Financial Accounting and Accounting Standards

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• Introduction to Business
• Combinations and the
• Conceptual Framework

Advanced Accounting, Fourth Edition
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Learning Objectives

1. Describe historical trends in types of business
   combinations.
2. Identify the major reasons firms combine.
3. Identify the factors that managers should
   consider in exercising due diligence in business
   combinations.
4. Identify defensive tactics used to attempt to
   block business combinations.
5. Distinguish between an asset and a stock
   acquisition.
6. Indicate the factors used to determine the price
   and the method of payment for a business
   combination.
7. Calculate an estimate of the value of goodwill to
   be included in an offering price by discounting
   expected future excess earnings over some period
   of years.
8. Describe the two alternative views of
   consolidated financial statements the economic
   entity and the parent company concepts.
9. List and discuss each of the seven Statements of
   Financial Accounting Concepts (SFAC).
10. Describe some of the current joint projects of
    the FASB and the International Accounting
    Standards Board (IASB), and their primary
    objectives.

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Introduction

• On December 4, 2007, FASB released two new
  standards,
• FASB Statement No. 141 R, Business Combinations,
  and
• FASB Statement No. 160, Noncontrolling Interests
  in Consolidated Financial Statements.
• These standards
• Became effective for years beginning after
  December 15, 2008, and
• Are intended to improve the relevance,
  comparability and transparency of financial
  information related to business combinations, and
  to facilitate the convergence with international
  standards.

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Business Combinations Why? Why Not?
Advantages of External Expansion

1. Rapid expansion
2. Operating synergies
3. International marketplace
4. Financial synergy
5. Diversification
6. Divestitures

LO 2 Reasons firms combine.
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Terminology and Types of Combinations
What Is Acquired?
What Is Given Up?
Net assets of S Company (Assets and Liabilities)

• Cash
• 2. Debt
• 3. Stock
• Combination of above

Figure 1-1
Common Stock of S Company

• Asset acquisition, a firm must acquire 100 of
  the assets of the other firm.
• Stock acquisition, control may be obtained by
  purchasing 50 or more of the voting common stock
  (or possibly less).

LO 5 Distinguish between an asset and a stock
acquisition.
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Terminology and Types of Combinations
Possible Advantages of Stock Acquisition

• Lower total cost.
• Direct formal negotiations may be avoided.
• Maintaining the acquired firm as a separate legal
  entity.
• Liability limited to the assets of the individual
  corporation.
• Greater flexibility in filing individual or
  consolidated tax returns.

LO 5 Distinguish between an asset and a stock
acquisition.
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Terminology and Types of Combinations
Classification by Method of Acquisition
Statutory Merger
A Company
B Company
A Company


One company acquires all the net assets of
another company. The acquiring company survives,
whereas the acquired company ceases to exist as a
separate legal entity.
LO 5 Distinguish between an asset and a stock
acquisition.
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Terminology and Types of Combinations
Classification by Method of Acquisition
Statutory Consolidation
A Company
B Company
C Company


A new corporation is formed to acquire two or
more other corporations through an exchange of
voting stock the acquired corporations then
cease to exist as separate legal
entities. Stockholders of A and B become
stockholders in C.
LO 5 Distinguish between an asset and a stock
acquisition.
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Terminology and Types of Combinations
Classification by Method of Acquisition
Consolidated Financial Statements
Consolidated Financial Statements of A Company
and B Company
Financial Statements of A Company
Financial Statements of B Company


When a company acquires a controlling interest in
the voting stock of another company, a
parentsubsidiary relationship results.
LO 5 Distinguish between an asset and a stock
acquisition.
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Takeover Premiums
Takeover Premium the excess amount agreed upon
in an acquisition over the prior stock price of
the acquired firm. Possible reasons for the
premiums

• Acquirers stock prices may be at a level which
  makes it attractive to issue stock in the
  acquisition.
• Credit may be generous for mergers and
  acquisitions.
• Bidders may believe target firm is worth more
  than its current market value.
• Acquirer may believe growth by acquisitions is
  essential and competition necessitates a premium.

LO 5 Distinguish between an asset and a stock
acquisition.
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Alternative Concepts
Consolidated Net Income
Parent Company Concept, consolidated net income
consists of the combined income of the parent
company and its subsidiaries after deducting the
noncontrolling interest in income as an expense
in determining consolidated net income. Economic
Entity Concept, consolidated net income consists
of the total combined income of the parent
company and its subsidiaries. Total combined
income is then allocated proportionately to the
noncontrolling interest and the controlling
interest.
LO 8 Economic entity and parent company concepts.
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Alternative Concepts
Consolidated Balance Sheet Values
Parent Company Concept, the net assets of the
subsidiary are included in the consolidated
financial statements at their book value plus the
parent companys share of the difference between
fair value and book value on the date of
acquisition. Economic Entity Concept, on the date
of acquisition, the net assets of the subsidiary
are included in the consolidated financial
statements at their book value plus the entire
difference between their fair value and their
book value.
LO 8 Economic entity and parent company concepts.
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Conceptual Framework
SFAC Nos. 1 2 Objectives Provide
Information 1. Usefulness in investment and
credit decisions 2. Usefulness in future cash
flows 3. About enterprise resources, claims to
resources, and changes
Objectives
Figure 1-2 Conceptual Framework for Financial
Accounting and Reporting
SFAC No. 2 Qualitative Characteristics 1.
Relevance 2. Reliability 3. Comparability 4.
Consistency AlsoUsefulness,Understandability
SFAC No. 6 (replaced SFAC No. 3) Elements of
Financial Statements Provides definitions of key
components of financial statements
Fundamental
SFAC No. 5 7 Recognition and Measurement
Operational

• PRINCIPLES
• Historical cost
• Revenue recognition
• Matching
• Full disclosure

• Assumptions
• Economic entity
• Going concern
• Monetary unit
• Periodicity

• Constraints
• Cost-benefit
• Materiality
• Industry practice
• Conservatism

• Principles
• Historical cost
• Revenue recognition
• Matching
• Full disclosure

SFAC No. 7 Using future cash flows present
values in accounting measures
LO 8 Economic entity and parent company concepts.
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FASBs Conceptual Framework
Economic Entity vs. Parent Concept and the
Conceptual Framework
The parent concept is tied to the historical cost
principle, which would suggest that the net
assets related to the noncontrolling interest
remain at their previous book values. This
approach might be argued to produce more
reliable values (SFAC No. 2).
LO 8 Economic entity and parent company concepts.
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FASBs Conceptual Framework
Economic Entity vs. Parent Concept and the
Conceptual Framework
The economic entity assumption views a parent and
its subsidiaries as one economic entity even
though they are separate legal entities. The
economic entity concept is an integral part of
the FASBs conceptual framework and is named
specifically in SFAC No. 5 as one of the basic
assumptions in accounting.
LO 8 Economic entity and parent company concepts.
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2

• Accounting for Business Combinations

Advanced Accounting, Fourth Edition
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Learning Objectives

1. Describe the major changes in the accounting for
   business combinations passed by the FASB in
   December 2007, and the reasons for those changes.
2. Describe the two major changes in the accounting
   for business combinations approved by the FASB in
   2001, as well as the reasons for those changes.
3. Discuss the goodwill impairment test described in
   SFAS No. 142 ASC 3502035, including its
   frequency, the steps laid out in the new
   standard, and some of the likely implementation
   problems.
4. Explain how acquisition expenses are reported.
5. Describe the use of pro forma statements in
   business combinations.
6. Describe the valuation of assets, including
   goodwill, and liabilities acquired in a business
   combination accounted for by the acquisition
   method.
7. Explain how contingent consideration affects the
   valuation of assets acquired in a business
   combination accounted for by the acquisition
   method.
8. Describe a leveraged buyout.
9. Describe the disclosure requirements according to
   SFAS No. 141R ASC 8051050, Business
   Combinations, related to each business
   combination that takes place during a given year.
10. Describe at least one of the differences between
    U.S. GAAP and IFRS related to the accounting for
    business combinations.

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Perspective on Business Combinations

• Goodwill Impairment Test
• SFAS No. 142 ASC 350-20-35 requires impairment
  be tested annually.
• All goodwill must be assigned to a reporting
  unit.
• Impairment should be tested in a two-step process.

Step 1 If fair value is less than the carrying
amount of the net assets (including goodwill),
then perform a second step to determine possible
impairment. Step 2 Determine the fair value of
the goodwill (implied value of goodwill) and
compare to carrying amount.
LO 3 Goodwill impairment assessment.
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Perspective on Business Combinations
LO 3
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Perspective on Business Combinations
E2-10 On January 1, 2010, Porsche Company
acquired the net assets of Saab Company for
450,000 cash. The fair value of Saabs
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

Not including goodwill
LO 3 Goodwill impairment assessment.
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Perspective on Business Combinations
E2-10 On January 1, 2010, the acquisition
date, what was the amount of goodwill acquired,
if any?
Acquisition price 450,000
Fair value of identifiable net assets 375,000
Recorded value of Goodwill 75,000
LO 3 Goodwill impairment assessment.
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Perspective on Business Combinations

• Disclosures Mandated by FASB
• SFAS No. 141R ASC 805 requires
• Total amount of acquired goodwill and the amount
  expected to be deductible for tax purposes.
• Amount of goodwill by reporting segment (in
  accordance with SFAS No. 131 ASC 280,
  Disclosures about Segments of an Enterprise and
  Related Information), unless not practicable.

LO 3 Goodwill impairment assessment.
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Perspective on Business Combinations

• Disclosures Mandated by FASB
• SFAS No. 142 ASC 350-20-45 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.

LO 3 Goodwill impairment assessment.
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Perspective on Business Combinations

• Disclosures Mandated by FASB
• When an impairment loss occurs, SFAS No. 142 ASC
  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.

LO 3 Goodwill impairment assessment.
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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.
• Indefinite life
• Should not be amortized.
• Should be tested annually (minimum) for
  impairment.

LO 3 Goodwill impairment assessment.
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Pro Forma Statements and Disclosure Requirement

• If a material business combination occurred,
  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.

LO 5 Use of pro forma statements.
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Explanation and Illustration of Acquisition
Accounting

• Four steps in the accounting for a business
  combination
• Identify the acquirer.
• Determine the acquisition date.
• Measure the fair value of the acquiree.
• Measure and recognize the assets acquired and
  liabilities assumed.

LO 6 Valuation of acquired assets and
liabilities assumed.
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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 fair value
  amounts assigned to identifiable assets and
  liabilities is recorded as goodwill.
• SFAS No. 141R ASC 805-20, states in-process RD
  is measured and recorded at fair value as an
  asset on the acquisition date.

LO 6 Valuation of acquired assets and
liabilities assumed.
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Explanation and Illustration of Acquisition
Accounting
E2-1 Preston Company acquired the assets
(except for cash) and assumed the liabilities of
Saville Company. Immediately prior to the
acquisition, Saville Companys balance sheet was
as follows
Any Goodwill?
LO 6 Valuation of acquired assets and
liabilities assumed.
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Explanation and Illustration of Acquisition
Accounting
E2-1 Preston Company acquired the assets
(except for cash) and assumed the liabilities of
Saville Company. Immediately prior to the
acquisition, Saville Companys balance sheet was
as follows
Fair value of assets, without cash 1,824,000
LO 6 Valuation of acquired assets and
liabilities assumed.
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Explanation and Illustration of Acquisition
Accounting
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.
Calculation of Goodwill
Fair value of assets, without cash 1,824,000
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Price paid 1,560,000
Goodwill 330,000
LO 6 Valuation of acquired assets and
liabilities assumed.
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Explanation and Illustration of Acquisition
Accounting
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.
Receivables 228,000
Inventory 396,000
Plant and equipment 540,000
Land 660,000
Goodwill 330,000
Liabilities 594,000
Cash 1,560,000
LO 6 Valuation of acquired assets and
liabilities assumed.
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IFRS Versus U.S. GAAP

• The project on business combinations
• Was the first of several joint projects
  undertaken by the FASB and the IASB.
• Complete convergence has not yet occurred.
• International standards currently allow a choice
  between
• writing all assets, including goodwill, up fully
  (100 including the noncontrolling share), as
  required now under U.S. GAAP, or
• continuing to write goodwill up only to the
  extent of the parents percentage of ownership.

LO 10 Differences between U.S. GAAP and IFRS .
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IFRS Versus U.S. GAAP
Other differences and similarities
LO 10 Differences between U.S. GAAP and IFRS .
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IFRS Versus U.S. GAAP
Other differences and similarities
LO 10 Differences between U.S. GAAP and IFRS .
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IFRS Versus U.S. GAAP
Other differences and similarities
LO 10 Differences between U.S. GAAP and IFRS .
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IFRS Versus U.S. GAAP
Other differences and similarities
LO 10 Differences between U.S. GAAP and IFRS .
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IFRS Versus U.S. GAAP
Other differences and similarities
LO 10 Differences between U.S. GAAP and IFRS .