Business Combinations

Chapte
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Business Combinations

A business combination occurs

When two or more separate businesse
join into a single accounting entity.

Business Combinations
Business Combination

Acquisitions

Merger

Consolidation

Reasons for Business

Combinations
Lower risk
Fewer operating delays
Avoidance of takeovers
Acquisition of intangible assets
Other reasons

Concept of Business
Combination

The concept emphasizes the creation of

single entity and the independence of th
combining companies before their union
Dissolution of the legal entity is not
necessary within the accounting concep

Concept of Business
Combination

Single
Management

Concept of Business
Combination

One or more corporations become subsidiarie

One company transfers its net assets to anoth

Each company transfers its net assets
to a newly formed corporation.

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

Acquisition of Control
Acquisition 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 Control
Stock 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
Combinations
Purchase 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

Liabilities
As 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 Consideration
It 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 Cost

The 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 Cost

When 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

Price Paid
Price 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
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 the said shares is
$16 per share.

Applying Acquisition
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?

Applying Acquisition 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 finders and
consultants
fees and $40,000 for registering and
issuing
equity securities.

Applying Acquisition 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.

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
subsidiarys assets minus liabilities.

Cost Allocation in a Purchase

Business 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

Cost Allocation in a Purchase

Business 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.

Recognition and Measurement

of
Intangible Assets Other than
Separability
GoodwillContractualcriterion

legal criterion

Recognizable intangibles

Contingent Consideration in a
Purchase Business
Combination
Contingent consideration that
is determinable
at the date of acquisition is
recorded as
part of the cost of
Future earnings
combination.

level

Security prices

Contingent Consideration in a
Purchase Business
Combination
Compare

Investment cost

With

Total fair value of

identifiable asset
less liabilities

Cost and Fair Value Compared

IfInvestment cost
> Net fair value
Allocate to
2
Goodwill

Identifiable
net
1
assets according
to their fair value

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

Pitt

Seed

Illustration of a Purchase
Combination
Assets
Cash
Net receivables
Inventories
Land
Buildings, net
Equipment, net
Patents
Total assets

Book Value
Fair Value
$

50

150
200
50
300
250

$ 1,000

50
140
250
100
500
350
50
$ 1,440

Illustration of a Purchase
Combination
Book Value
Fair Value

Liabilities
Accounts payable
$ 60
Notes payable
150
Other liabilities
40
Total liabilities
$250
Net assets
$ 50

60
135
45
$ 240
$ 1,200

Illustration of a Purchase
Combination
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

Illustration of a Purchase
Combination
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

Illustration of a Purchase
Combination
Debit

Credit

Cash
50
Accounts payable
60
Net receivable
140 Notes payable
135
Inventories
250 Other liabilities
45
Land
100
Investment in
Buildings, net
500 Seed Company
1,400
Equipment, net
350
Patents
50
$1640 1,440 = 200
Goodwill
200

Illustration of a Purchase
Combination
Negative Goodwill

Pitt issues 40,000 shares of its $10 par commo

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

Illustration of a Purchase
Combination

stment in Seed
1,000,000
mmon Stock
400,000
ditional Paid-in Capital
400,000
% Note Payable
200,000
ecord issuance of 40,000 shares of $10 par
mon stock plus $200,000, 10% note in a
chase business combination with Seed Compan

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

Recognizing and Measuring

Impairment Losses
Step One
Compare
Carrying values

Fair values

Cost and Fair Value Compared

If

Fair value

Step 2

<Carrying amount

Measurement of the
impairment loss

Amortization versus
Non-amortization

irms must amortize intangible assets wit

a finite useful life over that life.

s will not amortize intangible assets with

efinite useful life that cannot be estimat