Name the different methods of business combinations (mergers): (5)
- Horizontal mergers
- Vertical mergers
- Diversified conglomerate mergers
- Congeneric mergers; hostile takeovers; corporate raiding; LBOs
- Global Expansion
Define diversified conglomerate mergers:
This is when a firm merges with another firm that has a totally unrelated business activity. By diversifying business activities, this also reduces the risk of loss as the business is no longer dependent on a singular market/industry.
Define horizontal mergers:
Mergers which involve an expansion to another company operating within the same industry and stage of production/distribution process.
Define vertical mergers:
The merger of two or more companies that provide different supply chain functions for a common good or service.
Define congeneric mergers:
This is where there is an acquiring company and target company. The target company often works in the same/related industry but have different business lines/products. (Like Colgate acquiring Oral-B)
Define global expansion:
This is where companies expand to foreign markets to expand their global presence.
What are some ethical considerations for complex business structures? (2)
- Acquisition and complex organizational structures are sometimes used to manipulate financial reporting with the aim of enhancing or enriching managers.
- Some companies create special-purpose entity (SPEs) that have been used to manipulate profits.
○ SPE–> A financing vehicle that is not a substantive operating entity.
What are the 2 types of expansion?
- Internal expansion
- External expansion
What are some reasons for internal expansion? (4)
- Establish a clear line of control
- Specialization in a particular type of activity
- Operate in regulatory environment
Protect the company from high-risk.
What is an internal expansion?
An identifiable segment of the company’s existing assets is transferred to the new entity (Subsidiary), and in exchange, the transferring company (Parent) receives equity ownership.
What are the 2 types of internal expansions?
- Spin-off: ownership of a subsidiary is distributed to the parent’s stockholders without the stockholders surrendering any of their stock in the parent company.
- Split-off: Subsidiary’s shares are exchanged to some of the parent’s shareholders for their parent company shares. Thereby, leading to a reduction in the parent company’s outstanding shares.
Define external expansion
A business combination occurs, when an acquirer obtains control of one or more businesses.
Define the concept of control:
Concept of control - the ability to direct policies and management; traditionally gained by acquiring a majority of the company’s common stock.
The types of business combinations are as diverse as the firms involved.
Explain the 2 ways a company can achieve control:
- The Usual Way
- Owning more than 50% of the subsidiary’s outstanding voting stock
○ (50% of shares plus 1 share would give them control).
2. The Unusual way - Having contractual agreements or financial arrangements that effectively achieve control.
○ Informal arrangements
○ Formal arrangements
§ Consummation of a written agreement requires recognition on the books of one or more of the companies that are a party to the combination.
- Owning more than 50% of the subsidiary’s outstanding voting stock
Business expansions change organizational structure, the new structure determines the appropriate financial reporting procedure. Name the 4 types of organizational structure:
- Merger
- Controlling ownership
- Non-controlling ownership
- Other beneficial interest
What are the types of business combinations for accounting? (3)
- Statutory Merger- only one of the combining companies survives and the other loses its separate identity.
- Statutory consolidation- both combining companies are legally dissolved and a new company is formed.
- Stock acquisition- one company acquires the voting shares of another company, and the two companies continue to operate as separate, but related legal entities (parent-subsidiary relationship). Special form of stock acquisition is a holding company.
What are the 2 types of takeovers?
- Friendly takeover
○ Acquisition of Assets - normally in (a) statutory merger or (b) statutory consolidation. - Unfriendly or “hostile takeover”
○ Acquisition of Stock - usually a majority of the outstanding voting shares is required.
What are the 3 characteristics of an Operating Segment?
- It engages in business activities from which it earns revenues and incurs expenses.
- Its operating results are regularly reviewed for performance and resource allocation.
- Separate financial information is available for it.
Related requirement based on IFRS 8:
Disclosure of information about an entity’s reportable operating segments in both its annual and its interim financial statements.
The FASB established 3 tests for identifying operating segments for which separate disclosure is required:
○ Revenue test - segment revenues, both “external and intersegment”, are 10 percent or more of the combined revenue, internal and external, of all reported operating segments
○ A profit for loss test - the absolute value of the segments profit or loss is 10% or more of the greater (absolute value) of:
§ The total profit of all operating segments that did not report a loss
§ The total loss of all operating segments that did report a loss.
○ An asset test- the segments assets are 10% or more of the total assets of all operating segments.
Explain the Comprehensive Disclosure Test: (2)
- 75% Consolidated Revenue Test
○ The total revenue from “external sources” by all separately reportable operating segments must equal 75% of the total consolidated revenue.
○ In the case that the test is not met (reportable segments percentage of consolidated revenue <75%), additional operating segments must be identified until this test is met.
In addition to operating segment reports, both IFRS and US GAAP require the following types of information (3)
- Information about Products and Services
- Information about Geographic Areas
- Information about Major Customers
Explain - Information about Products and Services:
a. The company is required to report the revenues from external customers for each major product and service or each group of similar products and services unless it is impracticable.
Explain - Information about Geographic Areas (3)
a. Revenues: From home + foreign countries in which the company generates revenues.
b. Long-lived productive assets located in the company’s home country and the total assets located in all foreign countries in which the company holds assets.
c. If revenues/assets in an individual country are material, then the country’s revenues/assets must also be separately disclosed.
Explain - Information about Major Customers (2)
a. What defines a major customer?
i. Any single customer (includes groups of customers, or companies under common control)
ii. Federal, state, or local governments or foreign governments
b. Materiality: 10% or more of the company’s revenue.
