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CT – Topic 5

Business Combinations
Separate organizations tied together through common control under common management are combined into a single entity.
Reasons Firms Combine
Vertical integration
Cost savings
Quick entry into new markets
Economies of scale
More attractive financing opportunities
Diversification of business risk
Business Expansion
Increasingly competitive environment
Expansion through Corporate Takeovers
The company that exerts control is known as the
parents
and the separate controlled companies are known as
subsidaries
Financial statements that represent a parent and its subsidiaries as a SINGLE ENTITY are known as
“consolidated” FS
Which of the following does not represent a primary motivation for business combinations?

Combinations as a vehicle for achieving rapid growth and competitiveness

Cost savings through elimination of duplicate facilities and staff

Quick entry for new and existing products into markets

Larger firms being less likely to fail.

Larger firms being less likely to fail.
Which of the following is the best theoretical justification for consolidated financial statements?

In form the companies are one entity; in substance they are separate

In form the companies are separate; in substance they are one entity.

In form and substance the companies are one entity

In form and substance the companies are separate

In form the companies are separate; in substance they are one entity.
The Consolidation Process
statements provide more meaningful information than separate statements

more fairly present the activities of the consolidated companies.

may retain their legal identities as separate corporations.

Business combinations . . .
can be achived through
through transactions or events in which an acquirer obtains control over one or more businesses.
biz combos create
single economic entities.
biz combos can be formed by
by a variety of events but can differ widely in legal form
biz combos require
consolidated financial statements
There are five types of combinations that are required to prepare consolidated statements
: 1.Statutory merger through asset acquisition
2.Statutory merger through capital stock acquisition 3. Statutory consolidation through capital stock or asset acquisition. 4. Acquisition of more than 50% of the voting stock 5. Control through ownership of variable interests.
Statutory:
only one of the original companies continues to exist
Statutory consolidation:
both companies are dissolved, leaving only the new organization
Legal control over another by
acquiring a majority of voting stocks
Control through ownership of variable interests
contractual control
What is a statutory merger?
A merger approved by the Securities and Exchange Commission (SEC)
An acquisition involving the purchase of both stock and assets
A takeover completed within one year of the initial tender offer
A business combination in which only one company continues to exist as a legal entity.
A business combination in which only one company continues to exist as a legal entity.
Parent’s and subsidiaries’ financial data are brought together to report
To report the financial position, results of operations, and cash flows for the combined entity.
Reciprocal accounts and intra-entity transactions are adjusted or eliminated to prepare
a single set of consolidated financial statements.
If dissolution occurs:
All account balances are actually consolidated in the financial records of the survivor.

Permanent consolidation occurs at the combination date.

Dissolved company’s records are closed out.
Surviving company’s accounts are adjusted to include all balances of the dissolved company

If separate incorporation maintained:
Financial statement information (on work papers, not the actual records) is consolidated.

Consolidation occurs at regular intervals, whenever financial statements are prepared.

Each company continues to retain its own records.

worksheets facilitates the periodic consolidation process
without disturbing individual accounting systems
acquisition method
used to account for biz combos
acquisition method requird masureing at FV
Consideration transferred for the acquired business
Noncontrolling interest
Separately identified assets and liabilities
Goodwill or gain from a bargain purchase
Any contingent considerations.
fair market approach
fair value can be estimated referecing similar market trades
income apprac
fair value can be estimated using dsicounted futue cash flow of the asset
cost approach
estimates fair values by reference to the current cost of replacing an asset with another of comparable ecoomic utility
If the consideration is MORE than the Fair Value of the Assets acquired, the difference is attributed
to goodwills
If the consideration is LESS than the Fair Value of the Assets acquired
have a baragin! record a gain on acquisition
FASB ASC 805, Business Combinations, provides principles for allocating the fair value of an acquired business. When the collective fair values of the separately identified assets acquired and liabilities assumed exceed the fair value of the consideration transferred, the difference should be:

Recognized as an ordinary gain from a bargain purchase.

Treated as a negative goodwill to be amortized over the period benefited, not to exceed 40 years

Treated as goodwill and tested fro impairment on an annual basis

Applied pro rata to reduce, but not below zero, the amounts initially assigned to specific noncurrent assets of the acquired firm

Recognized as an ordinary gain from a bargain purchase.
When does gain recognition accompany a business combination?

When a bargain purchase occurs.

In a combination created in the middle of a fiscal year

In a acquisition when the value of all assets and liabilities cannot be determined

When the amount of a bargain purchase exceeds the fair value of the applicable noncurrent assets (other than certain exceptions) held by the acquired company

When a bargain purchase occurs.
When negotiating a business acquisition, buyers sometimes agree to pay extra amounts to sellers in the future if performance metrics are achieved over specified time horizons. How should buyers account for such contingent consideration in recording an acquisition?

The amount ultimately paid under the contingent consideration agreement is added to goodwill when and if the performance metrics are met

The fair value of the contingent consideration is expensed immediately at acquisition date

The fair value of the contingent consideration is included in the overall fair value of the consideration transferred, and a liability or additional owners’ equity is recognized.

The fair value of the contingent consideration is recorded as a reduction of the otherwise determinable fair value of the acquired firm

The fair value of the contingent consideration is included in the overall fair value of the consideration transferred, and a liability or additional owners’ equity is recognized.
Direct Costs of the acquisition (attorneys, appraisers, accountants, investment bankers, etc.) are
NOT part of the fair value received and are immediately expensed
Indirect or Internal Costs of acquisition (secretarial and management time) are
period costs expensed as incurred
costs to registed and issue securities related to acquistion
reduce their fair values
According to the acquisition method of accounting for business combinations, costs paid to attorneys and accountants for services in arranging a merger should be

Capitalized as part of the overall fair value acquired in the merger

Recorded as an expense in the period the merger takes place.

Included in recognized goodwill

Written off over a five-year maximum useful life

Recorded as an expense in the period the merger takes place.
when separate incorporation is maintained
Dissolution does not occur.

Consolidation process is similar to previous example.

Fair value is the basis for initial consolidation of subsidiary’s net assets.

Subsidiary is a legally incorporated separate entity.

Consolidation of financial information is simulated.

Acquiring company does not physically record the transaction

consolidation worksheet entries steps:
1.Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition date fair value similar to the equity method procedures.
2. The financial information for Parent and Sub are recorded in the first two columns of the worksheet (with Sub’s prior revenue and expense already closed).
3. Remove the Sub’s equity account balances.
4. Remove the Investment in Sub balance.
5. Allocate Sub’s Fair Values, including any excess of cost over Book Value to identifiable assets or goodwill.
6. Combine all account balances and extend into the Consolidated totals column.
7. Subtract consolidated expenses from revenues to arrive at net income.
intangible are assets that
Lack physical substance (excluding financial instruments)
Arise from contractual or other legal rights
Can be sold or otherwise separated from the acquired enterprise
preexisitng goodwill recorded in acquired company’s accounts is
ignored in allocation of the purchase price
IPR&D that has reached tech feasibility is
capitalized as an intangible asset at fair value with an indefinite life taht is reviewd for impairment
ongoing R&D is
expensed as incurred
What is the appropriate accounting treatment for the value assigned to in-process research and development acquired in a business combination?

Expense over acquisition

Capitalize as an asset.

Expense if there is no alternative use for the assets used in the research and development and technological feasibility has yet to be reached

Expense until future economic benefits become certain and then capitalize as an asset

Capitalize as an asset.
valuaton basis is “cost”
The value of the consideration transferred,
PLUS the direct costs of the acquisition,
IGNORE any indirect costs of the acquisition,
IGNORE any contingent payments.
The total cost of the acquisition was allocated proportionately to the net assets based on their
fair values with any excess going to goodwill
“Pooling of Interests”
when one company acquired all of another companys stock using its own stock as considersion
Consolidation of financial information is required when
one firm gains control of another
Current financial reporting standards require the acquisition method to be used in accounting for
business combo
recognize goodwill is
purcahse price > fair value of net assets acquired
recognize a gain if
purchase price < fair value of net assets
Particular attention should be paid to the recognition
of intanfible assets in biz combos

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