Part 2
Part 2
Part 2
which became generally accepted in 1950 when the Committee on Accounting Procedure issued Accoznting Research Bulletin (ARB) No. 40. Although there are conceptual difficulties with the pooling method the underlying problem that arose withARB (pooling No. 40 was the infioduction of altemative methods of accounting for business combinations interests are involved in a business cornbination, and alternate versus purchase). Numerous financial accounting procedures may not be neutral with respect to different interests. That is, the individual financial interests and the final plan of combination may be affected by the method of accounting. Until 2001, accounting requirements for business combinations were found in APB Opinion No. l6,which recognizedLo*rthe pooling and purchase methods of accounting for business combinations. In August 1999, the FASB issued a report supporting its proposed decision to eliminate pooling. Principal reasons cited included the following:
I I r
Pooling provides less relevant information to statement users. Pooling ignores economic value exchanged in the transaction and makes subsequent performance evaluation impossible. Comparing firms using the alterriative methods is difficult for investors.
Pooling creates these problems because it uses historical book values to record combinations, .ather tlhan recosnizing fak values of net assets at the transaction date. Generally accepted accountingprinciples(GAAP)generallyrequirerecordingassetacquisitionsa.tfairvalues' Further, the FASB believes that the economiJnotion,of u pooling of interests rarely exists in business combinations. More realistically, virnrally all combinations are acquisitions, in which one firm gains control over another. FASB Statement No. 141 eliminated the pooling of interests method of accounting for all transactions initiated after June 30, 2001. Combinations initiated subsequent to that date must use the purchase method. The new standard also made other changes to accounting for business
combinations, which will be discussed in detail later. Because the new standard prohibits the use of the pooling method only for combinations initiated after the issuance of the revised stadar4 prior combinations accounted for under the pooling of interests method will be grandfathere( that is, both the purchase and pooling methods will continue to exist as acceptable financial repcting practices for past btlsiness combinations. Therefore, one cannot ignore the conditions fu and reporting requirements under the pooling approach. On the other hand, because no new poolings will be permitted. this discussion focuses on the acquisition method. Mdre-detailed coverage d tte gnoling of interests method is relegated to the Advanced Accounting Web site.
lHren1nnonn- AccouHnnc The
FASB eliminarion of
poling
to account for business combinations. The Interoatimal Accounting Standards Board (IASB) issued International Financial Reporting Snndad J (fRS 3), "Business Combinations,".on
March 31,2004, requiring business combinatioqs to be ronted for using the purchase methodIFRS 3 specifically prohibits the pooling of intere*s mclhod In introducing the new standard, IASB Chairman Sir David Tweedie noted:
Accounting business combinations diverged substantially &cross iurisdictions. IFRS 3 marks a significant step towardhigh quatiry* stodads inbusiness combination accounting, and in ultimately achieving international com'ergence in this area.
majr
ffiies
makes U.S. GAAP more consistent with prohibit the use of the pooling method
for
business combinations initiated after December 15, 2008, must be accounted for as acquisitions under.EASB Statement No. l4IR.The new standard supersedes APB Opinion No. 16, "Business Combinations," and supersedes or amends the numerous interpretations of the former standard. However, the FASB retains much of APB Opinion No. 16 except the pooling of interests method
23
Thetopicscoveredinthistextares0metimesc0mpleXandinvolvedetailedexhibitsandillustrative experience' illustrati0ns iS an integral part of the learnrng examples. Understanding tte r*n|blts and review the exhibits as they with the related text. Care{ully and y'u should study tf,rm'in"lonlunciion information and illustrations are designed to provide essential are intr'duced in the text. ixhibits'and
presented' exptanations {or understanding the concepts " "unor"tunoing transactions is an important the tinanciat statement impact of c0mplex business To assist you.in this learning endeav0r' ;;ounting topics element in the study ot uouunrtit*n;iai and the directional journal entries that include the typds oi accounts being affected this book depicts as f0llgws: A parenthetical reference the text are impact ol the event. conventions used thrgugh0ut e{tect of the ;y;iouinat intry indicates the tvpe 0f acc0unt and the "Accgunts added to each account accgunt' is denoted as rec;ivable, an asset entry. F0r example, an lncreiie rn aicounts "Accounts receivable (-A)." The symbol (+A)." A decrease in this account is denoted as receivable (E) for equity accounts, (R) for revenues, (A) stands for assets, tLr iriiiunitiii*, isr) tor stockholders' expenses, (Ga) for gains, and (Lo) for losses'
rfi;;il
in reiording other assets for recording a business combination as we follow the principle. In other words, we measure the cost to record the combination using ,t " fair value amount of cash by the another company in u blsiness combination
purchasing entity of acquiririg
same generally accepted accounting principles In general, the acquisition method follows the and liabilities'r We
under agement salaries, depreciation, and rent incuned to close duplicate facilities' cists stock for issues 100,000 shares of $10 pal common To illustrate, assume that Poppy corporation 2009 ' The market price of a business combination on July I ' the net assets of Sunny corporation in Additional direct costs of the business combi,,, poppy cornmon stock on this date is $16 per share. (SEC) fee^s of $5,000, accountants' fees in commission nation consist of securities and Exchange costs for printing and issuing the cor'nwith the SEC registration statement of $10,000' connection consultants' fees of $80'000' mon stock certiflcates of $Zi,OOO, and finder's'and (in thousands): shares on its books as follows Poppy records the issuance ofthe 100,000
Investment in SunnY (*A) Common stock, $10 Par (*SE) Additional Paid-in caPital (*SE) par To record issuance of 100,000 shares of $10 price of $16 per share common stock with a market in a business combination with Sunny Corporation' 1,600
1,000
disbursedorbytherairvatue-orotherassetsdistributedorsecuritiesissued. consulting' and finders' (such as accounting, legal' we expense the direct costs of combination or issuance of equity securities' We chargo registration fees) other than those for the registration of securities t"";nties issued in a combination against the fair value and issuance costs of such as mall"*t paid-in capital' we expense indirect costs issued, usually as a reduction of additional the acquisition method' we also expense indirect
600
of the business combination as follows: Poppy records additional direct costs 80 Investment expense fE' -SE) 40 Additiorral paid-in capitai {-SE) Cash'(or other net asstsl t-A)
r20
TorecordadditionaldirectcoslsofcombinilgwithSunny
Corporation: $80,000 for finder's and consultants'fees equiq securities' ana-$+O,OOO for registerilg and issuing
tu
"ntity.
iil;;;;;;;;;;p"-.,i*."gtt'"-i,tt..i,uptlers'on
consotidations
24
we accumulate the total cost incurreiin furcuasing another company in a single investment account' regardless of whether the other .oirpurry is oissot'veo or the combining companies continue to operate in a parent-subsidiary "o-Lioiog relationship. If we dissolve sunny corporation, we record its identifiable^net assets on Poppy's books at *reirialr values, and we record any excess of investment
cost over tair value
we treat registration and issuance costs of $40,000 as a reduction of the fair value of the stock issued and charge thes-e^:9s!s to Additional paid-in capital. w" other direct costs of the business combination ($90,000). The total ""p"nr" *r, ,o poppy of acquiring Sunny is $r,600,000, the amount entered in the lnvestment in Sunny account.
*t:ilHll
* g*d*itt. h
thtr
;;;;.
ar""","in"
Accounts payable
(*L)
Notes payable (-r-L) Investment in Sunny (_A) To record allocation of the $1,600,000 cost of acquiring Sunny Corporarion to identifiable net assets according to their fair values and to goodwill.
XXX XXX
1,600
company and subsidiary poppy will not record the entry to allocate the Investment in Sunny balance. Inrt"uo, poppy will account for its inrrestment in Sunny by means of the Iavestment in Sunny account, and we will make the allocation of the investment cost to identifiable net assets required L the consolidation process. Because of the additional complications of accounting ro, f*"ot-robsidiary operations, the remainder of this chapter is limited to business combinations in which a single acquiring entity receives the net assets of the other combining companies. subsequent chapters cover parentsubsidiary operations and the preparation ofconsolidatedfinanciar
statements.
OBJECTIVE Z+
Sunny shareholders are now shareholders of poppy. If Poppy and Sunn,v-- corporations operate as parent
LEARNING A
La,tl
t nl
2 N ot I
gstinalr
to specific categories of assets received and liabilities assumed. we record identifiable assets acquired, liabiliti-es assumed and any noncontrolling interest using fair values at the acquisition date. we determine fair values for all assets and tiabilities, regardless of whether they are recorded on the books of the acquired company. For example, an acquired company may have expensed the costs of developing patents, blueprints, formulas, and the like under the provisions of E4sB statement No. 2,'iccounting for Research ;il;;;;;;;t;r;r.,, However' we assign fair values to such identifiable intangible assets of an acquired company in a business combination accounted for as an acquisition.
the total market value of the consideration transferred by the acquirer, unless otherwise noted. MSB statement No' 14.lR.otrers additional guidance for assigning'amounts
cash flows, discounted based on an observable measure such as the prime interest rate. Level 3 includes other intemallv derived estimations. Throughout rhis rexr, ;;;;il;t;;;" tlat totar fair varue is equar to
but much of the work is done before and during the negotiating process of the proposed merglr' compaaies generally_retain outside appraisers and valualion experts to determine tair values"FASB statement N9. 157 provides guid*." on the determinatioq of fair values..EA^gB smtement No' 157 provides three levels of"reliabiliry for fair value estimates. Level 1 is fair value based on established market prices.. Level2 uses the present-value of estimated future
tangible and intangible assets acquired and liabilities assumed ia the combination. This can be a monumental task'
Recording Fair values in an Acquisition Business Gombination The first step ir recordiag an acquisition is to defermine fhe fair values of all identifiable
f;-;;;;'"n.the acquisition dbte. isset or iiabilitv arises rrom Y:::f^{;i;z:i3::;::tr;:":::::1T:.y;'il#:,";"l?ore,ike,y,hanno,,ha,an the contingeri;1i;,1#J:ffi,il:ffTJ:ilitnJ""i$"j,ll
;;:ombination ,n;a be accounted for in accordance No. r09 and rfi-u"7 ii.-p",^r*i benefits shourd fo'ow n MSB statement No' 158 ana retatet standards. op".ffi'und itucruld be recorded based capital 1ease contracts on the guidanJ n"diu ,***ent Ni. ts anl.rt, wo. zl. \r"e assign no varue to gooowill.""*o"a J^fe b.o,oks.gf_ar q,tr
There are few exceptions to the use of fair values. Contractuar contingencies (contingencies -lared to specific contracrs).ur"
25
r""ognJ"d ur rt"i,
p,y
starement
;il;
gni*lance
riJil;;ilree
ig*sB :::hdbecausew;;;il;"
The acquirer shall recognize goodwill as of the acquisition date, measured as the
a.
b'
*qremgx
The consideration transferred measured in accordance with this statement, i rei acq u i si r i on _da,, fr, r- r" t ii i pa ra g rap h 3 9 ) 2. Th e fa i r v a t u e of a i y non, o n r ro t t i n r, rrir',, r, ii2,i n u, 3' In a business combination achievei n ,rogr;,' ,n'J iiqursrtron_aatu of ,the acquirer,s previousty fair varue
w h i ch gen e ra I ty re q u
1'
ri)
n,
orrrrc acquired and the riab,ities assumed measured in accordance with this statement.a
nruo Mensungueilr
iarii'o'b'i,
*nu*""
Bemmizable intangibles
TnnH Gooow tt f..sB statement No. l4IR arso 'ttsifies the recognition of intangibl;;;;; business under the acquisition method. Ems should recognize intungiur!"t"parat" ";#;;;; u"'n
tn*
tn""t
''
The acquirer ,rr!!::::!:,r: .seryrarcty f:.m go.o.dwiil rhe identiJiabte intangibte assers acquired in a business combination' A'n"intangible asset is ideniifrabre i"f it meets either rtu separab,itv criterion or tt,, ,orrrornr;,r*r;;;;;;r* paragraph 3(k). _tccording to paragraph 3*) An asset is ictentifiable if it either:
illiirro
1' Isseparable'.thatis,capableofbeingseparated.ordividedfromtheentityandsold,
transferred, ricensed, rented, o,
f",ilii"ii|lii;
2'
,*iongrd, eitlter inaniiuitty or together with a identifiabte asset, or tiabitity, ,"ro,ra"rl,f whether the entity
Arises from contractuar or orher regar.rights,-regardress of whether those rights are transferabre or separabre the"entity or yroi, oinrr" rirrir, from ,ro obrigations.s ' Intangible assets that cannot be so identified should be included in gooa\Vru. For rq:uired firms will have a varuabte example, raed as an intangible separately r.om "*ptof"" *orkforce ,n p;"",;;; this asset cannot be recog_ gooa;iil.
in ffi.-J*?,:1"'J$",d?H::H*i'"'",,*'";""J;;;ff ;""ri,,"ri,i"igiJr".*o
corr,lstNnrrolr Some business combinations provide for x'ilrfil:Eal payments to the previorr r;;"-kh;;;rs of the acquired of, transactions' MsB ffiany, contingent on future statement No. trtn 'nroEi rn"r"o"ir""iiiii orlprovides guidance in rcns for contingent consideration in a businer,
Appendix A
Li'iroiirr,
uo. I4lR(reproduced
0mmgr
corustorRenou
tl n Puncxnse Busfirss
^J",s
lF!,,iff .]lolrm.rem
-l :.
J-tiR
--r--&
i{
paragraph 34.
qagraphAlg.
26
lntangible Assets
That Meet the
pp.27-28.
tion
We record the fair value of contingent consideration that is determjnable at the date of acquisias part of the cost of combination. When the contingency irvolves future earnings levels, we recognize the fair market value of the consideration distributed or issued as a transfer within the equity accounts. If the contingency is based on security prices, the recorded cost of the acquired company should not change. Instead, when the contingency is resolved, we record the additional consideration that is distributed at its fak market value. We should write down securities issued and recorded at the date of acquisition proportionately. When the acquiring entity issued capital stock, the write-down is usually to other paid-in capital. A write-down of debt securities would result in recording a discount on debt, which we must then amortize from the date of settlement of the contingency.
Gosr nno Fltn Vnue Coupnrco After assigning fair values to all identifiable assets acquired and liabilities assumed, we compare the investment cost with the total fair value of identifiable assets less liabilities. If the investment cost exceeds net fair value, we first allocate it to identifiable net asbets according to their fair values and then allocate the excess to goodwill.
27
In some business combinations, the total fair value of identifiable assets acquired over liabilities -.sumed may exceed the cost of the acquired company. Paragraph 36 of MSB Statement No. I4IR :'itrs accounting procedures to dispose of the excess fair value in this situation. The gain from
:a;b
lllustration of an Acquisition Combination Pem Corporation acquires the net assets of Seed Company in a combination consummated
on December 27,2008. The assets and liabilities of Seed Company on this date, at their book values at fair values, are as follows (in thousands):
':d
FairValue
$s0
150
s0.
140.
Inventories Land
200
50 300
250'
350
r00 .-
Buildings-net
Equipment-net
Patents
500'-
250 $1,09q
Total assets
50' Ei4q
Liabilities
Accounts payable Notes payable Other liabilities Total liabilities Net assets
$60
150
$60
135
$ $
40 2s0 750
45
z4o
$r,200
CASE 1: cooDwrrL Pin Corporation pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par :ililrmon stock with a market value of $20 per share for the net assets of Seed Company. The :rilowing entries record the business combination on the books of Pitt Corporation on December
r-.
2008.
Investment in Seed Company
Cash
(*A)
(-A)
(*A)
(*A)
50
\et
-
receivables
140 250
100
lf\entories (+A)
'nd 1*A)
'trmenr
3:idirgs (*A)
500
350
(+A)
:'--':s (*A)
50 200
-..,---ll
60"
135'
45'
1.400
l:
-t",,:r.:
-':
r.:;r::-:
lr-:i:
.li:r:
"l,:
;ost of Seed Company to identihable assets liabilities assumed on the basis of their fair
;.Urdg.ili.
n
We assign the amounts to the assets and liabilities based on fair values, except for goodwill. We determine goodwill by subtracting the $1,200,000 fair value of identifiable n"t urJ"t, acquired from the $1,400,000 purchase price for Seed Company's net assets.
CASE 2: FAIR vALUE ExcEEDs TNvESTMENT cosr (BAncilx RncHAsE) Pitt Corporation issues 40,000 shares of its $10 par common stock with a market value of $20 per share, and it also gives a lj%o, fle^year note payable for 5200,000 for the net assets of Seed Company. Pitt's books record the Pitt/Seed business combinarion on December 21 ,2}Og,with the following journal entries:
Investment in Seed Company
(*A)
1.000
(*L)
To record issuance of 40,000 shares of $10 par corlmon pius a $200,000,10Vo note in a business combinarion with Seed Company. Cash
(+A)
50
(*A)
140
(*A)
250
100 500
3s0
50
(+A)
Accounrs payable
Notes payable
(*L;
60
135
(*L)
(*L) (-A)
45 1,000
ir
Seed Company
200
fair Vaiues.
ago9" "Pushed to the brink of coliapse by the mortgage crisis. Bss Sre rns Cos. agreed - after prodding by the federal govemmenr - to be sold to J.p. Morgan Ctwse & Co, forthe fire_sale price of $2 a share' in stock' or about 5236 million. Bear Sterns had a stmk-market
notable transactions related to the sub-prime mortgage crisis il U.S. financial markets were reported intheWall Street Journal in early 2008."&ank af America offered an all-stock deal valued at $4 billion for Countrl'wide - a fraction of the companl's Sl-l biliion market value a year
value of the identifiable net assets acquired exceeds the S1.000.rir-rl purchase price by $200,000, so Pitt recognizes a $200,000 gair from a bargain purchase. Bargain purchases are infuequent, but sometimes occru erer rbr very large
We assign fair values to the individual asset and liabiliry ilcounts in this entry in accordance with the provisions of FASB Statement No. I4lR for business ci_rnbiaations. The $1,200,000 fair
corporations. Two
lion
as
of Friday
ire
6"Behind Bank of America's Big Gamble," wail s*eet Journar, January 12,200g, p. A1.
n
::3;ulation. Therefore, the amount thaf we generally capitalize as goodwill is the portion of the :rr;hase price left over after all other identifiable tangible and intangible assets and liabilities .,'e been valued. Errors in the valuation of other assets will affect the amount capitalized as : -- rdrl iil. {,nder EASB Statement No. 142, goodwill is not amortizedfor financial reporting purposes. -:i;re are also income tax controversies relating to goodwill. In some cases, firms can deduct good'; ril amortization for tax purposes over a 15-year period. The tax consequences of goodwill are
FoR GooDWLL U.S. companies had long complained that the accounting rule amortizing goodwill put them at a disadvantage in competing against foreign companies for ::.:ser pafiners. Some countries, for exampie, permit the immediate write-off of goodwill to stock,,-,Jers' equity. Even though the balance sheet of the combined company may show negative net .- :,rth. the company can begin showing income from the merged operations immediately. The new . .. '; dard should alleviate these competitive disadvantages. Companies in most other industrial countries historically capitalized and amortized goodwill .:-iired in business combinations. The amortization periods vary. For instance, the maximum .-:-,rrtization period in Australia and Sweden is 20 years; in Japan, it is 5 years. Some countries per--, deducting goodwill amortization for tax purposes, which makes short amortization periods
flmRuattou* Accouwnlc
::
::lar.
runting standards. The standard-setting bodies of the three trading partners are looking at ways -row the differences in accounting standards. Canadian companies no longer amortize good- " Canadian GA.A.P for goodwill is now consistent with the revised U.S. standards. Mexican - ::anies amortize intangibles over the period benefited, not to exceed 20 years. Negative good- -iom business combinations of Mexican companies is reported as a component of stockhold: -, :quity and is not amortized. -:e IASB is successor to the IASC, a private-sector organization formed il 1913 to develop =rational accounting standards and prornote harmonization of accounting standards worldwide. -,-:--ident with the issuance of 1FR.9 3 on March 31,2004, the iASB revised International ' . . .Lnring Standard (IAS) 36, "Impairment of Assets," and 1AS 38, "Intangible Assets." Under the :. -.:,i rules, goodwill and other intangible assets having indeterminate lives will no longer be : rtltilt but will be tested for value impairment. Impairment tests will be conducted annually, or : ,:= : .:.:ently if circumstances indicate a possible impairment. Firms may not reverse previously -:- :- -' -:rpairment losses for goodwill. These revisions make the IASB rules consistent with :' -: '- ! .- j Canadian GAAP. Although accounting organizations tiom all over the world are .: .r- -- = I \SB does not have the authority to require compliance. However, this situation is ' ".r ; - - *-',--i. The European Union requires IFRS in the financial reporting of all listed firms , 5. Many other countries are replacing, or considering replacing, their own GAAP
-
:::
The North American Free Trade Agreement (NAFIA) increased trade and investments between -.-ada, Mexico, and the United States and also increased the need for the harmonization of
r: ,
Jards.
.rd FASB are working to eliminate differences in accounting for business comLS and U.S. GAAP. The FASB is considering revising its standards to hamo:::*:r:ements" For example, under U.S. GAAP, amounts assigned to purchased :: C"^velopment must be expensed, whereas IFRS 3 permits capitaiization of and 160 were issued in 2001 , as the result of a joint project with the of /FRS 3 at the same time. Some differences still remain. For an acquirer to measure the noncontrolling interest at its fair value, -i:: *-: - ::rs to record noncontrolling interests at either fair value or a propor-
l'
. ::"'ision
':
-*^i l+l
$ A,sc,:rit ".; inr Goodwill and Other lntangible Assets r-r: - -,-::: ::,-ounting for goodwill in FASB Statement No. 142. They main-.,
": -'-- - -
.'-J-*ill.buttherevisedstandardsmitigatemanyof
theprevious
frt
. FASB Statement No. 141R provides clarification and more detailed guidance on when previously unrecorded intangibles should be recognized as assets, which can affect the amount ofloodwill that firms recognize. Under FASB Statements No. l41R and No. 142, firms record goodwill but do not amortize it. Instead, the FASB requires that firms periodically assess goodwill for impairment in its value. An impairment occurs when the recorded value of goodwill is greater than its fair value. We calculate the fair value of goodwill in &e same manner as in the original calculation at the date of the business combination. Should such impairment occur, firms will write down goodwill to a new estimated amount and will record an offsetting loss in calculating net income for the period.
FASB Statement No. 142 doesnot retroactively change treatment of goodwill, but firms will cease arnortization of previously recorded goodwill. In other-words, further imortization is not permitted, but firms may not write goodwill back up to reverse the impact of prior-period amortization charges. Firms no longer amortize goodwill or other intangible assets that have indefinite useful lives. Instead, firms will periodically review these assets (at least annually) and adjust for value impairment. The FASB provides detailed guidance for determining and measuring impairment of goodwill and other intangible assetS. FASB Starement No. 142 amends FASB Statement No. I2I, 'Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," to exclude goodwill and other nonamortizable intangible assqts. Firms must apply MSB Statement lio. 142 in all fiscal years beginning after December 15, 2001. The standard also redefines the reponing entity in accounting for intangible assets. Under APB Opinion No. 17, firms treated the acquired entity as a stand-alone reporting entity. The FASB recognized that many acquired entities are i,ntegrated into the operations of the acquirer. Under MSB Statement No' 142, firms will treat goodwill and other intangibles as assets of the business reporting unit, as defined under,EA,SB Statement No. 13l, "Disclosures About Segments of an Enterprise and Relaled Information." Firms will report intangible assets, other than those acquired in business combinations, based on their fair value at the acquisition date. Firms should allocate the cost of a group of assets acquired (which may include both tangible and intangible assets) to the individual assets based on relative fair values and "shall not give rise to goodnill" (paragraph 9). MSB Statement No- 142 (paragraph 10t retains A PB Opinion No. l7's accounting for internally developed intangible assets:
Costs of internally developing, maintaining, or restoring intantgible assets (inctuding goodwilt) that are not specificatty idenifiable, that haie indeleruninate lives,
are inherent in a continuing business and related to the entity as awhole, shall be recognized as an expense when incuned.
or that
Recoctltaue AffD MEASURII{G lupntnmru Losss The goodwill impairment test under MSB Statement No' 142 is a fwo-step process. Firms must firsi compare values (book values) to fair val"uoying ues at the business-reporting-unit level. Canl ing value includes the goodwill amount. If fair value
a current arm's-length transaction. The FASB considers quoted market prices as the best indicators of fair values, although these are often unavailable. When market prices are unavailable, firms may determine fair values using market prices of similar assets and tiaUitities or other commonly used
unit to all identifiable assets and liabilities as if they purchased the unit on the measur".n"rrt dut". Any excess fair value is the implied fair value of goodwill. Fair value of assets and liabilities is the value at which thel-could be sold, incurred, or settled in
not reverse previously recognized impairment losses. Firms should determine the implied fair value of goodnill ir rhe same manner used to originally record the goodwill at the business combination date. Firms allmare the fair value of the reiorting
for the difference. The loss amount cannot exceed the canlilg amount of the goodwiil. Firms can-
is less than the carrying amount, then firms u-ill proceed to the secJnd step, measurement of this impairment loss. The second step requires a comparison of the carn'ing amount of goodwill to its implied fair value. Firms should again make this comparison at the business-reporting-unit level. If the canying amount exceeds the implied fair value of the goodn-ill. the firm must recognize an impairmentioss
31
--ir"r:
Tt: ::
, i* :: .::r:raiies. For example, firms may employ present value techniques to value estimated - i: i--.-,s orearnings.Firmsmayalsoemploytechniquesbasedonmultiplesof earningsor
:r
r_- , - -,i conduct the impairment test for goodwill at least annually. MSB Statement No. 142 j-,-- : - - : iequires more-frequent impairment testing if any of the following events occurs:
.
-:i
adverse change in legal factors or in the business climqte .- ;.j'. erse action or (tssessment by a regulator -- -. ;.:- c ipate d comp etition
- . .:t:!-icant
-.
, -.:
--
r,
5 :. - zilition of a goodwill impairment loss in the financial statements of a , : ';iiary that is a component of a reporting unit r: : , ,::;. : ,l impairment testing required under E4SB Statement No' 142 is complex and may * ,:r , :-- , =l l-rnancial statement impact. A whole industry has sprung up to assist companies in -l*j.r:
::"..,: a
hnwr;s:nil\ Vfisus
Firms must amortize intangible assets with a finite useful life r jr- _: The FASB defines usefut tife as estimated useful life to the reporting entity. Firms must ' *i *,._: - ... eible assets with an indefinite useful life over the best estimate of that life. The :ir,t , . , .:: tnization should reflect the expected pattern of consumption of the economic benefits
Nonnm0RTtzATtoN
1''
: _:.- -:ttie. It firms cannot determine a pattern, then they should use straight-line amortization. :i*_i i _ rot amortize intangible assets with an indefinite useful life that cannot be estimated. If should be amottized at that point. Firms fru:; ,:: r,:r;tle s later have a life that can be estimated, they
.i, , - :-,-.-,:ica11-rreview intangibles that are not being amortized for possible impairment loss'
Srl r-0SURE REQUIREMENTS
I
.:.
r:,r I - .; ,.counted for by the acquisition method. The notes also should provide the name and of the .. ir-:i :::::tpiion of the acquired company, the period for which results of operations
,;
::
must disclose that the business com---nancial statements of the acquiring corporation
r .i .rj:- - . =iun1 are included in the income statement, the cost of the acquired company and' if '-: number and vaiuation of shares of stock issued or issuable, and a description of any --j:l . -::,: I --::-. :.1 ments. Inforrnation relating to several minor acquisitions may be combined for
=:: -.=:-.1 acquisitions, the financial statement notes for the period of combination should *'- tr:: , --:,:inental information on a pro forma basis as follows: (1) the results of operations for (2) the :erod as though the companies had combined at the beginning of the period and ,, * -. -r .* u i::. . : -:,e:.irons for tie immediately preceding period as though the companies had combined _ t** :r-' l-,..g of that period, if the firm presents comparative financial statements. The FASB .! lr I l-. '-- disclosure of these pro forma results for nonpublic enterprises'8 .ii related to recognized _ l , -i 1.' t:t No. l4l R expands required disclosures, especially those
r: ,
,"- .
r-:::*:!OSeS.
- .;
the combination and the :r*:r ;. 1 ;:: ;ri:-*:. Firms must disclose the primary business reason for for assets acquired and liabilities ,.,. : --. : rrchase price by major balance sheet categories
\o. j42 requires firms to report material aggregate amounts of goodwill as a -rtl lire item. Likewise, firms must show goodwill impairment losses separately rirTr"ir::lr ! -r - r: : ..r r:* .-r i: u i;r;L=lr. as a component of income from continuing operations (unless the impair- 1r;. : .*.Ji ; - -..-ued operaiions;. FASB Statement No. 142 aTso provides increased disclos'ure
, ,ri
1r
,ir
rn,r-r
r: -
j::r-:a-*i
can be found
Statevnents
No l4lR Under
.: -:.., :jated ircome statimeit *i11 include ', :- *'.'*iSd further in a latter chapter.
32
iequirements for intangible assets (FASB Statement No. 142, paragraphs 45 through 47, which are reproduced in Exhibit 1-3). Before completing the chapter, let's take a look at a summary example of required disclosures under ,E4SB Statements No. I4I and 142 from a real-world company.e In February 2006, Cisco Systems,lnc. completed its acquisition of Scientific-Atlanta, Inc. Cisco planned to use ScientificAtlanta's products and services to provide a more complete package of services for its customers. Exhibit 1-4 provides excerpts of Note 3 from Cisco's 200'7 annual report related to this acquisition.
No.142, pp.16-17.
''
:ir ::
:-
--:.;:
:.-.::
: - .'
-:-
"
::. rs:, :isclosures under E4SB Statement No. I 4 I R are L "\ . :: :::::sr:::rr iurhg ilscal rears be,einning a1:et D:::::*,
33
Note 3-Business
Combinations (pp.56-57)
Saurce: Excerpt from Clsco Sysfems, /nc' 2007 Annual RePort'
\lre,
to purchased intangible in particular, that $1.9 billion of the $7.1 billion price tag relates million to in-process research and ..sets. Cisco allocates $3.8 billion to goodwill and another $88
::r'elopment.
why we haven't rnentioned have likely heard about Sarbannes-oxley and ale wondering and WorldCoru (among others) and the demise The financial collapse of Enron Corporation
lou
it yet'
of
Congress to initiate legislation :ublic accounting firm Arthur Anilirsen and Company spurrecl abuse' The result was the sarbutes:r:ended to pfevent future financial reporting and auditing palt, the new rules focus on corporate goveflIance, auditing ,-t.-;lt-., .\ct of 2002 (sox) For the most presenlaljt': ,:j :"i:nal-control issues, rather than the details of financial reporting and statement al1 t'' ::: -:e topic of this text. However, you should recognize that the law rvill impact --::: .-: a few of the imporlant areas covered b.v SOX: . , ::. _, : -::panies that we study. Here are
34
I r I I r
Requires greater independence and oversight responsibilities for corporate boards of directors, especially for members of audit committees Requires management (CEO and CFO) certification of financial statements and interna.l controls Requires independent auditor review and attestation on management's internalcontrol assessments Increases disclosures about off-balance sheet arrangements and contraclual obligations Increases types of items requiring disclosure on Form 8-K and shortens the filing period
Enforcement of Sarbanes-Oxley is under .the jurisdiction of the Securities and F.xchange Commission. The SEC treats violations of SOX or rules of the PCAOB the same as violations of the Securities Exchange Act of 1934. Congress has also increased the SEC's budget to permit improved review and enforcement activities. SEC enforcement.actions and investigations have increased considerably since the Enron collapse. One recent example is Krispy Kreme Doughnuts, Inc. AJanuary 4,2005,press release on the company's Web site announced that earnings for fiscal 2004 and the last three quarters would be restated. Apparently the company did not make as much "dough" as originally reported. Pre-tax income will be reduced by between $6.2 million and $8.1 million. Another example appeared in a Reuters Limited story on January 6,2005, which noted that former directors of WbrldCom agreed to a $54 million settlement in a class-action lawsuit brought by investors. This included $18 million from personal funds, with the remainder being covered by
insurance.
Exhibit 1-5 provides an example of the required management responsibilities under SOX from the 2006 annual report of Chevron Corporation (p. 49). Notice that management's statement reads much
Report of
Management
Source:2006 Chevron Corp. annual repod.
,-r4
.s
-5[,i:
,::+
r:r++
35
a traditronal independent auditor's report. Management takes responsibility for preparation of ::e inancial reports, explicitly notes compliance with GAAP, and declares amounts to be fairly :'r*ented. Management also takes explicit responsibility for designing and maintaining internal
3"e
a:r.nr,ls. Finally, the statement indicates the composition and functioning of the Audit Committee, rn:-;h is designed to comply with SOX requirements. The statement is signed by the CEO, CFO, stj s66p6sller of the company. tre will note other relevant material from Sarbanes-Oxley throughout the text, as applicable. F:r erample, transactions with related parties and variable interest entities are included in
iAater
11.
*rr:.. Lnder FASB Statement No. l4lR, all combinations initiated after December 15, 2008, must rr .uc-nurted for as acquisitions. Acquisition accounting requires the recording of assets acquired
nr.,'
join into
a single
accounting
-:Si,lities assumed at their fair values at the date of the combination, illustrations in this chapter are for business combinations in which there is only one survivng :nd.ry. Later chapters cover accounting for parent-subsidiary operations in which more than
lk
nnre
'll,
-'i*ribe
:= i E-rplain. a;-: are the legal distinctions between a business combination, a merger, and a consolidation? I { a:br does goodwill result from a business combination? How does goodwill affect reported net income
rr-,= a business combination?
in order to have
a business combina-
in
?i
is a bargain purchase? Describe the accounting procedures necessary to record and account for
purchase.
r :*;ai-n
r-1
questions
1.,
ffi
{
ncr:
r.sas combination in which a new corporation is formed to take over the assets and operations of two or
separate business entities, with the previously separate entities being dissolved, is a/an:
e tamlidation b Hger
r ,
2.
h &Mged against other paid-in capital ot the combined entity c [t&sfud from income in the period of combination 6 tuE of the above
r : s..siness
investment account
f,[flMl
.T
accounts would be adjusted to its fair market value in a merger accounted for under the method, regardless of the price paid?
r ffiar t gfir from a bargain purchase i ffi h r ffiiaa af noncash assels before negative goodwill may be reported
36
t
d
5'
noncurrent assets other than marketabre securities to zero berore nesative goodwi, Appried to reduce goodwi, to zero before negative
Y:i;:::;:l:fr
Cork corporation acouires Dart corporation in a business combination. which of the following would from the process of assigning frir.-ritrrr;;;;;;l"e, be excluded of recording the acquisition?
'^
pavabte becaui
ii]i,'ii| ,*i,n*of
a
FASB srarement
,,
i,;;;;;;;,'r*d
ii;::t;r;1,:::X! "^*rt
E1-2
[AICPA adapted! Generat probtems
1
'
Fast corporation paid $50,000 cash for the net assets of Agge company, which consisted of the following:
Book Value
Fair Value
$14,000 s5,000 (e,000)
$60"00-o
Curent
assets
i0,000
Liabilities assumed
a $i5,000
ftis
at:
'
Jack companv pajd s800,000 for all the issued and outstanding common stock of Ann corporation pri.r'arr.'inir.rororu in ffiiliii;! of Ann corporation on Aprir 1a
,r;;t;il
ln1'sntor/
Property and equipment (net
$
depreciation
80,000
.,ifiiill,r,"o
of$320,000)
of
240.000 480,000
0n Aprir it was determinedrhat the inventorv ment (net) had a fair value of g560'000.
,,T;ii3:,,:Ir,rl:,f
d
E 1-3
b $50,000 c $150,000
$180,000
fi:::?, the
r,.o,n
business combination?
illt:ilto:li'otrs'
equities of Pillourcorporation and Sreep-bank corporation ai January 1 were as forows (in PiIlog' Capital stock, $10 oar Other paid-in capiul
Retained eamings
s
1,500
200
600
Stockholders, equity
$2300
sl Jo-0
srrffiu
::-re:.e
L,usiness combinarion on
January,. fi*,1,r
r."0#;:jil#H#:l
sheet rmmediately
J7 E 1-4
.&o'urnal entries
d,ifferences
-::--
-'-'---i.ry l.DandersCorporationpays$400,000cashandalsoissueslS,000sharesofg20parcommonstockwith . -.".-. 'r'aiue of $660,000 for all the outstanding common shares of Harrison Corporation. ln addition, oanoeii pays :a: --:iorregisteringandissuingthelS,000sharesand$l40,000fortheotherdirectcostsof thebusinesscombi-"''hichHarrisonCorporationisdissolved.summarybalancesheetinformationforthecompaniesimmeOiatety
mei-ger is as follows (in thousands):
-,:---: :-3
Harrison
Book Value
Harrison
tr'air Value
700
$Bo
160
244
60
$80
204
40
520
sl
;ro
320
160
40 360
s6m
560 s880
Current liabilities
Other iiabilities Common stock, 920 par Retained earnings Total liabiiities and
$60
100
$60
80
840 200
400
80
owners'equity
$_u?q
$!4q
: : : U I R E D: . -:::-:rn.
Prepare all journal entries on Danciers Corporation's books to account for the business
,tmfiurrral
entries to record husiness combination$ +*:; :_-oany issued 120,000 shares of $10 par common stock with a fair value of $2,550,000 **:-.:_r:kof JesterCompany. lnaddition,iceAgeincurredthefollowingcosts:
Legal fees to arrange the business combination Cost of SEC registration, including accounting and legal fees Cost ofprinting and issuing net stock certificates Indirect costs of combining, including allocated overhead and executive salaries
$25,000 12,000 3,000 20,000
Book Value
Fair Value
Current assets
PIant assets
Liabilities
Common stock
Retained earnings
$r,100
300
) )oo
200
; Ei :
il
*,,,:
!'uwffifrfi
mffiriiftiltmlffiB
$het after busines$ connbination :.-,::n corporation enters into a business combination with Seabird ..: -: :: dissolved. Pelican pays $825,000 for Seabird, the consideration
38
consisting of 33,000 shares of Pelican $ l0 par common stock with a market value of $25 per share. In addition, Pelican pays the following expenses in cash at the time of the merger:
Finders'fee
Accounting and legal fees Registration and issuance costs of securities
$140,000
Balance sheet and fair value information for the rn'o companies on December before the merger, is as follows (in thousands r:
Pelican Book \alue
Cash
3 1,
2008, immediately
Seabird
Seabird BookValue
FairValue
150
:_10
$30
50 80
100
$30
40
{|0
5:0
120
150 300
Buildings-net
Equipment-net
Total assets Accounts pay4ble Note payable Capital stock, $10 par Other paid-in capital
Retained eamings
: u s_-5r s
,1m 600 800 600
1.1:{n 500
200
300 $i6-o
250
s8e-0
$40
200
300 50
$40
180
-im
5t,8qq
170
$760
owners'equity
RE0UIRED: nepare
7-2
Comparative balance sheets for Pine and Sain Corporations at December 31, 2008, are as follows (in thousands):
Sain
Buildings---net
Equipment----aet
Total as-ts
Currenr liabilicies Capital srock- S10 par
60
100 100
240 $5oo
s60
2a0
140 100 $-m0
issues 30.000 shares of its stock w-ith a market value of g20 per share for all the outstanding shares of Sain Corporation in a bushess combination. Sain is dissolved. The recorded book values reflect fair values, except for the buildings of Pine, which have anetrealizable value of $400,000, and the current assets of Sain, which have a net realizable value of
il
25,000
RE0U
IRED:
Prepare the balance sheet of Pine Corporation immediately afterthe business combination-
P 1-3
Journal entries and balance sheet for business combination stock for all the lJa January 2,zl}g,Persis Corporation issues its own $10 par common
outstand-
Sineco is dissolved' In addition' Persis ,r1s stock of Sineco Corporation in a business combination' The issuing securities and $30,000 for other costs of combination' ;ar s $20,000 for regist#ng and Relevant balance sheet inforper share. :rarket price of persis's stJck on January 2,200g,is $30 just before the business combiSineco corporations on December 31, 2008, radon for Persis and -arion. is as follows (in thousands):
Persis Sineco Sineco
Ilistorical Cost
Cash
Historical Cosl
Fair Value
120
$to
30 90 20
$10
60
100 100
Inventories Other current assets Land Plant and equiPment-net Total assets
50
100
80 650
200
350
$Io=do
s556
$6m
Liabilities
Capital stock, $10 Par Additional paid-in caPital
Retained earnings
200 500
$s0
100 50 150 $350
$s0
200
100
$1,000
EQUIRED
1
its stock for all of Sineco's outstanding shares' -\ssume that Persis issues 25,000 shares of
2, -\ssume
t,
a.PreparejoumalentriestorecordthebusinesscombinationofPersisandSineco. business combination' b, Prepare a balance sheet for Persis corporation immediately after the outstanding shares' that Persis issues 15,000 shares of its stock for all of Sineco's
Prepare
rr"p*"
journal entries to record the business combination of Persis Td lt"::l: after the business combination' u uutunce sheet for Persis corporation immediately
F 1.4
at December balance sheets of Phule Corporation and Sen corporation (in thousands): --:C together with fair value information as follows
-:
Sen CorPoration
Fair
Value
ls
40 150 100 300
Book
Value
Fair Value
Cash
$1 15
$1
Receivables-net
Inventories Land
40
120
45
ts:ildings-net
T.ial
assets
200
180 $700
-;,:ipment-net
l-- ":,- j (
245 Seso
$3oo
$30 60
100
$10 20 50 30 100 90
10
20 30
100
.---,'--..payable ":,:- -.:lliiies - r-^ck. $10 Par -; ."..:.- :,, :-n capital
:-
$90
100
$e0 90
$30
70
300
100
.*
:;--:3\
- :>::-ted.
=.+incc
ll0
$Zqg
80 30
$igq
_--_.--]00g,PhuleCorporationacquiredallofSenCorporation'soutstandingstockfor
::-::.:dSl00,000cashandissuedafive-year'!2Tonoteforthebalance'Sen
-, : i::
40
REQUIRED
1, Prepare a schedule to show how the investment cost is allocated to identifiable assets and liabilities. 2, Prepare a balance sheet for Phule Corporation on January l,2009, immediately after the business
combination.
P 1-5
$
receivable-net
6,000
Accounts receivable-net
Notes
2,600
3,000 5,000 1,400 4,000 18,000
480 720
600 840 360
480
200
1,200 1,600
Buildings-net
Equipment-net
Total assets Accounts payable Mortgage payable-|l%o Capital stock, $20 par Other paid-in capital
Retained earnings Total equities
400 2,400
1,200
20,000
$60,000
$6,000
$r2qa
2,000 10,000
20,000
16,000 12,000 $60,000
600 1,200
s6.000
REQUIRED
1, Prepare journal entries for Celistia Corporation to record its acquisition of Dawn Corporation, including all allocations to individual asset and liability accounts.
2, Prepare a balance
sheet for Celistia Corporation on January 2,2009, immediately after the acquisition and
dissolution o[ Dawn.
,1
{i .i
,,$
,d
'i
,:d
't p
ji
IrHAPTER
Business Combinations
Charter One Finuncial, Inc., for $10.5 billion, making Citizens one of the
In october 200r, chevron and rexaco announced completion of their merger agreement valued in excess of $30 billion. In 199g, gasoline-producing rivals Exxon and,Mobit merged to formExxonMobil Corporaion in a deal valued at gg0 billion. Similar combinations had occurred in the industry including Bp Amoco's acquisition of Atlsntic Richfield. Bank of America acquired FleetBoston Finuncial Corporation for g47 billion in
2004
alnd
followed up with
a purchase
of
Japan Tobacco
Inc.
(a British tobacco maker) in December 2006. In 2001, America online (AoL) acquired conrrol of
nmr:ir3':r1se1.
&n'nnms"si
elcome to the world of business combinations. The 1990s witnessed a period of unparalleled growth in merger and acquisition activities in both the United States and in m.tional markets (often referred to as merger mania), and the trend continues. ]l,[,eger activities slowed with the stock market downturn in 2001, but as the market recovered, the mrulx regan to pick up. The following firms announced combinations in Decemb er 2004. Symantec of the Norton antivirus software) acquired veritss software for $13.5 billion. veritas is 'mmmrr---nrrer e firf,rse-slstem and backup-program manufacturcr. Oracle Cotporation acquired PeopleSoft, Inc., drr $:,r,i billion. Johnson & Johnson acquired Guidant for $25.4 billion. Guidant produces pacenrw{{e . itfibrillators, heart stents, and other medical devices. Sprint announced plansio acquire rival ild C-tCIrsnznications for approximately $35 billion, creating anew Sprint Nextel. Management qs-i'iriletl operating-cost savings and network upgrades of over $12 billion as a major motiva_ '"q{rt
their shareholders. enmr n -r; 5p21sgy, expansion has long been regarded as a proper goal of business entities. t$. fiusiffiF gfoso5s to expand either internally (building its own facilities) or externally =ar
rr[m:]'I@mflmnng
5:m:e, ot other firms in business combinations). The focus in this chapter will be on
,Hl"l1Hl:tft",ffi:";"1il:,T:i
riding objective of businesr
Horizontal integration
f*T[n:U;:*ffiTiJ",3:T;*'Y.
it trt"
activity in banking and other
In general terms' business combinations unite previously separate business entities. The oyer-urt u" rn"r"uring p'ro?tuurhty;towever, "o-uinuiJ.r,
"' ""ni""'v-J,"i,iii,
and garden equipmenr. Disney u"q*ir"d;;a-ilLrxirduring rsgri; p-urde consumer iawn_and_ broadcasting markers toi orsney-pr"J*Jnr-r, ready access ro mass other Disney products. In advertising outret for March 200 i, borpo*tio, Rx,Inc.,merged to form cvs/caremqrk corporatian in a dealuutu"o ui szo uithor. itr" joined the natiJn,s largest pharmacy chain with one of the leading ;ealthcare/phu..u""uJ.urs service companies. In September 2006' computer processor maiufacture, Devicesbought graphics chipmaker ATI Technologiis for Interner p*,"i a,,'"rrca online,s media giant Time warner in acquisirion of 2001 prouo"Jior un oppoiu"il;;;;", electronic access ro Time warner's vast media content' warner's cable televisi"t rr"rJiig, AoL an opportunity to expand its Internet presence l with high-speed, broadband access "rr*ed through cable conglomeration is the combiniti";;;;;-r with unrerared unJ-diu"rr. products functions' or both' Firms or service diversify to reduce the risk lnay with a particular line of business or to even out^cyclical "r*"i","d earnings, ,;;h might occur in u .riitity,, acquisition of a man_ ",
i,ioi"rr"a significanr consoridarion *rt cno* Manhattun. Kimberlyclark acqutred' scott Pwr' u "t"uting "o"t"# y*"1-a."rirJ p."oucrs giant. paint manufacturers sherwin-williams and Pratt t"a i.*iiicombined in a $aoO iittln a"a. control of its rival Western Air Derta Air Lines took Lines, at a cost of $7g7 mlfion.Automakers chrysler corporation were consolidated Daimler_Benz and to tty nytlcii"l"r. o"r"gurarion natural gas utilities islikely to of erectric and generare combinariorr'#rh;;inoustry in the turure. vertical integration i" tnJ ";; offirms with stages of production or disrribution "o,oli*J"r-"r ";;;;;; in different, but successive, ot iort, In June zodi,-iriir, & announced an agreeme.nr ro stratton corporation acquire Simplicity,lonuyo"turfni, ,rri., ,., $22j.5million. Briggs & stratton is'the world's t*g.rt proau*. teader in design, manufacture, "?,-;il gurorin"_po,"J.J "n*rn"r, whereas Simplicity is a una .*t"trng
of firms in the same business rines business combinations of chevron "i*uir",l"n and markets. The *a Exxon and naouil, Citigroup, and one are examples of horizontal Citizens and charter
r""g."""*
r"^"e
i"a"tti.t---Ci"*icir nank-.g"d
rrr";;r;;;" d
"?;;;;;J-;"._"#r",
ci;
$5/;iiii;"
systems.
rii,n
,;;0i"""
iili,l|,l.
diversify into a communicarions The earlv r990s saw business. iniii)'nrirri, food produce t Kraft in a combination that included over $11 biui;;#recorded goodwill atone. r"teptrone giant AT&T acquired computer maker NCR Corporiioo for 96.4 Uifh"" i"^rSii. artnougf, aI of us have probably purchased a light butb man'uia.i"r"i ut Generar u""iri" co*pany, rhe scope of rhe firm's operations goes well beyond ,rru, rrour"rrold product. Gen"rarirectric broadcasring when it ourchased ncA f"; $;.1 uinion ncA already owned made a move into the NBC network. t excerpts ri*" 2006 on irs major operaring
company' a local-exchang"
,*r.i.
t"t.pion"";;;;;t,ro
^iu*
c"*i"ry;"d"
ii r--;;'"*fti""tric's
lrl
";;i;;p",t
-:4r:lflJ lt*i:
=7
COn.{RoL
r*"C ;;;;
:;;;:;;-"'''
Lower Risk. The purchase of established product lines and martets is usually less risky than developing new products and markets. The risk is especially low when the goal is diversification. Scientists may discover that a certain product provides an environmental or health bazwd.A single-product, nondiversified firm may be forced into bankruptcy by such a discovery, while a multiproduct, diversified company is more likely to survive. For companies in ildustries already plagued with excess manufacturing capacity, business combinations may be the only way to grow. When ?oys R Us decided to diversify its operations to include baby furnishings and other related products, it purchased retail chain Baby Superstore in February 1997 for $376 million. X'ewer Operating Delays. Plant facilities acquired through a business combination are operative
and already meet environmental and other governmental regulations. The time to market is critical, especially in the technology industry. Firms constructing new facilities can expect nqmerous delays in construction, as well as in getting the necessary govemmental approval to commence operations. Environmental impact studies alone can take months or even years to comillete.
Avoidance of lhkeovers; Many companies combine to avoid being acquired themsetves. S;niiler companies tend to be riiore vulnerable to corporate takeovers; therefore, many of them adopt aggressive buyer strategies as the best defense against takeover attempts by other companies. Acquisition of Intarigible Assets. Business combinations bring together both intangible and tangible resources. Thus, the acquisition of patents, mineral rights, research, customer databases, or management expertise may be a primary motivating factor in a partieular business combination. When IBM purchased Lotus Development Corporation, $1.84 billion of the total cost of $3.2 billion.was allocated to purchase research and development in process.
business tax advantages
Other Reasons. Ftms may choose a business combination over other forms of expansion for (for example, tax-loss carryforwards), for personal incomq.and estate-tax advantages, and for personal reasons. One of several motivating factors in the combination of Wheeling-pittsburgh Stcel,a subsidiary of WHX,andHandy & frarmanwas Hanb! & Harman'$ overfunded pqnsion plan. rx'hich virtually eliminated Wheeling-Pittsburgh Steel's unfunded pension liability. The egos of company management and takeover specialists may also play an
important role in some bushess combinations.
ily
{iriqn of Afftce Depot, argtJingin federal court that the takeover would be anticompetitive.
20
On July 20,2004, The Wall Street Journql (p. 86) reported that the FTC had conditionally approved Sanoji-Synthelqbo SA's $64 billion takeover of Aventis SA, creating the world's thirdlargest drug manufacturer. Sanofi agreed to sell certain assets and royalty rights in overlapping markets in order to gain approval of the acquisition.
Business combinations in particular industries are subject to review by additional federal
agencies. The Federal Reserve Board reviews bank mergers, the Department of Transportation scrutinizes mergers of companies under its jurisdiction, the Department of Energy has jurisdiction over some electric utility mergers, and the Federal Comrnunications Commission (FCC) rules on the transfer of communication licenses. After the Justice Depafiment cleared a $23 billion merger between BelI Atlantic Corporation and Nynex Corporatinn, the merger was delayed by the FCC because of its concem that consumers would be deprived of competition. The FCC later approved the merger. Such disputes are settled in federal courts. In addition to federal antitrust laws, most states have some type of statutory takeover regulations. Some states try to prevent or delay hostile takeovers ofthe business enterprises incorporated within their borders. On the other hand, some states have passed antitrust exemption laws to protect hospitals from antitrust laws when they pursue cooperative projects. Interpretations of antitnrst laws vary from one administration to another, from department to department, and from state to state. Even the same department under the same administration can change its mind. A completed business combination can be reexamined by the FTC at any time. Deregulation in the banking, telecommunication, and utility industries permits business combinations that once would have been forbidden. In 1997, the Justice Department and the FTC jointly issued new guidelines for evaluating proposed business combinations that allow companies to argue that cost savings or better prodqcts could offset potential anticompetitive effects of a merger.
LEARNING
OBJECTIVE
nations are also acquisitions when one corporation obtains operating control over the productive facilities of another entity by acquiring a maiorit]' of its outstanding voting stock. The acquired company need not be dissolved; that is, the acquired company does not have to go out of existence. The terms merger and consolidation are often used as synonyms for. acquisitions. However legally and in accounting there is a difference. e@tntails the dissolution of all but one of the
businessentitieSinvolved.Alffid[affia.n,lffi.dissolutiffis
involved and the formation of a new comorati occurs when one corporation talies over all the operations of another business entir,r-and that entity is dissolved. For example, Company A purchases the assets of Company B directl-v from Company B for cash, other assets, or Company A securities (stocks, bonds; or notes). This business combination is an acquisition, but it is not a merger unless Company B goes out of existence. Alternatively, Company A ma1, purchase the stock of Company B directly from Company B's stockholders for cash, other assets, or Company A securities. This acquisition wiltr give Company A operating control over Company B's assets. It will not give Company A legal ownership of the assets unless it acquires al1 the stock of Company B and elects to dissolre
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AmoccurSwhenanewcorporationisformedtotakeovertheassetsandoperations of two or more separate business entities and dissdlves the previously separate entities. Fcx
example, Company D, a newly formed corporation, may acquire the net assets of Companies E and F
by issuing stock directly to Companies E and F. In this case, Companies E and F may continue tc hold Company D stock for the benefit of their stockholders (an acquisition), or they may disritrm the Company D stock to their stockholders and go out of existence (a consolidation). In either ca*re" Company D acquires ownership of the assets of Companies E and F. Alternatively, Company D could issue its stock directly to the stockholders of Companies E ann F in exchange for a majority of their shares. In this case, Company D controls the assets of Compr,rr E and Company fl but it does not obtain legal title unless Companies E and F are dissoh-aCompany D must acquire all the stock of Companies E and F and dissolve those compnnies if
frer
will operate
holding company, and Companies E and F will be its subsidiaries' business Future references in this chapter will use the term merger in the technical sense of a go out of existence. Similarly, the combination in which all but one of the combining companies in which all term consolidation willbeused in its technical serse to refer to a business combination is formed to take over their net the combining companies are dissolved and a new corporation process of combining assets. Consotidation is also used in accounting to refer to the accounting *principles ofconsolidation," parent and subsidiary financial statements, such as in the expressions iconsolidation procedures," alid "consolidated financial statements." In future chapters, the meanilgs of the terms will depend on the context in which they are found'
as a
and consolidations do not present special accounting problems or issues after the initial one combiriation, apart from those discussed in intermediate accounting texts. This is because only
-M"rg"r*
In June 2001, the Financiai Accounting Standards Board (FASB) defined the accounting concept, issuing MSB StqtementNo. l4l: A business combination is a tansaction or other event in which an acquirer obtains control or "mergof one or more businesses. Transactions sometimes referred to as "true mergers"
irs
of equals" also are business combinations qs thnt term is used in this Statement.l
single Note that the accounting concept of a business combination emphasizes the creation of a before their union. Although one or more cmtity and the independence of the combining companies qrgfte combining companies may lose its separate legal identity, dissolution of the legal entities is
mt
Decessary within the accounting concept. Previously separate businesses are brought together into one entity when their business Such control within ;E5ources and operations come under the control of a single management team' in which: i, established in business combinations me business
"ntity 1. One or more corporations become subsidiaries' 2, One company transfers its net assets to another, or 3. Each company transfers its net assets to a newly formed corporation.2
a majority (more need noi acquire all the stock of stock. Thus, on" Tfum 50Vo) ofits outstanding voting "o.poruiion in which motrer corporation to .onro*-ui" a business combination. In business combinations
records even cnryanies necessarily retainltheir separate legal identities and separate accounting
liess
than l00zo of the voting stock of other combining companies is acquired, the combining
have become one entity for primary reporting purposes'
fuugh they
can be consumtsLiness combinations in which one company transfers its net assets to another company must acquire substantially all thelet assets d in a variety of ways, but the acquiring n mI case. Alternatively, each combining company can transfer its net assets to a newly formed its stock ,mpmation. Because the newly formed corporation has no net assets of its own, it issues stockholders or owners. m fre other combining companies or to their
n B*f Background on Accounting for Business combinations and interesting'topics of -e*smthg for business combinations is one of the most important combi-
mming theory and practice. At the same time, it is complex and controversial. Business stories resF involve financial transactions of enormous magniiudes, business empires, success the 5 FsCInal fortunes, executive genius, and management fiascos. By their nature, they affect
5c rr dnafue campanies.
Each is unique and must be evaluated in terms of its economic substance, mnuqqrycre of its legal form. *,,f,U -8mme,1,o-.1{/R, paragraph 3.e. Statement 141R (2007) reaffirms' Sq.S forms e cnnsolidarion policy based on control of another enterprise rather than majority owaership'
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