CH-1 Advanced FA

CHAPTER
 ONE
CONSOLIDATION OF FINANCIAL
INFORMATION/ACCOUNTING
FOR BUSINESS COMBINATION
(IFRS 3)
Advanced Financial Accounting,
22/02/2023 1
prepared by Sisay Mulate (PhD)
Advanced Financial
Accounting (ACFN 612)

Sisay Mulate (PhD)
Department of Accounting and Finance
College of Business and Economics
Debre Birhan University
22/02/2023 2
Meaning of Accounting

 Accounting is the ﬁnancial information system that
provides reports to users about the economic activities
and condition of a business.
 Accounting consists of three basic activities—it
 identiﬁes,
 records, and
 communicates the economic events of an organization to
interested user

22/02/2023 3
Business combinations and the consoli
dation process

 A business combination refers to any set of
conditions in which two or more organizations are
joined together through common control.
 A transaction or other event in which an acquirer
obtains control of one or more businesses.
Transactions sometimes referred to as ‘true mergers’
or ‘mergers of equals’ are also business
combinations.
Commonly, business combinations are often referred
to as Mergers and Acquisitions (M&A).

22/02/2023 4
Business Combinations: Why?
 In recent years Growth has been main reason for business
enterprises to enter into a business combination.

 There could be many more reasons.
 Entities may increase their mkt share, diversify their
business or improve vertical integration of their
activities in a No. of ways, including by:
 organic growth or through acquisitions.
 Obtaining new mgt strength or better use of existing
management.

22/02/2023 5
Cont…


 Purchase of undervalued assets
Developing new concepts
 Vertical integration
 Quick entry into new markets
 Economies of scale/Cost savings - cost per unit of output generally
decreasing with increasing scale as fixed costs are spread out over
more units of output.
 More attractive financing opportunities
 Diversification of business risk / Reduction of risk
 Business Expansion
 Increasingly competitive environment/Elimination or reduction of
competition
 Use of price/earnings ratios
22/02/2023 6
CONT...

 Words such as
 ‘business combinations’
 merger,
 amalgamation,
 absorption,
 takeover and
 acquisition are all used to describe the coming
together of two or more businesses.
 used interchangeably

22/02/2023 7
cont…

 An acquirer might obtain control of an acquiree in a
variety of ways, for example:
a) by transferring cash, cash equivalents or other assets
(including net assets that constitute a business);
b) by incurring liabilities;
c) by issuing equity interests;
d) transferring other assets,
e) by providing more than one type of consideration; or
f) without transferring consideration, including by
contract alone, Eg CBE Merge with Construction BE
22/02/2023 8
cont…

 To explain the process of preparing consolidated f/s
for business combination, we address three
questions:
 How is a business combination formed?
 What constitutes a controlling financial interest?
 How is the consolidation process carried out?

22/02/2023 9
How is a business combination formed?/
Forms of Business Combinations
 A business combination can be created in several different ways:
1. Statutory merger—only one of the original companies remains in business as
legally incorporated enterprise.
 A+B=A 
a. Assets and liabilities can be acquired with the seller then dissolving itself as a
corporation. through assets acquisition
b. All of the capital stock of a company can be acquired with the assets and
liabilities then transferred to the buyer followed by the seller’s dissolution., often
remaining as a division of acquiring company. through stock acquisition
2. Statutory consolidation—assets or capital stock of two or more companies
are transferred to a newly formed corporation. through assets & stock
acquisition.
 Both combining companies are dissolved
 A+B=C
3. Stock acquisition/Acquisition of more that 50% voting stock. Acquisition
by one company of a controlling interest in the voting stock of a second.
 Dissolution does not take place; both parties retain their separate legal
incorporation.
22/02/2023 10
Advanced Financial Accounting, prepared by Sisay Mulate (PhD)
Business Combination
22/02/2023 11
What constitute s a controlling financial
interest?

 controlling is related to ownership (>50% voting
stock).
 Control means decision making ability that is not
shared with others.
22/02/2023 Advanced Financial Accounting, prepared by Sisay Mulate (PhD) 12

How is the consolidation process carried out?

 Financial information from the members of a business co
mbination must be
consolidated into a single set of financial statements repre
senting the entire economic entity.
1. If the acquired company is legally dissolved, a permanent c
onsolidation is produced on the date of acquisition by
entering all account balances into the financial records
of the surviving company.
2. If separate incorporation is maintained, consolidation is
periodically simulated whenever financial statements are to
be prepared. This process is carried out through the use of
22/02/2023
worksheets and consolidation entries
13
Accounting for business combination

 There are two methods of accounting to record
business combination.
1. Purchase method/acquisition –IFRS use this only
2. Pooling of interest method/merger method

22/02/2023 14
1. Purchase method/The acquisition method
Measurement principle

 The acquirer shall measure the identifiable assets acquired
and the liabilities assumed at their acquisition-date fair
values.
 The cost allocation procedure employed by the purchase
method is based on the fair values of the acquired assets and
liabilities at the date of acquisition.
 Fair value is the price at which an asset or liability could be
exchanged in a current transaction between knowledgeable,
unrelated willing parties.
 Because income can accrue to owners only after the purchase
of an asset, only revenue & expenses generated by these
assets and liabilities after the acquisition date are attributed
to the business combination.
22/02/2023 15
Cont…

 Applying the acquisition method requires:
a) identifying the acquirer;
b) determining the acquisition date;
c) recognising and measuring the identifiable assets
acquired, the liabilities assumed and any non-
controlling interest in the acquiree; and
d) recognising and measuring goodwill or a gain
from a bargain purchase.

22/02/2023 16
Recognition & measurement
• Recognition principle:
• separate recognition of identifiable NAs & contingent liabilities
assumed.
• A contingent liability is a potential liability that may occur depending on
the outcome of an uncertain future event. A contingent liability is
recorded in the accounting records if the contingency is probable and the
amount of the liability can be reasonably estimated. If both conditions
are not met, the liability may be disclosed in a footnote on the financial
statements or not reported at all.
• Measurement principle:
• assets and liabilities that qualify for recognition are measured at their
acquisition-date FVs.
• measurement at FV provides relevant information that is more
comparable & understandable
22/02/2023 Advanced Financial Accounting,

prepared by 17
Sisay Mulate (PhD)
Recognise and measure the identifiable net assets
acquired
• At acquisition date, allocate the cost of a business

combination by recognising the acquiree’s identifiable net
assets at their acquisition-date fair value
• Acquirer’s net assets – account for at carrying
amounts
• Net assets of the acquiree - remeasured to fair value.
22/02/2023 Advanced Financial Accounting, 18

Recognise and measure the identifiable net assets acquired
(cont’d)
• Recognition criteria for assets and liabilities that existed at the

acquisition date:
 Assets other than intangibles – probable that associated future
economic benefits will flow to the acquirer, and FV can be
measured reliably
 Intangible assets – FV can be measured reliably
 Liabilities other than contingent liabilities – probable outflow
of economic benefits, and fair value can be measured
reliably; not future losses or restructuring costs unless
previously recognised by acquiree
 Contingent liabilities – FV can be measured reliably

Consideration transferred
• The consideration transferred is measured at the FV of the sum
of assets transferred & liabilities assumed
• The fair values at the date of exchange, of assets given,
liabilities incurred, and equity instruments issued:
 Deferred amounts discounted to present value
 Published price of shares at date of exchange
 No provision for future losses or expected costs
 For contingent consideration, provide probable amount
• Any costs directly attributable to the business
combination are excluded e.g. professional fees,
allocation of admin costs, etc.

Acquisition-related costs
 Acquisition-related costs are costs the acquirer incurs to effect
a business combination.
 Those costs include
 finder’s fees;

 advisory,
 legal,
 accounting,
 valuation and other professional or consulting fees;
 general administrative costs, including the costs of maintaining
an internal acquisitions department; and
 costs of registering and issuing debt and equity securities.
 The acquirer shall account for acquisition-related costs as
periodic expenses in the periods in which the costs are
incurred and the services are received, with one exception.
 The costs to issue debt or equity securities shall be recognized
in accordance with IAS 32 and IFRS 9.
22/02/2023 21
Under GAAP

 In addition to the purchase prices (cash, common stock, e.t.c) an
acquiring firm typically incurs additional costs in connection
with a business combination .
 Direct combination costs include in the purchase price for the
acquired firm.
 E.g., accounting, legal, investment banking, appraisal fees, e.t.c
 Indirect combination costs recognize as expense as incurred.
 E.g., internal costs such as allocated secretarial or managerial time.
 Costs to register and issues securitises---Reduce the value

assigned to the fair value of the securities issued ( typically a
debit to additional paid-in capital).
22/02/2023 22
Example 1:
What is the cost of the Bus Com? 23
• Entity A acquires 75% of entity B in exchange for $85,000

cash and 1,000, $1 par entity A shares (fair value =
$10,000) issued for the transfer.
• Entity A incurred $5,000 advisory and legal costs directly
attributable to the business combination and $1,000
share issue expenses.
• Required: calculate the cost of purchased.

cont…
• 85,000+10,000=95,000

Deferred consideration
Example : (Deferred consideration)


The parent acquired 75% of the subsidiary's 80m $1 shares on 1
Jan 20X6. It paid $3.50 per share and agreed to pay a further
$108m on 1 January 20X7.
The parent company's cost of capital is 8%.
RQD: a) Compute the Total consideration.

22/02/2023 25
solution

$m
80m shares x 75% x $3.50 210
Deferred consideration:
$108m x 1 / 1.08 100
Total consideration 310

22/02/2023 26
Recognise and measure any non-controlling interest
IFRS 3 has an explicit option to measure NCI at the date of

acquisition at either:
 fair value (new method) e.g. if available, share price of NCI
equity shares; or using other valuation techniques if not publicly
traded;
or
 NCI’s proportionate share of the net identifiable assets of the entity
acquired (old method).
• Argued that old method of calculating goodwill only recognises

the goodwill acquired by the parent i.e. any goodwill
attributable to NCI is not recognised.
• In the new method goodwill is recognized for both parent and
NCI
Purchase method/The acquisition method

 We will see purchase method under two cases:-
a. Purchase method when dissolution takes place
b. Purchase method when separate incorporation is
maintained

22/02/2023 28
a) Purchase method when dissolution takes place

 The purchase method employ the cost principle in
recording business combination i.e the total value
assigned to the net assets received equal the total cost
of acquisition.
 There are four cases:
1. Purchase price = FMV of net assets
2. Purchase price > FMV of net assets
3. Purchase price <FMV of net assets
4. Purchase price substantially less than the FMV of the
net assets
22/02/2023 29
Case 1:Purchase price = FMV of net assets
 Example 1: Bignet Company owns Internet communications

equipment and other business software applications that
complement those of Small port. Bignet wants to expand its
operations and plans to acquire Smallport on December 31. The
accounts reported by both Bignet and Smallport on that date
are listed below.
 Small port net assets (assets less liabilities) have a book value
of $600,000 but a fair value of $2,550,000. only the assets and
liabilities have been appraised here; the capital stock, retained
earnings, dividend , revenue, and expense accounts represent
historical measurements rather than type of future values.
Although these equity and income accounts can give some
indication of the overall worth of the organization, they are not
property and thus not transferred in the combination .
22/02/2023 30

Cont...

 Assume that after negotiations with the owner of
Smallport, Bignet agrees to pay $2,550,000 for all of
Smallport’s assets and liabilities: cash of $550,000
and 20,000 unissued shares of its $5 par value
common stock that is currently selling for $100 per
share. Smallport will then dissolve itself as a legal
entity.

22/02/2023 31
Assets, Liabilities and Equities Big net co. Smallport company
Book value Book value Fair value
dec,31 dec,31
Current assets $1,100,000 $300,000 $300,000
Computers &equipment
Capitalized software 
1,300,000
500,000
400,000
100,000
900,000
1,600,000
Notes payable (300,000) (200,000) (250,000)
Net assets 2,600,000 $600,000 $2,550,000
Common stock-$5 par value $1,600,000
Common stock-$10 par value $100,000
Additional paid in capital 40,000 20,000
Retained earnings, 1/1 870,000 370,000
Dividends paid (110,000) (10,000)
Revenues 1,000,000 500,000
expenses (800,000) (380,000)
Owners’ equity 12/31 $2,600,000 $600,000
Retained earnings, 12/31 960,000 480,000
22/02/2023 32
Required: prepare the journal entry for the purchase
of Smallport co.
Case 1: FMV=PP
 PP=550,000+2,000,000=2,550,000 
Current assets ---------------------- 300,000
Computers &equipment--------- 900,000
Capitalized software------------ 1,600,000
Notes payable ----------------------------------- 250,000
Cash------------------------------------------------- 550,000
Common stock (5*20,000)--------------------- 100,000
Additional paid in capital(95*20,000)----1,900,000

22/02/2023 33
Case 2: PP>FMV of net assets

 The acquirer shall recognise goodwill as of the acquisition
date measured as the excess of (a) over (b) below:
a) the aggregate of:
i. the consideration transferred measured in accordance with
this IFRS, which generally requires acquisition-date fair
value
ii. the amount of any non-controlling interest in the acquiree
measured in accordance with this IFRS; and
iii. in a business combination, the acquisition-date fair value of
the acquirer’s previously held equity interest in the acquiree.
b) the net of the acquisition-date amounts of the identifiable
assets acquired and the liabilities assumed measured in
accordance with this IFRS.

22/02/2023 34
Case 2: PP>FMV of net assets

 PP= 3,000,000=1000000+2000000
 Mode of payment
 Cash= $1,000,000
 Common stock 20,000 shares with $100 mkt price
 PP-FMV = Good will
 3,000,000 – 2,550,000=450,000
 Good will recognized when purchase made.
Advanced Financial Accounting, prepared by Sisay Mulate

22/02/2023 35
(PhD)
Journal entry

Current assets ---------------------- 300,000
Computers &equipment--------- 900,000
Capitalized software------------ 1,600,000
Goodwill --------------------------- 450,000
Notes payable ----------------------------- 250,000
Cash---------------------------------------- 1,000,000
Common stock 5*20,000----------------- 100,000
Additional paid in capital------------1,900,000

22/02/2023 36
Case 3: PP<FMV of net assets

 The price paid to Smallport’s owners is assumed to be
$2,000,000.
 No cash payment
 Bignet issues 20,000 shares of common stock having a $100 per
share fair value.
 When a purchase price is less than total fair value of the net
assets, non current accounts, such as computers and
Equipment and Capitalized software, are consolidated at
reduced balances.
 Because Bignet paid $550,000 less that fair value ($2,000,000-
$2,550,000), the balances of the non current assets being
acquired must be decreased by that amount.
22/02/2023 37
FMV-PP
2550,000-2000,000=550,000

Non Current asset accounts Fair value % Amt reduce
Computer equipment $900,000 36% 198,000
Capitalized software 1,600,000 64% 352,000
Total 2,500,000 100% 550,000

22/02/2023 38
Journal entry

Current assets ---------------------- ------------------300,000
Computers &equipment (900,000-198,000)--- 702,000
Capitalized software (1,600,000-352,000) ----1,248,000
Notes payable --------------------------------------------- 250,000
Common stock-------------------------------------------- 100,000
Additional paid in capital----------------------------1,900,000

22/02/2023 39
Case 4: pp is substantially less than
FMV of net assets
 Assume pp=$40,000

 Mode of payment is cash
 Whenever a purchase price is less than fair value so that
the acquired applicable non current assets balances are
eliminated entirely, an additional reduction is needed.
 the additional reduction is reported as an extraordinary
gain.
 Extraordinary gain comes into existence only after the
applicable noncurrent assets are first decreased to zero.

22/02/2023 40
2,510,000=2,550,000-40,000
 The journal entry would do the following

 Recognize no balance for the two noncurrent assets account.
 Allocate the remaining $10,000 reduction to an extraordinary
gain .
 Report all remaining assets and liability accounts at fair value.
Current assets ---------------------- ------------------300,000

Computers &equipment (900,000-900,000)--- -0-
Capitalized software (1,600,000-1,600,000) --- -0-
Notes payable --------------------------------------------- 250,000
Extraordinary gain-excess of FV over cost of acquisition----- 10,000
Cash------------------------------------------------------------40,00041
22/02/2023
Summary of the purchase method

 Acquired assets and liabilities are normally
consolidated at their fair values.
 An excess payment leads to the creation of a
Goodwill.
 A low purchase price forces a reduction in the
recorded balance of applicable noncurrent assets and
possibly the recognition of an extraordinary gain.

22/02/2023 42
2. Purchase method when separate incorporation is
maintained

 Many aspects of the consolidation process are identical
here as previous cases.
 FMV remain the basis for considering the subsidiary
assets and liabilities.
 However, the consolidation is simulated rather than
physically recording the acquired assets and liabilities.
 Because dissolution doesn’t occur each Co. Maintain
separate accounting record.
 To facilitate the consolidation process, a worksheet is
used.
22/02/2023 43
Cont…

 One company obtains all of the capital stock of another in exchange
for cash, other assets, liabilities, stock, or a combination of these.
 After gaining control, the acquiring company can decide to transfer all
assets and liabilities to its own financial records with the second
company being dissolved as a separate corporation.
 The business combination is, once again, a statutory merger because
only one of the companies maintains legal existence.
 This statutory merger, however, is achieved by obtaining equity
securities rather than by buying the target company’s assets. Because
stock is obtained, the acquiring company must gain 100 percent
control of all shares before legally dissolving the subsidiary

22/02/2023 44
Illustration:
 Illustration: using the previous information, assume that
Bignet acquires Smallort Company on December 31 by

issuing 26,000 shares of $5 par value common stock valued
at $100 per share ( or $2,600,000 in total). BigNet also pays
direct combination costs of $40,000. For business reasons,
BigNet decides that Smallport should continue as a
separate corporation.
 Therefore, whenever financial statements for the combined
entity are prepared, a worksheet is utilized in simulating
the consolidation of these two companies. Although the
assets and liabilities are not transferred, BigNet must still
record the payment made to Smallport’s owners. When the
subsidiary remains separate, the parent establishes an
investment account that initially reflects the purchase price.
22/02/2023 45
Solution
 old method

Investment in Smallport Company (pp)............ 2,640,000
Cash( direct combination costs) ..................................... 40,000
Common stock (26,000*5 par value) ............................ 130,000
Additional PIC (26,000*95).......................................... 2,470,000
 New method
Investment in Smallport Company (pp)............ 2,600,000
Common stock (26,000*5 par value) ............................ 130,000
Additional PIC (26,000*95).......................................... 2,470,000

22/02/2023 46
The preparation of worksheet involves
seven steps

 Step1: allocation of the purchase price
Purchase price ........................................2,600,000
BV of Smallport ....................................... 600,00
Excess of cost over BV ........................... 2,000,000
 Allocation made to specific accounts based on d/ce in
FV and BV:
Computer & equipment ($900,000-$400,000).......$500,000
Capitalized software ($1,600,000-$100,000).........$1,500,000
Note payable ($250,000-$200,000) ......................... (50,000)
Excess cost not identified with specific accounts--- goodwill
(2,000,000-1,950,000).................................................. $50,000
22/02/2023 Advanced Financial Accounting, prepared by Sisay Mulate 47
(PhD)
Cont...
 Step2: Bignet accounts adds the investment entry.
 2,600,000

 Step3:Smallport stockholders equity accounts are
eliminated through entry S. These accounts are
historical measurements that that occurred prior to
the combination. Those accounts are common
stock, additional PIC and RE.
 by removing these accounts only Smallport assets
and liabilities are to be combined.
 Common stock......................... 100,000
 Additional PIC ........................ 20,000
 RE ending................................ 480,000
 Inv’t in Smallport ................................... 600,0000
22/02/2023 48
Step 4

 Also worksheet Entry S removes the $600,000
component of the investment in Smallprt company
account that equates to the book value of the
subsidiary’ s net assets.
 For internal reporting purposes, the combination
should report each individual account rather than a
single investment balance.

22/02/2023 49
Step 5

 Entry A removes the $2,000,000 excess payment in the
Investment in Smallport company and assigns it to the specific
accounts indicated by the purchase price allocation schedule.
 Consequently, computer and equipment is increased by
$500,000; 1,500,000 is to capitalized software; and 50,000 to
Notes payable.
 The unexplained excess of $50,000 is recorded as goodwill.
Computers &equipment (900,000-400,000)--- 500,000

Capitalized software (1,600,000-100,000) -----------1,500,000
GW-------------------------------------------------------- 50,000
Notes payable -------------------------------------------------- 50,000
INV’T IN SMALLPORT-------------------------------------------------2,000,000

22/02/2023 50
Step 6

 All accounts are extended into the consolidated total
column.
 Step 7: consolidated expenses are subtracted from

revenue to arrive at a net income of $200,000.

22/02/2023 51
Big net company & Smallport company
Consolidation worksheet
For period ending December 31
Accounts Bignet Smallport Consolidation entries Consolidat
 Debts credits ed total
I/S

Revenues (1,000,000) (1,000,000)
Expenses 800,000 800,000
Net income (200,000) (200,000)
Statme of RE
R/E,1/1 (870,000) (870,000)
NI (above) (200,000) 200,000
Dividend paid 110,000 (110,000)
RE, 12/31 (960,000) (960,000)

22/02/2023 52
B/Sheet
Current assetss 1,060,000* 300,000 1,360,000
Inv’t in Smallpo 2,640,000 -0-

 (S)600,000
(A)2,000,00
0
-0-
Compuer & Equ 1,300,000 400,000 (A)500,000 2,200,000
Capitalized soft 500,000 100,000 (A)1,500,000 2,100,000
Goodwill -0- -0- (A)50,000 90,000
Total assets 5,500,000 800,000 5,750,000
Notes payable (300,000) (200,000) (A)50,000 (550,000)
Common stock (1,730,000)* (100,000) (S)100,000 (1,730,000)
Addi PIC (2,510,000)* (20,000) (S)20,000 (2,510,000)
RE,12/31(Abov (960,000) (480,000) (S)480,000 (960,000)
Total lia&Equit (5,500,000)

22/02/2023 (800,000) (5,750,000)
53(

The end!!!
Thank you!!!
22/02/2023 54

CH-1 Advanced FA

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CHAPTER

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

22/02/2023 Advanced Financial Accounting, prepared by Sisay Mulate (PhD) 12

Advanced Financial Accounting,

Advanced Financial Accounting,

22/02/2023 Advanced Financial Accounting,

• At acquisition date, allocate the cost of a business

22/02/2023 Advanced Financial Accounting, 18

• Recognition criteria for assets and liabilities that existed at the

22/02/2023 Advanced Financial Accounting, 19

22/02/2023 Advanced Financial Accounting, 20

 Costs to register and issues securitises---Reduce the value

• Entity A acquires 75% of entity B in exchange for $85,000

22/02/2023 Advanced Financial Accounting, 23

22/02/2023 Advanced Financial Accounting, 24

Example : (Deferred consideration)

RQD: a) Compute the Total consideration.

Advanced Financial Accounting,

Advanced Financial Accounting,

IFRS 3 has an explicit option to measure NCI at the date of

• Argued that old method of calculating goodwill only recognises

Advanced Financial Accounting,

Advanced Financial Accounting, prepared by Sisay Mulate (PhD)

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting, prepared by Sisay Mulate

Advanced Financial Accounting,

Computer equipment $900,000 36% 198,000

Capitalized software 1,600,000 64% 352,000

Total 2,500,000 100% 550,000

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Current assets ---------------------- ------------------300,000

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Advanced Financial Accounting,

Computers &equipment (900,000-400,000)--- 500,000

Advanced Financial Accounting,

 Step 7: consolidated expenses are subtracted from

Advanced Financial Accounting,

 Debts credits ed total

Advanced Financial Accounting,

Current assetss 1,060,000* 300,000 1,360,000

Inv’t in Smallpo 2,640,000 -0-

Compuer & Equ 1,300,000 400,000 (A)500,000 2,200,000

Capitalized soft 500,000 100,000 (A)1,500,000 2,100,000

Goodwill -0- -0- (A)50,000 90,000

Total assets 5,500,000 800,000 5,750,000

Notes payable (300,000) (200,000) (A)50,000 (550,000)

Common stock (1,730,000)* (100,000) (S)100,000 (1,730,000)

Addi PIC (2,510,000)* (20,000) (S)20,000 (2,510,000)

RE,12/31(Abov (960,000) (480,000) (S)480,000 (960,000)

Total lia&Equit (5,500,000)

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