Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
CHAPTER 1
INTERCORPORATE ACQUISITIONS AND INVESTMENTS
IN OTHER ENTITIES
IMPORTANT NOTE TO INSTRUCTORS
The 11th edition of Advanced Financial Accounting continues the approach to
consolidation which was used in the 10th edition. While we encourage instructors to read through
the description of all changes in the 11th edition provided in the preface to the book, we
summarize this consolidation approach here since it is the fundamental organizational structure
for several chapters in the text. As this approach is developed in chapters 2-5 we believe it offers
students an intuitive foundation for developing consolidated financial statements. We summarize
the two main features in our approach to consolidation in the 11th edition here:
✓ A Building-Block Approach to Consolidation—Virtually all advanced financial
accounting classes cover consolidation topics. While this topic is perhaps the most
important to instructors, students frequently struggle to gain a firm grasp of consolidation
principles. This edition provides students with a learning friendly framework to
consolidations by introducing consolidation concepts and procedures gradually. This is
accomplished by a building-block approach which introduces consolidations earlier than
some texts by beginning the consolidation discussion in chapters 2 and 3. The building-
block approach can be summarized as follows:
• Chapter 2 begins with the most basic consolidation situation: the consolidation of
a wholly owned subsidiary that is either created or purchased at an amount equal
to the book value of net assets. Thus, students practice basic consolidation
procedures without having to worry about the complications associated with a
differential or with noncontrolling shareholders.
• Chapter 3 introduces the notion of partial ownership of a subsidiary that is
created or acquired at an amount equal to the book value of net assets. In this way
students are exposed to the nuances associated with the existence of
noncontrolling shareholders, but without the details associated with a differential.
• Chapter 4 exposes students to the intricacies of consolidation when the subsidiary
is acquired for an amount that exceeds the book value of net assets. In order to
isolate the new concepts and procedures that accompany the consolidation of a
subsidiary with a differential, this chapter focuses on wholly owned subsidiaries.
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
• Chapter 5 finally brings students full circle to the point where they are ready to
tackle more realistic situations where the parent company purchases a controlling
interest in a subsidiary (but less than 100% ownership) and the acquisition price
exceeds the book value of net assets. Thus, students learn how to simultaneously
handle all of the details associated with a differential and with noncontrolling
shareholders.
The overall coverage of the consolidation process by chapter is illustrated below.
✓ Organization of Consolidation Entries—Consistent with the building block approach to
consolidation, the this edition facilitates the elimination of the investment in a subsidiary
in two steps: (1) first the book value portion of the investment and income from the
subsidiary are eliminated and (2) then the differential portion of the investment and
income from subsidiary are eliminated with separate entries. This approach facilitates the
building-block approach in chapters 2-5. This edition also uses frequent illustrations to
help students visualize the steps in the consolidation process.
OVERVIEW OF CHAPTER 1
Chapter 1 provides students with an understanding of the legal forms of business
combinations and the financial statement effects of the accounting procedures used in recording
a business combination. It also discusses the proliferation of complex organizational structures
and regulatory as well as ethical considerations. This chapter fully illustrates accounting for
business combinations on the date of acquisition, using the acquisition method, both for business
combinations effected through an acquisition of net assets and by an acquisition of common
shares.
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
The discussions contain specific illustrations of the valuation of tangible and intangible
assets and liabilities held by the acquired company on the date of acquisition. Chapter 1 also
illustrates the measurement and reporting of goodwill and the treatment of a bargain purchase
and discusses the impairment of goodwill. It also explains the treatment of costs associated with
completing a merger and the associated disclosure requirements.
The Additional Considerations portion of the chapter discusses factors adding to
uncertainty in business combinations; in-process research and development; and noncontrolling
equity held prior to combination.
LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 1-1 Understand and explain the reasons for and different methods of business
expansion, the types of organizational structures, and the types of acquisitions.
LO 1-2 Understand the development of standards related to acquisition accounting over
time.
LO 1-3 Make calculations and prepare journal entries for the creation of a business entity.
LO 1-4 Understand and explain the differences between different forms of business
combinations.
LO 1-5 Make calculations and business combination journal entries in the presence of a
differential, goodwill, or a bargain purchase element.
LO 1-6 Understand additional considerations associated with business combinations.
SYNOPSIS OF CHAPTER 1
Intercorporate Acquisitions and Investments in Other Entities
Kraft’s Acquisition of Cadbury
A Brief Introduction
LO 1-1 Understand and explain the reasons for and different methods of business
expansion, the types of organizational structures, and the types of acquisitions.
An Introduction to Complex Business Structures
Enterprise Expansion
Business Objectives
Frequency of Business Combinations
Ethical Considerations
Business Expansion and Forms of Organizational Structure
Internal Expansion: Creating a Business Entity
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
External Expansion: Business Combinations
Organizational Structure and Financial Reporting
LO 1-2 Understand the development of standards related to acquisition accounting over
time.
The Development of Accounting for Business Combinations
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
LO 1-3 Make calculations and prepare journal entries for the creation of a business entity.
Accounting for Internal Expansion: Creating Business Entities
LO 1-4 Understand and explain the differences between different forms of business
combinations.
Accounting for External Expansion: Business Combinations
Legal Forms of Business Combinations
Methods of Effecting Business Combinations
Valuation of Business Entities
LO 1-5 Make calculations and business combination journal entries in the presence of a
differential, goodwill, or a bargain purchase element.
Acquisition Accounting
Fair Value Measurements
Applying the Acquisition Method
Goodwill
Combination Effected through the Acquisition of Net Assets
Combination Effected through Acquisition of Stock
Financial Reporting Subsequent to a Business Combination
LO 1-6 Understand additional considerations associated with business combinations.
Additional Considerations in Accounting for Business Combinations
Uncertainty in Business Combinations
In-Process Research and Development
Noncontrolling Equity Held Prior to Combination
NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
LO 1-1 Understand and explain the reasons for and different methods of business expansion,
the types of organizational structures, and the types of acquisitions.
• Slides 3-14 summarize basic concepts related to LO1.
• Slide 7 provides a visual overview of internal and external expansion
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
LO 1-2 Understand the development of standards related to acquisition accounting over time.
• Slides 18-20 summarize basic concepts related to LO 1-2.
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
•
LO 1-3 Make calculations and prepare journal entries for the creation of a business entity.
• Slide 26 summarize basic concepts related to LO3.
• Slide 27 provides a hands-on example about internal expansion to allow students to
think through the journal entries on the parent’s and subsidiary’s books. This
example is set up to engage students without spending a lot of time. Display the
example information and ask students to explain what journal entries the parent (Slide
28) and subsidiary (Slide 29) would make. Instructors can click to show each journal
entry as students give their answers.
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
LO 1-4 Understand and explain the differences between different forms of business
combinations.
• Slides 33-44 summarize basic business combinations as presented in the chapter.
• Slides 45-56 provide additional diagrams and detail to help students better understand
how these and other types of business combinations are consummated.
LO 1-5 Make calculations and business combination journal entries in the presence of a
differential, goodwill, or a bargain purchase element.
• Slides 60-69 introduce the concepts of this learning objective with a simple example.
• Slides 70-78 summarize the accounting for acquisition-related costs classified into
three general categories. The examples in slides 73–74 and 76-77 are helpful in giving
students hands on practice. Some instructors find it useful to have students take a few
minutes on each example to work individually or in small groups to attempt to solve
each exercise.
• Slides 79-87 summarizes acquisition accounting for a combination resulting in
goodwill using an asset acquisition to help students visualize the calculation and
recording of goodwill.
• Slides 88-89 summarize accounting for an asset acquisition that results in a bargain
purchase.
• Slides 90-97 use a practice exercise to help students visualize how accounting for a
bargain purchase differs from a goodwill scenario.
• Slides 98-102 provide an overview of how intangibles acquired in an acquisition
should be recorded. This topic is not covered extensively in the book. Instructors may
find it useful to take a few minutes to mention this topic using these slides. In
particular, slides 101-102 provide a brief example to help students understand how
separately identifiable intangibles should be recorded separately from goodwill.
• Slide 103 is an optional example to illustrate the journal entries associated with
acquisition accounting from the perspectives of both the acquiring and the target
companies.
• Slides 104-106 summarize the journal entries that would be used in an acquisition of
stock.
• Slide107 summarizes financial reporting subsequent to a business combination
LO 1-6 Understand additional considerations associated with business combinations.
• Slides 113-116 summarize basic concepts related to LO 1-6 (additional
considerations).
Preview Slides:
Slides 117-122 introduce the notion of consolidation in a very basic manner. While
chapter 1 alludes to consolidation briefly, it doesn’t go into any detail. Some
instructors find it useful to introduce a very simplistic view of consolidation in
chapter 1 as a teaser for chapters 2-5. While this material is not covered in the
students’ reading, some instructors find it useful to use these slides to preview what
students will be learning in the next several chapters.
Chapter 01 – INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
TEACHING IDEAS
1. Students could be asked to prepare a “Company Mergers & Acquisitions History.” Each
student (or group) is assigned a company from the Fortune 500 list that appears annually
in the April issue of Fortune. This could be reproduced and students could be assigned a
company based on their seating order in the class. Alternatively, the instructor may have
the list and then students may select a number between 1 and 100 at random and the
instructor will tell them the name of “their” company. The students then must obtain the
M&A activity of that company for the last 10 years from Moody’s Industrial Manual or
some similar source. Moody’s presents this information at the beginning of each
company’s profile information. The students should determine the number and magnitude
of the business combinations and investments for their company and prepare a historical
time line showing the business combinations and any other information they can obtain
on selected (or all) combinations. Several activities during the semester or quarter can be
based on the student’s company selection made at this time.
2. Students can be required to conduct a key word search online and asked to provide
examples and brief descriptions of several different types of merger activities.
3. Students could access the Wall Street Journal on-line article data base and search for an
article on a recent business combination. The students could be asked to provide a brief
oral or written summary of the article.