Вы находитесь на странице: 1из 43

Electronic

Presentations
in Microsoft
PowerPoint


Prepared by
James Myers,
C.A.
University of
Toronto
2010 McGraw-Hill
Ryerson Limited
Chapter 3, Slide 1
2010 McGraw-Hill Ryerson Limited
Chapter 3



Business Combinations

Chapter 3, Slide 2
2010 McGraw-Hill Ryerson Limited
Learning Objectives
1. Define a business combination, and describe the
two basic forms for achieving a business
combination
2. Compare and contrast the acquisition and new entity
methods
3. Evaluate relevant factors to determine whether
control exists in a business acquisition
4. Compare the balance sheet of the acquirer after a
purchase-of-net-assets business combination and
the consolidated balance sheet after a purchase-of-
shares business combination
5. Explain a reverse takeover and its reporting
implications



Chapter 3, Slide 3
2010 McGraw-Hill Ryerson Limited
Introduction

A business combination occurs when one company
unites with or obtains control of another company
The Parent is the controlling company and the
Subsidiary is the controlled company
Consolidated financial statements are required to report
the combined financial position and results of operations
of the Parent and the Subsidiary
Control over another company can be obtained by (i)
purchasing substantially all of its net assets, or (ii)
acquiring enough of the companys voting shares to
control the use of its net assets
LO 1
Chapter 3, Slide 4
2010 McGraw-Hill Ryerson Limited
Introduction

A conglomerate business combination
involves regular businesses operating in widely
different industries
A horizontal business combination involves
businesses whose products are similar
A vertical business combination involves
businesses where the output from one can be
used as input for the other

LO 1
Chapter 3, Slide 5
2010 McGraw-Hill Ryerson Limited
Business Combinations

Business combinations (takeovers,
amalgamations, acquisitions, or mergers)
can be friendly or hostile
In a friendly combination, management and the
board of directors of both companies
recommend that their shareholders approve the
combination proposal
In a hostile combination the management and
board of the target company recommends that
its shareholders reject the combination proposal,
and may employ various defences
LO 1
Chapter 3, Slide 6
2010 McGraw-Hill Ryerson Limited
Business Combinations
Payment for net assets or shares acquired can
be in cash, promises to pay cash in the future, or
the issuance of shares, or a combination of
these
The method of payment has a direct bearing on
the determination of which company is the
acquirer and which is being acquired

LO 1
Chapter 3, Slide 7
2010 McGraw-Hill Ryerson Limited
Forms Of Business Combinations
Purchase of assets Control over another companys
assets can be obtained by purchasing the assets
outright, leaving the selling company only with the
consideration received for the asset sale and any
liabilities present before the sale
Purchase of shares an alternative to the purchase of
assets is for the acquirer to purchase enough voting
shares from the shareholders of the acquiree that it can
determine the acquirees strategic operating, investing,
and financing policies
Share purchase can be less costly since control can be achieved
by purchasing less than 100% of the voting shares. Share
purchases can also have important income tax advantages.
LO 1
Chapter 3, Slide 8
2010 McGraw-Hill Ryerson Limited
Forms Of Business Combinations
Both forms of business combination result in the
assets and liabilities of the acquiree being
combined with those of the acquirer
If control is achieved with the purchase of net
assets, the combining takes place in the
accounting records of the acquiree
If control is achieved by purchasing shares, the
combining takes place when the consolidated
financial statements are prepared
LO 1
Chapter 3, Slide 9
2010 McGraw-Hill Ryerson Limited
Methods of Accounting for Business Combinations

There are four methods that have been used in
practice or discussed in theory over the years:
The purchase method
The acquisition method
The pooling-of-interests method
The new entity method
LO 2
Chapter 3, Slide 10
2010 McGraw-Hill Ryerson Limited
Methods of Accounting for Business Combinations

The purchase method is required GAAP prior
to adoption of the acquisition method which
must be adopted on or before January 1, 2011
The pooling-of-interest method was
acceptable in limited situations prior to July 1,
2001 and can no longer be used
The new entity method has never been
acceptable for GAAP but is worthy of future
consideration

LO 2
Chapter 3, Slide 11
2010 McGraw-Hill Ryerson Limited
The Purchase Method
Under the purchase method prior to 2011 or
earlier adoption of IFRS 3, the acquiring
company recorded the net assets of the
acquired company in its investment account
at the price it paid
Price includes cash payments, FMV of
shares issued, and PV of any future cash
payments promised
Excess of price paid over the fair value of the
acquired companys net assets are recorded
as goodwill
LO 2
Chapter 3, Slide 12
2010 McGraw-Hill Ryerson Limited
The Purchase Method
The fair values of identifiable net assets
acquired were charged against earnings
(amortized) to achieve expense matching
Goodwill was regularly reviewed for
impairment and impairment losses were
recorded as a charge against earnings
The purchase method is consistent with
historical cost principle of accounting record
the price paid for the net assets and amortize
the cost over their useful lives
LO 2
Chapter 3, Slide 13
2010 McGraw-Hill Ryerson Limited
The Acquisition Method
After January 1, 2011 or upon earlier adoption of
IFRS 3, the acquiring company will use the
acquisition method
The acquiring company records the identifiable net
assets at fair values regardless of price paid.
If purchase price is > FV of identifiable net assets
the excess is reported as goodwill similar to
purchase method
If price paid is < FV of identifiable net assets the
difference is reported as gain on purchase
Not consistent with historical cost principle but
consistent with general trend toward use of fair
values
LO 2
Chapter 3, Slide 14
2010 McGraw-Hill Ryerson Limited
The Pooling-of-interests Method
Prior to July 1, 2001, the pooling-of-interests
method was used to account for those business
combinations where an acquirer could not be
identified as a result of a share exchange between
the combining companies that made it appear that
the combination was a merger of equals
The former shareholders of each company in theory
were agreeing to combine and continue both
businesses as one new business, without disruption
to operations or key personnel
LO 2
Chapter 3, Slide 15
2010 McGraw-Hill Ryerson Limited
The Pooling-of-interests Method
Assets and liabilities are reflected in the combined
company's financial statements at their carrying value in
the combining companies' records, resulting in no
goodwill and no additional amortization, which made this
method attractive
Major problem of pooling-of-interests method was to
determine if the companies were truly equals
Cannot be used for combinations after July 1, 2001 but
combinations that took place prior to that date can still be
reported under the pooling-of-interests method

LO 2
Chapter 3, Slide 16
2010 McGraw-Hill Ryerson Limited
The New Entity Method

The new entity method has been proposed in
the past as an alternative to the pooling-of-
interests method requiring the revaluation of
assets and liabilities contributed by both
shareholder groups

This method has received virtually no support
because of the additional revaluation difficulty
and costs that would result

LO 2
Chapter 3, Slide 17
2010 McGraw-Hill Ryerson Limited
Acquisition Method
Acquisition method applies to all business combinations
Acquirer should be identified for all business combinations
Acquisition date is the date the acquirer obtains control of the
acquiree
Acquirer should measure FV of 100% of acquiree regardless of
percentage acquired based on:
fair value of consideration given by the controlling shareholder, plus
the fair value of either (i) non-controlling shares or (ii) the non-controlling
shareholders proportionate share of the acquirees identifiable net
assets. Business valuation techniques may be required to establish
these values
Acquirer should reflect the identifiable assets and liabilities acquired
at fair value separately from goodwill
LO 2
Chapter 3, Slide 18
2010 McGraw-Hill Ryerson Limited
Identifying the Acquirer
Identifying the acquirer using IFRS 3
If cash payments are required for acquisition, acquirer is usually
the company making the payments
If shares are exchanged for acquisition, acquirer is the company
whose shareholders hold more than 50% of the votes in the
combined company, or if more than 2 companies are involved
whose shareholders hold largest number of votes
If voting percentages are identical then examine makeup of board
and management to see which company is dominant
In a share exchange acquirer is often but not always the
company that issues shares
Acquirer is often but not always the larger company
LO 3
Chapter 3, Slide 19
2010 McGraw-Hill Ryerson Limited
Allocation of Acquisition Cost

Acquisition cost includes:
Any cash paid
The fair value of assets transferred
The PV of any promises to pay cash in the future
The FV of any shares issued, based on the market price of
shares on the acquisition date
The FV of contingent consideration (see Chapter 4)
Acquisition costs do not include fees of consultants,
accountants, and lawyers which do not increase the FV
of acquired company. These should be expensed in the
period of acquisition
The cost of issuing debt or shares are not included in
acquisition cost but are charged to the related debt or
share capital

LO 4
Chapter 3, Slide 20
2010 McGraw-Hill Ryerson Limited
Allocation of Acquisition Cost
Allocation of acquisition cost:
Allocate to acquirers percentage interest in the FV of identifiable
assets and liabilities of acquiree
Identifiable assets include those with value not presently
recorded by the acquiree, such as internally developed patents.
Also include identifiable intangible assets arising from contractual
or other legal rights, or being capable of being separated and
sold
Failure to allocate to identifiable intangible net assets would
inflate goodwill
Can allocate only to items that meet the definition of assets
and liabilities under IASBs Framework. For example, cannot
allocate expected cost of terminating the subsidiarys
employees to a liability if the terminations have not yet
occurred. In this case the termination cost would be recorded
in post-acquisition expense
LO 4
Chapter 3, Slide 21
2010 McGraw-Hill Ryerson Limited
Allocation of Acquisition Cost
Allocation of acquisition cost (contd):
Fair values are determined and allocated for contingent liabilities
arising from past events if probable and reliably measurable
Deferred income tax assets and liabilities recorded on the
subsidiarys balance sheet are not revalued and carried forward
but are instead replaced by new calculations of deferred taxes.
Any excess of cost over the foregoing represents goodwill
(premium paid to achieve control)
If acquisition cost < FV of identifiable net assets, negative
goodwill arises.
Reduce existing goodwill to zero, recognizing any remaining
excess as a gain on the acquisition date.
LO 4
Chapter 3, Slide 22
2010 McGraw-Hill Ryerson Limited
Disclosure
Financial reporting after combination:
Net income of the acquired company is reported in the
consolidated financial statements of the acquirer
commencing with the date of acquisition.
Expenses of acquired company must be adjusted to
reflect amortization of fair values and any goodwill
losses due to impairment.
The combination does not affect prior year
comparative balances.


LO 4
Chapter 3, Slide 23
2010 McGraw-Hill Ryerson Limited
Illustrations of Business Combination Accounting

To illustrate the accounting method using the
acquisition method, we will use the summarized
balance sheets of two companies See Exhibit
3-1

A Company Ltd will initiate the takeover of B
Corporation
LO 4
Chapter 3, Slide 24
2010 McGraw-Hill Ryerson Limited
Exhibit 3.1
LO 4
Chapter 3, Slide 25
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting

Assume that on January 1, Year 2, A Company
pays $95,000 in cash to B Corporation for all the
the net assets of that company, and that no
direct expenses are involved. Because cash is
the means of payment, A Company is the
acquirer
The acquisition is allocated as per the next slide:

LO 4
Chapter 3, Slide 26
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting
Illustration 1


Purchase price 95,000 $
Fair market value of net assets acquired 80,000
Difference - goodwill 15,000
A Company would make the following journal entry to record
the acquisition of B Corporation
Assets (in detail) 109,000
Goodwill 15,000
Liabilities (in detail) 29,000
Cash 95,000
A COMPANY LTD.
BALANCE SHEET
January 1, Year 2
Assets (300,000 - 95,000 + 109,000) 314,000 $
Goodwill 15,000
329,000 $
Liabilities (120,000 + 29,000) 149,000 $
Shareholder's equity
Common shares 100,000
Retained earnings 80,000
329,000 $
LO 4
Chapter 3, Slide 27
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting
Illustration 2 Assume that on January 1, Year 2, A
Company issues 4,000 common shares with a market
value of $23.75 per share, to B Corporation as payment for
the companys net assets. B Corporation will be wound up
after the sale of its net assets
Because the method of payment is shares, the following
analysis is made to determine which company is the
acquirer:
Shares of A Company
Group X now holds 5,000
Group Y will hold (on wind-up) 4,000
9,000
X holds 56% of A Companys 9,000 shares therefore X is
the acquirer
LO 4
Chapter 3, Slide 28
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting
Illustration 2


Purchase price (4,000 shares @ $23.75) 95,000 $
Fair market value of net assets acquired 80,000
Difference - goodwill 15,000
A Company would make the following journal entry to record
the acquisition of B Corporation's net assets and the issuance
of 4,000 common shares at fair value on January 1, Year 2:
Assets (in detail) 109,000
Goodwill 15,000
Liabilities (in detail) 29,000
Common shares 95,000
A COMPANY LTD.
BALANCE SHEET
January 1, Year 2
Assets (300,000 + 109,000) 409,000 $
Goodwill 15,000
424,000 $
Liabilities (120,000 + 29,000) 149,000 $
Shareholder's equity
Common shares (100,000 + 95,000) 195,000
Retained earnings 80,000
424,000 $
LO 4
Chapter 3, Slide 29
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements
Although parent and subsidiary companies may continue as
separate legal entities after a business combination, GAAP views
the substance of the relationship as a single economic entity that
should be reported as such since it has a group of economic
resources that are under the common control of the parent
An enterprise should consolidate all of its subsidiaries (IAS 27) to
inform primarily shareholders and creditors of the parent company
about the resources and results of operations of the parent and its
subsidiaries as a group, by eliminating all intercompany transactions
and presenting only transactions with outside entities
Consolidated financial statements are supplemented with footnote
disclosures showing operating segments
Parent and subsidiaries will still be required to prepare their own
separate-entity financial statements for income tax filing or internal
purposes

LO 3
Chapter 3, Slide 30
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements
IAS 27 does not require consolidated financial
statements for external reporting under the following
conditions:
Parent is itself a wholly owned subsidiary, or is a partially owned
subsidiary and its owners do not object to the parent not
presenting consolidated financial statements;
Parents debt or equity instruments are not publicly traded;
Parent has not or is not filing financial statements with a regulator
for the purpose of issuing debt or equity instruments on a publicly
traded market; and
The ultimate or intermediate parent of the parent produces IFRS-
compliant consolidated financial statements available to the
public

LO 3
Chapter 3, Slide 31
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements

How is control determined?
Ability to elect majority of board of directors (e.g. by holding
>50% of voting shares) is generally evidence of control
If Parent controls C Company which in turn controls D Company;
Parent has indirect control of D Company
If A Company holds 60% of the votes in B Company and C
Company holds the other 40%, A would normally have control of
B. However if C owns convertible bonds of B or options or
warrants to purchase Bs shares which if converted or exercised
would give C 62% of the voting shares of B, then C Company, not
A Company, would control B Company
LO 3
Chapter 3, Slide 32
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements
How is control determined? (contd)
Control can be present with less than 50% of voting shares if
other factors indicate control, e.g.:
Irrevocable agreement with other shareholders to convey
voting rights to parent
If parent holds rights, warrants, convertible debt, or convertible
preferred shares that would, if exercised or converted, give it
>50% of votes
Written agreements allow parent to dictate subsidiarys
operating policies and to receive income & intercompany
profits from subsidiary (e.g. special purpose entities examined
in Chapter 9 in which parent holds the risks and rewards of
ownership while owning few, if any, of the shares of the
controlled company).
LO 3
Chapter 3, Slide 33
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements
How is control determined? (contd)
One company may own the largest single block of shares of
another company, e.g. X Company owns 40% of Y Company
while the other 60% is widely held and rarely voted with the result
that X has no trouble electing the majority of Ys directors. IASB
Exposure Draft on Consolidated Financial Statements indicates
that X would have control of Y provided Ys shareholders are not
organized in such a way that they actively cooperate against X
when they vote their shares.
Under previous Canadian GAAP this would not have given X
control since it would require the cooperation of the other 60%
of shareholders not to vote.
Control and consolidation cease if for example the majority of a
subsidiarys assets are seized in a bankruptcy or if a foreign
subsidiary is restricted by law from paying dividends to the
parent.
LO 3
Chapter 3, Slide 34
2010 McGraw-Hill Ryerson Limited
Control and Consolidated Financial Statements
How is control determined? (contd)
The existence of certain protective rights held by other parties
does not necessarily provide those parties with control.
Examples:
Approve or veto rights that do not affect strategic operating
and financing policies
The right to approval capital expenditures greater than a
particular threshold, or the right to approve the issue of equity
or debt
The ability to remove the controlling party in the event of
bankruptcy or breach of contract
Certain limitations on the operating activities of an entity, such
as pricing or advertising limitations typically placed by
franchisors on franchisees
LO 3
Chapter 3, Slide 35
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting
Illustration 3: Assume that on January 1, Year 2,
A Company pays $95,000 cash to the
shareholders of B Corporation for all of their
shares, and that no expenses are involved.
Because cash was the means of payment, A
Company is the acquirer.
The financial statements of B Corporation have
not been affected by his transaction because the
shareholders of B, not the company itself, sold
their shares.
See Exhibit 3.2 & 3.3 on the next slides.
LO 4
Chapter 3, Slide 36
2010 McGraw-Hill Ryerson Limited
Exhibit 3.2
LO 4
Chapter 3, Slide 37
2010 McGraw-Hill Ryerson Limited
Exhibit 3.3
LO 4
Chapter 3, Slide 38
2010 McGraw-Hill Ryerson Limited
Illustration of Business Combination Accounting
Note the following for Exhibit 3.3:
A Companys Investment in B Corporation balance and B
Corporations common shares and retained earnings have been
eliminated in entry (1) because they are reciprocal
The acquisition differential does not appear on the consolidated
balance sheet but is reallocated to the net assets of B
Corporation in entry (2)
The book values of Bs net assets + difference between Bs FV
and BV = FV of Bs assets and liabilities
The elimination entries are made on the working paper only and
not in the books of either company
On the date of acquisition, consolidated shareholders equity is
always equal to the parents equity
LO 4
Chapter 3, Slide 39
2010 McGraw-Hill Ryerson Limited
Disclosure
IFRS 3 Appendix B lists the following significant
items to be disclosed for each business
combination:
The acquisition-date fair values of total consideration
given and each class of consideration given
The acquisition-date values recognized for each major
class of assets acquired and liabilities assumed
Legal and other restrictions and the carrying amount
of the assets and liabilities to which those restrictions
apply
LO 4
Chapter 3, Slide 40
2010 McGraw-Hill Ryerson Limited
GAAP for Private Enterprises
Section 1590: Subsidiaries of Part II of the CICA
Handbook requires:
All subsidiaries should either be consolidated or
accounted for using either the cost or the equity
method except when a subsidiarys equity securities
are publicly traded in which case they should be
recorded at market value with changes recorded in net
income
Investments in and income from non-consolidated
subsidiaries should be presented separately from
other investments
LO 4
Chapter 3, Slide 41
2010 McGraw-Hill Ryerson Limited
Reverse Takeovers
Occur when one company obtains ownership of the
shares of another by issuing enough voting shares as
consideration that control of the combined enterprise
passes to the shareholders of the acquired enterprise
Example: A Company has 5,000 shares outstanding and
issues an additional 7,000 shares to the shareholders of
B Company in order to acquire 100% of the shares of B
Company. The shareholders of B Company now own
7,000 out of 12,000 (58%) shares of A and are therefore
in control of the combined enterprise.
LO 5
Chapter 3, Slide 42
2010 McGraw-Hill Ryerson Limited
Reverse Takeovers
Legally, A is the parent of B but for accounting purposes
B is the parent of A
For acquisition accounting it is necessary to calculate the
acquisition price for Bs acquisition of A
Determine the number of shares of B that were outstanding
before the combination
Determine the number of additional shares that B would have
had to issue to reduce Bs shareholders to 58% ownership of B
Number of additional shares x FV = Acquisition cost
Disclose the nature of the reverse takeover in the notes
to Bs consolidated financial statements
LO 5
Chapter 3, Slide 43
2010 McGraw-Hill Ryerson Limited

Вам также может понравиться