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Acct: 70253: Business Combinations and Advanced Topics

Review for Exam I - SOLUTION


Problem I
On January 1, 2014, Ridge Road Company acquired 20 percent of the voting shares of Sauk
Trail, Inc. for $2,700,000 in cash. Both companies provide commercial Internet support services
but serve markets in different industries. Ridge Road made the investment to gain access to Sauk
Trail's board of directors and thus facilitate future cooperative agreements between the two firms.
Ridge Road quickly obtained several seats on Sauk Trail's board which gave it the ability to
significantly influence Sauk Trail's operating and investing activities.
The January 1, 2014, carrying amounts and corresponding fair values for Sauk Trail's assets and
liabilities follow:

Also as of January 1, 2014, Sauk Trail's computing equipment had a 7-year remaining estimated
useful life. The patented technology was estimated to have a 3-year remaining useful life. The
trademark's useful life was considered indefinite. Ridge Road attributed to goodwill any
unidentified excess cost.
During the next two years, Sauk Trail reported the following net income and dividends:

a. How much of Ridge Road's $2,700,000 payment for Sauk Trail is attributable to goodwill?
Acquisition price................................................................................... $2,700,000
Book value acquired ($5,175,000 20%)............................................ 1,035,000
Excess payment.................................................................................... $1,665,000
Excess fair value: Computing equipment ($700,000 20%)........
140,000
Excess fair value: Patented technology ($3,900,000 20%)........
780,000
Excess fair value: Trademark ($1,850,000 20%).........................
370,000
Goodwill................................................................................................. $ 375,000

Amortization:
Computing equipment ($140,000 7)........................................ $ 20,000
Patented technology ($780,000 3)...........................................
260,000
Trademark (indefinite).................................................................
-0Goodwill (indefinite)....................................................................
-0Annual amortization.......................................................................... $280,000
b. What amount should Ridge Road report for its equity in Sauk Trail's earnings on its income
statements for 2014 and 2015?
Basic equity accrual 2014 ($1,800,000 20%)...................................
Amortization2014 (above).................................................................
Equity in 2014 earnings of Sauk Trail.................................................

$360,000
(280,000)
$ 80,000

Basic equity accrual 2015 ($1,985,000 20%)...................................


Amortization2015 (above).................................................................
Equity in 2015 earnings of Sauk Trail.................................................

$397,000
(280,000)
$117,000

c. What amount should Ridge Road report for its investment in Sauk Trail on its balance sheets
at the end of 2014 and 2015?
Acquisition price................................................................................... $2,700,000
Equity in 2014 earnings of Sauk Trail (above)...................................
80,000
Dividends2014 ($150,000 20%)......................................................
(30,000)
Investment in Sauk Trail, 12/31/14....................................................... $2,750,000
Investment in Sauk Trail, 12/31/14....................................................... $2,750,000
Equity in 2015 earnings of Sauk Trail (above)................................... $117,000
Dividends2015 ($160,000 20%)......................................................
(32,000)
Investment in Sauk Trail, 12/31/15....................................................... $2,835,000

Problem II
Harper acquires 40 percent of the outstanding voting stock of Kinman Company on January 1,
2014, for $210,000 in cash. The book value of Kinman's net assets on that date was $400,000,
although one of the company's buildings, with a $60,000 carrying amount, was actually worth
$100,000. This building had a 10-year remaining life. Kinman owned a royalty agreement with a
20-year remaining life that was undervalued by $85,000.
Kinman sold inventory with an original cost of $60,000 to Harper during 2014 at a price of
$90,000. Harper still held $15,000 (transfer price) of this amount in inventory as of December
31, 2014. These goods are to be sold to outside parties during 2015.
Kinman reported a $40,000 net loss and a $20,000 other comprehensive loss for 2014. The
company still manages to declare and pay a $10,000 cash dividend during the year.
During 2015, Kinman reported a $40,000 net income and declared and paid a cash dividend of
$12,000. It made additional inventory sales of $80,000 to Harper during the period. The original
cost of the merchandise was $50,000. All but 30 percent of this inventory had been resold to
outside parties by the end of the 2015 fiscal year.
Prepare all journal entries for Harper for 2014 and 2015 in connection with this investment.
Assume that the equity method is applied.
1/1/14

During
2014

12/31/14

12/31/14

Investment in Kinman Co.............


Cash..........................................
(To record initial investment)

210,000
210,000

Dividends Receivable...................
4,000
Investment in Kinman Co........
(To record dividend declaration: $10,000 x 40%)

4,000

Cash................................................
Dividends Receivable..............
(To record receipt of dividend)

4,000

4,000

Equity in Kinman IncomeLoss.


16,000
Other Comprehensive Loss of Kinman
8,000
Investment in Kinman Co........
(To record accrual of income and OCI from
equity investee, 40% of reported balances)
Equity in Kinman IncomeLoss.
3,300
Investment in Kinman Co........
(To record amortization relating to acquisition
of Kinmansee Schedule 1 below)

24,000

3,300

12/31/14

During
2015

12/31/15

12/31/15

12/31/15

12/31/15

Equity in Kinman Income-Loss....


2,000
Investment in Kinman Co........
(To defer unrealized gross profit on intra-entity
sale see Schedule 2 below)

2,000

Dividends Receivable...................
4,800
Investment in Kinman Co........
(To record dividend declaration: $12,000 x 40%)

4,800

Cash................................................
Dividends Receivable..............
(To record receipt of dividend)

4,800

4,800

Investment in Kinman Co.............


16,000
Equity in Kinman Income........
(To record 40% accrual of income as earned by
equity investee)
Equity in Kinman Income.............
3,300
Investment in Kinman Co........
(To record amortization relating to acquisition
of Kinman)
Investment in Kinman Co.............
2,000
Equity in Kinman Income........
(To recognize income deferred from 2014)
Equity in Kinman Income.............
3,600
Investment in Kinman Co........
(To defer unrealized gross profit on intra-entity
salesee Schedule 3 below)

16,000

3,300

2,000

3,600

Schedule 1Allocation of Purchase Price and Related Amortization


Purchase price .........................................................
Percentage of book value acquired
($400,000 40%)......................................................
Payment in excess of book value...............................

$210,000
(160,000)
$50,000
Remaining Annual
Life Amortization

Excess payment identified with specific assets:


Building ($40,000 40%)
$16,000 10 yrs.
Royalty agreement ($85,000 40%)
34,000 20 yrs.
Total annual amortization

$1,600
1,700
$3,300

Schedule 2Deferral of Unrealized Gross Profit2014


Inventory remaining at end of year...................................................
Gross profit percentage ($30,000 $90,000)...................................
Gross profit remaining in inventory............................................
Ownership percentage.......................................................................
Unrealized gross profit to be deferred until 2015......................

$15,000
33%
$5,000
40%
$ 2,000

Schedule 3Deferral of Unrealized Gross Profit2015


Inventory remaining at end of year (30%)........................................
Gross profit percentage ($30,000 $80,000)...................................
Gross profit remaining in inventory............................................
Ownership percentage.......................................................................
Unrealized gross profit to be deferred until 2016......................

$24,000
37%
$9,000
40%
$ 3,600

Problem III
Following are pre-acquisition financial balances for Padre Company and Sol Company as of
December 31. Also included are fair values for Sol Company accounts.

On December 31, Padre acquires Sol's outstanding stock by paying $360,000 in cash and issuing
10,000 shares of its own common stock with a fair value of $40 per share. Padre paid legal and
accounting fees of $20,000 as well as $5,000 in stock issuance costs.
Determine the value that would be shown in Padre's consolidated financial statements for each of
the accounts listed.

Inventory = $670,000 (Padre's book value plus Sol's fair value)


Land = $710,000 (Padre's book value plus Sol's fair value)
Buildings and equipment = $930,000 (Padre's book value plus Sol's fair
value)
Franchise agreements = $440,000 (Padre's book value plus Sol's fair
value)
Goodwill = $80,000 ($760,000 consideration transferred exceeds the
$680,000 fair value of Sols net assets acquired)
Revenues = $960,000 (only parent company operational figures are
reported at date of acquisition)

Additional paid-in capital = $265,000 (Padre's book value adjusted for


stock issue less stock issuance costs)
Expenses = $940,000 (only parent company operational figures plus
acquisition-related costs are reported at date of acquisition)
Retained earnings, 1/1 = $390,000 (Padre's book value only)
Retained earnings, 12/31 = $410,000 (beginning retained earnings plus
revenues minus expenses, of Padre only)

Problem IV
Francisco Inc. acquired 100 percent of the voting shares of Beltran Company on January 1, 2014.
In exchange, Francisco paid $450,000 in cash and issued 104,000 shares of its own $1 par value
common stock. On this date, Francisco's stock had a fair value of $12 per share. The combination
is a statutory merger with Beltran subsequently dissolved as a legal corporation. Beltran's assets
and liabilities are assigned to a new reporting unit.
The following reports the fair values for the Beltran reporting unit for January 1, 2014, and
December 31, 2015, along with their respective book values on December 31, 2015.

a. Prepare Francisco's journal entry to record the assets acquired and the liabilities assumed
in the Beltran merger on January 1, 2014.

In accounting for the combination, the total fair value of Beltran (consideration
transferred) is allocated to each identifiable asset acquired and liability
assumed with any remaining excess as goodwill.
Cash paid
Fair value of shares issued
Consideration transferred

$ 450,000
1,248,000
$1,698,000

Consideration transferred (above)


Fair value of net assets acquired and
liabilities assumed
Goodwill recognized in the combination

$1,698,000
1,298,000
$ 400,000

Entry by Francisco to record assets acquired and liabilities assumed in the


combination with Beltran:
Cash
75,000
Receivables
193,000
Inventory
281,000
Patents
525,000
Customer relationships
500,000
Equipment
295,000
Goodwill
400,000
Accounts payable
Long-term liabilities
Cash
Common stock (Francisco Co., par value)
Additional paid-in capital

121,000
450,000
450,000
104,000
1,144,000

b. On December 31, 2015, Francisco opts to forego any goodwill impairment qualitative
assessment and estimates that the total fair value of the entire Beltran reporting unit is
$1,425,000. What amount of goodwill impairment, if any, should Francisco recognize on
its 2015 income statement?
Step one in goodwill impairment test:
Fair value of reporting unit as a whole
Book value of reporting unit's net assets

1,425,000
1,585,000

Because the total fair value of the reporting unit is less than its carrying value,
a potential goodwill impairment loss exists, step two is performed:
Fair value of reporting unit as a whole
$1,425,000
Fair values of reporting unit's net assets (excluding goodwill) 1,325,000
Implied fair value of goodwill
100,000
Book value of goodwill
400,000
Goodwill impairment loss
$ 300,000

Problem V
On January 3, 2013, Persoff Corporation acquired all of the outstanding voting stock of Sea
Cliff, Inc. in exchange for $6,000,000 in cash. Persoff elected to exercise control over Sea Cliff
as a wholly owned subsidiary with an independent accounting system. Both companies have
December 31 fiscal year-ends. At the acquisition date, Sea Cliff's stockholders' equity was
$2,500,000 including retained earnings of $1,700,000. Persoff pursued the acquisition, in part, to
utilize Sea Cliff's technology and computer software. These items had fair values that differed
from their values on Sea Cliff's books as follows:

Sea Cliff's remaining identifiable assets and liabilities had acquisition-date book values that
closely approximated fair values. Since acquisition, no assets have been impaired. During the
next three years, Sea Cliff reported the following income and dividends:

December 31, 2015, financial statements for each company appear on the following page.
Parentheses indicate credit balances. Dividends declared were paid in the same period.
Required:
Prepare a worksheet to determine the consolidated values to be reported on Persoff's financial
statements.

PERSOFF COMPANY AND CONSOLIDATED SUBSIDIARY


Consolidation Worksheet
For Year Ending December 31, 2015
Income Statement
Revenues
Cost of goods sold
Depreciation
Amortization
Equity earnings in Sea Cliff
Net income

Persoff
(2,720,000)
1,350,000
275,000
370,000
(575,000)
(1,300,000)

Sea Cliff
(2,250,000)
870,000
380,000
25,000

Statement of Retained Earnings


Retained earnings 1/1
Net income (above)
Dividends declared
Retained earnings 12/31

(7,470,000)
(1,300,000)
600,000
(8,170,000)

(3,240,000)
(975,000)
150,000
(4,065,000)

490,000
7,165,000

375,000

Balance Sheet
Current assets
Investment in Sea Cliff

Computer software
Patented technology
Goodwill
Equipment
Total assets
Liabilities
Common stock
Retained earnings 12/31
Total liabilities and equity

Adjustments & Eliminations

D
C

400,000
575,000

(975,000)

E 3,240,000
150,000 C

45,000
80,000
0
4,500,000
5,000,000

(520,000)
(2,000,000)
(8,170,000)
(10,690,000)

(135,000)
(800,000)
(4,065,000)
(5,000,000)

(7,470,000)
(1,300,000)
600,000
(8,170,000)

865,000
C

300,000
800,000
100,000
1,835,000
10,690,000

Consolidated
(4,970,000)
2,220,000
655,000
795,000
0
(1,300,000)

150,000

A 1,000,000
A 1,500,000
A 200,000

575,000 C
4,040,000 E
2,700,000 A
100,000 D
300,000 D

800,000
7,865,000

7,865,000

-01,245,000
2,080,000
300,000
6,335,000
10,825,000
(655,000)
(2,000,000)
(8,170,000)
(10,825,000)

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