66

Accounting for Business

Combinations

Advanced Accounting, Fifth Edition

 Learning
Learning Objectives
Objectives
1. Describe the major changes in the accounting for business combinations passed by
the FASB in December 2007, and the reasons for those changes. SELF-REVIEW
2. Describe the two major changes in the accounting for business combinations
approved by the FASB in 2001, as well as the reasons for those changes. SELF-
REVIEW
3. Discuss the goodwill impairment test described in SFAS No. 142 [ASC 350–
20–35], including its frequency, the steps laid out in the new standard, and
some of the likely implementation problems.
4. Explain how acquisition expenses are reported.
5. Describe the use of pro forma statements in business combinations.
6. Describe the valuation of assets, including goodwill, and liabilities acquired
in a business combination accounted for by the acquisition method.
7. Explain how contingent consideration affects the valuation of assets
acquired in a business combination accounted for by the acquisition
method. BASIC Concept!!
8. Describe a leveraged buyout. NOT COVERED
9. Describe the disclosure requirements according to Current GAAP related to
each business combination that takes place during a given year. SELF-STUDY
10. Describe at least one of the differences between U.S. GAAP and IFRS related
to the accounting for business combinations. SELF-STUDY
Historical
Historical Perspective
Perspective on
on Business
Business
Combinations
Combinations
What Changed? Issued December 2007

SFAS No. 141R [ASC 805], “Business

Combinations,” replaced FASB Statement No. 141.
Continues to support the use of a single method.

Uses the term “acquisition method” rather than

“purchase method.”

The fair values of all assets and liabilities on the

acquisition date, defined as the date the acquirer
obtains control of the acquiree, are reflected on the
financial statements.

LO 1 FASB’s two major changes for business

Historical
Historical Perspective
Perspective on
on Business
Business
Combinations
Combinations
What Changed? Issued December 2007

[ASC 810], “Noncontrolling Interests In Consolidated

Financial Statements,” replaced Accounting Research
Bulletin (ARB) No. 51.

Establishes standards for the reporting of the

noncontrolling interest when the acquirer obtains
control without purchasing 100% of the acquiree.

Additional discussion in Chapter 3.

LO 1 FASB’s two major changes for business

Historical
Historical Perspective
Perspective on
on Business
Business
Combinations
Combinations
Historically,
Historically two methods permitted in the U.S.:
purchase and pooling of interests.

Pronouncements in June 2001:

1. SFAS No. 141, “Business Combinations,” - pooling
method is prohibited for business combinations
initiated after June 30, 2001.

2. SFAS No. 142, “Goodwill and Other Intangible

Assets,” - Goodwill acquired in a business combination
after June 30, 2001, should not be amortized.

LO 2 FASB’s two major changes of 2001.

Perspective
Perspective on
on Business
Business Combinations
Combinations

Goodwill Impairment Test (LO # 3)

FASB ASC paragraph 350-20-35 requires
impairment be tested annually.
All goodwill must be assigned to a reporting unit.
Impairment should be tested in a two-step process.
Step 1: Does potential impairment exist?

Step 2: What is the amount of goodwill impairment?

LO 3 Goodwill impairment assessment.

Perspective
Perspective
on
on Business
Business
Combinations
Combinations

LO 3
Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: On January 1, 2010, Porsche Company acquired
the net assets of Saab Company for $450,000 cash. The
fair value of Saab’s identifiable net assets was $375,000
on this date. Porsche Company decided to measure
goodwill impairment using the present value of future
cash flows to estimate the fair value of the reporting unit
(Saab). The information for these subsequent years is as
follows:
Present Value Carry Value Fair Value
of Future of SAAB' s of SAAB' s
Year Cash Flows Net Assets * Net Assets
2011 $ 400,000 $ 330,000 $ 340,000
2012 $ 400,000 $ 320,000 $ 345,000
2013 $ 350,000 $ 300,000 $ 325,000

* Not including
LO 3 Goodwill impairment assessment.
goodwill
Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: On January 1, 2010, the acquisition date, what
was the amount of goodwill acquired, if any?

Acquisition price $450,000

Fair value of identifiable net assets 375,000
Recorded value of Goodwill $ 75,000

LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: Part A&B: For each year determine the amount
of goodwill impairment, if any, and prepare the journal
entry needed each year to record the goodwill impairment
(if any).
Step 1 - 2011
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets
Carrying value of goodwill
330,000
Total carrying value of unit
75,000
Excess of carrying value over fair value $ 5,000
405,000
Excess of carrying value over fair value means step 2 is
required.
LO 3 Goodwill impairment assessment.
Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: Part A&B (continued)

Step 2 - 2011
Fair value of reporting unit $400,000
Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Carrying value of goodwill 75,000
Impairment loss

$ 15,000
Journal Impairment loss 15,000
Entry Goodwill

15,000 LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: Part A&B (continued)

Step 1 - 2012
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets
Carrying value of goodwill *
320,000
Total carrying value of unit
60,000
Excess of fair value over carrying value $ 20,000
380,000
Excess of fair value over carrying value means step 2 is not
required.
* $75,000 (original goodwill) – $15,000 (prior year
impairment)
LO 3 Goodwill impairment assessment.
Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: Part A&B (continued)

Step 1 - 2013
Fair value of reporting unit $350,000
Carrying value of unit:
Carrying value of identifiable net assets
Carrying value of goodwill *
300,000
Total carrying value of unit
60,000
Excess of carrying value over fair value $ 10,000
360,000

Excess of carrying value over fair value means step 2 is required.

* $75,000 (original goodwill) – $15,000 (prior year
impairment)
LO 3 Goodwill impairment assessment.
Perspective
Perspective on
on Business
Business Combinations
Combinations
E2-10: Part A&B (continued)

Step 2 - 2013
Fair value of reporting unit $350,000
Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Carrying value of goodwill 60,000
Impairment loss

$ 35,000
Journal Impairment loss 35,000
Entry Goodwill

35,000 LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations

Review Question
The first step in determining goodwill impairment
involves comparing the
a. implied value of a reporting unit to its carrying
amount (goodwill excluded).
b. fair value of a reporting unit to its carrying amount
(goodwill excluded).
c. implied value of a reporting unit to its carrying
amount (goodwill included).
d. fair value of a reporting unit to its carrying amount
(goodwill included).

LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations
(Review)
(Review)
Disclosures Mandated by FASB (LO 9, Pg.
377-78)

FASB ASC paragraph 805-30-50-1 requires:

1. Total amount of acquired goodwill and the amount
expected to be deductible for tax purposes.

2. Amount of goodwill by reporting segment (if the

acquiring firm is required to disclose segment
information), unless not practicable.

LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations (Review)
(Review)

Disclosures Mandated by FASB

FASB ASC paragraph 350-20-45-1 specifies the
presentation of goodwill (if impairment occurs):
a. Aggregate amount of goodwill should be a
separate line item in the balance sheet.
b. Aggregate amount of losses from goodwill
impairment should be a separate line item in the
operating section of the income statement (unless
some of the impairment is associated with a
discontinued operation).

LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations
(Review)
(Review)
Disclosures Mandated by FASB
When an impairment loss occurs, FASB ASC
paragraph 350-20-50-2 mandates note disclosure:

1. Description of facts and circumstances leading to the

impairment.

2. Amount of impairment loss and method of determining

the fair value of the reporting unit.

3. Nature and amounts of any adjustments made to

impairment estimates from earlier periods, if
significant.
LO 3 Goodwill impairment assessment.
Perspective
Perspective on
on Business
Business Combinations
Combinations
(Review)
(Review)
Other Required Disclosures
FASB ASC paragraph 805-10-50-2 states that
disclosure should include:
The name and a description of the acquiree.
The acquisition date.
The percentage of voting equity instruments acquired.
The primary reasons for the business combination,
including a description of the factors that contributed
to the recognition of goodwill.

LO 3 Goodwill impairment assessment.

Perspective
Perspective on
on Business
Business Combinations
Combinations
(Review)
(Review)
Other Required Disclosures
FASB ASC paragraph 805-10-50-2 states that
disclosure should include:
The fair value of the acquiree and the basis for
measuring that value on the acquisition date.
The fair value of the consideration transferred.
The amounts recognized at the acquisition date for
each major class of assets acquired and liabilities
assumed.
The maximum potential amount of future payments
the acquirer could be required to make.
LO 3 Goodwill impairment assessment.
Perspective
Perspective on
on Business
Business Combinations
Combinations
(Review)
(Review)
Other Intangible Assets
Acquired intangible assets other than goodwill:

Limited useful life

 Should be amortized over its useful economic life.
 Should be reviewed for impairment.

Indefinite life
 Should not be amortized.
 Should be tested annually (minimum) for
impairment.

LO 3 Goodwill impairment assessment.

Acquisition
Acquisition Expenses
Expenses in
in aa Business
Business
Combinations
Combinations
Treatment of Acquisition Expenses (LO 4, Pg.
378-79)
FASB ASC paragraph 805-10-25-23 excludes
acquisition-related costs from measurement of
consideration paid.
both direct and indirect costs are expensed
the cost of issuing securities is also excluded from
the consideration.
Security issuance costs are assigned to the valuation
of the security, thus reducing the additional
Examples of Acquisition RELATED Costs:
contributed
Accounting capital
Costs, Legal for Consulting
Costs, stock issuescosts,
or adjusting
Mergersthe
department
premiumcost,
or Stock issue
discount oncosts
bond etc.
issues.
Perspective
Perspective on
on Business
Business Combinations
Combinations

Acquisition Costs—an Illustration (Page 379)

Suppose that SMC Company acquires 100% of the net assets
of Bee Company (net book value of $100,000) by issuing
shares of common stock with a fair value of $120,000. With
respect to the merger, SMC incurred $1,500 of accounting
and consulting costs and $3,000 of stock issue costs.
SMC maintains a mergers department that incurred a
monthly cost of $2,000. Prepare the journal entry to record
these direct and indirect costs.
Professional Fees Expense (Direct) 1,500
Merger Department Expense (Indirect) 2,000
Other Contributed Capital 3,000
Cash 6,500

LO 4 Reporting acquisition expenses.

Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure
Requirement
Requirement LO
LO 55 (Pages
(Pages 379
379 –– 384)
384)

Pro forma statements serve two functions in

relation to business combinations:

1) to provide information in the planning stages

of the combination and

2) to disclose relevant information subsequent

to the combination.

LO 5 Use of pro forma statements.

Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure
Requirement
Requirement

Illustration 2-1
LO 5 Use of pro forma statements.
ILLUSTRATION 2-2 (Page 384)
Balance Sheets of P and S Companies January 1, 2012
P Company S Company_______
Book Value Book Value Fair Value
Cash and receivables $ 250,000 $ 180,000 $ 170,000
Inventories 260,000 100,000 140,000
Land 600,000 120,000 400,000
Buildings & equipment 800,000 900,000 1,000,000
Accumulated depreciation (B & E) (300,000) (300,000) _________
Total assets $1,610,000 $1,000,000 $1,710,000
Current liabilities $ 110,000 $ 110,000 $ 150,000
Bonds payable* —0— 400,000 350,000
Total liabilities $ 110,000 $ 510,000 $ 500,000
Common stock **, *** 750,000 300,000
Other contributed capital 400,000 50,000
Retained earnings 350,000 140,000
Total Stockholders’ equity 1,500,000 490,000
Total Liab. and Stockholders’ equity $1,610,000 $1,000,000
Net assets at book value (A - L) $1,500,000 $ 490,000
Net assets at fair value $1,210,000
*Bonds payable, 9%, due 1/1/18, interest Payable on 6/30, 12/31* are valued at their present value by
discounting the future payments at the current market rate.
**$15 par value, 50,000 shares; ***$5 par value, 60,000 shares
Pro
Pro Forma
Forma Statements
Statements and
and Disclosure
Disclosure
Requirement
Requirement
If a material business combination occurred,
notes to financial statements should include
on a pro forma basis:

1. Results of operations for the current year as though

the companies had combined at the beginning of the
year.

2. Results of operations for the immediately preceding

period as though the companies had combined at
the beginning of that prior period if comparative
financial statements are presented.
LO 5 Use of pro forma statements.
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
LO
LO 66 (Pages
(Pages 381
381 -385)
-385)
Valuation
Valuation of
of acquired
acquired Assets
Assets andand Liabilities
Liabilities
assumed
assumed
Four steps in the accounting for a business
combination:

1. Identify the acquirer.

2. Determine the acquisition date.

3. Measure the fair value of the acquiree.

4. Measure and recognize the assets acquired

and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
Valuation of acquired Assets and Liabilities
assumed
 Identifiable assets acquired (including intangibles
other than goodwill) and liabilities assumed should
be recorded at their fair values at the date of acquisition.
 Any excess of total acquisition cost over the sum of
Fair Value amounts assigned to identifiable assets
and liabilities is recorded as goodwill.
 Under current GAAP, in-process R&D is measured and
recorded at fair value as an asset on the acquisition
date.
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
E2-1: Preston Company acquired the assets (except for cash)
and assumed the liabilities of Saville Company. Immediately
prior to the acquisition, Saville Company’s balance sheet was
as follows:

Any
Goodwill
?

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and and Illustration
Illustration of of Acquisition
Acquisition
Accounting
Accounting
E2-1: Preston Company acquired the assets (except for cash)
and assumed the liabilities of Saville Company.
The amount paid was $1,560,000 in cash.
Immediately prior to the acquisition, Saville Company’s
balance sheet was as follows:

Fair value
of assets,
without
cash
$1,824,000
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
E2-1: A. Prepare the journal entry on the books of
Preston Co. to record the purchase of the assets and
assumption of the liabilities of Saville Co. if the
amount paid was $1,560,000 in cash.

Calculation of
Goodwill
Fair value of assets, without cash $1,824,000
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Price paid 1,560,000
Goodwill $ 330,000

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
E2-1: A. Prepare the journal entry on the books of
Preston Co. to record the purchase of the assets and
assumption of the liabilities of Saville Co. if the amount
paid was $1,560,000 in cash.
Receivables 228,000
Inventory 396,000
Plant and equipment 540,000
Land 660,000
Goodwill 330,000
Liabilities 594,000
Cash 1,560,000

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
Bargain Purchase
When the fair values of identifiable net assets (assets
less liabilities) exceeds the total cost of the acquired
company, the acquisition is a bargain purchase.
Current standards require:
 fair values be considered carefully and
adjustments made as needed.
 any excess of acquisition-date fair value of net
assets over the consideration paid is
recognized
in current earnings (income statement) as
GAIN.
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
Bargain Acquisition Illustration
When the price paid to acquire another firm is lower than
the fair value of identifiable net assets (assets minus
liabilities), the acquisition is referred to as a bargain.
Any previously recorded goodwill on the seller’s
books is eliminated (and no new goodwill
recorded).

A gain is reflected in current earnings of the acquiree

to the extent that the fair value of net assets exceeds
the consideration paid.

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
E2-1: B. Repeat the requirement in (A) assuming that
the amount paid was $990,000.

Calculation of Goodwill or Bargain Purchase

Fair value of assets, without cash $1,824,000
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Price paid 990,000
Bargain purchase $ 240,000

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation
Explanation and
and Illustration
Illustration of
of Acquisition
Acquisition
Accounting
Accounting
E2-1: B. Repeat the requirement in (A) assuming that
the amount paid was $990,000.

Receivables 228,000
Inventory 396,000
Plant and equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on acquisition (ordinary) 240,000

LO 6 Valuation of acquired assets and liabilities assumed.

Contingent
Contingent Consideration
Consideration in
in an
an
Acquisition
Acquisition
Purchase agreements may provide that the
purchasing company will give additional
consideration to the seller if certain future
events or transactions occur.

The contingency may require

 the payment of cash (or other assets) or
 the issuance of additional securities.

Current GAAP requires that all contractual contingencies

as well as non-contractual liabilities for which it is more
likely than not that an asset or liability exists, be measured
and recognized at fair value on the acquisition date.
LO 7 Contingent consideration and valuation of assets.
Contingent
Contingent Consideration
Consideration (CASH)
(CASH) in
in an
an
Acquisition
Acquisition
Illustration: P Company acquired all the net assets of S
Company in exchange for P Company’s common stock.
P Company also agreed to pay an additional
$150,000 to the former stockholders of S Company if the
average post-combination earnings over the next
two years equaled or exceeded $800,000. Assume
that goodwill was recorded in the original acquisition
transaction. To complete the recording of the acquisition,
P Company will make the following entry:

Goodwill 150,000
Liability for Contingent Consideration
150,000

LO 7 Contingent consideration and valuation of assets.

Contingent
Contingent Consideration
Consideration (CASH)
(CASH) in
in an
an
Acquisition
Acquisition
Illustration: Assuming that the target is met!
P Company will make the following entry:

Liability for Contingent Consideration 150,000

Cash
150,000
Assume that the target is not met!
The adjustment will flow through the income statement in
the subsequent period, as follows:

Liability for Contingent Consideration 150,000

Income from Change in Estimate
150,000

LO 7 Contingent consideration and valuation of assets.

Contingent
Contingent Consideration
Consideration (Stocks)
(Stocks) in
in an
an
Acquisition
Acquisition
Illustration: P Company acquired all the net assets of S
Company in exchange for P Company’s common stock. P
Company also agreed to issue additional shares of
common stock to the former stockholders of S Company
if the average post-combination earnings over the next
two years equaled or exceeded $800,000. Assume that
the contingency is expected to be met, and goodwill
was recorded in the original acquisition transaction.
Based on the information available at the acquisition date,
the additional 10,000 shares (par value of $1 per share)
expected to be issued are valued at $150,000. To
complete the recording of the acquisition, P Company will
make the following entry:
Goodwill 150,000
Paid-in-Capital for Contingent Consideration
Contingent
Contingent Consideration
Consideration in
in an
an
Acquisition
Acquisition
Illustration: Assuming that the target is met, but the
stock price has increased from $15 per share to $18
per share at the time of issuance, P Company will not
adjust the original
amount recorded as equity. Thus, P Company will make
the following entry
Paid-in-Capital for Contingent Consideration 150,000
Common Stock ($1 par)
10,000
Paid-in-Capital in Excess of Par
140,000

LO 7 Contingent consideration and valuation of assets.

Contingent
Contingent Consideration
Consideration in
in an
an
Acquisition
Acquisition
Adjustments During the Measurement
Period
(NOT COVERED) ==========
The measurement period is the period after the
initial acquisition date during which the acquirer may
adjust the provisional amounts recognized at the
acquisition date.

The measurement period ends as soon as the

acquirer has the needed information about facts and
circumstances (or learns that the information is
unobtainable),
LO 7 not to exceed
Contingent one year
consideration andfrom the of assets.
valuation
Contingent
Contingent Consideration
Consideration in
in an
an
Acquisition
Acquisition
Contingency Based on Outcome of a
Lawsuit
Consideration contingently issuable may depend on
both
 future earnings and
In such cases, an additional cost of the acquired
 future security prices.
company should be recorded for all additional
consideration contingent on future events, based on the
best available information and estimates at the
acquisition date (as adjusted by the end of the
measurement period).

LO 7 Contingent consideration and valuation of assets.

IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP

The project on business combinations

 Was the first of several joint projects undertaken by
the FASB and the IASB.
 Complete convergence has not yet occurred.
 International standards currently allow a choice
between
 writing all assets, including goodwill, up fully
(100% including the noncontrolling share), as
required now under U.S. GAAP, or
 continuing to write goodwill up only to the extent
of the parent’s percentage of ownership.
LO 10 Differences between U.S. GAAP and IFRS .
IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP
Other differences and similarities:

LO 10 Differences between U.S. GAAP and IFRS .

IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP
Other differences and similarities:

LO 10 Differences between U.S. GAAP and IFRS .

IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP
Other differences and similarities:

LO 10 Differences between U.S. GAAP and IFRS .

IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP
Other differences and similarities:

LO 10 Differences between U.S. GAAP and IFRS .

IFRS
IFRS Versus
Versus U.S.
U.S. GAAP
GAAP
Other differences and similarities:

LO 10 Differences between U.S. GAAP and IFRS .