1、Intercorporate Acquisitions and Investments in Other Entities,1, 2009 The McGraw-Hill Companies, Inc. All rights reserved.,McGraw-Hill/Irwin,The Development of Complex Business Structures,Enterprise expansion as a means of survival and profitability Size often allows economies of scale New earning p
2、otential Earnings stability through diversification Management rewards for bigger company size Prestige associated with company size,Organizational Structure and Business Objectives,A subsidiary is a corporation that is controlled by another corporation, referred to as a parent company, usually thro
3、ugh majority ownership of its common stock Because a subsidiary is a separate legal entity, the parents risk associated with the subsidiarys activities is limited,Organizational Structure, Acquisitions, and Ethical Considerations,Manipulation of financial reporting Usage of subsidiaries or other ent
4、ities to borrow money without reporting the debt on their balance sheets Using special entities to manipulate profits Manipulation of accounting for mergers and acquisitions Pooling-of-interests,Business Expansion and Forms of Organizational Structure,Expansion from within: New subsidiaries or entit
5、ies such as partnerships, joint ventures, or special entities Motivating factors: Helps establish clear lines of control and facilitate the evaluation of operating results Special tax incentives Regulatory reasons Protection from legal liability Disposing of a portion of existing operations,Business
6、 Expansion and Forms of Organizational Structure,A spin-off Occurs when the ownership of a newly created or existing subsidiary is distributed to the parents stockholders without the stockholders surrendering any of their stock in the parent company A split-off Occurs when the subsidiarys shares are
7、 exchanged for shares of the parent, thereby leading to a reduction in the outstanding shares of the parent company,Business Expansion and Forms of Organizational Structure,Expansion through business combinations Entry into new product areas or geographic regions by acquiring or combining with other
8、 companies A business combination occurs when “. . . an acquirer obtains control of one or more businesses” The concept of control relates to the ability to direct policies and management,Business Expansion and Forms of Organizational Structure,Traditional view - Control is gained by acquiring a maj
9、ority of the companys common stock However, it is possible to gain control with less than majority ownership or with no ownership at all Informal arrangements Formal agreements Consummation of a written agreement requires recognition on the books of one or more of the companies that are a party to t
10、he combination,Frequency of Business Combinations,1960s - Merger boom Conglomerates 1980s - Increase in the number of business combinations Leveraged buyouts and the resulting debt 1990s - All previous records for merger activity shattered Downturn of the early 2000s, and decline in mergers Increase
11、d activity toward the middle of 2003 that accelerated through the middle of the decade Role of private equity Effect of the credit crunch of 2007-2008,Organizational Structure and Financial Reporting,Merger - A business combination in which the acquired companys assets and liabilities are combined w
12、ith those of the acquiring company results in no additional organizational components Financial reporting is based on the original organizational structure,Organizational Structure and Financial Reporting,Controlling ownership - A business combination in which the acquired company remains as a separ
13、ate legal entity with a majority of its common stock owned by the purchasing company leads to a parentsubsidiary relationship Accounting standards normally require consolidated financial statements,Organizational Structure and Financial Reporting,Noncontrolling ownership - The purchase of a less-tha
14、n-majority interest in another corporation does not usually result in a business combination or controlling situation Other beneficial interest - One company may have a beneficial interest in another entity even without a direct ownership interest The beneficial interest may be defined by the agreem
15、ent establishing the entity or by an operating or financing agreement,Creating Business Entities,The company transfers assets, and perhaps liabilities, to an entity that the company has created and controls and in which it holds majority ownership The company transfers assets and liabilities to the
16、created entity at book value, and the transferring company recognizes an ownership interest in the newly created entity equal to the book value of the net assets transferred,Recognition of fair values of the assets transferred in excess of their carrying values on the books of the transferring compa
17、ny is not appropriate in the absence of an arms-length transaction No gains or losses are recognized on the transfer by the transferring company,Creating Business Entities,Creating Business Entities : Example,Allen Company creates a subsidiary, Braine company, and transfers the following assets to B
18、laine in exchange for all 100,000 shares of Blaines $2 par common stock. (common stock is issued for the assets),Creating Business Entities : Example (contd),item Cost Book Value Cash $ 70,000 Inventory $ 50,000 50,000Land 75,000 75,000Building 100,000 80,000Equipment 250,000 160,000$435,000,Creatin
19、g Business Entities : Example (contd),Allen records the transfer with the following entry:Investment in Blaine Company Common Stock 435,000 Accumulated Depreciation 110,000Cash 70,000Inventory 50,000Land 75,000Building 100,000 Equipment 250,000$110,000 = ($100,000 - $80,000) + ($250,000 - $160,000),
20、Creating Business Entities : Example (contd),Cash 70,000 Inventory 50,000 Land 75,000 Building 100,000 Equipment 250,000Accumulated Depreciation 110,000Common Stock, $2 par 200,000Additional paid-in Capital 235,000 Blaine Company records the transfer of assets and the issuance of stock at the book v
21、alue of the assets transferred:,If the value of an asset transferred to a newly created entity has been impaired prior to the transfer and its fair value is less than the carrying value on the transferring companys books, the transferring company should recognize an impairment loss and transfer the
22、asset to the new entity at the lower fair value,Creating Business Entities,Forms of Business Combinations,A statutory merger The acquired companys assets and liabilities are transferred to the acquiring company, and the acquired company is dissolved, or liquidated The operations of the previously se
23、parate companies are carried on in a single legal entity A statutory consolidation Both combining companies are dissolved and the assets and liabilities of both companies are transferred to a newly created corporation,Forms of Business Combinations,A stock acquisition One company acquires the voting
24、 shares of another company and the two companies continue to operate as separate, but related, legal entities The acquiring company accounts for its ownership interest in the other company as an investment Parentsubsidiary relationship For general-purpose financial reporting, a parent company and it
25、s subsidiaries present consolidated financial statements that appear largely as if the companies had actually merged into one,Forms of Business Combinations,AA Company,BB Company,AA Company,(a) Statutory Merger,AA Company,BB Company,CC Company,AA Company,BB Company,AA Company,BB Company,(b) Statutor
26、y Consolidation,(c) Stock Acquisition,Determining the Type of Business Combination,AA Company invests in BB Company,Acquires net assets,Acquires stock,Record as statutory merger or statutory consolidation,Acquired company liquidated?,Record as stock acquisition and operate as subsidiary,Yes,No,Metho
27、ds of Effecting Business Combinations,Acquisition of assets Statutory Merger Statutory Consolidation Acquisition of stock A majority of the outstanding voting shares usually is required unless other factors lead to the acquirer gaining control Noncontrolling interest: The total of the shares of an a
28、cquired company not held by the controlling shareholder Acquisition by other means,Valuation of Business Entities,Value of individual assets and liabilities Value determined by appraisal Value of potential earnings “Going-concern value” based on: A multiple of current earnings. Present value of the
29、anticipated future net cash flows generated by the company. Valuation of consideration exchanged,Valuation of Long-term Liabilities: Example,If $100,000 of 10-year,6 percent bonds, payinginterest annually, had been issued at par three year ago, and the current market rate of interest for the same ty
30、pe of security is 10 percent, the value of the liability currently is computed as follows:,Present value for 7 years at 10% of principle payment of$100,000($100,000 .51316) $51,316 Present value at 10% of 7 interest payment of $6,000 ($6,000 4.86842) 29,211 Present value of bond $80,527,Valuation of
31、 Potential Earnings: Example,Bargain Company is expected to generate cash flows of $35,000 for each of the next 25 years, the present value of the firm at a discount rate of 10 percent is computed as follows:,Annual cash flow generated $ 35,000 Present value factor for an annuity of 25 annual paymen
32、ts at 10% 9.07704 Present value of future earnings $ 317,696,Accounting for Business Combinations,Two methods acceptable earlier: Purchase Pooling of interests 2001 - the FASB eliminated pooling of interests 2007 - FASB 141R replaced the purchase method with the acquisition method This must be used
33、to account for all business combinations for which the acquisition date is in fiscal years beginning on or after December 15, 2008 FASB 141R may not be applied retroactively,Acquisition Accounting,The acquirer recognizes all assets acquired and liabilities assumed in a business combination and measu
34、res them at their acquisition-date fair values If less than 100 percent of the acquiree is acquired, the noncontrolling interest also is measured at its acquisition-date fair value Fair value measurement The FASB decided in FASB 141R to focus directly on the value of the consideration given,Acquisit
35、ion Accounting,Points to consider: No separate asset valuation accounts related to assets acquired are recognized Long-lived assets classified at the acquisition date as held for sale are valued at fair value less cost to sell Deferred income taxes related to the business combination and assets and
36、liabilities related to an acquirees employee benefit plans are valued in accordance with the relevant FASB standards,Acquisition Accounting,Points to consider: Costs of bringing about and consummating a combination are charged to expense as incurred Costs of issuing equity securities used to acquire
37、 the acquiree are treated as a reduction in the paid-in capital associated with the securities,Goodwill,Components used in determining goodwill: The fair value of the consideration given by the acquirer The fair value of any interest in the acquiree already held by the acquirer The fair value of the
38、 noncontrolling interest in the acquiree, if any The total of these three amounts, all measured at the acquisition date, is compared with the acquisition-date fair value of the acquirees net identifiable assets, and the difference is goodwill,Goodwill: example1,Albert acquires all of the assets of Z
39、anfor for $400,000 when the fair value of Zanfors net identifiable assets is $380,000.,Fair value of consideration given $400,000 Fair value of net identifiable assets acquired (380,000) Goodwill $ 20,000,Goodwill: example2,Albert acquires 75% of the common stock of Zanfor for $300,000 when the fair
40、 value of Zanfors net identifiable assets is $380,000.The fair value of the NCI is $100,000.,Fair value of consideration given $300,000 Fair value of NCI 100,000$400,000 Fair value of net identifiable assets acquired (380,000) Goodwill $ 20,000,Acquisition Method - Illustration,Market value of share
41、s issued $610,000 Legal and appraisal fees $40,000 Stock issue costs $25,000,Point Corporation acquires all of the assets and assumes all of the liabilities of Sharp Company in a statutory merger by issuing to Sharp 10,000 shares of $10 par common stock.,Acquisition Method - Illustration,Acquisition
42、 Method - Illustration,Acquisition Accounting,Testing for goodwill impairment: When goodwill arises in a business combination, it must be assigned to individual reporting units To test for impairment, the fair value of the reporting unit is compared with its carrying amount If the fair value of the
43、reporting unit exceeds its carrying amount, the goodwill of that reporting unit is considered unimpaired If the carrying amount of the reporting unit exceeds its fair value, an impairment of the reporting units goodwill is implied,Acquisition Accounting,The amount of the reporting units goodwill imp
44、airment is measured as the excess of the carrying amount of the units goodwill over the implied value of its goodwill The implied value of its goodwill is determined as the excess of the fair value of the reporting unit over the fair value of its net assets excluding goodwill Goodwill impairment los
45、ses are recognized in income from continuing operations or income before extraordinary gains and losses,Example : Goodwill Impairment,Reporting unit A is assigned $100,000 of goodwill arising from a business combination. The following assets and liabilities are assigned to Reporting Unit A:,Item Car
46、rying Amount Fair Value Cash and receivables $ 50,000 $ 50,000 Inventory 80,000 90,000 Equipment 120,000 150,000 Goodwill 100,000 Total assets $ 350,000 $290,000 Current payables (10,000) (10,000) Net assets $ 340,000 $280,000,Example :Goodwill Impairment,If the fair value of the reporting unit is e
47、stimated to be $360,000,no impairment of goodwill is indicated. If the fair value of the reporting unit is estimated to be $320,000,a second comparison must be made to determine the amount of impairment loss.Fair value of the unit- Fair value of net assets (excluding goodwill) = Implied value of GoodwillCarrying value of goodwill Implied value of goodwill = Impairment Loss$100,000 ($320,000 - $280,000) = $60,000,
