Advanced Financial Accounting 9e Richard Baker


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SAMPLE CHAPTER 1

INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES




Questions LO1
Q1-1 What types of circumstances would encourage management to establish a complex organizational structure? LO1
Q1-2 How would the decision to dispose of a segment of operations using a split-off rather than a spinoff impact the financial statements of the company making the distribution? LO1
Q1-3 Why did companies such as Enron find the use of special-purpose entities to be advantageous? LO3
Q1-4 Describe each of the three legal forms that a business combination might take. LO2
Q1-5 What basis of accounting normally is used in recording the assets and liabilities transferred to a new wholly owned subsidiary? LO1
Q1-6 How might the concept of a beneficial interest impact the reporting of an interest in another company? LO1
Q1-7 When does a noncontrolling interest arise in a business combination? LO1
Q1-8 Why did corporate management often prefer pooling-of-interests accounting in recording business combinations? LO5
Q1-9 How is the amount reported as goodwill determined under the acquisition method? LO5
Q1-10 What impact does the level of ownership have on the amount of goodwill reported under the acquisition method? LO5
Q1-11 How is the amount of goodwill assigned to the noncontrolling interest determined when less than full ownership is acquired? LO5
Q1-12 What is a differential? LO4, LO5
Q1-13 When a business combination occurs after the beginning of the year, the income earned by the acquired company between the beginning of the year and the date of combination is excluded from the net income reported by the combined entity for the year. Why? LO4
Q1-14 What is the maximum balance in retained earnings that can be reported by the combined entity following a business combination? LO4
Q1-15 How is the amount of additional paid-in capital determined when recording a business combination? LO4, LO5
Q1-16 Which of the costs incurred in completing a business combination are capitalized under the acquisition method? LO4
Q1-17 Which of the costs incurred in completing a business combination should be treated as a reduction of additional paid-in capital? LO5
Q1-18 When is goodwill considered impaired following a business combination? LO5
Q1-19 When does a bargain purchase occur? LO5
Q1-20 * Within the measurement period following a business combination, the acquisition-date fair value of buildings acquired is determined to be less than initially recorded. How is the reduction in value recognized? LO4
Q1-21 * P Company reports its 10,000 shares of S Company at $40 per share. P Company then purchases an additional 60,000 shares of S Company for $65 each and gains control of S Company. What must be done with respect to the valuation of the shares previously owned? LO5
Q1-22A P Company purchased 80 percent of the shares of S Company in 20X6 under the purchase method. How would the amount of goodwill reported under the purchase method differ from the amount to be reported under the acquisition method? LO4
Q1-23A What major differences occur between using pooling-of-interests accounting for a business combination and using the acquisition method?


Cases
LO5

C1-1 Reporting Alternatives and International Harmonization
Accounting procedures for business combinations historically have differed across countries. Pooling-of-interests, for many years a preferred method in the United States, was not acceptable in most countries. In some countries, accounting standards permit goodwill to be written off directly against stockholders’ equity at the time of a business combination.
Required
 

a.
Over the years, many U.S. companies complained they were at a disadvantage when competing against foreign companies in purchasing other business enterprises because, unlike U.S. companies, many foreign companies either did not have to capitalize goodwill or could write it off immediately against stockholders’ equity. Historically, why were U.S. companies opposed to capitalizing goodwill? What happened during the past decade to improve the situation from the perspective of U.S. companies?
b.
Should U.S. companies care about accounting standards other than those that are generally accepted in the United States? Explain. LO4, LO5

C1-2 Assignment of Acquisition Costs

Troy Company notified Kline Company’s shareholders that it was interested in purchasing controlling ownership of Kline and offered to exchange one share of Troy’s common stock for each share of Kline Company submitted by July 31, 20X7. At the time of the offer, Troy’s shares were trading for $35 per share and Kline’s shares were trading at $28. Troy acquired all of the shares of Kline prior to December 31, 20X7, and transferred the assets and liabilities of Kline to its books. In addition to issuing its shares, Troy paid a finder’s fee of $200,000, stock registration and audit fees of $60,000, legal fees of $90,000 for transferring Kline’s assets and liabilities to Troy, and $370,000 in legal fees to settle litigation brought by Kline’s shareholders who alleged that the offering price was below the per share fair value of Kline’s net assets.
Troy is currently negotiating to purchase Lad Company through an exchange of common stock and expects to incur additional costs comparable to those involved in the acquisition of Kline. The acquisition of Lad is expected to close sometime late in 20X9.
Required
 
Troy Company’s vice president of finance has asked you to review the current accounting literature, including authoritative pronouncements, and prepare a memo reporting the Required treatment of the additional costs at the time Kline Company was acquired and the current requirements for reporting the additional costs of acquiring Lad Company. Support your recommendations with citations and quotations from the authoritative financial reporting standards or other literature. LO1, LO2

C1-3 Evaluation of Merger

One company may acquire another for a number of different reasons. The acquisition often has a significant impact on the financial statements. In 2005, 3M Corporation acquired CUNO Incorporated. Obtain a copy of the 3M 10-K filing for 2005. The 10-K reports the annual results for a company and is often available on the Investor Relations section of a company’s Web site. It is also available on the SEC’s Web site at www.SEC.gov .
Required
 
Use the 10-K for 2005 to find the answers to the following questions about 3M’s acquisition of CUNO Inc. ( Hint: You can search on the term CUNO once you have accessed the 10-K online.)
a.
Provide at least one reason why 3M acquired CUNO.
b.
How was the acquisition funded?
c.
What was the impact of the CUNO acquisition on net accounts receivable?
d.
What was the impact of the CUNO acquisition on inventories? LO3

C1-4 Business Combinations

A merger boom comparable to those of the 1960s and mid-1980s occurred in the 1990s and into the new century. The merger activity of the 1960s was associated with increasing stock prices and heavy use of pooling-of-interests accounting. The mid-1980s activity was associated with a number of leveraged buyouts and acquisitions involving junk bonds. Merger activity in the early 1990s, on the other hand, appeared to involve primarily purchases with cash and standard debt instruments. By the mid-1990s, however, many business combinations were being effected through exchanges of stock. In the first decade of the new century, the nature of many business acquisitions changed, and by late 2008, the merger boom had slowed dramatically.
a.
Which factors do you believe were the most prominent in encouraging business combinations in the 1990s? Which of these was the most important? Explain why.
b.
Why were so many of the business combinations in the middle and late 1990s effected through exchanges of stock?
c.
What factors had a heavy influence on mergers during the mid-2000s? How did many of the business combinations of this period differ from earlier combinations? Why did the merger boom slow so dramatically late in 2008 and in 2009?
d. If a major review of the tax laws were undertaken, would it be wise or unwise public policy to establish greater tax incentives for corporate mergers? Propose three incentives that might be used. e. If the FASB were interested in encouraging more mergers, what action should it take with regard to revising or eliminating existing accounting standards? Explain. LO5

C1-5 Determination of Goodwill Impairment
Plush Corporation purchased 100 percent of Common Corporation’s common stock on January 1, 20X3, and paid $450,000. The fair value of Common’s identifiable net assets at that date was $430,000. By the end of 20X5, the fair value of Common, which Plush considers to be a reporting unit, had increased to $485,000; however, Plush’s external auditor made a passing comment to the company’s chief accountant that Plush may need to recognize impairment of goodwill on one or more of its investments.
Required
 
Prepare a memo to Plush’s chief accountant indicating the tests used in determining whether goodwill has been impaired. Include in your discussion one or more possible conditions under which Plush may be Required  to recognize impairment of goodwill on its investment in Common Corporation.
In preparing your memo, review the current accounting literature, including authoritative pronouncements of the FASB and other appropriate bodies. Support your discussion with citations and quotations from the applicable literature. LO1

C1-6 Risks Associated with Acquisitions
Not all business combinations are successful, and many entail substantial risk. Acquiring another company may involve a number of different types of risk. Obtain a copy of the 10-K report for Google, Inc., for the year ended December 31, 2006, available at the SEC’s Web site ( www.sec.gov ). The report also can be accessed through Yahoo Finance or the company’s Investor Relations page.
Required
 
On page 21 of the 10-K report, Google provides information to investors about its motivation for acquiring companies and the possible risks associated with such acquisitions. Briefly discuss the risks that Google sees inherent in potential acquisitions. LO1

C1-7 Numbers Game

Arthur Levitt’s speech, “The Numbers Game,” is available on the SEC’s Web site at www.sec.gov/ news/speech/speecharchive/1998/spch220.txt . Read the speech, and then answer the following questions.
Required
 

a.
Briefly explain what motivations Levitt discusses for earnings management.
b.
What specific techniques for earnings management does Levitt discuss?
c.
According to Levitt, why is the issue of earnings management important? LO1, LO3

C1-8 MCI: A Succession of Mergers

MCI WorldCom, Inc. (later MCI), was known as a high-flying company, having had its roots in a small local company and rising to one of the world’s largest communications giants. The company’s spectacular growth was accomplished through a string of business combinations. However, not all went as planned, and MCI is no longer an independent company.
Required
 
Provide a brief history of, and indicate subsequent events related to, MCI WorldCom. Include in your discussion the following:
a.
Trace the major acquisitions leading to MCI WorldCom and indicate the type of consideration used in the acquisitions.
b.
Who is Bernard Ebbers, and where is he now?
c.
What happened to MCI WorldCom, and where is it now? LO3

C1-9 Leveraged Buyouts
A type of acquisition that was not discussed in the chapter is the leveraged buyout. Many experts argue that a leveraged buyout (LBO) is not a type of business combination but rather just a restructuring of ownership. Yet some would see an LBO as having many of the characteristics of a business combination. The number of LBOs in recent years has grown dramatically and, therefore, accounting for these transactions is of increased importance.
Required
 
a. What is a leveraged buyout? How does an LBO compare with a management buyout (MBO)?
b.
What authoritative pronouncements, if any, deal with leveraged buyouts?
c.
Is a leveraged buyout a type of business combination? Explain.
d.
What is the major issue in determining the proper basis for an interest in a company purchased through a leveraged buyout? LO5

C1-10 Curtiss-Wright and Goodwill

Accounting standards continually evolve. One area where significant change has occurred over the past decade is in recording and accounting for goodwill. Prior to 2002, companies were Required  to amortize goodwill over its useful life, not to exceed 17 years. Beginning in 2002, goodwill was no longer Required  to be amortized. One company that has been affected by the changes in accounting for goodwill is Curtiss-Wright.
Required
 

a.
By what amounts did Curtiss-Wright’s goodwill increase in 2001 and 2002, and what amounts did the company report at December 31, 2001 and 2002? What percentage of Curtis-Wright’s total assets does goodwill represent at December 31, 2002? How does this compare to other companies?
b.
What is the fair-value amount of assets Curtiss-Wright acquired in 2006 through business combinations? By what dollar amount did goodwill increase during 2006? What percentage increase does this represent? What percentage of Curtiss-Wright’s total assets does goodwill represent at December 31, 2006?
c.
What amount of goodwill impairment losses did Curtiss-Wright recognize for 2006 and 2005? What change did Curtiss-Wright make during 2006 in its goodwill impairment testing? Why was this change made? What effect did this change have on the financial statements for 2006 and prior years?
d.
Do you think the management of Curtiss-Wright prefers the treatment that was Required  for goodwill before 2002 or the current treatment? Explain. LO1

C1-11 Sears and Kmart: The Joining Together of Two of America’s Oldest Retailers
Kmart started in 1899 as the S. S. Kresge Company, better known as the five-and-dime store. Sears has its roots in the 1880s and incorporated as Sears, Roebuck and Company in 1893. In 2005, the two companies joined together in a business combination.
Required
 

a.
What major event for Kmart occurred in 2002? How was that issued resolved?
b.
What form of business combination brought Sears and Kmart together, and what was the resulting corporate structure?
c.
In the business combination involving Sears and Kmart, which company acquired the other? On what basis was this determination made? What accounting implications did the choice of acquirer have?

Exercises
LO1, LO3

E1-1 Multiple-Choice Questions on Complex Organizations

Select the correct answer for each of the following questions.
1. Growth in the complexity of the U.S. business environment
a.
Has led to increased use of partnerships to avoid legal liability.
b.
Has led to increasingly complex organizational structures as management has attempted to achieve its business objectives.
c.
Has encouraged companies to reduce the number of operating divisions and product lines so they may better control those they retain.
d.
Has had no particular impact on the organizational structures or the way in which companies are managed.
2. Which of the following is not an appropriate reason for establishing a subsidiary?
a.
The parent wishes to protect existing operations by shifting new activities with greater risk to a newly created subsidiary.
b.
The parent wishes to avoid subjecting all of its operations to regulatory control by establishing a subsidiary that focuses its operations in regulated industries.
c.
The parent wishes to reduce its taxes by establishing a subsidiary that focuses its operations in areas where special tax benefits are available.
d.
The parent wishes to be able to increase its reported sales by transferring products to the subsidiary at the end of the fiscal year.
3. Which of the following actions is likely to result in recording goodwill on Randolph Company’s books?
a.
Randolph acquires Penn Corporation in a business combination recorded as a merger.
b.
Randolph acquires a majority of Penn’s common stock in a business combination and continues to operate it as a subsidiary.
c.
Randolph distributes ownership of a newly created subsidiary in a distribution considered to be a spin-off.
d.
Randolph distributes ownership of a newly created subsidiary in a distribution considered to be a split-off.
4. When an existing company creates a new subsidiary and transfers a portion of its assets and liabilities to the new entity
a.
The new entity records both the assets and liabilities it received at fair values.
b.
The new entity records both the assets and liabilities it received at the carrying values of the original company.
c.
The original company records a gain or loss on the difference between its carrying values and the fair values of the assets transferred to the new entity.
d.
The original company records the difference between the carrying values and the fair values of the assets transferred to the new entity as goodwill.
5. When a company assigns goodwill to a reporting unit acquired in a business combination, it must record an impairment loss if
a.
The fair value of the net identifiable assets held by a reporting unit decreases.
b.
The fair value of the reporting unit decreases.
c.
The carrying value of the reporting unit is less than the fair value of the reporting unit.
d.
The fair value of the reporting unit is less than its carrying value and the carrying value of goodwill is more than the implied value of its goodwill. LO4, LO5

E1-2 Multiple-Choice Questions on Recording Business Combinations [AICPA Adapted]

Select the correct answer for each of the following questions.
1. Goodwill represents the excess of the sum of the consideration given over the
a.
Sum of the fair values assigned to identifiable assets acquired less liabilities assumed.
b.
Sum of the fair values assigned to tangible assets acquired less liabilities assumed.
c.
Sum of the fair values assigned to intangible assets acquired less liabilities assumed.
d.
Book value of an acquired company.
2. In a business combination, costs of registering equity securities to be issued by the acquiring company are a(n)
a.
Expense of the combined company for the period in which the costs were incurred.
b.
Direct addition to stockholders’ equity of the combined company.
c.
Reduction of the otherwise determinable fair value of the securities.
d.
Addition to goodwill.
3. Which of the following is the appropriate basis for valuing fixed assets acquired in a business combination carried out by exchanging cash for common stock?
a.
Historical cost.
b.
Book value.
c.
Cost plus any excess of purchase price over book value of assets acquired.
d.
Fair value.
4. In a business combination, the fair value of the net identifiable assets acquired exceeds the fair value of the consideration given. The excess should be reported as a
a.
Deferred credit.
b.
Reduction of the values assigned to current assets and a deferred credit for any unallocated portion.
c.
Pro rata reduction of the values assigned to current and noncurrent assets and a deferred credit for any unallocated portion.
d.
No answer listed is correct.
5. A and B Companies have been operating separately for five years. Each company has a minimal amount of liabilities and a simple capital structure consisting solely of voting common stock.
A Company, in exchange for 40 percent of its voting stock, acquires 80 percent of the common stock of B Company. This is a “tax-free” stock-for-stock (type B) exchange for tax purposes. B Company assets have a total net fair market value of $800,000 and a total net book value of $580,000.
The fair market value of the A stock used in the exchange is $700,000 and the fair value of the noncontrolling interest is $175,000. The goodwill reported following the acquisition would be
a.
Zero.
b.
$60,000.
c.
$75,000.
d.
$295,000. LO4, LO5

E1-3 Multiple-Choice Questions on Reported Balances [AICPA Adapted]

Select the correct answer for each of the following questions.
1. On December 31, 20X3, Saxe Corporation was merged into Poe Corporation. In the business combination, Poe issued 200,000 shares of its $10 par common stock, with a market price of $18 a share, for all of Saxe’s common stock. The stockholders’ equity section of each company’s balance sheet immediately before the combination was:
Poe Saxe

Common Stock $3,000,000 $1,500,000
Additional Paid-In Capital 1,300,000 150,000
Retained Earnings 2,500,000 850,000
 $6,800,000 $2,500,000
In the December 31, 20X3, consolidated balance sheet, additional paid-in capital should be reported at
a.
$950,000.
b.
$1,300,000.
c.
$1,450,000.
d.
$2,900,000.
2. On January 1, 20X1, Rolan Corporation issued 10,000 shares of common stock in exchange for all of Sandin Corporation’s outstanding stock. Condensed balance sheets of Rolan and Sandin immediately before the combination follow:
Rolan Sandin

Total Assets $1,000,000 $500,000
Liabilities $ 300,000 $150,000
Common Stock ($10 par) 200,000 100,000
Retained Earnings 500,000 250,000
Total Liabilities and Equities $1,000,000 $500,000
Rolan’s common stock had a market price of $60 per share on January 1, 20X1. The market price of Sandin’s stock was not readily determinable. The fair value of Sandin’s net identifiable assets was determined to be $570,000. Rolan’s investment in Sandin’s stock will be stated in Rolan’s balance sheet immediately after the combination in the amount of
a.
$350,000.
b.
$500,000.
c.
$570,000.
d.
$600,000.
3. On April 1, 20X2, Jack Company paid $800,000 for all of Ann Corporation’s issued and outstanding common stock. Ann’s recorded assets and liabilities on April 1, 20X2, were as follows:

Cash $ 80,000
Inventory 240,000
Property and equipment (net of accumulated depreciation of $320,000) 480,000 Liabilities (180,000) On April 1, 20X2, Ann’s inventory was determined to have a fair value of $190,000 and the property and equipment had a fair value of $560,000. What is the amount of goodwill resulting from the business combination?
a.
$0.
b.
$50,000.
c.
$150,000.
d.
$180,000.
4. Action Corporation issued nonvoting preferred stock with a fair market value of $4,000,000 in exchange for all the outstanding common stock of Master Corporation. On the date of the exchange, Master had tangible net assets with a book value of $2,000,000 and a fair value of $2,500,000. In addition, Action issued preferred stock valued at $400,000 to an individual as a finder’s fee in arranging the transaction. As a result of this transaction, Action should record an increase in net assets of
a.
$2,000,000.
b.
$2,500,000.
c.
$4,000,000.
d.
$4,400,000. LO4, LO5

E1-4 Multiple-Choice Questions Involving Account Balances

Select the correct answer for each of the following questions.
1. Topper Company established a subsidiary and transferred equipment with a fair value of $72,000 to the subsidiary. Topper had purchased the equipment with an expected life of 10 years four years earlier for $100,000 and has used straight-line depreciation with no expected residual value. At the time of the transfer, the subsidiary should record
a.
Equipment at $72,000 and no accumulated depreciation.
b.
Equipment at $60,000 and no accumulated depreciation.
c.
Equipment at $100,000 and accumulated depreciation of $40,000.
d.
Equipment at $120,000 and accumulated depreciation of $48,000.
2. Lead Corporation established a new subsidiary and transferred to it assets with a cost of $90,000 and a book value of $75,000. The assets had a fair value of $100,000 at the time of transfer. The transfer will result in
a.
A reduction of net assets reported by Lead Corporation of $90,000.
b.
A reduction of net assets reported by Lead Corporation of $75,000.
c.
No change in the reported net assets of Lead Corporation.
d.
An increase in the net assets reported by Lead Corporation of $25,000.
3. Tear Company, a newly established subsidiary of Stern Corporation, received assets with an original cost of $260,000, a fair value of $200,000, and a book value of $140,000 from the parent in exchange for 7,000 shares of Tear’s $8 par value common stock. Tear should record
a.
Additional paid-in capital of $0.
b.
Additional paid-in capital of $84,000.
c.
Additional paid-in capital of $144,000.
d.
Additional paid-in capital of $204,000.
4. Grout Company reports assets with a carrying value of $420,000 (including goodwill with a carrying value of $35,000) assigned to an identifiable reporting unit purchased at the end of the prior year. The fair value of the net assets held by the reporting unit is currently $350,000, and the fair value of the reporting unit is $395,000. At the end of the current period, Grout should report goodwill of
a.
$45,000.
b.
$35,000.
c.
$25,000.
d.
$10,000.
5. Twill Company has a reporting unit with the fair value of its net identifiable assets of $500,000. The carrying value of the reporting unit’s net assets on Twill’s books is $575,000, which includes $90,000 of goodwill. The fair value of the reporting unit is $560,000. Twill should report impairment of goodwill of
a.
$60,000.
b.
$30,000.
c.
$15,000.
d.
$0. LO2

E1-5 Asset Transfer to Subsidiary

Pale Company was established on January 1, 20X1. Along with other assets, it immediately purchased land for $80,000, a building for $240,000, and equipment for $90,000. On January 1, 20X5, Pale transferred these assets, cash of $21,000, and inventory costing $37,000 to a newly created subsidiary, Bright Company, in exchange for 10,000 shares of Bright’s $6 par value stock. Pale uses straight-line depreciation and useful lives of 40 years and 10 years for the building and equipment, respectively, with no estimated residual values.
Required
 

a.
Give the journal entry that Pale recorded when it transferred the assets to Bright.
b.
Give the journal entry that Bright recorded for the receipt of assets and issuance of common stock to Pale. LO2

E1-6 Creation of New Subsidiary

Lester Company transferred the following assets to a newly created subsidiary, Mumby Corporation, in exchange for 40,000 shares of its $3 par value stock:
Cost Book Value

Cash $ 40,000 $ 40,000
Accounts Receivable 75,000 68,000
Inventory 50,000 50,000
Land 35,000 35,000
Buildings 160,000 125,000
Equipment 240,000 180,000
Required
 

a.
Give the journal entry in which Lester recorded the transfer of assets to Mumby Corporation.
b.
Give the journal entry in which Mumby recorded the receipt of assets and issuance of common stock to Lester.

E1-7 Balance Sheet Totals of Parent Company

Foster Corporation established Kline Company as a wholly owned subsidiary. Foster reported the following balance sheet amounts immediately before and after it transferred assets and accounts payable to Kline Company in exchange for 4,000 shares of $12 par value common stock:
Amount Reported Before Transfer After Transfer

Cash $ 40,000 $ 25,000
Accounts Receivable 65,000 41,000
Inventory 30,000 21,000
Investment in Kline Company 66,000
Land 15,000 12,000
Depreciable Assets $180,000 $115,000
Accumulated Depreciation 75,000 105,000 47,000 68,000
Total Assets $255,000 $233,000
Accounts Payable $ 40,000 $ 18,000
Bonds Payable 80,000 80,000
Common Stock 60,000 60,000
Retained Earnings 75,000 75,000
Total Liabilities and Equities $255,000 $233,000
Required
 

a.
Give the journal entry that Foster recorded when it transferred its assets and accounts payable to Kline.
b.
Give the journal entry that Kline recorded upon receipt of the assets and accounts payable from Foster. LO2

E1-8 Creation of Partnership

Glover Corporation entered into an agreement with Renfro Company to establish G&R Partnership. Glover agreed to transfer the following assets to G&R for 90 percent ownership, and Renfro agreed to transfer $50,000 cash to the partnership for 10 percent ownership.
Cost Book Value

Cash $ 10,000 $ 10,000
Accounts Receivable 19,000 19,000
Inventory 35,000 35,000
Land 16,000 16,000
Buildings 260,000 200,000
Equipment 210,000 170,000
Required
 

a.
Give the journal entry that Glover recorded at the time of its transfer of assets to G&R.
b.
Give the journal entry that Renfro recorded at the time of its transfer of cash to G&R.
c.
Give the journal entry that G&R recorded upon the receipt of assets from Glover and Renfro. LO4, LO5

E1-9 Acquisition of Net Assets

Sun Corporation concluded the fair value of Tender Company was $60,000 and paid that amount to acquire its net assets. Tender reported assets with a book value of $55,000 and fair value of $71,000 and liabilities with a book value and fair value of $20,000 on the date of combination. Sun also paid $4,000 to a search firm for finder’s fees related to the acquisition.
Required
 
Give the journal entries to be made by Sun to record its investment in Tender and its payment of the finder’s fees. LO5

E1-10 Reporting Goodwill

Samper Company reported the book value of its net assets at $160,000 when Public Corporation acquired 100 percent ownership for $310,000. The fair value of Samper’s net assets was determined to be $190,000 on that date.
Required
 
Determine the amount of goodwill to be reported in consolidated financial statements presented immediately following the combination and the amount at which Public will record its investment in Samper if the amount paid by Public is
a.
$310,000.
b.
$196,000.
c.
$150,000. LO4

E1-11 Stock Acquisition

McDermott Corporation has been in the midst of a major expansion program. Much of its growth had been internal, but in 20X1 McDermott decided to continue its expansion through the acquisition of other companies. The first company acquired was Tippy Inc., a small manufacturer of inertial guidance systems for aircraft and missiles. On June 10, 20X1, McDermott issued 17,000 shares of its $25 par common stock for all 40,000 of Tippy’s $10 par common shares. At the date of combination, Tippy reported additional paid-in capital of $100,000 and retained earnings of $350,000. McDermott’s stock was selling for $58 per share immediately prior to the combination. Subsequent to the combination, Tippy operated as a subsidiary of McDermott.
Required
 
Present the journal entry or entries that McDermott would make to record the business combination with Tippy. LO4, LO5

E1-12 Balances Reported Following Combination

Elm Corporation and Maple Company have announced terms of an exchange agreement under which Elm will issue 8,000 shares of its $10 par value common stock to acquire all of Maple Company’s assets. Elm shares currently are trading at $50, and Maple $5 par value shares are trading at $18 each. Historical cost and fair value balance sheet data on January 1, 20X2, are as follows:
 Elm Corporation Maple Company
Balance Sheet Item Book Value Fair Value Book Value Fair Value

Cash and Receivables $150,000 $150,000 $ 40,000 $ 40,000
Land 100,000 170,000 50,000 85,000
Buildings and Equipment (net) 300,000 400,000 160,000 230,000
Total Assets $550,000 $720,000 $250,000 $355,000
Common Stock $200,000 $100,000
Additional Paid-In Capital 20,000 10,000
Retained Earnings 330,000 140,000
Total Equities $550,000 $250,000
Required
 
What amount will be reported immediately following the business combination for each of the following items in the combined company’s balance sheet?
a.
Common Stock.
b.
Cash and Receivables.
c. Land.
d.
Buildings and Equipment (net).
e.
Goodwill.
f.
Additional Paid-In Capital.
g.
Retained Earnings. LO5


E1-13 Goodwill Recognition
Spur Corporation reported the following balance sheet amounts on December 31, 20X1:
Balance Sheet Item Historical Cost Fair Value

Cash and Receivables $ 50,000 $ 40,000
Inventory 100,000 150,000
Land 40,000 30,000
Plant and Equipment 400,000 350,000
Less: Accumulated Depreciation (150,000)
Patent 130,000
Total Assets $440,000 $700,000
Accounts Payable $ 80,000 $ 85,000
Common Stock 200,000
Additional Paid-In Capital 20,000
Retained Earnings 140,000
Total Liabilities and Equities $440,000
Required
 
Blanket acquired Spur Corporation’s assets and liabilities for $670,000 cash on December 31, 20X1. Give the entry that Blanket made to record the purchase. LO4

E1-14 Acquisition Using Debentures

Fortune Corporation used debentures with a par value of $625,000 to acquire 100 percent of Sorden Company’s net assets on January 1, 20X2. On that date, the fair value of the bonds issued by Fortune was $608,000. The following balance sheet data were reported by Sorden:
Balance Sheet Item Historical Cost Fair Value

Cash and Receivables $ 55,000 $ 50,000
Inventory 105,000 200,000
Land 60,000 100,000
Plant and Equipment 400,000 300,000
Less: Accumulated Depreciation (150,000)
Goodwill 10,000
Total Assets $480,000 $650,000
Accounts Payable $ 50,000 $ 50,000
Common Stock 100,000
Additional Paid-In Capital 60,000
Retained Earnings 270,000
Total Liabilities and Equities $480,000
Required
 
Give the journal entry that Fortune recorded at the time of exchange.

E1-15 Bargain Purchase

Using the data presented in
E1-14 determine the amount Fortune Corporation would record as a gain on bargain purchase and prepare the journal entry Fortune would record at the time of the exchange if Fortune issued bonds with a par value of $580,000 and a fair value of $564,000 in completing the acquisition of Sorden. LO5

E1-16 Impairment of Goodwill

Mesa Corporation purchased Kwick Company’s net assets and assigned goodwill of $80,000 to Reporting Division K. The following assets and liabilities are assigned to Reporting Division K:
Carrying Amount Fair Value

Cash $ 14,000 $ 14,000
Inventory 56,000 71,000
Equipment 170,000 190,000
Goodwill 80,000
Accounts Payable 30,000 30,000
Required
 
Determine the amount of goodwill to be reported for Division K and the amount of goodwill impairment to be recognized, if any, if Division K’s fair value is determined to be
a.
$340,000.
b.
$280,000.
c.
$260,000. LO5

E1-17 Assignment of Goodwill

Double Corporation acquired all of the common stock of Simple Company for $450,000 on January 1, 20X4. On that date, Simple’s identifiable net assets had a fair value of $390,000. The assets acquired in the purchase of Simple are considered to be a separate reporting unit of Double. The carrying value of Double’s investment at December 31, 20X4, is $500,000.
Required
 
Determine the amount of goodwill impairment, if any, that should be recognized at December 31, 20X4, if the fair value of the net assets (excluding goodwill) at that date is $440,000 and the fair value of the reporting unit is determined to be
a.
$530,000.
b.
$485,000.
c.
$450,000. LO5

E1-18 Goodwill Assigned to Reporting Units

Groft Company purchased Strobe Company’s net assets and assigned them to four separate reporting units. Total goodwill of $186,000 is assigned to the reporting units as indicated:
Reporting Unit
A B C D

Carrying value of investment $700,000 $330,000 $380,000 $520,000
Goodwill included in carrying value 60,000 48,000 28,000 50,000
Fair value of net identifiable assets at year-end 600,000 300,000 400,000 500,000
Fair value of reporting unit at year-end 690,000 335,000 370,000 585,000

Required
 
Determine the amount of goodwill that Groft should report at year-end. Show how you computed it. LO5

E1-19 Goodwill Measurement
Washer Company has a reporting unit resulting from an earlier business combination. The reporting unit’s current assets and liabilities are
Carrying Amount Fair Value

Cash $ 30,000 $ 30,000
Inventory 70,000 100,000
Land 30,000 60,000
Buildings 210,000 230,000
Equipment 160,000 170,000
Goodwill 150,000
Notes Payable 100,000 100,000
Required
 
Determine the amount of goodwill to be reported and the amount of goodwill impairment, if any, if the fair value of the reporting unit is determined to be
a.
$580,000.
b.
$540,000.
c.
$500,000.
d.
$460,000. LO4, LO5

E1-20 Computation of Fair Value

Grant Company acquired all of Bedford Corporation’s assets and liabilities on January 1, 20X2, in a business combination. At that date, Bedford reported assets with a book value of $624,000 and liabilities of $356,000. Grant noted that Bedford had $40,000 of research and development costs on its books at the acquisition date that did not appear to be of value.
Grant also determined that patents developed by Bedford had a fair value of $120,000 but had not been recorded by Bedford. Except for buildings and equipment, Grant determined the fair value of all other assets and liabilities reported by Bedford approximated the recorded amounts. In recording the transfer of assets and liabilities to its books, Grant recorded goodwill of $93,000. Grant paid $517,000 to acquire Bedford’s assets and liabilities. If the book value of Bedford’s buildings and equipment was $341,000 at the date of acquisition, what was their fair value? LO4, LO5

E1-21 Computation of Shares Issued and Goodwill

Dunyain Company acquired Allsap Corporation on January 1, 20X1, through an exchange of common shares. All of Allsap’s assets and liabilities were immediately transferred to Dunyain, which reported total par value of shares outstanding of $218,400 and $327,600 and additional paid-in capital of $370,000 and $650,800 immediately before and after the business combination, respectively.
Required
 

a.
Assuming that Dunyain’s common stock had a market value of $25 per share at the time of exchange, what number of shares was issued?
b.
What is the par value per share of Dunyain’s common stock?
c.
Assuming that Allsap’s identifiable assets had a fair value of $476,000 and its liabilities had a fair value of $120,000, what amount of goodwill did Dunyain record at the time of the business combination? 42 Chapter 1 Intercorporate Acquisitions and Investments in Other Entities LO4

E1-22 Combined Balance Sheet

The following balance sheets were prepared for Adam Corporation and Best Company on January 1, 20X2, just before they entered into a business combination:
Adam Corporation Best Company
Item Book Value Fair Value Book Value Fair Value

Cash and Receivables $150,000 $150,000 $ 90,000 $ 90,000
Inventory 300,000 380,000 70,000 160,000
Buildings and Equipment 600,000 430,000 250,000 240,000
Less: Accumulated Depreciation (250,000) (80,000)
Total Assets $800,000 $960,000 $330,000 $490,000
Accounts Payable $ 75,000 $ 75,000 $ 50,000 $ 50,000
Notes Payable 200,000 215,000 30,000 35,000
Common Stock:
$8 par value 180,000
$6 par value 90,000
Additional Paid-In Capital 140,000 55,000
Retained Earnings 205,000 105,000
Total Liabilities and Equities $800,000 $330,000
Adam acquired all of Best Company’s assets and liabilities on January 1, 20X2, in exchange for its common shares. Adam issued 8,000 shares of stock to complete the business combination.
Required
 
Prepare a balance sheet of the combined company immediately following the acquisition, assuming Adam’s shares were trading at $60 each. LO4

E1-23 Recording a Business Combination

The following financial statement information was prepared for Blue Corporation and Sparse Company at December 31, 20X2:
Balance Sheets
December 31, 20X2
Blue Corporation Sparse Company

Cash $ 140,000 $ 70,000
Accounts Receivable 170,000 110,000
Inventory 250,000 180,000
Land 80,000 100,000
Buildings and Equipment $ 680,000 $ 450,000
Less: Accumulated Depreciation (320,000) 360,000 (230,000) 220,000
Goodwill 70,000 20,000
Total Assets $1,070,000 $700,000
Accounts Payable $ 70,000 $195,000
Bonds Payable 320,000 100,000
Bond Premium 10,000
Common Stock 120,000 150,000
Additional Paid-In Capital 170,000 60,000
Retained Earnings 390,000 185,000
Total Liabilities and Equities $1,070,000 $700,000
Blue and Sparse agreed to combine as of January 1, 20X3. To effect the merger, Blue paid finder’s fees of $30,000 and legal fees of $24,000. Blue also paid $15,000 of audit fees related to the issuance of stock, stock registration fees of $8,000, and stock listing application fees of $6,000.
At January 1, 20X3, book values of Sparse Company’s assets and liabilities approximated market value except for inventory with a market value of $200,000, buildings and equipment with a market value of $350,000, and bonds payable with a market value of $105,000. All assets and liabilities were immediately recorded on Blue’s books.
Required
 
Give all journal entries that Blue recorded assuming Blue issued 40,000 shares of $8 par value common stock to acquire all of Sparse’s assets and liabilities in a business combination. Blue common stock was trading at $14 per share on January 1, 20X3. LO4

E1-24 Reporting Income

On July 1, 20X2, Alan Enterprises merged with Cherry Corporation through an exchange of stock and the subsequent liquidation of Cherry. Alan issued 200,000 shares of its stock to effect the combination. The book values of Cherry’s assets and liabilities were equal to their fair values at the date of combination, and the value of the shares exchanged was equal to Cherry’s book value. Information relating to income for the companies is as follows:
 
20X1 Jan. 1–June 30, 20X2 July 1–Dec. 31, 20X2

Net Income:
Alan Enterprises $4,460,000 $2,500,000 $3,528,000
Cherry Corporation 1,300,000 692,000 —
Alan Enterprises had 1,000,000 shares of stock outstanding prior to the combination.
Required
 
Compute the net income and earnings-per-share amounts that would be reported in Alan’s 20X2 comparative income statements for both 20X2 and 20X1.

Problems
LO2

P1-25 Assets and Accounts Payable Transferred to Subsidiary

Tab Corporation decided to establish Collon Company as a wholly owned subsidiary by transferring some of its existing assets and liabilities to the new entity. In exchange, Collon issued Tab 30,000 shares of $6 par value common stock. The following information is provided on the assets and accounts payable transferred:
Cost Book Value Fair Value

Cash $ 25,000 $ 25,000 $ 25,000
Inventory 70,000 70,000 70,000
Land 60,000 60,000 90,000
Buildings 170,000 130,000 240,000
Equipment 90,000 80,000 105,000
Accounts Payable 45,000 45,000 45,000
Required
 

a.
Give the journal entry that Tab recorded for the transfer of assets and accounts payable to Collon.
b.
Give the journal entry that Collon recorded for the receipt of assets and accounts payable from Tab. LO2

P1-26 Creation of New Subsidiary

Eagle Corporation established a subsidiary to enter into a new line of business considered to be substantially more risky than Eagle’s current business. Eagle transferred the following assets and accounts payable to Sand Corporation in exchange for 5,000 shares of $10 par value stock of Sand:
Cost Book Value

Cash $ 30,000 $ 30,000
Accounts Receivable 45,000 40,000
Inventory 60,000 60,000
Land 20,000 20,000
Buildings and Equipment 300,000 260,000
Accounts Payable 10,000 10,000
Required
 

a.
Give the journal entry that Eagle recorded for the transfer of assets and accounts payable to Sand.
b.
Give the journal entry that Sand recorded for receipt of the assets and accounts payable from Eagle. LO2

P1-27 Incomplete Data on Creation of Subsidiary

Thumb Company created New Company as a wholly owned subsidiary by transferring assets and accounts payable to New in exchange for its common stock. New recorded the following entry when it received the assets and accounts payable:
Cash 3,000
Accounts Receivable 16,000

Inventory 27,000
Land 9,000
Buildings 70,000

Equipment 60,000
Accounts Payable 14,000
Accumulated Depreciation—Buildings 21,000
Accumulated Depreciation—Equipment 12,000
Common Stock 40,000
Additional Paid-In Capital 98,000
Required
 

a.
What was Thumb’s book value of the total assets transferred to New Company?
b.
What amount did Thumb report as its investment in New after the transfer?
c.
What number of shares of $5 par value stock did New issue to Thumb?
d.
What impact did the transfer of assets and accounts payable have on the amount reported by Thumb as total assets?
e.
What impact did the transfer of assets and accounts payable have on the amount that Thumb and the consolidated entity reported as shares outstanding? LO2

P1-28 Establishing a Partnership

Krantz Company and Dull Corporation decided to form a partnership. Krantz agreed to transfer the following assets and accounts payable to K&D Partnership in exchange for 60 percent ownership:
Cost Book Value

Cash $ 10,000 $ 10,000
Inventory 30,000 30,000
Land 70,000 70,000
Buildings 200,000 150,000
Equipment 120,000 90,000
Accounts Payable 50,000 50,000
Dull agreed to contribute cash of $200,000 to K&D Partnership.
Required
 

a.
Give the journal entries that K&D recorded for its receipt of assets and accounts payable from Krantz and Dull.
b.
Give the journal entries that Krantz and Dull recorded for their transfer of assets and accounts payable to K&D Partnership. LO2

P1-29 Balance Sheet Data for Companies Establishing a Partnership

Good Corporation and Nevall Company formed G&W Partnership in which Good received 75 percent ownership and Nevall received 25 percent ownership. The following assets were transferred by Good and Nevall:

Good Corporation Nevall Company

Cost Book Value Cost Book Value

Cash $ 21,000 $21,000 $ 3,000 $ 3,000

Inventory 4,000 4,000 25,000 25,000

Land 15,000 15,000

Buildings 100,000 70,000

Equipment 60,000 40,000 36,000 22,000

Required
 

a.
Give the journal entry that Good recorded for its transfer of assets to G&W Partnership.
b.
Give the journal entry that Nevall recorded for its transfer of assets to G&W Partnership.
c.
Give the journal entry that G&W recorded for its receipt of assets from Good and Nevall. LO4

P1-30 Acquisition in Multiple Steps

Deal Corporation issued 4,000 shares of its $10 par value stock with a market value of $85,000 to acquire 85 percent ownership of Mead Company on August 31, 20X3. The fair value of Mead was determined to be $100,000 on that date. Deal had earlier purchased 15 percent of Mead’s shares for $9,000 and used the cost method in accounting for its investment in Mead. Deal later paid appraisal fees of $3,500 and stock issue costs of $2,000 incurred in completing the acquisition of the additional shares.
Required
 
Give the journal entries to be recorded by Deal in completing the acquisition of the additional shares of Mead. LO4

P1-31 Journal Entries to Record a Business Combination


On January 1, 20X2, Frost Company acquired all of TKK Corporation’s assets and liabilities by issuing 24,000 shares of its $4 par value common stock. At that date, Frost shares were selling at $22 per share. Historical cost and fair value balance sheet data for TKK at the time of acquisition were as follows:
 
Balance Sheet Item Historical Cost Fair Value


Cash and Receivables $ 28,000 $ 28,000

Inventory 94,000 122,000

Buildings and Equipment 600,000 470,000

Less: Accumulated Depreciation (240,000)

Total Assets $ 482,000 $620,000

Accounts Payable $ 41,000 $ 41,000  Notes Payable 65,000 63,000

Common Stock ($10 par value) 160,000

Retained Earnings 216,000

Total Liabilities and Equities $ 482,000

Frost paid legal fees for the transfer of assets and liabilities of $14,000. Frost also paid audit fees of $21,000 and listing application fees of $7,000, both related to the issuance of new shares.

Required

 
Prepare the journal entries made by Frost to record the business combination. LO4

P1-32 Recording Business Combinations

Flint Corporation exchanged shares of its $2 par common stock for all of Mark Company’s assets and liabilities in a planned merger. Immediately prior to the combination, Mark’s assets and liabilities were as follows:

Assets

Cash and Equivalents $ 41,000

Accounts Receivable 73,000

Inventory 144,000

Land 200,000

Buildings 1,520,000

Equipment 638,000

Accumulated Depreciation (431,000)

Total Assets $2,185,000

Liabilities and Equities

Accounts Payable $ 35,000

Short-Term Notes Payable 50,000

Bonds Payable 500,000

Common Stock ($10 par) 1,000,000

Additional Paid-In Capital 325,000

Retained Earnings 275,000

Total Liabilities and Equities $2,185,000
 
Immediately prior to the combination, Flint reported $250,000 additional paid-in capital and $1,350,000 retained earnings. The fair values of Mark’s assets and liabilities were equal to their book values on the date of combination except that Mark’s buildings were worth $1,500,000 and its equipment was worth $300,000. Costs associated with planning and completing the business combination totaled $38,000, and stock issue costs totaled $22,000. The market value of Flint’s stock at the date of combination was $4 per share.

Required

 
Prepare the journal entries that would appear on Flint’s books to record the combination if Flint issued 450,000 shares. LO4, LO5

P1-33 Business Combination with Goodwill

Anchor Corporation paid cash of $178,000 to acquire Zink Company’s net assets on February 1, 20X3. The balance sheet data for the two companies and fair value information for Zink immediately before the business combination were:

Anchor Corporation Zink Company
Balance Sheet Item Book Value Book Value Fair Value

Cash $ 240,000 $ 20,000 $ 20,000
Accounts Receivable 140,000 35,000 35,000
Inventory 170,000 30,000 50,000
Patents 80,000 40,000 60,000
Buildings and Equipment 380,000 310,000 150,000
Less: Accumulated Depreciation (190,000) (200,000)
Total Assets $ 820,000 $ 235,000 $315,000
Accounts Payable $ 85,000 $ 55,000 $ 55,000
Notes Payable 150,000 120,000 120,000
Common Stock:
$10 par value 200,000
$6 par value 18,000
Additional Paid-In Capital 160,000 10,000
Retained Earnings 225,000 32,000
Total Liabilities and Equities $ 820,000 $ 235,000

Required
 

a.
Give the journal entry recorded by Anchor Corporation when it acquired Zink’s net assets.
b.
Prepare a balance sheet for Anchor immediately following the acquisition.
c.
Give the journal entry to be recorded by Anchor if it acquires all of Zink’s common stock for $178,000. LO4, LO5

P1-34 Bargain Purchase

Bower Company purchased Lark Corporation’s net assets on January 3, 20X2, for $625,000 cash. In addition, $5,000 of direct costs were incurred in consummating the combination. At the time of acquisition, Lark reported the following historical cost and current market data:
Balance Sheet Item Book Value Fair Value

Cash and Receivables $ 50,000 $ 50,000
Inventory 100,000 150,000 Buildings and Equipment (net) 200,000 300,000 Patent — 200,000 Total Assets $350,000 $700,000 Accounts Payable $ 30,000 $ 30,000 Common Stock 100,000 Additional Paid-In Capital 80,000 Retained Earnings 140,000 Total Liabilities and Equities $350,000
Required
 
Give the journal entry or entries with which Bower recorded its acquisition of Lark’s net assets. LO4, LO5

P1-35 Computation of Account Balances
Aspro Division is considered to be an individual reporting unit of Tabor Company. Tabor acquired the division by issuing 100,000 shares of its common stock with a market price of $7.60 each. Tabor management was able to identify assets with fair values of $810,000 and liabilities of $190,000 at the date of acquisition. At the end of the first year, the reporting unit had assets with a fair value of $950,000, and the fair value of the reporting entity was $930,000. Tabor’s accountants concluded it must recognize impairment of goodwill in the amount of $30,000 at the end of the first year.
Required
 

a.
Determine the fair value of the reporting unit’s liabilities at the end of the first year. Show your computation.
b.
If the reporting unit’s liabilities at the end of the period had been $70,000, what would the fair value of the reporting unit have to have been to avoid recognizing an impairment of goodwill? Show your computation. LO5

P1-36 Goodwill Assigned to Multiple Reporting Units
The fair values of assets and liabilities held by three reporting units and other information related to the reporting units owned by Rover Company are as follows:
 Reporting Unit A B C
Cash and Receivables $ 30,000 $ 80,000 $ 20,000
Inventory 60,000 100,000 40,000
Land 20,000 30,000 10,000
Buildings 100,000 150,000 80,000
Equipment 140,000 90,000 50,000
Accounts Payable 40,000 60,000 10,000
Fair Value of Reporting Unit 400,000 440,000 265,000
Carrying Value of Investment 420,000 500,000 290,000
Goodwill Included in Carrying Value 70,000 80,000 40,000

Required
 

a.
Determine the amount of goodwill that Rover should report in its current financial statements.
b.
Determine the amount, if any, that Rover should report as impairment of goodwill for the current period. LO4

P1-37 Journal Entries

On January 1, 20X3, PURE Products Corporation issued 12,000 shares of its $10 par value stock to acquire the net assets of Light Steel Company. Underlying book value and fair value information for the balance sheet items of Light Steel at the time of acquisition follow:
Balance Sheet Item Book Value Fair Value

Cash $ 60,000 $ 60,000
Accounts Receivable 100,000 100,000
Inventory (LIFO basis) 60,000 115,000
Land 50,000 70,000
Buildings and Equipment 400,000 350,000
Less: Accumulated Depreciation (150,000) —
Total Assets $ 520,000 $695,000
Accounts Payable $ 10,000 $ 10,000
Bonds Payable 200,000 180,000
Common Stock ($5 par value) 150,000
Additional Paid-In Capital 70,000
Retained Earnings 90,000
Total Liabilities and Equities $ 520,000
Light Steel shares were selling at $18 and PURE Products shares were selling at $50 just before the merger announcement. Additional cash payments made by PURE Products in completing the acquisition were
Finder’s fee paid to firm that located Light Steel $10,000
Audit fee for stock issued by PURE Products 3,000
Stock registration fee for new shares of PURE Products 5,000
Legal fees paid to assist in transfer of net assets 9,000
Cost of SEC registration of PURE Products shares 1,000
Required
 
Prepare all journal entries to record the business combination on PURE Products’ books. LO4, LO5

P1-38 Purchase at More than Book Value

Ramrod Manufacturing acquired all the assets and liabilities of Stafford Industries on January 1, 20X2, in exchange for 4,000 shares of Ramrod’s $20 par value common stock. Balance sheet data for both companies just before the merger are given as follows:
 
Ramrod Manufacturing Stafford Industries
Balance Sheet Items Book Value Fair Value Book Value Fair Value

Cash $ 70,000 $ 70,000 $ 30,000 $ 30,000
Accounts Receivable 100,000 100,000 60,000 60,000
Inventory 200,000 375,000 100,000 160,000
Land 50,000 80,000 40,000 30,000
Buildings and Equipment 600,000 540,000 400,000 350,000
Less: Accumulated Depreciation (250,000) (150,000)
Total Assets $ 770,000 $1,165,000 $ 480,000 $630,000
Accounts Payable $ 50,000 $ 50,000 $ 10,000 $ 10,000
Bonds Payable 300,000 310,000 150,000 145,000

Common Stock:

$20 par value 200,000

$5 par value 100,000

Additional Paid-In Capital 40,000 20,000

Retained Earnings 180,000 200,000

Total Liabilities and Equities $ 770,000 $ 480,000
Ramrod shares were selling for $150 on the date of acquisition.
Required

Prepare the following:
a.
Journal entries to record the acquisition on Ramrod’s books.
b.
A balance sheet for the combined enterprise immediately following the business combination. LO4

P1-39 Business Combination

Following are the balance sheets of Boogie Musical Corporation and Toot-Toot Tuba Company as of December 31, 20X5.

BOOGIE MUSICAL CORPORATION
Balance Sheet
December 31, 20X5
Assets Liabilities and Equities

Cash $ 23,000 Accounts Payable $ 48,000
Accounts Receivable 85,000 Notes Payable 65,000
Allowance for Uncollectible Accounts (1,200) Mortgage Payable 200,000
Inventory 192,000 Bonds Payable 200,000
Plant and Equipment 980,000 Capital Stock ($10 par) 500,000
Accumulated Depreciation (160,000) Premium on Capital Stock 1,000
Other Assets 14,000 Retained Earnings 118,800
Total Assets $1,132,800 Total Liabilities and Equities $1,132,800
TOOT-TOOT TUBA COMPANY
Balance Sheet
December 31, 20X5
Assets Liabilities and Equities

Cash $ 300 Accounts Payable $ 8,200
Accounts Receivable 17,000 Notes Payable 10,000
Allowance for Uncollectible Accounts (600) Mortgage Payable 50,000
Inventory 78,500 Bonds Payable 100,000
Plant and Equipment 451,000 Capital Stock ($50 par) 100,000
Accumulated Depreciation (225,000) Premium on Capital Stock 150,000
Other Assets 25,800 Retained Earnings (71,200)
Total Assets $347,000 Total Liabilities and Equities $347,000
In preparation for a possible business combination, a team of experts from Boogie Musical made a thorough examination and audit of Toot-Toot Tuba. They found that Toot-Toot’s assets and liabilities were correctly stated except that they estimated uncollectible accounts at $1,400. The experts also estimated the market value of the inventory at $35,000 and the market value of the plant and equipment at $500,000. The business combination took place on January 1, 20X6, and on that date Boogie Musical acquired all the assets and liabilities of Toot-Toot Tuba. On that date, Boogie’s common stock was selling for $55 per share.
Required
 
Record the combination on Boogie’s books assuming that Boogie issued 9,000 of its $10 par common shares in exchange for Toot-Toot’s assets and liabilities.

P1-40 Combined Balance Sheet

Bilge Pumpworks and Seaworthy Rope Company agreed to merge on January 1, 20X3. On the date of the merger agreement, the companies reported the following data:
Bilge Pumpworks Seaworthy Rope Company
Balance Sheet Items Book Value Fair Value Book Value Fair Value

Cash and Receivables $ 90,000 $ 90,000 $ 20,000 $ 20,000
Inventory 100,000 150,000 30,000 42,000
Land 100,000 140,000 10,000 15,000
Plant and Equipment 400,000 300,000 200,000 140,000
Less: Accumulated Depreciation (150,000) (80,000)
Total Assets $ 540,000 $680,000 $180,000 $217,000
Current Liabilities $ 80,000 $ 80,000 $ 20,000 $ 20,000
Capital Stock 200,000 20,000
Capital in Excess of Par Value 20,000 5,000
Retained Earnings 240,000 135,000
Total Liabilities and Equities $ 540,000 $180,000
Bilge Pumpworks has 10,000 shares of its $20 par value shares outstanding on January 1, 20X3, and Seaworthy has 4,000 shares of $5 par value stock outstanding. The market values of the shares are $300 and $50, respectively.
Required
 

a.
Bilge issues 700 shares of stock in exchange for all of Seaworthy’s net assets. Prepare a balance sheet for the combined entity immediately following the merger.
b.
Prepare the stockholders’ equity section of the combined company’s balance sheet, assuming Bilge acquires all of Seaworthy’s net assets by issuing:
1. 1,100 shares of common.
2. 1,800 shares of common.
3. 3,000 shares of common. LO4, LO5

P1-41 Incomplete Data Problem

On January 1, 20X2, End Corporation acquired all of Cork Corporation’s assets and liabilities by issuing shares of its common stock. Partial balance sheet data for the companies prior to the business combination and immediately following the combination are as follows:
 
End Corp. Cork Corp.
Book Value Book Value Combined Entity

Cash $ 40,000 $ 10,000 $ 50,000
Accounts Receivable 60,000 30,000 88,000
Inventory 50,000 35,000 96,000
Buildings and Equipment (net) 300,000 110,000 430,000
Goodwill ?
Total Assets $450,000 $185,000 $ ?
Accounts Payable $ 32,000 $ 14,000 $ 46,000
Bonds Payable 150,000 70,000 220,000
Bond Premium 6,000 6,000
Common Stock, $5 par 100,000 40,000 126,000
Additional Paid-In Capital 65,000 28,000 247,000
Retained Earnings 97,000 33,000 ?
Total Liabilities and Equities $450,000 $185,000 $ ?
Required
 

a.
What number of shares did End issue to acquire Cork’s assets and liabilities?
b.
What was the market value of the shares issued by End?
c.
What was the fair value of the inventory held by Cork at the date of combination?
d.
What was the fair value of the net assets held by Cork at the date of combination?
e.
What amount of goodwill, if any, will be reported by the combined entity immediately following the combination?
f.
What balance in retained earnings will the combined entity report immediately following the combination?
g.
If the depreciable assets held by Cork had an average remaining life of 10 years at the date of acquisition, what amount of depreciation expense will be reported on those assets in 20X2? LO4, LO5

P1-42 Incomplete Data Following Purchase

On January 1, 20X1, Alpha Corporation acquired all of Bravo Company’s assets and liabilities by issuing shares of its $3 par value stock to the owners of Bravo Company in a business combination. Alpha also made a cash payment to Banker Corporation for stock issue costs. Partial balance sheet data for Alpha and Bravo, before the cash payment and issuance of shares, and a combined balance sheet following the business combination are as follows:
 
Alpha Corporation Bravo Company
Book Value Book Value Fair Value Combined Entity

Cash $ 65,000 $ 15,000 $ 15,000 $ 56,000
Accounts Receivable 105,000 30,000 30,000 135,000
Inventory 210,000 90,000 ? 320,000
Buildings and Equipment (net) 400,000 210,000 293,000 693,000
Goodwill ?
Total Assets $780,000 $345,000 $448,000 $ ?
Accounts Payable $ 56,000 $ 22,000 $ 22,000 $ 78,000
Bonds Payable 200,000 120,000 120,000 320,000
Common Stock 96,000 70,000 117,000
Additional Paid-In Capital 234,000 42,000 553,000
Retained Earnings 194,000 91,000 ?
Total Liabilities and Equities $780,000 $345,000 $142,000 $ ?
Required
 

a.
What number of its $5 par value shares did Bravo have outstanding at January 1, 20X1?
b.
Assuming that all of Bravo’s shares were issued when the company was started, what was the price per share received at the time of issue?
c.
How many shares of Alpha were issued at the date of combination?
d.
What amount of cash did Alpha pay as stock issue costs?
e.
What was the market value of Alpha’s shares issued at the date of combination?
f.
What was the fair value of Bravo’s inventory at the date of combination?
g.
What was the fair value of Bravo’s net assets at the date of combination?
h.
What amount of goodwill, if any, will be reported in the combined balance sheet following the combination? LO4, LO5

P1-43 Comprehensive Business Combination Problem

Bigtime Industries Inc. entered into a business combination agreement with Hydrolized Chemical Corporation (HCC) to ensure an uninterrupted supply of key raw materials and to realize certain economies from combining the operating processes and the marketing efforts of the two companies.
Under the terms of the agreement, Bigtime issued 180,000 shares of its $1 par common stock in exchange for all of HCC’s assets and liabilities. The Bigtime shares then were distributed to HCC’s shareholders, and HCC was liquidated.
Immediately prior to the combination, HCC’s balance sheet appeared as follows, with fair values also indicated:
Book Values Fair Values Assets

Cash $ 28,000 $ 28,000
Accounts Receivable 258,000 251,500
Less: Allowance for Bad Debts (6,500)
Inventory 381,000 395,000
Long-Term Investments 150,000 175,000
Land 55,000 100,000
Rolling Stock 130,000 63,000
Plant and Equipment 2,425,000 2,500,000
Less: Accumulated Depreciation (614,000)
Patents 125,000 500,000
Special Licenses 95,800 100,000
Total Assets $3,027,300 $4,112,500
Liabilities

Current Payables $ 137,200 $ 137,200
Mortgages Payable 500,000 520,000
Equipment Trust Notes 100,000 95,000
Debentures Payable 1,000,000 950,000
Less: Discount on Debentures (40,000)
Total Liabilities $1,697,200 $1,702,200
Stockholders’ Equity

Common Stock ($5 par) 600,000
Additional Paid-In Capital from Common Stock 500,000
Additional Paid-In Capital from
Retirement of Preferred Stock 22,000
Retained Earnings 220,100
Less: Treasury Stock (1,500 shares) (12,000)
Total Liabilities and Equity $3,027,300
Immediately prior to the combination, Bigtime’s common stock was selling for $14 per share. Bigtime incurred direct costs of $135,000 in arranging the business combination and $42,000 of costs associated with registering and issuing the common stock used in the combination.
Required
 

a.
Prepare all journal entries that Bigtime should have entered on its books to record the business combination.
b.
Present all journal entries that should have been entered on HCC’s books to record the combination and the distribution of the stock received.



ANSWERS TO QUESTIONS

Q1-1   Complex organizational structures often result when companies do business in a complex business environment. New subsidiaries or other entities may be formed for purposes such as extending operations into foreign countries, seeking to protect existing assets from risks associated with entry into new product lines, separating activities that fall under regulatory controls, and reducing taxes by separating certain types of operations.

Q1-2   The split-off and spin-off result in the same reduction of reported assets and liabilities. Only the stockholders’ equity accounts of the company are different. The number of shares outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital is reduced. Shares of the parent are exchanged for shares of the subsidiary in a split-off, thereby reducing the outstanding shares of the parent company.

Q1-3   The management of Enron appears to have used special-purpose entities to avoid reporting debt on its balance sheet and to create fictional transactions that resulted in reported income. It also transferred bad loans and investments to special-purpose entities to avoid recognizing losses in its income statement.

Q1-4   (a)  A statutory merger occurs when one company acquires another company and the assets and liabilities of the acquired company are transferred to the acquiring company; the acquired company is liquidated, and only the acquiring company remains.

(b)  A statutory consolidation occurs when a new company is formed to acquire the assets and liabilities of two combining companies; the combining companies dissolve, and the new company is the only surviving entity.

(c)  A stock acquisition occurs when one company acquires a majority of the common stock of another company and the acquired company is not liquidated; both companies remain as separate but related corporations.

Q1-5   Assets and liabilities transferred to a new wholly-owned subsidiary normally are transferred at book value. In the event the value of an asset transferred to a newly created entity has been impaired prior to the transfer and its fair value is less than the carrying value on the transferring company’s books, the transferring company should recognize an impairment loss and the asset should then be transferred to the entity at the lower value.

Q1-6   The introduction of the concept of beneficial interest expands those situations in which consolidation is required. Existing accounting standards have focused on the presence or absence of equity ownership. Consolidation and equity method reporting have been required when a company holds the required level of common stock of another entity. The beneficial interest approach says that even when a company does not hold stock of another company, consolidation should occur whenever it has a direct or indirect ability to make decisions significantly affecting the results of activities of an entity or will absorb a majority of an entity’s expected losses or receive a majority of the entity’s expected residual returns.


Q1-7   A noncontrolling interest exists when the acquiring company gains control but does not own all the shares of the acquired company. The non-controlling interest is the shares not owned by the acquiring company.

Q1-8  Under pooling-of-interests accounting the book values of the combining companies were carried forward and no goodwill was recognized. Future earnings were not reduced by additional amortization, depreciation, or write-offs.

Q1-9   Goodwill is the excess of the sum of the fair value given by the acquiring company and the acquisition-date fair value of any noncontrolling interest over the acquisition-date fair value of the net identifiable assets acquired in the business combination.

Q1-10  The level of ownership acquired does not impact the amount of goodwill reported under the acquisition method. Prior to the adoption of the acquisition method the amount reported was determined by the amount paid by the acquiring company to attain ownership of the acquiree.

Q1-11  When less-than-100-percent ownership is acquired, goodwill must be allocated between the acquirer and the noncontrolling interest. This is accomplished by assigning to the acquirer the difference between the acquisition-date fair value of its equity interest in the acquiree and its share of the acquisition-date fair value of the acquiree’s net assets. The remaining amount of goodwill is assigned to the noncontrolling interest.
.
Q1-12  The total difference at the acquisition date between the fair value of the consideration exchanged and the book value of the net identifiable assets acquired is referred to as the differential.

Q1-13  The purchase of a company is viewed in the same way as any other purchase of assets. The acquired company is owned by the acquiring company only for the portion of the year subsequent to the combination. Therefore, earnings are accrued only from the date of purchase forward.

Q1-14  None of the retained earnings of the subsidiary should be carried forward under the acquisition method. Thus, consolidated retained earnings is limited to the balance reported by the acquiring company.

Q1-15  Additional paid-in capital reported following a business combination is the amount previously reported on the acquiring company's books plus the excess of the fair value over the par or stated value of any shares issued by the acquiring company in completing the acquisition.

Q1-16  When the acquisition method is used, all costs incurred in bringing about the combination are expensed as incurred. None are capitalized. However, costs associated with the issuance of stock are charged to additional paid-in capital.

Q1-17  When the acquiring company issues shares of stock to complete a business combination, the excess of the fair value of the stock issued over its par value is recorded as additional paid-in capital. All costs incurred by the acquiring company in issuing the securities should be treated as a reduction in the additional paid-in capital. Items such as audit fees associated with the registration of securities, listing fees, and brokers' commissions should be treated as reductions of additional paid-in capital when stock is issued. An adjustment to bond premium or bond discount is needed when bonds are used to complete the purchase.


Q1-18  If the fair value of a reporting unit acquired in a business combination exceeds its carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand, if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is implied. An impairment must be recognized if the carrying amount of the goodwill assigned to the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied value of the reporting unit’s goodwill is determined as the excess of the fair value of the reporting unit over the fair value of its net assets excluding goodwill.

Q1-19  When the fair value of the consideration given in a business combination, along with the fair value of any equity interest in the acquiree already held and the fair value of any noncontrolling interest in the acquiree, is less than the fair value of the acquiree’s net identifiable assets, a bargain purchase results.

Q1-20*  The acquirer should record the clarification of the acquisition-date fair value of buildings as a reduction to buildings and addition to goodwill.
.
Q1-21*  The acquirer must revalue the equity position to its fair value at the acquisition date and recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case.

Q1-22A  The purchase method calls for recording the acquirer’s investment in the acquired company at the amount of the total purchase price paid by the acquirer, including associated costs. The difference between this amount and the acquirer’s proportionate share of the fair value of the net identifiable assets is reported as goodwill.

Q1-23A  Under the pooling method, the book values of the assets, liabilities, and equity of the acquired company are carried forward without adjustment to fair value. No goodwill is recorded because the fair value of the Consideration given is not recognized. Consistent with the idea of the owners of the combining companies continuing as owners of the combined company, the retained earnings of both companies are carried forward.

SOLUTIONS TO CASES

C1-1  Reporting Alternatives and International Harmonization

a. In the past, U.S. companies were required to systematically amortize the amount of goodwill recorded, thereby reducing earnings, while companies in other countries were not required to do so. Thus, reported results subsequent to business combinations were often lower than for foreign acquirers that did not amortize goodwill. The FASB changed accounting for goodwill in 2001 to no longer require amortization. Instead, the FASB now requires goodwill to be tested periodically for impairment and written down if impaired. Also, international accounting standards and U.S. standards have become closer in recent years, and authoritative bodies are working to bring standards even closer.

b. U.S. companies must be concerned about accounting standards in other countries and about international standards (i.e., those issued by the International Accounting Standards Committee). Companies operate in a global economy today. Not only do they buy and sell products and services in other countries, but they may raise capital and have operations located in other countries. Such companies may have to meet foreign reporting requirements, and these requirements may differ from U.S. reporting standards. In recent years, the acceptance of international accounting standards has become widespread, and international standards are even gaining acceptance in the United States. Thus, many U.S. companies, and not just the largest, may find foreign and international reporting standards relevant if they are going to operate globally.

U.S. companies also sometimes acquire foreign companies, especially if they wish to move into a new geographic area or ensure a supply of raw materials. For the acquiring company to perform its due diligence with respect to a foreign acquisition, it must be familiar with international financial reporting standards.



C1-2  Assignment of Acquisition Costs

NOTE:  This memo is written assuming that 20X7 means 2007 prior to the FASB’s release of SFAS 141R. Accordingly, 20X9 is assumed to be 2009 after SFAS 141R came into effect. If students interpreted the years as generic years, they would assume that both acquisitions took place after the implementation of acquisition accounting required under SFAS 141R and the rules discussed in the last two paragraphs would apply to both acquisitions.

MEMO

To:    Vice-President of Finance
         Troy Company

From:                            , CPA


Re:      Recording Acquisition Costs of Business Combination

Troy Company incurred a variety of costs in acquiring the ownership of Kline Company and transferring the assets and liabilities of Kline to Troy Company. I was asked to review the relevant accounting literature and provide my recommendations as to what was the appropriate treatment of the costs incurred in the acquisition of Kline Company.

The accounting standards applicable to the 20X7 acquisition required that all direct costs of purchasing another company be treated as part of the total cost of the acquired company. The costs incurred in issuing common or preferred stock in a business combination were required to be treated as a reduction of the otherwise determinable fair value of the securities. [FASB 141, Par. 24]


A total of $720,000 was paid by Troy in completing its acquisition of Kline. The $200,000 finders’ fee and $90,000 legal fees for transferring Kline’s assets and liabilities to Troy should have been included in the purchase price of Kline. The $60,000 payment for stock registration and audit fees should have been recorded as a reduction of paid-in capital recorded when the Troy Company shares were issued to acquire the shares of Kline. The only cost potentially at issue is the $370,000 legal fees resulting from the litigation by the shareholders of Kline. If this cost is considered to be a direct cost of acquisition , it should have been included in the costs of acquiring Kline. If, on the other hand, it is considered an indirect or general expense, it should have been charged to expense in 20X7. [FASB 141, Par. 24]

While one might argue that the $370,000 was an indirect cost, it resulted directly from the exchange of shares used to complete the business combination and should have been included in the amount assigned to the cost of acquiring ownership of Kline. Of the total costs incurred, $660,000 should have been assigned to the purchase price of Kline and $60,000 recorded as a reduction of paid-in-capital.

You also requested information on how the costs of acquiring Lad Company should be treated under current accounting standards. Since the acquisition of Kline, the FASB has issued FASB 141R (ASC 805), “Business Combinations,” issued in December 2007. This standard can be found at the FASB website (www.fasb.org/pdf/fas141r.pdf).

Stock issue costs continue to be treated as previously. Acquired companies are to be valued under FASB 141R (ASC 805) at the fair value of the consideration given in the exchange, plus the fair value of any shares of the acquiree already held by the acquirer, plus the fair value of any noncontrolling interest in the acquiree at the date of combination [FASB 141R, Par. 34, ASC 805]. All other acquisition-related costs are accounted for expenses in the period incurred [FASB 141R, Par. 59, ASC 805].

Primary citation
FASB 141R; ASC 805

C1-3  Evaluation of Merger

Page numbers refer to the page in the 3M 2005 10-K report.

a. The CUNO acquisition improved 3M’s product mix by adding a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases (p. 4).

The CUNO acquisition added 5.1 percent to Industrial sales growth (p.13), and was the primary reason for a 1.0 percent increase in total sales in 2005 (p. 15).

b. The acquisition was funded primarily by debt (p.27):  The Company generates significant ongoing cash flow. Net debt decreased significantly in 2004, but increased in 2005, primarily related to the $1.36 billion CUNO acquisition.

c. As of December 31, 2005, the CUNO acquisition increased accounts receivable by $88 million (p. 27).

d. At December 31, 2005, the CUNO acquisition increased inventories by $56 million. Currency translation reduced inventories by $89 million year-on-year (p. 27).

C1-4  Business Combinations

It is very difficult to develop a single explanation for any series of events. Merger activity in the United States is impacted by events both within the U.S. economy and those around the world. As a result, there are many potential answers to the questions posed in this case.

a. The most commonly discussed factors associated with the merger activity of the nineties relate to the increased profitability of businesses. In the past, increases in profitability typically have been associated with increases in sales. The increased profitability of companies in the past decade, however, more commonly has been associated with decreased costs. Even though sales remained relatively flat, profits increased. Nearly all business entities appear to have gone through one or more downsizing events during the past decade. Fewer employees now are delivering the same amount of product to customers. Lower inventory levels and reduced investment in production facilities now are needed due to changes in production processes and delivery schedules. Thus, less investment in facilities and fewer employees have resulted in greater profits.

Companies generally have been reluctant to distribute the increased profits to shareholders through dividends. The result has been a number of companies with substantially increased cash reserves. This, in turn, has led management to look about for other investment alternatives, and cash buyouts have become more frequent in this environment.

In addition to high levels of cash on hand providing an incentive for business combinations, easy financing through debt and equity also provided encouragement for acquisitions. Throughout the nineties, interest rates were very low and borrowing was generally easy. With the enormous stock-price gains of the mid-nineties, companies found that they had a very valuable resource in shares of their stock. Thus, stock acquisitions again came into favor.


b. One factor that may have prompted the greater use of stock in business combinations recently is that many of the earlier combinations that had been effected through the use of debt had unraveled. In many cases, the debt burden was so heavy that the combined companies could not meet debt payments. Thus, this approach to financing mergers had somewhat fallen from favor by the mid-nineties. Further, with the spectacular rise in the stock market after 1994, many companies found that their stock was worth much more than previously. Accordingly, fewer shares were needed to acquire other companies.


c. Two of major factors appear to have had a significant influence on the merger movement in the mid-2000s. First, interest rates were very low during that time, and a great amount of unemployed cash was available worldwide. Many business combinations were effected through significant borrowing. Second, private equity funds pooled money from various institutional investors and wealthy individuals and used much of it to acquire companies.

Many of the acquisitions of this time period involved private equity funds or companies that acquired other companies with the goal of making quick changes and selling the companies for a profit. This differed from prior merger periods where acquiring companies were often looking for long-term acquisitions that would result in synergies.

In late 2007, a mortgage crisis spilled over into the credit markets in general, and money for acquisitions became hard to get. This in turn caused many planned or possible mergers to be canceled. In addition, the economy in general faltered toward the end of 2007 and into 2008.

C1-4 (continued)

d. Establishing incentives for corporate mergers is a controversial issue. Many people in our society view mergers as not being in the best interests of society because they are seen as lessening competition and often result in many people losing their jobs. On the other hand, many mergers result in companies that are more efficient and can compete better in a global economy; this in turn may result in more jobs and lower prices. Even if corporate mergers are viewed favorably, however, the question arises as to whether the government, and ultimately the taxpayers, should be subsidizing those mergers through tax incentives. Many would argue that the desirability of individual corporate mergers, along with other types of investment opportunities, should be determined on the basis of the merits of the individual situations rather than through tax incentives.

Perhaps the most obvious incentive is to lower capital gains tax rates. Businesses may be more likely to invest in other companies if they can sell their ownership interests when it is convenient and pay lesser tax rates. Another alternative would include exempting certain types of intercorporate income. Favorable tax status might be given to investment in foreign companies through changes in tax treaties. As an alternative, barriers might be raised to discourage foreign investment in United States, thereby increasing the opportunities for domestic firms to acquire ownership of other companies.


e. In an ideal environment, the accounting and reporting for economic events would be accurate and timely and would not influence the economic decisions being reported. Any change in reporting requirements that would increase or decrease management's ability to "manage" earnings could impact management's willingness to enter new or risky business fields and affect the level of business combinations. Greater flexibility in determining which subsidiaries are to be consolidated, the way in which intercorporate income is calculated, the elimination of profits on intercompany transfers, or the process used in calculating earnings per share could impact such decisions. The processes used in translating foreign investment into United States dollars also may impact management's willingness to invest in domestic versus international alternatives.


C1-5  Determination of Goodwill Impairment

MEMO

TO:   Chief Accountant
         Plush Corporation

From:                            , CPA

Re:      Determining Impairment of Goodwill

Once goodwill is recorded in a business combination, it must be accounted for in accordance with FASB Statement No. 142. Goodwill is carried forward at the original amount without amortization, unless it becomes impaired. The amount determined to be goodwill in a business combination must be assigned to the reporting units of the acquiring entity that are expected to benefit from the synergies of the combination. [FASB 142, Par. 34; ASC 350-20-35-41]

This means the total amount assigned to goodwill may be divided among a number of reporting units. Goodwill assigned to each reporting unit must be tested for impairment annually and between the annual tests in the event circumstances arise that would lead to a possible decrease in the fair value of the reporting unit below its carrying amount [FASB 142, Par. 28; ASC 350-20-35-30].

As long as the fair value of the reporting unit is greater than its carrying value, goodwill is not considered to be impaired. If the fair value is less than the carrying value, a second test must be performed. An impairment loss must be reported if the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill. [FASB 142, Par. 20; ASC 350-20-35-11]

At the date of acquisition, Plush Corporation recognized goodwill of $20,000 ($450,000 - $430,000) and assigned it to a single reporting unit. Even though the fair value of the reporting unit increased to $485,000 at December 31, 20X5, Plush Corporation must test for impairment of goodwill if the carrying value of Plush’s investment in the reporting unit is above that amount. That would be the case if the carrying value is $500,000. In the second test, the fair value of the reporting unit’s net assets, excluding goodwill, is deducted from the fair value of the reporting unit ($485,000) to determine the amount of implied goodwill at that date. If the fair value of the net assets is less than $465,000, the amount of implied goodwill is more than $20,000 and no impairment of goodwill is assumed to have occurred. On the other hand, if the fair value of the net assets is greater than $465,000, the amount of implied goodwill is less than $20,000 and an impairment of goodwill must be recorded.

With the information provided, we do not know if there has been an impairment of the goodwill involved in the purchase of Common Corporation; however, Plush must follow the procedures outlined above in testing for impairment at December 31, 20X5.

Primary citations
FASB 142, Par. 20; ASC 350-20-35-11
FASB 142, Par. 28; ASC 350-20-35-30
FASB 142, Par. 34; ASC 350-20-35-41

C1-6  Risks Associated with Acquisitions

Google discloses on page 21 of its 2006 Form 10-K that it does not have significant experience acquiring companies. It also notes that most acquisitions the company has already completed have been small companies. The specific risk areas identified include:

The potential need to implement controls, procedures, and policies appropriate for a public company that were not already in place in the acquired company

Potential difficulties in integrating the accounting, management information, human resources, and other administrative systems.

The use of management time on acquisitions-related activities that may temporarily divert attention from operating activities

Potential difficulty in integrating the employees of an acquired company into the Google organization

Retaining employees who worked for companies that Google acquires

Anticipated benefits of acquisitions may not materialize.

Foreign acquisitions may include additional unique risks including potential difficulties arising from differences in cultures and languages, currencies, and from economic, political, and regulatory risks.

C1-7  Numbers Game

a. A company is motivated to keep its stock price high. However, stock price is very sensitive to information about company performance. When the company reports lower earnings than the market anticipated, the stock price often falls significantly. A desire to increase reported earnings to meet the expectations of Wall Street may provide a company with incentives to manipulate earnings to achieve this goal.

b. Levitt discusses 5 specific techniques: (1) "big bath" restructuring charges, (2) creative acquisition accounting, (3) "cookie jar reserves," (4) improper application of the materiality principal, and (5) improper recognition of revenue. Following Levitt’s speech, the FASB subsequently dealt with each of these issues. Accounting standards since that time have limited these earnings management techniques.

c. Levitt notes meaningful disclosure to investors about company performance is necessary for investors to trust and feel confident in the information they are using to make investing decisions. Levitt believes this trust is the bedrock of our financial markets and is required for the efficient functioning of U.S. capital markets.


C1-8  MCI:  A Succession of Mergers

The story of MCI WorldCom (later, MCI) is the story of the man who is largely responsible for both the rise and fall of MCI WorldCom. Bernard Ebbers was Chief Executive Officer of MCI until he resigned under pressure from the Board of Directors in April 2002. He put together over five dozen acquisitions in the two decades prior to stepping down. In 1983, he and three friends bought a small phone company which they named LDDS (Long Distance Discount Services); he became CEO of the company in 1985 and guided its growth strategy. In 1989, LDDS combined with Advantage Co., keeping the LDDS name, to provide long-distance service to 11 Southern and Midwestern states. LDDS merged with Advanced Telecommunications Corporation in 1992 in an exchange of stock accounted for as a pooling of interests. In 1993, LDDS merged with Metromedia Communications Corporation and Resurgens Communications Group, with the combined company maintaining the LDDS name and LDDS treated as the surviving company for accounting purposes (although legally Resurgens was the surviving company). In 1994, the company merged with IDB Communications Group in an exchange of stock accounted for as a pooling. In 1995, LDDS purchased for cash the network services operations of Williams Telecommunications Group. Later in 1995, the company changed its name to WorldCom, Inc. In 1996, WorldCom acquired the large Internet services provider UUNET by merging with its parent company, MFS Communications Company, in an exchange of stock. In 1997, WorldCom purchased the Internet and networking divisions of America Online and CompuServe in a three-way stock and asset swap. In 1998, the Company acquired MCI Communications Corporation for approximately $40 billion, and subsequently the name of the company was changed to MCI WorldCom. This merger was accounted for as a purchase. In 1998, the Company also acquired CompuServe for 56 million MCI WorldCom common shares in a business combination accounted for as a purchase. In 1999, MCI WorldCom acquired SkyTel for 23 million MCI WorldCom common shares in a pooling of interests. An attempt to acquire Sprint in 1999, in a deal billed as the biggest in corporate history, was scuttled due to antitrust concerns.

MCI WorldCom’s long distance and other businesses experienced major declines in 2000 and profits began to fall. Continued deterioration of operations and cash flows and disclosure of a massive accounting fraud in June 2002, led MCI WorldCom to file for bankruptcy protection in July 2002, in the largest Chapter 11 case in U.S. history at that time.  Subsequent discoveries of additional inappropriate accounting activities and restatements of financial statements further blemished the company’s reputation. In April 2003, WorldCom filed a plan of reorganization with the SEC and changed the company name from WorldCom to MCI. The company went through a period of retrenchment, and in early 2006 merged with Verizon Communications. Thus, MCI is no longer a separate company but rather is part of Verizon’s wireline business.

Criminal charges were filed against Bernard Ebbers and five other former executives of WorldCom in connect with a major fraud investigation. The company also was charged and eventually reached a settlement with the SEC, agreeing to pay $500 million of cash and 10 million shares of common stock of MCI. Bernard Ebbers was tried for an $11 billion accounting fraud and in 2005 was found guilty of all nine counts with which he was charged. He was sentenced to 25 years in prison, with confiscation of nearly all of his assets. Ebbers is currently in the Oakdale Federal Correctional Complex in Louisiana.




C1-9  Leveraged Buyouts

a. A leveraged buyout (LBO) involves acquiring a company in a transaction or series of planned transactions that include using a very high proportion of debt, often secured by the assets of the target company. Normally, the investors acquire all of the stock or assets of the target company. A management buyout (MBO) occurs when the existing management of a company acquires all or most of the stock or assets of the company. Frequently, the investors in LBOs include management, and thus an LBO may also be an MBO

b. The FASB has not dealt with leveraged buyouts in either current pronouncements or exposure drafts of proposed standards. The Emerging Issues Task Force has addressed limited aspects of accounting for LBOs. In EITF 84-23, “Leveraged Buyout Holding Company Debt,” the Task Force did not reach a consensus. In EITF 88-16, “Basis in Leveraged Buyout Transactions,” the Task Force did provide guidance as to the proper basis that should be recognized for an acquiring company’s interest in a target company acquired through a leveraged buyout.

c. Whether an LBO is a type of business combination is not clear and probably depends on the structure of the buyout. The FASB has not taken a position on whether an LBO is a type of business combination. The EITF indicated that LBOs of the type it was considering are similar to business combinations. Most LBOs are effected by establishing a holding company for the purpose of acquiring the assets or stock of the target company. Such a holding company has no substantive operations. Some would argue that a business combination can occur only if the acquiring company has substantive operations. However, neither the FASB nor EITF has established such a requirement. Thus, the question of whether an LBO is a business combination is unresolved.

d. The primary issue in deciding the proper basis for an interest in a company acquired in an LBO, as determined by EITF 88-16, is whether the transaction has resulted in a change in control of the target company (a new controlling shareholder group has been established). If a change in control has not occurred, the transaction is treated as a recapitalization or restructuring, and a change in basis is not appropriate (the previous basis carries over). If a change in control has occurred, a new basis of accounting may be appropriate.



C1-10  Curtiss-Wright and Goodwill

a. Curtiss-Wright Corporation acquired seven businesses in 2001 and six businesses in 2002, with all of the acquisitions accounted for as purchases. Goodwill increased from $47,204,000 on January 1, 2001, to $83,585,000 at December 31, 2001, an increase of $36,381,000 or 77.1 percent. Goodwill of $181,101,000 was reported at December 31, 2002, an increase of $97,516,000 or 116.7 percent for the year. Goodwill represented 22.3 percent ($181,101,000/$812,924,000) of total assets at December 31, 2002. This amount represents a substantially higher proportion of total assets than is found in most manufacturing-related companies. Note that the company accounted for all of its acquisitions using the purchase method, one of the two acceptable methods of accounting for business combinations during that time, and the method that resulted in the recognition of goodwill.

b. Curtis-Wright acquired assets having a total fair value of $42.4 million (and assumed liabilities of $7.4 million) through business combinations in 2006. Goodwill increased in 2006 by $22.9 million ($411.1 - $388.2), for an increase of about 6 percent. The amount of goodwill at December 31, 2006, represents about 26 percent of total assets.

c. Curtis-Wright recognized no goodwill impairment losses for 2005 or 2006. At the end of 2006, Curtis-Wright changed its date for testing goodwill impairment from July 31 to October 31. This was done to better coincide with the company’s normal schedule for developing strategic plans and forecasts. This change had no effect on the financial statements for 2006 and prior years.

d. The management of Curtiss-Wright undoubtedly prefers the current treatment of goodwill. Curtiss-Wright has a large amount of goodwill in comparison with most companies, and amortizing that goodwill would have a negative impact on earnings. Given that Curtiss-Wright has had no goodwill impairment losses in recent years under the current treatment of goodwill, earnings has not been burdened by the company’s substantial goodwill. However, if the company’s market position were to deteriorate or a sustained general economic downturn were to occur, the company could incur significant goodwill impairment losses. Despite the economic crisis of 2008, Curtis-Wright had not recognized any goodwill impairment losses as of their 2009 annual report.

C1-11    Sears and Kmart: The Joining Together of Two of America’s Oldest Retailers

a. Kmart declared Chapter 11 bankruptcy on January 22, 2002. The company reorganized and emerged from bankruptcy on May 6, 2003.

b. The business combination was a stock acquisition in the form of a consolidation. That is, a new corporation was formed to acquire the two combining companies, Kmart and Sears, Roebuck. After the combination, the parent company, Sears Holdings Corporation, held all of the stock of Sears, Roebuck and Co. and Kmart Holding Corporation.

c. Kmart was designated as the acquiring company. This determination was made on the basis of relative share ownership subsequent to the combination, makeup of the combined company’s board of directors, makeup of senior management, and perhaps other factors. Given that Kmart was considered to be the acquirer, the historical balances of its accounts became those of the parent company, Sears Holdings.

SOLUTIONS TO EXERCISES

E1-1  Multiple-Choice Questions on Complex Organizations

1. b

2. d

3. a

4. b

5. d



E1-2  Multiple-Choice Questions on Recording Business Combinations
          [AICPA Adapted]

1. a

2. c

3. d

4. d

5. c




E1-3  Multiple-Choice Questions on Reported Balances [AICPA Adapted]

1. d

2. d

3. c

4. c







E1-4  Multiple-Choice Questions Involving Account Balances

1. c

2. c

3. b

4. b

5. b



E1-5  Asset Transfer to Subsidiary

a. Journal entry recorded by Pale Company for transfer of assets to Bright Company:

Investment in Bright Company Common Stock 408,000
Accumulated Depreciation – Buildings 24,000
Accumulated Depreciation – Equipment 36,000
    Cash 21,000
    Inventory 37,000
    Land 80,000
    Buildings 240,000
    Equipment 90,000


b. Journal entry recorded by Bright Company for receipt of assets from Pale Company:

Cash 21,000
Inventory 37,000
Land 80,000
Buildings 240,000
Equipment 90,000
    Accumulated Depreciation – Buildings 24,000
    Accumulated Depreciation – Equipment 36,000
    Common Stock 60,000
    Additional Paid-In Capital 348,000




E1-6  Creation of New Subsidiary

a. Journal entry recorded by Lester Company for transfer of assets to Mumby Corporation:

Investment in Mumby Corporation Common Stock 498,000
Allowance for Uncollectible Accounts Receivable 7,000
Accumulated Depreciation – Buildings 35,000
Accumulated Depreciation – Equipment 60,000
    Cash 40,000
    Accounts Receivable 75,000
    Inventory 50,000
    Land 35,000
    Buildings 160,000
    Equipment 240,000


b. Journal entry recorded by Mumby Corporation for receipt of assets from Lester Company:

Cash 40,000
Accounts Receivable 75,000
Inventory 50,000
Land 35,000
Buildings 160,000
Equipment 240,000
    Allowance for Uncollectible
        Accounts Receivable 7,000
    Accumulated Depreciation – Buildings 35,000
    Accumulated Depreciation – Equipment 60,000
    Common Stock 120,000
    Additional Paid-In Capital 378,000



E1-7  Balance Sheet Totals of Parent Company

a. Journal entry recorded by Foster Corporation for transfer of assets and accounts payable to Kline Company:

Investment in Kline Company Common Stock 66,000
Accumulated Depreciation 28,000
Accounts Payable 22,000
    Cash 15,000
    Accounts Receivable 24,000
    Inventory 9,000
    Land 3,000
    Depreciable Assets 65,000


b. Journal entry recorded by Kline Company for receipt of assets and accounts payable from Foster Corporation:

Cash 15,000
Accounts Receivable 24,000
Inventory 9,000
Land 3,000
Depreciable Assets 65,000
    Accumulated Depreciation 28,000
    Accounts Payable 22,000
    Common Stock 48,000
    Additional Paid-In Capital 18,000



E1-8  Creation of Partnership

a. Journal entry recorded by Glover Corporation for transfer of assets to G&R Partnership:

Investment in G&R Partnership 450,000
Accumulated Depreciation – Buildings 60,000
Accumulated Depreciation – Equipment 40,000
    Cash 10,000
    Accounts Receivable 19,000
    Inventory 35,000
    Land 16,000
    Buildings 260,000
    Equipment 210,000


b. Journal entry recorded by Renfro Company for the transfer of cash to G&R Partnership:

Investment in G&R Partnership 50,000
    Cash 50,000


c. Journal entry recorded by G&R Partnership for receipt of assets from Glover Corporation and Renfro Company:

Cash 60,000
Accounts Receivable 19,000
Inventory 35,000
Land 16,000
Buildings 260,000
Equipment 210,000
    Accumulated Depreciation – Buildings 60,000
    Accumulated Depreciation – Equipment 40,000
    Capital, Glover Corporation 450,000
    Capital, Renfro Company 50,000



E1-9  Acquisition of Net Assets

Sun Corporation will record the following journal entries:

(1) Assets 71,000
Goodwill 9,000
    Liabilities 20,000
    Cash 60,000

(2) Merger Expense 4,000
    Cash 4,000


E1-10  Reporting Goodwill

a. Goodwill:  $120,000  =  $310,000 - $190,000
      Investment:  $310,000

b. Goodwill:  $6,000  =  $196,000 - $190,000
      Investment:  $196,000

c. Goodwill:  $0; no goodwill is recorded when the purchase price is below the fair
          value of the net identifiable assets.
      Investment:  $190,000; recorded at the fair value of the net identifiable assets.



E1-11  Stock Acquisition

Journal entry to record the purchase of Tippy Inc., shares:

Investment in Tippy Inc., Common Stock 986,000
    Common Stock 425,000
    Additional Paid-In Capital 561,000

 $986,000 = $58 x 17,000 shares
 $425,000 = $25 x 17,000 shares
 $561,000 = ($58 - $25) x 17,000 shares


E1-12  Balances Reported Following Combination

a. Stock Outstanding: $200,000 + ($10 x 8,000 shares) $280,000

b. Cash and Receivables: $150,000 + $40,000 190,000

c. Land: $100,000 + $85,000 185,000

d. Buildings and Equipment (net): $300,000 + $230,000 530,000

e. Goodwill: ($50 x 8,000) - $355,000 45,000

f. Additional Paid-In Capital:
  $20,000 + [($50 - $10) x 8,000] 340,000

g. Retained Earnings 330,000



E1-13  Goodwill Recognition

Journal entry to record acquisition of Spur Corporation net assets:

Cash and Receivables 40,000
Inventory 150,000
Land 30,000
Plant and Equipment 350,000
Patent 130,000
Goodwill 55,000
    Accounts Payable 85,000
    Cash 670,000

Computation of goodwill

Fair value of consideration given $670,000
Fair value of assets acquired $700,000
Fair value of liabilities assumed  (85,000)
Fair value of net assets acquired 615,000
Goodwill $   55,000


E1-14  Acquisition Using Debentures

Journal entry to record acquisition of Sorden Company net assets:

Cash and Receivables 50,000
Inventory 200,000
Land 100,000
Plant and Equipment 300,000
Discount on Bonds Payable 17,000
Goodwill 8,000
    Accounts Payable 50,000
    Bonds Payable 625,000


   Computation of goodwill

Fair value of consideration given $608,000
Fair value of assets acquired $650,000
Fair value of liabilities assumed  (50,000)
Fair value of net assets acquired 600,000
Goodwill $   8,000





E1-15  Bargain Purchase

Journal entry to record acquisition of Sorden Company net assets:

Cash and Receivables 50,000
Inventory 200,000
Land 100,000
Plant and Equipment 300,000
Discount on Bonds Payable 16,000
    Accounts Payable 50,000
    Bonds Payable 580,000
    Gain on Bargain Purchase of Subsidiary 36,000

The gain represents the excess of  the $600,000 fair value of the net assets
acquired ($650,000 - $50,000) over the $564,000 paid to purchase ownership.






E1-16  Impairment of Goodwill

a. Goodwill of $80,000 will be reported. The fair value of the reporting unit ($340,000) is greater than the carrying amount of the investment ($290,000) and the goodwill does not need to be tested for impairment.

b. Goodwill of $35,000 will be reported (fair value of reporting unit of $280,000 - fair value of net assets of $245,000). An impairment loss of $45,000 ($80,000 - $35,000) will be recognized.

c. Goodwill of $15,000 will be reported (fair value of reporting unit of $260,000 - fair value of net assets of $245,000). An impairment loss of $65,000 ($80,000 - $15,000) will be recognized.



E1-17  Assignment of Goodwill

a. No impairment loss will be recognized. The fair value of the reporting unit ($530,000) is greater than the carrying value of the investment ($500,000) and goodwill does not need to be tested for impairment.

b. An impairment of goodwill of $15,000 will be recognized. The implied value of goodwill is $45,000 ($485,000 - $440,000), which represents a $15,000 decrease from the original $60,000.

c. An impairment of goodwill of $50,000 will be recognized. The implied value of goodwill is $10,000 ($450,000 - $440,000), which represents a $50,000 decrease from the original $60,000.

E1-18  Goodwill Assigned to Reporting Units

Goodwill of $158,000 ($60,000 + $48,000 + $0 + $50,000) should be reported, computed as follows:

Reporting Unit A:  Goodwill of $60,000 should be reported. The implied value of goodwill is $90,000 ($690,000 - $600,000) and the carrying amount of goodwill is $60,000.

Reporting Unit B:  Goodwill of $48,000 should be reported. The fair value of the reporting unit ($335,000) is greater than the carrying value of the investment ($330,000).

Reporting Unit C:   No goodwill should be reported. The fair value of the net assets ($400,000) exceeds the fair value of the reporting unit ($370,000).

Reporting Unit D: Goodwill of $50,000 should be reported. The fair value of the reporting unit ($585,000) is greater than the carrying value of the investment ($520,000).


E1-19  Goodwill Measurement

a. Goodwill of $150,000 will be reported. The fair value of the reporting unit ($580,000) is greater than the carrying value of the investment ($550,000) and goodwill does not need to be tested for impairment.

b. Goodwill of $50,000 will be reported. The implied value of goodwill is $50,000 (fair value of reporting unit of $540,000 - fair value of net assets of $490,000). Thus, an impairment of goodwill of $100,000 ($150,000 - $50,000) must be recognized.

c. Goodwill of $10,000 will be reported. The implied value of goodwill is $10,000 (fair value of reporting unit of $500,000 - fair value of net assets of $490,000). Thus, an impairment loss of $140,000 ($150,000 - $10,000) must be recognized.

d. No goodwill will be reported. The fair value of the net assets ($490,000) exceeds the fair value of the reporting unit ($460,000). Thus, the implied value of goodwill is $0 and an impairment loss of $150,000 ($150,000 - $0) must be recognized.

E1-20  Computation of Fair Value

Amount paid $517,000
Book value of assets $624,000
Book value of liabilities (356,000)
Book value of net assets $268,000
Adjustment for research and development costs  (40,000)
Adjusted book value $228,000
Fair value of patent rights 120,000
Goodwill recorded    93,000 (441,000)
Fair value increment of buildings and equipment $  76,000
Book value of buildings and equipment  341,000
Fair value of buildings and equipment $417,000



E1-21  Computation of Shares Issued and Goodwill

a. 15,600 shares were issued, computed as follows:

Par value of shares outstanding following merger $327,600
Paid-in capital following merger  650,800
Total par value and paid-in capital $978,400
Par value of shares outstanding before merger $218,400
Paid-in capital before merger  370,000
(588,400)
Increase in par value and paid-in capital $390,000
Divide by price per share ÷      $25
Number of shares issued   15,600

b. The par value is $7, computed as follows:

Increase in par value of shares outstanding
($327,600 - $218,400)
Divide by number of shares issued $109,200
Par value ÷  15,600
$      7.00

c. Goodwill of $34,000 was recorded, computed as follows:

Increase in par value and paid-in capital $390,000
Fair value of net assets ($476,000 - $120,000) (356,000)
Goodwill $  34,000
                                                   
E1-22  Combined Balance Sheet



Adam Corporation and Best Company
Combined Balance Sheet
January 1, 20X2

Cash and Receivables $  240,000 Accounts Payable $  125,000
Inventory 460,000 Notes Payable 235,000
Buildings and Equipment 840,000 Common Stock 244,000
Less: Accumulated Depreciation (250,000) Additional Paid-In Capital 556,000
Goodwill       75,000 Retained Earnings     205,000
$1,365,000 $1,365,000

Computation of goodwill

Fair value of compensation given $480,000
Fair value of net identifiable assets
($490,000 - $85,000) (405,000)
Goodwill $  75,000




E1-23  Recording a Business Combination

Merger Expense 54,000
Deferred Stock Issue Costs 29,000
    Cash 83,000

Cash 70,000
Accounts Receivable 110,000
Inventory 200,000
Land 100,000
Buildings and Equipment 350,000
Goodwill (1) 30,000
    Accounts Payable 195,000
    Bonds Payable 100,000
    Bond Premium 5,000
    Common Stock 320,000
    Additional Paid-In Capital (2) 211,000
    Deferred Stock Issue Costs 29,000

    Computation of goodwill

Fair value of consideration given (40,000 x $14) $560,000
Fair value of assets acquired $830,000
Fair value of liabilities assumed (300,000)
Fair value of net assets acquired (530,000)
Goodwill $  30,000


    Computation of additional paid-in capital

Number of shares issued 40,000
Issue price in excess of par value ($14 - $8) x       $6
Total $240,000
Less: Deferred stock issue costs   (29,000)
Increase in additional paid-in capital $211,000




E1-24  Reporting Income

20X2: Net income = $6,028,000 [$2,500,000 + $3,528,000]
Earnings per share = $5.48 [$6,028,000 / (1,000,000 + 100,000*)]

20X1: Net income = $4,460,000 [previously reported]
Earnings per share = $4.46 [$4,460,000 / 1,000,000]

* 100,000 = 200,000 shares x ½ year

SOLUTIONS TO PROBLEMS

P1-25  Assets and Accounts Payable Transferred to Subsidiary

    a. Journal entry recorded by Tab Corporation for its transfer of
        assets and accounts payable to Collon Company:

Investment in Collon Company Common Stock 320,000
Accounts Payable 45,000
Accumulated Depreciation – Buildings 40,000
Accumulated Depreciation – Equipment 10,000
    Cash 25,000
    Inventory 70,000
    Land 60,000
    Buildings 170,000
    Equipment 90,000


    b. Journal entry recorded by Collon Company for receipt of assets
        and accounts payable from Tab Corporation:

Cash 25,000
Inventory 70,000
Land 60,000
Buildings 170,000
Equipment 90,000
    Accounts Payable 45,000
    Accumulated Depreciation – Buildings 40,000
    Accumulated Depreciation – Equipment 10,000
    Common Stock 180,000
    Additional Paid-In Capital 140,000



P1-26  Creation of New Subsidiary

a. Journal entry recorded by Eagle Corporation for transfer of assets
     and accounts payable to Sand Corporation:

Investment in Sand Corporation Common Stock 400,000
Allowance for Uncollectible Accounts Receivable 5,000
Accumulated Depreciation 40,000
Accounts Payable 10,000
    Cash 30,000
    Accounts Receivable 45,000
    Inventory 60,000
    Land 20,000
    Buildings and Equipment 300,000


b. Journal entry recorded by Sand Corporation for receipt of assets and
     accounts payable from Eagle Corporation:

Cash 30,000
Accounts Receivable 45,000
Inventory 60,000
Land 20,000
Buildings and Equipment 300,000
    Allowance for Uncollectible Accounts Receivable 5,000
    Accumulated Depreciation 40,000
    Accounts Payable 10,000
    Common Stock 50,000
    Additional Paid-In Capital 350,000


P1-27  Incomplete Data on Creation of Subsidiary

a. The book value of assets transferred was $152,000 ($3,000 + $16,000 + $27,000 + $9,000 + $70,000 + $60,000 - $21,000 - $12,000).

b. Thumb Company would report its investment in New Company equal to the book value of net assets transferred of $138,000 ($152,000 - $14,000).

c. 8,000 shares ($40,000/$5).

d. Total assets declined by $14,000 (book value of assets transferred of $152,000 - investment in New Company of $138,000).

e. No effect. The shares outstanding reported by Thumb Company are not affected by the creation of New Company.



P1-28  Establishing a Partnership

a. Journal entry recorded by K&D partnership for receipt of assets and
     accounts payable:

Cash 210,000
Inventory 30,000
Land 70,000
Buildings 200,000
Equipment 120,000
    Accumulated Depreciation – Buildings 50,000
    Accumulated Depreciation – Equipment 30,000
    Accounts Payable 50,000
    Capital, Krantz Company 300,000
    Capital, Dull Corporation 200,000


b. Journal entry recorded by Krantz Company for transfer of assets and
     accounts payable to K&D Partnership:

Investment in K&D Partnership 300,000
Accumulated Depreciation – Buildings 50,000
Accumulated Depreciation – Equipment 30,000
Accounts Payable 50,000
    Cash 10,000
    Inventory 30,000
    Land 70,000
    Buildings 200,000
    Equipment 120,000


    Journal entry recorded by Dull Corporation for cash transferred to
    K&D Partnership:

Investment in K&D Partnership 200,000
    Cash 200,000




P1-29  Balance Sheet Data for Companies Establishing a Partnership

a. Journal entry recorded by Good Corporation for assets transferred to
     G&W Partnership:

Investment in G&W Partnership 150,000
Accumulated Depreciation – Buildings 30,000
Accumulated Depreciation – Equipment 20,000
    Cash 21,000
    Inventory 4,000
    Land 15,000
    Buildings 100,000
    Equipment 60,000


b. Journal entry recorded by Nevall Company for assets transferred to
     G&W Partnership:

Investment in G&W Partnership 50,000
Accumulated Depreciation – Equipment 14,000
    Cash 3,000
    Inventory 25,000
    Equipment 36,000


c. Journal entry recorded by G&W Partnership for assets received from
     Good Corporation and Nevall Company:

Cash 24,000
Inventory 29,000
Land 15,000
Buildings 100,000
Equipment 96,000
    Accumulated Depreciation – Buildings 30,000
    Accumulated Depreciation – Equipment 34,000
    Capital, Good Corporation 150,000
    Capital, Nevall Company 50,000




P1-30  Acquisition in Multiple Steps

Deal Corporation will record the following entries:

(1) Investment in Mead Company Stock 85,000
    Common Stock - $10 Par Value 40,000
    Additional Paid-In Capital 45,000

(2) Merger Expense 3,500
Additional Paid-In Capital 2,000
    Cash 5,500

(3) Investment in Mead Company Stock 6,000
    Gain on Increase in Value of Mead Company Stock 6,000


P1-31  Journal Entries to Record a Business Combination

Journal entries to record acquisition of TKK net assets:

(1) Merger Expense 14,000
    Cash 14,000
 Record payment of legal fees.

(2) Deferred Stock Issue Costs 28,000
    Cash 28,000
 Record costs of issuing stock.
   
(3) Cash and Receivables 28,000
Inventory 122,000
Buildings and Equipment 470,000
Goodwill 12,000
    Accounts Payable 41,000
    Notes Payable 63,000
    Common Stock 96,000
    Additional Paid-In Capital 404,000
    Deferred Stock Issue Costs 28,000
 Record purchase of TKK Corporation.

    Computation of goodwill

Fair value of consideration given (24,000 x $22) $528,000
Fair value of net assets acquired
($620,000 - $104,000) (516,000)
Goodwill $  12,000

    Computation of additional paid-in capital

Number of shares issued 24,000
Issue price in excess of par value ($22 - $4) x       $18
Total $432,000
Less: Deferred stock issue costs   (28,000)
Increase in additional paid-in capital $404,000

P1-32  Recording Business Combinations

Merger Expense 38,000
Deferred Stock Issue Costs 22,000
    Cash 60,000

Cash and Equivalents 41,000
Accounts Receivable 73,000
Inventory 144,000
Land 200,000
Buildings 1,500,000
Equipment 300,000
Goodwill 127,000
    Accounts Payable 35,000
    Short-Term Notes Payable 50,000
    Bonds Payable 500,000
    Common Stock  $2 Par 900,000
    Additional Paid-In Capital 878,000
    Deferred Stock Issue Costs 22,000

    Computation of goodwill

Fair value of consideration given (450,000 x $4) $1,800,000
Fair value of net assets acquired ($41,000
    + $73,000 + $144,000 + $200,000 + $1,500,000
    + $300,000 - $35,000 - $50,000 - $500,000)
(1,673,000)
Goodwill $  127,000


    Computation of additional paid-in capital

Number of shares issued 450,000
Issue price in excess of par value ($4 - $2) x       $2
Total $900,000
Less: Deferred stock issue costs   (22,000)
Increase in additional paid-in capital $878,000





P1-33  Business Combination with Goodwill

a. Journal entry to record acquisition of Zink Company net assets:

Cash 20,000
Accounts Receivable 35,000
Inventory 50,000
Patents 60,000
Buildings and Equipment 150,000
Goodwill 38,000
    Accounts Payable 55,000
    Notes Payable 120,000
    Cash 178,000


b. Balance sheet immediately following acquisition:

Anchor Corporation and Zink Company
 Combined Balance Sheet
February 1, 20X3

Cash $ 82,000 Accounts Payable $140,000
Accounts Receivable 175,000 Notes Payable 270,000
Inventory 220,000 Common Stock 200,000
Patents 140,000 Additional Paid-In
Buildings and Equipment 530,000   Capital 160,000
Less: Accumulated Retained Earnings 225,000
   Depreciation (190,000)
Goodwill    38,000            
$995,000 $995,000


c. Journal entry to record acquisition of Zink Company stock:

Investment in Zink Company Common Stock 178,000
    Cash 178,000

Computation of goodwill

Fair value of consideration given $178,000
Fair value of net assets acquired
    ($20,000 + $35,000 + $50,000 + $60,000
    + $150,000 - $55,000 -$120,000) (140,000)
Goodwill $ 38,000

P1-34  Bargain Purchase

Journal entries to record acquisition of Lark Corporation net assets:

Merger Expense 5,000
    Cash 5,000

Cash and Receivables 50,000
Inventory 150,000
Buildings and Equipment (net) 300,000
Patent 200,000
    Accounts Payable 30,000
    Cash 625,000
    Gain on Bargain Purchase of Lark Corporation 45,000


    Computation of gain

Fair value of consideration given $625,000
Fair value of net assets acquired
($700,000 - $30,000) (670,000)
Gain on bargain purchase $  45,000

P1-35  Computation of Account Balances
 
a. Liabilities reported by the Aspro Division at year-end:

Fair value of reporting unit at year-end $930,000
Acquisition price of reporting unit
($7.60 x 100,000) $760,000
Fair value of net assets at acquisition
($810,000 - $190,000) (620,000)
Goodwill at acquisition $140,000
Impairment in current year  (30,000)
Goodwill at year-end (110,000)
Fair value of net assets at year-end $820,000

Fair value of assets at year-end $950,000
Fair value of net assets at year-end (820,000)
Fair value of liabilities at year-end $130,000


b. Required fair value of reporting unit:
Fair value of assets at year-end $   950,000
Fair value of liabilities at year-end (given)     (70,000)
Fair value of net assets at year-end $   880,000
Original goodwill balance    140,000
Required fair value of reporting unit to avoid recognition of impairment of goodwill $1,020,000




P1-36  Goodwill Assigned to Multiple Reporting Units


a. Goodwill to be reported by Rover Company:

                 Reporting Unit                
    A         B         C  
Carrying value of goodwill $70,000 $80,000 $40,000
Implied goodwill at year-end 90,000 50,000 75,000
Goodwill to be reported at year-end 70,000 50,000 40,000

Total goodwill to be reported at year-end:
 Reporting unit A $  70,000
 Reporting unit B 50,000
 Reporting unit C    40,000
 Total goodwill to be reported $160,000

Computation of implied goodwill
Reporting unit A
 Fair value of reporting unit $400,000
 Fair value of identifiable assets $350,000
 Fair value of accounts payable  (40,000)
 Fair value of net assets (310,000)
 Implied goodwill at year-end $  90,000

Reporting unit B
 Fair value of reporting unit $440,000
 Fair value of identifiable assets $450,000
 Fair value of accounts payable  (60,000)
 Fair value of net assets (390,000)
 Implied goodwill at year-end $  50,000

Reporting unit C
 Fair value of reporting unit $265,000
 Fair value of identifiable assets $200,000
 Fair value of accounts payable  (10,000)
 Fair value of net assets (190,000)
 Implied goodwill at year-end $  75,000


b. Goodwill impairment of $30,000 ($80,000 - $50,000) must be reported in the current period for reporting unit B.




P1-37  Journal Entries

Journal entries to record acquisition of Light Steel net assets:

(1) Merger Expense 19,000
    Cash 19,000
  Record finder's fee and transfer costs.

(2) Deferred Stock Issue Costs 9,000
    Cash 9,000
  Record audit fees and stock registration fees.

(3) Cash 60,000
Accounts Receivable 100,000
Inventory 115,000
Land 70,000
Buildings and Equipment 350,000
Bond Discount 20,000
Goodwill 95,000
    Accounts Payable 10,000
    Bonds Payable 200,000
    Common Stock 120,000
    Additional Paid-In Capital 471,000
    Deferred Stock Issue Costs 9,000
  Record merger with Light Steel Company.

    Computation of goodwill

Fair value of consideration given (12,000 x $50) $600,000
Fair value of net assets acquired ($695,000 - $10,000
    - $180,000)
(505,000)
Goodwill $  95,000

    Computation of additional paid-in capital

Number of shares issued 12,000
Issue price in excess of par value ($50 - $10) x       $40
Total $480,000
Less: Deferred stock issue costs    (9,000)
Increase in additional paid-in capital $471,000

P1-38  Purchase at More than Book Value

a. Journal entry to record acquisition of Stafford Industries net
    assets:

Cash 30,000
Accounts Receivable 60,000
Inventory 160,000
Land 30,000
Buildings and Equipment 350,000
Bond Discount 5,000
Goodwill 125,000
    Accounts Payable 10,000
    Bonds Payable 150,000
    Common Stock 80,000
    Additional Paid-In Capital 520,000

b. Balance sheet immediately following acquisition:

Ramrod Manufacturing and Stafford Industries
Combined Balance Sheet
January 1, 20X2

Cash $    100,000   Accounts Payable $      60,000
Accounts Receivable 160,000 Bonds Payable $450,000
Inventory 360,000 Less: Discount    (5,000) 445,000
Land 80,000 Common Stock 280,000
Buildings and Equipment 950,000 Additional
Less: Accumulated  Paid-In Capital 560,000
         Depreciation (250,000) Retained Earnings 180,000
Goodwill     125,000                
$1,525,000 $1,525,000


Computation of goodwill

Fair value of consideration given (4,000 x $150) $600,000
Fair value of net assets acquired ($630,000 - $10,000
    - $145,000)
 (475,000)
Goodwill $125,000

P1-39  Business Combination

Journal entry to record acquisition of Toot-Toot Tuba net assets:

Cash 300
Accounts Receivable 17,000
Inventory 35,000
Plant and Equipment 500,000
Other Assets 25,800
Goodwill 86,500
    Allowance for Uncollectibles 1,400
    Accounts Payable 8,200
    Notes Payable 10,000
    Mortgage Payable 50,000
    Bonds Payable 100,000
    Capital Stock ($10 par) 90,000
    Premium on Capital Stock 405,000

Computation of fair value of net assets acquired

Cash $300
Accounts Receivable 17,000
Allowance for Uncollectible Accounts (1,400)
Inventory 35,000
Plant and Equipment 500,000
Other Assets 25,800
Accounts Payable (8,200)
Notes Payable (10,000)
Mortgage Payable (50,000)
Bonds Payable (100,000)
Fair value of net assets acquired $408,500

Computation of goodwill

Fair value of consideration given (9,000 x $55) $495,000
Fair value of net assets acquired (408,500)
Goodwill $86,500

P1-40  Combined Balance Sheet

a. Balance sheet:

Bilge Pumpworks and Seaworthy Rope Company
Combined Balance Sheet
January 1, 20X3

Cash and Receivables $110,000 Current Liabilities $     100,000
Inventory 142,000 Capital Stock 214,000
Land 115,000 Capital in Excess
Plant and Equipment 540,000  of Par Value 216,000
Less: Accumulated Retained Earnings 240,000
          Depreciation (150,000)
Goodwill    13,000                        
$770,000 $    770,000


Computation of goodwill

Fair value of consideration given (700 x $300) $210,000
Fair value of net assets acquired ($217,000 – $20,000) (197,000)
Goodwill $13,000


b. (1)  Stockholders' equity with 1,100 shares issued:

Capital Stock [$200,000 + ($20 x 1,100 shares)] $    222,000
Capital in Excess of Par Value
[$20,000 + ($300 - $20) x 1,100 shares] 328,000
Retained Earnings      240,000
$    790,000



(2)  Stockholders' equity with 1,800 shares issued:

Capital Stock [$200,000 + ($20 x 1,800 shares)] $    236,000
Capital in Excess of Par Value
[$20,000 + ($300 - $20) x 1,800 shares] 524,000
Retained Earnings     240,000
$1,000,000



(3)  Stockholders' equity with 3,000 shares issued:

Capital Stock [$200,000 + ($20 x 3,000 shares)] $   260,000
Capital in Excess of Par Value
[$20,000 + ($300 - $20) x 3,000 shares] 860,000
Retained Earnings     240,000
$1,360,000



P1-41  Incomplete Data Problem

a. 5,200 = ($126,000 - $100,000)/$5

b. $208,000 = ($126,000 + $247,000) - ($100,000 + $65,000)

c. $46,000 = $96,000 - $50,000

d. $130,000 = ($50,000 + $88,000 + $96,000 + $430,000 - $46,000 -
        $220,000 - $6,000) - ($40,000 + $60,000 + $50,000 + $300,000 -
        $32,000 - $150,000 - $6,000)

e. $78,000 = $208,000 - $130,000

f. $97,000 (as reported by End Corporation)

g. $13,000 = ($430,000 - $300,000)/10 years




P1-42  Incomplete Data Following Purchase

a. 14,000 = $70,000/$5

b. $8.00 = ($70,000 + $42,000)/14,000

c. 7,000 = ($117,000 - $96,000)/$3

d. $24,000 = $65,000 + $15,000 - $56,000

e. $364,000 = ($117,000 + $553,000 + $24,000) – ($96,000 + $234,000)

f. $110,000 = $320,000 - $210,000

g. $306,000 = ($15,000 + $30,000 + $110,000 + $293,000) -
         ($22,000 + $120,000)

h. $58,000 = $364,000 - $306,000



P1-43  Comprehensive Business Combination Problem

a. Journal entries on the books of Bigtime Industries to record the combination:

Merger Expense 135,000
    Cash 135,000

Deferred Stock Issue Costs 42,000
    Cash 42,000

Cash 28,000
Accounts Receivable 251,500
Inventory 395,000
Long-Term Investments 175,000
Land 100,000
Rolling Stock 63,000
Plant and Equipment 2,500,000
Patents 500,000
Special Licenses 100,000
Discount on Equipment Trust Notes 5,000
Discount on Debentures 50,000
Goodwill 109,700
    Current Payables 137,200
    Mortgages Payable 500,000
    Premium on Mortgages Payable 20,000
    Equipment Trust Notes 100,000
    Debentures Payable 1,000,000
    Common Stock 180,000
    Additional Paid-In Capital — Common 2,298,000
    Deferred Stock Issue Costs 42,000


    Computation of goodwill

Value of stock issued ($14 x 180,000) $2,520,000
Fair value of assets acquired $4,112,500
Fair value of liabilities assumed (1,702,200)
Fair value of net identifiable assets (2,410,300)
Goodwill $   109,700



P1-43  (continued)

b. Journal entries on the books of HCC to record the combination:

Investment in Bigtime Industries Stock 2,520,000
Allowance for Bad Debts 6,500
Accumulated Depreciation 614,000
Current Payables 137,200
Mortgages Payable 500,000
Equipment Trust Notes 100,000
Debentures Payable 1,000,000
    Discount on Debentures Payable 40,000
    Cash 28,000
    Accounts Receivable 258,000
    Inventory 381,000
    Long-Term Investments 150,000
    Land 55,000
    Rolling Stock 130,000
    Plant and Equipment 2,425,000
    Patents 125,000
    Special Licenses 95,800
    Gain on Sale of Assets and Liabilities 1,189,900
 Record sale of assets and liabilities.

Common Stock 7,500
Additional Paid-In Capital — Common Stock 4,500
    Treasury Stock 12,000
 Record retirement of Treasury Stock:*
 $7,500 = $5 x 1,500 shares
 $4,500 = $12,000 - $7,500

Common Stock 592,500
Additional Paid-In Capital — Common 495,500
Additional Paid-In Capital — Retirement
of Preferred 22,000
Retained Earnings 1,410,000
    Investment in Bigtime
Industries Stock 2,520,000
 Record retirement of HCC stock and
distribution of Integrated Industries stock:
 $592,500 = $600,000 - $7,500
 $495,500 = $500,000 - $4,500
 1,410,000 = $220,100 + $1,189,900

 *Alternative approaches exist.