CHAPTER 5

1. CHAPTER 5 THE PURCHASE METHOD:AT DATE OF ACQUISITION—100% OWNERSHIP

2. 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)

3. 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: Contingentconsideration —will be paid subsequent to the acquisition date (if paid at all).

4. 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. • Preferred stock. • Notes or Bonds Payable. • Used trucks. WSJ--11/22/06... 77 5/8

5. Acquirer’s Cost: Category 1—The Consideration Given • General Rule: • Use the FMV of the considerationgiven. • Exception: • Use the FMV of the propertyreceived if it is more readily determinable.

6. 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. • NOallocation allowed of G&A overhead. • NO direct costs of issuing stock (charge to APIC).

7. 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 thanthe “probable date.” • The cost of the acquisition is increased in later periods when the accrual is actually made (usually increases goodwill).

8. 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.

9. 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

10. 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.

11. Bargain Purchase Element:What to Do With It? • BARGAIN PURCHASE ELEMENT—Usually Exists When Acquiring a TroubledCompany: • Extinguish against certain specified assets to extent possible. • Any unextinguished amount is credited to earnings—reported as an extraordinary item.

12. Push-Down Accounting:The EASIER Way • Push-Down Accounting(an absolute gem): • In the subsidiary’s general ledger: • Adjust assets and liabilities to FVbased on the parent’s purchase price. • This establishes a new basis of accounting. • Record goodwill. Discussed in depth in Chapter 7.

13. 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).

14. 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).

15. 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.

16. 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 contractual right. #2: Intangible does not arise from a legal or contractual right but is separable.

17. Identifiable Intangible Assets • Marketing-related: • Trademarks, service marks • Trade dress (unique package color or design) • Non-compete agreements

18. Identifiable Intangible Assets • Customer-related: • Customer lists • Customer order backlog • Customer contracts • Customer relationships

19. 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

20. Review Question #1 What results for each of the following situations? UnableGoodwillBPETo Tell CV > BV…….. CV < BV…….. CV > Cost…… CV < Cost…… BV = Cost..…..

21. Review Question #1With Answer What results for each of the following situations? UnableGoodwillBPETo Tell CV > BV…….. X CV < BV…….. X CV > Cost…… X CV < Cost…… X BV = Cost..….. X

22. Review Question #2 What results for each of the following situations? UnableGoodwillBPETo Tell Cost > BV….... Cost < BV….... Cost > CV..….. Cost = CV..….. CV = BV……....

23. Review Question #2With Answer What results for each of the following situations? UnableGoodwillBPETo Tell Cost > BV….... X Cost < BV….... X Cost > CV..….. X Cost = CV..….. CV = BV…….... X

24. 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.

25. Review Question #3With 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.

26. 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.

27. Review Question #4With 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.

28. 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.

29. Review Question #5With 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.

30. 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.

31. Review Question #6With 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.

32. 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.

33. Review Question #7With 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 stockor 100% of the assets. C. Both A and B. D. Neither A or B.

34. End of Chapter 5 • Time to Clear Things Up—Any Questions?