SLS 1 - Question 1 Discuss the motivations for business...

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Unformatted text preview: 16/3/16 Question 1 Discuss the motivations for business combinations. AC3102 Risk Reporting & Analysis Student-led Seminar #1 Does the empirical evidence reported in Berkovitch and Narayanan support the hypothesized motivations? Article 1 Presented by Chow Shen Wei Goh Tian Ning Li Lanlan Hannah Ong Ming Xian Ng Jing Wen Regine Tan Jie Shi 1 Motivations For Business Combination Synergy Motive • Takeovers occur because of economic gains that result by merging the resources of the two firms • Assumes that managers of targets and acquirers maximize shareholder wealth • Engage in takeover activity only if it results in gains to both sets of shareholders • Gains to the target and acquirer, and the total gain will be positive and positively correlated with each other Agency Motive Synergy Motive 2 Hubris Motive 3 Agency Motive 4 Hubris Motive • Takeovers occur to enhance the acquirer’s management’s welfare at the expense of the acquirer shareholders • Primary motivated by the self-interest of the acquirer management • Reasons ❑ Diversification of management’s personal portfolio ❑ Use of free cash flow to increase the size of the firm ❑ Increase the firm’s dependence on the management • Inverse relation between total and target gains. Target and acquirer gains are negatively correlated 5 • Acquisitions are motivated by managers’ mistakes in evaluating target firms and engage in acquisitions even when there is no synergy gain • Suggests that managers might be too optimistic about the ability of target firms to add value to their company • Target and acquirer gains are negatively correlated. Target and total gains are uncorrelated. 6 1 16/3/16 Does the empirical evidence reported in Berkovitch and Narayanan support the hypothesized motivations? The Hypotheses Using a sample of tender offers during 1963-­‐1988 H1: Takeovers are primarily mo7vated by synergy: posi7ve correlated H2: Takeovers are primarily mo7vate by agency: nega7ve correlated H3: Takeovers with posi7ve measured total gains are mo7vated primarily by synergy. Takeovers with nega7ve measured total gains are mo7vated primarily by agency H4: Target and acquirer gains are nega7vely correlated in subset of nega7ve total gains. H5: Target and acquirer gains are posi7vely correlated in subset of posi7ve total gains 8 7 Testing the Hypotheses Testing the Hypotheses Total gain was positive in 76.4% (252/330) •  ¾ of the takeovers are motivated by synergy •  ¼ of the takeovers are motivated by agency and/ or hubris 9 Testing the Hypotheses Table 3 Panel B: : Provide the results of the regression between target and acquirer gains En7re Sample •  Correla7on between target and acquirer gain: nega7ve, not significantly different from zero •  Beta is -­‐0.0898 •  Support hubris hypothesis Sample of posi7ve total gain •  Beta is -­‐0.095 Sample of nega7ve total gain •  Beta is -­‐0.220 •  Correla7on between target and acquirer gains is significantly different from zero •  H4 cannot be rejected & results do not support H5 •  Suggests that managerial hubris might be present in many of the takeovers 11 Table 3 Panel A: : Provide the results of the regression between target and total gains En7re Sample •  Correla7on between target and total gain: posi7ve & significant •  Beta is 0.5445 •  Support synergy hypothesis Sample of posi7ve total gain •  Beta is 0.649 •  Support hypotheses that synergy is the primary mo7ve for takeovers in the posi7ve total gain subsample (Support H3) Sample of nega7ve total gain •  Beta is -­‐0.22 •  Agency is the primary mo7ve in the nega7ve total gain subsample (Support H3) 10 Question 2 Explain why a bank that extends a loan to a company (which is a subsidiary in a group) would be more interested in the consolidated financial statements of the group than the financial statements of the company. 12 2 16/3/16 Question 3 You are the chief accountant of B Ltd, a company incorporated in Singapore. B Ltd is the parent of C Ltd but • To understand the performance of the other companies in the group and seek corporate guarantee is a subsidiary of A Ltd. • If loan is guaranteed by the parent, the bank will have a claim against group resources (a) Discuss (i) the circumstances under which B Ltd is exempted from presenting consolidated financial statements under FRS 110, and (ii) the rationale for the exemption 13 (i) the circumstances under which B Ltd is exempted from presenting consolidated financial statements under FRS 110 FRS 110 (para 4[a]) 1. B is wholly owned by A, or NCI in B do not object 2. B is not listed, 3. B is not in process of being listed; and 4. A produces consolidated accounts available for public use. 14 (ii) the rationale for the exemption Condition 1: It helps to protect the interest of minority investors/ NCI of B, who may want to know the consolidated performance of Company B and C only. Condition 2/3: If it is a public listed company, it helps to protect the interest of public investors. Condition 4: Consolidated performance of company B and C are already included in consolidated performance of A, B and C. ALL of the above conditions must be met. 15 Question 3 (b) What is the difference, and the rationale for the difference, between Singapore FRS 110 and its equivalent International IFRS 10, as far as the exemption conditions are concerned? Prevent wastage of efforts (and resources) from having to prepare 16 too many consolidated financial statements in a group. (b) IFRS 10 4(a) requires A (its ultimate or any intermediate parent) to produce International Financial Reporting Standards compliant consolidated financial statements available for public use. FRS 110 para 4(a) does not require IFRS compliant consolidated financial statements. Rationale for the difference: Singapore functions as a global economic hub attract investors and business → Keeps the cost of compliance and reporting low 17 18 3 16/3/16 Question 4 Question 4(a) What is “fair value adjustment” -  ALL subsidiary’s identifiable assets and liabilities to be recognised in consol b/s at acquisition-date FV if they meet the recognition criteria: (a) In the context of consolidation, what is “fair value adjustment” (referred to in practice as purchase price allocation (PPA))? What is the rationale for “fair value adjustment” in 1.  meet the definition of asset/ liability 2.  subsidiary’s assets and liabilities are “transacted” in the business combination (not separate transaction) consolidation? 20 19 Question 4(a) Question 4 What is the rationale for “fair value adjustment”? -  Shareholders of A want to know cost of B’s net identifiable assets that A acquired in the market / how much is B worth in the market •  FV of individual subsidiary’s asset and liabilities = how much is B’s net identifiable assets worth between market participants (b) When A Ltd acquired 100% of B Ltd on 31 December 20x8, A Ltd has “Inventory” carried in its book at cost of $10 million but has fair value of $50 million, and B Ltd has “inventory” carried in its book at cost of $10 million but has fair value of $30 million. How much is “Inventory” in A Ltd’s consolidated balance sheet as at 31 December 20x8? -  Shareholders of A may want to know what A paid in excess of the FV of B’s net identifiable assets •  Goodwill = difference between FV and cost of investment 22 21 Question 4(b) Inventory A FRS 2: 10M 2) lower(FRS of cost or net realisable value B (subsidiary) What is “fair value adjustment” - ALL subsidiary’s identifiable assets and liabilities - to be recognised in consol b/s - At acquisition-date FV - if they meet the recognition criteria: 1.  meet the definition of asset/ liability 2.  part of business combination (not separate transaction) FRS 2: FRS 103: FV adjustment cost or net realisable value 1.  meet definition of asset: •  resource controlled by B •  as a result of past events •  from which future benefits are expected to flow to B (inventory = asset) 2.  part of business combination (inventory is bought before business combination for the benefit of B to carry out business) 10M 2) → 30M (FRScriteria 103) lower(FRS of 2 recognition Consolidated Question 4 (b) On this date, A Ltd and B Ltd each reported a =10M+30M =40M contingent liability in respect of a litigation for which there is 30% probability of having to pay damages of $10 million. How much is “Provision for litigation loss” in A Ltd’s consolidated balance sheet as at 31 December 20x8? 23 24 4 16/3/16 Question 4(b) Provision for litigation cost What is “fair value adjustment” - ALL subsidiary’s identifiable assets and liabilities - to be recognised in consol b/s - At acquisition-date FV - if they meet the recognition criteria: 1.  meet the definition of asset/ liability 2.  part of business combination (not separate transaction) Question 4(b) Provision for litigation cost •  Recap: AC2101 A Liabili;es -­‐ Present obliga7on AP, Con;ngent Liabili;es -­‐ Arises from past events Accruals -­‐  Future ouYlow of economic Type 1 Type 2 benefits -­‐ Present obliga7on not -­‐ Possible obliga7on not Provision (Es;mated recognised because recognised because Liabili;es due to uncertain -­‐  NOT PROBABLE Future -­‐  which will be known upon ;ming or amount) ouYlow of economic benefits the outcome of uncertain -­‐ Present obliga7on OR future events not within the -­‐ Arises from past events -­‐  NOT MEASURED RELIABLY company’s control -­‐  PROBABLE Future ouYlow of economic benefits -­‐  MEASURED RELIABLY B (subsidiary) FRS 37:27, 28: FRS 37:27, 28: FRS 103: FV adjustment 2 recognition criteria liability are not recognised, only disclose (if not remote) liability are not recognised, only disclose (if not remote) • Present obligation • Arises from past events • Future outflow of economic benefits (type 1 contingent liability “present obligation” = Liability) 2. part of business combination (litigation cost is incurred before business combination for the benefit of B) 1.  meet definition of liability: Contingent Contingent 0M (FRS 37) 0M (FRS 37) → 3M=30%*10m (FRS 103) Consolidated =0M+3M =3M 25 What is “fair value adjustment” - ALL subsidiary’s identifiable assets and liabilities - to be recognised in consol b/s - At acquisition-date FV - if they meet the recognition criteria: 1.  meet the definition of asset/ liability 2.  part of business combination (not separate transaction) Question 4(c) Freehold Land What is “fair value adjustment” - ALL subsidiary’s identifiable assets and liabilities - to be recognised in consol b/s - At acquisition-date FV - if they meet the recognition criteria: 1.  meet the definition of asset/ liability 2.  part of business combination (not separate transaction) A B (subsidiary) Consolidated Question 4 P S (subsidiary) Land at cost 100M 100M FV of land at acquisition date 500M 300M FV of land at 31 Dec 2008 800M 500M (c) 26 FRS 103: FV adjustment FRS 16: Cost FRS 16: Cost16) 100M 100M (FRS (FRS 16) → 300M (FRS 103) acquisition-date FV =100M+300M 2 recognition criteria Model Model =400M 1.  meet definition of asset: •  resource controlled by B •  as a result of past events •  from which future benefits are expected to flow to B (PPE = asset) 1.  part of business combination (land is bought before business combination for the benefit of B) 28 27 What is non-controlling interest? Question 5 (a) Explain why there is “Non-controlling interest” in the consolidated balance sheet when parent has less than 100% shareholding in subsidiary. 29 Non-controlling interest (NCI) NCI is the portion of equity ownership in a subsidiary not attributable to the parent company, who has a controlling interest. 30 5 16/3/16 How does it come about? Question 5 FRS 110 “Full Consolidation” Concept -  100% of Subsidiary’s Assets and Liabilities → added in Parent’s Consol BS. -  25% of Subsidiary’s Assets and Liabilities → accounted to “NCI” in Parent’s Consol BS In Parent’s Consol B/S, Why don’t we just present 75% of Subsidiary’s net identifiable assets? (b) Discuss the justification for and the implication of the two measurement bases for non-controlling interests provided for in FRS 103: (i) "acquisition-date fair value", and (ii) "acquisition-date fair values of the identifiable net assets of the subsidiary". 31 32 i) Acquisition-date fair value FRS 103 Measured based on fair value (Market price of shares) FRS 103 requires NCI to be measured based on either FV or FV of net identifiable assets (FVINA) Example 2.12 (NEJ P.55-­‐56) P Ltd acquired 60% of S Ltd. S Ltd comprised of 100 million shares at $0.90 per share Based on “fair value”: NCI = $0.90 X (40% X 100million) shares = $36 million 33 ii) Acquisition-date fair values of the identifiable net assets of the subsidiary Justifications Fair Value Measured based on acquisition-date fair value of identifiable net assets Example 2.12 (NEJ P.55-­‐56) P Ltd acquired 60% of S Ltd. The iden7fiable net assets of S Ltd were deemed to have a fair value of $80 million Based on “FVINA”: NCI = 40% X $80 million = $32 million 34 More consistent with fair-­‐value accoun7ng for business combina7ons Share price can be obtained easily for listed subsidiaries Market share price reflects the current returns to NCI shareholders should they sell their shares 35 FVINA NCI should have no share of goodwill (of which only the “transacted” amount is accounted NCI is not part of acquisi7on transac7on and should not be revalued Goodwill reflects the premium/discount parent paid/enjoyed when inves7ng in the subsidiary Thus we do not recognize NCI’s share of goodwill 36 6 16/3/16 Implications Item/Method Fair Value Question 6 FVINA Non-controlling interest $36 million $32 million NCI’s share of goodwill $4 million - Total FVINA $80 million Implications $80 million Identifiable assets/liabilities at acquisition date fair value Identifiable assets/liabilities at acquisition date fair value Goodwill depends 37 Goodwill = parent’s share only On 31 December 20x8, P Ltd acquires 90% of S Ltd and pays $270 million. Assume that, on this date, the S Ltd’s balance sheet consists of just Land $100 million and Share capital $100 million. The market value of the Land is deemed to be $150 million. S Ltd is deemed to have a brand which is worth $60 million, a contingent loss of $10 million (10% chance of having to pay damages of $100 million), and non-identifiable asset (unrecognised goodwill) of $100 million. The share capital of subsidiary comprises 100 million shares quoted at $2.40 per share. 38 Affects amount of non-controlling interest and the amount of goodwill on consolidation (can be positive/negative) Does not affect identifiable assets and liabilities Identifiable assets and liabilities are measured by fair value on acquisition date and are hence unaffected Question 6 4 easy steps What is the value of (i) “Land”, (ii) “Brand”, (iii) “Provision for loss”, (iv) “Goodwill on consolidation” and (v) “Non-controlling interest” in the Consolidated balance sheet as at 31 December 20x8 (assuming noncontrolling interest is measured based on (I) its acquisition-date fair value and (II) its share of the acquisition-date fair value of identifiable net assets of the subsidiary? (For all the following questions, support your answers with consolidation journal entries and the consolidation worksheets. Ignore the tax effect of consolidation Step 1) Eliminate S Equity, P cost of investment Step 2) Recognise unrecognised S identifiable assets and liabilities at acquisition-date FV (2 conditions) Step 3) Calculate NCI, Split journal entries except Cost of Investment and NCI Step 4) Calculate goodwill adjustments.) 39 Step 1) Step 2) Recognise unrecognised S identifiable assets and liabilities based on acquisition-date FV (2 conditions) Find all assets and liabili;es which may require FV adjustments Eliminate S Equity, P cost of investment Share capital: 100million Cost of investment= 270 million (given) Journal entry $’million Dr Share Capital Cr Investment in S 40 1) Land 2) Brand 3) Con7ngent liability 100 270 41 42 7 16/3/16 (i) Land Book value Fair value Adjustment (ii) Brand $’million Unrecognised 0 $’million 100 150 50 Journal entry Fair value Adjustment $’million Dr Land 50 60 Journal entry 60 $’million Dr Brand 60 43 44 (iii) Contingent Liability Step 3) Calculate NCI, Split JE except Cost of Investment and NCI $’million Unrecognised 0 Fair value Adjustment • Part of the net assets of the subsidiary that is attributable to interests not owned by the parent Measurement: • Fair value at acquisition date • Share of acquisition-date fair value of identifiable net assets of subsidiary 10 ($100m X 10%) 10 Journal entry $’million Cr Provision for loss 10 45 Step 3) Calculate NCI, Split JE except Cost of Investment and NCI Acquisi;on Date Fair value Journal entry =% X Share Price X Number of Shares $’million =10% X (100 million X $2.40) = $24 Million Cr NCI 24 Share of Acquisi;on-­‐Date Fair value of Iden;fiable Net Assets =% X Net Iden7fiable Asset =10% X (150 million + 60 million – 10 million ) = $20 Million Journal entry $’million Cr NCI 20 46 Step 3) Calculate NCI, Split JE except Cost of Investment and NCI NCI=Acquisi;on Date FV Subsidiary Dr $’M Dr Share Capital 100 Dr Land 50 Dr Brand 60 Cr Provision for loss Parent Dr $’M Cr $’M Dr Share Capital (90%X100m) 90 Dr Land (90%X50m) 45 P=90% Cr $’M NCI=10% 10 47 Cr Investment in S 270 Cr NCI 24 NCI Dr $’M Cr $’M Dr Brand (90%X60m) 54 Dr Share Capital (10%X100m) 10 Cr Provision for loss (90%X10m) 9 Dr Land (10%X50m) 5 Dr Brand (10%X60m) Cr Investment in S 6 48 270 Cr Provision for loss (10%X10m) 1 Cr NCI (10% X 240m) 24 8 16/3/16 Step 3) Calculate NCI, Split JE except Cost of Investment and NCI Step 4) Calculate Goodwill NCI=Acquisi;on Date FV Subsidiary Dr $’M Dr Share Capital 100 Dr Land 50 Parent Cr $’M NCI=Acquisi;on Date FVINA NCI=10% Difference f investment” and the Dr Brand between the “cost o60 “fair value of net iden;fiable assets of subsidiary acquired” Cr Provision 10 Parent Share ofor f Gloss oodwill on Consolida;on = 270m -­‐ 90%*(150m + 60m -­‐10m ) =90m Cr Investment in S 270 Cr NCI Dr $’M Cr $’M P=90% 24 Dr Share Capital (90%X100m) 90 Dr Land (90%X50m) 45 NCI Dr $’M Cr $’M Dr Brand (90%X60m) 54 Dr Share Capital (10%X100m) Dr Goodwill on Consolida7on 10 90 Subsidiary Dr $’M Dr Share Capital 100 Dr Land 50 Cr $’M NCI=10% 270 Cr NCI Dr Share Capital 100 Dr Land 50 Dr Brand 60 Dr Land (10%X50m) 5 Cr Provision for loss (90%X10m) Dr Brand (10%X60m) 6 Dr Goodwill on Consolida7on 4 20 Cr $’M NCI=10% 9 Cr Investment in S 270 Cr Provision for loss (10%X10m) 1 Cr NCI (10% X 200m) 24 Cr Investment in S 270 Cr NCI 20 Dr $’M Cr $’M Dr Share Capital (90%X100m) 90 Dr Land (90%X50m) 45 NCI Dr $’M Cr $’M Dr Brand (90%X60m) 54 Dr Share Capital (10%X100m) 10 Cr Provision for loss (90%X10m) 10 49 9 Dr Land (10%X50m) 5 Dr Brand (10%X60m) Cr Investment in S 6 50 270 Cr Provision for loss (10%X10m) 1 Cr NCI (10% X 200m) 20 Consolidation Worksheet Parent Dr $’M Cr $’M Dr Share Capital (90%X100m) 90 Dr Land (90%X50m) 45 (Acquisition Date FV) P Ltd $’million S Ltd $’million Adjustment Dr Cr $’million $’million Consolidated Balances $’million Goodwill -­‐ -­‐ 90 4 94 Land -­‐ 100 45 5 150 Brand -­‐ -­‐ 54 6 Investment 270 -­‐ 270 -­‐ Provision for loss -­‐ -­‐ 9 1 10 Share Capital 200(assumed) 100 90 10 200 NCI -­‐ -­‐ 24 24 P=90% Difference f investment” and the Dr Brand between the “cost o60 “fair value of net iden;fiable assets of subsidiary acquired” Cr Provision 10 Parent Share ofor f Gloss oodwill on Consolida;on = 270m -­‐ 90%*(150m + 60m -­‐10m ) =90m Cr Investment in S Dr $’M Cr Provision for loss Step 4) Calculate Goodwill NCI=Acquisi;on Date FVINA Subsidiary Parent P=90% NCI Dr $’M Cr $’M Dr Brand (90%X60m) 54 Dr Share Capital (10%X100m) Dr Goodwill on Consolida7on 10 90 Dr Land (10%X50m) 5 Cr Provision for loss (90%X10m) Dr Brand (10%X60m) 6 NIL NIL Cr P rovision for Investment in loss S (10%X10m) Cr NCI (10% X 200m) 51 60 52 9 1 270 20 Consolidation Worksheet Question 7 (Acq...
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