advanced accounting 6e by jeter chaney chapter 02

• Describe the valuation of assets, including goodwill, and liabilities acquired in a business combination accounted for by the acquisition method.. Porsche Company decided to measure go

• Discuss the goodwill impairment test, including its frequency, the steps laid out in the new

standard, and some of the implementation problems

• Explain how acquisition expenses are reported

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Learning Objectives

• Describe the use of pro forma statements in business combinations

• Describe the valuation of assets, including goodwill, and liabilities acquired in a business

combination accounted for by the acquisition method

• Explain how contingent consideration affects the valuation of assets acquired in a business combination accounted for by the acquisition method

• Describe a leveraged buyout

• Describe the disclosure requirements according to current GAAP related to each business

combination that takes place during a given year

• Describe at least one of the differences between U.S GAAP and IFRS related to the accounting for business combinations

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LO 1 FASB’s two major changes for business combinations.

What Changed?

• SFAS No 141R [ASC 805], “Business Combinations,” replaced FASB Statement No 141

– Supports the use of a single method

– Uses the term “acquisition method” rather than “purchase method.”

– The fair values of all assets and liabilities on the acquisition date, defined as the date the acquirer obtains control of the acquiree, are reflected on the financial statements

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Issued December 2007Historical Perspective on Business Combinations

What Changed?

• “Noncontrolling Interests In Consolidated

Financial Statements”, amended Accounting Research Bulletin (ARB) No 51 (now

included in FASB ASC 810 [Consolidations]),

– Established standards for the reporting of the noncontrolling interest when the acquirer

obtains control without purchasing 100% of the acquiree

– Additional discussion in Chapter 3

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Issued December 2007

LO 1 FASB’s two major changes for business combinations.

Historical Perspective on Business Combinations

LO 2 FASB’s two major changes of 2001.

• Historically, two methods permitted in the U.S.: purchase and pooling of interests

• Pronouncements in June 2001:

– SFAS No 141, “Business Combinations,” - pooling method is prohibited for business

combinations initiated since June 30, 2001 [FASB ASC 805]

– SFAS No 142, “Goodwill and Other Intangible Assets,” - Goodwill acquired in a business

combination since June 30, 2001, should not be amortized [FASB ASC 350]

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Historical Perspective on Business Combinations Accounting Standards on Business Combinations:

Background

LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

• For public companies, goodwill is no longer amortized.

– Goodwill of each reporting unit is tested for impairment on an annual basis.

• All goodwill must be assigned to a reporting unit

• Impairment should be tested in a two-step process

–Step 1: Does potential impairment exist?

–Step 2: What is the amount of goodwill impairment?

• Private companies can elect an alternative model: amortize goodwill over a period not to

exceed 10 years and utilize a simplified impairment model

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Issued January 2014

Accounting Standards on Business Combinations:

Background

Perspective on Business

Combinations

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LO 3

E2-10: On January 1, 2013, Porsche Company acquired the net assets of Saab Company for $450,000 cash The fair value of Saab’s identifiable net assets was $375,000 on this date Porsche Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Saab) The information for these subsequent years is as follows:

LO 3 Goodwill impairment assessment.9

* Goodwill is not included

*Goodwill Impairment Test

Goodwill Impairment Test

E2-10: On January 1, 2013, the acquisition date, what was the amount of goodwill acquired, if any?

LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

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LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

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Carrying value of unit:

Carrying value of identifiable net assets

E2-10: Part A&B: For each year determine the amount of goodwill impairment, if any, and prepare the journal entry needed

each year to record the goodwill impairment (if any)

Excess of carrying value over fair value means step 2 is required.

LO 3 Goodwill impairment assessment.12

E2-10: Part A&B (continued)

Goodwill Impairment Test

LO 3 Goodwill impairment assessment.

Carrying value of unit:

Carrying value of identifiable net assets

Excess of fair value over carrying value means step 2 is not required.

E2-10: Part A&B (continued)

* $75,000 (original goodwill) – $15,000 (prior year impairment)

*

Goodwill Impairment Test

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LO 3 Goodwill impairment assessment.

Carrying value of unit:

Carrying value of identifiable net assets

E2-10: Part A&B (continued)

* $75,000 (original goodwill) – $15,000 (prior year impairment)

*

Excess of carrying value over fair value means step 2 is required.

Goodwill Impairment Test

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LO 3 Goodwill impairment assessment.

Implied value of goodwill 25,000

E2-10: Part A&B (continued)

Goodwill Impairment Test

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Goodwill Impairment Test

Review Question

• The first step in determining goodwill impairment involves comparing the

a) implied value of a reporting unit to its carrying amount (goodwill excluded)

b) fair value of a reporting unit to its carrying amount (goodwill excluded)

c) implied value of a reporting unit to its carrying amount (goodwill included)

d) fair value of a reporting unit to its carrying amount (goodwill included)

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LO 3 Goodwill impairment assessment.

LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

Disclosures Mandated by FASB

• FASB ASC paragraph 805-30-50-1 requires:

– Total amount of acquired goodwill and the amount expected to be deductible for tax

purposes

– Amount of goodwill by reporting segment (if the acquiring firm is required to disclose

segment information), unless not practicable

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LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

Disclosures Mandated by FASB

• FASB ASC paragraph 350-20-45-1 specifies the presentation of goodwill (if impairment

occurs):

– Aggregate amount of goodwill should be a separate line item in the balance sheet

– Aggregate amount of losses from goodwill impairment should be a separate line item in the operating section of the income statement unless some of the impairment is associated with

a discontinued operation

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LO 3 Goodwill impairment assessment.

Goodwill Impairment Test

Disclosures Mandated by FASB

• When an impairment loss occurs, FASB ASC paragraph 350-20-50-2 mandates note

disclosure:

– Description of facts and circumstances leading to the impairment

– Amount of impairment loss and method of determining the fair value of the reporting unit – Nature and amounts of any adjustments made to impairment estimates from earlier periods,

if significant

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LO 9 New disclosure requirements for business combinations.

Perspective on Business Combinations

Other Required Disclosures

• FASB ASC paragraph 805-10-50-2 states that disclosure should include:

– The name and a description of the acquiree

– The acquisition date

– The percentage of voting equity instruments acquired

– The primary reasons for the business combination, including a description of the factors

that contributed to the recognition of goodwill

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LO 9 New disclosure requirements for business combinations.

Perspective on Business Combinations

Other Required Disclosures

• FASB ASC paragraph 805-10-50-2 states that disclosure should include:

– The fair value of the acquiree and the basis for measuring that value on the acquisition date.– The fair value of the consideration transferred

– The amounts recognized at the acquisition date for each major class of assets acquired and liabilities assumed

– The maximum potential amount of future payments the acquirer could be required to make

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LO 3 Goodwill impairment assessment.

Perspective on Business Combinations

Other Intangible Assets

• Acquired intangible assets other than goodwill:

– Limited useful life

• Should be amortized over its useful economic life

• Should be reviewed for impairment FASB ASC Section 350-30-35 – Indefinite life

• Should not be amortized

• Should be tested annually (at a minimum) for impairment

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LO 4 Reporting acquisition expenses.

Perspective on Business Combinations

Treatment of Acquisition Expenses

• FASB ASC paragraph 805-10-25-23 excludes acquisition-related from measurement of

consideration paid

– Both direct and indirect costs are expensed

– The cost of issuing securities is excluded from the consideration

• Security issuance costs are assigned to the valuation of the security, thus reducing the additional contributed capital for stock issues or adjusting the premium or discount

on bond issues.

– Expected restructuring costs (with no obligation at the acquisition date) are accounted for separately from the business combination

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Acquisition Costs—an Illustration

Suppose that SMC Company acquires 100% of the net assets of Bee Company (net book value of $100,000) by issuing shares of

common stock with a fair value of $120,000 With respect to the merger, SMC incurred $1,500 of accounting and consulting costs and

$3,000 of stock issue costs SMC maintains a mergers department that incurred a monthly cost of $2,000 Prepare the journal entry to record these costs.

LO 4 Reporting acquisition expenses.

Other Contributed Capital (Security Issue Costs) * 3,000

Pro Forma Statements and Disclosure Requirement

Pro forma statements (as-if statements) serve two functions in relation to business combinations:

– to provide information in the planning stages of the combination and

– to disclose relevant information subsequent to the combination.

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LO 5 Use of pro forma statements.

LO 5 Use of pro forma statements.

Illustration 2-2

Pro Forma Statements and Disclosure Requirement

Pro Forma Statements and Disclosure Requirement

Pro Forma Statements and Disclosure Requirement

• If a material business combination occurred during the year, notes to financial statements should

include on a pro forma basis:

– Results of operations for the current year as though the companies had combined at the

beginning of the year

– Results of operations for the immediately preceding period as though the companies had combined at the beginning of that period if comparative financial statements are presented

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LO 5 Use of pro forma statements.

Four steps in the accounting for a business combination:

1) Identify the acquirer

2) Determine the acquisition date

3) Measure the fair value of the acquiree

4) Measure and recognize the assets acquired and liabilities assumed

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LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting

Value of Assets and Liabilities Acquired

• Identifiable assets acquired (including intangibles other than goodwill) and liabilities assumed should be recorded at their fair values at the date of acquisition

• Any excess of total cost over the sum of amounts assigned to identifiable assets and liabilities is recorded as goodwill Goodwill should not be amortized but should be adjusted downward only when it is impaired (discussed earlier)

• Under current GAAP, in-process R&D is measured and recorded at fair value as an asset on the acquisition date

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LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting

Explanation and Illustration of Acquisition Accounting

Explanation and Illustration of Acquisition Accounting

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LO 6 Valuation of acquired assets and liabilities assumed.

E2-1: Preston Company acquired the assets ( except for cash ) and assumed the liabilities of Saville Company Immediately prior to the acquisition, Saville Company’s balance sheet was as follows:

Any Goodwill?

Explanation and Illustration of Acquisition Accounting

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LO 6 Valuation of acquired assets and liabilities assumed.

E2-1: Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company Immediately prior to the acquisition, Saville Company’s balance sheet was as follows:

Fair value of assets, without cash $1,824,000

Explanation and Illustration of Acquisition Accounting

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LO 6 Valuation of acquired assets and liabilities assumed.

Fair value of liabilities 594,000

Fair value of net assets 1,230,000

Fair value of assets, without cash $1,824,000

Explanation and Illustration of Acquisition Accounting

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LO 6 Valuation of acquired assets and liabilities assumed.

E2-1: A Prepare the journal entry on the books of Preston Co to record the purchase of the assets and assumption of the liabilities of Saville Co if the amount paid was $1,560,000 in cash.

Explanation and Illustration of Acquisition Accounting

Bargain Purchase

• When the fair values of identifiable net assets (assets less liabilities) exceeds the total cost of the

acquired company, the acquisition is a bargain

– In the past, FASB required that most long-lived assets be written down on a pro rata basis

before recognizing any gain

– Current requirements, FASB ASC paragraph 805-30-25-4: Acquirer must

• reassess whether it has correctly identified all of the assets acquired and all of the

liabilities assumed before recognizing a gain on bargain purchases and

• review procedures used to measure the amounts recognized at the acquisition date

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LO 6 Valuation of acquired assets and liabilities assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting

Explanation and Illustration of Acquisition Accounting

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LO 6 Valuation of acquired assets and liabilities assumed.

Calculation of Goodwill or Bargain Purchase

Fair value of liabilities 594,000

Fair value of net assets 1,230,000

Fair value of assets, without cash $1,824,000

E2-1: B Repeat the requirement in (A) assuming that the amount paid was $990,000.

LO 6 Valuation of acquired assets and liabilities assumed.

Explanation and Illustration of Acquisition Accounting

Measurement Period

The Measurement Period

 Period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination

 Ends as soon as the acquirer receives the information it was seeking about the facts and

circumstances that existed at the acquisition date, or learns that more information is not

Measurement Period

The Measurement Period

 Provides the acquirer with a reasonable time to obtain the information necessary to identify and measure any of the following as of the acquisition date:

a. Identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the

acquiree

b. Any consideration transferred to the acquiree

c. In a business combination achieved in stages, any previous equity interest held by the

Measurement Period Adjustments

Measurement Period Adjustments

If initial accounting is incomplete by the end of the first reporting period:

– Acquirer should use provisional amounts in the financial statements for any item in which the accounting is incomplete

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LO 6 Valuation of acquired assets and liabilities assumed.