CHAPTER 5THE PURCHASE

METHOD:AT DATE OF

ACQUISITION—100% OWNERSHIP

FOCUS OF CHAPTER 5• The Purchase Method in Depth:

– Total Acquisition Cost– Goodwill and Bargain Purchase

Elements– Consolidation Worksheets—At the

Acquisition Date:• Acquiring Assets vs. Common Stock• Non-Push-Down Accounting• Push-Down Accounting (a preview)

The Purchase Method: Items That Can Comprise The Acquirer’s Cost

• CATEGORY #1: The fair value of the consideration given.

• CATEGORY #2: Certain out-of-pocket direct costs—must be directly traceable to the specific acquisition.

• CATEGORY #3: Contingent consideration —will be paid subsequent to the acquisition date (if paid at all).

Acquirer’s Cost: Category 1—The Consideration Given

• Types of Consideration: In purchase accounting, the consideration given can be of any type:– Cash.– Common stock. – Preferred stock.– Notes or Bonds Payable.– Used trucks.

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Acquirer’s Cost: Category 1—The Consideration Given

• General Rule: – Use the FMV of the consideration given.

• Exception: – Use the FMV of the property received if

it is more readily determinable.

Acquirer’s Cost: Category 2—Certain Direct Costs

• Must Be Traceable to The Acquisition:– Legal fees—the acquisition agreement.– Purchase investigation fees.– Finder’s fees.– Travel costs.– Professional consulting fees.

• NO allocation allowed of G&A overhead.• NO direct costs of issuing stock (charge to APIC).

Acquirer’s Cost: Category 3—Contingent Consideration

• Contingencies Based on Other Than Security Prices: – Accrue when it becomes “determinable

beyond a reasonable doubt.”– This point in time is later than the

“probable date.”– The cost of the acquisition is increased

in later periods when the accrual is actually made (usually increases goodwill).

Acquirer’s Cost: Category 3—Contingent Consideration

• Contingencies Based on Security Prices (to be maintained or attained):– CANNOT result in an increase at a later

date in the initially recorded cost of the acquisition.• Use the security price to be

maintained or attained to record the acquisition.

–This price is the true bargained cost of the acquisition.

Goodwill Vs. A Bargain Purchase Element: Can Have ONE But Not BOTH

• Cost in excess of Current Value = • Current Value in excess of Cost =• Current Value equals Cost = Neither GW

nor BPE

GWBPE

Goodwill: What to Do With It?• GOODWILL—Usually Exists When Acquiring a

Winner or a Potential Winner:– Must capitalize as an asset.– Cannot amortize to earnings.– Must periodically (at least annually)

assess for impairment.– If impaired, must write it down—charge

to earnings.

Bargain Purchase Element:What to Do With It?

• BARGAIN PURCHASE ELEMENT—Usually Exists When Acquiring a Troubled Company:

– Extinguish against certain specified assets to extent possible.

– Any unextinguished amount is credited to earnings—reported as an extraordinary item.

Push-Down Accounting:The EASIER Way

• Push-Down Accounting (an absolute gem):– In the subsidiary’s general ledger:

• Adjust assets and liabilities to FVbased on the parent’s purchase price.

–This establishes a new basis of accounting.

• Record goodwill.Discussed in depth in Chapter 7.

Nonpush-Down Accounting:The HARDER Way

• Non-Push-Down Accounting:– Don’t touch the subsidiary’s general

ledger (treat like a “sacred cow”).

– Make fair value adjustments and record goodwill in consolidation (on the worksheets).

Consolidation Consequences:Push-Down Vs. Non-Push-Down

• Push-Down Accounting:– Consolidation effort is minimal (has

received the “Better Book-keeping” stamp of approval).

• Non-Push-Down Accounting:– Consolidation effort is cumbersome

(often a headache).

Push-Down Vs. Non-Push-Down Accounting: The Bottom Line

• The consolidated financial statement amounts are the SAME whether the parent selects:– Push-down accounting or– Non-push-down accounting.

• ONLY the accounting procedures differ.

Intangible Assets: More of Them Are Recognized under FAS 141

• Record at fair value only if either of the following two criteria are met:

#1: Intangible arises from a legal or contractual right.

#2: Intangible does not arise from a legal or contractual right but is

separable.

Identifiable Intangible Assets• Marketing-related:

– Trademarks, service marks– Trade dress (unique package color or

design)– Non-compete agreements

Identifiable Intangible Assets• Customer-related:

– Customer lists– Customer order backlog– Customer contracts– Customer relationships

Identifiable Intangible Assets• Technology-based:

– Secret formulas, processes, recipes– Patented and unpatented technology

• Contract-based:– Licensing, royalties– Advertising, supply contracts

• Artistic-related:– Video and audiovisual material– Pictures and photographs

Review Question #1What results for each of the following situations?

Unable Goodwill BPE To Tell

CV > BV……..CV < BV……..CV > Cost……CV < Cost……BV = Cost..…..

Review Question #1With Answer

What results for each of the following situations?

Unable Goodwill BPE To Tell

CV > BV…….. X CV < BV…….. XCV > Cost…… XCV < Cost…… XBV = Cost..….. X

Review Question #2What results for each of the following situations?

Unable Goodwill BPE To Tell

Cost > BV…....Cost < BV…....Cost > CV..…..Cost = CV..…..CV = BV……....

Review Question #2With Answer

What results for each of the following situations?

Unable Goodwill BPE To Tell

Cost > BV….... XCost < BV….... X Cost > CV..….. X Cost = CV..….. CV = BV…….... X

Review Question #3A form of consideration that is NOT allowed in purchase accounting is:

A. Cash.B. Bonds.C. Preferred stock.D. Common stock.E. None of the above.

Review Question #3With Answer

A form of consideration that is NOT allowed in purchase accounting is:

A. Cash.B. Bonds.C. Preferred stock.D. Common stock.E. None of the above.

Review Question #4Which of the following costs CANNOT be added to the cost of an acquisition?

A. Legal fees.B. Accounting fees.C. Costs of issuing common stock.D. A pro rata portion of the CEO’s salary.E. Travel costs.F. Costs of the M&A department.

Review Question #4With Answer

Which of the following costs CANNOT be added to the cost of an acquisition?

A. Legal fees.B. Accounting fees.C. Costs of issuing common stock.D. A pro rata portion of the CEO’s

salary.E. Travel costs.F. Costs of the M&A department.

Review Question #5An account of the acquired company that CANNOT be revalued to its current value under purchase accounting is:

A. Notes receivable.B. Bonds payable.C. Investment in marketable securities.D. Patents.E. None of the above.

Review Question #5With Answer

An account of the acquired company that CANNOT be revalued to its current value under purchase accounting is:

A. Notes receivable.B. Bonds payable.C. Investment in marketable securities.D. Patents.E. None of the above.

Review Question #6Push-down-accounting can be used:

A. Only in a goodwill situation.B. Only in a BPE situation.C. In either a goodwill situation or a BPE

situation.D. Only in a COST = CV situation.E. None of the above.

Review Question #6With Answer

Push-down-accounting can be used:

A. Only in a goodwill situation.B. Only in a BPE situation.C. In either a goodwill situation or a BPE

situation.D. Only in a COST = CV situation.E. None of the above.

Review Question #7The consolidated financial statements are identical regardless of whether the parent:

A. Uses push-down or non-push-down accounting.

B. Acquires 100% of the common stock or 100% of the assets.

C. Both A and B.D. Neither A or B.

Review Question #7With Answer

The consolidated financial statements are identical regardless of whether the parent:

A. Uses push-down or non-push-down accounting.

B. Acquires 100% of the common stock or 100% of the assets.

C. Both A and B.D. Neither A or B.

End of Chapter 5• Time to Clear Things Up—Any

Questions?