3 Business+Combinations+-+FINAL

BUSINESS
COMBINATIONS
Seda Oz, PhD
seda.oz@uwaterloo.ca
AFM 491, SAF, University of Waterloo
November 5, 2018 Copyright @ 2017 Seda Oz, PhD. All Rights Reserved 1
ROAD MAP
 Business Combinations
 Reasons
 Defensive Tactics
 IFRS 10
 Forms of Business Combinations
 Acquisition Method
 Consolidation
 Acquisition Differential
 Direct Approach
 Working paper approach
 Other Issues
Copyright @ 2017 Seda Oz, PhD. All Rights Reserved 2

BUSINESS
COMBINATIONS
 Business: integrated set of activities (inputs & processes)
and assets with the purpose of providing a return (dividends,
lower costs, or other benefits (outputs)).
 Business Combinations: A transaction or other event in
which one corporate entity (the acquirer) obtains control of
one or more operating businesses (IFRS 3)
 E.g. Mergers and Acquisitions
 If not a Business – it is a basket purchase of asset

BUSINESS
COMBINATIONS
 Reasons:
 Cost advantage
 Lower risk
 Fewer operating delays
 Avoidance of takeovers
 Acquisition of intangible assets
 Defend a competitive position
 Diversify into a new market and/or geographic region
 Access to new customers, products or services, expertise or
capabilities (e.g. Technology)

BUSINESS COMBINATIONS
 A business combination may be:

 Friendly - the boards of directors of the potential combining
companies negotiate mutually agreeable terms of a proposed
combination.
 Unfriendly (hostile) - the board of directors of a company
targeted for acquisition resists the combination.

 Defensive Tactics (for hostile takeovers):
 Poison pill: Issuing stock rights to existing shareholders to
purchase addt shares below the market value; exercisable only
in the event of a potential takeover.
 Greenmail: Purchasing its own shares held by the would-be
acquiring company at a price substantially in excess of fair
value.
 White knight: Encouraging a third firm, more acceptable to
the target company management, to acquire or merge with
the target company.
 Selling the crown jewels: Selling valuable assets to make the
firm less attractive to the would-be acquirer
 Pac-man defense: Attempting an unfriendly takeover of the
would-be acquiring company

 In 2006, Disney agreed to buy Pixar for approximately $7.4 billion in an
all-stock deal
 Normally, a merger indicates one entity absorbing another one.
 Additional conditions were laid out as part of the deal to ensure that Pixar
remained a separate entity.
 Pixar HR policies would remain intact.
 The Pixar name was guaranteed to continue, and the studio would remain
in its current Emeryville, California, location with the "Pixar" sign.
 Branding of films made post-merger would be "Disney•Pixar" (beginning
with Cars).

 Yahoo acquired Broadcast.com, an online television site
founded by Mark Cuban, for $5.7 billion in 1999.
 Slow dial-up connections made watching video impossible.
 The service soon disappeared, as did the executives who
engineered the deal.

WHEN A BUSINESS COMBINATION
OCCURS…
 A transaction or other event in which one corporate entity
(the acquirer) obtains control of one or more operating
businesses (IFRS 3)
 When a business combination occurs, consolidated

financial statements are required to report the combined
financial position and results of operations of the Parent and
the Subsidiary
 The Parent is the controlling company (Investor) and the

Subsidiary is the controlled company (Investee).

CONTROL (IFRS 10)
 An investor controls an investee when the investor is
exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect
those returns through its power over the investee
 If has control => structured entity / subsidiary
 There can only be 1 company with control
 If 2 or more parties = joint control or influence

YES
Subsidiary /
Full control? Structured Entity?
Consolidation
NO
YES
Joint control? YES Report share
Joint Joint of A, L, RE,
arrangement? operation EXP
NO
NO
Joint Venture
YES Equity
Significant Method
Influence? Associate
NO Non-strategic FVTPL or
Investment FVTOCI

IFRS 10
 Thus, an investor controls an investee if and only if the
investor has ALL the following:
a) Power criterion: power over the investee (i.e. the investor
has existing rights that give it the ability to direct the
relevant activities (the activities that significantly affect the
investee's returns)
 Power arises from rights (e.g. through voting rights,
embedded in contractual arrangements). Protective rights
do not indicate power
b) Return criterion: exposure, or rights, to variable returns
from its involvement with the investee and
c) The linkage: the ability to use its power over the investee
to affect the amount of the investor's returns

Professional
CONTROL Judgement
 Owning more than 50% of the voting shares usually, but not
always, indicate control.
 Control can be present with less than 50% of voting shares if
other factors indicate control:
 Ability to elect majority of Board
 Special voting arrangements - Irrevocable agreement conveying
voting rights to 1 party
 Special operating agreements
 Convertible securities (warrants/options/bonds etc.) -Potential
voting rights
 One company may own the largest single block of shares of another
company,
 X Company owns 40% of Y Company while the other 60% is widely
held and rarely voted with the result that X has no trouble electing
the majority of Y’s directors
 X Company could be deemed to have control in this situation as long
as the other shareholders do not actively cooperate against X when
they vote their shares

CONTROL
 Some parties might have limited specific rights that don’t
affect overall strategic control
 The existence of certain protective rights held by other
parties does not necessarily provide those parties with
control.
 Examples:
 Approval of veto rights that do not affect strategic operating
and financing policies.
 The right to approve capital expenditures greater than a
particular threshold, or the right to approve the issue of equity
or debt.
 The ability to remove the controlling party in the event of
bankruptcy or breach of contract.

CONTROL
 Might lose control if company in receivership or
bankruptcy situation
 Control and consolidation cease if, for example, the majority
of a subsidiary’s assets are seized in a bankruptcy or if a
foreign subsidiary is restricted by law from paying dividends
to the parent.

FORMS OF BUSINESS
COMBINATIONS
 One company can obtain control over the net assets of another
company by
 Purchasing its net assets (selling co wound up)
 Purchasing its shares (selling co continues to exist)
 Contractual arrangement
 agreement to control without acquiring shares (special purpose
entities)
 Could form a new Co, issue shares to both sets of old shareholders,
or buy assets of both (amalgamation)
 All forms of business combinations result in the assets and
liabilities of the acquiree being combined with those of the
acquirer.
 Payment can be done by:
 issuing existing shares or cash or both
 Accounting is interested in ECONOMIC form
 representational faithfulness (substance over form)

BUSINESS
COMBINATIONS
 For ACCOUNTING purposes obtain control of another
enterprise (not a legal definition).
1. Buy the shares of a company 2 legal entities
2. Contractual arrangements
3. Buy the assets of a company 1 legal entity

4. Create a new co and transfer
both companies’ assets to the new co (amalgamation)
 The effect is the same: 1 set of shareholders in charge of 2

groups of assets =>Accounting should be the same

BUYING THE ASSETS
Company P
1 economic
entity Company S’s
S Co
assets
1 legal entity $
If buy 100%, S Co left with cash (or shares of P) and maybe

the liabilities (but P usually assumes the liabilities on purchase).
- Usually distribute cash (or shares) to S’s shareholders &
wind-up S Company.
BUYING THE ASSETS
 If control is achieved with the purchase of net assets, the
combining takes place in the accounting records of the
acquirer (parent).
 The combining takes place in the separate entity accounting
records of the acquirer.
 If you get control through net assets, you’re making a journal
entry
 Purchasing a group of idle assets is not a business
combination. Control is key here!
 net assets that constitute a business

CONTROL VIA
PURCHASE OF SHARES
 Buying the net assets of another company is one way to
accomplish a business combination.
 A much more common method of acquiring control over
the assets of another company is to buy the voting shares of
the other business.
 An acquirer can obtain control by:
 buying sufficient shares on the open market,
 entering into private sale agreements with major shareholders,
 issuing a public tender offer to buy the shares.

CONTROL VIA
PURCHASE OF SHARES
 Transaction is with existing shareholders of target company.
 Transaction has no impact on Target’s books
 The buyer does not need the co-operation of the acquired
company itself
 Remember:
 If the target company’s board of directors opposes a takeover
attempt this is a hostile takeover

BUYING THE SHARES
1 economic Company P
entity Invst in S (Parent)
P owns S’s shares
2 legal Company S
entities (Subsidiary)

BUYING THE SHARES
 If control is achieved by purchasing shares, the combining
takes place when the consolidated financial statements are
prepared.
 Sub isn’t necessarily on parent’s books but they come on
the books when consolidation is done
 not recording liabilities on books but have parent and sub’s
set of FS then consolidating them at the end

REASONS FOR RETAINING 2
LEGAL ENTITIES
 Reduce financial risk
 owners/creditors risk limited to 1 company
 Laws & tax legislation
 regulated industry, or more economical to operate separately
 Contingent liabilities remain with Target.
 Seller’s gain is taxed as capital gain
 Expand or diversify with smaller investment
 only need 51% (or so)
 Shares may be selling at price below fair value of net
assets.
 Control can be obtained at less cost.
 Shares may be more saleable than net assets.

INVESTMENTS &
1 legal &
1Economic Entity
(buy assets)
FVTPL or
FVTOCI
Significant
2 legal &
influence 2 legal Entities &
2 economic
entities 1 Economic Entity
Consolidated F/S
(buy shares)
Non Strategic
Strategic
Investments Investments

BUYING ASSETS VS SHARES
Buy the Assets Buy the Shares

Deal with?
The Company The Shareholders
Result
The assets/liabilities are Has an Investment in S
on the acquirer’s books on the acquirer’s books
Financial Reporting
NO consolidated F/S Must do consolidated F/S
S’s A & L on P’s books
No separate legal entity Separate legal entity

BUYING ASSETS VS SHARES
Assets Shares
Control
Need to buy 100% Need to buy 51%
Tax for Sub (Target) Co
Recapture, capital gains, Capital gains for
other consequences S’s shareholders
Tax for Parent (Acquirer)
• New assets at FMV • Assets still at historical
• Goodwill on P’s books as cost on S’s books
eligible capital property • Goodwill is only on the
(tax deductible) consolidated F/S

ACCOUNTING FOR
BUSINESS
COMBINATIONS

ACCOUNTING FOR
 There are three consolidation choices / theories that have

either been recently used in practice or discussed in
theory:
 The purchase method (required pre-2011)
 The acquisition method (required GAAP)
 The new entity method (theory only, never used)

ACQUISITION
METHOD

ACQUISITION METHOD
 Under IFRS if a company has control of a subsidiary they must
use the Acquisition Method
 IFRS requires all business combinations to be treated as
acquisitions for accounting purposes
 one company must be identified as an acquirer and one company
must be identified as an acquiree even if the transaction creates a
new company.
 The acquiring company records the identifiable net assets at fair
values regardless of price paid.
 What happens if the price is paid is different than the FV?
 If price paid is > FV of identifiable net assets the excess is reported
as goodwill (similar to purchase method).
 If price paid is < FV of identifiable net assets the difference is
reported as a gain on purchase (“negative goodwill”).

MAIN PRINCIPLES
 Five-step process:
1. Identify the acquirer
2. Determine the acquisition date
3. Calculate the fair value of the purchase consideration
transferred
4. Recognize and measure the identifiable assets and
liabilities
5. Recognize and measure goodwill or gain on purchase

1. IDENTIFYING Professional
Judgement
ACQUIRER
 Acquirer is the corporation whose shareholders control the
combined economic entity.
 If cash, then corporation paying cash is the acquirer.
 If exchange of shares, must examine shareholder group that
has control (highest % ownership)
 If voting control is evenly split, additional factors to be
reviewed:
 Relative voting rights
 Presence of a group with significant voting interest
 Composition of board of directors
 Composition of management team
 Terms of share exchange and the group paying a premium is
the acquirer

2. DETERMINING
ACQUISITION DATE
 Date on which the acquirer obtains control
 The closing date
 Or, acquirer and acquiree can agree, in writing, to a different date
 Determining the correct acquisition date is important as the

following are affected by the choice of acquisition date:
 The fair values of net assets acquired
 Consideration given, where the consideration takes a non-
cash form
 Measurement of the non-controlling interest (discussed later).

3. FV OF CONSIDERATION
 Purchase consideration may include:
 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
 Fair value is basically market value and is determined by

judgement, estimation and a three-level ‘fair value hierarchy’
as described in IFRS 13.

 Measure consideration at fair value at date of acquisition.
 When cash is used the FV is straightforward
 When the acquirer issues its own shares to acquire the net
assets of another company:
 Use fair value of acquirer’s shares (market value) given up
unless fair value of acquiree’s shares received are more
reliably measurable
 When the acquiree’s shares can be more reliably measured?

 Acquisition-related costs are expensed.
 fees of consultants, accountants, and lawyers do not increase
the FV of acquired company. These should be expensed in the
period of acquisition.
 Cost of issuing debt are deducted from debt proceeds

OR
 Cost of issuing shares are deducted from equity (net of
related taxes).

 Measurement period is the period after the acquisition
during which adjustments are permitted.
 No longer than one year
 Provisional amounts may be used until final amounts can be
determined.
 Restatement required if statements issued prior to final
measurements being determined.

 Contingent consideration is additional consideration based
on future events or conditions being met at some future date.
 Considered part of purchase price
 May be based on:
 Fuller assessment of acquired company
 Outcome of negotiating debt agreements
 Achievement of earnings objectives or target share price
 Contingent consideration:
 If change relates to:
 Additional information obtained during measurement period:
• Adjust purchase consideration
 Events occurring after the acquisition date:
 Adjust to acquirer’s profit or loss

4. RECOGNIZE AND MEASURE
IDENTIFIABLE ASSETS AND
LIABILITIES
 Under acquisition method, acquirer must:

1. Recognize identifiable assets and liabilities separately from
goodwill.
2. Measure assets and liabilities at fair value at acquisition date.
 Identifiable is a key word for particularly intangible assets

and contingent liabilities
 FVINA = FV of identifiable net assets (including

contingent liabilities)

IDENTIFIABLE ASSETS
AND LIABILITIES
 IFRS 3 requires that contingent liabilities which can be
measured reliably are recognized by the acquirer.
 The above requirement does not consider issues of
probability.
 Therefore contingent liabilities where a present obligation
exists but that do not qualify for recognition in the acquiree's
books under IAS 37 may be recognized by the acquirer as
part of a business combination.
 The fair value of a contingent liability is the amount that a
third party would charge to assume those contingent
liabilities. Such an amount reflects the expectations about
possible cash flows.

IDENTIFIABLE ASSETS
AND LIABILITIES
 Identifiable Intangibles are either:
 Separable (sold, rented, licensed) or
 Arise from contractual or other legal rights regardless or
whether those rights are transferable (i.e. a lease at reduced
rates)
 For Business Combinations it can include “in-process R&D”
 Subsequent “research” costs would still be expensed unless
satisfy criteria for capitalization (e.g. feasibility)
 Ref: IAS 38 and IFRS 3 Appendix B

IDENTIFICATION OF
INTANGIBLES
 Classification of types of intangible assets that could be
identified:
 Artistic-related
 Contract-based
 Customer-related
 Market-related
 Technology-based
 Examples:
 Patents, Contracts, Brand names, customer relationships,
customer supply contracts, proprietary technology to be
further developed, licenses

FV MEASUREMENT
 Exceptions to fair valuation:
 Deferred income taxes (will be discussed later) – IAS 12
 Employee benefits – IAS 19
 Indemnification assets - IFRS 3.27-28
 Reacquired assets – IFRS 3.29
 Share-based payment awards – IFRS 2
 Assets held for sale – IFRS 5
 Measured using applicable IFRS standards

5. RECOGNIZE AND MEASURE
GOODWILL OR GAIN ON
PURCHASE
 Purchase consideration is usually different than FMV of what
bought (you pay more or less)
 The difference between the fair value of the identifiable net
assets and purchase consideration is:
 Goodwill when purchase consideration > FV of net asset values
 Gain on bargain purchase (negative goodwill) when purchase
consideration is < FV of net asset values
 Reduce existing goodwill to zero and recognize any remaining
excess as a gain in net earnings (will be discussed later)
 On the books of the acquirer as an asset they paid for
 Goodwill previously existing on the acquiree’s B/S does not
carry through as a separate asset
 Intangible that cannot be identified Appendix

SUMMARY: ACCOUNTING FOR
Method Measurement
Purchase • Record purchase at price paid

• Allocate price paid to net assets purchased
• Any excess is goodwill
• Previously used in Canada (pre-2011)
Acquisition • Measure acquiring company (parent) net assets at carrying amount

• Measure acquired company (subsidiary) assets and liabilities assumed at fair
value
• Acquisition differential = FV consideration – CV net assets acquired
• Goodwill based on difference between purchase consideration and fair value of net
assets acquired
• Current GAAP under IFRS (Part I) and ASPE (Part II)
Pooling of • Combine entities using carrying amounts of both
interests • (i.e., add carrying amounts of A and L together)
• Used in ASPE for related party combinations
New entity • Combine entities using fair value of both

• (i.e., add fair values of A and L together)
• Not GAAP

EXAMPLES
 Example 1:
 Purchase of net assets through cash and/or debt
 Example 2:
 Purchase of net assets through issuance of shares
 Objectives:
 Determine the amount of goodwill, if any
 Recording journal entries
 On the books of the acquirer and the acquiree

EXAMPLE 1
 On December 31, 2015,

WonderWoman Co. purchased all of
the net assets of AquaMan Ltd. for
$1,500,000 in cash;
 80% of the cash was obtained by
issuing a five-year note payable.
 The statements of financial position
of WonderWoman and AquaMan
immediately before the acquisition and
issuance of the notes payable were (in
000s):
 See next slide

EXAMPLE 1
WonderWoman AquaMan
Book Fair Book Fair
Value Value Value Value
Cash $360 $360 $200 $200
A/R 520 500 380 380
Inventory 800 880 400 450
PPE 1,820 2,000 1,420 1,520
$3,500 $2,400
Current liabilities $ 380 $380 $260 $260

LT liabilities 1,200 1,200 1000 1030
Common shares 500 600
Retained earnings 1,420 540
$3,500 $2,400

EXAMPLE 1
 Prepare the journal entry that WonderWoman and AquaMan
will post to record the acquisition, respectively.
 Prepare the statement of financial position for

WonderWoman immediately following the acquisition of
AquaMan.
 Prepare the statement of financial position for AquaMan

immediately following the acquisition.

EXAMPLE 1 - SOLUTION
Measurement: Calculation of goodwill (in 000s)
Consideration given $1,500

Consideration received:
Fair value of net assets acquired:
Cash $200
Accounts receivable 380
Inventories 450
Property, plant, and equipment 1,520
Current liabilities (260)
Long-term liabilities (1,030) 1,260
Goodwill $ 240

 WonderWoman would record the following entry:
Dr. Cash 200
A/R 380
Inventory 450
PPE 1,520
Goodwill 240
Cr. Current Liabilities 260
LT Liabilities 1,030
Cash 1,500 x 0.2 300
N/P 1,500 x 0.8 1,200
WonderWoman (the acquirer) is using the FVs
WonderWoman Co.
The Statement of Financial Position
December 31, 2015
(in 000s)
Cash (360 - 300+ 200) $ 260

Accounts receivable (520 + 380) 900
Inventory (800 + 450) 1,250
Property, plant, and equipment (1,820 + 1,520) 3,340
Goodwill 240
$5,990
Current liabilities (380 + 260) $ 640

Long-term liabilities (1,200 + 1,200 + 1,030) 3,430
Common shares 500
Retained earnings 1,420
$5,990

 AquaMan would record the following entry:
Dr. Cash 1,500
Current Liabilities 260
LT Liabilities 1,000
Cr. Cash 200
A/R 380
Inventory 400
PPE 1,420
Gain on sale of net assets 360
AquaMan (the acquiree) is using the BVs

AquaMan Co.
The Statement of Financial Position
December 31, 2015
(in 000s)
Cash (200+1,500 - 200) $ 1,500

$1,500
Common shares 600

Retained earnings (540+360) 900
$1,500

EXAMPLE 2
On December 31, 2016, the statements of financial position of the Power Company and
the Pro Company are as follows: (in 000s)
Power Pro (FV)

Cash $ 500 $ 800
Accounts receivable 1,500 1,700
Inventories 2,000 1,500
Property, plant, and equipment (net) 2,500 4,000 $4,300
Total assets $6,500 $8,000
Current liabilities $ 700 $ 400

Long-term liabilities 800 500 $ 550
Common shares 2,500 1,000
Contributed surplus 800 1,500
Retained earnings 1,700 4,600
Total equities $6,500 $8,000

EXAMPLE 2
 Power Company has 100,000 shares of common stock
outstanding. Pro Company has 45,000 shares outstanding.
 On January 1, 2017, Power issued 90,000 shares of
common stock in exchange for all the net assets of Pro.
 All assets and liabilities have book value equal to fair
values, except as noted.
 In addition, Pro has a patent that has an appraised fair value
of $450.
 Market value of the new shares issued was $95 per share at
the date of acquisition.

EXAMPLE 2
 Identify the acquirer
 Who are the shareholders, and what are their percentage
holdings on January 1, 2017?
 What is the amount of goodwill to be recorded for this
business combination?
 Prepare the journal entry that Power would record on
January 1, 2017, related to this acquisition.
 Prepare the statement of financial position for Power as at
January 1, 2017.
 Prepare the journal entry that Pro would record on January
1, 2017, related to this acquisition.
 Prepare the statement of financial position for Pro as at
January 1, 2017.

 Identify the acquirer:
 The shareholders of Power Company at January 1, 20X7:

The original shareholders of Power hold 100,000 common
shares, representing 52.6% (100,000/190,000), and Pro
Company owns 90,000 shares, representing 47.3%.
 Power is identified as the acquirer

Calculation of goodwill (in 000s):
Fair value of consideration (90,000 shares @ $95) $8,550

Consideration received:
Fair value of net assets acquired:
Cash $800
Accounts receivable 1,700
Inventories 1,500
Property, plant, and equipment 4,300
Patent 450
Current liabilities (400)
Long-term liabilities (550) 7,800
Goodwill $ 750

Journal entry recorded by Power to record the acquisition:
Dr. Cash $800
A/R 1,700
Inventories 1,500
PPE 4,300
Patent 450
Goodwill 750
Cr. Current liabilities 400
Long-term liabilities 550
Common shares 8,550

Power Company
Statement of Financial Position
At January 1, 2017 (in 000s)
Cash (500 + 800) $ 1,300

Accounts receivable (1,500 + 1,700) 3,200
Inventories (2,000 + 1,500) 3,500
Property, plant, and equipment (2,500 + 4,300) 6,800
Patent 450
Goodwill 750
Total assets $16,000
Current liabilities (700 + 400) $ 1,100

Long-term liabilities (800 + 550) 1,350
Common shares 2,500 + 8,550 11,050
Contributed surplus 800
$16,000

 Journal entry recorded by Pro:
Dr. Investment in shares of Power $8,550
Current liabilities 400
Long-term liabilities 500
Cr. A/R 1,700
Inventories 1,500
PPE 4,000
Cash 800
Gain on sale of net assets 1,450

Pro Company
Statement of Financial Position
At January 1, 2017 (in 000s)
Investments in Power $ 8,550

Total assets $8,550
Common shares 1,000

Contributed surplus 1,500
Retained earnings (4,600 + 1,450) 6,050
$8,550

CONSOLIDATED
FINANCIAL
STATEMENTS

BUSINESS
COMBINATIONS
 For ACCOUNTING purposes obtain control of another
enterprise (not a legal definition).
1. Buy the shares of a company 2 legal entities
2. Contractual arrangements
3. Buy the assets of a company 1 legal entity

4. Create a new co and transfer
both companies’ assets to the new co (amalgamation)
 The effect is the same: 1 set of shareholders in charge of 2

groups of assets =>Accounting should be the same

CONSOLIDATED FINANCIAL
STATEMENTS
 IFRS 10 Key Concepts:
 Consolidated financial statements are the financial statements
of a group in which the assets, liabilities, equity, income,
expenses, and cash flows of the parent and its subsidiaries are
presented as those of a single economic entity.
 Consolidated statements consist of a balance sheet, a statement of
comprehensive income, a statement of changes in equity, a cash
flow statement, and the accompanying notes.
 A Group is a parent and its subsidiaries.
 A Parent is an entity that controls one or more entities
 A Subsidiary is an entity that is controlled by another entity
 Non-controlling interest is equity in a subsidiary not
attributable, directly or indirectly, to a parent

STATEMENTS
 Parent and subsidiary companies may continue as separate
legal entities after a business combination but the substance
of the relationship as a single economic entity (a family of
companies) should be reported as such
 it has a group of economic resources that are under the
common control of the parent.
 Parent and subsidiaries will still be required to prepare their
own separate-entity financial statements for income tax
filing or internal purposes.

STATEMENTS
 An enterprise should consolidate all of its subsidiaries
(IFRS 10) to inform primarily shareholders and creditors of
the parent company about the resources and results of
operations of the parent and its subsidiaries as a group
 eliminate all intercompany transactions
 present only transactions with outside entities
 Consolidated financial statements are supplemented with

footnote disclosures showing operating segments.

STATEMENTS
 Performance of P is affected by performance & health of
subs.
 Limitations:
 might combine companies in different industries & from
different countries – less useful (leads to segmented
reporting)
 on consolidation weak performance of a sub may be hidden
 doesn’t meet the needs of non-controlling shareholders or
creditors

STATEMENTS
 IAS 27 does not require consolidated financial statements
for external reporting under the following conditions:
 Parent is itself a wholly owned subsidiary, or is a partially
owned subsidiary and its owners do not object to the parent
not presenting consolidated financial statements;
 Parents’ debt or equity instruments are not publicly traded;
 Parent has not, or is not, filing financial statements with a
regulator for the purpose of issuing debt or equity instruments
on a publicly traded market; and
 The ultimate or intermediate parent of the parent produces
IFRS-complaint consolidated financial statements for public
use.
 Would use:
 Cost or IFRS 9

SEPARATE ENTITY
REPORTING
 The parent must prepare separate entity financial statements
(e.g. tax reasons, to be used by lenders)
 Investments in unconsolidated subs reported at:
 Cost or as a financial instrument (i.e., FVTPL) for reports
prepared for general public use
 Equity method may be required by specific user
 Note: This is when we use the cost method discussed in
Chapter 2!

 Back to consolidation

BASIC PRINCIPLES
 Consolidated statements are from “parent’s” point of view.

 Elements of parent and all controlled entities are added
together:
 Assets and liabilities
 SFP
 Revenue and expenses
 SCI

BASIC PRINCIPLES
 Two types of changes that must be made before finalizing
the consolidated statements:
 Eliminations
 Changes that prevent certain amounts from appearing, avoid
double counting, and cancel off-setting balances
 Adjustments
 Alter reported amounts to reflect the economic substance of
transactions

ACQUISITION
DIFFERENTIAL
 Acquisition differential is the difference between the investor’s
cost and the investor’s % of the carrying amount of net assets of
the sub
 An investor pays more for 2 reasons:
 FV of nets assets > carrying value
 Goodwill (e.g. synergy, future expectations, cannot directly
observed)
 Acquisition differential =
Total consideration given –
carrying amount of the acquiree’s assets/liabilities

ACQUISITION
DIFFERENTIAL
 Acquisition differential must be allocated between Fair value
excess and goodwill
 How much of this difference is due to:
 fair value that is different than book value (observable / identifiable
net assets)
 Goodwill (unobservable / unidentified net assets)
 Note:
 In previous examples, when we were calculating the amount of
goodwill we always used the FVs
 When calculating the acquisition differential you start with the
Carrying values
 Don’t get confused!

EXAMPLE 3
 Wynonna Earp Inc. purchased all of the outstanding
common shares of Doc Holliday Inc. for $800,000. On the
date of acquisition, Doc Holliday’s assets included
$2,000,000 of Inventory, and Land with a book value of
$120,000.
 Doc Holliday also had $1,400,000 in liabilities on that date.
 Doc Holliday’s book values were equal to their fair market
values, with the exception of the company's Land, which was
estimated to have a fair market value which was $50,000
higher than its book value.
 How much goodwill would be created by Wynonna Earp’s

acquisition of Doc Holliday?

EXAMPLE - SOLUTION
Acquisition cost (consideration paid) $800,000
Less: Carrying value of net identifiable assets

of subsidiary
Inventory $2,000,000
Land $120,000
Liabilities ($1,400,000) $720,000
Acquisition differential $80,000
Allocation:
Land (FV excess) $50,000
Goodwill $30,000
$80,000

CONSOLIDATION
APPROACHES
 Two approaches for preparing consolidated statements:
 Direct approach
 Sets up the SCI and SFP formats and calculates each account
directly
 Each asset, liability, revenue or expense separately calculated and
then entered into SCI and SFP
 Works from the separate entity financial statements
 Intuitively appealing
 Used for simple consolidations
 Working paper approach (worksheet approach)

CONSOLIDATION
APPROACHES
 Two approaches for preparing consolidated statements:
 Direct approach
 Working paper approach (worksheet approach)
 Uses columns for trial balances of parent and subs
 Eliminations and adjustments posted to worksheet
 Accounts cross-added to arrive at consolidated trial balance, and
statements prepared
 More methodical and keeps better track of eliminations and
adjustments
 Used for complex consolidations
 Provides audit trail

WORKING PAPER
TAKE-AWAYS
 Eliminate “Investment in acquiree” balance recorded by the
acquirer and Acquiree’s common shares and retained
earnings accounts because they are reciprocal.
 The acquisition differential does not appear on the
consolidated balance sheet but is reallocated to the net assets
of the acquiree
 The elimination entries are made on the working paper only
and not in the books or either company.
 On the date of acquisition, consolidated shareholders’
equity is always equal to the parent’s equity.

DIRECT APPROACH
 The basic approach in the direct approach on the acquisition
date is as follows:
Carrying Carrying Acquisition Consolidated

amount + amount +/- differential = amounts
(parent) (Subsidiary)
 On the date of acquisition consolidated shareholders’ equity

= parent’s shareholders equity.
 Note that the investment account, acquisition differential,
and shareholders’ equity accounts of the subsidiary are
eliminated by simply ignoring or omitting them

P3-3

DIRECT METHOD –
CONSOLIDATION STEPS
 Calculate acquisition differential
 FV excess
 Goodwill
 Allocate FV excess to the A & L when consolidating
 Create goodwill account & allocate the amount
 Purchase of shares of the S done via:
 Shares  adjust P’s common shares account accordingly
 Cash  adjust P’s cash account accordingly
 P’s retained earnings account should NOT change
 S’s SE accounts are not (directly) used

P3-3 - SOLUTION
 Acquisition of shares recorded by G:
Dr. Investment in K (7,400 x $8) 59,200
Cr. Common Shares 59,200
 Acquisition method (Calculation of Goodwill):

Acquisition cost (7,400 shares @ $8.00) $59,200
Fair value of net assets of K Company 44,200
Goodwill $15,000

P3-3 - SOLUTION
G Company
Consolidated Balance Sheet
Current assets (47,000 + 16,200) $63,200
Plant assets (74,000 + 39,000) 113,000
Goodwill 15,000
$191,200
Current liabilities (21,400 + 6,400) $27,800

Long-term debt (22,000 + 4,600) 26,600
Common shares (44,000 + 59,200) 103,200
$191,200

WORKING PAPER METHOD
– CONSOLIDATION STEPS
 FV excess
 Goodwill
 Recognize Investment in S
 Eliminate Investment account; S’s retained earnings &
common shares by establishing acquisition differential
 Investment in S =
Net assets of S (essentially S’s SE) + Acquisition differential
 Allocate acquisition differential to assets & goodwill
 This will eliminate acquisition differential

 FV excess
 Goodwill
 Acquisition method (Calculation of Goodwill):

Acquisition cost (7,400 shares @ $8.00) $59,200
Fair value of net assets of K Company 44,200
Goodwill $15,000

CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER
G COMPANY
CONSOLIDATED BALANCE SHEET
December 31, Year 1
Eliminations
G COMPANY K COMPANY Ref # Dr. Cr. Consolidated
$
Current assets
$ 47,000 24,000
Plant assets (net) 74,000 34,000
Goodwill - -
Investment in K Company - -
Acquisition differential
$
$ 121,000 58,000
$
Current liabilities $ 21,400 6,400
Long-term debt 22,000 3,900
Common shares 44,000 24,000
Retained earnings
33,600 23,700
$
$ 121,000 58,000

 FV excess
 Goodwill

P3-3 - SOLUTION
1 Dr Investment in K Company $59,200
Cr. Common shares $59,200
To record investment in K Company

G COMPANY
December 31, Year 1
Eliminations
G COMPANY K COMPANY Ref # Dr. Ref# Cr. Consolidated
Current assets
$ 47,000 $ 24,000
Goodwill - -
Investment in K Company - - 1 59,200
Acquisition differential
$ 121,000 $ 58,000
Current liabilities $ 21,400 $ 6,400

Common shares 44,000 24,000 1 59,200
Retained earnings
33,600 23,700
$ 121,000 $ 58,000
Total

 FV excess
 Goodwill

P3-3 - SOLUTION
1 Dr Investment in K Company $59,200
Cr. Common shares $59,200
To record investment in K Company
2 Dr. Common shares 24,000

Dr. Retained earnings 23,700
Dr. Acquisition differential 11,500
Cr. Investment in K Company 59,200
To eliminate investment account and establish acquisition
differential

G COMPANY
December 31, Year 1
Eliminations
Current assets
$ 47,000 $ 24,000
Goodwill - -
Investment in K Company - - 1 59,200 2 59,200
Acquisition differential 2 11,500
$ 121,000 $ 58,000

Common shares 44,000 24,000 2 24,000 1 59,200
Retained earnings
33,600 23,700 2 23,700
$ 121,000 $ 58,000
Total

 FV excess
 Goodwill
 Allocate acquisition differential to assets & goodwill
 This will eliminate acquisition differential

P3-3 - SOLUTION
3 Cr. Current assets 7,800
Dr. Plant assets 5,000
Dr. Goodwill 15,000
Cr. Long-term debt 700
Cr. Acquisition differential 11,500
To allocate the acquisition differential

G COMPANY
December 31, Year 1
Eliminations
Current assets
$ 47,000 $ 24,000 3 $ 7,800
Plant assets (net) 74,000 34,000 3 $ 5,000
Goodwill - - 3 15,000
Investment in K Company - - 1 59,200 2 59,200
Acquisition differential 2 11,500 3 11,500
$ 121,000 $ 58,000

Long-term debt 22,000 3,900 3 700
Common shares 44,000 24,000 2 24,000 1 59,200
Retained earnings
33,600 23,700 2 23,700
$ 121,000 $ 58,000
Total $ 138,400 $ 138,400

G COMPANY
December 31, Year 1
Eliminations
Current assets
$ 47,000 $ 24,000 3 $ 7,800 $ 63,200
Plant assets (net) 74,000 34,000 3 $ 5,000 113,000
Goodwill - - 3 15,000 15,000
Investment in K Company - - 1 59,200 2 59,200 0
Acquisition differential 2 11,500 3 11,500
$ 121,000 $ 58,000 $ 191,200
Current liabilities $ 21,400 $ 6,400 $ 27,800

Long-term debt 22,000 3,900 3 700 26,600
Common shares 44,000 24,000 2 24,000 1 59,200 103,200
Retained earnings
33,600 23,700 2 23,700 33,600
$ 121,000 $ 58,000 $ 191,200

Total $ 138,400 $ 138,400

GOOD TO KNOW
 Consolidation can be done using either approach
 Remember there are no acctg books for Cons F/S
 I will (generally) start with Journal Entries and use a
working paper approach to enter the Journal Entries (helps
ensure that the finished F/S balance) but then switch to
Direct Adjustments.
 On exams, the final result is what counts…
 Do whichever works best for you

OTHER ISSUES

PUSH-DOWN
ACCOUNTING
 Not permitted under IFRS but may be in the future.
Permitted by GAAP for private enterprises (ASPE), with
disclosures required in the first year of application.
 Under CPA Canada Handbook, Section 1625 in Part II
(ASPE) of the Handbook push-down accounting is permitted
when the parent owns 90% or more of a subsidiary.
 In these cases the parent could revalue the subsidiary’s assets
and liabilities based on the parent’s acquisition cost.
 Could make S revalue their assets on S’s books to FMV
 Usually only done if own 100%
 Makes consolidation easier
 If < 100% is owned by a parent, a non-controlling interest
(Chapter 4) is present, complicating the consolidation
process.

SUBSIDIARY FORMED BY
PARENT
 When a parent company sets up a subsidiary company, the
preparation of the consolidated balance sheet on the date of
formation of the subsidiary requires only the elimination of
the parent’s investment against the subsidiary’s share capital
since the subsidiary would have no retained earnings on
formation.
 Carrying amounts = FV of the subsidiary’s net assets (no

goodwill).

INCOME STATEMENT IN YEAR
OF ACQUISITION
 Under the acquisition method, only the net income from

assets earned by the subsidiary after the date of acquisition is
included in consolidated net income.
 Do not retroactively adjust net income to what it would

have been had the assets always belonged to the purchaser.

REVERSE TAKEOVERS
 Occur when one company obtains ownership of the shares
of another by issuing enough voting shares as consideration
that control of the combined enterprise passes to the
shareholders of the acquired enterprise.
 Primary reason is to acquire a stock exchange listing

REVERSE TAKEOVERS
 An RTO is one of a few different ways of obtaining a listing
on a securities exchange, or “going public.”
 Backdoor merger
 The traditional method is an initial public offering (IPO),
which requires a prospectus to be prepared to provide
investors with detailed information about the company.
 a long and expensive process

REVERSE TAKEOVERS
 Typically, an RTO will involve a private company with
significant operations (the “target”) and a public company
with very few assets, if any.
 The transaction can be structured several ways, including a
share exchange, amalgamation or plan of arrangement.
 The end result is that the private company carries on largely
as it did prior to the RTO, but it assumes the listing of the
public company and the various securities exchange
requirements that go along with it.

REVERSE TAKEOVERS
 Example:
 A Company has 5,000 shares outstanding and issues an additional
7,000 shares to the shareholders of B Company in order to acquire
100% of the shares of B Company.
 The shareholders of B Company now own 7,000 of the 12,000
(58%) shares of A and are therefore in control of the combined
enterprise.
 Legally, A is the parent of B but for accounting purposes B is the
parent of A.
 For acquisition accounting it is necessary to calculate the
acquisition price for B’s acquisition of A.
 Determine the number of shares of B that were outstanding before
the combination.
 Determine the number of additional shares that B would have had to
issue to reduce B’s shareholders to 58% ownership of B.
 Number of additional shares × FV = Acquisition Cost.
 Disclose the nature of the reverse takeover in the notes to B’s
consolidated financial statements.

DISCLOSURE
 The acquirer must disclose information that enables users
of its financial statements to do the following:
 Evaluate the nature of, and risks associated with, its interests
in subsidiaries
 Evaluate the effects of those interests on its financial position,
financial performance, and cash flows
 Understand the significant judgement and assumptions it has
made in determining that it has control of another entity
 Understand the composition of the group
 Evaluate the nature and extent of significant restrictions on its
ability to access or use assets, and settle liabilities, of the
group.

ASPE
 Part II of the CPA Canada Handbook (Section 1590)
requires:
 All subsidiaries should either be consolidated or accounted
for using either the cost or the equity method except when a
subsidiary’s equity securities are publicly traded in which
case they should be recorded at market value with charges
recorded in net income.
 Investments in and income from non-consolidated
subsidiaries should be presented separately from other
investments.
 Private companies can apply push-down accounting but must
disclose the amount of the change in each major class of
assets, liabilities, and shareholders’ equity in the year that
push-down accounting is first applied.

REFERENCES
 IFRS 3 — Business Combinations
 IFRS 10 — Consolidated Financial Statements
 IAS 38 — Intangible Assets
 IAS 27 — Consolidated and Separate Financial Statements
 IFRS 13 — Fair Value Measurement

3 Business+Combinations+-+FINAL

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BUSINESS

AFM 491, SAF, University of Waterloo

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 If not a Business – it is a basket purchase of asset

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 A business combination may be:

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 When a business combination occurs, consolidated

 The Parent is the controlling company (Investor) and the

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3. Buy the assets of a company 1 legal entity

 The effect is the same: 1 set of shareholders in charge of 2

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If buy 100%, S Co left with cash (or shares of P) and maybe

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P owns S’s shares

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Buy the Assets Buy the Shares

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 There are three consolidation choices / theories that have

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 Determining the correct acquisition date is important as the

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 Fair value is basically market value and is determined by

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 Cost of issuing debt are deducted from debt proceeds

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 Under acquisition method, acquirer must:

 Identifiable is a key word for particularly intangible assets

 FVINA = FV of identifiable net assets (including

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Purchase • Record purchase at price paid

Acquisition • Measure acquiring company (parent) net assets at carrying amount