Business Combinations

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1: Economic Motivations
Business Combinations
Types of Business Combinations
Business combinations unite previously separate business
entities.
 Horizontal integration – same business lines and markets
 Vertical integration – operations in different, but successive
stages of production or distribution, or both
 Conglomeration – unrelated and diverse products or services
Reasons for Combinations
 Cost advantage
 Lower risk
 Fewer operating delays
 Avoidance of takeovers
 Acquisition of intangible assets
 Other: business and other tax advantages, personal reasons
Potential Prohibitions/ Obstacles
 Antitrust
 Federal Trade Commission prohibited Staples’ acquisition of
Office Depot
 Regulation
 Federal Reserve Board
 Department of Transportation
 Federal Communications Commission
 Some states have antitrust exemption laws to protect
hospitals
2: Forms of Business Combinations
Business Combinations
Legal Form of Combination
 Merger
 Occurs when one corporation takes over all the operations of
another business entity and that other entity is dissolved.
 Consolidation
 Occurs when a new corporation is formed to take over the
assets and operations of two or more separate business entities
and dissolves the previously separate entities.
Mergers: A + B = A
1) Company A purchases the assets of Company B for cash,
other assets, or Company A debt/equity securities. Company B is
dissolved; Company A survives with Company B’s assets
and liabilities.
2) Company A purchases Company B stock from its
shareholders for cash, other assets, or Company A debt/equity
securities. Company B is dissolved. Company A survives with
Company B’s assets and liabilities.
Consolidations: E + F = “D”
1) Company D is formed and acquires the assets of Companies
E and F by issuing Company D stock. Companies E and F are
dissolved. Company D survives, with the assets and
liabilities of both dissolved firms.
2) Company D is formed acquires Company E and F stock
from their respective shareholders by issuing Company D
stock. Companies E and F are dissolved. Company D
survives with the assets and liabilities of both firms.
3: Accounting for Business
Combinations
Business Combinations
Business Combination (def.)
“A business combination is a transaction or other event in which
an acquirer obtains control of one or more businesses.
Transactions sometimes referred to as ‘true mergers’ or
‘mergers of equals’ also are business combinations…” [FASB
Statement No. 141, para. 3.e.]
A parent – subsidiary relationship is formed when:
 Less than 100% of the firm is acquired, or
 The acquired firm is not dissolved.
International Accounting
 Most major economies prohibit the use of the pooling
method.
 The International Accounting Standards Board specifically
prohibits the pooling method and requires the acquisition
method. [IFRS 3]
Recording Guidelines (1 of 2)
 Record assets acquired and liabilities assumed using the fair
value principle.
 If equity securities are issued by the acquirer, charge
registration and issue costs against the fair value of the
securities issued, usually a reduction in additional paid-in-
capital.
 Charge other direct combination costs (e.g., legal fees, finders’
fees) and indirect combination costs (e.g., management salaries)
to expense.
 Recording Guidelines (2 of 2)
 When the acquiring firm transfers its assets other than cash as part
of the combination, any gain or loss on the disposal of those assets
is recorded in current income.
 The excess of cash, other assets and equity securities transferred
over the fair value of the net assets (A – L) acquired is
recorded as goodwill.
 If the net assets acquired exceeds the cash, other assets and equity
securities transferred, a gain on the bargain purchase is recorded in
current income.
Example: Poppy Corp. (1 of 3)
Poppy Corp. issues 100,000 shares of its $10 par value common
stock for Sunny Corp. Poppy’s stock is valued at $16 per
share. (in thousands)

Investment in Sunny Corp. 1,600

Common stock, $10 par 1,000
Additional paid-in-capital 600

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publishing as Prentice Hall
Example: Poppy Corp. (2 of 3)
Poppy Corp. pays cash for $80,000 in finder’s fees and consulting
fees and for $40,000 to register and issue its common stock. (in
thousands)

Investment expense 80
Additional paid-in-capital 40
Cash 120
Sunny Corp. is assumed to have been dissolved. So, Poppy Corp.
will allocate the investment’s cost to the fair value of the
identifiable assets acquired and liabilities assumed. Excess cost is
goodwill.
1-16 © Pearson Education, Inc.
publishing as Prentice Hall
4: Cost Allocations Using the
Acquisition Method
Business Combinations
Identify the Net Assets Acquired
Identify:
1. Tangible assets acquired,
2. Intangible assets acquired, and
3. Liabilities assumed
Include:
• Identifiable intangibles resulting from legal or contractual
rights, or separable from the entity
• Research and development in process
• Contractual contingencies
• Some noncontractual contingencies
Assign Fair Values to Net Assets
Use fair values determined, in preferential order, by:
1. Established market prices
2. Present value of estimated future cash flows, discounted
based on observable measures
3. Other internally derived estimations
Exceptions to Fair Value Rule
 Deferred tax assets and liabilities [FASB Statement No. 109 and
FIN No. 48]
 Pensions and other benefits [FASB Statement No. 158]
 Operating and capital leases [FASB Statement No. 13 and FIN.
No. 21]
 Goodwill on the books of the acquired firm is assigned no
value.
Goodwill
The excess of
 The sum of:
 Fair value of the consideration transferred,
 Fair value of any noncontrolling interest in the acquiree, and
 Fair value of any previously held interest in acquiree,
 Over the net assets acquired.
Example – Pitt Co. Data
Pitt Co. acquires the net assets of Seed Co. in a combination
consummated on 12/27/2008. The assets and liabilities of
Seed Co. on this date, at their book values and fair values, are
as follows (in thousands):
 Book Val. Fair Val.
Cash $ 50 $ 50
Net receivables 150 140
Inventory 200 250
Land 50 100
Buildings, net 300 500
Equipment, net 250 350
Patents 0 50
Total assets $1,000 $1,440
Accounts payable $ 60 $ 60
Notes payable 150 135
Other liabilities 40 45
Total liabilities $ 250 $ 240
Net assets $ 750 $1,200
Acquisition with Goodwill
Pitt Co. pays $400,000 cash and issues 50,000 shares of Pitt Co.
$10 par common stock with a market value of $20 per share
for the net assets of Seed Co.
Total consideration at fair value (in thousands):
$400 + (50 shares x $20) $1,400
Fair value of net assets acquired: $1,200
Goodwill $ 200
Entries with Goodwill
The entry to record the acquisition of the net assets:

Investment in Seed Co. 1,400

Cash 400
Common stock, $10 par 500
Additional paid-in-capital 500
The entry to record Seed’s assets directly on Pitt’s books:
Cash 50
Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Goodwill 200
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,400
Acquisition with Bargain Purchase
Pitt Co. issues 40,000 shares of its $10 par common stock with
a market value of $20 per share, and it also gives a 10%, five-
year note payable for $200,000 for the net assets of Seed Co.
Fair value of net assets acquired (in thousands):
$1,200
Total consideration at fair value:
(40 shares x $20) + $200 $1,000
Gain from bargain purchase $ 200
Entries with Bargain Purchase
The entry to record the acquisition of the net assets:

Investment in Seed Co. 1,000

10% Note payable 200
Common stock, $10 par 400
Additional paid-in-capital 400
The entry to record Seed’s assets directly on Pitt’s books:
Cash 50
Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,000
Gain from bargain purchase 200