Advanced Financial Accounting I
ADMS 4520 – Winter 2012 – Patrice Gelinas
Lecture 2 – Business Combinations – Jan 13
A business combination occurs when one company unites with or obtains control of
The ‘parent’ is the controlling company and the ‘subsidiary’ is the controlled company.
Consolidated financial statements are required to report the combined financial position
and results of operations of the parent and the subsidiary.
Control over another company can be obtained by (i) purchasing substantially all of its
net assets, or (ii) acquiring enough of the company’s voting shares to control the use of its
A conglomerate business combination involves regular businesses operating in widely
A horizontal business combination involves businesses whose products are similar.
A vertical business combination involves businesses where the output from one can be
used as input from the other.
Business combinations (‘takeovers’, ‘amalgamations’, ‘acquisitions’ or ‘mergers’) can be
friendly or hostile.
In a friendly combination, management and the board of directors of both companies
recommend that their shareholders approve the combination proposal.
In a hostile combination the management and board of the target company recommends
that its shareholders reject the combination proposal, and may employ various defences.
Payment for net assets or shares acquired can be in cash, promises to pay cash in the
future, or the issuance of shares, or a combination of these.
The method of payment has a direct bearing on the determination of which company is
the acquirer and which is being acquired.
Forms of Business Combinations
Purchase of Assets – Control over another company’s assets can be obtained by
purchasing the assets outright, leaving the selling company only with the consideration
received for the asset sale and any liabilities present before the sale.
Purchase of Shares – An alternative to the purchase of assets is for the acquirer to
purchase enough voting shares from the shareholders of the acquire that it can determine
the acquiree’s strategic operating, investing, and financial policies. o Share purchase can be less costly since control can be achieved by purchasing less
than 100% of the voting shares. Share purchases can also have important income
Both forms of business combination result in the assets and liabilities of the acquiree
being combined with those of the acquirer.
If control is achieved with the purchase of net assets, the combining takes place in the
accounting records of the acquiree.
If control is achieved by purchasing shares, the combining takes place when the
consolidated financial statements are prepared.
Methods of Accounting for Business Combinations
There are four methods that have been used in practice or discussed in theory over the
o The purchase method.
o The acquisition method.
o The poolingofinterests method.
o The new entity method.
The purchase method is required GAAP prior to adoption of the acquisition method
which must be adopted on or before January 1, 2011.
The poolingofinterest method was acceptable in limited situations prior to July 1, 2001
and can no longer be used.
The new entity method has never been acceptable for GAAP but is worthy of future
The Purchase Method
Under the purchase method prior to 2011 or earlier adoption of IFRS 3, the acquiring
company recorded the net assets of the acquired company in its investment account at the
price it paid.
Price includes cash payments, FMV of shares issued, and PV of any future cash payments
Excess of price paid over the fair value of the acquired company’s net assets are recorded
The fair values of identifiable net assets acquired were charged against earnings
(amortized) to achieve expense matching.
Goodwill was regularly reviewed for impairment and impairment losses were recorded as
a charge against earnings.
The purchase method is consistent with historical cost principle of accounting – record
the price paid for the net assets and amortizes the cost over their useful lives.
The Acquisition Method After January 1, 2011 or upon earlier adoption of IFRS 3, the acquiring company will use
the acquisition method.
The acquiring company records the identifiable net assets at fair values regardless of
If purchase price is > FV of identifiable net assets the excess is reported as goodwill
similar to purchase method.
If price paid is