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IntercorporateAcquisitionsandInvestmentsinOtherEntities1©2009TheMcGraw-HillCompanies,Inc.Allrightsreserved.McGraw-Hill/Irwin1-2TheDevelopmentofComplexBusinessStructures•Enterpriseexpansionasameansofsurvivalandprofitability–Sizeoftenallowseconomiesofscale–Newearningpotential–Earningsstabilitythroughdiversification–Managementrewardsforbiggercompanysize–Prestigeassociatedwithcompanysize1-3OrganizationalStructureandBusinessObjectives•Asubsidiaryisacorporationthatiscontrolledbyanothercorporation,referredtoasaparentcompany,usuallythroughmajorityownershipofitscommonstock•Becauseasubsidiaryisaseparatelegalentity,theparent’sriskassociatedwiththesubsidiary’sactivitiesislimited1-4OrganizationalStructure,Acquisitions,andEthicalConsiderations•Manipulationoffinancialreporting–Usageofsubsidiariesorotherentitiestoborrowmoneywithoutreportingthedebtontheirbalancesheets–Usingspecialentitiestomanipulateprofits–Manipulationofaccountingformergersandacquisitions•Pooling-of-interests1-5BusinessExpansionandFormsofOrganizationalStructure•Expansionfromwithin:Newsubsidiariesorentitiessuchaspartnerships,jointventures,orspecialentities•Motivatingfactors:–Helpsestablishclearlinesofcontrolandfacilitatetheevaluationofoperatingresults–Specialtaxincentives–Regulatoryreasons–Protectionfromlegalliability–Disposingofaportionofexistingoperations1-6BusinessExpansionandFormsofOrganizationalStructure–Aspin-off•Occurswhentheownershipofanewlycreatedorexistingsubsidiaryisdistributedtotheparent’sstockholderswithoutthestockholderssurrenderinganyoftheirstockintheparentcompany–Asplit-off•Occurswhenthesubsidiary’ssharesareexchangedforsharesoftheparent,therebyleadingtoareductionintheoutstandingsharesoftheparentcompany1-7BusinessExpansionandFormsofOrganizationalStructure•Expansionthroughbusinesscombinations–Entryintonewproductareasorgeographicregionsbyacquiringorcombiningwithothercompanies–Abusinesscombinationoccurswhen“...anacquirerobtainscontrolofoneormorebusinesses”–Theconceptofcontrolrelatestotheabilitytodirectpoliciesandmanagement1-8BusinessExpansionandFormsofOrganizationalStructure•Traditionalview-Controlisgainedbyacquiringamajorityofthecompany’scommonstock•However,itispossibletogaincontrolwithlessthanmajorityownershiporwithnoownershipatall–Informalarrangements–Formalagreements•Consummationofawrittenagreementrequiresrecognitiononthebooksofoneormoreofthecompaniesthatareapartytothecombination1-9FrequencyofBusinessCombinations–1960s-Mergerboom•Conglomerates–1980s-Increaseinthenumberofbusinesscombinations•Leveragedbuyoutsandtheresultingdebt–1990s-Allpreviousrecordsformergeractivityshattered–Downturnoftheearly2000s,anddeclineinmergers–Increasedactivitytowardthemiddleof2003thatacceleratedthroughthemiddleofthedecade•Roleofprivateequity–Effectofthecreditcrunchof2007-20081-10OrganizationalStructureandFinancialReporting•Merger-Abusinesscombinationinwhichtheacquiredcompany’sassetsandliabilitiesarecombinedwiththoseoftheacquiringcompanyresultsinnoadditionalorganizationalcomponents–Financialreportingisbasedontheoriginalorganizationalstructure1-11OrganizationalStructureandFinancialReporting•Controllingownership-Abusinesscombinationinwhichtheacquiredcompanyremainsasaseparatelegalentitywithamajorityofitscommonstockownedbythepurchasingcompanyleadstoaparent–subsidiaryrelationship–Accountingstandardsnormallyrequireconsolidatedfinancialstatements1-12OrganizationalStructureandFinancialReporting•Noncontrollingownership-Thepurchaseofaless-than-majorityinterestinanothercorporationdoesnotusuallyresultinabusinesscombinationorcontrollingsituation•Otherbeneficialinterest-Onecompanymayhaveabeneficialinterestinanotherentityevenwithoutadirectownershipinterest–Thebeneficialinterestmaybedefinedbytheagreementestablishingtheentityorbyanoperatingorfinancingagreement1-13CreatingBusinessEntities•Thecompanytransfersassets,andperhapsliabilities,toanentitythatthecompanyhascreatedandcontrolsandinwhichitholdsmajorityownership–Thecompanytransfersassetsandliabilitiestothecreatedentityatbookvalue,andthetransferringcompanyrecognizesanownershipinterestinthenewlycreatedentityequaltothebookvalueofthenetassetstransferred1-14•Recognitionoffairvaluesoftheassetstransferredinexcessoftheircarryingvaluesonthebooksofthetransferringcompanyisnotappropriateintheabsenceofanarm’s-lengthtransaction•NogainsorlossesarerecognizedonthetransferbythetransferringcompanyCreatingBusinessEntities1-15CreatingBusinessEntities:ExampleAllenCompanycreatesasubsidiary,Brainecompany,andtransfersthefollowingassetstoBlaineinexchangeforall100,000sharesofBlaine’s$2parcommonstock.(commonstockisissuedfortheassets)1-16CreatingBusinessEntities:Example(cont’d)itemCostBookValueCash$70,000Inventory$50,00050,000Land75,00075,000Building100,00080,000Equipment250,000160,000$435,0001-17CreatingBusinessEntities:Example(cont’d)Allenrecordsthetransferwiththefollowingentry:InvestmentinBlaineCompanyCommonStock435,000AccumulatedDepreciation110,000Cash70,000Inventory50,000Land75,000Building100,000Equipment250,000$110,000=($100,000-$80,000)+($250,000-$160,0