Chapter 1 BUSINESS COMBINATIONS Answers to Questions 1 According to IFRS 3, business combination is a process where a business entity acquires one or more other business entities. A business is defined as “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants”. This shows that a business entity should have three characteristics: (1) an input, which is a set of activities and assets, (2) a process, which is managing and conducting the input, and (3) an output, which is the return from conducting the process. For example, a business purchased a factory; normally this should be an acquisition of assets, however, if by purchasing the factory, the entity also hiring its management and workers of that certain factory this should be a business combination. The factory itself acted as an input, while the management and workers are a part of the process, and the products produced or any other economic benefits such as cost reduction is the output. This transaction is now a business combination. 2 The dissolution of all but one of the separate legal entities is not necessary for a business combination. An example of one form of business combination in which the separate legal entities are not dissolved is when one corporation becomes a subsidiary of another. In the case of a parent-subsidiary relationship, each combining company continues to exist as a separate legal entity even though both companies are under the control of a single management team. 3 A business combination occurs when two or more previously separate and independent companies are brought under the control of a single management team. Merger and consolidation in a generic sense are frequently used as synonyms for the term business combination. In a technical sense, however, a merger is a type of business combination in which all but one of the combining entities are dissolved and a consolidation is a type of business combination in which a new corporation is formed to take over the assets of two or more previously separate companies and all of the combining companies are dissolved. 4 In August 1999, FASB issued a report to eliminate the pooling of interest method because of the following reasons: (1) pooling provides less relevant information to statement users, (2) pooling ignores economic value exchanged in the transaction and makes subsequent performance evaluation impossible and (3) comparing firms using the alternative methods is difficult for investors. The above problems occurred because the pooling interest method uses historical book value rather than the fair value to recognize the net assets at the transaction date. 5 In a business combination, goodwill is the excess of investment cost over the fair value of the investee’s identifiable net assets. Under the GAAP and IFRS, goodwill arising from a business combination should be recorded as an asset. Goodwill should not be amortized because it has indefinite useful life, rather, it should be tested for any impairment at least annually.