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Slide 1-2 Introduction to Business Combinations and the Conceptual Framework Advanced Accounting, Fourth Edition 11

Slide Describe historical trends in types of business combinations Identify the major reasons firms combine Identify the factors that managers should consider in exercising due diligence in business combinations Identify defensive tactics used to attempt to block business combinations Distinguish between an asset and a stock acquisition Indicate the factors used to determine the price and the method of payment for a business combination Calculate an estimate of the value of goodwill to be included in an offering price by discounting expected future excess earnings over some period of years Describe the two alternative views of consolidated financial statements: the economic entity and the parent company concepts List and discuss each of the seven Statements of Financial Accounting Concepts (SFAC) Describe some of the current joint projects of the FASB and the International Accounting Standards Board (IASB), and their primary objectives. Learning Objectives

Slide 1-4 On December 4, 2007, FASB released two new standards,  FASB Statement No. 141 R, Business Combinations, and  FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements. These standards  Became effective for years beginning after December 15, 2008, and  Are intended to improve the relevance, comparability and transparency of financial information related to business combinations, and to facilitate the convergence with international standards. IntroductionIntroduction

Slide 1-5 Advantages of External Expansion Business Combinations: Why? Why Not? LO 2 Reasons firms combine. 1.Rapid expansion 2.Operating synergies 3.International marketplace 4.Financial synergy 5.Diversification 6.Divestitures

Slide 1-6 Asset acquisition, a firm must acquire 100% of the assets of the other firm. Stock acquisition, control may be obtained by purchasing 50% or more of the voting common stock (or possibly less). Terminology and Types of Combinations LO 5 Distinguish between an asset and a stock acquisition. What Is Acquired?What Is Given Up? Net assets of S Company (Assets and Liabilities) Common Stock of S Company 1.Cash 2. Debt 3. Stock 4.Combination of above Figure 1-1

Slide 1-7 Possible Advantages of Stock Acquisition Lower total cost. Direct formal negotiations may be avoided. Maintaining the acquired firm as a separate legal entity. Liability limited to the assets of the individual corporation. Greater flexibility in filing individual or consolidated tax returns. Terminology and Types of Combinations LO 5 Distinguish between an asset and a stock acquisition.

Slide 1-8 Classification by Method of Acquisition Terminology and Types of Combinations LO 5 Distinguish between an asset and a stock acquisition. A CompanyB CompanyA Company += Statutory Merger One company acquires all the net assets of another company. The acquiring company survives, whereas the acquired company ceases to exist as a separate legal entity.

Slide 1-9 Classification by Method of Acquisition Terminology and Types of Combinations LO 5 Distinguish between an asset and a stock acquisition. A CompanyB CompanyC Company += Statutory Consolidation A new corporation is formed to acquire two or more other corporations through an exchange of voting stock; the acquired corporations then cease to exist as separate legal entities. Stockholders of A and B become stockholders in C.

Slide 1-10 Classification by Method of Acquisition Terminology and Types of Combinations LO 5 Distinguish between an asset and a stock acquisition. Financial Statements of A Company Financial Statements of B Company Consolidated Financial Statements of A Company and B Company += Consolidated Financial Statements When a company acquires a controlling interest in the voting stock of another company, a parent–subsidiary relationship results.

Slide 1-11 Takeover Premium – the excess amount agreed upon in an acquisition over the prior stock price of the acquired firm. Possible reasons for the premiums: Acquirers’ stock prices may be at a level which makes it attractive to issue stock in the acquisition. Credit may be generous for mergers and acquisitions. Bidders may believe target firm is worth more than its current market value. Acquirer may believe growth by acquisitions is essential and competition necessitates a premium. Takeover Premiums LO 5 Distinguish between an asset and a stock acquisition.

Slide 1-12 Consolidated Net Income Parent Company Concept, consolidated net income consists of the combined income of the parent company and its subsidiaries after deducting the noncontrolling interest in income as an expense in determining consolidated net income. Economic Entity Concept, consolidated net income consists of the total combined income of the parent company and its subsidiaries. Total combined income is then allocated proportionately to the noncontrolling interest and the controlling interest. Alternative Concepts LO 8 Economic entity and parent company concepts.

Slide 1-13 Consolidated Balance Sheet Values Parent Company Concept, the net assets of the subsidiary are included in the consolidated financial statements at their book value plus the parent company’s share of the difference between fair value and book value on the date of acquisition. Economic Entity Concept, on the date of acquisition, the net assets of the subsidiary are included in the consolidated financial statements at their book value plus the entire difference between their fair value and their book value. Alternative Concepts LO 8 Economic entity and parent company concepts.

Slide 1-14 Conceptual Framework Conceptual Framework LO 8 Economic entity and parent company concepts. PRINCIPLES 1.Historical cost 2.Revenue recognition 3.Matching 4.Full disclosure SFAC Nos. 1 & 2 Objectives: Provide Information: 1. Usefulness in investment and credit decisions 2. Usefulness in future cash flows 3. About enterprise resources, claims to resources, and changes SFAC No. 2 Qualitative Characteristics 1. Relevance 2. Reliability 3. Comparability 4. Consistency Also:Usefulness,Understandability SFAC No. 6 (replaced SFAC No. 3) Elements of Financial Statements Provides definitions of key components of financial statements Assumptions 1.Economic entity 2.Going concern 3.Monetary unit 4.Periodicity Constraints 1.Cost-benefit 2.Materiality 3.Industry practice 4.Conservatism Principles 1.Historical cost 2.Revenue recognition 3.Matching 4.Full disclosure SFAC No. 5 & 7 Recognition and Measurement SFAC No. 7: Using future cash flows & present values in accounting measures Figure 1-2 Figure 1-2 Conceptual Framework for Financial Accounting and Reporting Objectives Fundamental Operational

Slide 1-15 Economic Entity vs. Parent Concept and the Conceptual Framework The parent concept is tied to the historical cost principle, which would suggest that the net assets related to the noncontrolling interest remain at their previous book values. This approach might be argued to produce more “reliable” values (SFAC No. 2). LO 8 Economic entity and parent company concepts. FASB’s Conceptual Framework

Slide 1-16 Economic Entity vs. Parent Concept and the Conceptual Framework The economic entity assumption views a parent and its subsidiaries as one economic entity even though they are separate legal entities. The economic entity concept is an integral part of the FASB’s conceptual framework and is named specifically in SFAC No. 5 as one of the basic assumptions in accounting. LO 8 Economic entity and parent company concepts. FASB’s Conceptual Framework

Slide 1-17 Accounting for Business Combinations Advanced Accounting, Fourth Edition 22

Slide Describe the major changes in the accounting for business combinations passed by the FASB in December 2007, and the reasons for those changes Describe the two major changes in the accounting for business combinations approved by the FASB in 2001, as well as the reasons for those changes Discuss the goodwill impairment test described in SFAS No. 142 [ASC 350–20–35], including its frequency, the steps laid out in the new standard, and some of the likely implementation problems Explain how acquisition expenses are reported Describe the use of pro forma statements in business combinations Describe the valuation of assets, including goodwill, and liabilities acquired in a business combination accounted for by the acquisition method Explain how contingent consideration affects the valuation of assets acquired in a business combination accounted for by the acquisition method Describe a leveraged buyout Describe the disclosure requirements according to SFAS No. 141R [ASC 805–10–50], “Business Combinations,” related to each business combination that takes place during a given year Describe at least one of the differences between U.S. GAAP and IFRS related to the accounting for business combinations. Learning Objectives

Slide 1-19 Goodwill Impairment Test SFAS No. 142 [ASC ] requires impairment be tested annually. All goodwill must be assigned to a reporting unit. Impairment should be tested in a two-step process. LO 3 Goodwill impairment assessment. Perspective on Business Combinations 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.

Slide 1-20 Perspective on Business Combinations LO 3

Slide 1-21 E2-10: 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: LO 3 Goodwill impairment assessment. Perspective on Business Combinations * * Not including goodwill

Slide 1-22 E2-10: On January 1, 2010, the acquisition date, what was the amount of goodwill acquired, if any? LO 3 Goodwill impairment assessment. Perspective on Business Combinations Acquisition price$450,000 Fair value of identifiable net assets 375,000 Recorded value of Goodwill $ 75,000

Slide 1-23 Disclosures Mandated by FASB SFAS No. 141R [ASC 805] requires: 1.Total amount of acquired goodwill and the amount expected to be deductible for tax purposes. 2.Amount of goodwill by reporting segment (in accordance with SFAS No. 131 [ASC 280], “Disclosures about Segments of an Enterprise and Related Information”), unless not practicable. LO 3 Goodwill impairment assessment. Perspective on Business Combinations

Slide 1-24 Disclosures Mandated by FASB SFAS No. 142 [ASC ] specifies the presentation of goodwill (if impairment occurs): a.Aggregate amount of goodwill should be a separate line item in the balance sheet. b.Aggregate amount of losses from goodwill impairment should be a separate line item in the operating section of the income statement. LO 3 Goodwill impairment assessment. Perspective on Business Combinations

Slide 1-25 Disclosures Mandated by FASB When an impairment loss occurs, SFAS No. 142 [ASC ] mandates note disclosure: 1.Description of facts and circumstances leading to the impairment. 2.Amount of impairment loss and method of determining the fair value of the reporting unit. 3.Nature and amounts of any adjustments made to impairment estimates from earlier periods, if significant. LO 3 Goodwill impairment assessment. Perspective on Business Combinations

Slide 1-26 Other Intangible Assets Acquired intangible assets other than goodwill: Limited useful life  Should be amortized over its useful economic life.  Should be reviewed for impairment. Indefinite life  Should not be amortized.  Should be tested annually (minimum) for impairment. LO 3 Goodwill impairment assessment. Perspective on Business Combinations

Slide 1-27 If a material business combination occurred, notes to financial statements should include on a pro forma basis: 1.Results of operations for the current year as though the companies had combined at the beginning of the year. 2.Results of operations for the immediately preceding period as though the companies had combined at the beginning of that period if comparative financial statements are presented. Pro Forma Statements and Disclosure Requirement LO 5 Use of pro forma statements.

Slide 1-28 Four steps in the accounting for a business combination: 1.Identify the acquirer. 2.Determine the acquisition date. 3.Measure the fair value of the acquiree. 4.Measure and recognize the assets acquired and liabilities assumed. Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed.

Slide 1-29 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 ], states in-process R&D is measured and recorded at fair value as an asset on the acquisition date. Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed.

Slide 1-30 Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed. 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?

Slide 1-31 Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed. 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

Slide 1-32 Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed. Fair value of liabilities594,000 Fair value of net assets1,230,000 Fair value of assets, without cash$1,824,000 Price paid1,560,000 Goodwill$ 330,000 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

Slide 1-33 Explanation and Illustration of Acquisition Accounting LO 6 Valuation of acquired assets and liabilities assumed. 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. Inventory396,000 Plant and equipment540,000 Receivables228,000 Goodwill330,000 Liabilities594,000 Land660,000 Cash1,560,000

Slide 1-34 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. IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.

Slide 1-35 Other differences and similarities: IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.

Slide 1-36 Other differences and similarities: IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.

Slide 1-37 Other differences and similarities: IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.

Slide 1-38 Other differences and similarities: IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.

Slide 1-39 Other differences and similarities: IFRS Versus U.S. GAAP LO 10 Differences between U.S. GAAP and IFRS.