accounting for business combinations - university of idaho€¦ · web view · 2013-01-31primary...

Acct 415/515 Prof. Teresa Gordon

Accounting for Business Combinations

GAAP: SFAS 94 (1987)SFAS 141 (2001)

What’s new in SFAS No. 141 as compared to APB Opinion 16?1. All business combinations are accounted for by the purchase method (no pooling of

interest)2. New criteria for recognizing identifiable intangibles (other than goodwill)3. Additional disclosure requirements, including:

a. Primary reasons for the business combinationb. The allocation of purchase price paid to the assets acquired and liabilities assumed

by major balance sheet captionc. When significant, disclosure of other information such as amount of goodwill by

reportable segment and the amount of purchase price assigned to each major intangible asset class.

What did NOT change:1. Guidance for determining the cost of an acquired entity2. Guidance for allocating the cost to the assets acquired and liabilities assumed3. Accounting for contingent consideration4. Accounting for pre-acquisition contingencies5. Write-off of R&D assets acquired

What’s in the works?FASB has current agenda item called “Business Combinations: Purchase Method Procedures”9/30/02 Newsletter reports that the FASB and IASB tentatively agreed on the following working principle for recording a business combination:

The accounting for a business combination is based on the assumption that the transaction is an exchange of equal values; the total amount to be recognized should be measured at either the fair value of the consideration paid or the fair value of the net assets acquired, whichever is more clearly evident of the fair value of the transaction.

If the consideration paid is cash or other assets (or liabilities incurred) of the acquiring entity, the fair value of the consideration paid generally determines the total amount to be recognized in the financial statements of the acquiring entity. If the consideration paid is in the form of equity instruments, the fair value of the equity instruments ordinarily is more clearly evident than the fair value of the net assets acquired and, thus, generally will determine the total amount to be recognized by the acquiring entity.

In a business combination, the acquiring entity obtains control over the acquired entity and therefore is responsible for the assets and liabilities of the acquired entity. The identifiable acquired assets and assumed liabilities should be recognized on the date control is obtained, and measured at their fair values at that date: [for more info, go to FASB webpage]

document.doc as of 05/08/23


To use the purchase method, one company must be designated as the “acquiring company”

Here are the guidelines from FAS141:

If cash or other assets are distributed or liabilities are incurred:In a business combination effected solely through the distribution of cash or other assets or by incurring liabilities, the entity that distributes cash or other assets or incurs liabilities is generally the acquiring entity. [FAS141, Par. 17]

If stock is exchanged:In a business combination effected through an exchange of equity interests, the entity that issues the equity interests is generally the acquiring entity. [FAS141, Par. 18]

In some business combinations (commonly referred to as reverse acquisitions), however, the acquired entity issues the equity interests. Commonly, the acquiring entity is the larger entity. However, the facts and circumstances surrounding a business combination sometimes indicate that a smaller entity acquires a larger one.

In some business combinations, the combined entity assumes the name of the acquired entity. Thus, in identifying the acquiring entity in a combination effected through an exchange of equity interests, all pertinent facts and circumstances shall be considered, in particular:

a. The relative voting rights in the combined entity after the combination—all else being equal, the acquiring entity is the combining entity whose owners as a group retained or received the larger portion of the voting rights in the combined entity. In determining which group of owners retained or received the larger portion of the voting rights, consideration shall be given to the existence of any unusual or special voting arrangements and options, warrants, or convertible securities.

b. The existence of a large minority voting interest in the combined entity when no other owner or organized group of owners has a significant voting interest—all else being equal, the acquiring entity is the combining entity whose single owner or organized group of owners holds the large minority voting interest in the combined entity.

c. The composition of the governing body of the combined entity—all else being equal, the acquiring entity is the combining entity whose owners or governing body has the ability to elect or appoint a voting majority of the governing body of the combined entity.

d. The composition of the senior management of the combined entity—all else being equal, the acquiring entity is the combining entity whose senior management dominates that of the combined entity. Senior management generally consists of the chairman of the board, chief executive officer, chief operating officer, chief financial officer, and those divisional heads reporting directly to them, or the executive committee if one exists.

e. The terms of the exchange of equity securities—all else being equal, the acquiring entity is the combining entity that pays a premium over the market value of the equity securities of the other combining entity or entities.



Determining the Total Cost of the Acquired Business

Include:1. Fair value of the consideration given2. Fair value of any contingent consideration given after acquisition date3. Direct costs incurred in connection with acquisition (except costs of registering

with SEC any securities given as consideration by the acquiring company*)

* See chart below

Direct costsINCLUDE EXCLUDEFinders fees Salary and overhead of internal acquisitions departmentTravel costs Allocation of general expensesAccounting fees Fees associated with registering securities with SECLegal fees Investment banker fees for underwriting registered equity securitiesa

Investment banker advising fees Investment banker fees for underwriting registered debt securitiesb

a Decreases additional paid-in capitalb Decreases proceeds (higher interest expense over life of debt)

Accounting for a Business Acquisition1. Record assets and liabilities at their fair values as of the acquisition date

2. If the cost of the acquired company exceeds the sum of the amounts assigned to the assets and liabilities acquired, record the excess as goodwill.

3. If the values assigned to the assets acquired and the liabilities assumed exceeds the cost of the acquired company:

a. Reduce by a proportionate amount the values assigned to the noncurrent assets acquired (other than long-term investments in marketable securities)

b. After the noncurrent assets have been reduced to zero, any excess of assigned values over cost of the acquired company is recorded as an extraordinary gain at acquisition.

c. Any goodwill is NOT amortized since it has an indefinite life. It is subject to impairment test at least annually.

Note: Only post-acquisition income statements can be consolidated.



Push-down accounting: In some situations when common stock is acquired, the subsidiary will adjust its books to reflect the current values at date of acquisition.

In other words, adjusting entries are made on the subsidiaries books rather than just workpaper entries. Therefore, subsequent workpapers will not have to deal with the excess value elements as they will be taken care of by the subsidiary’s accounting department (depreciation, amortization, etc.)

SEC Staff Bulletin No. 54 requires push-down accounting in the separate financial statements of a subsidiary acquired in a purchase transaction

Parent’s ownership percentage Guidelines

90% or more Substantially owned – push-down accounting is required80 to 89% Push-down accounting is encouraged but not requiredBelow 80% Push-down accounting may not be appropriate (e.g.,

subsidiary has substantial preferred stock or public debt outstanding

Leveraged BuyoutEquivalent to combination of acquisition and a refinancing – acquirer uses an extremely high percentage of debt and thus a very low percentage of equity. The debt is secured by the assets of the target company. Thus the resulting company is generally not a publicly traded company and the debt is often privately issued.

In most LBOs, the new ownership group forms a new corporation to acquire the common stock of the target company. Technically, this is NOT a business combination because there is only one operating company involved.

If a change in control has occurred, then a new basis of accounting should be established for the assets and liabilities of the new company. In some cases the write-up is only partial (see Pahler Chapter 7)



Business Combinations at Acquisition

Example Sun Inc . PA Corp .

Cash $ 1 M $190 MCurrent Assets 5 M 300 MPlant Assets 90 M 400 M **Other Assets 4 M * 10 M Total Assets $ 100 M $900 M Liabilities 60 M 400 MCommon Stock 20 M 200 MRetained Earnings 20 M 300 M

Shares outstanding 2 M 20 MPar value of common stock $10.00 $10.00Market value of common stock $25.00 $50.00Book value per share $20.00 $25.00Market value of company $50 M $1,000 M

* Sun Inc. assets include a patent with a book value of $1 M but a fair value of $10 M.

** The fair value of PA Corp. plant assets is $1,000 M.


Acct 415/515 Dr. Teresa Gordon

Acquisition of Assets

Before the Acquisition of Assets

PA Corp.(the acquiring

company)

Sun Inc.(the selling company)

After Acquisition


company)


1. PA Corp. purchases the noncash assets of Sun Inc. $120 M.



Acquisition of Common Stock

Before the Business CombinationAfter the Business

Combination


company)

Sun Inc.(the target company)

PA Corp.(the parent company)

Sun Inc.(the subsidiary

company)

2. PA Corp. acquires Sun Inc. by paying $55 M in cash to purchase all the outstanding common stock. Sun Inc. becomes a subsidiary of PA Corp.



Acquisition of Common Stock


Combination

Sun Inc.(the acquiring

company)

PA Corp.(the target company)

Sun Inc.(the parent company)

PA Corp.(the subsidiary

company)

3. Sun Inc. acquires 100% of PA Corp. by exchanging 2 shares of its own common stock for each share of PA Corp. common stock in a business combination. PA Corp. becomes a subsidiary of Sun Inc.



Statutory Merger


Combination


company)


PA Corp.(the surviving

company)

4. PA Corp. acquires 100% of Sun Inc. by exchanging 1 share of its own common stock for each 2 shares of Sun Inc. common stock in a statutory merger. Direct costs in connection with the acquisition are $3 M.



Statutory Combination


Combination

PA Corp. Sun Inc. Integrated Sunpacon

5. PA Corp. and Sun Inc. enter into a statutory combination agreement. A new entity called Integrated Sunpacon (IS) is formed. Each former stockholder of PA Corp. receives two shares of IS stock and each former stockholder of Sun Inc. receives one share of IS stock for each share of stock they own. Immediately after the combination, the $1 par value IS stock is traded at $25 per share.



Formation of a Holding Company

Before the Business Combination

After the Business Combination

PA Corp. Sun Inc. Integrated Sunpacon (the parent company)

| |

PA Corp.(a subsidiary

company)

Sun Inc.(a subsidiary

company)

6. Integrated Sunpacon (IS) is formed to be a holding company. It exchanges 2 shares of its $10 par value stock for each share of PA Corp. common stock and 1 share for each share of Sun Inc. common stock. Costs associated with SEC filings related to the IS stock is $2 M.



Acquisition of Assets - solution

Before the Acquisition of Assets


company)


After Acquisition


company)


PA Corp. purchases the noncash assets of Sun Inc. $120 M.

Sun Co. debit credit

Cash 120Assets 99Gain on sale of assets 21

Liabilities 60Cash 60

Sun Inc. Balance Sheet after combination and payment of liabilities:Cash 61Common Stock 20 Retained Earnings 41

61

Could be liquidated or could use cash to engage in other business activities.

PA Corp. debit credit

Assets 120Cash 120

No goodwill recorded because PA Corp. acquired only the assets and did not buy the company. Therefore, the amount paid would be assumed to be the fair market value and would be assigned to the assets acquired.



Acquisition of Common Stock – CASH (solution)

Before the Business Combination After the Business

Combination


company)


PA Corp.(the parent company)

Sun Inc.(the subsidiary

company)

PA Corp. acquires Sun Inc. by paying $55 M in cash to purchase all the outstanding common stock. Sun Inc. becomes a subsidiary of PA Corp.

Sun Inc. - No impact on its books, money is paid directly to its stockholders.


Investment in Sun Inc. 55 MCash 55 M

Conceptual Analysis of Purchase Price:

Book value component(Sun’s Common Stock & Retained Earnings) 40 M

Excess value of identified assets(Patent is worth $9 M more than book value – this amount wouldbe amortized over the patent’s remaining economic life) 9 M

Goodwill element(Purchase price less book value less excess fair value of identifiable assets) 6 M

55 M



Acquisition of Common Stock - EXCHANGE OF STOCK (solution)


Combination

Sun Inc.(the acquiring

company)

PA Corp.20,000,000 s/s =>40,000,000 s/s Sun@ $25 ea=$1,000M

Sun Inc.(the parent company)

PA Corp.(the subsidiary

company)

Sun Inc. acquires 100% of PA Corp. by exchanging 2 shares of its own common stock for each share of PA Corp. common stock in a business combination. PA Corp. becomes a subsidiary of Sun Inc.

PA Corp. books are unaffected. PA Corp.’s former stockholders are now stockholders of Sun Inc.

Sun Inc. debit credit

Investment in PA Corp. 1,000Common Stock (40,000,000 shares) 400Additional paid in capital 600

Conceptual Analysis of Purchase Price:

Book value component(PA Corp. Common Stock & Retained Earnings) 500 M

Excess value of identified assets(Plant assets are worth $600 M more than book value – this amount wouldbe depreciated over the assets’ remaining economic lives) 600 M *

Goodwill element(Purchase price less book value less excess fair value of identifiable assets) -100 M *

1000 M To eliminate the ‘bargain purchase element, the fair values of the noncurrent assets would be reduced proportionately.

CONSOLIDATED FINANCIAL STATEMENTS WILL BE PREPARED



Statutory Merger - solution


Combination


company)

Sun Inc.2,000,000 s/s =>

1,000,000 s/s PA @ $50 + $3 = $53 M

PA Corp.(the surviving

company)

PA Corp. acquires 100% of Sun Inc. by exchanging 1 share of its own common stock for each 2 shares of Sun Inc. common stock in a statutory merger. Direct costs in connection with the acquisition are $3 M.

Sun Inc. debit credit

Common stock (2,000,000 s/s) 20 MRetained Earnings 20 MLiabilities 60 M

Assets 100 M

Sun does not survive – books are closed.

Conceptual Analysis:Book value of Sun’s net assets $40Excess value of patent 9Fair value of Sun’s net assets $49Purchase price 53Goodwill = $ 4


Purchase price = (1,000,000 s/s * $50) + $3 M direct costs = $53 M

Assets (including cash) 109 MGoodwill 4 M

Liabilities 60 MCommon stock (1,000,000 s/s * $10) 10 MAdditional paid in capital 40 MCash 3 M

$113 M $113 M



Statutory Combination - solution


Combination

PA Corp. Sun Inc.2,000,000 s/s ==>

2,000,000 IS at $25 each = $50 M

Integrated Sunpacon

PA Corp. and Sun Inc. enter into a statutory combination agreement. A new entity called Integrated Sunpacon (IS) is formed. Each former stockholder of PA Corp. receives two shares of IS stock and each former stockholder of Sun Inc. receives one share of IS stock for each share of stock they own. Immediately after the combination, the $1 par value IS stock is traded at $25 per share.

PA Corp. and Sun Inc. both cease to exist -- all accounts are closed.

Integrated Sunpacon debit credit If we assume that PA Corp. as the larger entity is the acquiring company, its assets would be transferred to the new entity at carrying values while the assets of Sun Inc. would be transferred at fair values.

Cash (1 + 190) 191 MCurrent assets (5 + 300) 305 MPlant assets (90 + 400) 490 MOther assets (4 + 10 + 9 excess value) 23 MGoodwill (see below)` 1 M

Liabilities (60 + 400) 460 MCommon stock (42,000,000 s/s * $1 par) 42 MAdditional paid in capital (to balance) 208 MRetained earnings (PA Corp.) 300 M

1,010 M 1,010 MNote - Equity of new company is carrying value of PA Corp.’s equity ($500) + market value of acquired company ($50). [42 + 208 + 300]

Conceptual Analysis of Purchase Price:Book value component (Sun’s Common Stock & Retained Earnings) 40 MExcess value of identified assets

(Patent is worth $9 M more than book value – this amount wouldbe amortized over the patent’s remaining economic life) 9 M

Goodwill element 1 M (Sun is acquired by purchase of 2,000,000 shares at $25) 50 M



Formation of a Holding Company - solution

Before the Business Combination

After the Business Combination

PA Corp. Sun Inc. Integrated Sunpacon (the parent company)

| |

PA Corp.(a subsidiary

company)

Sun Inc.(a subsidiary

company)

Integrated Sunpacon (IS) is formed to be a holding company. It exchanges 2 shares of its $10 par value stock for each share of PA Corp. common stock and 1 share for each share of Sun Inc. common stock. Costs associated with SEC filings related to the IS stock is $2 M.

The former stockholders of PA Corp. and Sun Inc. are now stockholders of IS.

Integrated Sunpacon DEBIT CREDIT

Investment in PA Corp. (mkt.) 1,000 MInvestment in Sun Inc. (mkt.) 50 M

Common stock (42,000,000 * $10 par) 420 MAdditional paid in capital 630 M

Note: could instead be considered acquisition of one by the other in which case only one entity’s assets would be ‘stepped up’.


accounting for business combinations - university of idaho€¦ · web view · 2013-01-31primary...

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