Solution Manual For Advanced Accounting, 3rd Edition(2002 Fasb Update)

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1-1CHAPTER 1ANSWERS TO QUESTIONS1.Internal expansion involves a normal increase in business resulting from increased demand forproducts and services, achieved without acquisition of preexisting firms.Some companies expandinternally by undertaking new product research to expand their total market, or by attempting toobtain a greater share of a given market through advertising and other promotional activities.Marketing can also be expanded into new geographical areas.External expansion is the bringing together of two or more firms under common control byacquisition.Referred to as business combinations, these combined operations may be integrated, oreach firm may be left to operate intact.2.Four advantages of business combinations as compared to internal expansion are:(1) Management is provided with an established operating unit with its own experienced personnel,regular suppliers, productive facilities and distribution channels.(2) Expanding by combination does not create new competition.(3) Permits rapid diversification into new markets.(4) Income tax benefits.3.The primary legal constraint on business combinations is that of possible antitrust suits.The UnitedStates government is opposed to the concentration of economic power that may result from businesscombinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal withantitrust problems.4.(1) A horizontal combination involves companies within the same industry that have previouslybeen competitors.(2) Vertical combinations involve a company and its suppliers and/or customers.(3) Conglomerate combinations involve companies in unrelated industries having little productionor market similarities.5.A statutory merger results when one company acquires all of the net assets of one or more othercompanies through an exchange of stock, payment of cash or property, or the issue of debtinstruments.The acquiring company remains as the only legal entity, and the acquired companyceases to exist or remains as a separate division of the acquiring company.A statutory consolidation results when a new corporation is formed to acquire two or morecorporations, through an exchange of voting stock, with the acquired corporations ceasing to exist asseparate legal entities.A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of thevoting stock of another company.The stock may be acquired through market purchases or throughdirect purchase from or exchange with individual stockholders of the investee or subsidiary company.6.A tender offer is an open offer to purchase up to a stated number of shares of a given corporation at astipulated price per share.The offering price is generally set above the current market price of theshares to offer an additional incentive to the prospective sellers.7.A stock exchange ratio is generally expressed as the number of shares of the acquiring company thatare to be exchanged for each share of the acquired company.

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1-28.Defensive tactics include:(1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchaseadditional shares at a price below market value, but exercisable only in the event of a potentialtakeover. This tactic is effective in some cases.(2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amountsubstantially in excess of their fair value. The shares are then usually held in treasury. This tactic isgenerally ineffective.(3) White knight or white squire – when a third firm more acceptable to the target companymanagement is encouraged to acquire or merge with the target firm.(4) Pac-man defense – when the target firm attempts an unfriendly takeover of the would-beacquiring company.(5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firmless attractive to an acquirer.9.In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stockacquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stockacquisition, formal negotiations with the target’s management can sometimes be avoided. Further, ina stock acquisition, there might be advantages in keeping the firms as separate legal entities such asfor tax purposes.10. Does the merger increase or decrease expected earnings performance of the acquiring institution?From a financial and shareholder perspective, the price paid for a firm is hard to justify if earnings pershare declines. When this happens, the acquisition is considereddilutive. Conversely, if the earningsper share increases as a result of the acquisition, it is referred to as anaccretiveacquisition.11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary inthe consolidated financial statements is restricted to the amount by which the cost of the investmentis more or less than the book value of the net assets acquired. Noncontrolling interest in net assets isunaffected by such writeups or writedowns.The economic unit concept supports the writeup or writedown of the net assets of the subsidiary byan amount equal to the entire difference between the fair value and the book value of the net assetson the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjustedfor its share of the writeup or writedown of the net assets of the subsidiary.12.a) Under the parent company concept, noncontrolling interest is considered a liability of theconsolidatedentity whereasundertheeconomicunitconcept,noncontrollinginterestisconsidered a separate equity interest in consolidated net assets.b) The parent company concept supports partial elimination of intercompany profit whereas theeconomic unit concept supports 100 percent elimination of intercompany profit.c) The parent company concept supports valuation of subsidiary net assets in the consolidatedfinancial statements at book value plus an amount equal to the parent company’s percentageinterest in the difference between fair value and book value. The economic unit conceptsupports valuation of subsidiary net assets in the consolidated financial statements at their fairvalue on the date of acquisition without regard to the parent company’s percentage ownershipinterest.d) Under the parent company concept, consolidated net income measures the interest of theshareholders of the parent company in the operating results of the consolidated entity. Under the

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1-3economicunitconcept,consolidatednetincomemeasurestheoperatingresultsoftheconsolidated entity which is then allocated between the controlling and noncontrolling interests.13. The implied fair value based on the price may not be relevant or reliable since the price paid is anegotiated price which may be impacted by considerations other than or in addition to the fair valueof the net assets of the acquired company.There may be practical difficulties in determining thefair value of the consideration given and in allocating the total implied fair value to specific assetsand liabilities.In the case of a less than wholly owned company, valuation of net assets at implied fair valueviolates the cost principle of conventional accounting and results in the reporting of subsidiaryassets and liabilities using a different valuation procedure than that used to report the assets andliabilities of the parent company.14. The economic entity is more consistent with the principles addressed in the FASB’s conceptualframework. It is an integral part of the FASB’s conceptual framework and is named specifically inSFAC No. 5 as one of the basic assumptions in accounting. The economic entity assumption viewseconomic activity as being related to a particular unit of accountability, and the standard indicatesthat a parent and its subsidiaries represent one economic entity even though they may includeseveral legal entities.15. The FASB’s conceptual framework provides the guidance for new standards. The quality ofcomparability was very much at stake in FASB’s decision in 2001 to eliminate the pooling ofinterests method for business combinations. This method was also argued to violate the historicalcost principle as it essentially ignored the value of the consideration (stock) issued for theacquisition of another company.The issue of consistency plays a role in the recent proposal to shift from the parent concept to theeconomic entity concept, as the former method valued a portion (the noncontrolling interest) of agiven asset at prior book values and another portion (the controlling interest) of that same asset atexchange-date market value.16. Comprehensive income is a broader concept, and it includes some gains and losses explicitly statedby FASB to bypass earnings. The examples of such gains that bypass earnings are some changes inmarket values of investments, some foreign currency translation adjustments and certain gains andlosses, related to minimum pension liability.In the absence of gains or losses designated to bypass earnings, earnings and comprehensiveincome are the same.

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1-4ANSWERS TO BUSINESS ETHICS CASE1.The third item will lead to the reduction of net income of the acquired company beforeacquisition, and will increase the reported net income of the combined company subsequent toacquisition. The accelerated payment of liabilities should not have an effect on net income incurrent or future years, nor should the delaying of the collection of revenues (assuming thoserevenues have already been recorded).2.The first two items will decrease cash from operations prior to acquisition and will increase cashfrom operations subsequent to acquisition. The third item will not affect cash from operations.3.As the manager of the acquired company I would want to make it clear that my futureperformance (if I stay on with the consolidated company) should not be evaluated based upon afuture decline that is perceived rather than real. Further, I would express a concern thatshareholders and other users might view such accounting maneuvers as sketchy.4.a)Earnings manipulation may be regarded as unethical behavior regardless of which side ofthe acquirer/acquiree equation you’re on. The benefits that you stand to reap may differ,and thus your potential liability may vary. But the ethics are essentially the same.Ultimately the company may be one unified whole as well, and the users that are affectedby any kind of distorted information may view any participant in an unsavory light.b)See answer to (a).

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1-5ANSWERS TO EXERCISESExercise 1-1Part ANormal earnings for similar firms = ($15,000,000 - $8,800,000) x 15% = $930,000Expected earnings of target:Pretax income of Condominiums, Inc., 2008$1,200,000Subtract: Additional depreciation on building ($960,00030%)(288,000)Target’s adjusted earnings, 2008912,000Pretax income of Condominiums, Inc., 2009$1,500,000Subtract: Additional depreciation on building(288,000)Target’s adjusted earnings, 20091,212,000Pretax income of Condominiums, Inc., 2010$950,000Add: Extraordinary loss300,000Subtract: Additional depreciation on building(288,000)Target’s adjusted earnings, 2010962,000Target’s three year total adjusted earnings3,086,000Target’s three year average adjusted earnings ($3,086,0003)1,028,667Excess earnings of target = $1,028,667 - $930,000 = $98,667 per yearPresent value of excess earnings (perpetuity) at 25%:= $394,668 (Estimated Goodwill)Implied offering price = $15,000,000 – $8,800,000 + $394,668 = $6,594,668.Part BExcess earnings of target (same as in Part A) = $98,667Present value of excess earnings (ordinary annuity) for three years at 15%:$98,6672.28323 = $225,279Implied offering price = $15,000,000 – $8,800,000 + $225,279 = $6,425,279.Note: The sales commissions and depreciation on equipment are expected to continue at thesame rate, and thus do not necessitate adjustments.%,$2566798

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1-6Exercise 1-2Part ACumulative 5 years net cash earnings$850,000Add nonrecurring losses48,000Subtract extraordinary gains(67,000)Five-years adjusted cash earnings$831,000Average annual adjusted cash earnings$166,200(a) Estimated purchase price = present value of ordinary annuity of $166,200 (n=5, rate= 15%)$166,2003.35216 =$557,129(b) Less: Market value of identifiable assets of Beta$750,000Less: Liabilities of Beta320,000Market value of net identifiable assets430,000Implied value of goodwill of Beta$127,129Part BActual purchase price$625,000Market value of identifiable net assets430,000Goodwill purchased$195,000Exercise 1-3Part ANormal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000Excess earnings = $150,000 – $120,000 = $30,000(1)Goodwill based on five years excess earnings undiscounted.Goodwill = ($30,000)(5 years) = $150,000(2)Goodwill based on five years discounted excess earningsGoodwill = ($30,000)(3.6048) = $108,144(present value of an annuity factor for n=5, I=12% is 3.6048)(3)Goodwill based on a perpetuityGoodwill = ($30,000)/.20 = $150,000Part BThe second alternative is the strongest theoretically if five years is a reasonable representation ofthe excess earnings duration. It considers the time value of money and assigns a finite life.Alternative three also considers the time value of money but fails to assess a duration period forthe excess earnings. Alternative one fails to account for the time value of money. Interestingly,alternatives one and three yield the same goodwill estimation and it might be noted that theassumption of an infinite life is not as absurd as it might sound since the present value becomesquite small beyond some horizon.Part CGoodwill = [Cost less (fair value of assets less the fair value of liabilities)],5000831,$

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1-7Or, Cost less fair value of net assetsGoodwill = ($800,000 – ($1,000,000 - $400,000)) = $200,000

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2 - 1CHAPTER 2Note: The letter A or B indicated for a question, exercise, or problem means that the question, exercise,or problem relates to a chapter appendix.ANSWERS TO QUESTIONS1.At the acquisition date, the information available (and through the end of the measurement period)is used to estimate the expected total consideration at fair value.If the subsequent stock issuevaluation differs from this assessment, the Exposure Draft (SFAS 1204-001) expected to replaceFASB Statement No. 141 specifies that equity should not be adjusted.The reason is that thevaluation was determined at the date of the exchange, and thus the impact on the firm’s equity wasmeasured at that point based on the best information available then.2.Proformafinancialstatements(sometimesreferredtoas“asif”statements)are financialstatements that are prepared to show the effect of planned or contemplated transactions.3.For purposes of the goodwill impairment test, all goodwill must be assigned to a reporting unit.Goodwill impairment for each reporting unit should be tested in a two-step process. In the firststep, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at thedate of the periodic review. The fair value of the unit may be based on quoted market prices,prices of comparable businesses, or a present value or other valuation technique. If the fair valueat the review date is less than the carrying amount, then the second step is necessary. In the secondstep, the carrying value of the goodwill is compared to its implied fair value. (The calculation ofthe implied fair value of goodwill used in the impairment test is similar to the method illustratedthroughout this chapter for valuing the goodwill at the date of the combination.)4.The expected increase was due to the elimination of goodwill amortization expense. However, theimpairment loss under the new rules was potentially larger than a periodic amortization charge, andthis is in fact what materialized within the first year after adoption (a large impairment loss).Ifthere was any initial stock price impact from elimination of goodwill amortization, it was only ashort-term or momentum effect.Another issue is how the stock market responds to the goodwillimpairment charge.Some users claim that this charge is a non-cash charge and should bedisregarded by the market.However, others argue that the charge is an admission that the pricepaid was too high, and might result in a stock price decline (unless the market had already adjustedfor this overpayment prior to the actual writedown).5B. The acquisition method treats a combination as the acquisition of one or more companies byanother.The pooling of interests method, in contrast, interprets a business combination as theprocess of two or more groups of stockholders uniting ownership interest by an exchange of equitysecurities.This method (pooling) is no longer allowed for acquisitions after June 30, 2001.However, accounts resulting from previous acquisitions that used the pooling method will continueto be carried forward under the valuations implied by that method.Under the acquisition method the identifiable assets acquired and liabilities assumed are recordedat their fair values at the date of acquisition.Any excess of total implied value over the sum ofthese fair values is recorded as goodwill.Under the pooling method fair values of assets and

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2 - 2liabilities were ignored, and the assets acquired and liabilities assumed were carried forward to thenew or surviving entity at their recorded (book) values.Financial statement differences resulted from the use of one method rather than the other.Thepurchase method normally results in higher asset values.To the extent that these higher valuesrelate to depreciable assets and inventories, future income charges are greater.(Also, bonddiscounts, under the purchase method, must be amortized to future periods, and in the pastgoodwill was amortized under the purchase method.)Thus, the use of the pooling methodgenerally resulted in greater future earnings, lower asset values, and greater returns on assets.6B.Net income would be the highest under the pooling method (no excess depreciation or goodwillamortization), lowest under the former purchase rules (before FASB Statement No. 141, bothexcess depreciation and goodwill amortization), and intermediate under the purchase rules afterFASB Statement No. 141 (excess depreciation only).Assets would be higher under the purchasemethod, either old or new rules.In fact, under the new rules, total assets will remain higher thanunder the old purchase rules because goodwill, once recorded, is not amortized.

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2 - 3Business Ethics SolutionsBusiness ethics solutions are merely suggestions of points to address.The objective is to raise thestudents' awareness of the topics, and to invite discussion.In most cases, there is clear room fordisagreement or conflicting viewpoints.The board has responsibility to look into anything that might suggest malfeasance or inappropriateconduct. Such incidents might suggest broader problems with integrity, honesty, and judgment. Inother words, can you trust any reports from the CEO? If the CEO is not fired, does this send a messageto other employees that ethical lapses are okay? Employees might feel that top executives are treateddifferently.ANSWERS TO EXERCISESExercise 2-1Part AReceivables228,000Inventory396,000Plant and Equipment540,000Land660,000Goodwill ($2,154,000 - $1,824,000)330,000Liabilities594,000Cash1,560,000Part BReceivables228,000Inventory396,000Plant and Equipment540,000Land660,000Liabilities594,000Cash990,000Gain on Business Combination ($1,230,000 - $990,000)240,000

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2 - 4Exercise 2-2Cash$680,000Receivables720,000Inventories2,240,000Plant and Equipment (net) ($3,840,000 + $720,000)4,560,000Goodwill120,000Total Assets$8,320,000Liabilities1,520,000Common Stock, $16 par ($3,440,000 + (.50$800,000))3,840,000Other Contributed Capital ($400,000 + $800,000)1,200,000Retained Earnings1,760,000Total Equities$8,320,000Entries on Petrello Company’s books would be:Cash200,000Receivables240,000Inventory240,000Plant and Equipment720,000Goodwill *120,000Liabilities320,000Common Stock (25,000$16)400,000Other Contributed Capital ($48 - $16)25,000800,000* ($4825,000) – [($1,480,000 – ($800,000 – $720,000) – $320,000]= $1,200,000 – [$1,480,000 – $80,000 – $320,000] = $1,200,000 – $1,080,000 = $120,000

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2 - 5Exercise 2-3Accounts Receivable231,000Inventory330,000Land550,000Buildings and Equipment1,144,000Goodwill848,000Allowance for Uncollectible Accounts ($231,000 - $198,000)33,000Current Liabilities275,000Bonds Payable450,000Premium on Bonds Payable ($495,000 - $450,000)45,000Preferred Stock (15,000$100)1,500,000Common Stock (30,000$10)300,000Other Contributed Capital ($25 - $10)30,000450,000Cash50,000Cost paid ($1,500,000 + $750,000 + $50,000) =$2,300,000Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) =1,452,000Goodwill =$848,000Exercise 2-4Cash96,000Receivables55,200Inventory126,000Land198,000Plant and Equipment466,800Goodwill*137,450Accounts Payable44,400Bonds Payable480,000Premium on Bonds Payable**45,050Cash510,000** Present value of maturity value, 12 periods @ 4%:0.6246$480,000 =$299,808Present value of interest annuity, 12 periods @ 4%:9.38507$24,000 =225,242Total present value525,050Par value480,000Premium on bonds payable$ 45,050*Cash paid$510,000Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000)(373,200)Excess of cash paid over book value136,800Increase in inventory to fair value(15,600)Increase in land to fair value(28,800)Increase in bond to fair value45,050Total increase in net assets to fair value650Goodwill$137,450

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2 - 6Exercise 2-5Current Assets960,000Plant and Equipment1,440,000Goodwill336,000Liabilities216,000Cash2,160,000Liability for Contingent Consideration360,000Exercise 2-6The amount of the contingency is $500,000 (10,000 shares at $50 per share)Part AGoodwill500,000Paid-in-Capital for Contingent Consideration500,000Part BPaid-in-Capital for Contingent Consideration500,000Common Stock ($10 par)100,000Paid-In-Capital in Excess of Par400,000Platz Company does not adjust the original amount recorded as equity.Exercise 2-7Current Assets$3,000Plant Assets (1)24,350Goodwill (2)23,400Debt50,000Stockholders’ Equity (3)750(1)$12,000 + [.95($25,000 – $12,000)] =$24,350(2)Cost of shares$50,000Book value of net assets acquired (.95$15,000)14,250Excess of cost over book value35,750Assigned to plant assets [.95$25,000 - $12,000)]12,350Assigned to goodwill$23,400(3).05$15,000 =750

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2 - 7Exercise 2-81. (c)Cost (8,000 shares @ $30)$240,000Fair value of net assets acquired228,800Excess of cost over fair value (goodwill)$ 11,2002. (c)Cost (8,000 shares @ $30)$240,000Fair value of net assets acquired ($90,000 + $242,000 – $56,000)276,000Excess of fair value over cost (gain)$ 36,000Exercise 2-9Current Assets362,000Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000)2,013,000Goodwill *395,000Liabilities119,000Long-term Debt491,000Common Stock (144,000$5)720,000Other Contributed Capital (144,000$15 - $5))1,440,000* (144,000$15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000Total shares issued5000205000700$,$$,$= 144,000Fair value of stock issued (144,000$15)= $2,160,000Exercise 2-10Case ACost (Purchase Price)$130,000Less: Fair Value of Net Assets120,000Goodwill$ 10,000Case BCost (Purchase Price)$110,000Less: Fair Value of Net Assets90,000Goodwill$ 20,000Case CCost (Purchase Price)$15,000Less: Fair Value of Net Assets20,000Gain($ 5,000)

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2 - 8Exercise 2-10 (Continued)AssetsLiabilitiesRetainedEarnings (Gain)GoodwillCurrent AssetsLong-Lived AssetsCase A$10,000$20,000$130,000$30,0000Case B20,00030,00080,00020,0000Case C020,00040,00040,0005,000Exercise 2-11Part A.2008:Step 1: Fair value of the reporting unit$400,000Carrying value of unit:Carrying value of identifiable net assets$330,000Carrying value of goodwill ($450,000 - $375,000)75,000405,000Excess of carrying value over fair value$ 5,000The excess of carrying value over fair value means that step 2 is required.Step 2:Fair value of the reporting unit$400,000Fair value of identifiable net assets340,000Implied value of goodwill60,000Recorded value of goodwill($450,000 - $375,000)75,000Impairment loss$ 15,0002009:Step 1: Fair value of the reporting unit$400,000Carrying value of unit:Carrying value of identifiable net assets$320,000Carrying value of goodwill ($75,000 - $15,000)60,000380,000Excess of fair value over carrying value$ 20,000The excess of fair value over carrying value means that step 2 isnotrequired.2010:Step 1: Fair value of the reporting unit$350,000Carrying value of unit:Carrying value of identifiable net assets$300,000Carrying value of goodwill ($75,000 - $15,000)60,000360,000Excess of carrying value over fair value$ 10,000The excess of carrying value over fair value means that step 2 is required.

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