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CHAPTER 5

CHAPTER 5. THE PURCHASE METHOD: AT DATE OF ACQUISITION-- 100% OWNERSHIP. FOCUS OF CHAPTER 5. The Purchase Method in Depth: Total Acquisition Cost Goodwill and Bargain Purchase Elements Consolidation Worksheets--At the Acquisition Date:

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CHAPTER 5

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  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 beof any type: • Cash. • Common stock. • Preferred stock. • Notes or Bonds Payable. • Used trucks. WSJ--10/14/X1... 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 Traceableto 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 Versus A Bargain Purchase Element: Can Have ONE But Not BOTH • Costin excess of Current Value= GW • Current Valuein excess of Cost = BPE • Current Valueequals Cost= Neither GW nor BPE

  10. Goodwill: What to Do With It? #1 • 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. red ink galore

  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 basisof 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 likea “sacred cow”). • Make fair value adjustments and record goodwill in consolidation (on the worksheets).

  14. Consolidation Consequences:Push-Down Versus Non-Push-Down • Push-Down Accounting: • Consolidation effort isminimal (has received the “Better Book-keeping” stamp of approval). • Non-Push-Down Accounting: • Consolidation effort is cumber-some (often a headache). Aspirin

  15. Push-Down Versus Non-Push-Down Accounting: The Bottom Line • The consolidated financial statement amounts are the SAMEwhether 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 isseparable.

  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 #1--With 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 #2--With 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 #3--With 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 #4--With 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 #5--With 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 #6--With 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 #7--With 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?

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