BUSINESS COMBINATIONS

Answers to Questions

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. Three situations 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.

 

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.

 

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.

 

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 GAAP, goodwill is not 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 recognized.

 

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 as an ordinary gain during the period of the acquisition. The gain equals the difference between the investment cost and the fair value of the identifiable net assets acquired.

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SOLUTIONS TO EXERCISES

Solution E1-1

a

 

b

 

a

 

d

Solution E1-2 [AICPA adapted]

a

 

Plant and equipment should be recorded at the $220,000 fair value.

 

c

Investment cost

$1,600,000

Less: Fair value of net assets

$

160,000

Cash

Inventory

380,000

Property and equipment — net

1,120,000

1,300,000

Liabilities

(360,000)

Goodwill

$

300,000

Solution E1-3

Stockholders’ equity — Pal Corporation on January 2

Capital stock, $10 par, 600,000 shares outstanding

$ 6,000,000

Other paid-in capital

3,390,000

[$400,000 + $3,000,000 – $10,000]

Retained earnings[$1,200,000 – $20,000]

1,180,000

Total stockholders’ equity

$10,570,000

Entry to record combination

Investment in Sip

6,000,000

Capital stock, $10 par

3,000,000

Other paid-in capital

3,000,000

Investment expense

20,000

Other paid-in capital

10,000

Cash

30,000

Check: Net assets per books(book value)

$ 7,600,000

Goodwill and write-up assets

3,000,000

Less: Expense of direct costs

(20,000)

Less: Issuance of stock

(10,000)

$10,570,000

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Chapter 1

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Solution E1-4

Journal entries on Pan’s books to record the acquisition
Investment in Set

10,200,000

Common stock, $10 par

4,800,000

Additional paid-in capital

5,400,000

To record issuance of 480,000 shares of $10 par common stock with a fair value of $10,200,000 for the common stock of Set in a business combination.

Additional paid-in capital

60,000

Investment expenses

100,000

Salary and overhead expenses

80,000

Other assets or cash

240,000

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

4,400,000

Plant assets

8,800,000

Liabilities

1,200,000

Investment in Set

10,200,000

Gain from bargain purchase

1,800,000

To record allocation of the $10,200,000 cost of Set Company to identifiable assets and liabilities according to their fair values and the gain from the bargain purchase. The gain from bargain purchase is computed as follows:

Cost

$10,200,000

Fair value of net assets acquired

12,000,000

Bargain purchase amount

$ 1,800,000

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Solution E1-5

Journal entries on the books of Pan Corporation to record merger with Sis Corporation

Investment in Sis

1,060,000

360,000

Common stock, $10 par

Additional paid-in capital

300,000

Cash

400,000

To record issuance of 36,000 common shares and payment of cash in the
acquisition of Sis Corporation in a merger.

Investment expenses

140,000

Additional paid-in capital

60,000

200,000

Cash

To record costs of registering and issuing securities and additional
direct costs of combination.

Cash

80,000

Inventories

200,000

Other current assets

40,000

Plant assets — net

560,000

Goodwill

320,000

60,000

Current liabilities

Other liabilities

80,000

Investment in Sis

1,060,000

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
$1,060,000

Fair value of net assets acquired

740,000

Goodwill

$
320,000

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Chapter 1

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SOLUTIONS TO PROBLEMS

Solution P1-1

Preliminary computations

Fair Value: Cost of investment in San at January 2
$2,400,000

(60,000 shares   $40)

Book value of net assets ($2,000,000 – $240,000)
(1,760,000)

Excess fair value over book value

$

640,000

Excess assigned to:

$160,000

Current assets

Remainder to goodwill
480,000

Excess fair value over book value

$640,000

Note: $100,000 direct costs of combination are expensed. The

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

Pin Corporation

Balance Sheet at January 2, 2011

Assets

Current assets
$

760,000

($520,000 + $240,000 + $160,000 excess – $160,000 direct costs)

Land ($200,000 + $400,000)

600,000

Buildings — net ($1,200,000 + $400,000)

1,600,000

Equipment — net ($880,000 + $960,000)

1,840,000

Goodwill

480,000

Total assets

$

5,280,000

Liabilities and Stockholders’ Equity

Current liabilities ($200,000 + $240,000)

Capital stock, $10 par ($2,000,000 + $600,000 new issue)

Additional paid-in capital

[$200,000 + ($30 60,000 shares) — $60,000 costs of issuing and registering securities]

$   440,000 2,600,000

1,940,000

Retained earnings (subtract

$100,000 expensed direct cost)

300,000

Total liabilities and

stockholders’ equity

$ 5,280,000

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Business Combinations
Solution P1-2

Preliminary computations

$1,650,000

Fair Value: Cost of acquiring Sea

Fair value of assets acquired and liabilities assumed

1,340,000

Goodwill from acquisition of Sea

$

310,000

Pet Corporation

Balance Sheet

at January 2, 2011

Assets

Current assets

Cash [$300,000 + $60,000 – $280,000 expenses paid]

$

80,000

Accounts receivable — net [$460,000 + $80,000 fair value]

540,000

Inventories [$1,040,000 + $240,000 fair value]

1,280,000

Plant assets

Land [$800,000 + $300,000 fair value]

1,100,000

Buildings — net [$2,000,000 + $600,000 fair value]

2,600,000

Equipment — net [$1,000,000 + $500,000 fair value]

1,500,000

Goodwill

310,000

Total assets

$7,410,000

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable [$600,000 + $80,000]

$

680,000

Note payable [$1,200,000 + $360,000 fair value]

1,560,000

Stockholders’ equity

Capital stock, $10 par [$1,600,000 + (66,000 shares   $10)]

2,260,000

Other paid-in capital

2,110,000

[$1,200,000 – $80,000 + ($1,650,000 – $660,000)]

Retained earnings (subtract $200,000 expensed direct costs)

800,000

Total liabilities and stockholders’ equity

$7,410,000

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Chapter 1

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Solution P1-3

Par issues 25,000 shares of stock for Sin’s outstanding shares
1a
Investment in Sin

1,500,000

Capital stock, $10 par

250,000

Additional paid-in capital

1,250,000

To record issuance of 25,000, $10 par shares with a market price

of $60 per share in a business combination with Sin.

Investment expenses

60,000

Additional paid-in capital

40,000

Cash

100,000

To record costs of combination in a business combination with Sin.

Cash

20,000

Inventories

120,000

Other current assets

200,000

Land

200,000

Plant and equipment — net

700,000

Goodwill

360,000

Liabilities

100,000

Investment in Sin

1,500,000

To assign investment cost to identifiable assets and liabilities according to their fair values and the remainder to goodwill. Goodwill is computed: $1,500,000 cost – $1,140,000 fair value of net assets acquired.

1b

Par Corporation

Balance Sheet

January 2, 2011

(after business combination)

Assets

$

160,000

Cash [$240,000 + $20,000 – $100,000]

Inventories [$100,000 + $120,000]

220,000

Other current assets [$200,000 + $200,000]

400,000

Land [$160,000 + $200,000]

360,000

Plant and equipment — net [$1,300,000 + $700,000]

2,000,000

Goodwill

360,000

Total assets

$3,500,000

Liabilities and Stockholders’ Equity

$

500,000

Liabilities [$400,000 + $100,000]

Capital stock, $10 par [$1,000,000 + $250,000]

1,250,000

Additional paid-in capital [$400,000 + $1,250,000 –

1,610,000

$40,000]

140,000

Retained earnings (subtract $60,000 direct costs)

Total liabilities and stockholders’ equity

$3,500,000

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Business Combinations

Solution P1-3 (continued)

Par issues 15,000 shares of stock for Sin’s outstanding shares
2a
Investment in Sin (15,000 shares   $60)

900,000

Capital stock, $10 par

150,000

Additional paid-in capital

750,000

To record issuance of 15,000, $10 par common shares with a market

price of $60 per share.

60,000

Investment expense

Additional paid-in capital

40,000

Cash

100,000

To record costs of combination in the acquisition of Sin.

Cash

20,000

Inventories

120,000

Other current assets

200,000

Land

200,000

Plant and equipment — net

700,000

Liabilities

100,000

Investment in Sin

900,000

Gain on bargain purchase

240,000

To record Sin’s net assets at fair values and gain on bargain

purchase.

Fair value of net assets acquired

$1,140,000

Investment cost (Fair value of consideration)

900,000

Gain on Bargain Purchase

$

240,000

2b

Par Corporation

Balance Sheet

January 2, 2011

(after business combination)

Assets

$

160,000

Cash [$240,000 + $20,000 – $100,000]

Inventories [$100,000 + $120,000]

220,000

Other current assets [$200,000 + $200,000]

400,000

Land [$160,000 + $200,000]

360,000

Plant and equipment — net [$1,300,000 + $700,000]

2,000,000

Total assets

$3,140,000

Liabilities and stockholders’ equity

$

500,000

Liabilities [$400,000 + $100,000]

Capital stock, $10 par [$1,000,000 + $150,000]

1,150,000

Additional paid-in capital [$400,000 + $750,000 –

1,110,000

$40,000]

380,000

Retained earnings (subtract $60,000 direct costs

and add $240,000 Gain from bargain purchase)

$3,140,000

Total liabilities and stockholders’ equity

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Chapter 1

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Solution P1-4

Schedule to allocate investment cost to assets and liabilities

Investment cost (fair value), January 1

$300,000

Fair value acquired from Sun ($360,000   100%)

360,000

Excess fair value over cost (bargain purchase gain)

$ 60,000

Allocation:

Cash

Allocation

$

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

Pub Corporation

Balance Sheet

at January 1, 2011

(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

570,000

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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Solution P1-5

Journal entries to record the acquisition of Saw Corporation

Investment in Saw

5,000,000

Capital stock, $10 par

1,000,000

Other paid-in capital

3,000,000

Cash

1,000,000

To record acquisition of Saw for 100,000 shares of common stock

and $1,000,000 cash.

200,000

Investment expense

Other paid-in capital

100,000

Cash

300,000

To record payment of costs to register and issue the shares of

stock ($100,000) and other costs of combination ($200,000).

Cash

480,000

Accounts receivable

720,000

Notes receivable

600,000

Inventories

1,000,000

Other current assets

400,000

Land

400,000

Buildings

2,400,000

Equipment

1,200,000

Accounts payable

600,000

Mortgage payable, 10%

1,200,000

Investment in Saw

5,000,000

Gain on bargain purchase

200,000

To record the net assets of Saw at fair value and gain on bargain purchase.

Gain on Bargain Purchase Calculation

$5,000,000

Acquisition price
Fair value of net assets acquired

5,400,000

Gain on bargain purchase

$

400,000

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Chapter 1

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Solution P1-5 (continued)

2

Pat Corporation

Balance Sheet

at January 2, 2011

(after business combination)

Assets

Current Assets

$ 5,180,000

Cash

Accounts receivable — net

3,320,000

Notes receivable — net

3,600,000

Inventories

6,000,000

$ 19,900,000

Other current assets

1,800,000

Plant Assets

$ 4,400,000

Land

Buildings — net

20,400,000

46,000,000

Equipment — net

21,200,000

Total assets

$65,900,000

Liabilities and Stockholders’ Equity

Liabilities

$ 2,600,000

Accounts payable

$13,800,000

Mortgage payable, 10%

11,200,000

Stockholders’ Equity

$21,000,000

Capital stock, $10 par

Other paid-in capital

18,900,000

52,100,000

Retained earnings*

12,200,000

Total liabilities and stockholders’

equity

$65,900,000

Subtract $200,000 direct combination costs and add $400,000 gain on bargain purchase.

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Business Combinations
RESEARCH CASE

Research Case

Requirement 1

(Amounts in millions)

Investment in Target (1 Billion x $50)

50,000

Common Stock (1 Billion x $0.10)

100

Capital in Excess of Par Value

49,900

Cash and Cash Equivalents

2,200

Credit Card Receivables

6,966

Inventory

7,897

Other Current Assets

2,079

Land

6,952

Buildings and Improvements

26,582

Fixtures and Equipment

5,692

Computer Hardware and Software

3,090

Construction in Progress

502

Other Noncurrent Assets

829

Accumulated Other Comprehensive

Loss

581

Goodwill

26,301

Accumulated Depreciation

10,485

Accounts Payable

6,511

Accrued and Other Current Liabilities

3,120

Unsecured Debt and Other

Borrowings(short-term)

796

Nonrecourse Debt Collaterized by Credit

Card Receivables(short-term)

900

Unsecured Debt and Other

Borrowings(long-term)

10,643

Nonrecourse Debt Collaterized by Credit

Card Receivables(long-term)

4,475

Deferred Income Taxes

835

Other Noncurrent Liabilities

1,906

Investment in Target

50,000

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Chapter 1

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Requirement 2

Wal-Mart
Target
Total

(Amounts in millions)

Assets

Current Assets:

Cash and Cash Equivalents

$7,907

$2,200

$10,107

Receivables, net

4,144

6,966

11,110

Inventories

33,160

7,897

41,057

Prepaid Expenses and Other

2,980

2,079

5,059

Current Assets of Discontinued Operations

140

140

Total Current Assets

$48,331

$19,142

$67,473

Property and Equipment:

Land

$22,591

$6,952

$29,543

Buildings and Improvements

77,452

26,582

104,034

Fixtures and Equipment

35,450

5,692

41,142

Transportation Equipment

2,355

2,355

Computer Hardware and Software

3,090

3,090

Construction in Progress

502

502

Total Property and Equipment

137,848

42,818

180,666

Less Accumulated Depreciation

-38,304

-10,485

-48,789

$

131,87

Property and Equipment, Net

$99,544

$32,333

7

Property Under Capital Leases:

Property Under Capital Leases

$5,669

$5,669

Less Accumulated Amortization

-2,906

-2,906

Property Under Capital Leases, Net

$2,763

$2,763

Goodwill(16,126 + 26,301)

$16,126

$42,427

Other Assets and Deferred Charges

3,942

829

4,771

Total Assets

$

170,70

$

249,31

6

1

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1-14

Business Combinations

Liabilities and Stockholders’ Equity

Current Liabilities:

Short-term Borrowings

$523

$523

Accounts Payable

30,451

$6,511

36,962

Accrued Liabilities

18,734

3,120

21,854

Accured Income Taxes

1,365

1,365

Long-term Debt Due Within One Year

4,050

4,050

Obligations Under Capital Leases Due

Within One Year

346

346

Current Liabilities of Discontinued

92

Operations

92

Unsecured debt and Other Borrowings

796

796

Nonrecourse Debt Collaterized by Credit

900

Card Receivables

900

Total Current Liabilities

$55,561

$11,327

$66,888

Long-term Liabilities:

Long-Term Debt

$33,231

$33,231

Long-Term Obligations Under Capital

Leases

3,170

3,170

Deferred Income Taxes and other

5,508

$835

6,343

Unsecured Debt and Other Borrowings

10,643

10,643

Nonrecourse Debt Collaterized by Credit

Card Receivables

4,475

4,475

Other Noncurrent Liabilities

1,906

1,906

Redeemable Noncontrolling Interest

307

307

Total Long-Term Liabilities

$42,216

$17,859

$60,075

Stockholders’ Equity

Preferred Stock

Common Stock(100 + 378)

$478

Capital in Excess of Par Value(3,803+49,900)

53,703

Retained Earnings

66,638

Accumulated Other Comprehensive Loss

(70 + 581)

-651

Total Stockholders’ Equity

120,168

Noncontrolling Interest

2,180

Total Stockholders’ Equity

122,348

Total Liabilities and Stockholders’ Equity

$249,31

1

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