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CHAPTER 1
BUSINESS COMBINATIONS
Business combinations unite previously separate business entities
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Horizontal integration  the combination of firms in the same business lines and
markets
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b
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Example : CVS
Corporation and Caremark Rx Inc
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c
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Example : Phillip Morris and Kraft
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The acquired
company need not be dissolved; the acquired company does not have to go out of
existence
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(A+B=A, depend on which one has more control
or the one who acquire)
- Consolidation : when 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
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One or more corporations become subsidiaries
2
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Each company transfers its net assets to a newly formed corporation
 Method used for each percentage of ownership:
More than 20%  cost method (no significant influence)
20%-50%  equity method (has significant influence)
More than 50%  equity method with consolidated financial statement (control of
the acquired company)
 Pooling interest :


By: Anita Eva Erdina

The pooling-of-interests method allowed assets and liabilities to be transferred
from the acquired company to the acquirer at book values
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The purchase method recorded assets and liabilities at fair value, and
any excess of consideration paid for the target over the target's net tangible
assets was recorded as goodwill to be amortized
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



Why is it eliminated?
o Pooling provides less relevant information to statement users
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o Comparing firms using the alternative methods is difficult for investors
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- We charge registration and issuance costs of equity securities issued in a
combination against the fair value of securities issued, usually as a reduction of
additional paid-in capital
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We also expense indirect cost incurred to close
duplicate facilities
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- The excess of cash, other assets, debt, and equity securities transferred over
the fair value of the net assets (A – L) acquired is recorded as goodwill
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Case example:
Pop Corp
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Pop’s
stock is valued at $16 per share
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pays cash for $160,000 in finder’s and consulting fees and for $80,000 to
register and issue its common stock
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is assumed to have been dissolved
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allocates the investment’s
cost to the fair value of the identifiable assets acquired and liabilities assumed
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

Recording Fair Values in Acquisition
 Identify:
o Tangible assets acquired,
o Intangible assets acquired, and
o Liabilities assumed

 Include:
o Identifiable intangibles resulting from legal or contractual rights, or
separable from the entity
o Research and development in process
o Contractual contingencies
o Some noncontractual contingencies
 Use fair values determined, in preferential order, by:
o Established market prices
o Present value of estimated future cash flows, discounted based on an
observable measure, such as the prime interest rate
o Other internally derived estimations
 Exceptions for fair values:

By: Anita Eva Erdina

Use normal guidance for:
o Deferred tax assets and liabilities
o Pensions and other benefits
o Operating and capital leases
[FASB ASC 740]
Goodwill on the books of the acquired firm is assigned no value
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 Contingent Considerations
o The fair value of contingent consideration is determined or estimated at
the acquisition date and it is included along with other consideration given
as part of the combination
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

Case example:
Pit Corp
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in a combination consummated on
12/27/2011
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on this date, at their book values and fair values, are
as follows (in thousands):
Book Val
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$100

$100

Net receivables

300

280

Inventory

400

500

Land

100

200

Buildings, net

600

1
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pays $800,000 cash and issues 100,000 shares of Pit Corp
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Total consideration at fair value (in thousands):
$800 + (100 shares x $20)
$2,800
Fair value of net assets acquired:
Goodwill

$2,400
$ 400

The entry to record the acquisition of the net assets:

The entry to record Sad’s assets directly on Pit’s books:

Bargain Purchase
Pit Corp
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By: Anita Eva Erdina

The entry to record the acquisition of the net assets:

The entry to record Sad’s assets directly on Pit’s books:



Other issues: Impairments, disclosures, and the sarbanes-oxley act
 Goodwill controversies
- Capitalized goodwill is the purchase price not assigned to identifiable assets and
liabilities
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- Historically goodwill in most industrialized countries was capitalized and
amortized
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S
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o Step 1: Compare the unit’s net book value to its fair value to determine if
there has been a loss in value
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- Record a loss if the implied fair value is less than the carrying value of the
goodwill
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More frequent
testing may be needed:
o Significant adverse change in business
 Adverse action by regulator
 Unanticipated competition
 Loss of key personnel
o Impairment or expected disposal losses of:
 Reporting unit or part of one
 Significant long-lived asset group
 Subsidiary
Disclosure Requirements
FASB requires specific disclosures that are categorized by :
1
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Disclosures when a business combination occurs after a reporting period ends, but
before issuance of the financial statements
3
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Disclosures about adjustment related to business combinations
Thespecific information that must be disclosed in the financial statements for the period
in which a business combination occurs can be categorized as follows:
1
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Information about goodwill or a gain from a bargain purchase that results from the
business combination
3
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Details about specific assets acquired, liabilities assumed and any noncontrolling
interest recognized in connection with the business combination

By: Anita Eva Erdina

5
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Information about transactions with the acquiree accounted for separately from the
business combination
7
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If the acquirer is a public company, additional disclosuresare required such as pro
forma information

By: Anita Eva Erdina



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