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Hardin Tool Company

Case: 12-1

Page: 354

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Hardin Pratt Hardin PrattAssetsCurrent assets $432 $246 39% 44%Plant and equipment 690 312 61% 56%Total assets $1,122 $558 100% 100%Liabilities and EquitiesCurrent liabilities $263 107 23% 19%Long-term debt 195 10 17% 2%Common stock ($1 par) 100 40 9% 7%Additional paid-in capital 218 94 19% 17%Retained earnings 346 307 31% 55%Total liabilities and equity $1,122 $558 100% 100%

Condensed Balance Sheets as of the Proposed Acquisition Date (Thousands of Dollars)

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Hardin Pratt Hardin PrattSales $2,100 1500 100% 100%Expenses 1620 1120 77% 75%Income $480 $380 23% 25%Income tax expense 168 133 8% 9%Net income $312 $247 15% 16%

Condensed Balance Sheets as of the Proposed Acquisition Date (Thousands of Dollars)

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Pooling vs. Purchase Method

Hardin Pratt Pooling PurchaseAssetsCurrent assets $432 $246 $678 $678Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441)

Goodwill 200 (100,000*8=800,000)-$600,000

Total assets $1,122 $558 $1,680 $2,039Liabilities and EquitiesCurrent liabilities $263 107 $370 $370Long-term debt 195 10 $205 $205Common stock ($1 par) 100 40 $200 $200Additional paid-in capital 218 94 $252 $918 plug in

Retained earnings 346 307 $653 346Total liabilities and equity $1,122 $558 $1,680 $2,039

Condensed Balance Sheets as of the Proposed Acquisition Date

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Hardin Pratt Polling PurchaseSales $2,100 1500 $3,600 $3,600Expenses 1620 1120 $2,740 $2,740Income $480 $380 $860 $860Additional depreciation $16 $159,000/ 10 years = 16,000

Taxable income $860 $844Income tax expense $301.0 $295.4Net income $559.0 $548.6Earnings Per Share $2.80 $2.74

Condensed Income Statement as of the Proposed

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Equity Preferred DebenturesUnadjusted income $860 $860 $860Additional depreciation 16 16 16Additional interest 40Taxable income $844 $844 $804Income tax expense $295.40 $295.40 $281.40Net income $548.60 $548.60 $522.60Preferred dividend $40Income available to common stock $548.60 $508.60 $522.60EPS (150,000 shares for preferred and debetntures and 200,000 shares for equity) $2.74 $3.39 $3.48

Pooling on Equity

ExchangeDebt/ equity 14.00% 14.00% 56.86% 18.55%ROE (Common) 37.50% 47.84% 49.15% 50.59%

Equity Stock vs. Preferred Stock vs. Debentures

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Economic Values of Business Combinations

Economies of scale Economies of scope Improved target management Tax benefits Availability of low cost financing for financially

constrained targets

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Business Combination

Bringing together of separate entities or businesses into one reporting entity

Includes.., Purchase of all assets, liabilities and rights to the activities

of an entity Purchase of some of assets, liabilities and rights to the

activities of an entity that together meets the definition of a businesses

Establishment of new legal entity in which assets, liabilities and activities of combined business will be held

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Exception to Business Combination

Joint venture Businesses under common control Two or more mutual entities Separate entities brought together to form a

reporting entity by contract alone without obtaining of an ownership interest

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Identifying Acquirer

>1/2 voting rights in combined entity Power to appoint or remove majority of BOM Power to cast majority of voting in meetings of BOD Ability to determine combine entities management team

Other factors.., Fair value of companies Terms of arrangements Specific voting rights provided Other conditions Statutory requirements options or warrants on issue

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Accounting for Amalgamation (AS) 14

Amalgamation in the nature of merger All A&L of transferor company becomes A&L of transferee

company Shareholders holding >90% of face value of shares of

transferor company become shareholders of transferee company

Consideration paid in equity shares + cash for fractional shares

No adjustments intended to be made in book values of A&L Use: Pooling of interests method

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Accounting for Amalgamation (AS) 14

Amalgamation in the nature of acquisition May not all of A&L of transferor company becomes A&L of

transferee company Shareholders holding shares of transferor company do not

hold bigger proportion of shares in amalgamated company Consideration paid = fair value of A&L – market value of

A&L Adjustments intended to be made in book values of A&L Use: purchase method

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Goodwill

Amortize goodwill over a period not exceeding 5 years unless a longer period can be justified

Factors considered in estimating life of goodwill..,

Foreseeable life of business or industry Effects of product obsolescence and changes in demand Service life expectation of key employees Expected actions by competitors or potential competitors Legal, regulatory or contractual provisions affecting useful

life

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Criteria for Pooling of Interest Accounting

Combining companies must be autonomous Combining companies must be independent Single transaction or transaction in one year Exchange of common stock not less than 90% No equity changes in contemplation No shares reacquired for purpose of combination No change in proportionate equity interest Voting rights immediately exercisable Combination resolved at consummation Combining may not agree to reacquire or retire any of the stock issued to effect

the combination Combined company may not enter into any agreement for the benefit of former

shareholders of the combining companies Combined company may not plan to dispose of substantial amounts of assets of

the combining companies within two years of combination

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Business Combinations

Types of Business

Combinations

Acquisition or purchase

Uniting / Pooling of Interests

Group Reorganization

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Intangible Assets

What is an intangible asset? Non monetary asset Without physical substance Controlled by the entity and held for use either

in the production or supply of goods or services; or for rental to others; or for administration purposes May be purchased or internally generated

When to initially recognize? future economic benefits attributable to the asset are probable the cost of the asset can be measured reliably

Initial Measurement at Fair Value

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Intangible AssetsRevaluation, Amortization and Impairment

Revaluation

IFRS US GAAP / IGAAP

Although allowed, but

rare

Not allowed

Amortization and Impairment

US GAAP / IFRS

IGAAP

Amortize if asset has a finite life

If indefinite life, annual test for impairment

No Presumed Maximum Life

Reversal of Impairment Losses permitted in some circumstances in IFRS – Not permitted in US GAAP

Rebuttable presumption of 10 year life

If life exceeds 10 years, annual review for impairment

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Accounting Standards

India – AS 14 International accounting standard

IAS 22 business combination IAS 36 impairment of assets IAS 38 intangible assets FAS 141 Business combinations FAS 142 Goodwill and other intangible assets

International – IFRS 3

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Indication for Impairment Testing

External indication Significant drop in market value of an asset Significant adverse change at firm level environments Change in market rates affecting recoverable value of an asset Carrying amount of net assets of the firm > market capitalization

Internal indication Evidence of obsolescence or physical damage on net asset Change in firm operations Evidences from internal reporting for lower value of asset

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Measuring Recoverable Amount

RA is higher of.., Net selling price Value in use

Requires cash flow forecast for atleast 5 years Estimated on present condition of the asset Cash flows and discount rate should be pre tax basis

No impairment required if either of above is more than carrying cost

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Impairment Test

Measuring recoverable amount of an asset Impairment loss = assets carrying amount >

recoverable amount Goodwill is allotted to cash-generating unit to

assess recoverability

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Reversal of Impairment Loss

Reversal should be sustainable Allowed to the extent of carrying cost in the

previous period On reversal requires correction in depreciation

for earlier years

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Impairment Model

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Assessment of Recoverable Amount

= higher of {‘fair value less costs to sell’ and ‘value in use’}

Fair value less costs to sell Price agreed in a binding sales agreement for cash-

generating unit in an arm’s length transaction, adjusted for incremental costs attributable to the disposal

Cannot be determined by reference to an active market

Value in use Present value of estimated future cash flows Based on most recent financial budget / forecast approved

by management

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Allocation of Goodwill to Cash-Generating Units

Allocated on the date of acquisition Based on relative value of cash-generating

units Minority portion of the goodwill should be

accounted for minority

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Impairment Test for Cash Generating Unit

To be tested annually Difference can be tested at different time

during the year Impairment test within cash generating unit

must be tested for impairment before testing cash-generating as a whole

Any impairment loss must be first applied against goodwill

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Accounting for Impairment Loss

Recognized in P&L statement in the period in which it is identified

First allocated to any recognized goodwill with in the cash-generating unit

Additional losses treated as impairment of individual assets

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Impairment of Assets DifferencesDifference Criterion IFRS and IGAAP US GAAP

Timing of impairment review Annually whenever events or changes in circumstances indicate that the carrying amount may not be recoverable

Asset is Impaired if Recoverable amount <

Carrying amount

Fair value < Carrying amount

Recoverable Amount / Fair Value

Recoverable amount is

higher of Net Selling Price Value in use

Fair Value is the amount at which an asset or liability could be bought or settled in a current transaction between willing parties

Cash Flows for calculating value in use / fair value

Use discounted cash flows for calculating the value in use

Use undiscounted cash flows for calculating the fair value

Reversal of impairment loss Whenever there is a change in the economic conditions

Prohibited

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