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Business Combinations

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Separate organizations tied together through common control under common management are combined into a single entity.

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Reasons Firms Combine

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Vertical integration Cost savings Quick entry into new markets Economies of scale More attractive financing opportunities Diversification of business risk Business Expansion Increasingly competitive environment Expansion through Corporate Takeovers

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The company that exerts control is known as the

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parents

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and the separate controlled companies are known as

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subsidaries

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Financial statements that represent a parent and its subsidiaries as a SINGLE ENTITY are known as

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"consolidated" FS

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Which of the following does not represent a primary motivation for business combinations? Combinations as a vehicle for achieving rapid growth and competitiveness Cost savings through elimination of duplicate facilities and staff Quick entry for new and existing products into markets Larger firms being less likely to fail.

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Larger firms being less likely to fail.

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Which of the following is the best theoretical justification for consolidated financial statements? In form the companies are one entity; in substance they are separate In form the companies are separate; in substance they are one entity. In form and substance the companies are one entity In form and substance the companies are separate

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In form the companies are separate; in substance they are one entity.

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The Consolidation Process

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statements provide more meaningful information than separate statements more fairly present the activities of the consolidated companies. may retain their legal identities as separate corporations.

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Business combinations . . . can be achived through

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through transactions or events in which an acquirer obtains control over one or more businesses.

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biz combos create

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single economic entities.

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biz combos can be formed by

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by a variety of events but can differ widely in legal form

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biz combos require

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consolidated financial statements

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There are five types of combinations that are required to prepare consolidated statements

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: 1.Statutory merger through asset acquisition 2.Statutory merger through capital stock acquisition 3. Statutory consolidation through capital stock or asset acquisition. 4. Acquisition of more than 50% of the voting stock 5. Control through ownership of variable interests.

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Statutory:

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only one of the original companies continues to exist

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Statutory consolidation:

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both companies are dissolved, leaving only the new organization

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Legal control over another by

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acquiring a majority of voting stocks

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Control through ownership of variable interests

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contractual control

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What is a statutory merger? A merger approved by the Securities and Exchange Commission (SEC) An acquisition involving the purchase of both stock and assets A takeover completed within one year of the initial tender offer A business combination in which only one company continues to exist as a legal entity.

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A business combination in which only one company continues to exist as a legal entity.

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Parent's and subsidiaries' financial data are brought together to report

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To report the financial position, results of operations, and cash flows for the combined entity.

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Reciprocal accounts and intra-entity transactions are adjusted or eliminated to prepare

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a single set of consolidated financial statements.

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If dissolution occurs:

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All account balances are actually consolidated in the financial records of the survivor. Permanent consolidation occurs at the combination date. Dissolved company's records are closed out. Surviving company's accounts are adjusted to include all balances of the dissolved company

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If separate incorporation maintained:

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Financial statement information (on work papers, not the actual records) is consolidated. Consolidation occurs at regular intervals, whenever financial statements are prepared. Each company continues to retain its own records.

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worksheets facilitates the periodic consolidation process

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without disturbing individual accounting systems

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acquisition method

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used to account for biz combos

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acquisition method requird masureing at FV

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Consideration transferred for the acquired business Noncontrolling interest Separately identified assets and liabilities Goodwill or gain from a bargain purchase Any contingent considerations.

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fair market approach

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fair value can be estimated referecing similar market trades

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income apprac

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fair value can be estimated using dsicounted futue cash flow of the asset

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cost approach

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estimates fair values by reference to the current cost of replacing an asset with another of comparable ecoomic utility

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If the consideration is MORE than the Fair Value of the Assets acquired, the difference is attributed

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to goodwills

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If the consideration is LESS than the Fair Value of the Assets acquired

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have a baragin! record a gain on acquisition

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FASB ASC 805, Business Combinations, provides principles for allocating the fair value of an acquired business. When the collective fair values of the separately identified assets acquired and liabilities assumed exceed the fair value of the consideration transferred, the difference should be: Recognized as an ordinary gain from a bargain purchase. Treated as a negative goodwill to be amortized over the period benefited, not to exceed 40 years Treated as goodwill and tested fro impairment on an annual basis Applied pro rata to reduce, but not below zero, the amounts initially assigned to specific noncurrent assets of the acquired firm

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Recognized as an ordinary gain from a bargain purchase.

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When does gain recognition accompany a business combination? When a bargain purchase occurs. In a combination created in the middle of a fiscal year In a acquisition when the value of all assets and liabilities cannot be determined When the amount of a bargain purchase exceeds the fair value of the applicable noncurrent assets (other than certain exceptions) held by the acquired company

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When a bargain purchase occurs.

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When negotiating a business acquisition, buyers sometimes agree to pay extra amounts to sellers in the future if performance metrics are achieved over specified time horizons. How should buyers account for such contingent consideration in recording an acquisition? The amount ultimately paid under the contingent consideration agreement is added to goodwill when and if the performance metrics are met The fair value of the contingent consideration is expensed immediately at acquisition date The fair value of the contingent consideration is included in the overall fair value of the consideration transferred, and a liability or additional owners' equity is recognized. The fair value of the contingent consideration is recorded as a reduction of the otherwise determinable fair value of the acquired firm

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The fair value of the contingent consideration is included in the overall fair value of the consideration transferred, and a liability or additional owners' equity is recognized.

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Direct Costs of the acquisition (attorneys, appraisers, accountants, investment bankers, etc.) are

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NOT part of the fair value received and are immediately expensed

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Indirect or Internal Costs of acquisition (secretarial and management time) are

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period costs expensed as incurred

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costs to registed and issue securities related to acquistion

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reduce their fair values

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According to the acquisition method of accounting for business combinations, costs paid to attorneys and accountants for services in arranging a merger should be Capitalized as part of the overall fair value acquired in the merger Recorded as an expense in the period the merger takes place. Included in recognized goodwill Written off over a five-year maximum useful life

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Recorded as an expense in the period the merger takes place.

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when separate incorporation is maintained

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Dissolution does not occur. Consolidation process is similar to previous example. Fair value is the basis for initial consolidation of subsidiary's net assets. Subsidiary is a legally incorporated separate entity. Consolidation of financial information is simulated. Acquiring company does not physically record the transaction

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consolidation worksheet entries steps:

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1.Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition date fair value similar to the equity method procedures. 2. The financial information for Parent and Sub are recorded in the first two columns of the worksheet (with Sub's prior revenue and expense already closed). 3. Remove the Sub's equity account balances. 4. Remove the Investment in Sub balance. 5. Allocate Sub's Fair Values, including any excess of cost over Book Value to identifiable assets or goodwill. 6. Combine all account balances and extend into the Consolidated totals column. 7. Subtract consolidated expenses from revenues to arrive at net income.

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intangible are assets that

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Lack physical substance (excluding financial instruments) Arise from contractual or other legal rights Can be sold or otherwise separated from the acquired enterprise

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preexisitng goodwill recorded in acquired company's accounts is

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ignored in allocation of the purchase price

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IPR that has reached tech feasibility is

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capitalized as an intangible asset at fair value with an indefinite life taht is reviewd for impairment

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ongoing R is

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expensed as incurred

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What is the appropriate accounting treatment for the value assigned to in-process research and development acquired in a business combination? Expense over acquisition Capitalize as an asset. Expense if there is no alternative use for the assets used in the research and development and technological feasibility has yet to be reached Expense until future economic benefits become certain and then capitalize as an asset

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Capitalize as an asset.

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valuaton basis is "cost"

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The value of the consideration transferred, PLUS the direct costs of the acquisition, IGNORE any indirect costs of the acquisition, IGNORE any contingent payments.

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The total cost of the acquisition was allocated proportionately to the net assets based on their

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fair values with any excess going to goodwill

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"Pooling of Interests"

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when one company acquired all of another companys stock using its own stock as considersion

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Consolidation of financial information is required when

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one firm gains control of another

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Current financial reporting standards require the acquisition method to be used in accounting for

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business combo

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recognize goodwill is

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purcahse price > fair value of net assets acquired

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recognize a gain if

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purchase price < fair value of net assets

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Particular attention should be paid to the recognition

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of intanfible assets in biz combos

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