Chapter 1

BUSINESS COMBINATIONS

Answers to Questions

1 A business combination is a union of business entities in which two or more previously separate and
independent companies are brought under the control of a single management team. FASB Statement No.
141R describes three situations that establish the control necessary for a business combination, namely,
when one or more corporations become subsidiaries, when one company transfers its net assets to
another, and when each combining company transfers its net assets to a newly formed corporation.

2 The dissolution of all but one of the separate legal entities is not necessary for a business combination.
An example of one form of business combination in which the separate legal entities are not dissolved is
when one corporation becomes a subsidiary of another. In the case of a parent-subsidiary relationship,
each combining company continues to exist as a separate legal entity even though both companies are
under the control of a single management team.

3 A business combination occurs when two or more previously separate and independent companies are
brought under the control of a single management team. Merger and consolidation in a generic sense are
frequently used as synonyms for the term business combination. In a technical sense, however, a merger
is a type of business combination in which all but one of the combining entities are dissolved and a
consolidation is a type of business combination in which a new corporation is formed to take over the
assets of two or more previously separate companies and all of the combining companies are dissolved.

4 Goodwill arises in a business combination accounted for under the acquisition method when the cost of
the investment (fair value of the consideration transferred) exceeds the fair value of identifiable net assets
acquired. Under FASB Statement No. 142, goodwill is no longer amortized for financial reporting
purposes and will have no effect on net income, unless the goodwill is deemed to be impaired. If
goodwill is impaired, a loss will be reocnized.

5 A bargain purchase occurs when the acquisition price is less than the fair value of the identifiable net
assets acquired. The acquirer records the gain from a bargain purchase amount as an extraordinary gain
during the period of the acquisition, under FASB Statement No. 141R.

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1-1
1-2 Business Combinations
SOLUTIONS TO EXERCISES

Solution E1-1

1 a
2 b
3 a
4 a
5 d

Solution E1-2 [AICPA adapted]

1 a
Plant and equipment should be recorded at the $55,000 fair value.

2 c
Investment cost $800,000

Less: Fair value of net assets

Cash $ 80,000
Inventory 190,000
Property and equipment — net 560,000
Liabilities (180,000) 650,000
Goodwill $150,000

Solution E1-3

Stockholders’ equity — Pillow Corporation on January 3

Capital stock, $10 par, 300,000 shares outstanding $3,000,000

Additional paid-in capital

[$200,000 + $1,500,000 – $5,000] 1,695,000

Retained earnings 600,000

Total stockholders’ equity $5,295,000

Entry to record combination

Investment in Sleep-bank 3,000,000

Capital stock, $10 par 1,500,000
Additional paid-in capital 1,500,000

Investment expense 10,000

Additional paid-in capital 5,000
Cash 15,000

Check: Net assets per books $3,800,000

Goodwill 1,510,000
Less: Expense of direct costs (10,000)
Less: Issuance of stock (5,000)
$5,295,000

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Chapter 1 1-3

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1-4 Business Combinations
Solution E1-4

Journal entries on IceAge’s books to record the acquisition

Investment in Jester 2,550,000

Common stock, $10 par 1,200,000
Additional paid-in capital 1,350,000
To record issuance of 120,000 shares of $10 par common stock with a fair
value of $2,550,000 for the common stock of Jester in a business
combination.

Additional paid-in capital 15,000

Investment expenses 45,000
Other assets 60,000
To record costs of registering and issuing securities as a reduction of paid-
in capital, and record direct and indirect costs of combination as
expenses.

Current assets 1,100,000

Plant assets 2,200,000
Liabilities 300,000
Investment in Jester 3,000,000
To record allocation of the $2,550,000 cost of Jester Company to identifiable
assets and liabilities according to their fair values, computed as
follows:
Cost $2,550,000
Fair value acquired 3,000,000
Bargain purchase amount $ 450,000

Investment in Jester 450,000

Gain from bargain purchase 450,000
To record gain from bargain purchase.

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Chapter 1 1-5
Solution E1-5

Journal entries on the books of Danders Corporation to record merger with

Harrison Corporation

Investment in Harrison 530,000

Common stock, $10 par 180,000
Additional paid-in capital 150,000
Cash 200,000
To record issuance of 18,000 common shares and payment of cash in the
acquisition of Harrison Corporation in a merger.

Investment expenses 70,000

Additional paid-in capital 30,000
Cash 100,000
To record costs of registering and issuing securities and additional
direct costs of combination.

Cash 40,000
Inventories 100,000
Other current assets 20,000
Plant assets — net 280,000
Goodwill 160,000
Current liabilities 30,000
Other liabilities 40,000
Investment in Harrison 530,000
To record allocation of cost to assets received and liabilities assumed
on the basis of their fair values and to goodwill computed as follows:

Cost of investment $530,000

Fair value of assets acquired 370,000
Goodwill $160,000

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1-6 Business Combinations
SOLUTIONS TO PROBLEMS

Solution P1-1

Preliminary computations
Fair Value: Cost of investment in Sain at January 2
(30,000 shares ´ $20) $600,000
Book value (440,000)
Excess fair value over book value $160,000

Excess allocated to:

Current assets $ 40,000
Remainder to goodwill 120,000
Excess fair value over book value $160,000

Note: $25,000 direct costs of combination are expensed. The

excess fair value of Pine’s buildings is not considered.

Pine Corporation
Balance Sheet at January 2, 2009

Assets

Current assets
($130,000 + $60,000 + $40,000 excess - $40,000 direct costs) $ 190,000

Land ($50,000 + $100,000) 150,000

Buildings — net ($300,000 + $100,000) 400,000

Equipment — net ($220,000 + $240,000) 460,000

Goodwill 120,000
Total assets $1,320,000

Liabilities and Stockholders’ Equity

Current liabilities ($50,000 + $60,000) $ 110,000

Common stock, $10 par ($500,000 + $300,000) 800,000

Additional paid-in capital

[$50,000 + ($10 ´ 30,000 shares) — $15,000 costs of issuing 335,000
and registering securities]

Retained earnings (subtract $25,000 expensed direct cost) 75,000

Total liabilities and stockholders’ equity $1,320,000

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Chapter 1 1-7
Solution P1-2

Preliminary computations
Fair Value: Cost of acquiring Seabird $825,000
Fair value of assets acquired and liabilities assumed 670,000
Goodwill from acquisition of Seabird $155,000

Pelican Corporation
Balance Sheet
at January 2, 2009

Assets

Current assets

Cash [$150,000 + $30,000 - $140,000 expenses paid] $ 40,000

Accounts receivable — net [$230,000 + $40,000 fair value] 270,000

Inventories [$520,000 + $120,000 fair value] 640,000

Plant assets

Land [$400,000 + $150,000 fair value] 550,000

Buildings — net [$1,000,000 + $300,000 fair value] 1,300,000

Equipment — net [$500,000 + $250,000 fair value] 750,000

Goodwill 155,000
Total assets $3,705,000

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable [$300,000 + $40,000] $ 340,000

Note payable [$600,000 + $180,000 fair value] 780,000

Stockholders’ equity

Capital stock, $10 par [$800,000 + (33,000 shares ´ $10)] 1,130,000

Other paid-in capital

[$600,000 - $40,000 + ($825,000 - $330,000)] 1,055,000

Retained earnings (subtract $100,000 expensed direct costs) 400,000

Total liabilities and stockholders’ equity $3,705,000

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1-8 Business Combinations
Solution P1-3

Persis issues 25,000 shares of stock for Sineco’s outstanding shares

1a Investment in Sineco 750,000

Capital stock, $10 par 250,000
Other paid-in capital 500,000
To record issuance of 25,000, $10 par shares with a market price
of $30 per share in a business combination with Sineco.
Investment expenses 30,000
Other paid-in capital 20,000
Cash 50,000
To record costs of combination in a business combination with
Sineco.
Cash 10,000
Inventories 60,000
Other current assets 100,000
Land 100,000
Plant and equipment — net 350,000
Goodwill 180,000
Liabilities 50,000
Investment in Sineco 750,000

To record allocation of investment cost to identifiable assets and

liabilities according to their fair values and the remainder to
goodwill. Goodwill is computed: $750,000 cost - $570,000 fair
value of net assets acquired.

1b Persis Corporation
Balance Sheet
January 2, 2009
(after business combination)

Assets
Cash [$70,000 + $10,000] $ 80,000
Inventories [$50,000 + $60,000] 110,000
Other current assets [$100,000 + $100,000] 200,000
Land [$80,000 + $100,000] 180,000
Plant and equipment — net [$650,000 + $350,000] 1,000,000
Goodwill 160,000
Total assets $1,750,000

Liabilities and Stockholders’ Equity

Liabilities [$200,000 + $50,000] $ 250,000
Capital stock, $10 par [$500,000 + $250,000] 750,000
Other paid-in capital [$200,000 + $500,000 - $20,000] 680,000
Retained earnings (subtract $30,000 direct costs) 70,000
Total liabilities and stockholders’ equity $1,750,000

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Chapter 1 1-9
Solution P1-3 (continued)

Persis issues 15,000 shares of stock for Sineco’s outstanding shares

2a Investment in Sineco (15,000 shares ´ $30) 450,000

Capital stock, $10 par 150,000
Other paid-in capital 300,000
To record issuance of 15,000, $10 par common shares with a market
price of $30 per share.
Investment expense 30,000
Other paid-in capital 20,000
Cash 50,000
To record costs of combination in the acquisition of Sineco.
Cash 10,000
Inventories 60,000
Other current assets 100,000
Land 100,000
Plant and equipment — net 350,000
Liabilities 50,000
Investment in Sineco 570,000
To record Sineco’s net assets at fair values.
Investment in Sineco 120,000
Gain on bargain purchase 120,000
To record gain on bargain purchase and adjust Investment in
Sineco to reflect total fair value.

Fair value of net assets acquired $570,000

Investment cost (Fair value of consideration) 450,000
Gain on Bargain Purchase $120,000

2b Persis Corporation
Balance Sheet
January 2, 2009
(after business combination)

Assets
Cash [$70,000 + $10,000] $ 80,000
Inventories [$50,000 + $60,000] 110,000
Other current assets [$100,000 + $100,000] 200,000
Land [$80,000 + $100,000] 180,000
Plant and equipment — net [$650,000 + $350,000] 1,000,000
Total assets $1,570,000

Liabilities and stockholders’ equity

Liabilities [$200,000 + $50,000] $ 250,000
Capital stock, $10 par [$500,000 + $150,000] 650,000
Other paid-in capital [$200,000 + $300,000 - $20,000] 480,000
Retained earnings (subtract $30,000 direct costs 190,000
and add $120,000 Gain from bargain purchase)
Total liabilities and stockholders’ equity $1,570,000

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1-10 Business Combinations
Solution P1-4

1 Schedule to allocate investment cost to assets and liabilities

Investment cost (fair value), January 1 $300,000

Fair value acquired from Sen ($360,000 ´ 100%) 360,000
Excess fair value over cost (bargain purchase gain) $ 60,000

Allocation:

Allocation
Cash $ 10,000
Receivables — net 20,000
Inventories 30,000
Land 100,000
Buildings — net 150,000
Equipment — net 150,000
Accounts payable (30,000)
Other liabilities (70,000)
Gain on bargain purchase (60,000)
Totals $ 300,000

2 Phule Corporation
Balance Sheet
at January 1, 2009
(after combination)
Assets Liabilities

Cash $ 25,000 Accounts payable $ 120,000

Receivables — net 60,000 Note payable (5 years) 200,000
Inventories 150,000 Other liabilities 170,000
Land 145,000 Liabilities 490,000
Buildings — net 350,000
Equipment — net 330,000 Stockholders’ Equity

Capital stock, $10 par 300,000

Other paid-in capital 100,000
Retained earnings* 170,000
Stockholders’ equity 510,000
Total assets $1,060,000 Total equities $1,060,000

* Retained earnings reflects the $60,000 gain on the bargain purchase.

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Chapter 1 1-11
Solution P1-5

1 Journal entries to record the acquisition of Dawn Corporation

Investment in Dawn 2,500,000

Capital stock, $10 par 1,000,000
Other paid-in capital 1,000,000
Cash 500,000
To record acquisition of Dawn for 100,000 shares of common stock
and $500,000 cash.
Investment expense 100,000
Other paid-in capital 50,000
Cash 150,000
To record payment of costs to register and issue the shares of
stock ($50,000) and other costs of combination ($100,000).
Cash 240,000
Accounts receivable 360,000
Notes receivable 300,000
Inventories 500,000
Other current assets 200,000
Land 200,000
Buildings 1,200,000
Equipment 600,000
Accounts payable 300,000
Mortgage payable, 10% 600,000
Investment in Dawn 2,700,000
To record the net assets of Dawn at fair value.
Investment in Dawn 200,000
Gain on bargain purchase 200,000
To adjust Investment account to total fair value and recognize
the gain from the bargain purchase.

Gain on Bargain Purchase Calculation

Acquisition price $2,500,000
Fair value of net assets acquired 2,700,000
Gain on bargain purchase $ 200,000

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1-12 Business Combinations
Solution P1-5 (continued)

2 Celistia Corporation
Balance Sheet
at January 2, 2009
(after business combination)

Assets
Current Assets
Cash $ 2,590,000
Accounts receivable — net 1,660,000
Notes receivable — net 1,800,000
Inventories 3,000,000
Other current assets 900,000 $ 9,950,000

Plant Assets
Land $ 2,200,000
Buildings — net 10,200,000
Equipment — net 10,600,000 23,000,000
Total assets $32,950,000

Liabilities and Stockholders’ Equity

Liabilities
Accounts payable $ 1,300,000
Mortgage payable, 10% 5,600,000 $ 6,900,000

Stockholders’ Equity
Capital stock, $10 par $11,000,000
Other paid-in capital 8,950,000
Retained earnings* 6,000,000 26,050,000
Total liabilities and stockholders’ equity $32,950,000

* Subtract $100,000 direct combination costs and add $200,000 gain on bargain
purchase.

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Chapter 1 1-13
RESEARCH CASE

1. Journal entry to record the acquisition (in millions of $)

Investment in Target 50,000

Common stock, $0.10 par 100
Additional paid-in capital 49,900
To record acquisition of Target for 1 billion shares of common
stock having a fair value of $50 per share.
Cash 240,000
Accounts receivable 360,000
Notes receivable 300,000
Inventories 500,000
Other current assets 200,000
Land 190,000
Buildings 1,140,000
Equipment 570,000
Accounts payable 300,000
Mortgage payable, 10% 600,000
Investment in Target 2,600,000
Assign the excess of fair value over book value of assets and
liabilities as shown in the following allocation schedule:
Acquisition price $50,000
Excess fair value of assets acquired
Inventory (10%) 625
Land (20%) 987
Buildings and improvements (20%) 3,222
Fixtures and equipment (20%) 711
Computer hardware and software (20%) 438
21,859
Goodwill $ 28,141

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1-14 Business Combinations
2. Consolidated Balance Sheet at January 31, 2007

WAL- CONSOLI-
(millions, except footnotes)   MART TARGET DR CR DATED
Assets            
Cash and cash equivalents   7,373 813     8,186
Accounts receivable, net   2,840 6,194     9,034
Inventory   33,685 6,254 625   40,564
Other current assets   2,690 1,445     4,135
Total current assets   46,588 14,706     61,294
Property and equipment            
Land   18,612 4,934 987   24,533
Buildings and improvements   64,052 16,110 3,222   83,384
Fixtures and equipment   25,168 3,553 711   29,432
Computer hardware and software     2,188 438   2,626
Construction-in-progress     1,596     1,596
Transportation equipment   1,966       1,966
Accumulated depreciation   (24,408) (6,950)     (31,358)
Property and equipment, net   85,390 21,431     106,821
Property Under Capital Lease   5,392       5,392
Less: Accumulated amortization   (2,342)       (2,342)
Property Under Lease - net   3,050       3,050
Goodwill   13,759   28,141   41,900
Investment in Target   50,000     50,000 0
Other non-current assets   2,406 1,212     3,618
Total assets   201,193 37,349     238,542

             
Liabilities and shareholders' investment            
Commercial Paper   2,570       2,570
Accounts payable   28,090 6,575     34,665
Accrued and other current liabilities   14,675 2,758     17,433
Income taxes payable   706 422     1,128
Current portion of long-term debt and notes payable 5,428 1,362     6,790
Current obligations capital leases   285       285
             
Total current liabilities   51,754 11,117     62,871
             
Long-term debt   27,222 8,675     35,897
Long term capital leases   3,513       3,513
Deferred income taxes   4,971 577     5,548
Noncontrolling Interest   2,160       2,160
Other non-current liabilities     1,347     1,347
Shareholders' investment            
Common stock   513 72 72   513
Additional paid-in-capital   52,734 2,387 2,387   52,734
Retained earnings   55,818 13,417 13,417   55,818
Accumulated other comprehensive income (loss) 2,508 (243)     2,265
Total shareholders' investment   111,573 15,633     127,206
Total liabilities and shareholders' investment 201,193 37,349 50,000 50,000 238,542

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