Chapter 1 Test Bank

BUSINESS COMBINATIONS

Multiple Choice Questions

LO1

1. Research and development is a driver of business combinations for all of the following reasons except?

a. Lower operating costs b. Acquisition of intangible assetsc. Operating loss carryforwardsd. Reduced business risk of acquiring established product

lines

LO2

2. A business combination in which a new corporation is created and two or more existing corporations are combined into the newly created corporation is called a:

a. merger.b. purchase transaction.c. pooling-of-interests.d. consolidation.

3. A business combination occurs when a company acquires an equity interest in another entity and has:

a. at least 20% ownership in the entity.b. more than 50% ownership in the entity.c. 100% ownership in the entity. d. control over the entity, irrespective of the percentage

owned.

4. FASB favors consolidation of two entities when

a. One acquires at least 20% equity ownership of the other.b. One acquires between 20% and 50% equity ownership in the

other.c. One acquires two thirds equity ownership in the other. d. One gains control over the entity, irrespective of the

equity percentage owned.

LO3LO4

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5. Michangelo Co. paid accountants and lawyers $100,000 in order to acquire Florence Company. Michangelo will treat the $100,000:

a. an expense for the current year. b. a prior period adjustment to retained earnings. c. additional cost to investment of Florence on the

consolidated balance sheet. d. a reduction in paid-in capital.

6. Picasso Co. issued 10,000 shares of its $1 par common stock, valued at $400,000, to acquire shares of Bull Company in an all-stock transaction. Picasso paid the investment bankers $35,000. Picasso will treat the investment banker fee as:

a. an expense for the current year. b. a prior period adjustment to Retained Earnings. c. additional goodwill on the consolidated balance sheet. d. a reduction in paid-in capital.

7. Durer Inc acquired Sea Corporation in a business combination and Sea Corp went out of existence. Sea Corp developed a patent listed as an asset on Sea Corp’s books at the patent office filing cost. In recording the combination:

a. fair value is not assigned to the patent because the research and development costs have been expensed by Sea Corp.

b. Sea Corp’s prior expenses to develop the patent are recorded as an asset by Durer at purchase.

c. the patent is recorded as an asset at fair market value.d. the patent's market value increases goodwill.

8. In an acquisition, the company whose assets are acquired:

a. will go out of existence.b. will become a subsidiary of the acquiring company.c. will be dissolved along with the acquiring company to form

a new corporation.d. None of the above are correct.

9. According to FASB Statement 141, which one of the following items may not be accounted for as an intangible asset apart from goodwill?

a. a production backlogb. talented employee workforcec. noncontractual customer relationshipsd. employment contracts

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10. When negative goodwill occurs in a business combination calculation,

a. The negative goodwill is considered an impairment.b. The value is allocated first to reduce proportionately

(according to market value) non-current assets, then to non-monetary current assets, and any negative remainder is classified as a deferred credit.

c. allocated first to reduce proportionately (according to market value) non-current assets, and any negative remainder is classified as an extraordinary gain.

d. allocated first to reduce proportionately (according to market value) non-current, depreciable assets to zero, and any negative remainder is classified as a deferred credit.

11. With respect to goodwill, an impairment

a. Will be amortized over the remaining useful life.b. Is a two step process which analyzes each business unit of

the entity. c. Is a one step process considering the entire firm.d. Occurs when asset values are adjusted to fair value in a

purchase.

Use the following information in answering questions 12 and 13.

Manet Corporation exchanges 150,000 shares of newly issued $1 par value common stock with a fair market value of $25 per share for all of the outstanding $5 par value common stock of Gardner Inc and Gardner is then dissolved. Manet paid the following costs and expenses related to the business combination:

Costs of special shareholders’ meeting to vote on the merger 6,000 Registering and issuing securities $14,000 Accounting and legal fees 9,000 Salaries of Manet’s employees assigned To the implementation of the merger 15,000 Cost of closing duplicate facilities 11,000 Costs of special shareholders’ meeting to vote on the merger 7,000

12. In the business combination of Manet and Gardner:

a. the costs of registering and issuing the securities are included as part of the purchase price for Gardner.

b. only the salaries of Manet's employees assigned to the merger are treated as expenses.

c. all of the costs except those of registering and issuing

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the securities are included in the purchase price of Gardner.

d. only the accounting and legal fees are included in the purchase price of Gardner.

13. In the business combination of Manet and Gardner

a. all of the items listed above are treated as expenses.b. all of the items listed above except the cost of

registering and issuing the securities are expensed.c. the costs of registering and issuing the securities are

deducted from the fair market value of the common stock used to acquire Gardner.

d. only the costs of closing duplicate facilities, the salaries of Manet's employees assigned to the merger, and the costs of the shareholders' meeting would be treated as expenses.

LO5

14. Which of the following methods would does FASB consider best in Statement 142 in the evaluation of goodwill impairment?

a. Senior executive estimateb. Financial analyst forecastsc. Market valued. Present value of future cash flows discounted at the firm’s

cost of capital

15. Raphael Company paid $2,000,000 for the net assets of Paris Corporation and Paris was then dissolved. Paris had no liabilities. The fair values of Paris’ assets were $2,500,000. Paris’s only non-current assets were land and equipment with fair values of $160,000 and $640,000, respectively. At what value will the equipment be recorded by Raphael?

a. $0b. $240,000c. $400,000d. $640,000

16. According to FASB 141, liabilities assumed in a purchase acquisition will be valued at:

a. estimated fair value.b. historical book value.c. current replacement cost.d. present value using market interest rates.

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17. Medici Corporation acquires all of the voting stock of Zeus Corporation for $900,000 cash. The book values of Zeus’ assets are $850,000, but the fair values are $820,000 because inventory has a fair value below its book value. Zeus has no liabilities. Goodwill from the combination is computed as:

a. $900,000 less the fair value of Zeus’ net assets.b. $900,000 less the book value of Zeus net assets.c. $900,000 less (the assets’ fair values minus the assets’

book values).d. $900,000 less (the assets’ book values minus the assets’

fair values).

18. Goodwill arising from a business combination is:

a. charged to Retained Earnings after the acquisition is completed.

b. amortized over 40 years or its useful life, whichever is longer.

c. amortized over 40 years or its useful life, whichever is shorter.

d. never amortized.

19. The founders of an acquired company are granted a contingent payment for three years after the acquisition based on those years earnings:

a. The acquirer typically recognizes the payment as goodwill when the contingency is resolved and payment is given.

b. The acquirer typically recognizes the payment as goodwill when the contingency is resolved.

c. The acquirer typically includes the expected payments based on future earnings as goodwill at acquisition.

d. The acquirer typically amortizes contingencies over the applicable award period.

20. The first step in assigning the cost of an acquired company is to determine the fair values of all identifiable assets and liabilities. According to FASB Statement 141, the current replacement costs be the values for which of the following:

a. both raw materials and finished goods inventories.b. plant and equipment and finished goods inventories.c. plant and equipment and raw materials inventories.d. land and plant and equipment.

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Exercises

LO2Exercise 1

On January 2, 2005 Bison Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Deer Corporation’s outstanding common shares. Bison paid $15,000 to register and issue shares. Bison $10,000 for the direct combination costs of the accountants. The fair value and book value of Deer's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows:

Bison Deer

Cash $ 150,000 $ 120,000Inventories 320,000 400,000Other current assets 500,000 500,000Land 350,000 250,000Plant assets-net 4,000,000 1,500,000Total Assets $5,320,000 $2,770,000

Accounts payable $1,000,000 $ 300,000Notes payable 1,300,000 660,000Capital stock, $5 par 2,000,000 500,000Paid-in capital 1,000,000 100,000Retained Earnings 20,000 1,210,000Total Liabilities & Equities $5,320,000 $2,770,000

Required:

1. Prepare Bison's general journal entry for the acquisition of Deer assuming that Deer survives as a separate legal entity.

2. Prepare Bison's general journal entry for the acquisition ofDeer assuming that Deer will dissolve as a separate legal entity.

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LO2

Exercise 2

On January 2, 2005 Altamira Company issued 80,000 new shares of its $2 par value common stock valued at $12 a share for all of Lascaux Corporation’s outstanding common shares. Altamira $5,000 for the direct combination costs of the accountants. Altamira paid $10,000 to register and issue shares. The fair value and book value of Lascaux's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows:

Altamira LascauxCash $ 75,000 $ 60,000Inventories 160,000 200,000Other current assets 200,000 250,000Land 175,000 125,000Plant assets-net 1,500,000 750,000Total Assets $2,110,000 $1,385,000

Accounts payable $ 100,000 $ 155,000Notes payable 700,000 330,000Capital stock, $2 par 600,000 250,000Paid-in capital 450,000 50,000Retained Earnings 260,000 600,000Total Liabilities & Equity $2,110,000 $1,385,000

Required:

1. Prepare Altamira's general journal entry for the acquisition ofLascaux assuming that Lascaux survives as a separate legal entity.

2. Prepare Altamira's general journal entry for the acquisition ofLascaux assuming that Lascaux will dissolve as a separate legal entity.

LO4

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Exercise 3

Dolmen Corporation purchased the net assets of Carnac Inc on January 2, 2005 for $280,000 and also paid $10,000 in direct acquisition costs. Carnac's balance sheet on January 2, 2005 was as follows:

Accounts receivable-net $ 90,000 Current liabilities $ 35,000Inventory 180,000 Long term debt 80,000Land 20,000 Common stock ($1 par) 10,000Building-net 30,000 Paid-in capital 215,000Equipment-net 40,000 Retained earnings 20,000Total assets $360,000 Total liab. & equity $360,000

Fair values agree with book values except for inventory, land, and equipment, that have fair values of $200,000, $25,000 and $35,000, respectively. Carnac has patent rights valued at $10,000.

Required:

Prepare Dolmen's general journal entry for the cash purchase of Carnac's net assets.

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LO4

Exercise 4

The balance sheets of Palisade Company and Salisbury Corporation were as follows on December 31, 2004:

Palisade SalisburyCurrent Assets $ 260,000 $ 120,000Equipment-net 440,000 480,000Buildings-net 600,000 200,000Land 100,000 200,000Total Assets $1,400,000 $1,000,000Current Liabilities 100,000 120,000Common Stock, $5 par 1,000,000 400,000Paid-in Capital 100,000 280,000Retained Earnings 200,000 200,000Total Liabilities and Stockholders' equity

$1,400,000 $1,000,000

On January 2, 2005 Palisade issued 60,000 of its shares with a market value of $40 per share in exchange for all of Salisbury's shares, and Salisbury was dissolved. Palisade paid $20,000 to register and issue the new common shares. It cost Palisade $50,000 in direct combination costs. Book values equal market values except that Salisbury’s land is worth $250,000.

Required:

Prepare a Palisade balance sheet after the business combination on January 1, 2005.

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LO4

Exercise 5

Paradise Inc purchased the net assets of Sublime Company on January 2, 2005 for $160,000 and also paid $5,000 in direct acquisition costs. Sublime's balance sheet on January 2, 2005 was as follows:

Accounts receivable-net $180,000 Current liabilities $ 25,000Inventory 180,000 Long term debt 90,000Land 30,000 Common stock ($1 par) 10,000Building-net 30,000 Paid-in capital 225,000Equipment-net 30,000 Retained earnings 100,000Total assets $450,000 Total liab. & equity $450,000

Fair values agree with book values except for inventory, land, and equipment, that have fair values of $200,000, $25,000 and $35,000, respectively. Solitaire has patent rights valued at $10,000.

Required:

Prepare Paradise's general journal entry for the cash purchase of Sublime's net assets.

LO4

Exercise 6

On January 2, 2005 Tennessee Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Alaska Company’s outstanding common shares in a purchase acquisition. Tennessee paid $15,000 for registering and issuing securities and $10,000 for other direct costs of the business combination. The fair value and book value of Alaska's identifiable assets and liabilities

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were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows:

Tennessee AlaskaCash $ 150,000 $ 120,000Inventories 320,000 400,000Other current assets 500,000 500,000Land 350,000 250,000Plant assets-net 4,000,000 1,500,000Total Assets $5,320,000 $2,770,000

Accounts payable $1,000,000 $ 300,000Notes payable 1,300,000 660,000Capital stock, $5 par 2,000,000 500,000Paid-in capital 1,000,000 100,000Retained Earnings 20,000 1,210,000Total Liabilities & Equities $5,320,000 $2,770,000

Required:

Prepare a balance sheet for Tennessee Corporation immediately after the business combination.

LO4&5

Exercise 7

New York Corp. purchased the net assets of Arizona Company on January 2, 2005 for $200,000 and also paid $5,000 in direct acquisition costs. Arizona's balance sheet on January 2, 2005 was as follows:

Accounts receivable-net $ 90,000 Current liabilities $ 27,000Inventory 180,000 Long term debt 88,000Land 30,000 Common stock ($1 par) 15,000Building-net 30,000 Paid-in capital 215,000Equipment-net 30,000 Retained earnings 15,000Total assets $360,000 Total liab. & equity $360,000

Fair values agree with book values except for inventory, land, and equipment, that have fair values of $200,000, $25,000 and $35,000, respectively. Arizona has patent rights valued at $10,000.

Required:

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1. Prepare an allocation schedule for the purchase of Arizona's net assets.

2. Prepare New York's general journal entry for the cash purchase of Arizona's net assets.

LO5

Exercise 8

Book values and fair values of Portrait Corporation’s assets and liabilities at January 2, 2005, are shown below:

AssetsBook

ValuesFair

ValuesOther current assets $ 250,000 $ 250,000Inventories 300,000 380,000Land 200,000 400,000Buildings-net 600,000 480,000Equipment-net 460,000 460,000

$1,810,000 $1,970,000

Liabilities and EquitiesCurrent liabilities $ 190,000 $ 190,0007% Bonds payable 600,000 540,000Common stock 1,000,000Retained earnings 20,000

$1,810,000 $1,970,000

Palette Corporation acquires all of the outstanding common voting stock of Portrait for $1,400,000 cash and Portrait Corporation then goes out of existence.

Required:

Prepare a schedule to allocate the $1,400,000 investment cost to Portrait’s assets and liabilities on January 2, 2005.

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LO5

Exercise 9In a business combination on January 2, 2005 Horus Inc issues 20,000 shares of its $5 par common for all of the outstanding stock of Namar. Namar is dissolved. Horus pays $60,000 for direct combination costs and $40,000 to register its securities. Horus’ stock has a market price of $60 on January 2, 2005. Balance sheet information for both firms on January 2, 2005 is as follows

HorusCost

NamarCost

NamarFair Value

Cash $ 240,000 $ 20,000 $ 20,000Inventories 100,000 60,000 60,000Accounts receivable 200,000 180,000 200,000Land 160,000 40,000 200,000Plant assets-net 1,350,000 400,000 700,000Total assets $2,000,000 $700,000

Notes payable $ 400,000 $ 100,000 $ 50,000Capital stock, $5 par 1,000,000 200,000Paid-in capital 400,000 100,000Retained earnings 200,000 300,000Total Liabilities & Equities $2,000,000 $700,000

Required:

Prepare journal entries to record the business combination.

LO 5Exercise 10

Balance sheet information for Sphinx Company at January 1, 2005, is summarized as follows:

Current assets $ 230,000 Liabilities $ 300,000Plant assets 450,000 Capital stock $10 par 200,000

Retained earnings 180,000 $ 680,000 $ 680,000

Sphinx’s assets and liabilities are fairly valued except for plant assets that are undervalued by $50,000. On January 2, 2005, Pyramid Corporation issues 20,000 shares of its $10 par value common stock

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for all of Sphinx’s net assets and Sphinx is dissolved. Market quotations for the two stocks on this date are:

Pyramid common: $28.00 Sphinx common: $19.50

Butler pays the following fees and costs in connection with the combination:

Finder’s fee $10,000 Costs of registering and issuing stock 5,000 Legal and accounting fees 6,000

Required:

1. Calculate Pyramid’s investment cost of Sphinx Corporation.

2. Calculate any goodwill from the business combination.

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15

Solutions:

Multiple Choice Questions

1 A 2 d 3 d 4 b 5 c6 D 7 b 8 d 9 b 10 d11 B 12 b 13 c 14 c 15 b16 D 17 c 18 d 19 a 20 c

Exercise 1

1. General journal entry recorded by Bison for the acquisition of Deer (Deer survives as a separate legal entity):

Investment in Roger 1,900,000 Common stock 500,000 Paid-in capital 1,400,000Investment in Roger 10,000Paid-in capital 15,000 Cash 25,000

2. General journal entry recorded by Bison for the acquisition of Deer (Deer dissolves as a separate legal entity):

Cash 95,000 Inventories 400,000 Other current assets 500,000 Land 250,000 Plant assets 1,500,000 Goodwill 100,000 Accounts payable 300,000 Notes payable 660,000 Common stock 500,000 Paid-in capital 1,385,000

Exercise 2

1. General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux survives as a separate legal entity):

Investment in Lascaux 960,000 Common stock 100,000 Paid-in capital 860,000Investment in Lascaux 5,000Paid-in capital 10,000

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Cash 15,000

3. General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux dissolves as a separate legal entity):

Cash 60,000 Inventories 200,000 Other current assets 250,000 Land 125,000 Plant assets 750,000 Goodwill 55,000 Accounts payable 155,000 Notes payable 330,000 Common stock 100,000 Paid-in capital 850,000

Exercise 3

General journal entry for the purchase of Carnac's net assets:

Accounts receivable 90,000Inventory 200,000Land 25,000Building 30,000Equipment 35,000Patent 10,000Goodwill 15,000 Current liabilities 35,000 Long-term debt 80,000 Cash 290,000

Exercise 4

The stockholders' equity section for Palisade Corporation subsequent to its acquisition of Salisbury Corporation on January 1, 2005 will appear as follows:

Palisade CorporationBalance SheetJanuary 1, 2005Current Assets $ 310,000Equipment-net 920,000Buildings-net 800,000Land 350,000Goodwill 180,000Total Assets $2,460,000Current Liabilities 220,000Common Stock, $5 par 1,150,000Paid-in Capital 890,000

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Retained Earnings 200,000Total Liabilities and Stockholders' equity

$2,460,000

Exercise 5

General journal entry for the purchase of Sublime's net assets:

Accounts receivable 90,000Inventory 200,000 Current liabilities 35,000 Long-term debt 80,000 Cash 165,000 Extraordinary gain 10,000

Exercise 6

Tennessee Corporation Balance Sheet

January 1, 2005

Assets: Liabilities: Cash $ 245,000 Accounts payable $1,300,000 Inventory 720,000 Notes payable 1,960,000 Other current assets 1,000,000 Total liabilities 3,260,000 Total current assets 1,965,000 Land 600,000 Equity: Plant assets-net 5,500,000 Common stock ($5 par) 2,500,000 Goodwill 100,000 Paid-in capital 2,385,000 Total L.T. assets 6,200,000 Retained earnings 20,000 Total equity 4,905,000 Total assets $8,165,000 Total liab.& eq. $8,165,000

Exercise 7

1. Allocation schedule for Arizona's net assets.

Total purchase price $205,000Fair value of current assets $290,000Less: fair value of all liabilities 115,000 Net difference 175,000Amount allocable to non-current assets $ 30,000

Allocation Schedule for Non-current Assets

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Non-current Asset

Fair Value $

% of Total Fair Value

Allocable $ Amount

$ Amount Allocated

Land 25,000 25 30,000 7,500Building 30,000 30 30,000 9,000Equipment 35,000 35 30,000 10,500Patent 10,000 10 30,000 3,000 Total 100,000 100 30,000 30,000

2. General journal entry for the purchase of Arizona's net assets:

Accounts receivable 90,000Inventory 200,000Land 7,500Building 9,000Equipment 10,500Patent 3,000 Current liabilities 27,000 Long-term debt 88,000 Cash 205,000

Exercise 8

ItemAllocatedFair Value

Purchase Cost 1,400,000Book Value 1,020,000Cost in excess of book 380,000

Market in excess of bookInventory 80,000Land 200,000Building net -120,0007% Bonds 60,000Identifiable Differences 220,000

Goodwill 160,000

Exercise 9

ItemAllocatedFair Value

Purchase Cost 1,260,000Book Value 600,000Cost in excess of book 660,000

Market in excess of bookAccounts Receivable 20,000Land 160,000Plant Assets net 300,000

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Notes Payable 50,000Identifiable Differences 530,000

Goodwill 130,000

Investment 1,260,000Paid-in capital 40,000 Common stock 100,000 Paid-in capital 1,100,000 Cash 100,000

Cash 20,000 Inventories 60,000 Accounts Receivable 200,000 Land 200,000 Plant assets 700,000 Goodwill 130,000 Notes payable 50,000 Investment 1,260,000

Exercise 10

Requirement 1

FMV of shares issued by Pyramid: 20,000 x $28.00= $ 560,000Finder’s fees 10,000Legal and accounting fees 6,000Total acquisition cost for Sphinx Corporation: $ 576,000

Requirement 2

Investment cost from above: $ 576,000Less: Fair value of Sphinx’s net assets ($680,000 of total assets plus $50,000 of undervalued plant assets minus $300,000 of debt) 430,000Equals: Goodwill from investment in Sphinx: $ 146,000

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