MHLV is a public company based in Montreal, Quebec that specializes in luxury consumer products and trades on the Toronto Stock Exchange, with 100 million common shares issued and outstanding. It grows by expanding into new markets and acquiring existing companies that fit with its consumer profile. MHLV has a December 31st year end. See Exhibit 2 for the December 31, 2021 Income Statement. MHLV follows International Financial Reporting Standards. It is important that any acquisitions MHLV undertakes fit with its mission and objectives. In addition, MHLV is planning another share issuance in the near future and potential investors are concerned about the profitability and net income of MHLV as a whole. You work as an accountant for MHLV and have been asked to prepare a report to the CFO of MHLV analyzing two transactions. The first transaction, the acquisition of Gephora occurred this year and you have been asked to evaluate the effect on the financial statements of MHLV. Information on the acquisition is contained in Exhibit 1. This transaction is already reflected in the MHLV Financial Statements as part of investments. The second transaction is the potential acquisition of Chrior. MHLV is interested in possibly acquiring an interest in Chrior, another luxury consumer goods company. The CFO of MHLV has been in negotiations and has presented you with three options that have been proposed (Exhibit 3). The CFO would like to know what the impacts would be for each of the potential acquisition options. The CFO would like a memo analyzing your opinion on the possible reporting implications of each of the options.
Exhibit 1-Acquisition of Gephora
Gephora is a company that operates a chain of retail stores selling luxury makeup and beauty products. On September 30, 2021 MHLV assumed the Gephora operations, including the patents and processes associated with Gephora branded products. These patents and processes are important to MHLV and are part of the reason for acquiring Gephora. The transaction consisted of purchasing the net assets, which MHLV obtained control of on September 30, 2021.
MHLV engaged a third-party specialist to assist it in the measurement of the fair value of the assets required. The specialist determined that the fair value of the assets acquired exceeded the cost of the acquisition. The excess value of the net assets acquired over the purchase price has been recorded as a bargain purchase gain, which is included in gain on acquisition of a business in MHLV's consolidated statements of income. The following table summarizes the fair values of the assets acquired and liabilities assumed(in millions of dollars) as determined by the third-party specialist, in the Gephora acquisition at the date of purchase.
Cash $ 15
Property, plant and equipment $250
Accounts receivable $75
Intangible assets $150
Total Assets acquired
$490
Current liabilities$ 50
Long term debt 125 (5% due December 31, 2026)
Total liabilities assumed 175
Net assets acquired 315
Total consideration paid 275
Gain on acquisition 40
The initial consideration of approximately $275 million was comprised of approximately $225 million in cash and 25 million shares of MHLV's common stock. For accounting purposes the stock portion of the initial consideration was valued at approximately $50 million based on the average closing price of MHLV's common stock surrounding the acquisition announcement date of September 2, 2021. At September 30, 2021 the market value of the MHLV shares was $2.50/share.
The identifiable intangible assets, which includes the patents and processes, were appraised and valued at a range between $100 million and $150 million. The property plant and equipment is primarily an office building valued at $150 million and equipment valued at $ 50 million. MHLV will not need the building as they already have an existing office building with excess space and will sell it immediately for an estimated $100 million.
Exhibit 1- Acquisition of Gephora (Continued)
MHLV has agreed to pay an additional amount to the selling shareholders of Gephora in the future. The maximum amount potentially payable is approximately 10 million dollars and would be payable in cash or common stock at MHLV’s option. The payment is contingent upon Gephora achieving certain revenue, gross profit, and net income targets. The amounts would be payable if the targets are achieved over any four-quarter period from January 1, 2022 through December 31, 2023. Additional bonus payments of up to an aggregate of approximately $250 million would be payable if Gephora exceeds the targets during the fiscal year ended December 31, 2022. The probability of achieving all of these targets has been assessed at 30%.
EXHIBIT 2
MHLV Inc. Income Statement for the Year Ended December 31, 2021 (in thousands $)
Revenues.$150,000
Cost of Goods Sold.50,000
Gross Profit.100,000
Operating Expenses.25,000
Earnings before Interest and Tax.75,000
Interest Expense.10,000
Income Tax Expense.20,000
Net Income.
$45,000
EXHIBIT 3 - CHRIOR ACQUISITION INFORMATION
MHLV is considering one of the following options in order to acquire Chrior.
1. Buy all of the net assets of Chrior for $500 million.
2. Buy 100% of the shares of Chrior for $400 million
3. Buy 50% of the shares for $150 million and buy 10,000 convertible securities for $300 million. Maximum 10,000 shares could be issued Presently, Chrior has 5,000 shares outstanding and the net assets of Chrior have a book value of $350 million. The 5,000 shares are owned by one shareholder.
The memo you draft should analyze the effects of each option on reporting.