CHAPTER 5

THE PURCHASE METHOD: AT DATE OF ACQUISITION 100% OWNERSHIP

FOCUS OF CHAPTER 5
The Purchase Method in Depth: Total Acquisition Cost Goodwill and Bargain Purchase Elements Consolidation WorksheetsAt the Acquisition Date: Acquiring Assets vs. Common Stock Non-Push-Down Accounting Push-Down Accounting (a preview)

The Purchase Method: Items That Can

Comprise The Acquirers Cost

CATEGORY #1: The fair value of the consideration given. CATEGORY #2: Certain out-of-pocket direct costsmust be directly traceable to the specific acquisition. CATEGORY #3: Contingent consideration will be paid subsequent to the acquisition date (if paid at all).

Acquirers Cost: Category 1The Consideration Given

Types of Consideration: In purchase accounting, the consideration given can be of any type:

Cash. Common stock. WSJ--11/22/06... 77 5/8 Preferred stock. Notes or Bonds Payable. Used trucks.

Category 1The Consideration Given

General Rule:

Acquirers Cost:

Use the FMV of the consideration given. Use the FMV of the property received if it is more readily determinable.

Exception:

Acquirers Cost: Category 2Certain Direct Costs

Must Be Traceable to The Acquisition:

Legal feesthe acquisition agreement. Purchase investigation fees. Finders fees. Travel costs. Professional consulting fees.

NO allocation allowed of G&A overhead. NO direct costs of issuing stock (charge to APIC).

Category 3Contingent Consideration

Contingencies Based on Other Than Security Prices:

Acquirers Cost:

Accrue when it becomes determinable beyond a reasonable doubt. This point in time is later than the probable date. The cost of the acquisition is increased in later periods when the accrual is actually made (usually increases goodwill).

Acquirers Cost: Category 3Contingent Consideration

Contingencies Based on Security Prices (to be maintained or attained): CANNOT result in an increase at a later date in the initially recorded cost of the acquisition. Use the security price to be maintained or attained to record the acquisition. This price is the true bargained cost of the acquisition.

Goodwill Vs. A Bargain Purchase Element: Can Have ONE But Not BOTH
Cost in excess of Current Value = Current Value in excess of Cost = Current Value equals Cost =

GW BPE Neither GW nor BPE

Goodwill: What to Do With It?

GOODWILLUsually Exists When Acquiring a Winner or a Potential Winner:

Must capitalize as an asset. Cannot amortize to earnings. Must periodically (at least annually) assess for impairment. If impaired, must write it downcharge to earnings.

Bargain Purchase Element:

What to Do With It?

BARGAIN PURCHASE ELEMENTUsually Exists When Acquiring a Troubled Company:

Extinguish against certain specified assets to extent possible. Any unextinguished amount is credited to earningsreported as an extraordinary item.

Push-Down Accounting:

The EASIER Way

Push-Down Accounting (an absolute gem): In the subsidiarys general ledger: Adjust assets and liabilities to FV based on the parents purchase price. This establishes a new basis of accounting. Record goodwill. Discussed in depth in Chapter 7.

Nonpush-Down Accounting:

The HARDER Way

Non-Push-Down Accounting:

Dont touch the subsidiarys general ledger (treat like a sacred cow).
Make fair value adjustments and record goodwill in consolidation (on the worksheets).

Push-Down Vs. Non-Push-Down

Push-Down Accounting: Consolidation effort is minimal (has received the Better Book-keeping stamp of approval). Non-Push-Down Accounting: Consolidation effort is cumbersome (often a headache).

Consolidation Consequences:

Push-Down Vs. Non-Push-Down Accounting: The Bottom Line The consolidated financial statement amounts are the SAME whether the parent selects: Push-down accounting or Non-push-down accounting. ONLY the accounting procedures differ.

Intangible Assets: More of Them Are Recognized under FAS 141

Record at fair value only if either of the following two criteria are met: #1: Intangible arises from a legal or #2:

contractual right. Intangible does not arise from a legal or contractual right but is separable.

Identifiable Intangible Assets

Marketing-related: Trademarks, service marks Trade dress (unique package color or design) Non-compete agreements

Identifiable Intangible Assets

Customer-related: Customer lists Customer order backlog Customer contracts Customer relationships

Identifiable Intangible Assets

Technology-based: Secret formulas, processes, recipes Patented and unpatented technology Contract-based: Licensing, royalties Advertising, supply contracts Artistic-related: Video and audiovisual material Pictures and photographs

Review Question #1
What results for each of the following situations? Goodwill CV CV CV CV BV > < > < = BV.. BV.. Cost Cost Cost.... BPE Unable To Tell

Review Question #1
With Answer
What results for each of the following situations? Goodwill BPE Unable To Tell X X

CV CV CV CV BV

> < > < =

BV.. BV.. Cost Cost Cost....

X
X

Review Question #2
What results for each of the following situations? Goodwill BPE Unable To Tell

Cost Cost Cost Cost CV =

> BV.... < BV.... > CV.... = CV.... BV....

Review Question #2
With Answer
What results for each of the following situations? Goodwill BPE Unable To Tell X X

Cost Cost Cost Cost CV =

> BV.... < BV.... > CV.... = CV.... BV....

X X

Review Question #3
A form of consideration that is NOT allowed in purchase accounting is: A. Cash. B. Bonds. C. Preferred stock. D. Common stock. E. None of the above.

Review Question #3
With Answer
A form of consideration that is NOT allowed in purchase accounting is: A. Cash. B. Bonds. C. Preferred stock. D. Common stock. E. None of the above.

Review Question #4
Which of the following costs CANNOT be added to the cost of an acquisition? A. Legal fees. B. Accounting fees. C. Costs of issuing common stock. D. A pro rata portion of the CEOs salary. E. Travel costs. F. Costs of the M&A department.

Review Question #4
With Answer
Which of the following costs CANNOT be added to the cost of an acquisition? A. Legal fees. B. Accounting fees. C. Costs of issuing common stock. D. A pro rata portion of the CEOs salary. E. Travel costs. F. Costs of the M&A department.

Review Question #5
An account of the acquired company that CANNOT be revalued to its current value under purchase accounting is: A. Notes receivable. B. Bonds payable. C. Investment in marketable securities. D. Patents. E. None of the above.

Review Question #5
With Answer
An account of the acquired company that CANNOT be revalued to its current value under purchase accounting is: A. Notes receivable. B. Bonds payable. C. Investment in marketable securities. D. Patents. E. None of the above.

Review Question #6
Push-down-accounting can be used: A. Only in a goodwill situation. B. Only in a BPE situation. C. In either a goodwill situation or a BPE situation. D. Only in a COST = CV situation. E. None of the above.

Review Question #6
With Answer
Push-down-accounting can be used: A. Only in a goodwill situation. B. Only in a BPE situation. C. In either a goodwill situation or a BPE situation. D. Only in a COST = CV situation. E. None of the above.

Review Question #7
The consolidated financial statements are identical regardless of whether the parent: A. Uses push-down or non-push-down accounting. B. Acquires 100% of the common stock or 100% of the assets. C. Both A and B. D. Neither A or B.

Review Question #7
With Answer
The consolidated financial statements are identical regardless of whether the parent: A. Uses push-down or non-push-down accounting. B. Acquires 100% of the common stock or 100% of the assets. C. Both A and B. D. Neither A or B.

End of Chapter 5
Time to Clear Things UpAny Questions?