Chapter 1
Intercorporate
Acquisitions and
Investments in
Other Entities
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Why acquire other companies?
§ Buying an existing unit with its experienced employees,
existing customers and suppliers, production and
distribution facilities could result either reduced costs or
increased revenues or both
§ Product diversification
§ Lower competition after acquisition
§ Economies of scale
§ International marketplace: Easier entry in case of heavy
regulations.
§ Save taxes by combining with loss-making entities.
§ Sharing of loan repayment.
1-2
Companies Acquiring Other Companies
w Two basic ways to acquire control over another
company
n
CREATE a new company – called Internal Expansion
company to create it
n
BUY all or part of an existing company – called External
Expansion
1-4
Internal Expansion
n
n
n
n
creating
new
company
The existing company transfers cash and/or other assets
(and possibly liabilities) to the newly created company
The existing company becomes the PARENT COMPANY
The newly created company becomes a SUBSIDIARY of
the parent company
The parent company owns all the shares of the
subsidiary company.
1-5
Acquisition Buy
External Expansion
purchas
w Merger: Buy the existing company’s ASSETS AND LIABILITIES
and then liquidate the company. A + B = A
A
bought
B
only
A
stays
e shares
w Stock Acquisition: Buy the existing company’s STOCK. When
the percentage stock owned is more than 50%, the parent
company is said to have controlling interest in the subsidiary
company. The subsidiary continues to exist as a separate legal
entity, i.e., A + B = A + B
B continues to exist
Irene
bsubsiduary
w Consolidation: Two companies liquidate to form a new
consolidated company, i.e., A + B = C
fits
anymore
w E.g., Chrysler Corp. and Diamler-Benz consolidated to become
Diamlerchrysler.
1-6
External Expansion
w A + B = B = Merger
w A + B = ZZ = Consolidation
w Both are external expansion
w STOCK ACQUISITION EXAMPLES:
w Apple buys 10% stock of Microsoft – Both continue to exist.
w Apple buys more than 50% shares of Microsoft = Apple has
control over Microsoft
w Apple is the parent company and Microsoft is Subsidiary
company
1-7
Accounting for Internal Expansion
w A company transfers assets, and possibly
liabilities, (at book value) to an entity that it
creates and in which it holds majority
ownership.
The transferring
Creating Business
Entities company
recognizes an ownership interest equal to
the book value of the net assets transferred.
when
assets
are
transferred
book value
w No gains or losses are recognized on the
transfer by the transferring company.
be
book
value
1-6
Internal Expansion
I
sample
transfers
machinery
becomes
I
of 1.000
of all shares of
with a Book value
owner
Be
machinery goes out
Booksoff
suppose we buy to
shares of apple company
D
for
1000
Machinery
Cr
to
100 cash
er cash
Booksoft
Dr
machinery
Share
Example2
capital
I
Dr cash
er share capital
1000
I transfers machinery
2000 cash to 13
and
all
of
with
shares
0ft
Dr
investment in B
Cr
er
suppose B sells shares
for 1000 cash
1000
Machinery
er
in
3000
cash
machinery
book value of 1000
I becomes
owner
Debit
1000
credit
p
E
o
A
g
2000
1000
Books of B
Dr
Dr
cash
machinery
Cr share
capital
2000
1000
3000
Accumulated
total
A transfers machinery with BV 11000 cost 41000
3 2,000 cash to
accumulated depreciation 3,000
Example 3
I becomes
Review
owner of all
I
shares
Be
we record depreciation when
buyinglong term assets
subtract from cost of asset contrasset
from ace 2oz
accum depr
and
in Bs
9000
8000
7000
jredicthbe contrasset
will never change
i ooo
30.8.2021
IE
Dr
5
enein
Accumulated
er
Cr
3000
Depr
cash
Machinery
2,000
6 000
Booksoff
Dr
Do
Machinery
Cash
Cr
er
Accum
Share
Depr
4,000
2,000
capital
3000
3000
Review
by
Acc
2
Pt
2
BV 51000
Dr
Dr
Dr
er
1 5
If
Gloss be
r
or
sold for15,000
30.08.2021
Internal Expansion
Example 1
I transfers
of
all
21000 cash to
shares of B
Booksoff
Dr
Cr
Investment in B
cash
2
2000
Booksoft
er
Efare capita
2000
2000
Be I becomes
owner
4755
understand
didnt
cash
equip
AccDepr
Sharecapita
2.092021
101000
30,000
6000
sharepremium
Goldfor more than
par value
17.000
17.000
depreciation
is on
too
pale created new company and transferred all 5 assets
6 par value
pale will relieve 10,000 shares
yearlydepreciation
Building
240,000 40
Equipment
90,000110
will record
Building
Equipment
what is
the
91000
yearlydep
6000
9000
10 yrs
inventory
6,000
y years of depreciation be
useful life
40 yrs
cash
land
2001
Acettep
2005
241000 2401000
361000 901000
4 years
Bv after 4 years
2161000
54,000
total book value of all assets being transferred
cash
inventory
Land
Building
Equipment
Total BV
211000
371000
801000
2161000
541000
408,000
Journal
assets given
Entry
Building
of parent company
Books
also
pale
Dr
Dr
Dr
408,000
Depr Equipment
36.000
Accu Depr Building
Accu
inventory
er
er
er
Books
debitaccudep
211000
371000
801000
land
er
so
241000
Cash
er
ace
accu depr
to close
Bright
investment in
credit
should be closed
away
Buildings
240,000
90,000
Equipment
cost
cost
of
Subsiduary company
bright
Dr cash
Dr inventory
Dr land
371000
801000
Yfftract
yo ooo
zyging
pp
90,000
er
er
ACU
241000
36.000
Depr Equipment
601000
Share capital
share premium
3481000
two ways
I
4081000 60100
now for
shares
101000 x Opar
601000 to
G
share
capital
goes to
share premium
whatever is left
Accounting for Internal Expansion
w Parent transfers assets to the new company.
w Subsidiary begins to operate.
w Example: P creates a new company S and
transfers $1,000 in cash for common stock.
Parent:
Investment in S
Cash
1,000
Subsidiary:
Cash
Common Stock
1,000
1,000
1,000
1-10
Practice Quiz Question #2 Solution
When a parent company creates a
subsidiary through internal expansion,
the parent’s journal entry to transfer
assets to the newly created entity will
include a debit to
a.
b.
c.
d.
e.
Acquisition Expense.
Cash.
Investment in Subsidiary.
Common Stock.
none of the above.
1-13
Accounting for Internal Acquisition
w E 1- 6
w E 1- 7
1-9
6 09 2021
merger
stock acquisition
1-14
Accounting for a External Expansion
w Acquiring company recognizes assets acquired and
liabilities assumed at fair values as of the acquisition date
w The acquiring company pays for the purchase with cash,
stock or other forms of payment
w If purchase consideration > The fair value of the net assets
of the sub company - We record goodwill
w If purchase consideration < The fair value of the net assets
of the sub company - We record bargain or profit.
1-15
S doesnt
exist
anymore
ownership change
external
internal
book value
greater
G
jess
external
newly created subsiduary
to parent
completely
expansion
talas
set
liabilities
1-12
Goodwill vs. Bargain Purchase Element
13 09.2021
è
Goodwill
w FMV Given < FMV of Net Assets
è
Bargain
Element
w FMV Given = FMV of Net Assets
è
w FMV Given > FMV of Net Assets
Neither GW
nor Bargfin
1-16
Acquisition involving Goodwill
Assume Bigco Corp. pays $400,000 for Littleco Inc. and
that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
assets
200,000
4001000
FV of net
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
200,000
payed more than FV
4001000
Goodwill
200,000
y
Liabilities
be
2001000
1-17
Acquisition involving Goodwill
Assume Big Corp. pays $400,000 for Little Inc. and that the
estimated fair market values of assets, liabilities, and
equity accounts of Little are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
Liabilities
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
Net Assets = Total Assets – Total Liabilities
Net Assets = $ 400,000 – $200,000 = $200,000
Goodwill = Acquisition price – FMV Net Assets
= $400,000 – $200,000 = $200,000
1-14
Acquisition involving Goodwill
Journal Entry in books of Bigco:
Accounts Receivable
Inventory
Marketable Securities
PP&E
Goodwill
Cash
Liabilities
$ 100,000
100,000
60,000
140,000
200,000
$ 400,000
200,000
1-15
Acquisition involving Bargain Purchase
Assume Bigco Corp. pays $150,000 for Littleco Inc. and
that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
Liabilities
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
1-20
Acquisition involving Bargain Purchase
Assume Big Corp. pays $150,000 for Little Corp. and that
the estimated fair market values of assets, liabilities, and
equity accounts are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
Liabilities
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
Net Assets = Total Assets – Total Liabilities
Net Assets = $ 400,000 – $200,000 = $200,000
Gain
= Acquisition price – Net Assets
= $150,000 – $200,000 = $(50,000)
1-21
Acquisition involving Bargain Purchase
Journal Entry in the books of Big Corp:
Accounts Receivable
$ 100,000
Inventory
100,000
Marketable Securities
60,000
PP&E
140,000
Gain on acquisition of Little
$ 50,000
Cash
150,000
Liabilities
200,000
1-22
Accounting for a Stock Acquisition
Pete Inc. acquired 100% of the outstanding
common stock of Sake Inc. for $2,500,000 cash and
20,000 shares of its own common stock ($1 par
value), which was trading at $50 per share at the
Tetuan
acquisition date.
purchase
consideration
purchase consideration
Acquisition Cost:
Cash
$2,500,000
Stock
1,000,000
Total
$3,500,000
Journal
entry
to record
Buying
Giving cash
giving
shares
acquisition
Investment in Sake
3,500,000
Cash
Common Stock
Additional Paid-in Cap. share
Dr investment
shares
cash
er
er
er
share capital
par value
share prem
49
2,500,000
20,000 purchase consider
total amountgiving
980,000
2010004 50
1-23
Stock acquisition
w E1-8
w E1-12
1-24
Accounting for Internal Expansion
w Journal entry of existing company (Parent)
Investment in Sub
Cash/Other Assets
XXX
XXX
w Journal entry of created company (Subsidiary)
Cash/Other Assets
Common Stock
XXX
XXX
1-11
More About Goodwill
n
n
n
n
Goodwill must capitalized as an asset
w
off
Cannot be amortized (unlike other intangible
assets)
Must be assessed for impairment at year end
If impaired, must write it down—charge to
earnings loss reduces profit
recorded
on
impairment
the
day
loss in
we
acquire
value of
goodwill
1-27
Testing for GW impairment
1. To test for impairment, the fair value of the
business unit is compared with the BV of the net
assets.
2. If the fair value of the reporting unit exceeds its BV,
goodwill is not considered impaired.
3. If the BV of the reporting unit exceeds its fair value,
Goodwill is considered impaired.
1-23
Acquisition accounting : Goodwill impairment rules
1. Calculate implied value of GW (the value that GW needs to
reflected at) :
n
FV of the business unit - FV of its net assets
(excluding goodwill)
2. Calculate GW impairment:
n
Carrying amount of goodwill (on books) - implied FV
of GW
1-24
w E1-15 page 34
w E1-16
1-30
Simple example of how consolidation is done
Cash
Receivable from Sub
Investment in Sub
PP&E
Total Assets
Parent Sub
$ 200 $100
100
500
800
600
$1,600 $700
Liabilities
Payable to Parent
Equity
Total Liabilities & Equity
$ 300 $100
100
1,300 500
$1,600 $700
DR CR
100
500
100
500
Cons.
$ 300
0
0
1,400
$1,700
$ 400
0
1,300
$1,700
1-31
Expenses paid during Acquisition
deleted
Two kinds:
w Costs associated with the acquisition itself
w Costs associated with issuing new stock if the
acquiring company pays for the acquisition with its
own stock
1-26