Advanced Accounting, First Edition 1 Introduction to Business Combinations Advanced Accounting, First Edition

Historical Perspective on Business Combinations What’s New? SFAS No. 141R [ASC 805], “Business Combinations,” would replace FASB Statement No. 141. Continues to support the use of a single method. Uses the term “acquisition method” rather than “purchase method.” The acquired business should be recognized at its fair value on the acquisition date rather than its cost, regardless of whether the acquirer purchases all or only a controlling percentage. Issued on December 2007 LO 1 FASB’s two major changes for business combinations.

Historical Perspective on Business Combinations What’s New? [ASC 810], “Noncontrolling Interests In Consolidated Financial Statements,” will replace Accounting Research Bulletin (ARB) No. 51. Establishes standards for the reporting of the noncontrolling interest when the acquirer obtains control without purchasing 100% of the acquiree. Issued on December 2007 LO 1 FASB’s two major changes for business combinations.

Historical Perspective on Business Combinations Historically, two methods permitted: purchase and pooling of interests. Pronouncements in June 2001: SFAS No. 141, “Business Combinations,” - pooling method is prohibited for business combinations initiated after June 30, 2001. SFAS No. 142, “Goodwill and Other Intangible Assets,” - Goodwill acquired in a business combination after June 30, 2001, should not be amortized. LO 2 FASB’s two major changes of 2001.

Perspective on Business Combinations Goodwill Impairment Test SFAS No. 142 [ASC 350-20-35] requires impairment be tested annually. All goodwill must be assigned to a reporting unit. Impairment should be tested in a two-step process. Step 1: If fair value is less than the carrying amount of the net assets (including goodwill), then perform a second step to determine possible impairment. Step 2: Determine the fair value of the goodwill (implied value of goodwill) and compare to carrying amount. LO 3 Goodwill impairment assessment.

Perspective on Business Combinations LO 3

Perspective on Business Combinations Exercise: On January 1, 2010, Porsche Company acquired the net assets of Saab Company for $450,000 cash. The fair value of Saab’s identifiable net assets was $375,000 on this date. Porsche Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Saab). The information for these subsequent years is as follows: * * Not including goodwill LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: On January 1, 2010, the acquisition date, what was the amount of goodwill acquired, if any? Acquisition price $450,000 Fair value of identifiable net assets 375,000 Recorded value of Goodwill $ 75,000 LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: Part A&B: For each year determine the amount of goodwill impairment, if any, and prepare the journal entry needed each year to record the goodwill impairment (if any). Step 1 - 2011 Fair value of reporting unit $400,000 Carrying value of unit: Carrying value of identifiable net assets 330,000 Carrying value of goodwill 75,000 Total carrying value of unit 405,000 Excess of carrying value over fair value $ 5,000 Excess of carrying value over fair value means step 2 is required. LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: Part A&B (continued) Step 2 - 2011 Fair value of reporting unit $400,000 Fair value of identifiable net assets 340,000 Implied value of goodwill 60,000 Carrying value of goodwill 75,000 Impairment loss $ 15,000 Journal Entry Impairment loss 15,000 Goodwill 15,000 LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: Part A&B (continued) Step 1 - 2012 Fair value of reporting unit $400,000 Carrying value of unit: Carrying value of identifiable net assets 320,000 Carrying value of goodwill 60,000 * Total carrying value of unit 380,000 Excess of fair value over carrying value $ 20,000 Excess of fair value over carrying value means step 2 is not required. * $75,000 (original goodwill) – $15,000 (prior year impairment) LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: Part A&B (continued) Step 1 - 2013 Fair value of reporting unit $350,000 Carrying value of unit: Carrying value of identifiable net assets 300,000 Carrying value of goodwill 60,000 * Total carrying value of unit 360,000 Excess of carrying value over fair value $ 10,000 Excess of carrying value over fair value means step 2 is required. * $75,000 (original goodwill) – $15,000 (prior year impairment) LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Exercise: Part A&B (continued) Step 2 - 2013 Fair value of reporting unit $350,000 Fair value of identifiable net assets 325,000 Implied value of goodwill 25,000 Carrying value of goodwill 60,000 Impairment loss $ 35,000 Journal Entry Impairment loss 35,000 Goodwill 35,000 LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Review Question The first step in determining goodwill impairment involves comparing the implied value of a reporting unit to its carrying amount (goodwill excluded). fair value of a reporting unit to its carrying amount (goodwill excluded). implied value of a reporting unit to its carrying amount (goodwill included). fair value of a reporting unit to its carrying amount (goodwill included). LO 3 Goodwill impairment assessment.

Perspective on Business Combinations Treatment of Acquisition Expenses The Exposure Draft requires that: both direct and indirect costs be expensed. the cost of issuing securities also be excluded from the consideration. Security issuance costs are assigned to the valuation of the security, thus reducing the additional contributed capital for stock issues or adjusting the premium or discount on bond issues. LO 4 Reporting acquisition expenses.

Perspective on Business Combinations Acquisition Costs—an Illustration Suppose that SMC Company acquires 100% of the net assets of Bee Company (net book value of $100,000) by issuing shares of common stock with a fair value of $120,000. With respect to the merger, SMC incurred $1,500 of accounting and consulting costs and $3,000 of stock issue costs. SMC maintains a mergers department that incurred a monthly cost of $2,000. Prepare the journal entry to record these direct and indirect costs. Professional Fees Expense (Direct) 1,500 Merger Department Expense (Indirect) 2,000 Additional Paid-In Capital (Security Issue Costs) 3,000 Cash 6,500 LO 4 Reporting acquisition expenses.

Explanation and Illustration of Acquisition Accounting Four steps in the accounting for a business combination: Identify the acquirer. Determine the acquisition date. Measure the fair value of the acquiree. Measure and recognize the assets acquired and liabilities assumed. LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting Value of Assets and Liabilities Acquired Identifiable assets acquired (including intangibles other than goodwill) and liabilities assumed should be recorded at their fair values at the date of acquisition. Any excess of total cost over the fair value amounts assigned to identifiable assets and liabilities is recorded as goodwill. SFAS No. 141R [ASC 805-20], states in-process R&D is measured and recorded at fair value as an asset on the acquisition date. LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company. Immediately prior to the acquisition, Saville Company’s balance sheet was as follows: Any Goodwill? LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company. Immediately prior to the acquisition, Saville Company’s balance sheet was as follows: Fair value of assets, without cash $1,824,000 LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: A. Prepare the journal entry on the books of Preston Co. to record the purchase of the assets and assumption of the liabilities of Saville Co. if the amount paid was $1,560,000 in cash. Calculation of Goodwill Fair value of assets, without cash $1,824,000 Fair value of liabilities 594,000 Fair value of net assets 1,230,000 Price paid 1,560,000 Goodwill $ 330,000 LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: A. Prepare the journal entry on the books of Preston Co. to record the purchase of the assets and assumption of the liabilities of Saville Co. if the amount paid was $1,560,000 in cash. Receivables 228,000 Inventory 396,000 Plant and equipment 540,000 Land 660,000 Goodwill 330,000 Liabilities 594,000 Cash 1,560,000 LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting Bargain Purchase When the fair values of identifiable net assets (assets less liabilities) exceeds the total cost of the acquired company, the acquisition is a bargain. In the past, FASB required that most long-lived assets be written down on a pro rata basis before recognizing a gain. Current standards require: fair values be reconsidered and adjustments made as needed. any excess of acquisition-date fair value of net assets over the consideration paid is recognized in income. LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting Bargain Acquisition Illustration When the price paid to acquire another firm is lower than the fair value of identifiable net assets (assets minus liabilities), the acquisition is referred to as a bargain. Under SFAS No. 141R: Any previously recorded goodwill on the seller’s books is eliminated (and no new goodwill recorded). An ordinary gain is recorded to the extent that the fair value of net assets exceeds the consideration paid. LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: B. Repeat the requirement in (A) assuming that the amount paid was $990,000. Calculation of Goodwill or Bargain Purchase Fair value of assets, without cash $1,824,000 Fair value of liabilities 594,000 Fair value of net assets 1,230,000 Price paid 990,000 Bargain purchase $ 240,000 LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting E2-1: B. Repeat the requirement in (A) assuming that the amount paid was $990,000. Receivables 228,000 Inventory 396,000 Plant and equipment 540,000 Land 660,000 Liabilities 594,000 Cash 990,000 Gain on acquisition 240,000 LO 6 Valuation of acquired assets and liabilities assumed.

IFRS Versus U.S. GAAP The project on business combinations Was the first of several joint projects undertaken by the FASB and the IASB. Complete convergence has not yet occurred. International standards currently allow a choice between writing all assets, including goodwill, up fully (100% including the noncontrolling share), as required now under U.S. GAAP, or continuing to write goodwill up only to the extent of the parent’s percentage of ownership. LO 10 Differences between U.S. GAAP and IFRS .

IFRS Versus U.S. GAAP Other differences and similarities: LO 10 Differences between U.S. GAAP and IFRS .

IFRS Versus U.S. GAAP Other differences and similarities: LO 10 Differences between U.S. GAAP and IFRS .

IFRS Versus U.S. GAAP Other differences and similarities: LO 10 Differences between U.S. GAAP and IFRS .

IFRS Versus U.S. GAAP Other differences and similarities: LO 10 Differences between U.S. GAAP and IFRS .

IFRS Versus U.S. GAAP Other differences and similarities: LO 10 Differences between U.S. GAAP and IFRS .

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