18: Business Combinations & Consolidations
3. On August 31, year 1, Wood Corp. issued 100,000 shares of its $20 par value common stock for the net assets of Pine, Inc., in a business combination accounted for by the acquisition method. The market value of Wood's common stock on August 31 was $36 per share. Wood paid a fee of $160,000 to the consultant who arranged this acquisition. Costs of registering and issuing the equity securities amounted to $80,000. No goodwill was involved in the acquisition. What amount should Wood capitalize as the cost of acquiring Pine's net assets? a. $3,600,000 b. $3,680,000 c. $3,760,000 d. $3,840,000
Correct Answer: A) $3,600,000 Notes (a) In a business combination accounted for as an acquisition, the fair market value of the net assets is used as the valuation basis for the combination. In this case, the net assets of the subsidiary have an implied fair market value of $3,600,000 which is the value of the common stock issued to Pine's shareholders (100,000 shares × $36). The direct cost of acquisition should not be included as part of the cost of a company acquired, and the cost of registering equity securities should be a reduction of the issue price of the securities (i.e., additional paid-in capital). Thus, the $160,000 paid for a consultant who arranged the acquisition should be expensed, and the $80,000 cost for registering and issuing the equity securities should be treated as a reduction of additional paid-in capital. Answer (a) is correct because the total amount to be capitalized is $3,600,000.
78. Under IFRS the asset goodwill may be recognized a. When it is acquired by purchase. b. When it is internally generated or acquired by purchase. c. When it is clear that it exists and has value. d. When it has future economic benefits.
Correct Answer: A) When it is acquired by purchase. Notes (a) The requirement is to identify the statement that correctly describes how goodwill may be recognized under IFRS. Answer (a) is correct because goodwill can only be recognized if it is acquired by purchase.
60. On January 2, year 1, Pare Co. purchased 75% of Kidd Co.'s outstanding common stock. On that date, the fair value of the 25% noncontrolling interest was $35,000. During year 1, Kidd had net income of $20,000. Selected balance sheet data at December 31, year 1, is as follows: Pare: Total Assets: $420,000 Liabilities: $120,000 Common Stock: $100,000 Retained Earnings: $200,000 Kidd: Total Assets: $180,000 Liabilities: $60,000 Common Stock: $50,000 Retained Earnings: $70,000 During year 1 Pare and Kidd paid cash dividends of $25,000 and $5,000, respectively, to their shareholders. There were no other intercompany transactions. In its December 31, year 1 consolidated balance sheet, what amount should Pare report as common stock? a. $50,000 b. $100,000 c. $137,500 d. $150,000
Correct Answer: B) $100,000 Notes (b) In the consolidated balance sheet, neither the parent company's investment account nor the subsidiary's stockholders' equity is reported. These amounts are eliminated in the same journal entry that records the excess of cost over book value. The portion of the subsidiary's stockholders' equity that is not eliminated is reported as noncontrolling interest. Therefore, the amount reported as common stock in the 12/31/Y1 consolidated balance sheet consists solely of Pare's common stock ($100,000). Kidd's common stock ($50,000) is eliminated along with the rest of its stockholders' equity.
55. Planet Company acquired a 70% interest in the Star Company in year 1. For the year ended December 31, year 2, Star reported net income of $80,000. During year 2, Planet sold merchandise to Star for $10,000 at a profit of $2,000. The merchandise remained in Star's inventory at the end of year 2. For consolidation purposes what is the noncontrolling interest's share of Star's net income for year 2? a. $23,400 b. $24,000 c. $24,600 d. $26,000
Correct Answer: B) $24,000 Notes (b) Because Planet owns 70% interest in Star, the noncontrolling interest in star is 30%. Therefore, the noncontrolling interest's share in Star's net income of $80,000 is 30% × $80,000 = $24,000. Planet's sale of merchandise to Star for $10,000 will be eliminated on the consolidated worksheet, and Planet's income will be reduced by the intercompany profit of $2,000. This will not affect the noncontrolling interest's share of income because it was a downstream sale from the parent to the subsidiary and is eliminated by the parent.
7. Consolidated financial statements are typically prepared when one company has a controlling financial interest in another unless a. The subsidiary is a finance company. b. The fiscal year-ends of the two companies are more than three months apart. c. The investee is in bankruptcy. d. The two companies are in unrelated industries, such as manufacturing and real estate.
Correct Answer: C) The investee is in bankruptcy. Notes (c) A subsidiary should not be consolidated when it is in bankruptcy. Consolidation of all majority-owned subsidiaries is required regardless of the industry or business of the subsidiary. A difference in fiscal periods of a parent and a subsidiary does not of itself justify the exclusion of the subsidiary from consolidation.
58. On January 2, year 1, Pare Co. purchased 75% of Kidd Co.'s outstanding common stock. On that date, the fair value of the 25% noncontrolling interest was $35,000. During year 1, Kidd had net income of $20,000. Selected balance sheet data at December 31, year 1, is as follows: Pare: Total Assets: $420,000 Liabilities: $120,000 Common Stock: $100,000 Retained Earnings: $200,000 Kidd: Total Assets: $180,000 Liabilities: $60,000 Common Stock: $50,000 Retained Earnings: $70,000 During year 1 Pare and Kidd paid cash dividends of $25,000 and $5,000, respectively, to their shareholders. There were no other intercompany transactions. In its December 31, year 1 consolidated statement of retained earnings, what amount should Pare report as dividends paid? a. $5,000 b. $25,000 c. $26,250 d. $30,000
Correct Answer: B) $25,000 Notes (b) Pare paid cash dividends of $25,000 and Kidd, the 75%-owned subsidiary, paid cash dividends of $5,000. The dividends paid by Pare are all payments to owners of the consolidated company and are reported as dividends paid in the consolidated statement of retained earnings. The $5,000 dividend paid by Kidd is paid 75% to Pare, and 25% to outside parties (the noncontrolling interest in Kidd's stock). The 75% share to Pare is eliminated when determining consolidated dividends declared because it is an intracompany transaction. The remaining 25% to the noncontrolling interest is likewise not included in consolidated dividends declared because, from the parent company's point of view, subsidiary dividends do not represent dividends of the consolidated entity.
8. On January 1, year 1, Lake Corporation acquired 100% of the outstanding common stock of Shore Corporation for $800,000. On the date of acquisition, the fair value of Shore's net identifiable assets is $820,000. The book value of Shore Corporation's net assets is $760,000. In Lake's year 1 financial statements, Lake should recognize a. Goodwill on the balance sheet. b. A gain from bargain purchase. c. A reduction in certain noncurrent assets on the balance sheet. d. An extraordinary gain.
Correct Answer: B) A gain from bargain purchase. Notes (b) The consideration paid plus the fair value of the noncontrolling interest plus the fair value of any previous purchases of common stock is less than the fair value of the net identifiable assets acquired, the acquirer should recognize a gain from bargain purchase on the income statement. The gain would be equal to $20,000 ($820,000 - 800,000). Answer (a) is incorrect because goodwill is only recognized when the purchase price is greater than the fair value of the recorded assets. Answer (c) is incorrect because it describes an inappropriate method. Answer (d) is incorrect because the gain is not treated as extraordinary.
2. Which of the following expenses related to the business acquisition should be included, in total, in the determination of net income of the combined corporation for the period in which the expenses are incurred? I. Fees of finders and consultants II. Registration fees for equity securities issued a. Both I and II b. I only c. II only d. Neither I nor II
Correct Answer: B) I only Notes (b) Acquisition costs such as finder's fees are expensed in the period incurred. Registration fees for equity securities are a reduction in the issue price of the securities. Therefore, answer (b) is correct.
Question 3: 59. On January 2, year 1, Pare Co. purchased 75% of Kidd Co.'s outstanding common stock. On that date, the fair value of the 25% noncontrolling interest was $35,000. During year 1, Kidd had net income of $20,000. Selected balance sheet data at December 31, year 1, is as follows: Pare: Total Assets: $420,000 Liabilities: $120,000 Common Stock: $100,000 Retained Earnings: $200,000 Kidd: Total Assets: $180,000 Liabilities: $60,000 Common Stock: $50,000 Retained Earnings: $70,000 During year 1 Pare and Kidd paid cash dividends of $25,000 and $5,000, respectively, to their shareholders. There were no other intercompany transactions. In Pare's December 31, year 1 consolidated balance sheet, what amount should be reported as noncontrolling interest in net assets? a. $30,000 b. $35,000 c. $38,750 d. $40,000
Correct Answer: C) $38,750 Notes (c) The percentage of the subsidiary's stockholders' equity not owned by the parent represents the noncontrolling interest's share of the fair value of net assets of the subsidiary. The fair value of the noncontrolling interest is measured at the acquisition date, and adjusted in future periods for the portion of the acquiree's income and dividends attributable to the noncontrolling interest. Therefore, the noncontrolling interest at 12/31/Y1 is calculated as follows: FV of noncontrolling interests: $35,000 + Share of net income ($20,000 x 25%): $ 5,000 - Share of dividends ($5,000 x 25%): ($ 1,250) Equals 12/31/Y1 noncontrolling interest: $38,750
6. On December 31, year 1, Neal Co. issued 100,000 shares of its $10 par value common stock in exchange for all of Frey Inc.'s outstanding stock. The fair value of Neal's common stock on December 31, year 1, was $19 per share. Carrying Amounts: Cash: $240,000 Receivables: $270,000 Inventory: $435,000 PP&E: $1,305,000 Liabilities: ($525,000) Equals - Net Assets: $1,725,000 Fair Values: Cash: $240,000 Receivables: $270,000 Inventory: $405,000 PP&E: $1,440,000 Liabilities: ($525,000) Equals - Net Assets: $1,830,000 The carrying amounts and fair values of Frey's assets and liabilities on December 31, year 1, were as follows: What is the amount of goodwill resulting from the business combination? a. $175,000 b. $105,000 c. $70,000 d. $0
Correct Answer: C) $70,000 Notes (c) In a business combination accounted for as an acquisition, the fair market value of the net assets is used as the valuation basis for the combination. In this case, Frey's assets have an implied fair market value of $1,900,000 which is the market value of the common stock issue (100,000 shares × $19). The value assigned to goodwill is $70,000, which is the value of the stock minus the fair value of Frey's identifiable assets ($1,900,000 - $1,830,000).
22. On April 1, year 1, Parson Corp. purchased 80% of the outstanding stock of Sloan Corp. for $700,000 cash. Parson determined that the fair value of the net identifiable assets was $800,000 on the date of acquisition. The fair value of Sloan's stock at date of acquisition was $18 per share. Sloan had a total of 50,000 shares of stock issued and outstanding prior to the acquisition. What is the amount of goodwill that should be recorded by Parson at date of acquisition? a. $0 b. $60,000 c. $80,000 d. $120,000
Correct Answer: C) $80,000 Notes $700,000 +180,000 -800,000 Equals: $80,000
79. Under IFRS a parent may exclude a subsidiary from consolidation only if all of the following conditions exist, except a. It is wholly or partially owned and its owners do not object to nonconsolidation. b. It does not have any debt or equity instruments publicly traded. c. It has one class of stock. d. Its parent prepares consolidated financial statements that comply with IFRS.
Correct Answer: C) It has one class of stock. Notes (c) The requirement is to identify the item that is not a condition to exclude a subsidiary from consolidation under IFRS. Answer (c) is correct because it is not required that the subsidiary have only one class of stock.
57. On January 1, year 1, Ritt Corp. purchased 80% of Shaw Corp.'s $10 par common stock for $975,000. On this date, the carrying amount of Shaw's net assets was $1,000,000. The fair values of Shaw's identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) with fair values of $100,000 in excess of their carrying amount. The fair value of the noncontrolling interest in Shaw on January 1, year 1, was $250,000. For the year ended December 31, year 1, Shaw had net income of $190,000 and paid cash dividends totaling $125,000. In the December 31, year 1 consolidated balance sheet, noncontrolling interest should be reported at a. $200,000 b. $213,000 c. $233,000
Correct Answer: D) $263,000 Notes (d) The percentage of the subsidiary's stockholders' equity not owned by the parent represents the noncontrolling interest's share of the fair value of net assets of the subsidiary. The fair value of the noncontrolling interest is measured at the acquisition date, and adjusted in future periods for the portion of the acquiree's income and dividends attributable to the noncontrolling interest. Therefore, the noncontrolling interest at 12/31/Y1 is calculated as follows: FV of noncontrolling interests: $250,000 + Share of net income ($190,000 x 20%): $ 38,000 - Share of dividends ($125,000 x 20%): ($ 25,000) Equals 12/31/Y1 noncontrolling interest: $263,000