Business Combinations by Lecturer YIN SOKHENG, Master in Finance

8/4/2019 Business Combinations by Lecturer YIN SOKHENG, Master in Finance

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Business Combinations

Chapter One

Prepared by: YIN SOKHENG,

Master in Finance


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Business combination involves obtaining the net

asset of an entire firm by obtaining the firmscommon stock.

Business combination occurs when two or more

companies are brought together into accounting

entity.

Mr. YIN SOKHENG, senior accounting teacher 2

I. Business Combinations

Combination = Merger = Consolidation

Net asset = Total asset + Total liabilities


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Types of business combinations are divided into threeforms:

1. Merger: dissolution of all business involved but oneof all of firms remaining.

2. Consolidation: dissolution of all business involvedand formation of a new company.

3. Stock acquisition: occurs when one company acquiresthe voting shares of another company and the two

companies continue to operate as separate, butrelated, legal entities. The relationship that is createdin a stock acquisition is referred to as a parent-subsidiary relationship.


Types of Business Combinations


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Types of Business CombinationsAA Company

BB Company

AA Company

BB Company

AA Company

CC Company

AA Company

BB Company

AA Company

BB Company

1. Merger

2. Consolidation

3. Stock Acquisition


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Types of Business Combinations

AA Company invests in BB Company

Acquires StockAcquires Net Assets

Acquired CompanyLiquidated?

Record as StockAcquired and Operate

as Subsidiary

Record as Merger orConsolidation

Yes

No


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There are two methods of accounting for formal

business combinations:1. Purchase Method

2. Pooling of Interests Method


Accounting Method

for Business Combinations


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Purchase method is allowed by generally acceptedaccounting principle (GAAP) in recording the business

combination.

The investment or purchase is recorded based on

historical cost principle.

Under the purchase method, the direct expenses

related to business combination such as accounting fees,

legal, consulting, and finders fees are debited to the

investment account (assets account).

But registration and issuance of equity securities are

recorded as a reduction of the additional paid-in capital.


II. Purchase Method


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Assume that Poppy Company issues 100,000 shares

of $10 per common stock for the net assets of Sunny

Company in a purchase business combination on

July 01, 2004. The market value of Poppy Company

stock on this date is $16 per share. Additional directcost of business combination consist of Securities

and Exchange Commission (SEC) fees of $5,000.

Accountant fees in connection with SEC registration

of $10,000, cost of printing and issuing the commonstock certificate of $25,000 and finders and

consultants fees of $80,000.


Example:


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Journal entries to record to the investment and additional

expenses


General Journal Page 3

Date Account Titles P.R Debit Credit

Journal entries to record to the investment in Sunny Company

Investment in Sunny Company 1,600,000

Common Stock, $ 10 par value 1,000,000

Paid-in Capital 600,000

Journal entries to record to the additional expenses

Investment in Sunny Company 80,000


Cash 120,000


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Now assume that Sunny Company is dissolved. Poppy Company receives

the assets and liabilities from Sunny as follows:

cash, $20,000; account receivable, $80,000; inventories, $500,000; land,$800,000; building, $100,000; and account payable, $50,000.


Total investment in Sunny Company (1,600,000+80,000) $ 1680,000

Net assets received:

- Cash $ 20,000

- Account receivable 80,000

- Inventories 500,000

- Land 800,000

- Building 100,000- Account payable (50,000)

Total net assets $ 1,450,000

Goodwill $ 230,000


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Journal entries to record the assets received from Sunny and

liabilities assumed




Cash 20,000

Account Receivable 80,000

Inventories 500,000

Land 800,000

Building 100,000

Goodwill 230,000

Account Payable (50,000)

Investment in Sunny Company 1,680,000


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Illustration of business combination under the purchase method

Example: Pitt Corporation acquires the net assets of Seed Company on

December 27, 2004. The total assets and liabilities of Seed on this date at

book value and fair value are as follow:

M

r.YINSOKHENG,senio

raccountingteacher

12

Assets Book Value Fair Value

- Cash $ 50,000 $ 50,000

- Note receivable 150,000 140,000

- Inventories 200,000 250,000

- Land 50,000 100,000

- Building, net 300,000 500,000

- Equipment, net 250,000 350,000

- Patents - 50,000

Total assets $ 1,000,000 $ 1,440,000

Liabilities Book Value Fair Value

- Account payable $ 60,000 $ 60,000

- Note payable 150,000 135,000

- Other liabilities 40,000 45,000

Total liabilities $ 250,000 $ 240,000

Net assets $ 750,000 $ 1,200,000


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Case 1: Good will


Pitt Corporation pays $400,000 cash and issues $50,000 shares, $10 par

common stock with a market value of $20 per share.



Journal entries to record to the investment in Seed Company

Investment in Seed Company 1,400,000

Cash 400,000

Common Stock, $ 10 par value 500,000


Journal entries to record the dissolution of Seed Company.Determine the goods will:

To investment in Sunny Company 1,400,000

Net assets received 1,200,000

Good will 200,000


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Record the assts received and liabilities assumed




Cash 50,000

Note Receivable 140,000

Inventories 250,000

Land 100,000

Building, net 500,000

Equipment, net 350,000

Patents 50,000

Goodwill 200,000Account Payable 60,000

Notes payable 135,000

Other liabilities 45,000



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Pitt Corporation issues $40,000 shares of its $10 parcommon stock with a market value of $20 per share, and

it also give a 10%, five years notes payable for $200,000

for the net assets of Seed Company.

So, total investment in Seed

= ($40,000 x $20) + 200,000= $1,000,000

Net assets received from Seed 1,200,000

Negative goodwill $200,000 Negative goodwill of $200,000 is not record in the

Pitts book.

It is deducted from fair value of each noncurrent assets.


Case 2: Negative goodwill


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Noncurrent assets Fair Value Percentage of Deduction (%)

Amount to berecorded

- Land $ 100,000 $ 20,000 $ 80,000

- Building, net 500,000 100,000 400,000

- Equipment, net 350,000 70,000 280,000

- Patents 50,000 10,000 40,000

Total $ 1,000,000 $ 200,000 $ 800,000



Journal entries on Pitts book to record the investment in Seed Co.



Common Stock, $10 par value 400,000



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As Seed Company is dissolved, Pitt Corporation must record the asstsreceived from Seed.




Cash 50,000

Note Receivable 140,000

Inventories 250,000Land 80,000

Building, net 400,000

Equipment, net 280,000

Patents 40,000

Account Payable 60,000


Other liabilities 45,000



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Under the pooling of interest method, the assetsand liabilities received are recorded at the book

value.

The stock issued is recorded at book value.

Example: On January 01, 2005, Point Corporation

issues 10,000 shares of its $10 par common stock in

exchange for all assets of Sharp Company. Sharp

distributes the shares to its shareholders and retiresits own stock.

The balance sheet of Point and Sharp, at book

value are as follows:


III. Pooling of Interest Method


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M

r.YINSOKHENG,senio

raccountingteacher

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Book Value

Assets Point Sharp

- Cash $ 75,000 $ 45,000

- Inventories 125,000 65,000

- Land 100,000 40,000

- Building 600,000 400,000

Accumulated depreciation (200,000) (150,000)

Total assets $ 1,000,000 $ 1,440,000

Liabilities and Shareholders Equity

- Current liabilities $ 150,000 $ 100,000

- Common Stock:

. Point Corporation, $10 par 300,000

. Sharp Company 100,000

- Paid-in Capital 30,000 50,000

- Retained Earnings 220,000 150,000

Total Liabilities and Equity $ 700,000 $ 1,440,000


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Journal entry on Points book to record the assets, liabilities & equitiesreceived from Sharp.


General Journal Page 3Date Account Titles P.R Debit Credit

Journal entry on Points book to record the assets, liabilities & equities received fromSharp.

Cash 45,000

Inventories 65,000Land 40,000

Building 400,000

Accumulated depreciation 150,000

Current liabilities 100,000Common Stock 100,000


Retained Earnings 150,000


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Journal entry on Sharps book to record the stock received from Point.

Investment 300,000

Current liabilities 100,000

Accumulated depreciation 150,000

Cash 45,000

Inventories 65,000

Land 40,000

Building 400,000

Journal entry to record the distribution of stock to shareholders.

Common Stock 100,000Paid-in Capital 50,000

Retained Earnings 150,000

Investment in Point 300,000


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Difference in total par valueItem Original

Shareholdersequity account

Change in Shareholders equity account

recorded by Point

Point Sharp Case 1 Case 2 Case 3 Case 4

Shares issue by Point:

- Number Shares 10,000 8,000 14,000 21,000

- Total Value 100,000 80,000 140,000 210,000

Common Stock 300,000 100,000 100,000 80,000 140,000 210,000

Paid-in Capital 30,000 50,000 50,000 70,000 10,000 (30,000)

Retained Earnings 220,000 150,000 150,000 150,000 150,000 120,000

Total Shareholders equity 550,000 300,000 300,000 300,000 300,000 300,000

Case 4: 210,000 100,000 = 110,000 50,000 (Paid-n Capital of Sharp)

30,000 (Paid-n Capital of Point)

30,000 (150,000 30,000)


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Difference in total par value

Item OriginalShareholdersequity account

Total Shareholders equity account ofcombined company

Point Sharp Case 1 Case 2 Case 3 Case 4

Shares issue by Point:

- Number Shares

- Total Value

Common Stock 300,000 100,000 400,000 380,000 440,000 510,000

Paid-in Capital 30,000 50,000 80,000 100,000 40,000 0

Retained Earnings 220,000 150,000 370,000 370,000 370,000 340,000

Total Shareholders equity 550,000 300,000 850,000 850,000 850,000 850,000

$ 850,000


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Thank You

thank you all for yourattention.

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Business Combinations by Lecturer YIN SOKHENG, Master in Finance