Sample Chapter

INSTANT DOWNLOAD COMPLETE TEST BANK WITH ANSWERS

 

Test Bank for Advanced Accounting-10th Edition By Fischer

 

SAMPLE QUESTIONS

 

Chapter 1—Business Combinations: New Rules for a Long-Standing Business Practice

 

MULTIPLE CHOICE

 

  1. An economic advantage of a business combination includes
a. Utilizing duplicative assets.
b. Creating separate management teams.
c. Coordinated marketing campaigns.
d. Horizontally combining levels within the marketing chain.

 

 

ANS:  C                    DIF:    E                    OBJ:   1-1

 

  1. A tax advantage of business combination can occur when the existing owner of a company sells out and receives:
a. cash to defer the taxable gain as a “tax-free reorganization.”
b. stock to defer the taxable gain as a “tax-free reorganization.”
c. cash to create a taxable gain.
d. stock to create a taxable gain.

 

 

ANS:  B                    DIF:    E                    OBJ:   1-1

 

  1. A controlling interest in a company implies that the parent company
a. owns all of the subsidiary’s stock.
b. has acquired a majority of the subsidiary’s common stock.
c. has paid cash for a majority of the subsidiary’s stock.
d. has transferred common stock for a majority of the subsidiary’s outstanding bonds and debentures.

 

 

ANS:  B                    DIF:    M                   OBJ:   1-2

 

  1. Company B acquired the net assets of Company S in exchange for cash. The acquisition price exceeds the fair value of the net assets acquired. How should Company B determine the amounts to be reported for the plant and equipment, and for long-term debt of the acquired Company S?

 

Plant and Equipment           Long-Term Debt

a. Fair value                    S’s carrying amount
b. Fair value                    Fair value
c. S’s carrying amount           Fair value
d. S’s carrying amount           S’s carrying amount

 

 

ANS:  B                    DIF:    E                    OBJ:   1-4

 

  1. Publics Company acquired the net assets of Citizen Company during 20X5. The purchase price was $800,000. On the date of the transaction, Citizen had no long-term investments in marketable equity securities and $400,000 in liabilities. The fair value of Citizen assets on the acquisition date was as follows:

 

Current assets $   800,000
Noncurrent assets      600,000
$1,400,000

 

How should Publics account for the $200,000 difference between the fair value of the net assets acquired, $1,000,000, and the cost, $800,000?

a. Retained earnings should be reduced by $200,000.
b. Current assets should be recorded at $685,000 and noncurrent assets recorded at $515,000.
c. A $200,000 gain on acquisition of business should be recognized
d. A deferred credit of $200,000 should be set up and subsequently amortized to future net income over a period not to exceed 40 years.

 

 

ANS:  C                    DIF:    M                   OBJ:   1-4

 

  1. ABC Co. is acquiring XYZ Inc. XYZ has the following intangible assets:

 

Patent on a product that is deemed to have no useful life $10,000.
Customer list with an observable fair value of $50,000.
A 5-year operating lease with favorable terms with a discounted present value of $8,000.
Identifiable R & D of $100,000.

 

ABC will record how much for acquired Intangible Assets from the purchase of XYZ Inc?

a. $168,000
b. $58,000
c. $158,000
d. $150,000

 

 

ANS:  C                    DIF:    D                   OBJ:   1-4

 

  1. Vibe Company purchased the net assets of Atlantic Company in a business combination accounted for as a purchase. As a result, goodwill was recorded. For tax purposes, this combination was considered to be a tax-free merger. Included in the assets is a building with an appraised value of $210,000 on the date of the business combination. This asset had a net book value of $70,000, based on the use of accelerated depreciation for accounting purposes. The building had an adjusted tax basis to Atlantic (and to Vibe as a result of the merger) of $120,000. Assuming a 36% income tax rate, at what amount should Vibe record this building on its books after the purchase?
a. $120,000
b. $134,400
c. $140,000
d. $210,000

 

 

ANS:  D                    DIF:    M                   OBJ:   1-4

 

  1. Goodwill represents the excess cost of an acquisition over the
a. sum of the fair values assigned to intangible assets less liabilities assumed.
b. sum of the fair values assigned to tangible and identifiable intangible assets acquired less liabilities assumed.
c. sum of the fair values assigned to intangibles acquired less liabilities assumed.
d. book value of an acquired company.

 

 

ANS:  B                    DIF:    M                   OBJ:   1-4

 

  1. When an acquisition of another company occurs, FASB recommends disclosing all of the following EXCEPT:
a. goodwill assigned to each reportable segment.
b. information concerning contingent consideration including a description of the arrangements and the range of outcomes
c. results of operations for the current period if both companies had remained separate.
d. A qualitative description of factors that make up the goodwill recognized

 

 

ANS:  C                    DIF:    M                   OBJ:   1-6

  1. Cozzi Company is being purchased and has the following balance sheet as of the purchase date:

 

Current assets $200,000 Liabilities $  90,000
Fixed assets   180,000 Equity   290,000
     Total $380,000      Total $380,000

 

The price paid for Cozzi’s net assets is $500,000. The fixed assets have a fair value of $220,000, and the liabilities have a fair value of $110,000. The amount of goodwill to be recorded in the purchase is ____.

a. $0
b. $150,000
c. $170,000
d. $190,000

 

 

ANS:  D                    DIF:    M                   OBJ:   1-4

 

  1. Separately identified intangible assets are accounted for by amortizing:
a. exclusively by using impairment testing.
b. based upon a pattern that reflects the benefits conveyed by the asset.
c. over the useful economic life less residual value using only the straight-line method.
d. over a period not to exceed a maximum of 40 years.

 

 

ANS:  B                    DIF:    E                    OBJ:   1-4

 

  1. While performing a goodwill impairment test, the company had the following information:

 

Estimated implied fair value of reporting unit (without goodwill) $420,000
Existing net book value of reporting unit (without goodwill) $380,000
Book value of goodwill $  60,000

 

Based upon this information the proper conclusion is:

a. The existing net book value plus goodwill is in excess of the implied fair value, therefore, no adjustment is required.
b. The existing net book value plus goodwill is less than the implied fair value plus goodwill, therefore, no adjustment is required.
c. The existing net book value plus goodwill is in excess of the implied fair value, therefore, goodwill needs to be decreased.
d. The existing net book value is less than the estimated implied fair value; therefore, goodwill needs to be decreased.

 

 

ANS:  C                    DIF:    D                   OBJ:   1-7

 

  1. Balter Inc. acquired Jersey Company on January 1, 20X5. When the purchase occurred Jersey Company had the following information related to fixed assets:

 

Land $  80,000
Building 200,000
Accumulated Depreciation (100,000)
Equipment 100,000
Accumulated Depreciation (50,000)

 

The building has a 10-year remaining useful life and the equipment has a 5-year remaining useful life. The fair value of the assets on that date were:

Land $100,000
Building 130,000
Equipment 75,000

 

What is the 20X5 depreciation expense Balter will record related to purchasing Jersey Company?

a. $8,000
b. $15,000
c. $28,000
d. $30,000

 

 

ANS:  C                    DIF:    M                   OBJ:   1-4

 

  1. In performing  impairment test for goodwill, the company had the following 20X6 and 20X7 information available.

 

20X6 20X7
Fair value of the reporting unit $350,000 $400,000
Net book value (including $50,000 goodwill) $360,000 $380,000

 

Assume that the carry value of the identifiable assets are a reasonable approximation of their fair values. Based upon this information what are the 20X6 and 20X7 adjustment to goodwill, if any?

20X6                    20X7

a. no adjustment          $20,000 decrease
b. $10,000 increase       $20,000 decrease
c. $10,000 decrease       $20,000 decrease
d. $10,000 decrease       no adjustment

 

 

ANS:  D                    DIF:    D                   OBJ:   1-7

 

ACME Co. paid $110,000 for the net assets of Comb Corp. At the time of the acquisition the following information was available related to Comb’s balance sheet:

 

Book Value Fair Value
Current Assets $50,000 $  50,000
Building 80,000 100,000
Equipment 40,000 50,000
Liabilities 30,000 30,000

 

 

  1. Refer to ACME Co. and Comb Corp. What is the amount recorded by ACME for the Building?
a. $110,000
b. $20,000
c. $80,000
d. $100,000

 

 

ANS:  D                    DIF:    M                   OBJ:   1-7

 

  1. Refer to ACME Co. and Comb Corp. What amount of gain (loss) on disposal of a business should Comb Corp. recognize?
a. Gain of $30,000
b. Gain of $60,000
c. Loss of $30,000
d. Loss of $60,000

 

 

ANS:  C                    DIF:    M                   OBJ:   1-1

 

  1. Polk issues common stock to acquire all the assets of the Sam Company on January 1, 20X5. There is a contingent share agreement, which states that if the income of the Sam Division exceeds a certain level during 20X5 and 20X6, additional shares will be issued on January 1, 20X7. The impact of issuing the additional shares is to

 

a. increase the price assigned to fixed assets.
b. have no effect on asset values, but to reassign the amounts assigned to equity accounts.
c. reduce retained earnings.
d. record additional goodwill.

 

 

ANS:  B                    DIF:    D                   OBJ:   1-4

 

  1. Orbit Inc. purchased Planet Co. in 20X3. At that time an existing patent was not recorded as a separately identified intangible asset. At the end of fiscal year 20X4, the patent is valued at $15,000, and goodwill has a book value of $100,000. How should intangible assets be reported at the beginning of fiscal year 20X5?

 

a. Goodwill $100,000       Patent $0
b. Goodwill $115,000       Patent $0
c. Goodwill $100,000       Patent $15,000
d. Goodwill $85,000         Patent $15,000

 

 

ANS:  A                    DIF:    M                   OBJ:   1-4

 

  1. Which of the following income factors should not be factored into an estimation of goodwill?

 

a. sales for the period
b. income tax expense
c. extraordinary items
d. cost of goods sold

 

 

ANS:  C                    DIF:    M                   OBJ:   1-8 | Appendix A

 

  1. Acquisition costs such as the fees of accountants and lawyers that were necessary to negotiate and consummate the purchase are

 

a. recorded as a deferred asset and amortized over a period not to exceed 15 years
b. expensed if immaterial but capitalized and amortized if over 2% of the acquisition price
c. expensed in the period of the purchase
d. included as part of the price paid for the company purchased

 

 

ANS:  C                    DIF:    M                   OBJ:   1-4

 

 

PROBLEM

 

  1. Internet Corporation is considering the acquisition of Homepage Corporation and has obtained the following audited condensed balance sheet:

 

Homepage Corporation

Balance Sheet

December 31, 20X5

Assets Liabilities and Equity
Current assets $  40,000 Current Liabilities $  60,000
Land 20,000 Capital Stock (50,000
Buildings (net) 80,000      shares, $1 par value) 50,000
Equipment (net) 60,000 Other Paid-in Capital 20,000
               Retained Earnings     70,000
$200,000 $200,000

 

Internet also acquired the following fair values for Homepage’s assets and liabilities:

 

Current assets $  55,000
Land 60,000
Buildings (net) 90,000
Equipment (net) 75,000
Current Liabilities    (60,000)
$220,000

 

Internet and Homepage agree on a price of $280,000 for Homepage’s net assets. Prepare the necessary journal entry to record the purchase given the following scenarios:

 

a. Internet pays cash for Homepage Corporation and incurs $5,000 of acquisition costs.
b. Internet issues its $5 par value stock as consideration. The fair value of the stock at the acquisition date is $50 per share. Additionally, Internet incurs $5,000 of security issuance costs.

 

 

ANS:

Debit Credit
a. Current assets 55,000
Land 60,000
Buildings 90,000
Equipment 75,000
Goodwill 60,000
Acquisition expense 5,000
     Current Liabilities 60,000
     Cash 285,000

 

Debit Credit
b. Current assets 55,000
Land 60,000
Buildings 90,000
Equipment 75,000
Goodwill 60,000
     Current Liabilities 60,000
     Common Stock 28,000
     Other Paid-in Capital 252,000
Acquisition expense 5,000
     Cash 5,000

 

 

DIF:    M                   OBJ:   1-5

 

  1. On January 1, 20X5, Brown Inc. acquired Larson Company’s net assets in exchange for Brown’s common stock with a par value of $100,000 and a fair value of $800,000. Brown also paid $10,000 in direct acquisition costs and $15,000 in stock issuance costs.

 

On this date, Larson’s condensed account balances showed the following:

 

Book Value Fair Value
Current Assets $280,000 $370,000
Plant and Equipment 440,000 480,000
Accumulated Depreciation (100,000)
Intangibles – Patents 80,000 120,000
Current Liabilities (140,000) (140,000)
Long-Term Debt (100,000) (110,000)
Common Stock (200,000)
Other Paid-in Capital (120,000)
Retained Earnings (140,000)

 

Required:

 

Record Brown’s purchase of Larson Company’s net assets.

 

ANS:

Debit Credit
Current Assets $370,000
Plant and Equipment 480,000
Intangibles – Patents 120,000
Intangibles – Goodwill 80,000
     Current Liabilities $140,000
     Long-term Debt 110,000
     Common Stock 100,000
     Other Paid-in Capital 700,000
Acquisition expenses* 25,000
     Cash 25,000

*alternative treatment: debit Paid-In Capital for issue costs

 

DIF:    M                   OBJ:   1-3 | 1-11 | 1-12 | Appendix B

 

  1. The Chan Corporation purchased the net assets (existing liabilities were assumed) of the Don Company for $900,000 cash. The balance sheet for the Don Company on the date of acquisition showed the following:

 

Assets
Current assets $100,000
Equipment 300,000
Accumulated depreciation (100,000)
Plant 600,000
Accumulated depreciation  (250,000)
Total $650,000
Liabilities and Equity
Bonds payable, 8% $200,000
Common stock, $1 par 100,000
Paid-in capital in excess of par 200,000
Retained earnings   150,000
Total $650,000

 

Required:

 

The equipment has a fair value of $300,000, and the plant assets have a fair value of $500,000. Assume that the Chan Corporation has an effective tax rate of 40%. Prepare the entry to record the purchase of the Don Company for each of the following separate cases with specific added information:

 

a. The sale is a nontaxable exchange to the seller that limits the buyer to depreciation and amortization on only book value for tax purposes.
b. The bonds have a current fair value of $190,000. The transaction is a taxable exchange.
c. There are $100,000 of prior-year losses that can be used to claim a tax refund. The transaction is a taxable exchange.
d. There are $150,000 of past losses that can be carried forward to future years to offset taxes that will be due. The transaction is a nontaxable exchange.

 

 

ANS:

a. Current Assets 100,000
Equipment 300,000
Plant 500,000
Goodwill 300,000
     Deferred Tax Liability* 100,000
     Bonds Payable 200,000
     Cash 900,000
* .4 ´ ($800,000 Fair Value  $550,000 Book Value of fixed assets)

 

b. Current Assets 100,000
Equipment 300,000
Plant 500,000
Goodwill 190,000
     Bonds Payable 190,000
     Cash 900,000

 

c. Current Assets 100,000
Equipment 300,000
Plant 500,000
Tax Refund Receivable 40,000
Goodwill 160,000
     Bonds Payable 200,000
     Cash 900,000

 

d. Current Assets 100,000
Equipment 300,000
Plant 500,000
Deferred Tax Expense ($150,000 ´ .4) 60,000
Goodwill 240,000
     Bonds Payable 200,000
     Cash 900,000
     Deferred Tax Liability

($250,000 ´ .4)

 

100,000

 

 

DIF:    D                    OBJ:   1-8

 

  1. On January 1, 20X5, Zebb and Nottle Companies had condensed balance sheets as shown below:

 

Zebb Nottle
Company Company
Current Assets $1,000,000 $   600,000
Plant and Equipment   1,500,000      800,000
$2,500,000 $1,400,000
Current Liabilities $   200,000 $   100,000
Long-Term Debt 300,000 300,000
Common Stock, $10 par 1,400,000 400,000
Paid-in Capital in Excess of Par 0 100,000
Retained Earnings      600,000      500,000
$2,500,000 $1,400,000

 

Required:

 

Record the acquisition of Nottle’s net assets, the issuance of the stock and/or payment of cash, and payment of the related costs. Assume that Zebb issued 30,000 shares of new common stock with a fair value of $25 per share and paid $500,000 cash for all of the net assets of Nottle. Acquisition costs of $50,000 and stock issuance costs of $20,000 were paid in cash. Current assets had a fair value of $650,000, plant and equipment had a fair value of $900,000, and long-term debt had a fair value of $330,000.

 

ANS:

Current Assets 650,000
Plant and Equipment 900,000
Goodwill 130,000
Acquisition expenses* 70,000
     Current Liabilities 100,000
     Long-Term Debt 330,000
     Common Stock 300,000
     Paid-in Capital in Excess of Par 450,000
     Cash ($500,000 + 70,000) 570,000

*alternative treatment: debit Paid-in Capital in Excess of Par for issue costs

 

DIF:    M                   OBJ:   1-5

  1. On January 1, 20X1, Honey Bee Corporation purchased the net assets of Green Hornet Company for $1,500,000. On this date, a condensed balance sheet for Green Hornet showed:

 

Book Fair
Value Value
Current Assets $   500,000 $800,000
Long-Term Investments in Securities 200,000 150,000
Land 100,000 600,000
Buildings (net)      700,000 900,000
$1,500,000
Current Liabilities $   300,000 $300,000
Long-Term Debt 550,000 600,000
Common Stock (no-par) 300,000
Retained Earnings      350,000
$1,500,000

 

Required:

 

Record the entry on Honey Bee’s books for the acquisition of Green Hornet’s net assets.

 

ANS:

Current Assets 800,000
Long-Term Investments in Securities 150,000
Land 600,000
Building 900,000
     Current Liabilities 300,000
     Long-Term Debt 600,000
     Gain on acquisition of business 50,000
     Cash 1,500,000

 

 

DIF:    M                   OBJ:   1-4

 

  1. Poplar Corp. acquires the net assets of Sapling Company, which has the following balance sheet:

 

Accounts Receivable $  50,000
Inventory 80,000
Equipment, Net 50,000
Land & Building, Net   120,000
Total Assets $300,000
Bonds Payable $  90,000
Common Stock 100,000
Retained Earnings   110,000
Total Liabilities and Stockholders’ Equity $300,000

 

Fair values on the date of acquisition:

 

Accounts Receivable $  50,000
Inventory 100,000
Equipment 30,000
Land & Building 180,000
Customer List 30,000
Bonds Payable 100,000
Acquisition costs: $  10,000

 

If Poplar paid $300,000 what journal entries would be recorded by both Poplar Corp. and Sapling Company?

 

ANS:

Poplar Corp:

Accounts Receivable   50,000
Inventory 100,000
Equipment 30,000
Land & Building 180,000
Customer List 30,000
Goodwill* 10,000
Acquisition expenses 10,000
     Bonds Payable   90,000
     Premium on Bonds Payable 10,000
     Cash ($300,000 + $10,000) 310,000
*Goodwill: Price paid $300,000 – Fair value of net identifiable assets $290,000 = $10,000

 

Sapling Company:

Cash 300,000
Bonds Payable 90,000
     Accounts Receivable   50,000
     Inventory 80,000
     Equipment 50,000
     Land & Building, net 120,000
     Gain on Sale of Business 90,000

 

 

DIF:    M                   OBJ:   1-3

 

  1. Diamond acquired Heart’s net assets. At the time of the acquisition Heart’s Balance sheet was as follows:

 

Accounts Receivable $130,000
Inventory 70,000
Equipment, Net 50,000
Building, Net 250,000
Land & Building, Net   100,000
Total Assets $600,000
Bonds Payable $100,000
Common Stock 50,000
Retained Earnings   450,000
Total Liabilities and Stockholders’ Equity $600,000

 

Fair values on the date of acquisition:

 

Inventory $100,000
Equipment 30,000
Building 350,000
Land 120,000
Brand name copyright 50,000
Bonds payable 120,000
Acquisition costs: $    5,000

 

Required:

 

Record the entry for the purchase of the net assets of Heart by Diamond at the following cash prices:

 

a. $700,000
b. $300,000

 

 

ANS:

a. Accounts Receivable 130,000
Inventory 100,000
Equipment 30,000
Building 350,000
Land 120,000
Brand Name 50,000
Goodwill 40,000
Acquisition expenses 5,000
     Bonds Payable 100,000
     Premium on Bonds Payable 20,000
     Cash ($700,000 + $5,000) 705,000

 

b. Accounts Receivable 130,000
Inventory 100,000
Equipment 30,000
Building 350,000
Land 120,000
Brand Name 50,000
Acquisition expenses 5,000
     Bonds Payable 100,000
     Premium on Bonds Payable 20,000
     Gain on acquisition of business 360,000
     Cash ($300,000 + $5,000) 305,000

 

 

DIF:    M                   OBJ:   1-5 | 1-7

 

  1. On January 1, July 1, and December 31, 20X5, a condensed trial balance for Nelson Company showed the following debits and (credits):
01/01/X5 06/30/X5 12/31/X5
Current Assets $200,000 $260,000 $340,000
Plant and Equipment (net) 500,000 510,000 510,000
Current Liabilities (50,000) (70,000) (60,000)
Long-Term Debt (100,000) (100,000) (100,000)
Common Stock (150,000) (150,000) (150,000)
Other Paid-in Capital (100,000) (100,000) (100,000)
Retained Earnings, January 1 (300,000) (300,000) (300,000)
Dividends Declared 10,000
Revenues (400,000) (900,000)
Expenses 350,000 750,000

Assume that, on July 1, 20X5, Systems Corporation purchased the net assets of Nelson Company for $750,000 in cash. On this date, the fair values for certain net assets were:

 

Current Assets $280,000
Plant and Equipment (remaining life of 10 years) 600,000

 

Nelson Company’s books were NOT closed on June 30, 20X5.

 

For all of 20X5, Systems’ revenues and expenses were $1,500,000 and $1,200,000, respectively.

 

Required:

(1) Record the entry on Systems’ books for the July 1, 20X5 purchase of Nelson.

 

 

ANS:

1. Debit Credit
Current Assets 280,000
Plant and Equipment 600,000
Goodwill 40,000
     Current Liabilities   70,000
     Long-Term Debt 100,000
     Cash 750,000

 

 

DIF:    D                    OBJ:   1-5

 

  1. Mans Company is about to purchase the net assets of Eagle Incorporated, which has the following balance sheet:

 

Assets
Accounts receivable $  60,000
Inventory 100,000
Equipment $  90,000
Accumulated depreciation   (50,000) 40,000
Land and buildings $300,000
Accumulated depreciation (100,000) 200,000
Goodwill     60,000
     Total assets $460,000
Liabilities and Stockholders’ Equity
Bonds payable $  80,000
Common stock, $10 par 200,000
Paid-in capital in excess of par 100,000
Retained earnings     80,000
     Total liabilities and equity $460,000

 

Mans has secured the following fair values of Eagle’s accounts:

 

Inventory $130,000
Equipment 60,000
Land and buildings 260,000
Bonds payable 60,000

 

Acquisition costs were $20,000.

Required:

 

Record the entry for the purchase of the net assets of Eagle by Mans at the following cash prices:

 

a. $450,000
b. $310,000
c. $480,000

 

 

ANS:

NOTE: In all scenarios, the pre-existing goodwill on Mans’ balance sheet is disregarded when measuring the goodwill inherent in Eagle’s purchase transaction.

a. Accounts Receivable   60,000
Inventory 130,000
Equipment 60,000
Land and Buildings 260,000
Discount on Bonds Payable 20,000
Acquisition expenses 20,000
     Bonds Payable   80,000
     Cash (includes acquisition costs) 470,000

 

b. Accounts Receivable   60,000
Inventory 130,000
Equipment 60,000
Land and Buildings 260,000
Discount on Bonds Payable 20,000
Acquisition expenses 20,000
     Gain on acquisition of a business 140,000
     Bonds Payable 80,000
     Cash (includes acquisition costs) 330,000

 

c. Accounts Receivable   60,000
Inventory 130,000
Equipment 60,000
Land and Buildings 260,000
Discount on Bonds Payable 20,000
Acquisition expenses 20,000
Goodwill 30,000
     Bonds Payable   80,000
     Cash (includes acquisition costs) 500,000

 

 

DIF:    M                   OBJ:   1-5 | 1-7

 

  1. On January 1, 20X1 the fair values of Pink Coral’s net assets were as follows:

 

Current Assets 100,000
Equipment 150,000
Land 50,000
Buildings 300,000
Liabilities 80,000

 

On January 1, 20X1, Blue Reef Company purchased the net assets of the Pink Coral Company by issuing 100,000 shares of its $1 par value stock when the fair value of the stock was $6.20. It was further agreed that Blue Reef would pay an additional amount on January 1, 20X3, if the average income during the 2-year period of 20X1-20X2 exceeded $80,000 per year. The expected value of this consideration was calculated as $184,000; the measurement period is one year.

 

Required: Prepare Blue Reef’s entries:

  1. a) on January 1, 20X1 to record the acquisition
  2. b) on August 1, 20X1 to revise the contingent consideration to $170,000
  3. c) on January 1, 20X3 to settle the contingent consideration clause of the agreement for $175,000

 

ANS:

a. Current Assets 100,000
Equipment 150,000
Land 50,000
Buildings 300,000
Goodwill 284,000
     Liabilities 80,000
     Estimated liability for contingent consideration 184,000
     Common Stock, $1 Par 100,000
     Paid-in Capital in Excess of Par 520,000

 

b. Estimated liability for contingent consideration 14,000
     Goodwill 14,000

 

c. Estimated liability for contingent consideration 170,000
Loss on estimated contingent consideration 5,000
     Cash 175,000

 

 

DIF:    M                   OBJ:   1-8

 

  1. The Blue Reef Company purchased the net assets of the Pink Coral Company on January 1, 20X1, and made the following entry to record the purchase:

 

Current Assets 100,000
Equipment 150,000
Land 50,000
Buildings 300,000
Goodwill 100,000
     Liabilities 80,000
     Common Stock, $1 Par 100,000
     Paid-in Capital in Excess of Par 520,000

 

Required:

 

Make the required entry on January 1, 20X3, assuming that additional shares would be issued on that date to compensate for any fall in the value of Blue Reef common stock below $16 per share. The settlement would be to cure the deficiency by issuing added shares based on their fair value on January 1, 20X3. The fair price of the shares on January 1, 20X3 was $10.

 

ANS:

Paid-in Capital in Excess of Par 60,000
     Common Stock, $1 par 60,000
Deficiency: ($16 – $10) ´ 100,000 shares issued to acquire $600,000
Divide by $10 fair value  ÷ $10.00
Added number of shares to issue   60,000

 

 

DIF:    M                   OBJ:   1-4

 

ESSAY

 

  1. Goodwill is an intangible asset. There are a variety of recommendations about how intangible assets should be included in the financial statements. Discuss the recommendations for proper disclosure of goodwill. Include a comparison with disclosure of other intangible assets.

 

ANS:

Goodwill arises when a company is purchased and the value assigned to identifiable assets, including intangible assets, is in excess of the price paid. As such goodwill represents the value of intangible assets that could not be valued individually.

 

During a purchase some intangible assets such as patents, customer lists, brand names, and favorable lease agreements may exist but have not been recorded. The fair value of these intangible assets should be determined and recorded separate from the value of goodwill associated with the purchase.

 

Intangible assets other than goodwill will be amortized over their economic lives. The amortization method should reflect the pattern of benefits conveyed by the asset, so that a straight-line method is to be used unless another systematic method is appropriate.

 

Intangible assets may be reported individually, in groups, or in the aggregate on the balance sheet after fixed assets and are displayed net of cumulative amortization. Details for current and cumulative amortization, along with significant residual values, are shown in the footnotes to the balance sheet.

 

Goodwill is subject to impairment procedures. These concerns must be addressed related to goodwill:

 

1. Goodwill must be allocated to reporting units if the purchased company contains more than one reporting unit.
2. A reporting unit valuation plan must be established within one year of a purchase. This will be used as the measurement process in future periods.
3. Impairment testing is normally done on an annual basis.
4. The procedure for determining impairment must be established.
5. The procedure for determining the amount of the impairment loss, which is also the decrease in the goodwill amount recorded, must be established.

 

Goodwill is considered impaired when the implied fair value of reporting unit is less than the carrying value of the reporting unit’s net assets. Once goodwill is written down, it cannot be adjusted to a higher amount.

 

Changes to goodwill must be disclosed. The disclosure would include the amount of goodwill acquired, the goodwill impairment losses, and the goodwill written off as part of a disposal of a reporting unit.

 

DIF:    D                    OBJ:   1-4 | 1-5 | 1-6 | 1-9

  1. While acquisitions are often friendly, there are numerous occasions when a party does not want to be acquired. Discuss possible defensive strategies that firms can implement to fend off a hostile takeover attempt.

 

ANS:

GREENMAIL: A strategy is which the target company pays a premium price to purchase treasury shares. The shares purchased are owned by the hostile acquirer or shareholders who might sell to the hostile acquirer.

 

WHITE KNIGHT: A strategy in which the target company locates a different company to take it over, a company that is more likely to keep current management and employees in place.

 

SELLING THE CROWN JEWELS: A strategy in which the target company sells off vital assets in order to make the company less attractive to prospective acquirers.

 

POISON PILL: A strategy in which the target company issues stock rights to existing shareholders at a price far below fair value. The rights are only exercisable if an acquirer makes a bid for the target company. The resulting new shares make the acquisition more expensive.

 

LEVERAGED BUYOUT: A strategy in which the management of the target company attempts to purchase a controlling interest in the target company, in order to continue control of the company.

 

DIF:    M                   OBJ:   1-2

 

Chapter 3—Consolidated Statements: Subsequent to Acquisition

 

MULTIPLE CHOICE

 

Scenario 3-1

 

Pedro purchased 100% of the common stock of the Sanburn Company on January 1, 20X1, for $500,000. On that date, the stockholders’ equity of Sanburn Company was $380,000. On the purchase date, inventory of Sanburn Company, which was sold during 20X1, was understated by $20,000. Any remaining excess of cost over book value is attributable to patent with a 20-year life. The reported income and dividends paid by Sanburn Company were as follows:

 

20X1 20X2
Net income $80,000 $90,000
Dividends paid 10,000 10,000

 

 

  1. Refer to Scenario 3-1. Using the simple equity method, which of the following amounts are correct?

 

Investment Income      Investment Account Balance

20X1                    December 31, 20X1

a. $80,000                  $570,000
b. $70,000                  $570,000
c. $70,000                  $550,000
d. $80,000                  $550,000

 

 

ANS:  A                    DIF:    M                   OBJ:   3-1

 

  1. Refer to Scenario 3-1. Using the sophisticated (full) equity method, which of the following amounts are correct?

 

Investment Income      Investment Account Balance

20X1                    December 31, 20X1

a. $55,000                   $555,000
b. $55,000                   $545,000
c. $75,000                   $565,000
d. $80,000                   $570,000

 

 

ANS:  B                    DIF:    M                   OBJ:   3-1

 

  1. Refer to Scenario 3-1. Using the cost method, which of the following amounts are correct?

 

Investment Income      Investment Account Balance

20X1                    December 31, 20X1

a. $10,000                   $500,000
b. $10,000                   $570,000
c.      $0                   $570,000
d. $80,000                   $500,000

 

 

ANS:  A                    DIF:    M                   OBJ:   3-1

  1. What is the effect if an unconsolidated subsidiary is accounted for by the equity method but consolidated statements are being prepared for the parent company and other subsidiaries?
a. All of the unconsolidated subsidiary’s accounts will be included individually in the consolidated statements.
b. The consolidated retained earnings will not reflect the earnings of the unconsolidated subsidiary.
c. The consolidated retained earnings will be the same as if the subsidiary had been included in the consolidation.
d. Dividend revenue from the unconsolidated subsidiary will be reflected in consolidated net income.

 

 

ANS:  C                    DIF:    M                   OBJ:   3-1 | 3-2 | 3-4

 

Scenario 3-2

 

On January 1, 20X1, Promo, Inc. purchased 70% of Set Corporation for $469,000. On that date the book value of the net assets of Set totaled $500,000. Based on the appraisal done at the time of the purchase, all assets and liabilities had book values equal to their fair values except as follows:

 

Book Value Fair Value
Inventory $100,000 $120,000
Land 75,000 85,000
Equipment (useful life 4 years) 125,000 165,000

 

The remaining excess of cost over book value was allocated to a patent with a 10-year useful life.

 

During 20X1 Promo reported net income of $200,000 and Set had net income of $100,000.

 

  1. Refer to Scenario 3-2. What is consolidated net income if Promo recognizes income from Set using the sophisticated equity method?
a. $42,000
b. $70,000
c. $200,000
d. $270,000

 

 

ANS:  D                    DIF:    M                   OBJ:   3-1 | 3-4 | 3-6

 

  1. Refer to Scenario 3-2. What income from subsidiary did Promo include in its net income if Promo uses the simple equity method?
a. $33,000
b. $42,000
c. $70,000
d. $100,000

 

 

ANS:  C                    DIF:    D                   OBJ:   3-1 | 3-6

 

  1. Refer to Scenario 3-2. What income from subsidiary did Promo include in its net income if Promo uses the sophisticated equity method?
a. $33,000
b. $49,000
c. $70,000
d. $100,000

 

 

ANS:  B                    DIF:    D                   OBJ:   3-1 | 3-6

  1. On January 1, 20X1, Rabb Corp. purchased 80% of Sunny Corp.’s $10 par common stock for $975,000. On this date, the carrying amount of Sunny’s net assets was $1,000,000. The fair values of Sunny’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net), which were $100,000 in excess of the carrying amount.

 

In the January 1, 20X1, consolidated balance sheet, goodwill should be reported at ____.

a. $0
b. $75,750
c. $95,000
d. $118,750

 

 

ANS:  D                    DIF:    E                    OBJ:   3-2 | 3-3 | 3-4

 

  1. Which of the following statements applying to the use of the equity method versus the cost method is true?
a. The equity method is required when one firm owns 20% or more of the common stock of another firm.
b. If no dividends were paid by the subsidiary, the investment account would have the same balance under both methods.
c. The method used has no significance to consolidated statements.
d. An advantage of the equity method is that no amortization of excess adjustments needs to be made on the consolidated worksheet.

 

 

ANS:  C                    DIF:    E                    OBJ:   3-2 | 3-3

 

  1. In consolidated financial statements, it is expected that:
a. Dividends declared equals the sum of the total parent company’s declared dividends and the total subsidiary’s declared dividends.
b. Retained Earnings equals the sum of the controlling interest’s separate retained earnings and the noncontrolling interest’s separate retained earnings.
c. Common Stock equals the sum of the parent company’s outstanding shares and the subsidiary’s outstanding shares.
d. Net Income equals the sum of the income distributed to the controlling interest and the income distributed to the noncontrolling interest.

 

 

ANS:  D                    DIF:    E                    OBJ:   3-2 | 3-3 | 3-4

 

  1. How is the portion of consolidated earnings to be assigned to noncontrolling interest in consolidated financial statements determined?
a. The net income of the parent is subtracted from the subsidiary’s net income to determine the noncontrolling interest.
b. The subsidiary’s net income is extended to the noncontrolling interest.
c. The amount of the subsidiary’s earnings is multiplied by the noncontrolling’s percentage ownership and is adjusted for the excess cost amortization applicable to the NCI.
d. The amount of consolidated earnings determined on the consolidated working papers is multiplied by the noncontrolling interest percentage at the balance-sheet date.

 

 

ANS:  C                    DIF:    M                   OBJ:   3-2 | 3-3 | 3-4

 

  1. Patti Corp. has several subsidiaries (Aeta, Beta, and Gaeta) that are included in its consolidated financial statements. In its 12/31/X1 separate balance sheet, Patti had the following intercompany balances before eliminations:
Debit Credit
Current Receivable due from Aeta $  40,000
Noncurrent Receivable due from Beta 100,000
Cash Advance to Beta 26,000
Cash Advance from Gaeta $75,000
Intercompany Payable to Gaeta 40,000

 

In its 12/31/X1 consolidated balance sheet, what amount should Patti report as intercompany receivables?

a. $166,000
b. $51,000
c. $26,000
d. $0

 

 

ANS:  D                    DIF:    E                    OBJ:   3-2 | 3-3 | 3-4

 

Scenario 3-3

 

Balance sheet information for Pawnee Company and its 90%-owned subsidiary, Sioux Corporation, at December 31, 20X1, is summarized as follows:

 

Pawnee Sioux
Current assets-net $   200,000 $  50,000
Property, plant, and equipment-net 1,000,000 600,000
Investment in Sioux      558,000               
$1,758,000 $650,000
Current liabilities $   100,000 $  30,000
Capital stock 800,000 400,000
Retained earnings      858,000   220,000
$1,758,000 $650,000

 

Pawnee acquired its interest in Sioux for cash at book value several years ago when Sioux’s assets and liabilities were equal to their fair values.

 

  1. Refer to Scenario 3-3. Consolidated total assets of Pawnee and Sioux, at December 31, 20X1, will be ____.
a. $1,785,000
b. $1,850,000
c. $2,343,000
d. $2,408,000

 

 

ANS:  B                    DIF:    E                    OBJ:   3-2 | 3-3 | 3-4 | 3-7

 

  1. Refer to Scenario 3-3. The consolidated balance sheet of Pawnee and Sioux at December 31, 20X1 will show
a. Investment in Sioux, $558,000.
b. Capital stock, $800,000.
c. Retained earnings, $1,078,000.
d. Noncontrolling interest, $65,000.

 

 

ANS:  B                    DIF:    E                    OBJ:   3-2 | 3-3 | 3-4 | 3-7

 

  1. Pahl Corporation owns a 60% interest in Sauer Corporation, acquired at book value equal to fair value at the beginning of 20X1. On December 20, 20X1 Sauer declares dividends of $80,000, and the dividends remain unpaid at year end. Pahl has not recorded the dividends receivable at December 31. A consolidated working paper entry is necessary to
a. Enter the $80,000 dividends receivable in the consolidated balance sheet.
b. Enter $48,000 dividends receivable in the consolidated balance sheet.
c. Reduce the dividend payable account to $32,000 in the consolidated balance sheet.
d. Eliminate the dividend payable account in the consolidated balance sheet.

 

 

ANS:  C                    DIF:    M                   OBJ:   3-3

 

  1. If the investment in subsidiary account is increased or decreased by the amount determined by the following calculation:

the investment account is being converted from

a. cost to simple equity.
b. cost to sophisticated equity.
c. simple equity to sophisticated equity.
d. simple equity to cost.

 

 

ANS:  A                    DIF:    M                   OBJ:   3-3

 

  1. On January 1, 20X1, Payne Corp. purchased 70% of Shayne Corp.’s $10 par common stock for $900,000. On this date, the carrying amount of Shayne’s net assets was $1,000,000. The fair values of Shayne’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net), which were $200,000 in excess of the carrying amount. For the year ended December 31, 20X1, Shayne had net income of $150,000 and paid cash dividends totaling $90,000. Excess attributable to plant assets is amortized over 10 years.

In the December 31, 20X1, consolidated balance sheet, noncontrolling interest should be reported at ____.

a. $282,714
b. $300,500
c. $397,714
d. $345,500

 

 

ANS:  C                    DIF:    M                   OBJ:   3-5

 

  1. Alpha purchased an 80% interest in Beta on June 30, 20X1. Both Alpha’s and Beta’s reporting periods end December 31. Which of the following represents the controlling interest in consolidated net income for 20X1?
a. 100% of Alpha’s July 1-December 31 income plus 80% of Beta’s July 1-December 31 income
b. 100% of Alpha’s July 1-December 31 income plus 100% of Beta’s July 1-December 31 income
c. 100% of Alpha’s January 1-December 31 income plus 80% of Beta’s July 1-December 31 income
d. 100% of Alpha’s January 1-December 31 income plus 80% of Beta’s January 1-December 31 income

 

 

ANS:  C                    DIF:    D                   OBJ:   3-6

  1. In a mid-year purchase when the subsidiary’s books are not closed until the end of the year, the purchased income account contains the parent’s share of the
a. subsidiary’s income earned for the entire year.
b. subsidiary’s income earned from the beginning of the year to the date of acquisition.
c. subsidiary’s income earned from the date of acquisition to the end of the year.
d. Consolidated Net Income.

 

 

ANS:  B                    DIF:    E                    OBJ:   3-6

 

  1. On January 1, 20X1, Piston, Inc. acquired Spur Corp. While recording the acquisition, Piston established a deferred tax liability. It is most likely that this account was created because
a. the transaction was a tax-free exchange to Piston.
b. Piston had not paid all of the income taxes due the government when acquiring Spur.
c. the transaction was a tax-free exchange to Spur.
d. Spur had not paid all of the income taxes due the government prior to the acquisition by Piston.

 

 

ANS:  A                    DIF:    E                    OBJ:   3-8

 

PROBLEM

 

Scenario 3-4

 

On January 1, 20X1, Parent Company purchased 80% of the common stock of Subsidiary Company for $316,000. On this date, Subsidiary had common stock, other paid-in capital, and retained earnings of $40,000, $120,000, and $190,000, respectively. Net income and dividends for 2 years for Subsidiary Company were as follows:

 

20X1 20X2
Net income $50,000 $90,000
Dividends 10,000 20,000

 

On January 1, 20X1, the only tangible assets of Subsidiary that were undervalued were inventory and building. Inventory, for which FIFO is used, was worth $5,000 more than cost. The inventory was sold in 20X1. Building, which was worth $15,000 more than book value, has a remaining life of 8 years, and straight-line depreciation is used. Any remaining excess is goodwill.

 

  1. Refer to Scenario 3-4.

 

Required:

  1. Prepare a value analysis schedule
  2. Prepare a determination and distribution of excess schedule

 

ANS:

a: Value analysis schedule

Company Implied Fair Value Parent Price NCI Value
Implied entity fair value       395,000 316,000 79,000
Fair value of entity net identifiable assets       370,000 296,000 74,000
Goodwill        25,000 20,000 5,000

 

  1. Determination and distribution schedule
Company Implied Fair Value Parent Price NCI Value
Fair value of subsidiary       395,000 316,000 79,000
Less book value:
C Stk         40,000
APIC       120,000
R/E       190,000
Total S/E       350,000 350,000 350,000
Interest Acquired      80%      20%
Book value 280,000            70,000
Excess of fair over book         45,000 36,000     9,000
Adjust identifiable accounts:  Life  Amort/Year
Inventory          5,000  [ FIFO; sold in Yr 1]
Building         15,000 8              1,875
Goodwill         25,000
Total         45,000

 

 

DIF:    M                   OBJ:   3-1 | 3-2 | 3-5

 

  1. Refer to Scenario 3-4.

Prepare Parent’s 20X1 and 20X2 journal entries (after the purchase has been recorded) to record the transactions related to its investment in Subsidiary under the

a. cost method
b. simple equity method

 

 

ANS:

  1. cost method journal entries:
20X1 20X2
Debit Credit Debit Credit
Cash 8,000 (1) 16,000 (2)
     Dividend Income 8,000 16,000
(1) 80% of $10,000 dividends
(2) 80% of $20,000 dividends

 

  1. simple equity method:
20X1 20X2
Debit Credit Debit Credit
Investment in Subsidiary 40,000 (1) 72,000 (2)
     Subsidiary Income 40,000 72,000
Cash 8,000 (3) 16,000 (4)
     Investment in Subsidiary 8,000 16,000
(1) 80% of $50,000 net income
(2) 80% of $90,000 net income
(3) 80% of $10,000 dividends
(4) 80% of $20,000 dividends

 

DIF:    M                   OBJ:   3-1

  1. Refer to Scenario 3-4.

Prepare Parent’s 20X1 and 20X2 journal entries (after the purchase has been recorded) to record the transactions related to its investment in Subsidiary under the sophisticated equity method.

 

ANS:

        20X1                 20X2       
Debit Credit Debit Credit
Investment in Subsidiary 34,500 (1) 70,500 (2)
     Subsidiary Income 34,500 70,500
Cash 8,000 (3) 16,000 (4)
     Investment in Subsidiary 8,000 16,000
(1) 80% of $50,000 net income less amortization of $5,500
(2) 80% of $90,000 net income less amortization of $1,500
(3) 80% of $10,000 dividends
(4) 80% of $20,000 dividends

 

Amortization: 20X1 20X2
    Inventory: $5,000 ´ 80% 4,000
    Building: $15,000 ´ 80% ÷ 8 years 1,500 1,500
$5,500 $1,500

 

 

DIF:    M                   OBJ:   3-1

 

  1. Refer to Scenario 3-4.

Prepare the necessary date alignment entries for the consolidating worksheet for December 31, 20X1 and December 31, 20X2 assuming that Parent records its investment in Subsidiary using

  1. the cost method
  2. the simple equity method

If date alignment entries are not required, give rationale.

 

ANS:

  1. elimination entries for cost method
       12/31/X1          12/31/X2    
CV Investment in Subsidiary n/a 32,000 [1]
   R/E-Parent n/a 32,000
CY2 Dividend Income  8,000 16,000
   Dividends Declared-Sub  8,000 16,000

n/a for first year: date alignment is automatic; the investment in subsidiary and the subsidiary retained earnings are both as of January 1, 20X1.

[1] (Sub RE 1/1/X2 – Sub RE 1/1/X1 = $40,000) ´ 80%

 

  1. elimination entries for simple equity method
  12/31/X1 12/31/X2
CY1 Subsidiary Income  40,000   72,000
   Investment in Subsidiary  40,000  72,000
CY2 Investment in Subsidiary   8,000  16,000
   Dividends Declared-Sub  8,000  16,000

 

DIF:    M                   OBJ:   3-3 | 3-2

  1. Refer to Scenario 3-4.

Prepare all necessary elimination entries for the consolidating worksheet of December 31, 20X1. Assume Parent uses the simple equity method of accounting for its investment in Subsidiary.

ANS:

CY1 Subsidiary Income    40,000
   Investment in Subsidiary 40,000
CY2 Investment in Subsidiary   8,000
   Dividends Declared-Sub  8,000
EL C Stk-Sub    32,000
APIC-Sub    96,000
R/E-Sub  152,000
   Investment in Sub  280,000
D Cost of Goods Sold   5,000
Building    15,000
Goodwill    25,000
   Investment in Sub 36,000
   R/E-Sub (NCI)   9,000
A Dep Exp   1,875
   A/D-Building  1,875

 

DIF:    M                   OBJ:   3-2 | 3-5

 

  1. Refer to Scenario 3-4.

Prepare all necessary elimination entries for the consolidating worksheet of December 31, 20X2. Assume Parent uses the simple equity method of accounting for its investment in Subsidiary.

ANS:

CY1 Subsidiary Income    72,000
   Investment in Subsidiary    72,000
CY2 Investment in Subsidiary    16,000
   Dividends Declared-Sub    16,000
EL C Stk-Sub    32,000
APIC-Sub    96,000
R/E-Sub  184,000
   Investment in Sub  312,000
D R/E-Sub (20% inventory)      1,000
R/E-Par (80% inventory)      4,000
Building    15,000
Goodwill    25,000
   Investment in Sub    36,000
   R/E-Sub (NCI)      9,000
A Dep Exp      1,875
R/E-Sub        375
R/E-Par      1,500
   A/D-Building (2 yrs)      3,750

 

DIF:    M                   OBJ:   3-2 | 3-5

  1. Refer to Scenario 3-4 and Worksheet 3-1.

Required:

  1. Complete the consolidating worksheet for December 31, 20X2.
  2. Prepare supportive Income Distribution Schedules for Subsidiary and Parent.

 

ANS:

  1. Consolidating worksheet December 31, 20X2
  2. Income distribution schedules:
Subsidiary Income Distribution
    Internally generated net income $90,000
    Building amortization    (1,875)
    Adjusted income 88,125
    Distribution to NCI    ´ 20%
    Noncontrolling share $17,625

 

Parent Income Distribution
    Internally generated net income $100,000
    Controlling share of subsidiary 70,500
    Total $170,500

 

DIF:    M                   OBJ:   3-2 | 3-5

 

  1. The Paris Company purchased an 80% interest in Seine, Inc. for $600,000 on July 1, 20X1, when Seine had the following balance sheet:
Assets
Accounts receivable $  50,000
Inventory 120,000
Land 80,000
Building 270,000
Equipment     80,000
     Total $600,000
Liabilities and Equity
Current liabilities $100,000
Common stock, $5 par 50,000
Paid-in capital in excess of par 150,000
Retained earnings (July 1)   300,000
     Total $600,000

 

The inventory is understated by $20,000 and is sold in the third quarter of 20X1. The building has a fair value of $320,000 and a 10-year remaining life. The equipment has a fair value of $120,000 and a remaining life of 5 years. Any remaining excess is attributed to goodwill.

 

From July 1 through December 31, 20X1, Seine had net income of $100,000 and paid $10,000 in dividends.

 

Assume that Paris uses the cost method to record its investment in Seine.

 

Required:

 

a. Prepare a determination and distribution of excess schedule as of July 1, 20X1.
b. Prepare the eliminations and adjustments that would be made on the December 31, 20X1, consolidated worksheet to eliminate the investment in Seine. Distribute and amortize any excess.

 

 

ANS:

  1. Determination and distribution of excess schedule as of July 1, 20X1:
Company Implied Fair Value Parent Price NCI Value
Fair value of subsidiary       750,000 600,000 150,000
Less book value:
C Stk    50,000
APIC  150,000
R/E  300,000
Total S/E  500,000  500,000 500,000
Interest Acquired 80% 20%
Book value    400,000   100,000
Excess of fair over book   250,000   200,000   50,000
Adjust identifiable accounts:  Life  Amort/Year
Inven    20,000  [sold in third quarter]
Building   50,000 10  5,000
Equipment  40,000 5  8,000
Goodwill   140,000
Total   250,000
  1. Eliminations and adjustments for the December 31, 20X1, consolidating worksheet
Debit Credit
CV Investment in Subsidiary* n/a
   R/E-Par n/a
CY2 Investment in Subsidiary  8,000
   Dividends Declared-Sub  8,000
EL C Stk-Sub  40,000
APIC-Sub  120,000
R/E-Sub  240,000
   Investment in Sub  400,000
D Cost of Goods Sold   20,000
Building  50,000
Equipment  40,000
Goodwill  140,000
   Investment in Sub  200,000
   R/E-Sub (NCI)    50,000
A Dep Exp   5,000
   A/D-Building  5,000
Dep Exp  8,000
     A/D-Equipment  8,000

*conversion from cost to simple equity not required at end of first year

 

DIF:    M                   OBJ:   3-3 | 3-5

  1. Dickinson Corporation is considering the acquisition of Williston Company through the acquisition of Williston’s common stock. Dickinson Corporation will issue 15,000 shares of its $5 par common stock, with a fair value of $30 per share, in exchange for all 10,000 outstanding shares of Williston Company’s voting common stock. The acquisition meets the criteria for a tax-free exchange as to the seller. Because of this, Dickinson Corporation will be limited for future tax returns to the book value of the depreciable assets. Dickinson Corporation falls into the 30% tax bracket. The appraisal of the assets of Williston Company shows that the inventory has a fair value of $120,000, and the depreciable fixed assets have a fair value of $250,000 and a 10-year life. Any remaining excess is attributed to goodwill. Williston Company has the following balance sheet just before the acquisition:

 

Williston Company
Balance Sheet
December 31, 20X1
Assets Liabilities & Equities
Cash  $  40,000 Current Liabilities  $  50,000
Accts Rec    150,000 Bonds Payable    100,000
Inventory    100,000 C Stk ($10 par)    100,000
Depreciable Assets    210,000 Retained Earnings    250,000
 $500,000  $500,000

 

Required:

a. Prepare a value analysis and a determination and distribution of excess schedule.
b. Prepare the elimination entries that would be made on the consolidated worksheet on the date of acquisition.

 

ANS:

  1. Value analysis and determination and distribution of excess schedule:
Company Implied Fair Value Parent Price
Implied entity fair value       450,000         450,000
Fair value of entity net identifiable assets [1]       392,000         392,000  
Goodwill         58,000           58,000  
[1] $350,000 + [($20,000 + $40,000) ´ 70%]
Company Implied Fair Value Parent Price
Fair value of subsidiary       450,000         450,000  
Less book value:
C Stk   100,000
APIC         –
R/E       250,000
Total S/E       350,000         350,000
Interest Acquired 100%  
Book value         350,000
Excess of fair over book       100,000         100,000  
Adjust identifiable accounts:  Life Annual Amort
Inventory  20,000 1
DTL   (6,000) 1
Building    40,000    10 4,000
DTL   (12,000)    10 (1,200)
Goodwill         58,000
Total       100,000
  1. Elimination entries on the date of acquisition.
EL C Stk-Sub   100,000
R/E-Sub   250,000
   Investment in Sub  350,000
D Inventory  20,000
Building   40,000
Goodwill   58,000
   DTL  18,000
   Investment in Sub 100,000

 

DIF:    M                   OBJ:   3-9

 

  1. The determination and distribution schedule for the consolidation of Petoskey (80% interest) and Sable reads in part:
Adjust identifiable accounts:  Life  Amort/Year
Inventory         20,000  [sold in third quarter]
Building         50,000 10 5,000
Equipment         40,000 5 8,000
Goodwill       140,000
Total       250,000

Prepare the elimination entries to distribute and amortize the excess purchase cost on

  1. 1/1/X1, the date of acquisition
  2. 12/31/X1, the end of the first year following the acquisition
  3. 12/31/X3, the end of the third year following the acquisition.

 

ANS:

  1. On date of acquisition
D Inventory    20,000
Building    50,000
Equipment    40,000
Goodwill  140,000
   Investment in Sub  200,000
   R/E-Sub (NCI)    50,000

 

  1. At the end of the first year following the acquisition
D Cost of Goods Sold    20,000
Building    50,000
Equipment    40,000
Goodwill  140,000
   Investment in Sub  200,000
   R/E-Sub (NCI)    50,000
A Dep Exp      5,000
   A/D-Building      5,000
Dep Exp      8,000
     A/D-Equipment      8,000
  1. at the end of the third year following the acquisition.
D R/E-Par (80% inven)    16,000
R/E-Sub (20% inven) 4,000
Building    50,000
Equipment    40,000
Goodwill  140,000
   Investment in Sub  200,000
   R/E-Sub (NCI)    50,000
A Dep Exp      5,000
Dep Exp      8,000
R/E-Par    20,800
R/E-Sub      5,200
   A/D-Building    15,000
     A/D-Equipment    24,000

 

 

DIF:    M                   OBJ:   3-5

Special Appendix 2—Equity Method for Unconsolidated Investments

 

MULTIPLE CHOICE

 

  1. For each of the following accounting methods, indicate how the investor’s investment account will be affected by the investor’s share of the investee’s earnings after the date of acquisition

 

Cost Method     Equity Method

a. No effect       No effect
b. Increase        Increase
c. Increase        No effect
d. No effect       Increase

 

 

ANS:  D                    DIF:    E

 

  1. On January 1, 20X1, Company P purchased a 30% interest in the Company S for $345,000. At that time, Company S had stockholders’ equity of $1,000,000. Any excess cost over book value was attributed to a patent with a 15-year life. During 20X1, Company S earned $60,000 and paid dividends of $15,000. What is the balance in the investment account on December 31, 20X1, using the sophisticated equity method?
a. $363,000
b. $360,000
c. $355,500
d. $349,500

 

 

ANS:  C                    DIF:    M

 

  1. Company P owns a 30% interest in Company S and accounts for the investment under the sophisticated equity method. The investment was purchased at underlying book value, and there is no excess of cost or book value. Company S sells merchandise to Company P at cost plus 25%. Intercompany sales during 20X1 were $100,000. There were $20,000 worth of such goods in Company P’s beginning inventory and $30,000 worth of such goods in Company P’s ending inventory. Company S’s reported income for 20X1 is $40,000, and no dividends were paid. What amount will Company P record as investment income in 20X1?
a. $12,000
b. $11,400
c. $9,750
d. $4,500

 

 

ANS:  B                    DIF:    M

 

  1. Company P Company uses the equity method to account for its January 1, 20X1, purchase of 30% of Company S’s common stock. On January 1, 20X1, the market values of Company S’s FIFO inventory and land exceed their book values. How do these excesses of market values over book values affect Company P’s reported equity in Company S’s 20X1 earnings?

 

Inventory Excess     Land Excess

a. Decrease             Decrease
b. Decrease             No effect
c. Increase             Increase
d. Increase             No effect

 

 

ANS:  B                    DIF:    E

 

  1. Company P purchased a 30% interest in Company S on January 1, 20X1, for $100,000. The price was equal to the book value of the equity acquired. The reported income (loss) and dividends paid by the Company S are as follows:
Income Dividends
Year    (loss)          Paid
20X1 $     5,000 $5,000
20X2 (270,000) 0
20X3 (100,000) 0
20X4 50,000 5,000

Investment income reported in 20X4 under the sophisticated equity method would be ____.

a. $15,000
b. $13,500
c. $4,000
d. $0

 

 

ANS:  C

Equity-Level Investment in Company S
DR (CR) Balance
initial investment 100,000
X1 income 1,500 101,500
X1 dividends (1,500) 100,000
X2 loss (81,000) 19,000
X3 loss (19,000) Memo: loss limited to investement balance; unrecognized loss is $11,000
X4 income 4,000 4,000 Memo: $15,000 share of income is reduced by cumulative unrecognized  loss of $11,000
X5 dividends (1,500) 2,500

 

 

DIF:    M

 

  1. Company P uses the sophisticated equity method of accounting for its 30% investment in Company S’s common stock. During 20X9, Company S reported net earnings of $650,000 and paid dividends of $150,000. Assume that all the undistributed earnings of Company S will be distributed as dividends in future periods. The dividends received from Company S are eligible for the 80% dividends received deduction. Company P’s 20X9, tax rate is 30%. Tax rates after 20X9 are 25%. In its December 31, 20X9, balance sheet, the increase in the deferred tax liability from these transactions would be ____.
a. $7,500
b. $9,000
c. $150,000
d. $30,000

 

 

ANS:  A                    DIF:    D

 

  1. Assume that Company P purchases a 10% common stock interest in Company S for $12,000 on January 1, 20X2, and an additional 20% interest on January 1, 20X3, for $26,000. There was no excess of cost or book value on either investment. The balance sheets of Company, S which pays no dividends, follow:
12/31/X3 12/31/X2 01/01/X2
Total assets $160,000 $130,000 $120,000
Common stock $100,000 $100,000 $100,000
Retained earnings     60,000     30,000     20,000
Total equity $160,000 $130,000 $120,000

For 20X3, Company P reports investment income of ____.

a. $18,000
b. $12,000
c. $9,000
d. $6,000

 

 

ANS:  C                    DIF:    M

 

  1. Company P acquired 30% of Company S’s common stock on January 1, 20X8, for $100,000. Company P’s 30% interest constitutes significant influence. There is no excess of cost over book value. During 20X8, Company S earned $40,000 and paid dividends of $25,000. During 20X9, Company S’s $50,000 income was earned evenly, and the company paid dividends of $15,000 on April 1 and $15,000 on October 1. On July 1, 20X9, Company P sold half of its interest in Company S for $66,000 cash; thus, Company P no longer had significant influence The gain on the sale of the investment in Company P’s 20X9 income statement should be ____.
a. $16,000
b. $13,700
c. $12,250
d. $10,000

 

 

ANS:  C                    DIF:    M

 

PROBLEM

 

  1. Company P purchased a 30% interest in Company S for $120,000 on January 1, 20X7, when Company S had the following stockholders’ equity:

 

Common stock ($10 par) $100,000
Paid-in capital in excess of par 200,000
Retained earnings (deficit)    (20,000)
Total $280,000

 

Any excess cost was due to equipment that is being depreciated over 5 years using straight-line depreciation.

 

Since the investment, Company P has consistently sold goods to Company S to realize a 30% gross profit. Such sales totaled $50,000 during 20X9. Company S had $10,000 of such goods in its beginning inventory and $40,000 in its ending inventory.

 

On January 1, 20X9, Company S sold a machine with a book value of $15,000 to Company P for $30,000. The machine has a 5-year life and is being depreciated on a straight-line basis.

 

Company S reported income of $75,000 before taxes for 20X9. Both firms are subject to a 30% corporate tax rate. Company S paid no dividends in 20X9. An 80% dividend earned exclusion rate applies.

 

Required:

Prepare all entries caused by Company P’s investment in Company S for 20X9 (including tax ramifications). Assume that Company P has recorded the tax on its internally generated income. Company P has properly recorded the investment in previous periods. Assume that sufficient previously recorded tax liability exists to offset any deferred tax expense.

 

ANS:

Determination and Distribution of Excess Schedule:

Price paid $120,000
Less interest acquired, $280,000  .3     84,000
Excess cost attributable to equipment (5-year life, $7,200 per year) $  36,000

 

Company S Company Income Distribution
Deferred gain on machine $15,000 Internally generated net income $75,000
Realized gain on machine 3,000
Adjusted income $63,000
Tax, 30%   18,900
After-tax income $44,100
Parent’s ownership interest        30%
Share of income $13,230
Less equipment depreciation   (7,200)
Company P’s share of income $  6,030

 

Investment in Company S 6,030
     Investment Income 6,030
Provision for Income Tax 794
     Deferred Tax Liability 794
          (20% × 30% × $13,230 – includes depreciation)
Sales Revenue 2,700
     Deferred Gross Profit 2,700
          ($30,000 net increase × .3 × .3)
Deferred Tax Liability 810
     Provision for Income Tax 810
          ($2,700 × 30%)

 

 

DIF:    D

 

ESSAY

 

  1. On January 1, 20X3, Company P purchased a 15% interest in Company S. On July 1, 20X6, Company P purchased an additional 20% interest in Company S. Both purchases were at a cost in excess of underlying book value. Company S paid dividends each December from 20X3 to 20X6.

Required:

a. How would Company P record its investment in Company S in its financial statements originally issued for 20X3 to 20X5?
b. Does a 35% ownership interest absolutely require the use of the equity method?
c. How will Company P account for its investment in Company S in its 20X6 financial statements?
d. How will Company P account for its investment in Company S in the 20X3 to 20X6 comparative statements published in March 20X7?

 

ANS:

a. The investment would be accounted for under the cost method. Only the dividends received would be recorded as income.
b. Ownership of 20% or more of the voting common shares of another firm presumes that the sophisticated equity method should be used. The investor may, however, assume the burden of showing that there is not effective influence. This could be the case if the investor is in a regulated industry or there is a powerful NCI, aside from Company P.
c. The 20% investment will be accounted for under the sophisticated equity method for the last 6 months of the year. The sophisticated equity method will also be used for the 15% interest for the entire year. The prior ownership interest is brought to its sophisticated equity balance retroactively.
d. The old 15% ownership interest will be accounted for retroactively under the sophisticated equity method. Thus, the 15% interest will be accounted for under the sophisticated equity method for all periods, 20X3 to 20X6.

 

 

DIF:    M