Importance of Accounting

 M&As require understanding of

accounting
• Need to see “behind the numbers”
• Combining firms results in substantially
different financial statements
 Controversy regarding M&A accounting
• Purchase accounting
• Pooling-of-interests accounting

Chapter 3-1
 Historical Background
 1970 – Accounting Principles Board
(APB) ruling established:
• Pooling-of-interests method: retains
historical basis
• Purchase method: requires determination
of new basis
• Rules regarding treatment of goodwill

Chapter 3-2
 Pooling of Interests Accounting
 Logic for when to use pooling:
• Acquisitions are mainly by stock and
nontaxable
• Acquiring firm and target firm
approximately the same size
 Twelve tests must be met to qualify for
pooling
 Consolidated income statement is a
summation of each account
 Accounting treatment reflected in prior year
financial data
Chapter 3-3
 Purchase Accounting
 One company is buyer – records target at
price paid
 Identifiable assets and liabilities assigned
portion of the cost (usually FMV)
 Excess of price paid over acquired book net
worth assigned to
• Tangible depreciable assets at FMV
• Identifiable intangible assets with definite
lives
• Intangible assets with indefinite lives
• Goodwill
Chapter 3-4
 Purchase Accounting
 Goodwill accounting
• Under 1970 rules, goodwill amortized over
no longer than 40 years
• New rules call for annual impairment tests
based on the market value (for both goodwill
and intangible assets with indefinite lives)
• Impairment rules equivalent to standard
valuation methods
• Can result in large write-offs (example AOL
Time Warner $99 billion loss in 2002)
Chapter 3-5