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Business Combinations

Business Combinations. Business combinations. The acquisition of an entire company Understanding the reporting benefits that caused firms to favor the pooling method prior to July 1, 2001 Purchase accounting procedures at alternative prices

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Business Combinations

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  1. Business Combinations

  2. Business combinations • The acquisition of an entire company • Understanding the reporting benefits that caused firms to favor the pooling method prior to July 1, 2001 • Purchase accounting procedures at alternative prices • Pooling of Interests accounting procedures (appendix) C01

  3. Basic issues in combinations • The motivation to combine • Pre-acquisition audit confirms value • Every deal focuses on market values • Asset acquisition versus stock acquisition (investment) C01

  4. 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 C01

  5. Major issues Purchase Pooling C01

  6. Major issues (continued) Purchase Pooling C01

  7. Major issues (concluded) Purchase Pooling C01

  8. Purchase price rules Premium Price - Price high enough to record all accounts at fair value, excess price is goodwill with no amortization, but required impairment testing Bargain- Priority accounts at fair value, balance of price allocated to non priority accounts. Extraordinary Gain - Price paid is less than priority accounts, excess of priority accounts over price is extraordinary gain. C01

  9. Priority accounts • All current assets • All liabilities • Deferred tax assets • Pension and other post retirement benefit plan assets • Nonpriority assets that are to be sold C01

  10. Basic purchase example AssetsLiabilities & Equity Inventory 120,000 Bonds payable 100,000 Land 50,000 Common stock, $5 par 10,000 Building 250,000 Retained earnings 310,000 Total 420,000 Total 420,000 Fair Values: Inventory (priority) 170,000 Bonds pay (priority) 105,000 Land 100,000 Building 300,000 Patent (unrecorded) 50,000 C01

  11. Price zone analysis 1. Calculate the market value net assets: • Using fair values, net assets = $515,000 C01

  12. Price zone analysis (continued) 2. Determine the 3 price zones: • Premium: Over $515,000 all accounts at fair value, goodwill for price over $515,000 • Bargain: $65,000 [priority] to $515,000 priority accounts at fair value; balance allocated to nonpriority accounts • Extraordinary Gain: Below $65,000 priority accounts at fair value; other accounts not recorded; extraordinary gain for excess of priority accounts over price paid C01

  13. Purchase entrypremium price: $600,000 Inventory (fair value) 170,000 Land (fair value) 100,000 Building (fair value) 300,000 Patent 50,000 Goodwill (price over $515,000) 85,000 Bonds payable 100,000 Premium on bonds payable (to fair value) 5,000 Cash 600,000 Goodwill is not amortized, but could be impairment adjusted at a later date C01

  14. Purchase allocationbargain price: $365,000 $65,000 for priority accounts; $300,000 allocated to fixed & identifiable intangible assets Allocation Table C01

  15. Purchase entrybargain price: $365,000 Inventory (fair value) 170,000 Land (allocated) 66,000 Building (allocated) 201,000 Patent (allocated) 33,000 Bonds payable 100,000 Premium on bonds pay (to fair value) 5,000 Cash 365,000 C01

  16. Purchase entryextraordinary gain: $50,000 Price is below $65,000; there is no value to assign to fixed or identifiable intangible assets: Inventory (fair value) 170,000 Land (no value available) 0 Building (no value available) 0 Patent (no value available) 0 Extraordinary gain 15,000 Bonds payable 100,000 Prem on bonds pay (to fair value) 5,000 Cash 50,000 C01

  17. Goodwill impairment Test: Goodwill is impaired if estimated value of business unit is less that remaining book value of net assets (including goodwill). New GW estimate = (estimated value of business unit) – (new estimate of identifiable net assets at fair value) Impairment Loss = Book value of GW – new estimate. C01

  18. Impairment example Recorded $100,000 goodwill in purchase three years ago. Now Net assets at book value = $650,000 Fair value of the business unit = $625,000 Fair value net identifiable assets (not including goodwill) = $580,000 C01

  19. Test Est. value of business unit $625,000 Book value of assets (including goodwill) 650,000 Excess book $25,000 Goodwill is impaired Adjustment Est. value of business unit $625,000 Fair value of ident. assets, not incl. GW 580,000 New GW est. 45,000 GW bookvalue 100,000 Impair. loss $55,000 Impairment calculations C01

  20. 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 C01

  21. Purchase complications • May have to calculate market value of debt issues • Leases retain classification, related accounts recorded at market value • DTL goes with assets in non-taxable exchange • Tax loss carry over is usually recorded as an asset. If realization is uncertain, it is not recorded and is buried in goodwill C01

  22. 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 C01

  23. Example of tax-free exchange • The price paid for a company is $480,000 • The only asset is a machine with a book value of 300,000 and a market value of $400,000 • The tax rate is 40% • A $40,000 DTL goes with the Machine • The remaining price is $120,000 ($480 - $400 + $40) • $120,000 is available for goodwill net of a 40% DTL • Goodwill = $120,000  (1.0 - .4) = $200,000 C01

  24. Tax-free exchange: journal entry Machine (fair value) 400,000 Goodwill (gross value) 200,000 Deferred Tax Liability* 120,000 Cash 480,000 * $40,000 on machine and $80,000 on goodwill The DTLs are amortized over the same life (and by the same method) as the assets to which they attach C01

  25. Total Paid-in Total Paid-in Retained Earnings (2) Retained Earnings Pooling: equity transfer rules Combiner: Add to Issuer: (2)Take RE to meet total pd-in (if (1) is not enough) Par Par Additional Paid-in Additional Paid-in (1) (1)Take from parent pd-in to meet total pd-in C01

  26. Pooling example AssetsLiabilities & Equity Inventory 120,000 Bonds payable 100,000 Land 50,000 C. stock, $5 par 10,000 Paid-in capital in excess of par 100,000 Building 250,000 Retained earnings 210,000 Total 420,000 Total 420,000 Market Values Inventory 170,000 Bonds payable 105,000 Land 100,000 Building 300,000 Estimated goodwill 135,000 C01

  27. Pooling analysis Issuer will issue $50 market value shares to meet the $600,000 market value. $600,000  $50 = 12,000 shares issued. The deal is based on market values; but they are not recorded! • The assets and liabilities are recorded at book value • Pooling transfer rule is used to assign equity amounts • Assume the following par values for shares issued: $.50 $5 $10 C01

  28. Equity transfer for $0.50 par Combiner Add to Issuer Common Stock 10,000 Common Stock* 6,000 Paid-in Capital Paid-in Capital in Excess of Par 100,000 in Excess of Par 104,000 Total Paid-in 110,000 Total Paid-in 110,000 R E(adjusted) 210,000 RE 210,000 320,000 320,000 *12,000 shares, par $0.50 C01

  29. Journal entry for $0.50 par Inventory 120,000 Land 50,000 Building 250,000 Bonds payable 100,000 Common stock 6,000 Paid-in capital in excess of par 104,000 Retained earnings 210,000 C01

  30. Equity transfer for $5.00 par Combiner Add to Issuer Common Stock 10,000 Common Stk* 60,000 Paid-in Capital Paid-in Capital in Excess of Par 100,000 in Excess of Par 54,000 Total Paid-in 110,000 Total Paid-in 110,000 R E(adjusted) 210,000 RE 210,000 320,000 320,000 *12,000 shares, par $5.00 C01

  31. Journal entry for $5.00 par Inventory 120,000 Land 50,000 Building 250,000 Bonds payable 100,000 Common stock 60,000 Paid-in capital in excess of par 50,000 Retained earnings 210,000 C01

  32. Equity transfer for $10.00 par Combiner Add to Issuer Common Stock 10,000 Common Stk* 120,000 Paid-in Capital Paid-in Capital in Excess of Par 100,000 in Excess of Par -0- Total Paid-in 110,000 Total Paid-in 120,000 R E(adjusted) 210,000 RE 200,000 320,000 320,000 *12,000 shares, par $10.00 C01

  33. Entry for $10.00 par Inventory 120,000 Land 50,000 Building 250,000 Bonds payable 100,000 Common stock 120,000 Retained earnings 200,000 C01

  34. Special issues in a pooling • Direct, indirect and issue costs are expensed • Combiner existinggoodwill is recorded • Adjustments may be made to accounts for: • Lower of cost or market adjustments • Changes in accounting principles (for uniformity) • Record unrecorded items • Error correction All adjustments are made to combiner retained earnings before the equity transfer diagram is applied C01

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