Chapter 2: Business Combination

• The overriding objective of IFRS 3 is to improve the

relevance, representational faithfulness, transparency and
comparability of information provided in financial statements
about business combinations and their effects on the reporting
entity by establishing principles and requirements with respect to
how an acquirer, in its consolidated financial statements:
• 1. Recognizes and measures identifiable assets acquired,
liabilities assumed and the non-controlling interest in the
acquiree, if any;
• 2. Recognizes and measures acquired goodwill or a gain from a
bargain purchase
• 3. Determines the nature and extent of disclosures sufficient to
enable the reader to evaluate the nature of the business
combination and its financial effects on the consolidated
reporting entity;
• 4. Accounts for and reports non-controlling interests in
subsidiaries; and
• 5. Deconsolidates a subsidiary when it ceases to hold a
controlling interest in it
 Business Combination.
• A transaction or other event that results in an acquirer
obtaining control over one or more businesses. Transactions
that are sometimes referred to as “true mergers” or
“mergers of equals” are also considered to be business
combinations with an acquirer and one or more acquirees.
• Acquirer is an entity that obtains control over the acquiree.
• A merger of equals is when two firms of about the same
size come together to form a single new company.
Shareholders from both firms surrender their shares and
receive securities issued by the new company.
• Business is an integrated set of assets (input) and activities
(processes) capable of being conducted and managed in
order to provide a return (dividend, low cost or other
economic benefit) directly to investors or other owners,
members or participants.
 Cont…
• Acquiree is one or more businesses in which an acquirer
obtains control in a business combination
• Acquisition is a business combination in which one entity
(the acquirer) obtains control over the net assets and
operations of another (the acquiree) in exchange for the
transfer of assets, incurrence of liability or issuance of
equity.
• Control. The power to govern the financing and operating
policies of an entity so as to obtain benefits from its
activities and increase, maintain or protect the amount of
those benefits.
• Control of an entity can be obtained either by:
– 1. Obtaining ownership of a majority of its outstanding voting
power; or
– 2. Obtaining contractual rights to receive the majority of the
financial benefits and/or by assuming contractual obligations to
bear the financial consequences that occur in the future
• Business combination may take two forms viz. Friendly
Takeover and Hostile Takeover.
• Stock acquisitions are said to be “friendly” when the
stockholders of the target corporation, as a group, decide to
sell or exchange their shares. In such a case, an offer may be
made to the board of directors by the acquiring company.
But the shareholders a two-thirds vote is required. Once
approval is gained, the exchange of shares will be made with
the individual share-holders.
• If the shareholders decline the offer, or if no offer is made,
the acquiring company may deal directly with individual
shareholders in an attempt to secure a controlling interest.
Frequently, the acquiring company may make a formal
tender offer.
• If the management and/or a significant number of share-
holders oppose the purchase of the company by the intended
buyer, the acquisition is viewed as hostile.
• Unfriendly offers are so common that several standard
defensive mechanisms have evolved.
• Following are the common defensive moves:
– Greenmail
– White Knight
– Poison Pill
– Selling the Crown Jewels (Scorched earth policy)
– Golden Parachutes
– Increasing Debt
– Acquiring the Acquirer
– Harassment
– Leveraged Buyouts
– Urge Shareholders to Side with Management
• Unfriendly offers are so common that several standard defensive
mechanisms have evolved. Following are the common defensive moves:
•  Greenmail. The target company may pay a premium price
(“greenmail”) to purchase treasury shares. It may either buy shares already
owned by a potential acquiring company or purchase shares from a current
owner who, it is feared, would sell to the acquiring company. The price
paid for these shares in excess of their market price may not be deducted
from stockholders’ equity; instead, it is expensed.
• (Greenmail: the practice of buying enough shares in a company to
threaten a takeover, forcing the owners to buy them back at a higher
price in order to retain control.)
•  White Knight. The target company locates a different company to
acquire a controlling interest. This could occur when the original acquiring
company is in a similar industry and it is feared that current management
of the target company would be displaced. The replacement acquiring
company, the “white knight,” might be in a different industry and could be
expected to keep current management intact.
• (White knight: a person or company making an acceptable counter offer
for a company facing a hostile takeover bid.)
•  Poison Pill. The “poison pill” involves the
issuance of stock rights to existing shareholders to
purchase additional shares at a price far below fair
value. However, the rights are exercisable only
when an acquiring company purchases or makes a
bid to purchase a stated number of shares. The
effect of the options is to substantially raise the
cost to the acquiring company. If the attempt fails,
there is at least a greater gain for the original
shareholders.
• (Poison pill: a tactic used by a company
threatened with an unwelcome takeover bid to
make itself unattractive to the bidder.)
•  Selling the Crown Jewels. This approach has the
management of the target company selling vital assets
(the “crown jewels”) of the target company to others
to make the company less attractive to the acquiring
company. It is also sometimes referred to as Scorched
earth policy
•  Golden Parachutes: Key employees (the current
manager) receive very high severance pay.
•  Increasing Debt: Increasing debt as a defensive
strategy has been deployed in the past. By increasing
debt significantly, companies hope to deter raiders
concerned about repayment after the acquisition.
However, adding a large debt obligation to a
company's balance sheet can significantly erode stock
prices
•  Acquiring the Acquirer: Ironically, a
takeover defense that has been successful in the
past, albeit rarely, is to turn the tables on the
acquirer and mount a bid to take over the raider.
– This requires resources and shareholder support, and it
removes the possibility of activating the other defensive
strategies.
•  Harassment. By bringing lawsuits alleging
fraud or antitrust objections, managers can raise
the cost to someone who is trying to gain control of
the firm.
•  Leveraged Buyouts. The management of the existing
target company attempts to purchase a controlling interest in
that company. Often, substantial debt will be incurred to
raise the funds needed to purchase the stock, hence the term
“leveraged buyout.”
– When bonds are sold to provide this financing, the bonds may be
referred to as “junk bonds,” since they are often high-interest
and high-risk due to the high debt-to-equity ratio of the resulting
corporation.
•  Urge Shareholders to Side with Management.
Managers can try to convince stockholders that their long-
run interests are better served by refusing to sell to someone
who is trying to take over the firm (even at a price above the
current share price).
– Shareholders are asked to believe that the current management
will make the company even more profitable than those trying to
take over the company.
 REASON FOR BUSINESS COMBINATIONS
• Business combinations are typically viewed as a way
to jump-start economies of scale.
• Savings may result from the elimination of duplicative
assets.
– Perhaps both companies will utilize common facilities and
share fixed costs.
– It may be possible to better coordinate production,
marketing, and administrative actions.
• Cost Advantage
• Lower Risk
• Fewer Operating Delays
• Avoidance of Takeovers
• Acquisition of Intangible Assets
• Other Reasons
 REASON FOR BUSINESS COMBINATIONS
• Cost Advantage. It is frequently less expensive for
a firm to obtain needed facilities through
combination than through development. This is
particularly true in periods of inflation.
– Reduction of the total cost for research and
development activities was a prime motivation.
 Cont…
• Lower Risk. The purchase of established product lines and
markets is usually less risky than developing new products and
markets.
• The risk is especially low when the goal is diversification.
Scientists may discover that a certain product provides an
environmental or health hazard.
– A single-product, non-diversified firm may be forced into bankruptcy
by such a discovery; while a multiproduct, diversified company is
more likely to survive.
• Fewer Operating Delays. Plant facilities acquired in a business
combination are operative and already meet environmental and
other governmental regulations.
• The time to market is critical, especially in the technology
industry. Firms constructing new facilities can expect numerous
delays in construction, as well as in getting the necessary
governmental approval to commence operations.
– Environmental impact studies alone can take months or even years to
complete.
 Cont…
• Avoidance of Takeovers. Many companies combine to
avoid being acquired themselves. Smaller companies tend to
be more vulnerable (weak) to corporate takeovers; therefore,
many of them adopt aggressive buyer strategies to defend
against takeover attempts by other companies.
• Acquisition of Intangible Assets. Business combinations
bring together both intangible and tangible resources.
– The acquisition of patents, mineral rights, research, customer
databases, or management expertise may be a primary
motivating factor in a business combination.
• Other Reasons. Firms may choose a business combination
over other forms of expansion for business tax advantages
(for example, tax-loss carry forwards), for personal income
and estate-tax advantages, or for personal reasons.
 Types of Business Combination
• There are three types of business combination.
These are:
– A. Horizontal Combination
– B. Vertical Combination
– C. Conglomerate Combination
• Horizontal Combination: Combination involving
enterprises in the same industry.
– Elimination or reduction in competition, putting an end
to price cut, economics of scale of production, research
and development, marketing and management are often
motives underlying such merger.
Horizontal Integration (E.g.)

3-16
 Cont…
• Vertical Integration: combination between an
enterprise and its customers and/or supplier.
– Lowers buying cost of raw materials,
– lower distribution costs,
– assuring suppliers and market,
– increasing or creating barriers to entry for potential
competitor or placing them at a cost disadvantage are
the chief gains accruing from such merger.
Vertical integration (E.g.)

3-18
 Cont…
• Conglomerate Combination: Combination
between enterprises in unrelated industries or
markets.
– The rational for such kind of merger includes
diversification of risk constitutes, reduce income
volatility, and reduce the likelihood of antitrust
challenges by the government.
Conglomeration integration (E.g.)

3-20
 Methods for Arranging Business Combinations
• The four common methods for carrying out a
business combination are statutory merger,
statutory consolidation, acquisition of common
stock and acquisition of assets.
• 1. Statutory Merger
• A statutory merger refers to the absorption of one
or more former legal entities by another company
that continues as the sole surviving legal entity.
– The absorbed company ceases to exist as a legal entity
but may continue as a division of the surviving
company.
 Cont…
• In a statutory merger, the boards of directors of the
constituent companies approve a plan for the exchange of
voting common stock (and perhaps some preferred stock,
cash, or long-term debt) of one of the corporations (the
survivor) for all the outstanding voting common stock of
the other corporations.
• Stockholders of all constituent corporations must approve
the terms of the merger; some states require approval of a
two-thirds majority of stockholders.
• The survivor corporation issues its common stock or other
consideration to the stockholders of the other corporations in
exchange for all their holdings, thus acquiring ownership of
those corporations.
• The other corporations then are dissolved and liquidated but
their activities often are continued as divisions of the
survivor
• For example: Company “A” acquires Company
“B” then dissolves “B” and liquidates “B”.
Company “B” ceases to exist as separate legal
entities. Company “B” (dissolved) often continues
as a division of the survivor (“A”), which now
owns the net assets, rather than the outstanding
common stock, of the liquidated corporations.
 A- Corporation
Combinor
or Acquirer
or the only Survivor
B-Corporation
Acquiree/Combinee D-Corporation
dissolved often continues Acquiree/Combinee
as a division of the dissolved often continues
survivor as a division of the
survivor
C-Corporation
Acquiree/Combinee
dissolved often continues as
a division of the survivor
• To summarize, the procedures in a statutory merger
are as follows:
– 1. The boards of directors of the constituent companies work out
the terms of the merger.
– 2. Stockholders of the constituent companies approve the terms
of the merger, in accordance with applicable corporate bylaws
and state laws.
– 3. The survivor issues its common stock or other consideration to
the stockholders of the other constituent companies in exchange
for all their outstanding voting common stock of those
companies.
– 4. The survivor dissolves and liquidates the other constituent
companies, receiving in exchange for its common stock
investments the net assets of those companies.
 2. Statutory Consolidation
• A statutory consolidation refers to the combining of
two or more previously independent legal entities into
one new legal entity. The previous (prior) companies
are dissolved and are then replaced by a single
continuing company.
• A statutory consolidation is consummated in
accordance with applicable state laws. However, in a
consolidation a new corporation is formed to issue its
common stock for the outstanding common stock of
two or more existing corporations, which then go out
of existence.
• The new corporation thus acquires the net assets of the
defunct (non-operational) corporations, whose
activities may be continued as divisions of the new
corporation.
 Cont…
E-Corporation
legally dissolved
and Continues as
Subsidiary

Form New
Equals to G-
corporation
F-Corporation
legally dissolved
and Continues as
Subsidiary
 Cont…
• To summarize, the procedures in a statutory
consolidation are as follows:
• 1. The boards of directors of the constituent
companies work out the terms of the consolidation.
• 2. Stockholders of the constituent companies approve
the terms of the consolidation, in accordance with
applicable corporate bylaws and state laws.
• 3. A new corporation is formed to issue its common
stock to the stockholders of the constituent companies
in exchange for all their outstanding voting common
stock of those companies.
• 4. The new corporation dissolves and liquidates the
constituent companies, receiving in exchange for its
common stock investments the net assets of those
companies.
 3. Acquisition of Common Stock
• In a stock acquisition, a controlling interest (typically,
more than 50%) of another company’s voting common
stock is acquired. The company making the
acquisition is termed the parent, and the company
acquired is termed a subsidiary.
• Both the parent and the subsidiary remain separate
legal entities and maintain their own financial records
and statements.
– However, for external financial reporting purposes, the
companies usually will combine their individual financial
statements into a single set of consolidated statements.
• Thus, a consolidation may refer to a statutory
combination or, more commonly, to the consolidated
statements of a parent and its subsidiary.
 Cont…
• One corporation (the investor) may issue preferred
or common stock, cash, debt or a combination
thereof to acquire from present stockholders a
controlling interest in the voting common stock of
another corporation (the investee).
• This stock acquisition program may be
accomplished through direct acquisition in the
stock market, through negotiations with the
principal stockholders of a closely held
corporation, or through a tender offer to
stockholders of a publicly owned corporation.
 Cont…
• If a controlling interest in the combinee’s voting
common stock is acquired, that corporation
becomes affiliated with the combinor parent
company as a subsidiary, but is not dissolved and
liquidated and remains a separate legal entity.
• Business combinations arranged through common
stock acquisitions requires authorization by the
combinor’s board of directors and may require
ratification (approval) by the combinee’s
stockholders.
• Most hostile takeovers are accomplished by this
means.
 Cont…
Y-Corporation
Controlled
Subsidiary but continues
as separate legal entity

X-Corporation
Z-Corporation
Controlled
Controlled
Subsidiary but continues as
separate legal entity Subsidiary but continues
as separate legal entity
M-Corporation
Parent
Acquirer
Prepares consolidated financial
statement
Acquire more than 50% of
outstanding common stocks of
subsidiaries
 4. Acquisition of Assets
• A business enterprise may acquire from another
enterprise all or most of the gross assets or net
assets of the other enterprise for cash, debt,
preferred or common stock, or a combination
thereof.
• The transaction generally must be approved by the
boards of directors and stockholders or other
owners of the constituent companies.
• The selling enterprise may continue its existence
as a separate entity or it may be dissolved and
liquidated; it does not become an affiliate of the
combinor.
 Cont…
Y-Corporation
Controlled
Dissolved or continues
as separate legal entity
X-Corporation Z-Corporation
Controlled Controlled
Dissolved or continues as Dissolved or continues
separate legal entity as separate legal entity

M-Corporation
Parent
Acquirer
Prepares consolidated financial
statement
Acquire net assets of the others
 Techniques for Structuring Business Combinations
• A business combination can be structured in a number
of different ways that satisfy the acquirer’s strategic,
operational, legal, tax and risk management
objectives.
• Some of the more frequently used structures are:
• 1. One or more businesses become subsidiaries of the
acquirer. As subsidiaries, they continue to operate as
separate legal entities.
• 2. The net assets of one or more businesses are legally
merged into the acquirer. In this case, the acquiree
entity ceases to exist (in legal vernacular, this is
referred to as a statutory merger and normally the
transaction is subject to approval by a majority of the
outstanding voting shares of the acquiree).
 Cont…
• 3. The owners of the acquiree transfer their equity interests
to the acquirer entity or to the owners of the acquirer entity
in exchange for equity interests in the acquirer.
• 4. All of the combining entities transfer their net assets or
their owners transfer their equity interests into a new entity
formed for the purpose of the transaction. This is sometimes
referred to as a roll-up or put-together transaction.
• 5. A former owner or group of former owners of one of the
combining entities obtains control of the combined entities
collectively
• 6. An acquirer might hold a non-controlling equity interest in
an entity and subsequently purchase additional equity
interests sufficient to give it control over the investee.
– These transactions are referred to as step acquisitions or business
combinations achieved in stages.
 Establishing the Price for a Business Combination
• An important early step in planning a business
combination is deciding on an appropriate price to
pay.
• The amount of cash or debt securities, or the
number of shares of preferred or common stock, to
be issued in a business combination generally is
determined by variations of the following methods:
• 1. Capitalization of expected average annual
earnings of the combinee at a desired rate of
return.
• 2. Determination of current fair value of the
combinee’s net assets (including goodwill).
 Accounting for Business Combinations under the Acquisition Method
• There was two accounting methods for business
combination (in GAAP)
– 1. Purchase Method of business combination and
– 2. Pooling of Interest Method of business Combination
• The acquirer is to account for a business combination
using the acquisition method. This term represents an
expansion of the now-outdated term “purchase
method.”
• The acquisition method approaches a business
combination from the point of view of the acquirer,
the entity that obtains control of the other entity or
entities in the business combination.
– Under the acquisition method, the buyer identifies all
assets and liabilities and reports them on the consolidated
Statement of Financial Positions at their fair values
 Cont…
• The following steps are required to apply the acquisition method:
1. Identify the acquirer;
2. Determine the acquisition date:
3. Identify the assets and liabilities, if any, requiring
separate accounting
4. Identify assets and liabilities that require acquisition
date classification or designation decisions to facilitate
application of IFRS in post-combination
5. Recognize and measure the identifiable tangible and
intangible assets acquired and liabilities assumed;
6. Recognize and measure any non-controlling interest in
the acquiree;
7. Measure the consideration transferred;
• Contingent consideration. In many business
combinations, the acquisition price is not
completely fixed at the time of the exchange, but is
instead dependent on the outcome of future events.
• There are two major types of contingent future
events that might commonly be used to modify the
acquisition price:
– the performance of the acquired entity (acquiree) and
– the market value of the consideration initially given for
the acquisition
• Goodwill represents an intangible that is not
specifically identifiable.
– It results from situations when the amount the acquirer is
willing to pay to obtain its controlling interest exceeds the
aggregate recognized values of the net assets acquired,
measured following the principles of IFRS 3.
• It arises largely from the synergies (collaboration) and
economies of scale expected from combining the
operations of the acquirer and acquiree.
• Goodwill’s elusive (intangible) nature as an
unidentifiable, residual asset means that it cannot be
measured directly but rather can only be measured by
reference to the other amounts measured as a part of
the business combination.
• Bargain purchases. A bargain purchase occurs
when the value of net assets acquired is in excess
of the acquisition-date fair value of the
consideration transferred plus the amount of any
non-controlling interest and plus fair value of the
acquirer’s previously held equity interest.
 Acquisition-related costs
• Acquisition-related costs, under IFRS 3, are
generally to be charged as an expense in the
period in which the costs are incurred and the
related services received. Examples of these costs
include:
– Accounting fees
– Internal acquisitions department costs
– Advisory fees
– Legal fees
– Consulting fees
– Other professional fees
– Finder’s fees
– Valuation fees
• Under the previous IFRS 3, such costs were to be
included in the cost of the business combination
and accordingly also included in the calculation of
goodwill.
– In accordance with the revised standard, IFRS 3,
because such costs are not part of the fair value
exchange between the buyer and the seller for the
acquired business, they are accounted for separately as
operating costs in the period in which services are
received.
• This departure from past practice may significantly
affect the operating results reported for the period
of any acquisition.
Illustration of Purchase Accounting for Statutory Merger, with Goodwill

• On December 31, 1999, Mason Company (the

acquiree or combinee) was merged into Saxon
Corporation (the acquirer or combinor or the
survivor). Both companies used the same accounting
principles for assets, liabilities, revenue and expenses
and both had a December 31 fiscal year. Saxon issued
150,000 shares of its $10 par common stock (current
fair value is $25 a share) to Mason’s stockholders for
all 100,000 issued and outstanding shares of no-par,
$10 stated value common stock. In addition, Saxon
paid the following out of pocket costs associated with
the business combination:
Illustration of Purchase Accounting for Statutory Merger, with Goodwill
• Accounting fees:
• For investigation of Mason as prospective combinee 5,000
• For SEC registration statement for Saxon common stock 60,000
• Legal fees:
• For the business combination 10,000
• For SEC registration statement for Saxon common stock 50,000
– Finder’s fee 51,250
– Printer’s charges for printing securities and SEC reg statement 23,000
– SEC registration statement fee 750
• Total out of pocket expenses 200,000
• There was no contingent consideration in the merger
contract.
• Immediately prior to the merger, Mason Company’s
condensed balance sheet was as follows:
 – Mason Company (combinee)
– Balance Sheet (prior to business combination)
– December 31, 1999
– Assets
– Current assets 1,000,000
– Plant assets (net) 3,000,000
– Other assets 600,000

– Total assets 4,600,000

– Current liabilities 500,000

– Long term debt 1,000,000
– Common stock, no par, $10 stated value 1,000,000
– Additional paid in capital 700,000
– Retained earnings 1,400,000
– Total liabilities and capital 4,600,000
• Using the guidelines in APB Opinion No. 16, the
board of directors of Saxon Corporation determined
the current fair values of Mason Company’s assets
and liabilities (identifiable net assets) as follows:
– Current assets 1,150,000
– Plant assets 3,400,000
– Other assets 600,000
– Total identifyable Assets 5,150,000
– Current liabilities (500,000)
– Long term debt (present value) (950,000)
– Total identifiable Liabilities 1,450,000
– Identifiable net assets of combinee 3,700,000
• Required: prepare journal entries for Saxon Corporation (the
combinor) on Dec. 31,1999, to record the merger with Mason
Company, as a purchase-type business combination.
• Solution
• Saxon uses the investment ledger to accumulate the total cost
prior to assigning the cost to identifiable net assets and goodwill.
• 1. To record merger with Mason Company as purchase
– Investment in Mason Co common stock
– (150,000*25) 3,750,000
– Common stock (150,000*10) 1,500,000
– Paid in capital in excess of par 2,250,000
–
• 2. To record out of pocket costs incurred with Mason company.
• Investment Expense (5,000+10,000+51,250) 66,250
– Paid in capital in excess of par(60,000+50,000+23,000+750) 133,750
– Cash 200,000
• Accounting, legal, and finder’s fees are investment (operating)
expense; other out of pocket costs are recorded as a reduction in the
proceeds received from issuance of common stock.
• 3. To allocate total cost of liquidated Mason
company to identifiable assets and liabilities, with the
remainder to goodwill. (income tax effects
disregarded).
– Current assets 1,150,000
– Plant assets 3,400,000
– Other assets 600,000
– Discount on long term loan (1,000,000-50,000) 50,000
– Goodwill 50,000
– Current liabilities 500,000
– Long term debt 1,000,000
– Investment in Mason co common stock 3,750,000
• Amount of goodwill is computed as follows:
– Total cost of Mason company 3,750,000
– Mason’s identifiable net assets
– (4,600,000-1,500,000) 3,100,000
– Excess (deficiency) of current fair
– value over carrying amounts
– Current assets 150,000
– Plant assets 400,000
– Long term debt 50,000 = 600,00 3,700,000
• Amount of goodwill 50,000
Or Goodwill can be calculated
• Identifiable Assets
– Current Assets ---------------------- 1,150,000
– Plant Assets -------------------------- 3,400,000
– Other Asset --------------------------- 600,000
• Total identifiable Assets (at fair Value) ---------5,150,000
– Current Liabilities -------------------- 500,000
– Long term debt ------------------------950,000
• Total Liability (500,000+950,000) --------1,450,000
• Net identifiable Assets (5,150,000-1,450,000) ---- 3,700,00
• GW = Acquisition cost (AC) at fair value –
Net Identifiable Assets (NIAs) at fair value
– GW = 3,750,000 – 3,700,000 = 50,000
• No adjustments are made to reflect the current fair values of
Saxon’s identifiable net assets or goodwill as Saxon is the
combinor.
• Mason company records (the combinee) prepares the
following condensed journal entry to record the dissolution and
liquidation of the company on Dec 31,1999.
– Current liabilities 500,000
– Long term debt 1,000,000
– Common stock, $10 stated value 1,000,000
– Paid in capital in excess of stated value 700,000
– Retained Earnings 1,400,000
– Current assets 1,000,000
– Plant assets (net) 3,000,000
– Other assets 600,000
– To record liquidation of company in conjunction with merger
with Saxon Corporation
 Illustration of purchase accounting for acquisition of net assets,
with bargain purchase excess (negative Good will)

• On December 31,1999, Davis Corporation acquired

the net assets of Fairmont Corporation directly from
Fairmont for $400,000 cash, in a purchase type
business combination. Davis paid legal fees of
$40,000 in connection with the combination.
• The condensed balance sheet of Fairmont prior to
the business combination, with related current fair
value data, is presented below:
 Cont…
– FAIRMONT CORPORATION (combinee)
– Balance Sheet (prior to business combination)
– December 31,1999
• Carrying Amounts Assets Current Fair Values
– Current assets 190,000 200,000
– Investment in marketable debt 50,000 60,000
– Plant assets (net) 870,000 900,000
– Intangible assets (net) 90,000 100,000
– Total assets 1,200,000 1,260,000
• Liabilities and Stockholders’ Equity
– Current liabilities 240,000 240,000
– Long term debt 500,000 520,000
– Total liabilities 740,000 760,000
– Common stock, $1 par 600,000
– Deficit (140,000)
– Total stockholders’ equity 460,000
– Total liab & stockholders’ equity 1,200,000
– Deficit exist because of total liability and common stock (equity) 1,340,000
(740,000+600,000) so, this is excess of from total asset by 140,000 (1,340,000-
1,200,000). So, to make balance the asset total and liability and stockholders
equity total the excess amount deducted from the common stock.
 Cont…
• Thus, Davis acquired identifiable net assets with current fair
value of 500,000 (1,260,000-760,000) for a total cost of
400,000. The 100,000 excess of the current fair value of the
assets over their cost will be reported by crediting a separate
account of gain from bargain purchase.
• The journal entries below record Davis Corporation’s
acquisition of the net assets of Fairmont Corporation and
payment of 40,000 legal fee.
– Investment in Net Assets of Fairmont Corp 400,000
– Cash 400,000
– To record acquisition of net assets of Fairmont Corporation
• Investment expense 40,000
– Cash 40,000
– To record legal fee paid in acquisition of net assets of Fairmont
Corporation
– Current assets 200,000
– Investment in Marketable Debt Securities 60,000
– Plant assets 900,000
– Intangible assets 100,000
– Current liabilities 240,000
– Long term debt 500,000
– Premium on long term debt (520,000-500,000) 20,000
– Investment in net assets of Fairmont 400,000
– Gain from Bargain Purchase 100,000
• To allocate total cost of net assets acquired to
identifiable net assets, with excess of current fair
value of the net assets over cost allocated a separate
account of Gain from Bargain Purchase
End of Chapter 2