Chapter 7: Accounting Treatment
Learning Outcomes
Distinguish between the pooling of interest and acquisition accounting methods
Explain and apply the steps taken during the application of acquisition accounting
Discuss various issues with regard to the classification and measurement of items considered curing
acquisition accounting
Opening Case Study
Towards to end of 1997 it was announced that Shoprite Holdings Ltd has bought the OK Bazaars Group for an
amount of only R1. According to the deal, Shoprite would take over OK Bazaars Group from South African
Breweries (SAB), who had been struggling to turn around the loss-making company for years (at that stage it
was estimated that the OK Bazaars Group had cost SAB a total of R1 billion in capital injections since it was
delisted from the JSE in 1994). As a result of the deal, Shoprite became the largest food retail group in the
country. Subsequent to the takeover of the OK Bazaar Group, Shoprite integrated the OK Bazaars Group stores
into its corporate structure, and managed to complete a successful turnaround.
OKThe OK Bazaars Group deal included a guarantee of R540 million in assets and loan accounts. The obvious
question that arises from this transaction is how Shoprite was able to obtain a company with guaranteed
assets to the value of more than half a billion rand for R1? Furthermore, how did this transaction influence
their financial statements?
- OK held a lot of debt and there were many factors that influenced the utilisation of the asset value
- Once all debt and liabilities had been paid off – the value was left at R1.
Introduction
- Must understand how the financial performance and position of the companies involved in M&A will be
reflected in financial statements of the new entity
- Valuation of assets and liabilities plays a large role
Pooling of Interest vs. Acquisition Accounting
Pooling of Interest: combining the respective items from the separate companies in the relevant financial
statements
- Simplest and easiest manner – simply add the values from the separate companies and form a new set of
financial statements
- Reflect the book values of the items of the target company in the financial statements of the acquiring
company
- Total value of the transaction and the current value of assets and liabilities aren’t considered
- Not a true reflection
- External analyst utilise the values of the assets in the statement of financial position
- Major Problem – assets usually reported at historical value - may not be a true reflection of assets fair values
- Intangible Assets also provide a problem book values from SFP are inaccurate
- The value of the transaction is also not reflected when using this method
1|Page
, - International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) scrapped
this method in 2001
- Replaced with the acquisition accounting method
Acquisition Accounting Method: require all companies that engage in a business combination to reflect the assets
and liabilities at fair value.
- Valuation of assets and liabilities both tangible and intangible, as well as non-controlling interest
- Net value of the target firm is compared to the value of the transaction
- If net value is less than the transaction value = creation of goodwill
- Benefits 1.) Companies assets and liabilities will be reflected at fair value accurate
2.) The value of the transaction is reflected due to the creation of goodwill
- Makes it possible to analyse and determine whether the price paid was a fair price
- Draw back – the goodwill that is created has to be reassessed every year, identify impairment
- If fair value is less than the goodwill reflected in the financial statements – difference must be impaired
- Charged to the statement of comprehensive income expense
Steps in the Acquisition Accounting Method
Four steps need to be completed when applying the acquisition accounting method.
Step 1: Identification of the Acquiring Company
- Must determine who the acquiring company is
- The company that acquires control of the target company
- Very NB step effect of the transaction need to be reflected in the acquiring company’s financial statement
Step 2: Determining the Acquisition Date
- Date on which the acquiring company gains control of the target company
- Important as this is the dates that the values of the assets and liabilities must be calculated
- Formulation of goodwill is based on valuation on this date
Step 3: Recognition & Measurement of the assets, liabilities & non-controlling
interest in the target company
- Very important step
- The following groups need to be considered
1.) Tangible Assets and Liabilities
Measured at their fair value on the acquisition date
Not too complex to calculate the values since they are all tangible
Fair Value of Net Tangible Assets = Total Assets – Total
Total Assets = sum of all tangible assets of target company
Total Liabilities = sum of all liabilities of target company
2|Page
Learning Outcomes
Distinguish between the pooling of interest and acquisition accounting methods
Explain and apply the steps taken during the application of acquisition accounting
Discuss various issues with regard to the classification and measurement of items considered curing
acquisition accounting
Opening Case Study
Towards to end of 1997 it was announced that Shoprite Holdings Ltd has bought the OK Bazaars Group for an
amount of only R1. According to the deal, Shoprite would take over OK Bazaars Group from South African
Breweries (SAB), who had been struggling to turn around the loss-making company for years (at that stage it
was estimated that the OK Bazaars Group had cost SAB a total of R1 billion in capital injections since it was
delisted from the JSE in 1994). As a result of the deal, Shoprite became the largest food retail group in the
country. Subsequent to the takeover of the OK Bazaar Group, Shoprite integrated the OK Bazaars Group stores
into its corporate structure, and managed to complete a successful turnaround.
OKThe OK Bazaars Group deal included a guarantee of R540 million in assets and loan accounts. The obvious
question that arises from this transaction is how Shoprite was able to obtain a company with guaranteed
assets to the value of more than half a billion rand for R1? Furthermore, how did this transaction influence
their financial statements?
- OK held a lot of debt and there were many factors that influenced the utilisation of the asset value
- Once all debt and liabilities had been paid off – the value was left at R1.
Introduction
- Must understand how the financial performance and position of the companies involved in M&A will be
reflected in financial statements of the new entity
- Valuation of assets and liabilities plays a large role
Pooling of Interest vs. Acquisition Accounting
Pooling of Interest: combining the respective items from the separate companies in the relevant financial
statements
- Simplest and easiest manner – simply add the values from the separate companies and form a new set of
financial statements
- Reflect the book values of the items of the target company in the financial statements of the acquiring
company
- Total value of the transaction and the current value of assets and liabilities aren’t considered
- Not a true reflection
- External analyst utilise the values of the assets in the statement of financial position
- Major Problem – assets usually reported at historical value - may not be a true reflection of assets fair values
- Intangible Assets also provide a problem book values from SFP are inaccurate
- The value of the transaction is also not reflected when using this method
1|Page
, - International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) scrapped
this method in 2001
- Replaced with the acquisition accounting method
Acquisition Accounting Method: require all companies that engage in a business combination to reflect the assets
and liabilities at fair value.
- Valuation of assets and liabilities both tangible and intangible, as well as non-controlling interest
- Net value of the target firm is compared to the value of the transaction
- If net value is less than the transaction value = creation of goodwill
- Benefits 1.) Companies assets and liabilities will be reflected at fair value accurate
2.) The value of the transaction is reflected due to the creation of goodwill
- Makes it possible to analyse and determine whether the price paid was a fair price
- Draw back – the goodwill that is created has to be reassessed every year, identify impairment
- If fair value is less than the goodwill reflected in the financial statements – difference must be impaired
- Charged to the statement of comprehensive income expense
Steps in the Acquisition Accounting Method
Four steps need to be completed when applying the acquisition accounting method.
Step 1: Identification of the Acquiring Company
- Must determine who the acquiring company is
- The company that acquires control of the target company
- Very NB step effect of the transaction need to be reflected in the acquiring company’s financial statement
Step 2: Determining the Acquisition Date
- Date on which the acquiring company gains control of the target company
- Important as this is the dates that the values of the assets and liabilities must be calculated
- Formulation of goodwill is based on valuation on this date
Step 3: Recognition & Measurement of the assets, liabilities & non-controlling
interest in the target company
- Very important step
- The following groups need to be considered
1.) Tangible Assets and Liabilities
Measured at their fair value on the acquisition date
Not too complex to calculate the values since they are all tangible
Fair Value of Net Tangible Assets = Total Assets – Total
Total Assets = sum of all tangible assets of target company
Total Liabilities = sum of all liabilities of target company
2|Page
