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• Cost advantage• Lower risk• Fewer operating delays• Avoidance of takeovers• Acquisition of intangible assets• Other: business and other tax advantages,
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 B’s 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 B’s assets and liabilities.
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.
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 consolidations will involve only 100% acquisitions with the dissolution of the acquired firm(s). These assumptions will be relaxed in later chapters.
“Consolidation” is also an accounting term used to describe the process of preparing consolidated financial statements for a parent and its subsidiaries.
“A business combination is a transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ also are business combinations…” [FASB Statement No. 141, para. 3.e.]
A parent – subsidiary relationship is formed when:– Less than 100% of the firm is acquired, or– The acquired firm is not dissolved.
• Since the 1950s both the pooling-of-interests method and the purchase method of accounting for business combinations were acceptable. [ARB 40, APB Opinion 16]
• Combinations initiated after June 30, 2001, use the purchase method. [FASB Statement No. 141]
• Firms should use the acquisition method for business combinations occurring in fiscal periods beginning after December 15, 2008 [FASB Statement No. 141R]
• 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.
• 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.
Poppy Corp. pays cash for $80,000 in finder’s fees and consulting fees and for $40,000 to register and issue its common stock. (in thousands)
Sunny Corp. is assumed to have been dissolved. So, Poppy Corp. will allocate the investment’s cost to the fair value of the identifiable assets acquired and liabilities assumed. Excess cost is goodwill.
• Contingencies based on future earnings increase the cost of the investment.
• Contingencies based on future security prices do not change the cost of the investment. Additional consideration distributed is recorded at its fair value with an offsetting write-down of the equity or debt securities issued.
In some cases the contingency may involve a return of consideration.
Pitt Co. acquires the net assets of Seed Co. in a combination consummated on 12/27/2008. The assets and liabilities of Seed Co. on this date, at their book values and fair values, are as follows (in thousands):
Pitt Co. pays $400,000 cash and issues 50,000 shares of Pitt Co. $10 par common stock with a market value of $20 per share for the net assets of Seed Co.
Total consideration at fair value (in thousands):$400 + (50 shares x $20) $1,400
Fair value of net assets acquired: $1,200Goodwill $ 200$ 200
Pitt Co. issues 40,000 shares of its $10 par common stock with a market value of $20 per share, and it also gives a 10%, five-year note payable for $200,000 for the net assets of Seed Co.
Fair value of net assets acquired (in thousands): $1,200
Total consideration at fair value: (40 shares x $20) + $200 $1,000
• Firms must test annually for the impairment of goodwill at the business unit reporting level.– If the unit’s 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).
• FASB Statement No. 141R and 142 prescribe disclosures for business combinations and intangible assets. This includes, but is not limited to:– Reason for combination,– Allocation of purchase price among assets
and liabilities,– Pro-forma results of operations, and– Goodwill or gain from bargain purchase.
– Greater independence of auditors and clients– Greater independence of corporate boards– Independent audits of internal controls– Increased disclosures of off-balance sheet
arrangements and obligations– More types of disclosures on Form 8-K