CH01SMF

CHAPTER 1

CORPORATE EXPANSION AND ACCOUNTING FOR BUSINESS COMBINATIONS

ANSWERS TO QUESTIONS - PART I

Q1-1 (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.

Q1-2 Continuity of ownership requires that voting shareholders of the combining companies emerge as shareholders of the combined entity. Continuity of ownership is considered the primary factor in determining whether purchase or pooling of interests accounting is to be used in recording a business combination.

Q1-3 Goodwill arises when purchase accounting is used and the fair value of the compensation given to acquire another company is greater than the fair value of its identifiable net assets. Goodwill is recorded on the books of the acquiring company when the net assets of the acquired company are transferred to the acquiring company and recorded on the acquiring company's books. When the acquired company is operated as a separate entity, the amount paid by the purchaser is included in the investment account and goodwill, as such, is not recorded on the books of either company. In this case, goodwill is only reported when the investment account of the parent is eliminated in the consolidation process.

Q1-4 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.

Q1-5 None of the retained earnings of the subsidiary should be carried forward under purchase treatment. Thus, consolidated retained earnings is limited to the balance reported by the acquiring company.

Q1-6 Some companies have attempted to establish the corporate name as a symbol of quality or product availability. An acquiring company may be fearful that customers will be lost if the company is liquidated. Debt covenants are likely to require repayment of virtually all existing debt if the acquired company is liquidated. The cost of issuing new debt may be prohibitive. A parent-subsidiary relationship may be the only feasible means of proceeding if it is impossible to acquire 100 percent ownership of an acquired company. When the acquiring company does not plan to retain all operations of the acquired company, it may be easier to dispose of the portions not wanted by leaving them in the existing corporate shell and later disposing of the ownership of the company.

Q1-7 Negative goodwill is said to exist when a purchaser pays less than the fair value of the identifiable net assets of another company in acquiring its ownership. This difference normally is treated as a pro rata reduction of all of

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the acquired assets other than cash and cash equivalents, trade receivables, inventory, financial instruments that are required by U.S. generally accepted accounting principles (GAAP) to be carried on the balance sheet at fair value, assets to be disposed of by sale, and deferred tax assets.

Q1-8 Additional paid-in capital reported following a business combination recorded as a purchase 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.

Q1-9 Purchase treatment must be used. A company issuing preferred shares in an acquisition has not met the requirement for an exchange of voting common shares and cannot report the business combination as a pooling of interests.

Q1-10 A purchase is treated prospectively. None of the financial statement data of the acquired company is included along with the financial statement data of the acquiring company for periods prior to the business combination.

Q1-11 When purchase treatment is used, all costs incurred in purchasing the ownership of another company are capitalized. These normally include items such as finder's fees, the costs of title transfer, and legal fees associated with the purchase.

Q1-12 When the acquiring company issues shares of stock to complete a business combination recorded as a purchase, 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.


ANSWERS TO QUESTIONS - PART II

Q1-13 Under purchase treatment, the assets and liabilities of the acquired company are recorded at their fair values and goodwill commonly is recognized. The assets and liabilities of the acquired company are carried forward at their book values under pooling treatment and the retained earnings of the acquired company normally is carried forward.

Q1-14 In concept, there is no change in ownership when pooling treatment is applied and therefore the retained earnings of the individual companies should be combined when the ownership is combined.

Q1-15 If a business combination is treated as a pooling, the earnings of both the acquiring company and the acquired company for the entire year would be included in the income of the combined company for the year. Earnings for the full year are combined because the companies are viewed as always having been combined.

Q1-16 When pooling of interests treatment is used, consolidated retained earnings cannot exceed the sum of the retained earnings balances of the separate companies immediately before the combination.

Q1-17 The additional paid-in capital in a pooling of interests is equal to the additional paid-in capital of the issuing company together with that of the other combining company, with the total adjusted for change in the total par or stated value of the stock outstanding. The adjustment to additional paid-in capital depends on whether the total par or stated value of shares held by the stockholders of the acquired company increases or decreases as a result of the exchange of shares. When the total par or stated value of the shares issued by the issuing company at the time of the business combination is less than the par or stated value of the shares acquired, the amount reported as additional paid-in capital increases by the difference. When the total par or stated value increases, additional paid-in capital decreases.

Q1-18 Pooling is treated retroactively and prior financial statements of the companies are combined and reported as if the companies had always been together.

Q1-19 None of the costs are capitalized. In a pooling, there is no change of ownership and therefore all costs incurred must be charged to expense in the period they are incurred.

Q1-20 All costs associated with issuing common shares in a pooling should be treated as an expense in the period the costs are incurred. As a result, there should be no adjustment to additional paid-in capital for such costs.


SOLUTIONS TO CASES

C1-1 Reporting Alternatives and International Harmonization

a. In the past, when goodwill was capitalized, U.S. companies were required to systematically amortize the amount recorded, thereby reducing earnings, while companies in other countries were not required to do so. Recent changes in accounting for goodwill have substantially eliminated this objection.

b. In most business combinations, one company targets another company for acquisition. The fact that stock rather than cash or some other type of consideration is used to effect the combination does not change the basic nature of the acquisition. The substance of nearly all business combinations is that one company purchases another, and, accordingly, purchase accounting should be used for nearly all combinations. Pooling might be reserved, as it is in some countries, for those rare instances in which no one company in a business combination can be identified as the acquirer.

c. 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. 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.


C1-2 Goodwill and the Effects of Purchase versus Pooling of Interests Treatment

a. The nature of goodwill is not completely clear and is the subject of some disagreement. In general, goodwill is viewed as the collection of all those factors that allow a company to earn an excess return; that is, all those hard-to-identify intangible qualities that permit a firm to earn a return in excess of a normal return. Goodwill is identified with the firm as a whole and generally is considered as being not separable from the firm. Goodwill presumably arises from bringing together a particular set of resources that produces higher earnings than could the individual resources or other similar collections of resources. Factors contributing to excess earnings often are considered to include superior management, outstanding reputation, prime location, special economies, and many other factors. Some would argue that, if these factors can be identified, they each should be treated separately rather than being lumped together in a single "catch-all" account called goodwill.

The primary characteristics of an asset are that it represents (1) probable future benefits (2) controlled by a particular entity (3) resulting from past transactions or events. If one company purchases another company and is willing to pay more for that company than the fair value of its net identifiable assets, this implies the existence of some set of factors, generally called goodwill, that is expected to contribute future benefits to the combined company in the form of higher earnings. Thus, the first characteristic of an asset would seem to be present in goodwill. If these factors arose as a result of past transactions or events, the third characteristic is present. Whether a particular entity can control the factors leading to excess earnings is a matter of some debate, especially when it may be difficult to identify the factors. Nevertheless, at least some portion of those factors generally is viewed as being under at least partial control of the particular entity. Current accounting practice assumes all three elements are present and treats goodwill as an asset. Because of a lack of objectivity leading to measurement problems, goodwill may not be recognized in all situations where it is thought to exist. In particular, "self-developed" goodwill is not recognized.

Goodwill is recorded only when one or more identifiable assets are acquired in a purchase-type transaction, usually in a business combination. As with other assets, goodwill is recorded at its historical cost to the acquiring company at the time it is purchased. Its historical cost to the acquiring company in a business combination is computed as the excess of the total purchase price paid (for the stock or net assets of the acquired company) over the fair value of the net identifiable assets acquired.

b. The FASB recently changed accounting for goodwill. Under the new standard, goodwill will not be amortized in any circumstance. The carrying amount of goodwill is reduced only if it is found to be impaired or was associated with assets to be sold or otherwise disposed of.


c. C1-2 (continued)

c. On a balance sheet prepared subsequent to a business combination treated as a pooling, the assets and liabilities of the acquired company will be reported based on book values prior to the combination. Subsequent to a purchase-type combination the assets and liabilities of the acquired company are reported based on their fair values at the date of combination. Some contra accounts, such as accumulated depreciation, will be carried forward under pooling treatment but are not carried forward under purchase treatment. Further, stock issued by the acquiring company in the combination is recorded based on the book value of the net assets or stock acquired in a pooling. The fair value of the stock issued is used in a purchase. Finally, the retained earnings balance of a company acquired in a pooling normally is carried over, in whole or in part, to become part of the retained earnings of the combined company, while such is not the case in a purchase-type combination.

On an income statement prepared for the combined company subsequent to a combination, depreciation, amortization, and some other expense items often are higher under purchase treatment than under pooling. This occurs because the fair values of the assets recorded in a purchase-type combination often are higher than the book values recorded in a pooling. Because of the higher asset values in a purchase-type combination, any depreciation or amortization based on these amounts subsequent to the combination also will be higher. Similarly, some liabilities may have fair values lower than their book values, and any resulting amortization of discount or premium would result in higher expenses under purchase accounting than under the pooling approach. In addition, the income statement prepared at the end of the year in which the combination takes place will include the revenues and expenses for both combining companies for the entire year if the combination is treated as a pooling; if the combination is treated as a purchase, the income statement will include the acquiring company's revenues and expenses for the entire year, but those of the acquired company only from the date of combination.

d. Pooling is likely to result in higher income being reported by the combined company in the year of the combination for the reasons given in part c.


C1-3 Differences between Purchase and Pooling of Interests [AICPA Adapted]

a. (1) In a pooling of interests, the recorded amounts of the assets and liabilities of the separate companies generally become the recorded amounts of the assets and liabilities of the combined corporation. The existing basis of accounting continues. A pooling of interests transaction is regarded as an arrangement among stockholder groups, with the ownership of all groups continuing. Because ownership remains substantially the same, the combination is not viewed as an event significant enough to require a change in the basis of accounting.

(2) In a pooling of interests, the registration fees and direct costs related to effecting the business combination should be deducted in determining the net income of the resulting combined corporation for the period in which the expenses are incurred.

(3) In a pooling of interests, the results of operations for the year in which the business combination occurred should be reported as though the companies had been combined as of the beginning of the year.

b. (1) In a purchase, the acquiring corporation should allocate the cost of the acquired company to the assets acquired and liabilities assumed. All identifiable assets acquired and liabilities assumed in the business combination should be recorded at their fair values at date of acquisition. The excess of the cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed should be recorded as goodwill. A purchase transaction is regarded as a bargained transaction (i.e., a significant economic event that results from bargaining between independent parties); such an event normally establishes a new basis of accounting.

(2) In a purchase, the registration fees related to securities issued in effecting the business combination are a reduction of the otherwise determinable fair value of the securities, usually treated as a reduction of paid-in capital. The direct costs related to effecting the business combination are included as part of the acquisition cost of the acquired company.

(3) In a purchase, the results of operations for the year in which the business combination occurred should include income of the acquired company after the date of acquisition by including the revenues and expenses of the acquired company based on the cost to the acquiring corporation.


(4) 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 our 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.


C1-4 (continued)

b. 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.

c. 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.

d. 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.


C1-5 Reasons for Business Combinations

a. The answers to this part will depend on the particular companies chosen by the students. Much of the information for this part of the case can be obtained from 10-K and 8-K filings with the Securities and Exchange Commission, found through the EDGAR (Electronic Data Gathering, Analysis, and Retrieval system) database on the Internet (www.sec.gov). Several major combinations that have occurred in the recent past include McDonnell Douglas and Boeing (aerospace/defense), NationsBank and Bank of America (banking), and SBC Communications and Ameritech (telecommunications). The combination of McDonnell Douglas and Boeing was a merger and was accounted for as a pooling of interests. Boeing exchanged 1.3 shares of its common stock for each share of McDonnell Douglas common stock outstanding. When NationsBank merged with BankAmerica in 1998, it exchanged 1.1316 shares of its common stock for each share of BankAmerica common stock outstanding. The combination was accounted for as a pooling of interests. In the 1999 combination of SBC Communications and Ameritech, which involved an exchange of 1.316 shares of SBC common stock for each share of Ameritech common stock, Ameritech was merged with a subsidiary of SBC and became a wholly owned subsidiary of SBC. The combination was treated as a pooling of interests.

b. In the defense industry, the end of the cold war and subsequent reductions in defense spending have had a considerable effect on companies. The number of major defense contractors has shrunk significantly, with only a few large companies remaining in the industry, along with a number of smaller companies. With the reduction in defense spending leaving too few major contracts to support a number of large companies, large defense contractors were forced to merge to remain strong. In banking and financial services, important factors leading to increased merger activity include deregulation and the globalization of capital flows. Many of the previous restrictions on banks relating to branch banking, interstate banking, and the types of services banks can offer have been eliminated. As a result, many banks are expanding and moving into types of financial services they had not previously provided, such as security brokerage and mutual funds. In the field of telecommunications, technology has been the primary factor resulting in change, although deregulation also has had an impact. Many companies are merging so they can move into new geographic areas and can provide a full range of communication services, including local and long-distance phone service, cellular phone service, cable and satellite television service, and internet connections.

c. Companies in the defense industry are less likely to be involved in major combinations in the future because most of the large companies have already merged. Any further consolidation of the industry might be viewed as anticompetitive by the government. In banking and financial services, future mergers are virtually certain because of the large number of banks still attempting to move into different financial services and geographic areas, and brokerage firms attempting to increase geographic coverage and expand available capital. In telecommunications, the rapid pace of technological change and the changing regulatory situation will certainly lead to future business combinations.


C1-6 Planning for Acquisitions: Cisco Systems and Quaker Oats

The answers to this case can be obtained from the homepages for Cisco Systems (www.cisco.com) and Quaker Oats (www.quakeroats.com) and from the annual filings of the companies (Form 10-K) with the Securities and Exchange Commission, found through the EDGAR (Electronic Data Gathering, Analysis, and Retrieval system) database on the Internet (www.sec.gov). Numerous articles also can be found detailing the acquisitions of both Cisco Systems and Quaker Oats, especially Quaker Oats' history with Snapple; many of these articles are available on the Internet and on the Lexis/Nexis database, or other electronic databases.

a. Cisco Systems is in the business of providing networking solutions for its customers, especially with respect to the Internet. It provides a wide range of leading edge, high technology products and services relating to all aspects of information network connections.

b. The Quaker Oats Company’s goal, as stated on its homepage, is “to be the undisputed leader in the food and beverage industry.” While previously Quaker Oats indicated a focus on the beverage and grain-based food arenas, it now appears to view the entire field of packaged foods as its area of operations.

c. Cisco Systems describes recent business acquisitions on its homepage and provides detail about how each fits into its core business. In addition, the company's Form 10-K describes how its acquisitions, investments, and alliances have contributed to its range of products and how these fit within its business plan. It also provides a detailed description of its methodical approach to satisfying its need for new or enhanced products and solutions.

d. Quaker Oats' overall business seems less well defined than that of Cisco Systems. In addition, no specific discussion of Quaker Oats’ approach to investments and acquisitions can be found that justifies them in terms of the company's overall mission, although individual acquisitions have been justified to the press (e.g., The acquisition of Snapple was to help make the company the leading provider of healthful beverages). In addition, a summary of Quaker Oats' acquisitions and divestitures indicates a pattern of buying and later selling (e.g., Brookstone Company, Fisher-Price) that seems to lack coherence.

e. Cisco Systems has fared very well over the past few years. Cisco indicates that it is number one or two in every market segment that it serves. Its revenues have grown from $69 million in 1990 to $6.4 billion in 1997 to $18.9 billion in 2000, although revenue growth fell off somewhat with the economic slowdown in 2001. Many of Cisco's current products have come from its business acquisitions. On the other hand, the acquisition of Snapple by Quaker Oats was not at all successful. Snapple encountered large losses after its acquisition by Quaker Oats, and Quaker Oats was never able to find a strategy for stemming the losses. Finally in 1997, Quaker Oats sold the $1.7 billion dollar acquisition for $300 million to Triarc Companies (owner of Mistic and Royal Crown soft drinks). In 2001, Quaker Oats entered into a merger agreement with Pepsico.


C1-7 Companies Built through Business Combinations: MCI WorldCom and Citigroup

a. MCI WorldCom Inc. is one of the largest communications companies in the world and one of the largest providers of Internet access and services. Citigroup is a financial services holding company; through its subsidiaries, it provides a broad range of financial services to consumer and corporate customers in 101 countries and territories.

b.,c. Sanford Weill and John Reed were, until recently, both Chairmen and Co-Chief Executive Officers of Citigroup; John Reed left Citigroup in 2000. This unusual management arrangement came about as a result of the 1998 merger of Traveler’s Group Inc. and Citicorp. At the time of the merger, John Reed headed Citigroup. Sanford Weill was Chairman of Travelers, having put it together in its form at the time it merged with Citigroup. In 1986, Weill acquired the consumer-credit division (Commercial Credit) of Control Data Corporation. In 1986, he also acquired Primerica Corp., parent company of brokerage firm Smith Barney, and combined it with Commercial Credit under the Primerica name. The company also acquired A.L. Williams insurance company and purchased Drexel Burnham Lambert's retail brokerage offices. In 1992, the company acquired a 27 percent share of Travelers Insurance. In 1993, the company acquired Shearson brokerage group from American Express and later purchased the remaining 73 percent of Travelers; the combined company was renamed Travelers Group. In 1996, the company purchased Aetna's property and casualty insurance business, and, in 1997, the company acquired Salomon Inc. Both stock and cash have been used in the various acquisitions. The acquisition of Travelers in two stages was accounted for as a purchase, and the acquisition of Salomon, which was effected with an exchange of stock, was accounted for as a pooling of interests. The merger of Travelers and Citicorp was accounted for as a pooling of interests.

Bernard Ebbers is the Chief Executive Officer of MCI WorldCom. 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 has guided its growth strategy ever since. 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.

C1-8 Assignment of the Difference between Cost and Book Value


a. Negative goodwill arose from Centrex’s Home Building subsidiary’s 1997 combination transaction with Vista Properties. Centrix has been amortizing the negative goodwill as a reduction of costs and expenses over a seven-year period.

b. Compaq Computer, Analog Devices, and Mylan Laboratories write off to expense the amounts paid for in-process research and development in the periods they purchase other companies and assign part of the purchase price to the in-process research and development results of those companies. Although these in-process research and development results have considerable value to the purchasing companies, given the large dollar amounts assigned to them, the costs are not capitalized as assets. The justification for expensing these costs immediately is that FASB Statement No. 2 requires research and development expenditures be expensed as incurred, although it does not specifically address the issue of the in-process research and development costs of companies purchased in a business combination. The FASB will undertake a comprehensive review of the treatment of research and development costs in the near future.


SOLUTIONS TO EXERCISES -- PART I

E1-1 Multiple-Choice Questions on Recording Business Combinations [AICPA Adapted]

1. a

2. c

3. d

4. d

5. d

6. b

E1-2 Multiple-Choice Questions on Reported Balances [AICPA Adapted]

1. d

2. d

3. c

4. c

5. d

E1-3 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


E1-4 Balances Reported under Purchase Treatment

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

E1-5 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


E1-6 Negative Goodwill

Journal entry to record acquisition of Sorden Company net assets:

Cash and Receivables 50,000 Inventory 200,000 Land 91,000 Plant and Equipment 273,000 Discount on Bonds Payable 16,000 Accounts Payable 50,000 Bonds Payable 580,000

Computation of negative goodwill

Purchase price $564,000 Fair value of assets acquired $650,000 Fair value of liabilities assumed (50,000) Fair value of net assets acquired 600,000 Negative goodwill $ 36,000

Assignment of negative goodwill to noncurrent assets

Reduction for Assigned Asset Fair Value Negative Goodwill* Valuation Land $100,000 $36,000 x (100/400) $ 91,000 Plant and Equipment 300,000 $36,000 x (300/400) 273,000 $400,000 $364,000

*Based on relative fair values.


E1-7 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

E1-8 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) $109,200 Divide by number of shares issued 15,600 Par value $ 7.00

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

Increase in par value and paid-in capital $390,000Fair value of net assets ($476,000 - $120,000) (356,000)

Goodwill $ 34,000


E1-9 Combined Balance Sheet under Purchase Treatment

a. Purchase balance sheet based on $60 market price: Adam Corporation and Best Company Combined Balance Sheet January 1, 20X2

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

Computation of goodwill Total purchase price ($60 x 8,000 shares) $480,000 Fair value of net identifiable assets ($490,000 - $85,000) (405,000) Goodwill $ 75,000

b. Purchase balance sheet based on $48 market price:

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

Cash and Receivables $ 240,000 Accounts Payable $ 125,000Inventory 460,000 Notes Payable 235,000Buildings and Equipment 819,000 Common Stock 244,000Less: Accumulated Additional Paid-In Depreciation (250,000) Capital 460,000 Retained Earnings 205,000 $1,269,000 $1,269,000


Fair value of buildings and equipment $240,000 Fair value of total assets acquired $490,000 Less: Fair value of liabilities assumed (85,000) Fair value of net assets acquired $405,000 Value of shares issued in acquisition (384,000) Negative goodwill assigned against noncurrent assets (21,000) Valuation of Best's noncurrent assets included in balance sheet $219,000


E1-10 Recording a Business Combination

a. Deferred Merger Costs 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) 84,000 Accounts Payable 195,000 Bonds Payable 100,000 Bond Premium 5,000 Common Stock 320,000 Additional Paid-In Capital (2) 211,000 Deferred Merger Costs 54,000 Deferred Stock Issue Costs 29,000

(1) Computation of goodwill:

Market value of shares issued ($14 x 40,000) $560,000 Merger costs 54,000 Purchase price $614,000 Fair value of assets acquired $830,000 Fair value of liabilities assumed (300,000)

Fair value of net assets acquired (530,000) Goodwill $ 84,000

(2) Computation of additional paid-in capital:

Market value of shares issued ($14 x 40,000) $560,000 Par value of shares issued ($8 x 40,000) (320,000) Additional paid-in capital from issuing shares $240,000 Stock issue costs (29,000) Additional paid-in capital recorded $211,000


E1-10 (continued)

b. Deferred Merger Costs 54,000 Deferred Stock Issue Costs 29,000 Cash 83,000

Cash 70,000 Accounts Receivable 110,000 Inventory 200,000 Land (3) 83,111 Buildings and Equipment (3) 290,889 Accounts Payable 195,000 Bonds Payable 100,000 Bond Premium 5,000 Preferred Stock ($10 x 8,000) 80,000 Additional Paid-In Capital (4) 291,000 Deferred Merger Costs 54,000 Deferred Stock Issue Costs 29,000

(3) Computation of negative goodwill:

Market value of shares issued ($50 x 8,000) $400,000 Merger costs 54,000 Purchase price $454,000 Fair value of assets acquired $830,000 Fair value of liabilities assumed (300,000) Fair value of net assets acquired (530,000) Negative goodwill $ 76,000

Assignment of negative goodwill:

Reduction for Assigned Item Fair Value Negative Goodwill Valuation Land $100,000 $76,000 x (100/450) $ 83,111 Buildings and Equip. 350,000 $76,000 x (350/450) 290,889 $450,000 $374,000

(4) Market value of shares issued ($50 x 8,000) $400,000 Par value of shares issued ($10 x 8,000) (80,000) Additional paid-in capital from issuing shares $320,000 Stock issue costs (29,000) Additional paid-in capital recorded $291,000


E1-11 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]

SOLUTIONS TO EXERCISES -- PART II

E1-12 Multiple-Choice Questions on Recording Business Combinations [AICPA Adapted]

1. d

2. c

3. c

4. c

E1-13 Multiple-Choice Questions on Pooling Treatment [AICPA Adapted]

1. b

2. d

3. d

4. a

5. a

6. c


E1-14 Stock Acquisition

Journal entry to record the acquisition of Tippy Inc., shares as a pooling of interests: Investment in Tippy Inc., Common Stock 850,000 Common Stock 425,000 Additional Paid-In Capital 75,000 Retained Earnings 350,000 $850,000 = $400,000 + $100,000 + $350,000 $425,000 = $25 x 17,000 shares $75,000 = $100,000 - ($425,000 - $400,000) $350,000 = Tippy's retained earnings

E1-15 Stockholders' Equity Amounts under Pooling Treatment

a. 8,000 shares issued: Journal Entry Combined Stockholders' EquityNet Assets 250,000 Common Stock $280,000 Common Stock 80,000 Additional Paid-In Additional Paid-In Capital 50,000 Capital 30,000 Retained Earnings 470,000 Retained Earnings 140,000 $800,000

b. 12,000 shares issued: Journal Entry Combined Stockholders' EquityNet Assets 250,000 Common Stock $320,000Additional Paid-In Additional Paid-In Capital 10,000 Capital 10,000 Common Stock 120,000 Retained Earnings 470,000 Retained Earnings 140,000 $800,000

c. 16,000 shares issued: Journal Entry Combined Stockholders' EquityNet Assets 250,000 Common Stock $360,000Additional Paid-In Retained Earnings 440,000 Capital 20,000 $800,000 Common Stock 160,000 Retained Earnings 110,000


E1-16 Recording Pooling of Interests

a. 450,000 shares issued:

Current Assets 600,000 Plant and Equipment 1,610,000 Current Liabilities 110,000 Long-Term Debt 1,000,000 Common Stock 450,000 Additional Paid-In Capital 250,000 Retained Earnings 400,000

b. 600,000 shares issued:

Current Assets 600,000 Plant and Equipment 1,610,000 Current Liabilities 110,000 Long-Term Debt 1,000,000 Common Stock 600,000 Additional Paid-In Capital 100,000 Retained Earnings 400,000

c. 1,100,000 shares issued:

Current Assets 600,000 Plant and Equipment 1,610,000 Additional Paid-In Capital 350,000 Current Liabilities 110,000 Long-Term Debt 1,000,000 Common Stock 1,100,000 Retained Earnings 350,000


E1-17 Combining Balance Sheets under Pooling Treatment Regal Company and Sour Corporation Combined Balance Sheet January 1, 20X1

Cash and Receivables $ 140,000 Accounts Payable $ 60,000Inventory 300,000 Common StockLand 110,000 ($10 Par Value) 380,000Buildings and Equipment 1,100,000 Additional Paid-InLess: Accumulated Capital 170,000 Depreciation (400,000) Retained Earnings 640,000 $1,250,000 $1,250,000

E1-18 Combined Balance Sheet under Pooling of Interests Treatment

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

Cash and Receivables $ 240,000 Accounts Payable $ 125,000Inventory 370,000 Notes Payable 230,000Buildings and Equipment 850,000 Common Stock 244,000Less: Accumulated Additional Paid-In Depreciation (330,000) Capital 221,000 Retained Earnings 310,000 $1,130,000 $1,130,000


E1-19 Recording a Business Combination

Business Combination Expenses 83,000 Cash 83,000

Cash 70,000 Accounts Receivable 110,000 Inventory 180,000 Land 100,000 Buildings and Equipment 450,000 Goodwill 20,000 Additional Paid-In Capital (1) 110,000 Accumulated Depreciation 230,000 Accounts Payable 195,000 Bonds Payable 100,000 Bond Premium 10,000 Common Stock 320,000 Retained Earnings 185,000

(1) Computation of reduction in additional paid-in capital:

Par value of shares issued by Blue Corporation ($8 x 40,000) $320,000 Par value of Sparse shares acquired (150,000) Increase in par value of shares outstanding $170,000 Additional paid-in capital reported by Sparse (60,000) Reduction in additional paid-in capital reported by Blue Corporation $110,000

E1-20 Reporting Income

20X2: Net income = $6,720,000 [$2,500,000 + $692,000 + $3,528,000] Earnings per share = $5.60 [$6,720,000 / (1,000,000 + 200,000)]

20X1: Net income = $5,760,000 [$4,460,000 + $1,300,000] Earnings per share = $4.80 [$5,760,000 / (1,000,000 + 200,000)]


SOLUTIONS TO PROBLEMS - PART I

P1-21 Journal Entries-Purchase Treatment

Journal entries to record acquisition of TKK net assets under purchase treatment:

(1) Deferred Merger Costs 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 26,000 Accounts Payable 41,000 Notes Payable 63,000 Common Stock 96,000 Additional Paid-In Capital 404,000 Deferred Merger Costs 14,000 Deferred Stock Issue Costs 28,000 Record purchase of TKK Corporation.

Computation of goodwill

Values of shares issued ($22 x 24,000) $528,000 Legal fees 14,000 Total purchase price $542,000 Fair value of net assets acquired ($620,000 - $104,000) (516,000) Goodwill $ 26,000

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


P1-22 Recording Business Combinations


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

Cash and Equivalents 41,000 Accounts Receivable 73,000 Inventory 144,000 Land (1) 196,500 Buildings (1) 1,473,750 Equipment (1) 294,750 Accounts Payable 35,000 Short-Term Notes Payable 50,000 Bonds Payable 500,000 Common Stock-$2 Par 800,000 Additional Paid-In Capital (2) 778,000 Deferred Merger Costs 38,000 Deferred Stock Issue Costs 22,000

(1) Negative goodwill: Total purchase price: Value of stock issued ($4 x 400,000) $1,600,000 Merger costs 38,000 Total purchase price $1,638,000 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) Negative goodwill $ (35,000)

Allocation of negative goodwill: Land $ 200,000 / $2,000,000 = .10 Buildings 1,500,000 / $2,000,000 = .75 Equipment 300,000 / $2,000,000 = .15 $2,000,000 1.00

Land $ 200,000 - ($35,000 x .10) = $ 196,500 Buildings 1,500,000 - ($35,000 x .75) = 1,473,750 Equipment 300,000 - ($35,000 x .15) = 294,750

(2) Additional paid-in capital: $778,000 = $800,000 - $22,000


P1-22 (continued)


Deferred Merger Costs 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 (1) 1,965,000 Accounts Payable 35,000 Short-Term Notes Payable 50,000 Bonds Payable 500,000 Common Stock-$2 Par 1,800,000 Additional Paid-In Capital (2) 1,778,000 Deferred Merger Costs 38,000 Deferred Stock Issue Costs 22,000

(1) Goodwill: Total purchase price: Value of stock issued ($4 x 900,000) $3,600,000 Merger costs 38,000 Total purchase price $3,638,000 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 $1,965,000

(2) Additional paid-in capital: $1,778,000 = [($4 - $2) x 900,000] - $22,000


P1-23 Purchase Treatment 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 $140,000Accounts Receivable 175,000 Notes Payable 270,000Inventory 220,000 Common Stock 200,000Patents 140,000 Additional Paid-In Buildings and Equipment 530,000 Capital 160,000Less: 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


P1-24 Negative Goodwill

Journal entries to record acquisition of Lark Corporation net assets:

Deferred Merger Costs 5,000 Cash 5,000

Cash 50,000 Inventory 150,000 Buildings and Equipment (net) 240,000 Patent 160,000 Accounts Payable 30,000 Cash 565,000 Deferred Merger Costs 5,000

Computation of negative goodwill

Purchase price $570,000 Fair value of net assets acquired ($700,000 - $30,000) (670,000) Negative goodwill $100,000


Reduction for Assigned Item Fair Value Negative Goodwill Valuation Buildings and Equipment $300,000 $100,000 x (300/500) $240,000 Patent 200,000 $100,000 x (200/500) 160,000 $500,000 $400,000


P1-25 Journal Entries-Purchase Treatment

Journal entries to record acquisition of Light Steel net assets under purchase treatment:

(1) Deferred Merger Costs 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 114,000 Accounts Payable 10,000 Bonds Payable 200,000 Common Stock 120,000 Additional Paid-In Capital 471,000 Deferred Merger Costs 19,000 Deferred Stock Issue Costs 9,000 Record purchase-type merger with Light Steel Company.


Value of shares issued ($50 x 12,000) $600,000 Finder's fee 10,000 Legal fees for asset transfer 9,000 $619,000 Fair value of net assets acquired (505,000) Goodwill $114,000


P1-26 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 $ 60,000Accounts Receivable 160,000 Bonds Payable $450,000Inventory 360,000 Less: Discount (5,000) 445,000Land 80,000 Common Stock 280,000Buildings and Equipment 950,000 AdditionalLess: Accumulated Paid-In Capital 560,000 Depreciation (250,000) Retained Earnings 180,000Goodwill 125,000 $1,525,000 $1,525,000

P1-27 Business Combination

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

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


P1-28 Combined Balance Sheet under Purchase Treatment

a. Purchase balance sheet: Bilge Pumpworks and Seaworthy Rope Company Combined Balance Sheet January 1, 20X3

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

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


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


P1-29 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

P1-30 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. $364,000 = ($117,000 + $577,000) - ($96,000 + $234,000)

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

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

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

h. $82,000 = $364,000 + $24,000 - $306,000


P1-31 Comprehensive Problem: Purchase Accounting

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

(1) Purchase Treatment:

Deferred Merger Costs 135,000 Cash 135,000

Deferred Stock Issue Costs 42,000 Cash 42,000

Cash 28,000 Accounts Receivable 258,000 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 244,700 Allowance for Bad Debts 6,500 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 Merger Costs 135,000 Deferred Stock Issue Costs 42,000


Value of stock issued ($14 x 180,000) $2,520,000 Direct merger costs 135,000 Total purchase price $2,655,000 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 $ 244,700


P1-31 (continued)

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

Investment in Integrated 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 Bonds 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 Integrated 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.


SOLUTIONS TO PROBLEMS - PART II

P1-32 Recording Procedures under Pooling of Interests Treatment

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

Cash 10,000 Accounts Receivable 7,000 Inventory 60,000 Land 8,000 Buildings and Equipment 150,000 Additional Paid-In Capital 6,000 Accumulated Depreciation 120,000 Accounts Payable 70,000 Common Stock 40,000 Retained Earnings 11,000

b. Balance sheet immediately following acquisition: Obscure Advertising and Brown Company Combined Balance Sheet January 1, 20X1

Cash $ 85,000 Accounts Payable $145,000Accounts Receivable 12,000 Common Stock 90,000Inventory 130,000 Additional Paid-InLand 13,000 Capital 2,000Buildings and Equipment 250,000 Retained Earnings 93,000Less: Accumulated Depreciation (160,000) $330,000 $330,000

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

Investment in Brown Company Common Stock 45,000 Additional Paid-In Capital 6,000 Common Stock 40,000 Retained Earnings 11,000


P1-33 Journal Entries-Pooling Treatment

b. Journal entries to record acquisition of TKK net assets under pooling of interests treatment:

(1) Business Combination Expenses 42,000 Cash 42,000 Record expenses associated with acquisition of TKK Corporation.

(2) Cash and Receivables 28,000 Inventory 94,000 Buildings and Equipment 600,000 Accumulated Depreciation 240,000 Accounts Payable 41,000 Notes Payable 65,000 Common Stock 96,000 Additional Paid-In Capital 64,000 Retained Earnings 216,000 Record pooling-type merger with TKK.


P1-34 Recording Business Combinations


Merger Expenses 60,000 Cash 60,000

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 Accounts Payable 35,000 Short-Term Notes Payable 50,000 Bonds Payable 500,000 Common Stock-$2 Par 800,000 Additional Paid-In Capital (1) 525,000 Retained Earnings 275,000

(1) Additional paid-in capital $525,000 = $325,000 + (1,000,000 - $800,000)


Merger Expenses 60,000 Cash 60,000

Cash and Equivalents 41,000 Accounts Receivable 73,000 Inventory 144,000 Land 200,000 Buildings 1,520,000 Equipment 638,000 Additional Paid-In Capital (1) 250,000 Accumulated Depreciation 431,000 Accounts Payable 35,000 Short-Term Notes Payable 50,000 Bonds Payable 500,000 Common Stock-$2 Par 1,800,000 Retained Earnings (2) 50,000

(1) Additional paid-in capital: Taylor's additional paid-in capital

(2) Retained Earnings: $50,000 = $275,000 - ($1,800,000 - $1,000,000 - $325,000 - $250,000)


P1-35 Journal Entries-Pooling of Interests

Journal entries to record acquisition of Light Steel net assets under pooling of interests treatment:

(1) Business Combination Expense 28,000 Cash 28,000 Record costs associated with the acquisition of Light Steel Company.

(2) Cash 60,000 Accounts Receivable 100,000 Inventory 60,000 Land 50,000 Buildings and Equipment 400,000 Accounts Payable 10,000 Bonds Payable 200,000 Accumulated Depreciation 150,000 Common Stock 120,000 Additional Paid-In Capital 100,000 Retained Earnings 90,000 Record pooling-type merger with Light Steel Company.


P1-36 Pooling Treatment

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

Cash 30,000 Accounts Receivable 60,000 Inventory 100,000 Land 40,000 Buildings and Equipment 400,000 Accumulated Depreciation 150,000 Accounts Payable 10,000 Bonds Payable 150,000 Common Stock 80,000 Additional Paid-In Capital 40,000 Retained Earnings 200,000

b. Balance sheet immediately following acquisition: Ramrod Manufacturing and Stafford Industries Combined Balance Sheet January 1, 20X2

Cash $ 100,000 Accounts Payable $ 60,000Accounts Receivable 160,000 Bonds Payable 450,000Inventory 300,000 Common Stock 280,000Land 90,000 Additional Paid-InBuildings and Equipment 1,000,000 Capital 80,000Less: Accumulated Retained Earnings 380,000 Depreciation (400,000) $1,250,000 $1,250,000


P1-37 Business Combinations

a. Journal entry to record acquisition of Toot-Toot Tuba net assets under pooling of interests:

Cash 300 Accounts Receivable 17,000 Inventory 35,000 Plant and Equipment 451,000 Other Assets 25,800 Retained Earnings 115,500 Allowance for Uncollectibles 1,400 Accumulated Depreciation 225,000 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 160,000

Computation of retained earnings deficit Balance of Toot-Toot, as stated $ (71,200) Write-down of inventory (43,500) Increase in allowance for uncollectibles (800) Adjusted retained earnings deficit of Toot-Toot $(115,500) Note: Solution assumes that the allowance for uncollectible accounts receivable should be adjusted to the estimated allowance and that inventory should be reduced under the lower-of-cost-or-market rule whether or not a business combination occurs.


P1-37 (continued)

b. Capital Stock ($10 par) $760,000 Retained Earnings (5,700) Total $754,300

Computation of retained earnings deficit

Adjusted retained earnings deficit of Toot-Toot $115,500 Par value of Boogie shares issued $260,000 Par value of Toot-Toot shares acquired (100,000) Increase in par value $160,000 Absorbed by premium on capital stock of Toot-Toot (150,000) Absorbed by reduction of premium on capital stock of Boogie (1,000) Amount charged to retained earnings 9,000 $124,500 Retained earnings of Boogie (118,800) Retained earnings deficit of combined entity $ 5,700

c. Investment in Toot-Toot Stock 134,500 Retained Earnings 115,500 Capital Stock ($10 par) 90,000 Premium on Capital Stock 160,000


P1-38 Combined Balance Sheet under Pooling Treatment

a. Pooling of interests balance sheet:

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

Cash and Receivables $110,000 Current Liabilities $100,000Inventory 130,000 Capital Stock 214,000Land 110,000 Capital in ExcessPlant and Equipment 600,000 of Par Value 31,000Less: Accumulated Retained Earnings 375,000 Depreciation (230,000) $720,000 $720,000

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 + $5,000 - $2,000) 23,000 Retained Earnings ($240,000 + $135,000) 375,000 $620,000


Capital Stock [$200,000 + ($20 x 1,800 shares)] $236,000 Capital in Excess of Par Value ($20,000 + $5,000 - $16,000) 9,000 Retained Earnings ($240,000 + $135,000) 375,000 $620,000


Capital Stock [$200,000 + ($20 x 3,000 shares)] $260,000 Retained Earnings [$240,000 + $135,000 - $15,000] 360,000 $620,000

Par value of shares issued $60,000 Par value of shares previously outstanding (20,000) Increase in par value $40,000 Reduction of excess over par-Seaworthy (5,000) $35,000 Reduction of excess over par-Bilge (20,000) Reduction of retained earnings $15,000


P1-39 Comprehensive Problem with Incomplete Data

a. Value of shares issued in acquiring Flash Heating Company:

Increase in par value of shares ($240,000 - $200,000) $ 40,000 Increase in paid-in capital-purchase ($420,000 - $60,000) 360,000 Value of shares issued $400,000

b. Value of net assets held by Flash Heating Company:

Amount of total assets-purchase $1,130,000 Amount of Speedy Plumbers assets (650,000) $480,000 Amount of total liabilities-purchase $ 220,000 Amount of Speedy Plumbers liabilities (140,000) (80,000 ) Fair value of Flash Heating net assets plus goodwill $400,000 Less: Goodwill (55,000) Fair value of Flash Heating net assets $345,000

c. Shares issued by Speedy Plumbers:

Par value of stock following acquisition $240,000 Par value of stock before acquisition (200,000) Increase in par value $ 40,000 Par value per share $5 Number of shares issued 8,000

d. Market price of Speedy Plumbers stock:

Value of shares computed in part a $400,000 Number of shares issued computed in part c 8,000 Market price per share $ 50

e. The full retained earnings balance of Flash Heating Company was carried forward in the pooling case. Additional paid-in capital increased in the pooling, which means there was no need to capitalize retained earnings.


P1-39 (continued)

f. Book value of net assets of Flash Heating Company:

Book value of combined assets-pooling $980,000 Book value of Speedy Plumbers assets (650,000) $330,000 Book value of combined liabilities-pooling $220,000 Book value of Speedy Plumbers liabilities (140,000) (80,000 ) Book value of Flash Heating net assets $250,000

g. Increase in inventory value of Flash Heating Company:

Inventory valued at fair value-purchase $220,000 Inventory valued at book value-pooling (170,000) Increase in value of Flash Heating inventory $ 50,000

h. Flash Heating working capital balance before acquisition:

Cash balance ($100,000 - $70,000) $ 30,000 Accounts receivable ($180,000 - $130,000) 50,000 Inventory-pooling ($170,000 - $100,000) 70,000 $150,000 Accounts payable ($60,000 - $40,000) (20,000)

Working capital at time of acquisition $130,000


P1-40 Incomplete Data for Purchase and Pooling

a. Inventory reported by Spice at date of combination:

Inventory reported following pooling $170,000 Inventory reported by Roto (100,000) Inventory reported by Spice $ 70,000

b. Fair value of total assets reported by Spice:

Fair value of cash $ 20,000 Fair value of accounts receivable 55,000 Fair value of inventory 110,000 Buildings and equipment reported following purchase $570,000 Buildings and equipment reported by Roto (350,000) 220,000 Fair value of Spice's total assets $405,000

c. Market value of Spice's bond:

Book value reported by Spice $100,000 Bond premium reported following purchase 5,000 Market value of bond $105,000

d. Shares issued by Roto Corporation:

Par value of stock following acquisition $190,000 Par value of stock before acquisition 120,000 Increase in par value of shares outstanding $ 70,000 Divide by par value of per share $5 Number of shares issued 14,000

e. Market price per share of stock issued by Roto Corporation:

Par value of stock following acquisition $190,000 Additional paid-in capital following acquisition 262,000 $452,000

Par value of stock before acquisition $120,000 Additional paid-in capital before acquisition 10,000 (130,000) Market value of shares issued in acquisition $322,000 Divide by number of shares issued 14,000 Market price per share $ 23.00

f. Goodwill reported by Spice prior to the acquisition:

Goodwill reported using pooling treatment $70,000 Goodwill reported by Roto prior to acquisition (30,000) Goodwill reported by Spice $40,000


P1-40 (continued)

g. Goodwill reported if the business combination is recorded as a purchase:

Market value of shares issued by Roto $322,000 Fair value of Spice's assets $405,000 Fair value of Spice's liabilities: Accounts payable $ 30,000 Bond payable 105,000 Fair value of liabilities (135,000) Fair value of Spice's net asset (270,000) Goodwill recorded in business combination $ 52,000 Goodwill previously on the books of Roto 30,000 Goodwill reported $ 82,000

h. Retained earnings reported by Spice:

Retained earnings reported following pooling $210,000 Retained earnings reported by Roto (120,000) Retained earnings reported by Spice $ 90,000

Note: Roto was able to carry all of Spice's retained earnings forward. This must be the case because additional paid-in capital was increased under pooling.

i. Roto's retained earnings of $120,000 would be reported.


P1-40 (continued)

j. Additional paid-in capital reported by Spice prior to the combination:

Total reported liabilities and stockholders' equity $325,000 Accounts payable $ 30,000 Bonds payable 100,000 Common stock 50,000 Retained earnings: Balance reported following pooling $210,000 Balance reported by Roto (120,000) Balance reported by Spice 90,000 Total equity excluding paid-in capital (270,000) Additional paid-in capital $ 55,000

Alternate calculation:

Additional paid-in capital following pooling $45,000 Reduction of additional paid-in capital for increase in par value of shares outstanding: Par value following acquisition $190,000 Par value reported by Roto before combination (120,000) Par value of shares issued $ 70,000 Par value of Spice shares acquired (50,000) Reduction of additional paid-in capital 20,000 Additional paid-in capital reported by Roto prior to combination (10,000) Additional paid-in capital reported by Spice $55,000

k. 1. Business Combination Expenses 26,800 Cash 26,800

2. Deferred Merger Costs 17,000 Deferred Stock Issue Costs 9,800 Cash 26,800

3. Goodwill previously computed $82,000 Deferred merger costs added to investment account 17,000 Total goodwill reported $99,000

4. Additional paid-in capital reported following combination $262,000 Deferred stock issue costs (9,800) Total Additional paid-in capital reported $252,200

5. They would have no effect on the amounts reported as goodwill or additional paid-in capital if pooling treatment is used. The full amount is charged to business combination expense, as illustrated in part 1 above.


P1-41 Reporting Results of Operations

a. Pooling of interests: 20X1 20X2 20X3 Revenue $1,750,000 $2,000,000 $2,100,000 Net Income 600,000 620,000 700,000 Earnings per Share $4.80a $4.96b $5.60c

a $600,000 / 125,000 shares b $620,000 / 125,000 shares c $700,000 / 125,000 shares

Note that in a pooling the companies are viewed as always having been combined; therefore, the shares issued in the combination are treated as always having been outstanding.

b. Purchase: 20X1 a 20X2 20X3 Revenue $1,400,000 $1,800,000b $2,100,000 Net Income 500,000 545,000c 660,000d

Earnings per Share $5.00 $4.84e $5.28f

a Separate figures for Amalgamated Transport only b $2,000,000 - $200,000 c $620,000 - $55,000 - $20,000* d $700,000 - $40,000* e $545,000 / 112,500 shares** f $660,000 / 125,000 shares

*Amortization of differential: Total purchase price ($96 x 25,000 shares) $2,400,000 Net book value (2,000,000) Differential assigned to equipment $ 200,000

Differential amortized 20X2 ($200,000 / 5) x 1/2 year $20,000 Differential amortized 20X3 ($200,000 / 5) $40,000

**Weighted average number of shares = (100,000 + 125,000) / 2


P1-42 Comprehensive Problem: Pooling of Interests

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



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 Discount on Debentures 40,000 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 Common Stock 180,000 Additional Paid-In Capital-Common 908,000 Additional Paid-In Capital- Retirement of Preferred 22,000 Retained Earnings 220,100

Computation of additional paid-in capital-common

Par value of HCC stock acquired $600,000 Par value of Integrated Industries stock issued 180,000 Difference to combined additional paid-in capital $420,000 less HCC treasury stock retired (12,000) HCC's additional paid-in capital-common 500,000 Credit to combined additional paid-in capital-common $908,000


P1-42 (continued)

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

Investment in Integrated Industries Stock 1,330,100 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 Bonds 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 Record exchange of assets and liabilities for stock.

Common Stock 7,500 Additional Paid-In Capital-Common Stock 4,500 Treasury Stock 12,000 Record retirement of Treasury Stock.*

Common Stock 592,500 Additional Paid-In Capital-Common 495,500 Additional Paid-In Capital-Retirement of Preferred 22,000 Retained Earnings 220,100 Investment in Integrated Industries Stock 1,330,100 Record retirement of HCC stock and distribution of Integrated Industries Stock.

*Alternative approaches exist.


CH01SMF

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