Ch 2 Consolidation: Business Combination Flashcards
(149 cards)
0
Q
Consolidated financial statements
A
Financial statements that represent more than one corporation
1
Q
Business combination
A
Separate organizations tied together through common control
2
Q
Subsidiaries
A
Companies controlled by parent corporation
3
Q
What is the usual condition for controlling financial interest?
A
Ownership of majority voting interest
4
Q
How can the power of control exist with lesser percentage of ownership? 3 possible
A
1 governance contracts
2 leases
3 agreement with other stockholders
5
Q
Purchase and pooling interest methods after 2009
A
No longer allowed except in the footnotes
Acquisition method required instead
6
Q
What was the number and value of mergers and acquisitions globally in 2012?
2) value in the US
A
42,000 for value of $2.6 trillion
2) $773 billion in US
7
Q
Business combinations can be part of an overall managerial strategy to…
A
Maximize shareholder value
8
Q
Business combinations: increase scale to produce larger profits
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Coordinating business lines (raw materials, manufacturing, delivery)
Significant cost savings can occur
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Q
characteristic business combinations may share to increase profitability: vertical integration of one firm’s output and another firm’s…
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Distribution or further processing
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Q
characteristic business combinations may share to increase profitability: cost savings through…
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Elimination of duplicate facilities and staff
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Q
characteristic business combinations may share to increase profitability: quick entry for new and existing…
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Products into domestic and foreign markets
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Q
characteristic business combinations may share to increase profitability: greater efficiency and negotiating power due to…
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Economies of scale
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Q
characteristic business combinations may share to increase profitability: ability to access…
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Financing at more attractive rates
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Q
In terms of obtaining financing, as firm size increases…
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Negotiating power with financial institutions can also increase
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Q
characteristic business combinations may share to increase profitability: diversification of…
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Business risk
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Business combination also occur because many firms seek continuous…
A
Expansion of their organizations, often into diversified areas
17
Q
Expansion of organizations into diversified areas allows for entry of parent into new industries without having to do 4 things?
A
1 construct facilities
2 develop products
3 train management
4 create market recognition
18
Q
The primary motivation for many business combinations can be traced to…
A
An increasingly competitive environment
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Q
Motivation for Campbell soup to acquire bolt house Farms
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Acquisition positions Campbell into rapidly growing market of
Healthy packaged fresh foods
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Motivation for Microsoft to acquire Skype
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Expansion into internet consumer market designed to increase
Accessibility of realtime video and voice communications
21
Q
3 motivations for Duke Energy’s acquisition of Progress Energy
A
1 With falling demand for energy, utilities companies are turning
To consolidations for cost saving
2 rising cost with compliance Regulation
3 spread fixed costs over larger asset platform
22
Q
When does the consolidation of financial information into a single set of statements become necessary?
A
When business combination of 2 or more companies creates
single economic entity
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Q
Consolidated statements are necessary for fair presentation of financial information when one or more entities in consolidated group…
A
Directly or indirectly has controlling interest in the other entities
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What 3 questions explain the process of preparing consolidated financial statements for a business combination?
1 how is a business combination formed?
2 what constitutes a controlling financial interest?
3 how is the consolidation process carried out?
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Business combination refers to a transaction or other event in which an acquirer obtains...
Control over 1 or more businesses
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Statutory merger
Business combination in which only one of the original companies continues to exist
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Statutory merger through a share acquisition: what's required? 2 things
1 100% control of all shares, target corp is given cash, liabilities
stock and other assets as compensation (combination)
2 Dissolve target corporation
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How does a statutory merger occur with asset acquisition?
Acquirer obtains assets, liabilities or some stock (combination)
Target company is dissolved
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Statutory consolidation
2 or more companies transfer either their assets or capital stock
To a newly formed corporation
Both original companies are dissolved leaving only new
organization in existence
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Business combination: one company achieves legal control over another by acquiring a majority of voting stock,
describe control and existence of entities.
Although control is present, no dissolution takes place
Each company remains in existence as an incorporated operation
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Maintaining an independent information system for a subsidiary often...
Often enhances its market value for an eventual sale or IPO
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Business combination: one company achieves legal control over another by acquiring a majority of voting stock
How is this accounted for by the parent? By the target?
Acquiring company enters takeover into its own records
establishing a single investment asset account
Target corp omits any recording of this event
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VIE
Variable interest entity
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Control of variable interest entity (VIE)
Control is exercised through contractual arrangements with
| sponsoring firm
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VIE: sponsoring firm
Sponsoring firm technically may not own VIE, becomes its primary
Beneficiary with rights to its residual profits
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Variable interest entity VIE: form of contracts to rights to residual profits, 4 things
1 leases
2 participation rights
3 guarantees
4 other interests
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Why is past use of VIEs criticized 2
1 Provide sponsoring firms with off balance sheet financing
2 questionable profits on sales to VIEs
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VIEs: Current GAAP expands notion of control and thus requires...
Consolidation of VIEs by their primary beneficiary
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Type of Combination: statutory merger through asset acquisition
1 action of acquiring company
2 action of acquired company
1 acquiring company acquires assets and often liabilities
2 target company dissolves and goes out of business
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Type of Combination: statutory merger through capital stock acquisition
1 action of acquiring company
2 action of acquired company
1 acquirer acquires all stock and then transfers assets and
liabilities to its own books
2 target dissolves as separate corporation, often remaining
As division of acquiring company
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Type of Combination: Acquisition of more than 50% of voting stock
1 action of acquiring company
2 action of acquired company
1 acquirer acquires stock that is recorded as an investment;
Controls decision making of acquired company
2 target remains in existence as legal corp. although now
subsidiary of acquirer
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Type of Combination: control through ownership of variable interests
1 action of acquiring company
2 action of acquired company
1 acquirer establishes contractual control over a variable interest
Entity to engage in a specific activity
2 target remains in existence as separate legal entity (often a trust
Or partnership)
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In the business combination where control through ownership of variable interests risks and rewards often flow to...
A sponsoring firm that may or may not hold equity shares
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How is control of one firm by another most often achieved?
Through acquisition of voting shares
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By exercising majority voting power, one firm can literally dictate... 2 things
Financing and operating activities of another firm
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Control
Direct or indirect ability to determine the direction of management
And policies through ownership, contract or otherwise
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Several parties may participate in directing the activities of another entity in order to what?
Reduce their risk
Ex, parent with majority ownership may grant certain decision rights to no controlling shareholders in exchange for economic support
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When one company gains control over another...
A business combination is established
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3 objectives of consolidation, to report for the combined entities:
1 financial position
2 results of operations
3 cash flows
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As part of the process of consolidation reciprocal accounts and intra entity transactions must be...
Adjusted or eliminated to ensure that all reported balances truly
Represent the single entiy
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For a statutory merger or a statutory consolidation, when the acquired company (companies) are legally dissolved...
Only once accounting consolidation ever occurs
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For a statutory merger or statutory consolidation, after the balances have been transferred to the survivor, what happens to the financial records of the target corp?
Financial records are permanently closed out as part of dissolution
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In a combination when all companies retain incorporation, what set of consolidation procedures are appropriate?
Each corporation continues to maintain its accounting records
No permanent consolidation of account balances is ever made
Consolidation must be carried out each time entity files financials
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When separate record keeping is maintained, what is the unique problem faced by the accountant?
Financial info must be brought together periodically without
Disturbing the accounting systems of individual companies
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Financial info must be brought together periodically without
Disturbing the accounting systems of individual companies. How is this process expedited?
Use of worksheets to organize and adjust information
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Legal characteristics of business combination have significant impact on...
Approach taken in consolidation process
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What is to be consolidated if dissolution takes place?
appropriate account balances are physically consolidated in
| surviving company's financials
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What is to be consolidated if separate incorporation is maintained
Only financial statement info (not actual records) is consolidated
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When does consolidation take place if dissolution occurs?
Permanent consolidation occurs at date of combination
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When does consolidation occur if separate incorporation is maintained?
Consolidation process is carried out in regular intervals whenever financial statements are to be prepared
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How are accounting records affected if dissolution takes place?
The surviving company's accounts are adjusted to include
appropriate balances of dissolved company
Dissolved company's records are closed out
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How are the accounting records affected if separate incorporation is maintained?
Each company continues to retain its own records
Worksheets are used to facilitate periodic consolidation process
Without disturbing individual accounting systems
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Regardless of whether the acquired firm maintains its separate incorporation or dissolution takes place, what do current accounting standards require to account for business combinations?
Use of the acquisition method
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Applying the acquisition method involves recognizing and measuring 3 things?
1 consideration transferred for acquired business and any
noncontrolling interest
2 separately identified assets acquired and liabilities assumed
3 goodwill, or gain from bargain purchase
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Measurement attribute used to recognize acquisition method aspects of business combination?
Fair value
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The fair value of consideration transferred to acquire a business from its former owners is the starting point in...
Valuing and recording a business combination
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The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of: 3 things
1 acquisition date fair values of assets transferred by acquirer
2 liabilities incurred by acquirer
3 equity interests issued by the acquirer
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Fair value definition
Price that would be received to sell an asset (or paid to transfer
A liability) in market on measurement date
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What are often the best source of evidence of e fair value of consideration transferred in a business combination?
Market values
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Contingent consideration (when present in business combination)
Additional element of consideration transferred
Can be useful in negotiation when 2 parties disagree with estimates
Of future cash flows for target firm or valuation uncertainty
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Acquisition agreement often contain provisions to...
Pay former owners (typically cash or additional shares of acquirer's
Stock) upon achievement of specified future performance measures
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GT Solar (acquirer of Crystal Systems) included the fair value of the contingent consideration as...
A component of the fair value of the consideration transferred
To Crystal Systems
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How does the acquisition method treat contingent consideration obligations?
As negotiated component of fair value of consideration transferred
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Determining the fair value of contingent future payments typically involves...
Probability and risk assessments based on circumstance existing
On acquisition date
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What is the fundamental principle of the acquisition method?
Acquirer must identify the assets acquired and liabilities assumed
In the business combination
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Once the acquired assets and liabilities have been indentified, the acquirer measures the assets acquired and liabilities assumed at their...
Acquisition date fair values
With only a few exceptions
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6 exceptions to fair value measurement principal
```
1 deferred taxes
2 certain employee benefits
3 indemnification assets
4 reacquired rights
5 share-based awards
6 assets held for sale
```
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3 valuation techniques typically employed to determine the acquisition date fair values?
1 market approach
2 income approach
3 cost approach
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Market approach define, with 3 examples
1 Estimates fair values using other market transactions involving
Similar assets or liabilities
2 Ex. Assets acquired such as tangible assets and marketable
Securities may have established markets that provide comparable
Market values,
3 ex. compare debt instruments
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Income approach 3 things (including example)
1 Relies on multiperiod estimates of future Cashflows projected
To be generated by an asset
2 Projected cashflows are discounted to time value of money
And risk associated with realizing future cash flows
3 Ex. Good for estimates for intangibles and acquired in process R&D
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Cost Approach
Estimates fair values by reference of current cost of replacing
Asset with another of comparable economic utility
Ex. Used to estimate property plant and equipment
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Cost approach: used assets can present a particular valuation challenge if...
2) the cost to replace a particular asset reflects both its...
Active markets only exist for newer versions of the asset
2) estimated replacement cost and effects of obsolescence
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For combinations resulting in complete ownership by the acquirer, the acquirer recognizes the asset goodwill, as The excess of consideration transferred over the...
collective Fair values of net identified assets acquired and liabilities assumed
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Goodwill
An asset representing the future economic benefits arising in a
business combination that are not individually identified
And not separately recognized
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What happens if the collective fair value of the net identified assets acquired and liabilities assumed exceeds the consideration transferred?
The acquirer recognizes a "gain on bargain purchase"
Fair value of net assets acquired replaces consideration transferred
As valuation basis for acquired firm
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What is the asymmetrical accounting difference that GAAP recognizes in an acquisition for the acquirer?
In one situation acquirer recognizes an asset (goodwill)
In a situation where fair value exceeds price paid, acquirer
Recognizes a gain
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What 2 situations can bargain purchases result from?
1 business divestitures forced by regulatory agencies
2 other types of distress sales
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When the acquired firm's legal status is dissolved in a business combination, what does the continuing firm do?
Continuing firm takes direct ownership of former firm's assets
And assumes its liabilities
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Journals entries prepared by continuing firm using Acquisition method when dissolution takes place. 2
1 fair value of consideration transferred by acquiring firm to former
Owners of acquiree
2 identified assets acquired and liabilities assumed at their
Individual FMVs
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Revenue, expense, dividend and equity accounts cannot be...
Transferred to parent and are omitted in recording business
| Combination
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What 5 factors might enter into paying more than fair value in acquisition?
```
1 synergy between companies
2 profitable history
3 reputation
4 quality of personnel
5 economic condition in industry business operates
```
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Why is goodwill unidentifiable?
We presume it emerges from several other assets acting together
To produce expectation of enhance profitability
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Reporting unit
Line of business (often segment) where acquired asset or liability
Will be employed
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What's the objective of assigning acquired assets and liabilities to reporting units?
To facilitate periodic goodwill impairment testing
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Acquisition method records the identified assets acquired and liabilities assumed at...
Their individual fair values
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In a bargain purchase situation the net asset fair value...
replaces consideration transferred as acquired firm's basis
| In financial reporting
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When does the consideration transferred serve as the acquired firm's valuation basis?
Consideration equals or exceeds net amount of fair values of
Assets acquired and liabilities assumed
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Consolidation values: consideration equals the fair value of net identified assets acquired.
What is recorded under acquisition accounting?
Identified assets acquired and liabilities assumed are recorded
At their FMVs
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Consolidation values: consideration transferred is greater than the fair values of net identified assets acquired.
What is recorded under acquisition accounting? 2
1 Identified assets acquired and liabilities assumed are recorded at
Their FMVs
2 excess consideration transferred over net identified asset
Fair value is recorded as goodwill
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Consolidation values: bargain purchase
What is recorded under acquisition accounting? 2
1 Identified assets acquired and liabilities assumed are recorded at
Their FMVs
2 net identified asset fair value over consideration transferred
Is recorded as gain on bargain purchase
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Bargain purchase definition
Consideration transferred is less than fair values of net identified
Assets acquired
Total of individual fair values of net identified assets acquired
Becomes acquired business fair value
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3 typical categories of costs accompany business combinations?
1 combination related services
2 acquiring firm's internal costs
3 expenses to issue and register securities
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Combination related services AKA professional service fees, who's involved?
Firm's engage attorneys, accountants, investment bankers,
| Other professionals
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Combination related services AKA professional service fees, accounting treatment under acquisition method?
Not considered part of fair value received by the acquirer
Professional service fees expensed in period incurred
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Examples of acquiring firm's internal costs,
2) What is there accounting treatment?
Secretarial and management time allocated to acquisition activity
Indirect costs reported in current year expenses
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Accounting treatment of: amounts incurred to register and issue securities, (in connection with business combination)
Reduce determinable fair value of those securities
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What is the journal entry to record direct combination costs?
Professional Services Exp. Xxx
| Cash. Xxx
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What is the journal entry to record indirect combination costs?
Salaries and administrative exp. Xxx
| A/P (or cash). Xxx
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What is the entry to record costs to register and issue stock in connection with acquisition?
Additional Paid in Capital. Xxx
| Cash. Xxx
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3 types of combination costs
1 direct combination costs
2 indirect combination costs
3 amounts incurred to register and issue securities
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Example of direct combination cost
Accounting, legal, investment banking, appraisal fees etc.
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Example of indirect combination costs
Internal costs such as allocated to secretarial and managerial
Time
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How are direct combination costs treated under acquisition accounting?
Expense as incurred
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How are indirect combination costs treated under acquisition accounting?
Expense as incurred
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How are amounts incurred to register and issue securities treated under acquisition accounting?
Reduce value assigned to fair value of securities issued
typically debit additional paid in capital
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Acquisition method when separate incorporation is maintained:
What remains the basis for initially consolidating the subsidiary's assets and liabilities?
Fair value
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3 significant differences between consolidating with subsidiary maintained as opposed to target corp being dissolved?
1 consolidation of financial info is only simulated
2 acquiring company doesn't physically record acquired assets
And liabilities
3 each company (parent and target)!maintain independent
Record keeping
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Acquisition method when separate incorporation is maintained:
Integral process of consolidation of worksheet entries
Adjustments and elimination are entered on worksheet
and represent alterations that would be required if financial
Records were physically United
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Worksheet entries: because no actual Union occurs, neither company records...
Consolidation entries in its journals
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Acquisition method when separate incorporation is maintained: Where do consolidation entries appear?
2) What do they derive?
Solely appear on worksheet
2) derive consolidated balances for financial reporting purposes
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Worksheet mechanics: In general totals such as Net Income and Retained Earnings are...
Not directly consolidated across on the worksheet
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Bargain purchase of separately incorporated subsidiary, what is the accounting treatment? 2
1 Parent records bargain purchase gain on books as part of
Investment journal entry
2 Bargain purchase gain appears on acquisition date consolidated
Income statement
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Intangible assets often comprise of...
The largest portion of the acquired firm
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Franchise costs (associated with AT&T acquiring AT&T broadband)
Form an intangible asset representing the value attributed to
Agreements with local authorities and allow access to homes
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Intangibles assets, basic definition
Include both current and Noncurrent assets (not including financial
Instruments) that Lack physical substance
Allow firm exclusive use of asset
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In determining whether to recognize an intangible asset in a business combination, what 2 specific criteria are essential?
1 does the intangible asset arise from contractual or other
Legal rights?
2 is the intangible asset capable of being sold or otherwise
Separated from the acquired enterprise?
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5 common intangibles that can be acquired?
```
1 trademarks
2 patents
3 copyrights
4 franchise agreements
5 government protected intangibles/contracts
```
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Most intangible assets recognized in business combinations meet what criterion?
The contractual-legal criterion
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Intangibles: separable to criterion, when is an acquired intangible recognized as being separated?
Capable of being separated or divided from acquiree and sold,
Transferred, licensed, rented, exchanged
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The acquirer is not required to have the intention to sell, license or otherwise exchange the intangible in order to...
Meet the separability criterion
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Preexisting goodwill on target corp (subsidiary's) books, accounting treatment, why?
Owner excludes carrying amount of Preexisting goodwill from subsidiary's acquisition date book value
Because Preexisting goodwill is not considered identifiable
By parent
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The new owner also ignores Preexisting subsidiary goodwill in allocating...
Acquisition date fair value
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What's the logic behind not allocating Preexisting subsidiary goodwill to acquisition date fair value?
Total business fair value is first allocated to identified assets
And liabilities
Only if an excess remains is goodwill recognized
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In all business combinations, only goodwill reflected in current acquisition is...
Brought forward in consolidated entity's financials
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Many firms, especially in pharmaceutical and high tech industries have allocated significant portions of acquired businesses to...
In process research and development (IPR&D)
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What do current accounting standards require for acquired IPR&D?
Be measured at acquisition date fair value
And recognized in consolidated financial statements as an asset
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What is typically used to valuate IPR&D
Discounted cashflow models
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What 3 common significant estimates/assumptions are made when valuating IPR&D?
1 projecting regulatory approvals
2 estimating future cashflows from product sales of completed
Products and in process projects
3 developing appropriate discount rates and probability rates
By project
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IPR&D is initially considered what kind of intangible asset?
2) what does this mean?
Indefinite lived intangible asset
2) Not subject to amortization
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Impairment testing of IPR&D
Tested for impairment annually
Or more frequently if events or changes in circumstances
Indicate impairment
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Accounting treatment of IPR&D costs
Expensed as incurred in ongoing business activities
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Because the acquirer paid for the IPR&D, an expectation of...
Future economic benefit is assumed
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IPR&D assets should be considered indefinite lived until...
The project is completed or abandoned
Or intangible considered to no longer have indefinite life
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Difference between IASB and FASB in accounting for business combinations
Difference in non controlling interest valuation
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IASB VS FASB: control difference
FASB has different standards for voting interest control and
Variable interest control
IASB has same standards for voting interest control and variable
Interest control
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Which of the following does not represent a primary motivation for business combinations?
A. Combinations as a vehicle for achieving rapid growth and competitiveness.
B. Cost savings through elimination of duplicate facilities and staff.
C. Quick entry for new and existing products into markets.
D. Larger firms being less likely to fail.
D. Larger firms being less likely to fail.
147
Which of the following is the best theoretical justification for consolidated financial statements?
A. In form the companies are one entity; in substance they are separate.
B. In form the companies are separate; in substance they are one entity.
C. In form and substance the companies are one entity.
D. In form and substance the companies are separate.
B. In form the companies are separate; in substance they are one entity.
148
What is a statutory merger?
A. A merger approved by the SEC.
B. An acquisition involving the purchase of both stock and assets.
C. A takeover completed within one year of the initial tender offer.
D. A business combination in which only one company continues to exist as a legal entity.
D. A business combination in which only one company continues to exist as a legal entity.
