Business Combinations

C012 Business combinations uThe acquisition of an entire company uUnderstanding the reporting benefits that caused firms to favor the pooling method prior to July 1, 2001 uPurchase accounting procedures at alternative prices uPooling of Interests accounting procedures (appendix)

C013 Basic issues in combinations uThe motivation to combine uPre-acquisition audit confirms value uEvery deal focuses on market values uAsset acquisition versus stock acquisition (investment)

C014 Basic issues in combinations (continued) uPurchase versus pooling –purchase is group asset acquisition at market values –pooling was merging of accounts at book value uPooling not allowed after July 1, 2001

C015 Major issues PurchasePooling

C016 Major issues (continued) PurchasePooling

C017 Major issues (concluded) PurchasePooling

C018 Purchase price rules Premium Price - Price high enough to record all accounts at fair value, excess price is goodwill with no amortization, but required impairment testing Bargain - Priority accounts at fair value, balance of price allocated to non priority accounts. Extraordinary Gain - Price paid is less than priority accounts, excess of priority accounts over price is extraordinary gain.

C019 Priority accounts uAll current assets uAll liabilities uDeferred tax assets uPension and other post retirement benefit plan assets uNonpriority assets that are to be sold

C0110 Basic purchase example AssetsLiabilities & Equity Inventory120,000Bonds payable100,000 Land50,000Common stock, $5 par10,000 Building250,000Retained earnings310,000 Total420,000Total420,000 Fair Values: Inventory (priority)170,000Bonds pay (priority)105,000 Land100,000 Building300,000 Patent (unrecorded) 50,000

C0111 Price zone analysis 1. Calculate the market value net assets: Using fair values, net assets = $515,000

C0112 Price zone analysis (continued) 2. Determine the 3 price zones: Premium: Over $515,000 all accounts at fair value, goodwill for price over $515,000 Bargain: $65,000 [priority] to $515,000 priority accounts at fair value; balance allocated to nonpriority accounts Extraordinary Gain: Below $65,000 priority accounts at fair value; other accounts not recorded; extraordinary gain for excess of priority accounts over price paid

C0113 Purchase entry premium price: $600,000 Inventory (fair value)170,000 Land (fair value)100,000 Building (fair value)300,000 Patent 50,000 Goodwill (price over $515,000)85,000 Bonds payable100,000 Premium on bonds payable (to fair value)5,000 Cash600,000 Goodwill is not amortized, but could be impairment adjusted at a later date

C0114 Purchase allocation bargain price: $365,000 $65,000 for priority accounts; $300,000 allocated to fixed & identifiable intangible assets Allocation Table

C0115 Purchase entry bargain price: $365,000 Inventory (fair value)170,000 Land (allocated)66,000 Building (allocated)201,000 Patent (allocated)33,000 Bonds payable100,000 Premium on bonds pay (to fair value)5,000 Cash365,000

C0116 Purchase entry extraordinary gain: $50,000 Price is below $65,000; there is no value to assign to fixed or identifiable intangible assets: Inventory (fair value)170,000 Land (no value available)0 Building (no value available)0 Patent (no value available)0 Extraordinary gain15,000 Bonds payable100,000 Prem on bonds pay (to fair value)5,000 Cash50,000

C0117 Goodwill impairment Test: Goodwill is impaired if estimated value of business unit is less that remaining book value of net assets (including goodwill). New GW estimate = (estimated value of business unit) – (new estimate of identifiable net assets at fair value) Impairment Loss = Book value of GW – new estimate.

C0118 Impairment example Recorded $100,000 goodwill in purchase three years ago. Now Net assets at book value=$650,000 Fair value of the business unit=$625,000 Fair value net identifiable assets (not including goodwill)=$580,000

C0119 Impairment calculations Test Est. value of business unit$625,000 Book value of assets (including goodwill) 650,000 Excess book$25,000 Goodwill is impaired Adjustment Est. value of business unit$625,000 Fair value of ident. assets, not incl. GW580,000 New GW est.45,000 GW bookvalue100,000 Impair. loss$55,000

C0120 Purchase: some fine points uDirect acquisition costs are paid to outside parties; include them in the price paid uIndirect acquisition costs are internally incurred; they are expensed uIssue costs are to issue bonds or stock; they are subtracted from the value assigned to the securities uStocks and bonds issued are always recorded at fair value in a purchase

C0121 Purchase complications uMay have to calculate market value of debt issues uLeases retain classification, related accounts recorded at market value uDTL goes with assets in non-taxable exchange uTax loss carry over is usually recorded as an asset. If realization is uncertain, it is not recorded and is buried in goodwill

C0122 Purchase complications (continued) uThere may be contingent goodwill payment. Added goodwill is recorded uPrice guarantees cover decline in value of securities issued in purchase. If issued, value assigned to securities is adjusted

C0123 Example of tax-free exchange uThe price paid for a company is $480,000 uThe only asset is a machine with a book value of 300,000 and a market value of $400,000 uThe tax rate is 40% uA $40,000 DTL goes with the Machine uThe remaining price is $120,000 ($480 - $400 + $40) u$120,000 is available for goodwill net of a 40% DTL uGoodwill = $120,000  ( ) = $200,000

C0124 Tax-free exchange: journal entry Machine (fair value)400,000 Goodwill (gross value)200,000 Deferred Tax Liability* 120,000 Cash480,000 * $40,000 on machine and $80,000 on goodwill The DTLs are amortized over the same life (and by the same method) as the assets to which they attach

C0125 Pooling: equity transfer rules (2)Take RE to meet total pd-in (if (1) is not enough) Total Paid-in Retained Earnings (2)Retained Earnings Combiner: Add to Issuer: Par Additional Paid-inAdditional Paid-in (1) (1)Take from parent pd-in to meet total pd-in

C0126 Pooling example AssetsLiabilities & Equity Inventory120,000Bonds payable100,000 Land50,000C. stock, $5 par10,000 Paid-in capital in excess of par 100,000 Building250,000Retained earnings210,000 Total420,000Total420,000 Market Values Inventory170,000Bonds payable105,000 Land100,000 Building300,000 Estimated goodwill135,000

C0127 Pooling analysis Issuer will issue $50 market value shares to meet the $600,000 market value. $600,000  $50 = 12,000 shares issued. The deal is based on market values; but they are not recorded! uThe assets and liabilities are recorded at book value uPooling transfer rule is used to assign equity amounts uAssume the following par values for shares issued: $.50$5$10

C0128 Equity transfer for $0.50 par Common Stock10,000Common Stock* 6,000 Paid-in Capital in Excess of Par 100,000 in Excess of Par 104,000 Total Paid-in 110,000Total Paid-in 110,000 R E(adjusted)210,000RE210,000320,000 CombinerAdd to Issuer *12,000 shares, par $0.50

C0129 Journal entry for $0.50 par Inventory120,000 Land 50,000 Building250,000 Bonds payable100,000 Common stock6,000 Paid-in capital in excess of par104,000 Retained earnings210,000

C0130 Equity transfer for $5.00 par Common Stock 10,000Common Stk* 60,000 Paid-in Capital in Excess of Par100,000in Excess of Par54,000 Total Paid-in110,000Total Paid-in 110,000 R E(adjusted)210,000RE210,000320,000 CombinerAdd to Issuer *12,000 shares, par $5.00

C0131 Journal entry for $5.00 par Inventory120,000 Land50,000 Building250,000 Bonds payable100,000 Common stock60,000 Paid-in capital in excess of par50,000 Retained earnings210,000

C0132 Equity transfer for $10.00 par Common Stock 10,000Common Stk* 120,000 Paid-in Capital in Excess of Par100,000in Excess of Par -0- Total Paid-in110,000Total Paid-in120,000 R E(adjusted)210,000RE200,000320,000 CombinerAdd to Issuer *12,000 shares, par $10.00

C0133 Entry for $10.00 par Inventory120,000 Land50,000 Building250,000 Bonds payable100,000 Common stock120,000 Retained earnings200,000

C0134 Special issues in a pooling uDirect, indirect and issue costs are expensed uCombiner existing goodwill is recorded uAdjustments may be made to accounts for: –Lower of cost or market adjustments –Changes in accounting principles (for uniformity) –Record unrecorded items –Error correction All adjustments are made to combiner retained earnings before the equity transfer diagram is applied