Financial Reporting Issues in
M&A
Case: Impairing the Microsoft/Nokia
Pairing
Deal (Example)
Hardin to issue 100,000 shares for 40,000 shares of Pratt
Hardin Tool Pratt Engineering
Company No inter company transactions Company
Appraised value of Net Assets: $600,000
New public offering of 100,000 Asset’s book value: $441,000
shares of Hardin can be made
public at $8 per share
2
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Assets
Current assets $432 $246 39% 44%
Plant and equipment 690 312 61% 56%
Total assets $1,122 $558 100% 100%
Liabilities and Equities
Current liabilities $263 107 23% 19%
Long-term debt 195 10 17% 2%
Common stock ($1 par) 100 40 9% 7%
Additional paid-in capital 218 94 19% 17%
Retained earnings 346 307 31% 55%
Total liabilities and equity $1,122 $558 100% 100% 3
Pooling vs. Purchase Method
Condensed Income Statement as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Sales $2,100 1500 100% 100%
Expenses 1620 1120 77% 75%
Income $480 $380 23% 25%
Income tax expense 168 133 8% 9%
Net income $312 $247 15% 16%
4
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
Hardin Pratt Pooling Purchase
Assets
Current assets $432 $246 $678 $678
Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441)
Goodwill 200 (100,000*8=800,000)-$600,000
Total assets $1,122 $558 $1,680 $2,039
Liabilities and Equities
Current liabilities $263 107 $370 $370
Long-term debt 195 10 $205 $205
Common stock ($1 par) 100 40 $200 $200
Additional paid-in capital 218 94 $252 $918 plug in
Retained earnings 346 307 $653 346
Total liabilities and equity $1,122 $558 $1,680 $2,039
5
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed
Hardin Pratt Polling Purchase
Sales $2,100 1500 $3,600 $3,600
Expenses 1620 1120 $2,740 $2,740
Income $480 $380 $860 $860
Additional depreciation $16 $159,000/10 years = 16,000
Taxable income $860 $844
Income tax expense $301.0 $295.4
Net income $559.0 $548.6
Earnings Per Share $2.80 $2.74
Life of plant and equipment: 10 years
Depreciation method: Straight line depreciation 6
Income tax rate: 35%
Conditions for Amalgamation in the Nature
of Merger (AS 14)
Shareholders of the transferor Consideration payable to the
All the assets and liabilities of the company holding not less than shareholders of the transferor
transferor company become the 90% of the face value of equity company should be paid through
assets and liabilities of the shares, including subsidiaries, issue of shares in the transferee
transferee company become the shareholders of the company. Fractional shares, if any,
transferee company can however be paid for in cash
The assets and liabilities of the
transferor company are
Transferee has the intention of incorporated into the balance
Combining companies must be
carrying on the business of the sheet of the transferee company.
autonomous
target Also the assets and liabilities
should be shown using uniform
accounting policies
7
Conditions for Amalgamation in the Nature
of Merger (AS 14)
Combining Single transaction Exchange of
companies must or transaction in common stock not
be independent one year less than 90%
No shares
No change in
No equity changes reacquired for
proportionate
in contemplation purpose of
equity interest
combination
8
Conditions for Amalgamation in the Nature
of Merger (AS 14)
Combining may not agree
Voting rights immediately Combination resolved at to reacquire or retire any of
exercisable consummation the stock issued to effect
the combination
Combined company may
Combined company may
not plan to dispose of
not enter into any
substantial amounts of
agreement for the benefit
assets of the combining
of former shareholders of
companies within two
the combining companies
years of combination
9
Identifying Acquirer
Power to cast Ability to
Power to appoint
>1/2 voting rights majority of voting determine
or remove
in combined entity in meetings of combine entities
majority of BOM
BOD management team
Fair value of Terms of Specific voting
Other conditions
companies arrangements rights provided
Statutory Options or
requirements warrants on issue
10
Intangible Asset Classification and Impairment
Test Requirements
Intangible Assets
Indefinite Useful Life Determinable Useful Life
No Amortization Amortization over useful
Required Life
Should do Impairment (Impairment test if
Testing (Annually or on indication of
Indication) impairment)
11
Impairment Model
New Carrying
Amount (After
Written Down)
Lowest of…
Carrying
Recoverable
Amount Before
Amount
the Impairment
Highest of..
Price agreed in a binding sales agreement Requires cash flow
for cash-generating unit in an arm’s length forecast for atleast 5
transaction, adjusted for incremental costs Fair Value Less years, Estimated on
attributable to the disposal Value in Use present condition of the
Cannot be determined by reference to an
active market
Cost to Sell asset, and Cash flows
and discount rate should
be pre tax basis
12
Example for Impairment Testing
Entity EY Assessing Cash Generating Unit CGU for Impairment
Assets in the Books of CGU (Thousand $)
PP&E 200
Licenses 50
Land (at Revalued Amount) 400 (Cost 320) • Goodwill is written off fully, and
cannot be reversed
Goodwill 50
• Entity EY analyses the remaining
Total 700 assets after wards
Through Impairment test CGU is found to have a recoverable amount of $550 • Impairment loss on land hits the
revaluation reserve – preferred
Assets in the Books of CGU (Thousand $) by the firm
PP&E 200 – 31 =169
Licenses 50-8=42
Land (at Revalued Amount) 400-61=339 (Cost 320)
Goodwill 50-50=0
Total 550
13
Accounting for the Deal Value
• Assets
• Cash: 1,503
• Accounts receivable (net): 754 • Liabilities
• Inventories: 544 • Current liabilities: (4,576)
• Other current assets: 960 • Long-term liabilities: (917)
• Property and equipment: 981 • Cash Paid: (7,100)
• Intangible assets: 4,509 • Convertible Notes (2,100)
• Goodwill (b): 5,458 • Unknown (plug): 265
• Other: 249
• Total purchase price: 9.465
It could be that the $265 million is due to the cash payment noted in the narrative section of the
partial Note 9 disclosure of $7.1 billion and the convertible notes figure of $2.1 billion, both being
rounded figures, leaving the $265 million unexplained
Alternatively, that disclosure does state that the purchase price “consisted primarily of” the $7.1
billion cash and $2.1 billion convertible notes, so there may have also been some small amount of
other consideration given that equates to the $265 million or some additional liabilities assumed
What are the Methods Available to
Mitigate Goodwill Hangover Problems?
Extend
Amortization Write Down the
period to Max. 40 Goodwill
years
Use Pooling
Method of
Accounting?
215
Relevant Accounting Standards
Accounting
Standards
India International
International IFRS
Accounting
AS 14 3
Standard
FAS 142
IAS 22 FAS 141
IAS 36 Impairment IAS 38 Goodwill and
Business of Assets Business
Intangible Assets Other Intangible
Combination Combinations
Assets
225
Taxes in an M&A Transaction
Income tax
(Individuals
and
Corporations)
Real estate
Stamp duty
transfer tax
Real estate
Withholding
capital gains
tax
tax
Value Added Securities
Tax transfer tax
251
Amalgamation Terms under IT Act
Fulfill section 2(1B) of
Amount to be in the
Income tax act by No cash to be received
form of shares
transferor company
Foreign Direct
Fulfill section 72A of the
investments in selected Shareholders can not
IT act so as to reap the
sector can not exceed transfer their holdings
benefit by transferee
74% by foreign with in 5 years.
company
company
What are the losses can
Set off and carry
Sales tax at the rate of be carried forward and
forward of losses is
8% can not be avoided. set off? How many
possible.
years?
252
Tax Related Benefits to Buyer
Deduction
Deduction Flexibility in
of the Multiple
of the taxation or tax
integration /
financing Reorganisatio
transaction privileges
costs (Debt n
costs
push down)
Capitalisatio Utilisation of Repayment of
n and losses purchase price Revaluation of
amortisation carried as quickly as the assets
of goodwill forward possible
257
Tax Impact Comparison
Asset Stock
Deal Deal
Tax exempt private
Gain subject to tax at capital gain
the level of seller (individuals) or
(corporation) participation relief
(corporation)
Liquidation proceed
But: Indirect partial
subject to tax at the
liquidation regime
level of shareholder
Amortisation of
goodwill and No goodwill
depreciation of other amortisation
assets possible
258
Tax Impact Comparison
Asset Stock
Deal Deal
Tax losses can not be
carried forward by Tax losses can be
buyer, but be used by carried forward by
seller to set off gain company
on sale
Higher initial financing
Lower initial financing
costs, but as a result
costs, but as a result
lower tax burden for
higher tax burden
buyer
Very limited debt
Tax efficient interest
push down
deduction
possibilities
259
Rules for Claiming Tax Benefits on
Loss of Acquired
Amalgamated company
Accumulated losses 75% of book value to be
continues to hold 3/4th of
remain unabsorbed for 3 held atleast for 2 years
book value atleast for 5
or more years before amalgamation
years
New company should
New company should achieve atleast 50% of
continue for another 5 installed capacity before
years end of 5 years and should
continue for 5 years
260
Rules for Claiming Tax Benefits on
Loss of Acquired
Amalgamating company has
Amalgamated company to
been in that business for at
continue the business (all
least 3 years, and has held at
businesses) of amalgamating
least 3/4th of book value of fixed
co. for at least 5 years
assets for 2 years
Amalgamated company to fulfill
Amalgamated company to hold such other conditions as may be
least 3/4th of book value of fixed prescribed to ensure the revival
assets of amalgamating of business of amalgamating co.
company for 5 years or that amalgamation is for
genuine business purpose
261
Value Terms
Fair Value • = (Net Asset value +Profit Earning Capacity Value)/2
• Year 1: (High + Low)/2
Average Market • Year 2: (High + Low)/2
• Current Year: Month wise Average
Price • Average Market Price is estimated in total for three years
• If MV not more than 20% of FV: 15%
Capitalization • If MV more than 20%-50% of FV: 12%
• If MV Between 51%-75% of FV: 10%
Rate • If MV above 75%: 8%
• Average P/E ratio of related companies are Considered to
PE Multiple discount
262
Deal
Alternative Package consisting of 50,000 shares of Hardin
common stock and $400,000 of either cumulative preferred stock
with a 10% dividend or debentures with a 10% interest rates
Hardin to issue 100,000 shares for 40,000 shares of Pratt
Hardin Tool Pratt Engineering
Company No inter company transactions Company
Appraised value of Net Assets: $600,000
New public offering of 100,000 Asset’s book value: $441,000
shares of Hardin can be made
public at $8 per share
283
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Assets
Current assets $432 $246 39% 44%
Plant and equipment 690 312 61% 56%
Total assets $1,122 $558 100% 100%
Liabilities and Equities
Current liabilities $263 107 23% 19%
Long-term debt 195 10 17% 2%
Common stock ($1 par) 100 40 9% 7%
Additional paid-in capital 218 94 19% 17%
Retained earnings 346 307 31% 55%
Total liabilities and equity $1,122 $558 100% 100%285
Pooling vs. Purchase Method
Condensed Income Statement as of the Proposed Acquisition Date
(Thousands of Dollars)
Hardin Pratt Hardin Pratt
Sales $2,100 1500 100% 100%
Expenses 1620 1120 77% 75%
Income $480 $380 23% 25%
Income tax expense 168 133 8% 9%
Net income $312 $247 15% 16%
286
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed Acquisition Date
Hardin Pratt Pooling Purchase
Assets
Current assets $432 $246 $678 $678
Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441)
Goodwill 200 (100,000*8=800,000)-$600,000
Total assets $1,122 $558 $1,680 $2,039
Liabilities and Equities
Current liabilities $263 107 $370 $370
Long-term debt 195 10 $205 $205
Common stock ($1 par) 100 40 $200 $200
Additional paid-in capital 218 94 $252 $918 plug in
Retained earnings 346 307 $653 346
Total liabilities and equity $1,122 $558 $1,680 $2,039
287
Pooling vs. Purchase Method
Condensed Balance Sheets as of the Proposed
Hardin Pratt Polling Purchase
Sales $2,100 1500 $3,600 $3,600
Expenses 1620 1120 $2,740 $2,740
Income $480 $380 $860 $860
Additional depreciation $16 $159,000/10 years = 16,000
Taxable income $860 $844
Income tax expense $301.0 $295.4
Net income $559.0 $548.6
Earnings Per Share $2.80 $2.74
Life of plant and equipment: 10 years
Depreciation method: Straight line depreciation 288
Income tax rate: 35%
Alternative Methods
Equity Stock vs. Preferred Stock vs. Debentures
Equity Preferred Debentures
Unadjusted income $860 $860 $860
Additional depreciation 16 16 16
Additional interest 40
Taxable income $844 $844 $804
Income tax expense $295.40 $295.40 $281.40
Net income $548.60 $548.60 $522.60
Preferred dividend $40
Income available to common stock $548.60 $508.60 $522.60
EPS (150,000 shares for preferred Pooling on
and debetntures and 200,000 Equity
shares for equity) $2.74 $3.39 $3.48 Exchange
Debt/equity 14.00% 14.00% 56.86% 18.55%
ROE (Common) 37.50% 47.84% 49.15% 50.59%
289
Criteria for Pooling of Interest Accounting
Combining companies must Combining companies must Single transaction or Exchange of common stock
be autonomous be independent transaction in one year not less than 90%
No equity changes in No shares reacquired for No change in proportionate Voting rights immediately
contemplation purpose of combination equity interest exercisable
Combined company may not Combined company may not
Combining may not agree to
enter into any agreement for plan to dispose of substantial
Combination resolved at reacquire or retire any of the
the benefit of former amounts of assets of the
consummation stock issued to effect the
shareholders of the combining companies within
combination
combining companies two years of combination
294
Identifying Acquirer
Power to cast Ability to
Power to appoint
>1/2 voting rights majority of voting determine
or remove
in combined entity in meetings of combine entities
majority of BOM
BOD management team
Fair value of Terms of Specific voting
Other conditions
companies arrangements rights provided
Statutory Options or
requirements warrants on issue
298
Intangible Asset Classification and Impairment
Test Requirements
Intangible Assets
Indefinite Useful Life Determinable Useful Life
No Amortization Amortization over useful
Required Life
Should do Impairment (Impairment test if
Testing (Annually or on indication of
Indication) impairment)
308
Impairment Model
New Carrying
Amount (After
Written Down)
Lowest of…
Carrying
Recoverable
Amount Before
Amount
the Impairment
Highest of..
Price agreed in a binding sales agreement Requires cash flow
for cash-generating unit in an arm’s length forecast for atleast 5
transaction, adjusted for incremental costs Fair Value Less years, Estimated on
attributable to the disposal Value in Use present condition of the
Cannot be determined by reference to an
active market
Cost to Sell asset, and Cash flows
and discount rate should
be pre tax basis
309
Example for Impairment Testing
Entity EY Assessing Cash Generating Unit CGU for Impairment
Assets in the Books of CGU (Thousand $)
PP&E 200
Licenses 50
Land (at Revalued Amount) 400 (Cost 320) • Goodwill is written off fully, and
cannot be reversed
Goodwill 50
• Entity EY analyses the remaining
Total 700 assets after wards
Through Impairment test CGU is found to have a recoverable amount of $550 • Impairment loss on land hits the
revaluation reserve – preferred
Assets in the Books of CGU (Thousand $) by the firm
PP&E 200 – 31 =169
Licenses 50-8=42
Land (at Revalued Amount) 400-61=339 (Cost 320)
Goodwill 50-50=0
Total 550
310
Accounting Treatment of Good Will
Country Predominant Method Comments
US Caiptalize Amortize expense over useful life (not to exceed 40 years)
UK Write against RE May capitalize if life known
Canada Caiptalize if > 40 years Amortize expense over useful life
Japan Capitalize; Price - Book Value of net assets Amortize in life (not to exceed 5 years)
France Capitalize Amortize expense over 5 to 20 years
Germany Capitalize Amortize expense over 4 years (can extend if justified)
Switzerland Both write against RE and capitalize allowed Amortize
Netherlands Both write against Equity or as expenses Amortize expense over 5 years (can extend to 10 if justified)
Hong Kong Both write against Equity or as expenses Amortize only to the extent the value has diminished
Australia Capitalize Amortize in life (not to exceed 20 years)
Malaysia Capitalize Amortize expense over useful life
Goodwill arises from purchase m ethod
Goddwill = Purchase price > fair v alue of net assets
Am ortization of goodwill m ay not be tax deductible unless its allowed
312
Impairment of Assets Differences
Difference Criterion IFRS and IGAAP US GAAP
Timing of impairment review Annually whenever events or changes in
circumstances indicate that the
carrying amount may not be
recoverable
Asset is Impaired if Recoverable amount < Fair value < Carrying amount
Carrying amount
Recoverable Amount / Fair Recoverable amount is Fair Value is the amount at which
Value higher of an asset or liability could be
Net Selling Price bought or settled in a current
transaction between willing
Value in use
parties
Cash Flows for calculating Use discounted cash Use undiscounted cash flows for
value in use / fair value flows for calculating the calculating the fair value
value in use
Reversal of impairment loss Whenever there is a Prohibited
change in the economic
conditions
313
Taxes in an M&A Transaction
Income tax
(Individuals
and
Corporations)
Real estate
Stamp duty
transfer tax
Real estate
Withholding
capital gains
tax
tax
Value Added Securities
Tax transfer tax
318
Amalgamation Terms under IT Act
Fulfill section 2(1B) of
Amount to be in the
Income tax act by No cash to be received
form of shares
transferor company
Foreign Direct
Fulfill section 72A of the
investments in selected Shareholders can not
IT act so as to reap the
sector can not exceed transfer their holdings
benefit by transferee
74% by foreign with in 5 years.
company
company
What are the losses can
Set off and carry
Sales tax at the rate of be carried forward and
forward of losses is
8% can not be avoided. set off? How many
possible.
years?
319
Rules for Claiming Tax Benefits on
Loss of Acquired
Accumulated losses remain unabsorbed for 3 or more years
75% of book value to be held atleast for 2 years before amalgamation
Amalgamated company continues to hold 3/4th of book value atleast for 5
years
New company should continue for another 5 years
New company should achieve atleast 50% of installed capacity before end of 5
years and should continue for 5 years
327
Rules for Claiming Tax Benefits on Loss of
Acquired
Amalgamating company has been in that business for at least 3 years, and has held at least 3/4th
of book value of fixed assets for 2 years
Amalgamated company to continue the business (all businesses) of amalgamating co. for at
least 5 years
Amalgamated company to hold least 3/4th of book value of fixed assets of amalgamating
company for 5 years
Amalgamated company to fulfill such other conditions as may be prescribed to ensure the revival
of business of amalgamating co. or that amalgamation is for genuine business purpose
328
