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Accounting for Lawyers Final > Module 4: M&As > Flashcards

Module 4: M&As Flashcards

1
Q

earnout

A

payment to T’s old shareholders that is contingent on the future performance of T, common in smaller deals where T shareholders continue to manage T after the sale bc it provides incentive to give best efforts in managing the company even though you no longer own it

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2
Q

goodwill

A

excess of the purchase price over the FMV of the net identifiable assets (identifiable assets include tangible assets and certain intangible assets

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3
Q

3 methods of accounting for a stock purchase:

A
  1. cost method
  2. equity method
  3. consolidation method
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4
Q

cost method

A

when B has little influence over T (usually when B owns

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5
Q

accounting for stock acquisitions varies depending on

A

level of influence B has over T (which usually depends on % of T stock owned by B)

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6
Q

equity method

A

when B has significant influence over T (usually when B owns between 20% - 50% of T)

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7
Q

consolidation method

A

when B controls T (usually when B owns > 50% of T)

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8
Q

Under the cost method, B buys 10% of T at a cost of $100 mill, B records?

A

DR investment in T 100 mill / CR cash 100 mill

under the cost method, any time a company buys the stock of another company, the initial purchase is recorded at the cost of the purchase

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9
Q

marked to market

A
  • if the market value of T stock goes up, B records: DR investment in T XX / CR gain (net income) XX
  • if the market value of T stock goes down, B records: DR loss (net income) XX / CR investment in T XX

ALWAYS under the cost method, can elect under equity method, can elect for bonds

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10
Q

2 flavors of cost method investments

A
  1. trading: hold for up to a few months, gains and losses from marking-to-market go into “regular” NI
  2. available-for-sale: hold for more than a few months, gains and losses from marking-to-market go into other comprehensive income (OCI)
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11
Q

OCI : What are the 4 specific items that don’t have an immediate economic impact on the company?

A

other comprehensive income is a side basket of income that is for 4 specific items that don’t have an immediate economic impact on the company:
1. unrealized gains and losses on “available-for-sale” securities
2. foreign currency translation adjustments
3. some weird adjustments pertaining to pension plans
4. gains and losses on certain derivative Ks
OCI is added to regular net income to give us total comprehensive income

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12
Q

JE when accounting for asset acquisitions?

A

DR asset being purchased XX / CR cash XX

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13
Q

poolings of interest

A

B records T’s assets at T’s BV in those assets (so, goodwill would not be recorded since T does not have any book value in its own goodwill)

poolings are no longer allowed

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14
Q

acquisition method of accounting

A

B records T’s assets at FMV

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15
Q

if purchase price

A

the difference is recorded as a gain on the I/S

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16
Q

Greece, Inc., desperate for cash, sells you the following assets for 80 mill cash:

Asset (FMV):
Acropolis (50 mill)
Parthenon (50 mill)

Record?

A

DR Acropolis 50 mill
DR Parthenon 50 mill
CR cash 80 mill
CR gain 20 mill

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17
Q

accumulated other comprehensive income

A

OCI is accumulated and reported on the B/S as a SE equity account

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18
Q

the items that go into OCI _____ have an immediate economic impact on the company

A

do not

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19
Q

Under the cost method, Berkshire Hathaway buys 10% of American Express for 1 billion cash. BH records:

BH is a buy-and-hold investor, so the investment in AE would be classified as?

Will BH mark-to-market it’s investment in American Express?

A

DR Inv. in AE 1 bill / CR cash 1 bill

Available-for-sale

Yes, the resulting gains/losses will go to OCI, not net income

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20
Q

items that go into OCI do not have an immediate impact on the company, but when these items do have an economic impact on the company, we move them out of OCI and into _____

A

items that go into OCI do not have an immediate impact on the company, but when these items do have an economic impact on the company, we move them out of OCI and into net income

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21
Q

Under the cost method, the stock investment is:

  1. recorded at its _____ and then
  2. _____
A
  1. recorded at its initial cost and then
  2. marked to market

additionally, B records any dividends it gets from T as dividend income

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22
Q

B owns 10% of T. T pays 100k of dividends (so B’s share of the dividends is 10k). B records:

A

Cost method!

DR cash 10k / CR dividend income 10k

Note: this dividend goes into net income, not other comprehensive income, regardless of whether the stock is classified as a trading security or an available-for-sale security

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23
Q

BV of a specific asset = ?

A

BV = cost - accumulated depreciation

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24
Q

BV of a company as a whole = ?

A

stockholder’s equity

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25
Q

equity method investments are marked to changes in T’s BV, so as T earns income (which increases earnings and thus increases T’s BV), B records:

A

DR Investment in T XX / CR Income from T XX

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26
Q

B owns 30% of T. T earns 100k. B records:

A

Equity method!

DR investment in T 30k / CR income from T 30k

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27
Q

B owns a % of T. T earns $. When T pays dividends, B records ________ under cost method.

Under equity method?

A

Cost method: DR cash XX / CR dividend income XX

Equity method: DR cash XX / CR inv in T XX

28
Q

Under equity method, when T pays dividends, _____ is decreased and T’s BV is _____

A

when T pays dividends under the equity method, retained earnings is decreased and T’s BV is decreased

B records: DR cash XX / CR investment in T XX

29
Q

B owns 30% of T, T pays 50k of dividends (in total, B’s share is 15k). B records:

A

Equity method

DR cash 15k / CR investment in T 15k

This entry reflects that B has enjoyed an increase in one asset (cash) but has suffered a decline in another asset (investment in T, which goes down because T has shrunk by the size of the dividend)

30
Q

under the consolidation method (used if ownership > __%), we refer to B as _____ and T as _____

A

under the consolidation method (used if ownership > 50%), we refer to B as parent (P) and T as subsidiary (S)

31
Q

under the consolidation method, when P buys S’s stock, P records:

A

DR investment in S XX / CR cash XX

32
Q

consolidation method of accounting

you buy 100% of S’s stock for 500k, you record: ?

At the time of the deal, S had the following B/S:
A = assets 800k; L & SE = debt 300k, equity 500k

To consolidate, you record:

A

DR investment in S 500k / CR cash 500k

to consolidate: DR assets 800k / CR debt 300k, CR investment in S 500k
(get rid of investment in S account and replace it with the actual A [and sometimes L] account(s))

33
Q

To consolidate:

  • P’s investment in T’s account _____
  • S’s actual A & L accounts are _____
A

To consolidate:

  • P’s investment in T’s account goes away
  • S’s actual A & L accounts are added in
34
Q

Are consolidation JEs made on P’s own financial statements?

A

no!

consolidations pertain to stock acquisitions, where P & Ss maintain their own separate legal identities and thus continue to maintain their own separate accounting records BUT we show the outside world P & S’s financial info as if they were one big company on informal consolidation work paper, not on P’s own actual books and records

35
Q

when P owns > 50% of S:

during the accounting period, we use the _____ method

then, at the end of the the accounting period, we prepare the _____ B/S and the _____ I/S

A

when P owns > 50% of S:

during the accounting period, we use the equity method

then, at the end of the the accounting period, we prepare the consolidated B/S and the consolidated I/S

36
Q

prepare consolidated B/S by replacing P’s _____ account with S’s _____ account(s)

A

prepare consolidated B/S by replacing P’s investment in S account with S’s actual A & L accounts

37
Q

prepare consolidated I/S by replacing P’s _____ account with S’s actual _____ account(s)

A

prepare consolidated I/S by replacing P’s income from S account with S’s actual income and expense accounts

38
Q

Phrank owns 100% of Sinatra’s stock. Sinatra has the following I/S:

Sales 100 mill
Expenses 40 mill
Net income 60 mill

Under the equity method, P records:

To consolidate at the end of the accounting period, P records (on consolidation workpaper):

A

DR investment in S 60 mill / income from S 60 mill

DR income from S 60 mill, DR expenses 40 mill / sales 100 mill

39
Q

whether P uses the equity method or consolidates, its net income will be _____ and its assets will be _____

A

whether P uses the equity method or consolidates, its net income will be the same and its assets will be the same

the only difference is that consolidation provides more detail

40
Q

debt:equity ratio

A

a leverage ratio

41
Q

noncontrolling interest (NCI)

A

when P owns > 50% but

42
Q

NCI-NA

A

NCI: noncontrolling interest’s share of S’s
NA: net assets (assets - L, or E)

43
Q

when B buys S’s assets in an asset deal, B always records S’s assets at _____

A

FMV

44
Q

when B buys S’s stock in a stock deal and then consolidates, the consolidation process records S’s assets at _____

A

FMV

45
Q

P pays for 100k for S’s asset (building) when the building has
BV on S’s books = 90k
FMV = 100k
What does P record?

A

DR building 100k / CR cash 100k

when B buys S’s stock in an asset deal and then consolidates, the consolidation process also records S’s asset at FMV

46
Q

when consolidating, record S’s assets (and liabilities) at _____, not _____

A

when consolidating, record S’s assets (and liabilities) at FMV, not BV

Record B’s A & L at BV

47
Q

pushdown accounting

A

adjust S’s A & L from BV to FMV right on S’s own books, adjustments to record the assets at FMV are being pushed down to S’s own books

48
Q

pushdown accounting is accomplished by…?

A
  1. debiting S’s asset accounts: by the diffs between the FMVs and BVs of the assets
  2. debiting S’s retained earnings: to bring it down to 0, to reflect that since S is revaluing its As and Ls from BV to FMV it is, in essence, starting all over from an accounting perspective and so RE must be reset to 0
  3. crediting pushdown capital: you have to credit something to offset the debits records in #1 and #2 above, so make up an equity account called pushdown capital and credit that
49
Q

unlike most Buyers in an M&A, PE firms are usually looking to own T for the _____-term

A

short-term (3-7 years), often take the form of an initial public offering (IPO)

50
Q

pushdown means Sub will record _____ write-ups on its _____, and this will result in _____ on Sub’s _____

A

pushdown means Sub will record asset write-ups on its own B/S, and this will result in higher expenses on Sub’s own I/S

51
Q

Do PE firms like pushdown accounting?

A

No! PE firms would often buy less than 95% of a T company to avoid T having to apply pushdown accounting

52
Q

Why are intracompany accounts and transactions eliminated from the consolidated financial statements?

A

the purpose of consolidated financial statements is to report their financial results as if they were one economic entity

53
Q

transfer prices

A

prices charged on the intercompany transactions

54
Q

SBC announced it had agreed to acquire Ameritech in a stock swap which gave Ameritech shareholders a 27% premium over Ameritech’s $43.875 closing price. SBC was trading at $42.38.

What was the exchange ratio?

A

($43.875 x 1.27) / $42.38 = 1.316:1

55
Q

WorldCom bought MCI for $40 bill when MCI’s net identifiable assets had a FMV of $14 bill. The transaction was accounted using the acquisition method. How much goodwill was recorded?

How much goodwill would have been recorded if the transaction had been accounted for as a poolings?

A

acquisition method: record 26 bill in goodwill

poolings: 0 in goodwill

56
Q

Advantages and disadvantages when B pays with stock?

A

Advantages: conserves cash, easier to pay for big deals

Disadvantages: must go through registration process with SEC (time consuming), Q of how much the stock is really worth

57
Q

Stock exchange ratio

A

how many shares of B’s stock must be issued from every share of T?

58
Q

How can B deal with declines in B’s stock price between when the merger is reached and the closing date?

A

Walkaway provisions
Floating exchange rates
Collars

59
Q

What does crossing a collar trigger?

A

implementation of a floating exchange rate

60
Q

What kind of collars would a T shareholder like?

A
  • narrow collar on the floor (so the downside protection kicks in quickly)
  • wide collar on the ceiling (so the limit on the upside gain does NOT kick in for a while
61
Q

What are collars on the collar?

A

Limit the absolute number of B shares that’ll be issued if B’s stock price goes down, effectively limiting the protection to a T shareholder

62
Q

If cash is being paid for T, the deal will be accretive as long as __________

A

T’s earnings > interest that B was getting on the cash used to pay for T

63
Q

If stock is being paid for T, the deal will be accretive as long as __________

A

B’s P/E ratio > T’s P/E ratio

P/E ratio = stock price per share / EPS

64
Q

When P owns > 50% but

A

When P owns > 50% but

65
Q

If consolidated B/S includes S’s As & Ls at FMV, future consolidated I/S must report the expenses those assets turn into based on ________.

A

If consolidated B/S includes S’s As & Ls at FMV, then future consolidated I/S must also report the expenses those assets turn into based on FMV.

66
Q

SEC: when you’re selling shares of S to the public, need to disclose ________ for the last ________.

A

SEC: when you’re selling shares of S to the public, need to disclose Sub’s own I/S for the last 3 years.

67
Q

The effects of transfer prices are not eliminated if ________.

A

The effects of transfer prices are not eliminated if one of the companies is foreign.

IRS’s goal: prices charged between affiliated corps should reflect “arms-length” prices (i.e. what it sells for in the market)

Accounting for Lawyers Final (4 decks)

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