beams11_ppt01_final.pptx

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to accompanyAdvanced Accounting, 11th edition

by Beams, Anthony, Bettinghaus, and Smith

Chapter 1:

BusinessCombinations

Copyright ©2012 Pearson Education,Inc. Publishing as Prentice Hall

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Business Combinations: Objectives

1. Understand the economic motivationsunderlying business combinations.

2. Learn about the alternative forms of

business combinations, from both the legaland accounting perspectives.

3. Introduce concepts of accounting forbusiness combinations, emphasizing the

acquisition method.4. See how firms record fair values of assets

and liabilities in an acquisition.


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1: ECONOMIC MOTIVATIONS

Business Combinations


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Types of Business Combinations

Business combinations unite previously separatebusiness entities.

Horizontal integration – same business lines and

markets Vertical integration – operations in different, but

successive stages of production or distribution, orboth

Conglomeration – unrelated and diverse productsor services


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Reasons for Combinations

Cost advantage Lower risk Fewer operating delays

Avoidance of takeovers Acquisition of intangible assets Other: business and other tax advantages,

personal reasons


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Potential Prohibitions / Obstacles

Antitrust Federal Trade Commission prohibited Staples’

acquisition of Office DepotRegulation Federal Reserve Board Department of Transportation Department of Energy

Federal Communications Commission

Some states have antitrust exemption laws toallow hospitals to pursue cooperative projects.


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2: FORMS OF BUSINESSCOMBINATIONS



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Legal Form of Combination

Merger Occurs when one corporation takes over all the

operations of another business entity and that

other entity is dissolved.

Consolidation Occurs when a new corporation is formed to take

over the assets and operations of two or moreseparate business entities and dissolves thepreviously separate entities.


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Mergers:A + B = A X + Y = X

Company A acquires the net assets ofCompany B for cash, other assets, orCompany A debt/equity securities. CompanyB is dissolved; Company A survives with

Company B’s assets and liabilities.

Company X acquires the stock of Company Yfrom its shareholders for cash, other assets,

or Company X debt/equity securities.Company Y is dissolved. Company X surviveswith Company Y’s assets and liabilities.


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Consolidations:E + F = “D” K + L = “J”

Company D is formed and acquires the netassets of companies E and F by issuingCompany D stock. Companies E and F aredissolved. Company D survives with the assets

and liabilities of both dissolved firms.Company J is formed and acquires the stock ofcompanies K and L from their respectiveshareholders by issuing Company J stock.

Companies K and L are dissolved. Company Jsurvives with the assets and liabilities of bothfirms.


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Keeping the Terms Straight

In the general business sense, mergers andconsolidations are business combinations and mayor may not involve the dissolution of the acquiredfirm(s).

In Chapter 1, mergers and consolidations will involveonly 100% acquisitions with the dissolution of theacquired firm(s). These assumptions will be relaxedin later chapters.

“Consolidation” is also an accounting term used todescribe the process of preparing consolidatedfinancial statements for a parent and its subsidiaries.


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3: ACCOUNTING FORBUSINESS COMBINATIONS



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Business Combination (def.)

A business combination is “a transaction orother event in which an acquirer obtainscontrol of one or more businesses.Transactions sometimes referred to as true

mergers or mergers of equals also arebusiness combinations. [FASB ASC 805-10]

A parent-subsidiary relationship is formed

when: Less than 100% of the firm is acquired, or The acquired firm is not dissolved.


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U.S. GAAP for Business Combinations

Since the 1950s both the pooling-of-interestsmethod and the purchase method of accounting forbusiness combinations were acceptable.

Combinations initiated after June 30, 2001 use thepurchase method. [FASB ASC 805]

Firms now use the acquisition method for businesscombinations. This began with combinations in

fiscal periods beginning after December 15, 2008.[FASB ACS 810-10-5-2]


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International Accounting

Most major economies prohibit the use of thepooling method.

The International Accounting Standards Boardspecifically prohibits the pooling method andrequires the acquisition method.


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Recording Guidelines (1 of 2)

Record assets acquired and liabilities assumedusing the fair value principle.

If equity securities are issued by the acquirer,

charge registration and issue costs against the fairvalue of the securities issued, usually a reductionin additional paid-in-capital.

Charge other direct combination costs (e.g., legal

fees, finders’ fees) and indirect combination costs(e.g., management salaries) to expense.


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Recording Guidelines (2 of 2)

When the acquiring firm transfers its assets otherthan cash as part of the combination, any gain orloss on the disposal of those assets is recorded incurrent income.

The excess of cash, other assets, debt, and equitysecurities transferred over the fair value of the netassets (A – L) acquired is recorded as goodwill.

If the net assets acquired exceeds the cash, otherassets, debt, and equity securities transferred, again on the bargain purchase is recorded in currentincome.


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Example: Pop Corp. (1 of 3)

Investment in Son Corp. (+A) 1,600

Common stock, $10 par (+SE) 1,000

Additional paid-in-capital (+SE) 600


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Pop Corp. issues 100,000 shares of its $10 parvalue common stock for Son Corp. Pop’sstock is valued at $16 per share. (inthousands)




Investment expense (E, -SE) 80 Additional paid-in-capital (-SE) 40

Cash (-A) 120


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Pop Corp. pays cash for $80,000 in finder’s andconsulting fees and for $40,000 to register and issueits common stock. (in thousands)

Son Corp. is assumed to have been dissolved. So, PopCorp. allocates the investment’s cost to the fair valueof the identifiable assets acquired and liabilitiesassumed. The excess cost is goodwill.




Receivables (+A) XXX

Inventories (+A) XXX

Plant assets (+A) XXX

Goodwill (+A) XXX

Accounts payable (+L) XXX

Notes payable (+L) XXX

Investment in Son Corp. (-A) 1,600


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4: RECORDING FAIR VALUE

USING THE ACQUISITIONMETHOD



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Identify the Net Assets Acquired

Identify: Tangible assets acquired, Intangible assets acquired, and

Liabilities assumedInclude: Identifiable intangibles resulting from legal or

contractual rights, or separable from the entity

Research and development in process Contractual contingencies Some noncontractual contingencies


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Assign Fair Values to Net Assets

Use fair values determined, in preferentialorder, by: Established market prices

Present value of estimated future cash flows,discounted based on an observable measure, suchas the prime interest rate

Other internally derived estimations


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Exceptions to Fair Value Rule

Use normal guidance for: Deferred tax assets and liabilities Pensions and other benefits

Operating and capital leases[FASB ASC 740]

Goodwill on the books of the acquired firm is

assigned no value.


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Goodwill

Goodwill is the excess ofThe sum of: Fair value of the consideration transferred,

Fair value of any noncontrolling interest in theacquiree, and Fair value of any previously held interest in

acquiree,

Over the net assets acquired.


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Contingent Consideration

The fair value of contingent consideration isdetermined or estimated at the acquisitiondate and it is included along with other

consideration given as part of thecombination.Classifying contingencies: Contingent share issuances are equity

Contingent cash payments are liabilitiesEstimated contingencies are revalued to fairvalue at each subsequent reporting date.


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Example – Pit Corp. Data

Pit Corp. acquires the net assets of Sad Co. ina combination consummated on 12/27/2011.

The assets and liabilities of Sad Co. on thisdate, at their book values and fair values, areas follows (in thousands):


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Book Val. Fair Val. Cash $50 $50Net receivables 150 140Inventory 200 250Land 50 100Buildings, net 300 500Equipment, net 250 350Patents 0 50

Total assets $1,000 $1,440 Accounts payable $60 $60Notes payable 150 135Other liabilities 40 45

Total liabilities $250 $240Net assets $750 $1,200



Acquisition with Goodwill

Pit Corp. pays $400,000 cash and issues 50,000shares of Pit Corp. $10 par common stockwith a market value of $20 per share for the

net assets of Sad Co.

Total consideration at fair value (in thousands):$400 + (50 shares x $20) $1,400

Fair value of net assets acquired: $1,200Goodwill $ 200


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Entries with Goodwill

The entry to record the acquisition of the netassets:

The entry to record Sad’s assets directly on

Pit’s books:


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Investment in Sad Co. (+A) 1,400

Cash (-A) 400

Common stock, $10 par (+SE) 500




Cash (+A) 50Net receivables (+A) 140Inventories (+A) 250Land (+A) 100Buildings (+A) 500

Equipment (+A) 350Patents (+A) 50Goodwill (+A) 200

Accounts payable (+L) 60

Notes payable (+L) 135Other liabilities (+L) 45Investment in Sad Co. (-A) 1,400


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Acquisition with Bargain Purchase

Pit Corp. issues 40,000 shares of its $10 parcommon stock with a market value of $20 pershare, and it also gives a 10%, five-year notepayable for $200,000 for the net assets of Sad

Co.


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Fair value of net assets acquired(in thousands)

$1,200

Total consideration at fair value(40 shares x $20) + $200

$1,000

Gain from bargain purchase $200



Entries with Bargain Purchase

The entry to record the acquisition of the netassets:

The entry to record Sad’s assets directly on

Pit’s books:


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10% Note payable (+L) 200

Common stock, $10 par (+SE) 400




Cash (+A) 50

Net receivables (+A) 140

Inventories (+A) 250Land (+A) 100

Buildings (+A) 500

Equipment (+A) 350Patents (+A) 50

Accounts payable (+L) 60

Notes payable (+L) 135

Other liabilities (+L) 45


Gain from bargain purchase (G, +SE) 200


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5: OTHER ISSUES:

IMPAIRMENTS,DISCLOSURES, AND THE

SARBANES-OXLEY ACT



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Goodwill Controversies

Capitalized goodwill is the purchase price notassigned to identifiable assets and liabilities. Errors in valuing assets and liabilities affect the

amount of goodwill recorded.Historically goodwill in most industrializedcountries was capitalized and amortized.Current IASB standards, like U.S. GAAP

Capitalize goodwill, Do not amortize it, and Test it for impairment


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Goodwill Impairment Testing

Firms must test for the impairment of goodwillat the business unit reporting level. Step 1: Compare the unit’s net book value to its fair

value to determine if there has been a loss in value. Step 2: Determine the implied fair value of the

goodwill, in the same manner used to originallyrecord the goodwill, and compare that to the

goodwill on the books.Record a loss if the implied fair value is lessthan the carrying value of the goodwill.


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When to Test for Impairment

Goodwill should be tested for impairment atleast annually.More frequent testing may be needed:Significant adverse change in business Adverse action by regulator Unanticipated competition Loss of key personnel

Impairment or expected disposal losses of:

Reporting unit or part of one Significant long-lived asset group Subsidiary

Copyright ©2012 Pearson Education,Inc. Publishing as Prentice Hall 1-38



Business Combination Disclosures

Business combination disclosures include, butare not limited to: Reason for combination,

Nature and amount of consideration, Allocation of purchase price among assets and

liabilities, Pro-forma results of operations, and

Goodwill or gain from bargain purchase




Intangible Asset Disclosures

Specific disclosures are needed: In the fiscal period when intangibles are acquired, Annually, for each period presented, and

In the fiscal period that includes an impairment

Disclosures are needed for: Intangibles which are amortized,

Intangibles which are not amortized, Research & development acquired, and Intangibles with renewal or extension terms




Sarbanes-Oxley Act of 2002

Establishes the PCAOBRequires: Greater independence of auditors and clients

Greater independence of corporate boards Independent audits of internal controls Increased disclosures of off-balance sheet

arrangements and obligations

More types of disclosures on Form 8-KSEC enforces SOX and rules of the PCAOB




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