1. CHAPTER 1 1
Business Combinations: America’s Most Popular Business Activity, Bringing an End to the Controversy Fundamentals of Advanced Accounting 1st Edition Fischer, Taylor, and Cheng

2. Business Combinations
All acquisitions of one firm by another
Two categories of business combinations:
Merger
Consolidation
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3. Merger vs. Consolidation
Existing company acquires another company
Acquired company’s operations are merged with its own.
Consolidation
Two or more previously separate firms are combined into one new company.
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4. Economic Advantages of Combinations
Combinations utilize economies of scale
Horizontal combinations – firms with similar functions
Vertical combinations – firms at different levels in marketing chain
Conglomerates – dissimilar businesses
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5. Economic Advantages of Combinations (continued)
Defer capital gains on sale of stock
Owner accepts Purchaser’s stock in exchange for their stock
Structure combination as “tax-free” reorganization
New shares are at basis of old shares
Taxable to owner when new shares are sold
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6. Economic Advantages of Combinations (continued)
Additional tax benefits:
Tax losses are transferable in a business combination.
Combined operations may reduce taxable income.
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7. Obtaining Control Two methods to obtain control of another company:
Purchase assets of an existing company
May assume liabilities as well
Purchase > 50% of outstanding voting stock of another company
Parent/subsidiary relationship
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8. Accounting for Control
Purchase of “net assets”
Acquiring firm records assets/liabilities purchased in its own ledger.
Acquisition of stock
Acquiring firm (parent) records a single “investment” account
Parent and subsidiary remain separate legal entities
Parent/subsidiary financial statements are combined (consolidated).
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9. Basic Issues in Combinations (continued)
Purchase versus pooling
Purchase is group asset acquisition at market values
Pooling was merging of accounts at book value
Pooling not allowed after July 1, 2001
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10. Purchase Method - Valuation
All assets and liabilities are recorded at Fair Market Value.
First identify and value tangible assets
Next identify and value intangible assets
Goodwill - Price paid in excess of Fair Market value of the net assets.
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11. Basic Purchase: Example with Goodwill
Acquisitions, Inc. purchases net assets of Johnson Company:
Net assets (per books) = $148,000
Purchase price = $350,000 cash
Direct acquisition costs = $10,000
Fair value (current appraisal) of net assets = $297,000
Goodwill = $63,000
Cost $360,000 less $297,000 fair value
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12. Example: Johnson, Inc. Net Asset Values
Assets Book Value Fair Value
Accounts receivable , ,000
Inventory 40,000 45,000
Land 10,000 50,000
Buildings (net) 40,000 80,000
Equipment (net) 20,000 50,000
Patent 15,000 30,000
Copyright ,000
Goodwill 20,
Total Assets 173, ,000
Liabilities & Equity
Current liabilities ,000 5,000
Bonds payable 20,000 21,000
Total liabilities 25,000 26,000
Net assets 148, ,000
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13. Entry to Record Purchase
Accounts Receivable 28,000
Inventory (fair value) 45,000
Land (fair value) 50,000
Building (fair value) 80,000
Equipment 50,000
Patent 30,000
Copyright 40,000
Goodwill (based on current price) 63,000
Current liabilities 5,000
Bonds payable 20,000
Bonds payable premium (to fair value) 1,000
Cash 360,000
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14. Basic Purchase: Example with Goodwill Purchased with Stock
Assume same facts as in prior example.
Acquisitions, Inc. issues $1 par value common stock for the $350,000 purchase price.
Calculation of shares required:
Fair value of shares = $50
Shares required = 7,000 ($350,000 / $50)
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15. Entry to Record Purchase
Accounts Receivable 28,000
Inventory (fair value) 45,000
Land (fair value) 50,000
Building (fair value) 80,000
Equipment 50,000
Patent 30,000
Copyright 40,000
Goodwill (based on current price) 63,000
Current liabilities 5,000
Bonds payable 20,000
Bonds payable premium (to fair value) 1,000
Cash 10,000
Common Stock (7,000 x $1) 7,000
Paid-in Capital in Excess of Par 343,000
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16. Required Disclosures Schedule of fair value of accounts
Name and description of firm purchased
Reason for purchase
Cost of acquisition
Valuation of stock (If payment method)
Contingent payment agreements
Pro Forma income disclosure
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17. Entry for Johnson, Inc. (Seller)
Investment in Acquisitions, Inc. Stock 350,000
Current liabilities 5,000
Bonds payable 20,000
Accounts receivable 28,000
Inventory 40,000
Land 10,000
Buildings 40,000
Equipment 20,000
Patent 15,000
Goodwill 20,000
Gain on Sale of Business 202,000
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18. Accounting for Acquired Assets
Tangible assets and liabilities – normal depreciation and amortization procedures.
Intangible assets amortized over useful lives.
Goodwill is not amortized
Subject to impairment
Tested on an annual basis
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19. Goodwill Impairment
Test: Goodwill is impaired if estimated value of business unit is less than remaining book value of net assets (including goodwill).
New goodwill estimate:
Estimated value of business unit
– New estimate of identifiable net assets at fair value
= New goodwill estimate
Impairment Loss:
Book value of goodwill
– New goodwill estimate
= Impairment loss
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20. Recording a Bargain Purchase
Bargain purchase – price of acquisition is less than Fair Value of Net Assets
No Goodwill exists (none recorded)
Cost of acquisition is allocated to individual asset and liability accounts.
Priority accounts – always recorded at fair value
Non-priority accounts – discounted
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21. Priority Accounts All current assets All liabilities
All investments (exception- controlled entities)
Excess assets included in purchase
Deferred tax assets and liabilities
Prepaid assets relating to postretirement benefits
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22. Price Zone Analysis Fair Value Group Total Cum. Total
Price zone analysis – guides assignment of price paid.
Example: Johnson Company
Calculate the market value net assets:
Fair Value Group Total Cum. Total
Priority Accounts receivable 28,000
Inventory 45,000
Current liabilities (5,000)
Bonds payable (21,000) 47,000 47,000
Non-priority Land 50,000
Buildings (net) 80,000
Equipment (net) 50,000
Patent (net) 30,000
Copyright 40, , ,000
Total Market Value = $297,000
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23. Price Zone Analysis (continued)
Determine the 3 price zones:
Premium: Over $297,000
All accounts at fair value; goodwill for price over $297,000
Bargain: $47,000 [priority] to $297,000
Priority accounts at fair value; balance allocated to nonpriority accounts
Extraordinary Gain: Below $47,000
Priority accounts at fair value; other accounts not recorded; extraordinary gain for excess of priority accounts over price paid
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24. Purchase Allocation Bargain Price: $210,000
$47,000 for priority accounts; $163,000 allocated to fixed and identifiable intangible assets
Allocation Table
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25. Purchase Entry Bargain Price: $210,000
Accounts Receivable 28,000
Inventory (fair value) 45,000
Land (allocation) 32,600
Building (allocation) 52,160
Equipment (allocation) 32,600
Patent (allocation) 19,560
Copyright (allocation) 26,080
Current liabilities 5,000
Bonds payable (face value) 20,000
Bonds payable premium (to fair value) 1,000
Cash 10,000
Common Stock (4,000 shares x $1) 4,000
Paid-in Capital in Excess of Par 196,000
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26. Purchase Entry Extraordinary Gain: $30,000 Purchase Price
Price is below $47,000; there is no value to assign to fixed and identifiable intangible assets
Accounts receivable 28,000
Inventory (fair value) 45,000
Extraordinary gain 7,000
Current liabilities 5,000
Bonds payable 20,000
Bonds pay premium (to fair value) 1,000
Cash 10,000
Common Stock (600 shares x $1) 600
Paid-In Capital in Excess of Par 29,400
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27. Purchase Complications
May have to calculate market value of debt issues
Leases retain classification; related accounts recorded at market value
Deferred tax liability (DTL) goes with assets in nontaxable exchange
Tax loss carryover is usually recorded as an asset; if realization is uncertain, it is not recorded and is buried in goodwill
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28. Purchase Complications (continued)
There may be contingent goodwill payment
Added goodwill is recorded
Price guarantees cover decline in value of securities issued in purchase
If issued, value assigned to securities is adjusted
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29. Purchase: Some Fine Points
Direct acquisition costs are paid to outside parties; include them in the price paid
Indirect acquisition costs are internally incurred; they are expensed
Issue costs are to issue bonds or stock; they are subtracted from the value assigned to the securities
Stocks and bonds issued are always recorded at fair value in a purchase
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30. Example of Tax-Free Exchange
The price paid for a company is $431,000
$6,000 in direct costs
8,500 shares of $10 par value common stock with a fair value of $40 per share
Priority Accounts: Fair Value
Inventory 50,000
Liabilities (80,000)
Non-priority Accounts:
Land: Book Value = $100, ,000
Building: Book Value = $200, ,000
Deferred tax liability – Bldg. (30,000)
Total $340,000
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31. Example of Tax-Free Exchange - Continued
The tax rate is 30%
A $30,000 DTL goes with the machine
($100,000 x 30%)
$91,000 is available for goodwill (net of a 30% DTL)
($431,000 – 340,000)
Goodwill = $130,000
$39,000  (1.0 – .3)
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32. Tax-Free Exchange: Journal Entry
Inventory 50,000
Land (fair value) 100,000
Building (fair value) 300,000
Goodwill (gross value) 130,000
Liabilities 80,000
Deferred tax liability* 69,000
Cash 6,000
Common Stock ($10 par, 8500 shares) 85,000
Paid-in Capital in Excess of Par 340,000
*$30,000 on Building and $39,000 on goodwill
The DTLs are amortized over the same life (and by the same method) as the assets to which they attach
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