Business Combinations

Chapter One
Prepared by: YIN SOKHENG, Master in Finance

I. Business Combinations
Combination = Merger = Consolidation
Business combination involves obtaining the net

asset of an entire firm by obtaining the firms common stock. Business combination occurs when two or more companies are brought together into accounting entity. Net asset = Total asset + Total liabilities
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Types of Business Combinations

Types of business combinations are divided into three forms: 1. Merger: dissolution of all business involved but one of all of firms remaining. 2. Consolidation: dissolution of all business involved and formation of a new company. 3. Stock acquisition: occurs when one company acquires the voting shares of another company and the two companies continue to operate as separate, but related, legal entities. The relationship that is created in a stock acquisition is referred to as a parentsubsidiary relationship.
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Types of Business Combinations

AA Company AA Company BB Company 1. Merger AA Company CC Company BB Company 2. Consolidation AA Company BB Company 3. Stock Acquisition
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AA Company BB Company

Types of Business Combinations

AA Company invests in BB Company

Acquires Net Assets

Acquires Stock

Yes

Acquired Company Liquidated? No

Record as Merger or Consolidation

Record as Stock Acquired and Operate as Subsidiary

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Accounting Method for Business Combinations

There are two methods of accounting for formal business combinations: 1. Purchase Method 2. Pooling of Interests Method

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II. Purchase Method

Purchase method is allowed by generally accepted

accounting principle (GAAP) in recording the business combination. The investment or purchase is recorded based on historical cost principle. Under the purchase method, the direct expenses related to business combination such as accounting fees, legal, consulting, and finders fees are debited to the investment account (assets account). But registration and issuance of equity securities are recorded as a reduction of the additional paid-in capital.
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Example:
Assume that Poppy Company issues 100,000 shares of $10 per common stock for the net assets of Sunny Company in a purchase business combination on July 01, 2004. The market value of Poppy Company stock on this date is $16 per share. Additional direct cost of business combination consist of Securities and Exchange Commission (SEC) fees of $5,000. Accountant fees in connection with SEC registration of $10,000, cost of printing and issuing the common stock certificate of $25,000 and finders and consultants fees of $80,000.
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Journal entries to record to the investment and additional expenses

General Journal Date Account Titles Investment in Sunny Company Common Stock, $ 10 par value Paid-in Capital Journal entries to record to the additional expenses Investment in Sunny Company Paid-in Capital Cash 80,000 40,000 120,000 P.R Page 3 Debit 1,600,000 1,000,000 600,000 Credit

Journal entries to record to the investment in Sunny Company

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Now assume that Sunny Company is dissolved. Poppy Company receives the assets and liabilities from Sunny as follows: cash, $20,000; account receivable, $80,000; inventories, $500,000; land, $800,000; building, $100,000; and account payable, $50,000.
Total investment in Sunny Company (1,600,000+80,000) Net assets received: - Cash - Account receivable - Inventories - Land - Building - Account payable Total net assets Goodwill
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$ 1680,000 $ 20,000 80,000 500,000 800,000 100,000 (50,000) $ 1,450,000 $ 230,000

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Journal entries to record the assets received from Sunny and liabilities assumed
General Journal Date Cash Account Receivable Inventories Land Building Goodwill Account Payable Investment in Sunny Company Account Titles P.R Page 3 Debit 20,000 80,000 500,000 800,000 100,000 230,000 (50,000) 1,680,000 Credit

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Illustration of business combination under the purchase method Example: Pitt Corporation acquires the net assets of Seed Company on December 27, 2004. The total assets and liabilities of Seed on this date at book value and fair value are as follow:
Assets Book Value Fair Value - Cash - Note receivable - Inventories - Land - Building, net - Equipment, net - Patents Total assets Liabilities - Account payable - Note payable - Other liabilities Total liabilities Net assets $ 50,000 150,000 200,000 50,000 300,000 250,000 $ 1,000,000 Book Value $ 60,000 150,000 40,000 $ 250,000 $ 750,000 $ 50,000 140,000 250,000 100,000 500,000 350,000 50,000 $ 1,440,000 Fair Value $ 60,000 135,000 45,000 $ 240,000 $ 1,200,000
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Case 1: Good will

Pitt Corporation pays $400,000 cash and issues $50,000 shares, $10 par common stock with a market value of $20 per share.
General Journal Date Account Titles Investment in Seed Company Cash Common Stock, $ 10 par value Paid-in Capital Journal entries to record the dissolution of Seed Company. Determine the goods will: To investment in Sunny Company Net assets received Good will
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Page 3 P.R Debit 1,400,000 400,000 500,000 500,000 Credit

Journal entries to record to the investment in Seed Company

1,400,000 1,200,000 200,000

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Record the assts received and liabilities assumed

General Journal Date Cash Note Receivable Inventories Land Building, net Equipment, net Patents Goodwill Account Payable Notes payable Other liabilities Investment in Seed Company
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Page 3 P.R Debit 50,000 140,000 250,000 100,000 500,000 350,000 50,000 200,000 60,000 135,000 45,000 1,400,000
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Account Titles

Credit

Case 2: Negative goodwill

Pitt Corporation issues $40,000 shares of its $10 par common stock with a market value of $20 per share, and it also give a 10%, five years notes payable for $200,000 for the net assets of Seed Company. So, total investment in Seed = ($40,000 x $20) + 200,000= $1,000,000 Net assets received from Seed 1,200,000 Negative goodwill $200,000 Negative goodwill of $200,000 is not record in the Pitts book. It is deducted from fair value of each noncurrent assets.
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Noncurrent assets - Land - Building, net - Equipment, net - Patents Total

Fair Value $ 100,000 500,000 350,000 50,000 $ 1,000,000

Percentage of Deduction (%) $ 20,000 100,000 70,000 10,000 $ 200,000

Amount to be recorded $ 80,000 400,000 280,000 40,000 $ 800,000

General Journal Date Account Titles Investment in Seed Company Notes payable Common Stock, $10 par value Paid-in Capital
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Page 3 P.R Debit 1,000,000 200,000 400,000 400,000

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Credit

Journal entries on Pitts book to record the investment in Seed Co.

As Seed Company is dissolved, Pitt Corporation must record the assts received from Seed.
General Journal Date Cash Note Receivable Inventories Land Building, net Equipment, net Patents Account Payable Notes payable Other liabilities Investment in Seed Company
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Page 3 P.R Debit 50,000 140,000 250,000 80,000 400,000 280,000 40,000 60,000 135,000 45,000 1,000,000
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Account Titles

Credit

III. Pooling of Interest Method

Under the pooling of interest method, the assets

and liabilities received are recorded at the book value. The stock issued is recorded at book value. Example: On January 01, 2005, Point Corporation issues 10,000 shares of its $10 par common stock in exchange for all assets of Sharp Company. Sharp distributes the shares to its shareholders and retires its own stock. The balance sheet of Point and Sharp, at book value are as follows:
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Book Value Assets - Cash - Inventories - Land - Building Accumulated depreciation Total assets Liabilities and Shareholders Equity - Current liabilities - Common Stock: . Point Corporation, $10 par . Sharp Company - Paid-in Capital - Retained Earnings Total Liabilities and Equity 30,000 220,000 $ 700,000 300,000 100,000 50,000 150,000 $ 1,440,000 $ 150,000 $ 100,000 Point $ 75,000 125,000 100,000 600,000 (200,000) $ 1,000,000 Sharp $ 45,000 65,000 40,000 400,000 (150,000)
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$ 1,440,000

Journal entry on Points book to record the assets, liabilities & equities received from Sharp.
General Journal Date Account Titles P.R Page 3 Debit Credit

Journal entry on Points book to record the assets, liabilities & equities received from Sharp.

Cash Inventories Land Building Accumulated depreciation Current liabilities Common Stock Paid-in Capital Retained Earnings
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45,000 65,000 40,000 400,000 150,000 100,000 100,000 50,000 150,000

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General Journal Date Investment Current liabilities Accumulated depreciation Cash Inventories Land Building Common Stock Paid-in Capital Retained Earnings Investment in Point
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Page 3 P.R Debit 300,000 100,000 150,000 45,000 65,000 40,000 400,000 100,000 50,000 150,000 300,000
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Account Titles

Credit

Journal entry on Sharps book to record the stock received from Point.

Journal entry to record the distribution of stock to shareholders.

Difference in total par value

Item
Original Shareholders equity account Change in Shareholders equity account recorded by Point

Point Shares issue by Point: - Number Shares - Total Value Common Stock Paid-in Capital Retained Earnings Total Shareholders equity 300,000 30,000 220,000

Sharp

Case 1 10,000 100,000

Case 2 8,000 80,000 80,000 70,000 150,000

Case 3 14,000 140,000 140,000 10,000 150,000

Case 4 21,000 210,000 210,000 (30,000) 120,000 300,000

100,000 50,000 150,000

100,000 50,000 150,000

550,000 300,000 300,000 300,000 300,000

Case 4: 210,000 100,000 = 110,000 50,000 (Paid-n Capital of Sharp) 30,000 (Paid-n Capital of Point) 30,000 (150,000 30,000)
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Difference in total par value

Item
Original Shareholders equity account Total Shareholders equity account of combined company

Point Shares issue by Point: - Number Shares - Total Value Common Stock Paid-in Capital Retained Earnings Total Shareholders equity 300,000 30,000 220,000

Sharp

Case 1

Case 2

Case 3

Case 4

100,000 400,000 380,000 440,000 50,000 80,000 100,000 40,000 150,000 370,000 370,000 370,000

510,000 0 340,000 850,000

550,000 300,000 850,000 850,000 850,000 $ 850,000

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Thank You
thank you all for your attention.

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