Hunting for Business Combination

Jul 12, 2024

Hunting for Business Combination

Types of Business Combinations

  • Merger or Acquisition

    • Represented as A + B = A or B
    • One company absorbs the other
    • Example: Grab acquiring Uber Philippines
    • Only one set of financial statements required

  • Consolidation

    • Represented as A + B = C
    • New company C is formed
    • Three sets of financial statements: Parent, Subsidiary, and Consolidated
    • Similar to combined financial statements in home office and branch accounting

Major Stages in Consolidation

  1. At the Date of Acquisition
  2. Subsequent to the Date of Acquisition
  3. Intercompany Transactions

Example Problem Breakdown

Given:

  • Statement of financial position for Brad and Finn
  • Types of assets, liabilities, ordinary shares, share premiums, and retained earnings

Questions to Solve:

  1. Compute for Goodwill
  2. Compute for Gain on Bargain Purchase
  3. Net Increase/Decrease in Retained Earnings of Interval Corporation
  4. Net Increase/Decrease in Stockholders’ Equity of Pinnacle Corporation
  5. Net Increase/Decrease in Identifiable Assets of Interval Corporation

Solutions:

Goodwill Calculation

  • Consideration paid (cash + shares) minus fair value of net assets
    • Brad: Goodwill = 81,250 (Consideration) - 74,750 (Net Assets) = 650,000
    • Finn: Gain on Bargain Purchase = 246,000 (Consideration) - 257,500 (Net Assets) = -11,500
  • Goodwill appears as an asset on the financial statement
  • Gain on Bargain Purchase appears in the income statement

Retained Earnings Calculation

  • Impact of acquisition-related expenses on retained earnings
    • Compute total indirect costs and finder’s fees
    • Final decrease in retained earnings = Total expenses (296,250) - Gain on Bargain Purchase (11,500)
    • Net decrease in retained earnings = 284,750

Stockholders’ Equity Calculation

  • Issuance of shares should be valued at market value
    • Compute total market value of shares issued
    • Total impact on equity = Market value of shares - Total expenses related to issuance
    • Net increase in equity = 890,400

Identifiable Assets Calculation

  • Consider identifiable assets excluding goodwill
    • Compute total assets acquired, subtract cash payments and expenses
    • Net increase in identifiable assets = 1,305,500

Key Points to Remember

  • Book value can differ from fair value; use fair value as a standard
  • Classification of costs: incorporation costs charged to additional premium capital (APIC); indirect costs and finder’s fees charged to expenses
  • Analyze each entity separately for accurate results

Additional Considerations

  • Contingent consideration treatments
  • Handling insufficient share premium to cover incorporation costs
  • Estimations of goodwill within one year
  • Pre-existing goodwill in the acquiree’s records

Helpful Tips

  • Focus on using market value where appropriate
  • Accurate classification of expenses
  • Separate analysis for each entity during acquisitions

Class dismissed, see you next meeting!