Transcript Document 7217300

CHAPTER
7
NEW BASIS OF
ACCOUNTING
FOCUS OF CHAPTER 7
• Recognizing a New Basis of
Accounting
• The Push-Down Basis of
Accounting
• Leveraged Buyouts
Push-Down Accounting:
What’s Important—Form or Substance?
• Rationale for Push-Down Accounting:
– Relevant factor is the acquisition itself.
– Form of the acquisition is NOT relevant.
– Parent controls the “form of the
ownership.”
• Parent can ALWAYS liquidate the
subsidiary into a branch/division.
Push-Down Accounting:
The 3 Step Implementation Process
• STEP 1:
– Adjust all assets and liabilities to
current values (“cleanses” the
target’s G/L of OLD BASIS).
• Record GOODWILL as well.
• Offsetting credit is to Revaluation
Capital. (As always, capital is
shown by source.)
Push-Down Accounting:
The 3 Step Implementation Process
• STEP 2:
– Eliminate balance in the
Accumulated Depreciation account.
• Thus depreciation cycle begins
anew.
Push-Down Accounting:
The 3 Step Implementation Process
• STEP 3:
– Close out the balance in the
Retained Earnings account to
APIC.
• Thus retained earnings starts
afresh.
Push-Down Accounting:
When Is It Critical That It Be Used?
• Theoretically: Whenever a subsidiary
issues its OWN financial statements to
external users.
• GAAP Requirements:
– Only the SEC mandates its use. (Only
subsidiaries of publicly-owned
companies fall under the SEC’s
jurisdiction.)
– The FASB has yet to require it.
Push-Down Accounting:
Tastes Great And Less Filling
• Push-down accounting:
– Easy to implement.
– Record-keeping is on one set of books
instead of two.
– Consolidation effort is easy as pie.
Push-Down Accounting:
Why Not Used Exclusively?
–
One of the great unsolved mysteries of
accounting.
–
Inertia, stubbornness???
–
Clinging to “the way we have always
done it”!
Push-Down Accounting:
Is There Hope on the Horizon?
–
YES! Practitioners tell us they are
seeing it more and more.
Leveraged Buyouts:
A Combination Purchase & Refinancing
• Basic Elements of a Leveraged Buyout:
– Acquisition of a target’s assets or
common stock.
– Refinancing of the target’s debt
structure—usually increased
substantially.
– Minimal equity investment by buyers.
Leveraged Buyouts: “Let’s Get
Management In On The Act”
• An Additional Common Features of LBOs:
– Existing management becomes part of the
new ownership.
– Existing management’s ownership is often
as high as 50%.
• Such LBOs are often called “MBOs.”
• Advantage of Management Being Owners:
– Alignment of interests occurs between
management and remaining stockholders.
Leveraged Buyouts:
They Are NOT Business Combinations
• Business Combinations:
– One active business combines with
another active business.
Leveraged Buyouts:
They Are NOT Business Combinations
• Business Combinations:
– A single corporation becomes the new
owner of the target’s business.
• This one legal entity now controls
the target’s business.
Leveraged Buyouts:
They Are NOT Business Combinations
• Leveraged Buyouts:
– A group of investors (and often the
target’s management) acquire either
• The target’s assets or
• Some or all of the target’s common
stock.
Leveraged Buyouts:
They Are NOT Business Combinations
• Leveraged Buyouts:
– After the buyout, the ownership of the
target’s business may include any of the
following groups:
• New investors.
• Management (at the same or a
higher or lower level of ownership).
• Former nonmanagement owners.
Leveraged Buyouts:
The Change in Control Concept
• A new basis of accounting is allowed
ONLY IF:
– A change in control occurs.
• To assess whether a change in control
has occurred, the control group concept
is used.
Leveraged Buyouts:
The “Control Group” Concept
• The control group can consist of:
– New investors and
– Prior owners who did NOT previously
have control. Could include:
• Management.
• Nonmangement owners who
owned less than 50% of the
outstanding stock.
Leveraged Buyouts:
The Control Group Concept
• BEFORE:
Management
Nonmanagement
Owners
Owners (one individual)
10%
+
90%
= 100%
• AFTER:
Management
Nonmanagement
Owners
Owners
30%
+
25%
+
• CONTROL GROUP:
30% + 45% = 70%
New
Investors
45%
=
100%
Leveraged Buyouts:
Manner of Consummating The Buyout
• Creating a New Legal Entity (NLE):
– Investors create an NLE.
– Investors invest cash in NLE.
– NLE acquires target’s common stock
or assets.
• If common stock is acquired, NLE
is merely a nonoperating company.
Leveraged Buyouts:
Manner of Consummating The Buyout
• Reasons for Creating the New Legal Entity:
– Facilitates the change in ownership control:
• Attaining the agreed upon ownership
percentage of the various new owners
is much easier to accomplish.
– Enables NEW BASIS of accounting to be
used for target’s assets (GAAP compliance).
• An important objective for most LBOs.
Leveraged Buyouts: The KEY
Issue—Has A Change In Control Occurred?
• Significance of a Change in Control:
– Enables use of a NEW BASIS of
accounting for target’s assets.
– New basis of accounting is highly
important for most LBOs.
• Avoids reporting negative
stockholders’ equity (NSE).
• Reporting NSE to lenders is highly
undesirable.
Leveraged Buyouts:
What Constitutes a Change in Control?
• The change in control must be:
– Genuine
– Substantive
– Nontemporary
• If not—no change in basis of accounting
(record transaction as a recapitalization).
Leveraged Buyouts:
Accounting for a Change in Control
• Types of Changes in Control:
– No continuing ownership situations:
• Enables 100% use of NEW BASIS of
accounting (use Purchase
procedures).
– Continuing ownership situations:
• Results in partial use of NEW BASIS.
• Retains partial use of OLD BASIS.
• Applying can be somewhat involved.
Leveraged Buyouts:
Continuing Ownership Situations
• In continuing ownership situations, the
accounting depends on whether the
continuing ownership percentage
(hereafter C-O-P)
– Increases or
– Decreases.
Leveraged Buyouts:
Continuing Ownership Situations
• C-O-P Increases:
– Continuing owners are called bulls.
• C-O-P Decreases:
– Continuing owners are called bears.
Leveraged Buyouts:
C-O-P INCREASES
• Accounting Procedures:
– Use OLD BASIS of accounting to the
extent of the former ownership
percentage that continues as owners.
• Called “carryover of predecessor
basis.”
• Ignore their personal cost basis.
– Use NEW BASIS of accounting for the
remaining ownership interest.
Leveraged Buyouts:
C-O-P DECREASES
• Accounting Procedures:
– C-O-P Is BELOW 20%:
• Use NEW BASIS of accounting for
entire transaction (with some
exceptions).
– C-O-P Is 20% or HIGHER:
• Use OLD BASIS of accounting to the
extent of the former ownership
percentage that continues as owners.
• Use NEW BASIS for remainder.
Review Question #1
In push-down accounting, which accounts
are adjusted to a zero balance?
A.
B.
C.
D.
E.
F.
Accumulated Depreciation.
Additional Paid-in Capital.
Retained earnings.
Revaluation capital.
Goodwill.
None of the above.
Review Question #1
With Answer
In push-down accounting, which accounts
are adjusted to a zero balance?
A.
B.
C.
D.
E.
F.
Accumulated Depreciation.
Additional Paid-in Capital.
Retained earnings.
Revaluation capital.
Goodwill.
None of the above.
Review Question #2
In recording a leverage buyout, which
accounts are adjusted to a zero balance?
A.
B.
C.
D.
E.
F.
Accumulated Depreciation.
Additional Paid-in Capital.
Retained earnings.
Revaluation capital.
Goodwill.
None of the above.
Review Question #2
With Answer
In recording a leverage buyout, which
accounts are adjusted to a zero balance?
A.
B.
C.
D.
E.
F.
Accumulated Depreciation.
Additional Paid-in Capital.
Retained earnings.
Revaluation capital.
Goodwill.
None of the above.
End of Chapter 7
• Time to Clear Things Up—Any
Questions?