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Business Combinations

Business Combinations. Chapter 1. Learning Objective 1. Understand the economic motivations underlying business combinations. Business Combinations. A business combination occurs when two or more separate businesses join into a single accounting entity. Reasons for Business Combinations.

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Business Combinations

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  1. Business Combinations Chapter 1

  2. Learning Objective 1 Understand the economic motivations underlying business combinations.

  3. Business Combinations A business combination occurs when two or more separate businesses join into a single accounting entity.

  4. Reasons for Business Combinations Cost advantage Lower risk Fewer operating delays Avoidance of takeovers Acquisition of intangible assets Other reasons

  5. Learning Objective 2 Learn about the alternative forms of business combinations, from both the legal and accounting perspectives.

  6. The Legal Form ofBusiness Combinations Business Combination Acquisitions Merger Consolidation

  7. The Legal Form ofBusiness Combinations A B A Merger

  8. The Legal Form ofBusiness Combinations A B C Consolidation

  9. The Accounting Concept ofBusiness Combinations 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.

  10. The Accounting Concept ofBusiness Combinations Single management

  11. The Accounting Concept ofBusiness Combinations One or more corporations become subsidiaries. One company transfers its net assets to another. Each company transfers its net assets to a newly formed corporation.

  12. Background on Accounting forBusiness Combinations Much of the controversy concerning accounting requirements for business combinations historically involved the pooling of interest method. ARB No. 40introduced an alternative method: the purchase method.

  13. Background on Accounting forBusiness Combinations Until 2001, accounting requirements for business combinations were found in APB Opinion No. 16. APB No. 16 recognized both the pooling and purchase methods.

  14. Background on Accounting forBusiness Combinations FASB Statement No. 141eliminated the pooling of interest method for transactions initiated after June 30, 2001. Combinations initiated after this date must use the purchase method. Prior combinations will be grandfathered.

  15. Learning Objective 3 Understand alternative approaches to the financing of mergers and acquisitions.

  16. Pooling Method Pooling uses historical book values to record combinations rather than recognizing fair values of net assets at the transaction date. Most of the detailed issues related to poolings concern the original recording of the combination.

  17. Purchase Method Purchase accounting requires the recording of assets acquired and liabilities assumed at their fair values at the date of combination.

  18. Learning Objective 4 Introduce concepts of accounting for business combinations emphasizing the purchase method.

  19. Accounting for Business CombinationsUnder the Purchase 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 Poppy is $16 per share

  20. Accounting for Business CombinationsUnder the Purchase Method 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?

  21. Accounting for Business CombinationsUnder the Purchase Method Investment in Sunny 1,600,000 Common Stock, $10 par 1,000,000 Additional Paid-in Capital 600,000 To record issuance of 100,000 shares of $10 par common stock with a market value of $16 per share in a purchase business combination with Sunny. How are the additional direct costs recorded?

  22. Accounting for Business CombinationsUnder the Purchase Method Investment in Sunny 80,000 Additional Paid-in Capital 40,000 Cash (other assets) 120,000 To record additional direct costs of combining with Sunny: $80,000 finder’s and consultants’ fees and $40,000 for registering and issuing equity securities.

  23. Accounting for Business CombinationsUnder the Purchase Method The total cost to Poppy of acquiring Sunny is $1,680,000. This is the amount entered into the investment in the Sunny account. What is goodwill?

  24. Goodwill 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 subsidiary’s assets minus liabilities.

  25. Learning Objective 5 See how firms make cost allocations in a purchase method combination.

  26. Cost Allocation in a PurchaseBusiness 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.

  27. Cost Allocation in a PurchaseBusiness Combination No value is assigned to goodwill recorded on the books of an acquired subsidiary. Why? Such goodwill is an unidentifiable asset. Goodwill resulting from the combination is valued directly.

  28. Recognition and Measurement ofIntangible Assets Other than Goodwill Separability criterion Contractual- legal criterion Recognizable intangibles

  29. Contingent Consideration in aPurchase Business Combination Contingent consideration that is determinable at the date of acquisition is recorded as part of the cost of combination. Future earnings level Security prices

  30. Cost and Fair Value Compared Compare Investment cost Total fair value of identifiable assets less liabilities With

  31. If Investment cost > Net fair value Identifiable net assets according to their fair value 1 Allocate to 2 Goodwill Cost and Fair Value Compared

  32. Illustration of a PurchaseCombination Pitt Corporation acquires the net assets of Seed Company on December 27, 2003. Pitt Seed

  33. Illustration of a PurchaseCombination Book Value Fair Value Assets Cash $ 50 $ 50 Net receivables 150 140 Inventories 200 250 Land 50 100 Buildings, net 300 500 Equipment, net 250 350 Patents 50 Total assets $1,000 $1,440

  34. Illustration of a PurchaseCombination Book Value Fair Value Liabilities Accounts payable $ 60 $ 60 Notes payable 150 135 Other liabilities 40 45 Total liabilities $250$ 240 Net assets $ 50$1,200

  35. Illustration of a PurchaseCombination Goodwill Pitt pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par common stock with a market value of $20 per share. 50,000 × $10 = $500,000

  36. Illustration of a PurchaseCombination Investment in Seed 1,400,000 Cash 400,000 Common Stock 500,000 Additional Paid-in Capital 500,000 To record issuance of 50,000 shares of $10 par common stock plus $400,000 cash in a purchase business combination with Seed Company

  37. Illustration of a PurchaseCombination Debit Credit Cash 50 Net receivable 140 Inventories 250 Land 100 Buildings, net500 Equipment, net 350 Patents 50 Accounts payable 60 Notes payable 135 Other liabilities 45 Investment in Seed Company 1,400 $1640 – 1,440 = 200 Goodwill 200

  38. Illustration of a PurchaseCombination Negative Goodwill Pitt issues 40,000 shares of its $10 par common stock with a market value of $20 per share and also gives a 10%, five-year note payable for $200,000 for the net assets of Seed Company. 40,000 × $10 = $400,000

  39. Illustration of a PurchaseCombination Investment in Seed 1,000,000 Common Stock 400,000 Additional Paid-in Capital 400,000 10% Note Payable 200,000 To record issuance of 40,000 shares of $10 par common stock plus $200,000, 10% note in a purchase business combination with Seed Company

  40. Illustration of a PurchaseCombination Debit Credit Cash 50 Net receivable 140 Inventories 250 Land 80 Buildings, net400 Equipment, net 280 Patents 40 Accounts payable 60 Notes payable 135 Other liabilities 45 Investment in Seed Company 1,000

  41. Illustration of a PurchaseCombination $1,200,000 fair value is greater than $1,000,000 purchase price by $200,000. Amounts assignable to assets are reduced by 20%.

  42. The Goodwill Controversy Under FASB Statement No. 142, goodwill is no longer amortized for financial reporting purposes. – income tax controversies – international accounting issues

  43. The Goodwill Controversy Under FASB Statements No. 141 and No. 142, the FASB requires that firms periodically assess goodwill for impairment of its value. An impairment occurs when the recorded value of goodwill is less than its fair value.

  44. Recognizing and MeasuringImpairment Losses Step One Compare Carrying values Fair values

  45. If Fair value < Carrying amount Measurement of the impairment loss Step Two Cost and Fair Value Compared

  46. Amortization versus Nonamortization Firms must amortize intangible assets with a finite useful life over that life. Firms will not amortize intangible assets with an indefinite useful life that cannot be estimated.

  47. End of Chapter 1

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