Ch02: Mergers and Acquisitions

Question 1

Statutory Merger

Answer 1

A buyer absorbs a seller’s firm’s assets and liabilities in exchange for stock, cash or debt. Usually, the buying firm remains as the legal entity.

Question 2

Statutory Consolidation

Answer 2

A new entity is formed by absorbing two or more entities. The buying firm’s assets and liabilities remain at BV and the seller’s assets and liabilities are revalued to market value.
The shares of the absorbed firms are retired.

Question 3

Asset Acquisition

Answer 3

A buyer acquires some of a seller’s assets or liabilities or both.
The seller may continue to exist.

Question 4

Stock Acquisition

Answer 4

When a buyer acquires all or most of the seller’s voting shares.
The merged entities will exist as separate legal entities with the acquired firm treated as an inter-corporate investment on the buyer’s books.

Question 5

Types of combinations

Answer 5

Statutory Merger
Statutory Consolidation
Asset-acquisition
Stock-acquisition

Question 6

Valuation of Intangibles, ASC 820

Fair-value Hierarchy

Answer 6

Level 01: fair-value at the quoted market price for an identical asset

Level 02: fair-value at the quoted market price for a comparable asset

Level 03: fair-value with unobserved estimation attributes

Question 7

Valuation of Intangibles, ASC 820

Cost valuation

Answer 7

Cost = direct cost + indirect cost + developer's profit + opportunity cost
Value = Cost - Estimated Obsolescence

Applicable to intangible assets that indirectly generate income and that don’t have observable market values

Question 8

Valuation of Intangibles, ASC 820
Market valuation (Lvl. 1 and 2)

Answer 8

Value = market price - selling cost

Derived from comparable asset sales to third-parties in an active market

Question 9

Valuation of Intangibles, ASC 820
Income valuation (Lvl. 3)

Answer 9

Value = PV of (Expected future benefits derived via the asset)

1. project revenue (benefits)
2. project revenue growth rate
3. estimate COGS, depreciation, amortization and OpEx
4. estimate effective tax-rate
5. estimate the useful life of the asset to determine the projection period (N) and to estimate for depreciation expenses
6. determine a discount rate
7. determine Net Cash Flow: 1. (Revenue - COGS - OpEx) = EBIT; 2. (EBIT - Taxes) = NI; 3. (NI + Depreciation + Amortization) - (CapEx + contributory-asset-capital charge) = Net Cash Flow

Question 10

Unreported Intangibles (identifiable) 
Capitalization Criteria

Answer 10

1. intangible arises from a contractual or legal obligation

2. intangible is separable; it can be removed, sold, rented, etc from the acquired company

Question 11

Unreported Intangibles (non-identifiable)

Answer 11

workforce
Potential contracts
locations
reputation

Question 12

Net Identifiable Assets, (NIdA)

Answer 12

NIdA = (Fair-value Assets + Unreported Identifiable Intangible Assets - Liabilities)

Question 13

Acquisition Cost

Answer 13

(Cash-paid) + (Fair-value Stock Issue) + (PV-Earnout)

measured at fair-value on the acquisition date
includes: 
cash paid to target
liability incurred by the buyer
stock issued by the buyer

Question 14

Goodwill

Answer 14

Goodwill = (Acquisition Cost) - (NIdA)

It exists if the cash-paid is greater than the NIdA; cash over the fair-value of NIdA is paid for the value associated with intangible assets that don’t meet the criteria for capitalizing intangibles.

1. Acquisition Cost: determine cash-paid, fair-value of stock issue, PV of Earnout
2. determine (debit) fair-value for the assets being acquired
3. determine unreported identifiable intangible assets
4. add (debit) unreported identifiable intangible assets to fair-value assets, then subtract liabilities to get NIdA
5. (Acquisition Cost) - NIdA = Goodwill

Question 15

Contingent Consideration

Answer 15

1. Liability if the buyer may be obligated to pay or transfer cash, or assets to the seller in the future; or if classified as equity
2. Compensation if former employees of seller become employees of the buyer in the future or if payments to the seller are terminated when the former owner is no longer employed
3. Reported on acquisition date at PV of the expected payout of contingency

Question 16

Earnings Contingency

Earnout

Answer 16

Reported on the date of acquisition at the PV (fair-value) of the expected payout

The buying company makes payments in addition to the acquisition cost post-transaction if certain performance goals (revenue, CFO, EBITDA) are met.

1. the buyer agrees to pay the seller an amount for every amount above a (revenue, CFO, EBITDA) threshold
2. the buyer determines the probability of certain performance amounts (revenue, CFO, EBITDA) occurring (expected amount)
3. Expected payout = (expected amount - threshold) x [Pr(occur)]
4. Earnings Contingency = PV(Expected payout)
5. Credit Earnings Contingency (if liability)
6. Add (Debit) Earnings Contingency to Goodwill

Question 17

Acquisition-Related Costs

Answer 17

Out-of-pocket costs (Expenses): consulting or advisory fees - (lawyers, bankers, accountants); DOES’NT increase the value of the seller

Security-registration costs: subtract these costs from Additional-Paid-in-Capital

Question 18

Acquisition-Related Restructuring Costs

Answer 18

Expensed as incurred (as it occurs); does not impact acquisition cost
Ex: shut down departments, fire people, supplier change

Question 19

Accounting for changes in asset, liability, and contingency values
(as of the date of acquisition)

Answer 19

Change the initial acquisition entry

Question 20

Accounting for changes in asset, liability, and contingency values
(due to events occurring after the date of acquisition)

Answer 20

Change is reflected in income

Change in assets:
Debit a gain, credit a loss
Change in liabilities and equity:
Debit a loss, credit a gain

Question 21

Reporting changes to assets and liabilities

Answer 21

As of the acquisition date:
Changes are debited or credited and the change is reflected in Goodwill

After the acquisition date:
Change is reflected in income

Question 22

Bargain Purchase

Answer 22

This happens if the acquisition cost is less than the fair value of acquired NIdA; this is the reverse of Goodwill.

NIdA - Acquisition Cost = Gain on Bargain Purchase

Gain on Bargain Purchase is credited (it should boost income; it will boost the equity account)

Question 23

Acquisition Method

Answer 23

Used to report all types of combinations (Statutory Merger, Statutory Consolidation, Asset-acquisition, Stock-acquisition) on the acquisition date, when consideration is paid; assets and liabilities valued at fair value.

Acquisition cost impact on the buyer’s balance sheet:
Assets: (+ seller assets + Goodwill) - (cash paid)
Liabilities: (+ seller liabilities and equity) - (expenses)