Business Combinations: New Rules for a LongStanding Business Practice

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FISCHER | TAYLOR | CHENG

Acquisition of Control
Acquire net assets
Acquire directly from target company Assume liabilities Payment in cash, debt, or equity

Acquire controlling interest

Typically more than 50% of targets voting common stock Creates parent/subsidiary relationship Separate legal entities remain

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Acquisition of Control
Accounting ramifications asset acquisition
Acquiring company records assets and liabilities Subsequent accounting procedures are same as for any single accounting entity

Accounting ramifications stock acquisition

Parent records an investment Parent and sub remain separate legal entities with their own separate sets of accounts and separate financial statements Consolidated financial statements reflect presence of one economic entity
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Applying the Acquisition Method

Measure the fair value of the acquiree Record the acquirees assets and liabilities that are assumed
Net assets = excess of assets over liabilities Identifiable assets never include pre-existing goodwill Only new goodwill is recorded in an acquisition Fair value of net assets NE fair value of the acquiree as an entire entity

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Valuation of Identifiable Assets and Liabilities

Current assets recorded at fair value Existing liabilities recorded at fair value Property, plant, and equipment recorded at fair value Assets scheduled for sale are recorded as current assets at net realizable value

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Valuation of Identifiable Assets and Liabilities

Acquiree was the lessee of assets in use
Leases retain their definition if terms are not modified Operating leases
Recognize an intangible asset if terms are favorable Record an estimated liability if the terms are unfavorable

Example: Excess of current payment over contractual amount Remaining term of lease (months) Annual discount rate Asset (present value beginning mode)
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$300 60 8% $14,894
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Valuation of Identifiable Assets and Liabilities

Acquiree acted as lessor
Leases retain their definition if terms are not modified Operating lease
Asset under lease is on books of acquiree Record at fair value Evaluate terms; record asset (liability) if favorable (unfavorable) to the acquiree/lessor

Intangible assets not separately recorded

Arises from contractual or other legal rights or is separable Identify and record separately

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Valuation of Identifiable Assets and Liabilities

Research and development
Fair values of tangible and intangible assets are recorded

Contingent assets and liabilities

Possessed by acquiree on the acquisition date

Liabilities associated with restructuring or exit activities

Existing liabilities to other entities

Employee benefit plans

Liability if projected benefit obligation > plan assets Asset if projected benefit obligation < plan assets

Deferred tax assets and liabilities

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Applying the Acquisition Model

Bal Sheet 10/1/2011 Cash Marketable securities Inventory Land Buildings (net) Equipment (net) Customer list Current liabilities 8% 5-yr bonds Premium on bond pay Warranty liability $1 par common stock Addn'l pd-in capital Retained earnings 40,000 60,000 100,000 30,000 150,000 80,000 FASB ASC 820-10-35 10/1/2011 40,000 66,000 110,000 72,000 288,000 145,000 125,000 (25,000) (100,000) (4,000) (12,000)

book value L1 - market L1 - market L2 - adj mkt L2 - adj mkt L1 - market L3 - other est (25,000) book value (100,000) face L2 - adj mkt L3 - other est (10,000) (140,000) (185,000) fair value of net identifiable assets

705,000

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Recording the Acquisition

All accounts are recorded at fair value Price paid > fair value of net identifiable assets
Recognize goodwill

Price paid < fair value of net identifiable assets

Recognize gain on acquisition of business

All acquisitions costs are expensed

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Recording the Acquisition: Goodwill

Price paid (40,000 shares $20 mkt value) Fair value of net assets acquired Goodwill $ 800,000 (705,000) $ 95,000

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Recording the Acquisition: Gain

Price paid (25,000 shares $20 mkt value) Fair value of net assets acquired Gain $ 500,000 (705,000) $ 205,000

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Accounting by the Acquiree

Record receipt of consideration Remove assets and liabilities at their book values Recognize gain or loss on sale of business Typical final step
Distribute consideration received to shareholders Cease operations

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Goodwill Impairment
Test: Goodwill is impaired if estimated value of business unit is less than remaining book value of net assets (including goodwill). New goodwill estimate:
Estimated value of business unit New estimate of identifiable net assets at fair value = New goodwill estimate

Impairment Loss:
Book value of goodwill New goodwill estimate = Impairment loss

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Impairment: Example
Recorded $100,000 goodwill in purchase three years ago. Now: Net assets at book value Fair value of the business unit Fair value net identifiable assets (not including goodwill)

$650,000 $625,000 $580,000

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Impairment Calculations
Test Adjustment

Estimated value of business unit $625,000 Book value of assets (including goodwill) 650,000 Excess book $25,000
Goodwill is impaired

Estimated value of business unit $625,000 Fair value of identifiable assets, not including GW 580,000 New GW estimate 45,000 GW book value 100,000 Impairment loss $55,000

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Suggested Problems
Exercise: 1, 2, 3, 4, and 9 Problem: 1, 2, and 5

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