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Consolidation

of Financial
Information

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All


rights reserved.

A business combination occurs when


two or more separate businesses join
into a single accounting entity.

Cost advantage Finding New Facilities Human resources SideResearch Development .


Lower risk _ purchase new products and markets less risky Than trying to
develops new market ,new products. This help Company to Reduce risk
by diversify their investment in different products
Fewer operating delays- Existing Business reduce delays operation_
Because Government regulation inspection , many things you have to do
In order to start your business. This will Minimize operation delays.
Avoidance of takeovers. _small companies afraid big Com. aggressive in
Buying other small business_ to defend their companies against
takeover By bid Companies
Acquisition of intangible assets _ Business combinations bring both
Tangible and intangible resources Patent, management Expertise research
customer data base Other reason_ tax Advantages saving,

Business Combination

Acquisitions

Merger

Consolidation

Merger

C
Consolidation

The concept emphasizes


the creation of a single entity and the independence
of the combining companies before their union.

Single management _Control

One or more corporations become subsidiaries.


One company transfers its net assets to another.

Each company transfers its net assets to a newly


formed corporation.

Accounting for Business Combination is one of the most important and


interesting topic Of accounting theory and practice and its complex topic.
Since 1950 Pooling of interest been generally accepted. Until 2001 accounting
requirements for business combination recognized Both pooling & purchase
methods.
In 1999 FASB issued a report supporting its proposed decision to eliminate
Pooling of interest for the following Reasons: Pooling provides less relevant
information to statement users & ignore economic value exchange in
the transaction. Pooling creates these problem because it uses Historical book
Value rather than Fair value of net assets at the transaction date.
GAAP requires recording asset Acquisitions at fair value. Gaap Eliminated the
pooling of interest method of accounting initiated after June 30, 2001.
Businesses must use the Acquisition Method because the new standard
prohibited use pooling method. IFRS also consistent with GAAP and requires
to use the purchase methods. Accounting for business combination was
a major joint project between FASB & IASB.

FASB Statement No. 141 eliminated the pooling of interest method


for transactions initiated after June 30, 2001. Combinations initiated
after this date must use the purchase method. Prior combinations will be
grandfathered.
Pooling uses historical book values to record combinations rather than
recognizing fair values of net assets at the transaction date.

Acquisitions Method requires the recording


of assets acquired and liabilities assumed at
their fair values at the date of combination.

The Acquisitions Method requires


We Expense the direct cost to business combination( accounting , legal
Consulting and finders fees) .
Registration and other issuance cost of equity securities Issued
in combination as a reduction of additional paid In capital.
We expense indirect costs such as management Salaries, deprecation
and rent, We also expense indirect costs incurred to close duplicate Facilities.

Poppy
PoppyCorporation
Corporationissues
issues100,000
100,000shares
sharesof
of$10
$10par
parcommon
commonstock
stock
for
forthe
thenet
netassets
assetsof
ofSunny
SunnyCorporation
Corporationin
inaapurchase
purchase Combination
Combinationon
on
July
July1,
1,2003.
2003.The
Themarket
marketprice
priceof
ofPoppy
Poppyisis$16
$16per
pershare.
share.
Additional
Additionaldirect
directcosts:
costs:
SEC
$$ 5,000
SECRegistration
Registrationfees
fees
5,000RedPInCapita
RedPInCapit
SEC
$$10,000
SECAccounting
Accountingfees
fees
10,000RedPInCapital
RedPInCapital
SEC
$$ 25,000
SECPrinting
Printingand
andissuing
issuing
25,000RedPInCapital
RedPInCapital
Finder
$$80,000
Finderand
andconsulting
consulting
80,000Investment
InvestmentExp.
Exp.
How
Howisisthe
theissuance
issuancerecorded?
recorded?

Investment
1,600,000
Investmentin
inSunny
Sunny
1,600,000
Common
CommonStock,
Stock,$10
$10par
par
Additional
AdditionalPaid-in
Paid-inCapital
Capital

1,000,000
1,000,000
600,000
600,000

To
Torecord
recordissuance
issuanceof
of100,000
100,000shares
sharesof
of$10
$10par
par
common
commonstock
stockwith
withaamarket
marketvalue
valueof
of$16
$16per
pershare
share
in
inaapurchase
purchasebusiness
businesscombination
combinationwith
withSunny.
Sunny.

How
How are
are the
the additional
additional direct
direct costs
costs recorded?
recorded?

Investment
$$80,000
InvestmentExpense
Expense
80,000
Additional
$$40,000
AdditionalPaid-in
Paid-inCapital
Capital
40,000
Cash
Cash(other
(otherassets)
assets)
To
Torecord
recordadditional
additionaldirect
directcosts
costsof
ofcombining
combining
with
withSunny:
Sunny:$80,000
$80,000finders
findersand
andconsultants
consultants
fees
feesand
and$40,000
$40,000for
forregistering
registeringand
andissuing
issuing
equity
equitysecurities.
securities.

$$120,000
120,000

The
The total
total cost
cost to
to Poppy
Poppy of
of acquiring
acquiring
Sunny
Sunny isis $1,680,000.
$1,680,000.

This
This isis the
the amount
amount entered
entered into
into the
the
investment
investment in
in the
the Sunny
Sunny account.
account.

Goodwill is an intangible asset that arises


when the purchase price to acquire a
subsidiary company is greater than
the sum of the market value of the
subsidiarys assets minus liabilities.

Determine the fair values of all identifiable tangible and


intangible assets Acquired & liabilities assumed.
FASB Statement No. 141 provides guidelines for assigning
amounts to specific categories of assets and liabilities.

No value is assigned to goodwill recorded


on the books of an acquired subsidiary.

Such goodwill is an unidentifiable asset.


Goodwill resulting from the
combination is valued directly.

Separability
criterion

Contractuallegal criterion

Recognizable intangibles

Investment cost

Total fair value of


identifiable assets
less liabilities

Investment cost

>
1

2
Goodwill

Net fair value


Identifiable net
assets according
to their fair value

Pitt Corporation acquires the net assets of


Seed Company on December 27, 2003. seed is dissolved

Pitt

Seed

Book Value
Cash
Net receivables
Inventories
Land
Buildings, net
Equipment, net
Patents
Total assets

Assets

50
150
200
50
300
250
$1,000

Fair Value
$

50
140
250
100
500
350
50
$1,440

Book
Value
Liabilities
Accounts payable
$ 60
Notes payable
150
Other liabilities
40
Total liabilities
$250
Net assets
$ 750

Fair
Value
$

60
135
45
$ 240
$1,200

Pitt pays $400,000 cash and issues 50,000


shares of Pitt Corporation $10 par common
stock with a market value of $20 per share.
50,000 $10 = $500,000

Illustration of a Purchase
Combination
Investment in Seed
Cash
Common Stock
Additional Paid-in Capital

1,400,000

To record issuance of 50,000 shares of $10 par


common stock plus $400,000 cash in a purchase
business combination with Seed Company

400,000
500,000
500,000

Illustration of a Purchase Combination

Cash
Net receivable
Inventories
Land
Buildings, net
Equipment, net
Patents

50
140
250
100
500
350
50

Accounts payable
Notes payable
Other liabilities
Investment in
Seed Company

$1640 1,440 = 200


Goodwill

200

60
135
45
1,400

Illustration of a Purchase Combination

Pitt issues 40,000 shares of its $10 par common


stock with a market value of $20 per share and
also gives a 10%, five-year note payable for
$200,000 for the net assets of Seed Company.
40,000 $10 = $400,000

Illustration of a Purchase Combination

Investment in Seed
Common Stock
Additional Paid-in Capital
10% Note Payable

1,000,000

To record issuance of 40,000 shares of $10 par


common stock plus $200,000, 10% note in a
purchase business combination with Seed Company

400,000
400,000
200,000

Illustration of a Purchase
Combination
Cash
Net receivable
Inventories
Land
Buildings, net
Equipment, net
Patents

50
140
250
100
500
350
50

Accounts payable
60
Notes payable
135
Other liabilities
45
Investment in
Seed Company
1,000
Gain from bargain purchase 200

Illustration of a Purchase 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%.

The Goodwill Controversy

Under FASB Statement No. 142, goodwill is no


longer amortized for financial reporting purposes.

income tax controversies


international accounting issues

The Goodwill Controversy


Under FASB Statements No. 141 and No. 142,
the FASB requires that firms periodically assess
goodwill for impairment of its value.

An impairment occurs when the recorded value


of goodwill is less than its fair value.

Compare
Carrying values

Fair values

Fair value

<

Carrying amount

Measurement of the
impairment loss

Amortization versus
Nonamortization
Firms must amortize intangible assets with
a finite useful life over that life.

Firms will not amortize intangible assets with an


indefinite useful life that cannot be estimated.

2-39

Consolidation of financial information is required when


one organization gains control of another.

If dissolution occurs, this consolidation is carried out at


the date of acquisition and a single set of accounting
records is maintained.

If separate identities are maintained, consolidation is a


periodic worksheet process not involving journal entries.
Separate accounting records are maintained.

The acquisition method is GAAP beginning in 2009.

Legacy effects for the purchase method (for combinations


occurring through 2008) and the pooling method (through
6/30/2002) remain in subsequent years financial reports.

Tool & Machinery

Company A

$
190,000
$
130,000
$
180,000
$
100,000
$
60,000

Company B
Book Value
$
25,000
$
45,000
$
60,000
$
40,000
$
10,000

Fair Value
$
25,000
$
40,000
$
62,000
$
45,000
$
30,000

Total Assets

$ 660,000

$
210,000
$
350,000
$
75,000
$
25,000

$ 180,000

$
30,000
$
120,000
$
20,000
$
10,000

$ 202,000

$
20,000

Assets
Cash
Account Receivable
Equipment
Inventory

Account Payable
Capital
Additional Paid In
Capital
Retain Earning