A Brief Background on Accounting for Business Combinations

Accounting for business combinations is one of the most important and interesting topics
of accounting theory and practice. At the same time, it is complex and controversial. Business
combinations involve financial transactions of enormous magnitudes, business empires, success
stories and personal fortunes, executive genius, and management fiascos. By their nature, they
affect the fate of entire companies. Each is unique and must be evaluated in terms of its economic
substance, irrespective of its legal form.

Historically, much of the controversy concerning accounting requirements for business
combinations involved the pooling of interests method, which became generally accepted in
1950. Although there are conceptual difficulties with the pooling method, the underlying problem
that arose was the introduction of alternative methods of accounting for business combinations
(pooling versus purchase). Numerous financial interests are involved in a business combination,
and alternate accounting procedures may not be neutral with respect to different interests. That is,
the individual financial interests and the final plan of combination may be affected by the method
of accounting.

Until 2001, accounting requirements for business combinations recognized both the pooling and
purchase methods of accounting for business combinations. In August 1999, the FASB issued a report
supporting its proposed decision to eliminate pooling. Principal reasons cited included the following:

1.Pooling provides less relevant information to statement users.

2.Pooling ignores economic value exchanged in the transaction and makes subsequent
performance evaluation impossible.

3.Comparing firms using the alternative methods is difficult for investors.

Pooling creates these problems because it uses historical book values to record combinations,
rather than recognizing fair values of net assets at the transaction date. Generally accepted
accounting principles (GAAP) generally require recording asset acquisitions at fair values.
Further, the FASB believed that the economic notion of a pooling of interests rarely exists in
business combinations. More realistically, virtually all combinations are acquisitions, in which one
firm gains control over another.


GAAP eliminated the pooling of interests method of accounting for all transactions initiated
after June 30, 2001. Combinations initiated subsequent to that date must use the acquisition
method. Because the new standard prohibited the use of the pooling method only for

combinations initiated after the issuance of the revised standard, prior combinations accounted

for under the pooling of interests method were grandfathered; that is, both the acquisition and

pooling methods continue to exist as acceptable financial reporting practices for past business

combinations.

Therefore, one cannot ignore the conditions for reporting requirements under the pooling

approach. On the other hand, because no new poolings are permitted, this discussion focuses on

the acquisition method. 

INTERNATIONAL ACCOUNTING Elimination of pooling made GAAP more consistent with international accounting standards. Most major economies prohibit the use of the pooling method to account for business combinations. International Financial Reporting Standards (IFRS) require business

combinations to be accounted for using the purchase method, and specifically prohibit the pooling

of interests method.

Accounting for business combinations was a major joint project between the FASB and IASB.

As a result, accounting in this area is now generally consistent between GAAP and IFRS. Some

differences remain, and we will point them out in later chapters as appropriate.

Common-Size Income Statements In Excel

A common technique among financial analysts is to examine common-size
financial statements. Common-size financial statements display the data not as
dollar amounts, but as percentages. These statements provide the analyst
with two key benefits:

1. They allow for easy comparisons between firms of different sizes.

2. They can aid in spotting important trends which otherwise might
be not be obvious when looking at dollar amounts.

A common-size income statement is one which shows all of the data as a
percentage of the firm’s total revenues. Excel makes the building of
common-size financial statements easy, as we’ll see with the EPI data.

To begin, we need to make room for the common-size income statements.
Select any cell in column B, or all of column B, by clicking on the column
header. From the menus choose Insert Columns which will insert a
new column to the left of the selected column. This new column will
need to be resized so that it is approximately the same size as column C,
which was formerly column B. Now, repeat this process with column D
(the 2003 data). In B4 and D4 enter the labels: 2004% and 2003%,
respectively. We will start building our common-size income statements
with the 2004 data. In B5 enter the formula: =C5/C$5.4 The resulting
display is likely to be nonsensical

because the formatting will be the same as the cells in column C.
So change the number format (Format Cells) to a Percentage
format with 2 decimal places. You should now see that the result
is 100.00%. Copy B5, select cells B6:B15, and then
choose Edit Paste. You have now created a common-size
income statement for 2004.

To create the common-size income statement for 2003, simply copy
B5:B15 and then paste into D5.

You can easily see why this is a useful tool for analysts. By looking
at row 8, you can instantly see that Selling and G&A expenses
have risen quite sharply in 2004 relative
to sales. Also, looking at row 15 instantly shows that the firm’s net profit margin

Accounting In Excel

Accounting In Excel, or the term “spreadsheet” that
covers a wide variety of elements useful for
quantitative analysis of all kinds. Essentially,
a spreadsheet is a simple tool consisting of a
matrix of cells that can store numbers, text,
or formulas. The spreadsheet’s power
comes from its ability to recalculate results
as you change the contents of other cells.
No longer does the user need to do
these calculations by hand or on a calculator.
Instead, with a properly constructed spreadsheet,
changing a single number (say, a sales forecast)
can result in literally
thousands of automatic changes in the model. The freedom
and productivity enhancement provided by modern
spreadsheets presents an unparalleled opportunity for
learning financial analysis.
Building an Income Statement in Excel(accounting in excel)

The image below presents the income statement for Elvis Products
International (EPI) for the year ending December 31, 2004. We
will build this income statement first, and then use it as a base
for creating the 2003 income statement.(click the image to enlarge)


Principle 1:
Make Excel do as much of the
work as possible. Whenever
possible, a formula should be
used rather than entering
numbers. In the long run this
will minimize errors.


Principle 2:
Format the worksheet so that
it is easy to understand.
Borders, shading, and font
choices are more than just
decorations. Properly chosen,
they can make important
numbers stand out and get the
attention they deserve.

While we are building the income statement, we want to keep
a couple of general principles in mind. Principle 1 says that we
want to make Excel do as much of the work as possible.
Any time a value can be calculated, we should use Excel to do
so. The reasoning behind this principle is that we want to avoid
mistakes and increase productivity. A little thought before
beginning the design of a worksheet can help to minimize data
entry errors, and increase productivity by reducing the
amount of data that needs to be entered. Principle 2 says
that we should format the worksheet in such a way as to make
it easy to comprehend. There are many times that you will be
creating a worksheet for others to use, or for your own use at a later
date. Properly organizing the cells and judicious use of color and
fonts can make the worksheet easier to use and modify.
1 Worksheets that are disorganized and sloppily formatted do not
engender faith in their results.

It is usually helpful when working with multiple worksheets in a
workbook for each sheet to be given a name other than the default.
With the right mouse button, click

Tag: Accounting In Excel

Calculating Your Print Ad’s Cost

I have good news and bad news about print media ad costs. The good news is
that most print media actually have easy-to-read (albeit somewhat difficultto-
understand) rate cards that list the various costs for assorted ad sizes — a
welcome relief from the way radio advertising is negotiated

The bad news is that the rate card is nothing more than a starting point in
the media-negotiation and buying process, because newspapers, especially,
have created so many permutations of their basic (or open) rates that even a
professional media buyer has trouble deciphering them in order to come up
with the most frugal media buy. And after you discover the nuances of one
publication’s rates and myriad discounts, you can then call the next publication
and start all over again — no two publications’ rates and discounts are
alike. (I think they do this just to totally confuse you and to give their salespeople
a reason for being.)

After deciding where you’re going to put your ad, you need the help of a sales
rep, But before you go into a meeting with a rep, you need to know a few things
about how print ads are priced.

For example, somewhere in the mists of time, all newspapers made the diabolical
decision that no two advertising pricing schemes would ever be the
same. Newspapers and other publications generally price print ads by multiplying
the number of columns wide, by the number of inches high, by a dollar
amount for each column inch. For example, a quarter-page ad in most newspapers
is 3 columns wide by 11 inches high, which makes it a 33-column-inch
ad. So if the open rate for your local paper is $50 per column inch, you have
an ad that can cost you $1,650 for one insertion.

Unfortunately, it’s not always that simple. Here are just a few of the seemingly
infinite variations possible to that simple pricing structure:

1, The initial $50 per-column-inch rate can change for numerous reasons,
because it’s the open rate (the rate paid by a new advertiser who runs an
ad only one time).

2 If you’re willing to commit to running your ad multiple times over a certain
time period, you can reduce the open rate by as much as 50 percent.

3 Newspapers and other publications often give discounts for new businesses,
minority-owned businesses, first-time advertisers, political advertisers, nonprofit
groups, and so on.

4 If you’re willing to commit to three ads per week, and if you’re also willing
to make a substantial dollar commitment over an extended time
period, you can dramatically reduce your rate per ad.

5 You may qualify for more than one of these discounts — for example, if
you’re willing to commit to a long-term buy and you’re also a nonprofit.

Usually, newspapers offer what they call pickup rates. A pickup rate is a discounted
rate newspapers give in return for running the same ad two or more
times in the same week. For instance, if your first ad runs in the Sunday
paper, your newspaper rep may quote you a pickup rate as follows: “Our
pickup rates are 20, 30, 40, then 50, 50, and 50.” That’s her way of saying that
if you run your ad a second time in the same week, you receive a 20-percent
discount; a third insertion in that week gets you a 30-percent discount; a
fourth insertion gets you a 40-percent discount; and for every time you run
the ad in that same week after that point, you receive a 50-percent discount.
And the discounts apply to all ads you run Clearly, the discounts definitely
have a way of adding up! The ad in my example earlier in this section, which
I priced at $1,650 for a single insertion, ends up costing $594 at the end of
one week if you run it multiple times — which gives you a discount of 64 percent!

Ad pricing is complicated, confusing, convoluted, and intimidating. The only
way you can be sure you’re getting the best rate possible is to tell your rep,
in no uncertain terms, “Give me all available rates.”

Double Entry Accounting System Design For Single-Entry Folks

Businesses and nonprofit entities use double-entry accounting.
But I’ve never met an individual
who uses double-entry accounting in personal bookkeeping. Instead, individuals use single-entry accounting. For example,
when you write a check to make a payment on your credit card balance, you undoubtedly
make an entry in your checkbook to decrease your bank balance. And
that’s it. You make just one entry — to decrease your checking account balance.
It wouldn’t occur to you to make a second, companion entry to
decrease your credit card liability balance. Why? Because you don’t keep a
liability account for what you owe on your credit card. You depend on the
credit card company to make an entry to decrease your balance.

Businesses and nonprofit entities have to keep track of their liabilities as well
as their assets. And they have to keep track of all sources of their assets.
(Some part of their total assets comes from money invested by their owners,
for example.) When a business writes a check to pay one of its liabilities, it
makes a two-sided (or double) entry — one to decrease its cash balance and
the second to decrease the liability. This is double-entry accounting in action.
Double-entry does not mean a transaction is recorded twice; it means both
sides of the transaction are recorded at the same time.

Double-entry accounting pivots off the accounting equation:

Total assets = Total liabilities + Total owners’ equity

The accounting equation is a very condensed version of the balance sheet.
The balance sheet is the financial statement that summarizes a business’s
assets on the one side and its liabilities plus its owners’ equity on the other
side. Liabilities and owners’ equity are the sources of its assets.

One main function of the bookkeeping/accounting system is to record all
transactions of a business — every single last one. If you look at transactions
through the lens of the accounting equation, there is a beautiful symmetry in
transactions (well, beautiful to accountants at least). All transactions have a
natural balance. The sum of financial effects on one side of a transaction
equals the sum of financial effects on the other side.

Suppose a business buys a new delivery truck for $65,000 and pays by check.
The truck asset account increases by the $65,000 cost of the truck, and cash
decreases $65,000. Here’s another example: A company borrows $2 million
from its bank. Its cash increases $2 million, and the liability for its note
payable to the bank increases the same amount.

Just one more example: Suppose a business suffers a loss from a tornado
because some of its assets were not insured. The assets destroyed
by the tornado are written off and the amount of the loss decreases
owners’ equity the same amount. The loss works its
way through the income statement but ends up as a decrease in owners’
equity.

Accumulated Depreciation Accounting

The basic theory of depreciation accounting is unarguable: The amount
of capital a business invests in a fixed asset, less its estimated future
residual (salvage) value when it will be disposed of, should be allocated
in a rational and systematic manner over its estimated useful life to the
business.

A fixed asset’s cost shouldn’t be charged entirely to expense in the year
the asset’s acquired. Doing so would heavily penalize the year of acquisition
and relieve future years from any share of the cost. But the opposite approach
is equally bad: The business shouldn’t wait until a fixed asset is eventually
disposed of to record the expense of using the asset. Doing so would heavily
penalize the final year and relieve earlier years from any share of the fixed
asset’s cost.

Essentially, cost less residual value should be apportioned to every year
of the fixed asset’s use. (Land has perpetual life, and therefore, its cost
isn’t depreciated.) The theory of depreciation is relatively simple, but
the devil is in the details. And, I mean details!

Frankly, there’s not much point in discussing the finer points of
depreciation accounting. I could refer you to many books written
by accounting scholars on depreciation. But as a practical matter the
federal income tax law dictates the depreciation methods and practices
used by most businesses. The IRS publication “How To Depreciate
property” (2005 edition) runs 112 pages. You ought to read this
pamphlet— if you have the time, and the stamina.

Let me step on the soapbox for a moment. The depreciation
provisions in the income tax law are driven mainly by political
and economic incentives, to encourage businesses to upgrade
and modernize their investments in long-term operating assets.
By and large, businesses follow income tax regulations on
depreciation. As the result, useful lives for depreciating
fixed assets are too short, salvage value is generally ignored,
and depreciation is stacked higher in the early years. In
other words: fixed assets generally last longer than their income
tax depreciation lives; when disposed of fixed assets often have
some salvage value; and, a strong case can be made for allocating
an equal amount of depreciation to each year over the useful life
of many fixed assets. In short, actual depreciation practices
deviate from depreciation theory. Okay, I’m off my soapbox now.

The cost of land is not depreciated. Land stays on the books at
original cost as long as the business owns the land. Ownership
of land is a right in perpetuity, which does not come to an end.
Land does not wear out in the physical sense, and generally holds
its economic value over time. Buildings, machines and other fixed
assets, on the other hand, wear out with use over time and generally
reach a point where they have no economic value. Assume the business
decides to maximize the amount of depreciation recorded in the year,
according to the provisions of the income tax law.