2 METHODS OF ACCOUNTING FOR BUSINESS COMBINATION

(A letter A after a question e!er"ise or #ro$le% %eans t&at t&e question

e!er"ise or #ro$le% relates to t&e "&a#ter a##en'i!()
Questions
*) Dis"uss t&e $asi" 'i+eren"es $et,een t&e #ur"&ase %et&o' an' t&e
#oolin- of interests %et&o') In"lu'e t&e i%#a"t on .nan"ial ratios)
2) /&en a "ontin-en"0 is $ase' on se"urit0 #ri"es an' a''itional sto"1 is
issue' &o, s&oul' t&e a''itional sto"1 issue' $e a""ounte' for2 /&02
3) /&at are #ro for%a .nan"ial state%ents2 /&at is t&eir #ur#ose2
4) Ho, ,oul' a "o%#an0 'eter%ine ,&et&er -oo',ill &as $een i%#aire'2
5) Des"ri$e t&e #otential 'i+eren"es $et,een a""ountin- for a %er-er
usin- t&e #ur"&ase rules as #res"ri$e' $0 FASB in State%ents No) *4* an'
*42 t&e for%er #ur"&ase rules (,it& -oo',ill a%orti6ation( an' t&e
#oolin- of interests %et&o') Assu%e t&at t&e "ost of t&e a"quisition
e!"ee's t&e fair 7alue of t&e i'enti.a$le net assets of t&e a"quire' .r%
an' t&at t&e fair 7alue of t&e i'enti.a$le net assets e!"ee's t&eir
#re"o%$ination $oo1 7alue)
8) AO9 announ"e' t&at $e"ause of a ne, a""ountin- "&an-e (FASB
Statements No. 141 and 142( earnin-s ,oul' $e in"reasin- o7er t&e ne!t
t,ent0:.7e 0ears $0 ;5)< $illion a 0ear) /&at "&an-e(s( require' $0 FASB
(in SFAS No. 141 and 142( resulte' in an in"rease in AO9=s in"o%e2 /oul'
0ou e!#e"t t&is in"rease in earnin-s to &a7e a #ositi7e i%#a"t on AO9=s
sto"1 #ri"e2 /&0 or ,&0 not2
Exercises
Exercise 2-1 Asset Purchase
>reston Co%#an0 a"quire' t&e assets (e!"e#t for "as&( an' assu%e' t&e
lia$ilities of Sa7ille Co%#an0) I%%e'iatel0 #rior to t&e a"quisition Sa7ille
Co%#an0?s $alan"e s&eet ,as as follo,s@
Boo1 Aalue Fair Aalue
Cas& ; *2BBBB ; *2BBBB
Re"ei7a$les (net( *<2BBB 22CBBB
In7entor0 38BBBB 3<8BBB
>lant an' equi#%ent (net( 4CBBBB 54BBBB
9an' 42BBBB 88BBBB
Total assets ;*5D2BBB ;*<44BBB
9ia$ilities ; 54BBBB ; 5<4BBB
Co%%on sto"1 (;5 #ar 7alue( 4CBBBB
Ot&er "ontri$ute' "a#ital *32BBB
Retaine' earnin-s 42BBBB
Total equities ;*5D2BBB
Required@
A) >re#are t&e Eournal entries on t&e $oo1s of >reston Co%#an0 to re"or'
t&e #ur"&ase of t&e assets an' assu%#tion of t&e lia$ilities of Sa7ille
Co%#an0 if t&e a%ount #ai' ,as ;*58BBBB in "as&)
B) Re#eat t&e require%ent in (A( assu%in- t&e a%ount #ai' ,as
;<<BBBB)
Exercise 2-2 Purchase Method
T&e $alan"e s&eets of >etrello Co%#an0 an' San"&e6 Co%#an0 as of
Fanuar0 * 2BB4 are #resente' $elo,) On t&at 'ate after an e!ten'e'
#erio' of ne-otiation t&e t,o "o%#anies a-ree' to %er-e) To e+e"t t&e
%er-er >etrello Co%#an0 is to e!"&an-e its unissue' "o%%on sto"1 for
all t&e outstan'in- s&ares of San"&e6 Co%#an0 in t&e ratio of G s&are of
>etrello for ea"& s&are of San"&e6) Mar1et 7alues of t&e s&ares ,ere
a-ree' on as >etrello ;4CH San"&e6 ;24) T&e fair 7alues of San"&e6
Co%#an0?s assets an' lia$ilities are equal to t&eir $oo1 7alues ,it& t&e
e!"e#tion of #lant an' equi#%ent ,&i"& &as an esti%ate' fair 7alue of
;D2BBBB)
>etrello San"&e6
Cas& ; 4CBBBB ; 2BBBBB
Re"ei7a$les 4CBBBB 24BBBB
In7entories 2BBBBBB 24BBBB
>lant an' equi#%ent (net( 3C4BBBB CBBBBB
Total assets ;8CBBBBB ;*4CBBBB
9ia$ilities ;*2BBBBB ; 32BBBB
Co%%on sto"1 ;*8 #ar 7alue 344BBBB CBBBBB
Ot&er "ontri$ute' "a#ital 4BBBBB ::B::
Retaine' earnin-s *D8BBBB 38BBBB
Total equities ;8CBBBBB ;*4CBBBB
Required@
>re#are a $alan"e s&eet for >etrello Co%#an0 i%%e'iatel0 after t&e
%er-er)
Exercise 2-3 Asset Purchase, Cash and Stock
>ret6el Co%#an0 a"quire' t&e assets (e!"e#t for "as&( an' assu%e' t&e
lia$ilities of Salt Co%#an0 on Fanuar0 2 2BB5) As "o%#ensation >ret6el
Co%#an0 -a7e 3BBBB s&ares of its "o%%on sto"1 *5BBB s&ares of its
*BI #referre' sto"1 an' "as& of ;5BBBB to t&e sto"1&ol'ers of Salt
Co%#an0) On t&e a"quisition 'ate >ret6el Co%#an0 sto"1 &a' t&e
follo,in- "&ara"teristi"s@
Pretzel Co!an"
Sto"1 >ar Aalue Fair Aalue
Co%%on ; *B ; 25
>referre' *BB *BB
I%%e'iatel0 #rior to t&e a"quisition Salt Co%#an0?s $alan"e s&eet
re#orte' t&e follo,in- $oo1 7alues an' fair 7alues@
SA9T COM>ANJ
Balan"e S&eet
Fanuar0 2 2BB5
Boo1 Aalue Fair Aalue
Cas& ; *85BBB ; *85BBB
A""ounts re"ei7a$le (net of ;**BBB allo,an"e( 22BBBB *<CBBB
In7entor0 : 9IFO "ost 2D5BBB 33BBBB
9an' 3<8BBB 55BBBB
Buil'in-s an' equi#%ent (net( **44BBB **44BBB
Total assets ; 22BBBBB ; 23CDBBB
Current lia$ilities ; 2D5BBB ; 2D5BBB
Bon's >a0a$le *BI 45BBBB 4<5BBB
Co%%on sto"1 ;5 #ar 7alue DDBBBB
Ot&er "ontri$ute' "a#ital 3<8BBB
Retaine' earnin-s 2*<BBB
Total lia$ilities an' sto"1&ol'ers? equit0 ; 2**BBBB
Required@
>re#are t&e Eournal entr0 on t&e $oo1s of >ret6el Co%#an0 to re"or' t&e
a"quisition of t&e assets an' assu%#tion of t&e lia$ilities of Salt Co%#an0)
Exercise 2-# Asset Purchase, Cash
> Co%#an0 a"quire' t&e assets an' assu%e' t&e lia$ilities of S Co%#an0
on Fanuar0 * 2BB3 for ;5*BBBB ,&en S Co%#an0?s $alan"e s&eet ,as as
follo,s@
S C$MPA%&
'alance Sheet
(anuar" 1, 2))3
Cas& ; <8BBB
Re"ei7a$les 552BB
In7entor0 **B4BB
9an' *8<2BB
>lant an' equi#%ent (net( 488CBB
Total ; C<D8BB
A""ounts #a0a$le ; 444BB
Bon's #a0a$le *BI 'ue *2K3*K2BBC >ar 4CBBBB
Co%%on sto"1 ;2 #ar 7alue *2BBBB
Retaine' earnin-s 2532BB
Total ; C<D8BB
Fair 7alues of S Co%#an0?s assets an' lia$ilities ,ere equal to t&eir $oo1
7alues e!"e#t for t&e follo,in-@
*) In7entor0 &as a fair 7alue of ;*28BBB)
2) 9an' &as a fair 7alue of ;*<CBBB)
3) T&e $on's #a0 interest se%iannuall0 on Fune 3B an' De"e%$er 3*) T&e
"urrent 0iel' rate on $on's of si%ilar ris1 is CI)
Required*
>re#are t&e Eournal entr0 on > Co%#an0?s $oo1s to re"or' t&e a"quisition
of t&e assets an' assu%#tion of t&e lia$ilities of S Co%#an0)
Exercise 2-+ Asset Purchase, Earnin,s Contin,enc"
>ritano Co%#an0 a"quire' all t&e net assets of Su""o Co%#an0 on
De"e%$er 3* 2BB3 for ;2*8BBBB "as&) T&e $alan"e s&eet of Su""o
Co%#an0 i%%e'iatel0 #rior to t&e a"quisition s&o,e'@
Boo1 7alue Fair 7alue
Current assets ; <8BBBB ; <8BBBB
>lant an' equi#%ent *BCBBBB *44BBBB
Total ; 2B4BBBB ; 24BBBBB
9ia$ilities ; *CBBBB ; 2*8BBB
Co%%on sto"1 4CBBBB
Ot&er "ontri$ute' "a#ital 8BBBBB
Retaine' earnin-s DCBBBB
Total ; 2B4BBBB
As #art of t&e ne-otiations >ritano a-ree' to #a0 t&e sto"1&ol'ers of
Su""o ;38BBBB "as& if t&e #ost"o%$ination earnin-s of >ritano a7era-e'
;2*8BBBB or %ore #er 0ear o7er t&e ne!t t,o 0ears)
Required*
A) >re#are t&e Eournal entries on t&e $oo1s of >ritano to re"or' t&e
a"quisition on De"e%$er 3* 2BB3)
B) Assu%in- t&e earnin-s "ontin-en"0 is %et #re#are t&e Eournal entr0 on
>ritano?s $oo1s nee'e' to settle t&e "ontin-en"0 on De"e%$er 3*
2BB5)
Exercise 2-- Asset Purchase, Stock Contin,enc"
On Fanuar0 * 2BB3 >lat6 Co%#an0 a"quire' all t&e net assets of Sat6
Co%#an0 $0 issuin- D5BBB s&ares of its ;*B #ar 7alue "o%%on sto"1 to
t&e sto"1&ol'ers of Sat6 Co%#an0) Durin- ne-otiations >lat6 Co%#an0
a-ree' t&at t&eir "o%%on sto"1 ,oul' &a7e at least its "urrent 7alue of
;5B #er s&are on Fanuar0 * 2BB4) T&e %ar1et #ri"e of >lat6 Co%#an0?s
"o%%on sto"1 on Fanuar0 * 2BB4 ,as ;4B #er s&are)
Required*
>re#are t&e Eournal entr0 on >lat6 Co%#an0?s $oo1s on Fanuar0 * 2BB4
assu%in-@
A) T&e "ontin-en"0 is settle' in "as&)
B) T&e "ontin-en"0 is settle' $0 issuin- a''itional s&ares of sto"1)
Exercise 2-. /e0era,ed 'u"-out
Mana-ers of Ba0"o o,n 5BB of its *BBBB outstan'in- "o%%on s&ares)
Dra"o is for%e' $0 t&e %ana-ers of Ba0"o to ta1e o7er Ba0"o in a
le7era-e' $u0out) T&e %ana-ers "ontri$ute t&eir s&ares in Ba0"o an'
Dra"o t&en $orro,s ;5BBBB to #ur"&ase t&e re%ainin- <5BB outstan'in-
s&ares of Ba0"o) Ba0"o is t&en %er-e' into Dra"o) Data rele7ant to Ba0"o
i%%e'iatel0 #rior to t&e le7era-e' $u0out follo,@
Boo1
7alue
Fair
7alue
Current assets ; 3BBB ; 3BBB
>lant assets *2BBB 25BBB
Sto"1&ol'ers? equit0 ;*5BBB ;2CBBB
Required@
Co%#lete t&e follo,in- s"&e'ule s&o,in- t&e 7alues to $e re#orte' in
Dra"o?s $alan"e s&eet i%%e'iatel0 after t&e le7era-e' $u0out)
Current assets ;
>lant assets
Goo',ill
De$t
Sto"1&ol'ers? equit0
Exercise 2-1 Multi!le Choice
>ri"e Co%#an0 issue' CBBB s&ares of its ;2B #ar 7alue "o%%on sto"1 for
t&e net assets of Si%s Co%#an0 in a $usiness "o%$ination un'er ,&i"&
Si%s Co%#an0 ,ill $e %er-e' into >ri"e Co%#an0) On t&e 'ate of t&e
"o%$ination >ri"e Co%#an0 "o%%on sto"1 &a' a fair 7alue of ;3B #er
s&are) Balan"e s&eets for >ri"e Co%#an0 an' Si%s Co%#an0 i%%e'iatel0
#rior to t&e "o%$ination ,ere@
>ri"e Si%s
Current assets ; 43CBBB ; 84BBB
>lant an' equi#%ent (net( 5D5BBB *38BBB
Total ;*B*3BBB ;2BBBBB
9ia$ilities ; 3BBBBB ; 5BBBB
Co%%on sto"1 ;2B #ar 7alue 55BBBB CBBBB
Ot&er "ontri$ute' "a#ital D25BB 2BBBB
Retaine' earnin-s <B5BB 5BBBB
Total ;*B*3BBB ;2BBBBB
Required*
Sele"t t&e letter of t&e $est ans,er)
*) If t&e $usiness "o%$ination is treate' as a #ur"&ase an' Si%s
Co%#an0?s net assets &a7e a fair 7alue of ;22CCBB >ri"e Co%#an0?s
$alan"e s&eet i%%e'iatel0 after t&e "o%$ination ,ill in"lu'e -oo',ill
of
(a( ;*B2BB)
($( ;*2CBB)
("( ;**2BB)
('( ;*CCBB)
2) If t&e $usiness "o%$ination is treate' as a #ur"&ase an' t&e fair 7alue
of Si%s Co%#an0?s "urrent assets is ;<BBBB its #lant an' equi#%ent is
;242BBB an' its lia$ilities are ;58BBB >ri"e Co%#an0?s $alan"e s&eet
i%%e'iatel0 after t&e "o%$ination ,ill in"lu'e
(a( Ne-ati7e -oo',ill of ;38BBB)
($( >lant an' equi#%ent of ;C*DBBB)
("( >lant an' equi#%ent of ;DC*BBB)
('( Goo',ill of ;38BBB)
Exercise 2-2 Purchase
E+e"ti7e De"e%$er 3* 2BB3 Lintel Cor#oration #ro#oses to issue
a''itional s&ares of its "o%%on sto"1 in e!"&an-e for all t&e assets an'
lia$ilities of S%it& Cor#oration an' >lat6 Cor#oration after ,&i"& S%it&
an' >lat6 ,ill 'istri$ute t&e Lintel sto"1 to t&eir sto"1&ol'ers in "o%#lete
liqui'ation an' 'issolution) Balan"e s&eets of ea"& of t&e "or#orations
i%%e'iatel0 #rior to %er-er on De"e%$er 3* 2BB3 follo,) T&e "o%%on
sto"1 e!"&an-e ratio ,as ne-otiate' to $e *@* for $ot& S%it& an' >lat6)
Lintel S%it& >lat6
Current assets ;*8BBBBB ; 35BBBB ; *2BBB
9on-:ter% assets (net( 5DBBBBB *C<BBBB <CBBB
Total ;D3BBBBB ;224BBBB ;**BBBB
Current lia$ilities ; DBBBBB ; **BBBB ; <BBB
9on-:ter% 'e$t **BBBBB 43BBBB 8*BBB
Co%%on sto"1 ;5 #ar 7alue 25BBBBB DBBBBB 2BBBB
Retaine' earnin-s 3BBBBBB *BBBBBB 2BBBB
Total ;D3BBBBB ;224BBBB ;**BBBB
Required*
>re#are Eournal entries on Lintel?s $oo1s to re"or' t&e "o%$ination)
Assu%e t&e follo,in-@
T&e i'enti.a$le assets an' lia$ilities of S%it& an' >lat6 are all reMe"te' in
t&e $alan"e s&eets (a$o7e( an' t&eir re"or'e' a%ounts are equal to t&eir
"urrent fair 7alues e!"e#t for lon-:ter% assets) T&e fair 7alue of S%it&=s
lon-:ter% assets e!"ee' t&eir $oo1 7alue $0 ;2BBBB an' t&e fair 7alue of
>lat6=s lon-:ter% assets e!"ee' t&eir $oo1 7alues $0 ;5BBB) Lintel?s
"o%%on sto"1 is tra'e' a"ti7el0 an' &as a "urrent %ar1et #ri"e of ;*5
#er s&are) >re#are Eournal entries on Lintel?s $oo1s to re"or' t&e
"o%$ination)
(AICPA adapted(
Exercise 2-10 Allocation of Purchase Price to Various Assets and Liabilities
Company S has no long-term marketable securities. Assume the following scenarios:
Case A
Assume that P Company paid $130,000 cash for 100% of the net assets of S Company.
S Company
Assets
Current Assets Long-lived Assets Liabilities Net Assets
Book Value $15,000 $85,000 $20,000 $80,000
Fair Value 20,000 130,000 30,000 120,000
Case B
Assume that P Company paid $110,000 cash for 100% of the net assets of S Company.
S Company
Assets
Current Assets Long-lived Assets Liabilities Net Assets
Book Value $15,000 $85,000 $20,000 $80,000
Fair Value 30,000 80,000 20,000 90,000
Case C
Assume that P Company paid $15,000 cash for 100% of the net assets of S Company.
S Company
Assets
Current Assets Long-lived Assets Liabilities Net Assets
Book Value $15,000 $85,000 $20,000 $80,000
Fair Value 20,000 40,000 40,000 20,000
Required: Complete the following schedule by listing the amount that would be recorded on
Ps books.
Assets Liabilities
Goodwill Current Assets Long-lived Assets
Case A
Case B
Case C
Exercise 2-11 3ood4ill 5!airent 6est
On Fanuar0 * 2BB3 >ors"&e Co%#an0 a"quire' t&e net assets of Saa$
Co%#an0 for ;45BBBB "as&) T&e fair 7alue of Saa$=s i'enti.a$le net
assets ,as ;3D5BBB on t&is 'ate) >ors"&e Co%#an0 'e"i'e' to %easure
-oo',ill i%#air%ent usin- t&e #resent 7alue of future "as& Mo,s to
esti%ate t&e fair 7alue of t&e re#ortin- unit (Saa$() T&e infor%ation for
t&ese su$sequent 0ears is as follo,s@
Carr0in- Aalue of Fair Aalue
>resent 7alue Saa$=s I'enti.a$le Saa$=s
I'enti.a$le
Jear of Future Cas& Flo,s
Net Assets
2BB4 ;4BBBBB ;33BBBB ;34BBBB
2BB5 ;4BBBBB ;32BBBB 345BBB
2BB8 ;35BBBB ;3BBBBB 325BBB
NI'enti.a$le net assets 'o not in"lu'e -oo',ill)
Required@
Part A@ For ea"& 0ear 'eter%ine t&e a%ount of -oo',ill i%#air%ent if
an0)
Part B@ >re#are t&e Eournal entries nee'e' each year to re"or' t&e
-oo',ill i%#air%ent (if an0( on >ors"&e=s $oo1s fro% 2BB4 to 2BB8@
Part C@ Ho, s&oul' -oo',ill (an' its i%#air%ent( $e #resente' on t&e
$alan"e s&eet an' t&e in"o%e state%ent in ea"& 0ear2
Part D@ If -oo',ill is i%#aire' ,&at a''itional infor%ation nee's to $e
'is"lose'2
Exercise 2-12 Accountin, 7or the 6ransition in 3ood4ill 6reatent
>or"& Co%#an0 a"quire' t&e net assets of Stairs Co%#an0 on Fanuar0 *
2BBB for ;8BBBBB) T&e %ana-e%ent of >or"& re"entl0 a'o#te' a 7erti"al
%er-er strate-0) On t&e 'ate of t&e "o%$ination (i%%e'iatel0 $efore t&e
a"quisition( t&e assets lia$ilities an' sto"1&ol'ers= equit0 of ea"&
"o%#an0 ,ere as follo,s@
>or"& Stairs
Current assets ; 4BBBBB ;*25BBB
>lant assets (net( CCBBBB 3CBBBB
Total ; *2CBBBB ; 5B5BBB
Total 9ia$ilities ; 3BBBBB ;*BBBBB
Co%%on sto"1 ;2B #ar 7alue 4BBBBB 2BBBBB
Ot&er "ontri$ute' "a#ital 25BBBB D5BBB
Retaine' earnin-s 33BBBB *3BBBB
Total ;*2CBBBB ;5B5BBB
On t&e 'ate of a"quisition t&e onl0 ite% on Stairs= $alan"e s&eet not
re"or'e' at fair 7alue ,as #lant assets ,&i"& &a' a fair 7alue of
;4BBBBB) >lant assets &a' a *B 0ear re%ainin- life an' -oo',ill ,as to
$e a%orti6e' o7er 2B 0ears)
In 2BB* t&e FASB issue' SFAS No) *4* an' *42 an' t&e >or"& Co%#an0
a'o#te' t&e ne, state%ents as of Fanuar0 2BB2) On Fanuar0 * 2BB2 t&e
fair 7alue of Stairs= i'enti.a$le net assets ,as ;45BBBB) Stairs is
"onsi'ere' to $e a re#ortin- unit for #ur#oses of -oo',ill i%#air%ent
testin-) Its fair 7alue ,as esti%ate' to $e ;55BBBB on Fanuar0 * 2BB2
an' its "arr0in- 7alue (in"lu'in- -oo',ill( on t&at 'ate ,as ;8BBBBB)
Required@
*) >re#are t&e Eournal entr0 as of Fanuar0 * 2BBB to re"or' t&e
a"quisition of Stairs $0 >or"&)
2) /&at is t&e "arr0in- 7alue of -oo',ill (una%orti6e' $alan"e( resultin-
fro% t&e a"quisition of Stairs as of Fanuar0 * 2BB22 Hint@ Re"all t&at
alt&ou-& -oo',ill is no lon-er a%orti6e' un'er "urrent GAA> it ,as
a%orti6e' for %ost "o%#anies in t&e 0ears 2BBB an' 2BB*)
3) A transitional -oo',ill i%#air%ent test is require' on t&e 'ate of
a'o#tion of t&e ne, FASB stan'ar's (to $e "arrie' out ,it&in t&e .rst si!
%ont&s after a'o#tion( for #ree!istin- -oo',ill) Base' on t&e fa"ts liste'
a$o7e #erfor% t&e i%#air%ent test an' "al"ulate t&e loss fro%
i%#air%ent if an0) If t&ere is an i%#air%ent of -oo',ill &o, s&oul' it $e
s&o,n in t&e .nan"ial state%ents for t&e 0ear 2BB22
4) /&at transitional 'is"losures are require' in t&e 0ear of initial a'o#tion
of SFAS No) *4* an' *422
Exercise 2-13 Relation 8et4een Purchase Price, 3ood4ill, and
%e,ati0e 3ood4ill
T&e follo,in- $alan"e s&eets ,ere re#orte' on Fanuar0 * 2BB4 for >ea"&
Co%#an0 an' Strea% Co%#an0
>ea"& Strea%
Cas& ; *BBBBB ; 2BBBB
In7entor0 3BBBBB *BBBBB
Equi#%ent (net( CCBBBB 3CBBBB
Total ; *2CBBBB ; 5BBBBB
Total 9ia$ilities ; 3BBBBB ;*BBBBB
Co%%on sto"1 ;2B #ar 7alue 4BBBBB 2BBBBB
Ot&er "ontri$ute' "a#ital 25BBBB DBBBB
Retaine' earnin-s 33BBBB *3BBBB
Total ;*2CBBBB ;5BBBBB
Required@ A##raisals re7eal t&at t&e in7entor0 &as a fair 7alue of
;*2BBBB an' t&e equi#%ent &as a "urrent 7alue of ;4*BBBB) T&e $oo1
7alue an' fair 7alue of lia$ilities are t&e sa%e) Assu%in- t&at >ea"&
Co%#an0 ,is&es to a"quire Strea% for "as& in an asset a"quisition
'eter%ine t&e follo,in- "uto+ a%ounts@
a) T&e #ur"&ase #ri"e a$o7e ,&i"& >ea"& ,oul' re"or' -oo',ill)
$) T&e #ur"&ase #ri"e $elo, ,&i"& t&e equi#%ent ,oul' $e re"or'e' at
less t&an its fair %ar1et 7alue)
") T&e #ur"&ase #ri"e $elo, ,&i"& >ea"& ,oul' re"or' an e!traor'inar0
-ain)
') T&e #ur"&ase #ri"e $elo, ,&i"& >ea"& ,oul' o$tain a O$ar-ain)P
e) T&e #ur"&ase #ri"e at ,&i"& >ea"& ,oul' re"or' ;5BBBB of -oo',ill)
Exercise 2-14 Comparison of Earnings Effects of Purchase (Old and New Rules) versus
Pooling of Interests
The Arthur Company is considering a merger with the Guinevere Corporation as of January 1,
2000. It has not been determined whether the transaction will meet the criteria for a pooling
of interests. It has been determined, however, that the deal will be structured so as to qualify
as a nontaxable exchange for tax purposes. If the deal goes through, the Arthur Company
expects to issue 20,000 shares of its $5 par stock; the stock is currently trading at $22.25 per
share.
The balance sheet of the Guinevere Corporation at the acquisition date is projected to appear
as shown below. Also shown are Arthurs assessments of Guineveres market values at
January 1, 2000.
Guinevere Guinevere
Book Values Market Values
Current assets:
Cash $20,000 $20,000
Accounts receivable 15,000 15,000
Inventory 30,000 30,000
Property, plant & equipment:
Building (net) $100,000 $250,000
Equipment (net) 60,000 120,000
Total assets $ 225,000
Total liabilities $ 30,000 $ 30,000
Common stock, $10 par value 80,000
Retained earnings 115,000
Total liabilities and equities $ 225,000
Because Arthur Companys management is worried about the relative effects of purchase and
pooling on future income statements, they have asked you to compare income before taxes for
the year 2000 under purchase versus pooling of interests accounting.
Combined revenues for Arthur and Guinevere are estimated at $300,000 for 2000. Estimated
expenses are $120,000, not including depreciation on Guineveres property and equipment or
any goodwill amortization related to the acquisition of Guinevere. Assume that the building
has a remaining useful life of 20 years, and the equipment of 10 years. Assume that any
goodwill was to be amortized over a 40 year period under old purchase rules (not at all under
new purchase rules), and straight-line depreciation and amortization are used.
Required:
Compare income before taxes for the year 2000 under the purchase methodold rules, the
purchase methodnew rules, and the pooling of interests method. Show support for your
calculations.
Exercise 2-1+A Acquisition Entr", 9e7erred 6axes
>atel Co%#an0 #ai' ;8BBBBB "as& for t&e net assets of Seel0 Co%#an0
on Fanuar0 * 2BB4 in a statutor0 %er-er) Seel0 Co%#an0 &a' t&e
follo,in- assets lia$ilities an' o,ners? equit0 at t&at ti%e@
Boo1 Aalue
Ta! Basis Fair Aalue E!"ess
Cas& ; 2BBBB ; 2BBBB ;:B:
A""ounts re"ei7a$le **2BBB **2BBB ::B::
In7entor0 (9IFO( C2BBB *34BBB 52BBB
9an' 3BBBB 55BBB 25BBB
>lant assets (net( 3<2BBB 483BBB D*BBB
Total assets ;838BBB ;DC4BBB
Allo,an"e for un"olle"ti$le
a""ounts
; *BBBB ; *BBBB ;:B:
A""ounts #a0a$le 54BBB 54BBB :B:
Bon's #a0a$le 2BBBBB *CBBBB 2BBBB
Co%%on sto"1 ;* #ar 7alue CBBBB
Ot&er "ontri$ute' "a#ital *32BBB
Retaine' earnin-s *8BBBB
Total equities ;838BBB
Required*
>re#are t&e Eournal entr0 to re"or' t&e assets a"quire' an' lia$ilities
assu%e') Assu%e an in"o%e ta! rate of 4BI)
Problems
Problem 2-1 Consolidation
Condensed balance sheets for Phillips Company and Solina Company on January 1, 2003, are
as follows:
Phillips Solina
Current assets $180,000 $ 85,000
Plant and equipment (net) 450,000 140,000
Total assets $ 630,000 $ 225,000
Total liabilities $ 95,000 $ 35,000
Common stock, $10 par value 350,000 160,000
Other contributed capital 125,000 53,000
Retained earnings (deficit) 60,000 (23,000)
Total equities $ 630,000 $ 225,000
On January 1, 2003, the stockholders of Phillips and Solina agreed to a consolidation
whereby a new corporation, McGregor Company, would be formed to consolidate Phillips
and Solina. McGregor Company issued 30,000 shares of its $20 par value common stock for
the net assets of Phillips and Solina.
On the date of consolidation, the fair values of Phillip's and Solina's current assets and
liabilities were equal to their book values. The fair value of plant and equipment for each
company was: Phillips, $530,000; Solina, $150,000.
The investment banking house of Bradly and Bradly estimated that the fair value of
McGregor Company's common stock was $35 per share. Phillips will incur $20,000 of direct
acquisition costs and $6,000 in stock issue costs.
Required:
Prepare the journal entries to record the consolidation on the books of McGregor Company
assuming that:
Problem 2-2 Merger and Consolidation
Stockholders of Acme Company, Baltic Company, and Colt Company are considering
alternative arrangements for a business combination. Balance sheets and the fair values of
each company's assets on October 1, 2004, were as follows:
Acme Baltic Colt
Assets $3,900,000 $7,500,000 $ 950,000
Liabilities $2,030,000 $2,200,000 $ 260,000
Common stock, $20 par
value
2,000,000 1,800,000 540,000
Other contributed capital --0-- 600,000 190,000
Retained earnings (deficit) (130,000) 2,900,000 (40,000)
Total equities $3,900,000 $7,500,000 $ 950,000
Fair values of assets $4,200,000 $9,000,000 $1,300,000
Acme Company shares have a fair value of $50. A fair (market) price is not available for
shares of the other companies because they are closely held. Fair values of liabilities equal
book values.
Required:
Prepare a balance sheet for the business combination. Assume the following:
Acme Company acquires all the assets and assumes all the liabilities of Baltic and Colt
Companies by issuing in exchange 140,000 shares of its common stock to Baltic Company
and 40,000 shares of its common stock to Colt Company.
Problem 2-3 Purchase of Net Assets Using Bonds
On January 1, 2004, Perez Company acquired all the assets and assumed all the liabilities of
Stalton Company and merged Stalton into Perez. In exchange for the net assets of Stalton,
Perez gave its bonds payable with a maturity value of $600,000, a stated interest rate of 10%,
interest payable semiannually on June 30 and December 31, a maturity date of January 1,
2011, and a yield rate of 12%.
Balance sheets for Perez and Stalton (as well as fair value data) on January 1, 2004, were
as follows:
Perez Stalton
Book Value Book Value Fair Value
Cash $ 250,000 $114,000 $114,000
Receivables 352,700 150,000 135,000
Inventories 848,300 232,000 310,000
Land 700,000 100,000 315,000
Buildings 950,000 410,000 54,900
Accumulated depreciation -
buildings
(325,000) (170,500)
Equipment 262,750 136,450 123,700
Accumulated depreciation -
equipment
(70,050) (90,450) (84,250)
Total assets $ 2,968,700 $ 881,500 $ 968,350
Current liabilities $ 292,700 $95,300 $95,300
Bonds payable, 8% due
1/1/2013, Interest
payable 6/30 and 12/31
300,000 260,000
Common stock, $15 par value 1,200,000
Common stock, $5 par value 236,500
Other contributed capital 950,000 170,000
Retained earnings 526,000 79,700
Total equities $ 2,968,700 $ 881,500
Required:
Prepare the journal entry on the books of Perez Company to record the acquisition of Stalton
Company's assets and liabilities in exchange for the bonds.
Problem 2-4 Cash Acquisition, Earnings Contingency
Pham Company acquired the assets (except for cash) and assumed the liabilities of Senn
Company on January 1, 2004, paying $720,000 cash. Senn Company's December 31, 2003,
balance sheet, reflecting both book values and fair values, showed:
Book Value Fair Value
Accounts receivable (net) $ 72,000 $ 65,000
Inventory 86,000 99,000
Land 110,000 162,000
Buildings (net) 369,000 450,000
Equipment (net) 237,000 288,000
Total $ 874,000 $ 1,064,000
Accounts payable $ 83,000 $ 83,000
Note payable 180,000 180,000
Common stock, $2 par value 153,000
Other contributed capital 229,000
Retained earnings 229,000
Total $ 874,000
As part of the negotiations, Pham Company agreed to pay the former stockholders of Senn
Company $135,000 cash if the postcombination earnings of the combined company (Pham)
reached certain levels during 2004 and 2005.
Required:
A. Record the journal entry on the books of Pham Company to record the acquisition on
January 1, 2004.
B. Assuming the earnings contingency is met, prepare the journal entry on Pham Company's
books to settle the contingency on January 2, 2006.
C. Repeat requirement (B) assuming the amount of the contingent payment was $80,000
rather than $135,000.
Problem 2-5 Leveraged Buyout
The managers of Park Company own 1,000 of its 20,000 outstanding common shares. Step
Company is formed by the managers of Park Company to take over Park Company in a
leveraged buyout. The managers contribute their shares in Park Company and Step Company
then borrows $90,000 to purchase the remaining 19,000 shares of Park Company for $80,000;
the remaining $10,000 is used for working capital. Park Company is then merged into Step
Company effective January 1, 2003. Data relevant to Park Company immediately prior to the
leveraged buyout follow:
Book Value Fair Value
Current assets $12,000 $12,000
Plant assets 35,000 70,000
Liabilities (7,000) (7,000)
Stockholders' equity $40,000 $75,000
Required:
A. Prepare journal entries on Step Company's books to reflect the effects of the leveraged
buyout.
B. Prepare a balance sheet for Step Company immediately after the merger.
Problem 2-6 Asset Acquisition, Proforma
Balance sheets for Salt Company and Pepper Company on December 31, 2003, follow:
Salt Pepper
ASSETS
Cash $95,000 $180,000
Receivables 117,000 230,000
Inventories 134,000 231,400
Plant assets 690,000 1,236,500
Total assets $ 1,036,000 $ 1,877,900
EQUITIES
Accounts payable $ 180,000 $ 255,900
Mortgage payable 152,500 180,000
Common stock, $20 par value 340,000 900,000
Other contributed capital 179,500 270,000
Retained earnings 184,000 272,000
Total equities $ 1,036,000 $ 1,877,900
Pepper Company tentatively plans to issue 30,000 shares of its $20 par value stock, which has
a current market value of $37 per share net of commissions and other issue costs. Pepper
Company then plans to acquire the assets and assume the liabilities of Salt Company for a
cash payment of $800,000 and $300,000 in long-term 8% notes payable. Pepper Company's
receivables include $60,000 owed by Salt Company. Pepper Company is willing to pay more
than the book value of Salt Company assets because plant assets are undervalued by $215,000
and Salt Company has historically earned above-normal profits.
Required:
Prepare a pro forma balance sheet showing the effects of these planned transactions.
Problem 2-7 Purchase, Decision to Accept
Spalding Company has offered to sell to Ping Company its assets at their book values plus
$1,800,000 representing payment for goodwill. Operating data for 2003 for the two
companies are as follows:
Ping
Company
Spalding
Company
Sales $3,510,100 $2,365,800
Cost of goods sold 1,752,360 1,423,800
Gross profit 1,757,740 942,000
Selling expenses $632,500 $292,100
Other expenses 172,600 150,000
Total expenses 805,100 442,100
Net income $ 952,640 $ 499,900
Ping Company's management estimates the following operating changes if Spalding Company
is merged with Ping Company through a purchase:
A. After the merger, the sales volume of Ping Company will be 20% in excess of the present
combined sales volume, and the sale price per unit will be decreased by 10%.
B. Fixed manufacturing expenses have been 35% of cost of goods sold for each company.
After the merger the fixed manufacturing expenses of Ping Company will be increased by
70% of the current fixed manufacturing expenses of Spalding Company. The current variable
manufacturing expenses of Ping Company, which is 70% of cost of goods sold, is expected to
increase in proportion to the increase in sales volume.
C. Selling expenses of Ping Company are expected to be 85% of the present combined selling
expenses of the two companies.
D. Other expenses of Ping Company are expected to increase by 85% as a result of the
merger.
Any excess of the estimated net income of the merged company over the combined present
net income of the two companies is to be capitalized at 20%. If this amount exceeds the price
set by Spalding Company for goodwill, Ping Company will accept the offer.
Required:
Prepare a pro forma (or projected) income statement for Ping Company for 2004 assuming the
merger takes place, and indicate whether Ping Company should accept the offer.
Pro8le 2-1A Acquisition Entr" and 9e7erred 6axes
On Fanuar0 * 2BB5 >ruitt Co%#an0 issue' 3BBBB s&ares of its ;2 #ar
7alue "o%%on sto"1 for t&e net assets of S&a& Co%#an0 in a statutor0
%er-er a""ounte' for as a #ur"&ase) >ruitt?s "o%%on sto"1 &a' a fair
7alue of ;2C #er s&are at t&at ti%e) A s"&e'ule of t&e S&a& Co%#an0
assets a"quire' an' lia$ilities assu%e' at $oo1 7alues (,&i"& are equal to
t&eir ta! $ases( an' fair 7alues follo,s)
Boo1 AalueK
5te Ta! Basis Fair Aalue E!"ess
Re"ei7a$les (net( ;*25BBB ; *25BBB ;::B::
In7entor0 *8DBBB *<5BBB 2CBBB
9an' C85BB *2BBBB 335BB
>lant assets (net( 48DBBB 58DBBB *BBBBB
>atents <5BBB 2BBBBB *B5BBB
Total ;<4B5BB ;*2BDBBB ;2885BB
Current lia$ilities ; C<5BB ; C<5BB ;::B::
Bon's #a0a$le 3BBBBB 38BBBB 8BBBB
Co%%on sto"1 *2BBBB
Ot&er "ontri$ute' "a#ital *84BBB
Retaine' earnin-s 28DBBB
Total ;<4BBBB
Additional 5n7oration*
*) >ruitt?s in"o%e ta! rate is 35I)
2) S&a&?s $e-innin- in7entor0 ,as all sol' 'urin- 2BB5)
3) Useful li7es for 'e#re"iation an' a%orti6ation #ur#oses are@
>lant assets *B 0ears
>atents C 0ears
Bon' #re%iu% *B 0ears
4) >ruitt uses t&e strai-&t:line %et&o' for all 'e#re"iation an'
a%orti6ation #ur#oses)
Required*
A) >re#are t&e entr0 on >ruitt Co%#an0?s $oo1s to re"or' t&e a"quisition
of t&e assets an' assu%#tion of t&e lia$ilities of S&a& Co%#an0)
B) Assu%in- >ruitt Co%#an0 &a' ta!a$le in"o%e of ;48CBBB in 2BB5
#re#are t&e in"o%e ta! entr0 for 2BB5)