act610-chapter1

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

to accompanyAdvanced Accounting, 11th edition

by Beams, Anthony, Bettinghaus, and Smith

Chapter 1:

Business Combinations

1-1



A business combination is a transaction or event in which an acquirer obtains control of one or more businesses.

1-2


Business Combinations: Objectives

1. Learn about the alternative forms of business combinations, from both the legal and accounting perspectives.

2. Introduce concepts of accounting for business combinations, emphasizing the acquisition method.

3. See how firms record fair values of assets and liabilities in an acquisition.

1-3


Types of Business Combinations

Business combinations unite previously separate business entities.

Horizontal integration – same business lines and markets

Vertical integration – operations in different, but successive stages of production or distribution, or both

Conglomeration – unrelated and diverse products or services

1-4


Reasons for Combinations

Cost advantage Lower risk Fewer operating delays Avoidance of takeovers Acquisition of intangible assets

1-5


2: FORMS OF BUSINESS COMBINATIONS


1-6


Legal Form of Combination

Merger Occurs when one corporation takes over all the

operations of another business entity and that other entity is dissolved.

Consolidation Occurs when a new corporation is formed to take

over the assets and operations of two or more separate business entities and dissolves the previously separate entities.

1-7


Mergers: A + B = A

Company A acquires the net assets or the stock of Company B for cash, other assets, or Company A debt/equity securities. Company B is dissolved; Company A survives with Company B’s assets and liabilities.

1-8


Consolidations: E + F = “D”

Company D is formed and acquires the net assets or stock of companies E and F by issuing Company D stock.

Companies E and F are dissolved. Company D survives with the assets and

liabilities of both dissolved firms.

1-9


Keeping the Terms StraightIn the general business sense, mergers and

consolidations are business combinations and may or may not involve the dissolution of the acquired firm(s).

In Chapter 1, mergers and consolidations will involve only 100% acquisitions with the dissolution of the acquired firm(s). These assumptions will be relaxed in later chapters.“Consolidation” is also an accounting term used to

describe the process of preparing consolidated financial statements for a parent and its subsidiaries.

1-10


3: ACCOUNTING FOR BUSINESS COMBINATIONS


1-11


Business Combination (def.)

• A business combination is “a transaction or other event in which an acquirer obtains control of one or more businesses.

• A parent-subsidiary relationship is formed when: Less than 100% of the firm is acquired, or The acquired firm is not dissolved.

1-12


International Accounting

The International Accounting Standards Board requires the acquisition method for business combinations.

1-13

Definition of Book Value

The value at which an asset is carried on a balance sheet. To calculate, take the cost of an asset minus the accumulated depreciation.

The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 1-14

Definition of Fair Value

fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset or commodity. It is the amount at which the asset could be bought or sold in a current transaction between willing parties, or transferred to an equivalent party, other than in a liquidation sale.


http://en.wikipedia.org/wiki/Prediction

http://en.wikipedia.org/wiki/Market_price

Definition of GoodWill

An account that can be found in the assets portion of a company's balance sheet.

Goodwill can often arise when one company is purchased by another company.

In an acquisition, the amount paid for the company over book value usually accounts for the target firm's intangible assets. (strong brand name, good customer relations, good employee relations etc…)



Recording Guidelines (1 of 2)

Record assets acquired and liabilities assumed using the fair value principle.

If equity securities are issued by the acquirer, charge registration and issue costs against the fair value of the securities issued, usually a reduction in additional paid-in-capital.

Charge other direct combination costs (e.g., legal fees, finders’ fees) and indirect combination costs (e.g., management salaries) to expense.

1-17


Recording Guidelines (2 of 2) The excess of cash, other assets, debt, and

equity securities transferred over the fair value of the net assets (A – L) acquired is recorded as goodwill.

If the net assets acquired exceeds the cash, other assets, debt, and equity securities transferred, a gain on the bargain purchase is recorded in current income.

1-18


Example: Pop Corp. (1 of 3)

Investment in Son Corp. (+A) 1,600 Common stock, $10 par (+SE) 1,000 Additional paid-in-capital (+SE) 600

1-19

Pop Corp. issues 100,000 shares of its $10 “par” value common stock for Son Corp.

Pop’s stock is valued at $16 per share. (in thousands)



Investment expense (E, -SE) 80 Additional paid-in-capital (-SE) 40 Cash (-A) 120

1-20

Pop Corp. pays cash for $80,000 in finder’s and consulting fees and for $40,000 to register and issue its common stock. (in thousands)



Receivables (+A) XXX Inventories (+A) XXX Plant assets (+A) XXX Goodwill (+A) XXX Accounts payable (+L) XXX Notes payable (+L) XXX Investment in Son Corp. (-A) 1,600

1-21

Son Corp. is assumed to have been dissolved. So, Pop Corp. allocates the investment’s cost to the fair value of the identifiable assets acquired and liabilities assumed. The excess cost is goodwill.


4: RECORDING FAIR VALUE USING THE ACQUISITION METHOD


1-22


Identify the Net Assets Acquired

Identify: Tangible assets acquired, Intangible assets acquired, and Liabilities assumed

Include: Identifiable intangibles resulting from legal or

contractual rights Research and development in process

1-23


Example – Pit Corp. Data

Pit Corp. acquires the net assets of Sad Co. in a combination consummated on 12/27/2011.

The assets and liabilities of Sad Co. on this date, at their book values and fair values, are as follows (in thousands):

1-24


SAD CORP.

1-25

Book Val. Fair Val.Cash $50 $50Net receivables 150 140Inventory 200 250Land 50 100Buildings, net 300 500Equipment, net 250 350Patents 0 50 Total assets $1,000 $1,440Accounts payable $60 $60Notes payable 150 135Other liabilities 40 45 Total liabilities $250 $240Net assets $750 $1,200


Acquisition with Goodwill

Pit Corp. pays $400,000 cash and issues 50,000 shares of Pit Corp $10 par common stock with a market value of $20 per share for the net assets of Sad Co.

Total consideration at fair value (in thousands):$400 + (50 shares x $20) $1,400

Fair value of net assets acquired: $1,200Goodwill $ 200

1-26


Entries with Goodwill

The entry to record the acquisition of the net assets:

1-27

Investment in Sad Co. (+A) 1,400 Cash (-A) 400 Common stock, $10 par (+SE) 500 Additional paid-in-capital (+SE) 500


Cash (+A) 50 Net receivables (+A) 140 Inventories (+A) 250 Land (+A) 100 Buildings (+A) 500 Equipment (+A) 350 Patents (+A) 50 Goodwill (+A) 200 Accounts payable (+L) 60 Notes payable (+L) 135 Other liabilities (+L) 45 Investment in Sad Co. (-A) 1,400

1-28

The entry to record Sad’s assets directly on Pit’s books:


Acquisition with Bargain PurchasePit Corp. issues 40,000 shares of its $10 par common stock with a market value of $20 per share, and it also gives a 10%, five-year note payable for $200,000 for the net assets of Sad Co.

1-29

Fair value of net assets acquired (in thousands) $1,200

Total consideration at fair value (40 shares x $20) + $200 $1,000Gain from bargain purchase $200


Entries with Bargain Purchase

The entry to record the acquisition of the net assets:

1-30

Investment in Sad Co. (+A) 1,000 10% Note payable (+L) 200 Common stock, $10 par (+SE) 400 Additional paid-in-capital (+SE) 400


Cash (+A) 50 Net receivables (+A) 140 Inventories (+A) 250 Land (+A) 100 Buildings (+A) 500 Equipment (+A) 350 Patents (+A) 50 Accounts payable (+L) 60 Notes payable (+L) 135 Other liabilities (+L) 45 Investment in Sad Co. (+A) 1,000 Gain from bargain purchase (G, +SE) 200

1-31

The entry to record Sad’s assets directly on Pit’s books:


5: OTHER ISSUES: IMPAIRMENTS, DISCLOSURES, AND THE SARBANES-OXLEY ACT


1-32


Goodwill Controversies

Capitalized goodwill is the purchase price not assigned to identifiable assets and liabilities.

Errors in valuing assets and liabilities affect the amount of goodwill recorded.

Historically goodwill in most industrialized countries was capitalized and amortized.Current IASB standards, like U.S. GAAP

Capitalize goodwill, Do not amortize it, and Test it for impairment

1-33


Goodwill Impairment Testing

Firms must test for the impairment of goodwill at the business unit reporting level.

Step 1: Compare the unit’s net book value to its fair value to determine if there has been a loss in value.

Step 2: Determine the implied fair value of the goodwill, in the same manner used to originally record the goodwill, and compare that to the goodwill on the books.

Record a loss if the implied fair value is less than the carrying value of the goodwill.

1-34


When to Test for Impairment

Goodwill should be tested for impairment at least annually. More frequent testing may be needed if:Significant adverse change in business

Adverse action by regulator Unanticipated competition Loss of key personnel

Impairment or expected disposal losses of: Reporting unit or part of one Significant long-lived asset group Subsidiary

1-35


Business Combination Disclosures

Business combination disclosures include, but are not limited to:

Reason for combination, Nature and amount of consideration, Allocation of purchase price among assets and

liabilities, and Goodwill or gain from bargain purchase

1-36


PROBLEMS

1-37


1-38


1-39


1-40

act610-chapter1

Documents

pearson education

prentice hall1

business entity

business lines

business combinations

separate business entities

dissolved company

company bs assets