Business Combinations

Chapter 1

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Learning Objective 1

Understand the economic motivations underlying business combinations.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Business Combinations
A business combination occurs when two or more separate businesses join into a single accounting entity.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Reasons for Business Combinations

Cost advantage Lower risk Fewer operating delays Avoidance of takeovers Acquisition of intangible assets

Other reasons
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Learning Objective 2

Learn about the alternative forms of business combinations, from both the legal and accounting perspectives.
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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The Legal Form of Business Combinations

Business Combination

Acquisitions

Merger

Consolidation
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2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Legal Form of Business Combinations

A B

Merger
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The Legal Form of Business Combinations

A B

Consolidation
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The Accounting Concept of Business Combinations

The concept emphasizes the creation of a single entity and the independence of the combining companies before their union. Dissolution of the legal entity is not necessary within the accounting concept.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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The Accounting Concept of Business Combinations

Single management

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The Accounting Concept of Business Combinations

One or more corporations become subsidiaries.
One company transfers its net assets to another. Each company transfers its net assets to a newly formed corporation.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Background on Accounting for Business Combinations

Much of the controversy concerning accounting requirements for business combinations historically involved the pooling of interest method. ARB No. 40 introduced an alternative method: the purchase method.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Background on Accounting for Business Combinations

Until 2001, accounting requirements for business combinations were found in APB Opinion No. 16. APB No. 16 recognized both the pooling and purchase methods.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Background on Accounting for Business Combinations

FASB Statement No. 141 eliminated the pooling of interest method for transactions initiated after June 30, 2001. Combinations initiated after this date must use the purchase method. Prior combinations will be grandfathered.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Learning Objective 3

Understand alternative approaches to the financing of mergers and acquisitions.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Pooling Method
Pooling uses historical book values to record combinations rather than recognizing fair values of net assets at the transaction date. Most of the detailed issues related to poolings concern the original recording of the combination.

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Purchase Method

Purchase accounting requires the recording of assets acquired and liabilities assumed at their fair values at the date of combination.

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Learning Objective 4

Introduce concepts of accounting for business combinations emphasizing the purchase method.

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Accounting for Business Combinations Under the Purchase Method

Poppy Corporation issues 100,000 shares of $10 par common stock for the net assets of Sunny Corporation in a purchase combination on July 1, 2003. The market price of Poppy is $16 per share
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Accounting for Business Combinations Under the Purchase Method

Additional direct costs:
SEC fees Accounting fees Printing and issuing Finder and consulting $ 5,000 $10,000 $25,000 $80,000

How is the issuance recorded?

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Accounting for Business Combinations Under the Purchase Method

Investment in Sunny 1,600,000 Common Stock, $10 par 1,000,000 Additional Paid-in Capital 600,000 To record issuance of 100,000 shares of $10 par common stock with a market value of $16 per share in a purchase business combination with Sunny.

How are the additional direct costs recorded?

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Accounting for Business Combinations Under the Purchase Method

Investment in Sunny 80,000 Additional Paid-in Capital 40,000 Cash (other assets) 120,000 To record additional direct costs of combining with Sunny: $80,000 finders and consultants fees and $40,000 for registering and issuing equity securities.
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Accounting for Business Combinations Under the Purchase Method

The total cost to Poppy of acquiring Sunny is $1,680,000. This is the amount entered into the investment in the Sunny account.

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Goodwill

Goodwill is an intangible asset that arises when the purchase price to acquire a subsidiary company is greater than the sum of the market value of the subsidiarys assets minus liabilities.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

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Learning Objective 5

See how firms make cost allocations in a purchase method combination.

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Cost Allocation in a Purchase Business Combination

Determine the fair values of all identifiable tangible and intangible assets acquired and liabilities assumed. FASB Statement No. 141 provides guidelines for assigning amounts to specific categories of assets and liabilities.

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Cost Allocation in a Purchase Business Combination

No value is assigned to goodwill recorded on the books of an acquired subsidiary.

Such goodwill is an unidentifiable asset. Goodwill resulting from the combination is valued directly.
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Recognition and Measurement of Intangible Assets Other than Goodwill

Separability criterion Contractuallegal criterion

Recognizable intangibles

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Contingent Consideration in a Purchase Business Combination

Contingent consideration that is determinable at the date of acquisition is recorded as part of the cost of combination.

Future earnings level

Security prices
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Cost and Fair Value Compared

Investment cost

Total fair value of identifiable assets less liabilities

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Cost and Fair Value Compared

Investment cost

>
1

Net fair value

Identifiable net assets according to their fair value

Goodwill
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Illustration of a Purchase Combination

Pitt Corporation acquires the net assets of Seed Company on December 27, 2003.

Pitt

Seed
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2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

Book Value Assets Cash Net receivables Inventories Land Buildings, net Equipment, net Patents Total assets $ 50 150 200 50 300 250 Fair Value $ 50 140 250 100 500 350 50 $1,440
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$1,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

Book Value Liabilities Accounts payable Notes payable Other liabilities Total liabilities Net assets $ 60 150 40 $250 $ 750 Fair Value $ 60 135 45 $ 240 $1,200
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2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

Pitt pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par common stock with a market value of $20 per share. 50,000 $10 = $500,000

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Illustration of a Purchase Combination

Investment in Seed 1,400,000 Cash 400,000 Common Stock 500,000 Additional Paid-in Capital 500,000 To record issuance of 50,000 shares of $10 par common stock plus $400,000 cash in a purchase business combination with Seed Company
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Illustration of a Purchase Combination

Cash Net receivable Inventories Land Buildings, net Equipment, net Patents Goodwill 50 140 250 100 500 350 50 200
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Accounts payable 60 Notes payable 135 Other liabilities 45 Investment in Seed Company 1,400 $1640 1,440 = 200

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

Pitt issues 40,000 shares of its $10 par common stock with a market value of $20 per share and also gives a 10%, five-year note payable for $200,000 for the net assets of Seed Company. 40,000 $10 = $400,000

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Illustration of a Purchase Combination

Investment in Seed 1,000,000 Common Stock 400,000 Additional Paid-in Capital 400,000 10% Note Payable 200,000 To record issuance of 40,000 shares of $10 par common stock plus $200,000, 10% note in a purchase business combination with Seed Company
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Illustration of a Purchase Combination

Cash Net receivable Inventories Land Buildings, net Equipment, net Patents 50 140 250 80 400 280 40 Accounts payable 60 Notes payable 135 Other liabilities 45 Investment in Seed Company 1,000

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Illustration of a Purchase Combination

$1,200,000 fair value is greater than $1,000,000 purchase price by $200,000.

Amounts assignable to assets are reduced by 20%.

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The Goodwill Controversy

Under FASB Statement No. 142, goodwill is no longer amortized for financial reporting purposes.

income tax controversies international accounting issues

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The Goodwill Controversy

Under FASB Statements No. 141 and No. 142, the FASB requires that firms periodically assess goodwill for impairment of its value.

An impairment occurs when the recorded value of goodwill is less than its fair value.
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Recognizing and Measuring Impairment Losses

Compare Carrying values Fair values

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Cost and Fair Value Compared

Fair value

<

Carrying amount Measurement of the impairment loss

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Amortization versus Nonamortization

Firms must amortize intangible assets with a finite useful life over that life. Firms will not amortize intangible assets with an indefinite useful life that cannot be estimated.

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End of Chapter 1

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