Background

At LSU Professor Xavier teaches micro-biology. As part of his employment agreement, LSU has the rights to any intellectual property or technology developed by Professor Xavier while he is employed there. During his employment at LSU, Professor Xavier founded several companies that use the technology he developed. This technology involves the use of adult human cells to reprogram genes within the cells into stem cells. Each company founded by Professor Xavier is an affiliate of LSU and has entered into an agreement whereby the company would license the technology developed by Professor Xavier from LSU in exchange for equity in the company and ongoing royalty payments to LSU.

Rhea

On July 21, 2XX8, Professor Xavier established Rhea, a biotechnology company that specializes in producing stem cells using the latest technology.

Phoebe

On February 20, 2XX6, Professor Xavier established Phoebe, a biotechnology company that specializes in producing stem cells using second-generation technology. Phoebe is developing products, but has had no revenue (except minimal grant revenue).

Wallace Company

On October 9, 2004, Professor Xavier established Wallace Company, a biotechnology company that specializes in producing stem cells using first-generation technology.

As of mid 2008, Wallace Company has several products and services, contracts with customers, and minimal revenue.

Wallace Company and Phoebe share office and lab space, equipment, and employees. Because of ethical concerns and the regulatory environment surrounding embryonic stem-cell research, both Wallace Company and Phoebe were unsuccessful in gaining significant market traction.

The Merger

On July 25, 2008, Wallace Company and Phoebe merged into Rhea, the surviving entity. Rhea issued its common shares to the shareholders of Wallace Company and Phoebe in exchange for their shares of Wallace Company and Phoebe. After the merger, the Wallace Company and Phoebe legal entities ceased to exist. The shareholders of Rhea, Wallace Company, and Phoebe agreed that the value of each of the respective companies was equal.

The initial financing for each of the three companies was provided by a venture investor, VC, in exchange for equity in each of the companies. VC is an investment company that accounts for its investments at fair value in accordance with the specialized accounting guidance in ASC 946. VC proposed the merger to Professor Xavier, who gave preliminary support for exploration of the proposal. The proposal was then discussed with the boards of each of the companies. The reasons for the merger include (1) the opportunity for all parties to participate in the benefits of Rheas technology and (2) the potential benefits of shared management, economies of scale, scientific cross-fertilization, and enhanced fundraising capacity. In addition, Rhea was able to acquire access to Wallace Companys and Phoebes employees, their stem-cell scientific know-how, equipment, and facilities.

Ownership, Governance, and Significant Financial Information

Before the merger, there was some common ownership among Rhea, Wallace Company, and Phoebe. Professor Xavier controlled Rhea, but no one shareholder controlled Wallace Company or Phoebe. In addition, each of the companies had individual investors. The following table illustrates the shareholder ownership of the entities pre-merger and post-merger.

	Pre- Merger			Post- Merger
	Rhea	Wallace Company	Phoebe
Prof. Xavier	55.3%	37.8%	36.3%	43.1%
VC	21.9%	27.2%	22.0%	23.7%
LSU	14.6%	7.0%	8.4%	10.0%
Mr. D		13.6%		4.5%
Mr. G		14.4%		4.8%
Ms. H			15.6%	5.2%
Ms. L			12.2%	4.1%
Mr. M	8.2%		5.5%	4.6%
Total	100.0%	100.0%	100.0%	100.0%

As noted above, Wallace Company, Phoebe, and Rhea had common investors and thus, had many common members of their boards of directors and some common members of senior management. Each director had a single vote, and there was no agreement among the directors that required board members to vote together. Certain significant decisions at each company, such as a change in control, merger, or change in capital structure (i.e., protective rights), required at least a 75 percent voting share approval. To effect the merger agreement, 75 percent of Wallace Companys voting shareholders, 80 percent of Phoebes voting shareholders, and 75 percent of Rheas voting shareholders were required to approve the transaction.

The following table illustrates the governance roles of the shareholders in the entities pre-merger and post-merger:

	Pre- Merger			Post- Merger
	Rhea	Wallace Company	Phoebe
Prof. Xavier	Director, Chief Science Officer (CSO)	Director, CSO	Director, CSO	Director, Chairman of the BOD, and CEO
VC Principle 1	Director, Chair	Director, Chair	Director, Chair	Director
VC Principle 2	Director, President, CEO, Treasurer	Director, President, CEO, Treasurer	Director, President, CEO, Treasurer	Director, Vice-Chairman of the BOD and President
LSU
Mr. D	Director, Chief Technology Officer			Director
Mr. G	Chief Operating Officer	Chief Operating Officer		Vice President and Chief Technology Officer
Ms. H		Director	Director
Ms. L			Director
Non-shareholder 1	Director			Director
Non-shareholder 2	Chief Business Officer (CBO)	CBO		Director
Non-shareholder 3		Director

The following table provides key financial information before the transaction:

	Pre-Merger
	Rhea	Wallace Company	Phoebe
Debt outstanding to VC	$8.0 million	$6.4 million	$4.7 million
Cash on hand	0	$584,000	$146,000
Employees	5	22	12
Fair value of licensed technology	$377,000	$154,000	$175,000

At the time of the merger, each company was deemed to be of equal of value, $5.3 million. However, no valuation assessment was performed to independently verify that. The majority of the value of each of the companies was related to the employees, scientific know-how, and technology. Rheas technology is estimated to have the highest fair value of $377,000.

In this case study, assume that VC meets the definition of an investment company under both U.S. GAAP and IFRSs

Required:

Be sure to cite the ASC that supports your answer.

1. How should Rhea account for its acquisition of 100 percent of equity interests in Wallace Company and Phoebe: as a merger of entities under common control or as a business combination?

2. If the merger of Rhea, Wallace Company, and Phoebe is a business combination, which entity should be identified as the accounting acquirer?