2-2 Reasons Firms Combine Vertical integration Cost savings Quick entry into new markets Economies of scale More attractive financing opportunities Diversification of business risk Business Expansion Increasingly competitive environment LO 1
2-3 Business Combinations Separate organizations tied together through common control under common management are combined into a single entity. FASB Accounting Standards Codification (ASC) Business Combinations (Topic 805) and Consolidation (Topic 810) provide guidance using the acquisition method. The acquisition method embraces a fair value measurement attribute that reflects the FASBs increasing emphasis on fair value for measuring and assessing business activity.
2-4 The Consolidation Process Consolidated financial statements provide more meaningful information than separate statements. Consolidated financial statements more fairly present the activities of the consolidated companies. Consolidated companies may retain their legal identities as separate corporations. There is a presumption that consolidated statements are more meaningful.. and that they are usually necessary for a fair presentation when one of the companies in the group… has a controlling financial interest.. FASB ASC (810-10-10-1) LO 2
Subsidiaries financial data Prepare a single set of consolidated financial statements. Parents financial data Consolidation of Financial Information 2-5 To report the financial position, results of operations, and cash flows for the combined entity. Reciprocal accounts and intra-entity transactions are adjusted or eliminated to... brought together 2-5
Business Combinations Business combinations... Can be achieved through transactions or events in which an acquirer obtains control over one or more businesses. Create single economic entities. Can be formed by a variety of events but can differ widely in legal form. Require consolidated financial statements. LO 3 2-6
2-8 The Acquisition Method Used to account for business combinations. Requires recognizing and measuring at fair value: Consideration transferred for the acquired business Noncontrolling interest Separately identified assets and liabilities Goodwill or gain from a bargain purchase Any contingent considerations. LO 4
2-9 Fair Value Asset valuations established using… The Market Approach – fair value can be estimated referencing similar market trades. The Income Approach – fair value can be estimated using the discounted future cash flows of the asset. The Cost Approach – estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility. LO 5
2-10 How does consolidation affect the accounting records? If dissolution occurs: Dissolved companys records are closed out. Surviving companys accounts are adjusted to include all balances of the dissolved company. If separate incorporation is maintained: Each company continues to retain its own records. worksheets facilitates the periodic consolidation process without disturbing individual accounting systems.
2-11 Acquisition Method What if the consideration transferred does NOT EQUAL the Fair Value of the Assets acquired? If the consideration is LESS than the Fair Value of the Assets acquired, we got a BARGAIN!! And we will record a GAIN on the acquisition!! If the consideration is MORE than the Fair Value of the Assets acquired, the difference is attributed to GOODWILL LO 6
2-12 Related Costs of Business Combinations Direct Costs of the acquisition (attorneys, appraisers, accountants, investment bankers, etc.) are NOT part of the fair value received, and are immediately expensed. Indirect or Internal Costs of acquisition (secretarial and management time) are period costs expensed as incurred. Costs to register and issue securities related to the acquisition reduce their fair value.
2-13 Acquisition Method Separate Incorporation Maintained Dissolution does not occur. Consolidation process is similar to previous example. Fair value is the basis for initial consolidation of subsidiarys net assets. Subsidiary is a legally incorporated separate entity. Consolidation of financial information is simulated. Acquiring company does not physically record the transaction. LO 7
2-14 Acquisition Method – Consolidation Workpaper Example
2-15 Acquisition Date Fair-Value Allocations – Additional Issues Intangibles are assets that: Lack physical substance (excluding financial instruments) Arise from contractual or other legal rights Can be sold or otherwise separated from the acquired enterprise Preexisting goodwill recorded in the acquired companys accounts is ignored in the allocation of the purchase price. IPR&D that has reached technological feasibility is capitalized as an intangible asset at fair value with an indefinite life that is reviewed for impairment. Ongoing R&D is expensed as incurred. LO 8
2-16 Legacy Methods – Purchase and Pooling of Interests Methods The acquisition method is applied to business combinations beginning in 2009, but previous accounting methods used are still in effect today. 2002 to 2008: Purchase Method Valuation basis was cost Purchase cost allocated proportionately to net assets based on their fair values, excess to goodwill. Prior to 2002: Purchase Method Or The Pooling Of Interests Method Only used when a company acquired all of another companys stock – using its own stock as consideration (no cash!) LO 9