© clarence byrd inc. 20081 chapter 3 business combinations

© Clarence Byrd Inc. 2008 1

Chapter 3

Business Combinations

2© Clarence Byrd Inc. 2008

Business Combinations Defined

Paragraph 1581.06(a) A business combination occurs when an enterprise acquires net assets that constitute a business, or acquires equity interests of one or more other enterprises and obtains control over that enterprise or enterprises.


Business Combinations

Legal Form A variety of legal forms can

be used

Accounting attempts to reflect economic substance

This may require “looking through” the legal form (e.g., reverse takeovers)


Basic Legal Alternatives

Company A Company B

B’s Assets And Liabilities

Cash Or A Shares



Company A

Company B

NewCompany

New Company Shares

New Company Shares

Assets And Liabilities



Company A Company BB Company

Shareholders

Majority Of B Shares

Cash Or A Shares



A Company B CompanyShareholdersOf A Company

ShareholdersOf B Company

New Company

Shares Of New Company

Majority Of A Company Shares

Majority Of B Company Shares


Tax Considerations

Acquisition Of Assets

Preferred by acquirer

Larger CCA deductions

No inherited tax assessment issues


Tax Considerations

Acquisition Of Shares

Preferred by acquiree

Capital gains taxed at low rates

Gains may be eligible for the lifetime capital gains deduction


Alternative Accounting Methods

The Purchase Method Treats combination as a

purchase of assets Must identify an acquirer Acquirer’s assets remain at

book value Acquiree’s assets recorded

at fair values.


Alternative Accounting Methods

Pooling-of-Interests Treats combination as an

inconsequential combining of interests

Both company’s assets remain at carrying values

Retroactive presentation of income

No longer GAAP in the industrialized world


Establishing the Acquisition Date

Paragraph 1581.19 either: the date on which the net assets or equity

interests are received and the consideration is given; or

the date of a written agreement, or a later date designated therein, that provides that control of the acquired enterprise is effectively transferred to the acquirer on that date, subject only to those conditions required to protect the interests of the parties involved.


Identification Of An Acquirer

Cash Consideration

Company providing the cash is the acquirer, without regard to whether assets or shares are acquired



Share consideration – no new company Acquirer is the predecessor company whose

shareholders wind up with the majority of the voting shares of the combined company



Share consideration – new company Acquirer is the predecessor company whose

shareholders wind up with the majority of the voting shares of the new company



Other Factors (If no clear cut solution) Relative voting rights If no control: largest non-controlling

interest Composition of the board of directors Composition of senior management Payment of a premium over market

value



Reverse Takeovers

The legal acquirer becomes the acquiree

Surprisingly common

Covered in an Appendix to Chapter 4


Recognition

Acquirer recognizes all of the acquiree’s assets and liabilities, even if they are not recognized on the acquiree’s books

Acquiree’s income recognized only from the date of the business combination transaction


Cost Of The Purchase

Cost determined by: the fair value of the

consideration given; or the fair value of the equity

interest acquired,

whichever is more determinable

Includes the direct costs of the combination transaction



On January 1, 2008, Mor issues 3 million no par shares in return for all of the outstanding voting shares of Mee. The shares are trading at $25 and have a total value of $75 million.

Mor agrees that if Mee’s earnings per share exceed $3.50 per share, they will pay an additional $10 million to the Mee shareholders.



Contingent Amount Is Paid Debit Credit

Investment In Mee $10,000,000

Cash $10,000,000



On January 1, 2008, Mor issues 3 million no par shares in return for all of the outstanding voting shares of Mee. The shares are trading at $25 and have a total value of $75 million.

Mor agrees to pay an additional $15 million if the Mor shares are not trading at or above $30 per share at the end of the year.


Cost Of Purchase

Contingent Amount Is Paid Debit Credit

No Par Common Stock $15,000,000

Cash $15,000,000


Allocation Of The Purchase Price

Step A: Determine the fair values of the acquiree’s identifiable assets and liabilities

Step B: Compare this value to the purchase price If purchase price is greater, you have

goodwill If identifiable assets are greater you have a

balance that is referred to informally as negative goodwill


Determination Of Fair Values

Inventories Finished goods and

work in process at net realizable value

Raw materials at replacement cost



Property, Plant, and Equipment

To be used: At replacement cost

To be sold: At fair value



Intangible Assets At estimated or

appraised values



Liabilities Present value of

amounts to be paid determined using appropriate current interest rates



Temporary Differences Fair values determined without

reference to their tax values Tax values may or may not be

changed by the combination Legal form Use of rollovers

Future income tax asset or liability based on the difference between fair value recorded and tax value


Determination Of Fair Values Loss Carry Forwards

Must determine if it is legally available

Must determine if it is more likely than not to be realized by the combined company

Fair value is the amount of the carry forward multiplied by the appropriate tax rate

May be recognized by the combined company even if not recognized by the acquiree



Identifiable Intangibles In the Past

Identifiable Intangibles (e.g., Development costs eligible for capitalization) were often lumped with goodwill, particularly if they were not recognized on the books of the acquiree

This became a problem once we stopped amortizing goodwill.



Identifiable Intangibles Paragraph 1581.48 an intangible asset should be

recognized apart from goodwill when: (a) the asset results from contractual or other legal rights

(regardless of whether those rights are transferable or separable from the acquired enterprise or from other rights and obligations); or

(b) the asset is capable of being separated or divided from the acquired enterprise and sold, transferred, licensed, rented, or exchanged (regardless of whether there is an intent to do so).


Goodwill The Concept: The

capitalized expected value of enterprise earning power in excess of a normal rate of return in the industry in which it operates

Rarely recognized when internally generated


Goodwill Recognition In Practice

The excess of the cost of an acquired company over the fair values assigned to individual assets acquired and liabilities assumed

May include identifiable intangibles if they do not meet the Paragraph 1581.48 criteria for separate recognition


Goodwill Procedures

Not subject to regular amortization Each reporting unit must be tested annually for

impairment Exceptions if:

Assets and liabilities have not changed significantly Recent determination shows large excess of fair

value over carrying amount Based on an analysis of events since last

evaluation, the likelihood of impairment seems remote


Goodwill Procedures

Circumstances that may require more frequent evaluation for impairment Change in legal factors Adverse decisions by a regulator Loss of key personnel Need to write down a significant asset

group within the reporting unit A goodwill impairment loss recognized by a

subsidiary


Goodwill Presentation

Aggregate amount as a separate line item in the Balance Sheet

Aggregate amount of impairment losses as a separate line item in the Income Statement


Goodwill Disclosure Paragraph 3062.51 The financial statements should

disclose the following information: (a) The changes in the carrying amount of goodwill

during the period including: (i) the aggregate amount of goodwill acquired; (ii) the aggregate amount of impairment losses

recognized; and (iii) the amount of goodwill included in the gain or loss

on disposal of all or a portion of a reporting unit. Enterprises that report segment information in

accordance with Segment Disclosures, Section 1701, should provide the above information about goodwill in total and for each reportable segment and should disclose any significant changes in the allocation of goodwill by reportable segment. When any portion of goodwill has not yet been allocated to a reporting unit at the date the financial statements are issued, the unallocated amount and the reasons for not allocating that amount should be disclosed.


Goodwill Disclosure Paragraph 3062.53 For each goodwill impairment loss

recognized, the following information should be disclosed in the financial statements that include the period in which the impairment loss is recognized:

(a) a description of the facts and circumstances leading to the impairment;

(b) the amount of the impairment loss; and (c) when a recognized impairment loss is an estimate

that has not yet been finalized, that fact and the reasons therefore and, in subsequent periods, the nature and amount of any significant adjustments made to the initial estimate of the impairment loss.

When the carrying amount of a reporting unit exceeds its fair value, but the second step of the impairment test is not complete and a reasonable estimate of the goodwill impairment loss cannot be determined (see paragraph 3062.28), that fact and the reasons therefore should be disclosed. [JAN. 2002]


Negative Goodwill

Sources

Overstated fair values

Bargain purchase approach

Inadequate rate of return on invested assets (consistent with treatment of goodwill)


Negative Goodwill

Allocated as a pro rata reduction in amounts assigned to acquired assets other than Financial assets

(other than equity investments) Assets to be sold Future income tax assets Future benefit plan prepayments Other current assets

Any remaining amount as extraordinary gain


Combined Company’s Shareholders’ Equity

Under the purchase method, it is equal to the Shareholders’ Equity of the acquiring company

Conflicts with corporate enabling legislation New companies Amalgamations

If conflict – Corporate legislation prevails


Disclosure – 1581.55For each material business combination completed during the period, the combined enterprise should disclose the following:

(a) the name and a brief description of the acquired enterprise and, when shares are acquired, the percentage of voting shares acquired;

(b) the period for which the earnings of the acquired enterprise are included in the income statement of the combined enterprise;

(c) the cost of the purchase and, when applicable, the number of equity instruments issued or issuable, the value assigned to those equity instruments, and the basis for determining that value;

(d) a condensed balance sheet disclosing the amount assigned to each major class of asset and liability of the acquired enterprise at the date of acquisition;

(e) contingent payments, options, or commitments specified in the acquisition agreement and the accounting treatment that will be followed should any such contingency occur (see also Accounting Guideline No. 14, Disclosure of Guarantees); and

(f) for any purchase price allocation that has not been finalized, that fact and the reasons therefore and, in subsequent periods, the nature and amount of any material adjustments made to the initial allocation of the purchase price.


Disclosure – 1581.56When the amounts assigned to goodwill or other intangible assets acquired are significant in relation to the total cost of the purchase, the combined enterprise should disclose the following: (a) for intangible assets subject to amortization, the

total amount assigned and the amount assigned to each major intangible asset class;

(b) for intangible assets not subject to amortization, the total amount assigned and the amount assigned to each major intangible asset class; and

(c) for goodwill: (i) the total amount of goodwill and the amount that is

expected to be deductible for tax purposes; and (ii) for enterprises that are required to disclose

segment information in accordance with Segment Disclosure, Section 1701, the amount of goodwill by reportable segment.


Disclosure – 1581.57

When a series of individually immaterial business combinations are completed during the period that are material in the aggregate, the combined enterprise should disclose the following: (a) the number of enterprises acquired and a brief description of

those enterprises; (b) the aggregate cost of the acquired enterprises, the number of

equity instruments issued or issuable, and the value assigned to those equity instruments;

(c) the aggregate amount of any contingent payments, options or commitments and the accounting treatment that will be followed should any such contingency occur (when potentially significant in relation to the aggregate cost of the purchases); and

(d) the information described in paragraph 1581.56, when the aggregate amount assigned to goodwill or to other intangible assets acquired is significant in relation to the aggregate cost of the purchases.


International Convergence

Business Combinations covered in IFRS No. 3 Will be revised in 1st

quarter 2008 CICA will adopt by

mid-2008 Revised version will be in

effect in Canada in 2009


International Convergence

Goodwill: Covered in IFRS No. 3 – Initial recognition

Also in IAS Nos. 36 and 38 – Subsequent treatment


IAS Nos. 36 and 38 Differences

IAS No. 38 provides more detailed guidance on intangible assets

IAS No. 38 permits revaluation to fair value in the case of intangible assets that have no active market

IAS Nos. 36 and 38 test impairment based on difference between an assets carrying value and its recoverable amount


FASB/IASB Convergence

FASB SFAS No.141, Business Combinations, has been issued

IFRS No. 3 revision expected in January, 2008

© clarence byrd inc. 20081 chapter 3 business combinations

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