1. Business Combinations
2-1
“A business combination occurs when an enterprise acquires net assets that constitute a business or equity interests of one or more other enterprises and obtains control over that enterprise or enterprises.”
- - SFAS No. 141
“A business combination occurs when two or more companies join under common control, meaning the ability to direct policies and management.”
- - BAKER, et.al. 2

2. MOTIVATION FOR BUSINESS COMBINATIONS
Growth
New markets
Increase in market share
Reduction in operating costs
Diversification
Tax reasons
Management incentives

3. BUSINESS COMBINATIONS Economic Substance
Horizontal combinations
Vertical combinations (integration)
Conglomerates

4. BUSINESS COMBINATIONS Legal Form
Merger
Consolidation (Statutory)
Acquisition
Variable interests

5. Types of Business Combinations
Merger
P Company
P Company
S Company

6. Statutory Consolidation
Types of Business Combinations
Statutory Consolidation
P Company
X Company
S Company

7. Types of Business Combinations
Stock Acquisition
P Company
P Company
S Company
&
S Company

8. Business Combinations
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Exh.
2-2
Business Combinations
Continued 3

9. Business Combinations – Continued
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Exh.
2-2
Business Combinations – Continued 3

10. 2-10
A Control Issue – SPE’s
Special Purpose Entities (a popular type of “variable interest entity”) were misused to hide debt and manipulate earnings
As a result, the FASB (in FIN 46R) expanded the definition of “control” beyond just the holding of a majority share position.
The following indicate a controlling financial interest in a variable interest entity:
Direct or indirect ability to make decisions about the entity’s activities
Obligation to absorb any expected losses of the entity
The right to receive any expected residuals of the entity

11. What is to be consolidated?
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What is to be consolidated?
If dissolution occurs:
All account balances are actually consolidated in the financial records of the survivor.
If separate incorporation maintained:
Financial statement information is consolidated on work papers and not in the actual records

12. When does consolidation occur?
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When does consolidation occur?
If dissolution occurs:
Permanent consolidation occurs at the combination date
If separate incorporation maintained:
Consolidation (on work papers, not in the actual records!!) occurs regularly, whenever financial statements are prepared

13. How does consolidation affect the accounting records?
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How does consolidation affect the accounting records?
If dissolution occurs:
Dissolved company’s records are closed out.
Surviving company’s accounts are adjusted to include all balances of the dissolved company
If separate incorporation maintained:
Each company continues to maintain its own records

14. BUSINESS COMBINATIONS Method of Accounting
Acquisition
Purchase
Pooling of interests

15. Accounting for Combinations
June 30, 2001
Calendar 2009
Purchase OR
Pooling
Purchase
only
(Not retroactive)
Acquisition
only
(Not retroactive)
Selection based on
specific criteria
for Pooling
All new combinations
must use Purchase
(no adjustment of
older results)
All new combinations
must use Acquisition
(no adjustment of
older results)

16. Pooling Purchase Acquisition Horizontal Vertical Conglomerate Merger
Statutory
Consolidation
Stock
Acquisition

17. The Acquisition Method
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The Acquisition Method
A replacement for the Purchase Method
Requires measurement of fair value of the acquired business as a whole
Requires measurement and recognition of the fair values of the separately identified assets acquired and liabilities assumed

18. Acquisition Methods – Key Changes
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Acquisition Methods – Key Changes
Adopts a “business fair value” measurement approach as opposed to the traditional “cost-based” measure
Direct combination costs will be expensed as incurred
Contingent consideration obligations are recognized as part of the purchase price
With bargain purchases, no assets will be recorded at less than fair value, which will produce recognized gains on purchase
Allows for capitalization of Purchased In-Process Research and Development (IPR&D)

19. Capitalization of In-Process Research and Development Costs (IPR&D)
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Capitalization of In-Process Research and Development Costs (IPR&D)
To be recognized and measured at fair value on the acquisition date
Reported as intangible assets with indefinite lives
Subject to periodic “impairment reviews”

20. Related Costs of Business Combinations (Acquisition Method)
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Related Costs of Business Combinations (Acquisition Method)
Costs incurred for outside services (attorneys, appraisers, accountants, investment bankers, etc.) related to the combination are NOT considered part of the fair value received, and so are immediately expensed
Internal costs of acquisition (secretarial and management time) are expensed as incurred.
Costs to register and issue securities related to the acquisition reduce their fair value

21. Acquisition Method - Summary
2-21
Acquisition Method - Summary
Consideration transferred equals fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values
Consideration transferred is greater than the fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values. Excess consideration recorded as goodwill
Consideration transferred is less than the fair values of net assets acquired
Assets acquired and liabilities assumed are recorded at their fair values. Excess of fair value over consideration is recorded as gain on bargain purchase

22. 2-22
Purchase Method – SFAS 141
Employed when there is a change in ownership resulting in control of one enterprise by another.
The appropriate valuation basis for any purchase transaction is “cost”.
(Total value assigned to the net assets received equals the total cost of the acquisition.)
When the acquisition is made by issuing stock, the cost of the acquisition equals the MARKET VALUE of the stock issued. 6

23. 2-23
Accounting Challenge!!!
Allocation of “cost of acquisition” among the various assets and liabilities obtained.
Allocation depends on the relation between total cost and “fair value” of the acquired firm’s assets and liabilities.
FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction of market participants at the measurement date.” (FASB, Statement of Financial Accounting Standards No. 157, Fair Value Measurements)

24. “Direct Costs” of Combination
2-24
“Direct Costs” of Combination
Typically includes fees to the following for advising services in arranging and structuring the combination:
Investment bankers
Accountants
Attorneys
These must be included in determining the purchase “cost.”

25. Purchase Method Situations
2-25
Purchase Method Situations
Dissolution of the acquired company:
Purchase Price = Fair Value
Purchase Price > FV
Purchase Price < FV
Separate incorporation maintained. 17

26. Purchase Method - Dissolution Purchase Price = Fair Value
2-26
Purchase Method - Dissolution Purchase Price = Fair Value
Ignore the Equity and Nominal accounts of the acquired company.
Determine fair value of the acquired company’s assets and liabilities.
Prepare a journal entry to
recognize the cost of acquisition
incorporate the FV of the acquired company’s assets and liabilities into the acquiring company’s books. 18

27. Purchase Method - Dissolution Purchase Price > Fair Value
2-27
Purchase Method - Dissolution Purchase Price > Fair Value
FV of acquired company’s assets and liabilities is added to acquiring company’s books.
Difference between Acquisition Cost and FV of acquired assets and liabilities is allocated to identifiable intangible assets and to goodwill.
Note: Goodwill should be viewed as a residual amount remaining after all other identifiable and separable intangible assets have been recognized. 22

28. Purchase Method - Dissolution Purchase Price < Fair Value
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Purchase Method - Dissolution Purchase Price < Fair Value
When fair value exceeds cost, full allocation of fair value is not possible.
Current assets and liabilities should be consolidated at their fair value.
Non-current assets should be proportionately reduced in value (with some exceptions) 26

29. Purchase Method - Dissolution Purchase Price < Fair Value
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Purchase Method - Dissolution Purchase Price < Fair Value
According to SFAS 141, the following non-current assets are exceptions to the proportionate reduction, and should be recorded at assessed fair values:
Financial assets other than equity method investments
Assets to be disposed of by sale
Deferred tax assets
Prepaid assets related to pension or other post-retirement benefit plans

30. Purchase Method - Dissolution Purchase Price < Fair Value
2-30
Purchase Method - Dissolution Purchase Price < Fair Value
In the event that the difference is substantial enough to eliminate all the non-current asset balances of the acquired company . . .
. . . The remainder is to be reported as an extraordinary gain (SFAS 141)

31. 2-31
Accounting for Additional Costs Associated with Business Combinations (SFAS 141)
Direct combination costs (Accounting, legal, investment banking and appraisal fees, etc.)
Include in the purchase price of the acquired firm
Indirect combination costs (additional internal costs such as secretarial or managerial time)
Expense as incurred
Costs to register and issue securities
Reduce the value assigned to the fair value of the securities issued (typically as a debit to APIC)

32. Let’s see what happens when the acquired company is not dissolved.
2-32
Let’s see what happens when the acquired company is not dissolved. 27

33. Purchase Method - No Dissolution
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Purchase Method - No Dissolution
The acquired company continues as a separate entity.
Reported on Parent’s books as the Investment in Subsidiary account.
Separate records for each company are still maintained.
The adjusted balances for the Parent and the Subsidiary are consolidated using a worksheet (no formal journal entries!) 28

34. Steps for Consolidation
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Steps for Consolidation
Record the financial information for both Parent and Sub on the worksheet.
Remove the Investment in Sub balance.
Remove the Sub’s equity account balances.
Adjust the Sub’s net assets to FV.
Allocate any excess of cost over BV to identifiable, separable intangible assets or goodwill.
Combine all account balances. 6

35. Purchase Price Allocations - Additional Issues, SFAS No. 141
2-35
Purchase Price Allocations - Additional Issues, SFAS No. 141
Intangibles
Current and noncurrent assets that lack physical substance.
Do not include financial instruments.
When should an Intangible be recognized?
Does it arise from contractual or other legal rights?
Can it be sold or otherwise separated from the acquired enterprise?

36. Purchase Price Allocations - Additional Issues, SFAS No. 141
2-36
Exh.
2-7
Purchase Price Allocations - Additional Issues, SFAS No. 141
Intangible Asset Examples
Databases
Technological know-how
Patents & Copyrights
Strong labor relations
Assembled, trained workforce
Favorable government relations
Customer Base
Trademarked Brand Names
Customer Routes
Effective Advertising Programs
Covenants
Rights (broadcasting, development, use, etc.)

37. Purchase Price Allocations - Additional Issues, SFAS No. 141
2-37
Purchase Price Allocations - Additional Issues, SFAS No. 141
In-Process R&D
Should be expensed immediately upon acquisition (unless there are alternative future uses.)
IPR&D that has reached technological feasibility, may be “capitalized”.
Determination of fair value is critical.

38. Unconsolidated Subsidiaries
2-38
Unconsolidated Subsidiaries

39. FASB Pooling of Interests
2-39
Pooling of Interests
Historically, many business combinations were accounted for as “Pooling of Interests.”
In SFAS 141, “Business Combinations”, the FASB stated that all business combinations should be accounted for using the “Purchase Method”.
FASB

40. Pooling of Interest POOLING OF INTERESTS What is essential
for a combination to
be viewed as a
pooling of interest?
An exchange of
common stock.

41. Past poolings of interests are left intact by SFAS No. 141.
2-41
Pooling of Interests
According to SFAS No. 141, the purchase method is not to be applied to past “Poolings of Interest.”
Past poolings of interests are left intact by SFAS No. 141.
Therefore, it is important to understand how to account for PAST poolings.
FASB

42. Historical Review of Pooling of Interests
2-42
Historical Review of Pooling of Interests
The ownership interests of two, or more, companies were combined into one new company.
No single company was dominant.
Precise cost figures were difficult to obtain.
To use pooling of interests, 12 strict criteria had to be met.
In a pooling, one company obtained essentially “all” of the other company’s stock.
The transaction involved the exchange of common stock. No exchange of cash was allowed. 7

43. CRITERIA FOR POOLING APB No. 16
Attributes of combining companies
- Autonomous
- Independent of one another
Manner of achieving combination
- Single transaction
- Common stock for Common stock
- For “substantially all” common stock (90%)
Absence of planned transactions
- Planned spin-off of assets
- Contingent agreements

44. Historical Review of Pooling of Interests
2-44
Historical Review of Pooling of Interests
The Book Values of the two combining companies were joined. No Goodwill was recorded.
Revenues and expenses were combined retroactively for the two companies. 38

45. POOLING OF INTERESTS Accounting Considerations
Combination of ownership interests
- NOT AN ACQUISITION
NO TRANSACTION by the corporate entities
- No new basis of accountability
- Total combined net assets unchanged
NO CHANGE in total combined stockholders’ equity
Reallocation of individual accounts may be required
Retained earnings accounts combined
Earnings - combined for entire year of pooling
Direct combination expenses = period expenses

46. = + + = + = POOLING OF INTERESTS
Assets +
Assets
Assets
Par RE + =
Liab.
Liab.
Liabilities
Par
OCC
Par
Par RE + =
Stockholders’
Equity
OCC
OCC RE RE
OCC
Par RE
Total par issued vs. Total par exchanged

47. 2-47
Summary
Consolidation of financial information is required when one organization gains control of another.
If dissolution occurs, this consolidation is carried out at the date of acquisition and a single set of accounting records is maintained.
If separate identities are maintained, consolidation is a periodic “worksheet” process not involving journal entries. Separate accounting records are maintained.
The purchase method is currently GAAP, although the FASB has proposed changing to the Acquisition Method

48. 2-48
Possible Criticisms
The proposed “business fair value” measurement approach involves a departure from traditional “cost-based” measurement. This violates the Historic Cost Principle.
The proposed capitalization of IPR&D departs from the traditional SFAS 2 approach of expensing R&D as incurred.
WHAT DO YOU THINK?