Question

Case 3-2 LO1 The directors of Atlas Inc. and Beta Corp. have reached an agreement in principle to merge the two companies and create a new company called AB Ltd. The basics of the agreement confirmed so far are outlined below: • The new company will purchase all of the assets and assume all of the liabilities of Atlas and Beta by issuing shares. After the sale, the two companies will be wound up. Some, but not all members of the top management of each company will be retained. The number of AB shares that will be issued has not yet been determined. The founding shareholders of Atlas Corp. who owned 60% of the voting shares of Atlas prior to the merger, have rights to veto any sale of patents, which they developed and registered. Some of the other shareholders of Atlas also owned non voting preferred shares of Atlas. These preferred shares are convertible into common shares of Atlas on a one-for-one basis. • Beta Corp, previously recognized several identifiable intangibles on its balance sheet. The management of Atlas expressed a desire to have these intangible assets valued at zero in AB Ltd. AB Ltd. will consist of two businesses that will generate income that can be tracked separately. However, management of Atlas wishes to combine the goodwill of the two companies in one account called Enterprise Goodwill. In this way, it hopes to minimize the possibility of goodwill impairment because a decline in goodwill in one business unit could be offset by an increase in the value of goodwill in another business unit. The chair of the merger committee has asked you to provide her with advice on the accounting implications that will result from this merger, even though many of the details have not yet been ironed out. She has requested that you submit a preliminary report to her Required Prepare an outline of your report.

refer to the cpa handbook please

Answer 1

Answer :

Basic outline of the contents of the report would be as follows:

1.            The acquisition method will have to be used to account for this merger, and one of the companies involved will have to be identified as the acquirer.

2.            The shares issued by AB Ltd. will end up in the hands of the shareholders of Atlas Inc. and Beta Corp. The company whose shareholders own the largest number of shares will be identified as the acquirer. In determining the number of shares held by the shareholders of Atlas, it will be necessary to take into account the common shares that will be issued as a result of the conversion of the preferred shares. If each group holds an identical number of shares, the makeup of the board of directors and top management of AB Ltd. will have to be examined to see if an acquirer can be identified. Domination by one company would indicate the acquirer. If this analysis is inconclusive, the existence of the veto rights with respect to the patents would be a factor in favour of control by the shareholders of Atlas. This would need to be taken into consideration along with other relevant factors. In the absence of a conclusion resulting from this analysis, the larger company would then be declared the acquirer. All of these problems could be avoided if the number of shares issued to each company were not equal.

3.            The assets and liabilities appearing on the balance sheet of AB Ltd., on the date of the merger, will be the result of the combining of the assets and liabilities of Atlas Inc. and Beta Corp.

4.            The combination will use the carrying amount of the net assets of acquirer, and the fair value of the net assets of the other company.

5.            In a combination where one company (the acquirer) issues shares to acquire the net assets of another company, the acquisition cost is compared with the fair value of the other company’s net assets and the difference is either positive or negative goodwill. The acquisition cost is determined by multiplying the number of shares issued by their value (which would be determined by examining their market price before and after the combination). Direct costs incurred in the combination (consultant, legal, and accounting fees) would be expensed.

6.            In this case the acquisition cost may be difficult to determine because a new company is being formed to purchase the net assets of the two companies that are part of the merger. If Atlas and Beta are public companies and AB Ltd. is to continue as a public company, the market price of its shares in a period after the merger would have to be used to determine the acquisition cost. If Atlas and Beta were both private companies, presumably AB Ltd. would also be private, and the acquisition cost would be almost impossible to determine with any degree of reliability.

7.            When the acquisition cost cannot be determined, no goodwill can be reported. The number of shares issued to the company identified as the acquirer will be measured at the carrying amount of that company’s net assets. The number of shares issued to the acquiree will be valued at the fair value of that company’s net assets.