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Chapter 02 โ Consolidation of Financial Information
CHAPTER 2
CONSOLIDATION OF FINANCIAL INFORMATION
Accounting standards for business combination are found in FASB ASC Topic 805, โBusiness
Combinationsโ and Topic 810, โConsolidation.โ These standards require the acquisition method
which emphasizes acquisition-date fair values for recording all business combinations.
In this chapter, we first provide coverage of expansion through corporate takeovers and an
overview of the consolidation process. Then we present the acquisition method of accounting for
business combinations followed by limited coverage of the purchase method and pooling of
interests provided in the Appendix 2A and pushdown accounting in Appendix 2B.
Chapter Outline
I.
Business combinations and the consolidation process
A. A business combination is the formation of a single economic entity, an event that
occurs whenever one company gains control over another
B. Business combinations can be created in several different ways
1. Statutory mergerโonly one of the original companies remains in business as a
legally incorporated enterprise.
a. Assets and liabilities can be acquired with the seller then dissolving itself as a
corporation.
b. All of the capital stock of a company can be acquired with the assets and
liabilities then transferred to the buyer followed by the sellerโs dissolution.
2. Statutory consolidationโassets or capital stock of two or more companies are
transferred to a newly formed corporation
3. Acquisition by one company of a controlling interest in the voting stock of a
second. Dissolution does not take place; both parties retain their separate legal
incorporation.
C. Financial information from the members of a business combination must be
consolidated into a single set of financial statements representing the entire economic
entity.
1. If the acquired company is legally dissolved, a permanent consolidation is
produced on the date of acquisition by entering all account balances into the
financial records of the surviving company.
2. If separate incorporation is maintained, the parent company simulates
consolidation whenever financial statements are to be prepared. This process is
carried out through the use of worksheets and consolidation entries. Consolidation
worksheet entries are used to adjust and eliminate subsidiary company accounts.
Entry โSโ eliminates the equity accounts of the subsidiary. Entry โAโ allocates
excess payment amounts to identifiable assets and liabilities based on the fair
value of the subsidiary accounts. (Consolidation journal entries are never
recorded in the books of either company, they are worksheet entries only.)
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Chapter 02 โ Consolidation of Financial Information
II.
III.
The Acquisition Method
A. For business combinations resulting in complete ownership, the acquisition method is
distinguished by four characteristics.
1. All assets acquired and liabilities assumed in the combination are recognized and
measured at their individual fair values (with few exceptions).
2. The fair value of the consideration transferred provides a starting point for valuing
and recording a business combination.
a. The consideration transferred includes cash, securities, and contingent
performance obligations.
b. Direct combination costs are expensed as incurred.
c. Stock issuance costs are recorded as a reduction in paid-in capital.
d. The fair value of any noncontrolling interest also adds to the valuation of the
acquired firm and is covered beginning in Chapter 4 of the text.
3. Any excess of the fair value of the consideration transferred over the net amount
assigned to the individual assets acquired and liabilities assumed is recognized by
the acquirer as goodwill.
4. Any excess of the net amount assigned to the individual assets acquired and
liabilities assumed over the fair value of the consideration transferred is
recognized by the acquirer as a โgain on bargain purchase.โ
B. In-process research and development acquired in a business combination is
recognized as an asset at its acquisition-date fair value.
Convergence between U.S. GAAP and IAS IFRS 3 โ nearly identical to U.S. GAAP
because of joint efforts
APPENDIX 2A:
I. The Purchase Method
A. The purchase method was applicable for business combinations occurring for fiscal
years beginning prior to December 15, 2008. It was distinguished by three
characteristics.
1. One company was clearly in a dominant role as the purchasing party
2. A bargained exchange transaction took place to obtain control over the second
company.
3. A historical cost figure was determined based on the acquisition price paid.
a. The cost of the acquisition included any direct combination costs.
b. Stock issuance costs were recorded as a reduction in paid-in capital and are
not considered to be a component of the acquisition price.
B. Purchase method procedures
1. The assets and liabilities acquired were measured by the buyer at fair value as of
the date of acquisition.
2. Any portion of the payment made in excess of the fair value of these assets and
liabilities was attributed to an intangible asset commonly referred to as goodwill.
3. If the price paid was below the fair value of the assets and liabilities (rarely
occurred), the acquired company accounts were still measured at fair value
except that certain noncurrent asset values were reduced by the excess cost. If
these values were not great enough to absorb the entire reduction, an
extraordinary gain was recognized.
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Chapter 02 โ Consolidation of Financial Information
II.
The Pooling of Interest Method (prohibited for combinations after June 2002)
A. A pooling of interests reflected united ownership of two companies through the
exchange of equity securities. The characteristics of a pooling are fundamentally
different from either the purchase or acquisition methods.
1. Neither party was truly viewed as an acquiring company.
2. Precise cost figures from the exchange of securities were difficult to ascertain.
3. The transaction affected the stockholders rather than the companies.
B. Pooling of interests accounting
1. Because of the nature of a pooling, an acquisition price was not relevant.
a. Since no acquisition price was computed, all direct costs of creating the
combination were expensed immediately.
b. No new goodwill was recognized from the combination. Similarly, no valuation
adjustments were recorded for any of the subsidiary assets or liabilities.
2. The book values of the two companies were simply brought together to produce
consolidated financial statements. A pooling was viewed as a uniting of the
owners rather than the two companies.
3. The results of operations reported by both parties were combined on a retroactive
basis as if the companies had always been together.
4. Controversy historically surrounded the pooling of interests method.
a. Cost figures indicated by the exchange transaction were ignored.
b. Income balances previously reported were combined on a retrospective basis.
c. Reported net income was usually higher in subsequent years than in a
purchase because the lack of valuation adjustments reduced amortization.
APPENDIX 2B: Pushdown Accounting
I. Pushdown accounting is the application of the parentโs acquisition-date valuations for the
subsidiaryโs standalone financial statements. A newly acquired entity may elect the option to
apply pushdown accounting in the reporting period immediately following the acquisition. The
rationale is that the acquisition-date fair values for the subsidiaryโs assets and liabilities are
more representationally faithful and relevant to users of the subsidiaryโs financial statements.
II. When push-down accounting is elected,
A. The subsidiary revalues its assets and liabilities based on the acquisition-date fair value
allocations. The subsidiary then recognizes periodic amortization expense on those
allocations with definite lives. Therefore, the subsidiaryโs recorded income equals its
impact on consolidated earnings (except in the presence of a bargain purchase gain).
B. Any goodwill from the combination is reported in the acquired entityโs separate financial
statements. In the case of a bargain purchase gain, pushdown accounting recognize an
adjustment to its additional paid-in capital, not as a gain in its income statement.
C. the subsidiaryโs retained earnings are revalued to zero recognizing the new reporting
entity as of the parentโs acquisition date.
III. The parent uses no special procedures when push-down accounting is being applied.
However, if the equity method is in use, amortization need not be recognized by the parent
since that expense is included in the figure reported by the subsidiary.
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Chapter 02 โ Consolidation of Financial Information
Answer to Discussion Question
What if an acquired entity is not a business?
The accounting and reporting implications to this question are included in the discussion followed
by an example of an asset acquisition by Celgene Corporation. The question is designed to
provide class discussion on the definition of a business and meeting that definition as a
requirement for use of the acquisition method.
The instructor can point out that the acquisition method can be very complex and costly to
implement. Companies that simply are acquiring an asset (even though it may be incorporated)
do not need to incur the additional costs of complying with FASB ASC Topic 805, โBusiness
Combinations.โ
Accounting cost savings in asset acquisitions (vs. a business combination that requires the
acquisition method) can result from less effort in determining fair values for contingent
consideration, assessing periodic impairment for in-process research and development, assessing
periodic impairment for goodwill, etc. Thus, companies that are simply purchasing an asset will
avoid many of the complications of ASC 805 compliance.
The FASB issued Accounting Standards Update 2017-01 to help companies evaluate whether a
set of acquired assets is a business or not by providing a new definition of a business. The new
definition replaces a previous one that was considered broad and challenging to apply. ASU 201701 is expected to restrict the number of acquisitions that qualify for the acquisition method.
Answers to Questions
1.
2.
3.
4.
A business combination is the process of forming a single economic entity by the uniting of
two or more organizations under common ownership. The term also refers to the entity
that results from this process.
Synergy is the concept that through combination, two or more companies will produce more
revenue than either one could separately, or eliminate or streamline duplicate efforts,
resulting in cost reductions. In a business combination, examples of synergies include
utilizing existing distribution channels of one firm for the combined firm to increase
revenues. Cost savings may be available through elimination of duplicate facilities. Larger
size and scale can also provide additional negotiating power for the combined firm.
(1) A statutory merger is created whenever two or more companies come together to form
a business combination and only one remains in existence as an identifiable entity. This
arrangement is often instituted by the acquisition of substantially all of an enterpriseโs
assets. (2) A statutory merger can also be produced by the acquisition of a companyโs
capital stock. This transaction is labeled a statutory merger if the acquired company
transfers its assets and liabilities to the buyer and then legally dissolves as a corporation.
(3) A statutory consolidation results when two or more companies transfer all of their assets
or capital stock to a newly formed corporation. The original companies are being
โconsolidatedโ into the new entity. (4) A business combination is also formed whenever
one company gains control over another through the acquisition of outstanding voting
stock. Both companies retain their separate legal identities although the common
ownership indicates that only a single economic entity exists.
Consolidated financial statements represent accounting information gathered from two or
more separate companies. This data, although accumulated individually by the
organizations, is brought together (or consolidated) to describe the single economic entity
created by the business combination.
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Education.
Chapter 02 โ Consolidation of Financial Information
5.
6.
7.
8.
9.
10.
11.
12.
Companies that form a business combination will often retain their separate legal identities
as well as their individual accounting systems. In such cases, internal financial data
continues to be accumulated by each organization. Separate financial reports may be
required for outside shareholders (a noncontrolling interest), the government, debt holders,
etc. This information may also be utilized in corporate evaluations and other decision
making. However, the business combination must periodically produce consolidated
financial statements encompassing all of the companies within the single economic entity.
The purpose of a worksheet is to organize and structure this process. The worksheet
allows for a simulated consolidation to be carried out on a regular, periodic basis without
affecting the financial records of the various component companies.
Several situations can occur in which the fair value of the 50,000 shares being issued might
be difficult to ascertain. These examples include:
โช The shares may be newly issued (if Jones has just been created) so that no accurate
value has yet been established;
โช Jones may be a closely held corporation so that no fair value is available for its shares;
โช The number of newly issued shares (especially if the amount is large in comparison to
the quantity of previously outstanding shares) may cause the price of the stock to
fluctuate widely so that no accurate fair value can be determined during a reasonable
period of time;
โช Jonesโ stock may have historically experienced drastic swings in price. Thus, a quoted
figure at any specific point in time may not be an adequate or representative value for
long-term accounting purposes.
For combinations resulting in complete ownership, the acquisition method allocates the fair
value of the consideration transferred to the separately recognized assets acquired and
liabilities assumed based on their individual fair values.
The revenues and expenses (both current and past) of the parent are included within
reported figures. However, the revenues and expenses of the subsidiary are consolidated
from the date of the acquisition forward within the worksheet consolidation process. The
operations of the subsidiary are only applicable to the business combination if earned
subsequent to its creation.
Morganโs additional acquisition value may be attributed to many factors: expected
synergies between Morganโs and Jenningsโ assets, favorable earnings projections,
competitive bidding to acquire Jennings, etc. In general however, any amount paid by the
parent company in excess of the fair values of the subsidiaryโs net assets acquired is
reported as goodwill.
In the vast majority of cases the assets acquired and liabilities assumed in a business
combination are recorded at their fair values. If the fair value of the consideration
transferred (including any contingent consideration) is less than the total net fair value
assigned to the assets acquired and liabilities assumed, then an ordinary gain on bargain
purchase is recognized for the difference.
Shares issued are recorded at fair value as if the stock had been sold and the money
obtained used to acquire the subsidiary. The Common Stock account is recorded at the
par value of these shares with any excess amount attributed to additional paid-in capital.
The direct combination costs of $98,000 are allocated to expense in the period in which
they occur. Stock issue costs of $56,000 are treated as a reduction of APIC.
2-5
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Chapter 02 โ Consolidation of Financial Information
Answers to Problems
1.
D
2.
B
3.
D
4.
A
5.
A
6.
B
7.
D
8.
A
9.
B
10. C
11. C
12. B Consideration transferred (fair value)
Cash
Accounts receivable
Software
Research and development asset
Liabilities
Fair value of net identifiable assets acquired
Goodwill
13. C Legal and accounting fees accounts payable
Contingent liability
Donovanโs liabilities assumed
Liabilities assumed or incurred
14. D Consideration transferred (fair value)
Current assets
Building and equipment
Unpatented technology
Research and development asset
Liabilities
Fair value of net identifiable assets acquired
Goodwill
Current assets
Building and equipment
Unpatented technology
Research and development asset
Goodwill
Total assets
$800,000
$150,000
140,000
320,000
200,000
(130,000)
680,000
$120,000
$15,000
20,000
60,000
$95,000
$420,000
$90,000
250,000
25,000
45,000
(60,000)
350,000
$ 70,000
$ 90,000
250,000
25,000
45,000
70,000
$480,000
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Chapter 02 โ Consolidation of Financial Information
15. C Value of shares issued (51,000 ร $3) ……………………………….. $153,000
Par value of shares issued (51,000 ร $1) …………………………..
51,000
Additional paid-in capital (new shares) …………………………… $102,000
Additional paid-in capital (existing shares) ……………………..
90,000
Consolidated additional paid-in capital (fair value)…………… $192,000
At the acquisition date, the parent makes no change to retained earnings.
16. B Consideration transferred (fair value) ……………………..
Book value of subsidiary (assets minus liabilities) ….
Fair value in excess of book value ………………………
Allocation of excess fair over book value
identified with specific accounts:
Inventory ……………………………………………………………
Patented technology …………………………………………..
Land ………………………………………………………………….
Long-term liabilities ……………………………………………
Goodwill …………………………………………………………….
$400,000
(300,000)
100,000
17. D TruData patented technology………………………………….
Webstat patented technology (fair value) ………………..
Acquisition-date consolidated balance sheet amount
$230,000
200,000
$430,000
18. C TruData common stock before acquisition………………
Common stock issued (par value) …………………………..
Acquisition-date consolidated balance sheet amount
$300,000
50,000
$350,000
19. B TruDataโs 1/1 retained earnings ………………………………
TruDataโs income (1/1 to 7/1) ………………………………….
Acquisition-date consolidated balance sheet amount
$130,000
80,000
$210,000
30,000
20,000
25,000
10,000
$15,000
20. C Patrickโs assets
$1,395,000
Less: investment in Sean ………………………………………. (460,000)
Seanโs assets ………………………………………………………..
415,000
Inventory write-up ………………………………………………….
25,000
Goodwill from the combination (see below) …………….
145,000
Total consolidated assets ……………………………………… $1,520,000
Consideration transferred ………………………………………
Fair value of net identifiable assets (see below) ………
Goodwill ………………………………………………………………..
$460,000
315,000
$145,000
Seanโs assets (carrying amount) …………………………………..
Seanโs liabilities (carrying amount = $95,000 + $30,000) ……
Seanโs net assets (carrying amount) …………………………….
Inventory adjustment to fair value ………………………………
Fair value of Seanโs net identifiable assets………………….
$415,000
125,000
290,000
25,000
$315,000
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Chapter 02 โ Consolidation of Financial Information
21. B Patrickโs stockholdersโ equity total.
22. a. An intangible asset acquired in a business combination is recognized as an
asset apart from goodwill if it arises from contractual or other legal rights
(regardless of whether those rights are transferable or separable from the
acquired enterprise or from other rights and obligations). If an intangible
asset does not arise from contractual or other legal rights, it shall be
recognized as an asset apart from goodwill only if it is separable, that is, it
is capable of being separated or divided from the acquired enterprise and
sold, transferred, licensed, rented, or exchanged (regardless of whether
there is an intent to do so). An intangible asset that cannot be sold,
transferred, licensed, rented, or exchanged individually is considered
separable if it can be sold, transferred, licensed, rented, or exchanged with
a related contract, asset, or liability.
b. โผ Trademarksโusually meet both the separability and legal/contractual
criteria.
โผ Customer listโusually meets the separability criterion.
โผ Copyrights on artistic materialsโusually meet both the separability and
legal/contractual criteria.
โผ Agreements to receive royalties on leased intellectual propertyโusually
meet the legal/contractual criterion.
โผ Unpatented technologyโmay meet the separability criterion if capable
of being sold even if in conjunction with a related contract, asset, or
liability.
23. (12 minutes) (Journal entries to record a mergerโacquired company
dissolved)
Inventory
Land
Buildings
Customer Relationships
Goodwill
Accounts Payable
Common Stock
Additional Paid-In Capital
Cash
600,000
990,000
2,000,000
800,000
690,000
Professional Services Expense
Cash
42,000
Additional Paid-In Capital
Cash
25,000
80,000
40,000
960,000
4,000,000
42,000
25,000
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Chapter 02 โ Consolidation of Financial Information
24. (12 minutes) (Journal entries to record a bargain purchaseโacquired company
dissolved)
Inventory
Land
Buildings
Customer Relationships
Accounts Payable
Cash
Gain on Bargain Purchase
600,000
990,000
2,000,000
800,000
Professional Services Expense
Cash
42,000
80,000
4,200,000
110,000
42,000
25. (15 Minutes) (Consolidated balances)
In acquisitions, the fair values of the subsidiary’s assets and liabilities are
consolidated (there are a limited number of exceptions). Goodwill is reported
at $80,000, the amount that the $760,000 consideration transferred exceeds the
$680,000 fair value of Solโs net assets acquired.
โช Inventory = $670,000 (Padre’s book value plus Sol’s fair value)
โช Land = $710,000 (Padre’s book value plus Sol’s fair value)
โช Buildings and equipment = $930,000 (Padre’s book value plus Sol’s fair
value)
โช Franchise agreements = $440,000 (Padre’s book value plus Sol’s fair
value)
โช Goodwill = $80,000 (calculated above)
โช Revenues = $960,000 (only parent company operational figures are
reported at date of acquisition)
โช Additional paid-in capital = $265,000 (Padre’s book value adjusted for
stock issue less stock issuance costs)
โช Expenses = $940,000 (only parent company operational figures plus
acquisition-related costs are reported at date of acquisition)
โช Retained earnings, 1/1 = $390,000 (Padre’s book value only)
โช Retained earnings, 12/31 = $410,000 (beginning retained earnings plus
revenues minus expenses, of Padre only)
2-9
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Chapter 02 โ Consolidation of Financial Information
26. (20 minutes) Journal entries for a merger using alternative values.
a. Acquisition date fair values:
Cash paid
Contingent performance liability
Consideration transferred
Fair values of net assets acquired
Gain on bargain purchase
$700,000
35,000
$735,000
750,000
$ 15,000
Receivables
90,000
Inventory
75,000
Copyrights
480,000
Patented Technology
700,000
Research and Development Asset
200,000
Current liabilities
160,000
Long-Term Liabilities
635,000
Cash
700,000
Contingent Performance Liability
35,000
Gain on Bargain Purchase
15,000
Professional Services Expense
Cash
100,000
100,000
b. Acquisition date fair values:
Cash paid
Contingent performance liability
Consideration transferred
Fair values of net assets acquired
Goodwill
$800,000
35,000
$835,000
750,000
$ 85,000
Receivables
90,000
Inventory
75,000
Copyrights
480,000
Patented Technology
700,000
Research and Development Asset
200,000
Goodwill
85,000
Current Liabilities
160,000
Long-Term Liabilities
635,000
Cash
800,000
Contingent Performance Liability
35,000
Professional Services Expense
Cash
100,000
100,000
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Chapter 02 โ Consolidation of Financial Information
27. (20 Minutes) (Determine selected consolidated balances)
Under the acquisition method, the shares issued by Wisconsin are recorded at
fair value using the following journal entry:
Investment in Badger (value of debt and shares issued) 900,000
Common Stock (par value) ……………………………………..
150,000
Additional Paid-In Capital (excess over par value) …..
450,000
Liabilities……………………………………………………………….
300,000
The payment to the broker is accounted for as an expense. The stock issue
cost is a reduction in additional paid-in capital.
Professional Services Expense……………………………………
Additional Paid-In Capital ……………………………………………
Cash ……………………………………………………………………
30,000
40,000
70,000
Allocation of Acquisition-Date Excess Fair Value:
Consideration transferred (fair value) for Badger Stock
Book Value of Badger, 6/30 …………………………………………
Fair Value in Excess of Book Value …………………………
Excess fair value (undervalued equipment) ………………….
Excess fair value (overvalued patented technology) …….
Goodwill ………………………………………………………………..
$900,000
770,000
$130,000
100,000
(20,000)
$ 50,000
CONSOLIDATED BALANCES:
a. Net income (adjusted for professional services expense. The
figures earned by the subsidiary prior to the takeover
are not included) …………………………………………………………….
$ 210,000
b. Retained earnings, 1/1 (the figures earned by the subsidiary
prior to the takeover are not included) ……………………………..
800,000
c. Patented technology (the parent’s book value plus the fair
value of the subsidiary) …………………………………………………..
1,180,000
d. Goodwill (computed above) …………………………………………….
50,000
e. Liabilities (the parent’s book value plus the fair value
of the subsidiary’s debt plus the debt issued by the parent
in acquiring the subsidiary) …………………………………………….
1,210,000
f. Common stock (the parent’s book value after recording
the newly-issued shares)…………………………………………………
510,000
g. Additional Paid-in Capital (the parent’s book value
after recording the two entries above) ……………………………..
680,000
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Chapter 02 โ Consolidation of Financial Information
28. (20 minutes) (Preparation of a consolidated balance sheet)*
CASEY CORPORATION AND CONSOLIDATED SUBSIDIARY KENNEDY
Worksheet for a Consolidated Balance Sheet
January 1, 2021
Cash
Accounts receivable
Inventory
Investment in Kennedy
Casey
457,000
1,655,000
1,310,000
3,300,000
Kennedy
172,500
347,000
263,500
-0-
Buildings (net)
Licensing agreements
Goodwill
Total assets
6,315,000
-0347,000
13,384,000
2,090,000
3,070,000
-05,943,000
Accounts payable
Long-term debt
Common stock
Additional paid-in cap.
Retained earnings
Total liab. & equities
(394,000)
(3,990,000)
(3,000,000)
-0(6,000,000)
(13,384,000)
(393,000)
(2,950,000)
(1,000,000)
(500,000)
(1,100,000)
(5,943,000)
Adjust. & Elim.
(A) 382,000
(A) 426,000
(S) 1,000,000
(S) 500,000
(S) 1,100,000
3,408,000
Consolidated
629,500
2,002,000
1,573,500
(S) 2,600,000
(A) 700,000
-08,787,000
(A) 108,000
2,962,000
773,000
16,727,000
(787,000)
(6,940,000)
(3,000,000)
-0(6,000,000)
3,408,000 (16,727,000)
*Although this solution uses a worksheet to compute the consolidated amounts, the
problem does not require it.
29. (50 Minutes) (Determine consolidated balances for a bargain purchase.)
a. Marshallโs acquisition of Tucker represents a bargain purchase because
the fair value of the net assets acquired exceeds the fair value of the
consideration transferred as follows:
Fair value of net assets acquired
$515,000
Fair value of consideration transferred
400,000
Gain on bargain purchase
$115,000
In a bargain purchase, the acquisition is recorded at the fair value of the
net assets acquired instead of the fair value of the consideration
transferred (an exception to the general rule).
Prior to preparing a consolidation worksheet, Marshall records the three
transactions that occurred to create the business combination.
Investment in Tucker ……………………………………….. 515,000
Long-term Liabilities ……………………………………………………… 200,000
Common Stock (par value) ……………………………………………..
20,000
Additional Paid-In Capital ………………………………………………. 180,000
Gain on Bargain Purchase …………………………………………….. 115,000
(To record liabilities and stock issued for Tucker acquisition fair value)
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Chapter 02 โ Consolidation of Financial Information
29. (continued)
Professional Services Expense……………………..
Cash ……………………………………………………..
(to record payment of professional fees)
30,000
Additional Paid-In Capital ……………………………..
Cash ……………………………………………………..
(To record payment of stock issuance costs)
12,000
30,000
12,000
Marshall’s trial balance is adjusted for these transactions (as shown in the
worksheet that follows).
Next, the $400,000 fair value of the investment is allocated:
Consideration transferred at fair value ……………………………..
$400,000
Book value (assets minus liabilities or
total stockholders’ equity) …………………………………………..
460,000
Book value in excess of consideration transferred ……..
(60,000)
Allocation to specific accounts based on fair value:
Inventory ………………………………………………………….
5,000
Land ………………………………………………………………
20,000
Buildings ………………………………………………………….
30,000 55,000
Gain on bargain purchase (excess net asset fair value
over consideration transferred) …………………………………..
$(115,000)
CONSOLIDATED TOTALS
โช Cash = $38,000. Add the two book values less acquisition and stock issue
costs
โช Receivables = $360,000. Add the two book values.
โช Inventory = $505,000. Add the two book values plus the fair value
adjustment
โช Land = $400,000. Add the two book values plus the fair value adjustment.
โช Buildings = $670,000. Add the two book values plus the fair value
adjustment.
โช Equipment = $210,000. Add the two book values.
โช Total assets = $2,183,000. Summation of the above individual figures.
โช Accounts payable = $190,000. Add the two book values.
โช Long-term liabilities = $830,000. Add the two book values plus the debt
incurred by the parent in acquiring the subsidiary.
โช Common stock = $130,000.The parent’s book value after stock issue to
acquire the subsidiary.
โช Additional paid-in capital = $528,000.The parent’s book value after the stock
issue to acquire the subsidiary less the stock issue costs.
โช Retained earnings = $505,000. Parent company balance less $30,000 in
professional services expense plus $115,000 gain on bargain purchase.
โช Total liabilities and equity = $2,183,000. Summation of the above figures.
2-13
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Chapter 02 โ Consolidation of Financial Information
29. (continued)
b.
MARSHALL COMPANY AND CONSOLIDATED SUBSIDIARY
Worksheet
January 1, 2021
Accounts
Cash ……………………………………..
Receivables ………………………….
Inventory ……………………………..
Land …………………………………….
Buildings (net) ……………………..
Equipment (net) ……………………
Investment in Tucker …………….
Marshall
Company*
18,000
270,000
360,000
200,000
420,000
160,000
515,000
Tucker
Company
20,000
90,000
140,000
180,000
220,000
50,000
Total assets ………………………….
1,943,000
700,000
Accounts payable ………………….
Long-term liabilities ……………..
Common stock ……………………..
Additional paid-in capital ………
Retained earnings, 1/1/21 ………
Total liab. and ownersโ equity ..
(150,000)
(630,000)
(130,000)
(528,000)
(505,000)
(1,943,000)
(40,000)
(200,000)
(120,000)
-0(340,000)
(700,000)
Consolidation Entries Consolidated
Debit
Credit
Totals
38,000
360,000
(A) 5,000
505,000
(A) 20,000
400,000
(A) 30,000
670,000
210,000
(S) 460,000
(A) 55,000
-02,183,000
(S) 120,000
(S) 340,000
515,000
(190,000)
(830,000)
(130,000)
(528,000)
(505,000)
515,000 (2,183,000)
Marshall’s accounts have been adjusted for acquisition entries (see part a.).
2-14
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30. (Prepare a consolidated balance sheet)
Consideration transferred at fair value …………..
Book value …………………………………………………..
Excess fair over book value ………………………….
Allocation of excess fair value to
specific assets and liabilities:
to computer software ……………………………….
to equipment……………………………………………
to client contracts ……………………………………
to in-process research and development …
to notes payable ………………………………………
Goodwill ………………………………………………………
Cash
Receivables
Inventory
Investment in Spider
Pratt
Spider
36,000
116,000
140,000
495,000
18,000
52,000
90,000
-0-
$495,000
265,000
230,000
$50,000
(10,000)
100,000
40,000
(5,000)
Debit
Credit
175,000
$ 55,000
Consolidated
54,000
168,000
230,000
(S) 265,000
(A) 230,000
-0280,000
725,000
338,000
100,000
Computer software
210,000
Buildings (net)
595,000
Equipment (net)
308,000
Client contracts
-0Research and
development asset
-0Goodwill
-0Total assets
1,900,000
20,000 (A) 50,000
130,000
40,000
(A) 10,000
-0- (A) 100,000
-0- (A) 40,000
-0- (A) 55,000
350,000
40,000
55,000
1,990,000
Accounts payable
Notes payable
Common stock
Additional paid-in
capital
Retained earnings
Total liabilities
and equities
(88,000)
(510,000)
(380,000)
(25,000)
(60,000)
(A) 5,000
(100,000) (S)100,000
(113,000)
(575,000)
(380,000)
(170,000)
(752,000)
(25,000) (S) 25,000
(140,000) (S)140,000
(170,000)
(752,000)
(1,900,000)
(350,000)
510,000
510,000 (1,990,000)
Chapter 02 โ Consolidation of Financial Information
30. (continued)
Pratt Company and Subsidiary
Consolidated Balance Sheet
December 31, 2021
Assets
Liabilities and Ownersโ Equity
Cash
$ 54,000
Accounts payable
$ 113,000
Receivables
168,000
Notes payable
575,000
Inventory
230,000
Computer software
280,000
Buildings (net)
725,000
Equipment (net)
338,000
Client contracts
100,000
Research and
Common stock
380,000
development asset
40,000
Additional paid in capital
170,000
Goodwill
55,000
Retained earnings
752,000
Total assets
$1,990,000
Total liabilities and equities $1,990,000
31. (15 minutes) (Acquisition method entries for a merger)
Case 1: Fair value of consideration transferred
Fair value of net identifiable assets
Excess to goodwill
$145,000
120,000
$25,000
Case 1 journal entry on Allertonโs books:
Current Assets
Building
Land
Trademark
Goodwill
Liabilities
Cash
60,000
50,000
20,000
30,000
25,000
40,000
145,000
Case 2: Bargain Purchase under acquisition method
Fair value of consideration transferred
Fair value of net identifiable assets
Gain on bargain purchase
$110,000
120,000
$ 10,000
Case 2 journal entry on Allertonโs books:
Current Assets
Building
Land
Trademark
Gain on Bargain Purchase
Liabilities
Cash
60,000
50,000
20,000
30,000
10,000
40,000
110,000
2-16
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Chapter 02 โ Consolidation of Financial Information
Problem 31. (continued)
In a bargain purchase, the acquisition method employs the fair value of the net
identifiable assets acquired as the basis for recording the acquisition. Because
this basis exceeds the amount paid, Allerton recognizes a gain on bargain
purchase. This is an exception to the general rule of using the fair value of the
consideration transferred as the basis for recording the combination.
32. (25 minutes) (Combination entriesโacquired entity dissolved)
Cash consideration transferred
Contingent performance obligation
Consideration transferred (fair value)
Fair value of net identifiable assets*
Goodwill
$310,800
17,900
328,700
294,700
$ 34,000
* Acquisition date Streeter book value
Excess building fair value
Unrecorded customer list
In-process research and development
Acquisition date Streeter fair value of net identifiable assets
$190,000
43,100
25,200
36,400
$294,700
Journal entries:
Receivables
83,900
Inventory
70,250
Buildings
122,000
Equipment
24,100
Customer List
25,200
Research and Development Asset 36,400
Goodwill
34,000
Current Liabilities
Long-Term Liabilities
Contingent Performance Liability
Cash
12,900
54,250
17,900
310,800
Professional Services Expense
Cash
15,100
15,100
2-17
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Chapter 02 โ Consolidation of Financial Information
33. (30 Minutes) (Overview of the steps in applying the acquisition method when
shares have been issued to create a combination. Part h. includes a bargain
purchase.)
a. The fair value of the consideration includes
Fair value of stock issued
Contingent performance obligation
Fair value of consideration transferred
$1,500,000
30,000
$1,530,000
b. Stock issue costs reduce additional paid-in capital.
c. In a business combination, direct acquisition costs (such as fees paid to
investment banks for arranging the transaction) are recognized as
expenses.
d. The par value of the 20,000 shares issued is recorded as an increase of
$20,000 in the Common Stock account. The $74 fair value in excess of par
value ($75 โ $1) is an increase to additional paid-in capital of $1,480,000
($74 ร 20,000 shares).
e. Fair value of consideration transferred (above)
Receivables
$ 80,000
Patented technology
700,000
Customer relationships
500,000
In-process research and development
300,000
Liabilities
(400,000)
Goodwill
$1,530,000
1,180,000
$ 350,000
f. Revenues and expenses of the subsidiary from the period prior to the
combination are omitted from the consolidated totals. Only the operational
figures for the subsidiary after the purchase are applicable to the business
combination. The previous owners earned any previous profits.
g. The subsidiaryโs Common Stock and Additional Paid-in Capital accounts
have no impact on the consolidated totals.
h. The fair value of the consideration transferred is now $1,030,000. This
amount indicates a bargain purchase calculated as follows:
Fair value of consideration transferred
Receivables
Patented technology
Customer relationships
Research and development asset
Liabilities
Gain on bargain purchase
$1,030,000
$ 80,000
700,000
500,000
300,000
(400,000)
1,180,000
$ 150,000
The values of SafeDataโs assets and liabilities would be recorded at fair value,
but there would be no goodwill recognized and a gain on bargain purchase
would be reported.
2-18
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Chapter 02 โ Consolidation of Financial Information
34. (50 Minutes) (Prepare balance sheet for a statutory merger using the
acquisition method. Also, use worksheet to derive consolidated totals.)
a. In accounting for the combination of NewTune and On-the-Go, the fair value of
the acquisition is allocated to each identifiable asset and liability acquired with
any remaining excess attributed to goodwill.
Fair value of consideration transferred (shares issued) $750,000
Fair value of net assets acquired:
Cash
$ 29,000
Receivables
63,000
Trademarks
225,000
Record music catalog
180,000
In-process research and development
200,000
Equipment
105,000
Accounts payable
(34,000)
Notes payable
(45,000)
723,000
Goodwill
$ 27,000
Journal entries by NewTune to record combination with On-the-Go:
Cash
29,000
Receivables
63,000
Trademarks
225,000
Record Music Catalog
180,000
Research and Development Asset
200,000
Equipment
105,000
Goodwill
27,000
Accounts Payable
Notes Payable
Common Stock (NewTune par value)
Additional Paid-In Capital
(To record merger with On-the-Go at fair value)
Additional Paid-In Capital
Cash
(Stock issue costs incurred)
34,000
45,000
60,000
690,000
25,000
25,000
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Chapter 02 โ Consolidation of Financial Information
Problem 34 (continued):
Post-Combination Balance Sheet:
Assets
Cash
Receivables
Trademarks
Record music catalog
Research and
development asset
Equipment
Goodwill
Total
$
64,000
213,000
625,000
1,020,000
200,000
425,000
27,000
$2,574,000
Liabilities and Ownersโ Equity
Accounts payable
$ 144,000
Notes payable
415,000
Common stock
Additional paid-in capital
Retained earnings
Total
460,000
695,000
860,000
$2,574,000
b. Because On-the-Go continues as a separate legal entity, NewTune first
records the acquisition as an investment in the shares of On-the-Go.
Journal entries:
Investment in On-the-Go
Common Stock (NewTune, Inc., par value)
Additional Paid-In Capital
(To record acquisition of On-the-Go’s shares)
750,000
Additional Paid-In Capital
Cash
(Stock issue costs incurred)
25,000
60,000
690,000
25,000
Next, NewTuneโs accounts are adjusted for the two immediately preceding
entries to facilitate the worksheet preparation of the consolidated financial
statements.
2-20
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Chapter 02 โ Consolidation of Financial Information
34. (continued)
b.
NEWTUNE, INC., AND ON-THE-GO CO.
Consolidation Worksheet
January 1, 2021
Consolidation Entries
Accounts
NewTune, Inc. On-the-Go Co.
Debit
Credit
Cash
35,000
29,000
Receivables
150,000
65,000
(A) 2,000
Investment in On-the-Go
750,000
-0(S) 270,000
(A) 480,000
Trademarks
400,000
95,000
(A) 130,000
Record music catalog
840,000
60,000
(A) 120,000
Research and development asset
-0-0(A) 200,000
Equipment
320,000
105,000
Goodwill
-0-0(A) 27,000
Totals
2,495,000
354,000
Accounts payable
110,000
34,000
Notes payable
370,000
50,000
(A) 5,000
Common stock
460,000
50,000
(S) 50,000
Additional paid-in capital
695,000
30,000
(S) 30,000
Retained earnings
860,000
190,000
(S) 190,000
Totals
2,495,000
354,000
752,000
752,000
Consolidated
Totals
64,000
213,000
-0625,000
1,020,000
200,000
425,000
27,000
2,574,000
144,000
415,000
460,000
695,000
860,000
2,574,000
Note: The accounts of NewTune have already been adjusted for the first three journal entries indicated in the answer to Part
b. to record the acquisition fair value and the stock issuance costs.
The consolidation entries are designed to:
โช Eliminate the stockholdersโ equity accounts of the subsidiary (S)
โช Record all subsidiary assets and liabilities at fair value (A)
โช Recognize the goodwill indicated by the acquisition fair value (A)
โช Eliminate the Investment in On-the-Go account (S, A)
c. The consolidated balance sheets in parts a. and b. above are identical. The financial reporting consequences for a 100%
stock acquisition vs. a merger are the same. The economic substances of the two forms of the transaction are identical
and, therefore, so are the resulting financial statements. The difference is in the journal entry to record the acquisition in
the parent company books.
2-21
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Chapter 02 โ Consolidation of Financial Information
35. (40 minutes) (Prepare a consolidated balance sheet using the acquisition
method).
a. Journal entries to record the acquisition on Pacificaโs records.
Investment in Seguros
1,062,500
Common Stock (50,000 ร $5)
250,000
Additional Paid-In Capital (50,000 ร $15)
750,000
Contingent Performance Obligation
62,500
The contingent consideration is computed as:
$130,000 payment ร 50% probability ร 0.961538 present value factor
Professional Services Expense
Cash
Additional Paid-In Capital
Cash
15,000
15,000
9,000
9,000
b. and c.
Revenues
Expenses
Net income
(1,200,000)
890,000
(310,000)
Consolidated
Balance
Sheet
(1,200,000)
890,000
(310,000)
Retained earnings, 1/1
Net income
Dividends declared
Retained earnings, 12/31
(950,000)
(310,000)
90,000
(1,170,000)
(950,000)
(310,000)
90,000
(1,170,000)
Cash
Receivables and inventory
Property, plant and equipment
Investment in Seguros
86,000
750,000
1,400,000
1,062,500
Pacifica
Seguros
85,000
190,000
450,000
Consolidation Entries
(A) 10,000
(A)150,000
(S) 705,000
(A) 357,500
Research and development asset
Goodwill
Trademarks
Total assets
(A)100,000
(A) 77,500
(A) 40,000
300,000
3,598,500
160,000
885,000
Liabilities
Contingent performance obligation
Common stock
Additional paid-in capital
(500,000)
(62,500)
(650,000)
(1,216,000)
(180,000)
(200,000)
(70,000)
(S) 200,000
(S) 70,000
Retained earnings
Total liabilities and equities
(1,170,000)
(3,598,500)
(435,000)
(885,000)
(S) 435,000
1,072,500
171,000
930,000
2,000,000
0
100,000
77,500
500,000
3,778,500
(680,000)
(62,500)
(650,000)
(1,216,000)
1,072,500
2-22
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(1,170,000)
(3,778,500)
Chapter 02 โ Consolidation of Financial Information
36. (30 minutes) Prepare an acquisition date consolidated balance sheet. Subsidiary
has pre-existing goodwill.
James
Johnson
Cash
Accounts receivable
Inventory
Investment in Johnson
245,000
1,830,000
3,500,000
3,050,000
110,000
360,000
280,000
0
Patents
Trademarks
Goodwill
Total assets
7,000,000
-0150,000
15,775,000
1,000,000
3,200,000
75,000
5,025,000
Accounts payable
Long-term debt
Common stock
Additional paid-in capital
Retained earnings
Total liabilities and equities
(100,000)
(4,300,000)
(5,000,000)
-0(6,375,000)
(15,775,000)
(515,000)
(2,210,000)
(1,000,000)
(200,000)
(1,100,000)
(5,025,000)
Consolidation Entries
Consolidated*
355,000
2,190,000
3,780,000
(S) 2,300,000
(A) 750,000
(A) 800,000
(A)
25,000
(S)1,000,000
(S) 200,000
(S)1,100,000
3,125,000
(A)
75,000
3,125,000
-08,800,000
3,200,000
175,000
18,500,000
(615,000)
(6,510,000)
(5,000,000)
-0(6,375,000)
(18,500,000)
Consolidation Worksheet Entry (S)
Common stock-Johnson
Additional paid-in capital-Johnson
Retained earnings-Johnson
Investment in Johnson
1,000,000
200,000
1,100,000
2,300,000
Consolidation Worksheet Entry (A)
Patents
800,000
Goodwill (new)
25,000
Goodwill (pre-existing subsidiary)
Investment in Johnson
75,000
750,000
*Although this solution uses a worksheet to compute the consolidated amounts, the
problem does not require it.
2-23
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Chapter 02 โ Consolidation of Financial Information
Answers to Appendix 2A Problems
37. (25 minutes) Journal entries for a merger using legacy purchase method.
Also compare to acquisition method.
a. Purchase Method
1. Purchase price (including acquisition costs)
Fair values of net assets acquired
Goodwill
$635,000
525,000
$110,000
Journal entry:
Current Assets
Equipment
Trademark
Goodwill
Liabilities
Cash
80,000
180,000
320,000
110,000
55,000
635,000
2. Acquisition date fair values:
Purchase price (including acquisition costs) $450,000
Fair values of net assets acquired
525,000
Bargain purchase
($ 75,000)
Allocation of bargain purchase to long-term assets acquired:
Equipment
Trademark
Fair value
Prop.
Total
reduction
Asset
reduction
$180,000
320,000
$500,000
36% x $75,000 =
64% x 75,000 =
$27,000
48,000
$75,000
Journal entry:
Current Assets
Equipment ($180,000 โ $27,000)
Trademark ($320,000 โ $48,000)
Liabilities
Cash
80,000
153,000
272,000
55,000
450,000
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Chapter 02 โ Consolidation of Financial Information
37. continued
b. Acquisition Method
1. Consideration transferred
Fair values of net assets acquired
Goodwill
$ 610,000
525,000
$ 85,000
Journal entry:
Current Assets
Equipment
Trademark
Goodwill
Liabilities
Cash
80,000
180,000
320,000
85,000
Professional Services Expense
Cash
25,000
55,000
610,000
25,000
2. Consideration transferred
Fair values of net assets acquired
Gain on bargain purchase
$425,000
525,000
($100,000)
Journal entry:
Current Assets
Equipment
Trademark
Liabilities
Gain on Bargain Purchase
Cash
80,000
180,000
320,000
Professional Services Expense
Cash
25,000
55,000
100,000
425,000
25,000
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Chapter 02 โ Consolidation of Financial Information
38. (25 minutes) (Pooling vs. purchase involving an unrecorded intangible)
a.
Inventory
Land
Buildings
Unpatented technology
Goodwill
Total
Purchase
Pooling
$ 650,000 $ 600,000
750,000
450,000
1,000,000
900,000
1,500,000
-0600,000
-0$4,500,000 $1,950,000
b. The purchase method excluded pre-acquisition revenues and expenses
from consolidated results, but the pooling method included them.
c. Poolings typically produced higher rates of return on assets than purchase
accounting because the denominator was often much lower. The Swimwear
acquisition pooling produced an increment to total assets of $1,950,000
compared to $4,500,000 under purchase accounting. Future EPS under
poolings were also higher because of lower future amortization of the
smaller asset base. Managers whose compensation contracts involved
accounting performance measures clearly had incentives to use pooling of
interest accounting whenever possible.
Answers to Appendix 2B Problems
39.
C
40. (12 minutes) (Pushdown Accounting Application)
Quigley Corporation
Balance Sheet
May 1
Cash
Receivables
Inventory
Land
Building and equipment (net)
Patented technology
Goodwill
Total assets
$
95,000
200,000
260,000
110,000
330,000
220,000
125,000
$1,340,000
Accounts payable
Long-term liabilities
Common stockโ5 par value
Additional paid-in capital
APIC from pushdown accounting
Retained earnings, 1/1
Total liabilities and stockholders’ equity
$ 120,000
510,000
210,000
90,000
410,000
-0$1,340,000
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Chapter 02 โ Consolidation of Financial Information
Chapter 2 Develop Your Skills
CONSIDERATION OR COMPENSATION CASE (estimated time 50 minutes)
According to FASB ASC (805-10-55-25):
If it is not clear whether an arrangement for payments to employees or selling
shareholders is part of the exchange for the acquiree or is a transaction separate from
the business combination, the acquirer should consider the following indicators:
a. Continuing employment. The terms of continuing employment by the selling
shareholders who become key employees may be an indicator of the substance of
a contingent consideration arrangement. The relevant terms of continuing
employment may be included in an employment agreement, acquisition
agreement, or some other document. A contingent consideration arrangement in
which the payments are automatically forfeited if employment terminates is
compensation for post combination services. Arrangements in which the
contingent payments are not affected by employment termination may indicate
that the contingent payments are additional consideration rather than
compensation.
b. Duration of continuing employment. If the period of required employment
coincides with or is longer than the contingent payment period, that fact may
indicate that the contingent payments are, in substance, compensation.
c. Level of compensation. Situations in which employee compensation other than
the contingent payments is at a reasonable level in comparison to that of other
key employees in the combined entity may indicate that the contingent payments
are additional consideration rather than compensation.
d. Incremental payments to employees. If selling shareholders who do not become
employees receive lower contingent payments on a per-share basis than the
selling shareholders who become employees of the combined entity, that fact may
indicate that the incremental amount of contingent payments to the selling
shareholders who become employees is compensation.
e. Number of shares owned. The relative number of shares owned by the selling
shareholders who remain as key employees may be an indicator of the substance
of the contingent consideration arrangement. For example, if the selling
shareholders who owned substantially all of the shares in the acquiree continue
as key employees, that fact may indicate that the arrangement is, in substance, a
profit-sharing arrangement intended to provide compensation for post
combination services. Alternatively, if selling shareholders who continue as key
employees owned only a small number of shares of the acquiree and all selling
shareholders receive the same amount of contingent consideration on a per-share
basis, that fact may indicate that the contingent payments are additional
consideration. The preacquisition ownership interests held by parties related to
selling shareholders who continue as key employees, such as family members,
also should be considered.
f. Linkage to the valuation. If the initial consideration transferred at the acquisition
date is based on the low end of a range established in the valuation of the
acquiree and the contingent formula relates to that valuation approach, that fact
may suggest that the contingent payments are additional consideration.
Alternatively, if the contingent payment formula is consistent with prior profitsharing arrangements, that fact may suggest that the substance of the
arrangement is to provide compensation.
2-27
Copyright ยฉ 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGrawHill Education.
Chapter 02 โ Consolidation of Financial Information
g. Formula for determining consideration. The formula used to determine the
contingent payment may be helpful in assessing the substance of the
arrangement. For example, if a contingent payment is determined based on a
multiple of earnings, that might suggest that the obligation is contingent
consideration in the business combination. Thus, the formula is intended to
establish or verify the fair value of the acquiree. In contrast, a contingent payment
that is a specified percentage of earnings might suggest that the obligation to
employees is a profit-sharing arrangement to compensate employees for services
rendered.
Suggested answer:
Note: This case was designed to have conflicting indicators across the various criteria
identified in the FASB ASC for determining the issue of compensation vs. consideration.
Thus, the solution is subject to alternative explanations and students can be encouraged
to use their own judgment and interpretations in supporting their answers.
In the authorโs judgment, the $8 million contingent payment (fair value = $4 million) is
contingent consideration to be included in the overall fair value AutoNav records for its
acquisition of Easy-C. This contingency is not dependent on continuing employment
(criteria a.), and uses a formula based on a component of earnings (criteria g.). Even
though the four former owners of Easy-C owned 100% of the shares (criteria e.), which
suggests the $8 million is compensation, the overall fact pattern indicates consideration
because no services are required for the payment.
The profit-sharing component of the employment contract appears to be compensation.
Criteria g. specifically identifies profit-sharing arrangements as indicative of
compensation for services rendered. Criteria a. also applies given that the employees
would be unable to participate in profit-sharing if they terminate employment. Although
the employees receive non-profit sharing compensation similar to other employees
(criteria c.), the overall pattern of evidence suggests that any payments made under the
profit-sharing arrangement should be recognized as compensation expense when
incurred and not contingent consideration for the acquisition.
2-28
Copyright ยฉ 2021 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 02 โ Consolidation of Financial Information
ASC RESEARCH CASEโDEFENSIVE INTANGIBLE ASSET (45 MINUTES)
a. The ASC Glossary defines a defensive intangible asset as
โAn acquired intangible asset in a situation in which an entity does not intend to actively
use the asset but intends to hold (lock up) the asset to prevent others from obtaining
access to the asset.โ
ASC 820-10-35-10D also observes that
To protect its competitive position, or for other reasons, a reporting entity may intend not
to use an acquired nonfinancial asset actively, or it may intend not to use the asset
according to its highest and best use. For example, that might be the case for an
acquired intangible asset that the reporting entity plans to use defensively by preventing
others from using it. Nevertheless, the reporting entity shall measure the fair value of a
nonfinancial asset assuming its highest and best use by market participants.
According to ASC 350-30-25-5 a defensive intangible asset should be accounted for as a
separate unit of accounting (i.e., an asset separate from other assets of the acquirer). It
should not be included as part of the cost of an entity’s existing intangible asset(s)
presumably because the defensive intangible asset is separately identifiable.
b. The identifiable assets acquired in a business combination should be measured at
their acquisition-date fair values (ASC 805-20-30-1).
c. A fair value measurement assumes the highest and best use of an asset by market
participants. Highest and best use is determined based on the use of the asset by market
participants, even if the intended use of the asset by the reporting entity is different (ASC
820-10-35-10). Importantly, highest and best use provides maximum value to market
participants. The highest and best use of the asset establishes the valuation premise used
to measure the fair value of the assetโin this case an in-exchange premise maximizes the
value of the asset at $2 million.
d. A defensive intangible asset shall be assigned a useful life that reflects the entity’s
consumption of the expected benefits related to that asset. The benefit a reporting entity
receives from holding a defensive intangible asset is the direct and indirect cash flows
resulting from the entity preventing others from realizing any value from the intangible
asset (defensively or otherwise). An entity shall determine a defensive intangible asset’s
useful life, that is, the period over which an entity consumes the expected benefits of the
asset, by estimating the period over which the defensive intangible asset will diminish in
fair value. The period over which a defensive intangible asset diminishes in fair value is a
proxy for the period over which the reporting entity expects a defensive intangible asset to
contribute directly or indirectly to the future cash flows of the entity. (ASC 350-30-35A)
It would be rare for a defensive intangible asset to have an indefinite life because the fair
value of the defensive intangible asset will generally diminish over time as a result of a
lack of market exposure or as a result of competitive or other factors. Additionally, if an
acquired intangible asset meets the definition of a defensive intangible asset, it shall not
be considered immediately abandoned. (ASC 350-30-35B)
2-29
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Chapter 02 โ Consolidation of Financial Information
RESEARCH CASEโHERSHEY’S ACQUISITION OF AMPLIFY SNACK BRANDS
(35 Minutes)
1. From Hersheyโs December 18, 2017 conference call announcing the acquisition:
The Amplify acquisition is โa strategic, financially compelling
transaction that is an important step in our journey to becoming an
innovative snacking powerhouse. This will enable us to bring scale and
category management capabilities to a key subsegment of the
warehouse snack aisle.โ
โThis deal, The Hershey Company’s largest acquisition to date, is
expected to create value for Hershey and Amplify’s shareholders and
also for consumers, who will soon be able to find these wonderful
brands available in more outlets.โ
โHershey’s snack mix and meat snack products, combined with
Amplify’s Skinny Pop, Tyrrells, Oatmega and Paqui and other
international brands will allow us to capture more consumers snacking
occasions by expanding our breadth across the snacking spectrum,
especially in the warehouse snacks aisle.โ
โฆโwe plan to expand Amplify’s existing SKUs into mainstream
channels using Hershey’s comprehensive distribution networkโฆโ
2. Hershey accounted for its acquisition of Amplify using the acquisition method.
Accordingly, Hershey recorded the acquisition at $915,457,000.
3. Hershey recognized $939,388,000 goodwill from the Amplify acquisition computed as
follows (amounts below in thousands):
Consideration transferred
Net assets acquired:
Accounts receivable
Other current assets
Plant, property and equipment, net
Other intangible assets
Other non-current assets
Accounts payable
Accrued liabilities
Current debt
Other current liabilities
Non-current deferred income taxes
Non-current liabilities
Total fair value of identifiable net assets
$915,457
$ 41,152
35,509
71,093
682,000
1,049
(32,394)
(109,565)
(610,836)
(2,931)
(93,859)
(5,149)
Goodwill
(23,931)
$939,388
2-30
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Chapter 02 โ Consolidation of Financial Information
RESEARCH CASEโHERSHEY’S ACQUISITION OF AMPLIFY SNACK BRANDS continued
4. From Hersheyโs 2018 10-K report:
We used various valuation techniques to determine fair value, with the primary
techniques being discounted cash flow analysis, relief-from-royalty, and a form of the
multi-period excess earnings valuation approaches, which use significant
unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under
these valuation approaches, we are required to make estimates and assumptions
about sales, operating margins, growth rates, royalty rates and discount rates based
on budgets, business plans, economic projections, anticipated future cash flows and
marketplace data.
5. Acquisition-related costs totaled $20,577,000 and consisted of legal fees, consultant
fee, valuation fees and other. They were recorded as part of selling, marketing, and
administrative costs in Hersheyโs consolidated income statement.
6. Hershey reported the Amplify acquisition, net of cash acquired, as an investing
activity in its statement of cash flows.
RESEARCH CASEโMICROCHIP’S ACQUISITION OF MICROSEMI (40 minutes)
1. Microsemi Corporation is the largest U.S. commercial supplier of military and
aerospace semiconductor equipment. Microsemi also supplies integrated circuits and
semiconductors to communications (telecom), data centers, and other industrial
firms. The deal opens Microchip to the aerospace and defense markets which had
accounted for only 2% of its sales in the past. Microsemi also bring high-end chip
design capability to the deal.
Overall the deal appears to be a response to increased growth and competitiveness in
the semiconductor chip market. According to its 3/31/19 10-K, Microchipโs primary
reason for this acquisition was to expand the Company’s range of solutions, products
and capabilities by extending its served available market.
2. The acquisition was accounted for under the acquisition method of accounting, with
Microchip identified as the acquirer for consideration transferred of $8.245 billion.
3. According to its 3/31/19 10-K (page F-22), Microchip included $53.9 million, which
represented the pre-acquisition vested service provided by employees to Microsemi,
in the total consideration transferred as part of the acquisition.
According to ASC 805-30-30-11
The portion of the fair-value-based measure of the replacement award that is
part of the consideration transferred in exchange for the acquiree equals the
portion of the acquiree award that is attributable to pre-combination service.
2-31
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Chapter 02 โ Consolidation of Financial Information
RESEARCH CASEโMICROCHIP’S ACQUISITION OF MICROSEMI – continued
(amounts in millions as adjusted)
4.
Consideration transferred
Cash and cash equivalents
Accounts receivable
Inventories
Other current assets
Property, plant and equipment
Purchased intangible assets
Long-term deferred tax assets
Other assets
Accounts payable
Other current liabilities
Long-term debt
Deferred tax liabilities
Long-term income tax payable
Other long-term liabilities
Total identifiable net asset acquired
Goodwill acquired
$8,244.5
$ 340.0
215.6
576.2
85.2
201.5
5,634.5
5.9
53.3
(233.8)
(149.3)
(2,056.9)
(565.1)
(177.7)
(49.8)
$3,879.6
$4,364.9
5. $4.569 billion of core and developed technology will be expensed over an
amortization period of 15 years. In-process research and development assets
recognized in the acquisition will be capitalized until they reach technological
feasibility, at which point they will be reclassified as core and developed technology
and begin amortization over its useful life. Abandoned in-process research and
development will be written off to expense.
2-32
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Chapter 02 โ Consolidation of Financial Information
RESEARCH CASEโKROGERโS ACQUISITION OF HOME CHEF (40 minutes)
1. Home Chef is the largest meal kit company in the US with annual sales exceeding
$250 million. Kroger will begin stocking the Home Chef meal kits in its 2,800
nationwide store and expects to generate revenues beyond the amounts Home Chef
could generate by itself. The deal is also a response to the increase competition in
the expanding meal kit market from Blue Apron, Walmart, HelloFresh, and
Amazon/Whole Foods. Kroger also acquires Home Chefโs on-line technology and
preparation and distribution systems.
2. Allocation of consideration transferred to fair values of assets and liabilities of
Home Chef:
(amounts in millions)
Cash paid
Fair value of contingent consideration*
Consideration transferred
Fair values of Home Chef net assets acquired:
Total current assets (includes $30 cash acquired)
Property, plant and equipment
Other assets
Identifiable intangibles
Total current liabilities
Other long-term liabilities*
Total identifiable net asset acquired
Goodwill
$227
91
$318
$ 36
6
1
143
(28)
(3)
$155
$163
* Krogerโs 11/10/18 10-Q page 10 allocation schedule includes the $91 million of contingent
consideration among the liabilities assumed in the acquisition. The above schedule shows
the $91 million as part of the consideration transferred and removes the $91 million from
the other long-term liabilities. Thus, the above schedule includes only the identifiable asset
and liability fair values of Home Chef acquired by Kroger.
3. According to Krogerโs 11/10/18 10-Q (page 9), there are โfuture earnout payments
of up to $500 over five years that are contingent on achieving certain milestones.
The contingent consideration is based on future performance of both the online
and offline business and the related customer engagement. The fair value of the
earnout liability in the amount of $91 recognized on the acquisition date was
measured using unobservable (Level 3) inputs and is included in โOther long-term
liabilitiesโ within the Consolidated Balance Sheetsโ
2-33
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