McGraw-Hill Education

Chapter 1

Intercorporate
Acquisitions and
Investments in
Other Entities
Copyright © 2016 by McGraw-Hill Education, All rights reserved.
Learning Objective 1-1

Understand and explain the

reasons for and different
methods of business
expansion, the types of
organizational structures, and
the types of acquisitions.

2
 Enterprise Expansion

◆ Reasons for enterprise expansion

■ Size often allows economies of scale
■ New earning potential
■ Earnings stability through diversification
■ Management rewards for bigger company size
■ Prestige associated with company size

3
 Business Objectives

◆ A subsidiary is a corporation that is

controlled by another corporation,
referred to as a parent company.
■ Control is usually through majority
ownership of its common stock.
P
◆ Because a subsidiary is a separate
legal entity, the parent’s risk
associated with the subsidiary’s S
activities is limited.

4
 Frequency of Business Combinations
◆ 1960s − Merger boom
■ Conglomerates
◆ 1980s − Increase in the number of business
combinations
■ Leveraged buyouts and the resulting debt
◆ 1990s − All previous records for merger activity
shattered
◆ Downturn of the early 2000s, and decline in
mergers
◆ Increased activity toward the middle of 2003 that
accelerated through the middle of the decade
■ Role of private equity
◆ Effect of the credit crunch of 2007-2008 5
 Ethical Considerations

◆ Manipulation of financial reporting

■ 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
● Pooling-of-interests allowed for manipulation
● The FASB did away with it and modified acquisition
accounting

6
 Business Expansion and Forms of
Organizational Structure
◆ Two Types of Expansion
■ Internal Expansion
■ External Expansion

P Assets

P
Sub
Shareholders
Internal Stock Assets External Stock
Expansion Expansion

S S
7
 Internal Expansion: Creating a Business Entity
◆ New entities are created
■ Subsidiaries
■ Partnerships
■ Joint ventures
■ Special entities
◆ Motivating factors:
■ Helps establish clear lines of control and facilitate the
evaluation of operating results
■ Special tax incentives
■ Regulatory reasons
■ Protection from legal liability
■ Disposing of a portion of existing operations

8
 Internal Expansion: Creating a Business Entity

◆ A spin-off
■ 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
◆ A 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

9
 External Expansion: Business Combinations

◆ Expansion through business combinations

■ Entry into new product areas or geographic regions by
acquiring or combining with other companies
■ A business combination occurs when “. . . an acquirer
obtains control of one or more businesses”
■ The concept of control relates to the ability to direct
policies and management

10
 Control: How?

◆ The Usual Way

■ Owning more than 50% of the subsidiary’s outstanding
voting stock (50% plus only 1 share will do it)
◆ The Unusual Way
■ Having contractual agreements or financial arrangements
that effectively achieve control
● Informal arrangements
● Formal agreements
◆ Consummation of a written agreement requires recognition on
the books of one or more of the companies that are a party to
the combination
11
 Organizational Structure and Financial
Reporting
◆ Merger
■ A business combination in which the acquired business’s
assets and liabilities are combined with those of the
acquiring company, resulting in no additional
organizational components
■ Two companies are merged into a single entity

12
 Organizational Structure and Financial
Reporting
◆ Controlling ownership
■ 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 consolidated
financial statements

13
 Organizational Structure and Financial
Reporting
◆ 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
◆ Other beneficial interest
■ One company may have a beneficial interest in another
entity even without a direct ownership interest
■ The beneficial interest may be defined by the agreement
establishing the entity or by an operating or financing
agreement

14
Practice Quiz Question #1

A common way to obtain corporate

control is
a. by purchasing more than 50% of
an entity’s non-voting preferred
stock.
b. by playing
bribing athe CEO.game about that
video
c. company.
d. by purchasing more than 50% of an
entity’s common stock.
e. none of the above.

15
Practice Quiz Question #1 Solution

A common way to obtain corporate

control is
a. by purchasing more than 50% of an
entity’s non-voting
preferred stock.
b. by bribing the CEO.
c. by playing a video game about that
company.

d. by purchasing more than 50% of an

entity’s common stock.
e. none of the above.

16
Learning Objective 1-2

Understand the development

of standards related to
acquisition accounting over
time.

17
 The Development and Accounting for
Business Combinations
◆ In the past, there were two methods of accounting
for business combinations:
■ Purchase method
■ Pooling-of-interests method
◆ Major changes
■ FASB eliminated the pooling-of-interests method
■ FASB issued ASC 805 that replaced the purchase method
with the acquisition method, which is now the only
acceptable method of accounting for business
combinations

18
 The Development and Accounting for
Business Combinations
◆ Pooling-of-interests 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!

19
 The Development and Accounting for
Business Combinations
◆ 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

20
Practice Quiz Question #4

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.

21
Practice Quiz Question #5

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.

22
Learning Objective 1-3

Make calculations and prepare

journal entries for the
creation of
a business entity.

23
 Accounting for Internal Expansion: Creating
Business Entities
◆ The transferring company creates a subsidiary that it owns
and controls.
◆ The company transfers assets and liabilities 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
book value of the net assets transferred.
◆ If assets are impaired at the time of transfer, the transferring
company should recognize an impairment loss and transfer
the assets to the new entity at the lower fair value.
◆ Subsidiary records all assets and liabilities received in the
transfer at the book values at the time of transfer.
24
 Accounting for Internal Expansion: Creating
Business Entities
As an illustration of a created entity, assume that Allen Company creates a
subsidiary, Blaine Company, and transfers the following assets to Blaine in
exchange for all 100,000 shares of Blaine’s $2 par common stock:

25
 Accounting for Internal Expansion: Creating
Business Entities
Allen records the transfer with the following entry:

26
 Accounting for Internal Expansion: Creating
Business Entities
Blaine Company records the transfer of assets and the issuance of stock (at
the book value of the assets) as follows:

27
Practice Quiz Question #2

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.

28
Learning Objective 1-4

Understand and explain the

differences between
different forms of business
combinations.

29
 Accounting for External Expansion: Business
Combinations
◆ There are three primary legal forms of business
combinations
■ Statutory merger
■ Statutory consolidation
■ Stock acquisition

30
 Statutory Merger
AA Company
AA Company

BB Company

◆ 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

31
 Statutory Consolidation
AA Company
CC Company

BB Company

◆ 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
32
 Stock Acquisition
AA Company AA Company

BB Company BB Company

◆ 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. 33
Legal Forms of Business Combinations
AA Company
AA Company

BB Company

(a) Statutory Merger

AA Company
CC Company

BB Company

(b) Statutory Consolidation

AA Company AA Company

BB Company BB Company

(c) Stock Acquisition

34
 Methods of Effecting Business Combinations
◆ Acquisition of assets
■ Sometimes one company acquires another company’s
assets through direct negotiations with its management
■ Statutory merger
■ Statutory consolidation
◆ Acquisition of stock
■ 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

35
 Valuation of Business Entities

◆ Value of individual assets and liabilities

■ Value usually determined by appraisal
◆ Value of potential earnings
■ “Going-concern value” based on:
● A multiple of current earnings
● Present value of the anticipated future net cash flows
generated by the company
◆ Valuation of consideration exchanged
■ Cash: little difficulty
■ Securities: unless traded in the market, estimates of their
value must be made
36
 Acquiring Assets vs. Stock

◆ Major Decision Factors

■ Legal considerations—Buyer must be extremely careful
NOT to assume responsibility for (and thus “inherit”) the
target company’s
● Unrecorded liabilities
● Contingent liabilities (lawsuits)

vs.
37
 Acquiring Assets vs. Stock

◆ Major Decision Factors (continued)

■ Tax considerations—Often requires major negotiations
involving resolution of
● Seller’s tax desires
● Buyer’s tax desires
■ Ease of consummation—acquiring common stock is
simple compared with acquiring assets

vs.
38
 Acquiring Assets

◆ Major Advantages of Acquiring Assets

■ Will not inherit a target’s contingent liabilities
(excluding environmental)
■ Will not inherit a target’s unwanted labor
union

◆ Major Disadvantages of Acquiring

Assets
■ Transfer of titles on real estate and other assets can be
time consuming
■ Transfer of contracts may not be possible

39
 Acquiring Common Stock

◆ Advantages of Acquiring Common Stock

■ Easy transfer
■ May inherit nontransferable contracts

◆ Disadvantages of Acquiring Common Stock

■ May inherit contingent liabilities or unwanted labor union
connection
■ May acquire unwanted facilities/units
■ Will likely be hard to access target’s cash

40
 Organizational Forms—What acquired?

Common Stock—Results Target’s Assets—Results in a

in a parent-subsidiary home office-branch/division
relationship relationship

P Home Office
P contr ols S

Branch/Division
S
One legal entity

41
 Forms of Business Combination—Details

◆ Option #1: Statutory Merger

■ Peaceful Merger:
● One entity transfers assets to another in exchange for
stock and/or cash
● It liquidates pursuant to state laws
■ 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
■ The result: one legal entity survives
42
 Statutory Merger: Peaceful Merger

A Shareholders T Shareholders

A stock + up
to 50%
boot
A stock
A Corp. T Corp.
+ boot

T assets

• Need SH approval from both corporations.

43
Statutory Merger: The Result

A and T Shareholders

A Corp.
(A & T Assets)

44
 Statutory Merger: Hostile Takeover

A Shareholders T Shareholders

+ $ ck
k o
stoc Ts
t
A

A Corp. T Corp.

45
 Statutory Merger: Hostile Takeover

◆ A takes all of T’s assets and liquidates the

corporate shell

A & T Shareholders

A
T T Assets

46
Statutory Merger: The (Same) Result

A and T Shareholders

A Corp.
(A & T Assets)

47
 Forms of Business Combination—Details

◆ Option #2: Statutory Consolidation

■ New corporation (Newco) is created
■ Newco issues stock to both combining companies in
exchange for their stock
■ Each combining company becomes a temporary
subsidiary of Newco
■ Both subs are liquidated into Newco and
become
divisions
■ Result: One legal entity survives

48
 Statutory Consolidation: The Process

X Shareholders Y Shareholders

N Stock N Stock
X Corp. Y Corp.

XA

ts
sse
sse

YA
ts

N Stock N Stock

Newco
Corp.

• Need SH approval from both corporations

49
Statutory Consolidation: The Result

X and Y Shareholders

Newco Corp.
(X & Y Assets)

50
 Forms of Business Combination—Details

◆ Option #3: HOLDING COMPANY:

■ 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.

51
Holding Company: The Starting Point

Newco
Corp.

X Shareholders Y Shareholders

X Y
Corp. Corp.

52
Holding Company: The Result

X&Y
Shareholders

N Stock X & Y Stock

Newco
Corp.

X Y
Corp. Corp.

53
Practice Quiz Question #3

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.

54
Learning Objective 1-5

Make calculations and

business combination journal
entries in the presence of a
differential, goodwill, or a
bargain purchase element.

55
 Acquisition Accounting
◆ The acquirer recognizes all assets acquired and
liabilities assumed in a business combination and
measures them at their acquisition-date fair values.
■ If less than 100 percent 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 its acquisition-date fair value.

56
 Fair Value Measurements

◆ The acquirer must value at fair value:

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.

◆ The value of the consideration given in the

exchange is usually the best measure of the value
received and, therefore, reflects the value of the
acquirer’s interest in the acquiree.
57
 Applying the Acquisition Method
◆ The full acquisition-date fair values 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 percentage ownership
acquired by the controlling entity.
◆ All costs of bringing about and consummating a
business combination are charged to an acquisition
expense as incurred.

58
 Goodwill

◆ 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 goodwill from a business
combination based on the difference between the
total fair value of the acquired company and the fair
value 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
goodwill.
59
 Example: Goodwill

■ Assume that Albert Company acquires all of the net assets

of Zanfor Company for $400,000 when the fair value of
Zanfor’s net identifiable assets is $380,000.
■ The fair value of all Zanfor’s assets and liabilities is equal
to Zanfor’s book value except for land where the fair value
is $100,000 greater than the book value.

Book
Value
Assets 400
Liabilities 120
Net Assets 280

60
 Example: Goodwill

■ Assume that Albert Company acquires all of the net assets

of Zanfor Company for $400,000 when the fair value of
Zanfor’s net identifiable assets is $380,000.
■ The fair value of all Zanfor’s assets and liabilities is equal
to Zanfor’s book value except for land where the fair value
is $100,000 greater than the book value.
Book Fair
Value Value
Assets 400 500 Net
Liabilities 120 120 identifiable
assets = 380
Net Assets 280 380

61
 Example: Goodwill

■ Assume that Albert Company acquires all of the net assets

of Zanfor Company for $400,000 when the fair value of
Zanfor’s net identifiable assets is $380,000.
■ The fair value of all Zanfor’s assets and liabilities is equal
to Zanfor’s book value except for land where the fair value
is $100,000 greater than the book value.
Book Fair
Value Value
Assets 400 500 Net
Liabilities 120 120 identifiable
assets = 380
Net Assets 280 380
Acquisition Price 400

62
 Example: Goodwill

■ Assume that Albert Company acquires all of the net assets

of Zanfor Company for $400,000 when the fair value of
Zanfor’s net identifiable assets is $380,000.
■ The fair value of all Zanfor’s assets and liabilities is equal
to Zanfor’s book value except for land where the fair value
is $100,000 greater than the book value.
Book Fair
Value Value
Assets 400 500 Net
Liabilities 120 120 identifiable
assets = 380
Net Assets 280 380
Acquisition Price 400
Goodwill 20
63
 Example: Goodwill
Goodwill only exists if purchase price exceeds the fair value that
can be assigned to IDENTIFIABLE assets.

Acquisition Price:
Book Fair
Value Value Goodwill =
Assets 400 500 20,000
Liabilities 120 120 Identifiable Excess =
Net Assets 280 380 100,000
Acquisition 400 Book value =
Price
Goodwill 20 280,000

New investment Net

recorded by identifiable
parent assets = 380

64
 Example: Controlling Interest Acquisition
■ If, instead of an acquisition of assets, Albert acquires
75 percent of the common stock of Zanfor for
$300,000, and the fair value of the noncontrolling
interest is $100,000, goodwill is computed as follows:

■ Note that the total amount of goodwill is not affected

by whether 100% of the acquiree or less than that is
acquired.

65
 The Acquisition Method: Items Included in the
Acquirer’s Cost

◆ 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

66
 Acquirer’s Cost: Category 1

◆ Types of Consideration: practically any

type
■ Cash
■ Common stock
■ Preferred stock
■ Notes receivable or bonds
■ Used trucks

67
 Acquirer’s Cost: Category 1

◆ General Rule
■ Use the FMV of the consideration given
◆ Exception
■ Use the FMV of the property received … if it is more
readily determinable

stock
Sub

P stock
Shareholde
rs

S
68
 Group Exercise 1: Basic Acquisition

Pete Inc. acquired 100% of the outstanding

common stock of Sake Inc. for $2,500,000 cash and
20,000 shares of its own common stock ($1 par
value), which was trading at $50 per share at the
acquisition date.
$+
Stock Sake
Pete Stock
Shareholde
rs

Sake
Required: Prepare the journal entry to record the acquisition.
69
 Group Exercise 1: Basic Acquisition

Pete Inc. acquired 100% of the outstanding

common stock of Sake Inc. for $2,500,000 cash and
20,000 shares of its own common stock ($1 par
value), which was trading at $50 per share at the
acquisition date.
$+
Stock Sake
Acquisition Cost:
Cash $2,500,000 Pete Stock
Shareholde
rs
Stock 1,000,000
Total $3,500,000

Investment in Sake Sake

Cash
Common Stock Additional
Paid-in Cap.
70
 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 expensed in the
acquisition period.
◆ Do not expense direct costs of issuing stock
■ Charge to Additional Paid-In Capital

71
 Group Exercise 2: Recording Direct Costs
Assume the same information provided in Exercise 1. In addition, assume
that Pete incurred the following direct costs:
Legal fees (acquisition) $ 52,000
Accounting fees 27,000 $+
Travel 11,000 Stock Sake
expenses
Legal fees (stock issue) 31,000
Accounting fees (review) 14,000
Pete Stock
Shareholde
rs
SEC filing fees 9,000
Total $144,000
Sake
Prior to the consummation date, $117,000 had been
paid and charged to a deferred charges account pending
consummation of the acquisition. The remaining
$27,000 has not been paid or accrued.

Required: Prepare the journal entry to record the direct costs.

72
Group Exercise 2: Solution
Charge To
Acquisition Additional
Expense Paid-in Capital
Legal fees
Accounting fees
Travel expenses
Legal fees—SEC
Accounting fees—SEC
Filing fees—SEC
Totals

Acquisition Expense
Additional Paid-in Capital
Deferred Charges
Accrued Liabilities

73
 Acquirer’s Cost: Category 3

◆ Contingent Consideration
■ Contingent payments depending on some unresolved
future event
● Example: agree to issue additional shares in
6 months if shares given lose value
■ Record at fair value as of the acquisition date.
■ Mark to market each subsequent period until the
contingent event is resolved

74
 Combination Effected through the Acquisition
of Net Assets

◆ Assume that Point Corporation acquires all of the

assets and assumes all of the liabilities of Sharp
Company in a statutory merger by issuing 10,000
shares of $10 par common stock to Sub.
◆ The shares issued have a total market value of
$610,000.
◆ Point incurs legal and appraisal fees of $40,000 in
connection with the combination.
◆ Point incurs stock issue costs of $25,000 in
connection with the combination.

75
 Combination Effected through the Acquisition
of Net Assets
◆ The book values and fair values of Sharp’s individual
assets and liabilities on the date of combination are
as follows:

76
 Combination Effected through the Acquisition
of Net Assets
The differential is the
total difference at
acquisition date between
the fair value of the
consideration exchanged
and the book value of
the net identifiable
assets acquired.
Fair Value of Consideration
Goodwill $100,000 $610,000
Total
Differential Fair Value of Net Identifiable Assets
$310,0 Excess Fair Value of Identifiable $510,000
00 Net Assets $210,000
Book Value of Net Identifiable Assets
Book Value of Net Identifiable $300,000
Assets $300,000

77
 Combination Effected through the Acquisition
of Net Assets
◆ The $40,000 of acquisition costs incurred by Point in
carrying out the acquisition are expensed as
incurred:

78
 Combination Effected through the Acquisition
of Net Assets
■ Portions of the $25,000 of stock issue costs related to the
shares issued to acquire Sharp may be incurred at various
times.
■ To facilitate accumulating these amounts before recording
the combination, Point may record them in a separate
temporary “suspense” account as incurred:

■ The stock issue costs are treated as a reduction in the

proceeds received from the issuance of the stock.
■ Thus, these costs are transferred from the temporary
account to Additional Paid-In Capital as a reduction.
79
 Combination Effected through the Acquisition
of Net Assets
▪ On the date of combination, Point records the acquisition of Sub with the following
entry:

▪ This entry records all of Sharp’s individual assets and liabilities, both tangible and
intangible, on Point’s books at their fair values on the date of combination.
▪ The $100,000 difference between the fair value of the shares given by Point ($610,000)
and the fair value of Sharp’s net assets is recorded as goodwill.
▪ The stock issue costs are transferred from the temporary account to Additional Paid-In
Capital as a reduction
▪ Point records the $610,000 of stock issued at its value minus the stock issue costs,
or $585,000 ($100,000 of this amount is recorded in the Common Stock account
and the remainder in Additional Paid-In Capital).
80
 Entries Recorded by Acquired Company

◆ On the date of the combination, Sharp records the

following entry to recognize receipt of the Point
shares and the transfer of all individual assets and
liabilities to Point:

81
 Entries Recorded by Acquired Company

◆ The distribution of Point shares to Sharp

shareholders and the liquidation of Sharp are
recorded on Sharp’s books with the
following entry:

82
 Subsequent Accounting for Goodwill by
Acquirer
◆ Goodwill must be tested for impairment at least annually, at the
same time each year.
◆ The process of testing goodwill for impairment is complex.
◆ When goodwill arises in a business combination, it must be
assigned to individual reporting units.
◆ To test for impairment, the fair value of the reporting unit is
compared with its carrying amount.
◆ The amount of reporting unit’s goodwill impairment is measured
as the excess of the carrying amount of the unit’s goodwill over the
implied value of its goodwill (the excess of the fair value of the
reporting unit over the fair value of its net assets excluding
goodwill).
◆ Goodwill impairment losses are recognized in income from
continuing operations or are included in gain/loss from
discontinued operations, if related.
83
 Bargain Purchase
◆ Occasionally, the fair value of the consideration given in a business
combination, along with the fair value of any equity interest in the
acquiree already held and the fair value of any noncontrolling
interest in the acquiree, may be less than the fair value of the
acquiree’s net identifiable assets, resulting in a bargain purchase.
◆ When a bargain purchase occurs, the acquirer must take steps to
ensure that all acquisition-date valuations are appropriate.
◆ If they are, the acquirer recognizes a gain at the date of acquisition
for the excess of the amount of the net identifiable assets acquired
and liabilities assumed at fair value over the sum of the fair value
of the consideration given in the exchange, the fair value of any
equity interest in the acquiree held by the acquirer at the date of
acquisition, and the fair value of any noncontrolling interest.

84
 Example: Bargain Purchase

◆ Using the data from the last example, assume that

Point company is able to acquire Sharp for
$500,000 cash even though the fair value of Sharp’s
net identifiable assets is estimated to be $510,000.
◆ Point would recognize a $10,000 gain.
◆ Point would record the following entry:

85
 Goodwill vs. Bargain Purchase Element

⬥ FMV Given > FMV of Net Assets Goodwill

Bargain
⬥ FMV Given < FMV of Net Assets Purchase
Element

⬥ FMV Given = FMV of Net Assets Neither GW

nor BPE

86
 Goodwill: How to calculate it?

◆ Goodwill is calculated as the residual amount

■ First, estimate the FMV of identifiable net assets
● Includes both tangible AND intangible assets

■ Second, subtract the total FMV of all identifiable net assets

from the total FMV given by owners
■ The residual is deemed to be goodwill

GW = Total FMV Given – FMV of Identifiable Net Assets

87
 Example: Goodwill

Assume Bigco Corp. pays $400,000 for Littleco Inc. and

that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000 Liabilities $200,000
Inventory 100,000
LT Marketable sec. 60,000 Retained Earnings 100,000
PP&E 140,000Common Stock 100,000
Total Assets $ 400,000 Total Liab/Equity $ 400,000

Net Assets = Total Assets – Total Liabilities

Net Assets =

Goodwill = Acquisition price – FMV Net Assets

=
88
Example: Goodwill

Journal Entry:

89
 Goodwill: What to Do With It?

◆ Goodwill
■ Must capitalize as an asset
■ Cannot amortize to earnings
■ Must periodically (at least annually) assess for
impairment
■ If impaired, must write it down—charge to
earnings

90
 Bargain Purchase Element: What to Do With It?

◆ Bargain Purchase Element

■ Still record assets and liabilities assumed at their fair
values
■ The amount by which consideration given exceeds the fair
value of net assets is a gain to the acquirer

91
 Example: Bargain Purchase

Assume Bigco Corp. pays $150,000 for Littleco Inc. and

that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000 Liabilities $200,000
Inventory 100,000
LT Marketable sec. 60,000 Retained Earnings 100,000
PP&E 140,000Common Stock 100,000
Total Assets $ 400,000 Total Liab/Equity $ 400,000

Net Assets = Total Assets – Total Liabilities

Net Assets =

Goodwill = Acquisition price – Net Assets

=
92
Example: Bargain Purchase

Journal Entry:

93
 Acquisition of Intangibles

◆ ASC 805
■ An intangible asset should be recognized separately from
goodwill only if its benefits can be separately identified.
■ Finite intangible assets should be amortized over their
useful life with no arbitrary cap (i.e., no 40-year limit).
■ Some intangible assets (such as goodwill) may have an
indefinite or infinite life. They should not be
amortized, but tested for impairment at least annually.

94
 Intangible Assets

◆ More are recognized under ASC 805

◆ Record at fair value but only if either of the following
two criteria are met:
1. Intangible arises from a legal or contractual right
2. Intangible does not arise from a legal or contractual
right but is separable

95
 Separately Recognized Intangibles
◆ ASC 805 specifies that the following
should be recognized separately
from goodwill: Key:
■ Marketing-related intangibles Purpose is to get
● Trademarks and internet domains companies to
■ Customer-related intangibles recognize
● Customer lists, order backlogs, etc. intangibles
■ Artistic-related intangibles separately from
● Normally items protected by goodwill.
copyrights
■ Contract-based intangibles
● Licenses, franchises, broadcast rights
■ Technology-based intangible
assets
96
 Group Exercise 3: Acquisition of Intangibles
On January 1, 2009, Buyer Company acquired 100-percent ownership of Target
Company’s assets for $9,400 cash and assumed its liabilities.
Current Assets $2,400
Property, Plant, and Equipment 1,500 3,900 Total Assets
Current Liabilities 500
Separately Long-term Debt 1,100 1,600 Total Liabilities
Identifiable: 2,300 Net Assets
In addition, Target Company had the following intangible items on the
acquisition date (not included in Target’s balance sheet):
Trademarks (not recognized on Target’s books) because they were
1,400 a.
internally developed. The trademarks have a value of $1,400. The useful
life of these trademarks is indefinite.
1,000 b. Ongoing research projects that have an estimated value of $1,000.
1,500 c. Internally-developed computer software with a value of $1,500. This
software has a useful life of three years.
Internally-developed patents with a value of $800. The patents have a
800 d.
useful life of seven years.
Other separately-identifiable intangibles with a value of $200. These assets
200 e.
have an average useful life of five years.
4,900
REQUIRED: Make Buyer’s journal entry to record the acquisition of Target.
97
 Group Exercise 3: Solution
Purchase Net Separately
Price − Assets – Identified = G.W.
Int.

Current Assets
Property, Plant, and Equipment
Trademarks
In-Process Research and Development
Computer Software
Patents
Other Intangible Assets
Goodwill
Current Liabilities
Long-term Debt
Cash
98
Comprehensive Example: Acquisition Method

99
 Combination Effected through Acquisition of
Stock
◆ Assume that Point Corporation exchanges 10,000
shares of its stock with a total market value of
$610,000 for all of Sharp Company’s shares.
◆ Point incurs merger costs of $40,000 in connection
with the combination.
◆ Point incurs stock issue costs of $25,000 in
connection with the combination.
◆ What entries should Point record upon receipt of the
Sharp stock?

100
 Combination Effected through Acquisition of
Stock
◆ Point would record merger and stock issue costs
related to acquisition of Sharp with the following
entry:

101
 Combination Effected through Acquisition of
Stock
◆ Point would record the acquisition of Sharp stock
with the following entry:

102
 Financial Reporting Subsequent to a Business
Combination
◆ Financial statements prepared subsequent to a
business combination reflect the combined entity
beginning on the date of combination going forward.
◆ When a combination occurs during a fiscal period,
income earned by the acquiree prior to the
combination is not reported in the income of the
combined enterprise.

103
Practice Quiz Question #6

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.

104
Practice Quiz Question #7

Which of the following costs can 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 CEO’s
salary.
e. Travel costs.
f. Costs of the M&A department.
g. None of the above.

105
Learning Objective 1-6

Understand additional
considerations associated with
business combinations.

106
 Uncertainty in Business Combinations

◆ Measurement Period
■ ASC 805 allows for this period of time to properly
ascertain fair values.
■ The period ends once the acquirer obtains the necessary
information about the facts as of the acquisition date.
■ May not exceed one year.

107
 Uncertainty in Business Combinations
◆ Contingent consideration
■ Sometimes the consideration exchanged is not fixed in
amount, but rather is contingent on future events; e.g., a
contingent-share agreement.
■ ASC 805 requires contingent consideration to be valued at
fair value as of the acquisition date and classified as either
a liability or equity.
◆ Acquiree contingencies
■ Under ASC 805, the acquirer must recognize all
contingencies that arise from contractual rights or
obligations and other contingencies if it is more likely than
not that they meet the definition of an asset/liability at
the acquisition date.
■ Recorded by the acquirer at acquisition-date fair value.
108
 In-Process Research and Development

◆ The FASB concluded that valuable ongoing research

and development projects of an acquiree are assets
and should be recorded at their acquisition-date fair
values, even if they have no alternative use.
◆ These projects should be classified as
indefinite-lived and, therefore, should not be
amortized until completed or abandoned.
◆ They should be tested for impairment.

109
 Noncontrolling Equity Held Prior to
Combination
◆ The total amount of the acquirer’s investment in the
acquiree subsequent to the combination is equal to
the acquisition-date fair value of the equity interest
previously held and the fair value of the
consideration given in the business combination.
◆ An acquirer that held an equity position in an
acquiree immediately prior to the acquisition date
must revalue that equity position to its fair value at
the acquisition date and recognize a gain or loss on
the revaluation.

110
 Consolidation: The Concept

◆ Parent creates or gains control of the subsidiary

◆ The result: a single reporting entity

111
Consolidation: The Big Picture

How do we report the results of subsidiaries?

Parent
Company

80% 5 21%
1
%
Sub A Sub C
Sub B
Consolidation Equity Method
(plus the Equity Method)
112
 Consolidation: The Concept

◆ Two or more separate entities under common

control
◆ Present “as if ” they were one company
◆ Two or more sets of books are merged together
into one set of financial statements

113
 Consolidation: Basic Idea
◆ Presentation:
■ Sum the parent’s and subsidiary’s accounts
■ We’ll start covering this in detail in Chapter 2

Replace with…
Parent Sub
Cash $ 200 Consolidated
Investment in Sub 500 $100
PP&E 900 600
Total Assets $1,600 $700

Liabilities $ 300 $200

Equity
Total 1,300
Liabilities & Equity $1,600 $700
500

114
 Consolidation Entries

◆ Just a quick introduction …

◆ Two examples of eliminating entries:
■ The “Basic” eliminating entry
● Removes the “investment” account from the parent’s balance
sheet and the subsidiary’s equity accounts
■ An intercompany loan (from Parent to Sub)

Worksheet
Entry
Only!

115
 Simple Consolidation Example

Parent Sub DR
Cash $ 200 CR
Receivable from Sub 100 $100 100
Investment in Sub 500 500
PP&E 800 600
Total Assets $1,600 $700

Liabilities $ 300 $100

Payable to Parent 100
Equity 100
Total Liabilities & 1,300
Equity $1,600 500 500
$700
116
The End