Advanced accounting 10th by a beams athony ch01

Chapter 1: Business Combinations
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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Business Combinations: Objectives
1. Understand the economic motivations
underlying business combinations.
2. Learn about the alternative forms of business
combinations, from both the legal and
accounting perspectives.
3. Introduce concepts of accounting for business
combinations, emphasizing the acquisition
method.
4. See how firms make cost allocations in an
acquisition method combination.
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Business Combinations

1: Economic Motivations

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Types of Business Combinations
Business combinations unite previously separate
business entities.
• Horizontal integration – same business lines and
markets
• Vertical integration – operations in different, but
successive stages of production or distribution,
or both
• Conglomeration – unrelated and diverse
products or services
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Reasons for Combinations
•
•
•
•
•
•

Cost advantage

Lower risk
Fewer operating delays
Avoidance of takeovers
Acquisition of intangible assets
Other: business and other tax advantages,
personal reasons

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Potential Prohibitions/ Obstacles
• Antitrust
– Federal Trade Commission prohibited Staples’
acquisition of Office Depot
• Regulation
– Federal Reserve Board
– Department of Transportation
– Federal Communications Commission
• Some states have antitrust exemption laws to
protect hospitals
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Business Combinations

2: Forms of Business Combinations

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Legal Form of Combination
• Merger
– Occurs when one corporation takes over all
the operations of another business entity and
that other entity is dissolved.
• Consolidation
– Occurs when a new corporation is formed to
take over the assets and operations of two or
more separate business entities and dissolves
the previously separate entities.
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Mergers: A + B = A
1) Company A purchases the assets of Company
B for cash, other assets, or Company A
debt/equity securities. Company B is dissolved;
Company A survives with Company B’s assets
and liabilities.
2) Company A purchases Company B stock from
its shareholders for cash, other assets, or
Company A debt/equity securities. Company B

is dissolved. Company A survives with
Company B’s assets and liabilities.
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Consolidations: E + F = “D”
1) Company D is formed and acquires the assets
of Companies E and F by issuing Company D
stock. Companies E and F are dissolved.
Company D survives, with the assets and
liabilities of both dissolved firms.
2) Company D is formed acquires Company E
and F stock from their respective shareholders
by issuing Company D stock. Companies E and
F are dissolved. Company D survives with the
assets and liabilities of both firms.
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Keeping the terms straight
In the general business sense, mergers and consolidations
are business combinations and may or may not involve
the dissolution of the acquired firm(s).
In Chapter 1, mergers and consolidations will involve
only 100% acquisitions with the dissolution of the
acquired firm(s). These assumptions will be relaxed in

later chapters.
“Consolidation” is also an accounting term used to
describe the process of preparing consolidated
financial statements for a parent and its subsidiaries.
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Business Combinations

3: Accounting for Business
Combinations
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Business Combination (def.)
“A business combination is a transaction or other
event in which an acquirer obtains control of
one or more businesses. Transactions sometimes
referred to as ‘true mergers’ or ‘mergers of
equals’ also are business combinations…”
[FASB Statement No. 141, para. 3.e.]
A parent – subsidiary relationship is formed
when:
– Less than 100% of the firm is acquired, or
– The acquired firm is not dissolved.
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U.S. GAAP for Business Combinations
• Since the 1950s both the pooling-of-interests method
and the purchase method of accounting for business
combinations were acceptable. [ARB 40, APB
Opinion 16]
• Combinations initiated after June 30, 2001, use the
purchase method. [FASB Statement No. 141]
• Firms should use the acquisition method for
business combinations occurring in fiscal periods
beginning after December 15, 2008 [FASB Statement
No. 141R]
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International Accounting
• Most major economies prohibit the use of the
pooling method.
• The International Accounting Standards Board
specifically prohibits the pooling method and
requires the acquisition method. [IFRS 3]

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Recording Guidelines (1 of 2)
• Record assets acquired and liabilities assumed
using the fair value principle.
• If equity securities are issued by the acquirer,
charge registration and issue costs against the
fair value of the securities issued, usually a
reduction in additional paid-in-capital.
• Charge other direct combination costs (e.g., legal
fees, finders’ fees) and indirect combination costs
(e.g., management salaries) to expense.
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Recording Guidelines (2 of 2)
• When the acquiring firm transfers its assets other
than cash as part of the combination, any gain or
loss on the disposal of those assets is recorded in
current income.
• The excess of cash, other assets and equity securities
transferred over the fair value of the net assets
(A – L) acquired is recorded as goodwill.
• If the net assets acquired exceeds the cash, other
assets and equity securities transferred, a gain on
the bargain purchase is recorded in current income.
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Example: Poppy Corp. (1 of 3)
Poppy Corp. issues 100,000 shares of its $10 par
value common stock for Sunny Corp. Poppy’s
stock is valued at $16 per share. (in thousands)
Investment in Sunny Corp.
Common stock, $10 par
Additional paid-in-capital

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1,600
1,000
600

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Example: Poppy Corp. (2 of 3)
Poppy Corp. pays cash for $80,000 in finder’s fees
and consulting fees and for $40,000 to register
and issue its common stock. (in thousands)
Investment expense
80
Additional paid-in-capital
40
Cash
120

Sunny Corp. is assumed to have been dissolved. So,
Poppy Corp. will allocate the investment’s cost to
the fair value of the identifiable assets acquired
and liabilities assumed. Excess cost is goodwill.
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Example: Poppy Corp. (3 of 3)
Receivables
Inventories
Plant assets
Goodwill
Accounts payable
Notes payable
Investment in Sunny Corp.
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XXX
XXX
XXX
XXX
XXX
XXX
1,600
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Business Combinations

4: Cost Allocations Using the
Acquisition Method
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Identify the Net Assets Acquired
Identify:
1. Tangible assets acquired,
2. Intangible assets acquired, and
3. Liabilities assumed
Include:
• Identifiable intangibles resulting from legal
or contractual rights, or separable from the
entity
• Research and development in process
• Contractual contingencies
• Some noncontractual contingencies
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Assign Fair Values to Net Assets
Use fair values determined, in preferential order,
by:
1. Established market prices
2. Present value of estimated future cash

flows, discounted based on observable
measures
3. Other internally derived estimations

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Exceptions to Fair Value Rule
• Deferred tax assets and liabilities [FASB
Statement No. 109 and FIN No. 48]
• Pensions and other benefits [FASB Statement No.
158]
• Operating and capital leases [FASB Statement
No. 13 and FIN. No. 21]
• Goodwill on the books of the acquired firm is
assigned no value.

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Goodwill
The excess of
• The sum of:
– Fair value of the consideration transferred,
– Fair value of any noncontrolling interest in
the acquiree, and

– Fair value of any previously held interest in
acquiree,
• Over the net assets acquired.

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