Business Combinations

Dr. Lenggogeni, SE. Ak. MM. CMA. CA. CBV. ASEAN CPA

1-1
Business Combinations: Objectives
1. Understand the economic motivations
underlying business combinations.
2. Learn about the alternative forms of business
combinations, from both the legal and
accounting perspectives.
3. Introduce concepts of accounting for business
combinations, emphasizing the acquisition
method.
4. See how firms make cost allocations in an
acquisition method combination.
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Business Combinations

1: Economic Motivations

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Types of Business Combinations
Business combinations unite previously separate
business entities.
• Horizontal integration – same business lines and
markets
• Vertical integration – operations in different,
but successive stages of production or
distribution, or both
• Conglomeration – unrelated and diverse
products or services

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Reasons for Combinations
• Cost advantage
• Lower risk
• Fewer operating delays
• Avoidance of takeovers
• Acquisition of intangible assets
• Other: business and other tax advantages,
personal reasons

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Business Combinations
2: Forms of Business Combinations

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Legal Form of Combination
• Merger
– Occurs when one corporation takes over all
the operations of another business entity and
that other entity is dissolved.
• Consolidation
– Occurs when a new corporation is formed to
take over the assets and operations of two or
more separate business entities and dissolves
the previously separate entities.

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Mergers: A + B = A
1) Company A purchases the assets of Company
B for cash, other assets, or Company A
debt/equity securities. Company B is dissolved;
Company A survives with Company B’s assets
and liabilities.
2) Company A purchases Company B stock from
its shareholders for cash, other assets, or
Company A debt/equity securities. Company B
is dissolved. Company A survives with
Company B’s assets and liabilities.
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Consolidations: E + F = “D”
1) Company D is formed and acquires the assets
of Companies E and F by issuing Company D
stock. Companies E and F are dissolved.
Company D survives, with the assets and
liabilities of both dissolved firms.
2) Company D is formed acquires Company E
and F stock from their respective shareholders
by issuing Company D stock. Companies E and
F are dissolved. Company D survives with the
assets and liabilities of both firms.
1-9
Business Combinations

3: Accounting for Business

Combinations

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 PSAK 7

Pihak-pihak berelasi adalah orang atau entitas yang

terkait dengan entitas yang menyiapkan laporan
keuangannya (dalam Pernyataan ini dirujuk sebagai
“entitas pelapor”). Suatu individu atau entitas dapat
diklasifikasikan sebagai pihak berelasi jika
memenuhi hal-hal yang ditentukan definisi pihak-
pihak berelasi dalam PSAK 7.

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Business Combination (def.)
“A business combination is a transaction or other
event in which an acquirer obtains control of
one or more businesses. Transactions sometimes
referred to as ‘true mergers’ or ‘mergers of
equals’ also are business combinations…
A parent – subsidiary relationship is formed
when:
– Less than 100% of the firm is acquired, or
– The acquired firm is not dissolved.

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 Recording Guidelines (1 of 2)
• Record assets acquired and liabilities assumed
using the fair value principle.
• If equity securities are issued by the acquirer,
charge registration and issue costs against the
fair value of the securities issued, usually a
reduction in additional paid-in-capital.
• Charge other direct combination costs (e.g.,
legal fees, finders’ fees) and indirect combination
costs (e.g., management salaries) to expense.

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 Recording Guidelines (2 of 2)
• When the acquiring firm transfers its assets other
than cash as part of the combination, any gain or
loss on the disposal of those assets is recorded in
current income.
• The excess of cash, other assets and equity securities
transferred over the fair value of the net assets
(A – L) acquired is recorded as goodwill.
• If the net assets acquired exceeds the cash, other
assets and equity securities transferred, a gain on
the bargain purchase is recorded in current income.
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 Example: Poppy Corp. (1 of 3)
Poppy Corp. issues 100,000 shares of its $10 par
value common stock for Sunny Corp. Poppy’s
stock is valued at $16 per share. (in thousands)

Investment in Sunny Corp. 1,600

Common stock, $10 par 1,000
Additional paid-in-capital 600

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 Example: Poppy Corp. (2 of 3)
Poppy Corp. pays cash for $80,000 in finder’s fees
and consulting fees and for $40,000 to register and
issue its common stock. (in thousands)
Investment expense 80
Additional paid-in-capital 40
Cash 120
Sunny Corp. is assumed to have been dissolved. So,
Poppy Corp. will allocate the investment’s cost to
the fair value of the identifiable assets acquired
and liabilities assumed. Excess cost is goodwill.
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 Example: Poppy Corp. (3 of 3)

Receivables XXX
Inventories XXX
Plant assets XXX
Goodwill XXX
Accounts payable XXX
Notes payable XXX
Investment in Sunny Corp. 1,600

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Business Combinations
4: Cost Allocations Using the
Acquisition Method

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 Identify the Net Assets Acquired
Identify:
1. Tangible assets acquired,
2. Intangible assets acquired, and
3. Liabilities assumed
Include:
• Identifiable intangibles resulting from legal
or contractual rights, or separable from the
entity
• Research and development in process
• Contractual contingencies
• Some noncontractual contingencies
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 Assign Fair Values to Net Assets
Use fair values determined, in preferential order,
by:
1. Established market prices
2. Present value of estimated future cash
flows, discounted based on observable
measures
3. Other internally derived estimations

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 Exceptions to Fair Value Rule
• Deferred tax assets and liabilities [FASB
Statement No. 109 and FIN No. 48]
• Pensions and other benefits [FASB Statement No.
158]
• Operating and capital leases [FASB Statement
No. 13 and FIN. No. 21]
• Goodwill on the books of the acquired firm is
assigned no value.

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 Goodwill
The excess of
• The sum of:
– Fair value of the consideration transferred,
– Fair value of any noncontrolling interest in
the acquiree, and
– Fair value of any previously held interest in
acquiree,
• Over the net assets acquired.

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 Contingent Consideration
• If the fair value of contingent consideration is
determinable at the acquisition date, it is
included in the cost of the combination.
• If the fair value of the contingent consideration
is not determinable at that date, it is recognized
when the contingency is resolved.
• Types of consideration contingencies:
– Future earnings levels
– Future security prices

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Recording Contingent Consideration
• Contingencies based on future earnings increase
the cost of the investment.
• Contingencies based on future security prices do
not change the cost of the investment. Additional
consideration distributed is recorded at its fair
value with an offsetting write-down of the equity
or debt securities issued.

In some cases the contingency may involve a

return of consideration.
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 Example – Pitt Co. Data
Pitt Co. acquires the net assets of Seed Co. in a
combination consummated on 12/27/2008. The
assets and liabilities of Seed Co. on this date, at
their book values and fair values, are as follows
(in thousands):

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 Book Val. Fair Val.
Cash $ 50 $ 50
Net receivables 150 140
Inventory 200 250
Land 50 100
Buildings, net 300 500
Equipment, net 250 350
Patents 0 50
Total assets $1,000 $1,440
Accounts payable $ 60 $ 60
Notes payable 150 135
Other liabilities 40 45
Total liabilities $ 250 $ 240
Net assets $ 750 $1,200
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 Acquisition with Goodwill
Pitt Co. pays $400,000 cash and issues 50,000
shares of Pitt Co. $10 par common stock with a
market value of $20 per share for the net assets
of Seed Co.
Total consideration at fair value (in thousands):
$400 + (50 shares x $20) $1,400
Fair value of net assets acquired: $1,200
Goodwill $ 200

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 Entries with Goodwill
The entry to record the acquisition of the net
assets:
Investment in Seed Co. 1,400
Cash 400
Common stock, $10 par 500
Additional paid-in-capital 500
The entry to record Seed’s assets directly on Pitt’s
books:

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Cash 50
Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Goodwill 200
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,400
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 Acquisition with Bargain Purchase
Pitt Co. issues 40,000 shares of its $10 par
common stock with a market value of $20 per
share, and it also gives a 10%, five-year note
payable for $200,000 for the net assets of Seed
Co.
Fair value of net assets acquired (in thousands):
$1,200
Total consideration at fair value:
(40 shares x $20) + $200 $1,000
Gain from bargain purchase $ 200
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 Entries with Bargain Purchase
The entry to record the acquisition of the net
assets:
Investment in Seed Co. 1,000
10% Note payable 200
Common stock, $10 par 400
Additional paid-in-capital 400
The entry to record Seed’s assets directly on Pitt’s
books:

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 Cash 50
Net receivables 140
Inventories 250
Land 100
Buildings 500
Equipment 350
Patents 50
Accounts payable 60
Notes payable 135
Other liabilities 45
Investment in Seed Co. 1,000
Gain from bargain purchase 200
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 Investment in Common Stock
Perusahaan memperoleh kepemilikan di perusahaan lain
karena berbagai alasan.
(1) mendapatkan kontrol suara,
(2) memasuki pasar produk baru dengan membeli perusahaan yang sudah mapan
di wilayah tersebut, (3) memastikan pasokan bahan baku atau input produksi
lainnya,
(4) memastikan pelanggan untuk hasil produksi,
(5) mendapatkan ekonomi yang terkait dengan
ukuran yang lebih besar,
(6) operasi diversifikasi,
(7) memperoleh teknologi baru,
(8) Pengurangan persaingan, dan
(9) membatasi risiko.

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 "Summary of Accounting for Equity Investment Securities

0% 20% 50% 100%

Insignificant Significant Control influence

influence
Cost method** Equity method** Equity method (or
cost method***)
+ consolidation"

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To illustrate the cost method, assume that ABC Company purchases 20
percent of XYZ Company’s common stock for $100,000 at the beginning
of the year but does not gain significant influence over XYZ. During the
year, XYZ has net income of $60,000 and declares dividends of $20,000.
Assuming the dividend is paid later, ABC Company
records the following entries relating to its investment in XYZ:

(1) Investment in XYZ Company Stock 100,000

Cash 100,000
Record purchase of XYZ Company stock.

(2) Dividends Receivable 4,000

Dividend Income 4,000
Record dividend declared by XYZ Company ($20,000 × 0.20).

Note that ABC records only its share of XYZ’s distributed earnings and
makes no entry for the undistributed portion. The carrying amount of the
investment is still theoriginal cost of $100,000.

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 Liquidating Dividends
To illustrate the computation of liquidating dividends received by the investor,
assume that Investor Company purchases 10 percent of the common stock of
Investee Company on January 2, 20X1. The annual income and dividends of
Investee, the amount
(1)Investment in XYZ Company Stock 100,000
Cash 100,000
Record purchase of XYZ Company stock.
(2) Dividends Receivable 4,000
Dividend Income 4,000
Record dividend declared by XYZ Company ($20,000 × 0.20).

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 "Investee Company Investor Company"
"Cumulative"
"Reduction"
"Net" "Undistributed" "Cash" "Dividend"
"of"
"Year" "Income""Dividends" "Income""Received"
"Income""Investment"
"20X1" 100000 70000 30000 7000 7000
"20X2" 100000 120000 10000 12000 12000
"20X3" 100000 120000 0 12000 11000 1000
"20X4" 100000 120000 0 12000 10000 2000
"20X5" 100000 70000 30000 7000 7000

Cash 12.000
Investment in Investee 1.000
Dividend Income 11.000

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 EQUITY METHODS

ABC Company acquires significant influence over XYZ

Company by purchasing 20 percent of XYZ’s common stock for
$100,000 at the beginning
of the year.

Investment in XYZ Company Stock 100,000

Cash 100,000

Record purchase of XYZ Company stock.

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 XYZ reports income of $60,000 for the year. ABC
records its 20 percent share of XYZ’s income
($12,000) in an account called “Income from XYZ
Company” as follows

Investment in XYZ Company Stock 12,000

Income from XYZ Company 12,000

Record income from XYZ Company ($60,000 Å~

0.20).

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 of XYZ Company’s income.
method relative to the cost method,
assume the same facts listed previously for
ABC’s
20 percent acquisition of XYZ’s common
stock. The carrying amount of the
investment
using the equity method at the end of the
period is $108,000 ($100,000 + $12,000 –
$4,000),
compared to the original acquisition price
of $100,000 under the cost method.
Investment income under the equity
method (the balance in the “Income from
XYZ”
account) is $12,000 while investment
income under the cost method is equal to
dividend
income, $4,000.
(6) Dividends Receivable 4,000
Investment in XYZ Company Stock 4,000
Record dividend from XYZ Company
($20,000 × 0.20).

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