Accounting Requirements and Challenges in Preparing Financial Statement - Research Paper Example

Multinational Acquisition Table of Contents INTRODUCTION 3 Overview 3 Research Objectives 3 Outline of the Study 4 LITERATURE REVIEW 4 Accounting Requirements and Challenges in preparing Financial Statement 4 Evaluation of Intangible Assets 6 Analysis of Special Issues in New Business Combination 7 Key Areas of Differences in the Acquired Company 8 References 10 INTRODUCTION Overview Multinational Acquisitions are common nowadays due to the turbulent global economic scenario which provides a very uncertain future for firms throughout the world. In this way, Multinational Acquisitions can be seen as a way that firms seek to reduce risk. Yet, various complications arise when a multinational company acquires another multinational company (Ernst & Young, 1994, p. 212). Similarly, due to difference in culture, regulations, tax laws and policies complications arise. In 2010, the world witnessed the acquisition of a famous multinational company Cadbury by Kraft Food Products. Kraft Foods, an American multinational, which deals in food products acquired Cadbury, a British multinational dealing in confectionary products, as a way to diversify its holdings. As such, in January 2010, Kraft Foods acquired Cadbury for £11.9 billion ($19.6 billion) (Merced & Nicholson, 2010). This made Kraft Foods the biggest confectioner in the world. It has been recorded as the biggest food and beverage deal in European history according Reuters. The initial offer of Kraft Foods was 745p, per share which was increase by 14 percent to 850p per share. Initially the acquisition was opposed by the trade unions because they had the prescient concern that such an acquisition would necessarily lead to job cuts. However, Kraft Foods confirmed that the combined company would be able to create more jobs in UK, apart from the existing employees that Cadbury currently employed (Jones, & Dorfman, 2010). Research Objectives The objective of this research is to focus on the issues that arise after a multinational acquisition acquires a different organizational culture, framework, process and system in comparison to the company which has acquired it. The motive would be to analyze the accounting requirements after acquisition, difficulties that arise with reference to preparation of combined financial statements, as well as to separately assess the goodwill of the business combination and other key issues. The objective would also be to study the IFRS and GAAP guidelines which are applicable in cases such as the one that will be studied. Outline of the Study The research study includes a detailed study of the multinational acquisition of Cadbury by Kraft Foods. General analysis of the scenario before acquisition is done; furthermore, the study will discuss the after effects of acquisition within the new business combination. As such, the study will begin with a brief overview of the acquisition that took place in January 2010. The research objective is stated to describe the motive behind conducting the research. Furthermore, a literature review will include analysis of the accounting requirements and the challenges faced by the company in preparing the combined financial statements. Apart from this discussion on the process of evaluating the intangible assets of the company and key changes that are made in the acquired company would be revealed, the study will attempt to give a complete view of the successful objectives required by such an approach. LITERATURE REVIEW Accounting Requirements and Challenges in preparing Financial Statement In the case of the acquisition of Cadbury by Kraft Foods, the holding company is Kraft Foods and Cadbury is the subsidiary. Therefore, the companies in this business combination need to apply for acquisition accounting to the newly united business. Similarly, the holding company is the one which holds majority of the shares of the subsidiary company. The holding company must also become responsible for the balance sheet and profit and loss statements of the subsidiary company. The holding company has to also reveal to the board of directors of the subsidiary all of the requisite information which has thus far been detailed. There are two methods that are generally applied in case of business combinations: pooling of interest method and what is referred to as the purchase method. However in the year 2001, the pooling of interest method was eliminated by FASB so only the purchase method was applicable in this case. In 2007, a modified version of FASB statement 141 was introduced. The purchase method was therefore replaced by the acquisition method for new business combinations after the specified date what has been listed. This method of accounting was applicable from 2008. Since Kraft acquired Cadbury on 2010, Kraft and Cadbury were necessitated to follow the acquisition method of accounting. In this acquisition accounting method, the acquirer must recognize all the assets and the liabilities that have been assumed in the business combination and calculate them at their fair value as of the date of acquisition. If the acquired company has been totally purchased then the uncontrollable interest is also calculated at fair value at the date of acquisition. The assets and the liabilities of the acquirer, meaning Kraft Foods, would not be affected through the new business combination (Rezaee, 2004, p. 217-219). In the acquisition method the acquisition of the tangible as well as the intangible assets and the liabilities are duly considered. It this type of method there is no different accounts for asset valuation are maintained in relation to assets acquired. The long-term assets are valued at their date of acquisition and sold off at their fair value by deducting the cost of sales. The deferred income tax, and the assets and liabilities of the business combination are valued at the specific standards stated by FASB for acquisition. All the cost that has been incurred for acquiring the company and expenses incurred would be regarded as an acquisition expense. The costs incurred for issuing the equity securities which are used for acquiring the acquiree are treated like cost of issuing stocks are generally treated. This means as a decrease in the paid up capital of the securities (Moeller, 2012). There are many challenges that Kraft might have faced just the generally cases of acquisition. In such cases as this issues arise in case of valuating the assets of the company because Cadbury too have few subsidiaries and Kraft have to ascertain the value of the assets and liabilities of Cadbury and its subsidiaries and adjust them in its financial statements. Secondly, different in the tax assumptions and tax policies of the countries where these companies operated before acquisition would also create hurdle. The tax assumptions and policies had to be unified. Thirdly, assessment of goodwill has to be written off as well. IFRS does not welcome or positively support these specific factors, so hurdles in these cases would arise. Apart from this depreciation calculation of the new business combination, deferred tax payments and calculations are also a few challenges which Kraft Foods would face in the preparing the financial statements (Rezaee, 2004, p. 217-219). Evaluation of Intangible Assets Valuation of intangible assets in case of acquisition becomes complex. The acquisition of multination is done at higher than the worth just to earn goodwill. So goodwill plays an important role in new business combinations. Goodwill involves all the intangible facts of the new business combination that will allow the business to make profits. FSAB states that goodwill is an asset which symbolizes the prospective benefits that might arise from any tangible asset from the business combination and not individually. Under the acquisition method, the acquirer would calculate and identify the goodwill from the new business combination on the basis of the different that would arise from the total fair value of Cadbury and the fair value of the net identifiable assets of Cadbury. However, FASB has determined not to solely focus on the acquiree’s total fair value, but on the component that provide the fair value. FSAB has also identified three items that should be recognized in the goodwill of the new business combination, they are: 1. Fair value of the concern agreed by the acquirer that is Kraft Foods. 2. Fair value of the interest of acquiree that is Cadbury held by acquirer, Kraft Foods. 3. Fair value of the interest that is uncontrollable in Cadbury. All these three amounts are measured at the date of acquisition and then compared to the fair value of net identifiable asset of the acquiree that is Cadbury. This differential in overall amount is the goodwill. Analysis of Special Issues in New Business Combination As it is already known, consolidation of business means combining two business firms through either acquiring the company or by merging to form a new company. In case of Kraft Foods, it acquired Cadbury. Kraft’s hostile bid for Cadbury became successful in 2010 January, when Cadbury agreed to be acquired by Kraft Foods at £11.6 billion. Obviously with this new business combination, Kraft had to follow the accounting standards stated by IAS, IFRS, or GAAP for acquisition accounting. The ownership of the acquired company is logically transferred to the company which has acquired it. Therefore, Cadbury as a company was delisted from the stock exchange because no separate legal entity named Cadbury existed. The accounting requirement and the ways of presenting the financial statement would also depend on the way the holding company represents itself. Due to the fact that Kraft Foods has what the law terms “total control” over Cadbury because it owns more than 50 percent stocks of Cadbury, the ways in which Kraft is therefore responsible for reporting requirements is fundamentally changed. Control in terms of deciding the board of directors, management, and the policies would be according to the framework of Kraft Foods. Therefore, the companies would have separate books of accounts but they would consolidate their accounting books in a combined financial statement and annual report at the end of the year. The intercompany transactions would therefore cease to exist. In this way, restricting the corporate governance, alternations in tax and accounting system, and human resource policies which also includes the salary slabs and performance appraisal system would change for Cadbury and to some extent in Kraft Foods in the new Business combination (Shukla & Subramanian, 2012). Key Areas of Differences in the Acquired Company The objective of Kraft Foods behind acquiring Cadbury was expanding in those markets where Cadbury was a market leader such as India and other Asian countries. Kraft therefore solely approached this acquisition from a profit/competitive advantage motive (as it wanted to become the major player in the confectionery industry by acquiring another leading company in the industry). Moreover, Mars was a strong competitor of Kraft Foods, so in order to win in this competition Kraft Foods went for a hostile acquisition of Cadbury. Cadbury already being a well-known brand and a revenue generating company initially did not agree to the price bid for its acquisition. However after toil of two years it finally settled the deal. Cadbury and Kraft are both companies in the same industry, so the objectives are similar. At the initial level it was decided that the name Cadbury would be changed to Mondelez, but Cadbury has become a brand name for chocolates, and customers would not recognize the new brand without the name Cadbury. So Kraft Foods was forced to take a more moderate approach and change this preliminary decision. Similarly, and perhaps most importantly, changes in the board of directors were made. The tax assumptions and policies were redefined according to the new framework. Apart from this the changes in the marketing strategies and the business model according to the strategies of Kraft Foods were ensured. Further downsizing was not done and the employee strength of Cadbury was kept intact (Beaudin, 2010). References Beaudin, G. (2010). Kraft-Cadbury: Making acquisitions work. Retrieved from: http://www.businessweek.com/managing/content/feb2010/ca2010028_928488.htm#p2. Ernst & Young. (1994). Mergers and acquisitions. (2nd ed.). New Jersey: John Wiley & Sons. Jones, D., & Dorfman, B. (2010). Kraft snares Cadbury for $19.6 billion. Retrieved from: http://www.reuters.com/article/2010/01/19/us-cadbury-idUSTRE60H1N020100119. Merced, M. J. D. L., & Nicholson, C. V. (2010). Kraft to acquire Cadbury in deal worth $19 billion. Retrieved from: http://www.nytimes.com/2010/01/20/business/global/20kraft.html. Moeller, S. (2012). Case study: Kraft’s takeover of Cadbury. Retrieved from: http://www.ft.com/intl/cms/s/0/1cb06d30-332f-11e1-a51e-00144feabdc0.html#axzz2CqyBpLaV. Rezaee, Z. (2004). Financial institutions, valuations, mergers, and acquisitions: The fair value approach. (2nd ed.). New Jersey: John Wiley & Sons. Shukla, G., & Subramanian, A. (2012). Change at the chocolate factory. Retrieved from: http://businesstoday.intoday.in/story/kraft-takes-over-cadbury-india-changes/1/21920.html. Read More