Occurs when one corporation takes over all the operations of another business entity and that other entity is dissolved.
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.
Mergers: A + B = A
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.
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.
Consolidations: E + F = “D”
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.
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.
Keeping the terms straight
In the general business sense, mergers and consolidations are business combinations and may or may not involve the dissolution of the acquired firm(s).
In Chapter 1, mergers and consolidations will involve only 100% acquisitions with the dissolution of the acquired firm(s). These assumptions will be relaxed in later chapters.
“Consolidation” is also an accounting term used to describe the process of preparing consolidated financial statements for a parent and its subsidiaries.
3: Accounting for Business Combinations
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…” [FASB Statement No. 141, para. 3.e.]
A parent – subsidiary relationship is formed when:
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.
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.
Example: Poppy Corp. (1 of 3)
Investment in Sunny Corp.
Common stock, $10 par
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)
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)
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.
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
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.
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):
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
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
Entries with Goodwill
The entry to record the acquisition of the net assets:
The entry to record Seed’s assets directly on Pitt’s books:
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.