Intercorporate Acquisitions and Investments in Other Entities
Intercorporate Acquisitions and Investments in Other Entities
Intercorporate Acquisitions and Investments in Other Entities
Acquisitions and
Investments in Other
Entities
Chapter One
LEARNING OBJECTIVES
When you finish studying this chapter, you should be able to:
LO 1-1 Understand and explain the reasons for and different methods of business
expansion, the types of organizational structures, and the types of acquisitions.
LO 1-2 Understand the history of the development of standards related to acquisition
accounting over time.
LO 1-3 Make calculations and prepare journal entries for the creation and purchase of
a business entity.
LO 1-4 Understand and explain the differences between different forms of business
combinations.
LO 1-5 Make calculations and business combination journal entries in the presence of
a differential, goodwill, or a bargain purchase element.
LO 1-6 Understand additional considerations associated with business combinations.
A subsidiary is a corporation that
another corporation, referred to as a
parent company, controls, usually
through majority ownership of its
common stock.
BUSINESS EXPANSION AND FORMS OF
ORGANIZATIONAL STRUCTURE
Acquisition of Assets
Acquisition of Stock
Acquisition by Other Means
ACQUISITION ACCOUNTING
When one company acquires all the net assets of another in a business
combination, the acquirer records on its books the individual assets
acquired and liabilities assumed in the combination and the
consideration given in exchange. Each identifiable asset and liability
acquired is recorded by the acquirer at its acquisition-date fair value. The
acquiring company records any excess of the fair value of the
consideration exchanged over the fair value of the acquiree’s net
identifiable assets as goodwill.
Combination Effected through the Acquisition of Net
Assets
Assume that Point Corporation acquires all of the assets and assumes all of the
liabilities of Sharp Company in a statutory merger by issuing 10,000 shares of
$10 par common stock to Sharp. The shares issued have a total market value of
$610,000. Point incurs legal and appraisal fees of $40,000 in connection with
the combination and stock issue costs of $25,000. Figure 1–2 shows the book
values and fair values of Sharp’s individual assets and liabilities on the date of
combination.
Combination Effected through the Acquisition of Net Assets
The relationships among the fair value of the consideration exchanged, the fair value
of Sharp’s net assets, and the book value of Sharp’s net assets are illustrated in the
following diagram:
Combination Effected through the Acquisition of Net Assets
The total difference at the acquisition date between the fair value of the consideration
exchanged and the book value of the net identifiable assets acquired is referred to as the
differential. In more complex situations, the differential is equal to the difference between
(1) the acquisition-date fair value of the consideration transferred by the acquirer, plus the
acquisition-date fair value of any equity interest in the acquiree previously held by the
acquirer, plus the fair value of any noncontrolling interest in the acquiree and (2) the
acquisition-date book values of the identifiable assets acquired and liabilities assumed. In
the Point/Sharp merger, the total differential of $310,000 reflects the difference between
the total fair value of the shares issued by Point and the carrying amount of Sharp’s net
assets reflected on its books at the date of combination. A portion of that difference
($210,000) is attributable to the increased value of Sharp’s net assets over book value. The
remainder of the difference ($100,000) is considered to be goodwill.
The $40,000 of acquisition costs incurred by Point in carrying out the
acquisition are expensed as incurred:
The acquirer records goodwill arising in a merger for the difference between the fair value of the
consideration exchanged and the fair value of the identifiable net assets acquired, as illustrated in
entry (5).
Goodwill is carried forward at the originally recorded amount unless it becomes impaired.
Goodwill must be reported as a separate line item in the balance sheet. A goodwill impairment
loss that occurs subsequent to recording goodwill must be reported as a separate line item within
income from continuing operations in the income statement unless the loss relates to discontinued
operations, in which case the loss is reported within the discontinued operations section.
Goodwill must be tested for impairment at least annually, at the same time each year, and more
frequently if events that are likely to impair the value of the goodwill occur.
Bargain Purchase
Occasionally, the fair value of the consideration given in a business
combination, along with the fair value of any equity interest in the acquiree
already held and the fair value of any noncontrolling interest in the acquiree,
may be less than the fair value of the acquiree’s net identifiable assets, resulting
in a bargain purchase.
To illustrate accounting for a bargain purchase, assume that in the previous
example of Point and Sharp, Point is able to acquire Sharp for $500,000 cash
even though the fair value of Sharp’s net identifiable assets is estimated to be
$510,000. In this simple bargain-purchase case without an equity interest
already held or a noncontrolling interest, the fair value of Sharp’s net
identifiable assets exceeds the consideration exchanged by Point, and,
accordingly, a $10,000 gain attributable to Point is recognized.
In accounting for the bargain purchase (for cash) on Point’s books, the
following entry replaces previous entry (5):
Combination Effected through Acquisition of
Stock
Many business combinations are effected by acquiring the voting
stock of another company rather than by acquiring its net assets. In
such a situation, the acquired company continues to exist, and the
acquirer records an investment in the common stock of the acquiree
rather than its individual assets and liabilities. The acquirer records
its investment in the acquiree’s common stock at the total fair value
of the consideration given in exchange.
For example, if Point Corporation ( a ) exchanges 10,000 shares of its stock with a total
market value of $610,000 for all of Sharp Company’s shares and ( b ) incurs merger costs
of $40,000 and stock issue costs of $25,000, Point records the following entries upon
receipt of the Sharp stock:
When a business combination is effected through a stock
acquisition, the acquiree may continue to operate as a
separate company or it may lose its separate identity and
be merged into the acquiring company. If the acquired
company is liquidated and its assets and liabilities are
transferred to the acquirer, the dollar amounts recorded are
identical to those in entry (5).
Financial Reporting Subsequent to a Business
Combination
Financial statements prepared subsequent to a business combination
reflect the combined entity beginning on the date of combination going
forward to the end of the fiscal period. When a combination occurs
during a fiscal period, income earned by the acquiree prior to the
combination is not reported in the income of the combined enterprise. If
the combined company presents comparative financial statements that
include statements for periods before the combination, those statements
include only the activities and financial position of the acquiring
company, not those of the acquiree.
To illustrate financial reporting subsequent to a business
combination, assume the following information for Point
Corporation and Sharp Company:
Point Corporation acquires all of Sharp Company’s stock at book value on January 1, 20X1, by issuing
10,000 shares of common stock. Subsequently, Point Corporation presents comparative financial
statements for the years 20X0 and 20X1. The net income and earnings per share that Point presents in
its comparative financial statements for the two years are as follows:
20X0:
Net Income $300,000
Earnings per Share ($300,000/30,000 shares) $10.00
20X1:
Net Income ($300,000 + $60,000) $360,000
Earnings per Share ($360,000/40,000 shares) $9.00
If Point Corporation had acquired Sharp Company in the middle of
20X1 instead of at the beginning, Point would include only Sharp’s
earnings subsequent to acquisition in its 20X1 income statement. If
Sharp earned $25,000 in 20X1 before acquisition by Point and
$35,000 after the combination, Point would report total net income for
20X1 of $335,000 ($300,000 + $35,000). Note that if the shares are
issued in the middle of the year, the weighted-average shares used in
the EPS calculation would change as well.
Uncertainty in Business Combinations