FINANCING, ACCOUNTING AND TAXATION IN M&A

Presented By Group 1:

Hesty Oktariza | Renate Shafrila D.P. Rista Marliyani | Siti Rachmanita Z. | Sabrina

President UniversityJune 28th, 2011

FINANCING ON M&A

Financing in M&A

Cash- Payment by cash. Usually use in acquisitions rather than in

merger.

Stock- Payment in the acquiring company’s stock, issued to the

shareholders of the acquired company at a given ratio proportional to the valuation of the latter.

CashCash on Hand :

- Consumes financial slack, may decrease debt rating, no major transaction cost.

Issue of Debt :- Consumes financial slack, increase cost of debt, transaction cost

include closing cost of 1% to 3% of the face value.

Issue of Stock :- Increase financial slack, reduce cost of debt, transaction cost include

fees for preparation.

Stock

Issue of stock :- Increase financial slack, reduce cost of debt

Shares in treasury :- Increase financial slack, improve debt rating and reduce

cost of debt. Transaction cost include brokerage fees if shares are repurchased in the market otherwise there are no major cost.

ACCOUNTING IMPLICATIONS OF M&A

Accounting for M&A

Depending on the characteristics of a merger or acquisition, firms could use one of two approaches to account for business combinations:

a) Purchase method

b) Pooling-of-interest (pooling) method

Purchase Method VS Pooling Method

Purchase Method

Used in acquisition, the acquired company is known as investment

No new balance sheet is prepared

Recording the Fair Market Value (FMV)

There is Goodwill

Taxable

Pooling of Interest Method

Basically used in the merging of two companies

New balance sheet of the combined company is created

Recording the Book Value on the historical basis.

No Goodwill

Free of Tax

Higher reported earning

The Purchase Method

What is Goodwill?

Goodwill is the difference between the purchase price and the sum of fair market value of net assets. It can be a positive or negative goodwill.

If the FMV > the target firm’s equity, the excess amount is goodwill and reported as an intangible asset on the left hand side of the balance sheet.

Goodwill is considered as the premium that the acquirer paid on its investment on the acquired company.

Goodwill is used to be amortized over the course of 40 years(until 2001), but it is no longer amortized but must be annually assessed to determine if has been permanently ‘impaired’ in which case, the value will be written down and charged against earnings per share.

The Purchase Method

In 2006, Nestle Co. Purchased the medical-nutrition division of Novartis AG for $1,250 million in cash.

Acquisitor Pre- Merger

Target Firm (Book Value)

Target Firm (Fair Market

Value)

Current assets 10,000 1,200 1,300Long-term assets 6,000 800 900GoodwillTotal Assets 16,000 2,000 2,200

Current liabilities 8,000 800 800Long-term debt 2,000 200 250Common stock 2,000 400 1,250Retained earnings 4,000 600Total Claims 16,000 2,000 2,300

Goodwill on the Purchase Method

Acquisitor Pre- Merger

Target Firm (Book Value)

Target Firm (Fair Market

Value)Acquisitor Post

Merger

Current assets 10,000 1,200 1,300 11,300Long-term assets 6,000 800 900 6,900Goodwill 100Total Assets 16,000 2,000 2,200 18,300

Current liabilities 8,000 800 800 8,800Long-term debt 2,000 200 250 2,250Common stock 2,000 400 1,250 3,250Retained earnings 4,000 600 4,000Total Claims 16,000 2,000 2,300 18,300

Book Values are not

relevant.

Acquisitor Value pre merger + Target Firm (FMV) = Acquisitor Post MergerGoodwill = Price paid – MV of Target firm Equity

= $1,250 – (MV of target assets – MV of target Liabilities)

= $1,250 – ($2,200 - $1,050)

= $100

Pooling Method Accounting

Controversy Over Pooling

While more popular in other countries, the pooling of interest is no longer allowed by:

• CICA in Canada

• Financial Accounting Standards Board (FASB) in the U.S. and

• International Accounting Standards Board (IASB)

Pooling Method Accounting

Controversy Over Pooling

Principal reasons to eliminate pooling method are including: Pooling provide less relevant information to statement

users. Pooling ignores economic value exchanged in the

transaction and makes subsequent performance evaluation impossible

Comparing firm using the alternative methods is difficult for investors

TAXATION ON M&A

Tax Considerations

In general, the target’s shareholders pay taxes on the gains or losses immediately when the transaction is concluded, while the acquirer restates the acquired assets at fair market value.

The asset write-up increases the amount of depreciation which is valuable for an acquirer in a tax paying status.

M&As can be tax-free, whereby the target’s shareholders recognize a loss or gain only if they sell the assets they receive in payment from the acquirer.

Qualifying for Tax Free Treatment: Mergers

1. The shareholders of the target have to retain a continuing equity interest in the acquirer.

2. The interest must be substantial in relation to the net assets of the target.

These two rules have been interpreted to mean that the target shareholders have to receive at least 50 percent of their payment in stock of the acquirer.

Qualifying for Tax Free Treatment: Acquisitions

1. All payment to the shareholders of the target has to be in the form of voting stock.

2. The acquirer must obtain at least 80 percent of the voting stock of the target.

CASE STUDY

Accounting Case in Mergers & Acquisition

Lehman Brothers

→ On September 20, 2008 Barclays plc acquire the core business of Lehman for $1.75 billion

→ Barclays Plc use purchase method for this transaction, mainly its $960-million headquarters, a 38-story office building

→ Barclays use combination between cash and stock, $47.4 billion in securities and $45.5 billion in trading liabilities

→ Nomura Holdings, Japan's top brokerage firm, agreed to buy the Asian division of Lehman Brothers for $225 million in cash

On September 29, 2008, Lehman agreed to sell Neuberger Berman, the bulk of its investment management business, to a pair of private-equity firms, Bain Capital Partners and Hellman & Friedman, for $2.15 billion

a 49% of $2.15 billion paid in common equity interest to Neuberger Berman Group LLC

Finace case

in 1929 Rio Tinto company issued stock for raising 2.5 million pounds of Rhodesian copper mining companies consolidated its holdings of these various firms under the Rhokana Corporation

On 14 November 2007, Rio Tinto completed its largest acquisition to date, purchasing Canadian aluminium company Alcan for $38.1 billion

The company sold three major assets in 2008, raising approximately $3 billion in cash

Rio Tinto has reached agreements to acquire the Corumba iron mine and the Jacobs Ranch coal mine, and completed sales of an aluminium smelter in China and the company's Potash operations, for an additional estimated $2.5 billion

Taxation Case

On July 2, 1998 NOVA Corporation merged with TRANSCANADA PIPELINES

The shareholders of NOVA and TransCanada use the Canadian income tax consequences of the transactions, described in the Plan of Agreement on July 2, 1998

Based on a valuation approach derived from the use of ten day weighted average prices, the fair market values were:

→ NOVA Common Share (pre-merger) $16.90

→ TransCanada Common Share $32.50

→ NOVA Common Share (post-merger) (referred to in the Joint Information Circular as a NOVA Chemicals Common Share) $27.85

Using this valuation approach,1. The proceeds of disposition of a NOVA Common Share were

$16.90;

2. The cost of a TransCanada Common Share received by a NOVA Common Shareholder was initially $32.50;

3. For purposes of calculating the cost of a TransCanada common share immediately after the Plan is effective, $5.57 (being .2 of $27.85 to reflect the 1 for 5 share consolidation) must be deducted from the adjusted cost base otherwise determined of each TransCanada Common Share;

4. The cost of a NOVA common share (post-merger) (referred to in the Joint Information Circular as a NOVA Chemicals Common Share) was $27.85.