CHAPTER 4

Business Combination
(Based on IFRS 3)

AcFN 3151, Ch 4 04/08/2024 1

Introduction
 Business combination: is a transaction or other event in

which an acquirer obtains control of one or more

businesses (the acquiree).

 The transaction which brings these two

parties together is known as a 'business
combination' and creates a 'group' of
entities.
 Commonly, business combinations are often
referred to as Mergers and Acquisitions (M&A).
AcFN 3151, Ch 4 04/08/2024 2
Cont…
 In general, control over other companies can be

obtained by acquiring all of the target company’s

assets or by acquiring more than 50% of the

target company’s outstanding voting common

stock.

AcFN 3151, Ch 4 04/08/2024 3

 Identification of BC
A transaction or other event is a business
combination if: The assets acquired and
liabilities assumed constitute a business.
If the asset acquired are not a business, it
must be accounted for as an asset
acquisition.
 BC: Definitions
 According to IFRS 3, A business combination is
a transaction or other event in which a
reporting entity (the acquirer) obtains control of
one or more businesses (the acquiree).
 IFRS 3 does not apply to the following:
 The formation of a joint venture
 The acquisition of an asset or group of assets that is not a
business as defined
 A combination of entities or businesses under common
control. 5
 Example
 E&P Co A (an oil and gas exploration and production

company) acquires a mineral interest from E&P Co B, on

which it intends to perform exploration activities to

determine if reserves exist. The mineral interest is an

unproven property and there have been no exploration

activities performed on the property.

◦ It is not a Business Combination.

 Cont…
• E&P Co A acquires a property similar to that in
Example above, except that oil and gas production
activities are in place. The target’s employees are
not part of the transferred set. E&P Co A will take
over the operations by using its own employees.
• It is a Business Combination.
 Types of interest in other entities
Subsidiary Associate Joint Investment
Interest Interest Arrangemen Interest
t (FIs)
Ownership >50% 20% - 50% Joint < 20%

Accounting IFRS 3 & IAS 28 IFRS 11 IFRS 9

Standards IFRS 10

Accountin Control = Significant Joint At fair

g Consolidati influence operation = value.
Treatment on = Equity in Separate
method accordance financial
Parties to a business combination

AcFN 3151, Ch 4 04/08/2024 9

 Cont…

Combined Enterprise: The accounting entity that results
from a business combination.
 Constituent Companies: The business enterprises that enter
into a combination.
 Combinor: A constituent company entering into a
combination whose owners as a group ends up with control of
the ownership interests in the combined enterprise. The term
acquirer, parent and combinor can be used interchangeably.
 Combinee: A constituent company other than the
combinor in a business combination. The term
acquired, acquiree, subsidiary and combinee can be
used interchangeably.
Motives for Business Combinations
 Some of the reasons behind Business Combinations are corporate
strategies intended to:
 achieve rapid corporate expansion,
 penetrate new markets,
 Tax advantages,
 attain economy of scale and
 Synergies through Consolidation
 Obtaining new management strength or better use of
existing management.
 Diversification of risk
Classes of Business Combinations

Business Com binations

Friendly Takeover Hostile Takeover

AcFN 3151, Ch 4 04/08/2024 12
Friendly Takeovers
 Board of Directors (BODs) of all

constituent companies amicably/smoothly

determine the terms of the business

combination.

 Proposal is submitted to share holders of

AcFN 3151, Ch 4 04/08/2024 13
Hostile Takeovers
 Target combinee typically resists the proposed

business combination.

 Target combinee uses one or more of the several

defensive tactics.

 Tactics for defense used in hostile takeovers

(Reading Asst.). AcFN 3151, Ch 4 04/08/2024 14

Tactics for Defense Used in Hostile
Takeovers
A. Pac-man Defense: the target firm then tries to acquire the
company that has made a hostile takeover attempt..
B. White Knight: A search for a candidate to be the combinor
in a friendly takeover.
C. Scorched Earth: The disposal, by sale or by spin-off to
stockholders, of one or more profitable business segments.
D. Shark Repellent: An acquisition of substantial amounts of
outstanding Common stocks for the treasury or for
retirement, or the incurring of substantial long term debt in
exchange for outstanding common stock.
AcFN 3151, Ch 4 04/08/2024 15
 Tactics for Defense Used in
Hostile Takeovers, ..
E. Poison Pill: An amendment of the articles of incorporation

or bylaws to make it more difficult to obtain s/holder

approval for a takeover.
F. Green Mail: An acquisition of common stock presently

owned by the prospective combinor at a price

substantially in excess of the prospective combinor’s
cost, with the stock thus acquired placed in the
treasury or retired.
AcFN 3151, Ch 4 04/08/2024 16
 Types of Business
Combinations
1. Horizontal Combination: is a combination involving enterprises in the same

industry. E.g. assume combination of Ethio flour and Sun flour.

2. Vertical Combination: A Combination involving an enterprise and its customers

or suppliers. It is a combination involving companies engaged in different stages

of production or distribution. It is classified into two:

 Backward Vertical Combination – combination with supplier

E.g.: A Brewery Co. acquiring a Malt Co. and

 Forward Vertical Combination – combination with customers.

E.g.: A Tannery Company acquiring a Shoes Company - Forward

3. Conglomerate Combination: is a combination between enterprises in unrelated

industries or markets.
Methods of Business
Combinations
 The Three common methods for carrying
out a business combination are:
A. Statutory Merger
B. Statutory Consolidation, and
C. Acquisition of Common Stock and
D. Assets Acquisitions.
Methods of Arranging Business
Combination
 Statutory Merger (or Absorption):
◦ One company (the Combinor) acquires all of
the voting stock or all of the assets of one or
more other companies (combinee or
combinees).
◦ Only the Combinor survives as a separate legal
entity.

AcFN 3151, Ch 4 04/08/2024 19

 Statutory Consolidation (or Amalgamation)
◦ A new company is formed from the net assets
of two or more old companies.
◦ Only the new company survives as a separate
legal entity.
◦ Mathematically it can be expressed as:
B+C=A.

AcFN 3151, Ch 4 04/08/2024 20

 Acquisition of Common Stock
◦ The acquiring company obtains a substantial amount
or all of the voting stock of one or more acquired
companies.
◦ all companies continue as separate legal entities.
◦ Acquiring company- the parent or holding,
◦ the acquired company (or companies - a subsidiary
(or subsidiaries).
◦ For financial reporting purposes, the companies
combine their information - consolidated financial
statement.

AcFN 3151, Ch 4 04/08/2024 21

 Statutory Merger
ABC
Company
ABC Company
XYZ
Company
 Statutory Consolidation
ABC
Company
EFG Company
XYZ
Company
 Acquisition of Common
Stock
ABC
ABC Company
Company
XYZ
XYZ Company
Company

ABC…….Parent
XYZ…….Subsidiary
Accounting Methods for Business Combinations

 Major accounting issues affecting business combinations and the

preparation of consolidated or combined financial statements
pertain to the following:
1. The proper recognition and measurement of the assets and
liabilities of the combining entities;
2. The accounting for goodwill or gain from a bargain purchase
(negative goodwill);
3. The elimination of intercompany balances and transactions in
the preparation of consolidated financial statements; and
4. The manner of reporting the non-controlling interest.

2
Accounting Methods for Business
Combinations (Contd…)
1. The Pooling of interest Method (prior to
2002)
2. Purchase Method (2002 to 2008)
3. Acquisition Method (Since 2009)

26
1 Pooling of interest method
 The pooling-of-interests method combined
the assets and liabilities of both companies
at book value or historical costs.
 Intangible assets, such as goodwill, were not
included in the pooling-of-interests method
 Only used when a company acquired all of
another company’s stock – using its own
stock as consideration (no cash!).
27
2. Purchase Method
 This method requires that all assets and liabilities,
tangible and intangible, be measured at fair market
value -it is valued at the amount that a third party would
have paid on the open market on the date that the
company acquired it.
 It treats the target firm as an investment.
 There is no pooling of assets.
 The amount paid by the acquirer over the net value of
the target's assets and liabilities is considered goodwill,
which is kept on the balance sheet and amortized yearly.

28
3. Acquisition Method
 The acquisition method is applied to business
combinations beginning in 2009, but previous
accounting methods used are still in effect today.
 Acquisition accounting is a set of formal
guidelines describing how assets, liabilities, non-
controlling interest (NCI) and goodwill of a
purchased company must be reported by the
buyer on its consolidated statement of financial
position.
29
Acquisition Method (Contd…)
 It is used to account for business combinations.
 It requires recognizing and measuring at fair
value:
 Consideration transferred for the acquired business
 Noncontrolling interest
 Separately identified assets and liabilities
 Goodwill or gain from a bargain purchase

 Any contingent considerations.

30
 Acquition Method (Contd…)
 In Fair value:
Asset valuations established using…
 The Market Approach – fair value can be estimated
referencing similar market trades.
 The Income Approach – fair value can be estimated using
the discounted future cash flows of the asset.
 The Cost Approach – estimates fair values by reference to
the current cost of replacing an asset with another of
comparable economic utility.

31
Acquisition Method (Contd…)
 What if the consideration transferred does NOT
EQUAL the Fair Value of the Assets acquired?
 If the consideration is MORE than the Fair Value of
the Assets acquired, the difference is attributed to
GOODWILL
 If the consideration is LESS than the Fair Value of
the Assets acquired, we got a BARGAIN!! And we
will record a GAIN on the acquisition!!is LESS than the
Fair Value of the Assets acquired, we got a BARGAIN!! And we
will record a GAIN on the acquisition!!
32
 Acquisition Method
 IFRS 3 establishes the accounting and reporting

requirements (known as ‘the acquisition method’) for

the acquirer in a business combination.

 The key steps in applying the acquisition method are

summarised below:
AcFN 3151, Ch 4 04/08/2024 34
 Step 1: Identify the acquirer

The guidance in IFRS 10 shall be used to

identify the acquirer—the entity that
obtains ‘control’ of another entity, i.e.
the acquiree.
 Cont…

 If the guidance in IFRS 10 does not clearly indicate which

of the combining entities is an acquirer, IFRS 3 provides
additional guidance which is then considered:
◦ The acquirer is usually the entity that transfers cash or other assets where
the business combination is effected in this manner.
◦ The acquirer is usually, but not always, the entity issuing equity interests
where the transaction is effected in this manner, however the entity also
considers other pertinent facts and circumstances including:
 relative voting rights in the combined entity after the business
combination
 the existence of any large minority interest if no other owner or
group of owners has a significant voting interest
 the composition of the governing body and senior management
of the combined entity
 the terms on which equity interests are exchanged
◦ The acquirer is usually the entity with the largest relative size (assets,
revenues or profit).
◦ For business combinations involving multiple entities, consideration is
given to the entity initiating the combination, and the relative sizes of the
combining entities.
Step 2: Determine the acquisition
date: date on which the acquirer
obtains control.
The date on which the acquirer obtains
control of the acquiree
◦ Is generally the date on which the acquirer legally transfers the
consideration, acquires the assets and assumes the liabilities of the
acquiree—the closing date.
◦ May be other dates (earlier or later than the closing
date) at which control is assumed.
 Cont…
 IFRS 3 does not provide detailed guidance on the
determination of the acquisition date and the date
identified should reflect all relevant facts and
circumstances.
 Considerations might include, among others, the date a
public offer becomes unconditional (with a controlling
interest acquired), when the acquirer can effect change in
the board of directors of the acquiree, the date of
acceptance of an unconditional offer, when the acquirer
starts directing the acquiree's operating and financing
policies, or the date competition or other authorities
provide necessarily clearances.
Step 3: Recognize and measure the
identifiable assets acquired, the
liabilities assumed and any non
controlling interest in the acquiree;
 IFRS 3 establishes the following principles in
relation to the recognition and measurement of
items arising in a business combination:
◦ Recognition principle: Identifiable assets acquired,
liabilities assumed, and non-controlling interests in the
acquiree, are recognised separately from goodwill.
◦ Measurement principle: The acquirer shall measure the
identifiable assets acquired and the liabilities assumed at
their acquisition-date fair values.
 Cont…
1. Marketable Securities: Recorded at Fair value.
2. Receivables: Recorded at Discounted Present Value
Amount.
3. Inventory:
◦ Raw Materials: Current Replacement Cost
◦ Work in Process: Net realizable value-Cost to complete-Cost to
sale
◦ Finished Goods: Net realizable value-Cost to sale
4. Intangible Assets: Recorded at Fair value.
5. Fixed Assets: Recorded at Fair value.
6. Liabilities: Recorded at Fair value.
 Non controlling interest
Non-controlling interest (NCI): Also known as minority interest,
refers to a shareholder owning less than 50% of outstanding
shares and having no control over decisions.
If less than 100% of the equity interests of another entity is acquired
in a business combination, non-controlling interest is recognized.
IFRS 3: allows an accounting policy choice for measuring non-
controlling interest (NCI) at the acquisition date:
1) fair value (sometimes called the full goodwill method)- new method; or
2) NCI’s proportion of the group values of the subsidiary’s net assets- old method.
IFRS for SMEs: NCI = NCI’s proportion of the group values of the
subsidiary’s net assets.
 Cont…
 Sometimes NCI is calculated through Implied value.
Implied value = Acquisition cost
% of controlling interest
NCI = Implied value-Acquisition cost
 For example, If Com. A acquired 80% of Com. B at Br.
800,000. Find the NCI:
Implied value= Br. 800,000/ 0.8 = Br. 1,000,000.00
NCI = Br. 1,000,000-Br. 800,000 = Br. 200,000.00
 Step 4:Recognize and measure the
goodwill or a gain from a bargain
purchase.
 If the acquisition cost(Implied value) exceed
the fair value of net identifiable asset, then
we recognize as goodwill.
 If the fair value of net identifiable asset
exceed the acquisition cost(Implied value),
then we recognize as Negative goodwill
 Gain on a bargain
purchase
Acquisition cost + Fair Value of Identifiable
Goodwill= Non Controlling Less Net Assets
Interest

Negative Goodwill could arise when the aggregate of the FVs

of the separable NAs acquired exceed what the parent
Company's paid for them.
Which is named (a.k.a) 'gain on a bargain purchase'.
In this situation:
(a) An entity should first re-assess the amount at which it has
measured both the cost of the combination and the
acquiree's identifiable NA. This exercise should identify any
errors.
(b) Any excess remaining should be recognised
immediately in profit or loss
AcFN 3151, Ch 4 04/08/2024 44
 Cont…
1. Determination of Cost of Acquisition – assets to be
acquired and liabilities to be assumed are identified and
then, like other exchange transactions, measured on the
basis of the fair values exchanged. The Cost of combinee
includes also some other costs as discussed below.
 The cost of a combine on a BC accounted for by

Acquisition method is the total of

a. The amount of consideration paid by the combiner,
b. Any contingent consideration that is determinable on the
date of the business combination.
 Cont…
a. Amount of Consideration:
 This is the total amount of

a. Cash paid,

b. The Current fair value of other assets distributed,

c. The present value of debt securities issued &

d. The Current fair value (Market) value of equity security issued by the combiner.

Investment in Subsidiary………………….xx

Cash/other assets…………………………………………………..……………xx

Bond Payable……………………………………………………...……………..xx

Common stock…………………………………………………………………...xx

Additional paid in capital in excess of par value……………………………xx

 Cont…
b. Contingent Consideration: Relates to an additional amount
paid by the parent to the shareholders of subsidiary if
certain conditions are met. It recorded at fair value.
Investment in subsidiary……………xx
Contingent Consideration………………xx
Acquisition cost = Amount of consideration + Contingent
consideration
Implied value = Acquisition cost + Non Controlling Interest
 Other costs
1. Direct combination costs: Associated with completing the business

combination (Legal, Accounting, Consulting, Appraisal and Finder`s fee).

Merger Expense………………xx
Cash……………………………………xx

2. Stock Issuance Cost: When the parent issues stock in conjunction with a

BC, any stock issuance costs, such as underwriter fee and exchange
fee.
Additional paid in capital in excess of par…………….xx

Cash………………………………………………………………………xx
 Cont…
2. Fair value of Net Identifiable Asset
(FVNIA):
FVNIA = Fair value of Asset - Fair value
of Liabilities
 Cont…
Goodwill
The acquirer shall, at the acquisition date:
(a) Recognize goodwill acquired in a business combination as an asset, and
(b) Initially measure that goodwill at its cost, being the excess of the cost of
the business combination over the acquirer’s interest in the net fair value
of the identifiable assets, liabilities and contingent liabilities recognized.
(c) Subsequently, goodwill acquired in a business combination to be tested
for impairment annually. So, the company doesn`t amortize the
Goodwill.
 EXAMPLE 1
Determine the value of the investment
ABCCo. acquires 100% of the equity of B on 31 December 2008.

There are 3 elements to the purchase consideration:

 an immediate payment of $5m cash, and

 two further payments of $1m if the return on capital

employed (ROCE) exceeds 10% in each of the
subsequent financial years ending 31 Dec.
All indicators have suggested that this target will be met.

ABC Co. uses a discount rate of 7% in any present value

calculations. AcFN 3151, Ch 4 04/08/2024 51
 Acquisition cost= $5m+ PV (Contingent Payment)
= $5m + $1.81m
= $6.81M
 Fair value of $(1m/1.07 + 1m/1.072)
=$1.81m
NB: All subsequent changes in debt-contingent
consideration are recognized in the Profit or loss,
rather than against goodwill

AcFN 3151, Ch 4 04/08/2024 52

 Example 2: NCI (Old and new methods)

P pays €800m to purchase 80% of the shares of S. The FV of 100% of S’s identifiable NAs
is €600m. (Assume published FV of minorities =€185m)
(I) proportionate (Partial) Method:
NCI = €120m (20% x €600m),
The CFS show goodwill = €320 (€800m + €120m – €600m).
(II) fair value (FULL) Method:
Goodwill = €800m + €185m – €600m

= €385m
NB: The FV of the 20% non-controlling interest in S will not necessarily be
proportionate to the price paid by P for its 80%, primarily due to control premium or
discount.

AcFN 3151, Ch 4 04/08/2024 53

 Example 3
 P com acquired S com on Dec. 31/2017 with the following balances:
 The carrying amount of Assets are Br 440,000.
 The carrying amount of liabilities are Br 140,000.
 The fair value of assets are Br 500,000.
 The fair value of liabilities are Br 170,000.
 On Dec.31/2017 P com issued 50,000 shares of its Br 5(CFV of Br 8)
CS for all the net asset of S.
 Issuance and out of pocket costs are Br 40,000 and Br 25,000,
respectively.
 Cont…
 Journal Entries:

1. Investment in S…..(8*50,000)…..................….400,000

Common Stock…(5*50,000)…………………….………250,000

Additional Paid in capital in excess of par…..………..150,000

2.Merger Expense…………………………………… 25,000

Additional Paid in capital in excess of par…...…….40,000

Cash…………………………………………………………….65,000
 Cont…
Goodwill Calculation
 Acquisition Cost = Br 400,000
 FVNIA = Fair Value of Asset – Fair Value of Liability
= Br 500,000 – Br 170,000
= Br 330,000
 Goodwill = AC-FVNIA
= Br 400,000 – Br 330,000
= Br 70,000.
Example 4
 Cont…
 Journal Entries:

1. Investment in Set…((100,000*13) + 50,000)…….1,350,000

Common Stock(100,000*10)…………………..…1,000,000

Additional Paid in Capital in Excess of Par ……300,000

Cash……………………..……………………… 50,000

2. Merger Expense………………………………….…180,000

Additional Paid in Capital in Excess of Par….…120,000

Cash……………………………………………………….300,000
 Cont…
Goodwill calculation
 Acquisition cost = Br 1,350,000
 FVNIA = Fair Value of Asset – Fair Value of Liability

= (60,000 + 500,000 + 450,000 + 300,000 + 250,000) – (180,000 + 240,000)

= 1,560,000 – 420,000

= 1,140,000
 Goodwill = AC-FVNIA

= Br 1,350,000 – Br 1,140,000

= Br 210,000.
End of CH4

 Thank You for Your Attention!!!