acquisition costs X
CR Cash X
Payment of share issue costs by acquirer:
DR Share capital X
CR Cash X

16. Goodwill
Goodwill is defined in Appendix A to IFRS 3 as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised”.
Goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of FEBs.
Goodwill is a residual amount after the aquiree’s interest in the identifiable tangible assets, intangible assets and liabilities of the acquiree are recognised.
After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost less any accumulated impairment losses.

17. How is goodwill measured?
Acquisition Analysis:
Consideration transferred = X
Acquirer’s interest in the net fair value of
the acquiree’s identifiable assets & liabilities
+ fair value of non-controlling interest +
fair value of any previously held equity interest = Y
Goodwill = X - Y

18. Acquisition analysis
Net FV of identifiable assets acquired and liabilities assumed:
Accounts receivable $12 000
Inventory
Plant and equipment
Accounts payable (11 000)
Net Fair Value
Consideration transferred:
Shares ( x $2.70)
Cash
Debentures ( x $1.05)
Shareholders ( x $1.00)
Land (FV)
Cost of the business combination
Goodwill: ($ – $ ) $13 500
Assume land had a historical cost of $32,000 and acquisition relation expenses were $1,500.

19. Accounting by the acquirer Journal entries of acquirer
Accounts receivable Dr
Inventory Dr
Plant and equipment Dr
Goodwill Dr
Accounts payable Cr
Consideration payable Cr
Share capital Cr
Proceeds on sale of land Cr
Acquisition related expenses Dr 1 500
Payable to acquiree Dr
Cash Cr
Carrying amount of land sold Dr
Land Cr

20. Test Your Understanding
On 1 July 2012, Flint Ltd acquired the following assets and liabilities from Jasper Ltd:
Carrying Amount Fair Value
Land $300,000 $350,000
Plant (cost $400,000) $280,000 $290,000
Inventory $80,000 $85,000
Cash $15,000 $15,000
Accounts Payable ($20,000) ($20,000)
Loans ($80,000) ($80,000)
In exchange for these assets and liabilities, Flint Ltd issued 100,000 shares that had been issued for $1.20 per share but at 1 July 2012 had a fair value of $6.50 per share. Prepare the acquisition analysis of Jasper Ltd.

21. Test Your Understanding
Acquisition analysis 1 July 2012:
Net fair value of identifiable assets and liabilities acquired:
Land $
Plant
Inventory
Cash
Accounts payable
Loans
Net assets $
Consideration transferred:
shares at $6.50 each $
Goodwill = $ $ = $10 000

22. Accounting for a gain on bargain purchase
Gain on bargain purchase = Acquirer’s interest in the net fair value of the acquiree’s identifiable assets and liabilities less
Consideration transferred
If an excess is identified, the acquirer must reassess whether it has correctly (Para 36):
a) identified all the assets acquired and liabilities assumed;
b) measured at fair value all the assets acquired and liabilities assumed;
c) measured the consideration transferred.

23. Accounting for a gain on bargain purchase
Net FV of identifiable assets acquired & liabilities assumed:
Accounts receivable $
Inventory
Equipment
Patents
Furniture
Accounts payable (8 000)
82 000
Consideration transferred:
Purchase consideration
Shares - ordinary
Shares – preference
Cash
Debentures
Cost of Liquidation
Cost of the business combination
Gain on Bargain Purchase: ($ – $76 562) $5 438

24. Accounting for a gain on Journal entries of acquirer
bargain purchase
Journal entries of acquirer
Accounts receivable Dr
Inventory Dr
Equipment Dr
Patent Dr
Furniture Dr 6 000
Accounts payable Cr
Consideration Payable Cr
Share capital – ordinary Cr
Share Capital – preference Cr
Gain (profit & loss) Cr

25. Acquisition of shares in an acquiree
Shares acquired are recorded at fair value + transaction costs.
Example: Acquirer acquired all shares in Acquiree for $60,000 in exchange for $ cash and shares valued at 50 cents each. Transaction costs were $700. Share issue costs were $2,000. They were paid in cash. Acquirer Journal entries: Shares in acquiree 60,700
Cash ,700
Share Capital 40,000
(Acquisition of shares in acquiree)
Share Capital 2,000
Cash 2,000
(Share issue costs)

26. Step Acquisition of shares
Assume X Ltd had previously held 20% of the shares in Y Ltd. X Ltd then acquired the remaining 80% of shares in Y Ltd.
In this example, it is the date of the second acquisition of shares that the business combination occurs.
Each purchase of shares prior to the date the acquirer obtains control will be accounted for as shown in the previous Slide (Slide 26).

27. Step Acquisition of shares
In a business combination achieved in stages, the acquirer shall measure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resulting gain or loss in profit and loss.
Example: Assume X Ltd had acquired 20% of Y Ltd’s shares on 1 January 2010 for $ and this investment has a fair value of $ on 1 January X Ltd then acquired the remaining 80% of Y Ltd on 1 January X Ltd would then record:
Shares in Y Ltd 5,000
Gain (Profit and Loss) 5,000
(remeasurement of previously held equity interest in Y Ltd)

28. Accounting by the acquiree
When acquiree does not liquidate after selling all of its net assets – gain or loss is recognised in the income statement.

29. Accounting by the acquiree
Acquiree does not liquidate
Receivable from acquirer Dr x
Liability A Dr x
Liability B Dr x
Asset A Cr x
Asset B Cr x
Asset C Cr x
Gain on sale Cr x
(gain on sale of operation)
Share in acquirer Dr x
Cash Dr x
Receivable from acquirer Cr x
(Receipt of consideration from acquirer) .

30. Accounting by the acquiree
Where acquiree liquidates after selling all of its net assets:
Accounts of acquiree are transferred to Liquidation account & Shareholder’s distribution account.
Transfer to Liquidation account:
All assets taken over by acquirer including goodwill
All liabilities taken over
Liquidation expenses & other unrecorded liabilities
Consideration from acquirer
All reserves & retained earnings
Balance of Liquidation account is then transferred to Shareholder’s Distribution account.

31. Accounting by the acquiree
Liquidation
Assets taken over x Contra asset accounts x
Unrecognised amounts Liabilities taken over x
(e.g. liquidation costs) x Reserves of acquiree x
Balance to Shareholders’ Receivable from acquirer x
distribution account x _
X x

32. Accounting by the acquiree SHAREHOLDERS’ DISTRIBUTION
Receivable from acquirer: Share capital x
cash x Balance from Liquidation
shares x account x
x x