INTRODUCTION%20TO

1
CHAPTER 4

• INTRODUCTION TO
• BUSINESS COMBINATIONS

2
FOCUS OF CHAPTER 4

• Business Combinations (EXTERNAL expansion)
• Legal Considerations
• The Arena in Which Takeover Battles Are Waged
• Purchase Accounting
• Accounting for Goodwill
• Appendix 4A Income Tax Considerations

3
The Purchase Method A Whole New Basis of
Accounting is Established

• The new basis of accounting is based on the
  acquirers purchase price.
• The depreciation cycle for fixed assets begins a
  new at a higher or lower level.
• If cost gt CV, goodwill exists. Recognize as an
  assetdo not amortize. Evaluate periodically for
  possible impairment.
• If cost lt CV, a bargain purchase element (or
  negative goodwill) exists.

4
The Pooling of Interests Method No Longer Allowed

• The target companys basis of accounting in its
  assets is used by the consolidated group.
• The depreciation cycle merely continues along as
  if no business combination had occurred.
• Goodwill is NEVER recognizedthus future income
  statements will NOT have goodwill expense.
  Managements loved it.

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Acquiring ASSETS Vs. Acquiring COMMON STOCK
Often a Major Issue

• Major Decision Factors
• Legal considerationsBuyer must be extremely
  careful NOT to assume responsibility for (and
  thus inherit)the target companys
• Unrecorded liabilities.
• Contingent liabilities (lawsuits).

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Acquiring ASSETS Vs. Acquiring COMMON STOCK
Often a Major Issue

• Major Decision Factors (continued)
• Tax considerationsOften requires major
  negotiations involving resolution of
• Sellers tax desires.
• Buyers tax desires.
• Ease of consummationAcquiring common stock is
  simple compared with acquiring assets.

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Acquiring ASSETS Advantages and Disadvantages

• Major Advantages of Acquiring Assets
• Will NOT inherit a targets contingent
  liabilities (excluding environmental).
• Will NOT inherit a targets unwantedlabor union.
• Major Disadvantages of Acquiring Assets
• Transfers of titles on real estate and other
  assets can be time-consuming.
• Transfer of contracts may NOT be possible.

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Acquiring COMMON STOCK Advantages and
Disadvantages

• Advantages of Acquiring Common Stock
• Will make transfer quite easy.
• Will inherit nontransferable contracts.
• Disadvantages of Acquiring Common Stock
• Will inherit contingent liabilities and an
  unwanted labor union.
• Will acquire unwanted facilities/units.
• Will be hard to access targets cash.

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Business Combinations Organizational Forms that
Can Result

• The focus is on what property is receivedNOT on
  what property is given.

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Organizational FormsTypes of Property that Can
Be Received

• Common StockResults in a parent-subsidiary
  relationship.
• Targets AssetsResults in a home
  office-branch/division relationship.

P
P controls S
S
2 legal entities
Home Office
Branch/Division
1 legal entity
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Organizational Forms Specialized Options

• Option 1 STATUTORY MERGER
• A temporary parent-subsidiary relationship is
  created.
• The parent then liquidates the subsidiary into
  the parent pursuant to state laws.
• The result ONE legal entity survives.

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Organizational FormsSpecialized Options

• Option 2 STATUTORY CONSOLIDATION
• New corporation (TOPCO) is created.
• TOPCO issues stock to BOTH combining companies in
  exchange for their o/s stock.
• Each combining company becomes a temporary
  subsidiary of TOPCO.
• Both subs are liquidated into TOPCO and become
  divisions.
• Result ONE legal entity survives.

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Organizational FormsSpecialized Options

• Option 3 HOLDING COMPANY
• Similar to a statutory consolidation except that
  the two subsidiaries are NOT liquidated into
  TOPCO.

TOPCO
P
S
3 legal entities
14
Review Question 1

• To qualify for for purchase accounting treatment
• A. One company must acquire common stock of
  the other combining company.B. A statutory
  consolidation must occur.C. Each company must be
  approximately the same size.D. A
  stock-for-stock exchange must occur.E. None of
  the above.

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Review Question 1With Answer

• To qualify for for purchase accounting treatment
• A. One company must acquire common stock of
  the other combining company.B. A statutory
  consolidation must occur.C. Each company must be
  approximately the same size.D. A
  stock-for-stock exchange must occur.E. None of
  the above.

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Review Question 2

• In purchase accounting
• A. Common stock must be the consideration given.
• B. Goodwill is not reported.
• C. A statutory merger occurs.
• D. A change of basis in accounting occurs.
• E. None of the above.

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Review Question 2With Answer

• In purchase accounting
• A. Common stock must be the consideration given.
• B. Goodwill is not reported.
• C. A statutory merger occurs.
• D. A change of basis in accounting occurs.
• E. None of the above.

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Review Question 3

• In purchase accounting
• A. Preferred stock must be the consideration
  given.
• B. Goodwill is always reported.
• C. A holding company must be created toeffect
  the merger.
• D. Financial reporting consistency occursbetween
  the two combining companies.
• E. None of the above.

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Review Question 3With Answer

• In purchase accounting
• A. Preferred stock must be the consideration
  given.
• B. Goodwill is always reported.
• C. A holding company must be created toeffect
  the merger.
• D. Financial reporting consistency occursbetween
  the two combining companies.
• E. None of the above.

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Review Question 4

• Which of the following COULD occur or result?
  
  Purchase Pooling A. Goodwill....................
  .......B. Change in basis..............C.
  Statutory merger.............D. Stock-for-stock
  exchangeE. Symmetrical reporting.....

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Review Question 4With Answer

• Which of the following COULD occur or result?
  
  Purchase Pooling A. Goodwill....................
  ...... YES NOB. Change in
  basis.............. YES NOC.
  Statutory merger............. YES
  YESD. Stock-for-stock exchange YES
  YESE. Symmetrical reporting..... YES
  YES

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Review Question 5

• Which of the following COULD occur or result?
  
  Purchase Pooling
• A. Preferred stock issuance. B.
  Parent-subsidiary............ C. Home
  office-division....... D. Acquisition of
  assets....... E. Acquisition of stock.........

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Review Question 5With Answer

• Which of the following COULD occur or result?
  
  Purchase Pooling A. Preferred stock
  issuance. YES NO B. Parent-subsidiary............
  YES YES C. Home office-division....... YES YES
  D. Acquisition of assets....... YES YES E.
  Acquisition of stock........ YES YES

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Review Question 6

• A way to force out a target companys dissenting
  shareholders is to use
• A. Purchase accounting.
• B. Pooling of interests accounting.
• C. A statutory merger.
• D. A statutory consolidation.
• E. None of the above.

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Review Question 6With Answer

• A way to force out a target companys dissenting
  shareholders is to use
• A. Purchase accounting.
• B. Pooling of interests accounting.
• C. A statutory merger.
• D. A statutory consolidation.
• None of the above.

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End of Chapter 4 (Appendix 4A material follows)

• Time to Clear Things UpAny Questions?

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Tax Rules CONSISTENCY Always Occurs Between
Seller and Buyer
Appendix 4A

• SELLERS TAX TREATMENT ALWAYS DETERMINES BUYERS
  TAX TREATMENT
• If seller has a taxable transaction, buyer uses
  new basis of accounting.
• If seller has a nontaxable transaction, buyer
  uses old basis of accounting.

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Taxable Business Combinations CONSISTENCY
Between Seller and Buyer

• Seller has taxable gain or loss.
• Buyer is required to use a new tax basis, which
  can be either
• A step up in tax basis (CVgtBV).
• A step down in tax basis (CVltBV).
• GOODWILL is reported if Cost gt CV.
• A Section 197 intangible asset.
• Mandatory amortization15 year life.

Form 1120 or Form 1040
Appendix 4A
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Nontaxable Business Combinations CONSISTENCY
Between Buyer and Seller
Appendix 4A

• Seller does NOT report taxable gain/loss.
• Buyer must use OLD tax basis of property
  acquiredregardless of FV of the consideration
  given for that property.
• Commonly Used Descriptions for Buyer
• Buyer inherits the old tax basis.
• Buyer is stuck with the old tax basis.