advanced accounting chapter1

5/19/2018 advanced accounting chapter1

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Introduction to BusinessIntroduction to Business

Combinations and theCombinations and the

Conceptual FrameworkConceptual Framework

Advanced Accounting, Fifth Edition

1111


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1. Describe historical trends in types of business combinations.

2. Identify the major reasons firms combine.

3. Identify the factors that managers should consider in exercising due diligence inbusiness combinations.

4. Identify defensive tactics used to attempt to block business combinations.

. Distinguish bet!een an asset and a stock ac"uisition.#. Indicate the factors used to determine the price and the method of payment for a

business combination.

$. %alculate an estimate of the value of good!ill to be included in an offering price bydiscounting expected future excess earnings over some period of years.

&. Describe the t!o alternative vie!s of consolidated financial statements' the economicentity and the parent company concepts.

(. )ist and discuss each of the *tatements of +inancial ,ccounting %oncepts -*+,%.

1/. Describe some of the current joint projects of the +,*0 and the International,ccounting *tandards 0oard -I,*0 and their primary objectives.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives


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n December 4 2//$ +,*0 released t!o ne! standards +,*0 Statement No. 141 R 0usiness %ombinations and

+,*0 Statement No. 160 oncontrolling Interests in%onsolidated +inancial *tatements. ,*% &/ 50usiness%ombinations6 and ,*% &1/ 5%onsolidations6 based on +,*07s ne!codification system8

9hese standards

0ecame effective for years beginning after December 12//& and

,re intended to improve the relevance comparability andtransparency of financial information related to businesscombinations and to facilitate the convergence !ith

international standards.

IntroductionIntroductionIntroductionIntroduction


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Business Combination: operations of t!o or morecompanies are brought under common control.

Nature of te CombinationNature of te CombinationNature of te CombinationNature of te Combination

, business combination may be'

!riend"# $ the boards of directors of the potentialcombining companies negotiate mutually agreeable termsof a proposed combination.

%nfriend"# &osti"e' : the board of directors of acompany targeted for ac"uisition resists thecombination.


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(efensive )actics


1. *oison +i"",Issuing stock rights to existingshareholders; exercisable only in the event of a

potential takeover.

-. reenmai",


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(efensive )actics &continued'


4. *ac$man defense,,ttempting an unfriendly takeoverof the !ould:be ac"uiring company.

2. Se""ing te cro3n je3e"s,*elling valuable assets tomake the firm less attractive to the !ould:be ac"uirer.

6. Leveraged bu#outs,


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9he defense tactic that involves purchasing shares heldby the !ould:be ac"uiring company at a price

substantially in excess of their fair value is calleda. poison pill.

b. pac:man defense.

c. greenmail.d. !hite knight.

Revie3 uestionRevie3 uestion



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5dvantages of 7terna" 7+ansion

Business Combinations, #8 # Not8Business Combinations, #8 # Not8Business Combinations, #8 # Not8Business Combinations, #8 # Not8

LO - Reasons firms combine.LO - Reasons firms combine.

1. >apid expansion

2. perating synergies

3. International marketplace

4. +inancial synergy

. Diversification

#. Divestitures


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)ree distinct +eriods

Business Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ective

1::0 troug 1;04 huge holding companies or trusts !ere

created to establish monopoly control over certain industries

-ori


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)ree distinct +eriods

Business Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ectiveBusiness Combinations, 9istorica" *ers+ective

1;42 to te +resent many of the mergers that occurred

from the 1(/s through the 1($/s !ere cong"omerate

mergers.

In contrast the 1(&/s !ere characteri?ed by a relaxation in

antitrust enforcement and by the emergence of high:yield

junk bonds to finance ac"uisitions.

Deregulation undoubtedly played a role in the popularity of

combinations in the 1((/s.

LO 1 (escribe istorica" trends in t#+es of business combinations.LO 1 (escribe istorica" trends in t#+es of business combinations.


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5sset ac=uisition a firm must ac"uire 1//@ of the assets of theother firm.

Stoc ac=uisition control may be obtained by purchasing /@ ormore of the voting common stock -or possibly less.

)ermino"og# and )#+es of Combinations)ermino"og# and )#+es of Combinations)ermino"og# and )#+es of Combinations)ermino"og# and )#+es of Combinations

LO 2 (istinguis bet3een an asset and a stoc ac=uisition.LO 2 (istinguis bet3een an asset and a stoc ac=uisition.

Ahat Is ,c"uiredB Ahat Is Civen pB

Net assetsof * %ompany-,ssets and )iabilities

Common Stocof * %ompany

1. %ash

2. Debt

3. *tock4. %ombination of

above

!igure 1$1!igure 1$1


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*ossib"e 5dvantages of Stoc 5c=uisition)o!er total cost.

Direct formal negotiations may be avoided.

Eaintaining the ac"uired firm as a separate legalentity.

)iability limited to the assets of the individual

corporation.Creater flexibility in filing individual or consolidated

tax returns.




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C"assification b# >etod of 5c=uisition



, %ompany 0 %ompany , %ompanyF G

Statutor# >erger

ne company ac"uires all the net assets of anothercompany.

9he ac"uiring company survives !hereas the ac"uiredcompany ceases to exist as a separate legal entity.


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, %ompany 0 %ompany % %ompanyF G

Statutor# Conso"idation

, ne! corporation is formed to ac"uire t!o or more othercorporations through an exchange of voting stock; the

ac"uired corporations then cease to exist as separate legalentities.

*tockholders of , and 0 become stockholders in %.


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+inancial*tatements of

, %ompany

+inancial*tatements of

0 %ompany

%onsolidated+inancial

*tatements of, %ompany and

0 %ompany

F G

Conso"idated !inancia" Statements

Ahen a company ac"uires a controlling interest in thevoting stock of another company a parentHsubsidiaryrelationship results.


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Ahen a ne! corporation is formed to ac"uire t!o ormore other corporations and the ac"uired corporationscease to exist as separate legal entities the result is a

statutory

a. ac"uisition.

b. combination.

c. consolidation.d. merger





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)aeover *remium ? the excess amount agreed upon in anac"uisition over the prior stock price of the ac"uired firm.

*ossib"e reasons for te +remiums,

,c"uirers7 stock prices may be at a level !hich makes itattractive to issue stock -rather than cash in theac"uisition.

%redit may be generous for mergers and ac"uisitions.

0idders may believe target firm is !orth more than itscurrent market value.

,c"uirer may believe gro!th by ac"uisitions is essential andcompetition necessitates a premium.

)aeover *remiums)aeover *remiums)aeover *remiums)aeover *remiums



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9he factors to be!are of include the follo!ing'0e cautious in interpreting any +ercentages.

Do not neglect to include assumed "iabi"ities in the

assessment of the cost of the merger.

Aatch out for the impact on earnings of the a""ocation of

e7+enses and the effects of production increases standard

cost variances )I+ li"uidations and byproduct sales.

ote any nonrecurring items that may boost earnings.

0e careful of CO egos.

5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"

LO / !actors to be considered in due di"igence.LO / !actors to be considered in due di"igence.


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Ahen an ac"uiring company exercises due diligence inattempting a business combination it should'

a. be skeptical about accepting the target company7sstated percentages

b. analy?e the target company for assumed liabilities as!ell as assets

c. look for nonrecurring items such as changes inestimates

d. all the above


5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"5voiding te *itfa""s Before te (ea"

LO / !actors to be considered in due di"igence.LO / !actors to be considered in due di"igence.


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Ahen a business combination is effected by a stocks!ap or exchange of securities both price and methodof payment problems arise.

9he price is expressed as a stoc e7cange ratio-generally defined as the number of shares of the ac"uiring company to beexchanged for each share of the ac"uired company.

=ach constituent makes t!o kinds of contributions tothe ne! entitynet assetsand future earnings.

(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#mentin Business Combinationsin Business Combinations


LO 6 !actors affecting +rice and metod of +a#ment.LO 6 !actors affecting +rice and metod of +a#ment.


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Net 5sset and !uture arnings Contributions




Determination of an e"uitable price for each

constituent company re"uires'9he valuation of each company7s net assets and

=ach company7s expected contribution to the future

earnings of the ne! entity.


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7cess arnings 5++roac to stimate ood3i""


*tep 1'Identify a normal rate of return on assets for firms

similar to the company being targeted.

*tep 2' ,pply the rate of return -step 1 to the net assets ofthe target to approximate 5normal earnings.6

*tep 3' =stimate the expected future earnings of the target.

7c"udeany nonrecurring gains or losses.

*tep 4' *ubtract the normal earnings -step 2 from the

expected target earnings -step 3. 9he difference is

5excess earnings.6

(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment


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7cess arnings 5++roac to stimate ood3i""


*tep ' %ompute estimated good!ill from 5excess earnings.6

If the excess earnings are expected to last indefinitely

the present value may be calculated by dividing theexcess earnings by the discount rate.

+or finite time periods compute the present value of anannuity.


*tep #' ,dd the estimated good!ill -step to the fair valueof the firm7s net identifiab"e assets to arrive at apossible offering price.


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, potential offering price for a company is computed by

adding the estimated good!ill to the

a. book value of the company7s net assets.b. book value of the company7s identifiable assets.

c. fair value of the company7s net assets.

d. fair value of the company7s identifiable net assets.





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7ercise 1$1,


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7ercise 1$1, -continuedB.%ondominiums Inc.7s pretax incomes for the years 2//

through 2//$ !ere K12///// K1///// and K(////

respectively.


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7ercise 1$1, -continuedRe=uired,

5.,ssume further that etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment


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7ercise 1$1, &*art 5'

LO @ stimating good3i"".LO @ stimating good3i"".


Ste+ 1 Identify a normal rate of return on assetsfor firms similar to the company being targeted.

7cess arnings 5++roac

12A

Ste+ - ,pply the rate of return -step 1 to the net assets ofthe target to approximate 5normal earnings.6

+air value of assets

K1//////+air value of liabilities

&&/////+air value of net assets


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Ste+ / =stimate the expected future earnings of the target.=xclude any nonrecurring gains or losses.

*reta7 income of Condominiums Inc. -002 1-00000B

Subtract, 5dditiona" de+reciation on bui"ding &B;60000 7 /0A' &-::000'

)argetDs adjusted earnings -002 ;1-000B

*reta7 income of Condominiums Inc. -006 1200000

Subtract, 5dditiona" de+reciation on bui"ding &-::000'

)argetDs adjusted earnings -006 1-1-000

*reta7 income of Condominiums Inc. -00@ ;20000

5dd, 7traordinar# "oss /00000

Subtract, 5dditiona" de+reciation on bui"ding &-::000'

)argetDs adjusted earnings -00@ ;6-000

)argetDs tree #ear tota" adjusted earnings /0:6000

)argetDs tree #ear average adjusted earnings &B/0:6000 E /' 10-:66@B



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Ste+ 4 *ubtract the normal earnings -step 2 from theexpected target earnings -step 3. 9he difference is 5excessearnings.6


=xpected target earnings

K1/2#$

)ess' ormal earnings

(3////

=xcess earnings per year

;:66@


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Ste+ 2 %ompute estimated good!ill from 5excess earnings.6


=xcess earnings K (#$


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7ercise 1$1 -continued

Re=uired,

B.,ssume that etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment(etermining *rice and >etod of *a#ment


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*art B


=xcess earnings of target -same a


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Slide1-35 LO : conomic entit# and +arent com+an# conce+ts.LO : conomic entit# and +arent com+an# conce+ts.

*arent Com+an# Conce+t: primary purpose of consolidatedfinancial statements is to provide information relevant tothe controlling stockholders.

9he noncontrolling interest presented as a liability or as aseparate component before stockholders7 e"uity.

5"ternative Conce+ts of Conso"idated5"ternative Conce+ts of Conso"idated!inancia" Statements!inancia" Statements

5"ternative Conce+ts of Conso"idated5"ternative Conce+ts of Conso"idated!inancia" Statements!inancia" Statements

conomic ntit# Conce+t: affiliated companies are a

separate identifiable economic entity.9he noncontrolling interest presented as a component ofstockholders7 e"uity.


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Conso"idated Net Income*arent Com+an# Conce+t consolidated net incomeconsists of the reali?ed combined income of the parentcompany and its subsidiaries after deducting the

noncontrolling interest in income -noncontrolling interestin income is an expense item.

conomic ntit# Conce+t consolidated net incomeconsists of the total combined income of the parentcompany and its subsidiaries. 9otal combined income isthen allocated proportionately to the noncontrollinginterest and the controlling interest.

5"ternative Conce+ts5"ternative Conce+ts5"ternative Conce+ts5"ternative Conce+ts

LO : conomic entit# and +arent com+an# conce+ts.LO : conomic entit# and +arent com+an# conce+ts.


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Conso"idated Ba"ance Seet Fa"ues*arent Com+an# Conce+t the net assets of the subsidiaryare included in the consolidated financial statements attheir book value plus the parent company7s sare of te

differencebet!een fair value and book value on the dateof ac"uisition.

conomic ntit# Conce+t on the date of ac"uisition thenet assets of the subsidiary are included in theconsolidated financial statements at their book value pluste entire difference bet!een their fair value and theirbook value.




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,ccording to the economic unit concept the primarypurpose of consolidated financial statements is toprovide information that is relevant to

a. majority stockholders.

b. minority stockholders.

c. creditors.

d. both majority and minority stockholders.





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Intercom+an# *rofit9!o alternative points of vie!'

1. 9otal -1//@ elimination

2.


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Conce+tua" !rame3orConce+tua" !rame3orConce+tua" !rame3orConce+tua" !rame3or


!igure 1$-!igure 1$-%onceptual+rame!ork for+inancial,ccounting and>eporting


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conomic ntit# vs. *arent Conce+t and teConce+tua" !rame3or

9he+arent conce+tis tied to the istorica" cost

principle !hich !ould suggest that the net assetsrelated to the noncontrolling interest remain at theirprevious book values.

9his approach might be argued to produce more

5reliable6values -*+,% 3o. &.


!5SBDs Conce+tua" !rame3or!5SBDs Conce+tua" !rame3or!5SBDs Conce+tua" !rame3or!5SBDs Conce+tua" !rame3or


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conomic ntit# vs. *arent Conce+t and teConce+tua" !rame3or

9he economic entit# assum+tionvie!s a parent and

its subsidiaries as one economic entity even thoughthey are separate legal entities.

9he economic entit# conce+tis an integral part ofthe +,*07s conceptual frame!ork and is named

specifically in *+,% o. as one of the basicassumptions in accounting.




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Overvie3 of !5SBDs Conce+tua" !rame3or

LO ; Statements of !inancia" 5ccounting Conce+ts.LO ; Statements of !inancia" 5ccounting Conce+ts.


S!5C No.1: bjectives of +inancial >eporting -replaced by *+,%

o. &S!5C No.-: Mualitative %haracteristics of ,ccounting Information

-replaced by *+,% o. &

S!5C No./: =lements of +inancial *tatements -replaced by*+,% o. #

9he *tatements of +inancial ,ccounting %oncepts issued bythe +,*0 include'


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Overvie3 of !5SBDs Conce+tua" !rame3or



S!5C No.4: bjectives of +inancial >eporting by onbusiness

rgani?ationsS!5C No.2: >ecognition and Eeasurement in +inancial *tatements

S!5C No.6: =lements of +inancial *tatements -replaces *+,% o. 3

S!5C No.@: sing %ash +lo! Information and


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(istinguising Bet3een arnings andCom+reensive Income



arningsis essentially revenues and gains minusexpenses and losses !ith the exception of any losses or

gains that bypass earnings and instead are reported asa component of other comprehensive income.

S!5C No. 2 describes them as 5principally certain

holding gains or losses that are recogni?ed in the periodbut are e7c"udedfrom earnings such as some changes inmarket values of investments... and foreign currencytranslation adjustments.6


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5sset Im+airment and te Conce+tua" !rame3or



S!5C No. 2 provides guidance !ith respect to expensesand losses'Consum+tion of benefit. =arnings are generally recogni?ed !hen

an entity7s economic benefits are consumed in revenue earningsactivities -or matched to the period incurred or allocatedsystematically -7am+"e,amorti?ation of limited:lifeintangibles; orLoss or "ac of benefit. =xpenses or losses are recogni?ed if itbecomes evident that previously recogni?ed future economicbenefits of assets have been reduced or eliminated or thatliabilities have increased !ithout associated benefits -7am+"e,revie! for impairment for indefinite:life intangibles.


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Slide1-47 LO 10 (escribe some of te current joint +rojects of te !5SB and te Internationa"LO 10 (escribe some of te current joint +rojects of te !5SB and te Internationa"5ccounting Standards Board &I5SB' and teir +rimar# objectives.5ccounting Standards Board &I5SB' and teir +rimar# objectives.

5++endi7, !5SB Codification *roject5++endi7, !5SB Codification *roject5++endi7, !5SB Codification *roject5++endi7, !5SB Codification *roject

n Nuly 1 2//( the +,*0 launched the +,*0 ,ccounting*tandards %odification.

*ingle source of authoritative nongovernmental .*.

generally accepted accounting principles -C,,


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Structure of te Codification >oughly (/ accounting topics

%ontains four groupings of numbers.

1 the topic2 the subtopic

3 the section and

4 the paragraph

9he code 4/:2/:2:2 refers to topic 4/ -!hich is

Ocontingencies7; subtopic 2/ -!hich is loss Ocontingencies7; section

2 -!hich is recognition; and 2 -refers to the second paragraph.


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a. +inancial ,ccounting *tandards 0oard -+,*0

1. *tatements -+,*-. Interpretations -+I/. 9echnical 0ulletins -+904. *taff


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-a >egulation *:Q -*Q

-b +inancial >eporting >eleases -+>>R,ccounting *eries

>eleases -,*>

-c Interpretive >eleases -I>

-d *=% *taff guidance in

1. *taff ,ccounting 0ulletins -*,02. =I9+ 9opic D and *=% *taff bserver comments.

LO 10 (escribe some of te current joint +rojects of te !5SB and te Internationa"LO 10 (escribe some of te current joint +rojects of te !5SB and te Internationa"5ccounting Standards Board &I5SB' and teir +rimar# objectives.5ccounting Standards Board &I5SB' and teir +rimar# objectives.


5dditiona" SC "iterature inc"uded in teCodificationfor reference


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Canges to 55*, %+dating te !5SB Standards

pdates to the %odification are called ,ccounting*tandards pdates and are referenced as

,* SSSS:xx !here the Ss indicate the year ofpdate and xx represents the number of the update+or that year.


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in *ection 11$ of the 1($# nited *tates %opyright ,ct

!ithout the express !ritten permission of the copyright o!ner

is unla!ful. >e"uest for further information should beaddressed to the

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advanced accounting chapter1