fischer11e ppt ch01

FISCHER | TAYLOR | CHENG

Business Combinations: New Rules for a Long-

Standing Business Practice

1

COPYRIGHT © 2012 South-Western/Cengage Learning 2

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. Understand that some non-publicly traded companies may use special rules that differ from the methods in this chapter.

9. Estimate the value of goodwill. (Appendix)


Economic Advantages of Combinations

• Types of mergers– Backward vertical integration– Forward vertical integration– Horizontal merger– Product extension merger– Market extension merger– Conglomerate merger


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


Acquisition of Control

• Acquire net assets– Acquire directly from target company– Assume liabilities– Payment in cash, debt, or equity

• Acquire controlling interest– Typically more than 50% of target’s voting common

stock– Creates parent/subsidiary relationship– Separate legal entities remain



• Defenses against unfriendly offers– Greenmail– White knight– Poison pill– Selling the crown jewels– Leveraged buyouts



• 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


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


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


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 acquiree’s 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


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

• Assets scheduled for sale are recorded at net realizable value



• Acquiree was the lessor 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:Excess of current payment over contractual amount $300Remaining term of lease (months) 60Annual discount rate 8%Asset (present value beginning mode) $14,894



• Acquiree acted as lessor – Leases retain their definition 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 separately recorded– Arises from contractual or other legal rights or is separable– Identify and record separately– Allows for recognition that acquiree was barred from recognizing



• 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


Applying the Acquisition Model

Bal Sheet

10/1/2011

Cash 40,000 book value 40,000 Marketable securities 60,000 L1 - market 66,000 Inventory 100,000 L1 - market 110,000 Land 30,000 L2 - adj mkt 72,000 Buildings (net) 150,000 L2 - adj mkt 288,000 Equipment (net) 80,000 L1 - market 145,000 Customer list L3 - other est 125,000 Current liabilities (25,000) book value (25,000) 8% 5-yr bonds (100,000) face (100,000) Premium on bond pay L2 - adj mkt (4,000) Warranty liability L3 - other est (12,000) $1 par common stock (10,000) Addn'l pd-in capital (140,000) Retained earnings (185,000)

-

fair value of net identifiable assets 705,000

FASB ASC 820-10-35

10/1/2011


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


Recording the Acquisition: Goodwill

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


Recording the Acquisition: Gain

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


Changes in ValueDuring 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



• 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



• Depreciation and amortization are adjusted retroactively


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


Recording Contingent Consideration

• Contingent consideration is additional stock– Treat as a change in estimate

• No liability is recorded on acquisition date• When triggers are met reassign the original

consideration assigned to the stock to a greater number of shares – Reduce additional paid-in capital– Record additional shares issued at par


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


Tax Issues: Tax Loss Carryovers

• On date of acquisition– Value of expected future tax loss carryovers is

recorded as a deferred tax asset (DTA)– Allowance for Unrealizable Tax Assets recorded to

reduce the DTA to the estimated realizable amount

• DTA fully offset by valuation account increases goodwill

• Within the measurement period– Valuation account adjustment– Goodwill adjustment


Tax Issues: Tax Values in an Acquisition

Limitations on value in a taxable exchange:Fair value of plant asset $90,000Tax value (accelerated depreciation) (50,000)Excess not deductible 40,000Tax rate 40%Deferred tax liability (DTL) $16,000

DTL is amortized to current tax liability over the depreciable life of the asset.


Tax Issues: Nontaxable Exchange

• Acquirer’s deductions for amortization and depreciation are limited to book value of acquiree

• All accounts are recorded at full fair value

Difference Results in

Fair value of identifiable asset exceeds book value

DTL

Book value of identifiable asset exceeds fair value

DTA

Fair value of liability exceeds book value DTA

Book value of liability exceeds fair value DTL


Goodwill Impairment

Test: Goodwill is impaired if estimated value of business unit is less than remaining book value of net assets (including goodwill).

New goodwill estimate:Estimated value of business unit

– New estimate of identifiable net assets at fair value= New goodwill estimate

Impairment Loss:Book value of goodwill

– New goodwill estimate= Impairment loss


Impairment: Example

Recorded $100,000 goodwill in purchase three years ago.

Now:

Net assets at book value $650,000

Fair value of the business unit$625,000

Fair value net identifiable assets

(not including goodwill) $580,000


Impairment Calculations

Test

Estimated value of business unit $625,000Book value ofassets (includinggoodwill) 650,000Excess book $25,000

Goodwill is impaired

Adjustment

Estimated value of business unit $625,000Fair value ofidentifiable assets,not including GW 580,000New GW estimate 45,000GW book value 100,000Impairment loss $55,000


Special Methods for Smaller Companies

IABS’s standards for small and medium-sized entities (SMEs)

– Available to companies that issue financial statements to external users but do not have publically traded debt or equity.

• Acquisition-related costs: include in purchase cost

• Goodwill: amortized over 10 years or another reliable estimate period


Appendix: Estimating Goodwill

• Goodwill is based on expectation of excess earnings– Forecast future continuing income– Estimate “normal” income of the entity

• Models using excess earnings to estimate goodwill– Excess earnings in perpetuity– Excess earnings for a given number of years

• Non-discounted• Discounted

fischer11e ppt ch01

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