Advanced Accounting Chapter 2：Methods of Accounting for Business Combinations

1、Advanced Accounting Chapter 2：Methods of Accounting for Business CombinationsAdvanced Accounting by Debra Jeter and Paul ChaneyChapter 2: Methods of Accounting for Business CombinationsAccounting Methods for Business CombinationsPurchase Methodtreats the combination as the purchase of one or more co

2、mpanies by another.Pooling of Interests Methodtreats the combination as two or more groups of stockholders uniting their ownership interests by an exchange of common stock.Comparison of Purchase and Pooling of InterestsPurchaseAssets and liabilities acquired are recorded at their fair values. Any ex

3、cess of cost over fair value of net assets acquired is recorded as goodwill.Pooling of InterestsAssets and liabilities are recorded at their precombination book values. No excess of cost over book value exists, and no new goodwill is recordedComparison of Purchase and Pooling of InterestsPurchaseThe

4、 acquired companys retained earnings are not added into the acquiring companys retained earnings.Equity securities issued are recorded at their fair market value.Pooling of InterestsThe acquired companys retained earnings are added into the acquiring companys retained earnings. Equity shares issued

5、are recorded at the book value of the acquired shares.Comparison of Purchase and Pooling of InterestsPurchaseThe excess of cost over book value is depreciated or amortized to reduce future earnings.The acquired companys earnings are included with the acquiring firms only from the date of combination

6、 forward.Pooling of InterestsThere is no additional depreciation or amortization expense.The issuer and combiner companies earnings are combined for the full fiscal year in which the combination occurs.Comparison of Purchase and Pooling of InterestsPurchaseDirect costs are capitalized as part of the

7、 acquisition cost.Indirect costs are expensed.Security issuance costs are deducted from additional paid-in capital.Pooling of InterestsDirect costs are expensed in the year in which incurred.Indirect costs are expensed.Security issuance costs are expensed.Acquisition Costs - An IllustrationFacts:SMC

8、 Company acquires 100% of the net assets of Bee Company by issuing shares of common stock with a fair value of $120,000. SMC incurred:$1,500 of accounting and consulting costs$3,000 of stock issue costs$2,000 monthly overhead cost for its mergers departmentAcquisition Costs - An IllustrationPooling

9、Accounting:Accounting and Consulting Expense (Direct) 1,500Merger Department Expense (Indirect) 2,000Securities Issue Expense (Security Issue Costs) 3,000Cash 6,500Purchase Accounting:Goodwill (Direct)1,500Merger Department Expense (Indirect)2,000Other Contributed Capital (Security Issue Costs)3,000

10、Cash 6,500Disadvantages of Pooling Method Values given and received are ignored in a negotiated transaction.“Instant earnings” can result from sale of newly pooled assets that are carried at their precombination low book values, and from including precombination earnings of other companies in the ye

11、ar of combination.Disadvantages of Purchase MethodSubjective - appraisal of assets or stock values are necessary.Inconsistent - accounting for one part of the combined company on a fair value and the other part of a historical basis.Pro Forma StatementsFinancial statements “as if” the combination ha

12、d been consummated.Functions provide information in the planning stages of the combinationdisclose relevant information subsequent to the combinationDisclosure RequirementsPurchase Methodnotes to financial statements should include pro forma informationin the year of combinationin the immediately pr

13、eceding period if comparative financial statements are presentedAnalysis of valuation differentialFair value ofidentifiable net assets acquiredBook value ofnet assets acquired Acquisition cost Analysis of the Valuation Differential for Net Assets Revaluation increment Goodwill Valuation differential

14、 Disclosure RequirementsPooling Methodfinancial statements should be restated on a pro forma basis for all years presentednotes to financial statements should includedisclosure that the statements of previously separately firms have been combinedoperating results of separate firms prior to the combi

15、nationPurchase Example - FactsOn January 1, 2000, P Company acquired the assets and assumed the liabilities of S Company. P Company gave one of its $15 par value common shares for each share of S company common stock.P Company common stock has a fair value per share of $948. Refer to Illustration 2-

16、4 for the companies balance sheet information.Purchase Example - Journal EntryCash and Receivables 170,000Inventories 140,000Land 400,000Buildings & Equipment (Net)1,000,000Discount on Bonds Payable 50,000Goodwill 230,000Current Liabilities150,000Bonds Payable400,000Common Stock450,000Other Cont

17、ributed Capital990,000Identifiablenet assets acquired arerecorded at their market value on theacquisitiondateGoodwill =excess cost overfair valueof identifiable assetsacquiredCommon stock issued is recorded at market value on the acquisition dateEquity Allocation in Pooling of Interests - Case AP is

18、sued shares with par value of $450,000Common stock -S$300,000Other ContributedCapital - S $50,000Retained Earnings- S$140,000Common Stock - P$750,000Other ContributedCapital - P$400,000Retained Earnings- P$350,000$300,000$50,000$100,000$140,000Journal Entry - Case ACash and Receivables 180,000Invent

19、ories 100,000Land 120,000Buildings & Equipment 900,000Other Contributed Capital 100,000Accumulated Depreciation300,000Current Liabilities110,000Bonds Payable400,000Common Stock 450,000Retained Earnings140,000net assets acquired are carriedforward at their book valueTotal shareholders equity of S

20、 Company ($490,000) is carried forward to P CompanyPar value of common stock issued is recordedEquity Allocation in Pooling of Interests - Case BP issued shares with par value of $800,000Common stock -S$300,000Other ContributedCapital - S $50,000Retained Earnings- S$140,000Common Stock - P$750,000Ot

21、her ContributedCapital - P$400,000Retained Earnings- P$350,000$300,000$50,000$400,000$90,000$50,000Journal Entry - Case BCash and Receivables 180,000Inventories 100,000Land 120,000Buildings & Equipment 900,000Other Contributed Capital 400,000Accumulated Depreciation300,000Current Liabilities110,

22、000Bonds Payable400,000Common Stock 800,000Retained Earnings 90,000net assets acquired are carriedforward at their book valueTotal shareholders equity of S Company ($490,000) is carried forward to P CompanyPar value of common stock issued is recordedEquity Allocation in Pooling of Interests - Case C

23、P issued shares with par value of $330,000Common stock -S$300,000Other ContributedCapital - S $50,000Retained Earnings- S$140,000Common Stock - P$750,000Other ContributedCapital - P$400,000Retained Earnings- P$350,000$300,000$30,000$140,000$20,000Journal Entry - Case CCash and Receivables 180,000Inv

24、entories 100,000Land 120,000Buildings & Equipment 900,000Accumulated Depreciation300,000Current Liabilities110,000Bonds Payable400,000Common Stock 330,000Other Contributed Capital 20,000Retained Earnings140,000net assets acquired are carriedforward at their book valueTotal shareholders equity of

25、 S Company ($490,000) is carried forward to P CompanyPar value of common stock issued is recordedEquity Allocation in Pooling of Interests - Case DP issued shares with par value of $275,000Common stock -S$300,000Other ContributedCapital - S $50,000Retained Earnings- S$140,000Common Stock - P$750,000

26、Other ContributedCapital - P$400,000Retained Earnings- P$350,000$275,000$25,000$140,000$50,000Pooling Example - Case DCash and Receivables 180,000Inventories 100,000Land 120,000Buildings & Equipment 900,000Accumulated Depreciation300,000Current Liabilities110,000Bonds Payable400,000Common Stock

27、275,000Other Contributed Capital 75,000Retained Earnings140,000net assets acquired are carriedforward at their book valueTotal shareholders equity of S Company ($490,000) is carried forward to P CompanyPar value of common stock issued is recordedBargain PurchaseBargain = Fair value of identifiable n

28、et assets acquired Less: Purchase price Valuation of Net Assets Acquired:Current assets, long-term investments in marketable securities, liabilities = fair valuePreviously recorded goodwill = 0Long-term assets = fair value - bargain allocation(The bargain is allocated to long-term assets in proporti

29、on to their fair value.)Any remaining bargain is recorded as negative goodwill and amortized over a maximum of 40 years.Bargain Purchase - ExampleBargain = Fair value of identifiable net assets ($23,000) - Purchase price ($17,000) = $6,000Building $4,500Land $1,500Current Assets 5,000Buildings ($15,

30、000-$4,500) 10,500Land ($5,000-$1,500) 3,500Liabilities 2,000Cash 17,000Building and Land is recorded atfair value minus allocated bargainCurrent assets and liabilities are recorded at fair valueContingent ConsiderationsContingencies based on earningsContingencies based on security prices Earnings C

31、ontingencyDefinitionadditional consideration to be made if the combined companys future earnings equal or exceed a threshold.Accounting Treatmentas additional cost of acquisitionStock Price ContingencyDefinitionadditional consideration to be made if the future market value of shares issued is less t

32、han the guaranteed value Accounting Treatmentno effect on acquisition costas an adjustment to Other Contributed CapitalLeveraged Buyout (LBO) A management group contributes stock they hold and borrows funds to a create new company, which acquires all the outstanding common shares of their employer c

33、ompany.Leveraged Buyout (LBO)Stock of employercompany held bymanagersBorrowed FundNew CompanyEmployer CompanyacquiresLeveraged Buyout (LBO)Valuation of New Companynet assets acquired by borrowed fund market valuenet assets contributed by managers book valueLeveraged Buyout (LBO) ExampleBook ValueMar

34、ket ValueNet assetscontributedby managersNet assets acquired by borrowed fund of $31,500Valuation of Net Assets in New Company$1,000$9,00010%90%Goodwill$9,000Excess cost applied to plant assets = $13,500Excess of costover bookvalueCriteria for Pooling of InterestsCompany Attributesautonomous of any other companiesindependent of other combining companiesCriteria for Pooling of InterestsExchange of Stocksingle trans