CHAPTER FIVE

BUSINESS COMBINATION
5.0 Learning Objectives
After studying this chapter, you should be able to:
 Understand the economic motivations underlying business combinations.
 Learn about the alternative forms of business combinations, from both the legal and accounting
perspectives.
 Introduce concepts of accounting for business combinations, emphasizing the acquisition
method.
 Appraisal of accounting standards for business combinations
 See how firms make cost allocations in an acquisition method combination.

5.1 Business Combinations Why and How?

Business combination: events or transactions in which two or more business
enterprises, or their net assets, (Assets-Liabilities) are brought under common
control & into one accounting entity that have been consummated in substantial
numbers in recent years.

Amalgamation – two or more firms may amalgamate, either by taking over or by the
formation of a new firm. A decision to amalgamate shall be taken by each of the firms
concerned. Special meetings of shareholders of different classes or meetings of
debenture holders shall approve the taking over or being taken over (Art.549 & 550,
Commercial Code of Ethiopia).

The FASB has provided the following definition of Business combinations as

“business combination occurs when an entity acquires net assets that
constitute a business or acquires equity interest of one or more other entities
and obtained control over that entity or entities”.

The FASB has suggested the following definition for the terms commonly used in
discussions of business combinations.
 Combined enterprise: the accounting entity that results from a business
combination. E.g. X and Y companies are decided to combine their net assets and
want to register as “XY Company”
 Constituent companies: the business enterprises that enter into a business
combination.
 Combinor: - a constituent company enters into a purchase-type business
combination whose owners as a group end up with control of the ownership
interest in the combined enterprise.
 Combinee: - a constituent company other than the combin0r in a business
combinations.

The following are the assertions relating to business combinations as per SFAS
No.141

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 1. Business combination is a transaction or other event in which an acquirer
obtains control of one or more businesses.
2. An acquirer can be identified in every business combination.
3. The business combination acquisition date is the date the acquirer obtains
control of the acquiree.
4. A business combination is accounted for by applying the acquisition method.
5. By obtaining control of an acquiree, an acquirer becomes responsible and
accountable for all of the acquiree’s assets, liabilities, and activities, regardless
of the percentage of its ownership in the acquiree.

5.2 Antitrust Considerations

Antitrust litigations are one obstacle faced by large corporations that undertake
business combinations. A business combination that leads to lessen the
competition or tend to create a monopoly is not allowed by the government.
Government on occasion has opposed concentration of economic power in large
business enterprises as the formation of monopoly discourages competition.
Antitrust is a law that encourages perfect competition and discourages monopoly.
Business combinations may lead to formation of monopoly so that they are
challenged department of government. The type of combination determines the
degree of concentration of economic power. Horizontal combinations create the
largest concentration of economic power and play a negative role in discouraging
competition than the other two types of business combinations.

5.3 Motives for business combination (why business combination?)

The followings are the basic motives often advanced in support of business
combinations.
 Growth
In recent years Growth has been main reason for business enterprises to enter
into a business combination. Firms can achieve growth through external and
internal methods. The external (e.g. business combination) method of achieving
growth is more rapid than growth through internal methods, as per advocates of
external method. There is no question that expansion and diversification of
product lines, or enlarging the market share for current products, is achieved
readily through a business combination with another enterprise. Combinations
enable satisfactory and balanced growth of an enterprise. The company can
cross many stages of growth at one time through combination. Growth through
combination is also cheaper and less risky. By acquiring other enterprises, a
desired level of growth can be maintained by an enterprise. When an enterprise
tries to enter new line of activities then it may face a number of problems in
production, marketing, purchasing, etc. when some enterprises already
operating indifferent lines, they must have crossed many obstacles and
difficulties. Combination will bring together there experiences of different
persons in varied activities. So combination will be the best way of Growth.
 Obtaining new management strength
Combinations results in better management. Combinations result running the
large scale enterprises. A large enterprise can offer to use the service of

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 expertise. Various managerial functions can be efficiently managed by those
persons who are qualified for such jobs. This is not possible for small individual
enterprises.
 Reduction in operating costs
It is frequently less expensive for a firm to obtain needed facilities through
combination than through development. This is particularly true in periods of
inflation. Reduction of the total cost for research and development activities was
a prime motivation.

 Diversification/ Lower risk/

The purchase of established product lines and markets is usually less risky than
developing new products and markets. The risk is especially low when the goal is
diversification.

 To undertake tax advantages

When an enterprise with accumulated losses merges with a profit-making
enterprise, it is able to utilize tax shields (benefits). An enterprise having losses
will not be able to set-off losses against future profits, because it is not a profit
earning unit. On the other hand, if it merges with an enterprise earning profits
then the accumulated losses of one unit will be set-off against future profit of the
other unit. In this way, combinations will enable an enterprise to avail tax
benefits. The tax law that permits setting off losses is either Loss Carry Forward
or Loss Carry Back.
 Many other advantages like exchange of technology, exchange of manpower etc.

5.4 Nature and Classes of the Business Combination

A business combination may be friendly or unfriendly based on nature.
Friendly Takeovers
The boards of directors of the potential combining companies negotiate
mutually agreeable terms of a proposed combination. The proposal is then
submitted to the stockholders of the involved companies for approval. Normally, a
two-thirds or three-fourths positive vote is required by corporate bylaws to bind all
stockholders to the combination.

Unfriendly (hostile) Takeover

The board of directors of a company targeted for acquisition resists the
combination. A formal tender offer enables the acquiring firm to deal directly with
individual shareholders. The tender offer, usually published in a newspaper,
typically provides a price higher than the current market price for shares made
available by a certain date. If a sufficient number of shares are not made available,
the acquiring firm may reserve the right to withdraw the offer. Because they are
relatively quick and easily executed (often in about a month), tender offers are the
preferred means of acquiring public companies.

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Defense Tactics
Resistance often involves various moves by the target company, generally with
colorful terms. Whether such defenses are ultimately beneficial to shareholders
remains a controversial issue. Academic research examining the price reaction to
defensive actions has produced mixed results, suggesting that the defenses are
good for stockholders in some cases and bad in others. For example, when the
defensive moves result in the bidder (or another bidder) offering an amount higher
than initially offered, the stockholder’s benefit. But when an offer of $40 a share is
avoided and the target firm remains independent with a price of $30, there is less
evidence that the shareholders have benefited. A certain amount of controversy
surrounds the effectiveness, as well as the ultimate benefits, of the following
defensive moves:
1. Poison pill: Issuing stock rights to existing shareholders enabling them to
purchase additional shares at a price below market value, but exercisable only in
the event of a potential takeover. This tactic has been effective in some
instances, but bidders may take managers to court and eliminate the defense.
2. Greenmail: The purchase of any shares held by the would-be acquiring
company at a price substantially in excess of their fair value. The purchased
shares are then held as treasury stock or retired. This tactic is largely ineffective
because it may result in an expensive excise tax; further, from an accounting
perspective, the excess of the price paid over the market price is expensed.
3. White knight or white squire: Encouraging a third firm more acceptable to
the target company management to acquire or merge with the target company.
4. Pac-man defense: Attempting an unfriendly takeover of the would-be acquiring
company.
5. Selling the crown jewels: The sale of valuable assets to others to make the firm
less attractive to the would-be acquirer. The negative aspect is that the firm, if it
survives, is left without some important assets.
6. Leveraged buyouts: The purchase of a controlling interest in the target firm by
its managers and third-party investors, who usually incur substantial debt in
the process and subsequently take the firm private. The bonds issued often take
the form of high-interest, high-risk “junk” bonds.

5.5 Legal forms, Types and Methods of arranging Business Combination

5.5.1 Legal Form of Business Combination

Business Combination

Acquisitions

Merger Consolidation

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When we use the term "merger", we are referring to the merging of two companies
where one new company will continue to exist. The term "acquisition" refers to the
acquisition of assets by one company from another company. In an acquisition,
both companies may continue to exist. However, throughout this course we will
loosely refer to Mergers and Acquisitions ( M & A) as a business transaction where
one company acquires another company. The acquiring company will remain in
business and the acquired company (which we will sometimes call the Target
Company) will be integrated into the acquiring company and thus, the acquired
company ceases to exist after the merger.

The terms merger and consolidation are often used as synonyms for
acquisitions. However, legally and in accounting there is a difference. A merger
entails the dissolution of all but one of the business entities involved. A
consolidation entails the dissolution of all the business entities involved and the
formation of a new corporation.

Activity: Differentiate between Takeover, Acquisition, Merger, and

Amalgamation.

5.5.2 Types of business combinations

Mergers can be categorized as follows:

Business combinations may be horizontal, vertical or conglomerate form
1. Horizontal form of business combinations (a merger between competitors):
A merger in which two firms in the same industry combine. Two firms are merged
across similar products or services. Horizontal mergers are often used as a way for
a company to increase its market share by merging with a competing company. For
example, the merger between Exxon and Mobil will allow both companies a larger
share of the oil and gas market.
 Eg. Arba Minch textile Co. may combine with another textile Co, Bedele Brewery
with Harar Brewery

2. Vertical form of business combination

A merger between a supplier and a customer. It is often in an attempt to control
supply or distribution channels. Two firms are merged along the value-chain, such
as a manufacturer merging with a supplier. Vertical mergers are often used as a
way to gain a competitive advantage within the marketplace. For example, Merck, a
large manufacturer of pharmaceuticals, merged with Medco, a large distributor of
pharmaceuticals, in order to gain an advantage in distributing its products like.
It can be classified into two:
 Forward Vertical combination: Combination with suppliers. Example: A
tannery company acquiring a shoe company.

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  Backward Vertical combination: Combination with customers. Example:
Weaving company acquiring both ginning and spinning company.

3. Conglomerate form of business combinations

A merger in which two firms in unrelated businesses combine to ‘diversify’ the
company by combining uncorrelated assets and income streams. Two firms in
completely different industries merge, such as a gas pipeline company merging
with a high technology company. Conglomerates are usually used as a way to
smooth out wide fluctuations in earnings and provide more consistency in long-
term growth. Typically, companies in mature industries with poor prospects for
growth will seek to diversify their businesses through mergers and acquisitions. For
example, General Electric (GE) has diversified its businesses through mergers and
acquisitions, allowing GE to get into new areas like financial services and television
broadcasting.

4. Cross-border (International) M&As: A merger or acquisition involving a foreign

firm an either the acquiring or target company.
5.5.3 Methods for arranging Business combination

Business combinations are sometimes classified by method of combination in to

four types:
 statutory mergers,  stock acquisitions and
 statutory consolidations,  Asset acquisition.

However, the distinction between these categories is largely a technicality, and the
terms mergers, consolidations, and acquisitions are popularly used
interchangeably.

Statutory Merger
Statutory merger results when one company acquires all the net assets of one or
more other companies through an exchange of stock, payment of cash or other
property, or issue of debt instruments (or a combination of these methods). The
acquiring company survives, 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. Thus, if A Company acquires B Company in a
statutory merger, the combination is often expressed as Statutory Merger.
Example: A company acquires all the outstanding common stocks or net assets of B
company where B company is legally liquidated.

A Company + B Company = A Company

The boards of directors of the companies involved normally negotiate the terms of a
plan of merger, which must then be approved by the stockholders of each company

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involved. State laws or corporation bylaws dictate the percentage of positive votes
required for approval of the plan.

Statutory Consolidation
A statutory consolidation results when a new corporation is formed to acquire two
or more other corporations through an exchange of voting stock; the acquired
corporations then cease to exist as separate legal entities.
For example, if C Company is formed to consolidate A Company and B Company,
the combination is generally expressed as Statutory Consolidation.

+ =
A Company B Company C Company

Stock Acquisition
A stock acquisition occurs when one corporation pays cash or issues stock or debt
for all or part of the voting stock of another company, and the acquired company
remains intact as a separate legal entity. When the acquiring company acquires a
controlling interest in the voting stock of the acquired company: (for example, if A
Company acquires 50% of the voting stock of B Company), a parent–subsidiary
relationship results.

A subsidiary is a corporation that is controlled (through common stock ownership) by

another corporation, that is, the parent corporation.
 Controlling Interest: The parent owns a majority of the common stock of the
subsidiary.
 Wholly-Owned Subsidiary: The parent owns all of the common stock of the
subsidiary.

Given that a subsidiary is a separate legal entity, the parent’s risk associated with
the subsidiary’s activities is limited.

Consolidated financial statements (explained in later chapters) are prepared and the
business combination is often expressed as Consolidated Financial Statements.

Financial Statements Financial Statements Consolidated Financial

of A Company Of B Company Statements
of A Company and B Company
+ + =

Possible advantages of Stock Acquisition

 Lower total cost.
 Direct formal negotiations may be avoided.
 Maintaining the acquired firm as a separate legal entity.
 Liability limited to the assets of the individual corporation.
 Greater flexibility in filing individual or consolidated tax returns.
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Asset Acquisition
In an asset acquisition, a firm must acquire 100% of the assets of the other firm.
In a stock acquisition, a firm may obtain control by purchasing 50% or more of the
voting common stock (or possibly even less). This introduces one of the most
obvious advantages of the stock acquisition over the asset acquisition: a lower total
cost in many cases. Also, in a stock acquisition, direct formal negotiations with the
acquired firm’s management may be avoided. Further, there may be advantages to
maintaining the acquired firm as a separate legal entity. The possible advantages
include liability limited to the assets of the Individual Corporation and greater
flexibility in filing individual or consolidated tax returns. Finally, regulations
pertaining to one of the firms do not automatically extend to the entire merged
entity in a stock acquisition. A stock acquisition has its own complications,
however, and the economics and specifics of a given situation will dictate the type of
acquisition preferred.

Summary
Type of Action of Acquiring Company Action of Acquired Company
Combination
Statutory Merger Acquires all stock or net assets and Dissolves & goes out of business. It may
then transfers assets & liabilities to also remain as separate
its own books. division of the acquiring company
Statutory Newly created to receive assets or Both original companies may dissolve while
Consolidation capital stock of original companies remaining as separate divisions of newly
created company.
Acquisition of Acquires more than 50% stock Remains in existence as legal corporation,
Common Stock that is recorded as an investment. although now a subsidiary of the acquiring
Controls decision making of company.
acquired company.
Acquisition of Assets Acquires all or most of the gross The acquiree company may remain in
assets existence or may be liquidated but not a
subsidiary of the acquiring
Company

5.6 Establishing the price for a business corporation

An important early step in planning a business combination is deciding on an
appropriate price to pay. The amount of cash or debt securities or the number of
preference shares or common stocks to be issued in a business combination
generally is determined by variation of the following methods.
1. Capitalization of expected average annual earnings of the combinee at a desired
rate of return.
2. Determination of current fair value of the combinee’s net assets including
goodwill.

Note: When common stocks are issued by the combinor in a business combination,
the price is expressed as a ratio of the number of shares of the combinor’s common
stock to the exchanged for each share of the combinee’s common stock.
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Example: The negotiating officers of the P Corporation have agreed with
stockholders of S Co. to acquire all 20,000 outstanding shares of S Co. stock for a
total price of Br.1, 800,000. P’s common stock presently is trading in a market at
Br.65 per share. Stockholders of S agreed to accept 30,000 shares of P’s common
stock at a value of Br.60 a share in exchange for their stock holdings in S Co.

Required: What is the exchange ratio of P’s common stock for each share of S’s Co.
stock?

Solution:

Exchange Ratio =Number of P’s common stock to be issued

Number of S’s common stock to be exchanged
= 30,000
20,000
= 1.5:1

Capitalization of Expected Average annual earnings

Example: Assume that the business earned the following profit for the last five years:
Year Net Income
2001 ..................................... Br 90,000
2002 ..................................... 110,000
2003 ..................................... 120,000
2004 ..................................... 140,000
2005 ..................................... 130,000

Note: the Br 140,000 profit in the Year 2004 included extraordinary gain of Br 40,000
which is required to be excluded in the computation of expected average profit, and thus
the profit for that same year is Br 100,000. The average operating income of the five years
is expected to continue in the future and in this industry the average return on asset is
10% of the fair market value of the identifiable assets.
Required: Determine the fair value of the assets under capitalization method.
 Calculation of Average expected future Income (earnings)
Average Expected Income = 90,000 + 110,000 + 120,000 + 100,000 + 130,000 = Br 110,000
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 Capitalized Fair Value of Assets = Br 110,000 / 10% = Br 1,100,000

5.7 Methods of Accounting for Business combinations

Business combinations may take many forms and may be referred to as merger,
Acquisitions or consolidations; they are all accounted for either as purchase method
or pooling method of accounting for business combination.
Two New Pronouncements in June 2001:
1. SFAS No. 141, “Business Combinations,” - pooling method is prohibited for
business combinations initiated after June 30, 2001.
Principal reasons:
 Pooling provides less relevant information to statement users.
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  Pooling ignores economic value exchanged in the transaction and makes subsequent
performance evaluation impossible.
 Comparing firms using the alternative methods is difficult for investors.
2. SFAS No. 142, “Goodwill and Other Intangible Assets,” - Goodwill acquired in
a business combination after June 30, 2001, should not be amortized rather it
should be impaired.

Note: A statement of financial accounting standards (SFAS) is a formal document issued by

the Financial Accounting Standards Board (FASB), which details accounting standards and
guidance on selected accounting policies set out by the FASB.

 The following are TWO accounting methods used for recording the
transactions of business combination
1. Purchase method of Accounting for business combinations.
2. Pooling-of Interest method for business combinations.

Comparison of Purchase and pooling of Interest Method

Basis of Comparisons Purchase Method Pooling of Interest Method
Meaning is an accounting method, wherein the is one in which the assets, liabilities
assets and liabilities of the transferor and reserves are combined and
company are shown at their market shown at their historical values, as
value in the books of the transferee of the date of amalgamation.
company, as of the date of
amalgamation.
Applicability Acquisition Merger
Assets and liabilities Assets and liabilities acquired are Assets and liabilities are recorded at
recorded at their fair values. their precombination book values.
Goodwill Recognition Any excess of cost over fair value of No excess of cost over book value
net assets acquired is recorded as exists, and no new goodwill is
goodwill. recorded.
Retained Earnings The acquired company’s retained The acquired company’s retained
earnings are not added into the earnings are added into the
acquiring company’s retained acquiring company’s retained
earnings. earnings.
Equity Securities Equity securities issued are recorded Equity shares issued are recorded
at their fair market value. at the book value of the acquired
shares.
Depreciation and The excess of cost over book value is There is no additional depreciation
amortization depreciated or amortized to reduce or amortization expense.
future earnings.
Direct Cost Direct costs are capitalized as part of Direct costs are expensed in the
the acquisition cost. year in which incurred.
Indirect Cost Indirect costs are expensed. Indirect costs are expensed.
Security issuance costs Security issuance costs are deducted Security issuance costs are
from additional paid-in capital. expensed.

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Example: Elias Company acquires 100% of the net assets of Seife Company by
issuing shares of common stock with a fair value of Birr120,000.
Elias incurred:
 Birr 1,500 of accounting and consulting costs
 Birr 3,000 of stock issue costs
 Birr 2,000 monthly overhead cost for its mergers department
Required: Prepare the necessary journal entries under both methods?

Solution:
Pooling Accounting:
Accounting and Consulting Expense (Direct) 1,500
Merger Department Expense (Indirect) 2,000
Securities Issue Expense (Security Issue Costs) 3,000
Cash 6,500
Purchase Accounting:
Goodwill (Direct) 1,500
Merger Department Expense (Indirect) 2,000
Other Contributed Capital (Security Issue Costs) 3,000
Cash 6,500
1. Purchase methods of Accounting for Business combination
If one corporation purchases the assets or stock of another company, such a
business combination is accounted as purchase. When a purchase takes the
owners of the subsidiary company gives up their interest and the owners of the
parent company obtains an interest in the combined business. The shareholders of
the subsidiary who sold their stock no longer have an interest in either the
subsidiary or consolidated entity.
In the purchase method of accounting for business combination, assets (including
Goodwill) acquired in a business combination for cash would be recorded at the
amount of cash, and assets acquired in a business combination involving the
issuance of capital stock would be recorded at the current fair values of the assets
or of the capital stock, whichever was more readily determinable.
If the subsidiary is obtained by purchase, the investment in subsidiary the choice
depends upon parent’s preference. Whether the Cost or Equity method used, the
consolidated statements are the same.
The purchase method of accounting was widely used prior to the increase in
popularity of pooling-of interests accounting.
According to SFAS No. 141, the following principles should be used for applying Acquisition (Purchase)
Method of Accounting for business combinations:
 Recognition Principle - in a business combination accounted for under purchase accounting, the
acquirer recognizes all of the assets acquired and all of the liabilities assumed.
 Fair Value Measurement Principle - in a business combination, the acquirer measures each
recognized asset acquired and each liability assumed and any non-controlling interests at its
acquisition date fair value.
 Disclosure Principle – the acquirer should include the information in its financial statement so as to

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 help users’ financial statements evaluate the nature and financial effect of business combinations
recognized by the acquirer. The disclosure should include primary reasons for the business
combination; the allocation of purchase price paid to the assets acquired and liabilities assumed by
major balance sheet caption; and when significant, disclosure of other information such as amount
of goodwill by reportable segment and the amount of purchase price assigned to each major
intangible asset class.
Procedures under Purchase Method of Accounting for Business Combinations
 Determination of the Combinor or the Acquiring Company – this steps deals with
identification of the combinor.
 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.
 Allocating Cost Combinee (Allocating Total Cost of Acquisition) – when assets are
acquired in groups, it requires not only ascertaining the cost of the asset (or net asset)
group but also allocating that cost to the individual assets (or individual assets and
liabilities) that make up the group.
 Determination of Goodwill –The goodwill should be determined and recorded under
purchased method.
 Recording the Acquisition – the transaction is recorded on the date of the business
combinations is consummated.
 Financial Statement and Accounting after business combinations - the nature of an asset
and not the manner of its acquisitions determines an acquiring entity’s subsequent
accounting for the asset.

The following steps are to be followed for calculation of total cost of the company,
identifiable current fair value of net assets of the subsidiary and to know the
amount of goodwill.
Step 1. Calculation of consideration amount to be paid
The value of the consideration given to the owners of the acquired company
normally constitutes the largest part of the total cost.
CONSIDERATION GIVEN

Amount of Consideration - this is the total amount of cash paid, the current fair value of
other assets distributed, the present value of debt securities issued, and the current fair (or
market) value of equity securities issued by the combinor.
Amount of consideration = Cash paid + current fair value of assets
distributed + current fair value of bond issued +
CFV of stock issued by the combinor.

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Step 2. Calculation of Direct- out- of- pocket cost
There are three types of other costs that may be incurred in effecting a business
combination:
 Direct costs  Indirect and general costs
 Costs of issuing securities

Out-of-Pocket Costs - included in this category are legal fees and finder’s fees. A finder’s fee is
paid to the investment banking firm or other organizations or individuals that investigated
the combinee, assisted in determining the price of the business combination, and otherwise
rendered services to bring about the combination. Costs of registering and issuing debt
securities in a business combination are debited to Bond Issue Costs; they are not part of the
cost of the combinee. Costs of registering and issuing equity securities are not direct costs of
the business combination but are offset against the proceeds from the issuance of the
securities. Indirect out-of-pocket costs of the combination, such as salaries of officers involved
in the combination, are expensed as incurred by the constituent companies.
Out-of-Pocket Costs of Business Combinations
Direct out-of-Pocket Costs Indirect out-of-Pocket Costs
Finders fees Salary and overhead costs incurred in negotiation
Travel costs Allocation of general expenses
Accounting fees Fees associated with registering securities with SEC
Legal fees Cost of issuing equity securities
Investment banker advisory fees Cost of debt securities
Direct-out-of pocket cost = Accounting fees + legal fees + finder’s fees +
Appraisal fees
Note:
a) Cost of registering with SEC (Security Exchange Commission) and cost of
issuing Equity stocks or preferred stocks are not direct-out –of-pocket cost of
the business combination.
b) Indirect out of pocket costs after combinations such as, salaries of the office
of constituent companies involved in negotiations and completion of the
combinations are recognized as expenses incurred by the constituent
companies.
Step 3. Calculation of total cost of a combinee
Determination of cost of the combinee
The cost of a combinee in a business combination accounted for by the purchase
method is the total of:
 The amount of consideration paid by the combinor.
 The combinor’s direct out-of-pocked costs of the combination.
 Any contingent consideration that is determinable on the date of the
business combination.

Total cost of a combinee = Amount of consideration paid + Direct out - of-

pocket cost + any contingent consideration
Contingent Consideration
 Contingent consideration is additional cash, other assets, or securities that may be issuable
in the future.

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  Contingent consideration that is determinable on the consummation date of a
combination is recorded as part of the cost of the combination.
 Contingent consideration not determinable on the date of the combination is recorded
when the contingency is resolved and the additional consideration is paid or issued (or
becomes payable or issuable).

Allocation of Cost of a Combinee

The cost of a combinee in a business combination must be allocated to assets (other
than goodwill) acquired and liabilities assumed based on their estimated fair values
on the date of the combination. Any excess of total costs over the amounts thus
allocated is assigned to goodwill. Methods for determining fair values included
present values for receivables and most liabilities, Net realizable value less a
reasonable profit for work in process and finished goods inventories and Appraised
values for land, natural resources, and non-marketable securities.

The following combinee intangible assets were to be recognized individually and

valued at fair value:
 Assets arising from contractual or legal rights, such as patents, copyrights, and
franchises.
 Other assets that are separable from the combinee entity and can be sold,
licensed, exchanged, and the like, such as customer lists and non-patented
technology.

Step 4. Calculation of identifiable Current Fair Value (CFV) of net assets of the
subsidiary
Identifiable CFV of net assets of the subsidiary
= CFV of Assets - CFV of Liabilities
Identifiable Assets and liabilities
As per SFAS No.141, methods for determining fair values of identifiable assets and liabilities of a
purchased combinee included:
 Present values for receivables and liabilities;
 Net realizable values for marketable securities, finished goods and goods-in-process inventories,
and for plant assets held for sale or for temporary use;
 Appraised values for intangible assets, land, natural resources, and non-marketable securities;
and
 Replacement cost for inventories of material and plant assets held for long-term use.
Step 5. Finding out Goodwill /Negative Goodwill/Bargain- purchase)
What is goodwill?
Goodwill is an intangible asset that arises when the purchase price to acquire a
subsidiary company is greater than the sum of the market value of the
subsidiary’s assets minus liabilities.
 Goodwill is recognized in business combination because the total cost of the
combinee exceeds the current fair value of identifiable net assets of the
combinee.
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  The amount of goodwill recognized on the date the business combination is
consummated may be adjusted subsequently when contingent consideration
becomes issuable.

When the price paid to acquire another firm is lower than the fair value of
identifiable net assets (assets minus liabilities), the acquisition is referred to as a
bargain. When a bargain acquisition occurs, some of the acquired assets must be
recorded at an amount below their market values under purchase accounting
rules. Although less common than purchases involving goodwill, bargain
purchases do occur and require the application of specific rules to conform to
generally accepted accounting principles.

1. Goodwill as payment for super profit (extra profit or excess income)

The purchaser (Combinor) may attempt to forecast the future income of the target company
(combinee) in order to arrive at a logical purchase price. Goodwill is a payment for above
normal expected future earnings. Earnings above the normal return are taken as the base for
calculating the value of Goodwill.
Example: You are given the following data:
Total Current Fair Value of Gross Assets ..................................................... Br 85,000
Industry Normal rate of return is................................................................... 10%
Expected average future earning ................................................................... 10,500
Required:
a) Calculate the goodwill at four years’ excess income
b) Calculate goodwill if the combinor expects the excess income for ever
c) Calculate goodwill when the combinor expects the excess income only for 10 years
d) Calculate goodwill if the current fair value of liabilities Br 10,000 and total acquisition cost
of Br 90,000
Determination of the Extra Profit:
Expected Profit .......................................................................... Br 10,500
Less: Normal Profit (= Br 85,000 @ 10%) .................................. (8,500)
Extra profit ............................................................................ 2,000
Calculation of Goodwill
A. Calculate the goodwill at four years’ excess income
 Goodwill = Extra Profit @ 4
 Goodwill = Br 2,000 @ 4= Br 8,000
B. Calculate goodwill if the combinor expects the excess income for ever
 Goodwill = Extra profit / industry normal rate of return = Br 2,000 / 10% = Br 20,000
C. Calculate goodwill when the combinor expects the excess income only for 10 years
 Goodwill = Extra profit @ PVIF of Ordinary Annuity (10% for 10 Years)
 Goodwill = Br 2,000 @ 6.145 = Br 12,290
D. Calculate goodwill if the current fair value of liabilities Br 10,000 and total acquisition cost
of Br 90,000
 Goodwill = Total Acquisition Cost – Current Fair Value of Net Assets
15
  Current Fair Value of Net Assets = Total CFV of Assets – CFV of Liabilities
 Current Fair Value of Net Assets = Br 85,000 – 10,000 = Br 75,000
 Goodwill = Br 90,000 – 75,000 = Br 15,000

2. Goodwill as excess cost of acquisition over the current fair value of net assets
When goodwill is determine as excess cost of acquisition over the current fair value of net
assets one of the following circumstances may occur:
 If total Acquisitions Cost = FMV of the net Assets, no goodwill is recognized
 If Total Acquisitions Cost > FMV of the net Assets, it will result in a positive goodwill
 If Total Acquisitions Cost < FMV of the net Assets, it will result in a Negative Goodwill

Negative Goodwill
 In some purchase-type business combinations (known as bargain purchases), the
current fair values assigned to the identifiable net assets acquired exceed the total cost
of the combinee (acquisition cost).
 A bargain purchase is most likely to occur for a combinee with a history of losses or
when common stock prices are extremely low.
 The excess of the current fair values over total cost is applied pro rata to reduce (but not
below zero) the amounts initially assigned to non-current assets other than investments
accounted for by the equity method; assets to be disposed of by sale; deferred tax assets;
prepaid assets relating to pension or other postretirement benefits; and any other
current assets.
 If the foregoing proration does not extinguish the bargain-purchases excess, a deferred
credit, sometimes termed negative goodwill, is established. Negative goodwill means
an excess of current fair value of the combinee’s identifiable net assets over their cost to
the combinor. Negative Goodwill is recognized as an extraordinary gain by the
combinor. (SFAS No. 141)
Recording the Acquisition
Under purchase accounting, both the combinor and combinee record transactions relating to
the business combination. The combinee that is dissolved and liquidated passed the
following journal entries:

Books of Combinee Company (Acquired Company)

General journal entry passed For Liquidation of the Combinee
Liabilities (individually).............................................. xxxxx
Common Stock ............................................................. xxxxx
PIC in excess of Par ...................................................... xxxxx
Retained Earnings ........................................................ xxxxx
All Assets (Individually) ................................... xxxxx

Books of Combinor Company (Acquiring Company)

General Journal Entry to be passed in the Books of the Combinor
1) Recording the payment (the purchase consideration or purchase price)
Investment in Combinee Company ....................................xxxxx
Cash.......................................................................... xxxxx
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 Common Stock......................................................... xxxxx
PIC in excess of Par ................................................. xxxxx
Bonds........................................................................ xxxxx
2) Recording direct out-of-pocket costs (legal and finder’s fee)
Investment in Combinee Company ................................. xxxxx
Cash.................................................................... xxxxx
3) Recording Assets and Liabilities (the Investment Account is replaced with assets and
liabilities)
All Assets (individually) at CFV ..........................................xxxxx
Goodwill ..................................................................................xxxxx
Liabilities (individually) at CFV .............................. xxxxx
Investment in Combinee Company .......................... xxxxx
4) Recording Indirect Out-of-Pocket Costs
Indirect Expenses ................................................................ xxxxx
Cash.................................................................... xxxxx
5) Recording Reduction in PIC in excess of par for indirect expenses
PIC in Excess of Par ............................................................ xxxxx
Indirect Expenses ............................................... xxxxx

Example 1: Green Co. is considering acquiring the assets of Gold Co. by assuming Gold’s
liabilities and by making cash payment. Gold Company has the following balance sheet on
the date of negotiations:

Gold Company
Balance Sheet
December 31, 2016
Assets Liabilities and Equity
Accounts Receivable............................... 100,000 Total Liabilities ................................. 200,000
Inventory ................................................. 100,000 Capital Stock (Br 10 Par)................... 100,000
Land ........................................................ 100,000 PIC in excess of par .......................... 200,000
Building (Net) ......................................... 220,000 Retained Earnings............................. 300,000
Equipment (Net)...................................... 280,000
Total Asset .............................................. 800,000 Total Liabilities and Equity ............... 800,000

Appraisal indicates that the inventory is undervalued by Br 25,000; building is undervalued

by Br 80,000; the equipment is overstated by Br 30,000; and the liability is overstated by Br
10,000. Determine the Goodwill that is recognized if Green Company pays Br 900,000 cash
for the net assets of Gold Company.
Calculation of Net Assets:
Particulars Birr
Accounts Receivable ..................................... 100,000
Inventory........................................................ 125,000
Land ............................................................... 100,000
Building (Net)................................................ 300,000
Equipment (Net) .......................................... 250,000
Gross Identifiable Assets ............................. 875,000
Less: CFV of total Liabilities ........................ (190,000)
Net Assets at CFV ......................................... 685,000

17
 Calculation of Goodwill:
Total Acquisition Cost............................ Br 900,000
Less: Net Assets at CFV ............................ (685,000)
Goodwill ..................................................... Br 215,000

Example 2: Combinor Company acquired Combinee Company On December 31, 2005 with
the following balance sheet items:

Combinee Company
Balance Sheet
December 31, 2015
Assets Liabilities and Equity
Cash.................................................... 60,000 Current Liabilities.......................... 180,000
Other Current Assets .......................... 420,000 Long-term debt .............................. 250,000
Land.................................................... 400,000 Capital Stock (Br 10 Par) .............. 200,000
Building (net) ..................................... 240,000 PIC in Excess of Par ..................... 320,000
Equipment (net).................................. 280,000 Retained Earnings ......................... 450,000
Total Asset ......................................... 1,400,000 Total Liabilities and Equity ........ 1,400,000
After in depth study, Combinor Company’s BOD established the following Current Fair
Value for assets and liabilities:
Other Current Assets ..................................................... 500,000
Land............................................................................... 450,000
Building (Net) ............................................................... 300,000
Equipment (Net)............................................................ 250,000
Long-term debt.............................................................. 240,000
Accordingly on December 31, 2015 Combinor issued 100,000 shares of its Br. 10 Par (Current
Fair Value of Br. 13) Common Stock for all the net asset of Combinee on a purchase type of
business combination. Also on December 31, 2015 Combinor paid the following out-of-
pocket costs in connection with the combination:
 Finder’s Fees and Legal Fees .......................................... 180,000
 Costs associated with issuance of shares......................... 120,000
Required: Prepared General Journal Entries for Combinor Company on December 31, 2002
Calculation of Total Acquisition Cost:
Common Stock (Br 13 @ 100,000 Shares)................................... 1,300,000
Finder’s Fees and Legal Fees ........................................................ 180,000
Total Acquisition Cost .................................................................. 1,480,000
Calculation of Net Assets at CFV:
Cash............................................................................................... 60,000
Other Current Assets ..................................................................... 500,000
Land............................................................................................... 450,000
Building (net) ................................................................................ 300,000
Equipment (net)............................................................................. 250,000
Total Assets at CFV ...................................................................... 1,560,000
Less: Liabilities at CFV (180,000 + 240,000)............................... (420,000)
Net Assets at CFV ......................................................................... 1,140,000

18
Calculation of Goodwill:
Total Purchase Cost....................................................................... 1,480,000
Less: Net Assets at CFV................................................................ (1,140,000)
Goodwill........................................................................................ 340,000
Journal Entries:
1. Recording the payment (the purchase consideration)
Investment in Combinee Company ........................................ 1,300,000
Common Stock.................................................. 1,000,000
PIC in excess of Par .......................................... 300,000
2. Recording Direct out-of-pocket costs (legal and finder’s fee)
Investment in Combinee Company...................................... 180,000
Cash.................................................................... 180,000
3. Recording Assets and liabilities
Cash ............................................................................... 60,000
Other Current Assets...................................................... 500,000
Land ............................................................................... 450,000
Building (net)................................................................. 300,000
Equipment (net) ............................................................. 250,000
Goodwill ........................................................................ 340,000
Current Liabilities...................................... 180,000
Long-term debt .......................................... 240,000
Investment in Combinee Company ........... 1,480,000
4. Recording indirect out-of-pocket costs
Indirect Expenses ......................................................... 120,000
Cash............................................................. 120,000
5. Recording reduction in PIC in excess of par for indirect expenses
PIC in Excess of Par............................................................. 120,000
Indirect Expenses .......................................... 120,000
Example 3: On December 31,2002, Mesfin company (the combinee) was merged
into Sara corporation (the combinor). Both companies used the same accounting
principles for assets, liabilities, revenue and expenses and both had a December 31,
fiscal year.
Sara issued 150,000 shares of its Br. 10 par common stocks (current face value of
Br 25) to Mesfin’s stockholders for all 100,000 issued and outstanding shares of
Mesfin’s no-par, Br 10 stated value common stock. In addition, Sara paid the
following Out-of –Pocket costs associated with business combination.
Accounting Fee
For investigation Mesfin company as prospective……………………………....Br5, 000
For SEC Registration for Sara corporation …………………………………….60, 000
Legal Fee
For the business Combination ……………………………………………..…….10, 000
For SEC Registration statement for Sara corporation………………….………50,000
Finder’s fee
Printer’s charges for printing securities and SEC registration statement…...........23, 000
SEC Registration statement fee …………………………………………………...750
Total costs………………………………………………………………….……200,000

19
There was no contingent consideration in merge company. Immediately, prior the
merger Mesfin company‘s condensed balance sheet was as follows:

Mesfin Company
Balance Sheet (Prior to business combination )
December 31,2002
Assets Liabilities and Stockholders’ Equity
Current Assets 1,000,000 Current liabilities 500,000
Plant assets 3,000,000 Long-term debt 1,000,000
Other assets 600,000 Common stock 1,000,000
(no par or Br.10 stated value )
Addition Paid-in capital 700,000
Retained earnings 1,400,000
Total 4,600,000 Total 4,600,000
The board of directors of Sara Corporation dated current fair value of Mesfin
Company’s identifiable assets and liabilities as follows:
Current Assets Br 1,150,000
Plant assets 3,400,000
Other assets 600,000
Current liabilities 500,000
Long-term debt 950,000
Required: Prepare journal entries for Sara Corporation to record its merger with
Mesfin Company on December 31, 2002 as a purchase.
Example 4: On dec.31, 2008 Dawit Corporation acquired the net assets of Paul
Corporation directly from Paul for $400,000 cash in a business combination. Dawit
paid legal fee of $40,000 in connection with the combination.
To condense balance sheet of Paul prior to the business combination, with related
current fair value data is presented below:

Paul corporation
Balance sheet (prior to business combinations)
December 31,2008
Items Carrying Current fair
amount values

20
 Assets ($) ($)
Cash 190,000 200,000
Investment in making debt securities 50,000 60,000
Plant assets 870,000 900,000
Intangible assets 90,000 100,000
Total Assets 1,200,000
Liabilities & SHE
Current liabilities 240,000 240,000
Long-term debt 500,000 520,000
Common stock, no par, no stated value 460,000
Total liabilities & Stockholders equity 1,200,000

Required: Prepare journal entries for Dawit Corporation to record its merger with
Paul Corporation on December 31, 2008 as purchase type of business combination

5.8 Pooling of –Interest accounting for business combination

The idea behind this accounting method is that the business combination is simply
an exchange of common stock between an issuer and the stockholders of a
combinee. Thus, this method is appropriated to be used in the case of business
combinations involving only common stock exchanges between companies of
approximately equal size.
Because neither party can be considered as the combinor (as previously defined),
the combined assets, liabilities and retained earnings of the constituent companies
are recorded at their carrying amounts. Both the market value of the common stock
issued for the combination and the fair value of the combinee’s net assets are
disregarded in this method. The term “issuer” identifies the corporation that
issues its common stock to accomplish the combination.
The acquired firm’s net assets are consolidated at their existing book value and
any accounting acquisition premium (AAP) is ignored.
Accounting Acquisition Premium (AAP) = purchase price – book value of the combinee.
Purchased Goodwill
= AAP – combine’s assets step-up.
Assets step up
= the fair market value of net assets of the combinee – the book value of these net assets.

Specified Conditions for Pooling of Interest Accounting

Under the provision of APB Opinion No. 16, 12 conditions must be met before a
business combination may be accounted for as a pooling of interests. These
conditions can be grouped under three main categories as listed below:
1) Attributes of the combining companies.
2) Manner of combining interests.
3) Absence of planned transactions.
21
1) Attributes of the combining companies:
a) Each of the combining companies should be autonomous and not have
operated as a subsidiary or division of another company within two years
before the plan of combination is initiated. An exception to this condition
concerns the divestiture of assets that was ordered by a governmental or
judicial body. A subsidiary that is divested under an order or a new company
that acquires assets disposed of under such an order is considered
autonomous for this condition.
b) Each of the combining companies must be independent of each other. That
means that no combining company or group of combining companies can
hold as an intercompany investment more than 10 percent of the outstanding
voting common stock of any other combining company. To illustrate the 10
percent requirement, let us assume that company A plans to issue its voting
common stock to acquire the voting common stock of companies B and C.

If companies A and B each own 7 percent of company C's outstanding

common stock, A can pool with B, but the combined entity cannot
subsequently pool with C since more than 10 percent of company C's
outstanding stock would have been held by the other combining companies.

2) Manner of combining interests:

a) The combination should be effected in a single transaction or should be
completed in accordance with a specific plan within one year after the plan is
initiated. The Opinion provides an exception to this one-year rule when the
delay is beyond the control of the combining companies because of proceedings
of a governmental authority or pending litigation.
b) The combination should involve the issuance of voting common stock only in
exchange for substantially all of the voting common stock interest of the
company being combined. “Substantially all” in this context means at least 90
percent of the voting common stock interest of the company being combined.
Thus, the issuer may purchase for cash or other nonvoting common stock
consideration up to 10 percent of the voting common shares of the company to
be pooled. Such a cash outlay may be necessary to eliminate fractional shares
or to pay dissenting stockholders. The rationale of this criterion is that
substantially all of the voting common stock interest in each party to a pooling
should be carried forward as a voting common stock interest in the issuer in
the pooling. The payment of cash, debt, or an equity instrument that does not
satisfy this test destroys the most fundamental basis of a pooling. If the
company being combined has securities other than voting stock, such
securities may be exchanged for common stock of the issuing corporation or
may be exchanged for substantially identical securities of the issuing
corporation.
c) None of the combining companies should change the equity interest of their
voting common stock in contemplation of effecting the combination. This
22
 restriction applies during the period from two years proceeding the date the
plan is initiated through the date the plan is consummated. Changes in the
equity interest of the voting common stock that may violate this condition
include distributions to shareholders, additional issuance or exchange of
securities, and the retirement of securities. The purpose of this rule is to
disallow changes in equity interests prior to a combination because such
changes indicate a sale rather than a combining and sharing of risks.
d) Each combining company may reacquire shares of voting common stock only
for purposes other than business combinations, and no company may
reacquire more than a normal number of shares between the dates the plan of
combination is initiated and consummated.
e) The ratio of the interest of an individual common stockholder to those of other
common shareholders in a combining company should remain the same as a
result of the exchange of stock to effect the combination. This condition
ensures that no common stockholder is denied his or her potential share of a
voting common stock interest in a combined corporation.
f) The stockholders of the resulting combined corporation cannot be deprived of,
nor restricted in, their ability to exercise their voting rights on common stock of
the combined corporation. For example, establishing a voting trust to hold
some of the shares issued in the combination disqualifies the combination as a
pooling of interests.
g) The combination must be resolved at the date the plan is consummated, and
there must be no contingent arrangements for the issuance of additional
securities or other consideration. All consideration to be given to effect the
combination of the companies must be determinable as of the date the plan of
combination is consummated. The only exception to this would be a provision
to adjust the exchange ratio as a result of a subsequent settlement of a
contingency such as an existing lawsuit.

3) Absence of planned transactions:

a) The combined corporation should not agree directly or indirectly to retire or
reacquire any of the common stock issued to effect the combination.
b) The combined corporation cannot enter into other financial arrangements for
the benefit of the former stockholders of a combining company, such as a
guarantee of loans secured by stock issued in the combination. This financial
arrangement may require the payment of cash in the future that would
negate the exchange of equity securities, and thus, the combination would
not qualify for pooling of interests treatment.
c) The combined corporation may not intend to dispose of a significant part of
the assets of the combining companies within two years after the
combination. Some disposal of assets may be effected within the two-year
period provided the disposals would have been in the ordinary course of

23
 business of the formerly separate companies or if the disposals were to
eliminate duplicate facilities or excess capacity.
If a combining company remains a subsidiary of the issuing corporation after
the combination is consummated, the combination could still be accounted
for as a pooling of interests as long as all the conditions for a pooling are met.
Any business combination that meets all the above conditions must be
accounted for under the pooling of interests method.
Journal Entries to be recorded under pooling-of-interest accounting method
1. To record the combination with subsidiary as pooling
Current Assets ………….. A/C ………. Dr [with BV]
Plant Assets ……………..A/C ……….. Dr [with BV]
Other Assets …………….A/C ………..Dr [with BV]
*paid in capital in excess of par [if Dr < Cr]
Current liabilities ………… A/C [with BV]
Long term debts………….. A/C [with BV]
Common Stock . ………… A/C [with BV]
Retained earning ………… A/C [with BV]
Additional paid in capital….. A/C [with BV]
Note:
 Common stock (No of common shares issued by Combinor X Par value of Combinor)
 Pain in capital in excess of par [if Dr > Cr]
Alternative Journal Entries
Investment in pooled subsidiary A/C…….. Dr ……….. Net
[Combinees Common Stock (BV) + Combinees REs (BV) + Combinees APIC (BV)]
Paid in capital in excess of par [if Dr < Cr]
Common Stock ………… A/C [with BV]
Retained earnings A/C [with BV]
Additional paid in A/C [with BV]
* Common stocks (No of common shares issued by Combinor X Par value of Combinor)
*Paid in capital in excess of par {if Dr > Cr}
2. For out of pocket costs
Expenses of business combination A/C ……..Dr
Cash…………………….A/C……………Cr

5.9 Appraisal of Accounting Standards for Business Combinations

IFRS 3 Business Combinations outlines the accounting when an acquirer obtains
control of a business (e.g. an acquisition or merger). Such business combinations
are accounted for using the 'acquisition method', which generally requires assets
acquired and liabilities assumed to be measured at their fair values at the
acquisition date.

A revised version of IFRS 3 was issued in January 2008 and applies to business
combinations occurring in an entity's first annual period beginning on or after 1
July 2009.

24
Scope
IFRS 3 must be applied when accounting for business combinations, but does not
apply to:

The formation of a joint venture* [IFRS 3.2(a)] The acquisition of an asset or group
of assets that is not a business, although general guidance is provided on how such
transactions should be accounted for [IFRS 3.2(b)] Combinations of entities or
businesses under common control (the IASB has a separate agenda project on
common control transactions) [IFRS 3.2(c)] Acquisitions by an investment entity of a
subsidiary that is required to be measured at fair value through profit or loss under
IFRS 10 Consolidated Financial Statements. [IFRS 3.2A]

Determining whether a transaction is a business combination

IFRS 3 provides additional guidance on determining whether a transaction meets
the definition of a business combination, and so accounted for in accordance with
its requirements. This guidance includes:

Business combinations can occur in various ways, such as by transferring cash,

incurring liabilities, issuing equity instruments (or any combination thereof), or by
not issuing consideration at all (i.e. by contract alone) [IFRS 3.B5] Business
combinations can be structured in various ways to satisfy legal, taxation or other
objectives, including one entity becoming a subsidiary of another, the transfer of net
assets from one entity to another or to a new entity [IFRS 3.B6] The business
combination must involve the acquisition of a business, which generally has three
elements: [IFRS 3.B7]

Inputs – an economic resource (e.g. non-current assets, intellectual property) that

creates outputs when one or more processes are applied to it Process – a system,
standard, protocol, convention or rule that when applied to an input or inputs,
creates outputs (e.g. strategic management, operational processes, resource
management) Output – the result of inputs and processes applied to those inputs.

Method of accounting for business combinations

Acquisition method
The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3)
is used for all business combinations. [IFRS 3.4] Steps in applying the acquisition
method are: [IFRS 3.5]

Identification of the 'acquirer' Determination of the 'acquisition date' Recognition

and measurement of the identifiable assets acquired, the liabilities assumed and
any non-controlling interest (NCI, formerly called minority interest) in the acquiree
Recognition and measurement of goodwill or a gain from a bargain purchase.
25
Identifying an acquirer
The guidance in IFRS 10 Consolidated Financial Statements is used to identify an
acquirer in a business combination, i.e. the entity that obtains 'control' of the
acquiree. [IFRS 3.7]

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 [IFRS 3.B14] 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: [IFRS 3.B15] 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) [IFRS 3.B16] For business combinations involving multiple entities,
consideration is given to the entity initiating the combination, and the relative sizes
of the combining entities. [IFRS 3.B17]
Acquisition date
An acquirer considers all pertinent facts and circumstances when determining the
acquisition date, i.e. the date on which it obtains control of the acquiree. The
acquisition date may be a date that is earlier or later than the closing date. [IFRS
3.8-9]
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.

Example: Balance sheet information for Sphinx Company at January

1, 2005, is summarized as follows:
Current assets $ 230,000 Liabilities $ 300,000
Plant assets 450,000 Capital stock $10 par 200,000
Retained earnings 180,000
$ 680,000 $ 680,000

26
Sphinx’s assets and liabilities are fairly valued except for plant
assets that are undervalued by $50,000. On January 2, 2005, Pyramid
Corporation issues 20,000 shares of its $10 par value common stock
for all of Sphinx’s net assets and Sphinx is dissolved. Market
quotations for the two stocks on this date are:
Pyramid common: $28.00
Sphinx common: $19.50
Butler pays the following fees and costs in connection with the
combination:
Finder’s fee $10,000
Legal and accounting fees 6,000
Required:
1. Calculate Pyramid’s investment cost of Sphinx Corporation.
2. Calculate any goodwill from the business combination.
Solution:
Requirement 1
FMV of shares issued by Pyramid: 20,000 x $28.00= $ 560,000
Finder’s fees 10,000
Legal and accounting fees 6,000
Total acquisition cost for Sphinx Corporation: $ 576,000
Requirement 2
Investment cost from above: $ 576,000
Less: Fair value of Sphinx’s net assets
($680,000 of total assets plus $50,000 of
undervalued plant assets minus $300,000 of debt) 430,000
Equals: Goodwill from investment in Sphinx: $ 146,000

27