1. Advanced Accounting, First Edition1
Introduction to Business Combinations
Advanced Accounting, First Edition

2. 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.

3. 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.

4. 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.

5. Perspective on Business Combinations
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.
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.

6. Perspective on Business Combinations
LO 3

7. 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.

8. 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.

9. 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
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.

10. Perspective on Business Combinations
Exercise: Part A&B (continued)
Step
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.

11. Perspective on Business Combinations
Exercise: Part A&B (continued)
Step
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.

12. Perspective on Business Combinations
Exercise: Part A&B (continued)
Step
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.

13. Perspective on Business Combinations
Exercise: Part A&B (continued)
Step
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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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 ], 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

25. 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.

26. 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.

27. 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 .

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

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

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

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

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

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