Reasons for Business Accounting by xwf12140

VIEWS: 4 PAGES: 17

Reasons for Business Accounting document sample

More Info
									Acct 415/515                                                                                      Prof. Teresa Gordon


                         Accounting for Business Combinations
GAAP:                                                          SFAS 94 (1987)
                                                               SFAS 141 (2001)

What’s new in SFAS No. 141 as compared to APB Opinion 16?
1.        All business combinations are accounted for by the purchase method (no pooling of
          interest)
2.        New criteria for recognizing identifiable intangibles (other than goodwill)
3.        Additional disclosure requirements, including:
          a.      Primary reasons for the business combination
          b.      The allocation of purchase price paid to the assets acquired and liabilities assumed
                  by major balance sheet caption
          c.      When significant, disclosure of other information such as amount of goodwill by
                  reportable segment and the amount of purchase price assigned to each major
                  intangible asset class.

What did NOT change:
1.        Guidance for determining the cost of an acquired entity
2.        Guidance for allocating the cost to the assets acquired and liabilities assumed
3.        Accounting for contingent consideration
4.        Accounting for pre-acquisition contingencies
5.        Write-off of R&D assets acquired

What’s in the works?
FASB has current agenda item called ―Business Combinations: Purchase Method Procedures‖
9/30/02 Newsletter reports that the FASB and IASB tentatively agreed on the following working
principle for recording a business combination:

The accounting for a business combination is based on the assumption that the transaction is an exchange of equal values; the total
amount to be recognized should be measured at either the fair value of the consideration paid or the fair value of the net assets
acquired, whichever is more clearly evident of the fair value of the transaction.

If the consideration paid is cash or other assets (or liabilities incurred) of the acquiring entity, the fair value of the consideration
paid generally determines the total amount to be recognized in the financial statements of the acquiring entity.
If the consideration paid is in the form of equity instruments, the fair value of the equity instruments ordinarily is more clearly
evident than the fair value of the net assets acquired and, thus, generally will determine the total amount to be recognized by the
acquiring entity.

In a business combination, the acquiring entity obtains control over the acquired entity and therefore is responsible for the assets
and liabilities of the acquired entity. The identifiable acquired assets and assumed liabilities should be recognized on the date
control is obtained, and measured at their fair values at that date: [for more info, go to FASB webpage]




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                                              Page 1
Acct 415/515                                                                           Prof. Teresa Gordon



    To use the purchase method, one company must be
         designated as the “acquiring company”
Here are the guidelines from FAS141:

If cash or other assets are distributed or liabilities are incurred:
In a business combination effected solely through the distribution of cash or other assets or by
incurring liabilities, the entity that distributes cash or other assets or incurs liabilities is
generally the acquiring entity. [FAS141, Par. 17]


If stock is exchanged:
In a business combination effected through an exchange of equity interests, the entity that issues
the equity interests is generally the acquiring entity. [FAS141, Par. 18]

          In some business combinations (commonly referred to as reverse acquisitions), however,
          the acquired entity issues the equity interests. Commonly, the acquiring entity is the
          larger entity. However, the facts and circumstances surrounding a business combination
          sometimes indicate that a smaller entity acquires a larger one.

          In some business combinations, the combined entity assumes the name of the acquired
          entity. Thus, in identifying the acquiring entity in a combination effected through an
          exchange of equity interests, all pertinent facts and circumstances shall be considered,
          in particular:

          a.        The relative voting rights in the combined entity after the combination—all else being equal, the
                    acquiring entity is the combining entity whose owners as a group retained or received the larger
                    portion of the voting rights in the combined entity. In determining which group of owners retained
                    or received the larger portion of the voting rights, consideration shall be given to the existence of
                    any unusual or special voting arrangements and options, warrants, or convertible securities.
          b.        The existence of a large minority voting interest in the combined entity when no other owner or
                    organized group of owners has a significant voting interest—all else being equal, the acquiring entity
                    is the combining entity whose single owner or organized group of owners holds the large minority
                    voting interest in the combined entity.
          c.        The composition of the governing body of the combined entity—all else being equal, the acquiring
                    entity is the combining entity whose owners or governing body has the ability to elect or appoint a
                    voting majority of the governing body of the combined entity.
          d.        The composition of the senior management of the combined entity—all else being equal, the
                    acquiring entity is the combining entity whose senior management dominates that of the combined
                    entity. Senior management generally consists of the chairman of the board, chief executive officer,
                    chief operating officer, chief financial officer, and those divisional heads reporting directly to them,
                    or the executive committee if one exists.
          e.        The terms of the exchange of equity securities—all else being equal, the acquiring entity is the
                    combining entity that pays a premium over the market value of the equity securities of the other
                    combining entity or entities.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                                 Page 2
Acct 415/515                                                                                Prof. Teresa Gordon



Determining the Total Cost of the Acquired Business

Include:
1. Fair value of the consideration given
2. Fair value of any contingent consideration given after acquisition date
3. Direct costs incurred in connection with acquisition (except costs of registering
   with SEC any securities given as consideration by the acquiring company*)

                                                                                                                 * See chart below


Direct costs
INCLUDE                                        EXCLUDE
Finders fees                                   Salary and overhead of internal acquisitions department
Travel costs                                   Allocation of general expenses
Accounting fees                                Fees associated with registering securities with SEC
Legal fees                                     Investment banker fees for underwriting registered equity securitiesa
Investment banker advising fees                Investment banker fees for underwriting registered debt securitiesb

                                                  a Decreases additional paid-in capital
                                                  b Decreases proceeds (higher interest expense over life of debt)




Accounting for a Business Acquisition
1.        Record assets and liabilities at their fair values as of the acquisition date

2.        If the cost of the acquired company exceeds the sum of the amounts assigned to the assets
          and liabilities acquired, record the excess as goodwill.

3.        If the values assigned to the assets acquired and the liabilities assumed exceeds the cost of
          the acquired company:

          a.        Reduce by a proportionate amount the values assigned to the noncurrent assets
                    acquired (other than long-term investments in marketable securities)

          b.        After the noncurrent assets have been reduced to zero, any excess of assigned
                    values over cost of the acquired company is recorded as an extraordinary gain at
                    acquisition.

          c.        Any goodwill is NOT amortized since it has an indefinite life. It is subject to
                    impairment test at least annually.

Note:               Only post-acquisition income statements can be consolidated.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                                       Page 3
Acct 415/515                                                                     Prof. Teresa Gordon


Push-down accounting: In some situations when common
        stock is acquired, the subsidiary will adjust its books to
        reflect the current values at date of acquisition.
                    In other words, adjusting entries are made on the subsidiaries books rather than just
                    workpaper entries. Therefore, subsequent workpapers will not have to deal with the
                    excess value elements as they will be taken care of by the subsidiary‘s accounting
                    department (depreciation, amortization, etc.)

SEC Staff Bulletin No. 54 requires push-down accounting in the separate financial
           statements of a subsidiary acquired in a purchase transaction


                    Parent‘s ownership
                                                                          Guidelines
                         percentage
                    90% or more                  Substantially owned – push-down accounting is required
                    80 to 89%                    Push-down accounting is encouraged but not required
                    Below 80%                    Push-down accounting may not be appropriate (e.g.,
                                                 subsidiary has substantial preferred stock or public debt
                                                 outstanding




Leveraged Buyout
Equivalent to combination of acquisition and a refinancing – acquirer uses an extremely high
percentage of debt and thus a very low percentage of equity. The debt is secured by the assets of
the target company. Thus the resulting company is generally not a publicly traded company and
the debt is often privately issued.

In most LBOs, the new ownership group forms a new corporation to acquire the common stock of
the target company. Technically, this is NOT a business combination because there is only one
operating company involved.

If a change in control has occurred, then a new basis of accounting should be established for the
assets and liabilities of the new company. In some cases the write-up is only partial (see Pahler
Chapter 7)




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                        Page 4
Acct 415/515                                                         Prof. Teresa Gordon



                 Business Combinations at Acquisition

Example
                                                          Sun Inc.         PA Corp.

Cash                                                         $ 1M                $190 M
Current Assets                                                 5M                 300 M
Plant Assets                                                  90 M                400 M **
Other Assets                                                   4M*                 10 M
Total Assets                                               $ 100 M               $900 M
Liabilities                                                   60 M                400 M
Common Stock                                                  20 M                200 M
Retained Earnings                                             20 M                300 M

Shares outstanding                                             2M                 20 M
Par value of common stock                                    $10.00              $10.00
Market value of common stock                                 $25.00              $50.00
Book value per share                                         $20.00              $25.00
Market value of company                                      $50 M            $1,000 M



*         Sun Inc. assets include a patent with a book value of $1 M
          but a fair value of $10 M.


** The fair value of PA Corp. plant assets is $1,000 M.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                          Page 5
Acct 415/515                                                 Dr. Teresa Gordon


Acquisition of Assets

       Before the Acquisition of Assets

      PA Corp.                                 Sun Inc.
    (the acquiring                            (the selling
      company)                                 company)


                   After Acquisition

      PA Corp.                                 Sun Inc.
    (the acquiring                            (the selling
      company)                                 company)



1. PA Corp. purchases the noncash assets of Sun Inc. $120 M.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                Page 6
Acct 415/515                                                          Dr. Teresa Gordon

Acquisition of Common Stock

                                                             After the
      Before the Business Combination                        Business
                                                            Combination

       PA Corp.                                Sun Inc.       PA Corp.
     (the acquiring                           (the target     (the parent
       company)                               company)         company)

                                                                  

                                                               Sun Inc.
                                                            (the subsidiary
                                                               company)



2.        PA Corp. acquires Sun Inc. by paying $55 M in cash to purchase all the
          outstanding common stock. Sun Inc. becomes a subsidiary of PA Corp.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                         Page 7
Acct 415/515                                                          Dr. Teresa Gordon

Acquisition of Common Stock

                                                             After the
      Before the Business Combination                        Business
                                                            Combination

        Sun Inc.                              PA Corp.         Sun Inc.
     (the acquiring                           (the target     (the parent
       company)                               company)         company)

                                                                  

                                                               PA Corp.
                                                            (the subsidiary
                                                               company)



3.        Sun Inc. acquires 100% of PA Corp. by exchanging 2 shares of its own
          common stock for each share of PA Corp. common stock in a business
          combination. PA Corp. becomes a subsidiary of Sun Inc.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                         Page 8
Acct 415/515                                                        Dr. Teresa Gordon

Statutory Merger

                                                             After the
      Before the Business Combination                        Business
                                                            Combination

       PA Corp.                                Sun Inc.       PA Corp.
     (the acquiring                           (the target   (the surviving
       company)                               company)        company)



4.        PA Corp. acquires 100% of Sun Inc. by exchanging 1 share of its own
          common stock for each 2 shares of Sun Inc. common stock in a statutory
          merger. Direct costs in connection with the acquisition are $3 M.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                       Page 9
Acct 415/515                                                     Dr. Teresa Gordon


Statutory Combination

                                                           After the
     Before the Business Combination                       Business
                                                          Combination

      PA Corp.                                 Sun Inc.    Integrated
                                                           Sunpacon




5.        PA Corp. and Sun Inc. enter into a statutory combination agreement. A new
          entity called Integrated Sunpacon (IS) is formed. Each former stockholder
          of PA Corp. receives two shares of IS stock and each former stockholder of
          Sun Inc. receives one share of IS stock for each share of stock they own.
          Immediately after the combination, the $1 par value IS stock is traded at $25
          per share.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                   Page 10
Acct 415/515                                                                       Dr. Teresa Gordon

Formation of a Holding Company

     Before the Business                                  After the Business
        Combination                                         Combination
 PA Corp.                       Sun Inc.                                   Integrated
                                                                            Sunpacon
                                                                           (the parent
                                                                            company)

                                                                               
                                                                    |                      |

                                                            PA Corp.                       Sun Inc.
                                                           (a subsidiary                 (a subsidiary
                                                             company)                      company)



6.        Integrated Sunpacon (IS) is formed to be a holding company. It exchanges
          2 shares of its $10 par value stock for each share of PA Corp. common stock
          and 1 share for each share of Sun Inc. common stock. Costs associated with
          SEC filings related to the IS stock is $2 M.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                        Page 11
Acct 415/515                                                            Dr. Teresa Gordon
 Acquisition of Assets - solution

       Before the Acquisition of Assets

      PA Corp.                                 Sun Inc.
    (the acquiring                            (the selling
      company)                                 company)


                   After Acquisition

      PA Corp.                                 Sun Inc.
    (the acquiring                            (the selling
      company)                                 company)



PA Corp. purchases the noncash assets of Sun Inc. $120 M.
Sun Co.                                                      debit              credit

Cash                                                          120
    Assets                                                                         99
    Gain on sale of assets                                                         21

Liabilities                                                    60
    Cash                                                                           60

Sun Inc. Balance Sheet after combination and payment of liabilities:
Cash                                                   61
Common Stock                                           20
Retained Earnings                                      41
                                                       61

Could be liquidated or could use cash to engage in other business activities.

PA Corp.                                                     debit              credit

Assets                                                        120
    Cash                                                                          120

No goodwill recorded because PA Corp. acquired only the assets and did not buy the company.
Therefore, the amount paid would be assumed to be the fair market value and would be assigned
to the assets acquired.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                              Page 12
Acct 415/515                                                                  Dr. Teresa Gordon

Acquisition of Common Stock – CASH (solution)

     Before the Business Combination                                 After the
                                                                     Business
                                                                    Combination

      PA Corp.                                 Sun Inc.               PA Corp.
    (the acquiring                            (the target             (the parent
      company)                                company)                 company)

                                                                          

                                                                       Sun Inc.
                                                                    (the subsidiary
                                                                       company)



PA Corp. acquires Sun Inc. by paying $55 M in cash to purchase all the
outstanding common stock. Sun Inc. becomes a subsidiary of PA Corp.
Sun Inc. - No impact on its books, money is paid directly to its stockholders.

PA Corp.                                                    debit                   credit

Investment in Sun Inc.                                        55 M
    Cash                                                                               55 M



Conceptual Analysis of Purchase Price:

Book value component
   (Sun‘s Common Stock & Retained Earnings)                                            40 M

Excess value of identified assets
    (Patent is worth $9 M more than book value – this amount would
    be amortized over the patent‘s remaining economic life)                             9M

Goodwill element
   (Purchase price less book value less excess fair value of
   identifiable assets)                                                                 6M
                                                                                       55 M




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                  Page 13
Acct 415/515                                                                   Dr. Teresa Gordon

Acquisition of Common Stock - EXCHANGE OF STOCK (solution)
                                             After the
   Before the Business Combination           Business
                                           Combination

       Sun Inc.                             PA Corp.                    Sun Inc.
    (the acquiring                      20,000,000 s/s =>              (the parent
      company)                          40,000,000 s/s Sun              company)
                                        @ $25 ea=$1,000M
                                                                           

                                                                        PA Corp.
                                                                     (the subsidiary
                                                                        company)


Sun Inc. acquires 100% of PA Corp. by exchanging 2 shares of its own common
stock for each share of PA Corp. common stock in a business combination. PA
Corp. becomes a subsidiary of Sun Inc.

PA Corp. books are unaffected. PA Corp.‘s former stockholders are now
stockholders of Sun Inc.
Sun Inc.                                                     debit                   credit

Investment in PA Corp.                                       1,000
    Common Stock (40,000,000 shares)                                                   400
    Additional paid in capital                                                         600

Conceptual Analysis of Purchase Price:

Book value component
   (PA Corp. Common Stock & Retained Earnings)                                         500 M

Excess value of identified assets
    (Plant assets are worth $600 M more than book value – this amount would
    be depreciated over the assets‘ remaining economic lives)              600 M *

Goodwill element
   (Purchase price less book value less excess fair value of
   identifiable assets)                                                        -100 M *
                                                                              1000 M
To eliminate the ‗bargain purchase element, the fair values of the noncurrent assets would be
reduced proportionately.
                      CONSOLIDATED FINANCIAL STATEMENTS WILL BE PREPARED


4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                   Page 14
Acct 415/515                                                                   Dr. Teresa Gordon
Statutory Merger - solution

                                                                       After the
     Before the Business Combination                                   Business
                                                                      Combination

      PA Corp.                                Sun Inc.                   PA Corp.
    (the acquiring                        2,000,000 s/s =>             (the surviving
      company)                          1,000,000 s/s PA @               company)
                                         $50 + $3 = $53 M


PA Corp. acquires 100% of Sun Inc. by exchanging 1 share of its own common
stock for each 2 shares of Sun Inc. common stock in a statutory merger. Direct
costs in connection with the acquisition are $3 M.

Sun Inc.                                                     debit                  credit

Common stock (2,000,000 s/s)                                    20 M
Retained Earnings                                               20 M
Liabilities                                                     60 M
    Assets                                                                              100 M

                    Sun does not survive – books are closed.

Conceptual Analysis:
Book value of Sun‘s net assets                                  $40
Excess value of patent                                            9
Fair value of Sun‘s net assets                                  $49
Purchase price                                                   53
Goodwill =                                                     $ 4

PA Corp.                                                     debit                  credit

Purchase price = (1,000,000 s/s * $50) + $3 M direct costs = $53 M

Assets (including cash)                                        109 M
Goodwill                                                         4M
    Liabilities                                                                           60 M
    Common stock (1,000,000 s/s * $10)                                                    10 M
    Additional paid in capital                                                            40 M
    Cash                                                                                   3M
                                                             $113 M                     $113 M




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                    Page 15
Acct 415/515                                                                Dr. Teresa Gordon
Statutory Combination - solution

                                                                   After the
     Before the Business Combination                               Business
                                                                  Combination

      PA Corp.                               Sun Inc.                 Integrated
                                         2,000,000 s/s ==>            Sunpacon
                                        2,000,000 IS at $25
                                           each = $50 M

PA Corp. and Sun Inc. enter into a statutory combination agreement. A new entity called
Integrated Sunpacon (IS) is formed. Each former stockholder of PA Corp. receives two shares of
IS stock and each former stockholder of Sun Inc. receives one share of IS stock for each share of
stock they own. Immediately after the combination, the $1 par value IS stock is traded at $25 per
share.

PA Corp. and Sun Inc. both cease to exist -- all accounts are closed.

Integrated Sunpacon                                      debit                 credit
If we assume that PA Corp. as the larger entity is the acquiring company, its assets would be
transferred to the new entity at carrying values while the assets of Sun Inc. would be transferred
at fair values.

Cash (1 + 190)                                                191 M
Current assets (5 + 300)                                      305 M
Plant assets (90 + 400)                                       490 M
Other assets (4 + 10 + 9 excess value)                         23 M
Goodwill (see below)`                                           1M
    Liabilities (60 + 400)                                                   460 M
    Common stock (42,000,000 s/s * $1 par)                                    42 M
    Additional paid in capital (to balance)                                  208 M
    Retained earnings (PA Corp.)                                             300 M
                                                    1,010 M                1,010 M
Note - Equity of new company is carrying value of PA Corp.‘s equity ($500) + market value of
acquired company ($50). [42 + 208 + 300]

Conceptual Analysis of Purchase Price:
Book value component (Sun‘s Common Stock & Retained Earnings)                      40 M
Excess value of identified assets
   (Patent is worth $9 M more than book value – this amount would
   be amortized over the patent‘s remaining economic life)                          9M
Goodwill element                                                                    1M
   (Sun is acquired by purchase of 2,000,000 shares at $25)                        50 M




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                              Page 16
Acct 415/515                                                                       Dr. Teresa Gordon
Formation of a Holding Company - solution

     Before the Business                                  After the Business
        Combination                                         Combination
 PA Corp.                       Sun Inc.                                   Integrated
                                                                            Sunpacon
                                                                           (the parent
                                                                            company)

                                                                               
                                                                    |                      |

                                                            PA Corp.                       Sun Inc.
                                                           (a subsidiary                 (a subsidiary
                                                             company)                      company)



Integrated Sunpacon (IS) is formed to be a holding company. It exchanges 2
shares of its $10 par value stock for each share of PA Corp. common stock and 1
share for each share of Sun Inc. common stock. Costs associated with SEC filings
related to the IS stock is $2 M.

The former stockholders of PA Corp. and Sun Inc. are now stockholders of IS.

Integrated Sunpacon                                            DEBIT                 CREDIT

Investment in PA Corp. (mkt.)                                   1,000 M
Investment in Sun Inc. (mkt.)                                      50 M
    Common stock (42,000,000 * $10 par)                                                  420 M
    Additional paid in capital                                                           630 M


Note: could instead be considered acquisition of one by the other in which case only one entity‘s
assets would be ‗stepped up‘.




4d65e3d6-df24-417f-9933-c2120f99bd3a.doc as of 10/29/10                                        Page 17

								
To top