4020 ch 1
subsidiary assets and liabilities book value of the net assets transferred. lower fair value book values
Accounting for Internal Expansion: Creating Business Entities The transferring company creates a _____ that it owns and controls. The company transfers _______ to an entity that the company has created and controls and in which it holds majority ownership. The company transfers assets and liabilities to the created entity at book value, and the transferring company recognizes an ownership interest in the newly created entity equal to the ________ If assets are impaired prior to the time of transfer, the transferring company should recognize an impairment loss and transfer the assets to the new entity at the _____. Subsidiary records all assets and liabilities received in the transfer at the _____ at the time of transfer.
•Cash •Common stock •Preferred stock •Notes receivable or bonds •Used trucks
Acquirer's Cost: Category 1 (1 of 2) types of consideration
•Use the FMV of the consideration given •Use the FMV of the property received . . . if it is more readily determinable
Acquirer's Cost: Category 1 (2 of 2) general rule... exception...
expense direct costs of issuing stock
Acquirer's Cost: Category 2 In the past, costs traceable to the acquisition were capitalized: •Legal fees—the acquisition agreement •Purchase investigation fees •Finder's fees •Travel costs •Professional consulting fees ASC 805 requires that they be ______ in the acquisition period. Do NOT expense _____; charge to Additional-Paid In Capital
unresolved future event FV market
Acquirer's Cost: Category 3 Contingent Consideration •Contingent payments depending on some _______ (Example: agree to issue additional shares in 6 months if shares given lose value) •Record at ____ as of the acquisition date. •Mark to ____ each subsequent period until the contingent event is resolved
legal considerations
Acquiring Assets vs. Stock Major Decision Factors ____—Buyer must be extremely careful NOT to assume responsibility for (and thus "inherit") the target company's
-tax considerations -ease of consummation
Acquiring Assets vs. Stock (2 of 2) Major Decision Factors (continued) -_________—Often requires major negotiations involving resolution of (1) seller's tax desires, (2) buyer's tax desires -______—acquiring common stock is simple compared with acquiring assets
<100% its acquisition-date fair value.
Acquisition Accounting •If ______ of the acquiree is acquired, the noncontrolling interest also is measured at its acquisition-date fair value. •If the acquiring company already had an ownership interest in the acquiree, that investment is also measured at ______
full acquisition-date fair values percentage ownership acquisition expense
Applying the Acquisition Method The _____ of the individual assets acquired, both tangible and intangible, and liabilities assumed in a business combination are recognized by the consolidated entity. This is true regardless of the ____ acquired by the controlling entity. All costs of bringing about and consummating a business combination are charged to an _____ as incurred.
limited
Because a subsidiary is a separate legal entity, the parent's risk associated with the subsidiary's activities is _____
statutory combination
Both combining companies are dissolved and the assets and liabilities of both companies are transferred to a newly created corporation. Result: one "new" legal entity survives In many situations, however, the resulting corporation is new in form only, and in substance it actually is one of the combining companies reincorporated with a new name.
•May inherit contingent liabilities or unwanted labor union connection •May acquire unwanted facilities/units •Will likely be hard to access target's cash
Disadvantages of Acquiring Common Stock
external expansion
Expansion through business combinations •Entry into new product areas or geographic regions by acquiring or combining with other companies
Bargain purchase element
FMV < FMV of net assets
neither goodwill or bargain purchase element
FMV = FMV of net assets
Good will
FMV > FMV of net assets
1.The consideration it exchanges in a business combination, 2.Each of the individual assets and liabilities acquired, 3.Any noncontrolling interest in the acquiree, and 4. Any interest already held in the acquiree best measure
Fair Value Measurements The acquirer must value at fair value: The value of the consideration given in the exchange is usually the _____ of the value received and, therefore, reflects the value of the acquirer's interest in the acquiree.
friendly merger or hostile takeover
Forms of Business Combination—Details Option #1: Statutory Merger 2 types of mergers
- new -both -temporary subsidiary -liquidated -One legal entity
Forms of Business Combination—Details (Option #2) Option #2: Statutory Consolidation •___ corporation (Newco) is created •Newco issues stock to ___ combining companies in exchange for their stock •Each combining company becomes a _____ of Newco •Both subs are _____ into Newco and become divisions •Result:_____ survives
holding company
Forms of Business Combination—Details (Option #3) Option #3: _______ •Similar to a statutory consolidation except that the two subsidiaries are NOT liquidated into newly formed parent corporation. Instead, the new company issues its stock to the shareholders of the two existing corporations in exchange for their stock in the two new subsidiary corporations
D. Has led to increasingly complex organizational structures as management has attempted to achieve its business objectives. As companies grow in size and respond to their unique business environment, they often develop complex organizational and ownership structures.
Growth in the complexity of the U.S. business environment Multiple Choice A. Has encouraged companies to reduce the number of operating divisions and product lines so they may better control those they retain. B. Has led to increased use of partnerships to avoid legal liability. C. Has had no particular impact on the organizational structures or the way in which companies are managed. D. Has led to increasingly complex organizational structures as management has attempted to achieve its business objectives.
d. a change of basis in accounting occurs
In acquisition accounting, a.common stock must be the consideration given. b.goodwill is not reported. c.a statutory merger occurs. d.a change of basis in accounting occurs. e.none of the above.
purchasing method, pooling of interests method
In the past, there were two methods of accounting for business combinations:
- pooling of interest -acquisition
Major changes •FASB eliminated the ______ method •FASB issued ASC 805 that replaced the purchase method with the ____ method, which is now the only acceptable method of accounting for business combinations
acquisition of stock
Methods of Effecting Business Combinations •A majority of the outstanding voting shares usually is required unless other factors lead to the acquirer gaining control •Noncontrolling interest: the total of the shares of an acquired company not held by the controlling shareholder
acquisition of assets
Methods of Effecting Business Combinations •Sometimes one company acquires another company's assets through direct negotiations with its management •Statutory merger •Statutory consolidation
stock aquitistion
One company acquires the voting shares of another company and the two companies continue to operate as separate, but related, legal entities. The acquiring company accounts for its ownership interest in the other company as an investment. The relationship that is created is referred to as a parent-subsidiary relationship. For general-purpose financial reporting, a parent company and its subsidiaries present consolidated financial statements.
C. No change in the reported net assets of Pead Corporation. The assets are transferred at the carrying value on Pead's books, and thus no change in reported net assets occurs.
Pead Corporation established a new subsidiary and transferred to it assets with a cost of $90,000 and a book value of $75,000. The assets had a fair value of $100,000 at the time of transfer. The transfer will result in Multiple Choice A. A reduction of net assets reported by Pead Corporation of $90,000. B. A reduction of net assets reported by Pead Corporation of $75,000. C. No change in the reported net assets of Pead Corporation. D. An increase in the net assets reported by Pead Corporation of $25,00
A. $15,000 $15,000. The carrying value of the reporting unit's net assets ($575,000) exceeds the fair value of the reporting unit's net assets ($560,000). The goodwill should be impaired by the amount by which the carrying value of the unit's net assets exceeds the fair value of its net assets, $15,000 ($575,000 - $560,000).
Pill Company has a reporting unit and the fair value of its net identifiable assets of $500,000. The carrying value of the reporting unit's net assets on Pill's books is $575,000, which includes $90,000 of goodwill. The fair value of the reporting unit's net assets is $560,000. Pill should report impairment of goodwill of Multiple Choice A. $15,000. B. $30,000. C. $0. D. $60,000.
B. Equipment at $100,000 and accumulated depreciation of $40,000. When the parent creates the subsidiary, the equipment is transferred at cost with the accompanying accumulated depreciation (which in effect is the book value). ($100,000/10 = $10,000 per year * 4 = $40,000.)
Popper Company established a subsidiary and transferred equipment with a fair value of $72,000 to the subsidiary. Popper had purchased the equipment with a 10-year expected life 4 years earlier for $100,000 and has used straight-line depreciation with no expected residual value. At the time of the transfer, the subsidiary should record Multiple Choice A. Equipment at $72,000 and no accumulated depreciation. B. Equipment at $100,000 and accumulated depreciation of $40,000. C. Equipment at $120,000 and accumulated depreciation of $48,000. D. Equipment at $60,000 and no accumulated depreciation.
A. $35,000 $35,000. Since the carrying value of the reporting unit ($330,000) is lower than the fair value of the reporting unit's net assets ($350,000), the goodwill of the reporting unit is not impaired and will remain at its carrying value of $35,000.
Pout Company reports assets with a carrying value of $420,000 (including goodwill with a carrying value of $35,000) assigned to an identifiable reporting unit purchased at the end of the prior year. The fair value of the reporting unit is currently $350,000, and the carrying value of the net assets held by the reporting unit is $330,000. At the end of the current period, Pout should report goodwill of Multiple Choice A. $35,000. B. $45,000. C. $10,000. D. $25,000.
- size - potential - diversification - management -prestige
Reasons for enterprise expansion •___ often allows economies of scale •New earning ___ •Earnings stability through ___ •____rewards for bigger company size - ____ associated with company size
B. Additional paid-in capital of $84,000. APIC = $140,000 (BV) - 7,000 * $8 = $84,000.
Salt Company, a newly established subsidiary of Pepper Corporation, received assets with an original cost of $260,000, a fair value of $200,000, and a book value of $140,000 from the parent in exchange for 7,000 shares of Salt's $8 par value common stock. Salt should record Multiple Choice A. Additional paid-in capital of $204,000. B. Additional paid-in capital of $84,000. C. Additional paid-in capital of $144,000. D. Additional paid-in capital of $0.
Category #1: The fair value of the consideration given Category #2: Certain out-of-pocket direct costs •In the past, these were included in acquisition •Now expense! Category #3: Contingent consideration •Paid subsequent to the acquisition date
The Acquisition Method: Items Included in the Acquirer's Cost 3 categories
statutory merger
The acquired company's assets and liabilities are transferred to the acquiring company, and the acquired company is dissolved, or liquidated. The operations of the previously separate companies are carried on in a single legal entity following the merger. Result: one legal entity survives
Acquisition Accounting
The acquirer recognizes all assets acquired and liabilities assumed in a business combination and measures them at their acquisition-date fair values.
e. non of the above
To qualify for acquisition accounting treatment, a.one company must acquire common stock of the other combining company. b.a statutory consolidation must occur. c.each company must be approximately the same size. d.a stock-for-stock exchange must occur. e.none of the above.
cash securities
Valuation of Business Entities Valuation of consideration exchanged -____: little dificulty -____: •unless traded in the market, estimates of their value must be made
Value
Valuation of Business Entities Value of individual assets and liabilities -_____usually determined by appraisal
goiing concern value
Valuation of Business Entities Value of potential earnings •"_______" based on: -A multiple of current earnings -Present value of the anticipated future net cash flows generated by the company
D. The fair value of the reporting unit is less than its carrying value. This is the proper impairment test required under US GAAP, according to FASB 142/ASC 350.
When a company assigns goodwill to a reporting unit acquired in a business combination, it must record an impairment loss if Multiple Choice A. The carrying value of the reporting unit is less than the fair value of the reporting unit. B. The fair value of the net identifiable assets held by a reporting unit decreases. C. The fair value of the reporting unit decreases. D. The fair value of the reporting unit is less than its carrying value.
c. investment in the subsidiary
When a parent company creates a subsidiary through internal expansion, the parent's journal entry to transfer assets to the newly created entity will include a debit to a.Acquisition Expense. b.Cash. c.Investment in Subsidiary. d.Common Stock. e.none of the above.
D. The new entity records both the assets and liabilities it received at the carrying values of the original company. In an internal expansion in which the existing company creates a new subsidiary, the assets and liabilities are recorded at the carrying values of the original company.
When an existing company creates a new subsidiary and transfers a portion of its assets and liabilities to the new entity Multiple Choice A. The original company records the difference between the carrying values and the fair values of the assets transferred to the new entity as goodwill. B. The new entity records both the assets and liabilities it received at fair values. C. The original company records a gain or loss on the difference between its carrying values and the fair values of the assets transferred to the new entity. D. The new entity records both the assets and liabilities it received at the carrying values of the original company.
D. Poker acquires Spade Corporation in a business combination recorded as a merger. When a merger occurs, all the assets and liabilities are transferred to the purchasing company and any excess of the purchase price over the fair value of the net assets is recorded as goodwill on the purchaser's books.
Which of the following actions is likely to result in recording goodwill on Poker Company's books? Multiple Choice A. Poker acquires a majority of Spade's common stock in a business combination and continues to operate it as a subsidiary. B. Poker distributes ownership of a newly created subsidiary in a distribution considered to be a spin-off. C. Poker distributes ownership of a newly created subsidiary in a distribution considered to be a split-off. D. Poker acquires Spade Corporation in a business combination recorded as a merger.
A. The parent wishes to be able to increase its reported sales by transferring products to the subsidiary at the end of the fiscal year. A transfer of product to a subsidiary does not constitute a sale for income purposes and as such would not increase profit for the parent.
Which of the following is not an appropriate reason for establishing a subsidiary? Multiple Choice A. The parent wishes to be able to increase its reported sales by transferring products to the subsidiary at the end of the fiscal year. B. The parent wishes to protect existing operations by shifting new activities with greater risk to a newly created subsidiary. C. The parent wishes to reduce its taxes by establishing a subsidiary that focuses its operations in areas where special tax benefits are available. D. The parent wishes to avoid subjecting all of its operations to regulatory control by establishing a subsidiary that focuses its operations in regulated industries.
goodwill goodwill/ TFV / FV goodwill
_____as it relates to business combinations consists of all those intangible factors that allow a business to earn above-average profits Under the acquisition method, an acquirer measures and recognizes ______ from a business combination based on the difference between the ______ of the acquired company and the ______ of its net identifiable assets. The fair value of the consideration given is compared with the acquisition-date fair value of the acquiree's net identifiable assets, and any excess is _____.
•Easy transfer •May inherit nontransferable contracts
advantages of aquiring common stock
1990s
al previous records of merger activity shattered
ASC 805
an intangible asset should be recognized separately from goodwill only if its benefits can be separately identified
early 2000s
downturn and decline of mergers
2007-2008
effect of the credit crunch
seller's tax desires buyer's tax desire
example of tax considerations when deciding whether to acquire stock or assets
ASC 805
finite intangible assets should be amortized over their useful life with no arbitrary cap
1980s
increase in number of business combos -leveraged buyouts and the resulting debt
2003
increased activity toward the middle of ___ that accelerated through the middle of the decade -role of private equity
1. intangible arises from a legal or contractual right. 2. intangible does not arise from a legal or contractual right but is separable
intangible assets recognized under the ASC 805 are recorded at fair value but only if either of the what 2 criteria are met:
subsidiary
is a corporation that is controlled by another corporation, referred to as a parent company
•Will not inherit a target's contingent liabilities (excluding environmental) •Will not inherit a target's unwanted labor union
major advantages of acquiring assets
•Transfer of titles on real estate and other assets can be time-consuming •Transfer of contracts may not be possible
major disadvantages of acquiring assets
1960s
merger boomer - conglomerates
- control/ operating results - tax - regulatory - legal liability - existing operations
motivating factors for internal expansion: •Helps establish clear lines of ____ and facilitate the evaluation of _______ •Special ____incentives •___ reasons •Protection from ___ •Disposing of a portion of ___
•Subsidiaries •Partnerships •Joint ventures •Special entities
new entities created through internal expansion
parent-subsidiary relationship
organization acquiring common stock results in a
homeoffice-branch/division relationship
organization acquiring target's assets results in ....
control
relates to the ability to direct policies and management
informal and formal
the unusual way includes 2 types of arrnagments
internal and external
two types of expansion
not be amortized, but tested for impairment
under the ASC 805, some intangible assets (such as goodwill) may have an indefinite or infinite life. They should...
unrecorded liabilities, contingent liabilites (lawsuits)
what are 2 examples of legal considerations with deciding whether to acquire stock or assets
to get companies to recognize intangibles separately from goodwill
what is the purpose of ASC 805
g. none of the above
which of the following costs can be added to the cost of an acquisition: a. legal fees. b. accounting fees. c. cost of issuing common stock. d. a pro rata portion of the CEO's salary e. travel costs f. costs of the M&A department g. none of the above
merger
•A business combination in which the acquired business's assets and liabilities are combined with those of the acquiring company
-controlling ownership -consolidated
•A business combination in which the acquired company remains as a separate legal entity with a majority of its common stock owned by the purchasing company leading to a parent-subsidiary relationship •Accounting standards normally require _____ financial statements
acquisition method
•Consistent with FASB's intention to move accounting in general more toward recognizing fair values •The acquirer values the acquired company based on the fair value of the consideration given in the combination and the fair value of any noncontrolling interest not acquired by the acquirer
formal arrangment
•Consummation of a written agreement requires recognition on the books of one or more of the companies that are a party to the combination
unusual way
•Having contractual agreements or financial arrangements that effectively achieve control
pooling of interest method
•No longer allowed! •The book values of the combining companies were carried forward to the combined company and no revaluations to fair value were made •Did not result in write-ups or goodwill that might burden future earnings with additional depreciation or write-offs •Managers loved it!
spinoff
•Occurs when the ownership of a newly created or existing subsidiary is distributed to the parent's stockholders without the stockholders surrendering any of their stock in the parent company
split off
•Occurs when the subsidiary's shares are exchanged for shares of the parent, thereby leading to a reduction in the outstanding shares of the parent company
hostile takeover
•One company buys the stock of another, creating a temporary parent-subsidiary relationship •The parent then liquidates the subsidiary into the parent pursuant to state laws - A comp takes all of T's assets and liquidates the corporate shell result: 1 entity survives
other beneficial interest
•One company may have a beneficial interest in another entity even without a direct ownership interest •_____ may be defined by the agreement establishing the entity or by an operating or financing agreement
friendly merger
•One entity transfers assets to another in exchange for stock and/or cash •It liquidates pursuant to state laws -need shareholder approval from both corps result: 1 entity survives
usual way
•Owning more than 50% of the subsidiary's outstanding voting stock (50% plus only 1 share will do it)
noncontrolling ownership
•The purchase of a less-than-majority interest in another corporation does not usually result in a business combination or a controlling situation
manipulation of financial statemenrs
•The use of subsidiaries or other entities to borrow money without reporting the debt on their balance sheets (using special entities to manipulate profits) •Manipulation of accounting for mergers and acquisitions (creative acquisition accounting)
business combination
•occurs when ". . . an acquirer obtains control of one or more businesses"
e. none of the above
A form of consideration that is not allowed in acquisition accounting is: a. cash b. bonds. c. preferred stock. d. common stock. e. none of the above
c. statutory merger
A way to force out a target company's dissenting shareholders is to use a.acquisition accounting. b.pooling-of-interests accounting. c.a statutory merger. d.a statutory consolidation. e.none of the above.
•Statutory merger •Statutory consolidation •Stock acquisition
Accounting for External Expansion: Business Combinations There are three primary legal forms of business combinations:
