Introduction to Corporate Finance

ONLINE CHAPTERS

8 List several different types of merger structures. Why might different types be used in different

settings?

9 How does a tender offer differ from a proxy fight? Why might these two corporate control actions

be considered different ways to achieve the same objective?

10 What are the two most important methods of paying for corporate acquisitions?

11 Who wins and who loses in corporate takeovers? Why do acquiring-company shareholders

generally lose in share-swap mergers, but either benefit or at least break even in acquisitions paid

for with cash?

CONCEPT REVIEW QUESTIONS 21-4

21-5 ACCOUNTING TREATMENT OF

MERGERS AND ACQUISITIONS

Under International Financial Reporting Standard IFRS-3, acquisitions (or business combinations) are

accounted for using the acquisition method. This usually means the acquiring company recognises the

target’s assets and liabilities in its consolidated financial statements at their fair values at the time of

the acquisition.^27 (Should the target continue to prepare its own separate financial statements, the

acquisition does not affect the carrying values of the target’s assets and liabilities.)

The acquiring company also determines whether there is a difference between the fair value

of the target’s net assets and the amount that it paid for the target. If the acquiring company paid

more than the fair value of the target’s net assets (for example, because of expected synergies from

combining the acquiring company’s and target’s assets), it recognises the difference as an intangible

asset on its balance sheet called goodwill. If the acquiring company paid less than the fair value of the

target’s net assets (a bargain purchase), it recognises the difference as a gain in earnings at the time

of the acquisition.

After the acquisition closes, the value of goodwill must be evaluated to determine if it has been

impaired because of a decline in fair value relative to carrying value. If the value of goodwill is impaired,

then the amount of the impairment is written down from the goodwill account on the balance sheet and

charged off against earnings. Otherwise, the goodwill balance remains unchanged on the balance sheet

indefinitely. The following Example details the treatment of accounting for acquisitions.

example

Assume that a target company has 5 million shares outstanding, priced at $10 per share. The acquiring

company offers a 20% takeover premium ($12 per share) for a transaction value of $60 million. The acquiring

company wants the R&D capabilities of the target company so that it can exploit synergies with its own assets,

and is willing to pay a premium to obtain those capabilities. The fair value of the target’s current assets is

27 Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market

participants at the measurement date.

goodwill

An intangible asset created

if the restated values of the

target in a merger lead to a

situation in which its assets

are less than its liabilities

and equity

thinking cap

question

How is goodwill created

through a merger? Under

what conditions may it be

subsequently adjusted?