GENERAL STEPS UNDER THE PURCHASE METHOD OF ACCOUNTING FOR THE BUSINESS
COMBINATION
1. Identification of ACQUIRER
a. Fair Value (FV) of an entity is SIGNIFICANTLY greater than the other combining
enterprise
b. the entity who will pay cash or consideration
c. management of one entity is able to dominate selection of management of the
combined entity
2. Measure the cost of the business combination at fair value.
a. The FV of the acquirer's investment cost, and the FV of the non-controlling interest in
the acquire equal the total FV of the acquiree company at the date of acquisition.
3. Measure the fair values of the net assets acquired/assumed together with contingent liabilities
that qualify for recognition
a. - an intangible item acquired in a bus. Combination must be recognize as an asset
separately from goodwill, either separable or arises from contractual or other legal
rights, and its FV can be measured reliably
4. Allocate the cost of business combination to the net assets (including contingent liabilities)
acquired and assumed.
a. -Goodwill is recognized by the acquirer as an asset from the acquisition date and is
initially measured as the excess of the cost of the business combination over the
acquirer’s share of the net FV of the acquiree’s identifiable assets, liabilities and
contingent liabilities
5. These steps result in determining the existence of any goodwill and excess on combination
which must be accounted for.
1. Cash or other monetary assets. The fair value of the cash and cash equivalents dispersed is
usually readily determinable. But if the settlement is deferred to a time subsequent to the
exchange date the fair value of that deferred component shall be the present value at the date
of exchange.
2. Non- monetary assets. These consist of assets such s property, plant a and equipment,
investments, licenses and patents. The acquirer is effectively selling the non-monetary asset
to the acquiree. Hence it is earning revenue equal to the fair value on the sale of the assets
and realizing a gain or incurring a loss if the carrying amount differs from the fair
3. Equity instruments. If an acquirer issues its own shares as consideration it will need to
determine the fair value of those shares at the date of exchange.
4. Liabilities undertaken- - the fair value of the liabilities undertaken al best measured by the
present value of future cash flows. Note that expected future losses and cost, as a result of
the combination are not liabilities of the acquirer and therefore not included ir the calculation
of the fair value of consideration paid.
5. Contingencies - Where the business combination agreement provides for an adjustment to
the cost of the combination contingent on future events, the acquirer shall include the amount
of that adjustment in the cost of the combination at the acquisition date if the adjustment is
probable and can be measured reliably.
6. Directly attributable costs; it includes costs such as professional fees paid to accountants,
legal advisers. valuers and other consultants to effect the combination. Also included in the
cost category are finders fees and brokerage fees. These are recognized as expenses if
acquirer is a non-SME.
7. Other cost that are not directly attributable to the business combination are
a. Cost to issue and register the shares issued by the acquirer are treated as a reduction in
the total fair value of the shares issued and are i recognized in equity and
b. Indirect acquisition costs recognized expenses.
-done-
On January 1, 2019, NT Company exchanges 15, 000 shares of its ordinary stock for all the
assets and liabilities of OTG Inc. Each of NT’s shares has a P 4 par value and a P 50 fair value.
The fair value of the stock exchanged in the acquisition was considered equal to OTG’s fair
value. NT also paid P 25, 000 in stock registration and issuance costs in connection with the
merger.
Several of OTG’s accounts have fair values that differ from their book value on this date:
Book Value Fair Value
Receivables P 65, 000 P 63, 000
Trademarks 95, 000 225, 000
Record music catalog 60, 000 180, 000
In-process research and development -0- 200, 000
Notes payable 50, 000 45, 000
Pre-combination January 1, 2019, book values for the two companies are as follows:
NT OTG
Cash P 60, 000 P 29, 000
Receivables 150, 000 65, 000
Trademarks 400, 000 95, 000
Record Music Catalog 840, 000 60, 000
Equipment (net) 320, 000 105, 000
Totals P 1, 770, 000 P 354, 000
Accounts Payable P 110 000 P 34, 000
Notes Payable 370, 000 50, 000
Ordinary Shares 400, 000 50, 000
Share Premium 30, 000 30, 000
Retained Earnings 860, 000 190, 000
Totals P 1, 770, 000 P 354, 000
Assume that this combination is a statutory merger so that OTG’s accounts will be transferred
to the records of NT. OTG will be dissolved and will no longer exist as legal entity. Immediately
the business combination using acquisition method, determine:
1. The total assets amounted to:
a. P 2, 124, 000
b. P 2, 547, 000
c. P 2, 574, 000
d. P 2, 599, 000
2. The total liabilities amounted to:
a. P 84, 000
b. P 480, 000
c. P 564, 000
d. P 559, 000
3. The ordinary shares amounted to:
a. P 50, 000
b. P 400, 000
c. P 450, 000
d. P 460, 000
4. The share premium amounted to:
a. P 30, 000
Bullen Inc. acquired assets and liabilities of Vicker Inc. on January 1, 20x4. The book value and fair
value of Vickers accounts on that date (prior to creating the combination) follow, along with the
book value of Bullen's accounts:
1. Assume that Bullen issued 12,000 shares of common stock with a P5 par value and a P47 fair
value to obtain all of Vicker's outstanding stock. In this transaction how much goodwill should
be recognized?
a. P144,000
b. P104,000
c. P64,000
d. P60,000
e. P-0-
2. Assume that Bullen issued 12.000 shares of common stock with a P5 par value and a P42 fair
value for all of the outstanding shares of Vicker. What will be the Additional Paid-in Capital and
Retained Earnings after the combination?
a. P20,000 and P160,000
b. P20,000 and P260,000
c. P380,000 and P160,000
d. P464,000 and P160,000
e. P380,000 and P260,000
3. Assume that Bullen issued preferred stock with a par value of P 240, 000 and a fair value of P
500, 000 for all of the net assets of Vicker in a business combination. What will be the balance
of Inventory and Land accounts after the business combination?
a. P440, 000; P496, 000
b. P440, 000; P520, 000
c. P425, 000; P505, 000
d. P402,000; P520, 000
e. P427,000; P510, 000
4. Assume that Bullen paid a total of P 480, 000 cash for all the shares of Vicker. In addition,
Bullen paid P 35, 000 to a group of attorneys for their work in arranging the combination to be
accounted for as an acquisition. What will be the balance of goodwill?
a. P-0-
b. P20, 000
c. P35, 000
d. P55, 000
On September 18, 20x4, OL Co. acquired all the TM Inc’s P 2, 000, 000 identifiable assets and P
500, 000 liabilities. Book values of the TM’s assets and liabilities equal to their fair values except
for the overvalued plant and equipment. As a consideration, OL issued its own shares of stock with
a market value of P 1, 600, 000. The merger resulted into P 700, 000 goodwill. Assuming OL had P
5, 000, 000 total assets prior the combination, how much is the combined total assets?
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A. P 6, 400, 000
B. P 6, 600, 000
C. P 7, 100, 000
D. P 7, 000, 000
Techniques of Consolidation
The basic procedure to consolidate the statement of financial position is to eliminate the
Investment account on the parent company’s statement of financial position against the
stockholder’s equity accounts in the statement of financial position of the subsidiary company. After
this, the remaining assets and liabilities of the parent company are then combined with the specific
assets and liabilities of the subsidiary company.
Required: Prepare journal entries on the books of AB Co. Prepare the determination and allocation
of excess schedule to compute for goodwill/ gain on acquisition. Prepare working paper entries.
Assuming the following independent information:
Price Paid Interest (control) Liabilities of AB FMV of NCI/Proportionate
On January 1, 20x4. Park Corporation and Strand Corporation and their condensed balance sheet
are as follows:
Park Corp Strand Corp
Current Assets P 70,000 P 20,000
Non-current Assets 90,000 40,000
Total Assets P160,000 P60,000
Current Liabilities P 30,000 P 10,000
Long-term Debt 50,000
Stockholders' Equity 80,000 50,000
Total Liabilities and Equities P160,000 P60,000
On January 2, 20x4, Park Corporation borrowed P60,000 and used the proceeds to obtain a 80% of
the outstanding common shares of Strand Corporation. The P60,000 debt is payable in 10 equal
annual principal payments, plus interest, beginning December 31, 20x4. The excess fair value of the
investment over the underlying book value of the acquired net assets is allocated to inventory (60%)
and to goodwill (40%).
On a consolidated balance sheet as of January 2. 20x4, what should be the amount for each of the
following?
Consolidated FS are prepared when an entity controls one or more other entities.
Control
An investor, regardless of the nature of its involvement with an entity (the investee), determines
whether it is a parent by assessing whether it controls the investee.
Pre-requisites on control
A. Power over the investee
B. Exposure, or rights, to variable returns for its investment with the investee; and
C. The ability to use its power over the investee to affect the amount of the investor’s returns.
THE CONSOLIDATION PROCESS
The approach followed to prepare a complete set of consolidated financial statements
subsequent to acquisition is quite similar to that used to prepare a consolidated statement of financial
position as of the date of acquisition. However, in addition to the Statement of Financial Position, the
Statement of Comprehensive Income and Retained Earnings Statement of the consolidating
companies must be combined.
ACCOUNTING PROCEDURES
When preparing consolidated financial statements, an entity must use uniform accounting
policies for reporting like transactions and other events in similar circumstances. If a member of the
group uses accounting policies other than those adopted in the consolidated financial statements for
like transactions and events in similar circumstances, appropriate adjustments are made to that
group member's financial statements in preparing the consolidated financial statements to ensure
conformity with the group's accounting policies.
Consolidation of an investee shall begin from the date the investor obtains control of the
investee and cease when the investor losses control of the investee.
Consolidated financial statements are prepared using the following basic accounting
procedures:
a. Combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent
with those of its subsidiaries.
b. Eliminate the carrying amount of the parent's investment in each subsidiary and the parent's
portion of equity of each subsidiary (IFRS3 explains how to account for the difference).
c. Eliminate in full intercompany assets and liabilities, equity, income, expenses and cash flows
relating to transactions between entities of the group (profits or losses resulting from
intercompany transactions that are recognized in assets, such an inventory and fixed assets,
are eliminated in full). Intercompany losses may indicate an impairment that requires
recognition in the consolidated financial statements
Cost Method
The cost method is used when the acquirer Parent) owns directly or indirectly more than half
of the voting power of an entity (Subsidiary), thereby exercising control (IAS 27).
Under this method, the Investment in Subsidiary account is retained at its original cost of-acquisition
(consideration given) balance. Income on the investment is limited to dividends received from the
subsidiary.
Equity Method
The equity method is used when the acquirer/investor owns 20% or more (less than 50%) of
the voting power of the investee/acquire, thereby exercising significant influence over the operations
of the investees (IFRS 12).
Under this method, the investment account is initially recorded at cost and is increased or decreased
to recognize the investors share of the income or loss of the investee after the date of acquisition.
Dividends received from an investee reduce the investment account balance. Adjustments to the
investment account may also be necessary for changes arising from revaluation of assets and
liabilities of the investee.
For two years ended December 31, P Co and S Co reported the following results of operations:
Required:
1. Prepare all journal entries required on the books of P Co during 2019 and 2020 to account for
its Investment in S Co and S Co.’s operating result using the cost method.
2. Prepare working paper elimination entries for consolidated financial statements on December
31, 2019 and December 31, 2020.
3. Compute the following on December 31, 2019 and 2020:
a. NCI in net income of subsidiary - NCINIS
b. Consolidated net income attributable to parent
c. NCI in net assets of subsidiary – NCINAS
d. Consolidated Retained Earnings
2. How much does Papa report as Income from Sasa for the year ended December 31, 20x4?
A. P 32, 000
B. P 74, 400
C. P 73, 000
D. P 42, 400
E. P 41, 000
3. How much does Papa report as Income from Sasa for the year ended December 31, 20x5?
A. P 90, 400
B. P 40, 000
C. P 89, 000
D. P 50, 400
E. P 56, 000
4. How much does Papa report as Income from Sasa for the year ended December 31, 20x6?
A. P 48, 000
B. P 56, 000
C. P 98, 400
D. P 97, 000
E. P 50, 400
5. Compute the NCI in net income of Sasa at December 31, 20x4
A. P 12, 000
B. P 10, 600
C. P 18, 600
D. P 20, 000
6. Compute the NCI in net income of Sasa at December 31, 20x5
A. P 18, 400
B. P 14, 000
C. P 22, 600
D. P 24, 000
E. P 12, 600
7. Compute the NCI in net income of Sasa at December 31, 20x6
A. P 24, 600
B. P 14, 600
C. P 26, 000
D. P 20, 400
E. P 12, 600
8. Compute the NCI of Sasa at December 31, 20x4
A. P 135, 600
B. P 80, 000
C. P 117, 000
D. P 100, 000
E. P 110, 600
9. Compute the NCI of Sasa at December 31, 20x5
A. P 126, 000
B. P 106, 000
C. P 109, 200
D. P 149, 600
E. P 148, 200
On January 2, 2019, Polo Corporation purchases 80% of Son Co. ordinary shares for P324, 000.
P15, 000 of the excess is attributable to goodwill and the balance to a depreciable asset with an
economic life of ten years. Non-controlling interest is measured at its fair value on date of
acquisition. On the date of acquisition, shareholders’ equity of the two companies is as follows:
Polo Co. Son Co.
Ordinary Shares P 525, 000 P 120, 000
Retained Earnings 780, 000 210, 000
On December 31, 2019, Son Company reported net income of P52, 500 and paid dividends of
P18, 000 to Polo. Polo reported earnings from its separate operations of P142, 500 and paid
dividends of P69, 000. Goodwill had been impaired and should be reported at P3, 000 on
December 31, 2019.
1. What is the consolidated net income on December 31, 2019?
A. P178, 875
B. P189, 375
C. P177, 000
D. P180, 000
2. What is the NCI in net income of Son Co. on December 31, 2019?
A. P9, 375
B. P9, 300
C. P10, 500
D. P6, 900
3. What amount of NCI is to be presented in the consolidated statement of financial position on
December 31, 2019?
A. P82, 125
B. P83, 400
C. P77, 250
D. P72, 750
4. What is the consolidated net income attributable to parent shareholders on December 31, 2019?
A. P170, 100
B. P168, 000
C. P178, 200
D. P180, 000
Inventory reported in the consolidated statement of financial position must be reported at cost to the
consolidated entity. Therefore, if profits or losses have been recorded on the inventory acquired in
an intercompany sale, those profits or losses must be eliminated to state the inventory in the
consolidated statement of financial position at its cost to the consolidated entity.
Until the point of resale, all intercompany profits must be deferred. Consolidated CI must be
based on the realized income of the selling affiliate. If the intercompany sales of merchandise are
made by the parent company or by a wholly owned subsidiary, there is no effect on any NCI in CI or
loss, because the selling affiliate does not have NCI.
When a company sells merchandise to an affiliate, one of two situations results: (1) the
merchandise is resold to outsiders during the same period, and (2) the merchandise is resold to
outsiders during the next period resulting to unrealized profit in ending
UPSTREAMSALE OFINVENTORY
Upstream intercompany sales are those from subsidiaries to the parent company. When an
upstream sale of inventory occurs, and the inventory is resold by the parent to outsider during the
same period, all the parent entries and the eliminating entries in the consolidated working paper are
identical to those in the downstream case.
When the inventory is not resold to outsiders before the end of the period, working paper
eliminating entries are different from the downstream case only by the apportionment of the
unrealized intercompany to both the controlling and NCI. The intercompany profit in an upstream
sale is recognized by the subsidiary and shared between the controlling interest and NCI. Therefore,
the elimination of the unrealized intercompany profit must reduce the interests of both ownership
groups until the profit is realized by resale of the inventory to outsiders.
MULTIPLE CHOICE PROBLEMS
On January 2, 2018, Par company purchase 80% of the outstanding shares of Sub Company by
paying P340, 000, the Sub company’s common stock and retained earnings on this date amounted
to P150, 000 and P230, 000 respectively. Also, on this date. an equipment is undervalued by
20,000 with a remaining life of 10 years.
Silence, Inc. is a 90% - owned subsidiary of Peace Corp. Summarized income statements for the
affiliated companies for the year ended December 31, 2019:
Peace Silence
Sales P1, 500, 000 P500, 000
Cost of sales (750, 000) (200, 000)
Operating expenses (550, 000) (200, 000)
Operating income P200, 000 P100, 000
Dividend Income 10, 000 -
Net Income P210, 000 P100, 000
Inventory, 12/31, 18 P220, 000 P160, 000
During 2019, Peace sold merchandise to Silence for P300, 000; and Silence sold to Peace,
merchandise for P30, 000. The beginning inventory of Peace were all acquired from outside
vendors; while the beginning inventory of Silence contained P30, 000 of goods acquired from
Peace. Twenty percent of the current year’s intercompany sales remained in the respective
ending inventories of the affiliated companies.
1. How much is the consolidated cost of goods sold for 2019?
A. P665, 000
B. P638, 600
C. P680, 000
D. P695, 000
2. How much is the consolidated net income (CNI) for 2019?
A. P288, 600
B. P271, 760
C. P281, 400
D. P291, 400
3. How much is the non-controlling interest in net income of Silence?
A. P10, 840
B. P2, 840
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C. P7, 200
D. P9, 640
6. Compute Simon's share of income from Wilson for consolidation for 20x5
A. P108,000
B. P110,000
C. P106,000
D. P109,825
E. P109,800
7. Compute Simon's share of income from Wilson for consolidation for 20x6.
A. P118,825
B. P115,000
C. P117,000
D. P119,000
E. P118,800
On January 1. 20x4, Smeder Company. an 80% owned subsidiary of Collns, Inc. transferred
equipment with a 10year life (six of which remain with no salvage value) to Colins in exchange for
P84,000 cash. At the date of transfer, Smeder's records carried the equipment at a cost of P120,
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000 less accumulated depreciation of P48,000. Straight-line depreciation is used. Smeder reported
net income of P28,000 and P32,000 for 20x4 and 20x5, respectively. Assume the use of equity
method)
1. Compute the gain recognized by Smeder Company relating to the equipment for 20x4.
A. P36,000
B. P34,000
C. P12,000
D. P10,000
E. P-0-
2. Compute Collins share of Smeders net income for 20x4.
A. P12,400
B. P14,400
C. P11,200
D. P12,800
E. P18,000
3. Compute Colins share of Smeders net income for 20x5.
A. P27,600
B. P23,600
C. P27,200
D. P24,000
E. P34,000
4. For consolidation purposes, what net debit or credit will be made in 20x4 relating to the equipment
transfer?
A. Debit accumulated depreciation, P46,000
B. Debit accumulated depreciation. P48,000
C. Credit accumulated depreciation, P48,000
D. Credit accumulated depreciation, P46,000
E. Debit accumulated depreciation, P2,000
5. What is the net effect on consolidated net income in 20x4, before allocation to controlling and
non-controlling interests, due to the equipment transfer?
A. Increase P2,000
B. Decrease P12,000
C. Decrease P10,000
D. Decrease P14,000
E. Increase P10,000
On January 1, 2014, Subsidiary Company Purchased a delivery truck with an expected useful life
of 5 years and scrap value of P6, 400. On January 1, 2016, Subsidiary Company sold the truck to
Parent Company and recorded the following entry:
Debit Credit
Cash 40, 000
Accumulated Dep’n 14, 400
Truck 42, 400
Gain on Sale of Truck 12, 000
Parent holds 60% of Subsidiary’s voting shares. Subsidiary reported net income of P44, 000,
and Parent reported separate income of P78, 400 for 2016.
1. In preparing the consolidated financial statements for 2016, how much is the depreciation
expense?
A. Debited for P12, 000 in the elimination entries
B. Credited for P12, 000 in the elimination entries
C. Debited for P4, 000 in the elimination entry
D. Credited for P4, 000 in the elimination entry
2. The consolidated net income for 2016 will be:
A. P122, 400
B. P114, 400
C. P100, 000
D. P94, 240