chapter 2-1. chapter 2-2 accounting for business combinations advanced accounting, third edition 22
TRANSCRIPT
Chapter 2-1
Chapter 2-2
Accounting for Business Accounting for Business CombinationsCombinations
Advanced Accounting, Third Edition
2222
Chapter 2-3
1. Describe the major changes in the accounting for business combinations proposed by the FASB in June 2005, and the reasons for those changes.
2. Describe the two major changes in the accounting for business combinations approved by the FASB in 2001, as well as the reasons for those changes.
3. Discuss the goodwill impairment test described in SFAS No. 142, including its frequency, the steps laid out in the new standard, and some of the likely implementation problems.
4. Explain how acquisition expenses are reported.
5. Describe the use of pro forma statements in business combinations.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
Chapter 2-4
6. Describe the valuation of assets, including goodwill, and liabilities acquired in a business combination accounted for by the acquisition method.
7. Explain how contingent consideration affects the valuation of assets acquired in a business combination accounted for by the acquisition method.
8. Describe a leveraged buyout.
9. Describe the disclosure requirements according to the Exposure Draft No. 1204-01 (June 2005), “Business Combinations,” related to each business combination that takes place during a given year.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
Chapter 2-5
HistoricallyHistorically, two distinct methods of accounting for business combinations were permitted: purchase and pooling of interests.
LO 2 FASB’s two major changes of 2001.LO 2 FASB’s two major changes of 2001.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Two New Pronouncements in June 2001:
1. SFAS No. 141, “Business Combinations,” - pooling method is prohibited for business combinations initiated after June 30, 2001.
2. SFAS No. 142, “Goodwill and Other Intangible Assets,” - Goodwill acquired in a business combination after June 30, 2001, should not be amortized.
Chapter 2-6
What’s New?
Exposure Draft No. 1204-01, “Business Combinations,” would replace FASB Statement No. 141.
Continues to support the use of a single method.
Uses the term “acquisition method” rather than “purchase method.”
All assets and liabilities, on the date the acquirer obtains control of the acquiree, will be reflected in the financial statements at fair value.
LO 1 New changes proposed by FASB in June 2005.LO 1 New changes proposed by FASB in June 2005.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Issued on June 30, 2005,
Chapter 2-7
What’s New?
Exposure Draft No. 1205-001, “ConsolidatedFinancial Statements, Including Accounting and Reporting of Noncontrolling Interests in Subsidiaries,” will replace Accounting Research Bulletin (ARB) No. 51.
Establishes standards for the reporting of the noncontrolling interest when the acquirer obtains control without purchasing 100% of the acquiree.
Additional discussion in Chapter 3.LO 1 New changes proposed by FASB in June 2005.LO 1 New changes proposed by FASB in June 2005.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Issued on June 30, 2005,
Chapter 2-8
Goodwill Impairment Test
SFAS No. 142 requires impairment be tested annually.
All goodwill must be assigned to a reporting unit.
Impairment should be tested in a two-step process.
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Step 1: If fair value is less than the carrying amount of the net assets (including goodwill), then perform a second step to determine possible impairment.
Step 2: Determine the fair value of the goodwill (implied value of goodwill) and compare to carrying amount.
Chapter 2-9
E2-11 On January 1, 2007, Porsche Company acquired the net assets of Saab Company for $450,000 cash. The fair value of Saab’s identifiable net assets was $375,000 on this date. Porsche Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Saab). The information for these subsequent years is as follows:Present Value Carry Value Fair Value
of Future of SAAB's of SAAB's Year Cash Flows Net Assets Net Assets
2008 400,000$ 330,000$ 340,000$
2009 400,000$ 320,000$ 345,000$
2010 350,000$ 300,000$ 325,000$
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
*
* Not including goodwill
Chapter 2-10
E2-11 On January 1, 2007, the acquisition date, what was the amount of goodwill acquired, if any?
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Acquisition price $450,000
Fair value of identifiable net assets 375,000
Recorded value of Goodwill $ 75,000
Chapter 2-11 LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets
330,000
Step 1 - 2008
Carrying value of goodwill
75,000Total carrying value of unit
405,000Excess of carrying value over fair value $ 5,000
E2-11 Part A&B: For each year determine the amount of goodwill impairment, if any, and prepare the journal entry needed each year to record the goodwill impairment (if any).
Excess of carrying value over fair value means step 2 is required.
Chapter 2-12 LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Fair value of reporting unit $400,000
Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Step 2 - 2008
Carrying value of goodwill 75,000
Impairment loss
$ 15,000Impairment loss 15,000
Goodwill
15,000
JournalEntry
E2-11 Part A&B (continued)
Chapter 2-13 LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Fair value of reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets
320,000
Step 1 - 2009
Carrying value of goodwill
60,000Total carrying value of unit
380,000Excess of fair value over carrying value $ 20,000
Excess of fair value over carrying value means step 2 is not required.
E2-11 Part A&B (continued)
* $75,000 (original goodwill) – $15,000 (prior year impairment)
*
Chapter 2-14 LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Fair value of reporting unit $350,000
Carrying value of unit:
Carrying value of identifiable net assets
300,000
Step 1 - 2010
Carrying value of goodwill
60,000Total carrying value of unit
360,000Excess of carrying value over fair value $ 10,000
E2-11 Part A&B (continued)
* $75,000 (original goodwill) – $15,000 (prior year impairment)
*
Excess of carrying value over fair value means step 2 is required.
Chapter 2-15 LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Fair value of reporting unit $350,000
Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Step 2 - 2010
Carrying value of goodwill 60,000
Impairment loss
$ 35,000Impairment loss 35,000
Goodwill
35,000
JournalEntry
E2-11 Part A&B (continued)
Chapter 2-16
The first step in determining goodwill impairment involves comparing the
a. implied value of a reporting unit to its carrying amount (goodwill excluded).
b. fair value of a reporting unit to its carrying amount (goodwill excluded).
c. implied value of a reporting unit to its carrying amount (goodwill included).
d. fair value of a reporting unit to its carrying amount (goodwill included).
Review QuestionReview Question
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-17
Disclosures Mandated by FASB
SFAS No. 141 requires:
1. The total amount of acquired goodwill and the amount expected to be deductible for tax purposes.
2. The amount of goodwill by reporting segment (in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”), unless not practicable.
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-18
Disclosures Mandated by FASB
SFAS No. 142 specifies the presentation of goodwill (if impairment occurs) as follows:
a. The aggregate amount of goodwill should be a separate line item in the balance sheet.
b. The aggregate amount of losses from goodwill impairment should be shown as a separate line item in the operating section of the income statement.
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-19
Disclosures Mandated by FASB
When an impairment loss occurs, SFAS No. 142 mandates the following disclosures in the notes:
1. A description of the facts and circumstances leading to the impairment.
2. The amount of the impairment loss and the method of determining the fair value of the reporting unit.
3. The nature and amounts of any adjustments made to impairment estimates from earlier periods, if significant.
LO 3 Goodwill impairment assessment.LO 3 Goodwill impairment assessment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-20
Other Required Disclosures
Exposure Draft (ED1204-001) states that disclosure should include:
The name and a description of the acquiree.
The acquisition date.
The percentage of voting equity instruments acquired.
The primary reasons for the business combination, including a description of the factors that contributed to the recognition of goodwill.
LO 9 New disclosure requirements for business LO 9 New disclosure requirements for business combinations.combinations.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-21
Other Required Disclosures
Exposure Draft (ED1204-001) states that disclosure should include:
The fair value of the acquiree and the basis for measuring that value on the acquisition date.
The fair value of the consideration transferred.
The amounts recognized at the acquisition date for each major class of assets acquired and liabilities assumed.
The maximum potential amount of future payments the acquirer could be required to make.
LO 9 New disclosure requirements for business LO 9 New disclosure requirements for business combinations.combinations.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
Chapter 2-22
Other Intangible Assets
Acquired intangible assets other than goodwill:
Limited useful life
Should be amortized over its useful economic life.
Should be reviewed for impairment.
Indefinite life
Should not be amortized.
Should be tested annually (minimum) for impairment.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
LO 9 New disclosure requirements for business LO 9 New disclosure requirements for business combinations.combinations.
Chapter 2-23
Treatment of Acquisition Expenses
The Exposure Draft requires that:
both direct and indirect costs be expensed.
the cost of issuing securities also be excluded from the consideration.
Security issuance costs are assigned to the valuation of the security, thus reducing the additional contributed capital for stock issues or adjusting the premium or discount on bond issues.
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
LO 4 Explain how acquisition expenses are reported.LO 4 Explain how acquisition expenses are reported.
Chapter 2-24
ACQUISITION COSTS—AN ILLUSTRATION
Suppose that SMC Company acquires 100% of the net assets of Bee Company (net book value of $100,000) by issuing shares of common stock with a fair value of $120,000. With respect to the merger, SMC incurred $1,500 of accounting and consulting costs and $3,000 of stock issue costs. SMC maintains a mergers department that incurred a monthly cost of $2,000. The following illustrates how these costs are recorded under proposed GAAP.
ACQUISITION ACCOUNTING:
Professional Fees Expense (Direct) 1,500Merger Department Expense (Indirect) 2,000Other Contributed Capital (Security Issue Costs) 3,000
Cash 6,500
Historical Perspective on Business Historical Perspective on Business CombinationsCombinationsHistorical Perspective on Business Historical Perspective on Business CombinationsCombinations
LO 4 Explain how acquisition expenses are reported.LO 4 Explain how acquisition expenses are reported.
Chapter 2-25
Pro forma statements serve two functions in relation to business combinations:
1) to provide information in the planning stages of the combination and
2) to disclose relevant information subsequent to the combination.
Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirementPro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirement
LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.
Chapter 2-26
Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirementPro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirement
LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.
P Company Pro Forma Balance SheetGiving Effect to Proposed Issue of Common Stock for All the Net Assets of S Company January 1, 2007
Illustration 2-1
Chapter 2-27
If a material business combination occurred, notes to financial statements should include on a pro forma basis:
1. Results of operations for the current year as though the companies had combined at the beginning of the year.
2. Results of operations for the immediately preceding period as though the companies had combined at the beginning of that period if comparative financial statements are presented.
Pro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirementPro Forma Statements and Disclosure Pro Forma Statements and Disclosure RequirementRequirement
LO 5 Use of pro forma statements.LO 5 Use of pro forma statements.
Chapter 2-28
The Exposure Draft specifies four steps in the accounting for a business combination:
1. Identify the acquirer.
2. Determine the acquisition date.
3. Measure the fair value of the acquiree.
4. Measure and recognize the assets acquired and liabilities assumed.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Chapter 2-29
Value of Assets and Liabilities Acquired
Identifiable assets acquired (including intangibles other than goodwill) and liabilities assumed should be recorded at their fair values at the date of acquisition.
Any excess of total cost over the fair value amounts assigned to identifiable assets and liabilities is recorded as goodwill.
Standards require that R&D costs be expensed as incurred, however, the Exposure Draft proposes that in-process R&D that is acquired as part of a business combination will be capitalized.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Chapter 2-30
Bargain Purchase
When the fair values of identifiable net assets (assets less liabilities) exceeds the total cost of the acquired company, the acquisition is a bargain.
In the past, FASB required that most long-lived assets be written down on a pro rata basis before recognizing a gain.
The Exposure Draft advises that:
fair values be reconsidered and adjustments made as needed.
any excess of acquisition-date fair value of net assets over the consideration paid is recognized in income.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Chapter 2-31
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
E2-1 Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company. Immediately prior to the acquisition, Saville Company’s balance sheet was as follows:
Any Goodwill
?
Chapter 2-32
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
E2-1 Preston Company acquired the assets (except for cash) and assumed the liabilities of Saville Company. Immediately prior to the acquisition, Saville Company’s balance sheet was as follows:
Fair value of assets, without
cash $1,824,000
Chapter 2-33
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Fair value of assets, without cash $1,824,000
Price paid 1,560,000
Goodwill $ 330,000
E2-1 A. Prepare the journal entry on the books of Preston Co. to record the purchase of the assets and assumption of the liabilities of Saville Co. if the amount paid was $1,560,000 in cash.
Calculation of Goodwill
Chapter 2-34
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
E2-1 A. Prepare the journal entry on the books of Preston Co. to record the purchase of the assets and assumption of the liabilities of Saville Co. if the amount paid was $1,560,000 in cash.
Inventory 396,000Plant and equipment 540,000
Receivables 228,000
Goodwill 330,000Liabilities 594,000
Land 660,000
Cash 1,560,000
Chapter 2-35
Bargain Acquisition Illustration
When the price paid to acquire another firm is lower than the fair value of identifiable net assets (assets minus liabilities), the acquisition is referred to as a bargain.
Under SFAS No. 141:
the excess of fair value over cost was allocated to reduce long-lived assets (with certain exceptions).
if long-lived assets were reduced to zero, and still an excess remained, an extraordinary gain was recognized.
The Exposure Draft, if adopted, will simplify this issue.LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
Chapter 2-36
Bargain Acquisition Illustration
Exposure Draft, if adopted, would require the following:
Any previously recorded goodwill on the seller’s books is eliminated (and no new goodwill recorded).
An ordinary gain is recorded to the extent that the fair value of net assets exceeds the consideration paid.
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
Chapter 2-37
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Calculation of Goodwill or Bargain Purchase
Fair value of liabilities 594,000
Fair value of net assets 1,230,000
Fair value of assets, without cash $1,824,000
Price paid 990,000
Bargain purchase $ 240,000
E2-1 B. Repeat the requirement in (A) assuming that the amount paid was $990,000.
Chapter 2-38
Bargain Fair ValueFair Value Purchase Less
Fair Value Percent Allocation Allocation(A) (B) (C) (A-C)
Plant and equipment 540,000$ 45% 108,000$ 432,000$ Land 660,000 55% 132,000 528,000
1,200,000$ 100% 240,000$ 960,000$
LO 6 Valuation of acquired asset and liabilities assumed.LO 6 Valuation of acquired asset and liabilities assumed.
Explanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccountingExplanation and Illustration of Acquisition Explanation and Illustration of Acquisition AccountingAccounting
E2-1 B. Repeat the requirement in (A) assuming that the amount paid was $990,000.
Inventory 396,000Plant and equipment 432,000
Receivables 228,000
Liabilities 594,000Land 528,000
Cash 990,000
Chapter 2-39
Purchase agreements may provide that the purchasing company will give additional consideration to the seller if certain future events or transactions occur.
The contingency may require
the payment of cash (or other assets) or
the issuance of additional securities.
The Exposure Draft requires that all contingent consideration in a business combination be measured and recognized at fair value on the acquisition date.
Contingent Consideration in an Contingent Consideration in an AcquisitionAcquisitionContingent Consideration in an Contingent Consideration in an AcquisitionAcquisition
LO 7 Contingent consideration and valuation of assets.LO 7 Contingent consideration and valuation of assets.
Chapter 2-40
Adjustments During the Measurement Period
The Exposure Draft defines the measurement period as the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized at the acquisition date.
The measurement period ends as soon as the acquirer has the needed information about facts and circumstances, not to exceed one year from the acquisition date.
Contingent Consideration in an Contingent Consideration in an AcquisitionAcquisitionContingent Consideration in an Contingent Consideration in an AcquisitionAcquisition
LO 7 Contingent consideration and valuation of assets.LO 7 Contingent consideration and valuation of assets.
Chapter 2-41
Contingency Based on Outcome of a Lawsuit
Consideration contingently issuable may depend on both
future earnings and
future security prices.
Contingent Consideration in an Contingent Consideration in an AcquisitionAcquisitionContingent Consideration in an Contingent Consideration in an AcquisitionAcquisition
LO 7 Contingent consideration and valuation of assets.LO 7 Contingent consideration and valuation of assets.
In such cases, an additional cost of the acquired company should be recorded for all additional consideration contingent on future events, based on the best available information and estimates at the acquisition date (as adjusted by the end of the measurement period).
Chapter 2-42
Which of the following statements best describes the Exposure Draft with regard to accounting for contingent consideration?
a. If contingent consideration depends on both future earnings and future security prices, an additional cost of the acquired company should be recorded only for the portion of consideration dependent on future earnings.
b. The measurement period for adjusting provisional amounts always ends at the year-end of the period in which the acquisition occurred.
c. A contingency based on security prices has no effect on the determination of cost to the acquiring company.
d. The purpose of the measurement period is to provide a reasonable time to obtain the information necessary to identify and measure the fair value of the acquiree’s assets and liabilities, as well as the fair value of the consideration transferred.
Review QuestionReview Question
Contingent Consideration in an Contingent Consideration in an AcquisitionAcquisitionContingent Consideration in an Contingent Consideration in an AcquisitionAcquisition
LO 7 Contingent consideration and valuation of assets.LO 7 Contingent consideration and valuation of assets.
Chapter 2-43
A leveraged buyout (LBO) occurs when a group of employees (generally a management group) and third-party investors create a new company to acquire all the outstanding common shares of their employer company.
The management group:
contributes the stock they hold to the new corporation and
borrows sufficient funds to acquire the remainder of the common stock.
The old corporation is merged into the new corporation.
Leveraged BuyoutsLeveraged BuyoutsLeveraged BuyoutsLeveraged Buyouts
LO 8 Leverage buyouts.LO 8 Leverage buyouts.
Chapter 2-44
The consensus position is that only the portion of the net assets acquired with the borrowed funds has actually been purchased and should therefore be recorded at their cost.
The portion of the net assets of the new corporation provided by the management group is recorded at book value since there has been no change in ownership.
Leveraged BuyoutsLeveraged BuyoutsLeveraged BuyoutsLeveraged Buyouts
LO 8 Leverage buyouts.LO 8 Leverage buyouts.
Chapter 2-45
Leveraged BuyoutsLeveraged BuyoutsLeveraged BuyoutsLeveraged Buyouts
LO 8 Leverage buyouts.LO 8 Leverage buyouts.
E2-7 Managers of Bayco own 500 of its 10,000 outstanding common shares. Draco is formed by the managers of Bayco to take over Bayco in a leveraged buyout. The managers contribute their shares in Bayco, and Draco then borrows $50,000 to purchase the remaining 9,500 outstanding shares of Bayco. Bayco is then merged into Draco. Data relevant to Bayco immediately prior to the leveraged buyout follow:
Chapter 2-46
Leveraged BuyoutsLeveraged BuyoutsLeveraged BuyoutsLeveraged Buyouts
LO 8 Leverage buyouts.LO 8 Leverage buyouts.
E2-7 Required: Complete the following schedule showing the values to be reported in Draco’s balance sheet immediately after the leveraged buyout.
Current assetsPlant assetsGoodwill
Debt
Stockholders’ equity
$3,00024,35023,400
$50,000
750
(1) $12,000 + [.95 x ($25,000 – $12,000)] = $24,350
(1)
(2)
(2)
(3) .05 x $15,000 = = $750
(3)
Chapter 2-47
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