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Advanced Accounting Review Exam 1

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ACCT 4022 – Advanced Accounting Notes
Chapter 1: Intercorporate Acquisitions and Investments in Other Entities The Development of Complex Business Structures
By expanding into new markets or acquiring other companies already in those markets, companies can develop new earnings potential and those in cyclical industries can add greater stability to earnings through diversification. A subsidiary is a corporation that is controlled by another corporation, referred to as a parent company. Control is usually through majority ownership of its common stock. Because a subsidiary is a separate legal entity, the parent’s risk associated with the subsidiary’s activities is limited. Reasons for creating subsidiary:

May transfer receivables to subsidiary. Other companies can hold interest in entity. Transferring company therefore able to share risk of receivables.

Tax benefits
Companies have used subsidiaries to borrow large amounts of money without reporting debt on balance sheets. A special purpose entity is a financing vehicle that is not a substantive operating entity, usually created for one specific purpose. May be in the form of a corporation, a trust, or a partnership. Can be done through contracts

Other manipulations include pooling of interests and assigning portions of purchase prices to in-process R&D so that the cost was expensed. Business Expansion and Forms of Organizational Structure

Recently companies have been expanding by means of acquiring other companies rather than product development or expanding existing product lines into new markets.

Internal Expansion
Conduct expanded operations through subsidiaries or partnerships, joint ventures, or special entities. Transfer assets to new entity and receive equity ownership in exchange May establish subs for tax incentives, less regulation, spreading of risk. May establish subs for disposition purposes, like shedding nonaligned operations, unprofitable operations, or to gain shareholder approval for merger with new company. A spin off occurs when the ownership of a newly created or existing subsidiary is distributed to the parent’s stockholders without the stockholders surrendering any of their stock in the parent company. Thus, the company divests itself of the sub since it is owned by the company’s shareholders after the spin-off. A split off occurs when the sub’s shares are exchanged for shares of the parent, thereby leading to a reduction in the outstanding shares of the parent company. While the two divestiture types are similar, the split-off could result in one set of the former parent shareholders exchanging their shares for those of the divested sub. Although transfer of ownership to one or more unrelated parties normally results in a taxable transaction, properly designed transfers of ownership to existing shareholders generally qualify as nontaxable exchanges. Investment account (parent) = BV of net assets (sub)

External Expansion Through Business Combinations
The concept of control relates to the ability to direct policies and management. Traditionally, control is majority ownership of stock. However, recently there has been greater possibility of control with less than majority or even no ownership. In some cases, a formal agreement may be equivalent in substance to a business combination, yet different in form. Ex: a company may sign agreement to lease all of another company’s assets for several decades is in effect acquiring the company.

Organizational Structure

Several approaches are possible, each with separate financial reporting procedures 1. Merger – a business combination in which the acquired company’s assets and liabilities are combined with those of the acquiring company. Thus, two companies are merged into a single entity still under the name of the original company. Financial reporting is based on the original organizational structure. 2. Controlling Ownership – the acquired company remains separate legal entity but purchasing company has majority stock. Parent sub relationship. Requires consolidated FR, even if the sub is created rather than purchased. 3. Noncontrolling ownership – purchase/creation of less than majority share in another corporation does not usually result in a business combination or controlling situation. Investor company reports interest in investee as investment. 4. Other beneficial interest – one company may have a beneficial interest in another entity even without a direct ownership interest. A company that has the ability to make decisions significantly affecting the results of another entity’s activities or is expected to receive a majority of the other entity’s profits and losses is considered to be that entity’s primary beneficiary. That entities FS would be consolidated with the PB. Creating Business Entities

In simple cases, the company transfers assets (and liabilities), to an entity that the company has created and controls and in which it holds majority ownership. The company transfers A&L at book value and recognizes an ownership interest in the entity equal to that BV. No gains or losses are recognized on the transfer by the transferring company. See example on page 11

Business Combinations
Statutory Merger – only one of the combining companies survives and the other loses its separate identity. Operations carried on as single legal entity following the merger. Peaceful merger Pursuant company exchanges stock for other company’s assets, and the other company passes along that stock to its shareholders. That entity is then liquidated. Company B’s shareholder stocks change to company A stock (?) Hostile takeover

Management of pursuant company makes tender offer directly to shareholders of company. Gains voting control and can install it’s own management. Acquired company liquidated. An acquisition of stock and subsequent liquidation of the acquired company is equivalent to an acquisition of assets. Statutory Consolidation – both combining companies are dissolved and the assets of both companies are transferred to a newly created corporation. In many situations, although a new legal entity the consolidation is new in form only and the two entities function as before. Stock Acquisition – one company acquires the voting shares of another company but the two companies continue to operate as separate, but related, legal entities. Because neither company is liquidated, the acquiring company accounts for its interest in the other as an investment. The acquiring company need not acquire all the other’s stock to gain control. Creates a parent-sub relationship. Present consolidated FS. Value of Individual Assets an Liabilities

CL are often viewed
as having FV equal to BV because they will be paid at face value soon. LTL must be valued based on current interest rates if different from effective rates. Value of Potential Earnings
Going-concern value – when assets operating together are valued higher than the sum of their individual parts. Valuation of Consideration Exchanged
Valuation may be more difficult when the acquiring company gives securities, particularly new untraded securities or securities with unusual features. The approach generally followed is to use the value of some similar security with a determinable market value and adjust for the estimated avlue of the differences in the features of the two securities. Accounting for Business Combinations

Two methods used to be used: the purchase method and the pooling-of interests method. FASB eliminated POI in 2001, and then changed the purchase method to the acquisition metod by FASB Statement No. 141 in 2007 After December 15, 2008 all combinations must use this method. Cannot be applied retroactively. Pooling of interests was the idea that no change in ownership occurred during business combination. The BV of companies were carried forward and not reevaluated As a result, no write-ups or goodwill that burdened future earnings with additional depreciation or write-offs. In purchase accounting, all direct costs of bringing about and consummating the combination were included in the total purchase price. Acquisition Accounting

Acquire business my measuring the fair value of assets and liabilities Acquirer must value at fair value:
1. The consideration it exchanges in a business combination
2. Each of the individual assets and liabilities acquired
3. Any noncontrolling interest in the acquiree
Under the acquisition method, the full acquisition-date fair values of the individual assets acquired, both tangible and intangible, and liabilities assumed in a business combination are recognized. This is true regardess of the percentage ownership acquired by the controlling entity. If the acquiring company acquires partial ownership of the acquiree in a stock acquisition, the assets acquired and liabilities assumed appear at their full acquisition-date fair values in a consolidated balance sheet prepared immediately after the combination. Other points to remember:

No separate asset valuation accounts related to assets acquired are recognized. Long-lived assets classified at the acquisition date as held for sale are valued at FV less cost to sell Deferred income taxes related to the business combination and assets and liabilities related to an acquiree’s employee benefit plans are valued in accordance with specific FASB standards relating to those topics. The amount of goodwill arising in a business combination is also unaffected by the percentage of acquiree acquired.


FASB decided not to focus directly on total FV of acquiree, but rather on components that provide an indication of FV. 3 components measured and summed: The FV of any consideration given by the acquirer

The FV of any interest in the acquiree already held by the acquirer The FV of the noncontrolling interest in the acquiree, if any. The total of these 3 amounts s then compared with the acquisition date FV of the acquiree’s net identifiable assets, and the difference is goodwill. Ex: A acquires assets of Z for $400,000. NFMVA of Z is $380,000. Goodwill is $20,000. If, instead of acquiring assets, A acquires 75% of C/S of Z for $300,000 and the FV of the noncontrolling intereset is $100,000, goodwill is computed as: FV of consideration given by A

+ FV of noncontrolling interest
Total FV of Z
NFMVA acquired

Combination Effected through the Acquisition of Net Assets
The total difference at the acquisition date between FV of the consideration exchanged and the BV of net identifiable assets acquired is referred to as the differential A portion of that differential is attribuatble to the increased value of net assets over book value and the remainder difference (if any) is considered goodwill. Stock issue costs are recorded in a temporary suspense account as a debit to Deferred Stock Issue Costs and a credit to cash. This account is then zero-d out with a credit that reduces the amount of APIC for the acquirer. Because a change in ownership has occurred, the basis of accounting used by the acquired company is not relevant to the acquirer. Consistent with this view, accumulated depreciation recorded by the acquiree on its buildings and equipment is not relevant and not recorded Goodwill must be tested for impairment at least annually, at the same time each year. Involves examining potential goodwill impairment by each of the company’s reporting units, where a reporting unit is an operating segment. Compare the FV of the reporting unit with its CV.

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