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IntercorporateAcquisitionsandInvestmentsinOtherEntities1©2009TheMcGraw-HillCompanies,Inc.Allrightsreserved.McGraw-Hill/IrwinTheDevelopmentofComplexBusinessStructuresEnterpriseexpansionasameansofsurvivalandprofitabilitySizeoftenallowseconomiesofscaleNewearningpotentialEarningsstabilitythroughdiversificationManagementrewardsforbiggercompanysizePrestigeassociatedwithcompanysizeOrganizationalStructureandBusinessObjectivesAsubsidiaryisacorporationthatiscontrolledbyanothercorporation,referredtoasaparentcompany,usuallythroughmajorityownershipofitscommonstockBecauseasubsidiaryisaseparatelegalentity,theparent’sriskassociatedwiththesubsidiary’sactivitiesislimitedOrganizationalStructure,Acquisitions,andEthicalConsiderationsManipulationoffinancialreportingUsageofsubsidiariesorotherentitiestoborrowmoneywithoutreportingthedebtontheirbalancesheetsUsingspecialentitiestomanipulateprofitsManipulationofaccountingformergersandacquisitionsPooling-of-interestsBusinessExpansionandFormsofOrganizationalStructureExpansionfromwithin:Newsubsidiariesorentitiessuchaspartnerships,jointventures,orspecialentitiesMotivatingfactors:HelpsestablishclearlinesofcontrolandfacilitatetheevaluationofoperatingresultsSpecialtaxincentivesRegulatoryreasonsProtectionfromlegalliabilityDisposingofaportionofexistingoperationsBusinessExpansionandFormsofOrganizationalStructureAspin-offOccurswhentheownershipofanewlycreatedorexistingsubsidiaryisdistributedtotheparent’sstockholderswithoutthestockholderssurrenderinganyoftheirstockintheparentcompany Asplit-offOccurswhenthesubsidiary’ssharesareexchangedforsharesoftheparent,therebyleadingtoareductionintheoutstandingsharesoftheparentcompanyBusinessExpansionandFormsofOrganizationalStructureExpansionthroughbusinesscombinationsEntryintonewproductareasorgeographicregionsbyacquiringorcombiningwithothercompaniesAbusinesscombinationoccurswhen“...anacquirerobtainscontrolofoneormorebusinesses”TheconceptofcontrolrelatestotheabilitytodirectpoliciesandmanagementBusinessExpansionandFormsofOrganizationalStructureTraditionalview-Controlisgainedbyacquiringamajorityofthecompany’scommonstockHowever,itispossibletogaincontrolwithlessthanmajorityownershiporwithnoownershipatallInformalarrangementsFormalagreementsConsummationofawrittenagreementrequiresrecognitiononthebooksofoneormoreofthecompaniesthatareapartytothecombinationFrequencyofBusinessCombinations1960s-MergerboomConglomerates1980s-IncreaseinthenumberofbusinesscombinationsLeveragedbuyoutsandtheresultingdebt1990s-AllpreviousrecordsformergeractivityshatteredDownturnoftheearly2000s,anddeclineinmergersIncreasedactivitytowardthemiddleof2003thatacceleratedthroughthemiddleofthedecadeRoleofprivateequityEffectofthecreditcrunchof2007-2008OrganizationalStructureandFinancialReportingMerger-Abusinesscombinationinwhichtheacquiredcompany’sassetsandliabilitiesarecombinedwiththoseoftheacquiringcompanyresultsinnoadditionalorganizationalcomponentsFinancialreportingisbasedontheoriginalorganizationalstructureOrganizationalStructureandFinancialReportingControllingownership-Abusinesscombinationinwhichtheacquiredcompanyremainsasaseparatelegalentitywithamajorityofitscommonstockownedbythepurchasingcompanyleadstoaparent–subsidiaryrelationshipAccountingstandardsnormallyrequireconsolidatedfinancialstatementsOrganizationalStructureandFinancialReportingNoncontrollingownership-Thepurchaseofaless-than-majorityinterestinanothercorporationdoesnotusuallyresultinabusinesscombinationorcontrollingsituationOtherbeneficialinterest-OnecompanymayhaveabeneficialinterestinanotherentityevenwithoutadirectownershipinterestThebeneficialinterestmaybedefinedbytheagreementestablishingtheentityorbyanoperatingorfinancingagreementCreatingBusinessEntitiesThecompanytransfersassets,andperhapsliabilities,toanentitythatthecompanyhascreatedandcontrolsandinwhichitholdsmajorityownershipThecompanytransfersassetsandliabilitiestothecreatedentityatbookvalue,andthetransferringcompanyrecognizesanownershipinterestinthenewlycreatedentityequaltothebookvalueofthenetassetstransferredRecognitionoffairvaluesoftheassetstransferredinexcessoftheircarryingvaluesonthebooksofthetransferringcompanyisnotappropriateintheabsenceofanarm’s-lengthtransactionNogainsorlossesarerecognizedonthetransferbythetransferringcompanyCreatingBusinessEntitiesCreatingBusinessEntities:ExampleAllenCompanycreatesasubsidiary,Brainecompany,andtransfersthefollowingassetstoBlaineinexchangeforall100,000sharesofBlaine’s$2parcommonstock.(commonstockisissuedfortheassets)CreatingBusinessEntities:Example(cont’d)itemCostBookValueCash$70,000Inventory$50,00050,000Land75,00075,000Building100,00080,000Equipment250,000160,000$435,000

CreatingBusinessEntities:Example(cont’d)Allenrecordsthetransferwiththefollowingentry:InvestmentinBlaineCompanyCommonStock435,000AccumulatedDepreciation110,000Cash70,000Inventory50,000Land75,000Building100,000Equipment250,000$110,000=($100,000-$80,000)+($250,000-$160,000)

CreatingBusinessEntities:Example(cont’d)Cash70,000Inventory50,000Land75,000Building100,000Equipment250,000AccumulatedDepreciation110,000CommonStock,$2par200,000Additionalpaid-inCapital235,000BlaineCompanyrecordsthetransferofassetsandtheissuanceofstockatthebookvalueoftheassetstransferred:Ifthevalueofanassettransferredtoanewlycreatedentityhasbeenimpairedpriortothetransferanditsfairvalueislessthanthecarryingvalueonthetransferringcompany’sbooks,thetransferringcompanyshouldrecognizeanimpairmentlossandtransfertheassettothenewentityatthelowerfairvalueCreatingBusinessEntitiesFormsofBusinessCombinationsAstatutorymerger

Theacquiredcompany’sassetsandliabilitiesaretransferredtotheacquiringcompany,andtheacquiredcompanyisdissolved,orliquidatedTheoperationsofthepreviouslyseparatecompaniesarecarriedoninasinglelegalentityAstatutoryconsolidationBothcombiningcompaniesaredissolvedandtheassetsandliabilitiesofbothcompaniesaretransferredtoanewlycreatedcorporationFormsofBusinessCombinationsAstockacquisition

Onecompanyacquiresthevotingsharesofanothercompanyandthetwocompaniescontinuetooperateasseparate,butrelated,legalentitiesTheacquiringcompanyaccountsforitsownershipinterestintheothercompanyasaninvestmentParent–subsidiaryrelationshipForgeneral-purposefinancialreporting,aparentcompanyanditssubsidiariespresentconsolidatedfinancialstatementsthatappearlargelyasifthecompanieshadactuallymergedintooneFormsofBusinessCombinationsAACompanyBBCompanyAACompany(a)StatutoryMergerAACompanyBBCompanyCCCompanyAACompanyBBCompanyAACompanyBBCompany(b)StatutoryConsolidation(c)StockAcquisitionDeterminingtheTypeofBusinessCombinationAACompanyinvestsinBBCompanyAcquiresnetassetsAcquiresstockRecordasstatutorymergerorstatutoryconsolidationAcquiredcompanyliquidated?RecordasstockacquisitionandoperateassubsidiaryYesNoMethodsofEffectingBusinessCombinationsAcquisitionofassetsStatutoryMergerStatutoryConsolidationAcquisitionofstockAmajorityoftheoutstandingvotingsharesusuallyisrequiredunlessotherfactorsleadtotheacquirergainingcontrolNoncontrollinginterest:ThetotalofthesharesofanacquiredcompanynotheldbythecontrollingshareholderAcquisitionbyothermeansValuationofBusinessEntitiesValueofindividualassetsandliabilitiesValuedeterminedbyappraisalValueofpotentialearnings“Going-concernvalue”basedon:Amultipleofcurrentearnings.Presentvalueoftheanticipatedfuturenetcashflowsgeneratedbythecompany.ValuationofconsiderationexchangedValuationofLong-termLiabilities:ExampleIf$100,000of10-year,6percentbonds,payinginterestannually,hadbeenissuedatparthreeyearago,andthecurrentmarketrateofinterestforthesametypeofsecurityis10percent,thevalueoftheliabilitycurrentlyiscomputedasfollows:

Presentvaluefor7yearsat10%ofprinciplepaymentof$100,000($100,000×.51316)$51,316Presentvalueat10%of7interestpaymentof$6,000($6,000×4.86842)29,211Presentvalueofbond$80,527ValuationofPotentialEarnings:ExampleBargainCompanyisexpectedtogeneratecashflowsof$35,000foreachofthenext25years,thepresentvalueofthefirmatadiscountrateof10percentiscomputedasfollows:Annualcashflowgenerated$35,000Presentvaluefactorforanannuityof25annualpaymentsat10%×9.07704Presentvalueoffutureearnings$317,696AccountingforBusinessCombinationsTwomethodsacceptableearlier:PurchasePoolingofinterests2001-theFASBeliminatedpoolingofinterests2007-FASB141RreplacedthepurchasemethodwiththeacquisitionmethodThismustbeusedtoaccountforallbusinesscombinationsforwhichtheacquisitiondateisinfiscalyearsbeginningonorafterDecember15,2008FASB141RmaynotbeappliedretroactivelyAcquisitionAccountingTheacquirerrecognizesallassetsacquiredandliabilitiesassumedinabusinesscombinationandmeasuresthemattheiracquisition-datefairvaluesIflessthan100percentoftheacquireeisacquired,thenoncontrollinginterestalsoismeasuredatitsacquisition-datefairvalueFairvaluemeasurementTheFASBdecidedinFASB141RtofocusdirectlyonthevalueoftheconsiderationgivenAcquisitionAccountingPointstoconsider:NoseparateassetvaluationaccountsrelatedtoassetsacquiredarerecognizedLong-livedassetsclassifiedattheacquisitiondateasheldforsalearevaluedatfairvaluelesscosttosellDeferredincometaxesrelatedtothebusinesscombinationandassetsandliabilitiesrelatedtoanacquiree’semployeebenefitplansarevaluedinaccordancewiththerelevantFASBstandardsAcquisitionAccountingPointstoconsider:CostsofbringingaboutandconsummatingacombinationarechargedtoexpenseasincurredCostsofissuingequitysecuritiesusedtoacquiretheacquireearetreatedasareductioninthepaid-incapitalassociatedwiththesecuritiesGoodwillComponentsusedindetermininggoodwill:ThefairvalueoftheconsiderationgivenbytheacquirerThefairvalueofanyinterestintheacquireealreadyheldbytheacquirerThefairvalueofthenoncontrollinginterestintheacquiree,ifanyThetotalofthesethreeamounts,allmeasuredattheacquisitiondate,iscomparedwiththeacquisition-datefairvalueoftheacquiree’snetidentifiableassets,andthedifferenceisgoodwillGoodwill:example1AlbertacquiresalloftheassetsofZanforfor$400,000whenthefairvalueofZanfor’snetidentifiableassetsis$380,000.Fairvalueofconsiderationgiven$400,000Fairvalueofnetidentifiableassetsacquired(380,000)Goodwill$20,000

Goodwill:example2Albertacquires75%ofthecommonstockofZanforfor$300,000whenthefairvalueofZanfor’snetidentifiableassetsis$380,000.ThefairvalueoftheNCIis$100,000.Fairvalueofconsiderationgiven

$300,000FairvalueofNCI

100,000$400,000Fairvalueofnetidentifiableassetsacquired(380,000)Goodwill

$20,000

AcquisitionMethod-Illustration

Marketvalueofsharesissued $610,000Legalandappraisalfees $40,000Stockissuecosts $25,000PointCorporationacquiresalloftheassetsandassumesalloftheliabilitiesofSharpCompanyinastatutorymergerbyissuingtoSharp10,000sharesof$10parcommonstock.AcquisitionMethod-Illustration

AcquisitionMethod-Illustration

AcquisitionAccountingTestingforgoodwillimpairment:Whengoodwillarisesinabusinesscombination,itmustbeassignedtoindividualreportingunitsTotestforimpairment,thefairvalueofthereportingunitiscomparedwithitscarryingamountIfthefairvalueofthereportingunitexceedsitscarryingamount,thegoodwillofthatreportingunitisconsideredunimpairedIfthecarryingamountofthereportingunitexceedsitsfairvalue,animpairmentofthereportingunit’sgoodwillisimpliedAcquisitionAccountingTheamountofthereportingunit’sgoodwillimpairmentismeasuredastheexcessofthecarryingamountoftheunit’sgoodwillovertheimpliedvalueofitsgoodwillTheimpliedvalueofitsgoodwillisdeterminedastheexcessofthefairvalueofthereportingunitoverthefairvalueofitsnetassetsexcludinggoodwillGoodwillimpairmentlossesarerecognizedinincomefromcontinuingoperationsorincomebeforeextraordinarygainsandlossesExample:GoodwillImpairment

ReportingunitAisassigned$100,000ofgoodwillarisingfromabusinesscombination.ThefollowingassetsandliabilitiesareassignedtoReportingUnitA:ItemCarryingAmountFairValueCashandreceivables$50,000$50,000Inventory80,00090,000Equipment120,000150,000Goodwill100,000Totalassets$350,000$290,000Currentpayables(10,000)(10,000)Netassets$340,000$280,000Example:GoodwillImpairmentIfthefairvalueofthereportingunitisestimatedtobe$360,000,noimpairmentofgoodwillisindicated.Ifthefairvalueofthereportingunitisestimatedtobe$320,000,asecondcomparisonmustbemadetodeterminetheamountofimpairmentloss.

Fairvalueoftheunit--Fairvalueofnetassets(excludinggoodwill)=ImpliedvalueofGoodwillCarryingvalueofgoodwill–Impliedvalueofgoodwill=ImpairmentLoss$100,000–($320,000-$280,000)=$60,000AcquisitionAccountingBargainPurchaseResultswhenthefairvalueoftheconsiderationgiven,alongwiththefairvalueofanyequityinterestintheacquireealreadyheldandthefairvalueofanynoncontrollinginterestintheacquiree,islessthanthefairvalueoftheacquiree’snetidentifiableassetsIfacquisition-datevaluationsareappropriate,theacquirerrecognizesagainatthedateofacquisitionTheamountofthegainmustbedisclosed,alongwithwherethegainisreportedandthefactorsthatledtoitNote:FASB141RdoesnotstateatreatmentforthesituationoppositetothatofabargainpurchaseBargainPurchase:exampleInthepreviousexample,PointisabletoacquireSharpfor$500,000casheventhoughthefairvalueofSharp’snetidentifiableassetsisestimatedtobe$510,000.Thefollowingentryreplacesentry(6)CashandReceivables45,000Inventory75,000Land70,000BuildingsandEquipment350,000Patent80,000Cash500,000Currentliablilities110,000GainonBargainpurchaseofS10,000AcquisitionAccountingCombinationeffectedthroughacquisitionofstockTheacquiredcompanycontinuestoexist,andtheacquirerrecordsaninvestmentinthecommonstockoftheacquireeratherthanitsindividualassetsandliabilitiesTheacquirerrecordsitsinvestmentintheacquiree’scommonstockatthetotalfairvalueoftheconsiderationgiveninexchangeTheacquireemaycontinuetooperateasaseparatecompany,oritmayloseitsseparateidentityandbemergedintotheacquiringcompanyExample:CombinationEffectthroughAcquisitionofStockPointCorporationexchanges10,000sharesofitsstockwithatotalmarketvalueof$610,000forallthesharesofSharpCompanyinapurchasetransactionandincursmergercostsof$40,000andstockissuecostsof$25,000.MergerExpense40,000DeferredStockissueCosts25,000 Cash65,000RecordmergerandstockissuecostsrelatedtoacquisitionofSharp.InvestmentinSharpStock 610,000 CommonStock 100,000 AdditionalPaid-InCapital 485,000 DeferredStockIssueCosts 25,000

RecordacquisitionofSharpstock.Example:CombinationEffectedthroughAcquisitionofStock(Cont’d.)NOTE:Withrespecttothepreviousslide,identifiableassetsandliabilitiesarenotrecordedatthedateofthebusinesscombinationsinceSharpisnotdissolved.AcquisitionAccountingFinancialreportingsubsequenttoabusinesscombinationFinancialstatementspreparedsubsequenttoabusinesscombinationreflectthecombinedentityonlyfromthedateofcombinationWhenacombinationoccursduringafiscalperiod,incomeearnedbytheacquireepriortothecombinationisnotreportedintheincomeofthecombinedenterpriseAcquisitionAccountingToillustratefinancialreportingsubsequenttoabusinesscombination,assumethefollowinginformationforPointCorporationandSharpCompany:PointacquiresallofSharp’sstockatbookvalueonJanuary1,20X1,byissuing10,000sharesofcommonstock.ThenetincomeandearningspersharethatPointpresentsinitscomparativefinancialstatementsforthetwoyearsareasfollows:AcquisitionAccounting

AdditionalConsiderationsinAccountingforBusinessCombinationsUncertaintyinbusinesscombinationsMeasurementPeriodFASB141RallowsforthisperiodoftimetoproperlyascertainfairvaluesTheperiodendsoncetheacquirerobtainsthenecessaryinformationaboutthefactsasoftheacquisitiondateMaynotexceedoneyearMeasurementPeriod:exampleLand10,000Goodwill10,000Adjustacquisition-datevalueoflandacquiredinbusinesscombination.BaineCompanyacquireslandinabusinesscombinationandprovisionallyrecordsthelandatitsestimatedfairvalueof$100,000.Duringthemeasurementperiod,Brainreceivesareliableappraisalthatthelandwasworth$110,000attheacquisitiondate.MeasurementPeriod:exampleImpairmentLoss35,000Land35,000Recognizedeclineinvalueoflandheld.Subsequently,duringthesameaccountingperiod,achangeinthezoningofaneighboringparceloflandreducesthevalueofthelandacquiredbyB