Financial Reporting Issues in

M&A
Case: Impairing the Microsoft/Nokia
Pairing
 Deal (Example)

Hardin to issue 100,000 shares for 40,000 shares of Pratt

Hardin Tool
Company
New public offering of 100,000
shares of Hardin can be made
public at $8 per share
Pratt Engineering
No inter company transactions Company
Appraised value of Net Assets: $600,000
Asset’s book value: $441,000

2
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Assets
Current assets $432 $246 39% 44%
Plant and equipment 690 312 61% 56%
Total assets $1,122 $558 100% 100%
Liabilities and Equities
Current liabilities $263 107 23% 19%
Long-term debt 195 10 17% 2%
Common stock ($1 par) 100 40 9% 7%
Additional paid-in capital 218 94 19% 17%
Retained earnings 346 307 31% 55%
Total liabilities and equity $1,122 $558 100% 100% 3
 Pooling vs. Purchase Method

Condensed Income Statement as of the Proposed Acquisition Date

(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Sales $2,100 1500 100% 100%
Expenses 1620 1120 77% 75%
Income $480 $380 23% 25%
Income tax expense 168 133 8% 9%
Net income $312 $247 15% 16%

4
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
Hardin Pratt Pooling Purchase
Assets
Current assets $432 $246 $678 $678
Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441)
Goodwill 200 (100,000*8=800,000)-$600,000
Total assets $1,122 $558 $1,680 $2,039
Liabilities and Equities
Current liabilities $263 107 $370 $370
Long-term debt 195 10 $205 $205
Common stock ($1 par) 100 40 $200 $200
Additional paid-in capital 218 94 $252 $918 plug in
Retained earnings 346 307 $653 346
Total liabilities and equity $1,122 $558 $1,680 $2,039
5
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed
Hardin Pratt Polling Purchase
Sales $2,100 1500 $3,600 $3,600
Expenses 1620 1120 $2,740 $2,740
Income $480 $380 $860 $860
Additional depreciation $16 $159,000/10 years = 16,000
Taxable income $860 $844
Income tax expense $301.0 $295.4
Net income $559.0 $548.6
Earnings Per Share $2.80 $2.74
Life of plant and equipment: 10 years
Depreciation method: Straight line depreciation 6
Income tax rate: 35%
 Conditions for Amalgamation in the Nature
of Merger (AS 14)

Shareholders of the transferor Consideration payable to the

All the assets and liabilities of the
transferor company become the
assets and liabilities of the
transferee company
company holding not less than
90% of the face value of equity
shares, including subsidiaries,
become the shareholders of the
transferee company
shareholders of the transferor
company should be paid through
issue of shares in the transferee
company. Fractional shares, if any,
can however be paid for in cash

The assets and liabilities of the

Transferee has the intention of
carrying on the business of the
target
transferor company are
incorporated into the balance
Combining companies must be
sheet of the transferee company.
autonomous
Also the assets and liabilities
should be shown using uniform
accounting policies

7
 Conditions for Amalgamation in the Nature
of Merger (AS 14)

Combining Single transaction Exchange of

companies must or transaction in common stock not
be independent one year less than 90%

No shares
No change in
No equity changes reacquired for
proportionate
in contemplation purpose of
equity interest
combination

8
 Conditions for Amalgamation in the Nature
of Merger (AS 14)

Combining may not agree

Voting rights immediately Combination resolved at to reacquire or retire any of
exercisable consummation the stock issued to effect
the combination

Combined company may

Combined company may
not plan to dispose of
not enter into any
substantial amounts of
agreement for the benefit
assets of the combining
of former shareholders of
companies within two
the combining companies
years of combination

9
 Identifying Acquirer

Power to cast Ability to

Power to appoint
>1/2 voting rights majority of voting determine
or remove
in combined entity in meetings of combine entities
majority of BOM
BOD management team

Fair value of Terms of Specific voting

Other conditions
companies arrangements rights provided

Statutory Options or
requirements warrants on issue

10
Intangible Asset Classification and Impairment
Test Requirements

Intangible Assets

Indefinite Useful Life Determinable Useful Life

No Amortization Amortization over useful

Required Life
Should do Impairment (Impairment test if
Testing (Annually or on indication of
Indication) impairment)

11
 Impairment Model
New Carrying
Amount (After
Written Down)
Lowest of…

Carrying
Recoverable
Amount Before
Amount
the Impairment

Highest of..

Price agreed in a binding sales agreement Requires cash flow

for cash-generating unit in an arm’s length forecast for atleast 5
transaction, adjusted for incremental costs Fair Value Less years, Estimated on
attributable to the disposal Value in Use present condition of the
Cannot be determined by reference to an
active market
Cost to Sell asset, and Cash flows
and discount rate should
be pre tax basis
12
 Example for Impairment Testing
Entity EY Assessing Cash Generating Unit CGU for Impairment
Assets in the Books of CGU (Thousand $)
PP&E 200
Licenses 50
Land (at Revalued Amount) 400 (Cost 320) • Goodwill is written off fully, and
cannot be reversed
Goodwill 50
• Entity EY analyses the remaining
Total 700 assets after wards

Through Impairment test CGU is found to have a recoverable amount of $550 • Impairment loss on land hits the
revaluation reserve – preferred
Assets in the Books of CGU (Thousand $) by the firm

PP&E 200 – 31 =169

Licenses 50-8=42
Land (at Revalued Amount) 400-61=339 (Cost 320)
Goodwill 50-50=0
Total 550
13
 Accounting for the Deal Value
• Assets
• Cash: 1,503
• Accounts receivable (net): 754
• Inventories: 544
• Other current assets: 960
• Property and equipment: 981
• Intangible assets: 4,509
• Goodwill (b): 5,458
• Other: 249
• Liabilities
• Current liabilities: (4,576)
• Long-term liabilities: (917)
• Cash Paid: (7,100)
• Convertible Notes (2,100)
• Unknown (plug): 265
• Total purchase price: 9.465

It could be that the $265 million is due to the cash payment noted in the narrative section of the
partial Note 9 disclosure of $7.1 billion and the convertible notes figure of $2.1 billion, both being
rounded figures, leaving the $265 million unexplained
Alternatively, that disclosure does state that the purchase price “consisted primarily of” the $7.1
billion cash and $2.1 billion convertible notes, so there may have also been some small amount of
other consideration given that equates to the $265 million or some additional liabilities assumed
 What are the Methods Available to
Mitigate Goodwill Hangover Problems?
Extend
Amortization Write Down the
period to Max. 40 Goodwill
years

Use Pooling
Method of
Accounting?

215
 Relevant Accounting Standards

Accounting
Standards

India International
International IFRS
Accounting
AS 14 3
Standard

FAS 142
IAS 22 FAS 141
IAS 36 Impairment IAS 38 Goodwill and
Business of Assets Business
Intangible Assets Other Intangible
Combination Combinations
Assets

225
Taxes in an M&A Transaction
Income tax
(Individuals
and
Corporations)

Real estate
Stamp duty
transfer tax

Real estate
Withholding
capital gains
tax
tax

Value Added Securities

Tax transfer tax

251
Amalgamation Terms under IT Act

Fulfill section 2(1B) of

Amount to be in the
Income tax act by No cash to be received
form of shares
transferor company

Foreign Direct
Fulfill section 72A of the
investments in selected Shareholders can not
IT act so as to reap the
sector can not exceed transfer their holdings
benefit by transferee
74% by foreign with in 5 years.
company
company

What are the losses can

Set off and carry
Sales tax at the rate of be carried forward and
forward of losses is
8% can not be avoided. set off? How many
possible.
years?

252
 Tax Related Benefits to Buyer

Deduction
Deduction Flexibility in
of the Multiple
of the taxation or tax
integration /
financing Reorganisatio
transaction privileges
costs (Debt n
costs
push down)

Capitalisatio Utilisation of Repayment of

n and losses purchase price Revaluation of
amortisation carried as quickly as the assets
of goodwill forward possible

257
Tax Impact Comparison
Asset Stock
Deal Deal
Tax exempt private
Gain subject to tax at capital gain
the level of seller (individuals) or
(corporation) participation relief
(corporation)

Liquidation proceed
But: Indirect partial
subject to tax at the
liquidation regime
level of shareholder

Amortisation of
goodwill and No goodwill
depreciation of other amortisation
assets possible

258
Tax Impact Comparison
Asset Stock
Deal Deal
Tax losses can not be
carried forward by Tax losses can be
buyer, but be used by carried forward by
seller to set off gain company
on sale

Higher initial financing

Lower initial financing
costs, but as a result
costs, but as a result
lower tax burden for
higher tax burden
buyer

Very limited debt

Tax efficient interest
push down
deduction
possibilities

259
 Rules for Claiming Tax Benefits on
Loss of Acquired

Amalgamated company
Accumulated losses 75% of book value to be
continues to hold 3/4th of
remain unabsorbed for 3 held atleast for 2 years
book value atleast for 5
or more years before amalgamation
years

New company should

New company should achieve atleast 50% of
continue for another 5 installed capacity before
years end of 5 years and should
continue for 5 years

260
Rules for Claiming Tax Benefits on
Loss of Acquired
Amalgamating company has
been in that business for at
least 3 years, and has held at
least 3/4th of book value of fixed
assets for 2 years
Amalgamated company to hold
least 3/4th of book value of fixed
assets of amalgamating
company for 5 years
Amalgamated company to
continue the business (all
businesses) of amalgamating
co. for at least 5 years
Amalgamated company to fulfill
such other conditions as may be
prescribed to ensure the revival
of business of amalgamating co.
or that amalgamation is for
genuine business purpose
261
 Value Terms

Fair Value • = (Net Asset value +Profit Earning Capacity Value)/2

• Year 1: (High + Low)/2

Average Market • Year 2: (High + Low)/2
• Current Year: Month wise Average
Price • Average Market Price is estimated in total for three years

• If MV not more than 20% of FV: 15%

Capitalization • If MV more than 20%-50% of FV: 12%
• If MV Between 51%-75% of FV: 10%
Rate • If MV above 75%: 8%

• Average P/E ratio of related companies are Considered to

PE Multiple discount

262
 Deal

Alternative Package consisting of 50,000 shares of Hardin

common stock and $400,000 of either cumulative preferred stock
with a 10% dividend or debentures with a 10% interest rates

Hardin to issue 100,000 shares for 40,000 shares of Pratt

Hardin Tool
Company
New public offering of 100,000
shares of Hardin can be made
public at $8 per share
Pratt Engineering
No inter company transactions Company
Appraised value of Net Assets: $600,000
Asset’s book value: $441,000

283
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Assets
Current assets $432 $246 39% 44%
Plant and equipment 690 312 61% 56%
Total assets $1,122 $558 100% 100%
Liabilities and Equities
Current liabilities $263 107 23% 19%
Long-term debt 195 10 17% 2%
Common stock ($1 par) 100 40 9% 7%
Additional paid-in capital 218 94 19% 17%
Retained earnings 346 307 31% 55%
Total liabilities and equity $1,122 $558 100% 100%285
 Pooling vs. Purchase Method

Condensed Income Statement as of the Proposed Acquisition Date

(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Sales $2,100 1500 100% 100%
Expenses 1620 1120 77% 75%
Income $480 $380 23% 25%
Income tax expense 168 133 8% 9%
Net income $312 $247 15% 16%

286
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
Hardin Pratt Pooling Purchase
Assets
Current assets $432 $246 $678 $678
Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441)
Goodwill 200 (100,000*8=800,000)-$600,000
Total assets $1,122 $558 $1,680 $2,039
Liabilities and Equities
Current liabilities $263 107 $370 $370
Long-term debt 195 10 $205 $205
Common stock ($1 par) 100 40 $200 $200
Additional paid-in capital 218 94 $252 $918 plug in
Retained earnings 346 307 $653 346
Total liabilities and equity $1,122 $558 $1,680 $2,039
287
 Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed
Hardin Pratt Polling Purchase
Sales $2,100 1500 $3,600 $3,600
Expenses 1620 1120 $2,740 $2,740
Income $480 $380 $860 $860
Additional depreciation $16 $159,000/10 years = 16,000
Taxable income $860 $844
Income tax expense $301.0 $295.4
Net income $559.0 $548.6
Earnings Per Share $2.80 $2.74
Life of plant and equipment: 10 years
Depreciation method: Straight line depreciation 288
Income tax rate: 35%
 Alternative Methods
Equity Stock vs. Preferred Stock vs. Debentures
Equity Preferred Debentures
Unadjusted income $860 $860 $860
Additional depreciation 16 16 16
Additional interest 40
Taxable income $844 $844 $804
Income tax expense $295.40 $295.40 $281.40
Net income $548.60 $548.60 $522.60
Preferred dividend $40
Income available to common stock $548.60 $508.60 $522.60
EPS (150,000 shares for preferred Pooling on
and debetntures and 200,000 Equity
shares for equity) $2.74 $3.39 $3.48 Exchange
Debt/equity 14.00% 14.00% 56.86% 18.55%
ROE (Common) 37.50% 47.84% 49.15% 50.59%
289
 Criteria for Pooling of Interest Accounting

Combining companies must Combining companies must Single transaction or Exchange of common stock
be autonomous be independent transaction in one year not less than 90%

No equity changes in No shares reacquired for No change in proportionate Voting rights immediately
contemplation purpose of combination equity interest exercisable

Combined company may not Combined company may not

Combining may not agree to
enter into any agreement for plan to dispose of substantial
Combination resolved at reacquire or retire any of the
the benefit of former amounts of assets of the
consummation stock issued to effect the
shareholders of the combining companies within
combination
combining companies two years of combination

294
 Identifying Acquirer

Power to cast Ability to

Power to appoint
>1/2 voting rights majority of voting determine
or remove
in combined entity in meetings of combine entities
majority of BOM
BOD management team

Fair value of Terms of Specific voting

Other conditions
companies arrangements rights provided

Statutory Options or
requirements warrants on issue

298
Intangible Asset Classification and Impairment
Test Requirements

Intangible Assets

Indefinite Useful Life Determinable Useful Life

No Amortization Amortization over useful

Required Life
Should do Impairment (Impairment test if
Testing (Annually or on indication of
Indication) impairment)

308
 Impairment Model
New Carrying
Amount (After
Written Down)
Lowest of…

Carrying
Recoverable
Amount Before
Amount
the Impairment

Highest of..

Price agreed in a binding sales agreement Requires cash flow

for cash-generating unit in an arm’s length forecast for atleast 5
transaction, adjusted for incremental costs Fair Value Less years, Estimated on
attributable to the disposal Value in Use present condition of the
Cannot be determined by reference to an
active market
Cost to Sell asset, and Cash flows
and discount rate should
be pre tax basis
309
 Example for Impairment Testing
Entity EY Assessing Cash Generating Unit CGU for Impairment
Assets in the Books of CGU (Thousand $)
PP&E 200
Licenses 50
Land (at Revalued Amount) 400 (Cost 320) • Goodwill is written off fully, and
cannot be reversed
Goodwill 50
• Entity EY analyses the remaining
Total 700 assets after wards

Through Impairment test CGU is found to have a recoverable amount of $550 • Impairment loss on land hits the
revaluation reserve – preferred
Assets in the Books of CGU (Thousand $) by the firm

PP&E 200 – 31 =169

Licenses 50-8=42
Land (at Revalued Amount) 400-61=339 (Cost 320)
Goodwill 50-50=0
Total 550
310
 Accounting Treatment of Good Will
Country Predominant Method Comments
US Caiptalize Amortize expense over useful life (not to exceed 40 years)
UK Write against RE May capitalize if life known
Canada Caiptalize if > 40 years Amortize expense over useful life
Japan Capitalize; Price - Book Value of net assets Amortize in life (not to exceed 5 years)
France Capitalize Amortize expense over 5 to 20 years
Germany Capitalize Amortize expense over 4 years (can extend if justified)
Switzerland Both write against RE and capitalize allowed Amortize
Netherlands Both write against Equity or as expenses Amortize expense over 5 years (can extend to 10 if justified)
Hong Kong Both write against Equity or as expenses Amortize only to the extent the value has diminished
Australia Capitalize Amortize in life (not to exceed 20 years)
Malaysia Capitalize Amortize expense over useful life
Goodwill arises from purchase m ethod
Goddwill = Purchase price > fair v alue of net assets
Am ortization of goodwill m ay not be tax deductible unless its allowed

312
 Impairment of Assets Differences
Difference Criterion
Timing of impairment review
Asset is Impaired if
Recoverable Amount / Fair
Value
Cash Flows for calculating
value in use / fair value
Reversal of impairment loss
313
IFRS and IGAAP US GAAP
Annually whenever events or changes in
circumstances indicate that the
carrying amount may not be
recoverable
Recoverable amount < Fair value < Carrying amount
Carrying amount
Recoverable amount is Fair Value is the amount at which
higher of an asset or liability could be
 Net Selling Price bought or settled in a current
transaction between willing
 Value in use
parties
Use discounted cash Use undiscounted cash flows for
flows for calculating the calculating the fair value
value in use
Whenever there is a Prohibited
change in the economic
conditions
Taxes in an M&A Transaction
Income tax
(Individuals
and
Corporations)

Real estate
Stamp duty
transfer tax

Real estate
Withholding
capital gains
tax
tax

Value Added Securities

Tax transfer tax

318
Amalgamation Terms under IT Act
Fulfill section 2(1B) of
Amount to be in the
Income tax act by No cash to be received
form of shares
transferor company

Foreign Direct
Fulfill section 72A of the
investments in selected Shareholders can not
IT act so as to reap the
sector can not exceed transfer their holdings
benefit by transferee
74% by foreign with in 5 years.
company
company

What are the losses can

Set off and carry
Sales tax at the rate of be carried forward and
forward of losses is
8% can not be avoided. set off? How many
possible.
years?

319
Rules for Claiming Tax Benefits on
Loss of Acquired
Accumulated losses remain unabsorbed for 3 or more years

75% of book value to be held atleast for 2 years before amalgamation

Amalgamated company continues to hold 3/4th of book value atleast for 5

years

New company should continue for another 5 years

New company should achieve atleast 50% of installed capacity before end of 5
years and should continue for 5 years

327
Rules for Claiming Tax Benefits on Loss of
Acquired

Amalgamating company has been in that business for at least 3 years, and has held at least 3/4th
of book value of fixed assets for 2 years

Amalgamated company to continue the business (all businesses) of amalgamating co. for at
least 5 years

Amalgamated company to hold least 3/4th of book value of fixed assets of amalgamating
company for 5 years

Amalgamated company to fulfill such other conditions as may be prescribed to ensure the revival
of business of amalgamating co. or that amalgamation is for genuine business purpose

328