Business Acquisition and Combinations

Learning Outcomes: Understand the definition of business combination Understand the FRS 3 Know the types of business combination Understand the determination of purchase price and purchase consideration

Definition

One business is combined with another business Occurs when one company acquires either the net assets or control of other business

Cont.

FRS 3: Business Combinations A business combination is the bringing together a separate entities or businesses into one reporting entity. The result of nearly all business combinations is that one entity, the acquirer, obtains control of one or more other businesses, the acquiree. (para. 4)

Cont.

The acquirer has to pay a specific sum to the owner of the business purchase price Purchase price could be settled by cash, shares, debenture or combination of them

Nature of the Combination

Friendly Combination

The BODs of the potential combining companies negotiate mutually agreeable terms of a proposed combination

Hostile Combination

The BODs of a company targeted for acquisition resists the combination Use tender offer to deal directly with individual shareholders

REASONS

Operating Synergies

Vertical combination elimination of certain costs related to negotiation & bargaining Horizontal combination pooling of sales forces, facilities & elimination of duplication costs

Cont.

Globalisation

Easy to enter new markets

Financial Synergy

Take advantage of tax laws e.g. when an acquisition is financed using debt, the interest payment is tax deductible

Cont.

Diversification

Easy to expand to another business area

Disadvantages

Loss of valuable goodwill Monopolies conditions

Types of Business Combination

Can be classified as:

Amalgamations Absorptions Merger and Acquisition

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Amalgamations

When two or more companies combined together to form a new company

A Bhd B Bhd

AB Bhd

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Cont

Characteristics:

New company is formed Old company will be wound up New company will acquire the assets and liabilities of the old companies Consideration given may consist of cash, shares and/or debentures in the new company Shareholders of the old companies can become the shareholder of a new company Suitable for companies in similar size

*Illustration
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Absorptions

When one dominant company acquired the assets and liabilities of another company
A Bhd A Bhd B Bhd

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Cont.

Characteristics:

The company that absorbs the small company will be bigger The company be acquired will be liquidated No new company is formed Consideration given may consist of cash, shares and/or debentures as in amalgamation Shareholders of the company being absorbed will become the shareholders of the company that absorbed them

*Illustration
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Purchase Price

In order to take over the assets and liabilities of the old business, the new company has to pay some amount known as purchase price Refers to the agreed value to be paid by the buyer (new company) to the seller (old company)

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Cont.

Could be settled in the form of:

Cash Shares Debentures Combination of the above

Purchase Consideration

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Cont.
Purchase price = Purchase consideration

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Cont.
Factors to be considered to determine the purchase price:(i) The net assets taken over by the buyer Only valued assets (tangible assets) will be taken over Fictitious assets (e.g. preliminary expenses, trademarks) will not be acquired by the buyer All the assets taken over normally will be revalued to the fair values

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Cont.
(ii) Liabilities taken over by the buyer

Sometimes liability is also being acquired by the buyer at the fair market value
Thus, purchase price = Net assets Taken Over (Assets Liabilities)

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Cont.
(iii) Goodwill Refers to the difference between the purchase price and the fair value of the net tangible assets taken over by the buyer Positive goodwill if the purchase greater than the fair value of net tangible assets taken over Negative goodwill if the purchase price lesser than the fair value of net tangible assets taken over

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Cont.
(iv) Liquidation expenses If an expense is incurred in the conversion process and the purchasing company agreed to pay these expenses, the purchase price will include this extra cost incurred

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Accounting Entries
*Refer to Handouts on accounting entries

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Merger & Acquisition (M&A)

M&A occurred in a business when an investor acquired the right to exercise control in another company (investee). If it acquires more than 50% voting shares, the investee becomes a subsidiary of the investor. The investee company is not wound up, only changes in composition of shareholders.

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Cont.

If investor acquires more than 20% but less than 50% of issued share capital, the investee company will become an associate company Acquisition is the term to describe the process of acquiring the majority of the issued share capital (merger).

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FRS 3

All entities shall apply this FRS 3 when accounting for business combination (para 5) Whats new

All the business combination shall use the purchase method (para 14)

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Cont.

New criteria for recognising identifiable intangibles (other than goodwill) Additional disclosure requirements, including:

Reasons for business combination Allocation of purchase price paid to the assets & liabilities

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Cont.
Purchase Method

Purchase Method means to record the business combination using the historical cost principle where the investor would record the purchase of another entity in a business combination by the amount of cash disbursed or by the fair value of other assets distributed or securities issued

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Cont.
Cost of business combination The acquirer shall measure the cost of a business also called purchase consideration as the aggregate: (a) the fair values, at the date of exchange, of assets given, liabilities incurred or assumed and equity instruments issued by the acquirer, in exchange for control of the acquiree; plus (b) any cost directly attributable to the business combination (Para 24)

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Cont.
Cost directly attributable to the business combination Included in the cost of combination direct costs or cost directly attributable to business combinations such as professional fees paid to accountants, legal advisers, finders fees, valuers, liquidation expense and other consultants to effect the combination other than those related cost of shares or securities issued (such as registration and issuance of equity securities issued).

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Cont.
Issuance costs of equity securities issued in a purchase combination are charged against the fair value of the securities issued. General administrative costs or indirect costs including the costs of maintaining an acquisitions department, and other costs that cannot be directly attributed (such as management, salaries, depreciation, rent, etc) are expensed to income in the year incurred.

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Cost of Acquisition
Old FRS 3
Internal Costs (i.e. general admin, including acquisition department) Professional fees paid to consultants Expense

New FRS 3
Expense

Cost of acquisition (impact GW) Equity

Expense

Equity raising costs

Equity

Debt raising costs

Debt

Debt

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Conclusion

Different types of business combination Roles of FRS 3

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