business combinations. c012 business combinations uthe acquisition of an entire company...
TRANSCRIPT
C01 2
Business combinations
The acquisition of an entire company Understanding the reporting benefits that
caused firms to favor the pooling method prior to July 1, 2001
Purchase accounting procedures at alternative prices
Pooling of Interests accounting procedures (appendix)
C01 3
Basic issues in combinations
The motivation to combine Pre-acquisition audit confirms value Every deal focuses on market values Asset acquisition versus stock acquisition
(investment)
C01 4
Basic issues in combinations (continued) Purchase versus pooling
– purchase is group asset acquisition at market values
– pooling was merging of accounts at book value
Pooling not allowed after July 1, 2001
C01 5
Major issues
Record stockissued at:
Fair valueBook withreassignment to meetpar
Record assetsand liabilities at:
Fair valueBook with someadjustments
Record goodwill:Common when thereis “premium” price
Only if it is thereexisting GW
Future incomebased on:
Fair valuedepreciation
Depreciation on oldbook values
Current yearincome prior topurchase:
Not included incurrent year income
Included in currentyear income
Purchase Pooling
C01 6
Prior period’sincome:
Not in prior yearcomparatives
Included in prioryear comparatives
Acquired firm RE:Not added to issuerbalance
Added to issuerbalance
Change inmethods:
Retroactive to priorperiods
Retroactive tooprior periods
Direct acquisitioncosts:
Add to price Expensed
Major issues (continued)
Purchase Pooling
C01 7
Indirectacquisition costs:
Expensed Expensed
Issue costs:Deduct from valueof securities issued
Expensed
Former criteria foruse (pre 7/1/01):
By default - FailsPooling criteria
Must meet allcriteria in text
Major issues (concluded)
Purchase Pooling
C01 8
Purchase price rulesPremium Price - Price high enough to record all accounts at fair value, excess price is goodwill with no amortization, but required impairment testing
Bargain - Priority accounts at fair value, balance of price allocated to non priority accounts.
Extraordinary Gain - Price paid is less than priority accounts, excess of priority accounts over price is extraordinary gain.
C01 9
Priority accounts
All current assets All liabilities Deferred tax assets Pension and other post retirement benefit
plan assets Nonpriority assets that are to be sold
C01 10
Basic purchase example
Assets Liabilities & EquityInventory 120,000 Bonds payable 100,000Land 50,000 Common stock, $5 par 10,000Building 250,000 Retained earnings 310,000Total 420,000 Total 420,000
Fair Values:Inventory (priority) 170,000 Bonds pay (priority) 105,000Land 100,000Building 300,000Patent (unrecorded) 50,000
C01 11
Price zone analysis
1. Calculate the market value net assets:
• Using fair values, net assets = $515,000
C01 12
Price zone analysis (continued)
2. Determine the 3 price zones:• Premium: Over $515,000
all accounts at fair value, goodwill for price over $515,000
• Bargain: $65,000 [priority] to $515,000priority accounts at fair value; balance allocated to nonpriority accounts
• Extraordinary Gain: Below $65,000priority accounts at fair value; other accounts not recorded; extraordinary gain for excess of priority accounts over price paid
C01 13
Purchase entrypremium price: $600,000Inventory (fair value) 170,000Land (fair value) 100,000Building (fair value) 300,000Patent 50,000Goodwill (price over $515,000) 85,000
Bonds payable 100,000Premium on bonds payable (to fair value) 5,000Cash 600,000
Goodwill is not amortized, but could be impairment adjusted at a later date
C01 14
Purchase allocationbargain price: $365,000$65,000 for priority accounts; $300,000 allocated to fixed & identifiable intangible assets
Asset Market Percent Available AmountLand 100,000 22% 300,000 66,000Building 300,000 67% 300,000 201,000Patent 50,000 11% 300,000 33,000
Allocation Table
C01 15
Purchase entrybargain price: $365,000
Inventory (fair value) 170,000Land (allocated) 66,000Building (allocated) 201,000Patent (allocated) 33,000
Bonds payable 100,000Premium on bonds pay (to fair value) 5,000Cash 365,000
C01 16
Purchase entryextraordinary gain: $50,000Price is below $65,000; there is no value to assign to fixed or identifiable intangible assets:
Inventory (fair value) 170,000Land (no value available) 0Building (no value available) 0Patent (no value available) 0Extraordinary gain 15,000
Bonds payable 100,000Prem on bonds pay (to fair value) 5,000Cash 50,000
C01 17
Goodwill impairment
Test: Goodwill is impaired if estimated value of business unit is less that remaining book value of net assets (including goodwill).
New GW estimate = (estimated value of business unit) – (new estimate of identifiable net assets at fair value)
Impairment Loss = Book value of GW – new estimate.
C01 18
Impairment example
Recorded $100,000 goodwill in purchase three years ago. Now
Net assets at book value = $650,000
Fair value of the business unit = $625,000
Fair value net identifiable assets
(not including goodwill) =$580,000
C01 19
Impairment calculations
Test
Est. value of business unit $625,000Book value ofassets (includinggoodwill) 650,000Excess book $25,000Goodwill is impaired
Adjustment
Est. value of business unit $625,000Fair value ofident. assets,not incl. GW 580,000New GW est. 45,000GW bookvalue 100,000Impair. loss $55,000
C01 20
Purchase: some fine points
Direct acquisition costs are paid to outside parties; include them in the price paid
Indirect acquisition costs are internally incurred; they are expensed
Issue costs are to issue bonds or stock; they are subtracted from the value assigned to the securities
Stocks and bonds issued are always recorded at fair value in a purchase
C01 21
Purchase complications May have to calculate market value of debt
issues
Leases retain classification, related accounts recorded at market value
DTL goes with assets in non-taxable exchange
Tax loss carry over is usually recorded as an asset. If realization is uncertain, it is not recorded and is buried in goodwill
C01 22
Purchase complications (continued) There may be contingent goodwill
payment. Added goodwill is recorded Price guarantees cover decline in value of
securities issued in purchase. If issued, value assigned to securities is adjusted
C01 23
Example of tax-free exchange
The price paid for a company is $480,000 The only asset is a machine with a book value of
300,000 and a market value of $400,000 The tax rate is 40% A $40,000 DTL goes with the Machine The remaining price is $120,000 ($480 - $400 + $40) $120,000 is available for goodwill net of a 40% DTL Goodwill = $120,000 (1.0 - .4) = $200,000
C01 24
Tax-free exchange: journal entry
Machine (fair value) 400,000Goodwill (gross value) 200,000
Deferred Tax Liability* 120,000Cash 480,000
* $40,000 on machine and $80,000 on goodwill
The DTLs are amortized over the same life (and by the same method) as the assets to which they attach
C01 25
Pooling: equity transfer rules
(2)Take RE to meet total pd-in (if (1) is not enough)
Total Paid-in Total Paid-in
Retained Earnings (2) Retained Earnings
Combiner: Add to Issuer:Par ParAdditional Paid-in Additional Paid-in (1)
(1)Take from parent pd-in to meet total pd-in
C01 26
Pooling example
Assets Liabilities & EquityInventory 120,000 Bonds payable 100,000Land 50,000 C. stock, $5 par 10,000
Paid-in capital in excess of par 100,000
Building 250,000 Retained earnings 210,000Total 420,000 Total 420,000
Market ValuesInventory 170,000 Bonds payable 105,000Land 100,000Building 300,000Estimated goodwill 135,000
C01 27
Pooling analysis
Issuer will issue $50 market value shares to meet the $600,000 market value. $600,000 $50 = 12,000 shares issued.
The deal is based on market values; but they are not recorded!
The assets and liabilities are recorded at book value Pooling transfer rule is used to assign equity amounts Assume the following par values for shares issued:
$.50 $5 $10
C01 28
Equity transfer for $0.50 par
Common Stock 10,000 Common Stock* 6,000
Paid-in Capital Paid-in Capital
in Excess of Par 100,000 in Excess of Par 104,000
Total Paid-in 110,000 Total Paid-in 110,000
R E(adjusted) 210,000 RE 210,000
320,000 320,000
Combiner Add to Issuer
*12,000 shares, par $0.50
C01 29
Journal entry for $0.50 par
Inventory 120,000
Land 50,000
Building 250,000
Bonds payable 100,000
Common stock 6,000
Paid-in capital in excess of par 104,000
Retained earnings 210,000
C01 30
Equity transfer for $5.00 par
Common Stock 10,000 Common Stk* 60,000
Paid-in Capital Paid-in Capital
in Excess of Par 100,000 in Excess of Par 54,000
Total Paid-in 110,000 Total Paid-in 110,000
R E(adjusted) 210,000 RE 210,000
320,000 320,000
Combiner Add to Issuer
*12,000 shares, par $5.00
C01 31
Journal entry for $5.00 par
Inventory 120,000
Land 50,000
Building 250,000
Bonds payable 100,000
Common stock 60,000
Paid-in capital in excess of par 50,000
Retained earnings 210,000
C01 32
Equity transfer for $10.00 par
Common Stock 10,000 Common Stk* 120,000
Paid-in Capital Paid-in Capital
in Excess of Par 100,000 in Excess of Par -0-
Total Paid-in 110,000 Total Paid-in 120,000
R E(adjusted) 210,000 RE 200,000
320,000 320,000
Combiner Add to Issuer
*12,000 shares, par $10.00
C01 33
Entry for $10.00 par
Inventory 120,000
Land 50,000
Building 250,000
Bonds payable 100,000
Common stock 120,000
Retained earnings 200,000
C01 34
Special issues in a pooling
Direct, indirect and issue costs are expensed Combiner existing goodwill is recorded Adjustments may be made to accounts for:
– Lower of cost or market adjustments– Changes in accounting principles (for uniformity)– Record unrecorded items– Error correction
All adjustments are made to combiner retained earnings before the equity transfer diagram is applied