Asset-V1 MITx+15.516x+1T2024+type@asset+block@module 5 Lecture Slides 2024
Asset-V1 MITx+15.516x+1T2024+type@asset+block@module 5 Lecture Slides 2024
Asset-V1 MITx+15.516x+1T2024+type@asset+block@module 5 Lecture Slides 2024
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Acquisitions – AT&T/DirecTV – objectives
§ Understand some of the basics of mergers and acquisitions
§ Introduce goodwill accounting and the inherent difficulties associated with accounting
for goodwill
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Announced or completed acquisitions since 2010
(WSJ 2/12/2020)
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AT&T’s Acquisition of DirecTV
§ What is DirecTV?
§ Satellite TV provider
§ Competitor to cable companies like Comcast
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The Acquisition
§ How much did AT&T pay for DirecTV and how did they finance the acquisition?
§ AT&T paid $47.8 billion
§ 70% stock / 30% cash deal
§ 38% premium to pre-announcement stock price
§ Assumed the assets and liabilities of DirecTV
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DirecTV
Before the acquisition, as of June 30, 2015:
DirecTV had a market value of equity (MVE) of $34.7 billion.
Its net assets (A – L) or book value of equity (BVE) was -$3.4 billion.
How does DirecTV have such a large market value and such a low book value of equity?
§ Valuable intangible assets are off-balance sheet
§ Intangible assets include:
§ Intellectual property (Patents, Copyrights, Trademarks) In this class, we see that
acquisitions put
§ Licenses, Franchise rights
intangible assets on B/S.
§ Brand value
§ Customer lists
§ Goodwill
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Let’s Think About the Acquisition Price…
§ What is AT&T’s acquisition price?
§ $47.8 billion
§ How is AT&T financing / paying for the acquisition?
§ Stock and cash
§ What is the book value of DirecTV’s Shareholders’ Equity at 6/30/15?
§ -$3.4 billion
§ What is AT&T paying for?
§ Intellectual Property (Patents, Copyrights, Trademarks)
§ Licenses, Franchise rights
§ Brand value
§ Customer Lists
§ Goodwill
§ Control -- to become the sole shareholder
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The Acquisition
§ Why did AT&T pay more than the prevailing stock price for DirecTV’s shares?
§ There may be “synergies” from the acquisition – the combination of AT&T and
DirecTV is worth more than the two separately.
§ The seller (DirecTV) is able to capture some of the premium associated with those
synergies
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DirecTV’s Balance Sheet (A – L = SE)
(June 30, 2015 10-Q - just prior to the merger)
BV before
merger
Tangible Assets 20,490
Intangible Assets 946
Goodwill 3,885
Total assets 25,321
-Total liabilities -28,784
Book value of net assets (SE) -3,463
Given the acquisition price, what is the market value of net assets?
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DirecTV’s Balance Sheet
(June 30, 2015 10-Q - just prior to the merger)
BV before MV after
merger merger
Tangible Assets 20,490
Intangible Assets 946
Goodwill 3,885
Total assets 25,321
-Total liabilities -28,784
Book value of net assets (SE) -3,463 47,763
Given the acquisition price, what is the market value of net assets?
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How Do We Account for the Acquisition?
Under purchase accounting the entire acquisition payment is added to the acquirer’s
balance sheet, and distributed across:
1. Fair value of tangible assets and liabilities
§ Satellites and PPE, financial assets, other assets, and liabilities
2. Identifiable intangible assets
§ Orbital slots, customer relationships, trade names, patents, etc.
3. Goodwill (an intangible asset that is not separately identifiable)
§ Everything else (the plug)
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Purchase Accounting –
Allocating Acquisition Payments
1) The accounting records say the PPE is worth $9.5 billion, but it might actually be
worth or less more than that.
§ Fair value of tangible assets
2) The value of DirecTV’s customer list is not reflected on the company’s balance sheet.
Nor is the value of DirecTV’s orbital slots and spectrum and trade names.
§ Identifiable intangibles
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490
Intangible Assets 946
Goodwill 3,885
Total assets 25,321
-Total liabilities -28,784
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946
Goodwill 3,885
Total assets 25,321
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946
Goodwill 3,885
Total assets 25,321 90,626
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946
Goodwill 3,885
Total assets 25,321 90,626
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946 36,195
Goodwill 3,885
Total assets 25,321 90,626
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946 36,195
Goodwill 3,885
Total assets 25,321 90,626
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Allocating the purchase price
BV before MV after
merger merger
Tangible Assets 20,490 20,004
Intangible Assets 946 36,195
Goodwill 3,885 34,427
Total assets 25,321 90,626
-Total liabilities -28,784 -42,863
Book value of net assets (SE) -3,463 47,763
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Under Purchase Accounting:
§ The entire acquisition payment is added to acquirer’s balance sheet, and distributed across:
1. FV tangible assets and liabilities
2. Identifiable Intangibles
3. Goodwill
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Difference in DirecTV balance sheet before and after
acquisition
Change
BV
MV-BV MV after
before
(Acquisition merger
merger
Adjustments)
Tangible Assets 20,490 -486 20,004
Intangible Assets 946 35,249 36,195
Goodwill 3,885 30,542 34,427
Total assets 25,321 65,305 90,626
-Total liabilities -28,784 -14,079 -42,863
Book value of net assets (SE) -3,463 51,226 47,763
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AT&T / DirecTV Pro Forma Combined Balance Sheet
Pre-Merger
Balance Sheets Pro Forma
AT&T DirecTV Acq. Acq. AT&T
6/30/15 6/30/15 Payment Adjustments Pro Forma
Cash 20,956 5,061 -14,378 11,639
Other Tangible Assets 147,306 15,429 -486 162,249
Intangible Assets 87,307 946 35,249 123,502
Goodwill 70,920 3,885 30,542 105,347
Total assets 326,489 25,321 402,737
-Total liabilities -238,988 -28,784 -14,079 -281,851
Book value of net assets 87,501 -3,463 33,384 3,463 120,886
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Facebook allocation of $18.0 billion purchase price for
2014 WhatsApp acquisition
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Facebook Pro Forma Combined Balance Historical
Sheet
at 6/30/2014 Facebook, Inc. WhatsApp Inc. Pro Forma Pro Forma
Adjustments Combined
Assets
Current assets:
Cash and cash equivalents $ 4,384 $ 152 $ (152) $ 4,384
Marketable securities Payment in cash and 9,572 — (4,437) 5,135
Accounts receivable, net stock 1,190 — — 1,190
Prepaid expenses and other current assets 411 8 83 502
Total current assets 15,557 160 (4,506) 11,211
Property and equipment, net 3,334 16 6 3,356
Goodwill and intangible assets, net 1,672 — 18,097 19,769
Other assets 206 2 158 366
Total assets $ 20,769 $ 178 $ 13,755 $ 34,702
Acquisition of
WhatsApp FV assets –
Liabilities and stockholders' equity
Total liabilities mainly intangibles 2,423 87 910 3,420
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Facebook identifiable intangible asset amortization
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Facebook / WhatsApp Pro Forma income statement
for the six months ended 6/30/2014
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Goodwill
§ What assets are included in the goodwill balance?
§ Intangibles that are not separable, such as:
- Synergies
- Future profit increases
- Growth options
- Employees
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Goodwill Impairment
§ What is goodwill impairment?
§ Write-down/reduction in value of goodwill
§ When? If the fair value of the goodwill is less than the book value of goodwill.
§ Intuition: lower of cost or market
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HP’s Autonomy Acquisition
(2011 10-K, footnote 6)
HP’s largest acquisition in fiscal 2011 was … Autonomy …
The acquisition date fair value consideration of $11 billion consisted of cash...
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Hewlett Packard 2012 Annual report
Note 7: Goodwill and Purchased Intangible Assets
§ The decline in the estimated fair value of the Autonomy reporting unit results from
lower projected revenue growth rates and profitability levels…
§ The lower projected operating results incorporate HP’s analysis of what it believes
were accounting improprieties, incomplete disclosures and misrepresentations at
Autonomy that occurred prior to the Autonomy acquisition…
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Goodwill Impairment: HP recorded an $8.8b writedown
§ Hewlett-Packard has $6.6 billion of goodwill related to Autonomy; decides the fair value
is $0
§ Where does the remainder of HP’s $8.8 billion write-off come from?
§ Probably “amortizable purchased intangible assets”
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Procter & Gamble writes down Gillette business
(CNBC 7/30/2019)
§ Procter & Gamble wrote down the value of its Gillette brand by $8 billion. (P&G bought
Gillette in 2005.)
§ In the past 5 years, the U.S. men’s market for shaving products has shrunk by over
11%.
§ The consumer products giant has also faced increased competition from disruptors
like Dollar Shave Club and Harry’s.
§ Net sales in the grooming business, which includes Gillette, have declined in 11 out of
the last 12 quarters.
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P&G takes $8 billion Gillette writedown
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P&G writes off $6.8 billion of Gillette (Grooming) goodwill
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DirecTV is bleeding subscribers and it’s dragging AT&T
shares lower (CNBC 10/24/2018)
The company’s satellite TV division DirecTV reported a staggering 346,000 net loss in
subscribers for the quarter. This 2% loss for the quarter is 8% on an annualized basis.
Note:
One might expect an impairment of DirecTV goodwill, but this has not happened.
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Takeaways
§ Acquisition vs. internal growth – the accounting is different. Understanding purchase
accounting is important
§ In the U.S. and under IFRS all firms are required to use purchase accounting
§ Basis of assets increased to market value
§ Identifiable intangibles added to balance sheet and amortized
§ Goodwill
§ Understanding goodwill
§ How does goodwill arise?
§ When is goodwill impaired?
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15.516x Financial Accounting
Financial Investments
John Core
MIT Sloan School of Management
Financial Investments –
Remaining Agenda
§ Understand when accounting departs from the “transactions based” / “historical cost”
model and moves towards market-driven valuations
§ Understand how financial investments affect the income statement and cash flow
statement of valuation adjustments
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When are Changes in Market Value Recognized?
We have covered a variety of transactions related to assets:
§ When and how are the market values of assets reflected in the financial statements?
Example: On 1/1/2000, Delta buys a plane for $20 million (0 salvage value, 10 year
useful life). What transactions does it record in 2000?
Cash PPE – Acc Dep = R/E
–20 20
2 -2 (Dep exp.)
On 1/1/2001, what transaction does it record if it sells the plane for $20 million?
Cash PPE – Acc Dep = R/E
20 -20 -2 2 (Gain)
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Changes in market value
Clearly market value is used at the time of the acquisition and at the time of sale. It is the
period in between where things get complicated…
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Lower of Cost or Market (“LCM”) – US GAAP
If market value of an asset < its book value, then the firm is obliged to:
§ Reduce the book value of the asset
§ Recognize a corresponding loss in the income statement
If market value of an asset > its book value, no accounting transaction is recorded.
For inventory and PP&E, most firms use LCM for most assets
In this class, we will examine one set of accounting transactions that deviate from the
LCM principle: passively-owned financial assets
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What are Financial Investments?
§ Financial Investments
§ Common stock (also called “equity”)
§ Corporate bonds
§ Government bonds, treasuries, etc…
§ Accounting Questions
§ (Q1) Should changes in market value of financial investments be recorded on the
balance sheet?
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How Important are Financial Investments?
Assets 1-Jul-17
Current Assets
Cash And Cash Equivalents 5.4% 18,571,000
Short Term Investments 16.9% 58,188,000
Net Receivables 6.6% 22,632,000
Inventory 0.9% 3,146,000
Other Current Assets 3.0% 10,338,000
Total Current Assets 32.7% 112,875,000
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Fair value vs. historical cost accounting
Fair value
Second part
Last part
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Passive investments
Statement of Financial Accounting Standard (SFAS) 115 (now modified by ASU 2016-01)
requires the firm to classify its securities into 3 categories based on the intent of the
acquirer:
Changes in market value affect the balance sheet for available for sale AND trading
securities
Changes in market value affect the income statement ONLY for trading securities
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An Illustration:
Trading Security vs. Available for Sale
§ On Jan. 1, 2004, Attila is trading at $1,000/bond. Eva acquires 100 bonds
§ On Dec. 31, 2004, Attila is trading at $1,050/bond. Eva elects to keep the bonds
§ On Dec. 31, 2005, Attila is trading at $1,020/bond. Eva elects to keep the bonds
§ On December 31, 2006, Attila is trading at $1,110/bond. Eva sells all of its bonds
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An Illustration: Trading Security
On Jan. 1, 2004, Attila is trading at $1,000/bond. Eva acquires 100 bonds
On Nov 30, 2004, Eva received $1,250 in interest ($12.5/bond of Attila)
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An Illustration: Trading Security
On Dec. 31, 2004, Attila is trading at $1,050/bond. Eva elects to keep the bonds
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An Illustration: Trading Security
On Dec. 31, 2005, Attila is trading at $1,020/bond. Eva elects to keep the bonds
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An Illustration: Trading Security
On Dec. 31, 2006, Attila is trading at $1,110/bond. Eva sells all of its bonds
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I Can’t See Berkshire’s Bottom Line
A new accounting rule makes it difficult for investors to make sense of annual
reports. WSJ 11/7/2018
This year, the FASB decreed that stock gains or losses must be reported as earnings.
So Berkshire’s reported pretax earnings jumped from $5.3 billion in the third quarter of
2017 to $23 billion in the same quarter of 2018.
Did its earnings quadruple? No, the FASB’s new accounting rules forced Berkshire to
record $14.6 billion in gains on its stocks.
The meaningful portion of Berkshire’s reports is the actual profits of its businesses... But
to arrive at that number, I had to look at Berkshire’s quarterly report and calculate it
myself.
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An Illustration: Available for Sale
On Jan. 1, 2004, Attila is trading at $1,000/bond. Eva acquires 100 bonds
On Nov 30, 2004, Eva received $1,250 in interest ($12.50/bond of Attila)
Note:
AFS and Trading Securities receive identical treatment for the initial purchase and receipts of
interest/dividends
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An Illustration: Available for Sale
On Dec. 31, 2004, Attila is trading at $1,050/bond. Eva elects to keep the bonds
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An Illustration: Available for Sale
On Dec. 31, 2005, Attila is trading at $1,020/bond. Eva elects to keep the bonds
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An Illustration: Available for Sale
On December 31, 2006, Attila is trading at $1,110/bond. Eva sells all of its bonds
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Other Comprehensive Income
(In Intel’s 2013 Statement of Stockholders Equity)
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Available for Sale Disclosure – Intel
Note 5: Cash and Investments
Available-for-Sale Investments
Gross Gross
Adjusted Estimated
Unrealized Unrealized
Cost Fair Value
Gains Losses
2013 $15,191 $2,902 $(7) $18,086
2012 $12,927 $1,079 $(5) $14,001
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Statement of Cash Flows Summary
The acquisition and sales of Financial Investments affect the Statement of Cash Flows
§ Transactions in trading securities can be reported in cash flows from operations and/or
cash flows from investment
Changes in the fair value of trading securities in net income are removed from CFO.
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Fair value vs. historical cost accounting
Historical cost
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Significant Influence -- Equity Method
§ If a firm exerts significant influence over the investee then the firm must use the equity
method of accounting
§ But can have significant influence with less than 20% (e.g., board seat).
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Gilead to Boost Stake in Belgian Biotech Galapagos as
Part of $5.1 Billion Deal (WSJ 7/15/19)
Gilead Sciences Inc. also will invest $1.1 billion to increase its stake in the drugmaker to
22% from 12.3%. That represents a 20% premium to the 30-day weighted average share
price of Galapagos.
Gilead will get two seats on Galapagos’s board of directors as part of the deal.
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The Equity Method
§ Initially record the investment at acquisition cost.
§ Adjust the book value of the investment by the investor’s share of dividends and
earnings or losses.
§ Dividends received reduce investment; they do not give rise to dividend income.
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Equity Method: Example
§ On January 1, 2010, Zsa Zsa purchased 1,000 shares of Zoltan common stock for $15
cash per share. This 1,000 shares represents a 30% interest in Zoltan.
§ Zoltan’s book value per share is $10. Zsa Zsa is paying a premium because it believes
that Zoltan has unrecorded patents (with a life of 10 years) of $5 per share.
§ On June 30, Zsa Zsa received a dividend of $1 per share on Zoltan common stock.
§ At December 31, 2010 the market price of Zoltan common stock is $13 per share.
§ Zsa Zsa sells the 1,000 shares of Zoltan common stock on June 30, 2011 for $17 per
share.
Equity Method: Example
§ On January 1, 2010, Zsa Zsa purchased 1,000 shares of Zoltan common stock for $15 cash per
share. These 1,000 shares represents a 30% interest in Zoltan.
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Equity Method: Example
§ On June 30, Zsa Zsa received a dividend of $1 per share on Zoltan common stock.
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Equity Method: Example
§ At December 31, 2010 the market price of Zoltan common stock is $13 per share.
§ No entry
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Equity Method: Example
§ Zoltan reports its earnings for 2010 as $20,000.
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Equity Method: Example
§ Zsa Zsa amortizes the unrecorded patents (with a life of 10 years) of $5 per share.
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Facebook / WhatsApp Pro Forma income statement
from earlier class
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Equity Method: Example
§ Zsa Zsa sells the 1,000 shares of Zoltan common stock on June 30, 2011 for $17 per share.
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Control -- Consolidation
§ If a firm exerts control over the investee then the firm report consolidated financial
statements.
§ More than 50% ownership of the investee’s stock implies control.
§ Consolidation accounting:
§ Replace the investment balance with investee’s assets and liabilities to which it
relates.
§ Replace the firm’s portion of reported income of the investee with investee’s sales
and expenses to which it relates.
§ Eliminate intercorporate transactions.
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DirecTV balance sheet after acquisition
Pre- Post-
Acquisition Change Acquisition
B/S B/S
Cash 5,061 5,061
Other Tangible Assets 15,429 -486 14,943
Intangible Assets 946 35,249 36,195
Goodwill 3,885 30,542 34,427
Total assets 25,321 65,305 90,626
-Total liabilities -28,784 -14,079 -42,863
Book value of net assets (SE) -3,463 51,226 47,763
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AT&T unconsolidated balance sheet after acquisition
Pre- Post-
Acquisition Change Acquisition
B/S B/S
Cash 20,956 -14,378 6,578
Investment in DirectTV 47,763 47,763
Other Tangible Assets 147,306 147,306
Intangible Assets 87,307 87,307
Goodwill 70,920 70,920
Total assets 326,489 359,874
-Total liabilities -238,988 -238,988
Book value of net assets 87,501 33,384 120,886
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AT&T / DirecTV Consolidated Balance Sheet
Balance Sheets
After Acquisition
Consolidating AT&T
AT&T DirecTV Adj. Consolidated
Cash 6,578 5,061 11,639
Investment in DirecTV 47,763 -47,763
Other Tangible Assets 147,306 14,943 162,249
Intangible Assets 87,307 36,195 123,502
Goodwill 70,920 34,427 105,347
Total assets 359,874 90,626 402,737
-Total liabilities -238,988 -42,863 -281,851
Book value of net assets 120,886 47,763 -47,763 120,886
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Example 1 – Parent owns 100% of Investee
(similar to DirecTV)
Liab/ Consolidating Liab/
Parent Assets Investee Adjustments Consolidated Assets
What if Parent owns more than 50% and less than 100% of Investee?
§ Balance Sheet:
§ Consolidate 100% of Investee’s individual assets and liabilities and use offsetting
account “Noncontrolling Interest in Equity of Investee”
§ Income Statement:
§ Consolidate 100% of Investee’s individual revenues and expenses and use offsetting
account “Noncontrolling Interest in Earnings of Investee”
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Example 2 – Parent owns 50.001% of Investee
(sells 49.999% of Investee in prior example for $2,000 cash)
Consolidating Liab/
Parent Investee Adjustments Consolidated Assets
Current Assets 12,000 2,000 14,000
Investment in Investee 2,000 0 (2,000) 0
PPE, net 10,000 6,000 16,000
Total Assets 24,000 8,000 30,000
This innovative deal turned out to be the bedrock of Coke’s global strategy, not to mention
a potent stimulus to its stock price.
Coke bought a bunch of U.S. bottlers that weren’t performing well and combined them
with its own bottling network, calling the new outfit Coca-Cola Enterprises (CCE).
Then it spun CCE off to the public but kept 49% of the stock and the right to throw its
weight around.
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Take Away Slide 2
§ When there are changes in market values, accountants make valuation adjustments
§ For inventory and PP&E, use lower of cost or market (LCM)
§ For large investments (20% +), use lower of cost or market (LCM)
§ For passive investments (<20%), use mark-to-market accounting
- Balance Sheet reflects market value of investments
- Type of security determines effect on Net Income
§ On trading securities both unrealized and realized gains are reported as part of
Net Income
§ On available for sale securities unrealized gains and losses are part of Other
Comprehensive Income. Only realized gains and losses affect Net Income.
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