FinancialReportingandTaxation IssuesinM&A

Case:AccountingforAcquisitionsat JDSUniphaseCorporation

JDSUQuarterlyResultsFY2001
NetSales CostofSales GrossProfit OperatingExpenses R&D Selling,General,andAdministrative Amort.OfPurchasedIntangibles AcquiredInProcessR&D ReudtcionofGoodwill andIntangibles RestructuringCharges TotalOperatingExpenses Income(Loss)fromOperations GainonSale ofSubsidiary EquityRelatedWritedowns/Losses InterestandOtherIncome,Net AvailableforSale Investments AvailableforsaleInvestments(Writedowns) Income(Loss)BeforeIncomeTaxes IncomeTaxExpenses NetIncome(Loss) NetIncome(Loss)PerShare 30Sep00 31Dec00 31Mar01 30Jun01 Total 30Sep00 31Dec00 31Mar01 30Jun01 Total 786.5 925.1 920.1 601.1 3232.8 100 100 100 100 100 436.7 449.8 494.2 926 2306.7 56 49 54 154 71 349.8 475.3 425.9 324.9 926.1 44 51 46 54 29 62.4 116.2 1107.4 8.9 71.2 105.2 1104.1 94.3 325.9 155.4 817.6 1055.3 5387 0.6 393.2 10307.8 50085 264.3 264.3 42819.9 11877.7 57273 42394 12202.6 56346.9 1770.2 1770.2 759.9 30.5 883.9 4.6 18.1 48.5 559.1 559.1 522.1 522.1 41379.1 13296.2 56493.8 468.8 934 371.7 41847.9 12362 56121.9 36.63 9.39 51.4 98 440.8 2120.2 383.7 39777.2 8 15 141 1 0 0 165 120 0 5 2 0 0 124 6 129 8 11 119 0 0 0 138 87 0 6 1 0 0 91 5 97 11 48 230 42 4323 0 4654 4608 192 83 0 0 0 4497 51 4548 16 26 176 0 1715 44 1976 2030 0 5 3 93 87 2212 155 2057 10 25 167 12 1549 8 1772 1743 55 27 2 17 16 1748 11 1736
2

1294.9 945.1 41.2 13.6

1280.5 805.2 52.3 12.2

972.7 43.9 1016.6 1.07

845.8 49.6 895.4 0.93

CondensedConsolidatedBalance Sheet
Interim FY2000 Interim FY2000 Assets Cash&CashEquivalents ShortTermInvestments AccountsReceivable Inventories OtherCurrentAssets TotalCurrentAssets Property,Plant,andEquipment,Net IntangibleAssets,IncludingGoodwill LongTermInvestments OtherAssets TotalAssets 430.1 319 700.6 795.3 631.9 381.6 493.9 375.4 140.5 101.6 2397 1972.9 930.7 670.7 20018.3 22337.8 893.6 760.9 705.6 646.8 24945.2 26389.1 2 3 3 2 1 10 4 80 4 3 100 1 3 1 1 0 7 3 85 3 2 100
3

CondensedConsolidatedBalance Sheet
Interim LiabilitiesandEquity AccountPayables AccruedPayroll andRelatedExpenses OtherCurrentLiabilities Total CurrentLiabilities DefferedTaxLiabilities OtherNonCurrentLiabilities LongTermDebt TotalLiabilities Stockholders'Equity CommonStockandAdiitional PaidinCapital AccumulatedDeficitandOtherStokcholders'Equity Total Stockholders'Equity Total LiabilitiesandStockHoldersEquity 232.9 114.6 331.4 678.9 926.9 21.3 27.2 1654.3 FY2000 Interim 195.2 98.8 353.2 647.2 902.1 20.2 41 1610.5 1 0 1 3 4 0 0 7 106 12 93 100 FY2000 1 0 1 2 3 0 0 6 98 4 94 100
4

26340.6 25900 3049.7 1122.3 23290.9 24777.7 24945.2 26388.2

ThreeAcquisitions
Acquisitions OCLI ETEK SDL Announced Nov.4,1999 Jan17,2000 Jul.10,2000 TotalValue $2.8billion $15billion $14billion JDSPrice $47.97 $97.84 $105.50

PurchaseCostBreakdownofSDL Acquisition
Tangible NetAssets Intangible Assets ExisitingTechnology Core Technology TrademarkandTradename Assembledworkforce DeferredCompensation Goodwill InProcessR&D Total Purchase Price 617.4 1.50% 455.4 1.11% 214.2 0.52% 46 0.11% 47.7 0.12% 203.7 0.49% 39,228.0 95.23% 380.7 0.92% 41193.1 100.00%
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JDSUAcquisitionofOCLI PurchasePriceAllocation
Tangible NetAssetsRequired Intangible AssetsAcquired DevelopedTechnology Telecommunications Flex Products AppliedPhotonics InformationIndustries ProprietaryKnow How TrademarkandTrade Name AssembledWorkforce In ProcessResearchandDevelopment Goodwill DeferredTax Liabilities Total Purchase Price Allocation Amount Percentage 253.2 9.4

115.1 92.2 1 23.9 161.9 38.5 14.3 84.1 1927.4 4.1 2707.5

4.3 3.4 0.0 0.9 6.0 1.4 0.5 3.1 71.2 0.2 100.0

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JDSUAcquisitionofETEK PurchasePriceAllocation
Tangibel NetAssetsAcquired Marketable EquityInvestments Intangible AssetsAcquired DevelopedTechnology ExtisitingTechnology 248.7 Core Technology 168.5 TrademarkandTrade Name 60.4 AssembledWorkforce 10.7 In ProcessR&D 250.6 Goodwill 15,422.50 Total Purchase Price Allocation 17506.4 Amount Percentage 395 2.3 950 5.4

1.4 1.0 0.3 0.1 1.4 88.1 100.0

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Deal(Example)

HardinTool Company

Hardintoissue100,000sharesfor40,000sharesofPratt Nointercompanytransactions

PrattEngineering Company

Newpublicofferingof100,000 sharesofHardincanbemade publicat$8pershare

AppraisedvalueofNetAssets:$600,000 Assetsbookvalue:$441,000

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Poolingvs.PurchaseMethod
Condensed Balance Sheets as of the Proposed Acquisition Date (Thousands of Dollars) Hardin Pratt Hardin Pratt Assets Current assets $432 $246 39% 44% Plant and equipment 690 312 61% 56% Total assets $1,122 $558 100% 100% Liabilities and Equities Current liabilities $263 107 23% 19% Long-term debt 195 10 17% 2% Common stock ($1 par) 100 40 9% 7% Additional paid-in capital 218 94 19% 17% Retained earnings 346 307 31% 55% 15 Total liabilities and equity $1,122 $558 100% 100%

Poolingvs.PurchaseMethod
Condensed Income Statement as of the Proposed Acquisition Date (Thousands of Dollars) Hardin Pratt Hardin Pratt Sales $2,100 1500 100% 100% Expenses 1620 1120 77% 75% Income $480 $380 23% 25% Income tax expense 168 133 8% 9% Net income $312 $247 15% 16%
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Poolingvs.PurchaseMethod
Condensed Balance Sheets as of the Proposed Acquisition Date Hardin Pratt Pooling Purchase Assets Current assets $432 $246 $678 $678 Plant and equipment 690 312 $1,002 $1,161 1002 + (600-441) Goodwill 200 (100,000*8=800,000)-$600,000 Total assets $1,122 $558 $1,680 $2,039 Liabilities and Equities Current liabilities $263 107 $370 $370 Long-term debt 195 10 $205 $205 Common stock ($1 par) 100 40 $200 $200 Additional paid-in capital 218 94 $252 $918 plug in Retained earnings 346 307 $653 346 Total liabilities and equity $1,122 $558 $1,680 $2,039
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Poolingvs.PurchaseMethod
Condensed Balance Sheets as of the Proposed Hardin Pratt Polling Purchase Sales $2,100 1500 $3,600 $3,600 Expenses 1620 1120 $2,740 $2,740 Income $480 $380 $860 $860 Additional depreciation $16 $159,000/10 years = 16,000 Taxable income $860 $844 Income tax expense $301.0 $295.4 Net income $559.0 $548.6 Earnings Per Share $2.80 $2.74
Lifeofplantandequipment:10years Depreciationmethod:Straightlinedepreciation Incometaxrate:35%
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WhataretheMethodsAvailableto MitigateGoodwillHangoverProblems?
Extend Amortization periodtoMax.40 years WriteDownthe Goodwill

UsePooling Methodof Accounting?

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WhatistheMotivationforJDSUtodo theWriteDownsatthisTime?
Giventhestateofthe marketfortechnology stocks,appropriatetimeto releasebadnews,alongwith othercompaniesinthis sector Simultaneouslyannounced pooroperatingperformance andwasannouncingano.of otherwritedowns inventoryandrestructuring charges

BigBathstrategies lumping oflosses

Writedownsalsoplacethe companyinafavorable positioninfutureperiods

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HowmuchisJDSUsavinginFutureGoodwill AmortizationonanAnnualBasis?
$44.8billionwritedownof goodwillreducestotal assetsfrom$65.7billionto $20.9billion

ImprovesROA

Companysfutureearnings willincreasebytheamount goodwillamortizationthat wouldhavebeencharged on$44.8billion=~$9billion peryearover5years

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WhatistheAdverseEffectofTakingtheWriteDowns SoonerratherthanLater?

Significantincreasetothenegative accumulateddeficitmayimpose restrictionsonthecompany(eg.:inability topaydividend)formanyyearstocome

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WhatistheOpportunityCostofthe Acquisition?
Insteadissuing538millionshares topayfortheacquisition Wouldnothavebeenabletosell suchalargeamountofstockinthe publicmarket Amountofcashraisedmaynot havebeensufficientforacash purchaseofSDL Couldriskindustrydominanceby notpurchasingSDLandraisecash 51 instead

Secondary Offering

RelevantAccountingStandards

Accounting Standards

India AS14

International Accounting Standard

InternationalIFRS 3

IAS22 Business Combination

IAS36Impairment ofAssets

IAS38 IntangibleAssets

FAS141 Business Combinations

FAS142 GoodwillandOther IntangibleAssets

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IdentifyingAcquirer
>1/2votingrights incombinedentity Powertoappoint orremove majorityofBOM Powertocast majorityofvoting inmeetingsof BOD Abilityto determine combineentities managementteam

Fairvalueof companies

Termsof arrangements

Specificvoting rightsprovided

Otherconditions

Statutory requirements

Optionsor warrantsonissue

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IntangibleAssetClassificationandImpairment TestRequirements
IntangibleAssets

IndefiniteUsefulLife

DeterminableUsefulLife

NoAmortization Required ShoulddoImpairment Testing(Annuallyoron Indication)

Amortizationoveruseful Life (Impairmenttestif indicationofimpairment)

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ImpairmentModel
NewCarrying Amount(After WrittenDown)
Lowestof

Carrying AmountBefore theImpairment

Recoverable Amount
Highestof..

Priceagreedinabindingsalesagreement forcashgeneratingunitinanarmslength transaction,adjustedforincrementalcosts attributabletothedisposal Cannotbedeterminedbyreferencetoan activemarket

FairValueLess CosttoSell

ValueinUse

Requirescashflow forecastforatleast 5 years,Estimatedon presentconditionofthe asset,andCashflows anddiscountrateshould bepretaxbasis

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ExampleforImpairmentTesting
EntityEYAssessingCashGeneratingUnitCGUforImpairment
Assets intheBooksofCGU(Thousand$) PP&E Licenses Land(atRevaluedAmount) Goodwill Total 200 50 400(Cost320) 50 700
Goodwilliswrittenofffully,and cannotbereversed EntityEY analysestheremaining assetsafterwards Impairmentlossonlandhitsthe revaluationreserve preferred bythefirm

ThroughImpairmenttestCGUisfoundtohavearecoverableamountof$550

Assets intheBooksofCGU(Thousand$) PP&E Licenses Land(atRevaluedAmount) Goodwill Total 200 31=169 508=42 40061=339(Cost320) 5050=0 550

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AccountingTreatmentofGoodWill
Country Predominant Method US Caiptalize UK Write against RE Canada Caiptalize if > 40 years Japan Capitalize; Price - Book Value of net assets France Capitalize Germany Capitalize Switzerland Both write against RE and capitalize allowed Netherlands Both write against Equity or as expenses Hong Kong Both write against Equity or as expenses Australia Capitalize Malaysia Capitalize
Goodwill arises from purchase m ethod Goddwill = Purchase price > fair v alue of net assets Am ortization of goodwill m ay not be tax deductible unless its allowed
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Comments Amortize expense over useful life (not to exceed 40 years) May capitalize if life known Amortize expense over useful life Amortize in life (not to exceed 5 years) Amortize expense over 5 to 20 years Amortize expense over 4 years (can extend if justified) Amortize Amortize expense over 5 years (can extend to 10 if justified) Amortize only to the extent the value has diminished Amortize in life (not to exceed 20 years) Amortize expense over useful life

Impairment of Assets Differences

Difference Criterion Timing of impairment review IFRS and IGAAP Annually US GAAP whenever events or changes in circumstances indicate that the carrying amount may not be recoverable Fair value < Carrying amount

Asset is Impaired if

Recoverable amount < Carrying amount Recoverable amount is higher of Net Selling Price Value in use Use discounted cash flows for calculating the value in use Whenever there is a change in the economic conditions

Recoverable Amount / Fair Value

Fair Value is the amount at which an asset or liability could be bought or settled in a current transaction between willing parties Use undiscounted cash flows for calculating the fair value Prohibited

Cash Flows for calculating value in use / fair value Reversal of impairment loss

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TaxesinanM&ATransaction
Incometax (Individualsand Corporations)

Realestate transfertax

Stampduty

Realestate capitalgainstax

Withholdingtax

ValueAdded Tax

Securities transfertax

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AmalgamationTermsunderITAct
Fulfillsection2(1B)of Incometaxactby transferorcompany Amounttobeinthe formofshares Nocashtobereceived

ForeignDirect investmentsinselected sectorcannotexceed 74%byforeign company

Fulfillsection72Aofthe ITactsoastoreapthe benefitbytransferee company

Shareholderscannot transfertheirholdings within5years.

Salestaxattherateof 8%cannotbeavoided.

Setoffandcarry forwardoflossesis possible.

Whatarethelossescan becarriedforwardand setoff?Howmany years?

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TaxRelatedBenefitstoBuyer
Deductionof thefinancing costs(Debt pushdown) Deductionof the transaction costs

Multiple taxationortax privileges

Flexibilityin integration/ Reorganisation

Capitalisation and amortisation ofgoodwill

Utilisationof lossescarried forward

Repaymentof purchaseprice asquicklyas possible

Revaluationof theassets

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TaxImpactComparison
AssetDeal
Gainsubjecttotaxat thelevelofseller (corporation)

StockDeal
Taxexemptprivate capitalgain (individuals)or participationrelief (corporation)

Liquidationproceed subjecttotaxatthe levelofshareholder

But:Indirectpartial liquidationregime

Amortisationof goodwilland depreciationofother assetspossible

Nogoodwill amortisation

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TaxImpactComparison
AssetDeal
Taxlossescannotbe carriedforwardby buyer,butbeusedby sellertosetoffgainon sale

StockDeal
Taxlossescanbe carriedforwardby company

Higherinitialfinancing costs,butasaresult lowertaxburdenfor buyer

Lowerinitialfinancing costs,butasaresult highertaxburden

Taxefficientinterest deduction

Verylimiteddebtpush downpossibilities

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RulesforClaimingTaxBenefitson LossofAcquired
Accumulatedlosses remainunabsorbedfor3 ormoreyears 75%ofbookvaluetobe heldatleastfor2years beforeamalgamation Amalgamatedcompany continuestohold3/4th of bookvalueatleast for5 years

Newcompanyshould continueforanother5 years

Newcompanyshould achieveatleast 50%of installedcapacitybefore endof5yearsandshould continuefor5years

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RulesforClaimingTaxBenefitson LossofAcquired
Amalgamatingcompanyhas beeninthatbusinessforat least3years,andhasheldat least3/4th ofbookvalueoffixed assetsfor2years Amalgamatedcompanyto continuethebusiness(all businesses)ofamalgamating co.foratleast5years

Amalgamatedcompanytohold least3/4th ofbookvalueoffixed assetsofamalgamating companyfor5years

Amalgamatedcompanytofulfill suchotherconditionsasmaybe prescribedtoensuretherevival ofbusinessofamalgamatingco. orthatamalgamationisfor genuinebusinesspurpose

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ValueTerms
FairValue AverageMarket Price Capitalization Rate PEMultiple
=(NetAssetvalue+ProfitEarningCapacityValue)/2

Year1:(High+Low)/2 Year2:(High+Low)/2 CurrentYear:MonthwiseAverage AverageMarketPriceisestimatedintotalforthreeyears IfMVnotmorethan20%ofFV:15% IfMVmorethan20%50%ofFV:12% IfMVBetween51%75%ofFV:10% IfMVabove75%:8%

AverageP/EratioofrelatedcompaniesareConsideredto discount

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