THE CPA BOARD EXAMS OUTLINES SERIES

by John Mahatma Agripa, CPA

ADVANCED FINANCIAL ACCOUNTING

AND REPORTING

BUSINESS
COMBINATIONS:
DATE OF ACQUISITION +
SUBSEQUENT TO ACQUISITION
Based on lectures by Rodiel C. Ferrer, CPA, Ph.D.
(CPAR)

GENERAL CONCEPTS:
BUSINESS COMBINATION AT DATE OF ACQUISITION

Business combinations are transactions where the acquirer

obtains control over another entity called the acquiree, through
either asset acquisition or purchase of at least 51% of the
acquirees voting stocks
In an asset acquisition, the entire net assets of the acquiree are
obtained, resulting to either the dissolution of the acquiree
(statutory merger) or the formation of a new entity with the
dissolution of both the acquirer and acquiree (statutory
consolidation). Since one or both entities are dissolved, there is no
parent-subsidiary relationship in asset acquisitions
In stock acquisition, on the other hand, both entities continue to
operate after the transaction. If the acquirer obtains less than the
entire voting stocks of the acquiree, there emerges a parentsubsidiary relationship, in which case the non-controlling interest
(NCI) is recognized
Accounting business combinations uses the purchase/acquisition
method, where acquiree assets are measured at fair value. The
outlawed pooling-of-interest method records acquiree assets at
book value
All business combinations require disclosure of who is the
acquirer, when is the acquisition date (when the fair value of
acquiree assets shall be based, which is still adjustable one year
after this date), the identifiable assets (excluding acquiree
goodwill), the non-controlling interest, and the goodwill or gain
from acquisition

TOTAL ASSETS, LIABILITIES AND EQUITY

ON DATE OF ACQUISITION

As an alternative to the CARLAS formula, the total assets,

liabilities and equity of the acquirer right after the acquisition can
be computed as follows. The items shall be discussed on
subsequent sections
Total acquirer assets, at book value
ADD: Total acquiree assets, at fair value
ADD: Goodwill
DEDUCT: Cash, non-cash assets paid
DEDUCT: Expenses paid
Total assets

xx
xx
xx
xx
xx
xx

Total acquirer liabilities, at book value

ADD: Total acquiree liabilities, at fair value
ADD: Bonds, notes and other debt issued
ADD: Contingent consideration
ADD: Expenses not yet paid
Total liabilities

xx
xx
xx
xx
xx
xx

Total acquirer equity

ADD: Non-controlling interest
ADD: Shares issued as part of payment, at fair value
ADD/DEDUCT: Gains/losses from bargain purchase,
previously-held investments, contingent consideration
DEDUCT: All expenses, regardless of payment
Total equity

xx
xx
xx
xx
xx
xx

GOODWILL / GAIN ON
BARGAIN PURCHASE OPTION

Goodwill results if the acquirer pays more than the fair value of
the net assets of the acquiree. Otherwise, a gain on bargain
purchase option emerges. Goodwill is not an identifiable asset,
and therefore not recorded by the acquirer if the acquiree has
preexisting ones (and thus not included in the formula above)
In cases that the business combination involves acquisition of
two or more acquirees, goodwill from the acquirees is not
combined. If theres a gain on one acquiree, it is not netted
against the goodwill of the other acquiree
Goodwill/gain from the combination can be computed with
either of the following formulas:

Fair value of previously-held interest

ADD: Fair value of additional consideration
ADD: Fair value of contingent consideration payable
ADD: Present value of deferred consideration
Purchase price
ADD: Fair value of non-controlling interest
Fair value of acquiree
DEDUCT: Book value of acquirees net asset
Excess
ADD: Overvalued assets
DEDUCT: Undervalued assets
Goodwill / (Gain)

xx
xx
xx
xx
xx
xx
xx
xx
xx
xx
xx
xx

Purchase price (includes control premium, if any)

DEDUCT: Fair value of acquiree net assets
Goodwill / (Gain)

xx
xx
xx

Control premium refers to additional payments made by the

acquirer to make sure the acquiree sells its assets to them
The fair value of acquiree net assets are provisional, which
means they can still be changed within one year from the date of
acquisition, subsequently affecting goodwill. The changes are
applied retrospectively, which means if there is a change on fair
values a few months from the date of acquisition, the resulting
goodwill shall be the goodwill as of the date of acquisition
Goodwill is allocated between the parent and subsidiary using
their interest percentages, while any gain is all allocated to the
parent

NON-CONTROLLING INTEREST
AND THE D&A SCHEDULE

As mentioned, non-controlling interest (NCI) is only recognized

in stock acquisitions of less than the entire voting shares of the
acquiree. This is measured at fair value or implied value, if fair
value is not available. This forms part of goodwill computation
and of total equity

 The implied value of NCI can be computed as follows:

Purchase price
DEDUCT: Control premium, only if included in purchase price
DIVIDE: Controlling interest %
MULTIPLY: Non-controlling interest %
NCI implied value

xx
xx
xx
xx%
xx
xx%
xx

The amount of NCI to be recorded follows the floor test it must

be the higher between the given fair or implied value of NCI, and
the proportionate/relevant share. In no instance should the NCI
be lower than the proportionate/relevant share. The floor test
may be overridden in some jurisdictions, but for examination
purposes it shall always be followed
NCI and goodwill can actually both be computed with the D&A
schedule, as follows:

Fair value of subsidiary

Relevant share
Goodwill / (gain)

Total
(f)
(b)
(g)

Purchase price
(a)
(c)
xx

NCI
(e)
(d)
xx

First enter the purchase price (includes the control premium) in

(a) and the fair value of the acquirees net assets in (b).
Remember that existing goodwill of acquiree is not included.
Multiply (b) with the controlling interest % for (c) and with the
NCI % for (d)
(d) is the proportionate/relevant share, which is the basis for the
floor test. If the NCIs fair value or implied value is lower than
this amount, (d) is copied to (e). (a) and (e) are then added, and
deducted with (b) for the goodwill/gain (g)

PREVIOUSLY-HELD INTEREST

This refer to the interest on the acquiree by the acquirer below

51% such as investments in associate and equity securities that

didnt grant it control over the former. Its fair value shall form
part of the purchase price for the computation of goodwill, which
can be computed as follows:
Additional consideration for the additional interest to obtain
control
DIVIDE: Additional interest %
MULTIPLY: % of previously-held interest
Fair value of previously-held interest

xx
xx%
xx
xx%
xx

For instance, if the acquirer previously had an investment in

associate (25%) over the acquiree, and pays Php 100,000 for
another 30% interest, thereby granting it control, Php 100,000
is the additional consideration and the 30% is the additional
interest percentage. 25% is the previously-held interest
percentage
Gains/losses from previously-held interest forms part of total
equity. To compute, the carrying value of the investment in
associate (or any other investment) has to be adjusted (for
income, dividends, impairment) and compared with the
computed fair value
A business combination in which this arises is called step-up
acquisition

CONTINGENT LIABILITY PAYABLE

Also called upfront fee, these are additional payments promised

by the acquirer to be paid if certain conditions are met. These
amounts are presented in their present values. The present
value forms part of purchase price, and gains/losses form part
of total equity
Since provisional, this present value may change within one year
of the acquisition, which retrospectively affects goodwill.

However, if the change is the result of meeting earnings targets,

milestones in research and development, or reaching specific
markets, goodwill is not adjusted. In such cases, a separate
account is made
The gains/losses are the changes in the consideration payable.
Since a liability, increases in the amount is a loss, and vice versa

EXPENSES AND OTHER ITEMS

There are generally three expense accounts in business

combinations direct costs, indirect costs, and costs to issue
and register (or stock issuance costs). They form part of the
computation for total assets, liabilities and equity
These expenses, including direct cost, are not capitalized in the
investment in subsidiary account
Also included in the purchase price in the computation of
goodwill are fully amortized and internally-generated intangible
assets, both of which are considered identifiable

GENERAL CONCEPTS:
BUSINESS COMBINATION SUBSEQUENT TO ACQUISITION

Problems on business combination subsequent to acquisition

revolve around the preparation of consolidated financial
statements and computation of consolidated net income in the
presence of a parent-subsidiary relationship
In its separate financial statements, the parent/holding company
accounts for its control over its subsidiary with an investment in
subsidiary account, measured with the cost model. The account is
composed of cash, share or contingent considerations given

COMPUTATION OF CONSOLIDATED
NET INCOME (CNI)

There are in total 27 items considered in the computation of

consolidated net income, divided into the parents and that of the
non-controlling interest. Components are discussed in the
subsequent sections
CNI - Parent CNI - NCI
Parent net income
xx
DEDUCT: Dividend from subsidiary
xx
Income from own operation of parent
xx
ADD/DEDUCT: Share in net income/loss
of subsidiary
xx
xx
DEDUCT: Amortization of undervaluations
xx
xx
ADD: Amortization of overvaluations
xx
xx
ADD: Gains from bargain purchase,
previously-held interest and
contingent considerations
xx
DEDUCT: Impairment losses
xx
xx
ADD: Realized profit from beginning
inventory (RPBI), downstream sales
xx
DEDUCT: Unrealized profit from ending
inventory (UPEI), downstream sales
xx
ADD: RPBI, upstream sales
xx
xx
DEDUCT: UPEI, upstream sales
xx
xx
ADD: Realized gains from upstream sales
xx
xx
ADD: Realized gains from downstream sales
xx
DEDUCT: Realized losses from upstream
xx
xx
DEDUCT: Realized losses from downstream
xx
DEDUCT: Unrealized gains from upstream
xx
xx
DEDUCT: Unrealized gains from downstream
xx
ADD: Unrealized losses from upstream
xx
xx
ADD: Unrealized losses from downstream
xx
xx
Consolidated net income (parent + NCI)
xx
xx

Items shared by both parent and the non-controlling interest

particularly share in net income/loss of subsidiary, amortization of
undervaluations and overvaluations, and profits/gains/losses
from upstream sales are divided according to ownership
percentage
If the business combination occurred sometime during the year,
say in May, the said items shall be prorated according to the
remaining months of the year (multiplied by 8/12)

The exception would be impairment losses, which is divided

according to the proportion of goodwill belonging to the parent
and NCI as computed with the D&A schedule (see page 5). This is
not prorated
Gains from bargain purchase, previous interest and contingent
consideration are only included in the computation if the net
income related to the year of the business combination

OVER/UNDERVALUATION OF
ASSETS

There is overvaluation if the book value of the asset exceeds its

market value. On the opposite case, theres undervaluation
Amortization of the over/undervaluation depends on the related
asset. If the asset is depreciable, the amount is amortized as it
is depreciated, according to remaining useful life. If the asset is
part of inventory or is non-depreciable like land, the amount is
amortized if the asset is sold
If silent, the amount of inventory given is assumed to be all sold
during the year, thus all amortized

INTERCOMPANY SALES:
UPSTREAM AND DOWNSTREAM SALES

Intercompany sales are transactions between the parent and

subsidiary, classified as either upstream (sale of subsidiary to
parent) or downstream (sale of parent to subsidiary). The sale
may be that of inventory, depreciable assets or land
As seen in the formula, all gains and losses, realized or
unrealized, from upstream sales go both to the parent and
subsidiary divided according to the percentage of interest.

Gains and losses from downstream sales only go to the parent

The gains and losses may be realized or unrealized. There is an
unrealized gain if the seller (parent or subsidiary) transfers the
asset to the buyer (subsidiary or parent) at a price higher than
book value. The gain is only between the two entities, so its
effect is removed from consolidated income unrealized gains
are deducted, while unrealized losses are added back. Realized
gains occur when the transferred asset is sold to a third party at
a price higher than the book value
The treatment of these gains and losses differ according to the
related asset inventory, depreciable asset or land
Unrealized profit from ending inventory (UPEI) is actually the
markup on inventory transferred from the parent/subsidiary still
remaining on the stocks. Ending inventory purchased from
outside sources does not constitute UPEI. On the following year,
this very amount becomes realized profit from beginning
inventory (RPBI), assuming of course that the entire inventory is
sold next year to third parties. If the same inventory is not sold,
UPEI for that inventory will remain the following year
Unrealized gains or losses from transfer of depreciable assets
and land is recorded only in the year they are transferred to the
parent/subsidiary. For depreciable assets, this amount is
amortized on a straight-line basis according to the assets
remaining useful life, and recorded as realized gains or losses. If
the asset is sold to third parties, the unamortized amount is fully
recorded as realized
For land, the unrealized amount becomes realized only if the
land is sold to third parties. This unrealized amount is strictly the
only amount that shall be realized, even if the land was sold at a
way higher price

10

CONSOLIDATED FINANCIAL
STATEMENTS

The preparation of consolidated financial statements is only

required for public entities. The computation of total assets and
liabilities follow the formulas on page 3. Formulas for other
consolidated components of the financial statements are as
follows:
Parent sales
ADD: Subsidiary sales
DEDUCT: Intercompany sales, at selling price
Consolidated sales

xx
xx
xx
xx

Parent COGS
ADD: Subsidiary COGS
DEDUCT: Intercompany purchases, at selling price
ADD: UPEI, upstream and downstream
DEDUCT: RPBI, upstream and downstream
Consolidated cost of goods sold

xx
xx
xx
xx
xx
xx

Parent gross profit

ADD: Subsidiary gross profit
DEDUCT: UPEI, upstream and downstream
ADD: RPBI, upstream and downstream
ADD: Amortization of inventory overvaluation
DEDUCT: Amortization of inventory undervaluation
Consolidated gross profit

xx
xx
xx
xx
xx
xx
xx

Parent expenses
ADD: Subsidiary expenses
ADD: Amortization of depreciable asset undervaluation
DEDUCT: Amortization of depreciable asset overvaluation
ADD: Realized losses from depreciable assets
DEDUCT: Realized gains from depreciable assets
Consolidated expenses

xx
xx
xx
xx
xx
xx
xx

Parent shareholders equity

ADD: Non-controlling interest, at date of acquisition
ADD: Parent net income
ADD: Subsidiary net income
DEDUCT: Parent dividend declarations
DEDUCT: Share of dividend from subsidiary
Consolidated shareholders equity

xx
xx
xx
xx
xx
xx
xx

Parent retained earnings, beginning

ADD: Parent net income
DEDUCT: Parent dividend declarations
Consolidated retained earnings

xx
xx
xx
xx

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