FAR - Specific Transactions, Events, & Disclosures - Business Combinations Flashcards
Business Combination - exam question types
1) recording acquisition
2) determining value assigned to components of acquisition
3) treatment of transaction costs
4) understand legal forms of combinations
Business Combination
transaction/event where an acquirer obtains control of a business
transaction = consideration transferred
event = 1 party gains control over another party w/o transaction/purchase
control = legal control (>50% voting ownership)
Business = integrated set of activities/assets capable of providing a return
Legal forms of business combos
1) merger- one entity acquires assets/controlling interest of another entity and collapses assets/entity into acquiring entity
2) consolidation - new entity consolidates net assets/equity interests of 2/more preexisting entities
3) acquisition - preexisting entity acquires controlling interest of another preexisting entity, but both continue to exist/operate as separate entities
Treatment of transaction costs
all costs associated with acquisition are expensed as incurred: legal, audit, and finder fees
Treatment of Stock Issue Costs
Costs associated with stock issue costs necessary to issue stock to complete the purchase are deferred until the combination occurs
DR: Deferred Stock Issue Costs
CR: Cash
When combo occurs:
DR: APIC
CR: Deferred Stock Issue Costs
Business Combo/Income Determination
1) At acquisition date: Consolidated net income = parent’s net income (immediately after combo)
2) full year of combo: Consolidated net income = parent’s net income + sub’s net income after combo
3) For years after combo:
Consolidated net income = parent’s net income + sub’s net income
primary mean of accomplishing a business combination
acquisition by one entity of the common stock of another entity to gain control of the investee
Describe how income is determined at the date of a combination
acquirer’s operating results up to the date of combination enter into determination of “consolidated” net income
describe a “legal acquisition”
entity acquires controlling interest of another entity, but both continue to exist and operate as separate legal entities
legal forms of business combination that will not require preparation of consolidated financial statements
legal merger or a legal consolidation will not require preparation of consolidated financial statements. Only a legal acquisition will require preparation of consolidated financial statements
true/false
In a merger and a consolidation, at least one preexisting entity ceases to exist, but in an acquisition, no entity ceases to exist
true
true/false
Legal form determines the entry accounts; accounting method determines entry amounts to record a combo
true
true/false
acquisition/purchase method of accounting is the only currently acceptable method of accounting for a business combination
true
true/false
In a merger and in a consolidation, the assets and liabilities of the acquired entity/entities are recorded on the books of the acquiring entity, but in an acquisition, the assets and liabilities of the acquired entity remain on the books of the acquired entity
true
Acquisition Method - Requirements
Requirements apply to all combinations EXCEPT:
1) joint venture formation
2) acquisition of group of assets that don’t constitute a business
3) Combo of entities under common contract
4) Combo between NFP orgs
5) NFP acquisition of for-profit firm
Steps in applying acquisition method of acct?
1) identify acquirer
2) determine acquisition date/measurement period
3) determine cost of acquired business
4) recognize/measure what you receive (assets/liab) and any NCI
5) recognize/measure goodwill or gain from bargain purchase
Criteria for identifying acquirer
1) entity distributing cash/other assets or incurring liab
2) entity owns more than 50% of voting stock of another entity
3) issues new securities/equity interest
4) former mgmt dominates combined entity
Considerations in determining acquirer when equity interests are exchanged
1) relative voting rights after combo
2) existence of large minority voting interest when no majority ownership
3) composition of governing body after combination
4) relative values of equities exchanged
Determining acquisition date
date acquirer obtains control of acquired business
- date acquirer transfers consideration to acquiree/former owners and acquires legal rights to assets and assumes liab of acquiree
- “closing date”
- can be before/after closing date if acquirer gains control at earlier/later date
Determining measurement period
measurement period - after acquisition date which acquirer may adjust accts/amounts of business combo (year 1)
Acquirer identify/measure:
1) identifiable assets/liab of acquiree and NCI & FV
2) consideration transferred
3) pre-combo interest in acquiree
4) goodwill/bargain purchase amount
(doesnt exceed 1 yr)
Length of measurement period
Period ends when acquirer :
1) obtains info it was seeking about facts existed @ acquisition date
2) learns that no additional info about facts that existed @ acquisition date is available
* period may not exceed 1 year
How to account for business combo?
acquisition method (not purchase/pooling of interest method)
What constitutes a business?
1) group of assets
2) group of net assets
3) separate legal entity
Acquisition date of a company may be on…
Before, On, After the closing date
*date on which the acquiring entity obtains control of the acquired business; usually, it is also the closing date
Ways to obtain control of business
1) transfer consideration to acquired entity/its owners
2) w/o transferring consideration
a) contract
b) lapse of veto rights held by minority S/H
3) acquiree reacquires shares of own stock so remaining S/H has controlling interest
Forms of consideration
1) Cash/assets transferred
2) liabilities/bonds incurred
3) Equity interest issued
4) Contingent consideration obligations of the acquirer
5) Required share-based employee awards for pre-combo services.
- Adj. assets/liab to FMV before transfer
- Recognize gains/losses in current income
Exception to use of FV for transferred assets/liab to acquiree
if asset/liab transferred remains under control of acquirer then transfer at carrying value
Contingent Consideration Transferred
obligation/right depends on future outcome
Ex:
1) obligation of acquirer to transfer additional assets/equity if outcome fails -> recognize as liab/equity
2) right of acquirer to return consideration if outcome fails -> recognize as asset
* measure @ FV @ acquisition date
Post-combination change in FV of contingent consideration
During measurement period:
if new info about FMV @ acquisition date -> change value of acquisition consideration paid
New info includes:
1) meeting earnings target
2) reaching specific share price
3) reaching R/D objectives
share-based payment awards TRANSFERRED
treatment depends on:
1) whether transfer is required/discretionary
2) transfer may be required by:
a) combo agreement terms
b) terms of acquiree’s awards
c) law/regulation
3) whether transferred awards relate to services before/after combo
Share-based payment awards TREATMENT
1) transfer required AND relate to PRE-combo services
- part of cost of acquired business
- measure as required by GAAP
2) Transfer required, BUT related to POST-combo services
- expense in post-combo financials
- measure as required by GAAP
3) Transfer NOT required
- expense in post-combo financials
- measure as required by GAAP
*exchange is voluntary, the value of the replacement awards is expensed
Obtain control W/O transferring consideration
when combo occurs by contract:
1) 1 of combining businesses must be acquirer
2) determine acquirer using criteria
Equity of acquiree held by other = NCI
- treat as NCI in financials
Treatment of Cost Acquisition
acquisition costs = costs to execute a business combo
- finder’s fees
- advertising, legal, acct fees
- administrative fees
- cost of registering/issuing securities
*expensed when incurred (except cost of registering/issuing securities)
Treatment of cost of registering/issuing securities
Debt issuance cost - legal feels, printing costs, etc
- recognize asset & amortize over life of debt OR expense when incurred
Equity issuance cost - legal fees, printing cost, registration fees, etc
- reduces proceeds from issuance
- reduces APIC
true/false
cost of carrying out a business combination should be included in the cost of an acquired business
false
expenses incurred are not part of the cost of an acquired business
(ex: acquisition costs/fees)
true/false
Changes in the fair value of contingent consideration resulting from occurrences that occur after the acquisition date are recognized as gains or losses when the contingent consideration is classified as an asset or a liability
true
true/false
When the transferred asset remains under the control of the acquiring entity, the asset is transferred at carrying value, not fair value
true
true/false
An obligation to pay contingent consideration in a business combination may be recognized by the acquirer as either a liability or as an equity item
true
Items recognized in business combo
Acquirer must recognize:
1) identifiable assets acquired
2) identifiable liab assumed
3) NCI in acquiree, if any
to be recognized, items must be:
1) meet definition of assets/liab
2) exist @ date of business combo
3) a part of business combo exchange, not separate transaction
Recognizing intangible assets acquired
acquirer recognized intangibles not recognized by acquiree
Intangibles recognized if identifiable and either
1) separable - being sold, leased, disposed OR
2) arise from contractual/legal right
3) goodwill previously recognized by acquiree isn’t recognized by acquirer
Measuring Assets/Liab
most assets/liab acquired should be measued @ FV
ALWAYS VALUED AT FV
Contingencies assumed
existing condition with uncertain outcome resolved in future
1) contractual contingency: recognize as asset/liab & measure @ FV (warranty obligation)
2) non-contractual contingency:
- if “more likely than not” to result in asset/liab = recognize @ FV (example lawsuit) otherwise, don’t recognize
Control obtained in steps/stages
Control result from multiple transactions over time
- Pre-combo ownership of investee
- investor accts for investment as trading, avail-for-sale, equity method
@ Combination
- adj. precombo investment to FMV & recognize gain/loss
- any amount in AOCI reclassified to current income
- FMV is part of cost of Acquirer’s investment
Noncontrolling Interest
shares of acquiree voting stock not owned directly/indirectly by acquirer
acquirer must determine FV of NCI @ combo date
to determine FMV:
1) stock traded in active market - use market price
2) stock not traded in active market - use valuation method
FMV doesn’t always equal proportional share of in Acquirer net assets based on acquirer’s FV
Identify items acquired in business combination for which acquirer has to make a decision as to classification/designation of item
1) Investments, as to whether held-to-maturity, held-for-trading, or available for sale;
2) Derivative instruments, as to whether used for hedging or speculation;
3) Embedded derivatives, as to whether they will be separated from the host instrument or not;
4) Long-term assets, as to whether they will be used or held for sale
Describe requirements of acquisition when a business combo is carried out in stages (or steps)
1) Equity interest in acquiree, acquired by acquirer prior to business combo = remeasured to FMV at date of combo (acquisition date).
2) difference between pre-combo carrying value and acquisition date FMV = gain/loss in income of the period of combo
3) FMV of pre-combo investment is included as part of cost of investment value to the acquirer
Identify five items acquired in a business combo that would be measured at something other than FMV
1) Income tax items
2) Acquiree’s employee benefit liability/asset, use various related GAAP;
3) Indemnification assets, use the same measurement basis as indemnified item;
4) Reacquisition rights, use unamortized balance;
5) Share-based employee awards
6) Long-term assets held for sale
true/false
value assigned to a NCI in an acquiree would not be based simply on the proportional share of that interest in the net assets of the acquiree, but rather on the separately determined FMV of the NCI
true
true/false
Contractual contingencies (contingencies related to existing contracts) are recognized by the acquirer and measured at fair value. Noncontractual contingencies (contingencies that do not result from an existing contract), including lawsuits, are recognized only if it is more likely than not that the contingency will give rise to a liability (or an asset). A probability of 20% that the suit will be lost is not more likely than not, and the lawsuit would not be recognized.
true
FMV of Entity as a whole
How much you GAVE for the acquiree:
- assets transferred
- liab incurred
- equity issued
- contingent consideration
- required share-based payments
- Previously held interest
- FMV of NCI @ combo
FMV of identifiable Net Assets
How much you RECEIVED from acquiree:
- FMV of identifiable assets
- FMV of all liab assumed
Measuring Goodwill/Bargain Purchase
Compare what you GAVE to what you RECEIVED
- you gave $1,000 of consideration and received $900 of value, difference = GW
- you gave $850 consideration, received $900 of value, difference = bargain purchase
- acquiree must have been under bankruptcy to accept lower price than net FMV -> bargain purchase
When does bargain purchase arise?
FMV of total investment (consideration + acquiree NCI) in an acquiree
values are compared to determine if there is Goodwill or a bargain purchase in a business combination?
FMV of total investment in the acquiree (consideration transferred + NCI in acquiree) & FMV of net assets (assets - liabilities) of acquiree
When does GW arise?
FMV of total investment (consideration + acquiree NCI) in an acquiree > FMV of acquiree’s net assets
Contingent Liab Assumed
initially recorded as asset/liab @ FV
As FV changes:
1) if liab, adjust to higher of
a) acquisition date FV or
b) amount recognized under ASC 450
2) if asset, adjust to lower of:
a) acquisition date FV or
b) best estimate of future settlement amount
*Derecognize only when settled/expires
Indemnification Right
Provision limits acquirer’s liab for uncertainty related to identified asset/liab
- initially measured on same basis as asset/liab that is indemnified
- continue to measure on same basis as asset/liab that is indemnified
- derecognize only when settled/expires
Contingent Consideration
measured @ FV
subsequent to combo:
1) if equity: don’t remeasure; adjust equity elements when contingency settled
2) if asset/liab:
a) adjust to FV @ each reporting date
b) recognize gain/loss in current income
assets or liabilities recognized in a business combination require “specialized” post-combination accounting treatments?
1) Reacquired rights asset
2) Assets/liab arising from contingencies;
3) Indemnification assets;
4) Contingent consideration as asset/liab (or equity).
true/false
acquiree cannot apply pushdown accounting to revalue its common stock to fair value as of the acquisition date.
true
true/false
reacquired right is an intangible asset that is amortized by the acquirer over the remaining contractual period of the contract that grants the right.
true
Non-quantitative disclosures
- name/description of acquiree
- acquisition date
- % voting equity acquired
- primary reason for combo
- description how acquirer obtained control
- qualitative description of factors that derive GW
Acquisition Date Value Disclosures
- FMV of each major class of consideration/total amount
- amount recognized for each class of asset acquired/liab assumed
- FMV of NCI & techniques/inputs used to determine FMV
Pre-combo Ownership - Acquisition Date Value Disclosures
- FMV of pre-combo ownership
- Gain/loss recognized in adj. to FMV
- where gains/loss show in financials
GW & Bargain Purchase Disclosures
GW
- amount allocated to each segment
- amount expected - tax deductible
Bargain Purchase
- amount of gain
- where gain shows in financials
- description of basis for gain
Publicly traded entity disclosures
- amount of post-combo revenues & earnings of acquiree included in consolidated income
- revenue & earnings for period as thru combo @ BOY
Publicly traded entity disclosures - comparative statements
- revenue/earnings of those periods as though combo occurred @ BOY
- if impracticable, show why
true/false
disclosures that enable users to evaluate the nature and financial effects of a business combination must be made both when the combination occurs during the reporting period and when the combination occurs after the reporting period but before the financial statements are released.
true
legal merger/consolidation
- 2/more entities combine into 1 entity
- accts of entities are combined
- GW or bargain purchase recognized @ merger/consolidation
Legal acquisition
- 1 entity gains control of another
- acquirer records investment in sub (asset)
- entities continue as separate legal entities
- separate financials are consolidated
method is used by a parent company to carry “investment in subsidiary” on its books?
cost, equity, other
Where is a Subsidiary reported?
consolidated statements, unless the parent lacks effective control
Variable Interest Entity Defined
legal entity, either:
- cannot finance its activities w/o add’tl subordinated financial support
- expected losses exceed its total equity investment at risk
- its equity holders, as a group, don’t have direct/indirect ability to make decisions about VIE’s activities
- S/Hs dont control entity
VIE Characteristics
- pship, JV, legal trust, corp
- limited purpose
- sponsor/sponsors provide resources
- activities governed by contract/agreement
- risks/rewards attribute to sponsors
- value of sponsor interest increases/decreases with changes in net asset value of VIE
Consoliation of entities w/no equity ownership
2 stage assessment process
- is entity VIE?
- if yes, consolidate VIE
- if not, dont consolidate VIE
If no, does investor have > 50% voting ownership?
- yes = consolidate
- no = dont consolidate, report as investment
Consolidation of VIEs
primary beneficiary of VIE will consolidate VIE
must meet 2 conditions:
1) power criterion- direct activities of VIE that impact VIEs economic performance
2) losses/benefits (risk/reward) criterion- obligation to absorb losses from or right to receive benefits of VIE that potentially could be significant to VIE
true/false
Only an acquisition form of business combination will require the preparation of consolidated financial statements. In the merger and consolidation forms of business combination, only one firm will remain after the combination. Therefore, there will not be two (or more) sets of financial statements to consolidate.
true
GAAP vs IFRS - Business Combos
GAAP
1) contingent assets/liab recognized
2) GW allocated to reporting units
3) GW impairment testing - 2 steps
4) must disclose pro-forma info for current/prior periods
5) not required to disclose assumptions for acquired contingencies
GAAP vs IFRS - Business Combos
IFRS
1) contingent assets/liab NOT recognized
2) GW allocated to cash generating units
3) GW impairment testing - 1 step
4) must disclose pro-forma info ONLY for current period
5) required to disclose assumptions for acquired contingencies
