Solution Manual For Advanced Accounting, 4th Edition
Solution Manual For Advanced Accounting, 4th Edition is the perfect resource for breaking down challenging problems step by step.
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1-1
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for
products and services, achieved without acquisition of preexisting firms. Some companies expand
internally by undertaking new product research to expand their total market, or by attempting to
obtain 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 by
acquisition. Referred to as business combinations, these combined operations may be integrated, or
each 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 United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt
instruments. The acquiring company remains as the only legal entity, and the acquired company
ceases 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 more
corporations, through an exchange of voting stock, with the acquired corporations ceasing to exist as
separate legal entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct 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 a
stipulated price per share. The offering price is generally set above the current market price of the
shares 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 that
are to be exchanged for each share of the acquired company.
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for
products and services, achieved without acquisition of preexisting firms. Some companies expand
internally by undertaking new product research to expand their total market, or by attempting to
obtain 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 by
acquisition. Referred to as business combinations, these combined operations may be integrated, or
each 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 United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt
instruments. The acquiring company remains as the only legal entity, and the acquired company
ceases 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 more
corporations, through an exchange of voting stock, with the acquired corporations ceasing to exist as
separate legal entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct 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 a
stipulated price per share. The offering price is generally set above the current market price of the
shares 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 that
are to be exchanged for each share of the acquired company.
1-1
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for
products and services, achieved without acquisition of preexisting firms. Some companies expand
internally by undertaking new product research to expand their total market, or by attempting to
obtain 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 by
acquisition. Referred to as business combinations, these combined operations may be integrated, or
each 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 United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt
instruments. The acquiring company remains as the only legal entity, and the acquired company
ceases 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 more
corporations, through an exchange of voting stock, with the acquired corporations ceasing to exist as
separate legal entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct 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 a
stipulated price per share. The offering price is generally set above the current market price of the
shares 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 that
are to be exchanged for each share of the acquired company.
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for
products and services, achieved without acquisition of preexisting firms. Some companies expand
internally by undertaking new product research to expand their total market, or by attempting to
obtain 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 by
acquisition. Referred to as business combinations, these combined operations may be integrated, or
each 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 United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt
instruments. The acquiring company remains as the only legal entity, and the acquired company
ceases 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 more
corporations, through an exchange of voting stock, with the acquired corporations ceasing to exist as
separate legal entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct 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 a
stipulated price per share. The offering price is generally set above the current market price of the
shares 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 that
are to be exchanged for each share of the acquired company.
1-2
8. Defensive tactics include:
(1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchase
additional shares at a price below market value, but exercisable only in the event of a potential
takeover. This tactic is effective in some cases.
(2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amount
substantially in excess of their fair value. The shares are then usually held in treasury. This tactic is
generally ineffective.
(3) White knight or white squire – when a third firm more acceptable to the target company
management 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-be
acquiring company.
(5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firm
less attractive to an acquirer.
9. In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stock
acquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stock
acquisition, formal negotiations with the target’s management can sometimes be avoided. Further, in
a stock acquisition, there might be advantages in keeping the firms as separate legal entities such as
for 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 per
share declines. When this happens, the acquisition is considered dilutive. Conversely, if the earnings
per share increases as a result of the acquisition, it is referred to as an accretive acquisition.
11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary in
the consolidated financial statements is restricted to the amount by which the cost of the investment
is more or less than the book value of the net assets acquired. Noncontrolling interest in net assets is
unaffected by such writeups or writedowns.
The economic unit concept supports the writeup or writedown of the net assets of the subsidiary by
an amount equal to the entire difference between the fair value and the book value of the net assets
on the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjusted
for 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 the
consolidated entity whereas under the economic unit concept, noncontrolling interest is
considered a separate equity interest in consolidated net assets.
b) The parent company concept supports partial elimination of intercompany profit whereas the
economic unit concept supports 100 percent elimination of intercompany profit.
c) The parent company concept supports valuation of subsidiary net assets in the consolidated
financial statements at book value plus an amount equal to the parent company’s percentage
interest in the difference between fair value and book value. The economic unit concept
supports valuation of subsidiary net assets in the consolidated financial statements at their fair
value on the date of acquisition without regard to the parent company’s percentage ownership
interest.
d) Under the parent company concept, consolidated net income measures the interest of the
shareholders of the parent company in the operating results of the consolidated entity. Under the
8. Defensive tactics include:
(1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchase
additional shares at a price below market value, but exercisable only in the event of a potential
takeover. This tactic is effective in some cases.
(2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amount
substantially in excess of their fair value. The shares are then usually held in treasury. This tactic is
generally ineffective.
(3) White knight or white squire – when a third firm more acceptable to the target company
management 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-be
acquiring company.
(5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firm
less attractive to an acquirer.
9. In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stock
acquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stock
acquisition, formal negotiations with the target’s management can sometimes be avoided. Further, in
a stock acquisition, there might be advantages in keeping the firms as separate legal entities such as
for 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 per
share declines. When this happens, the acquisition is considered dilutive. Conversely, if the earnings
per share increases as a result of the acquisition, it is referred to as an accretive acquisition.
11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary in
the consolidated financial statements is restricted to the amount by which the cost of the investment
is more or less than the book value of the net assets acquired. Noncontrolling interest in net assets is
unaffected by such writeups or writedowns.
The economic unit concept supports the writeup or writedown of the net assets of the subsidiary by
an amount equal to the entire difference between the fair value and the book value of the net assets
on the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjusted
for 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 the
consolidated entity whereas under the economic unit concept, noncontrolling interest is
considered a separate equity interest in consolidated net assets.
b) The parent company concept supports partial elimination of intercompany profit whereas the
economic unit concept supports 100 percent elimination of intercompany profit.
c) The parent company concept supports valuation of subsidiary net assets in the consolidated
financial statements at book value plus an amount equal to the parent company’s percentage
interest in the difference between fair value and book value. The economic unit concept
supports valuation of subsidiary net assets in the consolidated financial statements at their fair
value on the date of acquisition without regard to the parent company’s percentage ownership
interest.
d) Under the parent company concept, consolidated net income measures the interest of the
shareholders of the parent company in the operating results of the consolidated entity. Under the
1-3
economic unit concept, consolidated net income measures the operating results of the
consolidated 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 a
negotiated price which may be impacted by considerations other than or in addition to the fair value
of the net assets of the acquired company. There may be practical difficulties in determining the
fair value of the consideration given and in allocating the total implied fair value to specific assets
and liabilities.
In the case of a less than wholly owned company, valuation of net assets at implied fair value
violates the cost principle of conventional accounting and results in the reporting of subsidiary
assets and liabilities using a different valuation procedure than that used to report the assets and
liabilities of the parent company.
14. The economic entity is more consistent with the principles addressed in the FASB’s conceptual
framework. It is an integral part of the FASB’s conceptual framework and is named specifically in
SFAC No. 5 as one of the basic assumptions in accounting. The economic entity assumption views
economic activity as being related to a particular unit of accountability, and the standard indicates
that a parent and its subsidiaries represent one economic entity even though they may include
several legal entities.
15. The FASB’s conceptual framework provides the guidance for new standards. The quality of
comparability was very much at stake in FASB’s decision in 2001 to eliminate the pooling of
interests method for business combinations. This method was also argued to violate the historical
cost principle as it essentially ignored the value of the consideration (stock) issued for the
acquisition of another company.
The issue of consistency plays a role in the recent proposal to shift from the parent concept to the
economic entity concept, as the former method valued a portion (the noncontrolling interest) of a
given asset at prior book values and another portion (the controlling interest) of that same asset at
exchange-date market value.
16. Comprehensive income is a broader concept, and it includes some gains and losses explicitly stated
by FASB to bypass earnings. The examples of such gains that bypass earnings are some changes in
market values of investments, some foreign currency translation adjustments and certain gains and
losses, related to minimum pension liability.
In the absence of gains or losses designated to bypass earnings, earnings and comprehensive
income are the same.
economic unit concept, consolidated net income measures the operating results of the
consolidated 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 a
negotiated price which may be impacted by considerations other than or in addition to the fair value
of the net assets of the acquired company. There may be practical difficulties in determining the
fair value of the consideration given and in allocating the total implied fair value to specific assets
and liabilities.
In the case of a less than wholly owned company, valuation of net assets at implied fair value
violates the cost principle of conventional accounting and results in the reporting of subsidiary
assets and liabilities using a different valuation procedure than that used to report the assets and
liabilities of the parent company.
14. The economic entity is more consistent with the principles addressed in the FASB’s conceptual
framework. It is an integral part of the FASB’s conceptual framework and is named specifically in
SFAC No. 5 as one of the basic assumptions in accounting. The economic entity assumption views
economic activity as being related to a particular unit of accountability, and the standard indicates
that a parent and its subsidiaries represent one economic entity even though they may include
several legal entities.
15. The FASB’s conceptual framework provides the guidance for new standards. The quality of
comparability was very much at stake in FASB’s decision in 2001 to eliminate the pooling of
interests method for business combinations. This method was also argued to violate the historical
cost principle as it essentially ignored the value of the consideration (stock) issued for the
acquisition of another company.
The issue of consistency plays a role in the recent proposal to shift from the parent concept to the
economic entity concept, as the former method valued a portion (the noncontrolling interest) of a
given asset at prior book values and another portion (the controlling interest) of that same asset at
exchange-date market value.
16. Comprehensive income is a broader concept, and it includes some gains and losses explicitly stated
by FASB to bypass earnings. The examples of such gains that bypass earnings are some changes in
market values of investments, some foreign currency translation adjustments and certain gains and
losses, related to minimum pension liability.
In the absence of gains or losses designated to bypass earnings, earnings and comprehensive
income are the same.
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1-4
ANSWERS TO BUSINESS ETHICS CASE
1. The third item will lead to the reduction of net income of the acquired company before
acquisition, and will increase the reported net income of the combined company subsequent to
acquisition. The accelerated payment of liabilities should not have an effect on net income in
current or future years, nor should the delaying of the collection of revenues (assuming those
revenues have already been recorded).
2. The first two items will decrease cash from operations prior to acquisition and will increase cash
from 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 future
performance (if I stay on with the consolidated company) should not be evaluated based upon a
future decline that is perceived rather than real. Further, I would express a concern that
shareholders and other users might view such accounting maneuvers as sketchy.
4.
a) Earnings manipulation may be regarded as unethical behavior regardless of which side of
the 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 affected
by any kind of distorted information may view any participant in an unsavory light.
b) See answer to (a).
ANSWERS TO BUSINESS ETHICS CASE
1. The third item will lead to the reduction of net income of the acquired company before
acquisition, and will increase the reported net income of the combined company subsequent to
acquisition. The accelerated payment of liabilities should not have an effect on net income in
current or future years, nor should the delaying of the collection of revenues (assuming those
revenues have already been recorded).
2. The first two items will decrease cash from operations prior to acquisition and will increase cash
from 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 future
performance (if I stay on with the consolidated company) should not be evaluated based upon a
future decline that is perceived rather than real. Further, I would express a concern that
shareholders and other users might view such accounting maneuvers as sketchy.
4.
a) Earnings manipulation may be regarded as unethical behavior regardless of which side of
the 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 affected
by any kind of distorted information may view any participant in an unsavory light.
b) See answer to (a).
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1-5
ANSWERS TO EXERCISES
Exercise 1-1
Part A Normal earnings for similar firms = ($15,000,000 - $8,800,000) x 15% = $930,000
Expected earnings of target:
Pretax income of Condominiums, Inc., 2008 $1,200,000
Subtract: Additional depreciation on building ($960,000 30%) (288,000)
Target’s adjusted earnings, 2008 912,000
Pretax income of Condominiums, Inc., 2009 $1,500,000
Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2009 1,212,000
Pretax income of Condominiums, Inc., 2010 $950,000
Add: Extraordinary loss 300,000
Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2010 962,000
Target’s three year total adjusted earnings 3,086,000
Target’s three year average adjusted earnings ($3,086,000 3) 1,028,667
Excess earnings of target = $1,028,667 - $930,000 = $98,667 per year
Present 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 B Excess earnings of target (same as in Part A) = $98,667
Present value of excess earnings (ordinary annuity) for three years at 15%:
$98,667 2.28323 = $225,279
Implied offering price = $15,000,000 – $8,800,000 + $225,279 = $6,425,279.
Note: The sales commissions and depreciation on equipment are expected to continue at the
same rate, and thus do not necessitate adjustments.%
,$
25
66798
ANSWERS TO EXERCISES
Exercise 1-1
Part A Normal earnings for similar firms = ($15,000,000 - $8,800,000) x 15% = $930,000
Expected earnings of target:
Pretax income of Condominiums, Inc., 2008 $1,200,000
Subtract: Additional depreciation on building ($960,000 30%) (288,000)
Target’s adjusted earnings, 2008 912,000
Pretax income of Condominiums, Inc., 2009 $1,500,000
Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2009 1,212,000
Pretax income of Condominiums, Inc., 2010 $950,000
Add: Extraordinary loss 300,000
Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2010 962,000
Target’s three year total adjusted earnings 3,086,000
Target’s three year average adjusted earnings ($3,086,000 3) 1,028,667
Excess earnings of target = $1,028,667 - $930,000 = $98,667 per year
Present 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 B Excess earnings of target (same as in Part A) = $98,667
Present value of excess earnings (ordinary annuity) for three years at 15%:
$98,667 2.28323 = $225,279
Implied offering price = $15,000,000 – $8,800,000 + $225,279 = $6,425,279.
Note: The sales commissions and depreciation on equipment are expected to continue at the
same rate, and thus do not necessitate adjustments.%
,$
25
66798
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1-6
Exercise 1-2
Part A Cumulative 5 years net cash earnings $850,000
Add nonrecurring losses 48,000
Subtract extraordinary gains (67,000)
Five-years adjusted cash earnings $831,000
Average 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 $750,000
Less: Liabilities of Beta 320,000
Market value of net identifiable assets 430,000
Implied value of goodwill of Beta $127,129
Part B Actual purchase price $625,000
Market value of identifiable net assets 430,000
Goodwill purchased $195,000
Exercise 1-3
Part A
Normal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000
Excess 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 earnings
Goodwill = ($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 perpetuity
Goodwill = ($30,000)/.20 = $150,000
Part B
The second alternative is the strongest theoretically if five years is a reasonable representation of
the excess earnings duration. It considers the time value of money and assigns a finite life.
Alternative three also considers the time value of money but fails to assess a duration period for
the excess earnings. Alternative one fails to account for the time value of money. Interestingly,
alternatives one and three yield the same goodwill estimation and it might be noted that the
assumption of an infinite life is not as absurd as it might sound since the present value becomes
quite small beyond some horizon.
Part C
Goodwill = [Cost less (fair value of assets less the fair value of liabilities)],
5
000831,$
Exercise 1-2
Part A Cumulative 5 years net cash earnings $850,000
Add nonrecurring losses 48,000
Subtract extraordinary gains (67,000)
Five-years adjusted cash earnings $831,000
Average 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 $750,000
Less: Liabilities of Beta 320,000
Market value of net identifiable assets 430,000
Implied value of goodwill of Beta $127,129
Part B Actual purchase price $625,000
Market value of identifiable net assets 430,000
Goodwill purchased $195,000
Exercise 1-3
Part A
Normal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000
Excess 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 earnings
Goodwill = ($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 perpetuity
Goodwill = ($30,000)/.20 = $150,000
Part B
The second alternative is the strongest theoretically if five years is a reasonable representation of
the excess earnings duration. It considers the time value of money and assigns a finite life.
Alternative three also considers the time value of money but fails to assess a duration period for
the excess earnings. Alternative one fails to account for the time value of money. Interestingly,
alternatives one and three yield the same goodwill estimation and it might be noted that the
assumption of an infinite life is not as absurd as it might sound since the present value becomes
quite small beyond some horizon.
Part C
Goodwill = [Cost less (fair value of assets less the fair value of liabilities)],
5
000831,$
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1-7
Or, Cost less fair value of net assets
Goodwill = ($800,000 – ($1,000,000 - $400,000)) = $200,000
Or, Cost less fair value of net assets
Goodwill = ($800,000 – ($1,000,000 - $400,000)) = $200,000
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2 - 1
CHAPTER 2
Note: The letter A indicated for a question, exercise, or problem means that the question, exercise, or
problem relates to a chapter appendix.
ANSWERS TO QUESTIONS
1. 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 issue
valuation differs from this assessment, the Exposure Draft (SFAS 1204-001) expected to replace
FASB Statement No. 141R specifies that equity should not be adjusted. The reason is that the
valuation was determined at the date of the exchange, and thus the impact on the firm’s equity was
measured at that point based on the best information available then.
2. Pro forma financial statements (sometimes referred to as “as if” statements) are financial
statements 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 first
step, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at
the date 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 value
at the review date is less than the carrying amount, then the second step is necessary. In the
second step, the carrying value of the goodwill is compared to its implied fair value. (The
calculation of the implied fair value of goodwill used in the impairment test is similar to the
method illustrated throughout 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, the
impairment loss under the new rules was potentially larger than a periodic amortization charge,
and this is in fact what materialized within the first year after adoption (a large impairment loss).
If there was any initial stock price impact from elimination of goodwill amortization, it was only a
short-term or momentum effect. Another issue is how the stock market responds to the goodwill
impairment charge. Some users claim that this charge is a non-cash charge and should be
disregarded by the market. However, others argue that the charge is an admission that the price
paid was too high, and might result in a stock price decline (unless the market had already adjusted
for this overpayment prior to the actual writedown).
CHAPTER 2
Note: The letter A indicated for a question, exercise, or problem means that the question, exercise, or
problem relates to a chapter appendix.
ANSWERS TO QUESTIONS
1. 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 issue
valuation differs from this assessment, the Exposure Draft (SFAS 1204-001) expected to replace
FASB Statement No. 141R specifies that equity should not be adjusted. The reason is that the
valuation was determined at the date of the exchange, and thus the impact on the firm’s equity was
measured at that point based on the best information available then.
2. Pro forma financial statements (sometimes referred to as “as if” statements) are financial
statements 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 first
step, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at
the date 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 value
at the review date is less than the carrying amount, then the second step is necessary. In the
second step, the carrying value of the goodwill is compared to its implied fair value. (The
calculation of the implied fair value of goodwill used in the impairment test is similar to the
method illustrated throughout 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, the
impairment loss under the new rules was potentially larger than a periodic amortization charge,
and this is in fact what materialized within the first year after adoption (a large impairment loss).
If there was any initial stock price impact from elimination of goodwill amortization, it was only a
short-term or momentum effect. Another issue is how the stock market responds to the goodwill
impairment charge. Some users claim that this charge is a non-cash charge and should be
disregarded by the market. However, others argue that the charge is an admission that the price
paid was too high, and might result in a stock price decline (unless the market had already adjusted
for this overpayment prior to the actual writedown).
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ANSWERS TO BUSINESS ETHICS CASE
a and b. The board has responsibility to look into anything that might suggest malfeasance or
inappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, and
judgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does this
send a message to other employees that ethical lapses are okay? Employees might feel that top
executives are treated differently.
ANSWERS TO EXERCISES
Exercise 2-1
Part A Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Goodwill ($2,154,000 - $1,824,000) 330,000
Liabilities 594,000
Cash 1,560,000
Part B Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on Business Combination ($1,230,000 - $990,000) 240,000
ANSWERS TO BUSINESS ETHICS CASE
a and b. The board has responsibility to look into anything that might suggest malfeasance or
inappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, and
judgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does this
send a message to other employees that ethical lapses are okay? Employees might feel that top
executives are treated differently.
ANSWERS TO EXERCISES
Exercise 2-1
Part A Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Goodwill ($2,154,000 - $1,824,000) 330,000
Liabilities 594,000
Cash 1,560,000
Part B Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on Business Combination ($1,230,000 - $990,000) 240,000
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Exercise 2-2
Cash $680,000
Receivables 720,000
Inventories 2,240,000
Plant and Equipment (net) ($3,840,000 + $720,000) 4,560,000
Goodwill 120,000
Total Assets $8,320,000
Liabilities 1,520,000
Common Stock, $16 par ($3,440,000 + (.50 $800,000)) 3,840,000
Other Contributed Capital ($400,000 + $800,000) 1,200,000
Retained Earnings 1,760,000
Total Equities $8,320,000
Entries on Petrello Company’s books would be:
Cash 200,000
Receivables 240,000
Inventory 240,000
Plant and Equipment 720,000
Goodwill * 120,000
Liabilities 320,000
Common Stock (25,000 $16) 400,000
Other Contributed Capital ($48 - $16) 25,000 800,000
* ($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
Exercise 2-2
Cash $680,000
Receivables 720,000
Inventories 2,240,000
Plant and Equipment (net) ($3,840,000 + $720,000) 4,560,000
Goodwill 120,000
Total Assets $8,320,000
Liabilities 1,520,000
Common Stock, $16 par ($3,440,000 + (.50 $800,000)) 3,840,000
Other Contributed Capital ($400,000 + $800,000) 1,200,000
Retained Earnings 1,760,000
Total Equities $8,320,000
Entries on Petrello Company’s books would be:
Cash 200,000
Receivables 240,000
Inventory 240,000
Plant and Equipment 720,000
Goodwill * 120,000
Liabilities 320,000
Common Stock (25,000 $16) 400,000
Other Contributed Capital ($48 - $16) 25,000 800,000
* ($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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Exercise 2-3
Accounts Receivable 231,000
Inventory 330,000
Land 550,000
Buildings and Equipment 1,144,000
Goodwill 848,000
Allowance for Uncollectible Accounts ($231,000 - $198,000) 33,000
Current Liabilities 275,000
Bonds Payable 450,000
Premium on Bonds Payable ($495,000 - $450,000) 45,000
Preferred Stock (15,000 $100) 1,500,000
Common Stock (30,000 $10) 300,000
Other Contributed Capital ($25 - $10) 30,000 450,000
Cash 50,000
Cost paid ($1,500,000 + $750,000 + $50,000) = $2,300,000
Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) = 1,452,000
Goodwill = $848,000
Exercise 2-4
Cash 96,000
Receivables 55,200
Inventory 126,000
Land 198,000
Plant and Equipment 466,800
Goodwill* 137,450
Accounts Payable 44,400
Bonds Payable 480,000
Premium on Bonds Payable** 45,050
Cash 510,000
** Present value of maturity value, 12 periods @ 4%: 0.6246 $480,000 = $299,808
Present value of interest annuity, 12 periods @ 4%: 9.38507 $24,000 = 225,242
Total present value 525,050
Par value 480,000
Premium on bonds payable $ 45,050
*Cash paid $510,000
Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000) (373,200)
Excess of cash paid over book value 136,800
Increase in inventory to fair value (15,600)
Increase in land to fair value (28,800)
Increase in bond to fair value 45,050
Total increase in net assets to fair value 650
Goodwill $137,450
Exercise 2-3
Accounts Receivable 231,000
Inventory 330,000
Land 550,000
Buildings and Equipment 1,144,000
Goodwill 848,000
Allowance for Uncollectible Accounts ($231,000 - $198,000) 33,000
Current Liabilities 275,000
Bonds Payable 450,000
Premium on Bonds Payable ($495,000 - $450,000) 45,000
Preferred Stock (15,000 $100) 1,500,000
Common Stock (30,000 $10) 300,000
Other Contributed Capital ($25 - $10) 30,000 450,000
Cash 50,000
Cost paid ($1,500,000 + $750,000 + $50,000) = $2,300,000
Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) = 1,452,000
Goodwill = $848,000
Exercise 2-4
Cash 96,000
Receivables 55,200
Inventory 126,000
Land 198,000
Plant and Equipment 466,800
Goodwill* 137,450
Accounts Payable 44,400
Bonds Payable 480,000
Premium on Bonds Payable** 45,050
Cash 510,000
** Present value of maturity value, 12 periods @ 4%: 0.6246 $480,000 = $299,808
Present value of interest annuity, 12 periods @ 4%: 9.38507 $24,000 = 225,242
Total present value 525,050
Par value 480,000
Premium on bonds payable $ 45,050
*Cash paid $510,000
Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000) (373,200)
Excess of cash paid over book value 136,800
Increase in inventory to fair value (15,600)
Increase in land to fair value (28,800)
Increase in bond to fair value 45,050
Total increase in net assets to fair value 650
Goodwill $137,450
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Exercise 2-5
Current Assets 960,000
Plant and Equipment 1,440,000
Goodwill 336,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 360,000
Exercise 2-6
The amount of the contingency is $500,000 (10,000 shares at $50 per share)
Part A Goodwill 500,000
Paid-in-Capital for Contingent Consideration 500,000
Part B Paid-in-Capital for Contingent Consideration 500,000
Common Stock ($10 par) 100,000
Paid-In-Capital in Excess of Par 400,000
Platz Company does not adjust the original amount recorded as equity.
Exercise 2-7
1. (c) Cost (8,000 shares @ $30) $240,000
Fair value of net assets acquired 228,800
Excess of cost over fair value (goodwill) $ 11,200
2. (c) Cost (8,000 shares @ $30) $240,000
Fair value of net assets acquired ($90,000 + $242,000 – $56,000) 276,000
Excess of fair value over cost (gain) $ 36,000
Exercise 2-8
Current Assets 362,000
Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000) 2,013,000
Goodwill * 395,000
Liabilities 119,000
Long-term Debt 491,000
Common Stock (144,000 $5) 720,000
Other Contributed Capital (144,000 ($15 - $5)) 1,440,000
* (144,000 $15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000
Exercise 2-5
Current Assets 960,000
Plant and Equipment 1,440,000
Goodwill 336,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 360,000
Exercise 2-6
The amount of the contingency is $500,000 (10,000 shares at $50 per share)
Part A Goodwill 500,000
Paid-in-Capital for Contingent Consideration 500,000
Part B Paid-in-Capital for Contingent Consideration 500,000
Common Stock ($10 par) 100,000
Paid-In-Capital in Excess of Par 400,000
Platz Company does not adjust the original amount recorded as equity.
Exercise 2-7
1. (c) Cost (8,000 shares @ $30) $240,000
Fair value of net assets acquired 228,800
Excess of cost over fair value (goodwill) $ 11,200
2. (c) Cost (8,000 shares @ $30) $240,000
Fair value of net assets acquired ($90,000 + $242,000 – $56,000) 276,000
Excess of fair value over cost (gain) $ 36,000
Exercise 2-8
Current Assets 362,000
Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000) 2,013,000
Goodwill * 395,000
Liabilities 119,000
Long-term Debt 491,000
Common Stock (144,000 $5) 720,000
Other Contributed Capital (144,000 ($15 - $5)) 1,440,000
* (144,000 $15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000
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Total shares issued
+ 5
00020
5
000700
$
,$
$
,$ = 144,000
Fair value of stock issued (144,000 $15) = $2,160,000
Exercise 2-9
Case A
Cost (Purchase Price) $130,000
Less: Fair Value of Net Assets 120,000
Goodwill $ 10,000
Case B
Cost (Purchase Price) $110,000
Less: Fair Value of Net Assets 90,000
Goodwill $ 20,000
Case C
Cost (Purchase Price) $15,000
Less: Fair Value of Net Assets 20,000
Gain ($ 5,000)
Assets Liabilities Retained
Earnings (Gain)
Goodwill Current Assets Long-Lived Assets
Case A $10,000 $20,000 $130,000 $30,000 0
Case B 20,000 30,000 80,000 20,000 0
Case C 0 20,000 40,000 40,000 5,000
Total shares issued
+ 5
00020
5
000700
$
,$
$
,$ = 144,000
Fair value of stock issued (144,000 $15) = $2,160,000
Exercise 2-9
Case A
Cost (Purchase Price) $130,000
Less: Fair Value of Net Assets 120,000
Goodwill $ 10,000
Case B
Cost (Purchase Price) $110,000
Less: Fair Value of Net Assets 90,000
Goodwill $ 20,000
Case C
Cost (Purchase Price) $15,000
Less: Fair Value of Net Assets 20,000
Gain ($ 5,000)
Assets Liabilities Retained
Earnings (Gain)
Goodwill Current Assets Long-Lived Assets
Case A $10,000 $20,000 $130,000 $30,000 0
Case B 20,000 30,000 80,000 20,000 0
Case C 0 20,000 40,000 40,000 5,000
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Exercise 2-10
Part A.
2011: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $330,000
Carrying value of goodwill ($450,000 - $375,000) 75,000
405,000
Excess of carrying value over fair value $ 5,000
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $400,000
Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Recorded value of goodwill ($450,000 - $375,000) 75,000
Impairment loss $ 15,000
2012: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $320,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
380,000
Excess of fair value over carrying value $ 20,000
The excess of fair value over carrying value means that step 2 is not required.
2013: Step 1: Fair value of the reporting unit $350,000
Carrying value of unit:
Carrying value of identifiable net assets $300,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
360,000
Excess of carrying value over fair value $ 10,000
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $350,000
Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Recorded value of goodwill ($75,000 - $15,000) 60,000
Impairment loss $ 35,000
Exercise 2-10
Part A.
2011: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $330,000
Carrying value of goodwill ($450,000 - $375,000) 75,000
405,000
Excess of carrying value over fair value $ 5,000
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $400,000
Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Recorded value of goodwill ($450,000 - $375,000) 75,000
Impairment loss $ 15,000
2012: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $320,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
380,000
Excess of fair value over carrying value $ 20,000
The excess of fair value over carrying value means that step 2 is not required.
2013: Step 1: Fair value of the reporting unit $350,000
Carrying value of unit:
Carrying value of identifiable net assets $300,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
360,000
Excess of carrying value over fair value $ 10,000
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $350,000
Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Recorded value of goodwill ($75,000 - $15,000) 60,000
Impairment loss $ 35,000
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Part B.
2011: Impairment Loss—Goodwill 15,000
Goodwill 15,000
2012: No entry
2013: Impairment Loss—Goodwill 35,000
Goodwill 35,000
Part C.
SFAS No. 142 specifies the presentation of goodwill in the balance sheet and income statement (if
impairment occurs) as follows:
• The aggregate amount of goodwill should be a separate line item in the balance
sheet.
• The aggregate amount of losses from goodwill impairment should be shown as a
separate line item in the operating section of the income statement unless some of
the impairment is associated with a discontinued operation (in which case it is
shown net-of-tax in the discontinued operation section).
Part D.
In a period in which an impairment loss occurs, SFAS No. 142 mandates the following disclosures
in the notes:
(1) A description of the facts and circumstances leading to the impairment;
(2) The amount of the impairment loss and the method of determining the fair value of
the reporting unit;
(3) The nature and amounts of any adjustments made to impairment estimates from
earlier periods, if significant.
Exercise 2-11
a. Fair Value of Identifiable Net Assets
Book values $500,000 – $100,000 = $400,000
Write up of Inventory and Equipment:
($20,000 + $30,000) = 50,000
Purchase price above which goodwill would result $450,000
b. Equipment would not be written down, regardless of the purchase price, unless it was
reviewed and determined to be overvalued originally.
c. A gain would be shown if the purchase price was below $450,000.
d. Anything below $450,000 is technically considered a bargain.
e. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000).
Part B.
2011: Impairment Loss—Goodwill 15,000
Goodwill 15,000
2012: No entry
2013: Impairment Loss—Goodwill 35,000
Goodwill 35,000
Part C.
SFAS No. 142 specifies the presentation of goodwill in the balance sheet and income statement (if
impairment occurs) as follows:
• The aggregate amount of goodwill should be a separate line item in the balance
sheet.
• The aggregate amount of losses from goodwill impairment should be shown as a
separate line item in the operating section of the income statement unless some of
the impairment is associated with a discontinued operation (in which case it is
shown net-of-tax in the discontinued operation section).
Part D.
In a period in which an impairment loss occurs, SFAS No. 142 mandates the following disclosures
in the notes:
(1) A description of the facts and circumstances leading to the impairment;
(2) The amount of the impairment loss and the method of determining the fair value of
the reporting unit;
(3) The nature and amounts of any adjustments made to impairment estimates from
earlier periods, if significant.
Exercise 2-11
a. Fair Value of Identifiable Net Assets
Book values $500,000 – $100,000 = $400,000
Write up of Inventory and Equipment:
($20,000 + $30,000) = 50,000
Purchase price above which goodwill would result $450,000
b. Equipment would not be written down, regardless of the purchase price, unless it was
reviewed and determined to be overvalued originally.
c. A gain would be shown if the purchase price was below $450,000.
d. Anything below $450,000 is technically considered a bargain.
e. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000).
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Exercise 2-12A
Cash 20,000
Accounts Receivable 112,000
Inventory 134,000
Land 55,000
Plant Assets 463,000
Discount on Bonds Payable 20,000
Goodwill* 127,200
Allowance for Uncollectible Accounts 10,000
Accounts Payable 54,000
Bonds Payable 200,000
Deferred Income Tax Liability 67,200
Cash 600,000
Cost of acquisition $600,000
Book value of net assets acquired ($80,000 + $132,000 + $160,000) 372,000
Difference between cost and book value 228,000
Allocated to:
Increase inventory, land, and plant assets to fair value ($52,000 + $25,000 + $71,000) (148,000)
Decrease bonds payable to fair value (20,000)
Establish deferred income tax liability ($168,000 40%) 67,200
Balance assigned to goodwill $127,200
ANSWERS TO PROBLEMS
Problem 2-1
Current Assets 85,000
Plant and Equipment 150,000
Goodwill* 100,000
Liabilities 35,000
Common Stock [(20,000 shares @ $10/share)] 200,000
Other Contributed Capital [(20,000 ($15 – $10))] 100,000
Acquisition Costs Expense 20,000
Cash 20,000
Other Contributed Capital 6,000
Cash 6,000
To record the direct acquisition costs and stock issue costs
* Goodwill = Excess of Consideration of $335,000 (stock valued at $300,000 plus debt assumed of
$35,000) over Fair Value of Identifiable Assets of $235,000 (total assets of $225,000 plus PPE fair
value adjustment of $10,000)
Exercise 2-12A
Cash 20,000
Accounts Receivable 112,000
Inventory 134,000
Land 55,000
Plant Assets 463,000
Discount on Bonds Payable 20,000
Goodwill* 127,200
Allowance for Uncollectible Accounts 10,000
Accounts Payable 54,000
Bonds Payable 200,000
Deferred Income Tax Liability 67,200
Cash 600,000
Cost of acquisition $600,000
Book value of net assets acquired ($80,000 + $132,000 + $160,000) 372,000
Difference between cost and book value 228,000
Allocated to:
Increase inventory, land, and plant assets to fair value ($52,000 + $25,000 + $71,000) (148,000)
Decrease bonds payable to fair value (20,000)
Establish deferred income tax liability ($168,000 40%) 67,200
Balance assigned to goodwill $127,200
ANSWERS TO PROBLEMS
Problem 2-1
Current Assets 85,000
Plant and Equipment 150,000
Goodwill* 100,000
Liabilities 35,000
Common Stock [(20,000 shares @ $10/share)] 200,000
Other Contributed Capital [(20,000 ($15 – $10))] 100,000
Acquisition Costs Expense 20,000
Cash 20,000
Other Contributed Capital 6,000
Cash 6,000
To record the direct acquisition costs and stock issue costs
* Goodwill = Excess of Consideration of $335,000 (stock valued at $300,000 plus debt assumed of
$35,000) over Fair Value of Identifiable Assets of $235,000 (total assets of $225,000 plus PPE fair
value adjustment of $10,000)
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Problem 2-2 Acme Company
Balance Sheet
October 1, 2011
(000)
Part A.
Assets (except goodwill) ($3,900 + $9,000 + $1,300) $14,200
Goodwill (1) 1,160
Total Assets $15,360
Liabilities ($2,030 + $2,200 + $260) $4,490
Common Stock (180 $20) + $2,000 5,600
Other Contributed Capital (180 ($50 – $20)) 5,400
Retained Earnings (130)
Total Liabilities and Equity $15,360
(1) Cost (180 $50) $9,000
Fair value of net assets acquired:
Fair value of assets of Baltic and Colt $10,300
Less liabilities assumed 2,460 7,840
Goodwill $1,160
Problem 2-2 Acme Company
Balance Sheet
October 1, 2011
(000)
Part A.
Assets (except goodwill) ($3,900 + $9,000 + $1,300) $14,200
Goodwill (1) 1,160
Total Assets $15,360
Liabilities ($2,030 + $2,200 + $260) $4,490
Common Stock (180 $20) + $2,000 5,600
Other Contributed Capital (180 ($50 – $20)) 5,400
Retained Earnings (130)
Total Liabilities and Equity $15,360
(1) Cost (180 $50) $9,000
Fair value of net assets acquired:
Fair value of assets of Baltic and Colt $10,300
Less liabilities assumed 2,460 7,840
Goodwill $1,160
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Problem 2-2 (continued)
Part B.
Baltic
2012: Step1: Fair value of the reporting unit $6,500,000
Carrying value of unit:
Carrying value of identifiable net assets 6,340,000
Carrying value of goodwill 200,000*
Total carrying value 6,540,000
*[(140,000 x $50) – ($9,000,000 – $2,200,000)]
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $6,500,000
Fair value of identifiable net assets 6,350,000
Implied value of goodwill 150,000
Recorded value of goodwill 200,000
Impairment loss $ 50,000
(because $150,000 < $200,000)
Colt
2012: Step1: Fair value of the reporting unit $1,900,000
Carrying value of unit:
Carrying value of identifiable net assets $1,200,000
Carrying value of goodwill 960,000*
Total carrying value 2,160,000
*[(40,000 x $50) – ($1,300,000 – $260,000)]
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $1,900,000
Fair value of identifiable net assets 1,000,000
Implied value of goodwill 900,000
Recorded value of goodwill 960,000
Impairment loss $ 60,000
(because $900,000 < $960,000)
Total impairment loss is $110,000.
Journal entry:
Impairment Loss $110,000
Goodwill $110,000
Problem 2-2 (continued)
Part B.
Baltic
2012: Step1: Fair value of the reporting unit $6,500,000
Carrying value of unit:
Carrying value of identifiable net assets 6,340,000
Carrying value of goodwill 200,000*
Total carrying value 6,540,000
*[(140,000 x $50) – ($9,000,000 – $2,200,000)]
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $6,500,000
Fair value of identifiable net assets 6,350,000
Implied value of goodwill 150,000
Recorded value of goodwill 200,000
Impairment loss $ 50,000
(because $150,000 < $200,000)
Colt
2012: Step1: Fair value of the reporting unit $1,900,000
Carrying value of unit:
Carrying value of identifiable net assets $1,200,000
Carrying value of goodwill 960,000*
Total carrying value 2,160,000
*[(40,000 x $50) – ($1,300,000 – $260,000)]
The excess of carrying value over fair value means that step 2 is required.
Step 2: Fair value of the reporting unit $1,900,000
Fair value of identifiable net assets 1,000,000
Implied value of goodwill 900,000
Recorded value of goodwill 960,000
Impairment loss $ 60,000
(because $900,000 < $960,000)
Total impairment loss is $110,000.
Journal entry:
Impairment Loss $110,000
Goodwill $110,000
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Problem 2-3
Present value of maturity value, 20 periods @ 6%: 0.3118 $600,000 = $187,080
Present value of interest annuity, 20 periods @ 6%: 11.46992 $30,000 = 344,098
Total Present value 531,178
Par value 600,000
Discount on bonds payable $68,822
Cash 114,000
Accounts Receivable 135,000
Inventory 310,000
Land 315,000
Buildings 54,900
Equipment 39,450
Bond Discount ($40,000 + $68,822) 108,822
Current Liabilities 95,300
Bonds Payable ($300,000 + $600,000) 900,000
Gain on Purchase of Business 81,872
Computation of Excess of Net Assets Received Over Cost
Cost (Purchase Price) ($531,178 plus liabilities assumed of $95,300 and $260,000) $886,478
Less: Total fair value of assets received $968,350
Excess of fair value of net assets over cost ($ 81,872)
Problem 2-4
Part A January 1, 2011
Accounts Receivable 72,000
Inventory 99,000
Land 162,000
Buildings 450,000
Equipment 288,000
Goodwill* 54,000
Allowance for Uncollectible Accounts 7,000
Accounts Payable 83,000
Note Payable 180,000
Cash 720,000
Liability for Contingent Consideration 135,000
*Computation of Goodwill
Cash paid ($720,000 + $135,000) $855,000
Total fair value of net assets acquired ($1,064,000 - $263,000) 801,000
Goodwill $ 54,000
Problem 2-3
Present value of maturity value, 20 periods @ 6%: 0.3118 $600,000 = $187,080
Present value of interest annuity, 20 periods @ 6%: 11.46992 $30,000 = 344,098
Total Present value 531,178
Par value 600,000
Discount on bonds payable $68,822
Cash 114,000
Accounts Receivable 135,000
Inventory 310,000
Land 315,000
Buildings 54,900
Equipment 39,450
Bond Discount ($40,000 + $68,822) 108,822
Current Liabilities 95,300
Bonds Payable ($300,000 + $600,000) 900,000
Gain on Purchase of Business 81,872
Computation of Excess of Net Assets Received Over Cost
Cost (Purchase Price) ($531,178 plus liabilities assumed of $95,300 and $260,000) $886,478
Less: Total fair value of assets received $968,350
Excess of fair value of net assets over cost ($ 81,872)
Problem 2-4
Part A January 1, 2011
Accounts Receivable 72,000
Inventory 99,000
Land 162,000
Buildings 450,000
Equipment 288,000
Goodwill* 54,000
Allowance for Uncollectible Accounts 7,000
Accounts Payable 83,000
Note Payable 180,000
Cash 720,000
Liability for Contingent Consideration 135,000
*Computation of Goodwill
Cash paid ($720,000 + $135,000) $855,000
Total fair value of net assets acquired ($1,064,000 - $263,000) 801,000
Goodwill $ 54,000
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Problem 2-4 (continued)
Part B January 2, 2013
Liability for Contingent Consideration 135,000
Cash 135,000
Part C January 2, 2013
Liability for Contingent Consideration 135,000
Income from Change in Estimate 135,000
Problem 2-5 Pepper Company
Pro Forma Balance Sheet
Giving Effect to Proposed Issue of Common Stock and Note Payable for
All of the Common Stock of Salt Company under Purchase Accounting
December 31, 2010
Audited Pro Forma
Balance Sheet Adjustments Balance Sheet
Cash $180,000 405,000 $585,000
Receivables 230,000 (60,000) 287,000
117,000
Inventories 231,400 134,000 365,400
Plant Assets 1,236,500 905,000 (1) 2,141,500
Goodwill _________ 181,500 181,500
Total Assets $1,877,900 $3,560,400
Accounts Payable $255,900 (60,000) $375,900
180,000
Notes Payable, 8% 0 300,000 300,000
Mortgage Payable 180,000 152,500 332,500
Common Stock, $20 par 900,000 600,000 1,500,000
Additional Paid-in Capital 270,000 510,000 (2) 780,000
Retained Earnings 272,000 272,000
Total Liabilities and Equity $1,877,900 $3,560,400
Problem 2-4 (continued)
Part B January 2, 2013
Liability for Contingent Consideration 135,000
Cash 135,000
Part C January 2, 2013
Liability for Contingent Consideration 135,000
Income from Change in Estimate 135,000
Problem 2-5 Pepper Company
Pro Forma Balance Sheet
Giving Effect to Proposed Issue of Common Stock and Note Payable for
All of the Common Stock of Salt Company under Purchase Accounting
December 31, 2010
Audited Pro Forma
Balance Sheet Adjustments Balance Sheet
Cash $180,000 405,000 $585,000
Receivables 230,000 (60,000) 287,000
117,000
Inventories 231,400 134,000 365,400
Plant Assets 1,236,500 905,000 (1) 2,141,500
Goodwill _________ 181,500 181,500
Total Assets $1,877,900 $3,560,400
Accounts Payable $255,900 (60,000) $375,900
180,000
Notes Payable, 8% 0 300,000 300,000
Mortgage Payable 180,000 152,500 332,500
Common Stock, $20 par 900,000 600,000 1,500,000
Additional Paid-in Capital 270,000 510,000 (2) 780,000
Retained Earnings 272,000 272,000
Total Liabilities and Equity $1,877,900 $3,560,400
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Problem 2-5 (continued)
Change in Cash
Cash from stock issue ($37 30,000) $1,110,000
Less: Cash paid for acquisition (800,000)
Plus: Cash acquired in acquisition 95,000
Total change in cash $ 405,000
Goodwill:
Cost of acquisition $1,100,000
Net assets acquired ($340,000 + $179,500 + $184,000) 703,500
Excess cost over net assets acquired $396,500
Assigned to plant assets 215,000
Goodwill $ 181,500
(1) $690,000 + $215,000 (2) ($37 - $20) 30,000
Problem 2-6 Ping Company
Pro Forma Income Statement for the Year 2011
Assuming a Merger of Ping Company and Spalding Company
Sales (1) $6,345,972
Cost of goods sold:
Fixed Costs (2) $824,706
Variable Costs (3) 2,464,095 3,288,801
Gross Margin 3,057,171
Selling Expenses (4) $785,910
Other Expenses (5) 319,310 1,105,220
Net Income $1,951,951
$1,951,951 – ($952,640 + $499,900) = = $2,497,055
0.20
Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding.
(1) $3,510,100 + $2,365,800 = $5,875,900 1.2 .9 = $6,345,972
(2) ($1,752,360 .30) + ($1,423,800 .30 .70) = $824,706
(3) $1,752,360 .70 = $2,464,095
(4) ($632,500 + $292,100) .85 = $785,910
(5) $172,600 1.85 = $319,31020.0
411,499$1005103
219008755
,,$
.,,$
Problem 2-5 (continued)
Change in Cash
Cash from stock issue ($37 30,000) $1,110,000
Less: Cash paid for acquisition (800,000)
Plus: Cash acquired in acquisition 95,000
Total change in cash $ 405,000
Goodwill:
Cost of acquisition $1,100,000
Net assets acquired ($340,000 + $179,500 + $184,000) 703,500
Excess cost over net assets acquired $396,500
Assigned to plant assets 215,000
Goodwill $ 181,500
(1) $690,000 + $215,000 (2) ($37 - $20) 30,000
Problem 2-6 Ping Company
Pro Forma Income Statement for the Year 2011
Assuming a Merger of Ping Company and Spalding Company
Sales (1) $6,345,972
Cost of goods sold:
Fixed Costs (2) $824,706
Variable Costs (3) 2,464,095 3,288,801
Gross Margin 3,057,171
Selling Expenses (4) $785,910
Other Expenses (5) 319,310 1,105,220
Net Income $1,951,951
$1,951,951 – ($952,640 + $499,900) = = $2,497,055
0.20
Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding.
(1) $3,510,100 + $2,365,800 = $5,875,900 1.2 .9 = $6,345,972
(2) ($1,752,360 .30) + ($1,423,800 .30 .70) = $824,706
(3) $1,752,360 .70 = $2,464,095
(4) ($632,500 + $292,100) .85 = $785,910
(5) $172,600 1.85 = $319,31020.0
411,499$1005103
219008755
,,$
.,,$
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2 - 15
Problem 2-7A
Part A Receivables 125,000
Inventory 195,000
Land 120,000
Plant Assets 567,000
Patents 200,000
Deferred Tax Asset ($60,000 x 35%) 21,000
Goodwill* 154,775
Current Liabilities 89,500
Bonds Payable 300,000
Premium on Bonds Payable 60,000
Deferred Tax Liability 93,275
Common Stock (30,000 $2) 60,000
Other Contributed Capital (30,000 $26) 780,000
Cost of acquisition (30,000 $28) $840,000
Book value of net assets acquired ($120,000 + $164,000 + $267,000) 551,000
Difference between cost and book value 289,000
Allocated to:
Increase inventory, land, plant assets, and patents to fair value (266,500)
Deferred income tax liability (35% $266,500) 93,275
Increase bonds payable to fair value 60,000
Deferred income tax asset (35% $60,000) (21,000)
Balance assigned to goodwill $154,775
Part B Income Tax Expense (Balancing amount) 148,006
Deferred Tax Liability ($51,125 35%)* 17,894
Deferred Tax Asset ($6,000 35%) 2,100
Income Tax Payable ($468,000 35%) 163,800
* Inventory: $28,000
Plant Assets,10
000100,$ 10,000
Patents,8
000105,$ 13,125
Total $51,125
Problem 2-7A
Part A Receivables 125,000
Inventory 195,000
Land 120,000
Plant Assets 567,000
Patents 200,000
Deferred Tax Asset ($60,000 x 35%) 21,000
Goodwill* 154,775
Current Liabilities 89,500
Bonds Payable 300,000
Premium on Bonds Payable 60,000
Deferred Tax Liability 93,275
Common Stock (30,000 $2) 60,000
Other Contributed Capital (30,000 $26) 780,000
Cost of acquisition (30,000 $28) $840,000
Book value of net assets acquired ($120,000 + $164,000 + $267,000) 551,000
Difference between cost and book value 289,000
Allocated to:
Increase inventory, land, plant assets, and patents to fair value (266,500)
Deferred income tax liability (35% $266,500) 93,275
Increase bonds payable to fair value 60,000
Deferred income tax asset (35% $60,000) (21,000)
Balance assigned to goodwill $154,775
Part B Income Tax Expense (Balancing amount) 148,006
Deferred Tax Liability ($51,125 35%)* 17,894
Deferred Tax Asset ($6,000 35%) 2,100
Income Tax Payable ($468,000 35%) 163,800
* Inventory: $28,000
Plant Assets,10
000100,$ 10,000
Patents,8
000105,$ 13,125
Total $51,125
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CHAPTER 3
Note: 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 QUESTIONS
1. (1) Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in an
exchange of stock for stock in a complete takeover.
(2) Effective control can be accomplished with more than 50% but less than all of the voting stock
of a subsidiary; thus the necessary investment is smaller.
(3) An individual affiliate’s legal existence provides a measure of protection of the parent’s assets
from attachment by creditors of the subsidiary.
2. The purpose of consolidated financial statements is to present, primarily for the benefit of the
shareholders and creditors of the parent company, the results of operations and the financial position
of a parent company and its subsidiaries essentially as if the group were a single company with one
or more branches or divisions. The presumption is that these consolidated statements are more
meaningful than separate statements and necessary for fair presentation. Emphasis then is on
substance rather than legal form, and the legal aspects of the separate entities are therefore ignored
in light of economic aspects.
3. Each legal entity must prepare financial statements for use by those who look to the legal entity for
analysis. Creditors of the subsidiary will use the separate statements in assessing the degree of
protection related to their claims. Noncontrolling shareholders, too, use these individual statements
in determining risk and the amounts available for dividends. Regulatory agencies are concerned with
the net resources and results of operations of the individual legal entities.
4. (1) Control should exist in fact, through ownership of more than 50% of the voting stock of the
subsidiary.
(2) The intent of control should be permanent. If there are current plans to dispose of a subsidiary,
then the entity should not be consolidated.
(3) Majority owners must have control. Such would not be the case if the subsidiary were in
bankruptcy or legal reorganization, or if the subsidiary were in a foreign country where political
forces were such that control by majority owners was significantly curtailed.
5. Consolidated workpapers are used as a tool to facilitate the preparation of consolidated financial
statements. Adjusting and eliminating entries are entered on the workpaper so that the resulting
consolidated data reflect the operations and financial position of two or more companies under
common control.
6. Noncontrolling interest represents the equity in a partially owned subsidiary by those shareholders
who are not members in the affiliation and should be accounted and presented in equity, separately
from the parents’ shareholders equity. Alternative views have included: presenting the
noncontrolling interest as a liability from the perspective of the controlling shareholders; presenting
the noncontrolling interest between liabilities and shareholders’ equity to acknowledge its hybrid
status; presenting it as a contra-asset so that total assets reflect only the parent’s share; and
CHAPTER 3
Note: 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 QUESTIONS
1. (1) Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in an
exchange of stock for stock in a complete takeover.
(2) Effective control can be accomplished with more than 50% but less than all of the voting stock
of a subsidiary; thus the necessary investment is smaller.
(3) An individual affiliate’s legal existence provides a measure of protection of the parent’s assets
from attachment by creditors of the subsidiary.
2. The purpose of consolidated financial statements is to present, primarily for the benefit of the
shareholders and creditors of the parent company, the results of operations and the financial position
of a parent company and its subsidiaries essentially as if the group were a single company with one
or more branches or divisions. The presumption is that these consolidated statements are more
meaningful than separate statements and necessary for fair presentation. Emphasis then is on
substance rather than legal form, and the legal aspects of the separate entities are therefore ignored
in light of economic aspects.
3. Each legal entity must prepare financial statements for use by those who look to the legal entity for
analysis. Creditors of the subsidiary will use the separate statements in assessing the degree of
protection related to their claims. Noncontrolling shareholders, too, use these individual statements
in determining risk and the amounts available for dividends. Regulatory agencies are concerned with
the net resources and results of operations of the individual legal entities.
4. (1) Control should exist in fact, through ownership of more than 50% of the voting stock of the
subsidiary.
(2) The intent of control should be permanent. If there are current plans to dispose of a subsidiary,
then the entity should not be consolidated.
(3) Majority owners must have control. Such would not be the case if the subsidiary were in
bankruptcy or legal reorganization, or if the subsidiary were in a foreign country where political
forces were such that control by majority owners was significantly curtailed.
5. Consolidated workpapers are used as a tool to facilitate the preparation of consolidated financial
statements. Adjusting and eliminating entries are entered on the workpaper so that the resulting
consolidated data reflect the operations and financial position of two or more companies under
common control.
6. Noncontrolling interest represents the equity in a partially owned subsidiary by those shareholders
who are not members in the affiliation and should be accounted and presented in equity, separately
from the parents’ shareholders equity. Alternative views have included: presenting the
noncontrolling interest as a liability from the perspective of the controlling shareholders; presenting
the noncontrolling interest between liabilities and shareholders’ equity to acknowledge its hybrid
status; presenting it as a contra-asset so that total assets reflect only the parent’s share; and
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3 - 2
presenting it as a component of owners’ equity (the choice approved by FASB in its most recent
exposure drafts).
7. The fair, or current, value of one or more specific subsidiary assets may exceed its recorded value,
or specific liabilities may be overvalued. In either case, an acquiring company might be willing to
pay more than book value. Also, goodwill might exist in the form of above normal earnings.
Finally, the parent may be willing to pay a premium for the right to acquire control and the related
economic advantages gained.
8. The determination of the percentage interest acquired, as well as the total equity acquired, is based
on shares outstanding; thus, treasury shares must be excluded. The treasury stock account should be
eliminated by offsetting it against subsidiary stockholder equity accounts. The accounts affected as
well as the amounts involved will depend upon whether the cost or par method is used to account
for the treasury stock.
9. None. The full amount of all intercompany receivables and payables is eliminated without regard to
the percentage of control held by the parent.
10A. The decision in SFAS No. 109 and SFAS No. 141R [topics 740 and 805] is primarily a display
issue and would only affect the calculation of consolidated net income if there were changes in
expected future tax rates that resulted in an adjustment to the balance of deferred tax assets or
deferred tax liabilities. Prior to SFAS No. 109 and SFAS No. 141R, purchased assets and liabilities
were displayed at their net of tax amounts and related figures for amortization and depreciation
were based on the net of tax amounts. With the adoption of SFAS No. 109 and SFAS No. 141R,
assets and liabilities are displayed at fair values and the tax consequences for differences between
their assigned values and their tax bases are displayed separately as deferred tax assets or deferred
tax liabilities. Although the amounts shown for depreciation, amortization and income tax expense
are different under SFAS No. 109 and SFAS No. 141R, absent a change in expected future tax rates,
the amount of consolidated net income will be the same.
ANSWERS TO BUSINESS ETHICS CASE
Part 1
Even though the suggested changes by the CFO lie within GAAP, the proposed changes will
unfairly increase the EPS of the company, misleading the common investors and other users. It is
evident that the CFO is doing it for his or her personal gain rather than for the transparency of
financial reporting. Thus, manipulating the reserve in this case comes under the heading of
unethical behavior. Taking a stand in such a situation is a difficult and challenging test for an
employee who reports to the CFO.
Part 2
The tax laws permit individuals to minimize taxes by means that are within the law like using tax
deductions, changing one's tax status through incorporation, or setting up a charitable trust or
foundation. In the given case the losses reported were phony and the whole scheme was fabricated
to illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme.
Although there is no reason to pay more tax than necessary, the lack of risk in these types of
shelters makes participation in such schemes of questionable ethics, at the best.
presenting it as a component of owners’ equity (the choice approved by FASB in its most recent
exposure drafts).
7. The fair, or current, value of one or more specific subsidiary assets may exceed its recorded value,
or specific liabilities may be overvalued. In either case, an acquiring company might be willing to
pay more than book value. Also, goodwill might exist in the form of above normal earnings.
Finally, the parent may be willing to pay a premium for the right to acquire control and the related
economic advantages gained.
8. The determination of the percentage interest acquired, as well as the total equity acquired, is based
on shares outstanding; thus, treasury shares must be excluded. The treasury stock account should be
eliminated by offsetting it against subsidiary stockholder equity accounts. The accounts affected as
well as the amounts involved will depend upon whether the cost or par method is used to account
for the treasury stock.
9. None. The full amount of all intercompany receivables and payables is eliminated without regard to
the percentage of control held by the parent.
10A. The decision in SFAS No. 109 and SFAS No. 141R [topics 740 and 805] is primarily a display
issue and would only affect the calculation of consolidated net income if there were changes in
expected future tax rates that resulted in an adjustment to the balance of deferred tax assets or
deferred tax liabilities. Prior to SFAS No. 109 and SFAS No. 141R, purchased assets and liabilities
were displayed at their net of tax amounts and related figures for amortization and depreciation
were based on the net of tax amounts. With the adoption of SFAS No. 109 and SFAS No. 141R,
assets and liabilities are displayed at fair values and the tax consequences for differences between
their assigned values and their tax bases are displayed separately as deferred tax assets or deferred
tax liabilities. Although the amounts shown for depreciation, amortization and income tax expense
are different under SFAS No. 109 and SFAS No. 141R, absent a change in expected future tax rates,
the amount of consolidated net income will be the same.
ANSWERS TO BUSINESS ETHICS CASE
Part 1
Even though the suggested changes by the CFO lie within GAAP, the proposed changes will
unfairly increase the EPS of the company, misleading the common investors and other users. It is
evident that the CFO is doing it for his or her personal gain rather than for the transparency of
financial reporting. Thus, manipulating the reserve in this case comes under the heading of
unethical behavior. Taking a stand in such a situation is a difficult and challenging test for an
employee who reports to the CFO.
Part 2
The tax laws permit individuals to minimize taxes by means that are within the law like using tax
deductions, changing one's tax status through incorporation, or setting up a charitable trust or
foundation. In the given case the losses reported were phony and the whole scheme was fabricated
to illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme.
Although there is no reason to pay more tax than necessary, the lack of risk in these types of
shelters makes participation in such schemes of questionable ethics, at the best.
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ANSWERS TO EXERCISES
Exercise 3-1
a. Common Stock – Saltez 160,000
Other Contributed Capital - Saltez 92,000
Retained Earnings - Saltez 43,000
Property,Plant, and Equipment 56,000
Investment in Saltez 351,000
b. Common Stock – Saltez 190,000
Other Contributed Capital – Saltez 75,000
Property, Plant, and Equipment 21,778
($232,000/0.9-[$190,000+$75,000-$29,000])
Retained Earnings – Saltez 29,000
Investment in Saltez 232,000
Noncontrolling Interest 25,778
c. Common Stock – Saltez 180,000
Other Contributed Capital – Saltez 40,000
Retained Earnings – Saltez 4,000
Investment in Saltez 159,000
Gain on Purchase of Business – Prancer ** 13,800
Noncontrolling Interest (.2) ($198,750) + $3,450* 43,200
** The ordinary gain to Prancer is $159,000 – (.80)($216,000) = $13,800
* Noncontrolling interest reflects the noncontrolling share of implied value (.20 x $198,750, or
$39,750), plus the NCI portion of the bargain (.20 x $17,250)
NOTE: We know this is a bargain acquisition in part c because the investment cost of $159,000 implies
a total value of $198,750. Since this value is less than the book value of equity of $216,000
[$180,000+$40,000-$4,000], the difference is a bargain of $17,250. This bargain is allocated between
the parent (this portion is reflected as a gain) and the NCI.
Exercise 3-2
Part A Investment in Save (40,000 $17.50) 700,000
Common Stock 400,000
Other Contributed Capital ($700,000 – $20,000 – $400,000) 280,000
Cash 20,000
Part B Common Stock – Save 320,000
Other Contributed Capital – Save 175,000
Retained Earnings –Save 205,000
Investment in Save 700,000
ANSWERS TO EXERCISES
Exercise 3-1
a. Common Stock – Saltez 160,000
Other Contributed Capital - Saltez 92,000
Retained Earnings - Saltez 43,000
Property,Plant, and Equipment 56,000
Investment in Saltez 351,000
b. Common Stock – Saltez 190,000
Other Contributed Capital – Saltez 75,000
Property, Plant, and Equipment 21,778
($232,000/0.9-[$190,000+$75,000-$29,000])
Retained Earnings – Saltez 29,000
Investment in Saltez 232,000
Noncontrolling Interest 25,778
c. Common Stock – Saltez 180,000
Other Contributed Capital – Saltez 40,000
Retained Earnings – Saltez 4,000
Investment in Saltez 159,000
Gain on Purchase of Business – Prancer ** 13,800
Noncontrolling Interest (.2) ($198,750) + $3,450* 43,200
** The ordinary gain to Prancer is $159,000 – (.80)($216,000) = $13,800
* Noncontrolling interest reflects the noncontrolling share of implied value (.20 x $198,750, or
$39,750), plus the NCI portion of the bargain (.20 x $17,250)
NOTE: We know this is a bargain acquisition in part c because the investment cost of $159,000 implies
a total value of $198,750. Since this value is less than the book value of equity of $216,000
[$180,000+$40,000-$4,000], the difference is a bargain of $17,250. This bargain is allocated between
the parent (this portion is reflected as a gain) and the NCI.
Exercise 3-2
Part A Investment in Save (40,000 $17.50) 700,000
Common Stock 400,000
Other Contributed Capital ($700,000 – $20,000 – $400,000) 280,000
Cash 20,000
Part B Common Stock – Save 320,000
Other Contributed Capital – Save 175,000
Retained Earnings –Save 205,000
Investment in Save 700,000
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Exercise 3-3
Part A Investment in Sun Company 192,000
Cash 192,000
Part B PRUNCE COMPANY AND SUBSIDIARY
Consolidated Balance Sheet
January 2, 2011
Assets
Cash ($260,000 + $64,000 – $192,000) $132,000
Accounts Receivable 165,000
Inventory 171,000
Plant and Equipment (net) 484,000
Land ($63,000 + $32,000 + $28,333*) 123,333
Total Assets $1,075,333
Liabilities and Stockholders’ Equity
Accounts Payable $151,000
Mortgage Payable 111,000
Total Liabilities 262,000
Noncontrolling Interest ($192,000/0.9 0.1) $21,333
Common Stock 400,000
Other Contributed Capital 208,000
Retained Earnings 184,000
Total Stockholders’ Equity 813,333
Total Liabilities and Stockholders’ Equity $1,075,333
* [$192,000/0.9 – ($70,000 + $20,000 + $95,000)] = $28,333
Exercise 3-4
Part A Investment in Swartz Company ($60 1,500) 90,000
Common Stock ($20 1,500) 30,000
Other Contributed Capital ($40 1,500) 60,000
Other Contributed Capital 1,700
Cash 1,700
Part B Computation and Allocation of Difference
Parent Non- Entire
Share Controlling Value
Share
Purchase price and implied value $90,000 0 90,000
Less: Book value of equity acquired 83,000* 0 83,000
Difference between implied and book value 7,000 0 7,000
Goodwill (7,000) (0) (7,000)
Balance - 0 - - 0 - - 0 -
* $40,000 + $24,000 + $19,000 = $83,000
Exercise 3-3
Part A Investment in Sun Company 192,000
Cash 192,000
Part B PRUNCE COMPANY AND SUBSIDIARY
Consolidated Balance Sheet
January 2, 2011
Assets
Cash ($260,000 + $64,000 – $192,000) $132,000
Accounts Receivable 165,000
Inventory 171,000
Plant and Equipment (net) 484,000
Land ($63,000 + $32,000 + $28,333*) 123,333
Total Assets $1,075,333
Liabilities and Stockholders’ Equity
Accounts Payable $151,000
Mortgage Payable 111,000
Total Liabilities 262,000
Noncontrolling Interest ($192,000/0.9 0.1) $21,333
Common Stock 400,000
Other Contributed Capital 208,000
Retained Earnings 184,000
Total Stockholders’ Equity 813,333
Total Liabilities and Stockholders’ Equity $1,075,333
* [$192,000/0.9 – ($70,000 + $20,000 + $95,000)] = $28,333
Exercise 3-4
Part A Investment in Swartz Company ($60 1,500) 90,000
Common Stock ($20 1,500) 30,000
Other Contributed Capital ($40 1,500) 60,000
Other Contributed Capital 1,700
Cash 1,700
Part B Computation and Allocation of Difference
Parent Non- Entire
Share Controlling Value
Share
Purchase price and implied value $90,000 0 90,000
Less: Book value of equity acquired 83,000* 0 83,000
Difference between implied and book value 7,000 0 7,000
Goodwill (7,000) (0) (7,000)
Balance - 0 - - 0 - - 0 -
* $40,000 + $24,000 + $19,000 = $83,000
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3 - 5
Exercise 3-4 (continued)
Part C Peach Company and Subsidiary
Consolidated Balance Sheet
January 1, 2010
Assets
Cash ($73,000 + $13,000 - $1,700) $ 84,300
Accounts Receivable 114,000
Inventory 83,000
Plant and Equipment 138,000
Land 48,000
Goodwill* 7,000
Total Assets $ 474,300
Liabilities and Stockholders’ Equity
Accounts Payable $84,000
Notes Payable 103,000
Total Liabilities $187,000
Common Stock ($100,000 + $30,000) $130,000
Other Contributed Capital ($60,000 + $60,000 - $1,700) 118,300
Retained Earnings 39,000
Total Stockholders’ Equity 287,300
Total Liabilities and Stockholders’ Equity $ 474,300
* Cost of investment less fair value acquired equals goodwill or ($90,000 – $83,000 = $7,000).
Recall that the book value of net assets equals the fair value of net assets in this problem.
Exercise 3-5
(1)
Common Stock–Spruce 900,000
Other Contributed Capital–Spruce 440,000
Retained Earnings–Spruce 150,000
Land [$1,400,000/.90 – ($900,000 + $440,000 + $150,000 - $100,000)] 165,556
Investment in Spruce Company 1,400,000
Treasury Stock 100,000
Noncontrolling Interest ($1,400,000/.90 .10) 155,556
(2)
Common Stock–Spruce 900,000
Other Contributed Capital–Spruce 440,000
Retained Earnings–Spruce 150,000
Land 10,000
Investment in Spruce Company 1,160,000
Treasury Stock 100,000
Gain on Purchase of Business - Pool * 100,000
Noncontrolling Interest [($1,050,000 + $990,000 + $180,000 - $820,000) x .10] 140,000
* [$1,160,000 – ($1,050,000 + $990,000 + $180,000 – $820,000) x .90] = $100,000
Exercise 3-4 (continued)
Part C Peach Company and Subsidiary
Consolidated Balance Sheet
January 1, 2010
Assets
Cash ($73,000 + $13,000 - $1,700) $ 84,300
Accounts Receivable 114,000
Inventory 83,000
Plant and Equipment 138,000
Land 48,000
Goodwill* 7,000
Total Assets $ 474,300
Liabilities and Stockholders’ Equity
Accounts Payable $84,000
Notes Payable 103,000
Total Liabilities $187,000
Common Stock ($100,000 + $30,000) $130,000
Other Contributed Capital ($60,000 + $60,000 - $1,700) 118,300
Retained Earnings 39,000
Total Stockholders’ Equity 287,300
Total Liabilities and Stockholders’ Equity $ 474,300
* Cost of investment less fair value acquired equals goodwill or ($90,000 – $83,000 = $7,000).
Recall that the book value of net assets equals the fair value of net assets in this problem.
Exercise 3-5
(1)
Common Stock–Spruce 900,000
Other Contributed Capital–Spruce 440,000
Retained Earnings–Spruce 150,000
Land [$1,400,000/.90 – ($900,000 + $440,000 + $150,000 - $100,000)] 165,556
Investment in Spruce Company 1,400,000
Treasury Stock 100,000
Noncontrolling Interest ($1,400,000/.90 .10) 155,556
(2)
Common Stock–Spruce 900,000
Other Contributed Capital–Spruce 440,000
Retained Earnings–Spruce 150,000
Land 10,000
Investment in Spruce Company 1,160,000
Treasury Stock 100,000
Gain on Purchase of Business - Pool * 100,000
Noncontrolling Interest [($1,050,000 + $990,000 + $180,000 - $820,000) x .10] 140,000
* [$1,160,000 – ($1,050,000 + $990,000 + $180,000 – $820,000) x .90] = $100,000
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3 - 6
Exercise 3-6
Part A $37,412 Noncontrolling Interest = 15% Noncontrolling Interest
$249,412 Implied Value*
* Implied Value = Parent’s value $212,000 + NCI $37,412 = $249,412
Common Stock-Shipley 90,000
Other Contributed Capital-Shipley 90,000
Retained Earnings-Shipley 56,000
Land $249,412 - $236,000 13,412
Investment in Shipley Company 212,000
Noncontrolling Interest 37,412
Part B SHIPLEY COMPANY
Balance Sheet
December 31, 2010
Cash $ 15,900
Accounts Receivable 22,000
Inventory 34,600
Plant and Equipment 147,000
Land ($220,412 - $13,412 - $120,000) 87,000
Total Assets $ 306,500
Accounts Payable $ 70,500
Common Stock 90,000
Other Contributed Capital 90,000
Retained Earnings 56,000
Total Equities $ 306,500
Exercise 3-7
Part A. Long-term receivable from subsidiary $500,000
Current assets: interest receivable from subsidiary $50,000
Part B. None
Exercise 3-8
Investment in Shy Inc. [$2,500,000 + (15,000 $40)] 3,100,000
Cash 2,500,000
Common Stock 30,000
Other Contributed Capital ($40 - $2) 15,000 570,000
Exercise 3-6
Part A $37,412 Noncontrolling Interest = 15% Noncontrolling Interest
$249,412 Implied Value*
* Implied Value = Parent’s value $212,000 + NCI $37,412 = $249,412
Common Stock-Shipley 90,000
Other Contributed Capital-Shipley 90,000
Retained Earnings-Shipley 56,000
Land $249,412 - $236,000 13,412
Investment in Shipley Company 212,000
Noncontrolling Interest 37,412
Part B SHIPLEY COMPANY
Balance Sheet
December 31, 2010
Cash $ 15,900
Accounts Receivable 22,000
Inventory 34,600
Plant and Equipment 147,000
Land ($220,412 - $13,412 - $120,000) 87,000
Total Assets $ 306,500
Accounts Payable $ 70,500
Common Stock 90,000
Other Contributed Capital 90,000
Retained Earnings 56,000
Total Equities $ 306,500
Exercise 3-7
Part A. Long-term receivable from subsidiary $500,000
Current assets: interest receivable from subsidiary $50,000
Part B. None
Exercise 3-8
Investment in Shy Inc. [$2,500,000 + (15,000 $40)] 3,100,000
Cash 2,500,000
Common Stock 30,000
Other Contributed Capital ($40 - $2) 15,000 570,000
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3 - 7
Exercise 3-9
Investment in Shy Inc. [$2,500,000 + (15,000 $40)] 3,100,000
Cash 2,500,000
Common Stock 30,000
Other Contributed Capital ($40 - $2) 15,000 570,000
Acquisition Expense 97,000
Deferred Acquisition Charges 90,000
Acquisition Costs Payable 7,000
Exercise 3-10A
Note: This solution assumes a difference between the basis of acquired assets for accounting and tax
purposes for this stock acquisition.
Part A Investment in Seely Company 570,000
Common Stock*** 95,000
Additional Paid-in-Capital 475,000
***Note: Depending on the wording of this exercise, the credit may be cash instead of common stock
and additional paid-in-capital. If cash is paid, the credit to cash is $570,000.
Part B Common Stock - Seely 80,000
Other Contributed Capital – Seely 132,000
Retained Earnings - Seely 160,000
Difference between Implied and Book Value* 228,000
Investment in Seely Company 570,000
Noncontrolling Interest [($570,000/.95) x .05] 30,000
* [$570,000/.95 – ($80,000 + $132,000 + $160,000)]
Inventory 52,000
Land 25,000
Plant Assets 71,000
Discount on Bonds Payable 20,000
Goodwill** 127,200
Deferred Income Tax Liability* 67,200
Difference between Cost and Book Value 228,000
*(.40 ($52,000 + $25,000 + $71,000 + $20,000))
**228,000 – [($52,000 + $25,000 + $71,000 + $20,000) x 60%]
Exercise 3-9
Investment in Shy Inc. [$2,500,000 + (15,000 $40)] 3,100,000
Cash 2,500,000
Common Stock 30,000
Other Contributed Capital ($40 - $2) 15,000 570,000
Acquisition Expense 97,000
Deferred Acquisition Charges 90,000
Acquisition Costs Payable 7,000
Exercise 3-10A
Note: This solution assumes a difference between the basis of acquired assets for accounting and tax
purposes for this stock acquisition.
Part A Investment in Seely Company 570,000
Common Stock*** 95,000
Additional Paid-in-Capital 475,000
***Note: Depending on the wording of this exercise, the credit may be cash instead of common stock
and additional paid-in-capital. If cash is paid, the credit to cash is $570,000.
Part B Common Stock - Seely 80,000
Other Contributed Capital – Seely 132,000
Retained Earnings - Seely 160,000
Difference between Implied and Book Value* 228,000
Investment in Seely Company 570,000
Noncontrolling Interest [($570,000/.95) x .05] 30,000
* [$570,000/.95 – ($80,000 + $132,000 + $160,000)]
Inventory 52,000
Land 25,000
Plant Assets 71,000
Discount on Bonds Payable 20,000
Goodwill** 127,200
Deferred Income Tax Liability* 67,200
Difference between Cost and Book Value 228,000
*(.40 ($52,000 + $25,000 + $71,000 + $20,000))
**228,000 – [($52,000 + $25,000 + $71,000 + $20,000) x 60%]
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Exercise 3-11A
Investment in Starless Company 700,000
Common Stock 50,000
Other Contributed Capital (($70 – $5) 10,000) 650,000
Because the combination is consummated as a stock acquisition, the entry on the books of the acquirer
is no different than in the absence of deferred taxes. However, in the elimination entries, a deferred tax
liability will be recognized and the amount of goodwill will be altered accordingly.
Exercise 3-11A
Investment in Starless Company 700,000
Common Stock 50,000
Other Contributed Capital (($70 – $5) 10,000) 650,000
Because the combination is consummated as a stock acquisition, the entry on the books of the acquirer
is no different than in the absence of deferred taxes. However, in the elimination entries, a deferred tax
liability will be recognized and the amount of goodwill will be altered accordingly.
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