Chapter 1 Test Bank

BUSINESS COMBINATIONS
Multiple Choice Questions LO1 1. Which of the following is a reason why a company would expand through a combination, rather than by building new facilities? a. A combination might provide cost advantages. b. A combination might provide fewer operating delays. c. A combination might provide easier access to intangible assets. d. All of the above are possible reasons that a company might choose a combination. Solution: d LO2 2. A business combination in which a new corporation is created and two or more existing corporations are combined into the newly created corporation is called a a. b. c. d. merger. purchase transaction. pooling-of-interests. consolidation.

Solution: d LO2 3. A business combination occurs when a company acquires an equity interest in another entity and has a. b. c. d. at least 20% ownership in the entity. more than 50% ownership in the entity. 100% ownership in the entity. control over the entity, irrespective of the percentage owned.

Solution: d

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LO2 4.

FASB favors consolidation of two entities when a. one acquires less than 20% equity ownership of the other. b. one companys ownership interest in another gives it control of the acquired company, even if the acquiring company does not have a majority ownership in the acquired. Typically, this is in the 20%-50% interest range. c. one acquires two thirds equity ownership in the other. d. each entity holds stock in the other, regardless of percentage of ownership.

Solution: b LO3 LO4 5.

Michangelo Co. paid $100,000 in fees to its accountants and lawyers in acquiring Florence Company. Michangelo will treat the $100,000 as a. an expense for the current year. b. a prior period adjustment to retained earnings. c. additional cost to investment of Florence on the consolidated balance sheet. d. a reduction in paid-in capital.

Solution: a LO3 6. Picasso Co. issued 10,000 shares of its $1 par common stock, valued at $400,000, to acquire shares of Bull Company in an all-stock transaction. Picasso paid the investment bankers $35,000. Picasso will treat the investment banker fee as: a. b. c. d. an expense for the current year. a prior period adjustment to Retained Earnings. additional goodwill on the consolidated balance sheet. a reduction in paid-in capital.

Solution: d

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LO3 7.

Durer Inc acquired Sea Corporation in a business combination and Sea Corp went out of existence. Sea Corp developed a patent listed as an asset on Sea Corps books at the patent office filing cost. In recording the combination a. fair value is not assigned to the patent because the research and development costs have been expensed by Sea Corp. b. Sea Corps prior expenses to develop the patent are recorded as an asset by Durer at purchase. c. the patent is recorded as an asset at fair market value. d. the patent's market value increases goodwill.

Solution: c LO2 8. In a merger, which of the following will occur? a. A merger occurs when one corporation takes over the operations of another business entity, and the acquired entity is dissolved. b. None of the business entities will be dissolved. c. The acquired assets will be recorded at book value by the acquiring entity. d. None of the above is correct. Solution: a LO3 9. According to FASB Statement 141, which one of the following items may not be accounted for as an intangible asset apart from goodwill? a. b. c. d. A production backlog. A talented employee workforce. Noncontractual customer relationships. Employment contracts.

Solution: b

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LO4 10.

Under the provisions of FASB Statement No. 141R, in a business combination, when the fair value exceeds the investment cost, which of the following statements is correct? a. A gain from a bargain purchase is recognized for the amount that the fair value of the identifiable net assets acquired exceeds the acquisition price. b. the value is allocated first to reduce proportionately (according to market value) non-current assets, then to non-monetary current assets, and any negative remainder is classified as a deferred credit. c. it is allocated first to reduce proportionately (according to market value) non-current assets, and any negative remainder is classified as an extraordinary gain. d. It is allocated first to reduce proportionately (according to market value) non-current, depreciable assets to zero, and any negative remainder is classified as a deferred credit.

Solution: a LO4 11. With respect to goodwill, an impairment a. will be amortized over the remaining useful life. b. is a two-step process which analyzes each business unit of the entity. c. is a one-step process considering the entire firm. d. occurs when asset values are adjusted to fair value in a purchase. Solution: b Use the following information in answering questions 12 and 13. Manet Corporation exchanges 150,000 shares of newly issued $1 value common stock with a fair market value of $25 per share for of the outstanding $5 par value common stock of Gardner Inc Gardner is then dissolved. Manet paid the following costs expenses related to the business combination: Costs of special shareholders meeting to vote on the merger Registering and issuing securities Accounting and legal fees Salaries of Manets employees assigned to the implementation of the merger Cost of closing duplicate facilities 1-4 $13,000 14,000 9,000 15,000 11,000 par all and and

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LO3 12.

In the business combination of Manet and Gardner a. the costs of registering and issuing the securities are included as part of the purchase price for Gardner. b. the salaries of Manet's employees assigned to the merger are treated as expenses. c. all of the costs except those of registering and issuing the securities are included in the purchase price of Gardner. d. only the accounting and legal fees are included in the purchase price of Gardner.

Solution: b LO3 13. In the business combination of Manet and Gardner a. all of the items listed above are treated as expenses. b. all of the items listed above except the cost of registering and issuing the securities are expensed. c. the costs of registering and issuing the securities are deducted from the fair market value of the common stock used to acquire Gardner. d. only the costs of closing duplicate facilities, the salaries of Manet's employees assigned to the merger, and the costs of the shareholders' meeting would be treated as expenses. Solution: c LO3 14. In Statement 142, which of the following methods does the FASB consider the best indicators of fair values in the evaluation of goodwill impairment? a. b. c. d. Senior executives estimates. Financial analyst forecasts. Market value. The present value of future cash flows discounted at the firms cost of capital.

Solution: c

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LO4 15.

Raphael Company paid $2,000,000 for the net assets of Paris Corporation and Paris was then dissolved. Paris had no liabilities. The fair values of Paris assets were $2,500,000. Pariss only non-current assets were land and equipment with fair values of $160,000 and $640,000, respectively. At what value will the equipment be recorded by Raphael? a. b. c. d. $640,000 $240,000 $400,000 $0

Solution: a LO3 16. According to FASB 141, liabilities assumed in an acquisition will be valued at the a. b. c. d. estimated fair value. historical book value. current replacement cost. present value using market interest rates.

Solution: a LO3 17. In reference to the FASB disclosure requirements, which of the following is correct? a. Information related to several minor acquisitions may not be combined. b. Firms are not required to disclose the business purpose for a combination c. Notes to the financial statements of an acquiring corporation must disclose that the business combination was accounted for by the acquisition method. d. All of the above are correct. Solution: c

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LO4 18.

Goodwill arising from a business combination is a. charged to Retained Earnings after the acquisition is completed. b. amortized over 40 years or its useful life, whichever is longer. c. amortized over 40 years or its useful life, whichever is shorter. d. never amortized.

Solution: d LO3 19. In reference to international accounting for goodwill, which of the following statements is correct? a. U.S. companies have complained that past accounting rules for amortizing goodwill placed them at a disadvantage in competing against foreign companies for merger partners. b. Some foreign countries permitted the immediate write-off of goodwill to stockholders equity. c. The IASB and the FASB are working to eliminate differences in accounting for business combinations. d. All of the above are correct. Solution: d LO3 20. In recording acquisition costs, which of following procedures is correct? a. Registration costs are expensed, and not charged against the fair value of the securities issued. b. Indirect costs are charged against the fair value of the securities issued. c. Consulting fees are expensed. d. None of the above procedures are correct. Solution: c

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Exercises LO4 Exercise 1 On January 2, 2005 Bison Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Deer Corporations outstanding common shares. Bison paid $15,000 to register and issue shares. Bison also paid $10,000 for the direct combination costs of the accountants. The fair value and book value of Deer's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows: Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $5 par Paid-in capital Retained Earnings Total Liabilities & Equities Bison $ 150,000 320,000 500,000 350,000 4,000,000 $5,320,000 $1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000 Deer $ 120,000 400,000 500,000 250,000 1,500,000 $2,770,000 $ 300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Required:

1. Prepare Bison's general journal entry for the acquisition of

Deer, assuming that Deer survives as a separate legal entity.

2. Prepare Bison's general journal entry for the acquisition of

Deer, assuming that Deer will dissolve as a separate legal entity.

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Solution: Exercise 1 1. General journal entry recorded by Bison for the acquisition of Deer (Deer survives as a separate legal entity): Investment in Deer Common stock Paid-in capital Investment expense Paid-in capital Cash 2. 1,900,000 500,000 1,400,000 10,000 15,000 25,000

General journal entry recorded by Bison for the acquisition of Deer (Deer dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Investment expense Accounts payable Notes payable Common stock Paid-in capital 950,000 400,000 500,000 250,000 1,500,000 90,000 10,000 300,000 660,000 500,000 1,385,000

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LO4 Exercise 2 On January 2, 2005 Altamira Company issued 80,000 new shares of its $2 par value common stock valued at $12 a share for all of Lascaux Corporations outstanding common shares. Altamira paid $5,000 for the direct combination costs of the accountants. Altamira paid $10,000 to register and issue shares. The fair value and book value of Lascaux's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows: Altamira $ 75,000 160,000 200,000 175,000 1,500,000 $2,110,000 $ 100,000 700,000 600,000 450,000 260,000 $2,110,000 Lascaux $ 60,000 200,000 250,000 125,000 750,000 $1,385,000 $ 155,000 330,000 250,000 50,000 600,000 $1,385,000

Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $2 par Paid-in capital Retained Earnings Total Liabilities & Equity

Required:

1. Prepare Altamira's general journal entry for the acquisition of

Lascaux assuming that Lascaux survives as a separate legal entity.

2. Prepare Altamira's general journal entry for the acquisition of

Lascaux assuming that Lascaux will dissolve as a separate legal entity.

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Solution: Exercise 2 1. General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux survives as a separate legal entity):

Investment in Lascaux 960,000 Common stock 160,000 Paid-in capital 800,000 Investment expense 5,000 Paid-in capital 10,000 Cash 15,000 2. General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Investment expense Accounts payable Notes payable Common stock Paid-in capital 45,000 200,000 250,000 125,000 750,000 60,000 5,000

155,000 330,000 160,000 790,000

LO4
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Exercise 3 Dolmen Corporation purchased the net assets of Carnac Inc on January 2, 2005 for $280,000 and also paid $10,000 in direct acquisition costs. Carnac's balance sheet on January 2, 2005 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets $ 90,000 180,000 20,000 30,000 40,000 $360,000 Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total liab. & equity $ 35,000 80,000 10,000 215,000 20,000 $360,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $200,000, $25,000 and $35,000, respectively. Carnac has patent rights valued at $10,000. Required: Prepare Dolmen's general journal entry for the cash purchase of Carnac's net assets.

Solution: Exercise 3 General journal entry for the purchase of Carnac's net assets: Accounts receivable Inventory Land Building Equipment Patent Goodwill Investment expense Current liabilities Long-term debt Cash 90,000 200,000 25,000 30,000 35,000 10,000 5,000 10,000 35,000 80,000 290,000

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LO4 Exercise 4 The balance sheets of Palisade Company and Salisbury Corporation were as follows on December 31, 2004: Palisade Salisbury Current Assets $ 260,000 $ 120,000 Equipment-net 440,000 480,000 Buildings-net 600,000 200,000 Land 100,000 200,000 Total Assets $1,400,000 $1,000,000 Current Liabilities 100,000 120,000 Common Stock, $5 par 1,000,000 400,000 Paid-in Capital 100,000 280,000 Retained Earnings 200,000 200,000 Total Liabilities and $1,400,000 $1,000,000 Stockholders' equity On January 1, 2005 Palisade issued 30,000 of its shares with a market value of $40 per share in exchange for all of Salisbury's shares, and Salisbury was dissolved. Palisade paid $20,000 to register and issue the new common shares. It cost Palisade $50,000 in direct combination costs. Book values equal market values except that Salisburys land is worth $250,000. Required: Prepare a Palisade balance sheet after the business combination on January 1, 2005.

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Solution: Exercise 4 The balance sheet for Palisade Corporation subsequent to its acquisition of Salisbury Corporation on January 1, 2005 will appear as follows: Current Assets Equipment-net Buildings-net Land Goodwill Total Assets Current Liabilities Common Stock, $5 par Paid-in Capital Retained Earnings Total Liabilities and Stockholders' equity $ 310,000 920,000 800,000 350,000 270,000 $2,650,000 220,000 1,150,000 1,130,000 150,000 $2,650,000

Note that Current Assets of $310,000 results from the two companies contributing $260,000 and $120,000, less the cash paid out during the acquisition process of $70,000. Retained Earnings of the parent is reduced for the Investment incurred in the process of $50,000.

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LO4 Exercise 5 Paradise Inc purchased the net assets of Sublime Company on January 2, 2005 for $320,000 and also paid $5,000 in direct acquisition costs. Sublime's balance sheet on January 2, 2005 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets $180,000 180,000 30,000 30,000 30,000 $450,000 Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total liab. & equity $ 25,000 90,000 10,000 225,000 100,000 $450,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $200,000, $25,000 and $35,000, respectively. Sublime has patent rights valued at $10,000. Required: Prepare Paradise's general journal entry for the cash purchase of Sublime's net assets.

Solution: Exercise 5 General journal entry for the purchase of Sublime's net assets: Accounts receivable Inventory Land Building-net Equipment-net Patent rights Investment expense Current liabilities Long-term debt Cash Extraordinary gain 180,000 200,000 25,000 30,000 35,000 10,000 5,000 25,000 90,000 325,000 45,000

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LO4 Exercise 6 On January 2, 2005 Tennessee Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Alaska Companys outstanding common shares in an acquisition. Tennessee paid $15,000 for registering and issuing securities and $10,000 for other direct costs of the business combination. The fair value and book value of Alaska's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows: Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $5 par Paid-in capital Retained Earnings Total Liabilities & Equities Required: Prepare a balance sheet for Tennessee Corporation immediately after the business combination. Solution: Exercise 6 Tennessee Corporation Balance Sheet January 1, 2005 Liabilities: Accounts payable Notes payable Total liabilities $1,300,000 1,960,000 3,260,000 Tennessee $ 150,000 320,000 500,000 350,000 4,000,000 $5,320,000 $1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000 Alaska $ 120,000 400,000 500,000 250,000 1,500,000 $2,770,000 $ 300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Assets: Cash $ 245,000 Inventory 720,000 Other current assets 1,000,000 Total current assets 1,965,000 Land Plant assets-net Goodwill Total L.T. assets Total assets 600,000 5,500,000 90,000 6,200,000 $8,155,000 1-16

Equity: Common stock ($5 par) 2,500,000 Paid-in capital 2,385,000 Retained earnings 10,000 Total equity 4,895,000 Total liab.& eq. $8,155,000

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LO4 Exercise 7 Balance sheet information for Sphinx Company at January 1, 2005, is summarized as follows: Current assets Plant assets $ $ 230,000 450,000 680,000 Liabilities $ Capital stock $10 par Retained earnings $ 300,000 200,000 180,000 680,000

Sphinxs assets and liabilities are fairly valued except for plant assets that are undervalued by $50,000. On January 2, 2005, Pyramid Corporation issues 20,000 shares of its $10 par value common stock for all of Sphinxs net assets and Sphinx is dissolved. Market quotations for the two stocks on this date are: Pyramid common: Sphinx common: Butler pays the combination: $28.00 $19.50 fees and costs in connection $10,000 6,000 with the

following

Finders fee Legal and accounting fees Required:

1. Calculate Pyramids investment cost of Sphinx Corporation. 2. Calculate any goodwill from the business combination. Solution: Exercise 7 Requirement 1 FMV of shares issued by Pyramid: 20,000 x $28.00= $ 560,000

Requirement 2 Investment cost from above: Less: Fair value of Sphinxs net assets ($680,000 of total assets plus $50,000 of undervalued plant assets minus $300,000 of debt) Equals: Goodwill from investment in Sphinx: $ 560,000 430,000 130,000

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