Recording Business Combinations

A business combination in the form of a legal acquisition results in establishing a parent-subsidiary relationship. True False

True

Goodwill recognized in a business combination must be assessed for impairment at least annually. True False

True

If a legal merger is appropriately accounted for using the acquisition method of accounting, it is possible to recognize goodwill at the time of the business combination. True False

True

The acquisition method of accounting must be used for all current combinations, regardless of legal form. True False

True

The entry to record a business combination that is a legal consolidation would include recognition of multiple assets acquired. True False

True

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 What is the balance in Seashell's additional retained earnings account immediately following its issuing common stock to effect the consolidation? A. $-0- B. $70,000 C. $195,000 D. $245,000

A. $-0- As a newly formed entity, Seashell will have no retained earnings until after an operating period. Seashell's shareholders' equity immediately following the consolidation will consist of the common stock issued (at par), $250,000, and additional paid-in capital, $245,000. Immediately after the consolidation, there will be no retained earnings.

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its newly authorized $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 Which one of the following is the amount of goodwill Seashell would recognize upon issuing its common stock to effect the consolidation? A. $-0- B. $50,000 C. $195,000 D. $245,000

A. $-0- Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the consideration given (common stock issued) is equal to the fair value of net assets acquired, and no goodwill is recognized.

On August 31, 2005, 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 purchase. What 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

A. $3,600,000 The cost of acquiring a company includes all cash and other assets distributed, liabilities incurred, and equity shares issued, all at fair value. Direct costs of carrying out a combination (such as accounting, legal, consulting, and finders' fees) are expensed in the period incurred; they are not included as part of the acquired entity. The cost of registering and issuing securities used to effect a business combination are charged against the fair value of the securities issued and, for equity securities, serve to reduce the amount of additional paid-in capital recognized. Thus, this correct answer ($3,600,000) was computed as 100,000 shares issued x $36 per share (fair market value) = $3,600,000. The $160,000 fees paid to a consultant would have been expensed, and the $80,000 cost of registering and issuing the common stock would have reduced the amount recognized from the sale of the stock.

On September 29, 1995, Wall Co. paid $860,000 for all of the issued and outstanding common stock of Hart Corp. On that date, the carrying amounts of Hart's recorded assets and liabilities were $800,000 and $180,000, respectively. Hart's recorded assets and liabilities had fair values of $840,000 and $140,000, respectively. In Wall's September 30, 1995, balance sheet, what amount should be reported as goodwill? A. $20,000 B. $160,000 C. $180,000 D. $240,000

B. $160,000 Goodwill is measured as the amount by which the cost of an investment in an entity exceeds the fair value of the net assets acquired. In this question, the cost of the investment is $860,000, and the fair value of net assets acquired is $700,000 ($840,000 - $700,000), resulting in goodwill of $160,000.

Plant Company acquired controlling interest in Seed Company in a legal acquisition. Which one of the following could not be part of the entry to record the acquisition? A. Debit: Investment in Seed Company. B. Debit: Goodwill. C. Credit: Cash D. Credit: Common stock

B. Debit: Goodwill. The entry that Plant will make to record its legal acquisition of Seed cannot include a debit to Goodwill. The entry Plant makes will debit (only) the Investment account and credit whatever form(s) of consideration is given (e.g., Cash, Bonds Payable, Common Stock, etc.). Goodwill cannot be debited at the time of the acquisition, though it may be recognized at the time of consolidation.

Pine Company acquired all of the assets and liabilities of Straw Company for cash in a legal merger. Which one of the following would not be recognized by Pine on its books in recording the business combination? A. Accounts receivable. B. Investment in Straw. C. Intangible asset - Patent. D. Accounts payable.

B. Investment in Straw. Pine will not recognize on its books an investment in Straw. Because the business combination is a legal merger, Pine recognizes on its books almost all of Straw's assets and liabilities, not an investment in Straw. There can be no investment in Straw, because Straw will cease to exist.

Sayon Co. issues 200,000 shares of $5 par value common stock to acquire Trask Co. in an acquisition-business combination. The market value of Sayon's common stock is $12 per share. Legal and consulting fees incurred in relation to the acquisition are $110,000. Registration and issuance costs for the common stock are $35,000. What should be recorded in Sayon's additional paid-in capital account for this business combination? A. $1,545,000 B. $1,400,000 C. $1,365,000 D. $1,255,000

C. $1,365,000 The calculation is: Fair value (200,000 sh. x $12/sh.) $2,400,000 Par value (200,000 sh. x $5/sh) (1,000,000) Gross additional paid-in capital $1,400,000 Less: Registration and issuance costs 35,000 Net additional paid-in capital $1,365,000 The legal and consulting fees ($110,000) were paid in cash and would be expensed in the period incurred. The registration and issuance costs of the common stock are properly deducted from the additional paid-in capital derived from the issuance of the stock.

Key Corp. issued 1,000 shares of its nonvoting preferred stock for all of Lev Corp.'s outstanding common stock. On the date of the transaction, Key's nonvoting preferred stock had a market value of $100 per share, and Lev's tangible net assets had a book value of $60,000. In addition, Key issued 100 shares of its nonvoting preferred stock to an individual as a finder's fee for arranging the transaction. As a result of this business combination capital transaction, Key's total net assets would increase by: A. $-0- B. $60,000 C. $100,000 D. $110,000

C. $100,000 Net assets would increase by $100,000 as a result of Key issuing 1,000 shares of preferred stock with a market value of $100 per share (1,000 shares x $100 = $100,000). The $10,000 finder's fee (100 shares x $100 per share = $10,000) would be expensed in the period incurred, not capitalized as part of the cost of the combination. Thus, net assets would increase by $100,000.

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 Which of the following is the balance in Seashell's additional paid-in capital account immediately following its issuing common stock to effect the consolidation? A. $-0- B. $50,000 C. $125,000 D. $245,000

D. $245,000 Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the fair value of the stock issued is equal to the fair value (and book value) of the net assets acquired (i.e., A - L = SE), or $495,000. The par value of the stock issued is $250,000 (25,000 x $10). Therefore, additional paid-in capital is $495,000 - $250,000 = $245,000.

Under which one of the following circumstances will goodwill be recognized in a business combination carried out as a legal merger? A. Book value of net assets acquired > Cost of investment. B. Fair value of net assets acquired > Book value of net assets acquired. C. Fair value of net assets acquired > Cost of investment. D. Fair value of net assets acquired < Cost of investment.

D. Fair value of net assets acquired < Cost of investment. Goodwill is recognized when the cost of the investment is greater than the fair value of net assets acquired (= the fair value of net assets acquired is less than the cost of the investment). In a legal merger, the goodwill would be recognized on the books of the surviving firm at the time of the business combination.

Company L acquired all of the outstanding common stock of Company M in exchange for cash. The acquisition price exceeds the fair value of net assets acquired. How should Company L determine the amounts to be reported for the plant and equipment and long-term debt acquired from Company M? Plant and Equipment Long-Term Debt Fair Value M's Carrying Amount Fair Value Fair Value M's Carrying Amount Fair Value M's Carrying Amount M's Carrying Amount

Fair Value Fair Value When the required acquisition method of accounting is used to record a business combination, all acquired assets and liabilities should be reported at fair value. Therefore, both plant and equipment and long-term debt should be reported at fair value.

A business combination in the form of a legal acquisition can be carried out only if the acquiring firm issues its stock to acquire the other firm. True False

False

A business combination in the form of a legal merger results in establishing a parent-subsidiary relationship. True False

False

A legal consolidation, accounted for using the acquisition method of accounting, will result in the need to prepare consolidated financial statements. True False

False

A legal merger accounted for using the acquisition method of accounting will result in the need to prepare consolidated financial statements. True False

False

Goodwill recognized in a legal consolidation must be amortized over its expected life. True False

False

If a legal acquisition is appropriately accounted for as an acquisition, the investor will record on its books the individual assets and liabilities of the investee. True False

False

The assets recognized by the acquiring firm in a business combination that is a legal merger would include goodwill previously recognized by the acquired firm. True False

False

The entry to record a business combination that is a legal acquisition could include a debit to recognize goodwill. True False

False