Business Combination

Business Combinations
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
1-1
Learning Objective 1
Understand the economic

motivations underlying
business combinations.
1-2
A business combination occurs when
two or more separate businesses join
into a single accounting entity.
1-3
Reasons for Business Combinations

Cost advantage
Lower risk
Fewer operating delays
Avoidance of takeovers
Acquisition of intangible assets
Other reasons
1-4
Learn about the alternative

forms of business combinations,
from both the legal and
accounting perspectives.
1-5
The Legal Form of

Business Combination
Acquisitions
Merger
Consolidation
1-6
The Legal Form of

A
Merger
1-7
The Legal Form of

A
Consolidation
1-8
The Accounting Concept of

The concept emphasizes the creation of a
single entity and the independence of the
combining companies before their union.
Dissolution of the legal entity is not
necessary within the accounting concept.
1-9

Single management
1 - 10
Business Integration
Vertical combination of firms with
operations in different but successive stages of
distribution
Horizontal combination of firms in same
business lines and market
Conglomerate combination of firms with
unrelated and diverse products and or service
functions
1 - 11

One or more corporations become subsidiaries.
One company transfers its net assets to another.
Each company transfers its net assets
to a newly formed corporation.
1 - 12
Background on Accounting for

Much of the controversy concerning accounting
requirements for business combinations historically
involved the pooling of interest method.
ARB No. 40 introduced an alternative method:
the purchase method.
1 - 13

Until 2001, accounting requirements for business
combinations were found in APB Opinion No. 16.
APB No. 16 recognized both the pooling
and purchase methods.
1 - 14

FASB Statement No. 141 eliminated the
pooling of interest method for transactions
initiated after June 30, 2001.
Combinations initiated after this date
must use the purchase method.
IFRS 3 (2008) Purchase Method
1 - 15
Understand alternative
approaches to the financing
of mergers and acquisitions.
1 - 16
Pooling Method
Pooling uses historical book values to record
combinations rather than recognizing fair
values of net assets at the transaction date.
Most of the detailed issues related to poolings
concern the original recording of the combination.
1 - 17
Purchase Method
Purchase accounting requires the recording

of assets acquired and liabilities assumed at
their fair values at the date of combination.
1 - 18
Introduce concepts of accounting

for business combinations
emphasizing the purchase method.
1 - 19
Accounting for Business Combinations

Under the Purchase 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 Poppy is $16 per share
1 - 20

Additional direct costs:
SEC fees
Accounting fees
Printing and issuing
Finder and consulting
$ 5,000
$10,000
$25,000
$80,000
How is the issuance recorded?

1 - 21

Investment in Sunny
1,600,000
Common Stock, $10 par
1,000,000
Additional Paid-in Capital
600,000
To record issuance of 100,000 shares of $10 par
common stock with a market value of $16 per share
in a purchase business combination with Sunny.
How are the additional direct costs recorded?

1 - 22

Investment in Sunny
95,000
25,000
Cash (other assets)
120,000
To record additional direct costs of combining
with Sunny: $80,000 finders and &15,000
Sec and accounting fees and $25,000 for
Registering and issuing equity securities.
1 - 23

The total cost to Poppy of acquiring
Sunny is $1,695,000.
This is the amount entered into the
investment in the Sunny account.
1 - 24
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.
1 - 25
See how firms make cost

allocations in a purchase
method combination.
1 - 26
Cost Allocation in a Purchase

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
of assets and liabilities.
1 - 27
Cost Allocation in a Purchase

No value is assigned to goodwill recorded
on the books of an acquired subsidiary.
Such goodwill is an unidentifiable asset.

Goodwill resulting from the
combination is valued directly.
1 - 28
Recognition and Measurement of

Intangible Assets Other than Goodwill
Separability
criterion
Contractuallegal criterion
Recognizable intangibles
1 - 29
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 combination.
Future earnings
level
Security prices
1 - 30
Cost and Fair Value Compared
Investment cost
Total fair value of

identifiable assets
less liabilities
1 - 31

Investment cost
>
Net fair value
Identifiable net
assets according
to their fair value
Goodwill
1 - 32
Illustration of a Purchase
Combination
Pitt Corporation acquires the net assets of

Seed Company on December 27, 2003.
Pitt
Seed
1 - 33
Combination
Book
Value
Assets
Cash
Net receivables
Inventories
Land
Buildings, net
Equipment, net
Patents
Total assets
50
150
200
50
300
250
$1,000
Fair
Value
$
50
140
250
100
500
350
50
$1,440
1 - 34
Combination
Book
Value
Liabilities
Accounts payable
Notes payable
Other liabilities
Total liabilities
Net assets
$ 60
150
40
$250
$ 50
Fair
Value
$
60
135
45
$ 240
$1,200
1 - 35
Combination
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
1 - 36
Combination
Investment in Seed
1,400,000
Cash
400,000
Common Stock
500,000
500,000
common stock plus $400,000 cash in a purchase
business combination with Seed Company
1 - 37
Combination
Cash
Net receivable
Inventories
Land
Buildings, net
Equipment, net
Patents
50
140
250
100
500
350
50
Goodwill
200
Accounts payable
60
Notes payable
135
Other liabilities
45
Investment in
Seed Company 1,400
$1640 1,440 = 200
1 - 38
Combination
Pitt issues 40,000 shares of its $10 par common
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
1 - 39
Combination
Investment in Seed
1,000,000
Common Stock
400,000
400,000
10% Note Payable
200,000
common stock plus $200,000, 10% note in a
purchase business combination with Seed Company
1 - 40
Combination
Cash
Net receivable
Inventories
Land
Buildings, net
Equipment, net
Patents
50
140
250
80
400
280
40
Accounts payable
60
Notes payable
135
Other liabilities
45
Investment in
Seed Company 1,000
1 - 41
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%.
1 - 42
The Goodwill Controversy

Under FASB Statement No. 142, goodwill is no
longer amortized for financial reporting purposes.
income tax controversies

international accounting issues
1 - 43
The Goodwill Controversy

Under FASB Statements No. 141 and No. 142,
the FASB requires that firms periodically assess
goodwill for impairment of its value.
An impairment occurs when the recorded value

of goodwill is less than its fair value.
1 - 44
Recognizing and Measuring

Impairment Losses
Compare
Carrying values
Fair values
1 - 45

Fair value
<
Carrying amount
Measurement of the
impairment loss
1 - 46
Amortization versus
Nonamortization
Firms must amortize intangible assets with
a finite useful life over that life.
Firms will not amortize intangible assets with an
indefinite useful life that cannot be estimated.
1 - 47
End
1 - 48

Business Combination

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Business Combinations

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Understand the economic

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Reasons for Business Combinations

Learn about the alternative

The Legal Form of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Legal Form of

The Legal Form of

The Accounting Concept of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Accounting Concept of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Accounting Concept of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Background on Accounting for

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Background on Accounting for

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Background on Accounting for

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Purchase accounting requires the recording

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Introduce concepts of accounting

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Business Combinations

Accounting for Business Combinations

How is the issuance recorded?

Accounting for Business Combinations

How are the additional direct costs recorded?

Accounting for Business Combinations

Accounting for Business Combinations

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Goodwill is an intangible asset that arises

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

See how firms make cost

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Cost Allocation in a Purchase

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Cost Allocation in a Purchase

Such goodwill is an unidentifiable asset.

Recognition and Measurement of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Cost and Fair Value Compared

Total fair value of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Cost and Fair Value Compared

Net fair value

Pitt Corporation acquires the net assets of

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Pitt pays $400,000 cash and issues 50,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn