Advanced Accounting Review Exam 1

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ACCT 4022 – Advanced Accounting Notes
Chapter 1: Intercorporate Acquisitions and Investments in Other Entities The Development of Complex Business Structures
By expanding into new markets or acquiring other companies already in those markets, companies can develop new earnings potential and those in cyclical industries can add greater stability to earnings through diversification. A subsidiary is a corporation that is controlled by another corporation, referred to as a parent company. Control is usually through majority ownership of its common stock. Because a subsidiary is a separate legal entity, the parent’s risk associated with the subsidiary’s activities is limited. Reasons for creating subsidiary:

May transfer receivables to subsidiary. Other companies can hold interest in entity. Transferring company therefore able to share risk of receivables. Tax benefits
Companies have used subsidiaries to borrow large amounts of money without reporting debt on balance sheets. A special purpose entity is a financing vehicle that is not a substantive operating entity, usually created for one specific purpose. May be in the form of a corporation, a trust, or a partnership. Can be done through contracts

Other manipulations include pooling of interests and assigning portions of purchase prices to in-process R&D so that the cost was expensed. Business Expansion and Forms of Organizational Structure

Recently companies have been expanding by means of acquiring other companies rather than product development or expanding existing product lines into new markets. Internal Expansion
Conduct expanded operations through subsidiaries or partnerships, joint ventures, or special entities. Transfer assets to new entity and receive equity ownership in exchange May establish subs for tax incentives, less regulation, spreading of risk. May establish subs for disposition purposes, like shedding nonaligned operations, unprofitable operations, or to gain shareholder approval for merger with new company. A spin off occurs when the ownership of a newly created or existing subsidiary is distributed to the parent’s stockholders without the stockholders surrendering any of their stock in the parent company. Thus, the company divests itself of the sub since it is owned by the company’s shareholders after the spin-off. A split off occurs when the sub’s shares are exchanged for shares of the parent, thereby leading to a reduction in the outstanding shares of the parent company. While the two divestiture types are similar, the split-off could result in one set of the former parent shareholders exchanging their shares for those of the divested sub. Although transfer of ownership to one or more unrelated parties normally results in a taxable transaction, properly designed transfers of ownership to existing shareholders generally qualify as nontaxable exchanges. Investment account (parent) = BV of net assets (sub)

External Expansion Through Business Combinations
The concept of control relates to the ability to direct policies and management. Traditionally, control is majority ownership of stock. However, recently there has been greater possibility of control with less than majority or even no ownership. In some cases, a formal agreement may be equivalent in substance to a business combination, yet different in form. Ex: a company may sign agreement to lease all of another company’s assets for several decades is in effect acquiring the company. Organizational Structure

Several approaches are possible, each with separate financial reporting procedures 1. Merger – a business combination in which the acquired company’s assets and liabilities are combined with those of the acquiring company. Thus, two companies are merged into a single entity still under the name of the original company. Financial reporting is based on the original organizational structure. 2. Controlling Ownership – the acquired company remains separate legal entity but purchasing...
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