Beams10e Ch01 Business Combinations[1]

8/6/2019 Beams10e Ch01 Business Combinations[1]

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Chapter 1: Business Combinations

Advanced Accounting, 10th edition

by Floyd A. Beams, Robin P. Clement,

Joseph H. Anthony, and SuzanneLowensohn

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1: ECONOMIC MOTIVATIONS

Business Combinations

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A BUSINESS COMBINATION IS THE UNION OFPREVIOUSLY SEPARATE BUSINESS ENTITIES

Horizontal integration is the combination offirms in the same business lines and markets.

Vertical integration is the combination of firms

with operations in different, but successive,stages of production and/or distribution.

Conglomeration is the combination of firms

with unrelated and diverse products and/orservice functions.


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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 taxadvantages, personal reasons

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2: FORMS OF BUSINESSCOMBINATIONS


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Legal Form of Combination

Merger

Occurs when one corporation takes over allthe operations of another business entityand that other entity is dissolved.

Consolidation

Occurs when a new corporation is formed

to take over the assets and operations oftwo or more separate business entities anddissolves the previously separate entities.

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A Stock acquisition

Occurs when one company acquires the votingshares of another company and the twocompanies continue to operate as separate, butrelated, legal entities.

The acquiring company need not acquire all the

other companys stock to gain control. The relationship that is created in a stock

acquisition is referred to as a parent-subsidiaryrelationship.

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Legal Form of Combination


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Business Combination

Merger

Acquisitions

Consolidation


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A

B

A

Merger


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11

AA Company

BB Company

Stock Acquisition

AA Company

BB Company

The Legal Form ofBusiness Combinations


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Consolidations: E + F = D

1) Company D is formed and acquires theassets of Companies E and F by issuingCompany D stock. Companies E and F are

dissolved. Company D survives, with theassets and liabilities of both dissolved firms.

2) Company D is formed acquires Company Eand F stock from their respectiveshareholders by issuing Company D stock.Companies E and F are dissolved. CompanyD survives with the assets and liabilities ofboth firms.

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3: ACCOUNTING FORBUSINESS COMBINATIONS


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Much of the controversy concerning accountingrequirements for business combinations historicallyinvolved the pooling of interest method.

ARB No. 40introduced an alternative method:the purchase method.


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Major conclusions In May, 2001, the FASB issued Statement141 which reaffirmed the business combination concept withthe following exception:

The pooling of interest method of accounting was

eliminated for all transactions initiated after June 30,2001.

Prior combinations accounted for by the pooling ofinterests method will be allowed to continue as

acceptable financial reporting practice for past businesscombinations.

FASB Statement 141 makes U. S. GAAP more consistentwith international accounting standards. Most majoreconomies, including France, Japan, and Germany

prohibit the use of pooling of interests accounting


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International Accounting

Most major economies prohibit the use ofthe pooling method.

The International Accounting StandardsBoard issued IFRS3, on March 31, 2004,requiring business combination to be

accountedfor using the purchase

method.

IFRS3 specifically prohibits the pooling

of interest method.

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Application of the purchase method:

Cost in a purchase business combination is measuredby the cash disbursed, or the fair value of propertygiven up, or securities issued.

Direct costs of acquisition:1. Direct costs of registering and issuing securities are

charged against additional paid-in capital.

2. Other direct costs of combining are included in the

cost of the acquired company.3. Indirect costs and costs to close duplicate facilities

are expensed


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Recording Guidelines (1 of 2)

Record assets acquired and liabilitiesassumed using the fair value principle.

If equity securities are issued by the

acquirer, charge registration and issue costsagainst the fair value of the securities issued,usually a reduction in additional paid-in-capital.

Charge other direct combination costs (e.g.,legalfees, findersfees) and indirectcombination costs (e.g., managementsalaries) to expense.

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Recording Guidelines (2 of2)

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

in current income. The excess of cash, other assets and equity

securities transferred over the fair value of the netassets (A L) acquired is recorded as goodwill.

If the net assets acquired exceeds the cash, otherassets and equity securities transferred, a gain onthe bargain purchase is recorded in currentincome.

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Example: Poppy Corp. (1 of3)

Investment in Sunny Corp. 1,600,000

Common stock, $10 par 1,000,000

Additional paid-in-capital 600,000

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Poppy Corp. issues 100,000 shares ofits $10 par value common stock for

Sunny Corp. Poppys stock is valued at$16 per share.


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Example: Poppy Corp. (2 of 3)

Investment expense 80,000


Cash 120,000

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Poppy Corp. pays cash for $80,000 in finders feesand consulting fees and for $40,000 to registerand issue its common stock. (in thousands)

Sunny Corp. is assumed to have been dissolved.

So, Poppy Corp. will allocate the investments costto the fair value of the identifiable assets acquiredand liabilities assumed. Excess cost is goodwill.


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Example: Poppy Corp. (3 of 3)

Receivables XXX

Inventories XXX

Plant assets XXXGoodwill XXX

Accounts payable XXX

Notes payable XXX

Investment in Sunny Corp. 1,600,000

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4: COST ALLOCATIONS USINGTHE ACQUISITION METHOD


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Determine the fair values of all identifiable

tangible and intangible assets acquiredand liabilities assumed.

FASB Statement No. 141 provides guidelinesfor assigning amounts to specific categories

of assets and liabilities.


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

Such goodwill is an unidentifiable asset.

Goodwill resulting from thecombination is valued directly.


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Investment cost

Total fair value ofidentifiable assets

less liabilities


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Investment cost Net fair value>

Goodwill

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Identifiable netassets accordingto their fair value

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Book Value.FairValue.Cash $ 50 $ 50

Net receivables 150 140Inventory 200 250Land 50 100Buildings, net 300 500

Equipment, net 250 350Patents 0 50

Total assets $1,000 $1,440Accounts payable $ 60 $ 60

Notes payable 150 135Other liabilities 40 45

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


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Entries with Goodwill

The entry to record the acquisition of the netassets:

The entry to record Seeds assets directly onPitts books:

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Investment in Seed Co. 1,400,000

Cash 400,000

Common stock, $10 par 500,000



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Illustration of a Purchase

Combination

Cash 50

Net receivable 140Inventories 250Land 100Buildings, net 500

Equipment, net 350Patents 50

Accounts payable 60

Notes payable 135

Other liabilities 45Investment inSeed Company 1,400

$1640 1,440 = 200

Goodwill 200


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Combination

Pitt issues 40,000 shares of its $10 par commonstock with a market value of $20 per share andalso 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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Investment in Seed 1,000,000

Common Stock 400,000Additional Paid-in Capital 400,00010% Note Payable 200,000

To record issuance of 40,000 shares of $10 parcommon stock plus $200,000, 10% note in a

purchase business combination with Seed Company


Combination


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Combination

Cash 50

Net receivable 140Inventories 250Land 80Buildings, net 400

Equipment, net 280Patents 40

Accounts payable 60

Notes payable 135



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Combination

Cash 50

Net receivable 140Inventories 250Land 80Buildings, net 400Equipment, net 280

Patents 40

Accounts payable 60

Notes payable 135



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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

GAAP defines goodwill as the excess of the investment cost

over the fair value of assets received.

Theoretically, is is a measure of the present value of the

combined companys projected future excess earnings over thenormal earnings of a similar business.

Therefore, the amount that generally capitalize as goodwill is

the portion of the purchase price left over after all other

identifiable tangible and intangible assets and liabilities have

been valued.

Error in the valuation of other assets will affect the amount

capitalize as goodwill.

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The Goodwill Controversy

UnderFASB Statements No. 141 and No. 142,

the FASB requires that firms periodically assessgoodwill for impairment of its value.

An impairment occurs when the recorded valueof goodwill is less than its fair value.


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Carrying values

Compare

Fair values


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Fair value Carrying amount

Documents

Beams10e Ch01 Business Combinations[1]