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2.3 EXPLANATION AND ILLUSTRATION OF ACQUISITION ACCOUNTING used, present value of future payments represents cost.. identifiable assets less liabilities exceeds the total cost of the a

SOLUTION MANUAL FOR ADVANCED ACCOUNTING 6TH EDITION BY JETER

Chapter 2 – Accounting For Business Combinations

2.1 ACCOUNTING STANDARDS ON BUSINESS

COMBINATIONS: BACKGROUND

(purchase) method for accounting for mergers & acquisitions Until 2001, companies had a choice, albeit strictly regulated, between these two methods: 1) the pooling of interests

method (this method was grandfathered into the Codification), and 2) Acquisition (Purchase) method

2.2 PRO FORMA STATEMENTS AND DISCLOSURE

REQUIREMENT

relation to business combinations:

the combination, and

combination Note: This aspect was particularly important prior to the elimination of the pooling method,

as a means of enabling users to compare mergers despite the dissimilarity on the face of the principal statements between those accounted for under purchase and pooling

mergers, to indicate any calculations which are computed “as if” alternative rules or standards had been applied For

example, a firm may disclose in its press releases that earnings excluding certain one-time charges reflect a more positive trend than the GAAP-reported EPS However, the SEC has recently cracked down on the extent to which these types of pro forma

1

calculations may be presented, and the details that should

be included in such announcements

facilitate comparison between periods

2.3 EXPLANATION AND ILLUSTRATION OF ACQUISITION

ACCOUNTING

used, present value of future payments represents cost

the stock given or the assets received whichever is more clearly evident

of fair value than appraisal values

sum of amounts assigned to identifiable assets and liabilities

and, under SFAS No 142 [ASC 350] is no longer amortized

a reporting unit – generally a level lower than that of the entire entity If the implied fair value of the reporting unit’s goodwill

is less than its carrying amount, goodwill is considered impaired See Flowchart on the next page

presented as a separate line item in the operating section of the income statement

identifiable assets less liabilities exceeds the total cost of the

acquired company—a gain is recognized in the period of the acquisition under current GAAP

H When S Company acquires P Company with stock, common

stock is credited for the par value of the shares issued, with the remainder credited to other contributed capital Individual assets acquired and liabilities assumed are recorded at their fair values Plant assets and other long-lived assets are recorded at their fair values unless a bargain has occurred, in which case their values are reduced below fair value to the extent of the

bargain When the cost exceeds the fair value of identifiable net assets, any excess of cost over the fair value is recorded as goodwill

Combinations: deferred tax assets and/or liabilities must be recognized for differences between the assigned values and tax bases of the assets and liabilities acquired Such differences are likely when the combination is tax-free to the sellers

2.4 THE MEASUREMENT PERIOD (AND MEASUREMENT

PERIOD ADJUSTMENTS)

A The measurement period is the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination

B During the measurement period, the acquirer is required to retrospectively adjust the provisional amounts at the

acquisition date to reflect new information obtained about facts and circumstances that existed at the acquisition date

C The Measurement period shall not exceed one year from the acquisition date

2.5 CONTINGENT CONSIDERATION IN AN ACQUISITION

from parent to subsidiary, generally dependent of some measure of performance

but it may create conflicts upon implementation because of measures which are out of the control of certain managers after the merger, as well as creating possible incentives for

manipulation of earnings numbers (and may lead to decisions which are short-term rather than long-term focused)

the shortcomings of contingency calculations based on earnings (manipulation of numbers, for example), but leads to its own set of problems; for example, market prices fluctuate in response to many economy-wide factors that are almost completely outside the managers’ control

Illustration 2-4 Deals Reporting the Amount of Contingent Consideration (Earnouts)

Public Acquirers

2010 to 2014

$ Millions

Deals Value

Source: Thomson SDC

Platinum

* partial year 2014

2.6 LEVERAGED BUYOUTS

acquire all the outstanding shares of employer/original company

acquired with borrowed funds have actually been purchased and therefore recorded at cost

Illustration 2-5 The Leveraged Buyout Market

(LBO) 2000-2009

Source: Mergers and Acquisitions February

2009, 2010, 2011

2.7 IFRS versus U.S GAAP

Illustration 2-7

Comparison of Business Combinations and Consolidations under U.S

consideration recorded at acquisition approach

date, with subsequent adjustments

recognized through earnings if

contingent liability (no adjustment for

equity)

measured at fair value on the acquisition acquisition date if its fair value date if they can be reasonable estimated can be reliably measured

If not, they are treated according to

SFAS No 5

the proportionate share of the net assets acquired Also presented in equity

Qualified SPE (QSPEs) are no longer

exempted from consolidation rules

securities) are expenses

is recorded as an ordinary gain in

income (not extraordinary)

8 Fair value is based on exit prices, i.e 8 Fair value is the amount for

an asset or paid to transfer a liability in exchanged or a liability settled

transaction

portion is then amortized

policies do not need to conform accounting policies do need to

conform

combination and generally expensed

(unless conditions in SFAS no 146 are

met)

acquisition date, or b) the date when the

acquirer receives needed information to

consummate the acquisition

value, with any gain or loss recorded in

earnings

are required for significant events

in that period

exercisable

APPENDIX 2A- Deferred Taxes in Business Combinations

gain resulting is tax-free at the time of the combination

purchaser when the book value of the assets is used (inherited) for tax purposes, but the fair value is recognized in the

accounting books under purchase accounting rules