Business combinations

BUSINESS COMBINATIONS
Advanced Accounting II

Definition
IFRS 3 (2008)
Business combination is a transaction or event in which an acquirer obtains control of one or more businesses.
A business is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing return directly to investors or other owners, members or participants.
NOTE: An acquirer must be identified for all business combinations.

Definition
The term business combination refers in general to any set of conditions in which two or more organizations are joined together through common ownership. It is the term applied to external expansion in which separate enterprises are brought together into one economic entity as a result of one enterprise uniting with or obtaining control over the net assets and operations of another enterprise.
SCOPE: PFRS 3 Revised applies to all business combinations except the formation of a joint venture, the acquisition of an asset or a group of assets that does not constitute a business and a combination between entities or businesses under common control.

Definition
IFRS 3 (paragraph 3)
An entity shall determine whether a transaction or other event is a business combination by applying the definition in this IFRS, which requires that the assets acquired and liabilities assumed constitute a business.
If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as asset acquisition.

Classification of Business Combination
Structure of the Combination (Business Point of View)
Horizontal Integration-this type of combination is one that involves companies within the same industry that have been previously competitors.
Vertical Integration- this type of combination takes place between two companies involve in the same industry but at different levels. It normally involves a combination of a company and its suppliers or customers.
Conglomerate Combination- is one involving companies in unrelated industries having little, if any, production or market similarities for the purpose of entering into new markets or industries.
Circular Combination- entails some diversification, but does not have a drastic change in operation as a conglomerate. For example, San Miguel Corporation accomplished this when they diversify their activities by putting up Magnolia.

Methods of Combination (Legal Point of View)
1. Acquisition of Assets
Statutory Merger- results when one company acquires all the net assets (assets and liabilities) of one or more other companies through an exchange of stock, payment of cash or other property, or the issue of debt instruments (or a combination of these methods). The acquiring company survives (remains in existence), whereas the acquired company (or companies) ceases to exist as a separate legal entity, although it may be continued as a separate division of the acquiring company.
Statutory Consolidation – results when a new corporation is formed to acquire the net assets (assets and liabilities) of two or more other corporations. The acquired company, then, ceases to exist as a separate legal entity.

2. Stock Acquisition- an acquiring corporation may acquire majority ownership interest of outstanding voting stock or control of a corporation and the separate legal entity of each enterprise is preserved. In this case, the acquiring corporation is known as the parent and the acquired corporation as subsidiary.

What are the positive impacts of a business combination on the part of the acquirer? On the part of the acquiree?
What are the limitations and risks involved in a business combination?

Acquisition of Control
Control of another company may be achieved by
Acquiring the assets of the target company, or
Acquiring a controlling interest in the target company (usually over 50%)
ACQUISITION OF ASSETS
Statutory Consolidation: Refers to the combining of two or more existing legal entities into one new legal entityStatutory Merger: Refers to the absorption of one or more existing legal entities by another existing company that continues as the sole surviving entity

Acquisition of Control
STOCK ACQUISITION
A controlling interest of another company’s voting common stock is acquired. The acquiring company is called “parent” (also the acquirer) and the acquired company is termed as “subsidiary” (also the acquiree).
Both the parent and the subsidiary remain separate legal entities and maintain their own financial records and statements. However, for external financial reporting purposes, the companies will usually combine their individual financial statements into a single set of consolidated statements.

Methods of Business Combinations
Under the old standard, two methods were used to account for business combinations.
Purchase method (acquisition method under the revised IFRS 3)
Pooling of interests method (eliminated under the revised IFRS 3)

Acquisition Method
Steps in the application of acquisition method
Identify the acquirer
The company transferring cash or other assets and/or assuming liabilities is the acquiring company
In a stock acquisition, the company transferring cash or other assets for a controlling interest in the voting stock of the acquiree
The company issuing the voting stock is the acquirer
In some cases, the acquiree may issue the stock in the acquisition-”reverse acquisition”

Acquisition Method
2. Determine the acquisition date.
The acquisition date is the date on which the acquirer obtains control of the acquiree.
IFRS 3 explains that 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
Acquisition date may be earlier or later than the closing date
The acquisition date is critical because it is the date used to establish the fair value of the acquired company

Acquisition Method
3. Determine the consideration given (price paid) by the acquirer
Generally, the consideration given (price paid) by the acquirer is assumed to be the fair value of the acquiree as an entity.
IFRS 3 (2008) requires the consideration given in a business combination to be measured at fair value.
This is calculated as the sum of the acquisition-date fair values of
The assets transferred by the acquirer
The liabilities incurred by the acquirer to former owners of the acquiree, and
The equity interests issued by the acquirer

Acquisition Method
4. Recognize and measure the identifiable assets acquired, the liabilities assumed and any non-controlling interest (formerly called minority interest) in the acquiree. Any resulting goodwill or gain from a bargain purchase should be recognized.
When the price paid exceeds the fair values assigned to net assets, the excess is treated as goodwill. Goodwill is later on tested for impairment.
When the price paid is less than the fair values assigned to net assets, a “bargain purchase” has occurred. The excess is recorded as gain on the acquisition.

Contingent Consideration
Contingent consideration is an agreement to issue additional consideration (asset or stock) at a later date if specified events occur.
The most common agreements focus on a targeted sales or income performance by the acquiree company
Contingent consideration is measured at its acquisition-date fair value
Changes that are the result of the acquirer obtaining additional information about facts and circumstances that existed at the acquisition date, and that occur within the measurement period (maximum of one year from acquisition date) are recognized as adjustments against the original accounting for the acquisition.

Acquisition-Related Costs
These are costs the acquirer incurs to effect a business combination
These are not included in the price of the company acquired and are expensed.
Where the consideration given is the stock of the acquirer, the issue costs are usually deducted from the additional-paid in capital or share premium.

Unrecognized Assets and Liabilities
The acquirer may recognize some assets and liabilities that the acquiree had not previously recognized in its financial statements.

Assets with Uncertain Cash Flows
The acquirer shall not recognize a separate valuation allowance as of the acquisition date for assets acquired in a business combination that are measured at their acquisition-date fair values because the effects of uncertainty about future cash flows are included in their fair value measure.
For example, in the case of receivables and loans on acquisition date, no separate valuation allowance is recognized for the contractual cash flows that are deemed to be uncollectible at that date.
This also applies to property, plant and equipment

Application-Acquisition of Net Assets
Compute for the goodwill or gain on acquisition (bargain purchase gain) given the following cases.
Case 1. Big Net agrees to pay P 3,000,000 in exchange for all of Smallport’s assets and liabilities. Big Net transfers to the former owners of Smallport consideration of P1,000,000 in cash plus 20,000 shares of common stock with a fair value of P100 per share.
Case 2. Big Net transfers consideration of P2,000,000 to the owners of Smallport in exchange for their business. Big Net conveys no cash and issues 20,000 shares of common stock having a P100 per share fair value.

Business combinations

by Carol Montalban

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