1. Goodwill Is Assigned to Specific Reporting Units Within the Acquisition

Mergers-Notes – 2/10/03

A. Assignment of goodwill

1. Goodwill is assigned to specific reporting units within the acquisition

a. Could be to newly acquired reporting units

b. Could be to already existing, now enhanced reporting units

2. Reporting unit is a business

3. If there are multiple reporting units goodwill has been allocated to each

a. Assignment is on a ‘with and without’ approach

b. Reporting unit’s fair value is estimated before and after the business combination

c. The change is goodwill

d. Done for new units and existing units

4. Resulting total reporting unit goodwill

a. May differ from acquisition’s total goodwill

b. Leads to a reallocation of reporting unit goodwill

c. Adjusted to equal acquisition’s total goodwill

i) Reallocation can be done any way

ii) Can be an across the board % adjustment

B. Goodwill impairment

1. Test for impairment is annual

a. Special events may lead to more frequent testing

b. No testing if impairment is considered remote

c. Management reviews the operating results of the unit

i) Step 1 – compare current fair value to carrying value

(1) Includes goodwill in carrying value

(2) If fair value > carrying value – stop

(3) If fair value < carrying value – go to step 2

ii) Step 2 – repeat process carried out at acquisition

(1) Estimate current fair values of reporting unit

(2) Subtract current fair value of identifiable assets

(3) Difference is fair value of goodwill

(4) No impairment if current fair value of goodwill > recorded value of goodwill

(5) Impairment if current fair value of goodwill < reported value of goodwill

C. Mergers and acquisitions-special topics

1. Debt financed acquisitions

2. Leveraged buyouts

3. Restructuring

4. Defenses against acquisitions

D. Debt financed acquisitions

1. Issue of junk bonds – high yield, high risk bonds

a. Issue for cash is not an accounting problem

b. Exchange for common stock

i) Must estimate fair value of the bonds

ii) In market

iii) Or by assets OR stock acquired

2. Leveraged buyouts

a. Special type of acquisition

i) Some of current owners (managers) acquire firm

ii) First create a new firm

iii) Issue junk bonds

iv) Use cash to buyout firm

v) Merge buyout firm into new firm

(1) Firm has few owners

(2) Firm goes private

(3) Assets of buyout firm effectively collateral

b. Accounting issues

i) Need an acquisition to record assets at fair value (writeup)

ii) Without writeup may have negative equity

iii) Is LBO a real business combination?

(1) Must acquire a business

(2) Must show a change in control

(3) Needed to satisfy business acquisition concept

(a) New owners

(b) Owners get control

(c) Acquisition constitutes a business

iv) Change in control

(1) Ability to implement major operating and financial decisions is with new group

(2) Group or individuals in it did not have control before

v) Composition of new control group includes up to three types of shareholders

(1) Managers

(2) Investors with increase in ownership interest & >5%

(a) All types of shares are equal

(b) Based on shares owned

(3) Investors with over 20% interest even if % falls

(a) Can have significant voting interest

(i) Use full dilution if it increases voting interest

(ii) Voting interest has increased

(iii) Voting interest is at least 20%

(b) Can have significant economic interest

(i) Value of each investment position in the company

(ii) Not just ownership

(iii) Capital at risk includes guarantees

(iv) Go from riskiest to least risky

(v) Cumulative (If % ever exceeds 20% part of control group)