You are on page 1of 27

Business

Combinations:
New Rules for a
Long-Standing
Business
Practice

Chapter 1
2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.

Chapter 1 Learning Objectives


1. Describe the major economic advantages of business combinations.
2. Differentiate between accounting for an acquisition of assets and accounting
for an acquisition of a controlling interest in the common stock of a
company.
3. Explain the basics of the acquisition model.
4. Allocate the acquisition price to the assets and liabilities of the acquired
company.
5. Demonstrate an understanding of the tax issues that arise in an acquisition.
6. Explain the disclosure that is required in the period in which an acquisition
occurs.
7. Apply the impairment test to goodwill and adjust goodwill when needed.
8. Estimate the value of goodwill. (Appendix)

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Economic Advantages of Combinations


Types of mergers

Backward vertical integration


Forward vertical integration
Horizontal merger
Product extension merger
Market extension merger
Conglomerate merger

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Economic Advantages of Combinations


Possible tax advantages
Accept stock to create a tax free reorganization
Transferable carry-forward feature of net operating losses
Net taxable income reported for the consolidated company

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Acquisition of Control
Acquisition of assets
Acquire directly from target company
Assume liabilities
Payment in cash, debt, or equity

Stock Acquisition
Typically more than 50% of targets voting common stock; a
controlling interest
Creates parent/subsidiary relationship
Separate legal entities remain

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Acquisition of Control
Defenses against unfriendly offers

Greenmail
White knight
Poison pill
Selling the crown jewels
Leveraged buyouts

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Acquisition of Control
Accounting ramifications asset acquisition
Acquiring company records assets and liabilities
Subsequent accounting procedures are same as for any single
accounting entity

Accounting ramifications stock acquisition


Parent records an investment
Parent and sub remain separate legal entities with their own
separate sets of accounts and separate financial statements
Consolidated financial statements reflect presence of one
economic entity

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Evolution of Accounting Methods


Pre-2001
Purchase accounting: record net assets at fair value
Pooling of interests
Record net assets at their book value
A merger of equals
Specific qualifying criteria

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Evolution of Accounting Methods


FASB Statement #141, 2001
Pooling eliminated for new combinations
Pre-2001 combinations accounted for under pooling may continue

Purchase method recorded fair values for the portion of the net
assets acquired in the purchase

FASB Statement #141r, 2007 (ASC 805)


Acquisition method
All assets and liabilities recorded at fair value regardless of the
percentage interest
Discontinued the discounting of fixed and intangible assets to values
less than fair value

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

Applying the Acquisition Method


1. Identify the acquirer
2. Determine the acquisition date

Date used to establish fair value of the company acquired

3. Measure the fair value of the acquiree


4. Record the acquirees assets and liabilities that are
assumed

Net assets = excess of assets over liabilities


Fair values are determined per ASC 820
Identifiable assets never include pre-existing goodwill
Only new goodwill is recorded in an acquisition
Bargain purchase if fair value of net identifiable assets
exceed price paid

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

10

Valuation of Identifiable Assets and Liabilities


Current assets recorded at fair value
Valuation accounts are not used

Existing liabilities recorded at fair value


Property, plant, and equipment recorded at fair value
Accumulated depreciation is not recorded

Existing intangibles other than goodwill recorded as


estimated fair value
Assets scheduled for sale are recorded at net realizable
value as current assets

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

11

Valuation of Identifiable Assets and Liabilities


Acquiree was the lessee of assets in use
Leases retain their definition if terms are not modified
Operating leases
Recognize an intangible asset if terms are favorable
Record an estimated liability if the terms are unfavorable

Example:
Payment
n
Rate
Present value

$300

(excess of fair rent value over


contractual amount)

60 months (remaining lease term)


8% (annual)
$14,894 (beginning mode):

should be recorded as an asset (Favorable Operating Lease Terms) and


amortized of the remaining lease term using the effective interest
2016 Cengagemethod.
Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

12

Valuation of Identifiable Assets and Liabilities


Acquiree acted as lessor
Leases retain their classification if terms are not modified
Operating lease
Asset under lease is on books of acquiree
Record at fair value
Evaluate terms; record asset (liability) if favorable (unfavorable) to
the acquiree/lessor

Intangible assets not currently recorded by acquiree


Arises from contractual or other legal rights or is separable
Identify and record separately
Allows for recognition that acquiree was barred from recognizing

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

13

Valuation of Identifiable Assets and Liabilities


Research and development
Fair values of tangible and intangible assets are recorded

Contingent assets and liabilities


Possessed by acquiree on the acquisition date

Liabilities associated with restructuring or exit activities


Existing liabilities to other entities

Employee benefit plans


Asset if projected benefit obligation < plan assets
Liability if projected benefit obligation > plan assets

Deferred tax assets and liabilities

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

14

Applying the Acquisition Model

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

15

Recording the Acquisition


All accounts are recorded at fair value
Price paid > fair value of net identifiable assets
Recognize goodwill

Price paid < fair value of net identifiable assets


Recognize gain on acquisition of business

All acquisitions costs are expensed

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

16

Recording the Acquisition: Goodwill


Price paid (40,000 shares $20 mkt value) $ 800,000
Fair value of net assets acquired
(705,000)
Goodwill
$ 95,000

Also record acquisition costs as a current period expense.


2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

17

Recording the Acquisition: Gain


Price paid (25,000 shares $20 mkt value) $ 500,000
Fair value of net assets acquired
(705,000)
Gain on purchase of business $ 205,000

Also record acquisition costs as a current period expense.


2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

18

Changes in Value
During Measurement Period
Values recorded on the acquisition date are considered
provisional
During the measurement period values assigned to
accounts recorded during purchase may be adjusted to
better reflect the value as of the acquisition date
Changes in value caused by events that occur after the
acquisition date are not a part of this adjustment

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

19

Changes in Value
During Measurement Period
Adjust assets and liabilities to revised value as of
acquisition date
Net effect of adjustment will be recorded to
Goodwill
Gain
Retained Earnings if gain was recorded in prior period

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

20

Changes in Value
During Measurement Period
Depreciation and amortization are adjusted retroactively

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

21

Recording Contingent Consideration


Acquirer agrees to additional consideration if identified
triggers are met
Contingent consideration that is payable in any form
other than additional stock
Measure based on probability of achieving target
Include as part of consideration for determining goodwill or gain
Record as a contingent liability in acquisition entry

Revalue consideration in measurement period


Adjust Goodwill and Liability

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

22

Recording Contingent Consideration


Contingent consideration will be paid in cash
Record a contingent liability on acquisition date
Liability is adjusted
within measurement period: adjust Goodwill
after the measurement period: include in current period income

Contingent consideration is additional stock


Credit Paid-in Capital Contingent Share Agreement
Not subject to revision
When triggers are met, reassign the original consideration
assigned to the stock to a greater number of shares
Reduce contingent paid-in capital
Record additional shares issued at par
2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

23

Accounting by the Acquiree

Record receipt of consideration


Remove assets and liabilities at their book values
Recognize gain or loss on sale of business
Typical final step
Distribute consideration received to shareholders
Cease operations

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

24

Goodwill Accounting
After the Acquisition
Publically traded companies do not amortize goodwill; it
is tested for impairment each year, and impairment loss
is recorded when appropriate
Privately-held companies can elect to amortize goodwill
over no more than 10 years; testing for impairment
continues.
1.
2.
3.
4.

Goodwill must be allocated to multiple reporting units


Methods for valuing the reporting unit must be established.
Impairment testing is normally done on an annual basis.
The procedure for determining if impairment has occurred must be
established.
5. The procedure for determining the amount of the impairment loss
must be established.
2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

25

Impairment Procedures
for Goodwill after Acquisition
Optional: Qualitative assessment to determine whether it is
likely that the fair value of the reporting unit is
less than its fair value.
1. Quantitative impairment test:
Is implied fair value of the reporting unit less than the carrying
value of the reporting units net assets (including goodwill)?

2. Impairment loss calculation:


If yes, impartment loss is calculated as follows:
a.

b.

Implied fair value of goodwill is the excess of the implied fair value of the
reporting unit over the fair value of the reporting units identifiable net assets
(excluding goodwill)
Impairment loss of goodwill is the difference between the implied fair value of
goodwill and the existing recorded goodwill.

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

26

Goodwill Impairment: Example


Step 1:
Estimated implied fair value of the reporting unit $320,000
Existing net book value (including goodwill) 345,000
Goodwill is considered to be impaired
Step 2:
Estimated implied fair value of the reporting unit $320,000
Fair value of net assets, exclusive of goodwill
(285,000)
Implied fair value of goodwill$ 35,000
Existing goodwill
63,000
Estimated impairment loss
$(28,000)

2016 Cengage Learning. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.

27