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Business Combinations
1: Economic Motivations
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Cost advantage
Lower risk
Fewer operating delays
Avoidance of takeovers
Acquisition of intangible assets
Other: business and other tax advantages,
personal reasons
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Business Combinations
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Mergers: A + B = A
1) Company A purchases the assets of Company
B for cash, other assets, or Company A
debt/equity securities. Company B is dissolved;
Company A survives with Company Bs assets
and liabilities.
2) Company A purchases Company B stock from
its shareholders for cash, other assets, or
Company A debt/equity securities. Company B
is dissolved. Company A survives with
Company Bs assets and liabilities.
Pearson Education, Inc. publishing as Prentice
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Consolidations: E + F = D
1) Company D is formed and acquires the assets
of Companies E and F by issuing Company D
stock. Companies E and F are dissolved.
Company D survives, with the assets and
liabilities of both dissolved firms.
2) Company D is formed acquires Company E
and F stock from their respective shareholders
by issuing Company D stock. Companies E and
F are dissolved. Company D survives with the
assets and liabilities of both firms.
Pearson Education, Inc. publishing as Prentice
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Business Combinations
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International Accounting
Most major economies prohibit the use of the
pooling method.
The International Accounting Standards Board
specifically prohibits the pooling method and
requires the acquisition method. [IFRS 3]
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Recording Guidelines (1 of 2)
Record assets acquired and liabilities assumed
using the fair value principle.
If equity securities are issued by the acquirer,
charge registration and issue costs against the
fair value of the securities issued, usually a
reduction in additional paid-in-capital.
Charge other direct combination costs (e.g., legal
fees, finders fees) and indirect combination costs
(e.g., management salaries) to expense.
Pearson Education, Inc. publishing as Prentice
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Recording Guidelines (2 of 2)
When the acquiring firm transfers its assets other
than cash as part of the combination, any gain or
loss on the disposal of those assets is recorded in
current income.
The excess of cash, other assets and equity securities
transferred over the fair value of the net assets
(A L) acquired is recorded as goodwill.
If the net assets acquired exceeds the cash, other
assets and equity securities transferred, a gain on
the bargain purchase is recorded in current income.
Pearson Education, Inc. publishing as Prentice
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1,600
1,000
600
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XXX
XXX
XXX
XXX
XXX
XXX
1,600
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Business Combinations
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Goodwill
The excess of
The sum of:
Fair value of the consideration transferred,
Fair value of any noncontrolling interest in
the acquiree, and
Fair value of any previously held interest in
acquiree,
Over the net assets acquired.
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Contingent Consideration
If the fair value of contingent consideration is
determinable at the acquisition date, it is
included in the cost of the combination.
If the fair value of the contingent consideration
is not determinable at that date, it is recognized
when the contingency is resolved.
Types of consideration contingencies:
Future earnings levels
Future security prices
Pearson Education, Inc. publishing as Prentice
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Cash
Net receivables
Inventory
Land
Buildings, net
Equipment, net
Patents
Total assets
Accounts payable
Notes payable
Other liabilities
Total liabilities
Net assets
Book Val.
$ 50
150
200
50
300
250
0
$1,000
$ 60
150
40
$ 250
$ 750
Fair Val.
$ 50
140
250
100
500
350
50
$1,440
$ 60
135
45
$ 240
$1,200
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Cash
Net receivables
Inventories
Land
Buildings
Equipment
Patents
Goodwill
Accounts payable
Notes payable
Other liabilities
Investment in Seed Co.
Pearson Education, Inc. publishing as Prentice
50
140
250
100
500
350
50
200
60
135
45
1,400
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Cash
Net receivables
Inventories
Land
Buildings
Equipment
Patents
Accounts payable
Notes payable
Other liabilities
Investment in Seed Co.
Gain from bargain purchase
Pearson Education, Inc. publishing as Prentice
50
140
250
100
500
350
50
60
135
45
1,000
200
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Goodwill Controversies
Capitalized goodwill is the purchase price not
assigned to identifiable assets and liabilities.
Errors in valuing assets and liabilities affect
the amount of goodwill recorded.
Historically goodwill in most industrialized
countries was capitalized and amortized.
Current IASB standards, like U.S. GAAP
Capitalize goodwill,
Do not amortize it, and
Test it for impairment.
Pearson Education, Inc. publishing as Prentice
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Impairments
Firms must test annually for the impairment of
goodwill at the business unit reporting level.
If the units book value exceeds its fair value,
additional tests must be performed to
determine the impairment of goodwill and/or
other assets.
More frequent testing for goodwill impairment
may be needed (e.g., loss of key personnel,
unanticipated competition, goodwill
impairment of subsidiary).
Pearson Education, Inc. publishing as Prentice
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