Action of Type of Combination Acquiring Company Action of Acquired Company Statutory merger through asset acquisition. Acquires assets and often liabilities Dissolves and goes out of business. Statutory merger through transfers assets and liabilities to its own books. Acquires all stock and then Dissolves as a separate corporation, often remaining as a division of the acquiring company. Statutory consolidation ‘through capital stock or asset acquisition original companies. Newly created to receive assets or capital stock of Original companies may dissolve while remaining as separate divisions of newly created company, Acquisition of more than 50 percent of the voting stock. Acquires stock that is. recorded as an investment; controls decision making of acquired company. Remains in existence as legal corporation, although now a subsidiary of the acquiring company. Control through owners! of variable interests (see Chapter 6). Risks and rewards often flow to a sponsoring firrn rather than the equity holders. in a specific activity. Establishes contractual control over a variable interest entity ta engage Remains in existence as a separate legal entity—often a trust or partners! Types of Combination Costs Acquisition Accounting Direct combination costs (e.g., accounting, legal, investment banking, appraisal fees, etc.) Indirect combination costs (e.g., internal costs such as allocated secretarial or managerial time) Amounts ii curred to ragister and issue securities Expense as incurred Expense as incurred Reduce the value assigned to the fais value of the securities issued (typically a debit to additional paid-in capital) Consolidation Values Acquisition Accounting Consideration transferred equals the fair values of net identified assets acquired Consideration transferred is greater than the fair values of net identified assets acquired Bargain purchase—consideration transferred is less than the fair values of net identified assets acquired. The total of the individual fair values of the net identified assets acquired effectively becomes the acquired business fair value. Identified assets acquired and liabilities assumed are recorded at their fair values. Identified assets acquired and liabilities assumed are recorded at their fair values. The excess consideration transferred over the net identified asset fair value is re- corded as goodwill Identified assets acquired and liabilities assumed are recorded at their fair values. The excess amount of net identified asset fair value over the consideration transferred is recorded as a gain on bargain purchase.1. Consolidation of financial information is required for external reporting purposes when one organization gains control of another, thus forming a single economic entity. In many combi- nations, all but one of the companies is dissolved as a separate legal corporation, Therefore, the consolidation process is carried out fully at the date of acquisition to bring together all accounts into a single set of financial records. In other combinations, the companies retain their identities as separate enterprises and continue to maintain their own separate accounting systems. For these cases, consolidation 1s a periodic process necessary whenever the parent produces external financial statements, This periodic procedure is frequently accomplished through the use of a worksheet and consolidation entries. Current financial reporting standards require the acquisition method in accounting for business combinations. Under the acquisition method, the fair value of the consideration transferred provides the starting point for valuing the acquired firm. The fair value of the consideration transferred by the acquirer includes the fair value of any contingent consideration. The ac- quired company assets and liabilities are consolidated at their individual acquisition-date fair values. Direct combination costs are expensed as incurred because they are not part of the acquired business fair value. Also, the fair value of all acquired in-process research and devel- opment is recognized as an asset in business combinations and is subject to subsequent impair- ment reviews. If the consideration transferred for an acquired firm exceeds the total fair value of the ac- quired firm’s net assets, the residual amount is recognized in the consolidated financial state- ments as goodwill, an intangible asset. When a bargain purchase occurs, individual assets and liabilities acquired continue to be recorded at their fair values and a gain on bargain purchase is recognized. Particular attention should be paid to the recognition of intangible assets in business combina- tions. An intangible asset must be recognized in an acquiring firm’s financial statements if the asset arises from a legal or contractual right (¢.g., trademarks, copyrights, artistic materials, royalty agreements). If the intangible asset does not represent a legal or contractual right, the intangible will still be recognized if it is capable of being separated from the firm (e.g., customer lists, noncontractual customer relationships, unpatented technology). n we 5