Business combination

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. 141 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 purchase method when the cost of the investment (price paid plus direct costs) 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 Negative goodwill is the opposite of goodwill. It results from a purchase business combination in which the fair value of identifiable net assets acquired exceeds the investment cost. Any negative goodwill must be applied to a proportionate reduction of noncurrent assets other than marketable securities. If negative goodwill is greater than the fair value of all noncurrent assets acquired other than marketable securities, the excess is written off as an extraordinary loss on the income statement under FASB Statement No. 141.

SOLUTIONS TO EXERCISES

Solution E1-1

1 a

2 b

3 a

4 c

5 d

Solution E1-2 [AICPA adapted]

1 d

Plant and equipment should be recorded at $45,000, the $55,000 fair value less the $10,000 excess fair value of net assets acquired over investment cost.

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 in Sleep-bank		10,000
Additional paid-in capital		5,000
Cash			15,000

Check: Net assets per books	$3,800,000
Goodwill	1,510,000
Less: Issuance of stock	(15,000)
	$5,295,000

Solution E1-4

Journal entries on IceAge’s books to record the purchase

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 purchase business combination.

Investment in Jester	25,000
Additional paid-in capital	15,000
Expenses of combination	20,000
Other assets		60,000
To record costs of registering and issuing securities as paid-in capital, direct cost of combination as investment, and indirect costs of combination as expenses.

Current assets	1,100,000
Plant assets	1,775,000
Liabilities		300,000
Investment in Jester		2,575,000
To record allocation of the $2,575,000 cost of Jester Company to identifiable assets and liabilities according to their fair values, computed as follows:

Cost		$2,575,000
Fair value acquired		3,000,000
Negative goodwill		$ 425,000

Plant assets at fair value		$2,200,000

Less: Negative goodwill		425,000
Cost allocated to plant assets		$1,775,000

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 in Harrison	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	230,000
Current liabilities		30,000
Other liabilities		40,000
Investment in Harrison		600,000
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		$600,000
Fair value of assets acquired		370,000
Goodwill		$230,000

SOLUTIONS TO PROBLEMS

Solution P1-1

Preliminary computations
Cost of investment in Sain at January 2
(30,000 shares $20) + $25,000 direct costs of combination	$625,000
Book value acquired	(440,000)
Excess cost over book value acquired	$185,000

Excess allocated to:
Current assets	$ 40,000
Remainder to goodwill	145,000
Excess cost over book value acquired	$185,000

Pine Corporation

Balance Sheet at January 2, 2006

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	145,000
Total assets	$1,345,000

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 and registering securities]	335,000

Retained earnings	100,000
Total liabilities and stockholders’ equity	$1,345,000

Solution P1-2

Preliminary computations
Cost of acquiring Seabird ($825,000 + $100,000 direct costs)	$925,000
Fair value of assets acquired and liabilities assumed	670,000
Goodwill from acquisition of Seabird	$255,000

Pelican Corporation

Balance Sheet

at January 2, 2006

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	255,000
Total assets	$3,805,000

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	500,000
Total liabilities and stockholders’ equity	$3,805,000

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 purchase business combination with Sineco.

	Investment in Sineco	30,000
	Other paid-in capital	20,000
	Cash		50,000
To record costs of combination in a purchase 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	210,000
	Liabilities		50,000
	Investment in Sineco		780,000

To record allocation of investment cost to identifiable assets and liabilities according to their fair values and the remainder to goodwill. Goodwill is computed: $780,000 cost - $570,000 fair value of net assets acquired.

1b	Persis Corporation
	Balance Sheet
	January 2, 2006
	(after purchase 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	210,000
	Total assets	$1,780,000

	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	100,000
	Total liabilities and stockholders’ equity	$1,780,000

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 in Sineco	30,000
	Other paid-in capital	20,000
	Cash		50,000
To record costs of combination in the purchase of Sineco.

	Cash	10,000
	Inventories	60,000
	Other current assets	100,000
	Land	80,000
	Plant and equipment — net	280,000
	Liabilities		50,000
	Investment in Sineco		480,000
To assign the $480,000 cost of Sineco to current assets and liabilities on the basis of their fair values and to noncurrent assets on the basis of fair value less a proportionate share of the excess of fair value over investment cost as follows:

	Fair value of net assets acquired		$570,000
	Investment cost		480,000
	Excess fair value over cost		$ 90,000
	Excess allocated to reduce:
	Land ($100,000/$450,000 $90,000)		$ 20,000
	Plant and equipment ($350,000/$450,000 $90,000)		70,000
	Reduction in fair value of noncurrent assets		$ 90,000

Solution P1-3 (continued)

2b	Persis Corporation
	Balance Sheet
	January 2, 2006
	(after purchase 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 + $80,000]	160,000
	Plant and equipment — net [$650,000 + $280,000]	930,000
	Total assets	$1,480,000

	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	100,000
	Total liabilities and stockholders’ equity	$1,480,000

Solution P1-4

1 Schedule to allocate investment cost to assets and liabilities

	Investment cost, January 1, 2006	$300,000
	Fair value acquired from Sen ($360,000 100%)	360,000
	Excess fair value acquired over cost	$ 60,000

Allocation:

	Initial Allocation	Reallocation	Final Allocation
Cash	$ 10,000	---	$ 10,000
Receivables — net	20,000	---	20,000
Inventories	30,000	---	30,000
Land	100,000	$ (15,000)	85,000
Buildings — net	150,000	(22,500)	127,500
Equipment — net	150,000	(22,500)	127,500
Accounts payable	(30,000)	---	(30,000)
Other liabilities	(70,000)	---	(70,000)
Excess fair value	(60,000)	60,000	---
Totals	$ 300,000	0	$ 300,000

2	Phule Corporation
	Balance Sheet
	at January 1, 2006
			(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	130,000	Liabilities	490,000
	Buildings — net	327,500
	Equipment — net	307,500	Stockholders’ Equity

			Capital stock, $10 par	300,000
			Other paid-in capital	100,000
			Retained earnings	110,000
			Stockholders’ equity	510,000
	Total assets	$1,000,000	Total equities	$1,000,000

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 purchase of Dawn for 100,000 shares of common stock and $500,000 cash.

	Investment in Dawn	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	190,000
	Buildings	1,140,000
	Equipment	570,000
	Accounts payable		300,000
	Mortgage payable, 10%		600,000
	Investment in Dawn		2,600,000

To assign the cost of Dawn to current assets and liabilities on the basis of their fair values and to noncurrent assets on the basis of fair value less a proportionate share of the excess of fair value over investment cost as shown in the following allocation schedule:

	Purchase price		$2,600,000
	Fair value of net assets acquired		2,700,000
	Negative goodwill		$ 100,000

Excess applied to reduce noncurrent assets (noncurrent assets $100,000/$2,000,000 excess = 5% reduction):

Land	$ 200,000 - $10,000 =	$ 190,000
Buildings	1,200,000 - 60,000 =	1,140,000
Equipment	600,000 - 30,000 =	570,000

Solution P1-5 (continued)

2	Celistia Corporation Balance Sheet at January 2, 2006 (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	$ 2,190,000
	Buildings — net	10,140,000
	Equipment — net	10,570,000	22,900,000
	Total assets		$32,850,000

	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	25,950,000
	Total liabilities and stockholders’ equity		$32,850,000

Source: http://www.sba.oakland.edu/faculty/bazaz/acc401/beams9esm_ch01.doc

Web site to visit: http://www.sba.oakland.edu/

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Business combination

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