Financial Reporting & Analysis 1: Investments In Business Combinations

Question 1

On reporting Investments in business combinations, who is less strict, IFRS or GAAP?

Answer 1

In this case relatively speaking IFRS is actually less strict than GAAP because IFRS does not differentiate between the types of business combinations while GAAP does.

Question 2

What is the difference between GAAP and IFRS when it comes to reporting investments in business combinations>?

Answer 2

IFRS does not differentiate between the types of business combinations while GAAP does.

Question 3

When it comes to differentiating between business combinations, how do IFRS and GAAP classify?

Answer 3

IFRS does not differentiate between types of business combinations.

GAAP does differentiate. The investment can either be classified as a merger or an acquisition

Question 4

What is the difference between a merger and an acquisition?

Answer 4

Under a merger, the acquirer absorbs all of the assets of the acquired. The acquired ceases to exist.

Under an acquisition, both entities continue to exist and are connected through a parent-subsidiary relationship

Question 5

Under an acquisition, does each entity maintain their own balance sheets or do they share?

Answer 5

Remember in an acquisition, unlike a merger, both entities continue to exist though a parent-subsidiary relationship. Therefore, each entity will maintain their own balance sheets. *Remember, the parent must additionally prepare consolidated financial statements.

Question 6

Under an acquisition, is there any requirement for consolidated financial statements? Is it for the parent or subsidiary?

Answer 6

In an acquisition, both companies continue to exist through a parent-subsidiary relationship. In addition, the parent has to present consolidated financial statements.

Question 7

Consider 2 cases of an acquisition, the parent gets 100% equity interest vs parent gets less than 100% equity interest. When would the parent need to report non-controlling (minority) interests?

Answer 7

If the parent is acquiring less than 100% equity, they will be required to report minority interest.

Question 8

Compare the 3 types of a business combination under GAAP. How would IFRS treat each combination?

Answer 8

Remember, IFRS does not differentiate between business combinations.

GAAP:

Merger: The acquirer absorbs all net assets of the acquired, and the acquired company ceases to exist.

Acquisition: The acquirer and the acquired continue to exist through a parent-subsidiary relationship. They may own 100% or less than 100% equity interest. If they hold less than 100%, they’ll have to report minority interests.

Consolidation: A new entity is formed that absorbs both the acquired and the acquirer. Both companies cease to exits.

Question 9

What are the 3 methods of accounting for business combinations under IFRS and under GAAP?

Answer 9

IFRS and GAAP consider 3 methods, and they only differ on what they call one of the methods.

1) Pooling of Interests (GAAP) / Uniting of Interests (IFRS)
2) Purchase Method* not allowed, have to use acquisition
3) Acquisition Method

Question 10

If we are using the Pooling(GAAP)/Uniting(IFRS) of Interests, how do we account for a business combination?

Answer 10

The two firms will combine using their historical book values, and operating results will be restated as if the two companies had always operated as a single entity.

We don’t use Fair Values, and the actual price paid is not evident on Financial Statements.

Question 11

If we are using the Purchase method, how do we account for a business combination?

Answer 11

• Purchase method not allowed, have to use acquisition method. As is evident in the name, this method of accounting will actually reflect the purchase, unlike pooling/uniting.

The combination will be accounted for as a purchase of net assets (tangible/intangible assets minus any liabilities)

Net Assets will be reported at fair value.

Question 12

What is an advantage of the pooling/uniting of interest method of accounting vs purchase method?

Answer 12

Under the pooling/uniting of interest methods, the value of depreciable assets is higher, which will reduce net income.

• Purchase method not allowed, use acquisition method.

Question 13

IFRS and GAAP do not allow the purchase method. What do they require we use instead?

Answer 13

They require the acquisition method.

Question 14

What is combined when we use the acquisition method of accounting for a business combination?

Answer 14

Under the acquisition method we combine all the assets, liabilities, revenues, expenses of the acquirer and acquired.

Question 15

Under the acquisition method of accounting for a business combination, how do we a measure tangible and intangible net assets.

Answer 15

Under the acquisition method, we measure both tangible and intangible assets at Fair Value

Question 16

If we are using the acquisition method of accounting for business combinations and the acquired has some assets and liabilities that were not reported (like brand names or patents), how do we treat those?

Answer 16

The acquirer must recognize any previously unrecognized assets and liabilities.

Question 17

Under the acquisition method, how does the acquirer account for any contingent liabilities? What about liabilities that that are expected but not obliged?

Answer 17

Any contingent liabilities (already obliged) must be recognized. Liabilities that we know will come up in the future but we are not currently obligated to, we will not recognize those until they arise.

Question 18

Under thee acquisition method, if we acquire a company in a bargain acquisition, what does that mean and how do we account for it?

Answer 18

A bargain acquisition means that we acquired a company and paid less than fair value. The difference between the price paid and the fair value will immediately be recognized as a gain within profit and loss.

Question 19

Under the acquisition method, how do we recognize the shareholders equity of the acquired?

Answer 19

We ignore the shareholders equity of the acquired

Question 20

In the case of a business combination where the acquirer gets less than 100% equity interest, what kind of account must the parent create? What financial statements will the account show up?

Answer 20

If the parent owns less than 100% equity interest, they must create a non-controlling interest account. This reflects the portion of ownership of the subsidiary (minority interest). The non-controlling interest account will be present not he balance sheet as well as the income statement.

Question 21

What does the non-controlling interest account show?

Answer 21

The non-controlling interest account reflects the proportionate share in the net assets and net income of the subsidiary that belongs to entities other than the parent company.

Question 22

When we see the non-controlling interest account on the balance sheet, what is it reflecting?

Answer 22

The non-controlling interest account shows up on both the balance sheet and the income statement.

On the balance sheet, it reflects the minority share holders proportionate share of the net assets.

On the income statement, it shows their proportionate share of net income.

Question 23

When we see the non-controlling interest account on the income statement, what is it reflecting?

Answer 23

The non-controlling interest account shows up on both the balance sheet and the income statement.

On the balance sheet, it reflects the minority share holders proportionate share of the net assets.

On the income statement, it shows their proportionate share of net income.

Question 24

When it comes to who prepares financial statements and what kinds, compare the parent and subsidiary companies when it comes to business combinations where the acquirer does not own 100% equity interest.

Answer 24

In the case that there are minority share holders, both the parent and subsidiary must prepare separate financials statements.

In addition, the parent will prepare consolidated financial statements.

Question 25

When it comes to measuring goodwill and non-controlling interests, what are the 2 types of methods we can use. Compare IFRS and GAAP

Answer 25

GAAP only allows you to use the full goodwill method

IFRS allows the full goodwill method, as well as the partial goodwill method.

Question 26

If we choose to use the full goodwill method, how to we come to the value of goodwill?

Answer 26

Under the full goodwill method, goodwill equals the excess of the purchase price of the acquired over the fair value of the parents proportionate share of the subsidiary’s identifiable assets.

Question 27

Using the partial goodwill method, how do we find the value of goodwill?

Answer 27

Goodwill equals the excess of the purchase price over the fair value of the parents proportionate share of the subsidiary’s identifiable net assets.

Question 28

What is the difference between partial goodwill method and full goodwill method when it comes to valuing goodwill?

Answer 28

IF we use the full goodwill method, goodwill is equal to the the excess of the total fair value of the subsidiary over the fair value of its net identifiable assets.

If we use partial goodwill, goodwill is equal to the excess of purchase price over the fair value of its net identifiable assets.

Question 29

When reporting non controlling interest on the balance sheet using the full goodwill method, how do we report?

Answer 29

Using the full goodwill method, non-controlling interest is measured based on its proportionate share of the subsidiary’s total fair value

Question 30

When reporting non controlling interest on the balance sheet using the partial good will method, how do we report?

Answer 30

If we are using partial goodwill method, non-controlling interst is measured based on the parents proportionate share of the *fair value of the subsidiary’s *identifiable net assets**

Question 31

When reporting non-controlling interests what is the difference between the full goodwill method and partial goodwill method?

Answer 31

Under full, non controlling interested is based on the parents proportionate share of the total fair value of the subsidiary.

Under partial, non controlling interest is based on the parents proportionate share of the fair value of the subsidiary’s identifiable net assets

Question 32

In comparing the full to the partial goodwill method, which will result in higher total net assets and equity, and why?

Answer 32

Remember that when using the full goodwill method, non-controlling interest is based on the parents proportionate share of the total fair value of the subsidiary, where as partial is based on the parents proportionate share of the fair value of the identifiable net assets. So, the full goodwill method results in higher total net assets and equity.

Question 33

On the income statement, what is the difference between full and partial goodwill method when it comes to net income to the parent?

Answer 33

There is no difference.

Question 34

Which method, full or partial goodwill, will result in a lower ROA and ROE.

Answer 34

Remember that the full goodwill method has non-controlling interest based on the total fair value of the subsidiary, which makes assets and equity higher. Therefore, ROA and ROE would be lower under the full goodwill method vs the partial.

Question 35

Goodwill is an (tangible/intangible) with a (definite/indefinite) life, therefore impairment (is/is not) amortized.

Answer 35

Goodwill is an intangible asset with an indefinitely life, therefore it is not amortized. It is tested for impairment at least annually.

Question 36

Once you impair goodwill, can it be reversed?

Answer 36

No.

Question 37

When allocating goodwill across the unit, compare IFRS and GAAP.

Answer 37

Under IFRS, we allocate goodwill across all of the cash generating units that expects to benefit from the synergies within the acquirer.

Under GAAP, we allocate goodwill across all reporting units within the acquirer.

Question 38

When it comes to measuring impairment of goodwill, how many steps are in IFRS vs GAAP.

Answer 38

IFRS is a single step test. GAAP is a 2 step test.

Question 39

How do we test for goodwill impairment under IFRS?

Answer 39

Under IFRS, impairment testing is a one step process.

Goodwill is deemed impaired if the recoverable amount if the cash generating unit is lower than its carrying value (including goodwill)

Question 40

Under IFRS, how do we come to the value of the impairment of goodwill, and how do we allocate it?

Answer 40

Under IFRS, goodwill impairment is equal to the difference between the carrying value of the cash generating unit and the recoverable amount of the unit. Any impairment is first applied to the goodwill of the cash generating unit. Once goodwill of the cash generating unit is 0, we then apply further impairment against all other assets pro rata.

Question 41

How do we test for goodwill impairment under GAAP? How is the impairment applied?

Answer 41

Under GAAP, testing for impairment of goodwill is a 2 step process. Goodwill is deemed impaired if the carrying value (including goodwill) exceeds its fair value. Then, the measurement of that impairment loss equals the difference between the implied faire value of the units goodwill (implied goodwill) and its carrying amount.

Like IFRS, we apply the impairment to the goodwill of the reporting unit. However, unlike IFRS, once the goodwill is 0, we do not apply it to any other asset or liability.

Question 42

What is implied goodwill?

Answer 42

Implied goodwill equals the fair value of the unit minus the fair value of the net assets.

Question 43

Under GAAP and IFRS, impairment loss against goodwill is recognized as a _______ line item on the consolidated income statement.

Answer 43

Separate