Business Combinations

Business combinations takes many different forms. The combination of business

units often achieved through fusion of different companies into a larger single
unit. such fusion is accomplished either through merger or consolidation.
Business combination is also achieved by acquisition of control by one company
over the operations of another. Following are the types of business
combinations:
1. Merger: A merger is effected upon the direct acquisition of the
properties of one or more companies by another. The company taking over
the properties of others retains its identity and continues operations as a
larger unit; the other companies are dissolved and lose their separate
identities.

Ordinarily the acquiring company unit takes over all assets and assumes all
liabilities of the companies to be absorbed. Upon transfer of assets and
liabilities, the acquiring company makes payment for the acquisition with
cash, securities of the acquiring company, or both. Such payments are
distributed ato the companies that are to be dissolved.
 Business Combinations
2. Consolidations: A consolidation is effected when a corporation is
specifically organized to acquire the assets and to assume the liabilities
of two or more previously existing companies. A new company is
formed; the original companies are dissolved.
Ordinarily, the newly formed company issues securities that are given is
exchange for properties acquired. Stockholders of the original
companies thereby become stockholders of the new unit. In some cases
the new corporation may sell its stock and with such proceeds acquire
the net assets of the companies to be combined.
3. Acquisition of Control: Business combination is also achieved by
the acquisition of control by one company over the operations of
another. Control of corporate units is achieved through stock
ownership or through interlocking directorates. Such control results in
unified and integrated operation of business enterprises while
permitting component units to retain their separate corporate identities.
 Business Combinations
Exercise 2
A merger was affected on January 1st March 2016 whereby Nishat Textile Mills took over the assets
and assumed the liabilities of the Karim Textile Mills for total consideration of Rs. 85,000,000, paying
45,000,000 cash and 200,000 shares of its stock that have a market value of Rs 200 per share on the
date of acquisition. The Karim Textiles Mills Balance Sheet on the date of merger is as follows:

Current Assets Rs 20,000,000 Current Liabilities Rs 6,000,000

Plant and Equipment 55,000,000 Long Term Debt 14,000,000
Share Capital, Par Rs 10 40,000,000
Share Premium 7,000,000
Un-appropriated Profit 8,000,000
Total Liabilities &
Total Assets Rs 75,000,000 Stockholder equity 75,000,000

The Nishat Textiles Mill Ltd shares have a par value of Rs 10.
 
Required:
1. Give the entries that should be made on the books of the Karim Textile Mills and on the books of Nishat
Textiles Mill Ltd. in recording the merger.
2. How should the cash and the shares of the Nishat Textiles Mill Ltd. be distributed among the
shareholders of Karim Textiles Mill? Give your working.
 Business Combinations
Exercise 1
The Brooks corporation acquires net assets of the Wharton Corporation for $360,000,
paying cash of $160,000 and issuing 4,000 shares of its stock that have a market value
of $50 per share on the date of acquisition. The Books Corporation common stock
has a par value of $20. The Wharton corporation balance sheet on the date of the
merger is as follows:

Currents assets $100,000 current liabilities $20,000

Plant & equipment 125,000 Long-term debt 30,000
Capital Stock $10 par 50,000
Additional Paid-in-capital 35,000
Retained Earnings 90,000
Total Assets $225,000 Total Liabilities & Capital $225,000
Required:
a) Give the entries that should be made on the books of the Wharton Corporation
and on the books of the Brooks Corporation in recording the merger.
b) How should the cash and the shares of the Brooks Corporation be distributed
among the Wharton Corporation Stockholders?
 Business Combinations
Consolidation
Exercise 3

Asset and estimated annual earnings contributions of Companies M, N and O parties to

a consolidation are as follows
M N O Total
Asset contribution $1,000,000 $2,000,000 2,000,000 5,000,000
Estimated annual
Earnings contribution 90,000 200,000 240,000 530,000

Parties agree to the following:

A single class of stock, $10 par, is to be issued by the new corporation; stock is to be exchanged for
net assets as indicated plus allowances for goodwill represented by annual earnings in excess of 8%
on asset contributions as above, capitalized at 20%.

Required:
1. What entry is made by the new corporation assuming that stock is issued equal in
amount to the sum of assets and goodwill?
2. What entry is made assuming that stock of $5,000,000 is issued, goodwill calculations
being made simply to assure the equitable allotment of this stock?
3. How is the stock distributed among constituent companies.
 Business Combinations
Consolidation
Exercise 3
Solution:
M N O Total
Estimated annual
Earnings contribution 90,000 200,000 240,000 530,000
8% Return on Assets 80,000 160,000 160,000 400,000
Excess annual earnings 10,000 40,000 80,000 130,000
Excess annual earnings
Capitalized @ 20% 50,000 200,000 400,000 650,000
Asset contribution $1,000,000 $2,000,000 2,000,000 5,000,000
Total adjusted Assets 1,050,000 2,200,000 2,400,000 5,650,000

1. Journal Entries:
Dr. Cr.
Goodwill 650,000
Other Assets 5,000,000
Capital Stock $10 par 5,650,000
Distribution of Shares:
Shares to Co. M = 1,050,000/5,650,000 X (565,000) = 104,071
Shares to Co. N = 2,200,000/5,650,000 X (565,000) = 220,000
Shares to Co. O = 2,400,000/5,650,000 X (565,000) = 240,000

2. Assets 5,000,000
Capital Stock $10 par 5,000,000
 Business Combinations
Consolidation
Exercise 3
2. Assets 5,000,000
Capital Stock $10 par 5,000,000

Distribution of Shares:
Shares to Co. M = 1,050,000/5,650,000 X (500,000) = 92,920
Shares to Co. N = 2,200,000/5,650,000 X (500,000) = 194,690
Shares to Co. O = 2,400,000/5,650,000 X (500,000) = 212,390
 Business Combinations (Consolidation)
Exercise 4
L, M and N companies agrees to consolidate and form Company O. Net assets at appraised values and average
adjusted earnings of the past five years, which the parties believe offer the most reliable estimate of future
earning, are as follow:
 
Co. L Co. M Co. N Total
Rs, 000 Rs, 000 Rs, 000 Rs, 000
Net asset Contribution 80,000 120,000 200,000 400,000
Percentage of asset contribution 20% 30% 50% 100%
Earnings contribution 15,000 15,000 20,000 50,000 Percentage of earning 30% 30% 40%
100%

To give equitable weightage to all three companies, the parties decided to also consider the earnings contribution
of each company. In doing so they decided;
1. That 8% returns is to be to be regarded as fair return on identifiable net assets.
2. Excess earnings are to be capitalized at 20% in arriving at a value for goodwill.
Required:
1. Give your working to calculate the total contribution of each company by giving effect to the
foregoing.
2. Give journal entries that would be recorded on the books of new company O if goodwill is
recognized and also give working how the shares of Company O will be distributed among the
shareholders of the three companies. Assume the par value of Company P is Rs 10.
3. Give the journal entries supposing the goodwill is not recognized and the company O issues
30,000,000 shares.
 Business Combination
Acquisition of Subsidiary Company

Acquisition of Subsidiary Company: when a company acquires control of another

company through stock ownership is called acquisition of subsidiary. A company owning
more than 50% of the voting stock of another is in a position to elect the board of
directors of the latter unit and thus to control the resources and the operations of the
company. The control through stock ownership does not require to dissolve any of the
company, instead all the companies continue their separate legal existence. Furthermore,
it is preferred over the other possibilities (i.e. merger, consolidation) because of certain
financial, administrative, tax, or legal advantages found in this relationship.
The Power of a company to acquire stock of other company is generally granted by the
laws of the state. State law may specifically permit the organization of companies that are
formed for the sole purpose of acquiring and holding sock of other corporations.
From a practical point of view, the acquisition by one company of a controlling interest
in the stock of another company may be equivalent to a merger or a consolidation since
properties are now under unified management and control.
From a legal point of view, however, regardless of the degree of corporate control that
may be exercised, each company continues to be regarded as a separate entity.
 Business Combination
Acquisition of Subsidiary Company

• Parent and Holding Company: A company that holds the sotck of others
and controls their activities is called a Parent Company. When a corporation is
organized for the sole purpose of holding the stock of others and supervising
their activities, it is known as a Holding company. A holding company has a sole
purpose to exercise control over other companies, called the subsidiaries. A.
company that exercises control over others while engaged in its own trading or
manufacturing activities is sometimes called an operating holding company to
distinguish it from a pure holding company. A company that holds a major part
or all of the voting stock of another is referred to as the controlling interest.
Those holding any remaining interest in the controlled company are referred to
as the minority interest.
• Subsidiary Company: The companies that are controlled by a parent or
holding company are known as subsidiaries. Parent and subsidiary companies
are referred to as affiliated companies. A controlled company whose stock is
wholly owned by affiliated units is called a wholly owned subsidiary.
 Business Combination
Acquisition of Subsidiary Company

Acquisition of 100% Subsidiary Stock at Book Value:

 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company
 Business Combination
Acquisition of Subsidiary Company