Obtaining Control

Control of another company may be archived by either acquiring the assets of the target company or acquiring a controlling interest in the target company’s voting common stock. In an acquisition of assets, all of the company’s assets are acquired directly from the company. In most cases, existing liabilities of the acquired company also are assumed. When assets are acquired and liabilities are assumed, we refer to the transaction as an acquisition of “net assets.” Payment could be made in cash, exchanged property, or issuance of either debt or equity securities. It is common to issue securities, since this avoids depleting cash or other assets that may be needed in future operations. Legally, a statutory consolidation refers to the combining of two or more previously independent legal entities into one new legal entity. The previous companies are dissolved and are then replaced by a single continuing company. A statutory merger refers to the absorption of one or more former legal entities by another company that continues as the sole surviving legal entity. The absorbed company ceases to exist as a legal entity but may continue as a division of the surviving company.
In a stock acquisition, a controlling interest (typically, more than 50%) of another company’s voting common stock is acquired. The company making the acquisition is termed the parent, and the company acquired is termed a subsidiary. Both the parent and the subsidiary remain separate legal entities and maintain their own financial records and statements. However, for external financial reporting purposes, the company usually will combine their individual financial statements into a single set of consolidated statements. Thus, a consolidation may refer to a statutory combination or, more commonly, to the consolidated statements of a parent and its subsidiary.
There may be several advantages to obtaining control by purchasing a controlling interest in stock. Most obvious is that the total cost is lower, since only a controlling interest in the assets, and not the total assets, must be acquired. In addition, control through stock ownership may be simpler to achieve, since no formal negotiations or transactions with the acquired company’s man agreement are necessary. Further advantages may result from maintaining the separate legal identity of the former company. First at all, risk is lowered because the legal liability of any one corporation is limited to its own assets. Secondly, separate legal entities may be desirable when only one if the company is subject to government control. Lastly, there may be tax advantages resulting from the preservation of the legal entities.
Stock acquisition are said to be “friendly” when the stockholders of the target corporation, as a group, decide to sell or exchange their shares. In such a case, an offer may be made to the board of directors by the acquiring company. If the directors approve, they will recommend acceptance of the offer to the shareholders, who are likely to approve the transaction. Often, a two-thirds vote is required. Once approval is gained, the exchange of shares will be made with the individual shareholders. If the shareholders decline the offer, or if no offer is made, the acquiring company may deal directly with individual shareholders in an attempt to secure a controlling interest. Frequently, the acquiring company may make a formal tender offer. The tender offer typically will be published in newspapers and will offer a greater-than-market price for shares made available by a stated date. The acquiring company may reserve the right to withdraw the offer if an insufficient number of shares are made available to it. Where management and/or a significant number of shareholders oppose the purchase of the company by the intended buyer, the acquisition is viewed as hostile. Unfriendly offers are so common that several standards defensive mechanisms are evolved. Following are the common terms used to describe the defensive moves:
Greenmail. The target company may pay a premium price (“greenmail”) to purchase treasury shares. It may either buy shares already owned by a potential acquiring company or purchase shares from current owner who, it is feared, would sell to the acquiring company. The price paid for these shares in excess of their market price may not be deducted from stockholder’s equity; instead, it is expensed.
White Knight. The target company locates a different company to acquire a controlling interest. This could occur when the original acquiring company is in a similar industry and it is feared that current management of the target company would be displaced. The replacement acquiring company, the “white knight,” might be in a different industry and could be expected to keep current management intact.
Poison Pill. The “poison pill” involves the issuance of stock rights to existing shareholders to purchase additional shares at a price far below fair value. However, the rights are exercisable only when an acquiring company purchases or makes a bid to purchase a stated number of shares. The effect of the options is to substantially raise the cost to the acquiring company. If the attempt fails, there is at least a greater gain for the original shareholders.
Selling the Crown Jewels. This approach has the management of the target company selling vital assets (the “crown jewels”) of the target company to others to make the company less attractive to the acquiring company.
Leveraged Buyouts. The management of the existing target company attempts to purchase a controlling interest in that company. Often, substantial debt will be incurred to raise the funds needed to purchase the stock, hence the term “leveraged buyout.” When bonds are sold to provide this financing, the bonds may be referred to as “junk bonds,” since they are often high-interest and high-risk due to the high debt-to-equity ratio of the resulting corporation.
Further protection against takeovers is offered by federal and state law. The Clayton Act of 1914 (section 7) is a federal law that prohibits business combination in which “the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly.” The Williams Act of 1968 is a federal law that regulates tender offers; it is enforced by the SEC. Several states also have enacted laws to discourage hostile takeovers. These laws are motivated, in part, by the fear of losing employment and taxes.

Accounting Ramifications of Control
When control is achieved through an asset acquisition, the acquiring company records on its books the assets and assumed liabilities of the acquired company. From the acquisition date on, all transactions of both the acquiring and acquired company are recorded in one combined set of accounts.
The only new skill one needs to master is the proper recording of the acquisition when it occurs. Once the initial acquisition is properly recorded, subsequent accounting procedures are the same as for any single accounting entity. Combined statements of the new, larger company for periods following the combination are automatic.
Accounting procedures are more involved when control is achieved through a stock acquisition. The controlling company, the parent, will record only an investment account to reflect its interest in the controlled company, the subsidiary. Both the parent and the subsidiary remain separate legal entities with their own separate sets of accounts and separate financial statements. Accounting theory holds that where one company has effective control over another, there is only one economic entity, and there should be only one set of financial statements that combines the activities of the entities under common control. The accountant will prepare a worksheet, referred to as the consolidated worksheet, that starts with the separate accounts of the parent and the subsidiary. Various adjustments and eliminations will be made on this worksheet to merge the separate accounts of the two companies into a single set of financial statements, which are called consolidated statements.
This chapter discusses business combination resulting from asset acquisitions, since the accounting principles are more easily understood in this context. The principles developed are applied directly to stock acquisitions that are presented in the chapters that follow.