Business Combinations

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Business Combination Amendments

November 29, 2008

There have recently been a number of significant accounting changes due to FASB and the International Accounting Standards Board (IASB) making modifications for the accounting treatment of business combinations in SFAS 141(R) and IFRS 3. Business combinations have implemented the newly created accounting treatment called the “acquisition method.” It will replace of the current “purchase method” strategy effective January 1, 2011. The major changes in the acquisition method involve variations to fair value measurement, goodwill recognition, and non-controlling interests.

Purchase method
The purchase method was recommended for all business combinations as per Section 1581 of the CICA Handbook in July 2001. Under this method, the parent company reported the net assets of the acquired company at the price that it was paid for. This price included any cash payment, the fair market value of any shares issued, and the present value of any promises to pay cash in the future. A key aspect of the purchase method is that the parent consolidates the book value of all the subsidiary’s assets and liabilities and then the fair value, broken down between NBV and FMV increments, of the subsidiary's assets and liabilities are added to the parent's own assets and liabilities

The parent and the subsidiary prepare their own separate financial statements since they are two separate legal entities. The parent also prepares consolidated financial statements by combining the separate financial statements of both the parent and the subsidiary. Any inter-company transactions between the two are eliminated in the consolidated financial statements since the parent and the subsidiary is considered as one economic unit. Under a consolidated entity, the same results are produced regardless of how the transaction is legally structured as both the parent and the subsidiary are exposed to the same consequences and rewards.

The investment in a subsidiary should be valued at the most reliable value. For example, either at the fair value of consideration given or the fair value of consideration received. The purchase price is often different than the book value because balance sheet values do not necessarily equal market value. The purchase discrepancy is the excess of purchase price over net book value of the subsidiary's shareholders' equity or net book value of identifiable net assets and goodwill. The purchase discrepancy is first allocated to the recorded assets and liabilities to revalue them from book value to fair value on the acquisition date.

Under the purchase method, the cost of acquisition includes any direct costs such as finder's fees, costs of registering and issuing shares, and amounts paid to accountants, lawyers, appraisers, and other consultants according to section 1581.27 of the CICA Hand Book. Any expenses directly incurred for issuing shares (costs of registering and issuing shares) are treated as a capital transaction, which reduces the amount recorded for share issue.

Goodwill is recorded as the excess of the price paid over the fair value of the acquired company's identifiable net assets. In other words, it is based on the residual value of price paid. Only the parent’s proportionate interest in goodwill is recognized. Therefore, the non-controlling interest (NCI) share of the subsidiary’s net assets is only the subsidiary’s book value, with no goodwill allocation. The motivation behind this is that the consolidated company should only recognize the percentage of the fair value increment and goodwill that was actually purchased by the parent. Goodwill is also measured periodically for impairment. If it is deemed to be impaired, it is written down to the new reduced value. Any negative goodwill is eliminated by writing down to specified assets.

Acquisition Method
The approved business...
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