Accounting For Business Combination

Advanced
Accounting
Jeter ● Chaney
Accounting for
Business
Combinations
1
Prepared by Sheila Ammons, Austin Community College
Learning Objectives
• Describe the major changes in the accounting for
business combinations passed by the FASB in
December 2007, and the reasons for those changes.
• Describe the two major changes in the accounting for
business combinations approved by the FASB in 2001,
as well as the reasons for those changes.
• Discuss the goodwill impairment test, including its
frequency, the steps laid out in the new standard, and
some of the implementation problems.
• Explain how acquisition expenses are reported.
2
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Learning Objectives
• Describe the use of pro forma statements in business combinations.
• Describe the valuation of assets, including goodwill, and liabilities
acquired in a business combination accounted for by the acquisition
method.
• Explain how contingent consideration affects the valuation of assets
acquired in a business combination accounted for by the acquisition
method.
• Describe a leveraged buyout.
• Describe the disclosure requirements according to current GAAP related
to each business combination that takes place during a given year.
• Describe at least one of the differences between U.S. GAAP and IFRS
related to the accounting for business combinations.
3
Historical Perspective on
Business Combinations
What Changed? Issued December 2007
• SFAS No. 141R [ASC 805], “Business Combinations,”

replaced FASB Statement No. 141.
– Supports the use of a single method.
– Uses the term “acquisition method” rather than
“purchase method.”
– The fair values of all assets and liabilities on the
acquisition date, defined as the date the acquirer
obtains control of the acquiree, are reflected on the
financial statements.
LO 1 FASB’s two major changes for business combinations.
4
Historical Perspective on
What Changed? Issued December 2007
• “Noncontrolling Interests In Consolidated

Financial Statements”, amended Accounting Research
Bulletin (ARB) No. 51. (now included in FASB ASC
810 [Consolidations]),
– Established standards for the reporting of the
noncontrolling interest when the acquirer obtains
control without purchasing 100% of the acquiree.
– Additional discussion in Chapter 3.
LO 1 FASB’s two major changes for business combinations.

5
Historical
AccountingPerspective on Business
Standards on
Combinations: Background
• Historically, two methods permitted in the U.S.:
purchase and pooling of interests.
• Pronouncements in June 2001:
– SFAS No. 141, “Business Combinations,” - pooling
method is prohibited for business combinations
initiated since June 30, 2001. [FASB ASC 805]
– SFAS No. 142, “Goodwill and Other Intangible
Assets,” - Goodwill acquired in a business
combination since June 30, 2001, should not be
amortized. [FASB ASC 350]
LO 2 FASB’s two major changes of 2001.
6
Accounting Standards on Business
Combinations: Background
Goodwill Impairment Test
• For public companies, goodwill is no longer amortized.
– Goodwill of each reporting unit is tested for impairment on an
annual basis.
• All goodwill must be assigned to a reporting unit.
• Impairment should be tested in a two-step process.
– Step 1: Does potential impairment exist?
– Step 2: What is the amount of goodwill impairment?
• Private companies can elect an alternative model: amortize goodwill

over a period not to exceed 10 years and utilize a simplified impairment
model. Issued January 2014
LO 3 Goodwill impairment assessment.

7
Perspective on
Business
Combinations
8
LO 3
Goodwill Impairment
Test
E2-10: On January 1, 2013, Porsche Company acquired the net assets of
Saab Company for $450,000 cash. The fair value of Saab’s 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:
Present Value Carry Value Fair Value
of Future of SAAB's of SAAB's
Year Cash Flows Net Assets * Net Assets
2014 $ 400,000 $ 330,000 $ 340,000
2015 $ 400,000 $ 320,000 $ 345,000
2016 $ 350,000 $ 300,000 $ 325,000
* Goodwill is not included

9
E2-10: On January 1, 2013, the acquisition date, what was the amount
of goodwill acquired, if any?
Acquisition price $450,000
Fair value of identifiable net assets 375,000
Recorded value of Goodwill $ 75,000

10
E2-10: 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 - 2014
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets
Carrying value of goodwill
330,000
Total carrying value of unit
75,000
Excess of carrying value over fair value $ 5,000
405,000
Excess of carrying value over fair value means step 2 is required.
11
E2-10: Part A&B (continued)
Step 2 - 2014
Implied value of goodwill 60,000
Carrying value of goodwill 75,000
Impairment loss
$ 15,000
Journal Impairment Loss Goodwill 15,000
Entry Goodwill
15,000 LO 3 Goodwill impairment assessment.

12
Step 1 - 2015
Carrying value of goodwill *
320,000
60,000
Excess of fair value over carrying value $ 20,000
380,000
Excess of fair value over carrying value means step 2 is not required.
* $75,000 (original goodwill) – $15,000 (prior year impairment)
13
Step 1 - 2016
Carrying value of goodwill *
300,000
60,000
Excess of carrying value over fair value $ 10,000
360,000
Excess of carrying value over fair value means step 2 is required.

* $75,000 (original goodwill) – $15,000 (prior year impairment)
14
Step 2 - 2016
Implied value of goodwill 25,000
Carrying value of goodwill 60,000
Impairment loss
$ 35,000
Journal Impairment Loss Goodwill 35,000
Entry Goodwill
35,000 LO 3 Goodwill impairment assessment.

15
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).
16
Disclosures Mandated by FASB
• FASB ASC paragraph 805-30-50-1 requires:
– Total amount of acquired goodwill and the amount
expected to be deductible for tax purposes.
– Amount of goodwill by reporting segment (if the
acquiring firm is required to disclose segment
information), unless not practicable.

17
• FASB ASC paragraph 350-20-45-1 specifies the
presentation of goodwill (if impairment occurs):
– Aggregate amount of goodwill should be a separate
line item in the balance sheet.
– Aggregate amount of losses from goodwill
impairment should be a separate line item in the
operating section of the income statement unless
some of the impairment is associated with a
discontinued operation.
18
• When an impairment loss occurs, FASB ASC paragraph
350-20-50-2 mandates note disclosure:
– Description of facts and circumstances leading to the
impairment.
– Amount of impairment loss and method of determining
the fair value of the reporting unit.
– Nature and amounts of any adjustments made to
impairment estimates from earlier periods, if
significant.
19
Perspective on Business
Combinations
Other Required Disclosures
• FASB ASC paragraph 805-10-50-2 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.
LO 9 New disclosure requirements for business combinations.

20
Combinations
Other Required Disclosures
• FASB ASC paragraph 805-10-50-2 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.
LO 9 New disclosure requirements for business combinations.
21
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. FASB ASC
Section 350-30-35
– Indefinite life
• Should not be amortized.
• Should be tested annually (at a minimum) for
impairment.
22
Combinations
Treatment of Acquisition Expenses
• FASB ASC paragraph 805-10-25-23 excludes acquisition-related
from measurement of consideration paid.
– Both direct and indirect costs are expensed
– The cost of issuing securities is 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.
– Expected restructuring costs (with no obligation at the acquisition
date) are accounted for separately from the business combination.
LO 4 Reporting acquisition expenses.

23
Combinations
Acquisition Costs—an 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.
Prepare the journal entry to record these costs.
Professional Fees Expense (Direct) 1,500

Merger Department Expense (Indirect) 2,000
Other Contributed Capital (Security Issue Costs) * 3,000
Cash 6,500
*Costs to issue debt or equity securities shall be recognized in
accordance with other applicable GAAP - FASB ASC 805-10-25-23:
LO 4 Reporting acquisition expenses.
24
Pro Forma Statements and
Disclosure Requirement
Pro forma statements (as-if statements) serve two
functions in relation to business combinations:
– to provide information in the planning stages of the
combination and
– to disclose relevant information subsequent to the
combination.
LO 5 Use of pro forma statements.

25
Pro FormaStatements
Pro Forma Statements
and and
Disclosure
Requirement
Illustration 2-2 LO 5 Use of pro forma statements.

26
Pro Forma Statements and
• If a material business combination occurred during the
year, notes to financial statements should include on a
pro forma basis:
– Results of operations for the current year as though
the companies had combined at the beginning of the
year.
– 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.
LO 5 Use of pro forma statements.
27
Explanation and Illustration of
Acquisition Accounting
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.
LO 6 Valuation of acquired assets and liabilities assumed.

28
Explanation andIllustration
Explanation and Illustrationofof
Value of Assets and Liabilities Acquired
• Identifiable assets acquired (including intangibles other
than goodwill) and liabilities assumed should be recorded
at their fair values at the date of acquisition.
• Any excess of total cost over the sum of amounts assigned
to identifiable assets and liabilities is recorded as goodwill.
Goodwill should not be amortized but should be adjusted
downward only when it is impaired (discussed earlier).
• Under current GAAP, in-process R&D is measured and
recorded at fair value as an asset on the acquisition date.

29
E2-1: Preston Company acquired the assets (except for cash) and assumed the
liabilities of Saville Company. Immediately prior to the acquisition, Saville
Company’s balance sheet was as follows:
Any
Goodwill?

30
E2-1: Preston Company acquired the assets (except for cash) and assumed
the liabilities of Saville Company. Immediately prior to the acquisition, Saville
Company’s balance sheet was as follows:
Fair value of
assets, without
cash
$1,824,000

31
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 $1,824,000
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Price paid 1,560,000
Goodwill $ 330,000

32
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 (net) 228,000

Inventory 396,000
Plant and equipment (net) 540,000
Land 660,000
Goodwill 330,000
Liabilities 594,000
Cash 1,560,000

33
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 any gain.
– Current requirements, FASB ASC paragraph 805-30-25-4: Acquirer
must
• reassess whether it has correctly identified all of the assets acquired
and all of the liabilities assumed before recognizing a gain on bargain
purchases and
• review procedures used to measure the amounts recognized at the
acquisition date.

34
Bargain Acquisition
• When the price paid to acquire another firm is lower
than the fair value of identifiable net assets (assets
minus liabilities), the acquisition is referred to as a
bargain.
– Any previously recorded goodwill on the seller’s
books is eliminated (and no new goodwill recorded).
– A gain is reflected in current earnings of the acquiree
to the extent that the fair value of net assets exceeds
the consideration paid.
35
E2-1: B. Repeat the requirement in (A) assuming that the amount paid
was $990,000.
Calculation of Goodwill or Bargain Purchase
Fair value of assets, without cash $1,824,000
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Price paid 990,000
Bargain purchase $ 240,000

36
E2-1: B. Repeat the requirement in (A) assuming that the amount paid
was $990,000.
Receivables (net) 228,000
Inventory 396,000
Plant and equipment (net) 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on acquisition (ordinary) 240,000

37
Measurement Period
The Measurement Period
 Period after the acquisition date during which the
acquirer may adjust the provisional amounts recognized
for a business combination.
 Ends as soon as the acquirer receives the information it
was seeking about the facts and circumstances that
existed at the acquisition date, or learns that more
information is not available
 Shall not exceed one year from the acquisition date.

38
Measurement Period
The Measurement Period
 Provides the acquirer with a reasonable time to obtain the
information necessary to identify and measure any of the
following as of the acquisition date:
a. Identifiable assets acquired, liabilities assumed, and any
noncontrolling interest in the acquiree.
b. Any consideration transferred to the acquiree.
c. In a business combination achieved in stages, any previous
equity interest held by the acquirer.
d. The amount recognized as goodwill or the gain from a
bargain purchase.
39
Measurement Period Adjustments
If initial accounting is incomplete by the end of the first
reporting period:
– Acquirer should use provisional amounts in the
financial statements for any item in which the
accounting is incomplete.

40
During the measurement period, acquirer:
 Required to retrospectively adjust the provisional amounts
recognized at the acquisition date to reflect new
information obtained about facts and circumstances that
existed at the acquisition date.
 Recognizes additional assets or liabilities if new
information is obtained about facts and circumstances that
existed at the acquisition date which, if known, would have
resulted in the recognition of those assets and liabilities.

41
After the measurement period ends:
– The acquirer only revises the accounting for a
business combination to correct an error.

42
Contingent Consideration in an
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.
• Current GAAP requires that all contractual contingencies,
as well as non-contractual liabilities for which it is more
likely than not that an asset or liability exists, be measured
and recognized at fair value on the acquisition date.
LO 7 Contingent consideration and valuation of assets.

43
Acquisition
SFAS No 141R (FASB ASC Topic 805 Business Combinations)
 Changed the accounting for earnouts (contingencies based on
earnings) both on the measurement and subsequent dates.
 Requires the acquirer to recognize contingent consideration and to
measure the fair value of the consideration at the acquisition date.
 Potential methods for estimating the fair value of contingent
consideration are quite varied.
 For instance, the income approach involves estimating
expected cash flows under various scenarios and discounting
these using some appropriate discount rate and levels of
probability for each.

44
Acquisition
Contingent consideration classified as a liability:
Illustration: Assume that P Company acquired all the net assets of S
Company (current assets of $20,000, buildings for $400,000, and
liabilities of $50,000 for cash of $510,000. P Company also agreed to
pay an additional $150,000 to the former stockholders of S Company if
the post combination revenues over the next two years equaled or
exceeded $800,000. The fair value of the contingent consideration was
estimated to be $60,000.

45
Acquisition
Illustration: P Company will make the following entry on the date of
acquisition:
Current Assets 20,000
Buildings 400,000
Goodwill 200,000
Liabilities 50,000
Contingent Consideration 60,000
Cash 510,000

46
Acquisition
Since the contingent consideration is classified as a liability, P Company
must remeasure the contingent consideration each quarter and recognize
the change in income
Illustration: If at the end of the first year, the likelihood has increased
that the revenue target will be met, P Company should assess an increase
in the fair value of the contingent consideration. If the fair value at the
end of year one increased to $100,000 P Company would make the
following entry:
Increase in Liability:
Loss from Contingent Consideration 40,000

47
Acquisition
Illustration: If on the other hand, it has become unlikely that either
target will be met, P Company should remove the liability altogether,
and would make the following entry:
Decrease in Liability:
Gain from Contingent Consideration 60,000

48
Acquisition
Contingent consideration classified as equity:
Illustration: Suppose that in the previous example, P Company agreed
to issue an additional 10,000 shares of $1 par value common stock to the
former stockholders of S Company if the post combination revenues over
the next two years equaled or exceeded $800,000. The fair value of the
contingent consideration was estimated to be $40,000.

49
Acquisition
Illustration: P Company will make the following entry on the date of
acquisition:
Current Assets 20,000
Buildings 400,000
Goodwill 180,000
Liabilities 50,000
Paid In Capital Contingent Consideration 40,000
Cash 510,000

50
Acquisition
Illustration: P Company would not remeasure the paid in capital
balance based on changes in the fair value of the common stock.
Suppose that the contingent consider was paid. P Company would make
the following entry:
Consideration is paid:
Paid in Capital Contingent Consideration 40.000
Common Stock (10,000 shares at $1 par) 10,000
Paid in Capital – Common Stock 30,000

51
Acquisition
Illustration: P Company would not remeasure the paid in capital
balance based on changes in the fair value of the common stock.
Suppose it became unlikely that the target would be met. P Company
would make the following entry:
Consideration is not paid:

Paid in Capital Contingent Consideration 40.000
Paid in Capital –
From Unsatisfied Targets 40,000

52
Acquisition
Review Question
Which of the following statements best describes the current authoritative position
with regard to accounting for contingent consideration?
a) If contingent consideration depends on both future earnings and future
security prices, an additional cost of the acquired company should be
recorded only for the portion of consideration dependent on future earnings.
b) The measurement period for adjusting provisional amounts always ends at
the year-end of the period in which the acquisition occurred.
c) A contingency based on security prices has no effect on the determination of
cost to the acquiring company.
d) The purpose of the measurement period is to provide a reasonable time to
obtain the information necessary to identify and measure the fair value of the
acquiree’s assets and liabilities, as well as the fair value of the consideration
transferred.
53
Leveraged 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.
– The essence of the change suggests that the economic entity
concept should be applied; thus (LBO) transactions are to be
viewed as business combinations.
LO 8 Leverage buyouts.
54
IFRS Versus U.S. GAAP
• The project on business combinations
– Was the first of several joint projects undertaken by the
FASB and the IASB.
– Complete convergence has not yet occurred.
– International standards currently allow a choice between
• writing all assets, including goodwill, up fully (100%
including the noncontrolling share), as required now
under U.S. GAAP, or
• continuing to write goodwill up only to the extent of
the parent’s percentage of ownership.
LO 10 Differences between U.S. GAAP and IFRS
55 .
Other differences and similarities:

56 .

57 .

58 .
LO 10 Differences between U.S. GAAP and IFRS .

59
LO 10 Differences between U.S. GAAP and IFRS .

60

Accounting For Business Combination

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Advanced

• SFAS No. 141R [ASC 805], “Business Combinations,”

• “Noncontrolling Interests In Consolidated

LO 1 FASB’s two major changes for business combinations.

• Private companies can elect an alternative model: amortize goodwill

LO 3 Goodwill impairment assessment.

* Goodwill is not included

LO 3 Goodwill impairment assessment.

15,000 LO 3 Goodwill impairment assessment.

Excess of carrying value over fair value means step 2 is required.

35,000 LO 3 Goodwill impairment assessment.

LO 3 Goodwill impairment assessment.

LO 9 New disclosure requirements for business combinations.

LO 4 Reporting acquisition expenses.

Professional Fees Expense (Direct) 1,500

LO 5 Use of pro forma statements.

Illustration 2-2 LO 5 Use of pro forma statements.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

Receivables (net) 228,000

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

LO 7 Contingent consideration and valuation of assets.

Consideration is not paid:

LO 7 Contingent consideration and valuation of assets.

LO 10 Differences between U.S. GAAP and IFRS

LO 10 Differences between U.S. GAAP and IFRS

LO 10 Differences between U.S. GAAP and IFRS

LO 10 Differences between U.S. GAAP and IFRS .

LO 10 Differences between U.S. GAAP and IFRS .

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