Chapter 3 – Business Combinations

CHAPTER TOPICS CROSS-REFERENCED WITH THE CICA HANDBOOK, Part I - IFRS

Business Combinations IFRS 3
Consolidated Financial Statements IFRS 10 (including Appendix B)
Property, Plant and Equipment IAS 16
Separate Financial Statements IAS 27
Intangible Assets IAS 38

A. Definition of Business Combinations and Control

A business combination occurs when one company (the acquirer) unites with or obtains control of one or more
businesses (IFRS 3). Reasons for forming business combinations include:
 To defend a competitive position
 To diversify into a new market and/or geographic region
 To access to new customers, products or services, expertise or capabilities (eg. Technology)

An investor controls an investee when it has power over the investee, is exposed or has rights to variable returns
from its involvement with the investee, and it has the ability to use its power over the investee to affect the
amount of the investor’s returns.

B. Forms of Business Combinations and Control

There are three main forms of business combinations. All three forms of business combination result in the
assets and liabilities of the acquiree being combined with those of the acquirer in some manner. One company
can obtain control over the net assets of another company through:

1. The purchase of assets – Control over another company’s assets/net assets can be obtained by
purchasing the assets/net assets outright, with either cash or shares, leaving the selling company only
with the consideration received for the asset sale and any liabilities present before the sale.

The combining of the assets will take place on the acquirer’s books, much like the purchase of a single
piece of machinery.

2. The purchase of shares – This is an alternative to the purchase of assets is for the acquirer to purchase
enough voting share from the shareholders of acquiree that it can determine the acquiree’s strategic
operating and financing policies. Share purchase can be less costly since control can be achieved by
purchasing less than 100% of the voting shares.

If control is achieved by purchasing shares or through contractual agreement, the combining takes place
when the consolidated financial statements are prepared under IFRS. Note that ASPE allows acquirer’s
to use the cost, equity method, or consolidation.

Consolidated financial statements are additional statements that combine the separate entity financial
statements under the hypothetical situation that the 2 or more legal entities were operating as 1 single

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 entity. Note that consolidated financial statements should present the same results as if the parent had
acquired the net assets directly.

The acquirer and acquiree will continue to record each entity’s transactions in their own accounting
records. Under IFRS, the acquirer can use either the cost or the equity method to record this investment
on their books.

3. Control through contractual arrangement - The acquirer signs an agreement with the acquiree’s
shareholders to give it control without buying assets or shares.

C. Methods of Accounting for Business Combinations

There are two main methods for recording business combinations:
 Acquisition method – Required for IFRS
 New-entity method – Theoretical model

We will focus on the acquisition method:

 The acquiring company reports the identifiable net assets being acquired at the fair value of these net
assets, regardless of the amount paid for them.
 When the purchase price is greater than the fair value of identifiable net assets, the excess is reported as
goodwill.
 If the purchase price is less than the fair value of identifiable net assets, the identifiable net assets are
still reported at fair value and the deficiency is reported as a gain on purchase.

D. Accounting for Business Combinations (Acquisition Method)

Following are the main ideas around the acquisition method when accounting for business combinations.

1. The acquirer, or entity that attains control of one or more businesses, should be identified for all
business combinations. When the purchase is made in cash, it is clear which company is the acquirer.
However, with a purchase using shares, the final percentage of ownership must be calculated to
determine which party is the acquirer. If the percentages are equal, then factors such as which company
is issuing the shares, the size of the company, and the desire of the new shareholders to be involved in
company policy and operational decisions should be considered.

2. The acquisition date is the date the acquirer obtains control of the acquiree.

3. The acquirer should measure FV of the acquiree based on the fair value of consideration given by the
controlling shareholder, plus the fair value of either (i) non-controlling shares or (ii) non-controlling
shareholders’ proportionate share of the acquiree’s identifiable net assets. Business valuation techniques
may be required to establish the values.

4. The acquirer should reflect the identifiable assets and liabilities acquired at fair value separately from
goodwill.

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 Example 1 – Determining the Acquirer
Following are the account balances for three companies, on January 1, Year 2.
Company AB Company CD Company EF
Number of Common Shares 100,000 40,000 50,000
Assets ($) 5,000,000 2,000,000 2,600,000

Company AB will buy the assets and liabilities of companies CD and EF through issuing shares to the
company: 80,000 shares to CD and 100,000 shares to EF. Determine the acquiring company.

Acquisition Cost:
The acquisition Cost includes:
• Any cash paid
• The fair value of assets transferred
• The PV of any promises to pay cash in the future
• The FV of any shares issued, based on the market price of shares on the acquisition date
• The FV of contingent consideration (see chapter 4)

Acquisition costs do not include fees of consultants, accountants, and lawyers which do not increase the FV of
acquired company. These should be expensed in the period of acquisition. The cost of issuing debt or shares are
not included in acquisition cost but are charged to the related debt or share capital.

E. Examples
We will be focusing on the four examples based on Exhibit 3.2. Note that the examples in this chapter are quite
simple and focus only on financial statements on acquisition date. You can find similar examples in the text
(different numbering, and I have made slight changes). We will complete consolidations subsequent to
acquisition date in later chapters.

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 Example 2 – Control through Purchase of Net Assets using Cash
On Jan 1, Year 2, A Co paid $95,000 in cash to B Corp for all of the net assets of that company and that no
other direct costs are involved. Calculate goodwill, and complete the purchase entry and balance sheet after
purchase for each company.

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 Example 3 – Control through Purchase of Net Assets by issuing Shares
If, on Jan 1, Year 2, A Co issues 4,000 common shares, with a market value of $23.75 per share, to B Corp as
payment for the company’s assets. And the costs for issuing shares totals $100, how will the company’s balance
sheets change compared to Example 2?

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 Example 4 – Control through Purchase of Shares with Cash
A Co issues a tender offer to the shareholders of B Corp for all their shareholdings. They accept the offer. On
Jan 1, Year 2, A Co paid $95,000 in cash to the shareholders of B Corp for all of their shares and there were
$2,000 of legal costs involved in this acquisition. Fair value of current assets are outlined in Exhibit 3.2,
however, when a business valuation was done, a customer service contract was determined to exist, and was
valued at $7,000. Calculate goodwill and complete the consolidated balance sheet.

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 Working Paper: A Company Limited, January 1, Year 2
Adjustments and Consolidated
A B Eliminations Balance
$ Co. Corp Dr Cr Sheet
Assets 203,000 88,000
Investment in B Corp 95,000
Acquisition Differential

298,000 88,000
Liabilities 120,000 30,000
Common shares 100,000
Retained Earnings 78,000
Common shares 25,000
Retained Earnings 33,000
298,000 88,000

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 Example 5 – Control through Purchase of Shares with Shares
If instead, A Co issues a tender offer to the shareholders of B Corp for all their shareholdings. They accept the
offer. On Jan 1, Year 2, A Co issues 4,000 common shares, with a market value of $23.75 per share, to
shareholders of B Corp for all their shares and there are no direct costs are involved. How will the individual
statements, and the consolidated financial statement be different?

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 F. Other Issues
Depreciable Assets:
If a subsidiary has depreciable assets, how should the depreciation be recorded on the
consolidated balance sheet? You can either use the proportionate method (read in your text) or
the net method. Both are similar to the methods you used to deal with depreciation when using
the revaluation approach on PPE.

Example 6 – Net Method for Depreciable Assets:

Given the following information about a parent and subsidiary, calculate the values that belong
in the Consolidated statement.

Assets Parent Subsidiary Consolidated

Cost 500 200
Accumulated Depreciation 180 50
Carrying Value 320 150

Fair Value 375 210

We will use the net method throughout the course.

Read about the

 direct approach/method,
 push-down accounting,
 subsidiary formed by parent and,
 other consolidated financial statements in the year of acquisition.

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 G. Presentation and Disclosure
Review the textbook material on presentation and disclosure near the end of the chapter. Make
sure you also review the ASPE differences at the end of the chapter.

Read over Reverse Takeovers in Appendix 3A for your own knowledge. Ensure that you have
read the entire chapter as there are several concepts in it which will be covered in later chapters.

Suggested Problems for Chapter 3: Extra

Problems:
Self-Study Problem 1(only Part a(i)) P3-5
and Self-Study Problem 2 at the end of
the chapter
P 3-1, P 3-2 Case 3-4
P 3-6, P 3-7 P3-10*
P 3-9
*Note: Pro forma statements are statements designed to meet a particular purpose. In this case
they are not full statements of financial position, but just listings of the key totals. See the
solution if you need more detail.

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