B326: Advance Accounting

B326 Course Structure

There are 7 Course Chapters:
Chapter The Subject
1 Business combination
3 An introduction to consolidated financial statements
4 Consolidation techniques and procedures
5 Intercompany transaction - inventory
6 Intercompany transaction – plant asset
12 Derivatives and foreign currency- concepts and common transaction
Accounting for branches

Chapter 1: Business Combination

Objectives 1: Understand the economic motivations underlying business
combination

• The main objective of businesses today is to increase the wealth of its shareholders.
• To do so it has to expand internally (expand its facilities) or externally (mergers and
acquisitions).
• In general business combination is done, to increase its profitability or increase the efficiency
(vertical and horizontal integration).

• 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

Reasons for Combinations

1. Cost advantage
• It is less expensive to obtain the needed facilities through business combination than through
development.
• Lower risk
• The purchase of established product lines and markets is usually less risky than developing
new products and markets.
 • Diversification reduce the risk single-product companies may face. For example, a single-
product, non-diversified firm may be forced into bankruptcy, while a multiproduct, diversified
company is more likely to survive.
• Fewer operating delays
• Plant facilities acquired in a business combination are operative and already meet
environmental and other governmental regulations. Firms constructing new facilities can
expect numerous delays in construction, as well as in getting the necessary governmental
approval to commence operations. Environmental impact studies alone can take months or
even years to complete.
• Avoidance of takeovers
• Many companies combine to avoid being acquired themselves.
• Acquisition of intangible assets
• Business combinations bring together both intangible and tangible assets. The acquisition of
patents, mineral rights, research, customer databases, or management expertise may be a
primary motivating factor in a business combination.
• Other: Business and other tax advantages, personal reasons

Objective 2: Learn about alternative forms of business combinations,

from both the legal and accounting perspectives
Legal Forms of Business Combination

1- Merger
• Occurs when one corporation takes over all the operations of another business entity and that
other entity is dissolved.
• Example: Merger occur when (A+B=A) :
 Company A purchases the assets of Company B for cash, other assets, or Company A
debt/equity securities. Company B is dissolved; Company A survives with Company B’s
assets and liabilities.

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  Company A purchases Company B stock from its shareholders for cash, other assets, or
Company A debt/equity securities. Company B is dissolved. Company A survives with
Company B’s assets and liabilities.
2- 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.
• Example: Consolidation occur when (E+F=D):
 Company D is formed and acquires the assets of Companies E and F by issuing
Company D stock. Companies E and F are dissolved. Company D survives, with the
assets and liabilities of both dissolved firms.
 Company D is formed acquires Company E and F stock from their respective
shareholders by issuing Company D stock. Companies E and F are dissolved. Company
D survives with the assets and liabilities of both firms.
3- Acquisition
• When corporation acquires the productive asset of another business entity and integrates those
assets into its own operation.
• When one corporation obtains operating control over the productive facilities of another entity
by acquiring a majority of its outstanding voting stock.
• The acquired company may not be dissolve and does not have to go out of existence.
• Example: Acquisition occur (A+B=A+B):
 Company A buys asset of company B for cash or buys its shares for cash and does not
dissolve the company. Which will give company A legal owner ship of asset

Objective 3: Introduce accounting concepts for business combinations,

emphasizing the acquisition method
Business combination:
• According to GAAP “A business combination is a transaction or other event in which an
acquirer obtains control of one or more businesses.. Transaction sometimes referred to as true
mergers or mergers equals also are business combination”.
• Accounting concept for business combination focus on the creation of a single entity and the
independence of the combining companies before their union.
• previously, separate businesses are brought together into one when their recourse and
operation come under control of one single management which means:
• one or more corporation become subsidiaries
• one company transfers its net assets to another
• each company transfers its net assets to newly formed corporation

Parent – Subsidiary Relationship

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 A corporation that owns more than 50 percent of the voting stock of another corporation usually
controls that corporation through its stock ownership, and a parent–subsidiary relationship exists
between the two corporations. The acquired firm is not dissolved.

Subsidiary
 A corporation becomes a subsidiary when another corporation acquires a majority (more than
50 percent) of its outstanding voting stock.
 The combining companies necessarily retain separate legal entity and separate accounting
records even though they become one entity for financial reporting purposes.

Background of accounting for business combination

 Previously the accounting method for business combination is pooling interest method
 The pooling method has faced a lot of difficulties which had lead for the introduction of new method
called acquisition method.

 In 2001 the pooling method has been eliminated from FASB

Recording Guidelines
• 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 as a reduction in additional paid-in-capital.
• Charge other direct combination costs (e.g., legal fees, finders’ fees, Investment banking fees, Accounting
fees) and indirect combination costs (e.g., management salaries) to expense.
• The excess of cash, other assets and equity securities transferred over the fair value of the net assets (A –
L) acquired is recorded as goodwill.
• If the net assets acquired exceeds the cash, other assets and equity securities transferred, a gain on the
bargain purchase is recorded in current income.

Recording issuance of shares

Dr Cr
Investment in Subsidiary (#shares × per share) XX
Common Stock (#shares × par) XX
Additional Paid-in capital (difference) XX

Example:
Poppy Corp. issues 100,000 shares of its $10 par value common stock for Sunny Corp. Poppy’s
stock is valued at $16 per share. (in thousands)

Dr Cr
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 Investment in Subsidiary 1,600
Common Stock 1,000
Additional Paid-in capital 600

Poppy Corp. pays cash for $80,000 in finder’s fees and consulting fees and for $40,000 to
register and issue its common stock. (in thousands)

Dr Cr
Investment expense 80
Additional Paid-in capital 40
Cash 120

If Sunny Corp. is dissolved, Poppy Corp. will allocate the investment’s cost to the fair value of
the identifiable assets acquired and liabilities assumed. Any excess of investment cost over fair
value of net assets is recorded as goodwill.

If Subsidiary is dissolved:
Assigning the cost of subsidiary to net assets on the basis of their fair values

Dr Cr
Receivables XX
Inventories XX
Plant assets XX
Goodwill XX
Accounts payable XX
Notes payable O XX
Investment in Subsidiary R XX
Gain on bargain purchase XX

Objective 4: Cost Allocations Using the Acquisition Method

Recording Fair values in an acquisition
Identify the Net Assets Acquired
1. Tangible assets acquired,
2. Intangible assets acquired, and
3. Liabilities assumed
Assign Fair Values to Net Assets:
Use fair values determined, in preferential order, by:
1. Established market prices
2. Present value of estimated future cash flows, discounted based on observable measures
3. Other internally derived estimations

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Goodwill
• The goodwill resulting from business combination :
▫ The acquirer shall recognize goodwill as of the acquisition date measured as excess of
(A) over (B):
 The aggregate of the following:
 The consideration transferred measured at fair value at acquisition date
 The fair value of any non controlling interest
 The acquisition fate fair value of the acquirers previously held equity
interest in the acquire.
 The net of the acquisition date (fair value ) amount of the identifiable assets and
liabilities acquired and the liabilities assumed .
Recognition and measurement of other intangible asset:
• Firms should recognize intangible asset separate from goodwill only if they fall into one or
two category :
▫ Separable criterion
▫ Contractual legal criterion
Contingent consideration in an acquisition
Some business combinations provide for additional payments to the previous stockholders of the
acquired company, contingent on future events or transactions. The contingent consideration may
include the distribution of cash or other assets or the issuance of debt or equity securities.
The contingent consideration can be classified as equity or as a liability.
Contingent consideration as equity:
An acquirer may agree to issue additional shares of stock to the acquiree if the acquiree meets an
earnings goal in the future. Then, the contingent consideration is in the form of equity. At the date of
acquisition, the Investment and Paid-in Capital accounts are increased by the fair value of the
contingent consideration.

Contingent consideration as a liability:

Alternatively, an acquirer may agree to pay additional cash to the acquiree if the acquiree meets an
earnings goal in the future. Then, the contingent consideration is in the form of a liability. At the date
of the acquisition, the Investment and Liability accounts are increased by the fair value of the
contingent consideration.
• Intangible asset which is not separated should be recognize within the goodwill value.

Cost and fair value compared – Goodwill or Bargain Purchase

• We compare the cost of the investment of the identifiable asset which were recorded to the
fair value
▫ If cost of investment > total identifiable asset less liabilities then the excess will be
assigned to the goodwill.
▫ If cost of investment < total identifiable asset less liabilities then the excess will be
recorded as bargain purchase which recognized as a gain by the acquirer.
Current GAAP for goodwill and other intangible assets

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 • Goodwill is impaired not amortize
• All intangible and goodwill with indefinite useful should be impaired not amortize.
• Goodwill amortization is not permitted and firms may not write goodwill back up reverse the
impact of prior period amortization

Recognizing and measurement impairment losses

• Goodwill impairment test :

• Firms first compare carrying values to fair value at the business reporting unit level
• If the fair value is less than carrying amount then the impact of measurement has to recorded.
• Compare of the carrying amount of goodwill to its implies value . Impairment has to be
booked and we can not reverse previous impairment

Goodwill Impairment Test

Goodwill Impairment Test:
Firms must test for the impairment of goodwill at the business unit reporting level.
Step 1: Compare the unit’s net book value to its fair value to determine if there has been a loss in
value. If there is a loss, proceed to step 2
Step 2: Determine the implied fair value of 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.

Reasons:
Test for impairment of goodwill should be done at least once a year. If any of the below events occur a
test is required:
1. A significant adverse change in legal factors or in the business climate
2. An adverse action or assessment by a regulator
3. Unanticipated competition
4. Loss of key personnel
5. A more likely than not expectation that a reporting unit or a significant portion of the unit will be sold
6. Recognition of a goodwill impairment loss in the financial statements of a subsidiary of the reporting
unit.

Amortization versus Non-Amortization

Firms must amortize intangibles with a definite useful life over that life. The method of amortization should
reflect the expected pattern of consumption of the economic benefits of the intangible. If firms cannot
determine a pattern, then they should use straight-line amortization.
If intangibles with an indefinite life later have a life that can be estimated, they should be amortized

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at that point. Firms should periodically review intangibles that are not being amortized for possible
impairment loss.

Example 1: Acquisition with goodwill

Pitt Corporation acquires the net assets of Seed Company in an acquisition consummated on
December 27, 2016. The assets and liabilities of Seed Company on this date, at their book values and
at fair values, are as follows (in thousands):

Pitt Corporation pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par common
stock with a market value of $20 per share for the net assets of Seed Co.

Required: prepare the journal entries to record the previous transactions.

Answer
Cost of the investment > Fair value of net assets
Goodwill= cost of the investment - Fair value of net assets

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 = [cash + (shares * market value)] – [fair value of asset – fair value of liabilities]
[400 + (50 shares × $20)] – [1,440- 240]
=200
Journal Entries

1- Entry to record the acquisition of the net assets:

Dr Cr
Investment in Subsidiary 1,400
Cash 400
Common stock 500
Additional Paid-in capital 500

2- Entry to assign the cost of subsidiary to net assets on the basis of their fair values

Dr Cr
Cash 50
Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Goodwill 200
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,400

Example 2: Acquisition with Bargain Purchase

Pitt Corporation acquires the net assets of Seed Company in an acquisition consummated on
December 27, 2016. The assets and liabilities of Seed Company on this date, at their book values and
at fair values, are as follows (in thousands):

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Pitt Corporation 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 Seed
Company.

Required: prepare the journal entries to record the previous transactions.

Answer
Cost of the investment < Fair value of net assets
Gain on bargain purchase= cost of the investment - Fair value of net assets
= [(shares * market value) + Note payable] – [fair value of asset – fair value of liabilities]
[(40 shares × $20) + $200]– [1,440- 240]
=200
Journal Entries

1- Entry to record the acquisition of the net assets

Dr Cr
Investment in Subsidiary 1,000
Notes payable 200
Common stock 400
Additional paid-in capital 400

2- Entry to assign the cost of subsidiary to net assets on the basis of their fair values
Dr Cr
Cash 50
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Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,000
Gain on bargain purchase 200

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