business combinations by lecturer yin sokheng, master in finance
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Business Combinations
Chapter One
Prepared by: YIN SOKHENG,
Master in Finance
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Business combination involves obtaining the net
asset of an entire firm by obtaining the firmscommon stock.
Business combination occurs when two or more
companies are brought together into accounting
entity.
Mr. YIN SOKHENG, senior accounting teacher 2
I. Business Combinations
Combination = Merger = Consolidation
Net asset = Total asset + Total liabilities
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Types of business combinations are divided into threeforms:
1. Merger: dissolution of all business involved but oneof all of firms remaining.
2. Consolidation: dissolution of all business involvedand formation of a new company.
3. Stock acquisition: occurs when one company acquiresthe voting shares of another company and the two
companies continue to operate as separate, butrelated, legal entities. The relationship that is createdin a stock acquisition is referred to as a parent-subsidiary relationship.
Mr. YIN SOKHENG, senior accounting teacher 3
Types of Business Combinations
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Mr. YIN SOKHENG, senior accounting teacher 4
Types of Business CombinationsAA Company
BB Company
AA Company
BB Company
AA Company
CC Company
AA Company
BB Company
AA Company
BB Company
1. Merger
2. Consolidation
3. Stock Acquisition
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Mr. YIN SOKHENG, senior accounting teacher 5
Types of Business Combinations
AA Company invests in BB Company
Acquires StockAcquires Net Assets
Acquired CompanyLiquidated?
Record as StockAcquired and Operate
as Subsidiary
Record as Merger orConsolidation
Yes
No
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There are two methods of accounting for formal
business combinations:1. Purchase Method
2. Pooling of Interests Method
Mr. YIN SOKHENG, senior accounting teacher 6
Accounting Method
for Business Combinations
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Purchase method is allowed by generally acceptedaccounting principle (GAAP) in recording the business
combination.
The investment or purchase is recorded based on
historical cost principle.
Under the purchase method, the direct expenses
related to business combination such as accounting fees,
legal, consulting, and finders fees are debited to the
investment account (assets account).
But registration and issuance of equity securities are
recorded as a reduction of the additional paid-in capital.
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II. Purchase Method
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Assume that Poppy Company issues 100,000 shares
of $10 per common stock for the net assets of Sunny
Company in a purchase business combination on
July 01, 2004. The market value of Poppy Company
stock on this date is $16 per share. Additional directcost of business combination consist of Securities
and Exchange Commission (SEC) fees of $5,000.
Accountant fees in connection with SEC registration
of $10,000, cost of printing and issuing the commonstock certificate of $25,000 and finders and
consultants fees of $80,000.
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Example:
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Journal entries to record to the investment and additional
expenses
Mr. YIN SOKHENG, senior accounting teacher 9
General Journal Page 3
Date Account Titles P.R Debit Credit
Journal entries to record to the investment in Sunny Company
Investment in Sunny Company 1,600,000
Common Stock, $ 10 par value 1,000,000
Paid-in Capital 600,000
Journal entries to record to the additional expenses
Investment in Sunny Company 80,000
Paid-in Capital 40,000
Cash 120,000
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Now assume that Sunny Company is dissolved. Poppy Company receives
the assets and liabilities from Sunny as follows:
cash, $20,000; account receivable, $80,000; inventories, $500,000; land,$800,000; building, $100,000; and account payable, $50,000.
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Total investment in Sunny Company (1,600,000+80,000) $ 1680,000
Net assets received:
- Cash $ 20,000
- Account receivable 80,000
- Inventories 500,000
- Land 800,000
- Building 100,000- Account payable (50,000)
Total net assets $ 1,450,000
Goodwill $ 230,000
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Journal entries to record the assets received from Sunny and
liabilities assumed
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General Journal Page 3
Date Account Titles P.R Debit Credit
Cash 20,000
Account Receivable 80,000
Inventories 500,000
Land 800,000
Building 100,000
Goodwill 230,000
Account Payable (50,000)
Investment in Sunny Company 1,680,000
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Illustration of business combination under the purchase method
Example: Pitt Corporation acquires the net assets of Seed Company on
December 27, 2004. The total assets and liabilities of Seed on this date at
book value and fair value are as follow:
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Assets Book Value Fair Value
- Cash $ 50,000 $ 50,000
- Note receivable 150,000 140,000
- Inventories 200,000 250,000
- Land 50,000 100,000
- Building, net 300,000 500,000
- Equipment, net 250,000 350,000
- Patents - 50,000
Total assets $ 1,000,000 $ 1,440,000
Liabilities Book Value Fair Value
- Account payable $ 60,000 $ 60,000
- Note payable 150,000 135,000
- Other liabilities 40,000 45,000
Total liabilities $ 250,000 $ 240,000
Net assets $ 750,000 $ 1,200,000
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Case 1: Good will
Mr. YIN SOKHENG, senior accounting teacher 13
Pitt Corporation pays $400,000 cash and issues $50,000 shares, $10 par
common stock with a market value of $20 per share.
General Journal Page 3
Date Account Titles P.R Debit Credit
Journal entries to record to the investment in Seed Company
Investment in Seed Company 1,400,000
Cash 400,000
Common Stock, $ 10 par value 500,000
Paid-in Capital 500,000
Journal entries to record the dissolution of Seed Company.Determine the goods will:
To investment in Sunny Company 1,400,000
Net assets received 1,200,000
Good will 200,000
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Record the assts received and liabilities assumed
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General Journal Page 3
Date Account Titles P.R Debit Credit
Cash 50,000
Note Receivable 140,000
Inventories 250,000
Land 100,000
Building, net 500,000
Equipment, net 350,000
Patents 50,000
Goodwill 200,000Account Payable 60,000
Notes payable 135,000
Other liabilities 45,000
Investment in Seed Company 1,400,000
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Pitt Corporation issues $40,000 shares of its $10 parcommon stock with a market value of $20 per share, and
it also give a 10%, five years notes payable for $200,000
for the net assets of Seed Company.
So, total investment in Seed
= ($40,000 x $20) + 200,000= $1,000,000
Net assets received from Seed 1,200,000
Negative goodwill $200,000 Negative goodwill of $200,000 is not record in the
Pitts book.
It is deducted from fair value of each noncurrent assets.
Mr. YIN SOKHENG, senior accounting teacher 15
Case 2: Negative goodwill
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Mr. YIN SOKHENG, senior accounting teacher 16
Noncurrent assets Fair Value Percentage of Deduction (%)
Amount to berecorded
- Land $ 100,000 $ 20,000 $ 80,000
- Building, net 500,000 100,000 400,000
- Equipment, net 350,000 70,000 280,000
- Patents 50,000 10,000 40,000
Total $ 1,000,000 $ 200,000 $ 800,000
General Journal Page 3
Date Account Titles P.R Debit Credit
Journal entries on Pitts book to record the investment in Seed Co.
Investment in Seed Company 1,000,000
Notes payable 200,000
Common Stock, $10 par value 400,000
Paid-in Capital 400,000
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As Seed Company is dissolved, Pitt Corporation must record the asstsreceived from Seed.
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General Journal Page 3
Date Account Titles P.R Debit Credit
Cash 50,000
Note Receivable 140,000
Inventories 250,000Land 80,000
Building, net 400,000
Equipment, net 280,000
Patents 40,000
Account Payable 60,000
Notes payable 135,000
Other liabilities 45,000
Investment in Seed Company 1,000,000
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Under the pooling of interest method, the assetsand liabilities received are recorded at the book
value.
The stock issued is recorded at book value.
Example: On January 01, 2005, Point Corporation
issues 10,000 shares of its $10 par common stock in
exchange for all assets of Sharp Company. Sharp
distributes the shares to its shareholders and retiresits own stock.
The balance sheet of Point and Sharp, at book
value are as follows:
Mr. YIN SOKHENG, senior accounting teacher 18
III. Pooling of Interest Method
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Book Value
Assets Point Sharp
- Cash $ 75,000 $ 45,000
- Inventories 125,000 65,000
- Land 100,000 40,000
- Building 600,000 400,000
Accumulated depreciation (200,000) (150,000)
Total assets $ 1,000,000 $ 1,440,000
Liabilities and Shareholders Equity
- Current liabilities $ 150,000 $ 100,000
- Common Stock:
. Point Corporation, $10 par 300,000
. Sharp Company 100,000
- Paid-in Capital 30,000 50,000
- Retained Earnings 220,000 150,000
Total Liabilities and Equity $ 700,000 $ 1,440,000
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Journal entry on Points book to record the assets, liabilities & equitiesreceived from Sharp.
Mr. YIN SOKHENG, senior accounting teacher 20
General Journal Page 3Date Account Titles P.R Debit Credit
Journal entry on Points book to record the assets, liabilities & equities received fromSharp.
Cash 45,000
Inventories 65,000Land 40,000
Building 400,000
Accumulated depreciation 150,000
Current liabilities 100,000Common Stock 100,000
Paid-in Capital 50,000
Retained Earnings 150,000
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Mr. YIN SOKHENG, senior accounting teacher 21
General Journal Page 3
Date Account Titles P.R Debit Credit
Journal entry on Sharps book to record the stock received from Point.
Investment 300,000
Current liabilities 100,000
Accumulated depreciation 150,000
Cash 45,000
Inventories 65,000
Land 40,000
Building 400,000
Journal entry to record the distribution of stock to shareholders.
Common Stock 100,000Paid-in Capital 50,000
Retained Earnings 150,000
Investment in Point 300,000
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Mr. YIN SOKHENG, senior accounting teacher 22
Difference in total par valueItem Original
Shareholdersequity account
Change in Shareholders equity account
recorded by Point
Point Sharp Case 1 Case 2 Case 3 Case 4
Shares issue by Point:
- Number Shares 10,000 8,000 14,000 21,000
- Total Value 100,000 80,000 140,000 210,000
Common Stock 300,000 100,000 100,000 80,000 140,000 210,000
Paid-in Capital 30,000 50,000 50,000 70,000 10,000 (30,000)
Retained Earnings 220,000 150,000 150,000 150,000 150,000 120,000
Total Shareholders equity 550,000 300,000 300,000 300,000 300,000 300,000
Case 4: 210,000 100,000 = 110,000 50,000 (Paid-n Capital of Sharp)
30,000 (Paid-n Capital of Point)
30,000 (150,000 30,000)
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Mr. YIN SOKHENG, senior accounting teacher 23
Difference in total par value
Item OriginalShareholdersequity account
Total Shareholders equity account ofcombined company
Point Sharp Case 1 Case 2 Case 3 Case 4
Shares issue by Point:
- Number Shares
- Total Value
Common Stock 300,000 100,000 400,000 380,000 440,000 510,000
Paid-in Capital 30,000 50,000 80,000 100,000 40,000 0
Retained Earnings 220,000 150,000 370,000 370,000 370,000 340,000
Total Shareholders equity 550,000 300,000 850,000 850,000 850,000 850,000
$ 850,000
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Thank You
thank you all for yourattention.