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2-1
22
Accounting for Business
Combinations
Learning
Learning Objectives
Objectives
1.
2.
3.
4.
5.
Chapter
2-3
Learning
Learning Objectives
Objectives
6.
7.
8.
9.
Chapter
2-4
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Historically,
Historically two distinct methods of accounting for
business combinations were permitted: purchase and
pooling of interests.
Two New Pronouncements in June 2001:
1. SFAS No. 141, Business Combinations, - pooling
method is prohibited for business combinations initiated
after June 30, 2001.
2. SFAS No. 142, Goodwill and Other Intangible Assets,
- Goodwill acquired in a business combination after June
30, 2001, should not be amortized.
Chapter
2-5
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Whats New?
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Whats New?
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Goodwill Impairment Test
SFAS No. 142 requires impairment be tested annually.
All goodwill must be assigned to a reporting unit.
Impairment should be tested in a two-step process.
Step 1: If fair value is less than the carrying amount
of the net assets (including goodwill), then perform a
second step to determine possible impairment.
Step 2: Determine the fair value of the goodwill
(implied value of goodwill) and compare to carrying
amount.
Chapter
2-8
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 On January 1, 2007, Porsche Company acquired the
net assets of Saab Company for $450,000 cash. The fair
value of Saabs identifiable net assets was $375,000 on this
date. Porsche Company decided to measure goodwill
impairment using the present value of future cash flows to
estimate the fair value of the reporting unit (Saab). The
information for these subsequent years is as follows:
Year
2008
2009
2010
Chapter
2-9
Present Value
of Future
Cash Flows
$ 400,000
$ 400,000
$ 350,000
Carry Value
of SAAB's
Net Assets *
$ 330,000
$ 320,000
$ 300,000
Fair Value
of SAAB's
Net Assets
$ 340,000
$ 345,000
$ 325,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 On January 1, 2007, the acquisition date, what was
the amount of goodwill acquired, if any?
Acquisition price
$450,000
Chapter
2-10
375,000
$ 75,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 Part A&B: For each year determine the amount of
goodwill impairment, if any, and prepare the journal entry
needed each year to record the goodwill impairment (if any).
Step 1 - 2008
Fair value of reporting unit
$400,000
330,000
75,000
405,000
$ 5,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 Part A&B (continued)
Step 2 - 2008
Fair value of reporting unit
$400,000
340,000
60,000
75,000
Impairment loss
Journal
Entry
Chapter
2-12
Impairment loss
Goodwill
$ 15,000
15,000
15,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 Part A&B (continued)
Step 1 - 2009
Fair value of reporting unit
$400,000
320,000
60,000 *
380,000
$ 20,000
Excess of fair value over carrying value means step 2 is not required.
* $75,000 (original goodwill) $15,000 (prior year impairment)
Chapter
2-13
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 Part A&B (continued)
Step 1 - 2010
Fair value of reporting unit
$350,000
300,000
60,000 *
360,000
$ 10,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-11 Part A&B (continued)
Step 2 - 2010
Fair value of reporting unit
$350,000
325,000
25,000
60,000
Impairment loss
Journal
Entry
Chapter
2-15
Impairment loss
Goodwill
$ 35,000
35,000
35,000
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Review Question
The first step in determining goodwill impairment involves
comparing the
a. implied value of a reporting unit to its carrying
amount (goodwill excluded).
b. fair value of a reporting unit to its carrying amount
(goodwill excluded).
c. implied value of a reporting unit to its carrying
amount (goodwill included).
d. fair value of a reporting unit to its carrying amount
(goodwill included).
Chapter
2-16
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Disclosures Mandated by FASB
SFAS No. 141 requires:
1. The total amount of acquired goodwill and the amount
expected to be deductible for tax purposes.
2. The amount of goodwill by reporting segment (in
accordance with SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information),
unless not practicable.
Chapter
2-17
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Disclosures Mandated by FASB
SFAS No. 142 specifies the presentation of goodwill
(if impairment occurs) as follows:
a. The aggregate amount of goodwill should be a separate
line item in the balance sheet.
b. The aggregate amount of losses from goodwill
impairment should be shown as a separate line item in
the operating section of the income statement.
Chapter
2-18
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Disclosures Mandated by FASB
When an impairment loss occurs, SFAS No. 142
mandates the following disclosures in the notes:
1. A description of the facts and circumstances leading to
the impairment.
2. The amount of the impairment loss and the method of
determining the fair value of the reporting unit.
3. The nature and amounts of any adjustments made to
impairment estimates from earlier periods, if significant.
Chapter
2-19
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Other Required Disclosures
Exposure Draft (ED1204-001) states that disclosure
should include:
The name and a description of the acquiree.
The acquisition date.
The percentage of voting equity instruments acquired.
The primary reasons for the business combination,
including a description of the factors that contributed
to the recognition of goodwill.
Chapter
2-20
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Other Required Disclosures
Exposure Draft (ED1204-001) states that disclosure
should include:
The fair value of the acquiree and the basis for
measuring that value on the acquisition date.
The fair value of the consideration transferred.
The amounts recognized at the acquisition date for each
major class of assets acquired and liabilities assumed.
The maximum potential amount of future payments the
acquirer could be required to make.
Chapter
2-21
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Other Intangible Assets
Acquired intangible assets other than goodwill:
Limited useful life
Should be amortized over its useful economic life.
Should be reviewed for impairment.
Indefinite life
Should not be amortized.
Should be tested annually (minimum) for impairment.
Chapter
2-22
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
Treatment of Acquisition Expenses
The Exposure Draft requires that:
both direct and indirect costs be expensed.
the cost of issuing securities also be excluded
from the consideration.
Security issuance costs are assigned to the valuation
of the security, thus reducing the additional
contributed capital for stock issues or adjusting the
premium or discount on bond issues.
Chapter
2-23
Historical
Historical Perspective
Perspective on
on Business
Business Combinations
Combinations
ACQUISITION COSTSAN ILLUSTRATION
Suppose that SMC Company acquires 100% of the net assets of Bee
Company (net book value of $100,000) by issuing shares of common
stock with a fair value of $120,000. With respect to the merger,
SMC incurred $1,500 of accounting and consulting costs and $3,000
of stock issue costs. SMC maintains a mergers department that
incurred a monthly cost of $2,000. The following illustrates how
these costs are recorded under proposed GAAP.
ACQUISITION ACCOUNTING:
Professional Fees Expense (Direct)
Merger Department Expense (Indirect)
Other Contributed Capital (Security Issue Costs)
Cash
Chapter
2-24
1,500
2,000
3,000
6,500
Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure Requirement
Requirement
Pro forma statements serve two functions in relation
to business combinations:
1) to provide information in the planning stages of
the combination and
2) to disclose relevant information subsequent to
the combination.
Chapter
2-25
Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure Requirement
Requirement
P Company Pro Forma Balance Sheet
Giving Effect to Proposed Issue of Common Stock for All the
Net Assets of S Company January 1, 2007
Chapter
2-26
Illustration 2-1
Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure Requirement
Requirement
If a material business combination occurred, notes to
financial statements should include on a pro forma
basis:
1. Results of operations for the current year as though
the companies had combined at the beginning of the
year.
2. Results of operations for the immediately preceding
period as though the companies had combined at the
beginning of that period if comparative financial
statements are presented.
Chapter
2-27
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
The Exposure Draft specifies four steps in the
accounting for a business combination:
1. Identify the acquirer.
2. Determine the acquisition date.
3. Measure the fair value of the acquiree.
4. Measure and recognize the assets acquired and
liabilities assumed.
Chapter
2-28
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
Value of Assets and Liabilities Acquired
incurred, however, the Exposure Draft proposes that inprocess R&D that is acquired as part of a business
combination will be capitalized.
Chapter
2-29
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
Bargain Purchase
When the fair values of identifiable net assets (assets less
liabilities) exceeds the total cost of the acquired company,
the acquisition is a bargain.
In the past, FASB required that most long-lived assets be
written down on a pro rata basis before recognizing a gain.
The Exposure Draft advises that:
fair values be reconsidered and adjustments made as
needed.
any excess of acquisition-date fair value of net assets
over the consideration paid is recognized in income.
Chapter
2-30
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 Preston Company acquired the assets (except for cash) and
assumed the liabilities of Saville Company. Immediately prior to the
acquisition, Saville Companys balance sheet was as follows:
Any
Goodwill?
Chapter
2-31
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 Preston Company acquired the assets (except for cash) and
assumed the liabilities of Saville Company. Immediately prior to the
acquisition, Saville Companys balance sheet was as follows:
Fair value
of assets,
without cash
$1,824,000
Chapter
2-32
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 A. Prepare the journal entry on the books of Preston
Co. to record the purchase of the assets and assumption of
the liabilities of Saville Co. if the amount paid was
$1,560,000 in cash.
Calculation of Goodwill
Fair value of assets, without cash
Fair value of liabilities
Fair value of net assets
1,230,000
Price paid
1,560,000
Goodwill
Chapter
2-33
$1,824,000
594,000
$ 330,000
LO 6 Valuation of acquired asset and liabilities assumed.
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 A. Prepare the journal entry on the books of Preston
Co. to record the purchase of the assets and assumption of
the liabilities of Saville Co. if the amount paid was
$1,560,000 in cash.
Receivables
Inventory
Plant and equipment
Land
Goodwill
Liabilities
Cash
Chapter
2-34
228,000
396,000
540,000
660,000
330,000
594,000
1,560,000
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
Chapter
2-36
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 B. Repeat the requirement in (A) assuming that the
amount paid was $990,000.
1,230,000
990,000
Bargain purchase
Chapter
2-37
$1,824,000
594,000
$ 240,000
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition Accounting
Accounting
E2-1 B. Repeat the requirement in (A) assuming that the
amount paid was $990,000.
Fair Value
(A)
$ 540,000
660,000
$ 1,200,000
Receivables
Inventory
Plant and equipment
Land
Liabilities
Cash
Chapter
2-38
Fair Value
Percent
(B)
45%
55%
100%
Bargain
Purchase
Allocation
(C)
$ 108,000
132,000
$ 240,000
228,000
396,000
432,000
528,000
Fair Value
Less
Allocation
(A-C)
$ 432,000
528,000
$ 960,000
594,000
990,000
Contingent
Contingent Consideration
Consideration in
in an
an Acquisition
Acquisition
Purchase agreements may provide that the purchasing
company will give additional consideration to the seller
if certain future events or transactions occur.
The contingency may require
the payment of cash (or other assets) or
the issuance of additional securities.
The Exposure Draft requires that all contingent
consideration in a business combination be measured
and recognized at fair value on the acquisition date.
Chapter
2-39
Contingent
Contingent Consideration
Consideration in
in an
an Acquisition
Acquisition
Adjustments During the Measurement Period
The Exposure Draft defines the measurement period as
the period after the acquisition date during which the
acquirer may adjust the provisional amounts recognized
at the acquisition date.
The measurement period ends as soon as the acquirer has
the needed information about facts and circumstances,
not to exceed one year from the acquisition date.
Chapter
2-40
Contingent
Contingent Consideration
Consideration in
in an
an Acquisition
Acquisition
Contingency Based on Outcome of a Lawsuit
Consideration contingently issuable may depend on both
future earnings and
future security prices.
In such cases, an additional cost of the acquired company
should be recorded for all additional consideration
contingent on future events, based on the best available
information and estimates at the acquisition date (as
adjusted by the end of the measurement period).
Chapter
2-41
Contingent
Contingent Consideration
Consideration in
in an
an Acquisition
Acquisition
Review Question
Which of the following statements best describes the Exposure
Draft with regard to accounting for contingent consideration?
Chapter
2-42
a.
b.
c.
d.
Leveraged
Leveraged Buyouts
Buyouts
A leveraged buyout (LBO) occurs when a group of
employees (generally a management group) and third-party
investors create a new company to acquire all the
outstanding common shares of their employer company.
The management group:
contributes the stock they hold to the new
corporation and
borrows sufficient funds to acquire the remainder of
the common stock.
The old corporation is merged into the new corporation.
Chapter
2-43
LO 8 Leverage buyouts.
Leveraged
Leveraged Buyouts
Buyouts
The consensus position is that only the portion of the
net assets acquired with the borrowed funds has
actually been purchased and should therefore be
recorded at their cost.
The portion of the net assets of the new corporation
provided by the management group is recorded at book
value since there has been no change in ownership.
Chapter
2-44
LO 8 Leverage buyouts.
Leveraged
Leveraged Buyouts
Buyouts
E2-7 Managers of Bayco own 500 of its 10,000
outstanding common shares. Draco is formed by the
managers of Bayco to take over Bayco in a leveraged
buyout. The managers contribute their shares in Bayco, and
Draco then borrows $50,000 to purchase the remaining
9,500 outstanding shares of Bayco. Bayco is then merged
into Draco. Data relevant to Bayco immediately prior to the
leveraged buyout follow:
Chapter
2-45
LO 8 Leverage buyouts.
Leveraged
Leveraged Buyouts
Buyouts
E2-7 Required: Complete the following schedule showing
the values to be reported in Dracos balance sheet
immediately after the leveraged buyout.
Current assets
$3,000
Plant assets
24,350
Goodwill
23,400
Debt
(1)
(2)
Stockholders equity$50,000
750
(3)
LO 8 Leverage buyouts.
Copyright
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information contained herein.
Chapter
2-47