Hi WSO,
I've worked at a Big 4 firm for several years and will be heading to B school in a few months. I do get a kick out of helping people with accounting questions as it pertains to their finance work, so wanted to create a thread that could hopefully become a repository of knowledge for everyone. I do have an understanding of basic operating models, so happy to add color into how to the accounting interacts with them as well.
I'll do my best to answer whatever questions you may have - fire away.
This is awesome. Thank you!
If an acquiror acquires less than 100% of the target's equity, how does the purchase price accounting work?
On a high level, what asset base would be eligible to be written up? Conceptually I've always thought it's either the whole base that gets written up or nothing but wondering if that's the case.
For reference, for pre accounting diligence models, we usually allocate a certain percentage of the excess purchase price (Equity Purchase Price - Shareholder's Equity + Goodwill and Intangibles) to intangibles.
Hi, happy to help!
Since you are referring to purchase accounting, then I'll assume we are talking about an acquisition where over 50% of the target's equity has been acquired, or otherwise control has been transferred to the acquirer. The equity or cost methods would be required if "control" as defined by GAAP wasn't achieved.
Say you acquired 80% of a target's equity. Even though you don't have 100% control, GAAP requires you to allocate the purchase price across 100% of the net assets. You would need to go down each B/S line item and make upward/downward adjustments to each of the acquired assets and liabilities and push some of the purchase price toward each category. Any excess purchase price that cannot be associated with an identifiable asset/liability, will be recorded as goodwill, or in the event the FMV of the net assets is more than the purchase price, you have bargain purchase in which a gain is recorded to balance the accounting ledger. The 20% you don't own is then reflected in the equity section of the balance sheet as non-controlling interest, and the consolidated net income will be split between controlling and non-controlling interests at the bottom of the income statement.
So on a high level, the purchase accounting on a greater than 50% acquisition (but less than 100%) will operate very similarly to a 100% purchase, except that the "non-controlling interest" will need to be reflected on the balance sheet, and net income will need to be bifurcated. In your words, all of the asset bases are eligible for step up, as 100% of the target's balance sheet needs to be reflected on the new consolidated balance sheet, not just the % that you own (assuming consolidation accounting required).
Let me know if that doesn't answer your question.
**Thanks man, inhaling this! **
I do have 2 questions regarding this:
Highly appreciate your efforts!!
Exactly what I was looking for. Thank you!
Question on journal entries vs. effect on 3 financial statements. Say I’m selling PPE with book value of $100 and accumulated dep. of $80 for $30.
Effect on 3 financial statements:
IS: Gain of 10 Net income up by 6 (assuming 40% tax rate)
CFS: Net income up by 6 Subtract gain of 10 Add cash inflow of 30 in cf from investing Net inflow of 26 cash
BS: Cash up by 26 PPE down by 20 Equity down by 6
Both sides balance.
Now for the journal entry it should be.
Dr. Cash 30 Dr. Accum dep 80 Cr. PPE 100 Cr. Gain 10
But didnt cash technically only go up by 26? Do journal entries not take into effect taxes because that is determined at the end of the period whereas journal entries appear once the transaction is executed? Actually now that I think about that explanation makes sense. Thanks.
Happy to help.
One note on your statement effects, equity goes UP by $6 since you generated $6 of net income that closes to retained earnings (increases retained earnings). Also, as a quick note, the "book value" you are referring to is actually the "cost." Book value is defined as cost minus accum. dep.
On your entries, if you immediately record the tax entry, it would look like this: Dr. Cash $26 ($30 proceeds from sale less $4 of taxes paid to government) Dr. A/D $80 (remove A/D balance) Dr. Tax Expense $4 (record taxes on gain to P&L) Cr. PPE $100 (remove property cost) Cr. Gain $10 (record gain to P&L)
Most companies aren't going to record a proper tax provision until the end of each quarter, so some companies won't show the tax effect if you were to pull their financial statements in the middle of a random month.
Let me know if you need more help.
Thanks!
Flubbed this question in an interview - a company buys a new server with 50% debt and 50% equity. What's the effect on the 3 statements? Thanks!
no change in income statement
CFS: financing activities: up by total price (50% from debt issuance, other 50% from equity raising) investing activities: down by total price for investing in PPE no net change in cash
BS: A: PPE up by acquisition price L: up by debt issuance (50% of acquisition price) E: up by equity raising (50% of acquisition price)
Looking at it with simple facts and immediately after purchase, agreed.
Wanted to revive this - going through IB interviews in a few weeks and have been deep in the weeds. Any questions, just ask!
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