CHAPTER
5
THE PURCHASE
METHOD:
AT DATE OF
ACQUISITION—
100% OWNERSHIP
FOCUS OF CHAPTER 5
• The Purchase Method in Depth:
– Total Acquisition Cost
– Goodwill and Bargain Purchase
Elements
– Consolidation Worksheets—At the
Acquisition Date:
• Acquiring Assets vs. Common Stock
• Non-Push-Down Accounting
• Push-Down Accounting (a preview)
The Purchase Method: Items That Can
Comprise The Acquirer’s Cost
• CATEGORY #1: The fair value of the
consideration given.
• CATEGORY #2: Certain out-of-pocket direct
costs—must be directly traceable to the specific
acquisition.
• CATEGORY #3: Contingent consideration —will
be paid subsequent to the acquisition date (if paid
at all).
Acquirer’s Cost:
Category 1—The Consideration Given
• Types of Consideration: In purchase accounting,
the consideration given can be of any type:
–
–
–
–
–
Cash.
Common stock.
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Preferred stock.
Notes or Bonds Payable.
Used trucks.
Acquirer’s Cost:
Category 1—The Consideration Given
• General Rule:
–
Use the FMV of the consideration given.
• Exception:
–
Use the FMV of the property received if
it is more readily determinable.
Acquirer’s Cost:
Category 2—Certain Direct Costs
• Must Be Traceable to The Acquisition:
–
–
–
–
–
Legal fees—the acquisition agreement.
Purchase investigation fees.
Finder’s fees.
Travel costs.
Professional consulting fees.
• NO allocation allowed of G&A overhead.
• NO direct costs of issuing stock (charge to APIC).
Acquirer’s Cost:
Category 3—Contingent Consideration
• Contingencies Based on Other Than Security
Prices:
Accrue when it becomes “determinable
beyond a reasonable doubt.”
– This point in time is later than the
“probable date.”
– The cost of the acquisition is increased
in later periods when the accrual is
actually made (usually increases
goodwill).
–
Acquirer’s Cost:
Category 3—Contingent Consideration
• Contingencies Based on Security Prices
(to be maintained or attained):
– CANNOT result in an increase at a later
date in the initially recorded cost of the
acquisition.
• Use the security price to be
maintained or attained to record the
acquisition.
–This price is the true bargained cost
of the acquisition.
Goodwill Vs. A Bargain Purchase
Element: Can Have ONE But Not BOTH
• Cost in excess of Current Value =
• Current Value in excess of Cost =
• Current Value equals Cost =
GW
BPE
Neither GW
nor BPE
Goodwill: What to Do With It?
• GOODWILL—Usually Exists When Acquiring a
Winner or a Potential Winner:
–
Must capitalize as an asset.
– Cannot amortize to earnings.
– Must periodically (at least annually)
assess for impairment.
– If impaired, must write it down—charge
to earnings.
Bargain Purchase Element:
What to Do With It?
• BARGAIN PURCHASE ELEMENT—Usually Exists
When Acquiring a Troubled Company:
–
Extinguish against certain specified assets
to extent possible.
– Any unextinguished amount is credited to
earnings—reported as an extraordinary
item.
Push-Down Accounting:
The EASIER Way
• Push-Down Accounting (an absolute gem):
– In the subsidiary’s general ledger:
• Adjust assets and liabilities to FV
based on the parent’s purchase price.
–This establishes a new basis of
accounting.
• Record goodwill.
Discussed in depth in Chapter 7.
Nonpush-Down Accounting:
The HARDER Way
• Non-Push-Down Accounting:
–
Don’t touch the subsidiary’s general
ledger (treat like a “sacred cow”).
–
Make fair value adjustments and record
goodwill in consolidation (on the
worksheets).
Consolidation Consequences:
Push-Down Vs. Non-Push-Down
• Push-Down Accounting:
– Consolidation effort is minimal (has
received the “Better Book-keeping” stamp
of approval).
• Non-Push-Down Accounting:
– Consolidation effort is cumbersome
(often a headache).
Push-Down Vs. Non-Push-Down
Accounting: The Bottom Line
• The consolidated financial statement
amounts are the SAME whether the
parent selects:
– Push-down accounting or
– Non-push-down accounting.
• ONLY the accounting procedures differ.
Intangible Assets: More of Them
Are Recognized under FAS 141
• Record at fair value only if either of the
following two criteria are met:
#1: Intangible arises from a legal or
#2:
contractual right.
Intangible does not arise from a legal
or contractual right but is separable.
Identifiable Intangible Assets
• Marketing-related:
– Trademarks, service marks
– Trade dress (unique package color or
design)
– Non-compete agreements
Identifiable Intangible Assets
• Customer-related:
– Customer lists
– Customer order backlog
– Customer contracts
– Customer relationships
Identifiable Intangible Assets
• Technology-based:
– Secret formulas, processes, recipes
– Patented and unpatented technology
• Contract-based:
– Licensing, royalties
– Advertising, supply contracts
• Artistic-related:
– Video and audiovisual material
– Pictures and photographs
Review Question #1
What results for each of the following
situations?
Goodwill
CV
CV
CV
CV
BV
>
<
>
<
=
BV……..
BV……..
Cost……
Cost……
Cost..…..
BPE
Unable
To Tell
Review Question #1
With Answer
What results for each of the following
situations?
Goodwill
CV
CV
CV
CV
BV
>
<
>
<
=
BV……..
BV……..
Cost……
Cost……
Cost..…..
BPE
Unable
To Tell
X
X
X
X
X
Review Question #2
What results for each of the following
situations?
Goodwill
Cost
Cost
Cost
Cost
CV =
> BV…....
< BV…....
> CV..…..
= CV..…..
BV……....
BPE
Unable
To Tell
Review Question #2
With Answer
What results for each of the following
situations?
Goodwill
Cost
Cost
Cost
Cost
CV =
> BV…....
< BV…....
> CV..…..
= CV..…..
BV……....
BPE
Unable
To Tell
X
X
X
X
Review Question #3
A form of consideration that is NOT allowed
in purchase accounting is:
A. Cash.
B. Bonds.
C. Preferred stock.
D. Common stock.
E. None of the above.
Review Question #3
With Answer
A form of consideration that is NOT allowed
in purchase accounting is:
A. Cash.
B. Bonds.
C. Preferred stock.
D. Common stock.
E. None of the above.
Review Question #4
Which of the following costs CANNOT be
added to the cost of an acquisition?
A. Legal fees.
B. Accounting fees.
C. Costs of issuing common stock.
D. A pro rata portion of the CEO’s salary.
E. Travel costs.
F. Costs of the M&A department.
Review Question #4
With Answer
Which of the following costs CANNOT be
added to the cost of an acquisition?
A. Legal fees.
B. Accounting fees.
C. Costs of issuing common stock.
D. A pro rata portion of the CEO’s salary.
E. Travel costs.
F. Costs of the M&A department.
Review Question #5
An account of the acquired company that
CANNOT be revalued to its current value
under purchase accounting is:
A. Notes receivable.
B. Bonds payable.
C. Investment in marketable securities.
D. Patents.
E. None of the above.
Review Question #5
With Answer
An account of the acquired company that
CANNOT be revalued to its current value
under purchase accounting is:
A. Notes receivable.
B. Bonds payable.
C. Investment in marketable securities.
D. Patents.
E. None of the above.
Review Question #6
Push-down-accounting can be used:
A. Only in a goodwill situation.
B. Only in a BPE situation.
C. In either a goodwill situation or a BPE
situation.
D. Only in a COST = CV situation.
E. None of the above.
Review Question #6
With Answer
Push-down-accounting can be used:
A. Only in a goodwill situation.
B. Only in a BPE situation.
C. In either a goodwill situation or a BPE
situation.
D. Only in a COST = CV situation.
E. None of the above.
Review Question #7
The consolidated financial statements are
identical regardless of whether the parent:
A. Uses push-down or non-push-down
accounting.
B. Acquires 100% of the common stock
or 100% of the assets.
C. Both A and B.
D. Neither A or B.
Review Question #7
With Answer
The consolidated financial statements are
identical regardless of whether the parent:
A. Uses push-down or non-push-down
accounting.
B. Acquires 100% of the common stock
or 100% of the assets.
C. Both A and B.
D. Neither A or B.
End of Chapter 5
• Time to Clear Things Up—Any
Questions?