Business Combination

Business Combinations
Chapter 1
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1-1
Learning Objective 1
Understand the economic

motivations underlying
business combinations.
A business combination occurs when

two or more separate businesses join
into a single accounting entity.
Reasons for Business
Combinations
Cost advantage
Lower risk
Fewer operating delays
Avoidance of takeovers
Acquisition of intangible assets
Other reasons
Learn about the alternative

forms of business combinations,
from both the legal and
accounting perspectives.
The Legal Form of
Business Combination
Acquisitions
Merger Consolidation
The Legal Form of
A B
A
Merger
The Legal Form of
A B
C
Consolidation
The Accounting Concept of
The concept emphasizes the creation of a

single entity and the independence of the
combining companies before their union.
Dissolution of the legal entity is not
necessary within the accounting concept.
Single management
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 10

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.

Background on Accounting for
Much of the controversy concerning accounting

requirements for business combinations historically
involved the pooling of interest method.
ARB No. 40 introduced an alternative method:
the purchase method.

Until 2001, accounting requirements for business

combinations were found in APB Opinion No. 16.
APB No. 16 recognized both the pooling
and purchase methods.

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.

Understand alternative
approaches to the financing
of mergers and acquisitions.

Pooling Method
Pooling uses historical book values to record

combinations rather than recognizing fair
values of net assets at the transaction date.
Most of the detailed issues related to poolings
concern the original recording of the combination.

Purchase Method
Purchase accounting requires the recording

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

Introduce concepts of accounting

for business combinations
emphasizing the purchase method.

Accounting for Business
Combinations
Under the Purchase Method
Poppy Corporation issues 100,000 shares of

$10 par common stock for the net assets of
Sunny Corporation in a purchase combination
on July 1, 2003.
The market price of Poppy is $16 per share

Combinations
Additional direct costs:
SEC fees $ 5,000

Accounting fees $10,000
Printing and issuing $25,000
Finder and consulting $80,000
How is the issuance recorded?

Combinations
Investment in Sunny 1,600,000
Common Stock, $10 par 1,000,000
Additional Paid-in Capital 600,000
To record issuance of 100,000 shares of $10 par
common stock with a market value of $16 per share
in a purchase business combination with Sunny.
How are the additional direct costs recorded?

Combinations
Investment in Sunny 80,000
Cash (other assets) 120,000
To record additional direct costs of combining
with Sunny: $80,000 finder’s and consultants’
fees and $40,000 for registering and issuing
equity securities.

Combinations
The total cost to Poppy of acquiring
Sunny is $1,680,000.
This is the amount entered into the

investment in the Sunny account.

Goodwill
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
subsidiary’s assets minus liabilities.

See how firms make cost

allocations in a purchase
method combination.

Cost Allocation in a Purchase
Determine the fair values of all identifiable

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

Cost Allocation in a Purchase
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.

Recognition and Measurement of
Intangible Assets Other than
Goodwill
Separability Contractual-
criterion legal criterion
Recognizable intangibles

Contingent Consideration in a
Purchase Business Combination
Contingent consideration that is determinable

at the date of acquisition is recorded as
part of the cost of combination.
Future earnings
Security prices
level

Cost and Fair Value Compared
Total fair value of

Investment cost identifiable assets
less liabilities

Investment cost > Net fair value
1 Identifiable net
assets according
to their fair value
2
Goodwill

Illustration of a Purchase
Combination
Pitt Corporation acquires the net assets of

Seed Company on December 27, 2003.
Pitt Seed

Combination
Book Fair
Value Value
Assets
Cash $ 50 $ 50
Net receivables 150 140
Inventories 200 250
Land 50 100
Buildings, net 300 500
Equipment, net 250 350
Patents 50
Total assets $1,000 $1,440
Combination
Book Fair
Value Value
Liabilities
Accounts payable $ 60 $ 60
Notes payable 150 135
Other liabilities 40 45
Total liabilities $250 $ 240
Net assets $ 50 $1,200

Combination
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

Combination
Investment in Seed 1,400,000

Cash 400,000
Common Stock 500,000
common stock plus $400,000 cash in a purchase
business combination with Seed Company

Combination
Cash 50 Accounts payable 60

Net receivable 140 Notes payable 135
Inventories 250 Other liabilities 45
Land 100 Investment in
Buildings, net 500 Seed Company 1,400
Equipment, net 350
Patents 50 $1640 – 1,440 = 200
Goodwill 200
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

Combination
Investment in Seed 1,000,000

Common Stock 400,000
10% Note Payable 200,000
common stock plus $200,000, 10% note in a
purchase business combination with Seed Company

Combination
Cash 50 Accounts payable 60

Net receivable 140 Notes payable 135
Inventories 250 Other liabilities 45
Land 80 Investment in
Buildings, net 400 Seed Company 1,000
Equipment, net 280
Patents 40

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.

Recognizing and Measuring
Impairment Losses
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.

End of Chapter 1

Business Combination

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Business Combination

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Business Combinations

Understand the economic

A business combination occurs when

Learn about the alternative

The concept emphasizes the creation of a

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 10

One or more corporations become subsidiaries.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 11

Much of the controversy concerning accounting

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 12

Until 2001, accounting requirements for business

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 13

FASB Statement No. 141 eliminated the

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 14

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 15

Pooling uses historical book values to record

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 16

Purchase accounting requires the recording

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 17

Introduce concepts of accounting

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 18

Poppy Corporation issues 100,000 shares of

The market price of Poppy is $16 per share

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 19

SEC fees $ 5,000

How is the issuance recorded?

How are the additional direct costs recorded?

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 22

This is the amount entered into the

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 23

Goodwill is an intangible asset that arises

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 24

See how firms make cost

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 25

Determine the fair values of all identifiable

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 26

No value is assigned to goodwill recorded

Such goodwill is an unidentifiable asset.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 27

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 28

Contingent consideration that is determinable

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 29

Total fair value of

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 30

Investment cost > Net fair value

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 31

Pitt Corporation acquires the net assets of

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 32

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 34

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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 35

Investment in Seed 1,400,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 36

Cash 50 Accounts payable 60

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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 38

Investment in Seed 1,000,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 39

Cash 50 Accounts payable 60

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 40

$1,200,000 fair value is greater than $1,000,000

Amounts assignable to assets are reduced by 20%.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 1 - 41