Accounting, Taxes, and M&A Valuation What Every Investment Banker Needs to Know.

Slides:



Advertisements
Similar presentations
©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter 9 Consolidated Financial Statements: Income Taxes, Cash Flows, and Installment Acquisitions.
Advertisements

1 Financial Statements Three basic statements: Balance sheet Balance sheet Income statement Income statement Statement of cash flows Statement of cash.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Investments in Other Corporations Chapter 12.
Chapter Four Consolidated Financial Statements and Outside Ownership McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
The Mechanics of Financial Accounting Presentations for Chapter 4 by Glenn Owen.
©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston Chapter Pooling of Interests vs.
McGraw-Hill/Irwin© 2008 The McGraw-Hill Companies, Inc. All rights reserved. 4 Consolidation of Wholly Owned Subsidiaries.
Chapter Three Consolidations – Subsequent to the Date of Acquisition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights.
Stock Ownership Less Than 100%
CHAPTER 12 Group financial statements
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2007 All rights reserved. Clinic 5-1 Accounting Clinic V.
Chapter 3 Methods of accounting for business combination.
ACC 424 Financial Reporting II Lecture 5 Introduction to consolidations.
Accounting Methods for Business Combinations
Copyright © 2009 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Consolidation of Wholly Owned Subsidiaries 4.
1 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Business Combinations Chapter 1.
2 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Stock Investments – Investor Accounting Chapter.
© The McGraw-Hill Companies, Inc., 2001 Slide 2-1 McGraw-Hill/Irwin 2 C H A P T E R Consolidation of Financial Information Updated Sixth Edition.
Investments.
Chapter 3.
Consolidated Financial Statements and Outside Ownership
© The McGraw-Hill Companies, Inc., 2004 Slide 2-1 McGraw-Hill/Irwin Chapter Two Consolidation of Financial Information.
Copyright © 2009 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Consolidation of Less-than- Wholly Owned Subsidiaries 5.
Accounting Basics: Agenda Introduction to Financial Statements – Balance Sheet – Income Statement – Statement of Cash Flows Metrics and Ratios.
CHAPTER 1 1 Business Combinations: America’s Most Popular Business Activity, Bringing an End to the Controversy Fundamentals of Advanced Accounting 1st.
Consolidation of Financial Information
2 nd session: Introduction to Accounting. Firm of the Day 2.
Legal Form of Combination Merger  Occurs when one corporation takes over all the operations of another business entity and that other entity is dissolved.
McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 4 International Financial Reporting Standards (IFRSs)
Advanced Accounting, Fifth Edition
Consolidated Financial Statements and Outside Ownership
Acquisition Fair Value Allocations: Additional Issues, SFAS No. 141R Intangibles  Current and noncurrent assets that lack physical substance.  Do not.
Mergers and Acquisitions
Reporting and Analyzing Cash Flows Chapter 17. Purposes of the Statement of Cash Flows Designed to fulfill the following: – predict future cash flows.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Acquisitions and Consolidated Statements © The McGraw-Hill Companies, Inc., Part One:
Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University Statement of Cash Flows Chapter 14.
Intro to Financial Management Understanding Financial Statements and Cash Flows.
Accounting for Intangible Assets
13-1 Preview of Chapter 13 Financial and Managerial Accounting Weygandt Kimmel Kieso.
The Complete Income Statement Presentations for Chapter 13 by Glenn Owen.
課程 14: Mergers and Acquisitions - A Topic in Corporate Finance.
Chapter 14 The Statement of Cash Flows
Business Valuations. Reasons for wanting to know about value:  Market transactions  Scorecards  Estate planning  Family transfers  ESOP  Litigation.
Chapter Four Consolidated Financial Statements and Outside Ownership McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
23-0 Synergy 23.4 The whole is worth more than the sum of the parts Some mergers create synergies because the firm can either cut costs or use the combined.
Dinnul Alfian Akbar Kepemimpinan. 1-1 Kepemimpinan: Pengantar Dinnul Alfian Akbar.
1 Business Combination Two or more independent business entities combined into one larger accounting entity, with one firm acquiring control.
PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA APPENDIX.
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Accounting Clinic V McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Unit 3.5 Final Accounts. Financial Statements ▫Profit and Loss account ▫Balance sheet ▫Cash Flow statement Financial Accounting Management Accounting.
1-1 Chapter 1: Business Combinations. 1-2 Business Combinations: Objectives 1.Understand the economic motivations underlying business combinations. 2.Learn.
Chapter Two Consolidation of Financial Information McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 1: Business Combinations Copyright ©2012 Pearson Education,
Chapter 2: Stock Investments – Investor Accounting and Reporting
Stock Investments – Investor Accounting
1 BUSINESS COMBINATIONS. 2 A business combination is bringing together two or more Previously separate companies under Common control. Control over a.
COPYRIGHT © 2011 South-Western/Cengage Learning 8 PowerPoint Author: Catherine Lumbattis Operating Assets Property, Plant, and Equipment, and Intangibles.
Balance Sheet Basics! Purpose, elements, valuation, disclosures, loss/gain contingencies, subsequent events, IFRS highlights.
INVESTING DECISIONS.
Business Combinations
Advanced Financial Accounting
CHAPTER 1 1 Business Combinations: America’s Most Popular Business Activity, Bringing an End to the Controversy Fundamentals of Advanced Accounting 1st.
International Financial Reporting Standards (IFRSs)
Consolidation Following Acquisition
Advanced Accounting by Debra Jeter and Paul Chaney
Chapter Four Consolidated Financial Statements and Outside Ownership Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution.
The Guts of Acquisition Accounting
Consolidation of Wholly Owned Subsidiaries
Business combinations
Presentation transcript:

Accounting, Taxes, and M&A Valuation What Every Investment Banker Needs to Know

M&A Accounting Depending on the characteristics of a merger or acquisition transaction will be accounted for as a: –purchase combination or a –pooling-of-interest (pooling) combination.

Purchase Method Accounting Purchase accounting requires the acquirer to record in its financial statements the fair market value of all assets acquired. –Both tangible and intangible, and liabilities assumed. –The fair value of an asset is generally its market or appraised value, and liabilities are generally valued on a present value basis. Any excess or residual purchase price over the fair value of the net identifiable assets is considered goodwill that must be recorded as an asset and amortized over its useful life or a maximum of 40 years.

Pooling Method Accounting The pooling method accounts for a combination of two firms as a union of the ownership interests of the two previously separated groups of stockholders. No sale or purchase is considered to have occurred. The assets and liabilities of the combining firms continue to be carried at their book values, that is, on the basis of their historical costs. Any goodwill carried on the target’s books prior to the merger continues to be carried on the merged firm’s books at its historical cost, but no new goodwill is recognized as a result of the pooling. The stockholders’ equity of the merged firm is recorded at the sum of the book values of the two firms.

Pooling-of-Interest Treatment Twelve Criteria For A Pooling of Interests Merger –Attributes of the Combining Companies 1.Autonomous (two-year rule) 2.Independent (10% rule) –Manner of Combining Interests 3.Single transaction (completed in one year following the initiation) 4.Exchange of common stock (90% "substantially all" rule) 5.No equity changes in contemplation of combination (two-year rule) 6.Shares reacquired only for purposes other than combination 7.No change in proportionate equity interests 8.Voting rights immediately exercisable 9.Combination resolved at consummation (no pending provisions) –Absence of Planned Transactions 10.Issuing company does not agree to reacquire shares 11.Issuing company does not make deals to benefit former stockholders 12.Issuing company does not plan to dispose of assets within two years (Source:

Controversy Over Pooling On September 7, 1999, the FASB issued a draft with four significant changes to existing accounting practice: 1.Use of the pooling-of-interest method would be prohibited. 2.The current 40 year maximum amortization period for goodwill would be reduced to 20 years. 3.Companies would be required to present separate line items in the income statement for income before taxes and goodwill amortization, and for goodwill amortization net-of-tax basis. 4.The current 40-year maximum amortization period for acquired intangible assets (other than goodwill) would be replaced with a presumption that their useful lives are 20 years or less.

Example: Purchase of Assets Assume that Acquiror Co. buys Target Co. for $200,000 in stock. Acquiror Co. must then revalue the assets and liabilities of Target Co. to their fair values at the date of the acquisition and record any identifiable intangible assets that were not carried on Target’s books. Any difference between the purchase price and the fair value of the net assets would be shown as goodwill arising from the acquisition.

AssetsAcquirer Target’s Balance Sheet Prior to Acquisition Revalued Target’s Balance Sheet Merged Firm Cash$185,000$6,000 $191,000 Accounts Receivables$90,000$8,000 $98,000 Notes Receivable$55,000 Inventory$140,000$10,000$9,000$149,000 PPE (net)$250,000$35,000$50,000$300,000 Goodwill$12,000$113,000 Trademark$15,000 Patent $25,000 Total Assets$720,000$71,000$226,000$946,000 Liabilities and Equity Accounts Payable$90,000$14,000 $104,000 LT Notes Payable$170,000$15,000$12,000$182,000 Shareholders' Equity$460,000$42,000$200,000$660,000 Total Liabilities & Equity$720,000$71,000$226,000$946,000

Example Pooling of Assets Now the merged firm only recognizes the goodwill that existed prior to the acquisition.

AssetsAcquirer Target’s Balance Sheet Prior to Acquisition Revalued Target’s Balance Sheet Merged Firm Cash$185,000$6,000 $191,000 Accounts Receivables$90,000$8,000 $98,000 Notes Receivable$55,000 Inventory$140,000$10,000$9,000$150,000 PPE (net)$250,000$35,000$50,000$285,000 Goodwill$12,000$113,000$12,000 Trademark$15,000$0 Patent$25,000$0 Total Assets$720,000$71,000$226,000$791,000 Liabilities and Equity Accounts Payable$90,000$14,000 $104,000 LT Notes Payable$170,000$15,000$12,000$185,000 Shareholders' Equity$460,000$42,000$200,000$502,000 Total Liabilities & Equity$720,000$71,000$226,000$791,000

Value from Nothing Under pooling, the earnings of the merged firm “look better” than under purchase!

PurchasePooling Revenues$500,000 COGS$340,000 Gross Margin$160,000 Expenses Depreciation$75,000 Amortization$6,825$300 SGAE$70,000 Other$10,000 Total Expenses$161,825$151,550 Net Income-$1,825$8,450 Total Amortization uses the straight- line method with zero residual value. Goodwill amortized over 40 years. Amortization is $300 = $12,000/40. Straight-Line method of depreciation with zero residual value and a useful life of 4 years. Depreciation: $75,000 = $300,000/4. Total Amortization uses the straight-line method with zero residual value and a 10-year useful life for patents and trademarks, and goodwill amortized over 40 years. Amortization: $6,825 = ($250,000+$15,000)/10 + $113,000/40

Tax Considerations In general, the target’s shareholders pay taxes on the gains or losses immediately when the transaction is concluded, while the acquirer restates the acquired assets at fair market value. The asset write-up increases the amount of depreciation which is valuable for an acquirer in a tax paying status. M&As can be tax-free, whereby the target’s shareholders recognize a loss or gain only if they sell the assets they receive in payment from the acquirer.

Qualifying for Tax Free Treatment: Mergers 1.The shareholders of the target have to retain a continuing equity interest in the acquirer. 2.The interest must be substantial in relation to the net assets of the target. These two rules have been interpreted to mean that the target shareholders have to receive at least 50 percent of their payment in stock of the acquirer.

Qualifying for Tax Free Treatment: Acquisitions 1.All payment to the shareholders of the target has to be in the form of voting stock. 2.The acquirer must obtain at least 80 percent of the voting stock of the target.

Valuing Acquisitions Despite 30 years of evidence demonstrating that most acquisitions do not create value for the acquiring company, both the number and the volume of deals have been increasing from year to year. You need to understand however the several meanings of the word “value.”

It Depends on What You Mean by Value Intrinsic value. –NPV of the future cash flows of the target irrespective of any acquisition. –Conrail’s intrinsic value was around $71 per share when it was acquired. Market value. –The market adds a premium that incorporates the probability that the target firm be acquired. –Conrail stock price jumped to $85.13 the day the first bid by CSX was announced. Purchase price. –A.k.a. :anticipated takeout value.” How much the acquiror must pay to get the target. Synergy value. –The NPV of the future cash flows that result from integration. Value gap. –The difference between the intrinsic value and the purchase price.

Valuing Synergies Types of synergies: –Cost savings –Revenue enhancements –Process improvements –Financial engineering –Tax benefits

Valuation Assumptions Capital structure assumption. –The capital structure assumption should not be reflective of the financing used to buy the target per se, but should reflect the degree to which owning the target incrementally affects your debt capacity.

Valuation Assumptions Continued Pre-Tender Offer Strategy –The target firm’s stock price will exceed the present value of the firm’s future cash flows if it reflects the possibility that the firm may eventually be taken over at a premium. –Toeholds: Bidder buys shares in the open market prior to making the tender offer. Can buy up to 5% and then have a window in which to notify the markets that a tender offer will be forthcoming. At that point open market purchases must cease.

Target Firm Stock Prices Around a Tender Offer Information leakage: about 10% out of 27%. Total value about 27%.