Acct: 70253: Business Combinations and Advanced Topics Review for Exam I - SOLUTION Problem I On January 1, 2014, Ridge Road Company acquired 20 percent of the voting shares of Sauk Trail, Inc. for $2,700,000 in cash. Both companies provide commercial Internet support services but serve markets in different industries. Ridge Road made the investment to gain access to Sauk Trail's board of directors and thus facilitate future cooperative agreements between the two firms. Ridge Road quickly obtained several seats on Sauk Trail's board which gave it the ability to significantly influence Sauk Trail's operating and investing activities. The January 1, 2014, carrying amounts and corresponding fair values for Sauk Trail's assets and liabilities follow:
Also as of January 1, 2014, Sauk Trail's computing equipment had a 7-year remaining estimated useful life. The patented technology was estimated to have a 3-year remaining useful life. The trademark's useful life was considered indefinite. Ridge Road attributed to goodwill any unidentified excess cost. During the next two years, Sauk Trail reported the following net income and dividends:
a. How much of Ridge Road's $2,700,000 payment for Sauk Trail is attributable to goodwill? Acquisition price................................................................................... $2,700,000 Book value acquired ($5,175,000 × 20%)............................................ 1,035,000 Excess payment.................................................................................... $1,665,000 Excess fair value: Computing equipment ($700,000 × 20%)........ 140,000 Excess fair value: Patented technology ($3,900,000 × 20%)........ 780,000 Excess fair value: Trademark ($1,850,000 × 20%)......................... 370,000 Goodwill................................................................................................. $ 375,000
Amortization: Computing equipment ($140,000 ÷ 7)........................................ $ 20,000 Patented technology ($780,000 ÷ 3)........................................... 260,000 Trademark (indefinite)................................................................. -0Goodwill (indefinite).................................................................... -0Annual amortization.......................................................................... $280,000 b. What amount should Ridge Road report for its equity in Sauk Trail's earnings on its income statements for 2014 and 2015? Basic equity accrual 2014 ($1,800,000 × 20%)................................... Amortization—2014 (above)................................................................. Equity in 2014 earnings of Sauk Trail.................................................
$360,000 (280,000) $ 80,000
Basic equity accrual 2015 ($1,985,000 × 20%)................................... Amortization—2015 (above)................................................................. Equity in 2015 earnings of Sauk Trail.................................................
$397,000 (280,000) $117,000
c. What amount should Ridge Road report for its investment in Sauk Trail on its balance sheets at the end of 2014 and 2015? Acquisition price................................................................................... $2,700,000 Equity in 2014 earnings of Sauk Trail (above)................................... 80,000 Dividends—2014 ($150,000 × 20%)...................................................... (30,000) Investment in Sauk Trail, 12/31/14....................................................... $2,750,000 Investment in Sauk Trail, 12/31/14....................................................... $2,750,000 Equity in 2015 earnings of Sauk Trail (above)................................... $117,000 Dividends—2015 ($160,000 × 20%)...................................................... (32,000) Investment in Sauk Trail, 12/31/15....................................................... $2,835,000
Problem II Harper acquires 40 percent of the outstanding voting stock of Kinman Company on January 1, 2014, for $210,000 in cash. The book value of Kinman's net assets on that date was $400,000, although one of the company's buildings, with a $60,000 carrying amount, was actually worth $100,000. This building had a 10-year remaining life. Kinman owned a royalty agreement with a 20-year remaining life that was undervalued by $85,000. Kinman sold inventory with an original cost of $60,000 to Harper during 2014 at a price of $90,000. Harper still held $15,000 (transfer price) of this amount in inventory as of December 31, 2014. These goods are to be sold to outside parties during 2015. Kinman reported a $40,000 net loss and a $20,000 other comprehensive loss for 2014. The company still manages to declare and pay a $10,000 cash dividend during the year. During 2015, Kinman reported a $40,000 net income and declared and paid a cash dividend of $12,000. It made additional inventory sales of $80,000 to Harper during the period. The original cost of the merchandise was $50,000. All but 30 percent of this inventory had been resold to outside parties by the end of the 2015 fiscal year. Prepare all journal entries for Harper for 2014 and 2015 in connection with this investment. Assume that the equity method is applied. 1/1/14
During 2014
12/31/14
12/31/14
Investment in Kinman Co............. Cash.......................................... (To record initial investment)
210,000 210,000
Dividends Receivable................... 4,000 Investment in Kinman Co........ (To record dividend declaration: $10,000 x 40%)
4,000
Cash................................................ Dividends Receivable.............. (To record receipt of dividend)
4,000
4,000
Equity in Kinman Income—Loss. 16,000 Other Comprehensive Loss of Kinman 8,000 Investment in Kinman Co........ (To record accrual of income and OCI from equity investee, 40% of reported balances) Equity in Kinman Income—Loss. 3,300 Investment in Kinman Co........ (To record amortization relating to acquisition of Kinman—see Schedule 1 below)
24,000
3,300
12/31/14
During 2015
12/31/15
12/31/15
12/31/15
12/31/15
Equity in Kinman Income-Loss.... 2,000 Investment in Kinman Co........ (To defer unrealized gross profit on intra-entity sale see Schedule 2 below)
2,000
Dividends Receivable................... 4,800 Investment in Kinman Co........ (To record dividend declaration: $12,000 x 40%)
4,800
Cash................................................ Dividends Receivable.............. (To record receipt of dividend)
4,800
4,800
Investment in Kinman Co............. 16,000 Equity in Kinman Income........ (To record 40% accrual of income as earned by equity investee) Equity in Kinman Income............. 3,300 Investment in Kinman Co........ (To record amortization relating to acquisition of Kinman) Investment in Kinman Co............. 2,000 Equity in Kinman Income........ (To recognize income deferred from 2014) Equity in Kinman Income............. 3,600 Investment in Kinman Co........ (To defer unrealized gross profit on intra-entity sale—see Schedule 3 below)
16,000
3,300
2,000
3,600
Schedule 1—Allocation of Purchase Price and Related Amortization Purchase price ......................................................... Percentage of book value acquired ($400,000 × 40%)...................................................... Payment in excess of book value...............................
$210,000 (160,000) $50,000 Remaining Annual Life Amortization
Excess payment identified with specific assets: Building ($40,000 × 40%) $16,000 10 yrs. Royalty agreement ($85,000 × 40%) 34,000 20 yrs. Total annual amortization
$1,600 1,700 $3,300
Schedule 2—Deferral of Unrealized Gross Profit—2014 Inventory remaining at end of year................................................... Gross profit percentage ($30,000 ÷ $90,000)................................... Gross profit remaining in inventory............................................ Ownership percentage....................................................................... Unrealized gross profit to be deferred until 2015......................
$15,000 × 33⅓% $5,000 × 40% $ 2,000
Schedule 3—Deferral of Unrealized Gross Profit—2015 Inventory remaining at end of year (30%)........................................ Gross profit percentage ($30,000 ÷ $80,000)................................... Gross profit remaining in inventory............................................ Ownership percentage....................................................................... Unrealized gross profit to be deferred until 2016......................
$24,000 × 37½% $9,000 × 40% $ 3,600
Problem III Following are pre-acquisition financial balances for Padre Company and Sol Company as of December 31. Also included are fair values for Sol Company accounts.
On December 31, Padre acquires Sol's outstanding stock by paying $360,000 in cash and issuing 10,000 shares of its own common stock with a fair value of $40 per share. Padre paid legal and accounting fees of $20,000 as well as $5,000 in stock issuance costs. Determine the value that would be shown in Padre's consolidated financial statements for each of the accounts listed.
Inventory = $670,000 (Padre's book value plus Sol's fair value) Land = $710,000 (Padre's book value plus Sol's fair value) Buildings and equipment = $930,000 (Padre's book value plus Sol's fair value) Franchise agreements = $440,000 (Padre's book value plus Sol's fair value) Goodwill = $80,000 ($760,000 consideration transferred exceeds the $680,000 fair value of Sol’s net assets acquired) Revenues = $960,000 (only parent company operational figures are reported at date of acquisition)
Additional paid-in capital = $265,000 (Padre's book value adjusted for stock issue less stock issuance costs) Expenses = $940,000 (only parent company operational figures plus acquisition-related costs are reported at date of acquisition) Retained earnings, 1/1 = $390,000 (Padre's book value only) Retained earnings, 12/31 = $410,000 (beginning retained earnings plus revenues minus expenses, of Padre only)
Problem IV Francisco Inc. acquired 100 percent of the voting shares of Beltran Company on January 1, 2014. In exchange, Francisco paid $450,000 in cash and issued 104,000 shares of its own $1 par value common stock. On this date, Francisco's stock had a fair value of $12 per share. The combination is a statutory merger with Beltran subsequently dissolved as a legal corporation. Beltran's assets and liabilities are assigned to a new reporting unit. The following reports the fair values for the Beltran reporting unit for January 1, 2014, and December 31, 2015, along with their respective book values on December 31, 2015.
a. Prepare Francisco's journal entry to record the assets acquired and the liabilities assumed in the Beltran merger on January 1, 2014.
In accounting for the combination, the total fair value of Beltran (consideration transferred) is allocated to each identifiable asset acquired and liability assumed with any remaining excess as goodwill. Cash paid Fair value of shares issued Consideration transferred
$ 450,000 1,248,000 $1,698,000
Consideration transferred (above) Fair value of net assets acquired and liabilities assumed Goodwill recognized in the combination
$1,698,000 1,298,000 $ 400,000
Entry by Francisco to record assets acquired and liabilities assumed in the combination with Beltran: Cash 75,000 Receivables 193,000 Inventory 281,000 Patents 525,000 Customer relationships 500,000 Equipment 295,000 Goodwill 400,000 Accounts payable Long-term liabilities Cash Common stock (Francisco Co., par value) Additional paid-in capital
121,000 450,000 450,000 104,000 1,144,000
b. On December 31, 2015, Francisco opts to forego any goodwill impairment qualitative assessment and estimates that the total fair value of the entire Beltran reporting unit is $1,425,000. What amount of goodwill impairment, if any, should Francisco recognize on its 2015 income statement? Step one in goodwill impairment test: Fair value of reporting unit as a whole Book value of reporting unit's net assets
1,425,000 1,585,000
Because the total fair value of the reporting unit is less than its carrying value, a potential goodwill impairment loss exists, step two is performed: Fair value of reporting unit as a whole $1,425,000 Fair values of reporting unit's net assets (excluding goodwill) 1,325,000 Implied fair value of goodwill 100,000 Book value of goodwill 400,000 Goodwill impairment loss $ 300,000
Problem V On January 3, 2013, Persoff Corporation acquired all of the outstanding voting stock of Sea Cliff, Inc. in exchange for $6,000,000 in cash. Persoff elected to exercise control over Sea Cliff as a wholly owned subsidiary with an independent accounting system. Both companies have December 31 fiscal year-ends. At the acquisition date, Sea Cliff's stockholders' equity was $2,500,000 including retained earnings of $1,700,000. Persoff pursued the acquisition, in part, to utilize Sea Cliff's technology and computer software. These items had fair values that differed from their values on Sea Cliff's books as follows:
Sea Cliff's remaining identifiable assets and liabilities had acquisition-date book values that closely approximated fair values. Since acquisition, no assets have been impaired. During the next three years, Sea Cliff reported the following income and dividends:
December 31, 2015, financial statements for each company appear on the following page. Parentheses indicate credit balances. Dividends declared were paid in the same period. Required: Prepare a worksheet to determine the consolidated values to be reported on Persoff's financial statements.
PERSOFF COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2015 Income Statement Revenues Cost of goods sold Depreciation Amortization Equity earnings in Sea Cliff Net income
Persoff (2,720,000) 1,350,000 275,000 370,000 (575,000) (1,300,000)
Sea Cliff (2,250,000) 870,000 380,000 25,000
Statement of Retained Earnings Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31
(7,470,000) (1,300,000) 600,000 (8,170,000)
(3,240,000) (975,000) 150,000 (4,065,000)
490,000 7,165,000
375,000
Balance Sheet Current assets Investment in Sea Cliff
Computer software Patented technology Goodwill Equipment Total assets Liabilities Common stock Retained earnings 12/31 Total liabilities and equity
Adjustments & Eliminations
D C
400,000 575,000
(975,000)
E 3,240,000 150,000 C
45,000 80,000 0 4,500,000 5,000,000
(520,000) (2,000,000) (8,170,000) (10,690,000)
(135,000) (800,000) (4,065,000) (5,000,000)
(7,470,000) (1,300,000) 600,000 (8,170,000)
865,000 C
300,000 800,000 100,000 1,835,000 10,690,000
Consolidated (4,970,000) 2,220,000 655,000 795,000 0 (1,300,000)
150,000
A 1,000,000 A 1,500,000 A 200,000
E
575,000 C 4,040,000 E 2,700,000 A 100,000 D 300,000 D
800,000 7,865,000
7,865,000
-01,245,000 2,080,000 300,000 6,335,000 10,825,000 (655,000) (2,000,000) (8,170,000) (10,825,000)
