Chapter 2 - Business Combinations Flashcards
Acquisition Method
- Used to report all business combinations under US GAAP
- Requires careful identification and valuation of the assets acquired and liabilities assumed
Assets and liabilities of the acquired company are measured at:
fair value on the acquisition date
Acquisition date
The date the acquiring company takes control of the acquired company.
Usually the date consideration is paid
Why is it necessary to identify the acquiring company?
Acquired company’s assets and liabilities are revalued to fair value at the date of acquisition
Acquiring company’s assets and liabilities remain at book value
When acquisition cost > FV of net assets acquired
record goodwill
When acquisition cost
record gain on bargain purchase
Two criteria for separate recognition as an identifiable intangible by acquiring entity
Intangible arises from contractual or other legal rights, or
Intangible is separable: can be separated or divided from the acquired entity and sold, rented, licensed, or otherwise transferred
5 categories of identifiable intangible assets
- Contract-based
- Marketing related
- Customer-related
- Technology-based
- Artistic-based
Customer-related IIAs
Customer lists
Order backlogs
Customer contracts
Technology-based IIAs
Patent rights
Computer software
Databases
Trade secrets
Artistic-based IIAs
TV programs Motion pictures and videos Recordings Books and photographs Advertising jingles
Contract-based IIAs
Lease, franchise and licensing agreements Construction permits Employment contracts Broadcast rights Mineral rights
Marketing-related IIAs
Brand names Trademarks Internet domain names Newspaper mastheads Non-competition agreements
When no equity interests are exchanged
acquiring company distributes cash or other assets and/or incurs liabilities
when the business combination involves an equity exchange
Possible characteristics of acquiring company:
Entity that issues the equity interests
Entity that is larger
Owners have larger voting interest
Prior owners constitute a large minority (
Valuation of identifiable intangibles
Measurement guidelines of ASC Topic 820
Fair value hierarchy
Level 1: Quoted prices in an active market
Level 2: Quoted prices for similar assets, adjusted for attributes of acquired assets
Level 3: Valuation based on unobservable estimated attributes:
Discounted present value
Earnings and book value multiples
Intangibles Not Meeting Criteria as Identifiable Intangibles
Consideration paid reflects these intangibles Consideration paid > fair value of identifiable net assets Examples: Assembled workforce Potential contracts Long-standing customer relationships Favorable locations Business reputation
Goodwill
exists if the consideration paid exceeds the total fair value of the net identifiable assets acquired.
Excess consideration paid occurs due to value attributed to intangible assets not meeting criteria for capitalization as identifiable intangible assets
Amount is capitalized as goodwill, an intangible asset
Measurement of Acquisition Cost
Must be measured at fair value at the acquisition date
Acquisition cost includes
- Cash or other assets transferred to the former owners by the acquirer
- Liabilities incurred by the acquirer and owed to the former owners of the acquiree
- Stock issued by the acquirer to the former owners of the acquiree
Contingent consideration exists when
the acquirer agrees to make additional payments to the former owners of the acquiree if certain events occur or conditions are met
Contingent consideration
- Adds to acquisition cost
- Must be reported at date of acquisition
Requires good faith estimates of Probability, and
Timing - Based on present value of the expected payment
What is a Business Combination?
Occurs when one company obtains control over another company Terms used: Merger Acquisition Takeover
Business Strategies Achieved Through Acquisitions
Control a source of supply
Acquire new technology, production or distribution facilities
Expand into new geographic markets, acquire new customers
Diversify into new lines of business
Advantages of Acquisitions
Acquiring a going concern is less costly
Eliminates the need to start from scratch
Avoids duplication of efforts
Competition is often reduced
Complimentary products or services can lead to increased overall sales
Types of Business Combinations
Statutory merger
Statutory consolidation
Asset acquisition
Stock acquisition
Statutory Merger
A + B = A; where A is buyer or acquirer and B is acquired
Acquired company ceases to exist as a separate company
Subsequent transactions of acquired firm are reported on books of acquirer
Assets and liabilities acquired are recorded directly on acquiring company’s books
At fair value at the date of acquisition
Statutory Consolidation
A + B = C
New corporation (C) absorbs both companies
One of the existing companies is the acquirer (A), the other is the acquiree (B)
Acquiree’s assets and liabilities reported at fair value at date of acquisition
Acquirer’s assets and liabilities remain at book value
Same result as statutory merger
Stock Acquisition
Occurs when a company acquires the voting stock of another company
Each firm continues as a separate legal entity
Acquirer treats investment in the acquired firm as an intercorporate investment
Consolidated working paper used to combine the two companies’ results, with same result as statutory merger or consolidation.
Earning contingency
- AKA Earnout
- The former shareholders believe they are entitled to more consideration given their company will bolster postcombination earnings
- Acquirer makes an additional payment, in cash or stock, if certain performance goals are -met
- Performance goals often based on: Revenue, Cash from operations, EBITDA
Security Price Contingency
- Guarantee to the former shareholders of the acquired company
- Guarantees that the market value of securities issued to them in exchange for their stock does not fall below a specified amount
- Acquiring company issues additional shares or cash to the former shareholders to bring the total consideration value to the minimum level
Both earnings contingencies and security price contingencies increase acquisition price, however earnings contingencies are _________ while security price contingencies are ________
Earnings contingencies are liabilities
Security price contingencies are additional paid-in capital
