Acc U2 Mergers/Takeovers

Evaluate the treatment of goodwill in the accounts (Ammortization(like dep))

• Classification: Goodwill appears as an intangible asset on the balance sheet under non-current assets.

• Amortisation: The correct treatment involves amortising goodwill over its useful economic life, not writing it off immediately.

• Matching Concept: Amortisation spreads the cost of acquiring goodwill over the years it benefits the company, reflecting the matching concept.

• True and Fair View: This approach provides a more accurate picture of profitability by recognising the gradual decline in goodwill's value.

• Financial Performance: Immediate write-off could distort financial performance by making profits and tax charges unrealistically low.

• Recommended Practice: Amortisation aligns with accounting standards like FRS 10.

Evaluate the treatment of goodwill in the accounts (One time-expense)

• One-Time Expense: The entire cost of goodwill is recorded as an expense in the year of acquisition. This can significantly reduce reported profits for that year.

• Prudence Argument: Some might argue it follows the prudence concept, recognizing potential future losses upfront. However, immediate write-off doesn't necessarily reflect the actual decline in goodwill's value.

• Lower tax (temporary?)

• Difficulty in estimating the exact useful life of goodwill could lead to unrealistic annual amortization charges.

Evaluate the merger/ takeover (financial)

1. State if there is Goodwill

2. Goodwill as a percentage of pp

3. Calculate goodwill per share?

4. Evaluate purchase price?

5. Evaluate financial performance

6. Profit on realization

Evaluate the merger/ takeover (benefits)

• Vertical Integration Benefits: The new company might benefit from being in the same industry (vertical integration). This could lead to:

  • Economies of scale (e.g., bulk buying of machinery)

  • Managerial economies of scale

  • Marketing economies of scale

• Horizontal Integration Benefits: The new company would benefit from being in the same industry (horizontal integration), leading to:

  • Larger market share

  • Increased profits and dividends

• Financial Benefits: The larger company might find it easier to secure loans at lower interest rates.

• Increased Market Power: The new company might enjoy a larger market share and stronger market position.

• Proactive Management: The acquisition might reflect a proactive approach to increase profits and shareholder returns.

• Potential Future Growth: A positive market reaction to the merger and future profitability of the company could lead to a share price increase. This would allow to make a capital gain and potentially receive dividends.

• Gain survival : The company is struggling financially (losses, negative retained earnings, low market value compared to book value). The merger might prevent them from going out of business and protect shareholder investments.

Evaluate the merger/ takeover (drawbacks)

• Potential for Negative Publicity: Factory closure, redundancies, and product size reduction could lead to bad publicity.

• Shareholder Discontent: Some shareholders might be unhappy with these decisions.

• Dilution of Ownership & Voting Power: ownership and voting power in the new company will be diluted

• Uncertainty about Share Price: The future market price of shares (the new company) is unknown.

• Potential Underpayment for Assets

• No Benefit from Goodwill

• Diseconomies of Scale: The merger could lead to inefficiencies and reduced profits.

• Liquidity Concerns: The large cash payout for the takeover could negatively impact' liquidity.

• Potential Culture Clash: Merging company cultures could lead to employee demotivation and other issues

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• Reduced Dividends: An increase in shareholders could lead to lower dividends per share in the future.

Examples of Intangible assets

• Copyright

• Goodwill

• Patents

Ammortisation

The depreciation of intangible assets such as goodwill

Intangible assets

An asset that is not physical in nature, such as a patent, brand, trademark, or copyrighT

Goodwill

Goodwill is a sum paid in excess of the fair / agreed value net assets acquired when purchasing a business

Reasons why goodwill occur

•  Existing customer base

• Supply channels set up

• Suitable location

• Skilled workers

• Reputation of business

• Brand awareness

• Loyal staff

• Profitable business

Merger

When 2 or more companies combine to from a new single company

Takeover

when one company makes a successful bid to assume control of or acquire another

Benfits of revaluing assets and liabilities before a takover

• Protection for Weaker Party: Even if one party is stronger, the other party can refuse the sale if they disagree with the asset valuation.

• Fair Market Value: Revaluation ensures assets and liabilities are sold at their current market value, which may be different from the historical book value.

Against Revaluing Assets and Liabilities Before Takeover:

• Potential Abuse by Stronger Party: The larger company in the takeover might have more power and could undervalue assets for their own benefit.

• Unnecessary Work: Revaluation might be a waste of time and money since the buyer can decide on the goodwill price anyway.

• Valuation Costs: Hiring professional valuers can be expensive.

Advantages of Purchasing/takeover with cash

• Cash Availability: If they have sufficient cash reserves, they can comfortably afford the acquisition without impacting liquidity.

• Avoids Share Dilution & Price Decrease: Existing shareholders won't experience dilution of ownership or voting power, and there's no risk of a share price drop due to issuing new shares.

• Reduced Long-Term Costs: Cash purchase avoids potential future costs like issuing new shares and paying additional dividends to a larger shareholder base.

• Speed and Efficiency: Financing with cash can be a quicker, easier, and potentially cheaper option compared to other methods.

• Flexibility for Investment: The cash can be invested elsewhere, potentially offering higher returns than the acquiring company's shares

• Immediate Use: The cash can be used for immediate needs or consumption by the receiving shareholders.

• Value Stability: Cash holds its value well if inflation is low.

• Prevents future dividend payouts

Disdvantages of Purchasing/takeover with cash

• Reduced Liquidity: Using a significant amount of cash could limit the company's ability to access quick resources for other needs or take advantage of discounts for early payments.

• Loan Dependence: If insufficient cash is available, acquiring financing through loans could burden the company with debt.

• Borrowing cash increases costs with interest payments

• Inflation reduces the real value of cash over time

Advantages of Purchasing/takeover with shares

• Preserves Cash Flow: No upfront cash outlay avoids straining the buyer's liquidity.

• Potential Share Price Increase: A positive market reaction to the deal could increase the buyer's share price, benefiting existing shareholders.

• Improved Gearing Ratio: Issuing shares instead of debt improves the buyer's financial structure.

• No Repayment Obligation: Shares don't require repayment like loans.

• Flexible Dividend Payments: Dividends are only paid when profits are sufficient, unlike fixed loan interest payments.

• No Collateral Needed: Shares don't require collateral compared to some loan options.

• Future Dividends: The new shares might pay out regular dividends to the receiving shareholders.

• Protection Against Inflation: Shares might offer a hedge against inflation if their value increases alongside inflation

Disdvantages of Purchasing/takeover with shares

• Potential Share Price Decrease: A negative market reaction to the deal could decrease the buyer's share price, upsetting shareholders.

• Issuing Shares Requirements: The company's Memorandum of Association or Stock Exchange regulations might limit issuing new shares, requiring approval for changes.

• Dilution of Ownership & Voting Power: Existing shareholders experience a dilution of ownership and voting power due to the increased number of shareholders.

• Potentially Lower Dividends per Share: Issuing more shares increases the total number of shareholders receiving dividends, which could lead to lower dividends per share for existing shareholders.

• Issuing Costs: Costs associated with issuing new shares can add up.

One factor that would be considered when deciding on the value on each

Factors Affecting Goodwill Calculation

• Profitability: Higher profits tend to justify a higher goodwill value. A common formula might be three times the annual profit.

• Customer Base: A loyal customer base or a captive market increases goodwill value due to recurring revenue potential.

• Reputation and Brand Awareness: A strong reputation and brand awareness lead to higher goodwill value.

• Location: A prime location (e.g., city center) can increase goodwill value due to factors like increased foot traffic or visibility.

• Employee Skills: An experienced and effective workforce contributes to higher goodwill due to their expertise and efficiency.

Realisation account

an account created to eliminate the values of the assets and liabilities from the books of account

Acquisition account

• a temporary account used in the merger or acquisition of a company to eliminate the equity of the purchased company 

Sundry shareholders account

a control account used in the purchase of assets and liabilities from a company