0. Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 2: Methods of Accounting for Business Combinations
Slides Authored by Hannah Wong, Ph.D.
Rutgers University

1. Accounting Methods for Business Combinations
Purchase Method
treats the combination as the purchase of one or more companies by another.
Pooling of Interests Method
treats the combination as two or more groups of stockholders uniting their ownership interests by an exchange of common stock.

2. Comparison of Purchase and Pooling of Interests
Assets and liabilities acquired are recorded at their fair values.
Any excess of cost over fair value of net assets acquired is recorded as goodwill.
Pooling of Interests
Assets and liabilities are recorded at their precombination book values.
No excess of cost over book value exists, and no new goodwill is recorded

3. Comparison of Purchase and Pooling of Interests
The acquired company’s retained earnings are added into the acquiring company’s retained earnings.
Equity shares issued are recorded at the book value of the acquired shares.
Purchase
The acquired company’s retained earnings are not added into the acquiring company’s retained earnings.
Equity securities issued are recorded at their fair market value.

4. Comparison of Purchase and Pooling of Interests
There is no additional depreciation or amortization expense.
The issuer and combiner companies’ earnings are combined for the full fiscal year in which the combination occurs.
Purchase
The excess of cost over book value is depreciated or amortized to reduce future earnings.
The acquired company’s earnings are included with the acquiring firm’s only from the date of combination forward.

5. Comparison of Purchase and Pooling of Interests
Direct costs are capitalized as part of the acquisition cost.
Indirect costs are expensed.
Security issuance costs are deducted from additional paid-in capital.
Pooling of Interests
Direct costs are expensed in the year in which incurred.
Indirect costs are expensed.
Security issuance costs are expensed.

6. Acquisition Costs - An Illustration
Facts:
SMC Company acquires 100% of the net assets of Bee Company by issuing shares of common stock with a fair value of $120,000.
SMC incurred:
$1,500 of accounting and consulting costs
$3,000 of stock issue costs
$2,000 monthly overhead cost for its mergers department

7. Acquisition Costs - An Illustration
Pooling Accounting:
Accounting and Consulting Expense (Direct) 1,500
Merger Department Expense (Indirect) 2,000
Securities Issue Expense (Security Issue Costs) 3,000
Cash ,500
Purchase Accounting:
Goodwill (Direct) 1,500
Merger Department Expense (Indirect) 2,000
Other Contributed Capital (Security Issue Costs) 3,000
Cash ,500

8. Disadvantages of Pooling Method
Values given and received are ignored in a negotiated transaction.
“Instant earnings” can result
from sale of newly pooled assets that are carried at their precombination low book values, and
from including precombination earnings of other companies in the year of combination.

9. Disadvantages of Purchase Method
Subjective - appraisal of assets or stock values are necessary.
Inconsistent - accounting for one part of the combined company on a fair value and the other part of a historical basis.

10. Financial statements “as if” the combination had been consummated.
Pro Forma Statements
Financial statements “as if” the combination had been consummated.
Functions
provide information in the planning stages of the combination
disclose relevant information subsequent to the combination

11. Disclosure Requirements
Purchase Method
notes to financial statements should include pro forma information
in the year of combination
in the immediately preceding period if comparative financial statements are presented

12. Disclosure Requirements
Pooling Method
financial statements should be restated on a pro forma basis for all years presented
notes to financial statements should include
disclosure that the statements of previously separately firms have been combined
operating results of separate firms prior to the combination

13. Purchase Example - Facts
On January 1, 2000, P Company acquired the assets and assumed the liabilities of S Company.
P Company gave one of its $15 par value common shares for each share of S company common stock.
P Company common stock has a fair value per share of $48.
Refer to Illustration 2-4 for the companies balance sheet information.

14. Purchase Example - Journal Entry
Cash and Receivables ,000
Inventories ,000
Land ,000
Buildings & Equipment (Net) 1,000,000
Discount on Bonds Payable ,000
Goodwill ,000
Current Liabilities ,000
Bonds Payable ,000
Common Stock ,000
Other Contributed Capital 990,000
Identifiable
net assets
acquired are
recorded at
their market
value on the
acquisition
date
Goodwill =
excess
cost over
fair value of
identifiable
assets
acquired
Common stock issued is recorded at
market value on the acquisition date

15. Equity Allocation in Pooling of Interests - Case A
P issued shares with par value of $450,000
Other Contributed
Capital - S
$50,000
Retained Earnings
- S
$140,000
Common stock -S
$300,000
$300,000
$50,000
$140,000
Common Stock
- P
$750,000
Other Contributed
Capital - P
$400,000
Retained Earnings
- P
$350,000
$100,000

16. Journal Entry - Case A Cash and Receivables 180,000
net assets
acquired
are carried
forward at
their book
value
Cash and Receivables ,000
Inventories ,000
Land ,000
Buildings & Equipment ,000
Other Contributed Capital ,000
Accumulated Depreciation 300,000
Current Liabilities ,000
Bonds Payable ,000
Common Stock ,000
Retained Earnings ,000
Total shareholders’ equity of S
Company ($490,000) is carried
forward to P Company
Par value of common stock issued
is recorded

17. Equity Allocation in Pooling of Interests - Case B
P issued shares with par value of $800,000
Other Contributed
Capital - S
$50,000
Retained Earnings
- S
$140,000
Common stock -S
$300,000
$50,000
$50,000
$300,000
$90,000
Common Stock
- P
$750,000
Other Contributed
Capital - P
$400,000
Retained Earnings
- P
$350,000
$400,000

18. Journal Entry - Case B Cash and Receivables 180,000
net assets
acquired
are carried
forward at
their book
value
Cash and Receivables ,000
Inventories ,000
Land ,000
Buildings & Equipment ,000
Other Contributed Capital ,000
Accumulated Depreciation 300,000
Current Liabilities ,000
Bonds Payable ,000
Common Stock ,000
Retained Earnings ,000
Total shareholders’ equity of S
Company ($490,000) is carried
forward to P Company
Par value of common stock issued
is recorded

19. Equity Allocation in Pooling of Interests - Case C
P issued shares with par value of $330,000
Other Contributed
Capital - S
$50,000
Retained Earnings
- S
$140,000
Common stock -S
$300,000
$30,000
$20,000
$300,000
$140,000
Common Stock
- P
$750,000
Other Contributed
Capital - P
$400,000
Retained Earnings
- P
$350,000

20. Journal Entry - Case C Cash and Receivables 180,000
net assets
acquired
are carried
forward at
their book
value
Cash and Receivables ,000
Inventories ,000
Land ,000
Buildings & Equipment ,000
Accumulated Depreciation 300,000
Current Liabilities ,000
Bonds Payable ,000
Common Stock ,000
Other Contributed Capital ,000
Retained Earnings ,000
Total shareholders’ equity of S
Company ($490,000) is carried
forward to P Company
Par value of common stock issued
is recorded

21. Equity Allocation in Pooling of Interests - Case D
P issued shares with par value of $275,000
Other Contributed
Capital - S
$50,000
Retained Earnings
- S
$140,000
Common stock -S
$300,000
$25,000
$50,000
$275,000
$140,000
Common Stock
- P
$750,000
Other Contributed
Capital - P
$400,000
Retained Earnings
- P
$350,000

22. Pooling Example - Case D
net assets
acquired
are carried
forward at
their book
value
Cash and Receivables ,000
Inventories ,000
Land ,000
Buildings & Equipment ,000
Accumulated Depreciation 300,000
Current Liabilities ,000
Bonds Payable ,000
Common Stock ,000
Other Contributed Capital ,000
Retained Earnings ,000
Total shareholders’ equity of S
Company ($490,000) is carried
forward to P Company
Par value of common stock issued
is recorded

23. Valuation of Net Assets Acquired:
Bargain Purchase
Bargain = Fair value of identifiable net assets acquired
Less: Purchase price
Valuation of Net Assets Acquired:
Current assets, long-term investments in marketable securities, liabilities = fair value
Previously recorded goodwill = 0
Long-term assets = fair value - bargain allocation
(The bargain is allocated to long-term assets in proportion to their fair value.)
Any remaining bargain is recorded as negative goodwill and amortized over a maximum of 40 years.

24. Bargain Purchase - Example
Bargain = Fair value of identifiable net assets ($23,000) Purchase price ($17,000)
= $6,000 Building $4,500
Land $1,500
Current Assets ,000
Buildings ($15,000-$4,500) 10,500
Land ($5,000-$1,500) ,500
Liabilities ,000
Cash ,000
Building and Land is recorded at
fair value minus allocated
bargain
Current assets and liabilities
are recorded at fair value

25. Contingent Considerations
Contingencies based on earnings
Contingencies based on security prices

26. Earnings Contingency Definition Accounting Treatment
additional consideration to be made if the combined company’s future earnings equal or exceed a threshold.
Accounting Treatment
as additional cost of acquisition

27. Stock Price Contingency
Definition
additional consideration to be made if the future market value of shares issued is less than the guaranteed value
Accounting Treatment
no effect on acquisition cost
as an adjustment to Other Contributed Capital

28. Leveraged Buyout (LBO)
A management group contributes stock they hold and borrows funds to a create new company, which acquires all the outstanding common shares of their employer company.

29. Leveraged Buyout (LBO)
Borrowed Fund
Stock of employer
company held by
managers
New Company
acquires
Employer Company

30. Leveraged Buyout (LBO)
Valuation of New Company
net assets acquired by borrowed fund
market value
net assets contributed by managers
book value

31. Leveraged Buyout (LBO) Example
Valuation of Net Assets in New Company
Excess
of cost
over
book
value
Market Value
Excess cost applied to
plant assets = $13,500
Goodwill
$9,000
Book Value
$1,000
$9,000
10%
90%
Net assets
contributed
by managers
Net assets acquired
by borrowed fund
of $31,500

32. Criteria for Pooling of Interests
Company Attributes
autonomous of any other companies
independent of other combining companies

33. Criteria for Pooling of Interests
Exchange of Stock
single transaction
common stock for 90% common stock
no change in equity interest
no abnormal treasury stock transactions
same ratio of interest of individual stockholders
voting rights immediately exercisable
no provision for future issuance of stock

34. Criteria for Pooling of Interests
Absence of Planned Transactions
no agreement to reacquire stock
no financial arrangements for shareholders
no unusual disposal of assets

35. Advanced Accounting by Debra Jeter and Paul Chaney
Copyright © 2001 John Wiley & Sons, Inc. All rights reserved.
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