This era can be subdivided into separate trends ) Mergers from the 1950 to the sass were generally conglomerate mergers primarily motivated by a desire for diversification synergies, when firms’ strengths were complementary c. Most recently, the Federal Government is calling for a review of merger activity in general 1. 5 Terminology and Types of Combinations A. Asset acquisition (we’ll study this in Chapter 2): All (100 percent) of the assets of one company are bought by another company, and the acquired company ceases to exist 1. Statutory merger: (A Company + B Company = A Company) 2.
Statutory consolidation: (A Company + B Company = C Company) B. Stock acquisition (Chapters 3 – 9): The acquiring company lists the acquired company on its books as an investment, but the acquired company continues to be a separate legal entity, and the two companies are considered to be a single economic entity when the acquiring company owns a majority (50 percent or more) interest. 1. Separate legal entities: (A Company + B Company = A, Parent + B, Subsidiary) 2. Consolidated financial statements which combine the statements of both companies must be prepared 1. 6 Takeover premiums A.
When the acquiring company pays more than market price for the target company’s stock, a takeover premium arises B. Reasons for a takeover premium 1. The acquiring company’s own stock prices are at a level which makes it good to issue stock at a premium 2. The target company’s assets are worth more than its stock price would indicate 3. The acquiring company feels a pressing need to expand a. Expansion in the global marketplace b. Target company has high cash flows that can benefit the acquiring company c. Payout options for executives (golden parachutes) are very high 4.
Some analysts have suggested that companies are Just paying too much 1. 7 Avoiding Pitfalls before the Deal A. Be skeptical about percentages presented by selling company B. Analyze the target company for assumed liabilities as well as assumed assets C. Check expense allocations D. Look for nonrecurring items, changes in estimates, accruals E. Use caution when dealing with Coo’s egos 1. 8 Determining Price and Method of Payment A. The acquiring company must decide how to finance the acquisition – cash, stock, debt. B. In the sass, stock swaps were a common means of acquisition because of the high value of stocks.
That made determining the price difficult. 1. Stock exchange ratio 2. Negotiated price C. Companies also use net asset and future earnings combinations to determine the value of a company 1. The price should be based on the current value of the net assets acquired a. Goodwill is the excess of cost over the fair value of the net assets acquired b. Goodwill usually arises when expected earnings exceed the normal rate of return 2. The merger is dilative if PEPS decreases after the acquisition and creative if PEPS increases 1. 9 Alternative Concepts of Consolidated Financial Statements A.
When the business combination is the result of a stock acquisition (a parent- subsidiary relationship), then a consolidated entity results from that acquisition. FAST ASS Topics 805 [Business Combinations] and 810 [Consolidations] require that unconsolidated statements be presented viewing the firm as one entity (the economic entity concept). B. Parent company concept 1. Emphasis to parent company’s stockholders 2. Stockholders’ equity of the consolidated entity is also the stockholders’ equity of the parent company 3. The consolidated financial statements are meant to be informative about the parent’s total ownership C.
Economic entity concept 1. Emphasizes control of the whole by a single management 2. Consolidated financial statements are information about a group of legal entities operating as a single economic entity D. Noncontributing interest . Under the economic entity concept, a noncontributing interest is part of the ownership equity in the entire economic unit 2. Under the parent company concept, the nature and classification of noncontributing interest is unclear. It is reported below liabilities, but above stockholders’ equity E. Consolidated net income 1.
Parent company concept – only includes net income after deducting noncontributing interest in income 2. Economic entity concept – consolidated net income is the total realized combined income, some of which belongs to the noncontributing interest F. Consolidated balance sheet values 1. Parent company concept – write up the subsidiary assets by the parent company’s share of the difference between cost and fair value 2. Economic entity concept – write up the subsidiary assets by the entire difference between cost and fair value G. Interception profit 1.
Total elimination – eliminate 100 percent of all unrealized profit in interception sales 2. Partial elimination – eliminate only the parent’s percentage of unrealized profit in interception sales H. Current practice 1. The economic entity concept eight chapters! 1. 10 Abs’s Conceptual Framework A. Economic Entity vs.. Parent Concept and the Conceptual Framework . The adoption of the economic entity concept over the parent company concept is due in part to Joint project of the FAST and the SAAB to converge accounting standards and to have the same conceptual framework. 2.