Business Combination achieved in stages is also called “step acquisition.

”
In accounting for business combination achieved in stages, the acquirer:
1. Remeasures the previously held equity interest in the acquiree at acquisition-date fair value; and
2. Recognizes the gain or loss on the remeasurement in:
a. Profit or loss – if the previously held equity interest held was classified as FVPL, Investment in
Associate, or Investment in Joint Venture; or
b. Other Comprehensive Income – if the previously held equity interest was classified as FVOCI.

Illustration: Business combination achieved in stages

On January 1, 20x1, ABC Co. acquired 15% ownership interest in XYZ, Inc. for P100,000. ABC CO. classified
the investment as ‘held for trading securities’ (i.e., FVPL) in accordance with PFRS 9.

On January 1, 20x4, ABC Co. acquired additional 60% ownership interest in XYZ, Inc. for P800,000. Relevant
information follows:
a. The previously held 15% interest has a carrying amount of P170,000 on December 31, 20x3 and fair
value of P180,000 on January 1, 20x4.
b. XYZ’s net identifiable assets have a fair value of P1,000,000.
c. ABC elected to measure the NCI at ‘proportionate share’.

Requirement: Compute for the goodwill.

Solution:

Consideration transferred 800,000

Non-controlling interest in the acquiree (1M x 25%*) 250,000
Previously held equity interest in the acquire 180,000
Total 1,230,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill 230,000
*100% - (15%+60%) = 25%

Journal Entries
Jan. Held for trading securities 30,000  
1, Unrealized gain - P/L (180k - 150K   30,000
20x4 to remeasure the previously held equity    
interest to acquisition-date fair value    
Jan. Investment in subsidiary 800,000  
1, Cash   800,000
20x4 to recognize the newly acquired shares    
Jan. Investment in subsidiary 180,000  
1, Held for trading securities   180,000
20x4 to reclassify the previously    
  held equity interest    
Notes:
 The business combination is effected through stock acquisition. Accordingly, the acquisition is recorded
in the parents’ separate accounting record through the investment of the investment in subsidiary
account. The carrying amount of this account immediately after the combination is P980,000 (800k
consideration transferred +180K acquisition-date fair value of the previously held equity interest).
  When consolidated financial statements are prepared, the investment in subsidiary is eliminated and the
goodwill and NCI are recognized.
 The same accounting procedures apply if the previously held equity interest was classified as FVOCI,
investment in associate, or investment in joint venture. However, if the previous classification was
FVOCI, the remeasurement gain or loss is recognized in other comprehensive income. If the previous
classification was investment associate or joint venture, the remeasurement gain or loss is also
recognized in profit or loss.

Business combination without transfer of consideration

The acquisition method also applies to business combinations in which the acquirer obtains control without
transferring any consideration. The reason why the “purchase method” previously need for business
combinations has been replaced with the “acquisition method” is to emphasize that a business combination may
occur even when a purchase transaction is not involved.
Example 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.
For example, ABC Co. holds 40,000 out of the 100,000 outstanding ordinary shares of XYZ, Inc.
Subsequently, XYZ repurchases 25,000 shares from other investors. After the treasury share
transaction, ABC’s ownership interest is increased to 53.33% (40,000÷75,000).
b. Minority veto rights that previously kept the acquirer from controlling the acquiree have lapsed.
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 a 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 a business combination achieved by contract alone, the interests 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

ABC Co. owns 36,000 out of the 90,000 outstanding shares of XYZ, Inc. ABC accounts for the investment
under the equity method. XYZ subsequently reacquires 30,000 shares from other investors.
Information on acquisition date is as follows:
a. The previously held 40% interest has a fair value of P180,000.
b. XYZ’s net identifiable assets have a fair value of P1,000,000.
c. ABC elects to measure NCI at ‘proportionate share’.

Requirement: Compute for the goodwill

Consideration transferred (1Mx60%) 600,000

Non-controlling interest in the acquiree (1Mx40%) 400,000
Previously held equity interest in the acquire -
Total 1,000,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill -

Notes:
 XYZ’s treasury share transaction increased ABC’s interest to 60% [i.e., 36,000÷(90,000 – 30,000)].
Consequently, the NCI is 40%.
  The acquisition-date fair value of ABC’s interest in XYZ is substituted for the consideration transferred
(instead of attributing an amount to the previously held equity interest) because there is no consideration
transferred and there is no change in the number of shares held by ABC.

Illustration 2: By contract alone

ABC Co. and XYZ, Inc. enter into a contract whereby ABC obtains control of XYZ. No consideration is
transferred between the parties. The fair value of XYZ’s net identifiable assets at acquisition date is P1,000,000.
ABC chose to measure NCI at ‘proportionate share’.

Requirement: Compute for the goodwill.

Solutions:
Consideration transferred (1Mx60%) -
Non-controlling interest in the acquiree (1Mx40%) 1,000,000
Previously held equity interest in the acquire -
Total 1,000,000
Fair value of net identifiable assets acquired (1,000,000)
Goodwill -

Measurement period
If the initial accounting for a business combination is incomplete by the end of the reporting period in which the
combination occurred, the acquirer can use provisional amounts to measure any of the following for which the
accounting is incomplete:
a. Consideration transferred
b. Non-controlling interest in the acquire
c. Previously held equity interest in the acquire
d. Identifiable assets acquired and liabilities assumed

Within 12 months from the acquisition date (i.e., the ‘measurement period’), the acquirer retrospectively
adjusts the provisional amounts for any new information obtained that provides evidence of facts and
circumstances that existed as of the acquisition date, which is known
would have affected the measurement of the amounts recognized on that date. Any adjustment to a provisional
amount is recognized as an adjustment to goodwill or gain on a bargain purchase.
Adjustments for new information obtained beyond the 12-month measurement period are accounted for a
corrections of error in accordance with PAS 8 Accounting Policies, Changes in Accounting Estimates and
Error, rather than PFRS 3.

Illustration 1: Provisional amounts – identifiable assets acquired

Fact pattern
On October 1, 20x1, ABC Co. acquired all the identifiable assets and assumed all liabilities of XYZ, Inc. for
P1,000,000. On this date, XYZ’s assets and liabilities have fair values of P1,600,000 and P900,000,
respectively.
Case #1: Identifiable asset recognized at provisional amount
The assets acquired include a building which was assigned a provisional amount of P700,000 because the
appraisal is not yet complete by the time ABC authorized for issue its December 31, 20x1 financial
statements. The building was tentatively assigned a 10-year useful life and was depreciated for three months
in 20x1 using the straight-line method.
 On July 1, 20x2, ABC received the valuation report for the building. The building’s fair value on October 1,
20x1 is P500,000 and its remaining useful life from that date is 5 years.

Requirements:
a. What is the measurement period?
b. How should ABC account for the new information obtained on July 1, 20x2?
c. How much is the adjusted goodwill?
d. What are the adjusting entries?

Solutions:
Requirement (a): Measurement period
The measurement period is from October 1, 20x1 to September 30, 20x2, or if earlier, (i) the date ABC Co.
obtains the information it was seeking about facts and circumstances existed as of the acquisition date or (ii)
the date ABC Co. learns that more information is not obtainable.

Requirement (b): Accounting

The provisional amount assigned to the building is retrospectively adjusted with a corresponding adjustment
to goodwill. The 20x1 financial statements are restated, including a retrospective adjustment to depreciation
expense.

Requirement (c): Adjusted goodwill

Provisional Adjusted
Consideration transferred 1,000,000 1,000,000
NCI - -
Previously held equity interest - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets (700,000)(a) (500,000)(b)
Goodwill 300,000 500,000

(a) (1.6M – .9M) = 700,000

(b) (1.6M – 700,000 provisional amount + 500,000 fair value - .9M) = 500,000

Requirement (d): Adjusting entries

July Goodwill 200,000  

1, Building   200,000
20x2 to record the adjustment to the provisional    
amount assigned to the building    
July Retained earnings 7,500  
1, Accumulated depreciation (c)   7,500
20x2 to record the adjustment to 20x1 depreciation    

(c) Depreciation recognized (P700,000 ÷ 10 years x 3/12) 17,500

‘Should-be’ depreciation (P500,000 ÷ 5 years x 3/12) 25,000
Additional depreciation expense for 20x1 7,500
If monthly depreciation expenses were recognized during January to June 30, 20x2, those shall also be adjusted
accordingly.

Case #2: Unrecorded identifiable asset acquired

On July 1, 20x2, ABC obtained new information that XYZ has an unrecorded patent which was no known on
October 1, 20x1. The patent has a fair value of P100,000 and remaining useful life of 4 years as of October 1,
20x1.

Requirement: Compute for the adjusted goodwill and provide the adjusting entries.

Solutions:

Unadjusted Adjusted
Consideration transferred 1,000,000 1,000,000
NCI - -
Previously held equity interest - -
Total 1,000,000 1,000,000
Fair value of net identifiable assets (700,000)(a) (800,000)(b)
Goodwill 300,000 200,000

(a) (1.6M - .9M) = 700,000

(b) (1.6M + 100,000 patent - .9M) = 800,000

Adjusting entries:
July 1, Patent 100,000  
20x2 Goodwill   100,000
July 1, Retained earnings (100K ÷ 4 x 3/12) 6,250  
20x2 Accumulated amortization   6,250

Case #3: Information obtained beyond the measurement period

On November 1, 20x2, ABC’s auditors discovered that a patent with fair value of P100,000 was erroneously
omitted from the valuation listing on October 1, 20x1. The patent has a fair value of P100,000 and remaining
useful life of 4 years as of October 1, 20x1.

Requirement: How should ABC account for the new information obtained on November 1, 20x2?

Answer: Because the new information is obtained after the measurement period, it will be accounted for another
PAS 8 as correction of prior period error. A correction of prior period error is accounted for by retrospective
restatement. Therefore, the adjusted amounts and correcting entries would be similar to those in ‘Case #2’
above. However, the note disclosures will vary because PAS 8 will be applied instead of PFRS 3.
Correcting entries to restate the 20x1 financial statements:

Nov 1, Patent 100,000  

20x2 Goodwill   100,000
Nov 1, Retained earnings (100K ÷ 4 x 3/12) 6,250  
20x2 Accumulated amortization   6,250

The omitted patent is recognized with a corresponding charge to goodwill because if ABC had not
committed the error, the correct amount of goodwill that should have been recognized on acquisition date is
P200,000.

Illustration 2: Provisional amounts – consideration transferred

On October 1, 20x1, ABC., an unlisted entity, issued 10,000, P5 par value, shares in exchange for all the
identifiable assets and liabilities of XYZ, Inc.

Information on acquisition date:

 The shares issued were assigned a provisional amount of P100 per share.
 The fair values of some of the assets acquired are not readily determinable. Accordingly, a provisional
amount of P700,000 was assigned to XYZ’s net identifiable assets.

Information after the acquisition date:

 On April 1, 20x2, new information was obtained indicating that, on October 1, 20x1,
- the fair value of the shares issued was P110 per share; and
- the fair value of XYZ’s net identifiable assets was P900,000.
 On July 1, 20x2, two competitors f ABC have also merged. This led ABC to believe that the merger
with XYZ is not as profitable as expected. ABC estimates that the valuations of the consideration
transferred and XYZ ‘s net identifiable assets should have been P900,000 and P400,000, respectively.

Requirement: Compute for the adjusted goodwill.

Solution:

Provisional Adjusted
Consideration transferred 1,000,000 1,100,000(a)
NCI - -
Previously held equity interest - -
Total 1,000,000 1,100,000
Fair value of net identifiable assets (700,000) (900,000)(b)
Goodwill 300,000 200,000

(a) (10,000 sh. x P110 fair value based on new information obtained on Apr. 1, 20x1)
(b) (fair value based on new information obtained on Apr. 1, 20x1)
 The new information obtained on July 1, 20x2 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.

Determining what is part of the business combination transaction

Before the business combination, the acquirer and the acquiree may have pre-existing relationship or they may
enter into transactions during the negotiation period that are separate from the business combination.
In applying the acquisition method, the acquirer identifies and excludes amounts that are not part of the
consideration transferred on the business combination and the accounts for hem using other relevant PFRSs.
The acquirer considers the following when determining whether a transaction is part of a business
combination or a separate transaction:
a. A transaction that is arrange primarily for the benefit of the acquirer or the combined entity rather than
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.
Contrarily, a transaction that is arranged primarily for the benefit of the acquiree or its former
owners is more likely to be a part of the business combination transaction. The transaction price
is appropriately included in the consideration transferred.
b. A transaction initiated by the acquirer is likely for the benefit of the acquirer or the combined entity and,
therefore, a separate transaction.
Contrarily, a transaction initiated by the acquiree or its former owners is more likely to be a part
of the business combination transaction.
c. A transaction between the acquirer and acquiree during the negotiations of a business combination is
more likely to be part of the business combination.
However, the following are separate transactions that are excluded when applying the
acquisition method:
i. Settlement of pre-existing relationship between the acquirer and acquiree;
ii. Remuneration to employees or former owners of the acquiree for future services; and
iii. Reimbursement to the acquiree or its former owners for paying the acquirer’s acquisition-related
costs.

Illustration:
ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities have
fair values of P1,600,000 and P900,000, respectively.

Additional information:
a. XYZ incurred P10,000 legal fees in processing the regulatory requirements for the combination. ABC
agreed to reimburse the said amount.
b. XYZ will terminate its activities after the business combination. ABC agreed to reimbursed XYZ’s
estimated liquidation costs of P200,000.
c. ABC will retain XYZ’s former key employees. ABC agreed to pay the key employees P100,000 as
signing bonuses.
d. ABC agreed to pay an additional P50,000 directly to Mr. Five-six Numerix, the previous major
shareholder of XYZ, to persuade him in selling his shareholdings to ABC.
e. Ms. Vital Statistix, a former shareholder of XYZ, will acquire title to inventories with fair value of
P90,000 that were included in the asset valuation.

Requirement: Compute the goodwill.

Solutions:

Consideration transferred (a) 1,050,000

Non-controlling interest in the acquire -
Previously held equity interest in the acquire -
Total 1,050,000
Fair value of net identifiable assets acquired (b) (610,000)
Goodwill 440,000

(a) (1M + 50K additional payment to Mr. Numerix) = 1,050,000

(b) (1,6M – 90K inventories taken by MS. Statistix -.9M) = 610,00

Notes:
 The reimbursement for the legal fees is an acquisition-related cost. This is expensed.
 The reimbursement for liquidation costs is a restructuring provision. This is a post-combination
expense.
 The payment to key employees is a separate transaction because it is remuneration to employees for
future services.
 The additional P50,000 payment is included in the consideration transferred because it is for the benefit
of the acquiree’s former owner.
 The inventories are excluded because these are not assets acquired in the business combination.

Reacquired rights
A right that an acquirer has previously granted to the acquiree that is reacquired as a result of a business
combination is recognized as an intangible asset separately from goodwill.

Examples of reacquired right:

a. Right to use the acquirer’s intangible asset, such as trade name under a franchise agreement.
b. Right to use the acquirer’s technology under a technology licensing agreement.

Settlement of pre-existing relationship

Prior to business combination, the acquirer and the acquiree may have pre-existing relationship. Such a
relationship may be:
a. Contractual – e.g., as vendor and customer, licensor and licensee, or franchisor and franchisee. A pre-
existing relationship may be a contract that the acquirer recognizes as a reacquired right.
b. Nin-contractual – e.g., as plaintiff and the defendant on a pending lawsuit.

If the pre-existing relationship is settled due to the business combination, the acquirer recognizes a settlement
gain or loss measure as follows:
a. At the lower of (i) and (ii) below, if the pre-existing relationship is contractual.
i. The amount by which the contract is favorable or unfavorable, from the acquirer’s perspective,
when compared with market terms.
ii. Any settlement amount stated in the contract that is available to the counterparty to which the
contract is unfavorable. If this is less than the amount in (i), the difference is included as part of
the business combination accounting.
b. At fair value, if the pre-existing relationship is non-contractual.
 The settlement gain or loss is adjusted for the derecognition of any related asset or liability that the
acquirer has previously recognized.

Illustration 1: Reacquired right

ON January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets
and liabilities have fair values of P1,600,000 and P900,000, respectively.

Additional information:
 Prior to the business combination, ABC granted XYZ the right to use ABC’s patented technology over a
5-year period in exchange for P100,000 cash (payable at grant date) and royalty fees based on XYZ’s
sales over the 5-year period.
 ABC recognized the P100,000 license fee as deferred liability (unearned income) and amortized it over
5 years. The carrying amount of the deferred liability on January 1, 20x1 is P60,000.
 On the other hand, XYZ recognized the license fee as prepayment (prepaid asset) and amortized it based
on the number of products sold. The carrying amount o the prepayment on January 1,20x1 is P50,000.
 On acquisition date, the fair value of the license agreement is P120,000. This consists of the following
components:
- P40,000 “at-market” (based on market participants’ estimates); and
- P80,000 “off-market” (the excess of P120,000 fair value derived from cash flows estimates over
P40,000 ‘at-market’ value).
 The off-market component is favorable to XYZ and unfavorable to ABC, as royalty rates have increased
considerably in comparable markets since the initiation of the contract. The contract does not have any
cancellation clause or any minimum royalty payment requirements.

Requirement: Compute for the goodwill.

Solution:
As mentioned in the previous chapter (‘Exceptions to the measurement principle’), a reacquired right is
measured based on the remaining term of related contract. This is in contrast with other assets which are
measured based on market participation.
The measurement of a reacquired right could result to a difference between the value derived from
market participation (“at-market” value) and fair value based on cash flow estimates. The difference (“off-
market” value) makes a reacquired right favorable or unfavorable from the acquirer’s perspective.

In the illustration above, the P80,000 “off-market” value is unfavorable from the perspective of ABC
Co. (because the royalty fees that XYZ is paying ABC are below-market rate). Accordingly, ABC recognizes a
settlement loss.
The pre-existing relationship is contractual. Therefore, the settlement loss is measured at the lower of
(i) the unfavorable amount and (ii) the settlement amount in the contract. However, because the contract does
not have a cancellation clause or minimum royalty payment requirement, the settlement loss is measured based
on (i), after adjustment for the recognized deferred liability. This is computed as follows:

Settlement loss before adjustment (“off-market” value) 80,000

Carrying amount of deferred liability (60,000)
Adjusted settlement loss 20,000
 The settlement of the pre-existing relationship is a separate transaction. Therefore, the P80,000 “off-
market” value is excluded from the consideration transferred on the business combination and treated as
payment for the settlement of the pre-existing relationship.
ABC recognizes the P40,000 “at-market” value component of the reacquired right as an intangible
asset, separate from goodwill, to be amortized over the remaining term of the agreement.
The P50,000 prepayment recognized by XYZ is excluded from the identifiable asset on the reacquired
right.

The goodwill is computed as follows:

Consideration transferred (1M-80K ‘off-market’ value) 920,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 920,000
Fair value of net identifiable assets acquired
(1.6M + 40K intangible asset on reacquired rt. – 50K prepayment -.9M) (690,000)
Goodwill 230,000

Journal entries:
Jan. Identifiable assets acquired (1.6M +40K - 50K) 1,590,000  
1, Goodwill 230,000  
20x1 Liabilities assumed   900,000
  Cash (1M - 80K)   920,000
  to record the business combination    
Jan. Settlement loss 20,000  
1, Deferred liability 60,000  
20x1 Cash   80,000
  to record the effective settlement of pre-    
  existing relationship as a separate transaction    
  from business combination transaction    

Notes:
“Off-market” value
- used to determine settlement gain or loss from the acquirer’s
perspective.
- excluded from ‘consideration transferred’ and treated as a
separate transaction.
Total fair value of
reacquired right
consisting of:

“At-market” value
- recognized as intangible asset if it relates to a reacquired right.

Illustration 2: Contractual pre-

existing relationship
On January 1,20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. for P1,000,000. XYZ’s assets
and liabilities have fair values of P1,600,000 and P900,000, respectively.
Additional information:
 ABC and XYZ have a pre-existing supply contract under which ABC could purchase raw materials from
XYZ at discounted rates. The contract has a remaining term of three years, which ABC can terminate by
paying P100,000 penalty.
 The supply contract has a fair value of P160,000, of which P70,000 is “at-market” The “off-market”
component is unfavorable to ABC because it exceeds the price of current market transactions for similar
items.
 No assets or liabilities related to the contract were recognized in either of ABC’s or XYZ’s books as at
the acquisition date.

Requirement: Compute for the goodwill.

Solution:
The P90,000 “off-market” value (160K total fair value – 70K ‘at-market’ value) is unfavorable from the
perspective of ABC Co. accordingly, ABC recognizes a settlement loss.
The pre-existing relationship is contractual. Therefore, the settlement loss is measured at the lower of (i) the
unfavorable amount and (ii) the settlement amount in the contract. This is computed as follows;

Settlement loss (lower of P90K off-market and P100K settlement amt.) 90,000
Carrying amount of related asset or liability recognized -
Adjusted settlement loss 90,000

The P90,000 “off-market” value is excluded from the consideration transferred on the business
combination and treated as payment for the settlement of the pre-existing relationship (i.e., a separate
transaction).
The P70,000 “at-market” value is subsumed in goodwill and not recognized as intangible asset because
there is no reacquired right. Contrast this with Illustration 1 above.
 In Illustration 1, ABC (acquirer) granted the license to XYZ (acquiree). There is reacquired right
because ABC (supplier) takes back the license from XYZ (customer) as a result of the business
combination.
 In Illustration 2, XYZ (acquiree) granted the supply contract to ABC (acquirer). There is no reacquired
right because ABC (customer) gives back the supply contract to XYZ (supplier) as a result of the
business combination.

The goodwill is computed as follows:

Consideration transferred (1M-90K ‘off-market’ value) 910,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 910,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 210,000

Journal entries:
Jan. Identifiable assets acquired 1,600,000  
1, Goodwill 210,000  
20x1 Liabilities assumed   900,000
  Cash (1M - 90K)   910,000
Jan. 1, Settlement loss 90,000  
 20x1 Cash   90,000

Illustration 3: Non-contractual pre-existing relationship

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ Inc. for P1,000,000. XYZ’s assets
and liabilities have fair values of P1,600,000 and P900,000, respectively.

ABC is the defendant on a pending patent infringement suit filed by XYZ. ABC recognized a provision of
P130,000 on the lawsuit. After the business combination, the disputed patent will be transferred to ABC. The
fair value of settling the pending lawsuit is P100,000.

Requirement: Compute for the goodwill.

Solution:
The P100,000 fair value is excluded from the consideration transferred on the business combination and treated
as payment for the settlement of the pre-existing relationship (i.e., a separate transaction).

The pre-existing relationship is non-contractual. Therefore, the settlement gain or loss is measured at fair
value. This is computed as follows:

Payment for the settlement of pre-existing relationship 100,000

Carrying amount of related provision (liability) (130,000)
Settlement gain 30,000

There is gain because the liability is settled for the lower amount.

The goodwill is computed as follows:

Consideration transferred (1M-100K settlement amt.) 900,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 900,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 20,000

Journal entries:
Jan. Identifiable assets acquired 1,600,000  
1, Goodwill 200,000  
20x1 Liabilities assumed   900,000
  Cash (1M - 100K)   900,000
Jan. 1, Estimated liability on pending lawsuit 130,000  
20x1 Cash   100,000
Settlement gain 30,000

Subsequent measurement and accounting

Subsequent to acquisition date, the acquirer accounts for assets acquired, liabilities assumed and equity
instruments issued in a business combination in accordance with other PFRSs applicable for those items.
However, the following are subsequently accounted for under PFRS 3:
a. Reacquired rights
b. Indemnification assets
c. Contingent liabilities recognized as of the acquisition date
d. Contingent consideration

Reacquired rights
Reacquired rights recognized as intangible assets are amortized over the remaining term of the related contract.

Indemnification assets
Indemnification assets are measured on the same basis as the indemnified item, subject to assessments of
collectability for indemnification assets not measure at fair value.

Contingent liabilities
Contingent liabilities recognized in the business combination are measured at the higher of:
a. The amount that would be recognized by applying PAS 37; and
b. The amount initially recognized less, if appropriate, cumulative amount of income recognized in
accordance of PFRS 15 Revenue from Contracts with Customers.

Contingent consideration
Contingent consideration is additional consideration for a business combination that the acquirer agrees to
provide the acquiree upon the happening og contingency.

A contingency is an existing, unresolved condition that will be resolved by the occurrence or non-occurrence of
a possible future event.

An example of a contingent consideration is when the acquirer agrees to issue additional shares to the acquiree
when specified conditions are met, such as meeting an earnings target, reaching a specified share price or
reaching a milestone on a research and development project.

Initial recognition and measurement

A contingent consideration is measured at acquisition-date fair value and included in the consideration
transferred.

The obligation to pay the contingent consideration is classified either as liability or equity. A right to recover a
previously transferred consideration if specified conditions are met is classified as an asset.

Subsequent measurement
A change in the fair value of a contingent consideration resulting to additional information obtained during the
measurement period is accounted for as a retrospective adjustment to provisional amount. However, changes
resulting from meeting an earnings target, reaching a specified share price or reaching a milestone on a research
and development project are not measurement period adjustments.

Changes in fair value that are not measurement period adjustments are accounted for depending on the
classification of the contingent consideration:
 a. A contingent consideration classified as equity is not remeasured and its subsequent settlement is
accounted for within equity.
b. A contingent consideration classified as an asset or a liability is measured at fair value at each reporting
date. Changes in fair value are recognized in profit or loss.

Illustration 1: Contingent consideration classified as equity

On January 1, 20x1, ABC Co. issued 10,000 shares with par value of P10 per share and fair value of P100 per
share in exchange for all the assets and liabilities of XYZ. XYZ’s assets and liabilities have fair values of
P1,600,000 and P900,000, respectively.
IN addition, ABC agrees to issue additional 1,000 shares to the former owners of XYZ if the market price of
ABC’s shares increases to P120 per share by December 31, 20x1.The fair value of the contingent consideration
as of January 1, 20x1 is P90,000, based on consideration of the vesting conditions.

Requirement: Compute for the goodwill.

Solution:

Consideration transferred (1M+90K contingent consideration) 1,090,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,090,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 390,000

Journal entries:
Jan. 1, Identifiable assets acquired 1,600,000  
20x1 Goodwill 390,000  
Liabilities assumed   900,000
Share capital (10,000 x P10 par) 100,000
Share premium [10,000 x (P100 –P10)] 900,000
  Share premium – contingent consideration   90,000

Case #1:
The market price of ABC’s shares on December 31, 20x1 is P120.
The contingent consideration is settled on January 15,20x2.

Requirement: Provide the journal entries.

Solution:
Dec. No entry (a)
31,
20x1
Jan. Share premium – contingent consideration 90,000
15, Share capital (1,000 x P10 par) 10,000
20x2 Share premium (squeeze) 80,000
To record the issuance of 1,000 additional shares

(a) A contingent consideration that is classified as equity is not remeasured and its subsequent settlement is
accounted for within equity.
 Case #2:
The market price of ABC’s shares on December 31, 20x1 is P90.

Requirement: Provide the journal entries

Solution:
Dec. Share premium – contingent consideration 90,000
31, Share premium 90,000
20x1
Regardless of whether the vesting condition is met, the amount recognized in equity for a contingent
consideration remains in equity. This, however, does not preclude an entity from transferring amounts within
equity (i.e., reclassification between equity accounts).

Illustration 2: Contingent consideration classified as liability

On January 1, 20x1, ABC Co. acquired all the assets and liabilities of XYZ, Inc. of P1,600,000 and P900,000,
respectively.

ABC agrees to pay additional cash equal to 10% of the 20x1 year-end profit that exceeds P400,000. XYZ
historically has reported profits of P300,000 to P400,000 each year. The fair value of the contingent
consideration as of January 1, 20x1 is P10,000, based on assessments of the expected level of profits for year, as
well as forecasts, plans and industry trends.

Requirement compute for the goodwill.

Solution:
Consideration transferred (1M+10K contingent consideration) 1,010,000
Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 1,010,000
Fair value of net identifiable assets acquired (1.6M - .9M) (700,000)
Goodwill 310,000

Journal entries:
Jan. Identifiable assets acquired 1,600,000  
1, Goodwill 310,000  
20x1 Liabilities assumed   900,000
Liability for contingent consideration 10,000
  Cash   1,000,000

A contingent consideration representing an obligation to pay cash or other non-cash assets is classified as liability, and
measured at acquisition-date fair value, even if payment is not probable.

Continuation of Illustration 2 – Subsequent measurement:

Case #1:
The profit for the year is P550,000. The contingent consideration is settled in January 15, 20x2.

Requirement: Provide the journal entries.

Solution:
Dec. Unrealized loss – P/L (a) 5,000
 31, Liability for contingent consideration 5,000
20x1 To recognized loss on change in fair value of contingent
consideration classified as liability
Jan. Liability for contingent consideration 15,000
15, Cash 15,000
20x2
(a) Carrying amount of contingent consideration – 12/31/20x1 10,000
Fair value – 12/31/20x1 [(550K – 400K) x 10%] 15,000
Increase in fair value of liability (loss) (5,000)
A contingent consideration that is classified as liability is remeasured to fair value at each reporting date.
Changes in fair value are recognized in profit or loss.

Case #2
The profit for the year is P300,000.

Requirement: Provide the journal entry.

Solution:
Dec. Liability for contingent consideration 10,000
31, Gain on extinguishment of liability – P/L 10,000
20x1

The liability is extinguished because the earnings target is not met.

In Cases 1 & 2 above, the fair value changes relate to the meeting and non-meeting of the earnings target, which
are not measurement period adjustments. Accordingly, these are recognized in profit or loss. The recognized
goodwill is not affected regardless of the outcome of the contingency.

Illustration 3: Contingent payments to employees

ABC Co. acquired 90% interest in XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities have fair value of
P1,600,000 and P900,000, respectively. ABC measured the NCI at a fair value of P80,000.

Five years ago, XYZ appointed Mr. Boss as the CEO under a ten –year contract which requires XYZ to pay Mr.
Boss P100,000 if XYZ is acquired before the contract expires. ABC assumes the obligation to pay Mr. Boss the
contract amount.

Requirement: Compute for the goodwill.

Solution:
Consideration transferred 1,000,000
Non-controlling interest in the acquiree 80,000
Previously held equity interest in the acquiree -
Total 1,080,000
Fair value of net identifiable assets acquired
(1.6M - .9M – 100K payable to Mr. Boss) (600,000)
Goodwill 480,000

The employment contract existed long before the business combination, and for the purpose of obtaining the services of
the CEO. There is no evidence that the agreement was arranged primarily for the benefit of ABC or the combined entity.
Therefore, the P100,000 obligation is treated as an additional liability assumed rather han an adjustmen to the
consideration transferred.

Notable differences between the provisions of the full PFRS and the PFRS for SMEs:

Full PFRSs PFRS for SMEs

6. Previously held equity interest in the acquiree
In a business combination achieved in No equivalent provision under PFRS for
stages, the acquirer’s previously held equity SMEs.
interest in the acquiree is remeasured to fair
value and included in the computation of
goodwill
7.Contingent consideration
Initial measurement: Initial measurement:
 Included in the consideration  Included in the cost of business
transferred at acquisition-date fair combination if it is probable and
value. can be measured reliably.

Subsequent measurement Subsequent measurement:

 Change in fair value that is:  Change in fair value is treated as an
a. a “measurement period adjustment to the cost of business
adjustment’ is adjusted to combination (i.e., adjusted to
goodwill. goodwill).
b. not a measurement period
adjustment:
i. remains in equity, if the
contingent consideration
is classified as equity
ii. is recognized in profit or
loss, if the contingent
consideration is classified
as liability or asset.
Chapter 3
Business Combination (Part 3)

Related standard: PFRS 3 Business Combinations

Learning Objectives
1. Apply the methods of estimating goodwill.
2. Account for reverse acquisition.

Special accounting topics for business combination

This chapter discusses accounting for business combination in relation to the following:
1. Goodwill
2. Reverse acquisitions
3. Combination of mutual entities

Goodwill
Only a goodwill that arises from a business combination is recognized as an asset. Goodwill arising from other
sources (e.g., internally generated) is not recognized. Goodwill is measured and recognized in acquisition date.
Subsequent expenditures on maintaining goodwill are expensed immediately.

After initial recognition, goodwill is not amortized but rather tested for impairment at least annually. for thid
purpose, goodwill is allocated to each of the acquirer’s cash-generating units (CGU) in the year of business
combination. If the allocation is not completed by the end of that year, it must be completed before the end of
the immediately following year.

 Cash-generating unit (CGU) is “the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.”(PAS36.6)

Goodwill is allocated to the CGUs expected to benefit from the synergies of the business
combination using a methodology that is reasonable, supportable, and applied in a consistent manner. For
example, goodwill may be allocated based on the relative fair values of the CGUs.
Because goodwill is unidentifiable, it cannot be tested for impairment separately but only
in conjunction with groups of assets that generates independent cash inflows (i.e., CGUs). Goodwill does not
generates cash flows of CGUs.
A CGU to which goodwill has been allocated is tested for impairment annually. A CGU is
impaired if its recoverable amount is less than its carrying amount including the allocated goodwill. Impairment
loss is charged first to the CGU’s goodwill and any excess is charged to the other assets in the CGU.
Impairment goodwill is not reversed in a subsequent period.
If the CGU is disposed, the goodwill allocated to it is also derecognized and included in
the determination of gain or loss from the disposal.
The subsequent accounting for goodwill is discussed extensively in Intermediate Accounting Part 1B. The
accounting for impairment loss on goodwill in the consolidated financial statements is discussed in Chapter 6.

Due diligence
Before negotiations take place for a business combination, the acquirer normally initiates a due diligence audit
for the purpose of determining the appropriate amount of consideration to be transferred to the acquiree.
Due diligence audit refers to the investigation of all area of a potential acquiree’s business
before an investor agrees to a business combination transaction. The term “due diligence” may refer to the
exercise of care that a reasonable and prudent person should take before entering a contract with another party.
Due diligence audit is a service most commonly performed by CPAs or external auditing firms.
Due diligence audit helps an investor evaluate the possible risks and rewards of the
potential investment and determine whether it would be a good decision to pursue it.

Examples of potential risks which may be determined through a due diligence audit:
1. Possibility of future losses due to the acquiree’s pending litigations and other unrecorded contingencies.
2. Overstatement in the consideration for the business combination due to acquiree’s overstated assets and
understated liabilities.
3. Incompatibility of internal cultures, system, and policies.
Examples of potential rewards which may be determined through a due diligence audit:
1. Unrecorded assets, such as trade secrets, trade name, customer lists, and the like.
2. Understatement in the consideration for the business combination due to the acquiree’s understated
assets and overstated liabilities.

Methods of estimating goodwill

Before the actual business combination transaction takes place, the amount of goodwill may be estimated using
any of the following methods:
1. Indirect valuation – this is a residual approach wherein goodwill is measured as the excess of the sum
of consideration transferred, non-controlling interest in the acquiree, and previously held equity interest
in the acquiree over the fair value of net identifiable assets acquired. PFRS 3 requires this method and it
is the method illustrated in the preceding discussions.
2. Direct valuation – under this method, goodwill is measured based on expected future earnings from the
business to be acquired.

The application of the direct valuation method may require the determination of the following information:
a. Normal rate of return in the industry where the acquiree belongs. The normal rate of return may be the
industry average determined from examination of annual reports of similar entities or from published
statistical data.
- “Normal earnings” is equal to normal rate of return multiplied by the acquiree’s net assets.
b. Estimated future earnings of the acquiree.
i. For purposes of goodwill measurement, the earnings of the acquiree are “normalized,” meaning
earnings are adjusted for non-recurring income and expenses (e.g., expropriation gains or losses).
ii. The excess of the acquiree’s normalized earnings over the average return in the industry
represents the “excess earnings to which goodwill is attributed. Excess earnings are sometimes
referred to as “superior earning.”
 c. Discount rate to be applied to “excess earnings”
d. Probable duration of “excess earnings”

Illustration 1: Application of the Direct valuation method

ABC Co. is contemplating on acquiring XYZ, Inc. The following information was gathered through a due
diligence audit:
 The actual earnings of XYZ, Inc. for the past 5 years are shown below
Year Earnings
20x1 1,200,000
20x2 1,300,000
20x3 1,350,000
20x4 1,250,000
20x5 1,800,000
Total 6,900,000
 Earnings in 20x5 include an expropriation gain of P400,000
 The fair value of XYZ’s net assets as of the end of 20x5 is P10,000,000.
 The industry average rate of return is 12%.
 Probable duration of “excess earnings” is 5 years.

Method #1: Multiples of average excess earnings

Under this method, goodwill is measured at the average excess earnings multiplied by the probable duration
of excess earnings.

Total earnings for the last 5 years 6,900,000

Less: Expropriation gain (400,000)
Normalized earnings for the last 5 years 6,500,000
Divide by: 5
( a) Average annual earnings 1,300,000

Fair value of acquiree’s net assets 10,000,000

Multiply by: Normal rate of return 12%
( b) Normal earnings 1,200,000

Excess earnings (a) – (b) 100,000

Multiply by: Probable duration of excess earnings 5
Goodwill 500,000

Method #2: Capitalization of average excess earnings

Under this method, goodwill is measured at he average excess earnings divided by a pre-determined
capitalization rate. (Assume a capitalization rate of 25%).

Average earnings [(6,9M - .4M Expropriation gain) ÷ 5 yrs.] 1,300,000

Normal earnings (10M x 12%) (1,200,000)
Excess earnings 100,000
Divide by: Capitalization rate 25%
Goodwill 400,000

Method #3: Capitalization of average earnings

 Under this method, the average earnings are divided by a pre-determined capitalization rate to estimate the
purchase price of the business combination. The excess of the estimated purchase price over the fair value of
the acquiree’s net assets represents the goodwill. (Assume a capitalization rate of 12.5%).

Average earnings [(6,9M - .4M Expropriation gain) ÷ 5 yrs.] 1,300,000

Divide by: Capitalization rate 12.50%
Estimated purchase price 10,400,000
Fair value of XYZ’s net assets (10,000,000)
Goodwill 400,000

Notice that if the “excess earnings” is used in the computations, the amount directly computed is goodwill. On
the other hand, if the “average earnings” is used, the amount directly computed is estimated purchase price.
Method #4: Present value of average excess earnings
Under this method, goodwill is measured at the present value of average excess earnings discounted at a pre-
determined discount rate over the probable duration of excess earnings.(Assume a discount rate of 10%).

Average earnings [(6,9M - .4M Expropriation gain) ÷ 5 yrs.] 1,300,000

Normal earnings in the industry (10M x 12%) (1,200,000)
Excess earnings 100,000
Multiply by: PV of an ordinary annuity @10%, n=5 3.79079
Goodwill 379,079

Illustration 2: Application of Direct valuation method

ABC Co. is estimating the goodwill in the expected purchase of XYZ, Inc. in January 20x6. The following was
determined.

Year Earnings Year-end net assets

20x1 120,000 480,000
20x2 130,000 580,000
20x3 135,000 540,000
20x4 125,000 560,000
20x5 140,000 590,000
Total 650,000 2,750,000

Case #1: Excess earnings

Goodwill shall be measured by capitalizing excess earnings at 30%, with normal return on average net assets
at 10%. The year-end net assets in 20x5 approximate fair value.

Requirement: Compute for the estimated purchase price in the contemplated business combination.

Solution:
Average earnings (650,000 ÷ 5 yrs) 130,000
Normal earnings on average net assets [10% x (2.75M ÷5)] (55,000)
Excess earnings 75,000
Divide by: Capitalization rate 30%
Goodwill 250,000
Add: Fair value of net identifiable assets acquired 590,000
Estimated purchase price 840,000
 Case #2:Average earnings
Goodwill shall be measured by capitalizing average earnings at 16%. The year-end net assets in 20x5
approximate fair value.
Requirement: Compute for the estimated purchase price and goodwill in the contemplated business
combination.

Solution:
Average earnings (650,000 ÷ 5 yrs) 130,000
Divide by: Capitalization rate 16%
Estimated purchase price 812,500
Fair value of net identifiable assets acquired (590,000)
Goodwill 222,500
Illustration 3: Applications of the Direct valuation method
ABC Co. plans to acquire the net assets of XYZ, Inc. with carrying amount of P9,000,000. This amount
approximate fair value, except for one assets whose fair value exceeds its carrying amount by P1,000,000.
XYZ’s average earnings are P1,300,000. The industry average rate of return is 12% of the fair value of the net
assets. XYZ’s excess earnings are expected to last for 5 years. The expected return on the investment is 10%.

Requirement: Compute for the estimated purchase price using the “present value of average excess earnings”
approach.

Solution:
Average earnings 1,300,000
Normal earnings in the industry (12% x 10M*) (1,200,000)
Excess earnings 100,000
Multiply by: PV of an ordinary annuity @10%, n=5 3.79079
Goodwill 379,079

*Carrying amount of equity 9,000,000

Excess of fair value of one asset over its carrying amount 1,000,000
Fair value of XYZ’s net assets 10,000,000

Estimated purchased price (squeeze) 10,379,079

Less: Fair value of XYZ’s net assets 10,000,000
Goodwill 379,079

Illustration 4: Application of the Direct valuation method

ABC Co. acquired the net assets of XYZ, Inc. for P10.4M. The acquisition resulted to goodwill of P400,000
measured by capitalizing the annual superior earnings of XYZ at 25%. The normal rate of return is 12% on net
assets before recognition of goodwill.

Requirement: Compute for the average earnings of XYZ.

Solution:
Average earnings 1,300,000 (squeeze)
Normal earnings (12% x 10M*) (1,200,000
Excess earnings of superior earnings (given) 100,000
Divide by: Capitalization rate 25%
Goodwill (given) 400,000 (Start)

*Purchase price (Given) 10,400,000

Less: Fair value of net assets acquired (squeezed) (10,000,000)
Goodwill (given) 400,000

Illustration 5: Application of the Direct valuation method

ABC Co. and Xyz, Inc. decided to combine and set up a new entity – Alphabets Corporation. The individual
records of the combining constituents show the following:
ABC Co. XYZ, Inc.
Net assets (at fair value) 400,000 600,000
Average annual earnings 80,000 120,000
Alphabets Corporation issues 10% preference share with par value per share of P100 for the net assets
contribution of the combining constituents and ordinary shares with par value per share of P50 for the excess
total contributions (net asset contribution plus goodwill) over net assets contributions.

The normal rate of return is 10% of net assets. Excess earnings will be capitalized at 20%.

Requirements: Compute for the following:

a. Goodwill
b. Total contributions of ABC Co. and XYZ, Inc.
c. The ratio of total shares (preference and ordinary) issued to ABC Co. and XYZ, Inc.

Solution:
Requirement (a):
ABC Co. XYZ, Inc. Total
Average annual earnings 80,000 120,000
Normal earnings on net assets (40,000) (60,000)  
Excess earnings 40,000 60,000
Divide by: Capitalization rate 20% 20%  
Goodwill 200,000 300,000 500,000

Requirement (b):
ABC Co. XYZ, Inc. Total
Total contribution (squeeze) 600,000 900,000 1,500,000
Fair value of net assets (400,000) (600,000)  
Goodwill 200,000 300,000  

Requirement (c ):
ABC Co. XYZ, Inc. Total
Net asset contributions 400,000 600,000 1,000,000
Divide by: Par value per share of PS 100 100 100
Number of peference shares issued 4,000 6,000 10,000

Total contribution 600,000 900,000 1,500,000

Net asset contribution (400,000) (600,000) (1,000,000)
 Excess of total contribution 200,000 300,000 500,000
Divide by:Par value per share of OS 50 50 50
Number of ordinary shares issued 4,000 6,000 10,000

Total PS and OS issued 8,000 12,000 20,000

Ratio of shares issued 40% 60% 100%

Reverse acquisitions
In a business accomplished through exchange of equity interests, the acquirer is usually the entity that issues its
equity interests. However, the opposite is true for reverse acquisitions.
In a reverse acquisition, the entity that issues securities (the legal acquirer) is identified as
the acquiree for accounting purposes, while the entity whose equity interests are acquired (the legal acquiree) is
the acquirer for accounting purposes
For example, ABC Co., a private entity, wants to become a public entity but does not want
to register its shares. To accomplish this, ABC will arrange for a public entity to acquire its equity interests in
exchange for a public entity’s equity interests
In here, the public entity is the legal acquirer because it issued its equity interests, and
ABC Co. is the legal acquiree because its equity interests were acquired. However, when applying the
acquisition method:
a. the public entity is identified as the acquiree for accounting purposes (accounting acquiree);and
b. ABC Co. is identified as the accounting acquirer.

Measuring the consideration transferred

In substance, the accounting acquirer issues no consideration to the acquiree. Instead, the accounting acquiree
issues equity interests to the owners of the accounting acquirer for them to obtain control over the accounting
acquiree.
As such, the acquisition-date fair value of the consideration transferred by the accounting
acquirer is measured as an amount based on the number of equity interests the legal subsidiary (accounting
acquirer) would have had to issue to give the owners of the legal parent (accounting acquiree) the same
percentage of equity interest in the combined entity that results from the reverse acquisition.

Conventional acquisition vs. Reverse acquisition:

Conventional acquisition Reverse acquisition

Issuers of shares as - Accounting acquirer - Accounting acquiree.
consideration transferred
Reference to combining Accounting acquirer/
- - Accounting acquirer/
constituents Legal parent legal subsidiary
- Accounting acquire/ - Accounting acquire/
Legal subsidiary Legal parent
Measurement of consideration Fair value of consideration Fair value of the notional number
transferred transferred by the accounting of equity instruments that the
acquirer. accounting acquirer (legal
 subsidiary) would have to issue to
the accounting acquiree (legal
parent) to give the owners of the
accounting acquiree (legal parent)
the same percentage ownership in
the combined entity.

Illustration: Reverse acquisition

ABC Co., a public listed entity, and XYZ, Inc., an unlisted company, exchange equity interests.
 ABC Co. issues 5 shares in exchange for all the outstanding shares of XYZ, Inc.
 ABC’s shares are quoted at P40 per share, while XYZ’s shares have a fair value of P200 per share.
 The statement of financial position immediately before the combination are shown below:

ABC Co. XYZ, Inc.

Identifiable assets 1,600,000 2,400,000
Total assets 1,600,000 2,400,000

Liabilities 1,300,000 700,000

Share capital:
10,000 ordinary shares, P10 par 100,000
8,000 ordinary shares, P100 par 800,000
Retained earnings 200,000 900,000
Total Liabilities and equity 1,600,000 2,400,000

 The assets and liabilities approximate their fair values.

Requirements:
a. Identify the accounting acquirer.
b. Compute for the goodwill.

Solution:

Requirement (a):
Legal form of the contract: ABC issues 5 shares for each of the 8,000 outstanding shares of XYZ. After the
issuance, ABC’s equity will have the following structure:

ABC’s currently issued shares 10,000 20%

Shares issued to XYZ (5 x 8,000) 40,000 80%
Total shares after the combination 50,000

Analysis: The business combination is reverse acquisition because XYZ obtains control over ABC despite the
fact that ABC is the issuer of shares. In other word, XYZ let itself be acquired (legal form) in order to gain
control over ABC (substance).

 XYZ, Inc., the legal acquiree, is the accounting acquirer.

 ABC, Co., the legal acquirer, is the accounting acquiree.

Requirement (b):
Substance of the contract: XYZ obtains control over ABC in a reverse acquisition. Accordingly, the
consideration transferred is computed based on the number of shares XYZ (accounting acquirer) would have
had to issue to give ABC (accounting acquiree) the same percentage of equity interest in combined entity.

Reverse – XYZ (accounting acquirer) issues shares to ABC

Shares %
XYZ’s currently issued shares 8,000 80%
Shares issued to ABC [(8,000 ÷ 80%) x 20%] 2,000 20%
Total shares after the combination 10,000

If the business combination had taken the form of XYZ issuing additional ordinary shares to ABC’s
shareholders, XYZ would have had to issue 2,000 shares for the ratio of ownership interests in the combined
entity to be the same. XYZ’s shareholders would then own 8,000 of the 10,000 issued shares of XYZ (80% of
the combined entity), while ABC’s shareholders own 2,000 (20% of the combined entity).

Consideration transferred (2,000 sh. x P200) 400,000

Non-controlling interest in the acquiree -
Previously held equity interest in the acquiree -
Total 400,000
Fair value of ABC’s net assets (1.6M – 1.3M) (300,000)
Goodwill 100,000