Acquisition Fair Value Allocations: Additional Issues, SFAS No. 141R 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? 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? 2-1

Acquisition Fair Value Allocations: Additional Issues, SFAS No. 141R Intangible Asset Examples Customer Base Brand Names Trademarks Customer Routes Royalty agreements Internet domain names Rights (broadcasting, development, use, etc.) Customer Base Brand Names Trademarks Customer Routes Royalty agreements Internet domain names Rights (broadcasting, development, use, etc.) Databases Technological know- how Patents & Copyrights Franchise agreements Noncompetition agreements Many, many, more Databases Technological know- how Patents & Copyrights Franchise agreements Noncompetition agreements Many, many, more Exh

Acquisition Fair Value Allocations: Additional Issues, SFAS No. 141R In-Process R&D  Should be recognized at acquisition date as an ASSET.  Determination of fair value is critical.  Subsequent to acquisition, the IPR&D assets are tested for impairment at least annually. In-Process R&D  Should be recognized at acquisition date as an ASSET.  Determination of fair value is critical.  Subsequent to acquisition, the IPR&D assets are tested for impairment at least annually. 2-3

Unconsolidated Subsidiaries 2-4

LEGACY ACCOUNTING METHODS FOR BUSINESS COMBINATIONS Prior to the SFAS 141R acquisition method (effective 2009), the FASB required either the  Purchase method (GAAP through 2008, SFAS 141)  Pooling of interests method (GAAP through 6/30/02, APB 16)

Purchase Method Situations: GAAP for new combinations through 2008 Dissolution of the acquired company: Purchase Price = Fair Value Purchase Price > FV Purchase Price < FV Separate incorporation maintained. Dissolution of the acquired company: Purchase Price = Fair Value Purchase Price > FV Purchase Price < FV Separate incorporation maintained. 2-6

Purchase Method: Dissolution Purchase Price > or = 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.  Recognize goodwill as the excess of cost over FV of the net assets acquired.  Record any acquired in-process research and development as an expense 2-7

Purchase Method: Dissolution Purchase Price > Fair Value Archer agrees to pay $1,200,000 (10,000 unissued shares of its $1 par value common stock that is currently selling for $120 per share) for all of Baker’s assets and liabilities. Archer also paid $25,000 cash for legal and accounting fees directly related to the acquisition. Baker then dissolves itself as a legal entity. Under the purchase method both the fair value of the stock issued and the direct acquisition costs are included in the cost-based valuation of the combination. 2-8

Purchase Method: Dissolution Purchase Price > Fair Value 2-9 Acquisition-date information for Baker Co.

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) 2-10

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 2-11

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) 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) 2-12

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) 2-13

Pooling of Interests Historically, many business combinations were accounted for as “Pooling of Interests.” Acquisition Method In SFAS 141R, “Business Combinations”, the FASB stated that all business combinations should be accounted for using the “Acquisition Method”. Historically, many business combinations were accounted for as “Pooling of Interests.” Acquisition Method In SFAS 141R, “Business Combinations”, the FASB stated that all business combinations should be accounted for using the “Acquisition Method”. 2-14

Pooling of Interests According to SFAS No. 141R, the acquisition method is not to be retrospectively applied to past “Poolings of Interest.” Past poolings of interests are left intact by SFAS No. 141R. Therefore, it is important to understand how to account for PAST poolings. According to SFAS No. 141R, the acquisition method is not to be retrospectively applied to past “Poolings of Interest.” Past poolings of interests are left intact by SFAS No. 141R. Therefore, it is important to understand how to account for PAST poolings. 2-15

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. The ownership interests of two, or more, companies were combined into one new company. No single company was dominant. There was a continuity of previous ownership interests, not a purchase/sale. To use pooling of interests, 12 strict criteria had to be met. Historical Review of Pooling of Interests 2-16

Historical Review of Pooling of Interests The Book Values of the two combining companies were joined. No Goodwill was recorded. Internally developed intangibles developed by the sub were typically not recognized. Revenues and expenses were combined retroactively for the two companies. 2-17

Historical Review of Pooling of Interests Because poolings involved exchanges of voting stock, a continuity of ownership was deemed to exist. Neither Goodwill nor any unrecorded intangibles were recorded. Both companies were combined at BV. The pooling method was often criticized for it’s lack of completeness, comparability to other methods, and relevance for decision makers. Because poolings involved exchanges of voting stock, a continuity of ownership was deemed to exist. Neither Goodwill nor any unrecorded intangibles were recorded. Both companies were combined at BV. The pooling method was often criticized for it’s lack of completeness, comparability to other methods, and relevance for decision makers. 2-18

Historical Review of Pooling of Interests Prior Period Adjustments were made to account for differences in the ways the two companies accounted for income. A journal entry was recorded to recognize either an Investment in Subsidiary (sub not dissolved) or the individually acquired assets and liabilities (if the sub was dissolved). Prior Period Adjustments were made to account for differences in the ways the two companies accounted for income. A journal entry was recorded to recognize either an Investment in Subsidiary (sub not dissolved) or the individually acquired assets and liabilities (if the sub was dissolved). 2-19

Accounting for Pooling of Interests in Subsequent Periods: Dissolution The Investment in Sub account must be eliminated against the Sub’s Equity accounts Add together the BV’s of the remaining accounts. No excess amortization is applicable, because no acquisition-date write-ups occurred. 2-20

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 acquisition method is GAAP beginning in Legacy effects for the purchase method (for combinations occurring through 2008) and the pooling method (through 6/30/2002) remain in subsequent year’s financial reports. 2-21