CHAPTER
Business Combinations:
America’s Most Popular
Business Activity, Bringing an
End to the Controversy
Fundamentals of Advanced Accounting
1st Edition
Fischer, Taylor, and Cheng
1
Business Combinations
•
•
All acquisitions of one firm by another
Two categories of business
combinations:
1) Merger
2) Consolidation
Chapter 1, Slide #2
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Merger vs. Consolidation
Merger
• Existing company acquires another
company
• Acquired company’s operations are
merged with its own.
Consolidation
• Two or more previously separate firms
are combined into one new company.
Chapter 1, Slide #3
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Economic Advantages of Combinations
Combinations utilize economies of
scale
• Horizontal combinations – firms with
similar functions
• Vertical combinations – firms at different
levels in marketing chain
• Conglomerates – dissimilar businesses
Chapter 1, Slide #4
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Economic Advantages of Combinations
(continued)
Defer capital gains on sale of stock
• Owner accepts Purchaser’s stock in
exchange for their stock
• Structure combination as “tax-free”
reorganization
• New shares are at basis of old shares
• Taxable to owner when new shares are
sold
Chapter 1, Slide #5
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Economic Advantages of Combinations
(continued)
Additional tax benefits:
• Tax losses are transferable in a
business combination.
• Combined operations may reduce
taxable income.
Chapter 1, Slide #6
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Obtaining Control
Two methods to obtain control of another
company:
• Purchase assets of an existing
company
– May assume liabilities as well
• Purchase > 50% of outstanding voting
stock of another company
– Parent/subsidiary relationship
Chapter 1, Slide #7
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Accounting for Control
• Purchase of “net assets”
– Acquiring firm records assets/liabilities
purchased in its own ledger.
• Acquisition of stock
– Acquiring firm (parent) records a single
“investment” account
– Parent and subsidiary remain separate
legal entities
– Parent/subsidiary financial statements are
combined (consolidated).
Chapter 1, Slide #8
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
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
Chapter 1, Slide #9
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Purchase Method - Valuation
• All assets and liabilities are recorded at
Fair Market Value.
– First identify and value tangible assets
– Next identify and value intangible assets
• Goodwill - Price paid in excess of Fair
Market value of the net assets.
Chapter 1, Slide #10
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Basic Purchase: Example with Goodwill
Acquisitions, Inc. purchases net assets of
Johnson Company:
• Net assets (per books) = $148,000
• Purchase price = $350,000 cash
• Direct acquisition costs = $10,000
• Fair value (current appraisal) of net
assets = $297,000
• Goodwill = $63,000
– Cost $360,000 less $297,000 fair value
Chapter 1, Slide #11
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Example: Johnson, Inc. Net Asset Values
Assets
Book Value
Fair Value
Accounts receivable
Inventory
Land
Buildings (net)
Equipment (net)
Patent
Copyright
Goodwill
Total Assets
28,000
40,000
10,000
40,000
20,000
15,000
20,000
173,000
28,000
45,000
50,000
80,000
50,000
30,000
40,000
0
323,000
Liabilities & Equity
Current liabilities
Bonds payable
Total liabilities
5,000
20,000
25,000
5,000
21,000
26,000
148,000
297,000
Net assets
Chapter 1, Slide #12
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Entry to Record Purchase
Accounts Receivable
28,000
Inventory (fair value)
45,000
Land (fair value)
50,000
Building (fair value)
80,000
Equipment
50,000
Patent
30,000
Copyright
40,000
Goodwill (based on current price)
63,000
Current liabilities
Bonds payable
Bonds payable premium (to fair value)
Cash
Chapter 1, Slide #13
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
5,000
20,000
1,000
360,000
Basic Purchase: Example with Goodwill
Purchased with Stock
• Assume same facts as in prior example.
• Acquisitions, Inc. issues $1 par value
common stock for the $350,000
purchase price.
Calculation of shares required:
Fair value of shares = $50
Shares required = 7,000 ($350,000 / $50)
Chapter 1, Slide #14
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Entry to Record Purchase
Accounts Receivable
28,000
Inventory (fair value)
45,000
Land (fair value)
50,000
Building (fair value)
80,000
Equipment
50,000
Patent
30,000
Copyright
40,000
Goodwill (based on current price)
63,000
Current liabilities
Bonds payable
Bonds payable premium (to fair value)
Cash
Common Stock (7,000 x $1)
Paid-in Capital in Excess of Par
Chapter 1, Slide #15
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
5,000
20,000
1,000
10,000
7,000
343,000
Required Disclosures
•
•
•
•
Schedule of fair value of accounts
Name and description of firm purchased
Reason for purchase
Cost of acquisition
– Valuation of stock (If payment method)
• Contingent payment agreements
• Pro Forma income disclosure
Chapter 1, Slide #16
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Entry for Johnson, Inc. (Seller)
Investment in Acquisitions, Inc. Stock 350,000
Current liabilities
5,000
Bonds payable
20,000
Accounts receivable
28,000
Inventory
40,000
Land
10,000
Buildings
40,000
Equipment
20,000
Patent
15,000
Goodwill
20,000
Gain on Sale of Business
202,000
Chapter 1, Slide #17
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Accounting for Acquired Assets
• Tangible assets and liabilities – normal
depreciation and amortization
procedures.
• Intangible assets amortized over useful
lives.
• Goodwill is not amortized
– Subject to impairment
– Tested on an annual basis
Chapter 1, Slide #18
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Impairment
Test: Goodwill is impaired if estimated value
of business unit is less than remaining book
value of net assets (including goodwill).
New goodwill estimate:
Estimated value of business unit
– New estimate of identifiable net assets at fair value
= New goodwill estimate
Impairment Loss:
Book value of goodwill
– New goodwill estimate
= Impairment loss
Chapter 1, Slide #19
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Recording a Bargain Purchase
• Bargain purchase – price of acquisition
is less than Fair Value of Net Assets
• No Goodwill exists (none recorded)
• Cost of acquisition is allocated to
individual asset and liability accounts.
– Priority accounts – always recorded at fair
value
– Non-priority accounts – discounted
Chapter 1, Slide #20
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Priority Accounts
• All current assets
• All liabilities
• All investments (exception- controlled
entities)
• Excess assets included in purchase
• Deferred tax assets and liabilities
• Prepaid assets relating to
postretirement benefits
Chapter 1, Slide #21
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Price Zone Analysis
Price zone analysis – guides assignment of price paid.
Example: Johnson Company
Calculate the market value net assets:
Priority
Non-priority
Accounts receivable
Inventory
Current liabilities
Bonds payable
Land
Buildings (net)
Equipment (net)
Patent (net)
Copyright
Fair Value Group Total Cum. Total
28,000
45,000
(5,000)
(21,000)
47,000
47,000
50,000
80,000
50,000
30,000
40,000
250,000
297,000
Total Market Value = $297,000
Chapter 1, Slide #22
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Price Zone Analysis (continued)
2. Determine the 3 price zones:
• Premium: Over $297,000
All accounts at fair value; goodwill for price
over $297,000
• Bargain: $47,000 [priority] to $297,000
Priority accounts at fair value; balance
allocated to nonpriority accounts
• Extraordinary Gain: Below $47,000
Priority accounts at fair value; other accounts
not recorded; extraordinary gain for excess of
priority accounts over price paid
Chapter 1, Slide #23
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Purchase Allocation Bargain Price:
$210,000
$47,000 for priority accounts; $163,000 allocated
to fixed and identifiable intangible assets
Allocation Table
Land
50,000
20%
163,000
32,600
Building
80,000
32%
163,000
52,160
Equipment
50,000
20%
163,000
32,600
Patent
30,000
12%
163,000
19,560
Coyright
40,000
16%
163,000
26,080
Chapter 1, Slide #24
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Purchase Entry Bargain Price: $210,000
Accounts Receivable
28,000
Inventory (fair value)
45,000
Land (allocation)
32,600
Building (allocation)
52,160
Equipment (allocation)
32,600
Patent (allocation)
19,560
Copyright (allocation)
26,080
Current liabilities
Bonds payable (face value)
Bonds payable premium (to fair value)
Cash
Common Stock (4,000 shares x $1)
Paid-in Capital in Excess of Par
Chapter 1, Slide #25
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
5,000
20,000
1,000
10,000
4,000
196,000
Purchase Entry Extraordinary Gain:
$30,000 Purchase Price
Price is below $47,000; there is no value to assign
to fixed and identifiable intangible assets
Accounts receivable
28,000
Inventory (fair value)
45,000
Extraordinary gain
7,000
Current liabilities
5,000
Bonds payable
20,000
Bonds pay premium (to fair value)
1,000
Cash
10,000
Common Stock (600 shares x $1)
600
Paid-In Capital in Excess of Par
29,400
Chapter 1, Slide #26
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Purchase Complications
• May have to calculate market value of
debt issues
• Leases retain classification; related
accounts recorded at market value
• Deferred tax liability (DTL) goes with
assets in nontaxable exchange
• Tax loss carryover is usually recorded as
an asset; if realization is uncertain, it is
not recorded and is buried in goodwill
Chapter 1, Slide #27
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
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
Chapter 1, Slide #28
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
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
Chapter 1, Slide #29
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Example of Tax-Free Exchange
• The price paid for a company is $431,000
– $6,000 in direct costs
– 8,500 shares of $10 par value common stock with a
fair value of $40 per share
Priority Accounts:
Inventory
Liabilities
Non-priority Accounts:
Land: Book Value = $100,000
Building: Book Value = $200,000
Deferred tax liability – Bldg.
Total
Chapter 1, Slide #30
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Fair Value
50,000
(80,000)
100,000
300,000
(30,000)
$340,000
Example of Tax-Free Exchange - Continued
• The tax rate is 30%
• A $30,000 DTL goes with the machine
($100,000 x 30%)
• $91,000 is available for goodwill (net of
a 30% DTL)
($431,000 – 340,000)
• Goodwill = $130,000
$39,000  (1.0 – .3)
Chapter 1, Slide #31
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Tax-Free Exchange: Journal Entry
Inventory
50,000
Land (fair value)
100,000
Building (fair value)
300,000
Goodwill (gross value)
130,000
Liabilities
80,000
Deferred tax liability*
69,000
Cash
6,000
Common Stock ($10 par, 8500 shares) 85,000
Paid-in Capital in Excess of Par
340,000
*$30,000 on Building and $39,000 on goodwill
The DTLs are amortized over the same life (and by the
same method) as the assets to which they attach
Chapter 1, Slide #32
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.