Advanced Accounting
Week 1
The focus of this chapter is on why firms often prefer external over internal expansion options
and how financial reporting reflects the outcome of these activities.
Business combinations: unite previously separate business entities.
Horizontal integration: combination of firms in the same business lines and markets.
Facebook acquisition of Instagram.(both operated in same industry, social media)
Vertical integration: combination of firms with operations in different but successive stages
of production of distribution or both. . Instead of only manufacturing also go into to raw
materials.
Conglomeration: the combination of firms with unrelated and diverse products or service
functions or both. Firms may diversify to reduce risk.
A business expand through combination rather than by building new facilities because:
1. Cost advantage: it is less expensive for a firm to obtain needed facilities through
combination than through development. Particularly in times of inflation.
2. Lower risk: purchase of established product lines and markets is usually less risky
than developing new products and markets. Risk is low when the goal is
diversification.
3. Fewer operating delays: plant facilities acquired in a business combination are
operative and already meet environmental and other governmental regulations. The
time to market is critical especially in the technology industry. New facilities can
expect numerous days of construction and getting government approval.
4. Avoidance of take overs: many companies combine to avoid being acquired
themselves.
5. Acquisition of intangible assets: business combinations bring together both
intangible and tangible resources. The acquisition of patents mineral rights, research
customer databases or management expertise may be a primary motivating factor.
6. Other reasons: firms may choose a business combination over other forms of
expansion for business tax advantages, for personal income and estate-tax
advantages or for personal reasons.
Federal antitrust laws: prohibit business combinations that restrain trade or impair
competition. Regulates the concentration of economic power, particularly with regard to trust
and monopolies.
Business combinations in particular industries are subject to review by additional federal
agencies. The federal reserve board reviews bank mergers for example.
In addition to federal antitrust laws, most states have some type of statutory take over
regulations. Some states try to prevent or delay hostile takeovers of the business enterprises
incorporated within their borders. On the other hand states have passed antitrust exemption
laws to protect hospitals from antitrust laws when they pursue cooperative projects.
Deregulation for antitrust:
Decreased competition caused by mergers can be offset by lower prices and better products.
Business combination: general term that encompasses all forms of combining previously
separate business entities. Such combinations are:
Acquisitions: when one corporation acquires the productive assets of another business entity
and integrates those assets into its own operations. (Acquired company does not have to go
out of existence)
,Merger and consolidation: are often used as synonyms however they are different.
Merger: the dissolution of all but one of the business entities involved. One corporation takes
over all the operations of another business entity that is dissolved.
Consolidation: entails the dissolution of all the business entities involved and the formation
of a new corporation. New corporation is formed to take over the assets and operations of two
or more separate business entities and dissolves the previously separate entities.
Merger = A + B =A
Consolidation = A + B = C
Slides:
Merger: One corporation takes over all the operations of another business entity and that
other entity is dissolved
Consolidation: A new corporation is formed to take over the assets and operations of two or
more separate business entities and dissolves the previously separate entities.
In the general business sense, mergers and consolidations are business combinations and may
or may not involve the dissolution of the acquired firm(s).
In chapter 1 , mergers and consolidation will involve only 100% acquisition later other.
For this book: merger: a business combination in which all but one of the combining
companies go out of existence
Consolidation: a business combination in which all the combining companies are dissolved
and a new corporation is formed to take over their net assets.
GAAP: a transaction or other event in which an acquirer obtain control of one or more
businesses. Transactions sometimes referred to as true mergers or mergers of equals also are
business combinations.
Subsidiary: a corporation becomes a subsidiary when another corporation acquires a majority
>50% of its outstanding voting stock.
Pooling interest method: problem that arose wast he introduction of alternative methods of
accounting for business combinations. -> pooling eliminated in 1999 because see page 27.
Does not take into account fair values.
IFRS: accounting for business combinations diverged substantially across jurisdictions. IFRS
3 marks a significant step toward high quality standards in business combination accounting
and in ultimately achieving international convergence in this area.
Acquisition method (GAAP): we record the combination acquiring another company in a
business combination by the amount of cash disbursed or by the fair value of other assets
distributed or securities issued. We expense the direct cost of a business combination other
than those for registration or issuance of equity securities. We charge registration and
issuance cost in combination against the fair value of securities issued usually as a reduction
of additional paid in capital. We expense indirect costs such as management salaries
depreciation and rent under acquisition method.
Example
Purchase 100000 of 10,- for 16,-, accountant fees, printing fees and secutities commission =
40000and finders and consultants fees is 80000
Investment + 1600
Common stock +1000
Additional paid in capital +600
Investment expense -80
,Additiona paid in capital -40
Cash -120
If pop and son corporation operate as parent company and subsidiary pop will not record the
entry to allocate the investment in son balance. Pop will account for this investment in son by
means of the investment in son account and we will make the assignment of fair values to
identifiable net assets required in the consolidation process.
Recording fair values in an acquisition
Step 1: determine fair values of all identifiable tangible and intangible assets acquired and
liabilities assumed in the combination there are 3 levels of fair values:
1. Fair value based on established market prices
2. The present value of estimated future cash flows discounted based on observable
measure such as the prime interest rate.
3. Includes other internally derived estimations
Step 2: compare FV and Cost
Now we assume fair value is equal to market value.
Assets acquired and liabilities assumed in a business combination that arise from
contingencies should be recognized at fair value if fair value can be reasonably estimated. If
not it should be recognized in accordance with general FASB guidlines to account for
contingencies.
Exceptions to use fair value: deferred tax assets an d liabilities arising, pensions and other
employee benefits and leases.
The acquirer shall recognize separately from goodwill the identifiable intangible assets
acquired in a business combination. An intangible assets is identifiable if it meets either
separability criterion or the contractual legal criterion described in the definition of
identifiable.
Intangible assets that are not separable should be included in goodwill.
Contingent consideration in an acquisition
a business may provide for additional payments to the previous stockholders of the acquired
company, contingent on future events or transactions. The fair value of contingent
consideration is determined or estimated at the acquisition date as part of the acquisition
agreement. May include distribution of cash, must be at fair value, can be classified as equity
or as liability.
Contingent share issuances:
- investment and paid in capital accounts are increased by the fair value.
- Not remeasure fair value at each reporting date until contingency is resolved.
Investment in son +600
Additional paid in capital + 600
Contingent cash payments:
-investment and liability account are increased by the fair value.
-Revalued to fair value at each subsequent reporting date.
Investment in son +600
Contingent liability +600
Goodwill: if the investment cost exceeds net fair value. We first assign the excess to
identifiable net assets according to their fair values and then assign the rest of excess to
goodwill.
, Bargain purchase: if fair value of identifiable assets acquired over liabilities assumed exceed
to cost of the acquired company.
Goodwill: excess of the Investment cost over the fair value of net assets received. -> the
amount we capitalize as goodwill is the portion of the purchase price left over after all other
identifiable tangible and intangible assets and liabilities have been valued at fair value. Under
current gaap goodwill is not amortized. -> requires that firm periodically assess goodwill for
impairment in its value. An impairment happens when the recorded value of goodwill is
greater than its fair value.
Also other intangible assets will periodically be reviewed and adjusted for value impairment.
Goodwill impairment test:
1. Firms first compare book value (including goodwill) to fair values at the business
reporting unit level if there has been a loss in value. If the fair value is less than the
carrying amount he firms proceed to step 2.
2. Record a loss if the implied fair value is less than the carrying value of the goodwill.
Goodwill should be tested for impairment at least annually. More frequent testing may be
needed if significant adverse changes in business (adverse action by regulator, unanticipated
competition, loss of key personnel).
The specific information that must be disclosed in the financial statements for the period in
which a business combination occurs can be categorized as follows:
– General information including company names and description
– Reason for combination
– Nature and amount of consideration
– Allocation of purchase price among assets and liabilities
– Pro-forma results of operations
– Goodwill or gain from bargain purchase
– Intangible Asset (Specific disclosures are needed)
Amortization firms must amortize intangibles with a definite useful life over that life. Useful
life = estimated useful life to the reporting entity. The method of amortization should reflect
the expected pattern of consumption of economic benefits of the intangible.
Slides:
1. Acquisition cost (Fair value principle)
a. Cash disbursed
b. fair value of other assets distributed
c. fair value of of securities issued
2. direct cost of acquisition
a. cost of registering and issuing securities -> reduction in additional paid in
capital(-SE)
b. all other direct indirect cost such as accounting , consulting and legal fees -
>expense (E,-SE) income statement)
direct cost: accounting consulting and legal fees
indirect cost: management salaries, depreciation, rent, closing/duplicate
facility
Voordelen van het kopen van samenvattingen bij Stuvia op een rij:
Verzekerd van kwaliteit door reviews
Stuvia-klanten hebben meer dan 700.000 samenvattingen beoordeeld. Zo weet je zeker dat je de beste documenten koopt!
Snel en makkelijk kopen
Je betaalt supersnel en eenmalig met iDeal, creditcard of Stuvia-tegoed voor de samenvatting. Zonder lidmaatschap.
Focus op de essentie
Samenvattingen worden geschreven voor en door anderen. Daarom zijn de samenvattingen altijd betrouwbaar en actueel. Zo kom je snel tot de kern!
Veelgestelde vragen
Wat krijg ik als ik dit document koop?
Je krijgt een PDF, die direct beschikbaar is na je aankoop. Het gekochte document is altijd, overal en oneindig toegankelijk via je profiel.
Tevredenheidsgarantie: hoe werkt dat?
Onze tevredenheidsgarantie zorgt ervoor dat je altijd een studiedocument vindt dat goed bij je past. Je vult een formulier in en onze klantenservice regelt de rest.
Van wie koop ik deze samenvatting?
Stuvia is een marktplaats, je koop dit document dus niet van ons, maar van verkoper Sandraw. Stuvia faciliteert de betaling aan de verkoper.
Zit ik meteen vast aan een abonnement?
Nee, je koopt alleen deze samenvatting voor €2,99. Je zit daarna nergens aan vast.
