FAR - Specific Transactions, Events, & Disclosures - Business Combinations

Question 1

Business Combination - exam question types

Answer 1

1) recording acquisition
2) determining value assigned to components of acquisition
3) treatment of transaction costs
4) understand legal forms of combinations

Question 2

Business Combination

Answer 2

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

Question 3

Legal forms of business combos

Answer 3

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

Question 4

Treatment of transaction costs

Answer 4

all costs associated with acquisition are expensed as incurred: legal, audit, and finder fees

Question 5

Treatment of Stock Issue Costs

Answer 5

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

Question 6

Business Combo/Income Determination

Answer 6

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

Question 7

primary mean of accomplishing a business combination

Answer 7

acquisition by one entity of the common stock of another entity to gain control of the investee

Question 8

Describe how income is determined at the date of a combination

Answer 8

acquirer’s operating results up to the date of combination enter into determination of “consolidated” net income

Question 9

describe a “legal acquisition”

Answer 9

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

Question 10

legal forms of business combination that will not require preparation of consolidated financial statements

Answer 10

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

Question 11

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

Answer 11

true

Question 12

true/false

Legal form determines the entry accounts; accounting method determines entry amounts to record a combo

Answer 12

true

Question 13

true/false

acquisition/purchase method of accounting is the only currently acceptable method of accounting for a business combination

Answer 13

true

Question 14

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

Answer 14

true

Question 15

Acquisition Method - Requirements

Answer 15

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

Question 16

Steps in applying acquisition method of acct?

Answer 16

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

Question 17

Criteria for identifying acquirer

Answer 17

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

Question 18

Considerations in determining acquirer when equity interests are exchanged

Answer 18

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

Question 19

Determining acquisition date

Answer 19

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

Question 20

Determining measurement period

Answer 20

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)

Question 21

Length of measurement period

Answer 21

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

Question 22

How to account for business combo?

Answer 22

acquisition method (not purchase/pooling of interest method)

Question 23

What constitutes a business?

Answer 23

1) group of assets
2) group of net assets
3) separate legal entity

Question 24

Acquisition date of a company may be on…

Answer 24

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

Question 25

Ways to obtain control of business

Answer 25

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

Question 26

Forms of consideration

Answer 26

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

Question 27

Exception to use of FV for transferred assets/liab to acquiree

Answer 27

if asset/liab transferred remains under control of acquirer then transfer at carrying value

Question 28

Contingent Consideration Transferred

Answer 28

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

Question 29

Post-combination change in FV of contingent consideration

Answer 29

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

Question 30

share-based payment awards TRANSFERRED

Answer 30

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

Question 31

Share-based payment awards TREATMENT

Answer 31

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

Question 32

Obtain control W/O transferring consideration

Answer 32

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

Question 33

Treatment of Cost Acquisition

Answer 33

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)

Question 34

Treatment of cost of registering/issuing securities

Answer 34

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

Question 35

true/false

cost of carrying out a business combination should be included in the cost of an acquired business

Answer 35

false

expenses incurred are not part of the cost of an acquired business

(ex: acquisition costs/fees)

Question 36

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

Answer 36

true

Question 37

true/false

When the transferred asset remains under the control of the acquiring entity, the asset is transferred at carrying value, not fair value

Answer 37

true

Question 38

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

Answer 38

true

Question 39

Items recognized in business combo

Answer 39

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

Question 40

Recognizing intangible assets acquired

Answer 40

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

Question 41

Measuring Assets/Liab

Answer 41

most assets/liab acquired should be measued @ FV

ALWAYS VALUED AT FV

Question 42

Contingencies assumed

Answer 42

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

Question 43

Control obtained in steps/stages

Answer 43

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

Question 44

Noncontrolling Interest

Answer 44

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

Question 45

Identify items acquired in business combination for which acquirer has to make a decision as to classification/designation of item

Answer 45

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

Question 46

Describe requirements of acquisition when a business combo is carried out in stages (or steps)

Answer 46

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

Question 47

Identify five items acquired in a business combo that would be measured at something other than FMV

Answer 47

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

Question 48

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

Answer 48

true

Question 49

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.

Answer 49

true

Question 50

FMV of Entity as a whole

Answer 50

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

Question 51

FMV of identifiable Net Assets

Answer 51

How much you RECEIVED from acquiree:

• FMV of identifiable assets
• FMV of all liab assumed

Question 52

Measuring Goodwill/Bargain Purchase

Answer 52

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

Question 53

When does bargain purchase arise?

Answer 53

FMV of total investment (consideration + acquiree NCI) in an acquiree

Question 54

values are compared to determine if there is Goodwill or a bargain purchase in a business combination?

Answer 54

FMV of total investment in the acquiree (consideration transferred + NCI in acquiree) & FMV of net assets (assets - liabilities) of acquiree

Question 55

When does GW arise?

Answer 55

FMV of total investment (consideration + acquiree NCI) in an acquiree > FMV of acquiree’s net assets

Question 56

Contingent Liab Assumed

Answer 56

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

Question 57

Indemnification Right

Answer 57

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

Question 58

Contingent Consideration

Answer 58

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

Question 59

assets or liabilities recognized in a business combination require “specialized” post-combination accounting treatments?

Answer 59

1) Reacquired rights asset
2) Assets/liab arising from contingencies;
3) Indemnification assets;
4) Contingent consideration as asset/liab (or equity).

Question 60

true/false

acquiree cannot apply pushdown accounting to revalue its common stock to fair value as of the acquisition date.

Answer 60

true

Question 61

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.

Answer 61

true

Question 62

Non-quantitative disclosures

Answer 62

• 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

Question 63

Acquisition Date Value Disclosures

Answer 63

• 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

Question 64

Pre-combo Ownership - Acquisition Date Value Disclosures

Answer 64

• FMV of pre-combo ownership
• Gain/loss recognized in adj. to FMV
• where gains/loss show in financials

Question 65

GW & Bargain Purchase Disclosures

Answer 65

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

Question 66

Publicly traded entity disclosures

Answer 66

• amount of post-combo revenues & earnings of acquiree included in consolidated income
• revenue & earnings for period as thru combo @ BOY

Question 67

Publicly traded entity disclosures - comparative statements

Answer 67

• revenue/earnings of those periods as though combo occurred @ BOY
• if impracticable, show why

Question 68

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.

Answer 68

true

Question 69

legal merger/consolidation

Answer 69

• 2/more entities combine into 1 entity
• accts of entities are combined
• GW or bargain purchase recognized @ merger/consolidation

Question 70

Legal acquisition

Answer 70

• 1 entity gains control of another
• acquirer records investment in sub (asset)
• entities continue as separate legal entities
• separate financials are consolidated

Question 71

method is used by a parent company to carry “investment in subsidiary” on its books?

Answer 71

cost, equity, other

Question 72

Where is a Subsidiary reported?

Answer 72

consolidated statements, unless the parent lacks effective control

Question 73

Variable Interest Entity Defined

Answer 73

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

Question 74

VIE Characteristics

Answer 74

• 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

Question 75

Consoliation of entities w/no equity ownership

Answer 75

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

Question 76

Consolidation of VIEs

Answer 76

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

Question 77

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.

Answer 77

true

Question 78

GAAP vs IFRS - Business Combos

GAAP

Answer 78

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

Question 79

GAAP vs IFRS - Business Combos

IFRS

Answer 79

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