CHAPTER -FOUR

BUSINESS COMBINATIONS
4.1 MEANING AND TERMS USED IN BUSINESS COMBINATIONS
Two or more business enterprises or their net assets are brought under common control in a single
accounting entity. Mergers and Acquisitions are the other terms frequently applied to denote Business
Combinations. The FASB has suggested the following definitions for the terms commonly used in the
discussion of business combinations.
Constituent Companies
Business enterprises that enter in to a process of business combination are known as Constituent
Companies.
Combined Enterprise
The Accounting Entity that results from a business combination is known as combined enterprise.
Combinor
One of the constituent companies entering in to a business combination, whose owners as a group,
controls the ownership interest is known as Combinor. In other words company taking initiation for
combination and survives after combination. It is a corporation which distributes cash or other assets or
incurs liabilities to obtain the assets or stock of another company.
Combinee
A Constituent company other than the combinor in a business combination is known as Combinee.
E.g. Company A and Company B combine, Company A survives and controls the combined enterprise.
Constituent Companies - Company A & Company B
Combinor -Company A
Combinee -Company B
Classes of business combinations:
1. Friendly takeover
2. Hostile takeover
In friendly take over the board of directors of constituent companies prepares the terms and conditions of
the business combination and submits the proposal to the shareholders for approval. In hostile takeover
combinee usually resists the proposal of business combination. A target combinee in a hostile takeover
resists the proposed business combination by resorting to one or more defensive tactics with the
following designations:

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Pac-man defense: – It is a threat to undertake a hostile takeover of the prospective combinor
White knight: - It is a search for a candidate to be a combinor in a friendly takeover.
Scorched earth: It is the disposal, by sale or by a spin-off to stockholders, of one or more profitable
business segments.
Shark repellent: It is an acquisition of substantial amounts outstanding common stock for the treasury or
for retirement, or the incurring of substantial long term debt in exchange for outstanding common stock
Poison Pill: - It is an amendment of the articles of incorporation or byelaws to make it more difficult to
obtain stock holder approval for a takeover.
Green mail: - It is an acquisition of common stock presently owned by the prospective combinor at price
substantially in excess of the prospective combinor’s cost, with the stock thus acquired placed in the
treasury.
4.2 Why Business combination?
When business enterprises are combined competition to some extent could be avoided. Although a
number of reasons have been cited the overriding one for combinors in recent years has been to achieve
growth. Other reasons often advanced in support of business combination are obtaining new
management strength. Expansion of product lines is another reason together with the enjoyment of
income tax advantages. It is also possible to diversify the products and to find places in international
markets when business expands.
4.2.1. Types of Business combinations
A. Horizontal Combination
Combination between companies producing the same type of products in the same industry.
Co.A Co.B Co.C
Producing------------------------->Producing ------------------>Producing
Product -X Product-X Product -X
B. Vertical Combination
Combination between companies engaged in different stages of production & distribution suppliers and
customers but common product.
Co.A Co.B Co.C
Produces ------------------------> Supplier of --------------------->supplier of
Product X component P component Q

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Requires
Components P&Q
C. Conglomerate Combination
Combination between enterprises in unrelated industries or markets.
Co.A Co.B Co.C
Sugar Factory----------->Steel Factory --------------> Bricks Factory
4.3 Methods for Arranging Business Combination
Methods for Arranging Business Combination

E.g.
Statutory Statutory Acquisition Acquisition
Merger Consolidation of Common stock of Assets
Eg. Eg Eg
Co. A & Co. B Co. A & Co. B Co. A & Co.B One company
Combines & combines & a new combines & acquires all or
Co. A survives Co. (Co. C) comes after combination part of assets
in to existence keep separate for a consideration.
Legal entity. The other Co. may
Co. B is liquid- Co. A & Co. B are both are not or may not continue.
-ated liquidated. Liquidated.
A+B=A A+B=C
4.3.1 Statutory Merger
In statutory merger, the board of directors of constituent companies approves a plan for the exchange of
voting common stocks or sometimes preferred stock, cash or long term debt of one of the corporations
which is surviving for all outstanding common stock of other corporations. The survivor corporation
issues its common stock or other consideration in exchange for all their holdings, thus acquiring the
ownership of those corporations. The other corporations are dissolved and liquidated and thus ceases to
exist as separate legal entities and their activities are continued as a division of the survivor which owns
the net assets of the liquidated corporations.

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The Procedure of statutory merger:
*The board of directors of constituent companies works out the terms of merger.
*The stockholders of constituent companies approve the terms of merger
*The survivor company issues common stock or other forms of consideration to other constituent
companies in exchange of all their outstanding common stock of their companies.
*The survivor company dissolves and liquidated other constituent companies
4.3.2 Statutory Consolidation
In statutory consolidation, a new corporation is formed to issue its common stock for the outstanding
common stock of two or more existing corporations which are liquidated after combination. The new
corporation acquires the net assets of the defunct companies whose activities may be continued as
divisions of the new corporation.
The procedure of statutory consolidation:
*The board of directors of the constituent companies work out the terms of the consolidation.
*Shareholders of the constituent companies approve the terms of the consolidation.
* A new corporation is formed to issue its common stock to the share shareholders of the constituent
companies in exchange for all their outstanding common stock of those companies.
*The new corporation dissolves and liquidates the constituent companies receiving the net assets in
exchange for the common stock investments.
1.3.3. Acquisition of common stock
One corporation acquires from the present stock holders a controlling interest in the voting common
stock of another corporation by issuing a consideration in the form of preferred or common stock, cash or
debt or combination thereof. The corporation which issues the consideration is the investor and the
corporation which receives the consideration is the investee. The acquisition of shares may be
accomplished through direct acquisition or through a tender offer to stock holders of publicly owned
corporation. A tender offer is a publicly announced intention to acquire for a stated amount of
consideration. If the controlling interest in the combinee’s voting common stock is acquired, that
corporation becomes affiliated with the Combinor parent company as a subsidiary and is not dissolved
and liquidated and remains separate legal entity.
4.3.4. Acquisition of Assets
One business enterprise may acquire from another business enterprise all or part of the assets or net assets
for a consideration which may be in the form of cash debt, preferred stock or common stock or

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combination thereof. The selling enterprise may or may not continue as separate legal entity or it may be
dissolved and liquidated. It does not become an affiliate of the combinor. When one corporation is
purchasing another company, or when it is combining with another company, the combinor company has
to pay a particular amount combinee company. So it is to decide an appropriate price to pay. It may be
paid in the form of cash, debt securities or number of common or preferred shares. It is generally
determined in the following methods.
1. Capitalization of expected average annual earnings of the combine at a desired rate of return.
2. Determination of current fair value of combinee’s net assets including goodwill.
Although business combinations can take an unlimited variety of forms, the essential character of most
combinations is either an acquisition of net assets or an acquisitions of stock taking one of four basic
forms.
1. An acquisition of net assets for cash
2. An acquisition of net assets for stock
3 .An acquisition of stock for cash
4. An acquisition of stock for stock.
The first two forms are frequently referred to collectively as acquisition of net assets and the last two
forms as acquisition of stock.
1. Acquisition of net assets for cash
When one company acquires the net assets of another in exchange for cash, the acquiring company
records the detailed assets and liabilities acquired. To illustrate, suppose that G corporation acquires the
assets and liabilities of H Inc. for $90,000 cash; the various assets of H are valued at the total $130,000
and liabilities at $40,000 accordingly, G makes the following entry.
Various Assets (listed individually) 130,000
Various liabilities (listed individually) 40,000
Cash 90,000
The recipient of the net assets is identified as the acquiring company and the recipient of the cash is
identified as the acquired company. Unlike certain other forms of combination, an acquisition of net
assets for cash completely dissolves the acquired company’s equity interest in the net assets. The
acquired company receives cash which it may reinvest or distribute to its stock holders but has no further
interest in its former net assets. Of course if the acquired company reinvests the cash, then the purpose of
the continuing company differs from that of pre Combination Company.

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 2. Acquisition of net assets for stock
Following the second form of business combination, one corporation can acquire the net assets of another
in exchange for stock of the acquiring corporation. For example, if G Corporation has issued common
stock valued at $90,000, G would have made the following entry.
Various assets (Listed individually) 130,000
Various Liabilities (Listed individually) 40,000
Common Stock 90,000
3. Acquisition of Stock for Cash
A third form of business combination is an acquisition of stock for cash in which the recipient of the
stock is identified as the acquiring company. To illustrate, suppose that R Corporation acquires all the
outstanding common stock of S Inc. for $70,000 cash. R makes the following entry.
Investment in S Inc. 70,000
Cash 70,000
The acquiring company establishes an investment account rather than recording the detailed assets and
liabilities of the acquired company. When the stock holders of the acquired company surrender their
shares in exchange for cash they also surrender their equity interest in the assets of the acquired company.
The acquired company may continue to exist but to the extent that its stock is held by the acquiring
company, it has no substance apart from the acquiring company.
4. Acquisition of stock for stock
A fourth form of business combination is accomplished by exchanging shares of stock usually the
acquiring corporation issues new shares of its stock in exchange for the outstanding stock of the acquired
corporation. In most cases, the acquiring corporation will secure the outstanding shares directly from the
stock holders of the acquired corporation in a tender- offer procedure. To illustrate suppose that R
acquired S co’s outstanding share by issuing common stock at $70,000, then the entry would be
Investment in S inc 70,000
Common stock. 70,000
4.4 Methods of Accounting for Business combinations
Earlier there were two methods of Business combinations under APB opinion Number 16.
1) Purchase accounting method
2) Pooling of Interest method.

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In July 2001, Financial Accounting Standard Board (FASB), under Financial Accounting Standard
Number 141, made a pronouncement prohibiting future use of the Pooling of Interest method and
Purchase Accounting Method is required for all Business Combinations.
For the purpose of understanding pooling of interest method, it is explained as follows
Pooling of Interest method of Accounting:
The original premises of the pooling of interests methods was that certain business combinations
involving the exchange of common stock between the issuer and the stock holders of a combinee were
more in the nature of combining of existing stock holder interests than the acquisition of assets or raising
of capital. Combining of existing stock holder interests was evidenced by combinations involving
common stock exchanges between corporations approximately equal size. The stock holders and
management of these corporations continued their relative interests and activities in the combined
enterprise as they previously did in the constituent companies. The pooling of interest method of
accounting provided for carrying forward to the accounting records of the combined enterprise, the
combined assets, liabilities and the retained earnings of the constituent companies at their carrying
amounts in the accounting records of constituent companies. The current fair value of the common stock
issued to effect the business combination and the current fair value of combinee’s net assets are
disregarded in the pooling of interest accounting. Further because there is no identifiable combinor in the
pooling type business combination, the term issuer identifies the corporation that issues its common stock
to accomplish the combination.
Illustration on pooling of interest accounting
On December 31, 2010, Mason Company (The Combinee) was merged with Saxon Corporation (The
Combinor). Saxon company exchanged 150,000 shares of $10 par common stock (CFV $25 a share) for
all 100,000 issued and outstanding shares of Mason company's non-par $10 stated value common stock.
In addition Saxon company paid the following out-of -pocket cost associated with Business combination.
Accounting Fee
For investigation of Mason Company $ 5,000
For SEC registration statement for Saxon C/S 60,000

Legal Fee
For the business combination 10,000
For SEC registration statement for Saxon C/S 50,000

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 Finder's fee 51,250
Printer's charges for SEC registration statement 23,000
SEC registration statement fee 750
$200,000
Immediately prior to the merger, Mason Company's Balance Sheet was as follows:
Mason Company (combinee)
Balance Sheet (Prior to business combination)
December 31, 2010
Assets Liabilities & Shareholder's Equity
Current Assets $1,000,000 Current Liabilities $ 500,000
Plant Assets 3,000,000 Long Liabilities 1,000,000
Other Assets 600,000 C/S no par $10 stated value 1,000,000
Excess Over Par 700,000
Retained Earnings 1,400,000

4,600,000 4,600,000

Saxon Corporation (Survivor)

Journal entries
December 31, 2010
(Pooling type business combination – statutory merger)

Current assets 1,000,000

Plant Assets (net) 3,000,000
Other Assets 600,000
Continued
Current liabilities 500,000
Long term debt 1,000,000
Common Stock, $10 Par 1,500,000

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 Excess Over Par 200,000
Retained earnings 1,400,000
(To record the merger with Mason company as pooling of interest)
Expense of business combination 200,000
Cash 200,000
(To record the payment of out of pocket cost)
Because of pooling type business combination is a combining of existing stock holder interests rather
than an acquisition of assets, an investment in mason company common stock ledger account as
employed in purchase accounting is not used in the forgoing journal. In this case common stock issued by
Saxon corporation must be recorded at par. (15000 x $10 =$1,500,000) $ 200,000 credit in excess in
excess of par is a balancing amount for the journal entry.
Purchase Accounting Method
In Purchase accounting method, the Combinor acquires the assets including goodwill of combinee at
current fair value for cash or issuing debt security, preferred stock or common stock. According to APB
opinion No. 16, "Business combinations" set forth the concept of purchase accounting as follows.
'Accounting for business combination by purchase method follows principles normally applicable
under historical cost accounting to record acquisitions of assets and issuance of stock and to accounting
for assets and liabilities after acquisition.' It includes the following.
Determination of combinor
In the process of business combination, the amounts of net assets of the combinor are not affected and as
such the combinor must be identified accurately.
Computation of cost of Combinee
Includes amount of consideration paid by the Combinor, combinor's direct expense, &
Contingent consideration. APB opinion No.16 provides the following principles for allocating cost of
combinee in a purchase type business combination.
First, all identifiable assets acquired and liabilities assumed in a business combination should assign a
portion of cost of acquired company, normally equal to their values at date of acquisition.

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Amount of consideration
This is the total amount of cash paid, the current fair value of other assets distribute, the present value of
debt securities Issued and current fair (or market) value of equity securities Issued by the combinor.
4.5 Direct and Indirect Out-of -Pocket Cost
Some expenses are incurred when business enterprises are combined. Examples are legal fee, accounting
fee, finder's fee etc. Finder’s fee is paid to the finder, who investigated the combinee, assisted in
determining the consideration for the combination and otherwise rendered service to bring the
combination in to effect. A finder may an individual, organization or investment banking firm. It is
considered as direct expenses.
Salaries of officers of constituent companies involved in combination are recognized as indirect out of
pocket cost. Cost of registering with SEC, and issuing equity securities are not direct cost. It is set off
against the proceeds from the issue of securities. Cost of Registering with SEC, and issuing debt
securities in business combination are debited to debt securities. So direct expenses will be debited to
Investment account and Expenses in connection with SEC will be debited to either excess over par
account or concerned share capital account. For entering direct expense, investment account will be
debited and cash account will be credited. Like that for entering indirect expense, excess over par will be
debited and cash will be credited
4.6 Valuation Differential
It is a term created during the process of business combination. There are different terms raised like
goodwill, revaluation increment, revaluation decrement, fair value of net assets acquired, Book value of
net assets acquired etc. Valuation differential is the difference between Acquisition cost (or Investment)
paid by the Combinor and the Book value of net assets of combinee acquired by the combinor. Or it is the
sum of Goodwill and the Revaluation Increment. The difference between the Acquisition cost
(Investment) and Current Fair Value of Net Assets acquired by the combinor is known as the value of
GOOD WILL. The difference between Current Fair Value of Net Assets of Combinee acquired and the
Book value of the net assets of Combinee is known as REVALUATION INCREMENT
Chart Analysis of
Valuation Differential
(a) (b) (c)
Acquisition Cost Current Fair Value Book Value of
(Investment) Net assets of Net Assets of

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(Paid by Combinor) Combinee Combinee
$2000 $1500 $1200

Difference is Difference is

GOOD REVALUATION
WILL INCREMENT
$500 $300

THE SUM IS VALUATION DIFFERENTIAL

($800)
4.7 Good will and Negative Goodwill
Goodwill
As per APB opinion No.16, The excess of cost of the acquired company over the sum of the amounts
assigned to identifiable assets acquired less liabilities assumed should be recorded as goodwill. Good
will frequently is recognized in purchase type business combination because the total cost of combinee
exceeds the current fair value of identifiable net assets of the combinee. In other words Goodwill is the
excess of Investment by the combinor over the current fair value of net assets of the combinee
acquired by the combinor.
Excess of Investment over the current fair value of net assets = Goodwill
Negative Goodwill:
In some purchase type business combination (known as Bargain Purchase) the current fair value of net
assets of combinee acquired by the combinor exceeds the sum of Investment or cost of purchase.
Excess of current fair value of net assets of over investment = Negative Goodwill.
When Negative Goodwill arises it should be Pro- rated among the block assets (Block assets means Non-
current assets other than long term investment in marketable securities.)
Pro-Rated means proportionately divided among the Non-current assets.

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E. g. Suppose Negative goodwill is $10,000, and Current fair value of Plant assets $800,000, Value of
intangible assets $200,000. Then, Pro-ration
Ratio of Plant assets and Intangible assets = 8:2 or 4:1
Negative goodwill should be proportionally divided among Plant assets and Intangible assets
Plant Assets = 10,000x 8/10 =8000
Intangible assets = 10,000x2/10 =2000
When entering in the record of Combinor, current fair value of Plant assets should be reduced by 8,000
and intangible assets should be reduced by 2000.
4.8 Contingent Consideration
Contingent consideration is the issuance of additional cash, other assets or securities in the future by a
party to a business combination (usually acquiring company) upon the happening of a specified future
event.
If the specified event happens, the additional consideration in the above mentioned form will be given, if
not happens, not given.

Combinor Agrees to pay in the future combinee

->additional Cash, other assets or shares
Upon the happening of a future event
Future Events
May be

Contingency based on Contingency based on

Future earnings
(If the combined earnings
Reaches to a specified level
During the year the following
Acquisition)
security price fluctuation
(If the security price after combination
fluctuates (Usually reduces))

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If the contingency is based on the future earnings and if it is paid in the form of cash then goodwill will
be debited and cash will be credited. If it is paid in the form of shares, current fair value of shares should
be considered and the journal entry will be passed debiting good will and crediting common stock and
excess over par. If the contingency is based on the security price fluctuation and the consideration is in
the form of shares, excess over par will be debited and common stock will be credited. If the
consideration is given in the form of cash, cash equivalent to the current fair value of shares should be
paid by debiting excess over par and crediting cash.
4.9 Purchase Accounting method with Goodwill and Negative Goodwill (Statutory Merger)
 As it is statutory, statutory merger is executed on the basis of the provisions of law.
 The Board of Directors of constituent companies approve the terms of plan of merger in
accordance with the law.
 The plan is exchange the voting common stock of one of the corporations (called the survivor)
for all the outstanding voting common stock of other corporations.
 The survivor issues its common stock or other consideration (sometimes preferred stock, cash,
or long term debt) to the stockholders of other corporations in exchange for their holding.
 Thus the survivor acquires the ownership of combinee corporations.
 The corporations other than the survivor are then dissolved and liquidated and cease to exist as
separate legal entities and their activities are often continued as divisions of survivor.
 The survivor owns the net assets of the liquidated corporations.
E.g. Corporation A and Corporation B Combines, corporation A Survives and issues consideration to the
owners of corporation B, and corporation B is liquidated.
Corporation A & Corporation B

Combines

Corporation A survives
Corporation B is liquidated
Steps to record Transactions of business combination in connection with Statutory Merger in the
record of Combinor under Purchase Accounting
STATUTORY MERGER - PURCHASE ACCOUNTING

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RECORD OF COMBINOR
STEP-1
ISSUE OF PURCHASE CONSIDERATION TO COMBINEE
Investment xxxx
Common Stock (C/S) xxxx
Excess over Par (EOP) xxxx
Cash xxxx
(Payment of consideration in the form of C/S & Cash)
STEP-2
PAYMENT OF OUT OF POCKET COST BY COMBINOR
DIRECT OUT OF POCKET COST
Investment xxxx
Cash xxxx
(Payment of direct out of pocket cost)
PAYMENT OF OTHER OUT OF POCKET COST
Excess over Par xxxx
Cash xxxx
(Payment of out of pocket cost other than direct)
STEP-3
COMPUTATION OF GOODWILL OR NEGATIVE GOODWILL
Excess of Investment over the Current fair value of Net assets of combinee
=
Goodwill
Excess of Current Fair Value of Net Assets of combinee over the Investment
=
Negative Goodwill
STEP-4
RECORDING THE ACQUISITION OF NET ASSETS FROM THE COMBINOR
(In Current Fair Value-[CFV])
Assets (CFV) xxxx
Goodwill xxxx

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 Liabilities (CFV) xxxx
Investment xxxx
_____________________________________________________________________
RECORD OF COMBINEE - Liquidating Journal (Book Value is recorded)
_______________________________________________________________________
Liabilities (Book Value) xxxx
Common Stock xxxx
Excess over Par xxxx
Retained Earnings xxxx
Current Assets xxxx
Plant Assets xxxx
Other Assets xxxx
________________________________________________________________________
Illustration-1
On April 1, 2010, Company B (The combinee) was merged with Company A (the combinor). Following
is the Balance Sheet of company B just prior to business combination. Company B is liquidated after
combination.
Company B
Balance Sheet
April1, 2010
ASSETS LIABILITIES
Current Assets 800,000 Current liabilities 600,000
Plant Assets 4,000,000 Long Liabilities 1,200,000
Other Assets 200,000 C/S (no par $10
Stated value) 2,000,000
Retained Earnings 1,200,000
5,000,000 5,000,000
Company A (The combinor) Exchanged 200000 shares of its $10 par common stock (CFV$25) a share.
In addition Company A paid out of pocket expense as follows
Legal & Finder's fee $150,000
Other Combination expense 50,000

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 Total 200,000
The Current Fair Value of Company B's Assets and Liabilities were as follows
Current Assets $ 950,000
Plant Assets 4,500,000
Other Assets 250,000
Current Liabilities (600,000)
Long Liabilities (1,100,000)

Required:
Show Journal Entries
1. In the Record of Company A for Purchase type Business combination
2. In the Record of Company B For Liquidation
Solution: Combinor's journal entries for purchase type business combination (statutory Merger.
COMPANY - A (combinor)
Journal Entries
April 1, 2010
________________________________________________________________________
1. Investment (200,000 x 25) 5,000,000
Common Stock (200,000 x 10) 2,000,000
Excess Over Par (200,000 x 15) 3,000,000
(To record merger with Company B as purchase)
-------------------------------------------------------------------------------------
2. Investment 150,000
Excess Over par 50,000
Cash 200,000
(To record the payment of out-of-pocket cost,
Direct as investment and other as reduction of
Proceeds received from issue of C/S)
------------------------------------------------------------------------------------
3. Computation of Goodwill/ Negative goodwill
Excess of investment over the current fair value of net assets of combinee acquired

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 =
Goodwill
Investment = $5,000,000 + 150,000 = 5,150,000
CFV of net assets of combinee acquired
Assets Liabilities
Current Assets $ 950,000 Current Liabilities $ 600,000
Plant assets 4,500,000 Long liabilities 1,100,000
Other Assets 250,000

5,700,000 1,700,000
Current Fair Value of Net Assets:
$5,700,000 - 1,700,000 = 4,000,000
Investment 5,150,000
CFV of Net Assets 4,000,000

Goodwill 1,150,000
4. Current Assets 950,000
Plant Assets 4,500,000
Other assets 250,000
Discount on long liabilities 100,000
Goodwill 1,150,000
Current Liabilities 600,000
Long liabilities 1,200,000
Investment 5,150,000
(Acquisition Entry: To allocate total cost of
Liquidated company B, to identifiable assets
And liabilities with remainder to Goodwill)
Note: CFV of Long liabilities is estimated to
Be only 1,100,000. So there is a
Reduction in liabilities of 100,000,
to be treated as discount on liabilities.

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 Liabilities reduce to be debited.
________________________________________________________________________
Recording Liquidation of Combinee
________________________________________________________________________
Company B (Combinee)
Journal Entry
April 1, 2010
_______________________________________________________________________
Current Liabilities 600,000
Long liabilities 1,200,000
Common Stock 2,000,000
Retained Earnings 1,200,000
Current Assets 800,000
Plant Assets 4,000,000
Other Current Assets 200,000
(To record liquidation of company B
On account of Merger with Company A)

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