CH1

Chapter 1:
Business
Combinations
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education,

1-1
Inc. Publishing as Prentice Hall
Business Combinations
1: ECONOMIC MOTIVATIONS

1-2
Types of Business Combinations
Business combinations unite previously separate

business entities.
Horizontal integration same business lines and
markets
Vertical integration operations in different, but
successive stages of production or distribution, or
both
Conglomeration unrelated and diverse products
or services

1-3
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

1-4
2: FORMS OF BUSINESS
COMBINATIONS

1-5
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 more separate
business entities and dissolves the previously separate
entities.
1-6
3: ACCOUNTING FOR
BUSINESS COMBINATIONS

1-7
Business Combination (def.)
A business combination is a transaction or other

event in which an acquirer obtains control of one
or more businesses. Transactions sometimes
referred to as true mergers or mergers of equals
also are business combinations. [GAAP]
A parent-subsidiary relationship is formed when:

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

1-8
Methods
Since the 1950s both the pooling-of-interests method

and the purchase method of accounting for business
combinations were acceptable.
Combinations initiated after June 30, 2001 use the
purchase method. [FASB ASC 805]
Firms now use the acquisition method for business
combinations. This began with combinations in fiscal
periods beginning after December 15, 2008. [FASB
ACS 810-10-5-2]

1-9
International Accounting
Most major economies prohibit the use of the pooling

method.
The International Accounting Standards Board

specifically prohibits the pooling method and requires
the acquisition method.

1-10
Recording Guidelines (1 of 2)
Record assets acquired and liabilities assumed using

the fair value principle.
If equity securities are issued by the acquirer, charge
registration and issue costs against the fair value of the
securities issued, usually a reduction in 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.

1-11
Recording Guidelines (2 of 2)
When the acquiring firm transfers its assets other than
cash as part of the combination, any gain or loss on
the disposal of those assets is recorded in current
income.
The excess of cash, other assets, debt, and equity
securities transferred over the fair value of the net
assets (A L) acquired is recorded as goodwill.

1-12
Example: Pop Corp. (1 of 3)
Pop Corp. issues 100,000 shares of its $10 par

value common stock for Son Corp. Pops
stock is valued at $16 per share. (in
thousands)
Investment in Son Corp. (+A) 1,600

Common stock, $10 par (+SE) 1,000
Additional paid-in-capital (+SE) 600

1-13
Pop Corp. pays cash for $80,000 in finders and consulting
fees and for $40,000 to register and issue its common
stock. (in thousands)
Investment expense (E, -SE) 80
Additional paid-in-capital (-SE) 40
Cash (-A) 120
Son Corp. is assumed to have been dissolved. So, Pop Corp.
allocates the investments cost to the fair value of the
identifiable assets acquired and liabilities assumed. The
excess cost is goodwill.
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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

1-15
4: RECORDING FAIR VALUE

USING THE ACQUISITION
METHOD

1-16
Identify the Net Assets Acquired
Identify:
Tangible assets acquired,
Intangible assets acquired, and
Liabilities assumed
Goodwill on the books of the acquired firm is

assigned no value.

1-17
Assign Fair Values to Net Assets
Use fair values determined, in preferential

order, by:
Established market prices
Present value of estimated future cash flows,
discounted based on an observable measure, such as
the prime interest rate
Other internally derived estimations

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Contingent Consideration
The fair value of contingent consideration is

determined or estimated at the acquisition date
and it is included along with other consideration
given as part of the combination.
Classifying contingencies:
Contingent share issuances are equity
Contingent cash payments are liabilities
Estimated contingencies are revalued to fair value

at each subsequent reporting date.
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Example Pit Corp. Data
Pit Corp. acquires the net assets of Sad Co. in a

combination consummated on 12/27/2011.
The assets and liabilities of Sad Co. on this date,

at their book values and fair values, are as follows
(in thousands):

1-20
Book Val. Fair Val.
Cash $50 $50
Net receivables 150 140
Inventory 200 250
Land 50 100
Buildings, net 300 500
Equipment, net 250 350
Patents 0 50
Total assets $1,000 $1,440
Accounts payable $60 $60
Notes payable 150 135
Other liabilities 40 45
Total liabilities $250 $240
Net assets $750 $1,200
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Acquisition with Goodwill
Pit Corp. pays $400,000 cash and issues 50,000

shares of Pit Corp. $10 par common stock with 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: $1,200

Goodwill $ 200
1-22
Entries with Goodwill
The entry to record the acquisition of the net

assets:
Investment in Sad Co. (+A) 1,400
Cash (-A) 400
Common stock, $10 par (+SE) 500
The entry to record Sads assets directly on

Pits books:
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Cash (+A) 50
Net receivables (+A) 140
Inventories (+A) 250
Land (+A) 100
Buildings (+A) 500
Equipment (+A) 350
Patents (+A) 50
Goodwill (+A) 200
Accounts payable (+L) 60
Notes payable (+L) 135
Other liabilities (+L) 45
Investment in Sad Co. (-A) 1,400

1-24
Acquisition with Bargain Purchase
Pit Corp. issues 40,000 shares of its $10 par

common stock with a market value of $20 per
share, and it also gives a 10%, five-year note
payable for $200,000 for the net assets of Sad
Co.
Fair value of net assets acquired (in
$1,200
thousands)
Total consideration at fair value (40
$1,000
shares x $20) + $200
Gain from bargain purchase $200
1-25
Entries with Bargain Purchase
The entry to record the acquisition of the net

assets:

10% Note payable (+L) 200
Common stock, $10 par (+SE) 400
The entry to record Sads assets directly on

Pits books:
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Cash (+A) 50
Net receivables (+A) 140
Inventories (+A) 250
Land (+A) 100
Buildings (+A) 500
Equipment (+A) 350
Patents (+A) 50
Accounts payable (+L) 60
Notes payable (+L) 135
Other liabilities (+L) 45
Gain from bargain purchase (G, +SE) 200
1-27
5: OTHER ISSUES:
IMPAIRMENTS,
DISCLOSURES, AND THE
SARBANES-OXLEY ACT

1-28
Goodwill Controversies
Capitalized goodwill is the purchase price not

assigned to identifiable assets and liabilities.
Errors in valuing assets and liabilities affect the amount
of goodwill recorded.
Historically goodwill in most industrialized
countries 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 goodwill at

the business unit reporting level.
Step 1: Compare the units 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 originally record the
goodwill, and compare that to the goodwill on the
books.
Record a loss if the implied fair value is less than
the carrying value of the goodwill.
1-30

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Chapter 1:

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Business combinations unite previously separate

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

A business combination is a transaction or other

A parent-subsidiary relationship is formed when:

Copyright 2012 Pearson Education,

Since the 1950s both the pooling-of-interests method

Copyright 2012 Pearson Education,

Most major economies prohibit the use of the pooling

The International Accounting Standards Board

Copyright 2012 Pearson Education,

Record assets acquired and liabilities assumed using

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Pop Corp. issues 100,000 shares of its $10 par

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

Copyright 2012 Pearson Education,

Receivables (+A) XXX

Copyright 2012 Pearson Education,

4: RECORDING FAIR VALUE

Copyright 2012 Pearson Education,

Goodwill on the books of the acquired firm is

Copyright 2012 Pearson Education,

Use fair values determined, in preferential

Copyright 2012 Pearson Education,

The fair value of contingent consideration is

Estimated contingencies are revalued to fair value

Pit Corp. acquires the net assets of Sad Co. in a

The assets and liabilities of Sad Co. on this date,

Copyright 2012 Pearson Education,

Pit Corp. pays $400,000 cash and issues 50,000

Total consideration at fair value (in thousands):

Fair value of net assets acquired: $1,200

The entry to record the acquisition of the net

The entry to record Sads assets directly on

Copyright 2012 Pearson Education,

Pit Corp. issues 40,000 shares of its $10 par

The entry to record the acquisition of the net

Investment in Sad Co. (+A) 1,000

The entry to record Sads assets directly on

Copyright 2012 Pearson Education,

Capitalized goodwill is the purchase price not

Firms must test for the impairment of goodwill at

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