1. ©Cambridge Business Publishing, 2010 What is a Business Combination?  Occurs when one company obtains control over another company  Referred to as  Merger  Acquisition  Takeover  Sought out when the acquiring firm’s management believes it can accomplish its objectives more efficiently and at lower cost 1

2. ©Cambridge Business Publishing, 2010 Motivations for Acquisitions  To facilitate relationships with other companies as suppliers, subcontractors, customers  To add new facilities and capabilities  To control a source of supply  To add production or distribution facilities  To achieve customer relationships  To expand into new geographic markets  To diversify into new lines of business 2

3. ©Cambridge Business Publishing, 2010 Advantages of Acquiring a Company  Going concern is less costly  Eliminates the need to start from scratch  Avoids duplication of efforts that exist from growth from within  Competition is often reduced  Complementary products or services can lead to increased overall sales 3

4. ©Cambridge Business Publishing, 2010 Top M&A Deals Worldwide, 2000-2007 4 Exhibit 2.1

5. ©Cambridge Business Publishing, 2010 Types of Combinations 5 Statutory mergerStatutory consolidation Asset acquisition Stock acquisition Stock transactions governed by State laws All assets acquired and liabilities assumed are recorded directly on the books of the acquiring company

6. ©Cambridge Business Publishing, 2010 Statutory Merger Example IBM pays $10 million in cash to acquire DataFile, Inc. on January 1, 2010. The fair values of DataFile’s assets and liabilities are: 6 Current assets5,000,000 Equipment45,000,000 Patents and copyrights10,000,000 Current liabilities 15,000,000 Long-term debt 35,000,000 Cash 10,000,000 AccountFair Value Current assets$ 5,000,000 Equipment 45,000,000 Patents and copyrights 10,000,000 Current liabilities 15,000,000 Long-term debt 35,000,000 To record the acquisition of DataFile, Inc:

7. ©Cambridge Business Publishing, 2010 Statutory Merger Results  Acquired company ceases to exist as a separate company  Subsequent transactions of acquired firm are reported on books of acquirer  Assets and liabilities acquired are recorded directly on acquiring company’s books  Acquired assets and liabilities  Recorded at fair value at the date of acquisition  Acquiring company’s net assets are not revalued 7

8. ©Cambridge Business Publishing, 2010 Statutory Consolidation  New corporation absorbs both companies  Identify one of the companies as the acquirer  Only the acquired company’s assets and liabilities are reported by the new corporation at fair value on date of acquisition 8

9. ©Cambridge Business Publishing, 2010 Stock Acquisition  Occurs when a company acquires most or all of the voting stock of another company  Each firm continues as a separate legal entity  Investment in the acquired firm treated as an intercorporate investment  Consolidation working paper used to combine the two companies’ results 9 Investment in DataFile, Inc.10,000,000 Cash 10,000,000 To record the investment in stock:

10. ©Cambridge Business Publishing, 2010 Goodwill Goodwill exists if price paid by acquirer exceeds the total fair value of the specific net assets acquired. 10  Excess price paid occurs due to value attributable  To a company’s reputation, and  To a company’s competitive strengths  Amount is capitalized as goodwill, an intangible asset

11. ©Cambridge Business Publishing, 2010 Calculating Goodwill 11 IBM pays $10 million in cash to acquire DataFile, Inc. on January 1, 2010. The fair value of DataFile’s assets and liabilities are: Acquisition cost $10,000,000 Fair value of identifiable net assets acquired: Current assets$ 5,000,000. Equipment45,000,000. Patents and copyrights2,000,000. Current liabilities(15,000,000) Long-term debt(35,000,000)2,000,000 Goodwill $ 8,000,000 Current assets$ 5,000,000Current liabilities$15,000,000 Equipment45,000,000Long-term debt35,000,000 Patents and copyrights10,000,000 Goodwill is the excess of amount paid over the fair value of net assets acquired:

12. ©Cambridge Business Publishing, 2010 Recording an Acquisition with Goodwill To record the acquisition with goodwill at $8,000,000. 12 Current assets5,000,000 Equipment45,000,000 Patents and copyrights2,000,000 Goodwill8,000,000 Current liabilities 15,000,000 Long-term debt 35,000,000 Cash 10,000,000

13. ©Cambridge Business Publishing, 2010 Evolution of Reporting Business Combinations From 1970 to 2001, two accounting methods existed: 13 Purchase MethodPooling Method Viewed as an acquisition of one business by another Viewed as a union of two previously separate companies

14. ©Cambridge Business Publishing, 2010 Current U.S. GAAP for Business Combinations 14 Exhibit 2.3

15. ©Cambridge Business Publishing, 2010 Business Combinations Defined  Occurs when control is obtained over one or more businesses  When is control obtained?  Direct acquisition of the assets and liabilities of the acquired company  Statutory merger  Consolidation  Asset acquisition  Obtaining a controlling interest in the voting shares of the acquired company  Stock acquisition 15 Control is obvious Control must be evaluated

16. ©Cambridge Business Publishing, 2010 Transactions Excluded as Business Combinations Not covered under SFAS 141(R)  Formation of a joint venture by existing companies  Establishing a new business as a separate subsidiary  Combining companies already under common control 16

17. ©Cambridge Business Publishing, 2010 Acquisition Method  Used to report all business combinations  Requires careful identification and valuation of the  Fair value of the assets acquired, and  Fair value of the liabilities assumed  At acquisition date  The date the acquiring company obtains control of the acquired company  Normally date consideration is paid 17

18. ©Cambridge Business Publishing, 2010 Identifying the Acquiring Company  Acquiring company distributes cash or other assets and/or incurs liabilities  Characteristics of acquiring company  Entity that issues the equity interests  Entity that is larger  Owners have larger voting interest  Prior owners constitute a large minority (<50%)  Entity selects a majority of the governing body  Dominates senior management  Entity’s stockholders did not receive a premium over market value in the exchange 18

19. ©Cambridge Business Publishing, 2010 Measuring Assets and Liabilities Acquisition cost 19 Greater Than Fair value of the net assets acquired Report goodwill Acquisition cost Less Than Fair value of the net assets acquired A bargain purchase exists. Report a gain.

20. ©Cambridge Business Publishing, 2010 Estimation of Fair Values 20 Exhibit 2.4

21. ©Cambridge Business Publishing, 2010 Identification of Previously Unreported Intangibles  Two criteria leading to separate recognition as an intangible by acquiring entity  Intangible arises from contractual or other legal rights, or  Intangible is separable  Can be separated or divided from the acquired entity and sold, rented, licensed, or otherwise transferred 21 Separability Criterion

22. ©Cambridge Business Publishing, 2010 Examples of Identifiable Intangible Assets Lease, franchise, licensing agreements Construction permits Employment contracts Broadcast rights Mineral rights Contract-based intangible assets Brand names Trademarks Internet domain names Newspaper mastheads Non-competition agreements Marketing- related intangible assets 22

23. ©Cambridge Business Publishing, 2010 Examples of Identifiable Intangible Assets Customer lists Order backlogs Customer contracts Customer-related intangible assets Patent rights Computer software Databases Trade secrets Technology-based intangible assets Television programs Motion pictures and videos Recordings Books and photographs Advertising jingles Artistic-based intangible assets 23

24. ©Cambridge Business Publishing, 2010 Goodwill  Excess of acquisition cost over fair value of identifiable net assets acquired  Included as goodwill under SFAS 141(R)  Assembled workforce  Employees in place and able to run the business  Potential contracts  Being negotiated with prospective customers  Long-standing customer relationships  Favorable locations  Business reputation 24

25. ©Cambridge Business Publishing, 2010 Valuation of Intangibles  General measurement rules of SFAS 157 apply  Level 1: Quoted prices in an active market for identical assets  Level 2: Quoted market prices for similar assets, adjusted for the attributes of the assets in question  Level 3: Valuation based on unobservable estimated attributes 25 Always valued in the context of highest and best use

26. ©Cambridge Business Publishing, 2010 Three Approaches to Valuation (SFAS 157)  Market  Quoted market prices of identical or similar assets  Income  Valuation models used to calculate the present value of future cash flows or earnings  Cost  Estimation of replacement cost of the services provided by the asset 26

27. ©Cambridge Business Publishing, 2010 Illustration of Reporting Assets Acquired and Liabilities Assumed IBM pays $25 million in cash to acquire DataFile Inc. on July 1, 2010. Fair value of DataFile’s reported assets and liabilities are: 27 Identified and valued unreported intangible assets are: Current assets$ 2,000,000Current liabilities$10,000,000 Equipment60,000,000Long-term debt40,000,000 Patents and copyrights5,000,000 Brand names$1,000,000 Favorable lease agreements600,000 Assembled workforce5,000,000 In-process contracts with potential customers2,000,000 Contractual customer relationships3,000,000 Identifiable intangibles Unreported intangible assets

28. ©Cambridge Business Publishing, 2010 Illustration of Reporting Assets Acquired and Liabilities Assumed continued Determining goodwill for the acquisition of DataFile Inc. for $25 million cash: 28 Acquisition cost $25,000,000 Fair value of identifiable net assets acquired: Current assets$2,000,000. Plant and equipment60,000,000. Patents and copyrights5,000,000. Brand names1,000,000. Favorable lease agreements600,000. Contractual customer relationships3,000,000. Current liabilities(10,000,000) Long-term debt(40,000,000)21,600,000 Goodwill $3,400,000

29. ©Cambridge Business Publishing, 2010 Illustration of Reporting Assets Acquired and Liabilities Assumed continued Recording the acquisition of DataFile Inc for $25 million cash: 29 Current assets2,000,000 Plant and equipment60,000,000 Patents and copyrights5,000,000 Brand names1,000,000 Favorable lease agreements600,000 Contractual customer relationships3,000,000 Goodwill3,400,000 Current liabilities 10,000,000 Long-term debt 40,000,000 Cash 25,000,000

30. ©Cambridge Business Publishing, 2010 Contingent Consideration  Exists when the acquirer agrees to make additional payments to the former owners of the acquiree if certain events occur or conditions are met  Must be reported at date of acquisition  Requires good faith estimates of  Probability, and  Timing  Based on present value of the expected payment 30

31. ©Cambridge Business Publishing, 2010 Earnings Contingency  Derives from the beliefs of the former shareholders that they are entitled to more consideration given their company will bolster postcombination earnings  Also known as earnouts  Expected payments increase the acquisition cost  Often based on performance goals for  Revenue  Cash from operations 31

32. ©Cambridge Business Publishing, 2010 Out-of-Pocket Acquisition-Related Costs  Not included with acquisition costs  Why? Do not increase the value of the acquired business  Examples of out-of-pocket costs  Outside consulting fees and advisory services  Lawyers  Accountants  Security registration costs  Reduce the net value of the equity accounts affected  Do not increase total acquisition costs 32

33. ©Cambridge Business Publishing, 2010 Acquisition-Related Restructuring Costs  Must be expensed as incurred under SFAS 141(R)  Do not affect acquisition costs  Costs included  Shutting down departments  Reassigning or eliminating jobs  Changing supplier or production practices in connection with the combination 33

34. ©Cambridge Business Publishing, 2010 Reporting Consideration Given in an Acquisition Example 34 IBM pays acquires DataFile Inc. on July 1, 2010. The deal is structured as: Fair value of DataFile’s reported assets and liabilities are: Cash paid to former owners of DataFile$3,000,000 Fair value of stock issued to former owners of DataFile: 1,000,000 shares, par value $.5020,000,000 Cash paid for registration fees on stock issued600,000 Cash paid for outside merger advisory services1,200,000 Expected present value of earnout agreement1,500,000 Expected present value of stock price contingency agreement800,000 Current assets$ 2,000,000Brand Names$1,000,000 Plant and equipment60,000,000Favorable lease agreements600,000 Patents and copyrights5,000,000Assembled workforce5,000,000 Current liabilities10,000,000In-process contracts with potential customers2,000,000 Long-term debt40,000,000Contractual customer relationships3,000,000

35. ©Cambridge Business Publishing, 2010 Reporting Consideration Given in an Acquisition Example continued 35 IBM calculates goodwill for the acquisition of DataFile Inc. as: Acquisition cost Cash to former owners of DataFile$3,000,000 Cash paid for registration fees600,000 Fair value of stock issued, net19,400,000 Fair value of earnout1,500,000 Fair value of stock contingency800,000 $25,300,000 Fair value of identifiable net assets acquired: Current assets$2,000,000 Plant and equipment60,000,000 Patents and copyrights5,000,000 Brand names1,000,000 Favorable lease agreements600,000 Contractual customer relationships3,000,000 Current liabilities(10,000,000) Long-term debt(40,000,000)21,600,000 Goodwill $3,700,000

36. ©Cambridge Business Publishing, 2010 Reporting Consideration Given in an Acquisition Example continued 36 IBM records the acquisition of DataFile Inc. as: Current assets2,000,000 Plant and equipment60,000,000 Patents and copyrights5,000,000 Brand names1,000,000 Favorable lease agreements600,000 Contractual customer relationships3,000,000 Goodwill3,700,000 Merger expenses1,200,000 Current liabilities 10,000,000 Long-term debt 40,000,000 Earnout liability 1,500,000 Common stock, $.50 par 500,000 Additional paid-in-capital--stock issue 18,900,000 Additional paid-in-capital--stock contingency800,000 Cash 4,800,000

37. ©Cambridge Business Publishing, 2010 Subsequent Changes in Values Value changes resulting from clarification of facts existing as of the date of acquisition 37 Value changes caused by events occurring after the date of acquisition Treated as corrections to the initial acquisition entry Reported in income

38. ©Cambridge Business Publishing, 2010 Measurement Period  Defined as the period during which value changes may be reported as corrections to the initial acquisition entry (SFAS 141(R))  Ends when no more information can be obtained concerning estimated values as of the acquisition date  Limited to one year after the acquisition date 38

39. ©Cambridge Business Publishing, 2010 Reporting Subsequent Changes in Asset and Liability Values 39 IBM pays acquires DataFile Inc. on July 1, 2010. Three months after acquisition, new information reveals that equipment not belonging to DataFile was mistakenly included in the original valuation and the actual equipment fair value was $40 million instead of $60 million. IBM’s journal entry to correct the original acquisition: Goodwill20,000,000 Plant and equipment 20,000,000 If the equipment dropped in value after the date of acquisition, the decline in value would be recognized as a loss on equipment with no change to the original equipment cost.

40. ©Cambridge Business Publishing, 2010 Bargain Purchases  Occurs when the acquisition cost is less than the fair value of the acquired net assets at acquisition date  May be the results of a forced sale  Seller is attempting to avoid bankruptcy or other financial losses  Report a gain on the bargain purchase  Ensures accurate reporting of asset and liability balances 40

41. ©Cambridge Business Publishing, 2010 Bargain Purchase Example 41 IBM acquires DataFile Inc. for $20 million cash with the following fair values of assets acquired and liabilities assumed: To calculate the gain: Current assets$ 2,000,000Brand names$1,000,000 Plant and equipment60,000,000Favorable lease agreements600,000 Patents and copyrights5,000,000Assembled workforce5,000,000 Current liabilities10,000,000 I n-process contracts with potential customers 2,000,000 Long-term debt40,000,000Contractual customer relationships3,000,000 Acquisition cost $20,000,000 Fair value of identifiable net assets acquired: Current assets$2,000,000 Plant and equipment60,000,000 Patents and copyrights5,000,000 Brand names1,000,000 Favorable lease agreements600,000 Contractual customer relationships3,000,000 Current liabilities(10,000,000) Long-term debt(40,000,000)21,600,000 Gain on bargain purchase $1,600,000

42. ©Cambridge Business Publishing, 2010 Bargain Purchase Example continued 42 IBM acquires DataFile Inc. for $20 million cash with the following fair values of assets acquired and liabilities assumed: To record the bargain purchase: Current assets$ 2,000,000Brand names$1,000,000 Plant and equipment60,000,000Favorable lease agreements600,000 Patents and copyrights5,000,000Assembled workforce5,000,000 Current liabilities10,000,000 I n-process contracts with potential customers 2,000,000 Long-term debt40,000,000Contractual customer relationships3,000,000 Current assets2,000,000 Plant and equipment60,000,000 Patents and copyrights5,000,000 Brand names1,000,000 Favorable lease agreements600,000 Contractual customer relationships3,000,000 Current liabilities 10,000,000 Long-term debt 40,000,000 Cash 20,000,000 Gain on bargain purchase 1,600,000