Acknowledgement

These slides have been adapted from:

Advanced Accounting by Jeter, Debra C.,

Chaney, Paul K. [Wiley,2011] 5TH EDITION

Slide
2-1
 2
Accounting for Business
Combinations

Advanced Accounting, Fifth Edition

Slide
2-2
 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 350–20–35], 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 Current GAAP 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.

Slide
2-3
Historical Perspective on Business Combinations

What Changed? Issued December 2007

SFAS No. 141R [ASC 805], “Business Combinations,”

replaced FASB Statement No. 141.
Continues to support 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.

Slide
2-4
LO 1 FASB’s two major changes for business combinations.
Historical Perspective on Business Combinations

What Changed? Issued December 2007

[ASC 810], “Noncontrolling Interests In Consolidated

Financial Statements,” replaced Accounting Research Bulletin
(ARB) No. 51.

Establishes standards for the reporting of the

noncontrolling interest when the acquirer obtains control
without purchasing 100% of the acquiree.

Additional discussion in Chapter 3.

Slide
2-5
LO 1 FASB’s two major changes for business combinations.
Historical Perspective on Business Combinations

Historically, two methods permitted in the U.S.:

purchase and pooling of interests.

Pronouncements in June 2001:

1. SFAS No. 141, “Business Combinations,” - pooling method
is prohibited for business combinations initiated after
June 30, 2001.
2. SFAS No. 142, “Goodwill and Other Intangible Assets,” -
Goodwill acquired in a business combination after June 30,
2001, should not be amortized.

Slide
2-6
LO 2 FASB’s two major changes of 2001.
Perspective on Business Combinations

Goodwill Impairment Test

FASB ASC paragraph 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: Does potential impairment exist?

Step 2: What is the amount of goodwill impairment?

Tested as CGU (Cash Generating Unit)  See IAS 36/PSAK

48 : Penurunan Nilai

Slide
2-7
LO 3 Goodwill impairment assessment.
 Perspective on
Business
Combinations

Slide
2-8 LO 3
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
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:

Present Value Carry Value Fair Value

of Future of SAAB's of SAAB's
Year Cash Flows Net Assets * Net Assets
2011 $ 400,000 $ 330,000 $ 340,000
2012 $ 400,000 $ 320,000 $ 345,000
2013 $ 350,000 $ 300,000 $ 325,000

* Not including goodwill

Slide
2-9
LO 3 Goodwill impairment assessment.
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

Slide
2-10
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

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).

Step 1 - 2011
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets 330,000
Carrying value of goodwill 75,000
Total carrying value of unit 405,000
Excess of carrying value over fair value $ 5,000

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

Slide
2-11
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

E2-10: Part A&B (continued)

Step 2 - 2011
Fair value of reporting unit $400,000
Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Carrying value of goodwill 75,000
Impairment loss $ 15,000

Journal Impairment loss 15,000

Entry Goodwill 15,000

Slide
2-12
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

E2-10: Part A&B (continued)

Step 1 - 2012
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets 320,000
Carrying value of goodwill 60,000 *
Total carrying value of unit 380,000
Excess of fair value over carrying value $ 20,000

Excess of fair value over carrying value means step 2 is not required.
* $75,000 (original goodwill) – $15,000 (prior year impairment)
Slide
2-13
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

E2-10: Part A&B (continued)

Step 1 - 2013
Fair value of reporting unit $350,000
Carrying value of unit:
Carrying value of identifiable net assets 300,000
Carrying value of goodwill 60,000 *
Total carrying value of unit 360,000
Excess of carrying value over fair value $ 10,000

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

* $75,000 (original goodwill) – $15,000 (prior year impairment)
Slide
2-14
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

E2-10: Part A&B (continued)

Step 2 - 2013
Fair value of reporting unit $350,000
Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Carrying value of goodwill 60,000
Impairment loss $ 35,000

Journal Impairment loss 35,000

Entry Goodwill 35,000

Slide
2-15
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

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).

Slide
2-16
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

Disclosures Mandated by FASB

FASB ASC paragraph 805-30-50-1 requires:
1. Total amount of acquired goodwill and the amount
expected to be deductible for tax purposes.

2. Amount of goodwill by reporting segment (if the

acquiring firm is required to disclose segment
information), unless not practicable.

Slide
2-17
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

Disclosures Mandated by FASB

FASB ASC paragraph 350-20-45-1 specifies the
presentation of goodwill (if impairment occurs):
a. Aggregate amount of goodwill should be a separate line
item in the balance sheet.
b. 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).
Slide
2-18
LO 3 Goodwill impairment assessment.
Perspective on Business Combinations

Disclosures Mandated by FASB

When an impairment loss occurs, FASB ASC paragraph
350-20-50-2 mandates note disclosure:
1. Description of facts and circumstances leading to the
impairment.

2. Amount of impairment loss and method of determining the

fair value of the reporting unit.

3. Nature and amounts of any adjustments made to

impairment estimates from earlier periods, if significant.

Slide
2-19
LO 3 Goodwill impairment assessment.
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.

Slide
2-20
LO 3 Goodwill impairment assessment.
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.

Slide
2-21
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.

Indefinite life
 Should not be amortized.
 Should be tested annually (minimum) for impairment.

Slide
2-22
LO 3 Goodwill impairment assessment.
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 also 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.
Slide
2-23
LO 4 Reporting acquisition expenses.
Perspective on Business Combinations

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 direct and indirect costs.

Professional Fees Expense (Direct) 1,500

Merger Department Expense (Indirect) 2,000
Other Contributed Capital (Security Issue Costs) 3,000
Cash 6,500
Slide
2-24
LO 4 Reporting acquisition expenses.
Pro Forma Statements and Disclosure Requirement

Pro forma statements serve two functions in relation

to business combinations:

1) to provide information in the planning stages of

the combination and

2) to disclose relevant information subsequent to

the combination.

Slide
2-25
LO 5 Use of pro forma statements.
Pro Forma Statements and Disclosure Requirement

Illustration 2-1
Slide
2-26
LO 5 Use of pro forma statements.
Pro Forma Statements and Disclosure Requirement

If a material business combination occurred, notes to

financial statements should include on a pro forma basis:

1. Results of operations for the current year as though the

companies had combined at the beginning of the year.

2. Results of operations for the immediately preceding

period as though the companies had combined at the
beginning of that prior period if comparative financial
statements are presented.

Slide
2-27
LO 5 Use of pro forma statements.
Explanation and Illustration of Acquisition Accounting

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.

Slide
2-28
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.
 Under current GAAP, in-process R&D is measured and
recorded at fair value as an asset on the acquisition date.

Slide
2-29
LO 6 Valuation of acquired assets and liabilities assumed.
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 Company’s balance sheet was as follows:

Any
Goodwill?

Slide
2-30
LO 6 Valuation of acquired assets and liabilities assumed.
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 Company’s balance sheet was as follows:

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

Slide
2-31
LO 6 Valuation of acquired assets and liabilities assumed.
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

Slide
2-32
LO 6 Valuation of acquired assets and liabilities assumed.
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
Slide
2-33
LO 6 Valuation of acquired assets and liabilities assumed.
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 a gain.
Current standards require:
 fair values be considered carefully and adjustments
made as needed.
 any excess of acquisition-date fair value of net assets
over the consideration paid is recognized in income.
Slide
2-34
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation and Illustration of Acquisition Accounting

Bargain Acquisition Illustration

When the price paid to acquire another firm is lower than the
fair value of identifiable net assets (assets minus liabilities),
the acquisition is referred to as a bargain.
Any previously recorded goodwill on the seller’s books is
eliminated (and no new goodwill recorded).

A gain is reflected in current earnings of the acquiree to the

extent that the fair value of net assets exceeds the
consideration paid.

Slide
2-35
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation and Illustration of Acquisition Accounting

E2-1: B. Repeat the requirement in (A) assuming that the

amount paid was $990,000.

Calculation of Goodwill or Bargain Purchase

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 990,000
Bargain purchase $ 240,000

Slide
2-36
LO 6 Valuation of acquired assets and liabilities assumed.
Explanation and Illustration of Acquisition Accounting

E2-1: B. Repeat the requirement in (A) assuming that the

amount paid was $990,000.

Receivables 228,000
Inventory 396,000
Plant and equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on acquisition (ordinary) 240,000

Slide
2-37
LO 6 Valuation of acquired assets and liabilities assumed.
 Contingent Consideration in an Acquisition

Purchase agreements may provide that the purchasing

company will give additional consideration to the seller
if certain future events or transactions occur.

The contingency may require

 the payment of cash (or other assets) or
 the issuance of additional securities.

Current GAAP requires that all contractual contingencies, as well

as non-contractual liabilities for which it is more likely than not
that an asset or liability exists, be measured and recognized at
fair value on the acquisition date.

Slide
2-38
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Illustration: P Company acquired all the net assets of S

Company in exchange for P Company’s common stock. P Company
also agreed to pay an additional $150,000 to the former
stockholders of S Company if the average post-combination
earnings over the next two years equaled or exceeded
$800,000. Assume that goodwill was recorded in the original
acquisition transaction. To complete the recording of the
acquisition, P Company will make the following entry:

Goodwill 150,000
Liability for Contingent Consideration 150,000

Slide
2-39
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Illustration: Assuming that the target is met, P Company will

make the following entry:

Liability for Contingent Consideration 150,000

Cash 150,000

On the other hand, assume that the target is not met. The
adjustment will flow through the income statement
in the subsequent period, as follows:

Liability for Contingent Consideration 150,000

Income from Change in Estimate 150,000

Slide
2-40
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Illustration: P Company acquired all the net assets of S

Company in exchange for P Company’s common stock. P Company
also agreed to issue additional shares of common stock to the
former stockholders of S Company if the average post-
combination earnings over the next two years equalled or
exceeded $800,000. Assume that the contingency is expected
to be met, and goodwill was recorded in the original acquisition
transaction. Based on the information available at the
acquisition date, the additional 10,000 shares (par value of $1
per share) expected to be issued are valued at $150,000. To
complete the recording of the acquisition, P Company will make
the following entry:
Goodwill 150,000
Paid-in-Capital for Contingent Consideration 150,000
Slide
2-41
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Illustration: Assuming that the target is met, but the stock

price has increased from $15 per share to $18 per share at
the time of issuance, P Company will not adjust the original
amount recorded as equity. Thus, P Company will make the
following entry

Paid-in-Capital for Contingent Consideration 150,000

Common Stock ($1 par) 10,000
Paid-in-Capital in Excess of Par 140,000

Slide
2-42
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Adjustments During the Measurement Period

The measurement period is the period after the initial
acquisition date during which the acquirer may adjust the
provisional amounts recognized at the acquisition date.

The measurement period ends as soon as the acquirer has

the needed information about facts and circumstances
(or learns that the information is unobtainable), not to
exceed one year from the acquisition date.

Slide
2-43
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Contingency Based on Outcome of a Lawsuit

Consideration contingently issuable may depend on both

 future earnings and

 future security prices.
In such cases, an additional cost of the acquired company
should be recorded for all additional consideration
contingent on future events, based on the best available
information and estimates at the acquisition date (as
adjusted by the end of the measurement period).

Slide
2-44
LO 7 Contingent consideration and valuation of assets.
 Contingent Consideration in an Acquisition

Review Question
Which of the following statements best describes the current authoritative
position with regard to accounting for contingent consideration?
a. If contingent consideration depends on both future earnings and future
security prices, an additional cost of the acquired company should be
recorded only for the portion of consideration dependent on future
earnings.
b. The measurement period for adjusting provisional amounts always ends
at the year-end of the period in which the acquisition occurred.
c. A contingency based on security prices has no effect on the
determination of cost to the acquiring company.
d. The purpose of the measurement period is to provide a reasonable time
to obtain the information necessary to identify and measure the fair
value of the acquiree’s assets and liabilities, as well as the fair value of
the consideration transferred.
Slide
2-45
LO 7 Contingent consideration and valuation of assets.
 Leveraged Buyouts

A leveraged buyout (LBO) occurs when a group of

employees (generally a management group) and third-party
investors create a new company to acquire all the
outstanding common shares of their employer company.

 The management group contributes the stock they hold

to the new corporation and borrows sufficient funds to
acquire the remainder of the common stock.

 The old corporation is merged into the new corporation.

 The essence of the change suggests that the economic

entity concept should be applied; thus (LBO) transactions
are to be viewed as business combinations.
Slide
2-46
LO 8 Leverage buyouts.
 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 parent’s percentage of ownership.

Slide
2-47
LO 10 Differences between U.S. GAAP and IFRS .
 IFRS Versus U.S. GAAP
Other differences and similarities:

Slide
2-48
LO 10 Differences between U.S. GAAP and IFRS .
 IFRS Versus U.S. GAAP
Other differences and similarities:

Slide
2-49
LO 10 Differences between U.S. GAAP and IFRS .
 IFRS Versus U.S. GAAP
Other differences and similarities:

Slide
2-50
LO 10 Differences between U.S. GAAP and IFRS .
 IFRS Versus U.S. GAAP
Other differences and similarities:

Slide
2-51
LO 10 Differences between U.S. GAAP and IFRS .
 IFRS Versus U.S. GAAP
Other differences and similarities:

Slide
2-52
LO 10 Differences between U.S. GAAP and IFRS .
 Deferred Taxes in Business Combinations

To the extent that the seller accepts APPENDIX A

common stock rather than cash or debt
in exchange for the assets, the sellers may not have to pay
taxes until a later date when the shares accepted are sold.
When the acquirer has inherited the book values of the
assets for tax purposes but has recorded market values
for reporting purposes, a deferred tax liability needs to be
recognized.

Slide
2-53
 Deferred Taxes in Business Combinations

Illustration: Taxaware Company has net assets totaling

$700,000 (market value), including fixed assets with a market
value of $200,000 and a book value of $140,000. The book values
of all other assets approximate market values. Taxaware Company
is acquired by Blinko in a combination that qualifies as a
nontaxable exchange for Taxaware shareholders. Blinko issues
common stock valued at $800,000 (par value $150,000). First, if
we disregard tax effects, the entry to record the acquisition
would be:

Assets 700,000
Goodwill 100,000
Common Stock 150,000
Additional Contributed Capital 650,000
Slide
2-54
 Deferred Taxes in Business Combinations

Illustration: Now consider tax effects, assuming a 30% tax rate.

First, the excess of market value over book value of the fixed
assets creates a deferred tax liability because the excess
depreciation is not tax deductible. Thus, the deferred tax
liability associated with the fixed assets equals 30% $60,000
(the difference between market and book values), or $18,000.
The inclusion of deferred taxes would increase goodwill by
$18,000 to a total of $118,000. The entry to include goodwill is
as follow:
Assets 700,000
Goodwill 118,000
Deferred Tax Liability 18,000
Common Stock 150,000
Additional Contributed Capital 650,000
Slide
2-55
 Copyright

Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.

Slide
2-56