Business Combinations

Business CombinationsChapter 9

Business CombinationsA business combination occurs When two or more separate businesses join into a single accounting entity.

Business Combinations

Business CombinationMergerAcquisitionsConsolidation

Reasons for Business Combinations

Lower riskFewer operating delaysAvoidance of takeoversAcquisition of intangible assetsOther reasons

The concept emphasizes the creation of asingle entity and the independence of thecombining companies before their union.Dissolution of the legal entity is notnecessary within the accounting concept.Concept of Business Combination

Concept of Business Combination

Single Management

Concept of Business Combination

One or more corporations become subsidiaries.One company transfers its net assets to another.Each company transfers its net assetsto a newly formed corporation.

Acquisition of ControlControl by another company may be achieved by either acquiring the assets of the target company or acquiring the controlling interest.

Acquisition of ControlAcquisition 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.

Acquisition of ControlStock 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 CombinationsPurchase 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 LiabilitiesAs 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 ConsiderationIt 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 CostThe 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 CostWhen 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 PaidPrice 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 MethodPoppy Corporation issues 100,000 shares of$10 par common stock for the net assets ofSunny Corporation in a purchase combinationon July 1, 2003.The market price of the said shares is $16 per share.

Applying Acquisition Method

Additional Direct Costs:SEC fees$ 5,000Accounting fees$ 10,000Printing and issuing $ 25,000Finder and consulting$ 80,000

How is the issuance recorded?

Applying Acquisition Method

Investment in Sunny80,000Additional Paid-in Capital40,000Cash (other assets) 120,000

To record additional direct costs of combiningwith Sunny: $80,000 finders and consultantsfees and $40,000 for registering and issuingequity securities.

Applying Acquisition Method

The total cost to Poppy of acquiringSunny is $1,680,000.

This is the amount entered into theinvestment in the Sunny account.

GoodwillGoodwill is an intangible asset that ariseswhen the purchase price to acquire asubsidiary company is greater thanthe sum of the market value of thesubsidiarys assets minus liabilities.

Cost Allocation in a PurchaseBusiness Combination

Determine the fair values of all identifiabletangible and intangible assets acquiredand liabilities assumed.

FASB Statement No. 141 provides guidelines for assigning amounts to specific categoriesof assets and liabilities.

Cost Allocation in a PurchaseBusiness Combination

No value is assigned to goodwill recordedon the books of an acquired subsidiary.

Why?

Such goodwill is an unidentifiable assetGoodwill resulting from thecombination is valued directly.

Recognition and Measurement ofIntangible Assets Other than Goodwill

Recognizable intangiblesSeparabilitycriterionContractual-legal criterion

Contingent Consideration in aPurchase Business Combination

Contingent consideration that is determinableat the date of acquisition is recorded aspart of the cost of combination.

Future earningslevelSecurity prices

Contingent Consideration in aPurchase Business Combination

CompareInvestment costTotal fair value ofidentifiable assetsless liabilitiesWith

Cost and Fair Value Compared

Investment costNet fair value>IfGoodwill2Allocate toIdentifiable netassets accordingto their fair value1

Illustration of a PurchaseCombination

Pitt Corporation acquires the net assets ofSeed Company on December 27, 2003.

PittSeed

Illustration of a PurchaseCombination

Book ValueAssetsCash$ 50$ 50Net receivables 150 140Inventories 200 250Land 50 100Buildings, net 300 500 Equipment, net 250 350Patents 50Total assets $ 1,000 $ 1,440Fair Value

Illustration of a PurchaseCombination

Book ValueLiabilitiesAccounts payable $ 60$ 60 Notes payable 150 135Other liabilities 40 45Total liabilities $250$ 240Net assets$ 50$ 1,200

Fair Value

Illustration of a PurchaseCombination

Pitt pays $400,000 cash and issues 50,000shares of Pitt Corporation $10 par commonstock with a market value of $20 per share.50,000 $10 = $500,000

Goodwill

Illustration of a PurchaseCombination

Investment in Seed1,400,000Cash400,000Common Stock500,000Additional Paid-in Capital500,000To record issuance of 50,000 shares of $10 parcommon stock plus $400,000 cash in a purchasebusiness combination with Seed Company

Illustration of a PurchaseCombination

Accounts payable 60Notes payable 135Other liabilities 45Investment in Seed Company1,400$1640 1,440 = 200Cash 50Net receivable140Inventories250Land 100Buildings, net500Equipment, net350Patents 50DebitGoodwill200Credit

Illustration of a PurchaseCombination

Negative GoodwillPitt issues 40,000 shares of its $10 par commonstock with a market value of $20 per share andalso gives a 10%, five-year note payable for$200,000 for the net assets of Seed Company.40,000 $10 = $400,000

Illustration of a PurchaseCombination

Investment in Seed1,000,000Common Stock400,000Additional Paid-in Capital400,00010% Note Payable200,000To record issuance of 40,000 shares of $10 parcommon stock plus $200,000, 10% note in apurchase business combination with Seed Company

Illustration of a PurchaseCombination

1,200,000 fair value is greater than $1,000,000purchase price by $200,000.

Amounts assignable to assets are reduced by 20%.

Recognizing and MeasuringImpairment Losses

Carrying valuesCompareFair valuesStep One

Cost and Fair Value Compared

Fair valueCarrying amount