Mergers Acquisitions and Other Intercorporate Investments Robinson Munter

Mergers, Acquisitions, and Other Intercorporate Investments Robinson, Munter & Grant Chapter 13

Intercorporate Investments Involvement Passive Ownership < 20% Accounting treatment Cost and Market value Significant 20 -50% Equity method Joint venture Shared control Control Robinson, Munter & Grant Equity (GAAP) and proportionate consolidation (IAS) Consolidation > 50% Chapter 13 2

Passive Investments The Cost and Market Method • • • Use when recording the purchase of individual securities Ownership is generally less than 20% Mark-to-market in aggregate – Investment asset is adjusted periodically to reflect current market value of shares Robinson, Munter & Grant Chapter 13 3

Passive Investments The Cost and Market Method Specific steps: 1. Record investment at cost, price paid 2. Recognize dividend income when dividends are declared 3. Recognize investment impairment on the income statement and adjust asset value 4. Record gain/loss upon eventual stock sale Robinson, Munter & Grant Chapter 13 4

Passive Investments Marked-to-Market • • • Done in aggregate on the balance sheet date Carrying amount of individual securities may not be adjusted For trading and available for sale securities Robinson, Munter & Grant Chapter 13 5

Passive Investments Investment Classification Trading Securities • • • intention is to sell in the near term Unrealized gains (losses) increase (decrease) the carrying value of the investment on the balance sheet Unrealized gains (losses) are recorded on the income statement Robinson, Munter & Grant Chapter 13 6

Passive Investments Investment Classification Available-for-sale Securities • • • No clear intention to sell in the near term Unrealized gains (losses) increase (decrease) the carrying amount of the investment Unrealized gains (losses) increase (decrease) equity – Through the account other comprehensive income, a component of Equity Robinson, Munter & Grant Chapter 13 7

Passive Investments Investment Classification Held-to-Maturity Investments • Debt investments made with the intent and ability to hold to maturity – Bonds purchased as an investment • Do not recognize market changes Robinson, Munter & Grant Chapter 13 8

Significant Influence The Equity Method • • • Used when ownership is between 20% and 50% Used for joint ventures in the U. S. Investor records revenue or losses – a share of the investee’s net income – in proportion to it’s ownership percentage – Concurrent adjustment is made to the investment asset Robinson, Munter & Grant Chapter 13 9

Significant Influence The Equity Method • Carrying value of the investment asset on balance sheet is: – Recorded at cost initially – Increased (decreased) for percentage of profits (losses) equal to percentage of ownership – Decreased for dividends received Robinson, Munter & Grant Chapter 13 10

The Equity Method • Parent co. purchased 25% of shares in Baby Co. by paying 10. 000 YTL in cash at the end of 2005 • In 2006 Baby Co. reported 1. 000 YTL net income after taxes. • In 2007 Baby Co. distributed 100 YTL dividends in total • Determine the amounts to be presented by Parent co. in its income statement and balance sheet for 2005 and 2006 and 2007 Robinson, Munter & Grant Chapter 13 11

• Merger: when two or more companies agree to combine • Acquisition: when one company purchases substantially all of the shares or net assets of another company • Business: a self-sustaining set of activities and assets conducted and managed for the purpose of providing a return to investors. Robinson, Munter & Grant Chapter 13 12

Business Combinations US Standard & International Standards • Must use purchase method • Acquirer records (net) assets at fair market value, presumably the purchase price • Goodwill results if purchase price > FMV Robinson, Munter & Grant Chapter 13 13

Purchase Method Purchase 1. Identify the acquirer 2. Determine the price paid 3. Determine the fair value of assets and liabilities acquired 4. Record goodwill Robinson, Munter & Grant Chapter 13 14

Control Full Consolidation • • Appropriate when investor has control over investee’s activities Control can be established by – – Majority ownership Representation on board of directors Control over managerial decision making Through contractual arrangements Robinson, Munter & Grant Chapter 13 15

Control Full Consolidation • Investor includes 100% of investee’s assets, liabilities, revenues and expenses – Amounts are grossed-up • • Share of assets and liabilities not owned – minority share – are shown separately Minority share of income is deducted in the income statement Robinson, Munter & Grant Chapter 13 16

Shared Control – Joint Ventures Proportionate Consolidation The International Standard • • Include proportion of investee’s assets, liabilities, revenues and expenses equal to percentage ownership Also include excess from original investment – Excess is the difference between fair value and book value of underlying (net) assets Robinson, Munter & Grant Chapter 13 17