ASC Business Combinations. November 18, Acquisition Method 1-1. Regan Garey, DBA, CPA

Transcription

1 1-1 ASC Business Combinations November 18, 2017 Regan Garey, DBA, CPA 4-1 Acquisition Method ASC provides guidance on the acquisition method, specifically addressing the following: Whether a particular transaction or event is a business combination The identification of the acquirer and the acquisition date The period of time that an acquirer has to adjust provisional amounts, referred to as the measurement period. The determination of what is part of a business combination transaction. (FASB) 4-3

2 Identifiable Assets and Liabilities and Any Noncontrolling Interest ASC provides further guidance on the acquisition method, specifically discussing the recognition and measurement of the following: Key Components of ASC 805 Identifiable assets Liabilities Goodwill treatment Tax implications. 4-6 Overview Tax benefits can be a critical, motivating factor for entering into an alliance rather than an alternative structure. Mergers & acquisitions a snapshot Changing the way you think about tomorrow s deals Tax attributes available with an alliance formation can create advantages over traditional M&A transactions. (PWC)

3 1-3 Formation stage Immediate Tax Costs Here, the tax structure and initial decisions are made and the alliance is created. Tax decisions made at the onset of the alliance formation will carry impacts for the entire alliance life cycle, not just in the initial stage of formation. Each alliance structure will have its own tax advantages and consequences. Generally, limiting immediate tax costs is the primary objective at formation. This would include deferring immediate taxes and accelerating tax benefits. PWC 4-9 PWC PWC Example Unused tax benefits How an alliance is formed will impact the available tax benefits and associated tax costs for the alliance and its owners. In the U.S., pass through entities and other alliance tax structures can generally defer current tax costs, prevent double taxation, and allow for a more efficient use of existing tax attributes. The amounts of unused tax benefits at the participant level may impact the motivations and direction of the alliance formation. Participants should be aware that some structures may trigger immediate tax costs in the form of transfer or stamp taxes PWC 4-12

4 1-4 Contributions during Formation During formation, participants will decide what function the alliance will serve, and therefore what assets, such as: Fixed assets or intellectual property, the participants agree to contribute or provide access (such as licensing or leasing arrangements). Depending on the type of assets and method of providing access, there are different tax effects. An Example Suppose an alliance is formed as a partnership in a country with currency controls. There are regulatory limitations and exchange rate impacts to repatriating cash. Cash may be costly to repatriate to the participant in the U.S. and may be best spent on permanent reinvestment in the alliance. Determining which jurisdiction to form the alliance should include expectations for distributing income from the alliance Ongoing Stage Ongoing Stage During the ongoing stage, the alliance may distribute earnings to participants. A number of decisions made at formation will impact the amounts available for distribution: i) determining which participant should receive the benefits of the alliances tax attributes, ii) leaving enough working capital available for the alliance to meet its operational requirements, and iii) ensuring tax compliance.. PWC

5 1-5 Ongoing Stage Business Combination While ideally made at formation, the execution of these decisions and the actual results of the alliance operations will dictate the distributions to each participant. Understand that complete ownership is not a prerequisite for the formation of a business combination. alliances-tax-planning-considerations.pdf PWC 4-17 Noncontrolling Interest Break Out Questions What is the prior name and the current name of a parent company owning less than 100% of another? What is the significance of this name?? Although most parent companies do possess 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock. If the parent doesn t own 100% of the company, WHO owns the rest of it? Noncontrolling Shareholders The ownership interests of the Noncontrolling Shareholders must be reflected in the consolidated financial statements

6 1-6 Noncontrolling Interest The Parent, with controlling interest, must consolidate 100% of the Subsidiary s financial information. The acquisition method requires that the subsidiary be valued at the acquisition-date fair value. Total Acquired Firm Value/Partial Acquisitions The total acquired firm fair value in a partial acquisition is the sum of The fair value of the controlling interest. The fair value of the noncontrolling interest at the acquisition date Noncontrolling Interest Example Assume Parker Corporation wants to acquire 90% of Strong Company. Strong s stock has been trading for around $60 per share. Parker has to pay a premium for the shares needed to gain control. If Parker pays $70 per share to induce enough stockholders to sell, how will the 10% of Strong that Parker does not own be recorded? Noncontrolling Interest Example Parker purchased 9,000 shares at $70 per share. The fair value of their consideration transferred is $630,000. The remaining 1,000 shares trade at $60 per share indicating that the fair value of the noncontrolling interest is $60,000. The total acquisition-date fair value of the sub is $690,000. Fair value of controlling interest : ($70 X 9,000 shares) $630,000 Fair value of noncontrolling interest ($60 X 1,000 shares) ,000 Total fair value of sub $690,

7 1-7 Allocating Goodwill Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests. Noncontrolling Interest Example The total acquisition-date fair value (amount paid) of Strong of $690,000 is greater than the fair value of the identifiable net assets acquired of $600,000 (10,000 shares x $60 per share). The difference is allocated to Goodwill. The parent first allocates goodwill to its controlling interest for the excess of the fair value of the parent s equity interest over its share of the fair value of the net identifiable assets. ($600,000 X 90% = 540, 000). Goodwill allocated to the controlling and noncontrolling interests will not always be proportional to the percentages owned. Noncontrolling Interest Example Total acquisition-date fair value $690,000 Fair value of net identifiable net assets..... (600,000) Goodwill $ 90,000 Assign Goodwill: Controlling Noncontrolling Interest Interest Fair value at acquisition date..... $630,000 $60,000 Relative fair value of identifiable net assets acquired ($600,000 X 90%).. (540,000) and ($600,000 X 10%) ($60,000) Goodwill $90,000 $0 There is no excess goodwill to assign to the noncontrolling interest. Noncontrolling Interest - Example If the shares were not actively traded, the $70 per share consideration transferred by Parker would be considered the best measure of fair value of Strong, and the fair value of the noncontrolling interest would be estimated at $70,000. Fair value of controlling interest ($70 X 9,000 shares). $630,000 Fair value of noncontrolling interest ($70 X 1,000 shares). 70,000 Total fair value of Strong Company $700,000

8 1-8 Noncontrolling Interest - Example Allocation of Noncontrolling Interest Because the price per share paid by the parent equals the noncontrolling interest per share fair value, goodwill is recognized proportionately across the two ownership groups. Assign Goodwill: Controlling Noncontrolling Interest Interest Fair value at acquisition date..... $630,000 $70,000 Relative fair value of identifiable net assets acquired ($600,000 X 90%).. (540,000) and ($600,000 X 10%) ($60,000) Goodwill $90,000 $10,000 Understand the computation and allocation of consolidated net income in the presence of a noncontrolling interest. Allocating Subsidiary s Net Income Allocating Sub s NI cont d The subsidiary s net income (including excess acquisition-date fair-value amortizations) must be allocated to its owners - the parent and the noncontrolling interest - to properly measure their respective equity in the consolidated entity. Assume that the relative ownership percentages of the parent and noncontrolling interest represent an appropriate basis for attributing all elements (including excess acquisition-date fairvalue amortizations for identifiable assets and liabilities) of a subsidiary s income across the ownership groups. Including the excess fair-value amortizations is based on the assumption that the noncontrolling interest represents equity in the subsidiary s net assets as remeasured on the acquisition date. 4-32

9 1-9 Noncontrolling Interest - Example Four NCI Figures Calculated Strong earns $80,000 in the first year and there is a $30,000 annual excess fair value amortization. The $5,000 noncontrolling interest in the sub s net income is subtracted from the combined entity s consolidated net income to derive parent s interest in consolidated net income. Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest. Noncontrolling Interests and Consolidations Noncontrolling Interest - Example The consolidation process remains substantially unchanged with a noncontrolling interest. The parent company must determine and then enter each of these figures when constructing a worksheet: Noncontrolling interest: In subsidiary at beginning of the current year. In subsidiary s current year net income. In subsidiary s current year dividend payments. In subsidiary as of the end of the year. Assume that King Co. acquires 80% of Pawn Co s 100,000 outstanding voting shares on January 1, 2014, for $9.75 per share or a total of $780,000 cash. The shares are trading at an average of $9.75 per share before and after the acquisition. The total fair value of Pawn to be used initially in consolidation is: Consideration transferred by King $780,000 Noncontrolling interest fair value ,000 Pawn s total fair value on Jan. 1, $975,000

10 1-10 Noncontrolling Interest - Excess Fair Value Allocations Noncontrolling Interest - Example To complete the information needed for this combination, assume that Pawn Company reports the following changes in retained earnings since King s acquisition: Pawn Company changes in retained earnings since acquisition: Net income - Current year (2015) $90,000 Less: Dividends declared (50,000) Increase in retained earnings (2015) $40,000 Prior years (2014) Increase in retained earnings. $70,000 Using a Worksheet and Journal Entries Breakout Questions Why use a worksheet- what information is needed in this context? Why complete Journal Entries in this context?

11 1-11 Noncontrolling Interest - Worksheet Example Noncontrolling Interest - Worksheet Example King uses the Equity Method to account for Pawn subsequent to acquisition. The consolidation process is substantially the same. At each consolidation, worksheet JOURNAL ENTRIES S, A, I, D, and E are prepare AND A column will be added to the worksheet to record the noncontrolling interest in the subsidiary. Noncontrolling Interest Worksheet Example Noncontrolling Interest Worksheet Example

12 1-12 NCI in Consolidated F/S Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements. Consolidated Financial Statement 1. Consolidated net income is computed at the combined entity level and allocated to the noncontrolling and controlling interests. The statement of changes in owners equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders. 2. If appropriate, each component of other comprehensive income is allocated to the controlling and noncontrolling interest. The statement of changes in owners equity would also provide an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests. 3. Note the placement of the noncontrolling interest in the subsidiary s equity in the consolidated owners equity section Consolidated Financial Statement Income Statement, Owners Equity Consolidated Financial Statement Balance Sheet

13 1-13 Control Premium Noncontrolling Interest Premium Paid Determine the effect on consolidated financial statements of a control premium paid by the parent. If King had paid $11.00 for their shares, at a time when they were trading for $9.75, then the goodwill allocation would look like this: 4-49 Effects of using the Initial Value Method Effects of using the Initial Value Method The initial value method employs cash basis for income recognition. The parent recognizes dividend income rather than an equity income accrual. Parent does not accrue the percentage of the sub s income earned in excess of dividends (the increase in subsidiary retained earnings). The parent does not record amortization expense, therefore it must include it in the consolidation process if proper totals are to be achieved. If the Parent used the Initial Value Method to account for the Sub after acquisition, Entry *C is used to convert to the Equity Method. The entry will combine the increase in the Sub s Retained Earnings since acquisition X the parent s percentage of ownership, and the parent s share of amortization expense since acquisition. Entry D is not necessary.

14 1-14 Effects of using the Partial Equity Method Midyear Acquisitions If the Parent used the Partial Equity Method to account for the Subsidiary after acquisition, Entry *C is used to convert to the Equity Method. Entry *C converts from the Partial Equity Method to the Equity Method, but only the adjustment for the parent s share of amortization expense is necessary. Understand the impact on consolidated financial statements of a midyear acquisition. Mid-Year Acquisitions Step Acquisition When control of a Sub is acquired at a time subsequent to the beginning of the sub s fiscal year: The income statements are consolidated as usual The Sub s pre-acquisition revenues and expenses are excluded from the Parent s consolidated statements (adjusted via Entry S) Only a partial year s amortization on excess fair value is taken. Understand the impact on consolidated financial statements when a step acquisition has taken place.

15 1-15 Step Acquisitions Step Acquisitions A step acquisition occurs when control is achieved in a series of equity acquisitions, as opposed to a single transaction. As with all business combinations, the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained. The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed fair value at the date control is obtained. If the parent held a noncontrolling interest in the acquired firm, the parent remeasures that interest to fair value and recognizes a gain or loss. Step Acquisitions cont d Sale of a Subsidiary If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. The parent simply accounts for the additional subsidiary shares acquired as an equity transaction consistent with transactions with other owners, as opposed to outsiders. Record the sale of a subsidiary (or a portion of its shares)

16 1-16 Sales of Subsidiary Stock Breakout Questions: Comment!! What is reported on the consolidated statements when a Parent sells some of its ownership in a Subsidiary? If the parent maintains control, it recognizes no gains or losses the sale is shown in the equity section. If the sale results in the loss of control, the parent recognizes any resulting gain or loss in consolidated net income. If the parent maintains control, it recognizes no gains or losses the sale is shown in the equity section. If the sale results in the loss of control, the parent recognizes any resulting gain or loss in consolidated net income Sales of Subsidiary Stock If the parent retains any of its former sub s shares, the investment should be remeasured to fair value on the date control is lost. Any resulting gain or loss from the remeasurement should be recognized in the parent s net income. If it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase. For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied. Noncontrolling Interest International Accounting Standards US GAAP vs. IFRS U.S. GAAP requires fair value measurement. Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest which is adjusted for its share of subsidiary income and dividends subsequent to acquisition. IFRS permits fair value measurement, or the noncontrolling interest may be measured at a proportionate share of the Sub s identifiable net asset fair value, which excludes goodwill. This option assumes that any goodwill created via acquisition applies solely to the controlling interest.

17 1-17 Recap of Some Concepts Recap cont d 1. "Noncontrolling interest" refers to an equity interest that is held in a member of a business combination by an unrelated (outside) party. 2. A control premium is the portion of an acquisition price (above currently traded market values) paid by a parent company to induce shareholders to sell a sufficient number of shares to obtain control. The extra payment typically becomes part of the goodwill acquired in the acquisition attributable to the parent company. 3. When a company sells a portion of an investment, it must remove the carrying value of that portion from its investment account. The carrying value is based upon application of the equity method. Thus, if either the initial value method or the partial equity method has been used, a company must first restate the account to the equity method before recording the sales transaction. The same method is applied to the operations of the current period occurring prior to the time of sale Because a corporation is assumed to have infinite life, the analysis is broken into two parts: a forecast period and a terminal value. METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS Forecast Period Ideally, the forecast period should comprise the internal over which the firm is in a transitional state as when enjoying a temporary competitive advantage. (i.e., the circumstances where expected returns exceed required returns). In most circumstances, a forecast period of five or ten years is used

18 1-18 Terminal Value Steady- State assumption The terminal value of the company derived from free cash flows occurring after the forecast period, is estimated in the last year of the forecast period and Once a schedule of free cash flows is developed for the enterprise, the weighted average cost of capital (WACC) is used to discount them to determine the present value. Capitalizes the present value of all future cash flows beyond the forecast period Free cash flow Forecast Period Free cash flow equals: The sum of net operating profits after taxes (NOPAT), plus depreciation and noncash charges, less capital investment and less investment in working capital. NOPAT captures the earnings after taxes that are available to all providers of capital. This is, NOPAT has no deductions for financing costs. The forecast period is normally the years during which the analyst estimates free cash flows that are consistent with creating value. Value is created whenever earnings power increases or when asset efficiency is improved

19 1-19 From the Journal of Management Eroding Firm Value Study done on methodology designed to aid researchers in assessing market expectations of future cash flows related to discrete events, such as acquisition announcements. More specifically, acquisitions were often found to erode acquiring firm value and produce highly volatile market returns. Given that acquirers generally pay premiums to acquire targets, results showed that target shareholders generally fared well, often experiencing significant positive returns Environmental Uncertainty Firm Strategy Bergh and Lawless (1988) showed that highly diversified firms were most likely to pursue acquisitions in decreasing environmental uncertainty, whereas the opposite occurred in less diversified firms. Thornton (2001), however demonstrated that the failure to shift firms strategy with environmental changes increased acquisition likelihood

20 1-20 Comprehensive Framework External governance structure also influence acquisition likelihood This comprehensive theoretical framework categories recent acquisitions research into three broad areas: (a) antecedents, the factors that lead firms to undertake acquisitions; (b) moderators, internal and external factors that moderate acquisition performance; and (c) other acquisition outcomes. Antitrust laws did not appear to impede acquisition activity and furthermore, that countries with high accounting standards and stronger shareholder protection had a greater amount of acquisition activity than their counterparts (Rossi & Volpin, 2004) Ways to Finance Acquisitions Expertise A common argument asserts that managers finance acquisitions with cash when they perceive their firms are undervalued and with stock when they perceive their firms are overvalued suggesting that the market should perceive stock-financed deals as a signal of bidder overvaluation. Powerful banks with specialized expertise are quick to use this expertise and, thus direct clients to complex solutions, such as stock-financed deals. In support, he reported that using investment banks to advise stock-financed acquisitions harmed acquirer performance

21 1-21 Target-bidder Bidder Still other scholars have examined that effects of acquiring at different stages within acquisitions waves. For example, Carow et al. (2004) found moving early in acquisitions waves resulted in higher combined target-bidder abnormal returns. However, they further reported that early moving bidder accrued positive returns only when they: Possessed superior information Paid with cash Expanded in related industries during widespread expansion periods Early vs. Late Acquisitons? Barkema and Schijven (2008b) In a more fine-grained analysis of the performance consequences of acquiring at different wave stages. It was revealed that firms that acquired early within an industry acquisitions wave achieved positive returns, whereas the market punished later acquirers. Argued that although acquisitions are often treated as independent events, most are actually a component of a broader acquisitions strategy, And such broad acquisitions strategies are more likely to require significant sequential organizational restructuring to more fully realize benefits from multiple acquisitions

22 1-22 Barkema and Schijven (2008b) Barkema and Schijven (2008b) Following this argument, they demonstrated that the performance implications of a single acquisition are dependent on that acquisition s position within the acquirers acquisition sequence. Thus, accounting for post acquisition integration as a long-term process rather than a one-shot game can reveal acquirers gain that are often overlooked when examining single acquisition events Conclusion Questions? Today, we discussed the acquisition method, specifically: The accounting perspective, worksheet, journal entries Tax implications Strategic approach Cycle of business combinations and acquisition sequence. Thanks for your attention today! Regan Garey, regangarey@yahoo.com Accounting Professor, Lock Haven University 4-87