2. © Clarence Byrd Inc. 20091 Chapter 3 Business Combinations

3. 2 © Clarence Byrd Inc. 2009 Business Combinations Defined  Paragraph 1582.02A(e) 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” are also business combinations as that term is used in this Section.

4. 3 © Clarence Byrd Inc. 2009 Business Combinations  Legal Form A variety of legal forms can be used Accounting attempts to reflect economic substance This may require “looking through” the legal form (e.g., reverse takeovers)

5. 4 © Clarence Byrd Inc. 2009 Basic Legal Alternatives Company ACompany B B’s Assets And Liabilities Cash Or A Shares

6. 5 © Clarence Byrd Inc. 2009 Basic Legal Alternatives Company A Company B New Company New Company Shares New Company Shares Assets And Liabilities Of Company A and Company B

7. 6 © Clarence Byrd Inc. 2009 Basic Legal Alternatives Company ACompany B B Company Shareholders Majority Of B Shares Cash Or A Shares

8. 7 © Clarence Byrd Inc. 2009 Basic Legal Alternatives A CompanyB Company Shareholders Of A Company Shareholders Of B Company New Company Shares Of New Company Majority Of A Company Shares Majority Of B Company Shares

9. 8 © Clarence Byrd Inc. 2009 Tax Considerations  Acquisition Of Assets Preferred by acquirer Larger CCA deductions No inherited tax assessment issues

10. 9 © Clarence Byrd Inc. 2009 Tax Considerations  Acquisition Of Shares Preferred by acquiree Capital gains taxed at low rates Gains may be eligible for the lifetime capital gains deduction

11. 10 © Clarence Byrd Inc. 2009 Alternative Accounting Methods  The Acquisition Method (Formerly Purchase Method) Treats combination as a purchase of assets Must identify an acquirer Acquirer’s assets remain at book value Acquiree’s assets recorded at fair values.

12. Alternative Accounting Methods  New Entity When 2 businesses combine and result in a new business entity being created Both company’s assets are recorded at fair value © Clarence Byrd Inc. 2009

13. 12 © Clarence Byrd Inc. 2009 Alternative Accounting Methods  Pooling-of-Interests Treats combination as an inconsequential combining of interests Both company’s assets remain at carrying values Retroactive presentation of income No longer GAAP in the industrialized world

14. Alternative Accounting Methods  Section 1582.04: An entity shall account for each business combination by applying the acquisition method.  While it is likely that there are situations that reflect both the new entity and pooling of interest methods, they cannot be used. © Clarence Byrd Inc. 2009

15. 14 © Clarence Byrd Inc. 2009 Establishing the Acquisition Date  Paragraph 1582.08: The date on which the acquirer obtains control of the acquiree.  the date on which the net assets or equity interests are received and the consideration is given; or  the date of a written agreement, or a later date designated therein, that provides that control of the acquired enterprise is effectively transferred to the acquirer on that date, subject only to those conditions required to protect the interests of the parties involved.

16. 15 © Clarence Byrd Inc. 2009 Identification Of An Acquirer  Cash Consideration Company providing the cash is the acquirer, without regard to whether assets or shares are acquired

17. 16 © Clarence Byrd Inc. 2009 Identification Of An Acquirer  Share consideration – no new company Acquirer is the predecessor company whose shareholders wind up with the majority of the voting shares of the combined company

18. 17 © Clarence Byrd Inc. 2009 Identification Of An Acquirer  Share consideration – new company Acquirer is the predecessor company whose shareholders wind up with the majority of the voting shares of the new company

19. 18 © Clarence Byrd Inc. 2009 Identification Of An Acquirer  Other Factors (If no clear cut solution) Relative voting rights If no control: largest non-controlling interest Composition of the board of directors Composition of senior management Payment of a premium over market value

20. 19 © Clarence Byrd Inc. 2009 Identification Of An Acquirer RReverse Takeovers The legal acquirer becomes the acquiree Surprisingly common Covered in an Appendix B in Chapter 4

21. 20 © Clarence Byrd Inc. 2009 Cost Of The Acquisition  Cost determined by: the fair value – calculated by the sum of the acquisition date fair values of assets and liabilities and equity interests transferred Section 1582.37  Direct costs (Section 1582.53): These are accounted for as an EXPENSE in the period in which they were incurred.  This is a CHANGE from previous Cdn GAAP guidance

22. 21 © Clarence Byrd Inc. 2009 Cost Of The Purchase  Section 1582.39: The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. The acquirer shall recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree.

23. 22 © Clarence Byrd Inc. 2009 Cost Of The Purchase On January 1, 2008, Mor issues 3 million no par shares in return for all of the outstanding voting shares of Mee. The shares are trading at $25 and have a total value of $75 million. Mor agrees that if Mee’s earnings per share exceed $3.50 per share, they will pay an additional $10 million to the Mee shareholders. Fair Value estimated at $2,500,000

24. 23 © Clarence Byrd Inc. 2009 Cost Of The Purchase Contingent Amount Is PaidDebitCredit Contingent Liability$2,500,000 Loss on Contingency$7,500,000 Cash$10,000,000 Investment recordedDebitCredit Investment In Mee$77,500,000 Common Stock$75,000,000 Contingent Liability$2,500,000

25. 24 © Clarence Byrd Inc. 2009 Recognition of Acquired Assets  Section 1582.10 – As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. Must meet Section 1000 definitions Must be part of the exchange Unrecognized acquiree assets  Intangible assets must be recognized if they can be separately identified.  Assets/Liabilities are to be classified. These are made based on contractual terms, operating and accounting policies, or other conditions on acquisition date.

26. 25 © Clarence Byrd Inc. 2009 Measurement of Identifiable Assets and Liabilities  The acquirer shall measure the identifiable assets and liabilities at their acquisition-date fair values.

27. 26 © Clarence Byrd Inc. 2009 Fair Value  Fair value is the amount of the consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act.

28. 27 © Clarence Byrd Inc. 2009 Exceptions Of Measurement of Fair Value  Reacquired Rights  Stock-based Compensation and other Stock based payments (Section 3870)  Disposal of long lived assets and discontinued assets (Section 3475)

29. 28 © Clarence Byrd Inc. 2009 Exceptions to both recognition and measurement principles  Income taxes  Accrued Benefit obligations to employees

30. 29 © Clarence Byrd Inc. 2009 Determination Of Fair Values  Temporary Differences Fair values determined without reference to their tax values Tax values may or may not be changed by the combination  Legal form  Use of rollovers Future income tax asset or liability based on the difference between fair value recorded and tax value

31. 30 © Clarence Byrd Inc. 2009 Determination Of Fair Values Loss Carry Forwards  Must determine if it is legally available  Must determine if it is more likely than not to be realized by the combined company  Fair value is the amount of the carry forward multiplied by the appropriate tax rate  May be recognized by the combined company even if not recognized by the acquiree

32. 31 © Clarence Byrd Inc. 2009 Measurement of Non-Controlling Interest Cases where the legal form involves acquisition of shares where acquirer obtains controls through owning less than 100% of the shares. To be discussed in more detail in chapters to come.

33. 32 © Clarence Byrd Inc. 2009 Measurement of Non-Controlling Interest How the non-controlling interest is measured determines what portion of the fair value changes and goodwill will be recognized.  When NCI is based on carrying values – only the acquirer’s share of the fair value and goodwill are recognized in the consolidated assets  When NCI is based on the fair value of the identifiable assets, 100% of the fair value change is recognized, but only the acquirer’s share of goodwill  When NCI is based on the fair value of the enterprise, 100% of the fair value change and 100% of the goodwill are recognized in the consolidated assets

34. 33 © Clarence Byrd Inc. 2009 Measurement of Non-Controlling Interest Section 1582.19 – For each business combination, the acquirer shall measure any non-controlling interest in the acquiree either at its fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable assets. Provides for 2 different acquisition methods when there is NCI. This means 2 different methods for preparing consolidated statements.

35. 34 © Clarence Byrd Inc. 2009 Goodwill  The Concept: The capitalized expected value of enterprise earning power in excess of a normal rate of return in the industry in which it operates  Rarely recognized when internally generated

36. 35 © Clarence Byrd Inc. 2009 Goodwill  Measurement – Section 1582.32 The acquirer shall recognize goodwill as of the acquisition date measure as the excess of (a) over (b): (a) the aggregate of:  The consideration transferred measured in accordance with this section (acquisition-date fair value)  The amount of any non-controlling interest in the acquiree measured in accordance with this section  In a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree

37. 36 © Clarence Byrd Inc. 2009 Goodwill (b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measure in accordance with this section.  Section 1582 provides for 2 different way of measuring NCI therefore 2 ways of calculating Goodwill.

38. 37 © Clarence Byrd Inc. 2009 Goodwill Procedures (Section 3064)  Not subject to regular amortization  Each reporting unit must be tested annually for impairment  Exceptions if: Assets and liabilities have not changed significantly Recent determination shows large excess of fair value over carrying amount Based on an analysis of events since last evaluation, the likelihood of impairment seems remote

39. 38 © Clarence Byrd Inc. 2009 Goodwill Procedures  Circumstances that may require more frequent evaluation for impairment Change in legal factors Adverse decisions by a regulator Loss of key personnel Need to write down a significant asset group within the reporting unit A goodwill impairment loss recognized by a subsidiary

40. 39 © Clarence Byrd Inc. 2009 Goodwill Presentation  Aggregate amount as a separate line item in the Balance Sheet  Aggregate amount of impairment losses as a separate line item in the Income Statement  Intangible assets should be aggregated and presented as a separate line

41. 40 © Clarence Byrd Inc. 2009 Goodwill Disclosure  Paragraph 3064.96 The financial statements should disclose the following information: (a) The changes in the carrying amount of goodwill during the period including:  (i) the aggregate amount of goodwill acquired;  (ii) the aggregate amount of impairment losses recognized; and  (iii) the amount of goodwill included in the gain or loss on disposal of all or a portion of a reporting unit. Enterprises that report segment information in accordance with Segment Disclosures, Section 1701, should provide the above information about goodwill in total and for each reportable segment and should disclose any significant changes in the allocation of goodwill by reportable segment. When any portion of goodwill has not yet been allocated to a reporting unit at the date the financial statements are issued, the unallocated amount and the reasons for not allocating that amount should be disclosed.

42. 41 © Clarence Byrd Inc. 2009 Goodwill Disclosure  Paragraph 3064.98 For each goodwill impairment loss recognized, the following information should be disclosed in the financial statements that include the period in which the impairment loss is recognized: (a) a description of the facts and circumstances leading to the impairment; (b) the amount of the impairment loss; and (c) when a recognized impairment loss is an estimate that has not yet been finalized, that fact and the reasons therefore and, in subsequent periods, the nature and amount of any significant adjustments made to the initial estimate of the impairment loss.  When the carrying amount of a reporting unit exceeds its fair value, but the second step of the impairment test is not complete and a reasonable estimate of the goodwill impairment loss cannot be determined (see paragraph 3064.73), that fact and the reasons therefore should be disclosed. [JAN. 2002]

43. 42 © Clarence Byrd Inc. 2009 Bargain Purchase (Negative Goodwill)  Sources Overstated fair values Bargain purchase approach Inadequate rate of return on invested assets (consistent with treatment of goodwill)

44. 43 © Clarence Byrd Inc. 2009 Bargain Purchase  Before recognizing a gain on a bargain purchase, need to reassess whether correctly identified all asset acquired and all liabilities assumed. Then shall review the procedures use to measure the amounts to be recognized at the acquisition date for the following: Identifiable assets/liabilities Non-controlling interest in the acquiree, if any For a business combination in stages – acquirer’s previously held equity interest Consideration transferred

45. 44 © Clarence Byrd Inc. 2009 Bargain Purchase  If review fails to determine cause of negative goodwill, then Section 1582.34 If the access remains after applying the requirements in 1582.36, the acquirer shall recognize the resulting gain in net income on the acquisition date.

46. 45 © Clarence Byrd Inc. 2009 International Convergence  Business Combinations covered in IFRS No. 3 Section 1582 is identical to IFRS No.3

47. 46 © Clarence Byrd Inc. 2009 International Convergence  Differences between section 3064 and IAS No. 38 Different procedures for impairment testing of intangible assets IAS No. 38requires periodic review of residual values IAS No. 38 allows revaluation of intangible assets to fair value provided data is available in active market. IAS No. 38 – relocation and reorganization costs must be expensed. Section 3064 allows some costs to be capitalized.

48. 47 © Clarence Byrd Inc. 2009