Advanced accounting - chapter 1

What is a merger?

 When an existing company acquires another company and combines that

company's operations with its own

What is a business consolidation?

 2 or more companies join together to form one new continuing company

What is the pooling-of-interests method?

 Records the assets and liabilities of the acquired firm at their existing book values

What is the acquisition method?

 Requires that all assets and liabilities be recorded at fair value regardless of the
percentage of interest purchased by the acquiring company

What is a bargain purcase?

 Occurs when the price paid for a company is less than the sum of the fair value of
its net assets (sum of all assets minus all liabilities)

What are the 4 steps in applying the acquisition method?

 1. identify the acquirer

2. Determine the acquisition date
3. Measure the fair value of the acquiree
4. record the acquiree's assets and liabilities that are assumed

How does goodwill occur in an acquisition?

 results when the price paid exceeds the fair value of the acquiree's net identifiable
assets - goodwill is not amortized

How does a gain on acquisition occur?

 When a bargain purchase occurs and the amounts assigned to net identifiable
assets are not revalued enough to eliminate th difference in price paid, the excess
is recorded as a gain on the acquisiton by the acquirer
If the company being acquired has goodwill already on their books, how is it treated after
the acquisition?

 The goodwill is ignored on the acquiree's books

What is a deferred tax asset?

 A value assigned when the acquiree has operating losses in periods prior to the
acquisition, the acquirer is able to carry those losses forward to offset its income
taxes payable periods after the acquisition

Instead of being amortized, goodwill is now subject to ________?

 Impairment testing

Impairment testing is usually done on a _______ basis?

 Annual

What kind of situation would occur for impairment testing to be done sooner than
normal?

 The occurence of an adverse event that could diminish the unit's fair value, the
likelihood that the unit will be disposed of, the impairment of a group of the unit's
assets, or a goodwill impairment loss that is recorded in a higher-level
organization of which the unit is a part

When is goodwill considered impaired?

 When the impaired fair value of the reporting unit is less than the carrying value of
the reporting unit's net assets (including goodwill)

How is an impairment loss estimated?

 Impairment loss for goodwill is the excess of the implied fair value of the
reporting unit over the fair value of the reporting unit's identifiable net assets
(excluding goodwill) on the impairment date

What procedure is used to record current assets of an acquired firm?

 recorded at estimated fair values

What procedure is used to record existing liabilities of an acquired firm?

 recorded at fair value

What procedure is used to record Property, Plant and Equipment of an acquired firm?

 Operating assets will require an estimate of fair value and will be recorded at that
net amount with no separate accumulated depreciation account

What procedure is used to record existing intangible assets, other than goodwill, of an
acquired firm?

 Recorded at estimated fair value - typically requires the use of discounted cash
flow analysis

What procedure is used to record assets that are going to be sold rather than used in
operations of an acquired firm?

 Recorded at net realizable value and are listed as current assets

What procedure is used to record when the acquiree is a lessee with respect to assets in
use?

 The original classification of the lease as operating or capital is not changed by the
acquisition unless the terms of the lease are modified.

What procedure is used to record intangible assets not currently recorded by the
acquiree?

 must be separately recorded, value can't be swept into the goodwill classification.
An intangible asset is identifiable if it arises from contractual or other legal rights
or is separable

What procedure is used to record research and development assets?

 the fair values of both tangible and intangible R&D assets are recorded even where
the assets don't have alternative future uses

What procedure is used to record contingent assets and liabilities?

 The fair value of the contingent asset or liability is recorded at it's fair value on the
acquisition date
What procedure is used to record liabilities associated with restructuring or exit
activities?

 The fair value is recorded as a separate liability

What procedure is used to record employee benefit plans?

 A liability is recorded if the projected benefit obligation exceeds plan assets. An

asset is recorded when the plan assets exceed the projected benefit obligation

What procedure is used to record deferred taxes?

 a deferred tax liability is recorded for added estimated taxes casued by the excess
of fair value depreciation over book value depreciation. A deferred tax asset is
recorded for estimated future tax savings

Advanced Accounting Chapter 2

Reasons to expand through corporate takeover
 1.Part of overall manager plan to maximize shareholder value by increasing scale
and efficiency
2. Vertical integration of one firm's output and another firm's distribution or
further processing
3. Cost savings through duplicate elimination
4. Quick entry for new products into foreign or domestic markets
5. Economies of scale allow greater efficiency/negotiating power
6. Access financing at more attractive rates due to size increase and negotiating
potential
7. Diversification of business risk
3 Book examples of successful mergers and reason why
 Campbell Soup and Bolthouse farms - Bolthouse provided Campbell with a new
sale point for a shifting demographic ($695M goodwill)
Microsoft and Skype - mainly for the hope of future synergies between the
companies ($7.1B Goodwill involved in consideration
Duke Energy and Progress Energy - deregulation forces combination in order to
lower prices and cut costs
Types of Business Combination
 Statutory Merger through asset acquisition - assets/liabilities acquired, company
dissolves
Statutory merger through capital stock acquisition - acquires all stock and then
transfers liabilities, company dissolves and becomes division
Statutory Consolidation through capital stock or asset acquisition - newly created
 entities, both companies dissolve and form new entity
Acquisition of more than 50% of voting stock - acquired stock recorded as
investment, company becomes subsidiary of other company
Control through ownership of variable interests - contractual control established,
company separation maintained
Control
 Elusive because of multiple drivers, which is why the FASB is attempting to
regulate it
Statutory Merger vs. Consolidation
 Statutory Merger - combination on date of acquisition, entity dissolution occurs
Consolidation - separate entities maintained, consolidated only for purposes of
financial statements
Regardless of result, the acquisition method recognizes and measures:
 Consideration Transferred for the Acquired Business - FV is the starting point for
consideration; Contingent consideration is used to resolve disagreement over
estimate or high valuation uncertainty

2. Assets Acquired and Liabilities Assumed - very difficult to correctly assess

acquisition date FV of assets acquired and liabilities assumed

3. Goodwill and Gains on Bargain Purchases - complete ownership situations

result in an asset resulting from the net of consideration transferred over the
collective FV of net identified assets acquired and liabilities assumed
Methods of Determining Acquisition Date FV of assets acquired and liabilities assumed
1. Market Approach - comparable market values used to estimate
2. Income Approach - projected cash flows to estimate
3. Cost Approach - replacement cost and effects of obsolescence used to estimate
2 Types of Business Combinations
1. Acquisition Method when Dissolution takes place
2. Acquisition Method when Separate Incorporation in Maintained
Journal Entries for Dissolution
1. FV of the consideration transferred by the acquiring firm to the former owners
of the acquiree
2. The identified assets acquired and liabilities assumed at their individual FV
Comparing Consideration transferred to Net Asset FV (3 situations)
1.Equals
D: Assets
C: liabilities, cash, equity if stock is involved
2. Exceeds
D: Asset + Goodwill
C: liabilities, cash, equity if stock is involved
3. Less (Bargain Purchase)
 D: Assets
C: liabilities, cash, equity if stock is involved, gain on bargain purchase
Related Costs of Business Combination (3 types)
 1.Professional Services (attorneys, lawyers, accountants, etc.) - expensed
immediately against cash

2. Internal Costs - secretarial and managerial time for acquisitions

3. Registration and Issuance Costs - decrease the FV of the securities in question

proportionately
Consolidation Worksheet Entries
 these adjustments and eliminations are entered on the worksheet and represent
alterations that would be required if the financial records were physically united

Investment account initially reflects the acquired firm's transaction date FV

Steps to make Consolidation Worksheet Entries
 1.Prepare a formal allocation of the acquisition date FV similar to equity method
The equation depends on what the effects of the entries are
2. Remove any pre-combination subsidiary revenues or expenses in the
consolidated statements
3. Consolidation Entry S (stockholder's Equity)
D: Common Stock, APIC, R/E
C: Investment

4. Breakdown investment into the specific account totals that were brought over
5. Consolidation Entry A - enter the changes and credit the balance to investment
6. extend all accounts into the consolidated totals section
7. Find the new consolidated net income
Worksheet Mechanics
 totals are not extended, the components are simply extended and combined
vertically to find new totals
Bargain Purchase of a Separately Incorporated Subsidiary
 Can be reported on the consolidated income statement
Additional Issues for Acquisition-Date FV Allocations
 Intangibles:
1. Does it arise from contractual or legal rights?
2. Can it be sold or acquired?
Pre-existing goodwill - ignored
Acquired In-Process R&D - measure at ADFV & recognize at an asset; don't
amortize but test annually for impairment
Convergence between US and IFRS standards
 IFRS 3 - almost identical to GAAP rules with the exception of noncontrolling
interest valuation and other limited applications.
Advanced Accounting - Chapter 3
Equity Method - Investment Account
 Continually adjusted to reflect ownership of acquired company.
Equity Method - Income Account
 Income accrued as earned; amortization and other adjustments are recognized.
Initial Value - Investment Account
 Remains at initially recorded amount
Initial Value - Income Account
 Cash received recorded as dividend Income.
Partial Equity - Investment Account
 Adjusted only for accrued income and dividends received from acquired company.
Partial Equity - Income Account
 Income accrued as earned; no other adjustments recognized.
Advantage - Equity Method
 The acquiring company totals give a true representation of consolidation figures.
Advantage - Initial Value ("cost") Method
 It is easy to apply and gives a good measurement of cash flows generated by the
investment.
Advantage - Partial Equity Method
 Usually gives balances approximating consolidation figures, but is easier to apply
than equity method
Subsequent Consolidation -Equity Method
Procedure - 4 steps
 -Record the Investment in Sub on the acquisition date at fair value.
-Recognize receipt of dividends from the sub.
-Recognize a share of the sub's income (loss).
-Excess fair over book value amortizations adjust the income recognized in 3.
Subsequent Consolidation -Worksheet Entries - ENTRY S
 Eliminates the subsidiary's Stockholders' equity account beginning balances and
the book value component within the parent's investment account.
Subsequent Consolidation -Worksheet Entries - ENTRY A
 Recognizes the unamortized Allocations as of the beginning of the current year
associated with the adjustments to fair value.
Subsequent Consolidation -Worksheet Entries - ENTRY I
 Eliminates the subsidiary Income accrued by the parent.
Subsequent Consolidation -Worksheet Entries - ENTRY D
 Eliminates the subsidiary Dividends.
Subsequent Consolidation -Worksheet Entries - ENTRY E
 Recognizes excess amortization Expenses for the current period on the allocations
from the original adjustments to fair value.
 Goodwill impairment test (2 steps)
Step 1
-Does fair value of REPORTING UNIT exceed carrying value of the
REPORTING UNIT
YES Goodwill is NOT impaired. No further testing is required.
NO Go to Step 2

Step 2
-Compare fair value of GOODWILL to carrying value of GOODWILL