Ch 2 AA Consolidation of Financial Information: Questions

1. What is a business combination?

1. A business combination is the process of forming a single economic entity by the uniting of two or more organizations under common ownership. The term also refers to the entity that results from this process.

10. Sloane, Inc., issues 25,000 shares of its own common stock in exchange for all of the outstanding shares of Benjamin Company. Benjamin will remain a separately incorporated operation. How does Sloane record the issuance of these shares?

10. Shares issued are recorded at fair value as if the stock had been sold and the money obtained used to acquire the subsidiary. The Common Stock account is recorded at the par value of these shares with any excess amount attributed to additional paid-in capital.

11. To obtain all of the stock of Molly, Inc., Harrison Corporation issued its own common stock. Harrison had to pay $98,000 to lawyers, accountants, and a stock brokerage firm in connection with services rendered during the creation of this business combination. In addition, Harrison paid $56,000 in costs associated with the stock issuance. How will these two costs be recorded?

11. The direct combination costs of $98,000 are allocated to expense in the period in which they occur. Stock issue costs of $56,000 are treated as a reduction of APIC.

2. Describe the different types of legal arrangements that can take place to create a business combination.

2. (1) A statutory merger is created whenever two or more companies come together to form a business combination and only one remains in existence as an identifiable entity. This arrangement is often instituted by the acquisition of substantially all of an enterprise's assets. (2) A statutory merger can also be produced by the acquisition of a company's capital stock. This transaction is labeled a statutory merger if the acquired company transfers its assets and liabilities to the buyer and then legally dissolves as a corporation. (3) A statutory consolidation results when two or more companies transfer all of their assets or capital stock to a newly formed corporation. The original companies are being "consolidated" into the new entity. (4) A business combination is also formed whenever one company gains control over another through the acquisition of outstanding voting stock. Both companies retain their separate legal identities although the common ownership indicates that only a single economic entity exists.

3. What does the term consolidated financial statements mean?

3. Consolidated financial statements represent accounting information gathered from two or more separate companies. This data, although accumulated individually by the organizations, is brought together (or consolidated) to describe the single economic entity created by the business combination.

4. Within the consolidation process, what is the purpose of a worksheet?

4. Companies that form a business combination will often retain their separate legal identities as well as their individual accounting systems. In such cases, internal financial data continues to be accumulated by each organization. Separate financial reports may be required for outside shareholders (a noncontrolling interest), the government, debt holders, etc. This information may also be utilized in corporate evaluations and other decision making. However, the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity. The purpose of a worksheet is to organize and structure this process. The worksheet allows for a simulated consolidation to be carried out on a regular, periodic basis without affecting the financial records of the various component companies.

5. Jones Company obtains all of the common stock of Hudson, Inc., by issuing 50,000 shares of its own stock. Under these circumstances, why might the determination of a fair value for the consideration transferred be difficult?

5. Several situations can occur in which the fair value of the 50,000 shares being issued might be difficult to ascertain. These examples include: The shares may be newly issued (if Jones has just been created) so that no accurate value has yet been established; Jones may be a closely held corporation so that no fair value is available for its shares; The number of newly issued shares (especially if the amount is large in comparison to the quantity of previously outstanding shares) may cause the price of the stock to fluctuate widely so that no accurate fair value can be determined during a reasonable period of time; Jones' stock may have historically experienced drastic swings in price. Thus, a quoted figure at any specific point in time may not be an adequate or representative value for long-term accounting purposes.

6. What is the accounting valuation basis for consolidating assets and liabilities in a business combination?

6. For combinations resulting in complete ownership, the acquisition method allocates the fair value of the consideration transferred to the separately recognized assets acquired and liabilities assumed based on their individual fair values.

7. How should a parent consolidate its subsidiary's revenues and expenses?

7. The revenues and expenses (both current and past) of the parent are included within reported figures. However, the revenues and expenses of the subsidiary are consolidated from the date of the acquisition forward within the worksheet consolidation process. The operations of the subsidiary are only applicable to the business combination if earned subsequent to its creation.

8. Morgan Company acquires all of the outstanding shares of Jennings, Inc., for cash. Morgan transfers consideration more than the fair value of the company's net assets. How should the payment in excess of fair value be accounted for in the consolidation process?

8. Morgan's additional acquisition value may be attributed to many factors: expected synergies between Morgan's and Jennings' assets, favorable earnings projections, competitive bidding to acquire Jennings, etc. In general however, any amount paid by the parent company in excess of the fair values of the subsidiary's net assets acquired is reported as goodwill.

9. Catron Corporation is having liquidity problems, and as a result, it sells all of its outstanding stock to Lambert, Inc., for cash. Because of Catron's problems, Lambert is able to acquire this stock at less than the fair value of the company's net assets. How is this reduction in price accounted for within the consolidation process?

9. In the vast majority of cases the assets acquired and liabilities assumed in a business combination are recorded at their fair values. If the fair value of the consideration transferred (including any contingent consideration) is less than the total net fair value assigned to the assets acquired and liabilities assumed, then an ordinary gain on bargain purchase is recognized for the difference.