aa2e_hal_sm_ch02.docx

Solution Manual (Updated through November 11, 2013)

Chapter 2 - Introduction to Business Combinations and the Consolidation Process 1. The Scope section of FASB ASC 805-10-15 specifically excludes joint ventures from the provisions of the standard. As a result, joint ventures are not required to be consolidated and should be accounted for using the equity method.

2. FASB ASC 805-10-65-1: “The acquirer’s application of the recognition principle and conditions may result in recognizing some assets and liabilities that the acquiree had not previously recognized as assets and liabilities in its financial statements. For example, the acquirer recognizes the acquired identifiable intangible assets, such as a brand name, a patent, or a customer relationship, that the acquiree did not recognize as assets in its financial statements because it developed them internally and charged the related costs to expense.”

3. FASB ASC 805-30-30-8 provides the following guidance relating to the transfer of assets other than cash and stock: “The consideration transferred may include assets or liabilities of the acquirer that have carrying amounts that differ from their fair values at the acquisition date (for example, nonmonetary assets or a business of the acquirer). If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values as of the acquisition date and recognize the resulting gains or losses, if any, in earnings. However, sometimes the transferred assets or liabilities remain within the combined entity after the business combination (for example, because the assets or liabilities were transferred to the acquiree rather than to its former owners), and the acquirer therefore retains control of them. In that situation, the acquirer shall measure those assets and liabilities at their carrying amounts immediately before the acquisition date and shall not recognize a gain or loss in earnings on assets or liabilities it controls both before and after the business combination.” Bottom line – if the asset will not remain with the consolidated group following the acquisition, the acquirer can write up the asset before transfer and record the resulting gain in income. And, if the asset remains with the consolidated entity post-acquisition, it cannot be written up and no gain is recognized.

©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 2

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4. FASB ASC 805-20-25-12 allows the acquirer to determine if the operating leases are “favorable or unfavorable” compared with the market terms of similar leases at the acquisition date. The acquirer shall recognize an intangible asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are unfavorable relative to market terms. FASB ASC 805-20-25-13 also provides for the recognition of an intangible asset relating to operating leases, even if their terms are not deemed to be favorable, if the leases provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, for example, as a customer relationship.

5. FASB ASC 805-20-55-6 provides the following guidance: “The acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of the acquisition date. For example, an acquirer may attribute value to the existence of an assembled workforce, which is an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date. An assembled workforce does not represent the intellectual capital of the skilled workforce―the (often specialized) knowledge and experience that employees of an acquiree bring to their jobs. Because the assembled workforce is not an identifiable asset to be recognized separately from goodwill, any value attributed to it is subsumed into goodwill.”

6. FASB ASC 805-20-55-7 provides the following guidance: “The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at the acquisition date. For example, the acquirer might attribute value to potential contracts the acquiree is negotiating with prospective new customers at the acquisition date. Because those potential contracts are not themselves assets at the acquisition date, the acquirer does not recognize them separately from goodwill. ”

7. FASB ASC 805-20-55-25 provides the following guidance: The agreement, whether cancelable or not, meets the contractual-legal criterion. Additionally, because the Subsidiary establishes its relationship with Customer through a contract, not only the agreement itself but also the subsidiary’s relationship with the Customer meets the contractual-legal criterion.

©Cambridge Business Publishers, 2014 2-2

Advanced Accounting by Halsey & Hopkins, 2nd Edition

8. FASB ASC 805-20-55-22 provides the following guidance: “An order or production backlog arises from contracts such as purchase or sales orders. An order or production backlog acquired in a business combination meets the contractual-legal criterion even if the purchase or sales orders are cancelable.” Regardless of whether or not they are cancelable, the purchase orders from 60 percent of the Subsidiary’s customers meet the contractuallegal criterion. Additionally, because the Subsidiary has established its relationship with 60 percent of its customers through contracts, not only the purchase orders but also the Subsidiary’s customer relationships meet the contractual-legal criterion. Because the subsidiary has a practice of establishing contracts with the remaining 40 percent of its customers, its relationship with those customers also arises through contractual rights and therefore meets the contractual-legal criterion even though the Subsidiary does not have contracts with those customers as of the acquisition date.

9. FASB ASC 805-20-55-23 provides the following guidance: “If an entity establishes relationships with its customers through contracts, those customer relationships arise from contractual rights. Therefore, customer contracts and the related customer relationships acquired in a business combination meet the contractual-legal criterion….” Because the Subsidiary establishes its relationships with policyholders through insurance contracts, the customer relationship with policyholders meets the contractual-legal criterion, and can be identified as an intangible asset in the acquisition.

10. FASB ASC 805-10-55-35 provides the following guidance (the acquired company is referenced as the “Target”): “In this Example, Target entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of the chief executive officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition method.”

11. FASB ASC 805-10-55-36 provides the following guidance (the acquired company is referenced as the “Target”): “In other circumstances, Target might enter into a similar agreement with the chief executive officer at the suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer accounts for the liability to pay the chief executive officer in its postcombination financial statements separately from application of the acquisition method.”


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12. Yes, the investor has gained effective control of the investee company by virtue of its control of the Board of Directors. Even though it owns less than 50% of the outstanding voting stock, the license agreement gives it control of the investee company and, as a result, the investee must be consolidated with the investor.

13. The acquisition should be accounted for as a business combination, thus requiring consolidation. It is not necessary for the business to have outputs (i.e., products and sales). FASB ASC 805-10-55-4 defines a business as follows: “A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business.”

14. a. Assets and liabilities can be valued using any reasonable approach. Some common approaches to the tangible assets and liabilities in this example include the following: Accounts receivable: Inventories:

PPE: Current liabilities: Long-term liabilities:

Net realizable value (the amount we expect to collect) Estimated selling price less cost to complete (if work-inprocess) and less selling costs and a reasonable profit margin on the sale. Raw materials are valued at replacement cost. Current replacement costs if continued to be used in the business or at selling price less cost to sell if to be sold. Book value Present value (i.e., discounted expected cash outflows)

b. Before any portion of the purchase price can be allocated to the Goodwill asset, you must first ask if you are acquiring any intangible assets that are not recorded on the acquiree’s balance sheet. A complete listing is in Exhibit 2.12. FASB ASC 805 requires us to make a positive assessment whether any of these intangible assets were valued by us in arriving at our purchase price for the acquiree and, if so, we must assign that value to the intangible assets acquired before any of the purchase price can be assigned to the Goodwill asset. c. Intangible assets are typically valued at the present value of expected future cash flows. We must, first, project the cash flows to be derived from the intangible asset. Then, we need to discount those expected cash flows using an appropriate discount rate. This is a very subjective process, as both the estimate of future cash flows and the choice of the appropriate discount rate are difficult. We must make a reasonable attempt, however, to value these intangible assets using a reasonable and supportable methodology.



15. Intangible Asset Category Contract-based:

Examples lease agreements, franchise agreements, licensing agreements, construction contracts, employment contracts, and mineral rights

Marketing-related:

brand names, trademarks, and Internet domain names

Customer-related:

customer contracts, relationships, and orders

Technology-based:

patent rights, computer software, and trade secrets

Artistic-based:

television programs, motion pictures and videos, recordings, books, photographs, and advertising jingles

16. An indemnification asset represents the agreement by the seller to guarantee that the acquirer will not suffer a loss as a result of the outcome of a contingency related to all or part of a specific asset or liability. For example, the seller may indemnify the purchaser against losses above a specified amount on a liability arising from a particular contingency, such as a pending lawsuit. The acquirer recognizes an indemnification asset at the same time that it recognizes the indemnified item (the contingent liability, for example). In addition, both the indemnification asset and the related liability are revalued subsequent to the acquisition (FASB ASC 805-20-25-27 through 25-28 and FASB ASC 805-20-35-4).

17. FAASB ASC 805-20-55-20 identifies a number of customer-related intangible assets, including the following: a. Customer lists - a customer list acquired in a business combination normally meets the separability criterion. b. Order backlog - an order or production backlog acquired in a business combination meets the contractual-legal criterion even if the purchase or sales orders are cancelable. c. Customer Relationship - If an entity has relationships with its customers through sales orders, they meet the contractual-legal criterion. Customer relationships also may arise through means other than contracts, such as through regular contact by sales or service representatives.


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18. a. Restructuring plans typically include the termination of employees as departments are merged, the divestiture of lines of businesses with related plant closing costs, the relocation and training of employees, and the write-off of assets such as Goodwill on the acquiree’s balance sheet that relate to previous acquisitions that will no longer play a part in the consolidated company. b. FASB ASC 805-20-25-2 provides the following guidance relating to planned restructuring activities: “To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, at the acquisition date. For example, costs the acquirer expects but is not obligated to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer recognizes those costs in its postcombination financial statements in accordance with other applicable generally accepted accounting principles (GAAP).” 19. If financial statements are issued before the final allocations of the purchase can be made, FASB ASC 805-10-55-16 allows us to use “provisional amounts,” that is, estimates of those values. When the final allocation is made, we retrospectively adjust those amounts, provided that the final measurement of all assets and liabilities is completed within one year from the acquisition date. Also, during the measurement period, the acquirer can recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date.

20. A a. No, a contingent liability for the employee litigation is not recognized at fair value on the acquisition date because your attorney has determined that an unfavorable outcome is reasonably possible, but not probable (ASC 450-20-25-2). Therefore, your company would recognize a liability in the postcombination period when the recognition and measurement criteria in ASC 450 are met. b. The indemnification by the acquiree becomes an “indemnification asset” for the purchaser and can be recognized as such on the consolidated balance sheet at the same amount. Net assets acquired are, therefore, unaffected. Until the lawsuit is settled or finally adjudicated, the contingent liability and the indemnification asset must both be revalued at each balance sheet date and the change in value reflected in income (see problem 16). Since the asset and liability are offsetting, however, their revaluation will have offsetting amounts in the income statement, leaving net income unaffected.



21. A a. Equity investment Common Stock APIC Contingent earnings liability

21,500,000 800,000 19,200,000 1,500,000

(to record the acquisition)

b. Expense related to contingent earnings liability Contingent earnings liability

500,000 500,000

(to record the increase in the expected value of the contingent earnings liability)

c. Expense related to contingent earnings liability Contingent earnings liability Cash

3,000,000 2,000,000 5,000,000

(to record the increase in the value of the contingent earnings liability)

22. A Purchase price Less: Fair value of assets acquired Deferred tax liability Goodwill

$5,000,000 5,000,000 (350,000)

4,650,000 $350,000

($1 million x 35%)

23. Answer: d A business is “An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.” It is not necessary that the investee company currently produce products or generate a positive return. All that is necessary is that it a. has begun planned principal activities, b. has employees, intellectual property, and other inputs and processes that could be applied to those inputs, c. is pursuing a plan to produce outputs, and d. will be able to obtain access to customers that will purchase the outputs.


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24. Answer: b Company A has a controlling financial interest in both Companies B (90%) and C (90% x 70% = 63%). Therefore B and C should be consolidated with A. 25. Answer: b By holding 12,000 shares, former company B shareholders will own 55% (i.e., 12,000 / (10,000 + 12,000) of the common stock after the transaction, suggesting they control the company and can elect controlling Board within the next two years. 26. Answer: d Direct fees have no effect on recording the business combination; these costs are simply expensed as part of operating expenses for the period in which they are incurred. The entry is as follows: Expenses

200,000 Payables or cash (for direct acqu. costs)

200,000

Costs of registering and issuing securities are deducted from contributed capital; thus, they have no effect on the investment account. The fair value of the common stock that is issued (i.e., $5,000,000 = 500,000 shares x $10/share) will equal the amount of the net assets that will be recognized in a business combination. The entry is as follows: Investment in Investee Common Stock ($2 par) APIC Payables or cash (for registration costs)

5,000,000 1,000,000 3,950,000 50,000

27. Answer: a A controlling investment in an investee company’s common stock is accounted for in an equity investment account on the pre-consolidation books of the investor company. Thus, there is no separate pre-consolidation recognition of goodwill. The process of consolidation will eliminate the investment account and replace it with the fair value of the net assets of the subsidiary in the post-consolidation financial statements.



28. Answer: b The amount of goodwill implicit in an acquisition-date controlling investment in a subsidiary is equal to the fair value of the entire subsidiary (i.e., $1,100,000) minus the fair value of the identifiable net assets (FVINA). According to the facts, the book value of the identifiable net assets is equal to $800,000. The only identifiable difference between fair value and book value is $220,000 related to property and equipment. Thus, the FVINA is equal to $1,020,000 (i.e., $800,000 + $220,000). Therefore, goodwill is equal to $80,000 (i.e., $1,100,000 - $1,020,000).

29. Answer: d In the case where (1) the fair value of the identifiable net assets of a subsidiary equals the book value of identifiable net assets of the subsidiary, and there is no recorded goodwill or bargain acquisition gain, then the investment account will equal the book value of net assets of the subsidiary (i.e., which also equals the stockholders’ equity of the subsidiary). Net assets equals $170,000 (i.e., CS, $10,000 + APIC, $150,000 + RE, $10,000).

30. Answer: d In the absence of profits (losses) on intercompany transactions, the investment account at any point in time can be computed by taking p% of the book value of net assets (BVNA) of the subsidiary and adding the unamortized p% acquisition accounting premium (AAP). In this problem, p% = 100%. On the acquisition date, the unamortized AAP is equal to the following (note that the amounts are expressed in debits and credits):

Receivables & Inventories Land Property & Equipment Goodwill Liabilities Total AAP

AAP Dr (Cr) 10,000 (5,000) 20,000 25,000 7,000 57,000

100% BVNA(S) + 100% AAP = $170,000 + $57,000 = $227,000


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31. Answer: b Consolidated financial statements must be prepared by a company that has a “controlling financial interest” in other entities. In this case, Sun also prepares stand-alone financial statements (perhaps for a bank or other creditor). There is no evidence that Sun has a controlling financial interest in another entity.

32. Answer: b Assuming no intercompany payables/receivables, on the acquisition date, there are only two consolidating journal entries required: [E] and [A]. The [E] entry eliminates the book value of net assets of the subsidiary (i.e., which equals reported stockholders’ equity) form the investment account. Stockholders’ equity of S equals $562,500 (i.e., CS $125,000 + APIC $156,250 + RE $281,250). This means the [A] credit to the investment account must have been $312,500 (i.e., $875,000 - $562,500). 33. A Answer: c Generally speaking, in a nontaxable transaction, the pre-acquisition tax bases of the subsidiary’s net assets carry forward to the post-acquisition tax books. This can result in deferred taxes if the recognized fair values have temporary differences from the carried forward tax bases. In this case, the only asset that has a different tax basis from its newly recognized fair value is noncurrent assets with a fair value that is $20,000 greater than its previous book value and tax basis. The deferred tax liability on this $20,000 temporary difference is $8,000 (i.e., 40% x $20,000). Therefore, including the deferred tax, the fair value of the identifiable net assets (FVINA) for the subsidiary is equal to $112,000 (i.e., BVINA $100,000 + noncurrent asset AAP $20,000 – deferred tax liability AAP $8,000). Goodwill is equal to the fair value of the entire subsidiary minus the FVINA, which equals $38,000 (i.e., FV subsidiary $150,000 – FVINA $112,000).

34. A Answer: b Generally speaking, in a taxable transaction, the post-acquisition tax bases of the subsidiary’s net assets are equal to the fair value of the net assets of the subsidiary. Given no difference in financial versus tax bases, this means that there are no deferred taxes recognized pursuant to the acquisition. In this problem, the only asset that has a different tax basis from its newly recognized fair value is noncurrent assets with a fair value that is $20,000 greater than its previous book value and tax basis. Therefore, the fair value of the identifiable net assets (FVINA) for the subsidiary is equal to $120,000 (i.e., BVINA $100,000 + noncurrent asset AAP $20,000). Goodwill is equal to the fair value of the entire subsidiary minus the FVINA, which equals $30,000 (i.e., FV subsidiary $150,000 – FVINA $120,000).



35. Fair value of total assets acquired (excluding goodwill) Plus: Goodwill Less: Fair value of total liabilities assumed = Total consideration transferred

$49,973 ? $25,353 $24,659

Goodwill = $39

36. a. Goodwill = $20 million - $7 million - $6 million - $5 million = $2 million. The acquisition costs are expensed under GAAP (SFAS 141(R), ¶59). b. Goodwill is not amortized like other intangible assets. Instead, it remains on the balance sheet until management deems it to be impaired, at which time it is written down. c. Allocating more of the purchase price to goodwill reduces the allocation to assets that are depreciated or amortized and, therefore, reduces the depreciation and/or amortization expense hitting their income statements subsequent to the acquisition.

37. a. The amounts relating to working capital, inventories and PPE assets are the fair values of those assets on the acquisition date. These amounts reflect the book values of those assets on Wyeth’s balance sheet plus the AAP, the difference between fair value and book value. These are the amounts that will appear on the consolidated balance sheet relating to Wyeth, and the reported amounts will be the sum of these values plus the book value of these assets on Pfizer’s balance sheet on the acquisition date. b. In-process research and development (IPRD) assets relate to the acquisition-date value of research projects currently in process and during their developmental stages (i.e., before the research projects have reached technological feasibility). Under current GAAP, investors value and recognize IPRD assets acquired in a business combination at their fair values just like any other assets acquired (FASB ASC 350-30-30-1. After initial recognition, tangible net assets used to support research and development activities (e.g., R&D building and associated equipment) are accounted for in accordance with their nature (i.e., they are depreciated/amortized). Intangible research and development assets, on the other hand, should be considered indefinite-lived (i.e., not amortized) until the associated research and development activities are either completed (then, the intangible assets are amortized over the life of the related patent or copyright) or abandoned (in which case they are written off in the year of abandonment). Acquired intangible IPRD assets are included in the annual goodwill impairment tests (FASB ASC 350-20-35-15). c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a residual amount (i.e., the amount left over after all other assets and liabilities have been identified and valued). ©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 2

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38. a. The arguments in favor of Company A as the acquirer are the following: i. It issued the stock. ii. Its CEO will become CEO of the combined company. The arguments in favor of Company B as the acquirer are the following: i. Its Chairman will become Chairmen of the combined company. ii. Its CFO will become CFO of the combined company. On balance, it would appear that Company A is the acquirer. Its CEO will be the chief executive of the combined entity, and, in three years, Company A’s Chairman will become the new Company Chairman as well. During the interim, neither company can control the strategic direction of the combined company since each elects one-half of the Board of Directors. b. The allocation of the purchase price is quite different for the two potential acquirers:

Purchase Price Tangible net assets Identifiable intangible assets Goodwill

If Company A is deemed to be the Subsidiary $ 1.5 billion (1.0 billion) (0.3 billion) $ 0.2 billion

If Company B is deemed to be the Subsidiary $ 1.5 billion (0.4 billion) (0.6 billion) $ 0.5 billion

If Company B is the acquirer and Company A is the subsidiary, more of the purchase price will be allocated to the fair value of tangible net assets and identifiable intangible assets. Both of these categories must be depreciated or amortized. As a result, more of the purchase cost will hit the consolidated income statement (Goodwill is not amortized, and becomes an expense only if impaired). Also, if Company B is the acquirer, less Goodwill asset will be recognized. The choice of the acquirer is often not an issue. But, when it is, it can be a significant one. This analysis is made solely from a financial perspective. There are other significant implications of the choice of the acquirer, including  The acquirer may get to name the combined company with its name or using its name first.  The image of the combined company in the market place may be different depending on which company is viewed as the acquirer.  The acquirer’s philosophies and modes of operation may dominate the combined company.  The acquirer may get the choice of the home office.  The acquirer’s employees may feel a sense of superiority. Conversely, the acquiree’s employees may feel like they’ve been taken over. This can cause real morale problems if not handled well. ©Cambridge Business Publishers, 2014 2-12


39. a. Equity investment Common stock Additional paid-in capital

100,000 10,000 90,000


b. [E]

Common stock Retained earnings Equity investment

30,000 45,000 75,000

(to eliminate the Stockholders’ Equity of the subsidiary on the acquisition date)

[A]

PPE (net)

25,000 Equity Investment

25,000

(to record the [A] assets purchased on the acquisition date)

40. a. Equity investment Cash

250,000 250,000


b. [E]

Common stock Retained earnings Equity investment

50,000 50,000 100,000


[A]

Patent Goodwill

100,000 50,000 Equity investment

150,000



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41. a. Balance of Equity Investment account: Purchase price $300,000 Cumulative net income of subsidiary 400,000 Cumulative dividends received from subsidiary (50,000) Balance of Equity Investment account $650,000 b. The Equity Investment account is comprised of the fair values of the net assets of the subsidiary ($550,000, which happen to equal the book values) and the carrying amount of the Goodwill asset ($100,000).

42. a. [E]

Capital stock and Retained earnings Equity Investment

8,795 8,795

(to eliminate the stockholders’ equity of the subsidiary on the acquisition date)

[A]

Inventory Long-term Investments PPE (net) In-process R&D charge Identifiable intangible assets Goodwill ($20,447-$1,559) Long-term debt Benefit plan liabilities Other net assets Restructuring costs Tax adjustments Equity investment

2,979 40 439 5,052 37,221 18,888 370 1,471 431 1,578 13,592 47,177


b. In-Process Research & Development (IPRD) is expensed in the [A] entry in part (a) as required under previous GAAP. Under current GAAP, acquirers recognize IPRD assets acquired in a business combination at their fair values just like any other assets acquired (FASB ASC 350-30-30-1). After initial recognition, tangible net assets used to support research and development activities (e.g., R&D building and associated equipment) are accounted for in accordance with their nature (i.e., they are depreciated/amortized). Intangible research and development assets, on the other hand, should be considered indefinite-lived (i.e., not amortized) until the associated research and development activities are either completed (then, the intangible assets are amortized over the life of the related patent or copyright) or abandoned (in which case they are written off in the year of abandonment). Acquired intangible IPRD assets are included in the annual Goodwill impairment tests (FASB ASC 350-20-35-15). ©Cambridge Business Publishers, 2014 2-14


c. Pfizer accrued a liability for its anticipated restructuring costs in its allocation of the Pharmacia purchase price. That was acceptable practice under former GAAP. FASB ASC 805-20-25-2 provides the guidance relating to planned restructuring activities that is currently in effect: “costs the investor expects but is not obligated to incur in the future to affect its plan to exit an activity of an investee or to terminate the employment of or relocate an investee’s employees are not liabilities at the acquisition date.” Therefore, the investor does not recognize those costs as part of applying the acquisition method. Instead, the investor recognizes those costs in its post-combination financial statements in accordance with other applicable generally accepted accounting principles.” As a result, under current GAAP, acquisition-date Goodwill would have been smaller by the amount of the restructuring charge, as compared to pre-2008 GAAP.

43. a. No, this is the fair value of these assets. The [A] consolidation journal entry records the difference between the fair value and the book value of these assets on the acquiree’s acquisition-date balance sheet. b. [A]

Customer contracts Technology Trademarks Trade name Goodwill Equity Investment

1,942 1,501 74 1,422 14,450 19,389

(to record the intangible assets)

c. Amortizable intangible assets have a useful life and must be amortized over that useful life. The cost of these assets is ultimately reflected as expense in the income statement. To the extent that this portion of the purchase price is allocated to Goodwill, that cost does not impact the income statement unless and until the Goodwill asset is deemed to be impaired, at which time it is written down or off. SFAS 141(R) requires companies to, first, allocate the purchase price to identifiable intangible assets before recognizing any goodwill in the purchase. d. HP does not feel that the Compaq trade name will be diminished in value over time, that is, it will continue to generate cash flows indefinitely. Indefinite does not mean infinite. The accounting significance of this distinction is that indefinite-lived assets must be tested at least annually for impairment.


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44. a. Approach Market approach

Methodology Indicates value for a subject asset based on available market pricing for comparable assets

Asset Class Real property and investments

Income approach

Indicates value for a subject asset based on the present value of cash flow projected to be generated by the asset

Certain intangible assets such as customer relationships, as well as for favorable/unfavorable contracts

Cost approach

Estimates value by determining the current cost of replacing an asset with another of equivalent economic utility

The majority of personal property

b. The market approach (using comparable market prices for similar assets) and the cost approach (using replacement cost) are the least subjective approaches. The income approach (sometimes referred to as discounted cash flow or DCF approach) is the most subjective approach as it involves both the projection of cash flows and the choice of an appropriate discount rate. In its allocation of the purchase price for MCI to the assets acquired and the liabilities assumed, a significant portion of the purchase price was allocated to intangible assets using the income approach. This is not uncommon. Remember this next time you look at a purchase price allocation table. c. The allocation of the purchase price to net tangible and intangible assets is as follows: Current assets PPE Deferred income tax & other assets Current liabilities Long-term Debt Deferred income taxes & other liabilities Net tangible assets

$

6,001 6,453 1,995 (6,093) (6,169) (1,720) $ 467

Intangible assets subject to amortization: Customer relationships Right of way and other Goodwill Intangible assets

$

1,162 176 5,085 6,423

Total Purchase price

$

6,890

$

(7%)

(93%)



45. a. 40,000 shares x $25 market price per share = $1,000,000 b. [E]

Common stock APIC Retained earnings Equity investment

100,000 125,000 775,000 1,000,000

(to eliminate the stockholders’ equity of the subsidiary on the acquisition date)

c.

Balance sheet: Assets Cash Accounts receivable Inventory Equity investment PPE, net

Parent

Subsidiary

$ 405,000 1,280,000 1,940,000 1,000,000 9,332,000 $13,957,000

$ 226,000 348,000 447,000

Liabilities and Stockholders’ Equity Accounts payable $ 627,000 Accrued liabilities 736,000 Long-term liabilities 3,000,000 Common stock 1,370,000 APIC 3,200,000 Retained earnings 5,024,000 $13,957,000

Elimination entries Dr Cr

$

[E] 1,000,000 827,000 $1,848,000

$ 127,000 221,000 500,000 100,000 [E] 100,000 125,000 [E] 125,000 775,000 [E] 775,000 $1,848,000

Consolidated

631,000 1,628,000 2,387,000 0 10,159,000 $14,805,000

$

754,000 957,000 3,500,000 1,370,000 3,200,000 5,024,000 $14,805,000


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46. a. 70,000 shares x $25 market price per share = $1,750,000 b. [E]


100,000 125,000 775,000 1,000,000


[A]

Patent Goodwill

200,000 550,000 Equity investment

750,000


c.

Balance sheet: Assets Cash Accounts receivable Inventory Equity investment PPE, net Patent Goodwill

Parent

Subsidiary

$ 3,082,500 1,280,000 1,940,000 1,750,000

$ 226,000 348,000 447,000

9,332,000

827,000

Elimination entries Dr Cr Consolidated

[E] 1,000,000 [A] 750,000 [A] 200,000 [A] 550,000

$17,384,500

$1,848,000

Liabilities and Stockholders’ Equity Accounts payable $ 627,000 Accrued liabilities 736,000 Long-term liabilities 3,000,000 Common stock 2,397,500 APIC 5,600,000 Retained earnings 5,024,000 $17,384,500

$ 127,000 221,000 500,000 100,000 125,000 775,000 $1,848,000

$ 3,308,500 1,628,000 2,387,000 0 10,159,000 200,000 550,000 $18,232,500

$

[E] 100,000 [E] 125,000 [E] 775,000

754,000 957,000 3,500,000 2,397,500 5,600,000 5,024,000 $18,232,500

d. We have recognized the Patent and Goodwill assets. Previously, these assets were embedded in the Equity Investment account on the Parent’s balance sheet. In the consolidation process, they are explicitly recognized. ©Cambridge Business Publishers, 2014 2-18


47. a. The following acquisition date consolidated balance sheet can be used to answer questions a1-a7.

Balance sheet: Assets Cash Accounts receivable Inventory Equity investment PPE, net License agreement Customer list Goodwill

Parent

Subsidiary

$ 910,500 384,000 582,000 2,200,000

$ 201,600 417,600 536,400

2,799,600


[E] 1,200,000 [A] 1,000,000

992,400 [A] [A] [A] [A] $6,876,100 $2,148,000

Liabilities and Stockholders’ Equity Accounts payable $ 188,100 $ 127,000 Accrued liabilities 220,800 221,000 Long-term liabilities 1,000,000 600,000 Common stock 220,000 120,000 APIC 3,740,000 150,000 Retained earnings 1,507,200 930,000 $6,876,100 $2,148,000

500,000 250,000 100,000 150,000

$1,112,100 801,600 1,118,400 0 4,292,000 250,000 100,000 150,000 $7,824,100

$ 315,100 441,800 1,600,000 220,000 3,740,000 1,507,200 $7,824,100

[E] 120,000 [E] 150,000 [E] 930,000

b. We will report the License Agreement ($250,000), Customer List ($100,000), and Goodwill ($150,000).

48. a. Equity investment Common stock APIC

2,100,000 70,000 2,030,000


continued next page


2-19

b. [E]


130,000 162,500 1,007,500 1,300,000

(to eliminate the stockholders’ equity of the subsidiary as of the acquisition date)

[A]

Trademark Video library Patented technology Equity investment

200,000 500,000 100,000 800,000

(to record the Trademark, Video Library, and Patented Technology {a} assets)

c.

Balance sheet: Assets Cash Accounts receivable Inventory Equity investment PPE, net Trademark Video library Patented technology

Parent

Subsidiary

$ 428,200 256,000 388,000 2,100,000

$ 189,400 452,400 581,100

9,666,400

1,075,100


$

[E] 1,300,000 [A] 800,000 [A] [A] [A]

200,000 500,000 100,000

$12,838,600 $2,298,000 Liabilities and Stockholders’ Equity Accounts payable $ 125,400 $ 127,000 Accrued liabilities 147,200 221,000 Long-term liabilities 3,200,000 650,000 Common stock 357,000 130,000 APIC 2,730,000 162,500 Retained earnings 6,279,000 1,007,500 $12,838,600 $2,298,000

617,600 708,400 969,100 0

10,741,500 200,000 500,000 100,000 $13,836,600

$

[E] 130,000 [E] 162,500 [E] 1,007,500

252,400 368,200 3,850,000 357,000 2,730,000 6,279,000 $13,836,600

d. We have recognized three intangible assets in the consolidation process: the Trademark, the Video Library, and Patented Technology. Previously, these assets were embedded in the Equity investment account on the Parent’s balance sheet. In the consolidation process, they are explicitly recognized. ©Cambridge Business Publishers, 2014 2-20


49. a. Equity investment Common stock APIC Contingent consideration liability (to record the Equity investment, issuance of shares, and contingent consideration liability)

4,000,000 120,000 3,480,000 400,000

b.

Balance sheet: Assets Cash Accounts receivable Inventory Equity investment PPE, net Customer list Brand name Goodwill

Parent

Subsidiary

$ 783,300 384,000 582,000 4,000,000

$ 104,000 696,000 894,000

Elimination entries Dr Cr

$

[E] 2,000,000 [A] 2,000,000

14,499,600

1,654,000 [A] 1,000,000 [A] 200,000 [A] 500,000 [A] 895,000 $20,248,900 $3,348,000

Liabilities and Stockholders’ Equity Accounts payable $ 188,100 $ 127,000 Accrued liabilities 220,800 221,000 Long-term liabilities 2,000,000 1,000,000 Deferred tax liab. Common stock 680,000 200,000 APIC 5,200,000 250,000 Retained earnings $11,960,000 1,550,000 20,248,900 $3,348,000

Consolidated

887,300 1,080,000 1,476,000 0

17,153,600 200,000 500,000 895,000 $22,191,900

$

[A] [E] 200,000 [E] 250,000 [E] 1,550,000

595,000

315,100 441,800 3,000,000 595,000 680,000 5,200,000 11,960,000 $22,191,900

Notes: 1. The contingent consideration liability is reported on the Parent’s balance sheet on the date of acquisition. In subsequent periods, and until paid or discharged, that liability must be revalued and any change in fair value reflected in income. 2. A deferred tax liability of $595,000 is established for the book-tax difference of $1 million related to the PPE assets, $200,000 for the customer list, and $500,000 for the brand name asset (i.e., $1,700,000 total book-tax difference) multiplied by the tax rate of 35%. continued next page ©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 2

2-21

b. continued Notes continued: 3. Goodwill is computed as follows: Value of consideration (stock plus contingent consideration) Less: Fair value of net assets Deferred income tax liability Goodwill

$4,000,000

$3,700,000 (595,000)

3,105,000 $ 895,000

50. a. FASB ASC 805-10-25-13 through 25-19 permits companies to use “provisional” amounts, and to retrospectively adjust those amounts when better information becomes available, provided that the final measurement of all assets and liabilities is completed within one year from the acquisition date. b. In $millions Equity investment

7,295 Cash Common stock and APIC

7,196 99

c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a residual amount (i.e., the amount left over after all other assets and liabilities have been identified and valued). d. FASB ASC 805-20-30-1 requires that, as of the acquisition date, “The acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values,” and FASB ASC 820-10-20 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Companies can estimate these fair values using a “market approach,” an “income approach,” or a “cost approach.” Each of these approaches requires significant estimates. e. In-process research and development (IPRD) assets relate to the value of research projects currently in process and during their developmental states (i.e., before the research projects have reached technological feasibility) on the date of the acquisition. These might include, for example, patents received or applied for, blueprints, formulas, and specifications or designs for new products or processes, materials and supplies, equipment and facilities, and perhaps even a specific research project in process. continued next page ©Cambridge Business Publishers, 2014 2-22


e. continued Under current GAAP, acquirers recognize IPRD assets acquired in a business combination at their fair values just like any other assets acquired (FASB ASC 350-30-30-1). After initial recognition, tangible net assets used to support research and development activities (e.g., R&D building and associated equipment) are accounted for in accordance with their nature (i.e., they are depreciated/amortized). Intangible research and development assets, on the other hand, should be considered indefinite-lived (i.e., not amortized) until the associated research and development activities are either completed (then, the intangible assets are amortized over the life of the related patent or copyright) or abandoned (in which case they are written off in the year of abandonment). Acquired intangible IPRD assets are included in the annual goodwill impairment tests (FASB ASC 350-20-35-15). f. If the acquisition-date fair value of the asset or liability arising from a contingency can be determined during the measurement period, that asset or liability is recognized at the acquisition date (FASB ASC 805-20-25-19). g. Oracle credits the Equity Investment account for its book value of $7,295 million to remove that account from the consolidated balance sheet. The offsetting debits and credits will remove the beginning-of-year stockholders’ equity of Sun Microsystems, Inc., and recognizes, as reported assets and liabilities on the consolidated balance sheet, the excess of the fair value of the acquired assets and liabilities assumed in excess of their respective books values.


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