Business Combinations

Question 1

When is the fair value method used for recording interest in a separate company?

Answer 1

20% Ownership or Less Accounted for as a purchase. If amount paid is less than fair value; results in a gain in current period

Question 2

When is the equity method used when purchasing another company’s stock? How is it recorded?

Answer 2

Ownership 21% to 50%. Gives significant influence. Purchase Price - Par Value : Goodwill Dividends received from the investee reduce the investment account and are not income

Question 3

When are companies required to file consolidated financials? How is it recorded?

Answer 3

Ownership of other company is greater than 50%

Investment account is eliminated

Only parent company prepares consolidated statements; not subsidiary.

Acquired assets/liabilities are recorded at Fair Value on acquisition date.

Eliminating entries for inter-company sales of inventory & PPE; also inter-company investments

Question 4

When is consolidation not required?

Answer 4

Ownership less than 50% OR Majority owner does not control - i.e. bankruptcy or foreign bureaucracy

Question 5

What occurs under a step acquisition?

Answer 5

Acquirer held previous shares accounted for under Fair Value Method or Equity Method; and are now re-valued to Fair Value

Results in a Gain or Loss in current period

Question 6

What is the difference between an acquisition and a merger?

Answer 6

Acquired companies continue to exist as a legal entity - their books are just consolidated with the parent company in the parent’s financial statements

Merged companies cease to exist and only the parent remains

Question 7

How are acquisition costs recorded in a merger?

Answer 7

Expensed in period incurred - i.e. NOT capitalized. EXAMPLES: Accounting, Legal; Valuation; Consulting; Professional. Netted against stock proceeds: Stock registration and issuance costs

Question 8

Define Business Combination.

Answer 8

A TRANSACTION (consideration is transferred) or EVENT (one party may gain control w/out a transaction or outright purchase) where the acquirer obtains CONTROL (legal control = >50% voting ownership) of a BUSINESS (capable of generating return).

Question 9

Give an example of a Legal Merger Model.

Answer 9

Company A absorbs Company B, and only Company A is left. B ceases to exist.

Question 10

Give an example of a Legal Consolidation Model.

Answer 10

Companies A and B combine into Company C. A new entity consolidates the net assets or the equity interest of two (or more) preexisting entities.

Question 11

Give an example of a Legal Acquisition Model.

Answer 11

Company A and B operate separately, A purchases B, they still operate separately, but A consolidates B.

Question 12

How are stock issue costs treated?

Answer 12

Costs associated with stock issue fees necessary to issue the stock to complete the purchase are DEFERRED until the combination occurs.

DR Deferred stock issue costs (prepaid asset), CR Cash.

When combination occurs: DR APIC, CR Def. Stock issue costs.

Question 13

What are the requirements for applying the acquisition method of accounting to a business combination?

Answer 13

Applies to all business combinations except: Joint ventures, acquisition of group of assets not a business, combination of entities under common control, combination between NFP, or acquisition of for-profit firm by NFP.

Question 14

What are some considerations in determining acquirer when equity interests are exchanged (ex: common stock for common stock(?

Answer 14

1) Relative voting rights after combination (largest)
2) Existence of large minority voting interest when no majority ownership (largest)
3) Composition of governing body after combination (who has ability to select/remove voting majority of governing body)
4) Composition of senior management after combination (whose former management dominates that of combined entity)
5) Relative values of equities exchanged

Question 15

How do you determine the acquisition date?

Answer 15

Usually, acquisition date is the date the acquirer obtains control of the acquired business. Depends on date control is transferred, can be before or after closing date.

Question 16

How do you determine the measurement period in the acquisition method?

Answer 16

The period after the acquisition date during which the acquirer may adjust accounts and amounts of business combination, usually 1 year (may not exceed 1 year).

During this period, acquirer may identify and measure the assets/liabilities, goodwill, consideration transferred to obtain business, pre-combination interest in acquiree, etc.

MP ends when acquirer obtains info it was seeking about facts that existed at the acq date and learns that no additional info about facts that existed at acq date is available.

Question 17

Who is control of a business obtained?

Answer 17

1) By transferring consideration to the acquired entity or its owners
2) Without transferring consideration 1) by contract, 2) through lapse of veto rights held by minority s/h, 3) Acquiree reacquires shares of its own stock so that remaining s/h has control.

Question 18

What is a Variable Interest Entity (VIE)?

Answer 18

A legal entity set up for a very specific purpose - collects cash from one source, pays out to another. Cannot finance its activities w/out additional subordinated financial support, s/h do not control entity

Question 19

List the characteristics of a Variable Interest Entity (VIE).

Answer 19

1) May be a partnership, joint venture, legal trust, or corporation
2) Set up for well-defined, limited purpose
3) Sponsor or sponsors provide most of its resources
4) Activities governed largely by contract/agreement/sponsors - NOT s/h
5) Risks/rewards largely attributable to sponsors
6) Value of sponsor interest increases/decreases with changes in net asset value of VIE.

Question 20

When do you consolidate a VIE?

Answer 20

If it is VIE, whomever is the primary beneficiary consolidates the VIE.

Primary Beneficiary must meet 2 conditions:

1) Power criterion (power to direct the activities of VIE that most significantly impacts VIE’s economic performance)
2) Losses/benefits (risk/rewards) criterion: has obligation to absorb losses from or right to receive benefits of VIE that potentially could be significant to VIE)

If not a VIE, whomever has more than 50% voting ownership.

Question 21

When are Combined financial statements used?

Answer 21

In three situations:

1) Common control - one individuals owns two or more entities
2) Common management - two or more entities under common management
3) Unconsolidated subsidiaries - combine results of two or more unconsolidated subsidiaries

Question 22

Explain the process of combining financial statements.

Answer 22

Basically same as consolidation, but no goodwill or bargain purchase price differential. Combined statements equal the aggregate results of combined entities after eliminating inter-company items