Concepts of Bus. Combin. - 1 Business Combinations “A business combination occurs when an...
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Transcript of Concepts of Bus. Combin. - 1 Business Combinations “A business combination occurs when an...
Concepts of Bus. Combin. - 1
Business Combinations
“A business combination occurs when an enterprise
acquires net assets that constitute a business or equity interests of one
or more other enterprises and obtains
control over that enterprise or enterprises.”
- - SFAS No. 141
“A business combination occurs when an enterprise
acquires net assets that constitute a business or equity interests of one
or more other enterprises and obtains
control over that enterprise or enterprises.”
- - SFAS No. 141
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“A business combination occurs when two or more
companies join under common control,
meaning the ability to direct policies and
management.”
- - BAKER, et.al.
“A business combination occurs when two or more
companies join under common control,
meaning the ability to direct policies and
management.”
- - BAKER, et.al.
Concepts of Bus. Combin. - 2
MOTIVATION FOR BUSINESS COMBINATIONS
Growth– New markets– Increase in market share
Reduction in operating costs Diversification Tax reasons Management incentives
Concepts of Bus. Combin. - 3
BUSINESS COMBINATIONSEconomic Substance
Horizontal combinations
Vertical combinations (integration)
Conglomerates
Concepts of Bus. Combin. - 4
BUSINESS COMBINATIONSLegal Form
Merger
Consolidation (Statutory)
Acquisition
Variable interests
Concepts of Bus. Combin. - 5
Types of Business Combinations
P Company
S Company
P Company
Merger
Concepts of Bus. Combin. - 6
Types of Business Combinations
P Company
S Company
Statutory Consolidation
X Company
Concepts of Bus. Combin. - 7
Types of Business Combinations
P Company
S Company
Stock Acquisition
P Company
S Company
&
Concepts of Bus. Combin. - 8
Business Combinations
Exh.2-2
ContinuedContinued
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Concepts of Bus. Combin. - 9
Business Combinations – Continued
Exh.2-2
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Concepts of Bus. Combin. - 10
A Control Issue – SPE’s
Special Purpose Entities (a popular type of “variable interest entity”) were misused to hide debt and manipulate earnings
As a result, the FASB (in FIN 46R) expanded the definition of “control” beyond just the holding of a majority share position.
The following indicate a controlling financial interest in a variable interest entity:– Direct or indirect ability to make decisions about the
entity’s activities– Obligation to absorb any expected losses of the entity– The right to receive any expected residuals of the
entity
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Concepts of Bus. Combin. - 11
What is to be consolidated?
If dissolution occurs:All account balances are actually
consolidated in the financial records of the survivor.
If separate incorporation maintained:
Financial statement information is consolidated on work papers and not in the actual records
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Concepts of Bus. Combin. - 12
When does consolidation occur?
If dissolution occurs:– Permanent consolidation occurs at the
combination date
If separate incorporation maintained:– Consolidation (on work papers, not in the actual
records!!) occurs regularly, whenever financial statements are prepared
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Concepts of Bus. Combin. - 13
How does consolidation affect the accounting records?
If dissolution occurs:– Dissolved company’s records are closed out.– Surviving company’s accounts are adjusted to
include all balances of the dissolved company
If separate incorporation maintained:– Each company continues to maintain its own records
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Concepts of Bus. Combin. - 14
BUSINESS COMBINATIONSMethod of Accounting
Acquisition
Purchase
Pooling of interests
Concepts of Bus. Combin. - 15
Accounting for CombinationsJune 30, 2001 Calendar 2009
Purchase
ORPooling
Purchaseonly
(Not retroactive)
Acquisitiononly
(Not retroactive)
Selection based onspecific criteria
for Pooling
All new combinationsmust use Purchase(no adjustment of
older results)
All new combinationsmust use Acquisition
(no adjustment ofolder results)
Concepts of Bus. Combin. - 16
Purchase
Acquisition
Horizontal
Vertical
Conglomerate
Merger StatutoryConsolidation
StockAcquisition
Pooling
Concepts of Bus. Combin. - 17
The Acquisition Method
A replacement for the Purchase Method
Requires measurement of fair value of the acquired business as a whole
Requires measurement and recognition of the fair values of the separately identified assets acquired and liabilities assumed
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Concepts of Bus. Combin. - 18
Acquisition Methods – Key Changes
Adopts a “business fair value” measurement approach as opposed to the traditional “cost-based” measure
Direct combination costs will be expensed as incurred
Contingent consideration obligations are recognized as part of the purchase price
With bargain purchases, no assets will be recorded at less than fair value, which will produce recognized gains on purchase
Allows for capitalization of Purchased In-Process Research and Development (IPR&D)
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Concepts of Bus. Combin. - 19
Capitalization of In-Process Research and Development Costs (IPR&D)
To be recognized and measured at fair value on the acquisition date
Reported as intangible assets with indefinite lives
Subject to periodic “impairment reviews”
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Concepts of Bus. Combin. - 20
Related Costs of Business Combinations (Acquisition Method)
Costs incurred for outside services (attorneys, appraisers, accountants, investment bankers, etc.) related to the combination are NOT considered part of the fair value received, and so are immediately expensed
Internal costs of acquisition (secretarial and management time) are expensed as incurred.
Costs to register and issue securities related to the acquisition reduce their fair value
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Concepts of Bus. Combin. - 21
Acquisition Method - SummaryConsideration transferred equals fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values
Consideration transferred is greater than the fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values. Excess consideration recorded as goodwill
Consideration transferred is less than the fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values. Excess of fair value over consideration is recorded as gain on bargain purchase
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Concepts of Bus. Combin. - 22
When the acquisition is made
by issuing stock, the cost of the
acquisition equals the MARKET
VALUE of the stock issued.
When the acquisition is made
by issuing stock, the cost of the
acquisition equals the MARKET
VALUE of the stock issued.
Purchase Method – SFAS 141
Employed when there is a change in ownership resulting in control of one enterprise by another.
The appropriate valuation basis for any purchase transaction is “cost”.
(Total value assigned to the net assets received equals the total cost of the acquisition.)
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Concepts of Bus. Combin. - 23
Accounting Challenge!!!
Allocation of “cost of acquisition” among the various assets and liabilities obtained.
Allocation depends on the relation between total cost and “fair value” of the acquired firm’s assets and liabilities.
FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction of market participants at the measurement date.” (FASB, Statement of Financial Accounting Standards No. 157, Fair Value Measurements)
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Concepts of Bus. Combin. - 24
“Direct Costs” of Combination
Typically includes fees to the following for advising services in arranging and structuring the combination:– Investment bankers– Accountants– Attorneys
These must be included in determining the purchase “cost.”
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Concepts of Bus. Combin. - 25
Purchase Method Situations
Dissolution of the acquired company:Purchase Price = Fair ValuePurchase Price > FVPurchase Price < FV
Separate incorporation maintained.
Dissolution of the acquired company:Purchase Price = Fair ValuePurchase Price > FVPurchase Price < FV
Separate incorporation maintained.
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Concepts of Bus. Combin. - 26
Purchase Method - DissolutionPurchase Price = Fair Value
Ignore the Equity and Nominal accounts of the acquired company.
Determine fair value of the acquired company’s assets and liabilities.
Prepare a journal entry to – recognize the cost of acquisition– incorporate the FV of the acquired
company’s assets and liabilities into the acquiring company’s books.
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Concepts of Bus. Combin. - 27
Purchase Method - DissolutionPurchase Price > Fair Value
FV of acquired company’s assets and liabilities is added to acquiring company’s books.
Difference between Acquisition Cost and FV of acquired assets and liabilities is allocated to identifiable intangible assets and to goodwill.
Note: Goodwill should be viewed
as a residual amount
remaining after all other
identifiable and separable
intangible assets have been
recognized.
Note: Goodwill should be viewed
as a residual amount
remaining after all other
identifiable and separable
intangible assets have been
recognized.
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Concepts of Bus. Combin. - 28
Purchase Method - DissolutionPurchase Price < Fair Value
When fair value exceeds cost, full allocation of fair value is not possible.
Current assets and liabilities should be consolidated at their fair value.
Non-current assets should be proportionately reduced in value (with some exceptions)
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Concepts of Bus. Combin. - 29
Purchase Method - DissolutionPurchase Price < Fair Value
According to SFAS 141, the following non-current assets are exceptions to the proportionate reduction, and should be recorded at assessed fair values:
– Financial assets other than equity method investments
– Assets to be disposed of by sale– Deferred tax assets– Prepaid assets related to pension or other post-
retirement benefit plans
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Concepts of Bus. Combin. - 30
Purchase Method - DissolutionPurchase Price < Fair Value
In the event that the difference is substantial enough to eliminate all the non-current asset balances of
the acquired company . . .
. . . The remainder is to be reported as an extraordinary gain
(SFAS 141)
In the event that the difference is substantial enough to eliminate all the non-current asset balances of
the acquired company . . .
. . . The remainder is to be reported as an extraordinary gain
(SFAS 141)
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Concepts of Bus. Combin. - 31
Accounting for Additional Costs Associated with Business Combinations (SFAS 141)
Direct combination costs (Accounting, legal, investment banking and appraisal fees, etc.)
Include in the purchase price of the acquired firm
Indirect combination costs (additional internal costs such as secretarial or managerial time)
Expense as incurred
Costs to register and issue securities
Reduce the value assigned to the fair value of the securities issued (typically as a debit to APIC)
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Concepts of Bus. Combin. - 32
Let’s see what happens Let’s see what happens when the acquired company when the acquired company
is not dissolved.is not dissolved.
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Concepts of Bus. Combin. - 33
Purchase Method - No Dissolution
The acquired company continues as a separate entity.
– Reported on Parent’s books as the Investment in Subsidiary account.
Separate records for each company are still maintained.
The adjusted balances for the Parent and the Subsidiary are consolidated using a worksheet (no formal journal entries!)
The acquired company continues as a separate entity.
– Reported on Parent’s books as the Investment in Subsidiary account.
Separate records for each company are still maintained.
The adjusted balances for the Parent and the Subsidiary are consolidated using a worksheet (no formal journal entries!)
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Concepts of Bus. Combin. - 34
Steps for Consolidation
1. Record the financial information for both Parent and Sub on the worksheet.
1. Record the financial information for both Parent and Sub on the worksheet.
2. Remove the Investment in Sub balance.2. Remove the Investment in Sub balance.
3. Remove the Sub’s equity account balances.
3. Remove the Sub’s equity account balances.
4. Adjust the Sub’s net assets to FV.4. Adjust the Sub’s net assets to FV.
5. Allocate any excess of cost over BV to identifiable, separable intangible assets
or goodwill.
5. Allocate any excess of cost over BV to identifiable, separable intangible assets
or goodwill.
6. Combine all account balances.6. Combine all account balances.
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Concepts of Bus. Combin. - 35
Purchase Price Allocations - Additional Issues, SFAS No. 141
Intangibles– Current and noncurrent
assets that lack physical substance.
– Do not include financial instruments.
When should an Intangible be recognized?– Does it arise from
contractual or other legal rights?
– Can it be sold or otherwise separated from the acquired enterprise?
Intangibles– Current and noncurrent
assets that lack physical substance.
– Do not include financial instruments.
When should an Intangible be recognized?– Does it arise from
contractual or other legal rights?
– Can it be sold or otherwise separated from the acquired enterprise?
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Concepts of Bus. Combin. - 36
Purchase Price Allocations - Additional Issues, SFAS No. 141
Intangible Asset Examples
Customer Base Trademarked Brand
Names Customer Routes Effective Advertising
Programs Covenants Rights (broadcasting,
development, use, etc.)
Customer Base Trademarked Brand
Names Customer Routes Effective Advertising
Programs Covenants Rights (broadcasting,
development, use, etc.)
Databases Technological know-
how Patents & Copyrights Strong labor relations Assembled, trained
workforce Favorable
government relations
Databases Technological know-
how Patents & Copyrights Strong labor relations Assembled, trained
workforce Favorable
government relations
Exh.2-7
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Concepts of Bus. Combin. - 37
Purchase Price Allocations - Additional Issues, SFAS No. 141
In-Process R&D– Should be expensed
immediately upon acquisition (unless there are alternative future uses.)
IPR&D that has reached technological feasibility, may be “capitalized”.– Determination of fair value is
critical.
In-Process R&D– Should be expensed
immediately upon acquisition (unless there are alternative future uses.)
IPR&D that has reached technological feasibility, may be “capitalized”.– Determination of fair value is
critical.
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Concepts of Bus. Combin. - 38
Unconsolidated Subsidiaries
SF AS No . 94
W hen control does notactually rest w ith the 50%
ow ners.
W hen can a Parent exclude a 50%ow ned subsidiary from consolidation?
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Concepts of Bus. Combin. - 39
Pooling of Interests
Historically, many business combinations were accounted for as “Pooling of Interests.”
In SFAS 141, “Business Combinations”, the FASB stated that all business combinations should be accounted for using the
“Purchase MethodPurchase Method”.
Historically, many business combinations were accounted for as “Pooling of Interests.”
In SFAS 141, “Business Combinations”, the FASB stated that all business combinations should be accounted for using the
“Purchase MethodPurchase Method”.
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Concepts of Bus. Combin. - 40Pooling of Interest
What is essentialfor a combination to
be viewed as apooling of interest?
What is essentialfor a combination to
be viewed as apooling of interest?An exchange of
common stock.
An exchange ofcommon stock.
POOLING OF INTERESTS
Concepts of Bus. Combin. - 41
Pooling of Interests
According to SFAS No. 141, the purchase method is not to be applied to past “Poolings of
Interest.”
Past poolings of interests are left intact by SFAS No. 141.
Therefore, it is important to understand how to account for
PAST poolings.
According to SFAS No. 141, the purchase method is not to be applied to past “Poolings of
Interest.”
Past poolings of interests are left intact by SFAS No. 141.
Therefore, it is important to understand how to account for
PAST poolings.
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Concepts of Bus. Combin. - 42
In a pooling, one company obtained
essentially “all” of the other company’s
stock.
In a pooling, one company obtained
essentially “all” of the other company’s
stock.
The transaction involved the
exchange of common stock. No exchange of cash was allowed.
The transaction involved the
exchange of common stock. No exchange of cash was allowed.
The ownership interests of two, or more, companies were combined into one new company.
No single company was dominant.
Precise cost figures were difficult to obtain.
To use pooling of interests, 12 strict criteria had to be met.
Historical Review of Pooling of Interests
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CRITERIA FOR POOLINGAPB No. 16
Attributes of combining companies - Autonomous - Independent of one another Manner of achieving combination - Single transaction - Common stock for Common stock - For “substantially all” common stock (90%) Absence of planned transactions - Planned spin-off of assets - Contingent agreements
Concepts of Bus. Combin. - 44
Historical Review of Pooling of Interests
The Book Values of the two combining companies were
joined. No Goodwill was recorded.
The Book Values of the two combining companies were
joined. No Goodwill was recorded.
Revenues and expenses were combined retroactively for the
two companies.
Revenues and expenses were combined retroactively for the
two companies.
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POOLING OF INTERESTS Accounting Considerations
Combination of ownership interests- NOT AN ACQUISITION
NO TRANSACTION by the corporate entities - No new basis of accountability
- Total combined net assets unchanged
NO CHANGE in total combined stockholders’ equity Reallocation of individual accounts may be required
Retained earnings accounts combined
Earnings - combined for entire year of pooling
Direct combination expenses = period expenses
POOLING OF INTERESTS
=+Assets Assets Assets
+ = Liabilities Liab. Liab.
Par Par
OCC OCC
RE RE+ = Stockholders’
Equity
OCC
Par
OCC
Par
RE
RE
RE
Par
Total par issued vs. Total par exchanged
Concepts of Bus. Combin. - 47
Summary
Consolidation of financial information is required when one organization gains control of another.
If dissolution occurs, this consolidation is carried out at the date of acquisition and a single set of accounting records is maintained.
If separate identities are maintained, consolidation is a periodic “worksheet” process not involving journal entries. Separate accounting records are maintained.
The purchase method is currently GAAP, although the FASB has proposed changing to the Acquisition Method
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Concepts of Bus. Combin. - 48
Possible Criticisms
The proposed “business fair value” measurement approach involves a departure from traditional “cost-based” measurement. This violates the Historic Cost Principle.
The proposed capitalization of IPR&D departs from the traditional SFAS 2 approach of expensing R&D as incurred.
WHAT DO YOU THINK?
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