ACCOUNTING

FOR
BUSINESS
COMBINATIONS
(Advanced Accounting 2)

2019 Edition

BASED ON
PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRSs)

Nation’s Foremost CPA Review Inc. (NCPAR)

4F Pelizloy Centrum, Lower Session Road, Baguio City 2600, Philippines
Mobile Number: (0917) 870 6962

Nation's Foremost CPAR

ii

ALL RIGHTS RESERVED

2019

No part of this work covered by the

copyright hereon may be reproduced or
used in any form or by any means -
electronic or mechanical, including
photocopying – without the written
permission of the author.

ISBN 978-621-8029-11-8

Any copy of this book not bearing the

signature of the author shall be considered
as proceeding from an illegal source.

_______________________________________

Published by:

BANDOLIN ENTERPRISE
(Publishing and Printing)
#21 PARAMOUNT VILL., STO. TOMAS, BAGUIO CITY
CONTACT NOS. SMART (0928) 374 7571; GLOBE (0917) 813 6037;
AUTHOR: (0917) 870 6962
 iii

Dear Reader,
This book is intended for students taking up the CHED-
required subject “Accounting for Business Combinations” (formerly
Advanced Accounting 2).
This book is based on current Philippine Financial
Reporting Standards (PFRSs). It is a labor of love and it is
dedicated to you, my reader. I have written this book with the
following goals in mind: completeness, conciseness, simplicity,
fun to learn and practical application. Complex accounting
concepts are not eliminated simply because they are too difficult
to comprehend but rather they are simplified to the highest
possible extent.
Your thoughts about this book are important to me. If later
on you have queries, comments, or suggestions on how I can
improve my work, I would be glad if you inform me. Here are my
contact details: zeusvernonmillan@gmail.com and (0917) 870 6962.
Good luck in your learning and best wishes in your
journey through life…...thank you for making me a part of it.

Sincerely,

Zeus Vernon B. Millan

iv

Acknowledgements
I would like to extend my sincere gratitude to my family and
relatives for their support all throughout the writing of this book;
to my wife Eureka, my son Devin Joshua, and my daughter
Athena for their sacrifices; to my Dad and Mom for the source of
inspiration; to my in-laws Engr. John L. Socalo, Sr. and Dominga
S. Socalo for the assistance and trust; to my sister Donna Pamela
for the extra help; to my college instructors who have taught me
most of the techniques I have incorporated in this book; to Mr.
Darrell Joe Asuncion, Dean Renante D. Balocating, Mr. Rex B.
Banggawan, Mr. Christopher U. Ismael, Mr. John Carlo G.
Bandolin, and Mr. Einroul Aljohnza A. Bandolin for the much
needed encouragement and support; to my fellow instructors at
NCPAR; colleagues in the profession; previous clients; previous
students; to the staff of the Bandolin Enterprise; and friends who
in one way or another have contributed, directly or indirectly, to
the completion of this book.



About the Author

The author is a 6th Placer in the October 2006 CPA board
examinations. He is a co-founder of, and a CPA reviewer at,
Nation’s Foremost CPA Review Inc. (NCPAR), a teacher, and an
entrepreneur.
 v

Tips on using this book

To get the most out of this book, I strongly suggest you do the
following:

1. Re-solve the illustrations independently.

After reading a chapter, re-solve the illustrations
independently by covering the suggested solutions with a
piece of paper.

2. Read and reread the chapter summaries

Be sure to read the summary after reading each chapter. This
will reinforce what you have just learned. It is also advisable to
reread the chapter summaries from time to time to ensure that
you are not forgetting the concepts you have learned as you
learn additional concepts.
Long-term memory is invaluable in passing the board
exams (as well as making professional judgments in the
exercise of the profession). However, the human memory is not
without limit. The human brain tends to forget information as
new information is learned. To avoid this, one will need to
recall information previously learned repeatedly as many
times as needed. Studies show that when one forgets
information previously learned, he will need to spend the same
effort in learning that information again!

3. Enjoy learning. Nothing is difficult if you have the passion in

doing it.
vi

TABLE OF CONTENTS
CHAPTER 1
BUSINESS COMBINATIONS (PART 1) ........................................ 1
BUSINESS COMBINATION ....................................................................... 5
ACCOUNTING FOR BUSINESS COMBINATION .............................................. 8
Identifying the acquirer ............................................................... 9
Determining the acquisition date .............................................. 11
Recognizing and measuring goodwill ........................................ 11
Consideration transferred...................................................... 12
Acquisition-related costs .................................................... 13
Non-controlling interest......................................................... 13
Previously held equity interest in the acquiree ..................... 14
Net identifiable assets acquired ............................................ 14
RESTRUCTURING PROVISIONS ............................................................... 24
SPECIFIC RECOGNITION PRINCIPLES ........................................................ 26
1. Operating leases................................................................. 26
2. Intangible assets................................................................. 28
EXCEPTION TO THE RECOGNITION PRINCIPLE – CONTINGENT LIABILITIES ...... 32
EXCEPTIONS TO BOTH THE RECOGNITION AND MEASUREMENT PRINCIPLES ... 34
Additional concepts on Consideration transferred ................... 37
EXCEPTIONS TO THE MEASUREMENT PRINCIPLE ....................................... 39
CHAPTER 1: SUMMARY ....................................................................... 41
RELEVANT PROVISIONS OF THE PFRS FOR SMES ..................................... 43
Business combination ................................................................ 43
Accounting ................................................................................. 43
Identifying the acquirer ............................................................. 44
Cost of a business combination ................................................. 44
Allocating the cost of a business combination .......................... 44
Provisional amounts .................................................................. 45
Goodwill and Negative goodwill ................................................ 46
PROBLEMS ..................................................................................... 48
 vii

CHAPTER 2
BUSINESS COMBINATIONS (PART 2) ...................................... 64
SHARE-FOR-SHARE EXCHANGES ............................................................ 64
BUSINESS COMBINATION ACHIEVED IN STAGES ........................................ 68
BUSINESS COMBINATION WITHOUT TRANSFER OF CONSIDERATION ............. 70
MEASUREMENT PERIOD ...................................................................... 73
DETERMINING WHAT IS PART OF THE BUSINESS COMBINATION TRANSACTION78
Reacquired rights ....................................................................... 80
Settlement of pre-existing relationship ..................................... 81
SUBSEQUENT MEASUREMENT AND ACCOUNTING ..................................... 87
Contingent liabilities .................................................................. 88
Contingent consideration .......................................................... 88
CHAPTER 2: SUMMARY ....................................................................... 95
PROBLEMS: .................................................................................... 97

CHAPTER 3
BUSINESS COMBINATIONS (PART 3) .................................... 110
SPECIAL ACCOUNTING TOPICS FOR BUSINESS COMBINATION .................... 110
GOODWILL ...................................................................................... 110
Due diligence ........................................................................... 111
Methods of estimating goodwill .............................................. 112
REVERSE ACQUISITIONS ..................................................................... 120
CHAPTER 3: SUMMARY ..................................................................... 124
PROBLEMS: .................................................................................. 124

CHAPTER 4
CONSOLIDATED FINANCIAL STATEMENTS (PART 1)......... 129
CONTROL ........................................................................................ 130
Power ....................................................................................... 131
Administrative rights............................................................ 132
Unilateral rights ................................................................... 132
Protective rights ................................................................... 132
Substantive rights ................................................................ 133
Voting rights ......................................................................... 134
viii

Potential voting rights .......................................................... 137

Substantive removal and other rights held by other parties138
Exposure or rights to variable returns ..................................... 139
Ability to use power to affect investor’s returns ..................... 139
ACCOUNTING REQUIREMENTS ............................................................ 139
Reporting dates........................................................................ 139
Uniform accounting policies .................................................... 140
Consolidation period................................................................ 140
Measurement .......................................................................... 141
Income and expenses........................................................... 141
Investment in subsidiary ...................................................... 141
NON-CONTROLLING INTERESTS (NCI) .................................................. 142
PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS ........................ 142
CONSOLIDATION AT DATE OF ACQUISITION ........................................... 142
CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION ........................ 149
Step 1: Analysis of subsidiary’s net assets ............................... 150
Step 2: Goodwill computation ................................................. 151
Step 3: Non-controlling interest in net assets ......................... 151
Step 4: Consolidated retained earnings................................... 151
Step 5: Consolidated profit or loss........................................... 152
SUBSIDIARY’S CUMULATIVE PREFERENCE SHARES ................................... 162
CHAPTER 4: SUMMARY ..................................................................... 163
RELEVANT PROVISIONS OF THE PFRS FOR SMES ................................... 164
Consolidation procedures ........................................................ 165
Intragroup balances and transactions ..................................... 165
Uniform reporting date............................................................ 165
Uniform accounting policies .................................................... 165
Acquisition and disposal of subsidiaries .................................. 166
PROBLEMS: .................................................................................. 167

CHAPTER 5
CONSOLIDATED FINANCIAL STATEMENTS (PART 2)......... 189
INTERCOMPANY TRANSACTIONS .......................................................... 189
Intercompany sale of inventory ............................................... 199
Intercompany sale of property, plant and equipment ............ 206
Intercompany dividends .......................................................... 214
 ix

Intercompany bond transaction .............................................. 219

CHAPTER 5: SUMMARY ..................................................................... 225
PROBLEMS: .................................................................................. 226

CHAPTER 6
CONSOLIDATED FINANCIAL STATEMENTS (PART 3)......... 243
IMPAIRMENT OF GOODWILL............................................................... 243
INTERCOMPANY ITEMS IN-TRANSIT AND RESTATEMENTS ......................... 248
CHANGES IN OWNERSHIP INTEREST NOT RESULTING TO LOSS OF CONTROL . 258
LOSS OF CONTROL ............................................................................ 265
Derecognition of other comprehensive income...................... 269
Sale of a subsidiary to an associate or joint venture ............... 272
IMPORTANCE OF CONSOLIDATION ....................................................... 275
THEORIES OF CONSOLIDATION ............................................................ 276
Historical background .............................................................. 279
Advantages and disadvantages of the entity theory ............... 280
ADDITIONAL ILLUSTRATIONS:.............................................................. 281
CONSOLIDATION OF A REVERSE ACQUISITION ........................................ 298
SPECIAL PURPOSE ENTITIES................................................................. 306
CHAPTER 6: SUMMARY ..................................................................... 307
PROBLEMS: .................................................................................. 309

CHAPTER 7
CONSOLIDATED FINANCIAL STATEMENTS (PART 4)......... 318
INVESTMENT IN SUBSIDIARY MEASURED AT OTHER THAN COST ................. 318
COMPLEX GROUP STRUCTURES ........................................................... 326
Identifying the acquisition date ............................................... 327
Consolidation of a vertical group............................................. 329
Consolidation of a D-shaped (mixed) group ............................ 340
Complex group structure with Associate................................. 344
PUSH-DOWN ACCOUNTING ................................................................ 350
CHAPTER 7: SUMMARY ..................................................................... 358
PROBLEMS: .................................................................................. 358
x

CHAPTER 8
SEPARATE FINANCIAL STATEMENTS .................................. 371
PREPARATION OF SEPARATE FINANCIAL STATEMENTS ............................. 372
COST METHOD ................................................................................. 372
FAIR VALUE METHOD ........................................................................ 372
EQUITY METHOD .............................................................................. 373
DIVIDENDS ...................................................................................... 373
RELEVANT PROVISIONS OF THE PFRS FOR SMES ................................... 375
SECTION 9 CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS ......... 375
Separate financial statements ................................................. 375
Accounting policy election ....................................................... 376
Combined financial statements ............................................... 376
PROBLEMS: .................................................................................. 377

CHAPTER 9
FINANCIAL REPORTING IN HYPERINFLATIONARY
ECONOMIES .............................................................................. 381
PRICE LEVEL CHANGES AND PURCHASING POWER................................... 381
HYPERINFLATION.............................................................................. 383
IDENTIFYING HYPERINFLATION ............................................................ 383
Indicators of hyperinflation ..................................................... 383
CORE PRINCIPLE ............................................................................... 385
RESTATEMENT OF FINANCIAL STATEMENTS ........................................... 385
HISTORICAL COST (NOMINAL COST) TO CONSTANT PESO ........................ 386
Non-monetary items carried at cost........................................ 390
Non-monetary items carried at other than cost ..................... 390
Non-monetary items carried at NRV or Fair value .................. 390
Revalued non-monetary items ................................................ 391
Impairment after restatement ................................................ 391
Investment in associate ........................................................... 392
Borrowing costs ....................................................................... 392
Index-linked assets and liabilities ............................................ 392
Assets acquired through issuance of noninterest-bearing
liabilities ................................................................................... 392
First period application of PAS 29............................................ 392
Statement of profit or loss and other comprehensive income 393
 xi

Formula for restatement ......................................................... 393

Gain or loss on net monetary position .................................... 394
Statement of cash flows .......................................................... 395
Corresponding figures.............................................................. 395
Summary of restatement procedures – Historical to Constant
peso.......................................................................................... 395
CURRENT COST ACCOUNTING ............................................................. 412
CURRENT COST TO CONSTANT PESO .................................................... 420
TAXES ............................................................................................ 436
DEFERRED TAXES .............................................................................. 436
CONSOLIDATED FINANCIAL STATEMENTS .............................................. 437
DIFFERENT ENDS OF REPORTING PERIODS ............................................. 437
ECONOMIES CEASING TO BE HYPERINFLATIONARY .................................. 438
CHAPTER 9: SUMMARY ..................................................................... 438
PROBLEMS ................................................................................... 440

CHAPTER 10
THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE
RATES ........................................................................................ 453
TWO WAYS OF CONDUCTING FOREIGN ACTIVITIES .................................. 453
FUNCTIONAL CURRENCY .................................................................... 454
FOREIGN CURRENCY TRANSACTIONS .................................................... 457
Initial Recognition .................................................................... 457
Spot exchange rate vs. Closing rate ......................................... 459
Direct vs. Indirect quotation .................................................... 459
Exchange Differences............................................................... 460
Items measured at other than historical cost.......................... 472
Several exchange rates ............................................................ 474
Exchange differences recognized in OCI .................................. 476
Translation of Financial Statements ........................................ 477
FOREIGN OPERATION ........................................................................ 487
Net investment in a foreign operation .................................... 495
Disposal or partial disposal of a foreign operation.................. 509
TRANSLATION PROCEDURES – HYPERINFLATIONARY ECONOMY ................ 511
CHAPTER 10: SUMMARY ................................................................... 516
RELEVANT PROVISIONS OF THE PFRS FOR SMES ................................... 518
SECTION 30 FOREIGN CURRENCY TRANSLATION .................................... 518
xii

Two ways of conducting foreign activities............................... 518

Functional currency ................................................................. 518
Factors in determining functional currency ............................ 518
Reporting foreign currency transactions in the functional
currency ................................................................................... 519
Initial recognition ..................................................................... 519
Reporting at the end of the subsequent reporting periods .... 520
Net investment in a foreign operation .................................... 520
Change in functional currency ................................................. 521
Use of a presentation currency other than the functional
currency ................................................................................... 522
Translation to the presentation currency ................................ 522
PROBLEMS: .................................................................................. 523

CHAPTER 11
ACCOUNTING FOR DERIVATIVES AND HEDGING
TRANSACTIONS (PART 1) ....................................................... 539
PURPOSE OF DERIVATIVES .................................................................. 540
RISKS ............................................................................................. 540
DEFINITION OF A DERIVATIVE.............................................................. 542
COMMON TYPES OF DERIVATIVES ........................................................ 544
MEASUREMENT OF DERIVATIVES ......................................................... 548
NO HEDGING DESIGNATION................................................................ 549
HEDGING ........................................................................................ 549
HEDGING INSTRUMENT ..................................................................... 549
HEDGED ITEMS ................................................................................ 551
HEDGE ACCOUNTING ........................................................................ 552
HEDGING RELATIONSHIPS .................................................................. 554
Fair value hedges ..................................................................... 555
Cash flow hedges ..................................................................... 555
Hedges of a net investment in a foreign operation ................. 556
CHAPTER 11: SUMMARY ................................................................... 558
RELEVANT PROVISIONS OF THE PFRS FOR SMES ................................... 560
SECTION 12 OTHER FINANCIAL INSTRUMENTS ISSUES ............................ 560
Difference in scopes of Sections 11 and 12 ............................. 560
Scope of Section 12.................................................................. 560
Initial recognition of financial assets and liabilities ................. 562
 xiii

Initial measurement................................................................. 562

Subsequent measurement ...................................................... 562
Hedge accounting .................................................................... 563
PROBLEMS: .................................................................................. 567

CHAPTER 12
ACCOUNTING FOR DERIVATIVES AND HEDGING
TRANSACTIONS (PART 2) ....................................................... 575
ACCOUNTING FOR FORWARD CONTRACTS ............................................. 575
Illustration 1: Fair value hedge of a recognized asset ............. 575
Illustration 2: No hedging designation (Held for speculation). 579
Illustration 3: Fair value hedge of a recognized liability .......... 581
Illustration 4: No hedging designation (Held for speculation). 584
FAIR VALUE HEDGE OF AN UNRECOGNIZED FIRM COMMITMENT ............... 585
Illustration 5: Fair value hedge of a firm sale commitment .... 585
Illustration 6: Fair value hedge of a firm purchase commitment
................................................................................................. 590
Illustration 7: FV hedge - firm purchase commitment (Present
value) ....................................................................................... 593
Example of formal hedge designation documentation – Fair
value hedge .......................................................................... 594
Illustration 8: FV hedge - firm purchase commitment (Present
value) ....................................................................................... 597
FAIR VALUE HEDGE VS. CASH FLOW HEDGE ........................................... 600
FIRM COMMITMENT VS. FORECAST TRANSACTION ................................. 601
CHOICE TO DESIGNATE AS EITHER FAIR VALUE HEDGE OR CASH FLOW HEDGE
..................................................................................................... 602
SUBSEQUENT ACCOUNTING FOR ACCUMULATED OCI IN CASH FLOW HEDGE 602
Illustration 9: Cash flow hedge – forecasted purchase
transaction ............................................................................... 603
Illustration 10: Cash flow hedge of a forecasted sale transaction
– Present value (Indirect quotation) ........................................ 608
Illustration 11: CF hedge of a recognized liability – Present value
................................................................................................. 610
PROBLEMS: .................................................................................. 614
xiv

CHAPTER 13
ACCOUNTING FOR DERIVATIVES AND HEDGING
TRANSACTIONS (PART 3) ....................................................... 627
ACCOUNTING FOR FUTURES CONTRACT ................................................ 627
Illustration 1: No hedging designation..................................... 627
Illustration 2: FV hedge of a recognized asset measured at fair
value......................................................................................... 629
Illustration 3: FV hedge of a recognized asset measured at
LOCON...................................................................................... 632
Illustration 4: Fair value hedge of a firm sale commitment .... 633
CASH FLOW HEDGE – SPECIFIC ACCOUNTING......................................... 636
Illustration 5: CF hedge – Assessment of Hedge effectiveness 637
ACCOUNTING FOR OPTIONS ............................................................... 642
Illustration 1: Fair value hedge of a recognized asset – Put
option....................................................................................... 642
Illustration 2: No hedging designation – Call option ............... 644
Illustration 3: CF hedge - forecasted transaction (Indirect
quotation) ................................................................................ 647
ACCOUNTING FOR SWAPS .................................................................. 650
Illustration 1: CF hedge - variable-rate debt (Payment at
maturity) .................................................................................. 650
Illustration 2: CF hedge - variable-rate debt (Periodic payments)
................................................................................................. 653
FAIR VALUE HEDGE – HEDGED ITEM IS MEASURED AT AMORTIZED COST ..... 657
Illustration 3: Fair value hedge of a fixed-rate debt ................ 658
PROBLEMS: .................................................................................. 664

CHAPTER 14
ACCOUNTING FOR DERIVATIVES AND HEDGING
TRANSACTIONS (PART 4) ....................................................... 675
ACCOUNTING FOR NET INVESTMENT HEDGES ........................................ 675
Illustration: Hedge of a net investment in foreign operation.. 675
Case#1: No hedging instrument .......................................... 676
Case #2: With hedging instrument ...................................... 679
EMBEDDED DERIVATIVES ................................................................... 681
Hybrid contracts with financial asset hosts ............................. 682
 xv

Separation of embedded derivative from host contract ......... 682

Inability to measure fair value of embedded derivative...... 683
ADDITIONAL ILLUSTRATIONS:.............................................................. 683
CHAPTER 14: SUMMARY ................................................................... 694
PROBLEMS: .................................................................................. 696
REFERENCES............................................................................ 698
xvi

This page was intentionally left blank.