accounting for business combinations advanced accounting, fifth edition 66

Accounting for Business Accounting for Business CombinationsCombinations

Advanced Accounting, Fifth Edition

6666

1. Describe the major changes in the accounting for business combinations passed by the FASB in December 2007, and the reasons for those changes. SELF-REVIEW

2. 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. SELF-REVIEW

3. Discuss the goodwill impairment test described in SFAS No. 142 [ASC 350–20–35], including its frequency, the steps laid out in the new standard, and some of the likely implementation problems.

4. Explain how acquisition expenses are reported.

5. Describe the use of pro forma statements in business combinations.

6. Describe the valuation of assets, including goodwill, and liabilities acquired in a business combination accounted for by the acquisition method.

7. Explain how contingent consideration affects the valuation of assets acquired in a business combination accounted for by the acquisition method. BASIC Concept!!

8. Describe a leveraged buyout. NOT COVERED

9. Describe the disclosure requirements according to Current GAAP related to each business combination that takes place during a given year. SELF-STUDY

10. Describe at least one of the differences between U.S. GAAP and IFRS related to the accounting for business combinations. SELF-STUDY

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

What Changed?

SFAS No. 141R [ASC 805], “Business Combinations,” replaced FASB Statement No. 141.

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

Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations

Issued December 2007

What Changed?

[ASC 810], “Noncontrolling Interests In ConsolidatedFinancial Statements,” replaced Accounting Research Bulletin (ARB) No. 51.

Establishes standards for the reporting of the

noncontrolling interest when the acquirer obtains

control without purchasing 100% of the acquiree.

Additional discussion in Chapter 3.


Issued December 2007

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

HistoricallyHistorically, two methods permitted in the U.S.: purchase and pooling of interests.

LO 2 FASB’s two major changes of 2001.LO 2 FASB’s two major changes of 2001.


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.

Goodwill Impairment Test (LO # 3)

FASB ASC paragraph 350-20-35 requires impairment be tested annually.

All goodwill must be assigned to a reporting unit.

Impairment should be tested in a two-step process.

LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.

Perspective on Business CombinationsPerspective on Business CombinationsPerspective on Business CombinationsPerspective on Business Combinations

Step 1: Does potential impairment exist?

Step 2: What is the amount of goodwill impairment?

Perspective Perspective on Business on Business CombinationsCombinations

Perspective Perspective on Business on Business CombinationsCombinations

LO 3LO 3

E2-10: On January 1, 2010, 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 Valueof Future of SAAB's of SAAB's

Year Cash Flows Net Assets Net Assets

2011 400,000$ 330,000$ 340,000$

2012 400,000$ 320,000$ 345,000$

2013 350,000$ 300,000$ 325,000$



*

* Not including goodwill

E2-10: On January 1, 2010, 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



Fair value of reporting unit $400,000

Carrying value of unit:

Carrying value of identifiable net assets

330,000

Step 1 - 2011

Carrying value of goodwill

75,000Total carrying value of unit

405,000Excess of carrying value over fair value $ 5,000

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).

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





Implied value of goodwill 60,000

Step 2 - 2011

Carrying value of goodwill 75,000

Impairment loss

$ 15,000Impairment loss 15,000

Goodwill

15,000

JournalEntry

E2-10: Part A&B (continued)





320,000

Step 1 - 2012



380,000Excess of fair value over carrying value $ 20,000

Excess of fair value over carrying value means step 2 is not required.


* $75,000 (original goodwill) – $15,000 (prior year impairment)

*






300,000

Step 1 - 2013



360,000Excess of carrying value over fair value $ 10,000


* $75,000 (original goodwill) – $15,000 (prior year impairment)

*

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





Implied value of goodwill 25,000

Step 2 - 2013

Carrying value of goodwill 60,000

Impairment loss

$ 35,000Impairment loss 35,000

Goodwill

35,000

JournalEntry



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).

Review QuestionReview Question



Disclosures Mandated by FASB (LO 9, Pg. 377-78)

FASB ASC paragraph 805-30-50-1 requires:

1. Total amount of acquired goodwill and the amount

expected to be deductible for tax purposes.

2. Amount of goodwill by reporting segment (if the

acquiring firm is required to disclose segment

information), unless not practicable.


Perspective on Business Combinations Perspective on Business Combinations (Review)(Review)Perspective on Business Combinations Perspective on Business Combinations (Review)(Review)

Disclosures Mandated by FASB

FASB ASC paragraph 350-20-45-1 specifies the presentation of goodwill (if impairment occurs):

a. Aggregate amount of goodwill should be a

separate line item in the balance sheet.

b. 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).


Perspective on Business Combinations (Review)Perspective on Business Combinations (Review)Perspective on Business Combinations (Review)Perspective on Business Combinations (Review)

Disclosures Mandated by FASB

When an impairment loss occurs, FASB ASC paragraph 350-20-50-2 mandates note disclosure:

1. Description of facts and circumstances leading to the

impairment.

2. Amount of impairment loss and method of determining

the fair value of the reporting unit.

3. Nature and amounts of any adjustments made to

impairment estimates from earlier periods, if

significant.


Perspective on Business Combinations Perspective on Business Combinations (Review)(Review)


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.




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.




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.




Treatment of Acquisition Expenses (LO 4, Pg. 378-79)

FASB ASC paragraph 805-10-25-23 excludes acquisition-related costs from measurement of consideration paid.

both direct and indirect costs are expensed

the cost of issuing securities is also 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.

Acquisition Expenses in a Business Acquisition Expenses in a Business CombinationsCombinationsAcquisition Expenses in a Business Acquisition Expenses in a Business CombinationsCombinations

Examples of Acquisition RELATED Costs:Accounting Costs, Legal Costs, Consulting costs, Mergers department cost, Stock issue costs etc.

Acquisition Costs—an Illustration (Page 379)

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 direct and indirect costs.

LO 4 Reporting acquisition expenses.LO 4 Reporting acquisition expenses.

Professional Fees Expense (Direct) 1,500Merger Department Expense (Indirect) 2,000Other Contributed Capital 3,000

Cash 6,500


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.

Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure Requirement LO 5 (Pages 379 – 384)Requirement LO 5 (Pages 379 – 384)Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure Requirement LO 5 (Pages 379 – 384)Requirement LO 5 (Pages 379 – 384)

LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.

Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirementPro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirement

LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.Illustration 2-1

ILLUSTRATION 2-2 (Page 384)Balance Sheets of P and S Companies January 1, 2012 P Company S Company_______ Book Value Book Value Fair ValueCash and receivables $ 250,000 $ 180,000 $ 170,000Inventories 260,000 100,000 140,000Land 600,000 120,000 400,000Buildings & equipment 800,000 900,000 1,000,000Accumulated depreciation (B & E) (300,000) (300,000) _________Total assets $1,610,000 $1,000,000 $1,710,000Current liabilities $ 110,000 $ 110,000 $ 150,000Bonds payable* —0— 400,000 350,000Total liabilities $ 110,000 $ 510,000 $ 500,000Common stock **, *** 750,000 300,000Other contributed capital 400,000 50,000Retained earnings 350,000 140,000Total Stockholders’ equity 1,500,000 490,000Total Liab. and Stockholders’ equity $1,610,000 $1,000,000 Net assets at book value (A - L) $1,500,000 $ 490,000 Net assets at fair value $1,210,000*Bonds payable, 9%, due 1/1/18, interest Payable on 6/30, 12/31* are valued at their present value by discounting the future payments at the current market rate.**$15 par value, 50,000 shares; ***$5 par value, 60,000 shares

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 prior period if comparative

financial statements are presented.

Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirementPro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirement

LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.

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.

Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting LO 6 (Pages 381 -385) LO 6 (Pages 381 -385) Valuation of acquired Assets and Liabilities Valuation of acquired Assets and Liabilities assumedassumed

Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting LO 6 (Pages 381 -385) LO 6 (Pages 381 -385) Valuation of acquired Assets and Liabilities Valuation of acquired Assets and Liabilities assumedassumed

LO 6 Valuation of acquired assets and liabilities assumed.LO 6 Valuation of acquired assets and liabilities assumed.

Valuation of acquired Assets and Liabilities assumed

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 acquisition cost over the sum of

Fair Value amounts assigned to identifiable assets and liabilities is recorded as goodwill.

Under current GAAP, in-process R&D is measured and recorded at fair value as an asset on the acquisition date.

Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting




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

?



E2-1: Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company. The amount paid was $1,560,000 in cash. Immediately prior to the acquisition, Saville Company’s balance sheet was as follows:

Fair value of assets, without

cash $1,824,000



Fair value of liabilities 594,000

Fair value of net assets 1,230,000

Fair value of assets, without cash $1,824,000

Price paid 1,560,000

Goodwill $ 330,000

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



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.

Inventory 396,000

Plant and equipment 540,000

Receivables 228,000

Goodwill 330,000

Liabilities 594,000

Land 660,000

Cash 1,560,000

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 purchase.

Current standards require:

fair values be considered carefully and adjustments made as needed.

any excess of acquisition-date fair value of net assets over the consideration paid is recognized in current earnings (income statement) as GAIN.



Bargain Acquisition Illustration

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.





Calculation of Goodwill or Bargain Purchase

Fair value of liabilities 594,000

Fair value of net assets 1,230,000

Fair value of assets, without cash $1,824,000

Price paid 990,000

Bargain purchase $ 240,000

E2-1: B. Repeat the requirement in (A) assuming that the amount paid was $990,000.



E2-1: B. Repeat the requirement in (A) assuming that the amount paid was $990,000.

Inventory 396,000

Plant and equipment 540,000

Receivables 228,000

Gain on acquisition (ordinary) 240,000

Liabilities 594,000

Land 660,000

Cash 990,000

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.

Contingent Consideration in an Contingent Consideration in an AcquisitionAcquisitionContingent Consideration in an Contingent Consideration in an AcquisitionAcquisition

LO 7 Contingent consideration and valuation of assets.LO 7 Contingent consideration and valuation of assets.

Illustration: P Company acquired all the net assets of S Company in exchange for P Company’s common stock. P Company also agreed to pay an additional $150,000 to the former stockholders of S Company if the average post-combination earnings over the next two years equaled or exceeded $800,000. Assume that goodwill was recorded in the original acquisition transaction. To complete the recording of the acquisition, P Company will make the following entry:

Contingent Consideration Contingent Consideration (CASH) (CASH) in an in an AcquisitionAcquisitionContingent Consideration Contingent Consideration (CASH) (CASH) in an in an AcquisitionAcquisition


Goodwill 150,000

Liability for Contingent Consideration 150,000

Illustration: Assuming that the target is met! P Company will make the following entry:

Contingent Consideration Contingent Consideration (CASH) (CASH) in an in an AcquisitionAcquisitionContingent Consideration Contingent Consideration (CASH) (CASH) in an in an AcquisitionAcquisition



Cash 150,000

Assume that the target is not met! The adjustment will flow through the income statement in the subsequent period, as follows:


Income from Change in Estimate 150,000

Illustration: P Company acquired all the net assets of S Company in exchange for P Company’s common stock. P Company also agreed to issue additional shares of common stock to the former stockholders of S Company if the average post-combination earnings over the next two years equaled or exceeded $800,000. Assume that the contingency is expected to be met, and goodwill was recorded in the original acquisition transaction. Based on the information available at the acquisition date, the additional 10,000 shares (par value of $1 per share) expected to be issued are valued at $150,000. To complete the recording of the acquisition, P Company will make the following entry:

Contingent Consideration Contingent Consideration (Stocks) (Stocks) in an in an AcquisitionAcquisitionContingent Consideration Contingent Consideration (Stocks) (Stocks) in an in an AcquisitionAcquisition

Goodwill 150,000

Paid-in-Capital for Contingent Consideration

150,000

Illustration: Assuming that the target is met, but the stock price has increased from $15 per share to $18 per share at the time of issuance, P Company will not adjust the originalamount recorded as equity. Thus, P Company will make the following entry



Paid-in-Capital for Contingent Consideration 150,000

Common Stock ($1 par) 10,000

Paid-in-Capital in Excess of Par 140,000

Adjustments During the Measurement Period

(NOT COVERED) ==========

The measurement period is the period after the initial 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 (or learns that the information is unobtainable), not to exceed one year from the acquisition date.



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).

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.

IFRS Versus U.S. GAAPIFRS Versus U.S. GAAPIFRS Versus U.S. GAAPIFRS Versus U.S. GAAP

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

Other differences and similarities:

IFRS Versus U.S. GAAPIFRS Versus U.S. GAAPIFRS Versus U.S. GAAPIFRS Versus U.S. GAAP

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

accounting for business combinations advanced accounting, fifth edition 66

Documents

business combinationsissued

business combinationsstep

business combinationslo

major changes

goodwill impairment

goodwill impairment

historical perspective

purchase method