Introduction to Business Combination | Advanced Accounting | CPA Exam FAR

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These lectures cover net asset acquisition, stock acquisition and excess earning to estimate goodwill.

Intro to Net Asset Acquisition, Stock Acquisition, Business Consolidations

Asset and Stock Acquisition: Method of Payment

Excess Earnings to Estimate Goodwill

Example: Excess Earnings to Estimate Goodwill

Describe historical trends in types of business combinations. Horizontal integration was popular from 1880 to 1904, while vertical integration became more prevalent from 1905 through 1930. The period beginning after World War II was called merger mania. From the 1950’s through the 1970’s, conglomerate mergers between companies in different industries occurred in the face of antitrust regulation restricting combinations within a particular industry. A relaxation of antitrust regulation in the 1980’s and the emergence of high-yield junk bonds led to strategic acquisitions for firms seeking operating synergies. High stock prices in the 1990’s created a wealth of mergers with stock the medium of exchange.

Identify the major reasons firms combine. Firms combine to achieve growth goals to obtain operating synergies, to compete more effectively in the international marketplace, to take advantage of tax laws in some cases, and to diversify or to eliminate competition. 3 Identify the factors that managers should consider in exercising due diligence in business combinations. Be aware of unrecorded liabilities; take care in interpreting percentages quoted by the selling company; examine the impact on earnings from allocated expenses, changes in LIFO reserves and inventory levels, and product sales; note any nonrecurring items, changes in estimates, accruals, or methods; and be careful of CEO egos.

Identify defensive tactics used to attempt to block business combinations. These tactics include poison pills, greenmail, white knights or white squires, pacman defense, selling the crown jewels, and leveraged buyouts. Distinguish between an asset and a stock acquisition .An asset acquisition involves the purchase of all of the acquired company’s net assets, whereas a stock acquisition involves the attainment of control via purchase of a controlling interest in the stock of the acquired company.

Indicate the factors used to determine the price and the method of payment for a business combination. Factors include the effect of the acquisition on future earnings performance, (dilution or accretion), and the estimated value of the firm’s identifiable net assets and implied goodwill. The method of payment is affected by the liquidity position of the purchaser firm, the willingness of the sellers to accept alternative forms of financing, and tax issues.

Calculate an estimate  of the value of goodwill to be included in an offering price by discounting expected future excess earnings over some period of years. Identify a normal rate of return for firms similar to the company being targeted. Apply the rate of return to the level of identifiable assets of the target to approximate what the “normal” firm in this industry might generate. Estimate the expected future earnings of the target, and subtract the “normal” earnings to get “excess earnings.” Assume an appropriate time period and a discount rate to calculate the discounted value of the excess earnings.

Describe the two alternative views of consolidated financial statements: the economic entity and the parent company concepts. Under the parent company concept, the consolidated financial statements reflect the stockholders’ interests in the parent, plus their interests in the net assets of the subsidiaries. Thus the focus is on the interests of the parent’s shareholders. The economic entity concept emphasizes control of the whole by a single management. As a result, consolidated financial statements provide information about a group of legal entities—a parent company and its subsidiaries—operating as a single unit.

Discuss the Statements of Financial Accounting Concepts (SFAC). These statements provide a framework for use by FASB in addressing topics that arise, and by users in interpret- ing and implementing FASB standards updates. They address definitions of key terms in financial reporting, its objectives, the role of cash flows and present values, qualitative characteristics of useful information, and underlying principles.

Describe some of the current joint projects of the FASB and the International Accounting Standards Board (IASB), and their primary objectives. Joint projects between the FASB and IASB include revenue recognition, leases, insurance contracts, and financial instruments. The objectives are to develop a con- verged set of standards based on fundamental concepts rather than a collection of rules.