Chapter 9: Business Combination

Definition. A business combination occurs

When two or more separate businesses

join into a single accounting entity.

Reasons for Business Combinations

Lower risk Fewer operating delays Avoidance of takeovers Acquisition of intangible Other reasons

Concept of Business Combination

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.

Acquisition of Control

Control by another company may be

achieved by either acquiring the assets of

the target company or acquiring the

controlling interest.

Acquisition of Assets

- all of the companys assets are

acquired directly from the company. In

most cases, existing liabilities are also

assumed. Thus, the transaction is referred

to as acquisition of net assets.

Stock Acquisition

- a controlling interest (typically more than 50%) of another

companys voting stock is

acquired. The acquiring company

is termed as parent, while the

acquired company is subsidiary.

Methods of Business Combinations

- Purchase Method- all assets and liabilities of the acquired company

are usually recorded at fair

market value

- Pooling of Interest- recorded the assets and liabilities of the

acquired company at book value.

Note: IFRS 3 eliminated the pooling of

interest method.

Valuation of Assets and Liabilities

As a general rule, the assets and liabilities

of the acquired company are recorded at

their individually determined values that

is the quoted market value (or FMV). In

case when there is no active market value,

independent appraisals, discounted cash

flow analysis or other types of analysis

are used to estimate fair values.

Contingent Consideration

It is an agreement to issue additional

consideration (asset or stock) at a later

date if specified events occur. The most

common agreements focus on a targeted

sales or income performance by the

acquire company. It is measured at its

acquisition date fair value.

Acquisition Related Cost

The costs that acquirer incurs to effect a

business combination. Common examples

are brokers fees, legal and other

professional fees and general

administrative cost. These type of cost are

not included in the price of the company

acquired and are expensed outright.

Stock Issuance Cost

When the acquirer issued shares of stocks

for the net assets of subsidiary company

such as SEC registration fees,

documentary stamp tax and newspaper

publication fees are treated as a deduction

from the additional paid-in capital. In

case APIC is reduced to zero, the

remaining stock issuance cost is treated as

contra account from retained earnings.

Price Paid

Price paid exceeds the fair values of net assets (FVNA). The excess is the

new goodwill. The goodwill recorded

is not amortized but is impairment

tested in future accounting records.

Price paid is less than FVNA. In this case, there is bargain purchase

occurred. The excess of FVNA is

recorded as gain on the acquisition

by the acquirer.

Applying Acquisition 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 the said shares is $16

per share.

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?

To record additional direct costs of

combining with Sunny: $80,000 finders

and consultants fees and $40,000 for

registering and issuing equity securities.

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 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

subsidiarys assets minus liabilities.

Cost Allocation in a Purchase

Business Combination

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.

No value is assigned to goodwill recorded

on the books of an acquired subsidiary. It

is because such goodwill is an

unidentifiable asset. Goodwill resulting

from the combination is valued directly.

Recognition and Measurement of

Intangible Assets Other than Goodwill

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.

Illustration

Pitt Corporation acquires the net assets of

Seed Company on December 27, 2003.

Additional Information: Pitt pays

$400,000 cash and issues 50,000shares of

Pitt Corporation $10 par common stock

with a market value of $20 per share. So,

50,000 $10 = $500,000.

1,200,000 fair value is greater than

$1,000,000 purchase price by $200,000.

Therefore, amounts assignable to assets

are reduced by 20%.

Recognizing and Measuring

Impairment Losses

Amortization versus

Non-amortization

Amortization: Firms must amortize

intangible assets with a finite useful life

over that life.

Non-amortization: Firms will not

amortize intangible assets with an

indefinite useful life that cannot be

estimated.