2. Intercorporate Acquisitions and
Investments in Other Entities
This chapter provides an overview of complex
organizational arrangements (or structures).
• Complex organization structures often result from
complex business strategies such as:
• Extending operations into foreign countries.
• Initiating new product lines.
• Separating activities that fall under regulatory controls.
• Reducing taxes by separating certain types of
operations.
1-2
3. Intercorporate Acquisitions and
Investments in Other Entities
• Several accounting transactions may be required to
initiate a complex organization structure.
• Additionally, unlike most of your previous accounting
courses, you will need to analyze multiple transactions for
multiple companies simultaneously—not just one
transaction for one company.
• Thus you will need to “deal with” more than one set of
books in analyzing questions, cases, exercises, and
problems.
1-3
4. 1-4
Intercorporate Acquisitions and
Investments in Other Entities
Generally speaking, the accounting procedures
in this chapter are driven by such questions
as:
• Did the company acquire the common stock of
another company or the assets of another company
?
• Was the company dissolved (i.e. liquidated) or did
the company continue to exist?
• Was a new company formed ?
• Was there a change in ownership control ?
• Is the acquired company wholly-owned ?
5. 1-5
Bad News--Good News
Bad News: Numerous complex organizational
arrangements are discussed in this chapter. (Hint:
Look for similarities in the various complex
organizational arrangements.)
Good News: The next nine chapters focus primarily on
one complex organizational arrangement--stock
acquisitions.
6. 1-6
Creating Business Entities
--Basic Transactions
• Complex business structures are routinely grounded
in the following basic transactions:
• Transfer (Sale) of Assets/Entity Dissolved
• Receipt of Assets from Dissolved Entity
• Transfer (Sale) of Assets/Entity Survives
• Receipt of Assets from Surviving entity
NOTE: Assume that Book Values (BV) equal Fair Values (FV) for
these transactions (i.e., the next four slides). Also, assume that cash
was paid for the assets. The significance of both of these
assumptions will be discussed later.
7. 1-7
Transfer of Assets/Entity Dissolved
• Entries Recorded By Seller Company:
– To transfer net assets to Purchaser Company.
Cash (from Purchaser) ???
Current Liabilities BV
Accumulated Depreciation BV
Cash and Receivables BV
Inventory BV
Fixed Assets BV
[Continued on next slide.]
8. 1-8
Transfer of Assets/Entity Dissolved
• Entries Recorded By Seller Company:
– To distribute remaining assets to shareholders of Seller
Company.
Common Stock BV
Additional Paid-In Capital BV
Retained Earnings BV
Cash ???
9. 1-9
Receipt of Assets from Dissolved Entity
• Entry Recorded By Purchaser Company:
– To record net assets purchased
from Seller Company.
Cash and Receivables BV
Inventory BV
Fixed Assets (net) * BV
Cash (to Seller) ???
Current Liabilities BV
* Fixed Assets are recorded net of Accumulated Depreciation
10. 1-10
Transfer of Assets/Entity Survives
• Entries Recorded By Seller Company:
– To transfer net assets to Purchaser Company.
Cash (from Purchaser) ???
Current Liabilities BV
Accumulated Depreciation BV
Cash and Receivables BV
Inventory BV
Fixed Assets BV
[Continued on next slide.]
11. 1-11
Transfer of Assets/Entity Survives
– To distribute remaining assets to shareholders
of Seller Company.
NO ENTRY REQUIRED—Seller Company
was not dissolved. Thus the shareholders of
Seller Company may reinvest the Cash (from
Purchaser) as they wish.
12. 1-12
Receipt of Assets from Surviving Entity
• Entry Recorded By Purchaser Company:
– To record net assets purchased from Seller
Company.
Cash and Receivables BV
Inventory BV
Fixed Assets (net) * BV
Cash (to Seller) ???
Current Liabilities BV
* Fixed Assets are recorded net of Accumulated Depreciation.
13. 1-13
Receipt of Assets from Surviving Entity
NOTE: Since this was a purchase of the net assets of
Seller Company (and not the common stock of Seller
Company), dissolution or non-dissolution of Seller
Company does not involve Purchaser Company. Thus
Purchaser Company records the same entry as was
previously done when Seller Company was dissolved.
14. 1-14
Additional Thoughts
• Seller Company would have recorded a “GAIN
ON SALE” if their net assets would have been
sold for an amount greater than book value. In
turn, Seller Company would have recorded a
“LOSS ON SALE” if their net assets would have
been sold for an amount less than book value.
15. 1-15
Additional Thoughts
• In either case, Purchaser Company would have
recorded the various assets and liabilities at their
individual fair value (not book value).
• Frequency and size of merger transaction make
the potential impact on financial statements
critically important.
16. 1-16
Forms of Business Combinations
• There are three primary forms of business
combinations:
• Statutory Merger
• Statutory Consolidation
• Stock Acquisition
17. 1-17
Statutory Merger
• A statutory merger occurs when one company
acquires another company and the assets and
liabilities of the acquired company are transferred
to the acquiring company.
• In a statutory merger, the acquired company is
liquidated and the acquiring company continues
to exist.
18. 1-18
Types of Business Combination
AA Company
BB Company
AA Company
(a) Statutory Merger
Only one of the combining companies survives
and the other loses its separate identify.
19. 1-19
Statutory Consolidation
• A statutory consolidation occurs when a new
company is formed to acquire the assets and
liabilities of two combining company.
• In a statutory consolidation, the combining
companies are dissolved and the new company is
the only surviving entity.
20. 1-20
Types of Business Combination
AA Company
BB Company
(b) Statutory Consolidation
CC Company
Both the combining companies are dissolved and
the assets and liabilities of both companies are
transferred to a newly created corporation.
21. 1-21
Stock Acquisition
• A stock acquisition occurs when one company
acquires a majority of the common stock of
another company and the acquired company is not
liquidated.
• In a stock acquisition, both companies continue to
operate as separate but related corporations (i.e.,
affiliated corporations).
22. 1-22
Types of Business Combination
AA Company
BB Company
(c) Stock Acquisition
AA Company
BB Company
One company acquires the voting shares
of another company and the two
companies continue to operate separately.
23. 1-23
Stock Acquisition:
Parent-Subsidiary Relationship
• A subsidiary is a corporation that is controlled
(through common stock ownership) by another
corporation, that is, the parent corporation.
• Controlling Interest: The parent owns a
majority of the common stock of the
subsidiary.
• Wholly-Owned Subsidiary: The parent owns
all of the common stock of the subsidiary.
25. 1-25
Methods of Effecting Business Combinations
• Business combinations can be either friendly or
unfriendly.
– Friendly combinations involve both management
teams and recommend approval by the
stockholders
– Unfriendly combinations are known as ‘hostile
takeovers’ where the acquiring company makes a
direct tender offer to the stockholders.
26. 1-26
Valuation of Business Entities
• Assessing the overall value of a company often
includes:
• Valuation of Individual Assets and Liabilities
• Valuation of Potential Earnings
• Valuation of Consideration Exchanged
27. 1-27
Valuation of Individual
Assets and Liabilities
• The value of a company’s individual assets is
usually determined by appraisal.
• Current liabilities are often viewed as having fair
values equal to their book values because they
will be paid at face amount within a short time.
28. 1-28
Valuation of Individual
Assets and Liabilities
• Long-term liabilities must be valued based on
current interest rates if different from the effective
rates at the issue dates of the liabilities.
• Tax aspects must also be considered.
29. 1-29
Valuation of Potential Earnings
• Synergy occurs when assets operated together
have a value that exceeds the sum of their
individual values.
• This “going concern value” makes it desirable to
operate the assets as an ongoing entity rather than
sell them individually.
30. 1-30
Valuation of Potential Earnings
• Possible approaches to measuring the value of a
company’s future earnings include:
• Multiples of current earnings.
• Present value of anticipated future new
cash flows generated by the company.
• Sophisticated financial models.
31. 1-31
Valuation of Consideration Exchanged
• When one company acquires another, a value
must be placed on the consideration given in the
exchange.
• Little difficulty is encountered when cash is
used in an acquisition, but valuation may be more
difficult when securities are exchange,
particularly illiquid or privately held securities
or securities with unusual features (e.g.,
convertible or callable securities).
32. 1-32
Purchase Method
• The central idea underlying the purchase method
is the same idea underlying the purchase of any
asset or group of assets: there is a change in
ownership control.
• That is, since there is a change in ownership
control, the purchaser’s accounting is based on
the fair value of the assets and liabilities: not the
seller’s book values.
33. 1-33
Pooling Method
• The central idea underlying the pooling method
was opposite that of the purchase method—a
continuity of interest.
• That is, the owners of the combining companies
became the owners of the combined company.
34. 1-34
Pooling Method
• Thus, the book values of both companies were
carried forward since there was not a change in
ownership control (i.e., there was no arm’s length
transaction to determine a “fair” fair value).
35. 1-35
Purchase Method—
Critical Concepts and Terms
– Cost of Investment (a.k.a. Cost or
Investment Cost or Purchase Price)
– Goodwill
– Fair Value of Net Identifiable Assets
36. 1-36
Purchase Method—
Critical Concepts and Terms
– Book Value of Net Identifiable Assets
– Excess of Cost over Fair Value of
Net Identifiable Assets
– Excess of Fair Value over Book
Value of Net Identifiable Assets
– Total Differential
37. 1-37
Cost of Investment (a.k.a. Cost or Investment Cost
or Purchase Price)
• The value of the consideration given to the owners of the
acquired company normally constitutes the largest part of
the total cost.
• There are three types of other costs that may be incurred
in effecting a business combination:
• Direct costs
• Costs of issuing securities
• Indirect and general costs
38. 1-38
Purchase Price
--Direct Costs
• All direct costs associated with purchasing another
company are capitalized as part of the total cost of the
acquired company.
• Examples:
• Finders’ fees
• Accounting fees
• Legal fees
• Appraisal fees
39. 1-39
Purchase Price
--Costs of Issuing Securities
• Costs incurred in issuing equity securities in
connection with the purchase of a company
should be treated as a reduction in the issue price
of the equity securities issued. Examples include:
Listing fees; Audit and legal fees related to the
registration; and, Brokers’ commissions.
40. 1-40
Purchase Price
--Costs of Issuing Securities
• Costs incurred in issuing bonds payable in
connection with the purchase of a company
should be accounted for as bond issue costs and
amortized over the term of the bonds.
41. 1-41
Purchase Price
--Indirect and General Costs
• All indirect and general costs related to a business
combination or to the issuance of securities in a
combination should be expensed as incurred.
• For example, the salary costs of accountants on
the staff of the acquiring company in a business
combination would be expensed, even though
some of their time was spent on matters related to
the combination.
42. 1-42
Goodwill
• Any amount of the purchase price in excess of the fair
value of the identifiable assets and liabilities acquired
is viewed as the price paid for goodwill.
• In theory, goodwill is the excess earnings power of
the of the acquired company.
• In practice, goodwill represents the premium paid to
acquire control.
43. 1-43
Subsequent Accounting for Goodwill
• Goodwill is carried forward to subsequent accounting
periods at the original amount, and amortised over its
useful life
• Goodwill must be evaluated for impairment at least
annually, at the same time each year, and more
frequently if events occur that are likely to impair the
value of goodwill.
44. 1-44
Bargain Purchase Price
(a.k.a. Negative Goodwill)
• Negative goodwill is said to exist when a
purchaser pays less than the fair value of the
identifiable net assets of another company in
acquiring its ownership.
45. 1-45
Bargain Purchase Price
(a.k.a. Negative Goodwill)
• Negative goodwill is to be used to reduce the
amounts that otherwise would have been assigned
to the acquired assets except financial assets other
than equity-method investments, assets to be sold,
deferred tax assets, prepaid benefit assets and
other current assets.
46. 1-46
Fair Value of Net Identifiable Assets and Book
Value of Net Identifiable Assets
• Generally speaking, fair value is the amount that
would be required to buy an asset (or refinance a
liability) at the date of the business combination.
• Generally speaking, book value is the “GAAP
historical cost” of the asset (or the monetary amount
owed for liabilities—adjusted for premiums and
discounts, if applicable).
47. 1-47
Fair Value of Net Identifiable Assets and Book
Value of Net Identifiable Assets-Cont’d
• Identifiable Asset: Generally speaking, assets other
than Goodwill are considered identifiable.
• Identifiable Liability: Generally speaking, liabilities
that are known (or, if probable, can be reasonably
estimated) are considered identifiable.
48. 1-48
“Excess Cost over Fair Value” and
“Excess Fair Value over Book Value”
– Excess of Cost over Fair Value of Net
Identifiable Assets EQUALS Cost of
Investment LESS Fair Value of Net
Identifiable Assets
– Excess of Fair Value over Book Value of Net
Identifiable Assets EQUALS Fair Value of Net
Identifiable Assets LESS Book Value of Net
Identifiable Assets
49. 1-49
Total Differential
• Two Possible Views:
• Total Differential EQUALS Cost of Investment
LESS Book Value of Net Identifiable Assets
• Total Differential EQUALS Cost (of
Investment) over Fair Value Net Identifiable
Assets PLUS Fair Value over Book Value of
Net Identifiable Assets
50. 1-50
Example: Combination Effected
through Purchase of Net Assets
• PT Intan acquires the net assets of PT Antara in a
statutory merger by issuing Sharp 10,000 shares
of Rp10,000 par common stock. The shares have
a total market value of Rp600,000,000.
51. 1-51
Example: Combination Effected
through Purchase of Net Assets
• PT Intan incurs Rp40,000,000 in legal and
appraisal fees and Rp25 ,000,000 in stock
issuance costs.
• The net assets of PT Antara have a total fair value
of Rp510,000 ,000. (Do not worry about the
individual fair values for now.)
52. 1-52
PT Intan Corporation Illustration: PT Antara T/B (in ‘000)
Assets, Liabilities, and Equities Book Value Fair Value
Cash and Receivables Rp 45,000 Rp 45,000
Inventory 65,000 75,000
Land 40,000 70,000
Buildings and Equipment 400,000 350,000
Accumulated Depreciation (150,000
Patent 80,000
Total Assets Rp 400,000 Rp 620,000
Current Liabilities Rp 100,000 Rp 110,000
Common Stock (Rp5,000 par) 100,000
Additional Paid-In Capital 50,000
Retained Earnings 150,000
Total Liabilities and Equities Rp 400,000
Fair value of Net Assets Rp 510,000
)
53. 1-53
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
Entries Recorded By Acquiring Company (PT Intan)
• NOTE: All amounts on this slide (and the next slide)
are actual amounts incurred by PT Intan.
54. 1-54
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
– To record costs related to purchase of Acquired
Company (PT Antara).
Deferred Merger Costs Rp40,000,000
Cash Rp40,000,000
55. 1-55
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
• Entries Recorded By Acquiring Company (PT
Intan)
– To record costs related to issuance of PT Intan
common stock to PT Antara.
Deferred Stock Issue Costs Rp25,000,000
Cash Rp25,000,000
56. 1-56
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
• Entries Recorded By Acquiring Company (PT Intan).
– To record the combination of PT Antara by PT Intan.
Cash and Receivables Rp45,000,000 #
Inventory 75,000,000 #
Land 70,000,000 #
Buildings and Equipment 350,000,000 #
Patent 80,000,000 #
Goodwill 130,000,000 *
Current Liabilities Rp 110,000,000 #
Common Stock 100,000,000
Additional Paid-In Capital 475,000,000
Deferred Merger Costs 40,000,000 **
Deferred Stock Issue Costs 25,000,000 **
* See next slide. **See previous two slides. # Fair Market Value
57. 1-57
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
• Calculation of Goodwill:
Investment Cost:
Fair value of stock issued Rp600,000,000
PLUS: Other acquisition costs 40,000,000
Total purchase price Rp 640,000,000
LESS:
Fair value of net assets 510,000,000
Goodwill Rp 130,000,000
58. 1-58
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
Entries Recorded By Acquired Company (PT Antara).
• To record the transfer of net assets to PT Intan.
Investment in PT Intan Stock Rp600,000,000
Current Liabilities 100,000,000
Accumulated Depreciation 150,000,000
Cash and Receivables Rp 45,000,000
Inventory 65,000,000
Land 40,000,000
Buildings and Equipment 400,000,000
Gain on sale of Net Assets 300,000,000
59. 1-59
Example: Combination Effected
through Purchase of Net Assets (Cont’d.)
Entries recorded by acquired company (PT Antara).
To record the liquidation of PT Antara.
Common Stock Rp100,000,000
Additional Paid-In Capital 50,000,000
Retained Earnings 150,000,000
Gain on Sale of Net Assets 300,000,000
Investment in PT Intan Stock Rp 600,000,000
60. 1-60
Example: Combination Effected
through Purchase of Stock
• PT Intan acquires the all of the common stock of
PT Antara issuing the shareholders of PT Antara
10,000 shares of Rp10,000 par common stock.
The shares have a total market value of
Rp600,000,000.
61. 1-61
Example: Combination Effected
through Purchase of Stock
• PT Antara continues to operate as a separate
entity after the business combination transaction.
• PT Intan incurs Rp40,000,000 in legal and
appraisal fees and Rp25,000,000 in stock issuance
costs.
• Do not worry about fair values for now.
62. 1-62
Example: Combination Effected
through Purchase of Stock
• Entries Recorded By Acquiring Company (PT
Intan)
NOTE: All amounts on this slide (and the next
slide) are actual amounts incurred by PT Intan.
63. 1-63
Example: Combination Effected
through Purchase of Stock
– To record costs related to purchase of Acquired
Company (PT Antara).
Deferred Merger Costs Rp40,000,000
Cash Rp40,000,000
64. 1-64
Example: Combination Effected
through Purchase of Stock
• Entries Recorded By Acquiring Company (PT
Intan)
– To record costs related to issuance of PT Intan
common stock to PT Antara.
Deferred Stock Issue Costs Rp25,000,000
Cash Rp 25,000,000
65. 1-65
Example: Combination Effected
through Purchase of Stock (Cont’d.)
• Entries Recorded By Acquiring Company (PT Intan)
– To record the combination of PT Antara by PT Intan.
Investment in PT Antara Stock Rp640,000,000 *
Common Stock Rp100,000,000
Additional Paid-In Capital 475,000,000
Deferred Merger Costs 40,000,000 **
Deferred Stock Issue Costs 25,000,000 **
* Rp640,000,000 = Rp 600,000,000 Fair Value of PT Intan
Common Stock PLUS Rp 40,000,000 Merger Costs **See
previous two slides.
66. 1-66
Example: Combination Effected
through Purchase of Stock (Cont’d.)
• NOTE: With respect to the previous slide,
identifiable assets and liabilities are not recorded
at the date of the business combination since PT
Antara is not dissolved.
67. 1-67
Additional Thoughts
• As previously stated, PT Antara is not dissolved
and continues to operate as a separate entity after
the business combination transaction.
• The accounting and reporting procedures for
intercorporate investments in common stock
where the acquired company continues in
existence are discussed in the next nine chapters.
68. 1-68
Financial Reporting
Subsequent to a Purchase
• When a combination occurs during a fiscal year,
income earned by the acquired company prior to
the combination is not reported in the income
statement of the combined entity.
69. 1-69
Financial Reporting
Subsequent to a Purchase
• If the combined entity reports comparative
financial statements that include statements for
periods before the combination, those statements
include only the activities and financial
statements of the acquiring company and not
those of the acquired company.
70. 1-70
Alternative Method for Business Combination
• Pooling of interst is an alternative methodof
accounting for business combination
• In US, FASB has eliminated the pooling method
in 2001.
71. 1-71
You Will Survive This Chapter
ALWAYS ASK THESE QUESTIONS:
– Did the company acquire the common stock of
another company or the assets of another
company ?
– Was the company dissolved (i.e., liquidated) or
did the company continue to exist (i.e., survive)
?
[continued on next slide]
72. 1-72
You Will Survive This Chapter
ALWAYS ASK THESE QUESTIONS:
– Was a new company formed ?
– Was there a change in ownership control ?
– Is the acquired company wholly-owned ?
