Business Combinations

Question 1

What is a business combination?

Answer 1

is a transaction or an event where an acquirer obtains control of a business

Question 2

What is control?

Answer 2

is currently defined as voting control and is essentially greater than 50% voting interest.

Question 3

What are the three legal forms of business combinations?

Answer 3

Merger, Acquisition and Consolidation

Question 4

What is a merger?

Answer 4

One preexisting entity acquires either a group of assets that constitute a business or controlling equity interest of another preexisting entity and “collapses” the acquired assets or entity into the acquiring entity

Note, that only one entity (A) survives. (B) (a group of assets or another entity) ceases to exist separate from (A).

A + B = A

Question 5

What is a consolidation?

Answer 5

A new entity consolidates the net assets or the equity interests of two (or more) preexisting entities

A + B = C

Question 6

Waht is an acquisition?

Answer 6

One preexisting entity acquires controlling equity interest of another preexisting entity, but both continue to exist and operate as separate legal entities

A + B = A + B

Question 7

What happens in a Merger or Consolidation?

Answer 7

The acquirer records (picks-up) the group of assets or the assets and liabilities of the acquiree(s) onto its book. (The acquired entity/entities will no longer exist.)

Does not prepare consolidated financial statements

Question 8

What happens in an acquistion?

Answer 8

The acquirer does not record (pick up) on its books the assets and liabilities of the acquiree.
The assets and liabilities of the acquiree stay on that entity’s (separate) books.
Since after an acquisition two entities exist, one controlled by the other, an acquisition usually does require preparation of Consolidated Financial Statements, those of the acquirer together with those of the acquiree(s).

Question 9

How do you determine income at the date of combination?

Answer 9

Only the acquirer’s (acquiring firm’s) operating results (income/loss) up to the date of combination enter into determination of consolidated net income as of the date of the combination.
The acquiree’s (acquired firm’s) operating results (income/loss) up to the date of combination are part of what the acquirer purchases when it acquires the acquiree (i.e., makes its “Investment” in the acquiree), and are not part of consolidated net income as of the date of combination.
a. The acquiree’s operating results up to the date of the combination will be closed (or treated as closed) to its retained earnings.
b. The acquiree’s retained earnings as of the date of the combination is part of the equity “paid for” by the acquirer when it makes its investment.
c. The acquiree’s retained earnings as of the date of the combination will be part of the acquiree’s equity eliminated against the acquirer’s investment account in the consolidating process. (The consolidating process is covered as the next major topic.)

Question 10

How do you determine income in a combination at the end of the year of combination?

Answer 10

The acquirer’s operating results (income/loss) for the entire year plus the acquiree’s operating results (income/loss) after the date of the combination enter into the determination of consolidated income for the year of combination.

Question 11

How do you determine income in a combination in future years?

Answer 11

In periods subsequent to the period in which the combination occurs, both the acquirer’s and the acquiree’s operating results (income/loss) for the entire reporting period enter into the determination of consolidated net income or loss.

Question 12

What method must be used to account for business combinations?

Answer 12

Acquisition Method

Question 13

The acquisition method of accounting is not used for the following:

Answer 13

The formation of a joint venture.
The acquisition of an asset or group of assets that does not constitute a business.
A combination between entities under common control.
A combination between not-for-profit organizations.
The acquisition of a for-profit entity by a not-for-profit organization.

Question 14

What steps are taken to record a business combination using the acquisition method?

Answer 14

1. Identifying the acquiring entity (the acquirer).
2. Determining the acquisition date and measurement period.
3. Determining the cost of the acquisition.
4. Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired business (the acquiree).
5. Recognizing and measuring goodwill or a gain from a bargain purchase, if any.

Question 15

Can a business be a group of assets/net assets or a separate legal entity?

Answer 15

Yes, both

Question 16

How do you determine the acquirer?

Answer 16

the entity that distributes assets or incurs liabilities is generally the acquiring entity.

ownership by one entity (investor), directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity (investee) establishes the investor as the acquiring entity

Question 17

What is the acquisition date?

Answer 17

The acquisition date is the date on which the acquirer obtains control of the acquiree (i.e., business).

1. It is normally the date on which the acquirer legally transfers consideration for, and acquires the assets and assumes the liabilities of, the acquiree.
2. It is also called the “closing date” for the combination.
3. The acquisition date can be before or after the closing date, if by agreement or otherwise the acquirer gains control of the acquiree at an earlier or later date.

Question 18

What is the measurement period for a business combination?

Answer 18

The measurement period is the period after the acquisition date during which the acquirer may adjust any provisional amounts.
The measurement period provides the acquirer reasonable time (usually one year) to obtain information needed to identify and measure, as of the acquisition date, the following:
a. Identifiable assets, liabilities and noncontrolling interest in the acquiree;
b. Consideration transferred to obtain the acquiree;
c. Any precombination interest held in the acquiree;
d. Any goodwill or bargain purchase gain.

Question 19

How do you determine the cost of an acquired business?

Answer 19

The consideration used to effect a business combination generally must be measured at fair value
If any assets or liabilities transferred by the acquirer have a carrying value before transfer that is different than fair value at acquisition, the assets or liabilities must be adjusted (remeasured) to fair value at the date of the combination and the related gains or losses recognized in current income by the acquirer.

An exception to the requirement that assets and liabilities to be transferred as consideration in a business combination be remeasured to fair value applies when the transferred assets or liabilities remain under the control of the acquirer.
1. In that case, the assets or liabilities are not adjusted to fair value, but are transferred at carrying value and no gain or loss is recognized.

Question 20

What is contingent consideration?

Answer 20

An obligation of the acquirer to transfer additional assets or equity interest to the former owner(s) of the acquired business as part of the consideration if future events occur or conditions are met, or
A right of the acquirer to a return of previously transferred consideration if specific conditions are met.

Question 21

How do you recognize contingent consideration?

Answer 21

Contingent consideration should be recognized on the acquisition date at fair value as part of the consideration transferred in exchange for the acquired business.

a. An obligation to pay contingent consideration should be recognized as either a liability or as equity (according to the provisions of ASC 480, “Distinguishing Liabilities from Equity”).
b. A right to the return of previously transferred consideration should be recognized as an asset.

Question 22

How do you treat share based payment awards that are part of a business combination?

Answer 22

If the acquirer is obligated to exchange awards:

a. The portion (all or part) of the replacement awards (measured in accord with the provisions of ASC 718) that relates to precombination services based on conditions of the acquiree’s awards will be part of the consideration transferred in the business combination.
b. The portion (all or part) of the replacement awards (measured in accord with the provisions of ASC 718) that relates to post-combination services (the amount not allocated to precombination services) will be treated as compensation expense in post-combination financial statements.

If the acquirer elects to replace acquiree share-based awards, even though it is not obligated to do so, all of the value of the awards (measured in accord with the provisions of ASC 718) will be treated as compensation expense in post-combination financial statements.

Question 23

Can an entity acquire another entity without exchaning consideration?

Answer 23

Yes:
An entity (acquiree) reacquires a sufficient number of its own outstanding shares from selected investors so that another investor (acquirer) obtains control with its existing ownership.
Minority veto rights lapse that previously kept a majority owner (acquirer) from controlling the investee (acquiree).
Two entities agree to combine by contract alone; neither entity owns controlling equity interest in the other entity.

Question 24

What items are included in an acquisition cost?

Answer 24

1. Finder’s fees;
2. Advising, legal, accounting, valuation (appraisal) and other professional and consulting fees;
3. General administrative costs, including the cost of an internal acquisitions department;
4. Cost of registering and issuing debt and equity securities in connection with an acquisition.

Question 25

How do you treat acquistition costs?

Answer 25

expensed in the period in which the costs are incurred and the services are received; these costs are not included as part of the cost of an acquired business.

Question 26

What items do you include in the cost of an acquired business?

Answer 26

Fair value of assets transferred by the acquirer;
Fair value of liabilities incurred by the acquirer;
Fair value of equity interest issued by the acquirer;
Fair value of contingent consideration (net) obligations of the acquirer;
Fair value of share-based payment awards for precombination services that the acquirer is obligated to provide.

Question 27

What must be recorded on the acqusistion date?

Answer 27

The identifiable assets acquired, liabilities assumed and any noncontrolling interest.

Must also classigy the identitfiable assets adn liabilities

Question 28

Does an entity recognize the goodwill of its aquired entity?

Answer 28

no

Question 29

How does an acquiring entity treat contingencies?

Answer 29

Contingencies related to existing contracts (“contractual contingencies” - e.g., warranty obligation) should be recognized and measured at fair value.
Contingencies not related to existing contracts (“noncontractual contingencies” - e.g., a lawsuit) should be recognized and measured at fair value only if it is more likely than not as of the acquisition date that the contingency will give rise to an asset or a liability.

Question 30

How does an acquiring entity treat income tax issues ?

Answer 30

The acquirer will recognize and measure a deferred tax asset or liability related to assets acquired and liabilities assumed in a business combination as provided by the provisions of ASC 740.

Question 31

How does an acquiring entity treat employee benefits ?

Answer 31

The acquirer will recognize and measure a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accord with applicable GAAP.

Question 32

How does an acquiring entity treat indemnification provisions ?

Answer 32

The acquirer normally should recognize the indemnification benefit as an asset (indemnification asset) at the time and using the same measurement basis as the indemnified asset or liability.

Question 33

How does an acquiring entity treat reacquisition rights?

Answer 33

Prior to a business combination, the acquirer may have granted the acquiree the right to use an asset of the acquirer; for example, the right to use the acquirer’s trade name as part of a franchise agreement.
If, as part of the business combination, the acquirer reacquires that right, it should be recognized by the acquirer as an intangible asset and measured on the basis of the remaining contractual term of the contract that granted the right.
Subsequent to the business combination, the intangible asset “reacquired right” should be amortized over the remaining period of the contract that granted the right.

Question 34

How does an acquiring entity treat share based payment awards ?

Answer 34

An acquirer may grant its share-based payment awards (e.g., employee stock options) for awards held by the acquiree’s employees.
The liability or equity recognized as a result of such awards should be measured in accord with the provisions of ASC 718.

Question 35

How does an acquiring entity treat assets held for sale?

Answer 35

Long-term assets acquired by the acquirer which it classifies as held for sale at the acquisition date should be measured in accord with the provisions of ASC 360.
Basically, ASC 360 requires that assets held for sale be measured at fair value less cost to dispose.

Question 36

What do you do if the acquirer previously accounted for the entity with equity method?

Answer 36

At the acquisition date, the acquirer must measure (determine) the fair value of its previously held equity interest in the acquiree, if any.
1. An acquirer would have an equity interest in the acquiree prior to the acquisition date if the business combination was achieved in stages (also called a step acquisition).

Any difference between the fair value of the acquirer’s precombination equity interest in the acquiree and the carrying value of that interest on the acquirer’s books would be recognized by the acquirer as a gain or loss in income of the period of the combination.

Question 37

What is “Investment Value” under the acquisition method?

Answer 37

The sum of the following items:
A. The consideration transferred (cost) to effect the business combination (as detailed in the earlier lesson “Determining the Cost of an Acquired Business”), including the fair value of the following:
1. Assets transferred;
2. Liabilities incurred;
3. Equity interest issued;
4. Contingent consideration (at acquisition date);
5. Required share-based payment awards to employees for precombination services;
6. Precombination equity of the acquiree held by the acquirer (if the combination was achieved in stages or steps).

B. The fair value of the noncontrolling interest in the acquiree, if any (as detailed in the prior lesson “Recognizing and Measuring Assets Acquired, Liabilities Assumed and Noncontrolling Interest in an Acquiree”).

Question 38

When does goodwill result under the acquisition method?

Answer 38

Goodwill results when the investment value is greater than the net fair value of assets assumed and liabilities incurred at the date of the business combination

Question 39

When does a bargain purchase result under the acquisition method?

Answer 39

A bargain purchase results when the investment value is less than the net fair value of assets assumed and liabilities incurred as of the date of the business combination .

Question 40

Does either a bargain purchase or goodwill yield a gain under the acquisition method?

Answer 40

If, after reassessment, the acquirer still concludes that a bargain purchase exists, the amount of that bargain purchase shall be recognized as a gain in earnings as of the date of the business combination

Question 41

What entry do you make to record a legal merger or legal consolidation?

Answer 41

DR: Assets acquired (at FMV)
CR: Liabilities assumed (at FMV)
Consideration Paid (at FMV)

Question 42

What entry do you make to record a legal acquisition?

Answer 42

DR: Investment in Subsidiary X (at FMV of Consideration Paid)
CR: Consideration Paid (at FMV)

Question 43

What is a Variable Interest Entity (VIE) ?

Answer 43

A VIE is a legal entity which by design either:

1. Cannot finance its activities without additional subordinated financial support (i.e., its expected losses exceed its total equity investment at risk), or
2. Its equity holders, as a group, do not have the direct or indirect ability to make decisions about the VIE’s activities.

Question 44

What indicates which entity is the primary beneficiary of a VIE?

Answer 44

It has the power to direct activities of the VIE that most significantly impact the VIEs economic performance (called the power criterion), and
It has the obligation to absorb losses from or right to receive benefits of the VIE that potentially could be significant to the VIE (called the losses/benefits or risks/rewards criterion).

Question 45

How do you account for a VIE if you lack effective control?

Answer 45

An unconsolidated subsidiary would be reported as an “Investment” asset by the parent.
The parent would account for its investment in an unconsolidated subsidiary using either fair value or the equity method, depending on the extent of influence that it can exercise over the investee.