The document provides an overview of accounting and tax considerations related to structuring M&A deals. It discusses the purchase (acquisition) method of accounting required by SFAS 141R, which involves recording acquired assets and liabilities at fair value and any excess purchase price over net assets as goodwill. It also outlines different tax structures for M&A deals, including taxable transactions where basis is stepped up and tax-free reorganizations that must meet continuity of interest and business enterprise principles. Specific reorganization types discussed are Type A (merger), Type B (stock-for-stock), and Type C (stock-for-assets) transactions.

1. Structuring the Deal:
Tax and Accounting
Considerations

2. One person of integrity can
make a difference,
a difference of life and death.
—Elie Wiesel

3. Course Layout: M&A & Other
Restructuring Activities
Part IV: Deal
Structuring &
Financing
Part II: M&A
Process
Part I: M&A
Environment
Payment &
Legal
Considerations
Public Company
Valuation
Financial
Modeling
Techniques
M&A Integration
Business &
Acquisition
Plans
Search through
Closing
Activities
Part V:
Alternative
Strategies
Accounting &
Tax
Considerations
Business
Alliances
Divestitures,
Spin-Offs &
Carve-Outs
Bankruptcy &
Liquidation
Regulatory
Considerations
Motivations for
M&A
Part III: M&A
Valuation &
Modeling
Takeover Tactics
and Defenses
Financing
Strategies
Private
Company
Valuation
Cross-Border
Transactions

4. Learning Objectives
• Primary Learning Objective: To provide students with
knowledge of how accounting treatment and tax
considerations impact the deal structuring process.
• Secondary Learning Objectives: To provide students with
knowledge of
– Purchase (acquisition method) accounting used for
financial reporting purposes;
– Goodwill and how it is created; and
– Alternative taxable and non-taxable transactions.

5. Accounting Treatment Background
• Statement of Financial Accounting Standard 141 (SFAS 141) required effective 12/15/01
purchase accounting to be employed for all business combinations by allocating the
purchase price to acquired net assets. Limitations included difficulty in comparing
transactions (e.g., those with minority shareholders to those with none) and mixing of
historical and current values (e.g., staged purchases).
• Effective 12/15/08, SFAS 141R required that acquirers must
– Recognize, separately from goodwill,1 identifiable assets, and assumed liabilities at
their acquisition date2 fair values;3
– Recognize goodwill attributable to non-controlling shareholders;4
– Revalue acquired net assets in each stage of staged transactions to their current fair
value;
– Compute fair value of contingent payments5 as part of total consideration, revalue as
new data becomes available, and reflect on income statement;
– Capitalize “in-process” R&D on acquisition date with indefinite life until project’s
outcome is known (amortize if successful/write-off if not); and
– Expense investment banking, accounting, and legal fees at closing; capitalize
financing related expenses
1Goodwill is an asset representing future economic benefits from acquired assets not identified separately (i.e., control, brand name, etc.)
2Acquisition date is the point at which control changes hands (i.e., closing).
3Fair value is the amount at which an asset could be bought or sold in a current transaction between willing parties with access to the same
information.
4An acquirer must recognize 100% of the goodwill even if they acquired less than 100% of the target’s assets, if they have a controlling interest giving
them effective control over 100% of the assets.
5Recognize as a liability on balance sheet.

6. Purchase (Acquisition) Method of Accounting
• Requirements:
– Record acquired tangible and intangible assets and assumed
liabilities at fair market value on acquiring firm’s balance sheet.
– Record the excess of the price paid (PP) plus any non-controlling
interests1 over the target’s net asset value (i.e., FMVTA - FMVTL) as
goodwill (GW) on the consolidated balance sheet, where FMVTA and
FMVTL are the fair market values of total acquired assets and
liabilities.
• These relationships can be summarized as follows:
– Purchase price: PP = FMVTA– FMVTL+ FMVGW
– Goodwill estimation:2 FMVGW = PP – FMVTA + FMVTL
= PP - (FMVTA - FMVTL)
1The balance sheets of acquirers with a controlling interest that is less than 100% ownership must still record 100% of
goodwill reflecting their effective control over all of the target firm’s assets and liabilities.
2Goodwill and net acquired assets must be checked annually (or whenever a key event such as the loss of a major
acquired customer or patent takes place impacting value) for impairment.

7. Example of Estimating Goodwill
On January 1, 2009, Acquirer Inc. purchased 80 percent of Target Inc.’s 1,000,000
shares outstanding at $50 per share for a total value of $40,000,000 (i.e., .8 x
1,000,000 x $50). On that date, the fair value of total Target net assets was
$42,000,000. What is value of the goodwill shown on Acquirer’s balance sheet? What
portion of that goodwill is attributable to the minority interest retained by Target’s
shareholders?
100% of Goodwill shown on Acquirer’s balance sheet:
FMVGW = PP1 – (FMVTA – FMVTL) = $50,000,000 - $42,000,000
= $8,000,000
Goodwill attributable to the minority interest: Note that 20 percent of the total shares
outstanding equal 200,000 shares with a market value of $10,000,000 ($50 x
200,000). Therefore, the amount of goodwill attributable to the minority interest is
calculated as follows:
Fair Value of Minority Interest: $10,000,000
Less: 20% fair value of total Target net assets
(.2 x $42,000,000): $ 8,400,000
Equal: Goodwill attributable to minority interest: $ 1,600,000
1Purchase price as if acquirer purchased 100% of target firm (i.e., $50/share x 1,000,000 = $50,000,000).

8. Example of Purchase Method of Accounting
(Assume Acquirer Pays $1 Billion for Target)
Acquirer Pre-
Acquisition Book
Value ($Millions)
Col. 1
Target Pre-
Acquisition Book
Value ($Millions)
Col. 2
Target Fair Market
Value ($Millions)
Col. 3
Acquirer Post-
Acquisition Value
($Millions)
Col. 4
Current Assets 12,000 1,200 1,200 13,200
Long-Term Assets 7,000 1,000 1,400 8,400
Goodwill 1003
Total Assets 19,000 2,200 2,600 21,700
Current Liabilities 10,000 1,000 1,000 11,000
Long-Term Debt 3,000 600 700 3,700
Common Equity 2,000 300 1,0001 3,000
Retained Earnings 4,000 300 4,000
Equity + Liabilities 19,000 2,200 2,7002 21,700
1The fair value of the target’s equity is equal to the purchase price; target’s retained earnings implicitly included in the purchase price paid for the
target’s equity. Note that the change in acquirer’s pre- and post- acquisition common equity value equals the acquisition purchase price.
2The $100 million difference between the fair market value of the target’s equity plus liabilities less total assets represents unallocated portion of the
purchase price (i.e., the excess of the purchase price over the FMV of net acquired assets).
3Goodwill = Purchase price – FMV of Net Acquired Target Assets = $1,000 – ($2,600 - $1,000 - $700)

9. Discussion Questions
1. Acquirer and Target companies reach an agreement to
merge. Describe how the purchase method of
accounting would impact the income statement,
balance sheet, and cash flows statements of the
combined companies.
2. Goodwill is an accounting entry equal to the difference
between purchase price and the fair market value of
net acquired assets. As a business manager, what do
you believe goodwill represents? How could the
factors that goodwill represents actually contribute to
improving the combined firm’s future cash flows?
3. How might the treatment of contingent payments under
SFAS 141R affect the popularity of earnouts from the
acquirer’s perspective?

10. Choosing the Right Deal Structure
• Consider the Following Factors:
– Tax impact (Immediate or Deferred)
– Acquirer and Target Shareholder Approvals
– Exposure to Target Liabilities
– Payment Flexibility
– Target Survivability
– Limitations on Restructuring Efforts (e.g., tax-free
status of spin-offs 2 years before and after tax-free
deal could be jeopardized)

11. Alternative Tax Structures
• Mergers and acquisitions can be structured as either tax-free,
partially taxable, or wholly taxable to target shareholders.
• Taxable Transactions:
– The buyer pays primarily with cash, securities, or other non-
equity consideration for the target firm’s stock or assets
– Absent a special election, tax basis of target’s assets will not be
increased to FMV following a purchase of stock
– 338 election: Buyer can elect to have a taxable stock purchase
treated as an asset purchase and acquired assets increased to
FMV. Taxes must be paid on any gains on acquired assets.
– Impact of asset write-up on EPS and potential taxable gains
must be weighed against improved cash flow from tax savings
• Tax-Free Transactions:
– Mostly buyer stock used to acquire stock or assets of the target
– Buyer must acquire enough of the target’s stock and assets to
ensure that the IRS’ continuity of interests and business
enterprise principles are satisfied

12. Alternative Tax-Free Structures
• A tax-free transaction is also known as a tax-free
reorganization since it must satisfy the continuity of
interests and business enterprise principles
• Of the 8 different types of tax-free reorganizations
(Section 368 of the Internal Revenue Code), the most
common are:
– Type A reorganization (incl. statutory direct merger or
consolidation; forward and triangular mergers)
– Type B reorganization (stock-for-stock acquisition)
– Type C reorganization (stock-for-assets acquisition)
– Type D divisive reorganization (spin-offs, split-offs,
and split-ups)

13. Qualifying as a Tax-Free Reorganization
• Four conditions must be met:
– Continuity of ownership interest (usually satisfied if
purchase price at least 50% acquirer stock)1
– Continuity of business enterprise (“substantially all
requirement” usually satisfied if buyer acquires at
least 70% and 90% of FMV of target gross and net
assets)
– Valid business purpose (other than tax avoidance)
– Step transaction doctrine (must not be part of larger
plan that would have resulted in a taxable transaction)
1May be as low as 40% under some circumstances.

14. Continuity of Interests and Business
Enterprise Principles1
• Purpose: To ensure that subsidiary mergers do not
resemble sales, making them taxable events
• Continuity of interests: A substantial portion of the
purchase price must consist of acquirer stock to ensure
target firm shareholders have a significant ownership
position in the combined companies
• Continuity of business enterprise: The buyer must either
continue the acquired firm’s “historic business
enterprise” or buy “substantially all” of the target’s
“historic business assets” in the combined companies.
Continued involvement intended to demonstrate long-
term commitment by acquiring company to the target.
1These principles are intended to discourage acquirers from buying a target in a tax free transaction and immediately
selling the target’s assets, which would reflect the acquirer’s higher basis in the assets possibly avoiding any tax
liability when sold.

15. Type A Reorganization
• To qualify as a Type A reorganization, transaction must be a statutory
merger or consolidation; forward or reverse triangular merger
• No limits on composition of purchase price
• No requirement to use acquirer voting stock
• At least 50% of the purchase price must be in acquirer stock1
• Advantages:
– Acquirer can issue non-voting stock to target shareholders without
diluting its control over the combined companies
– Acquirer may choose not to acquire all of the target’s assets
– Allows use of more cash in purchase price than Types B and C
reorganizations
• Disadvantages:
– Acquirer assumes all undisclosed liabilities
– Requires acquirer shareholder approval if new shares are to be
issued or number of new shares exceeds 20% of the firm’s shares
traded on public exchanges.
– Limitations of asset dispositions within two years of closing
1As low as 40% in some circumstances.

16. Direct Statutory Merger (“A”
Reorganization)
Acquiring Firm
Target Firm (Liquidated as
assets and liabilities merged
with acquirer)
Target Shareholders
(Receive voting or
nonvoting acquirer stock
in exchange for target stock
and boot)
Assets &
Liabilities
Acquirer Stock &
Boot
Target Stock
Target liquidated and contracts dissolved. Contracts need to be assigned or transferred. Remaining target
assets/liabilities assumed by acquirer; acquirer & target shareholder approval required in most states; dissenting
shareholders may have appraisal rights. No asset write-up. Target’s tax attributes transfer to acquirer but are
limited by Section 382 and 383 of Internal Revenue Code (IRC).

17. Statutory Consolidation (“A”
Reorganization)
Company A
(Contributes assets &
liabilities to Newco)
Company B
(Contributes assets &
Liabilities to Newco)
Company A
Shareholders
Company B
Shareholders
New Company
(Newco)
Assets/Liabilities
Newco Stock
Companies A & B liquidated and contracts dissolved. Contracts need to be transferred or assigned; acquirer and
target shareholder approval required with dissenting shareholders having appraisal rights. Structure appropriate
for merger of equals. No asset writeup. Acquirer and target tax attributes transfer to Newco but are limited by
Sections 382 and 383 of IRC.

18. Forward Triangular Merger (“A” Reorganization)
Acquiring Company
Subsidiary (Shell created by
parent and funded by
parent’s cash or stock)
Target Firm (Merges assets
and liabilities with the
parent’s wholly-owned
subsidiary)
Target Shareholders (Receive
voting or nonvoting stock
held by parent’s wholly
owned subsidiary in
exchange for target stock)
Parent’s Stock
& Boot
Target Assets
and Liabilities
Subsidiary’s
Stock
Parent’s
Stock/Cash
“Substantially all” and “continuity of interests” requirements apply. Flexible form of payment. Avoids transfer taxes
and may insulate parent from target liabilities and eliminate acquirer shareholder approval unless required by
stock exchange or new shares issued exceed 20% of acquirer’s outstanding shares. No asset writeup. Target tax
attributes transfer but subject to limitation. Target shareholder approval required. However, as target eliminated,
nontransferable assets and contracts may be lost.
Target Stock

19. Reverse Triangular Merger (“A”
Reorganization)
Acquiring Company
Subsidiary (Shell created by
parent and funded by
parent’s voting stock merged
into target firm)
Target Firm (Receives assets
and liabilities of acquiring
firm’s wholly owned
subsidiary)
Target Shareholders (Receive
parent’s voting stock
held by parent’s wholly
owned subsidiary in
exchange for target stock)
Parent’s Stock
& Boot
Subsidiary’s Assets
and Liabilities
Subsidiary’s
Stock
Parent’s
Voting
Stock
Target survives as acquirer subsidiary. Target tax attributes and intellectual property and contracts transfer
automatically; may insulate acquirer from target liabilities and avoid acquirer shareholder approval. At least 80% of
purchase price must be in acquirer voting shares. No asset writeup. Acquirer must buy “substantially all” of the
FMV of the target’s assets and target tax attributes transfer subject to limitation.
Target Stock

20. Type “B” Stock for Stock Reorganization
• To qualify as a Type B Reorganization, acquirer must use only
voting stock to purchase at least 80% of the target’s voting stock
and at least 80% of the target’s non-voting stock
• Cash may be used only to acquire fractional shares
• Used mainly as an alternative to a merger or consolidation
• Advantages:
– Target may be maintained as an independent operating
subsidiary or merged into the parent
– Stock may be purchased over a 12 month period allowing for a
phasing of the transaction (i.e., “creeping acquisition”)
• Disadvantages:
– Lack of flexibility in determining composition of purchase price
– Potential dilution of acquirer’s current shareholders’ ownership
interest
– May have minority shareholders if all target shareholders do not
tender their shares

21. Type “B” Stock for Stock Reorganization
Acquiring Firm
(Exchanges voting
shares for at least 80%
of target voting & non-
Voting shares”)
Target Shareholders
Wholly-Owned
Shell Subsidiary
Target Firm
(Merged into acquiring
firm’s subsidiary)
Target Stock
Acquirer Voting Stock
(No Boot)
Buyer need not acquire 100% of target shares, shares may be required over time, and may insulate acquirer from
target liabilities. May insulate parent from target’s liabilities and tax attributes transfer subject to limitation. Suitable
for target shareholders with large capital gains and therefore willing to accept acquirer shares to avoid capital
gains taxes triggered in a stock for cash sale.
Target Assets
and Liabilities
Shell
Stock

22. Type “C” Stock for Assets Reorganization
• To qualify as a Type C reorganization, acquirer must purchase 70% and
90% of the fair market value of the target’s gross and net assets,
respectively.
• The acquirer must use only voting stock
• Boot cannot exceed 20% of FMV of target’s pre-transaction assets (value
of any assumed liabilities deducted from boot)1
• The target must dissolve following closing and distribute the acquirer’s
stock to the target’s shareholders for their canceled target stock
• Advantages:
– Acquirer need not assume any undisclosed liabilities
– Acquirer can purchase selected assets
• Disadvantages:
– Technically more difficult than a merger because all of the assets must
be conveyed
– Transfer taxes must be paid
– Need to obtain consents to assignment on contracts
– Requirement to use only voting stock potentially resulting in dilution of
the acquirer shareholders’ ownership interest
1Value of assumed liabilities viewed as part of purchase price.

23. Type “C” Stock for Assets Reorganization
Acquiring Firm
(Exchanges voting shares
for at least 80% of FMV of
Target assets)
Target Firm
(Liquidates and transfers
Acquiring Firm shares and
any remaining assets
to shareholders)
Target Shareholders
Acquirer Voting
Stock & Boot
Target Assets
Acquirer Voting
Stock & Boot
Enables buyer to be selective in choosing assets and any liabilities, if at all, it chooses to assume. Avoids
transfer taxes, requires consents to assignment, and potentially dilutive to acquirer shareholders. No asset
writeup. Tax attributes transfer to acquirer subject to limitation.
Target
Cancelled
Stock

24. Type D Divisive Reorganizations
• Type D Divisive Reorganizations apply to spin-offs, split-ups, and
split-offs
• Spin-Off: Stock in a new company is distributed to the original
company’s shareholders according to some pre-determined formula.
Both the parent and the entity to be spun-off must have been in
business for at least five years prior to the spin-off.
• Split-off: A portion of the original company is separated from the
parent, and shareholders in the original company may exchange
their shares for shares in the new entity. No new firm created.
• Split-up: The original company ceases to exist, and one or more
new companies are formed from the original business as original
shareholders exchange their shares for shares in the new
companies.
• For these reorganizations to qualify as tax-free, the distribution of
shares must not be for the purpose of tax avoidance.

25. Implications of Tax Considerations
for Deal Structuring
• In taxable transactions, target generally
demands a higher purchase price
• Higher purchase price often impacts form of
payment as buyer tries to maintain PV of
transaction by deferring some of purchase price
• Buyer may avoid EPS dilution by buying target
stock or assets using a non-equity form of
payment in a taxable transaction
• If buyer wants to preserve cash and obtain
target’s tax credits, buyer may use its stock to
purchase target stock in a non-taxable
transaction

26. Discussion Questions
1. Explain how tax considerations affect the deal
structuring process? From seller’s
perspective? From buyer’s perspective?
2. What is a Type A reorganization? When does
it make sense for a buyer to use a Type A
reorganization?
3. What is a reverse triangular merger? Under
what circumstances would a buyer wish to use
this type of reorganization?
4. How might the buyer structure the transaction
in order to avoid EPS dilution? (Hint: Consider
the factors that make a transaction taxable or
non-taxable.)

27. Things to Remember
• For financial reporting purposes, all M&As must be
accounted for using purchase accounting.
• Taxable transactions:
– Direct cash merger
– Cash purchase of assets
– Cash purchase of stock
• Tax-free transactions:
– Type A reorganization (Incl. direct statutory
merger or consolidation; forward and reverse
triangular merger)
– Type B stock-for-stock reorganization
– Type C stock-for-assets reorganization