Chapter 4
Business Combinations
Learning Objectives
– To define a business combination, and describe the
two basic forms for achieving a business combination
– To describe the current acceptable method of
accounting for a business combination
– To compare and contrast the purchase and pooling
methods
– To prepare a balance sheet immediately after a
purchase-of-net assets business combination, using
the purchase method
– To prepare a balance sheet following a purchase-ofshares business combination, using the purchase
method
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Commonly used terms:
• Combined enterprise: the accounting entity that
results from business combination.
• Constituent companies: the business enterprises
that enter into a business combination.
• Combinor: a constituent company entering into a
purchase type business combination whose
owners as a group end up with control of the
ownership interest in the combined enterprise.
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• Combinee: a constituent company other than the
combinor in a business combination.
Following are the common terms used to describe
defensive moves:
• Greenmail. The target company may pay a
premium price (“greenmail”) to purchase treasury
shares.
• White Knight. The target company locates a
different company to acquire a controlling interest.
• Poison Pill. The “poison pill” involves the issuance
of stock rights to existing shareholders to purchase
additional shares at a price far below fair value.
• Selling the Crown Jewels. This approach has
the management of the target company selling
vital assets (the “crown jewels”)
• Leveraged Buyouts. The management of the
existing target company attempts to purchase a
controlling interest in that company.
Introduction
A business combination occurs when the
enterprise requires net assets that constitute
a business, or requires equity interest of one
or more other enterprises and obtains control
over that enterprise or enterprises [1581.06]
Introduction
• Business combination – a transaction whereby
one economic unit unites with or obtains control
over another economic unit regardless of legal
avenue by which such control is obtained and
regardless of the form of economic unit emerging
from the transaction
• A conglomerate business combination involves
regular economic units operating in widely
different industries
Business Combinations
• Conceptually, a business combination occurs
when businesses combine their operations;
this can happen in two basic ways:
– As an acquisition or purchase of one business by
another, where control is acquired
– As a uniting of interest, where two existing
businesses join together to carry out business as
one economic entity
• Current Canadian rules do not differentiate;
all business combinations by corporations are
accounted for as purchases
Business Combinations
• A horizontal business combination
involves economic units whose products are
similar
• A vertical business combination involves
economic units where the outputs from one
can be used as inputs from another
Reasons for Business Combination
1. Growth
2. Economies of Scale: A combined enterprise will
3. Operating Economies: number of operating economies will be
available with the combination of two or more enterprises.
4. Better Management: Combinations results in better management.
5. Monopolistic Ambitions:
6. Diversification of Business Risk
8. Elimination of Fierce Competition
Methods for Arranging Business Combinations
The four common methods for carrying out a
business combination are:
Statutory Merger
Statutory Consolidation,
Acquisition of Common Stock, and
Acquisition of Assets
•
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1. Statutory Merger
A merger in which one of the merging companies continues
to exist as a legal entity while the other or others are
dissolved.
E.g. ABC Company acquires all the outstanding
common stock (net assets) of XYZ Company where
XYZ Company is legally liquidated.
ABC
+ XYZ =ABC
2. Statutory Consolidation: A business combination in
which a new corporation issues common stock for all
outstanding common stock of two or more other
corporations that are then dissolved and liquidated, with
their net assets owned by the new corporation. ABC
Company acquires XYZ Company; but a new
Company AYZ is created to issue common stocks for
the two companies which are now defunct.
ABC +XYZ =AYZ
3. Acquisition of common stock: One corporation (the investor)
may issue preferred or common stock, cash, debt or a combination
there of to acquire from present stockholders a controlling interest in
the voting common stock of another corporation (the investee). ABC
+XYZ = ABC +XYZ . ABC =PARENT
XYZ =SUBSIGIARY
4. Acquisition of Assets
A business enterprise may acquire from another enterprise all or
most of the gross asset or net assets of other enterprise for cash,
debt, preferred or common stock or a combination thereof. The
transaction generally must be approved by the board of directors and
stockholders of the constituent companies.
Methods of Accounting for Business Combinations
• There are three methods that have been
used in practice or discussed in theory over
the years:
– The purchase method
– The pooling-of-interests method
– The new entity method
Methods of Accounting for Business Combinations
• Under the purchase method, the acquiring
company's interest in assets acquired and
liabilities assumed is accounted for in the
acquiring company's financial statements at
the cost to the acquiring company
• The reported income of the acquiring
company includes the results of operations of
the acquired company from the date of
acquisition only
Books of Combinee Company (Acquired Company)
General journal entry passed For Liquidation of the Combinee
Liabilities (individually) ................................................ xxxxx
common Stock .............................................................. xxxxx
PIC in excess of Par ...................................................... xxxxx
Retained Earnings ......................................................... xxxxx
All Assets (Individually) ................................... xxxxx
1. Recording the payment (purchase price)
Investment in Combinee Company ........................ xxxxx
Cash .................................................................. xxxxx
Common Stock .................................................. xxxxx
PIC in excess of Par ........................................... xxxxx
Bonds .................................................................. xxxxx
2. Recording direct out-of-pocket costs (legal and finder’s fee)
Investment in Combinee Company .......................... xxxxx
Cash ..................................................................... xxxxx
3. (the Investment Account is replaced with assets and liabilities)
All Assets (individually) at CFV ............................... xxxxx
Goodwill .................................................................... xxxxx
Liabilities (individually) at CFV ............................... xxxxx
Investment in Combinee Company .......................... xxxxx
4. Recording Indirect Out-of-Pocket Costs
Indirect Expenses ............................................ xxxxx
Cash ........................................................................ xxxxx
5. Recording Reduction in PIC excess of par for indirect expenses
PIC in Excess of Par ................................................ xxxxx
Indirect Expenses............................................... xxxxx
• Illustration of Purchase Accounting Method for
Statutory Merger with Positive Goodwill
Combinee Company
Balance Sheet
December 31, 2014
Assets
Liabilities and Equity
Cash .......................................... 60,000
Current Liabilities ........................... 180,000
Other Current Assets ......... …..420,000
Long-term debts ............................... 250,000
Land ........................................ 400,000
Capital Stock (Br 10 Par) ............... 200,000
Building (net) ......................... 240,000
PIC in Excess of Par ........................ 320,000
Equipment (net) ...................... 280,000
Retained Earnings.............................. 450,000
Total Asset ........................... 1,400,000
Total Liabilities and Equity ............ 1,400,000
After in depth study, Combinor Company’s BOD established the following Current Fair Value for
assets and liabilities:
Other Current Assets .............................................. 500,000
Land ............................................................................... 450,000
Building (Net) ............................................................... 300,000
Equipment (Net) ............................................................ 250,000
Long-term debt ............................................................. 240,000
Accordingly on December 31, 2014 Combinor issued 100,000 shares of its Br. 10 Par (Current Fair
Value of Br. 13) Common Stock for all the net asset of Combinee on a purchase type of business
combination. Also on December 31, 2014 Combinor paid the following out-of-pocket costs in
connection with the combination:
Finder’s Fees and Legal Fees .............................................. 180,000
Costs associated with issuance of shares ......................... 120,000
Calculation of Total Acquisition Cost:
Common Stock (Br 13 @ 100,000 Shares) ............................... 1,300,000
Finder’s Fees and Legal Fees .......................................................... 180,000
Total Acquisition Cost .................................................................. 1,480,000
Calculation of Net Assets at CFV:
Cash ...................................................................................................... 60,000
Other Current Assets ..................................................................... 500,000
Land ....................................................................................................... 450,000
Building (net) ........................................................................................ 300,000
Equipment (net). ................................................................................... 250,000
Total Assets at CFV.......................................................................... 1,560,000
Less: Liabilities at CFV (180,000 + 240,000)............................... (420,000)
Net Assets at CFV .......................................................................... 1,140,000
Calculation of Goodwill:
Total Purchase Cost ............................................................................ 1,480,000
Less: Net Assets at CFV................................................................... (1,140,000)
Goodwill.................................................................................................. ….340,000
Journal Entries:
Recording the payment (the purchase consideration)
Investment in Combinee Company.......................... 1,300,000
Common Stock ......................................................... 1,000,000
PIC in excess of Par ................................................. 300,000
2. Recording Direct out-of-pocket costs (legal and finder’s fee)
Investment in Combinee Co............................... 180,000
Cash .............................................................................. 180,000
3. Recording Assets and liabilities
Cash ............................................................................................. 60,000
Other Current Assets............................................................ 500,000
Land ............................................................................................. 450,000
Building (net) .............................................................................. 300,000
Equipment (net) ......................................................................... 250,000
Goodwill ........................................................................................ 350,000
Current Liabilities .......................................... 180,000
Long-term debt .............................................. 240,000
Investment in Combinee Company ............... 1,480,000
4. Recording indirect out-of-pocket costs
Indirect Expenses.......................................................................... 120,000
Cash .............................................................................. 120,000
5. Recording reduction in PIC in excess of par for indirect expenses
PIC in Excess of Par ............................................................. 120,000
Indirect Expenses .......................................... 120,000
Example 2
• On December 31, Year 1, BITAMTU Company (the
combinee) was merged into BITTU Corporation (the
combinor or surviving company). Both companies
used the same accounting principles for assets,
liabilities, revenue, and expenses and both had a
December 31 fiscal year. BITTU exchanged
150,000 shares of its Br 10 par common stock
(Current Fair Value Br 25 a share) for all 100,000
issued and outstanding shares of BITAMTU’S nopar, Br 10 stated value common stock. In addition,
BITTU paid the following out-of-pocket costs
associated with the business combination:
Chapter 3
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• Accounting
fees:
• For investigation of BITAMTU Company as
prospective combine........................ Br 5,000
• For SEC registration statement for Saxon common
stock ..................................... 60,000
• For the business combination........10,000
• For SEC registration statement for Saxon common
stock ..................................... 50,000
• Finder’s fee .................... 51,250
• Printing charges for securities and SEC registration
statement .........23,000
• SEC registration statement fee ..... 750
• Total out –of- pocket costs............. 200,000
• There was no contingent consideration in the merger
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contract. Immediately prior to the merger,
BITAMTU Company’s condensed balance sheet was as follows:
BITAMTU COMPANY (Combinee)
Balance sheet (Prior to Business Combination)
December 31, Year 1
Assets
Current assets............................................................ Br 1,000,000
Plant assets (net).............................................................. 3,000,000
Other assets ........................................................................ 600,000
Total assets ........................................................................ 4,600,000
Liabilities & Stockholder Equity
Current liabilities ................................................................ 500,000
Long-term debt................................................................. 1,000,000
Common stock, no par Br 10 stated value ................... 1,000,000
Paid in capital ........................................................................ 700,000
Retained Earnings ............................................................. 1,400,000
Total .................................................................................... 4,600,000
Using the guidelines in SFAS No. 141, “Business Combinations,” the board of directors of BITTU Corporation determined
the current fair values of BITAMTU Company’s identifiable assets and liabilities (identifiable net assets) as follows:
Current asset.................................................................. Br 1,150,000
Plant assets ............................................................................ 3,400,000
Other assets ............................................................................ 600,000
Current liabilities.................................................................... (500,000)
Long-term debt (present value).......................................... (950,000)
Identifiable net assets of combinee................................... 3,700,000
Chapter 3
© 2005 McGraw-Hill Ryerson Limited
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Cont.
Determination of Goodwill:
Total cost of investment (Br 3,750,000 + Br 66,250).............................................................. Br 3,816,250
Less: Net Assets (NAs) at CFV
Carrying amount of BITAMTU’S identifiable NAs
(4,600,000–1,500,000)……………………………………… ……………………………... 3,100,000
Excess (Deficiency) of current fair values assets and liabilities
Current assets............................................................................................ 150,000
Plant assets ................................................................................................. 400,000
Long-term debt............................................................................................ 50,000
Total Net Assets at CFV..................................................................................................................... (3,700,000)
Amount of goodwill............................................................................................................................. Br 116,250