Solution Manual For Advanced Accounting, 4th Edition

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1-1CHAPTER 1ANSWERS TO QUESTIONS1.Internal expansion involves a normal increase in business resulting from increased demand forproducts and services, achieved without acquisition of preexisting firms.Some companies expandinternally by undertaking new product research to expand their total market, or by attempting toobtain a greater share of a given market through advertising and other promotional activities.Marketing can also be expanded into new geographical areas.External expansion is the bringing together of two or more firms under common control byacquisition.Referred to as business combinations, these combined operations may be integrated, oreach firm may be left to operate intact.2.Four advantages of business combinations as compared to internal expansion are:(1)Management is provided with an established operating unit with its own experienced personnel,regular suppliers, productive facilities and distribution channels.(2)Expanding by combination does not create new competition.(3)Permits rapid diversification into new markets.(4)Income tax benefits.3.The primary legal constraint on business combinations is that of possible antitrust suits.The UnitedStates government is opposed to the concentration of economic power that may result from businesscombinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal withantitrust problems.4.(1)A horizontal combination involves companies within the same industry that have previouslybeen competitors.(2)Vertical combinations involve a company and its suppliers and/or customers.(3)Conglomerate combinations involve companies in unrelated industries having little productionor market similarities.5.A statutory merger results when one company acquires all of the net assets of one or more othercompanies through an exchange of stock, payment of cash or property, or the issue of debtinstruments.The acquiring company remains as the only legal entity, and the acquired companyceases to exist or remains as a separate division of the acquiring company.A statutory consolidation results when a new corporation is formed toacquire two or morecorporations, through an exchange of voting stock, with the acquired corporations ceasing to exist asseparate legal entities.A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of thevoting stock of another company.The stock may be acquired through market purchases or throughdirect purchase from or exchange with individual stockholders of the investee or subsidiary company.6.A tender offer is an open offer to purchase up to a stated number of shares of a given corporation at astipulated price per share.The offering price is generally set above the current market price of theshares to offer an additional incentive to the prospective sellers.7.A stock exchange ratio is generally expressed as the number of shares of the acquiring company thatare to be exchanged for each share of the acquired company.

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1-28.Defensive tactics include:(1)Poison pill–when stock rights are issued to existing stockholders that enable them to purchaseadditional shares at a price below market value, but exercisable only in the event of a potentialtakeover. This tactic is effective in some cases.(2)Greenmail–when the shares held by a would-be acquiring firm are purchased at an amountsubstantially in excess of their fair value. The shares are then usually held in treasury. This tactic isgenerally ineffective.(3)White knight or white squire–when a third firm more acceptable to the target companymanagement is encouraged to acquire or merge with the target firm.(4)Pac-man defense–when the target firm attempts an unfriendly takeover of the would-beacquiring company.(5)Selling the crown jewels–when the target firms sells valuable assets to others to make the firmless attractive to an acquirer.9.In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stockacquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stockacquisition, formal negotiations with the target’s management can sometimes be avoided. Further, ina stock acquisition, there might be advantages in keeping the firms as separate legal entities such asfor tax purposes.10.Does the merger increase or decrease expected earnings performance of the acquiring institution?From a financial and shareholder perspective, the price paid for a firm is hard to justify if earnings pershare declines. When this happens, the acquisition is considereddilutive. Conversely, if the earningsper share increases as a result of the acquisition, it is referred to as anaccretiveacquisition.11. Under the parent company concept, the writeup or writedown of the net assetsof the subsidiary inthe consolidated financial statements is restricted to the amount by which the cost of the investmentis more or less than the book value of the net assets acquired. Noncontrolling interest in net assets isunaffected by such writeups or writedowns.The economic unit concept supports the writeup or writedown of the net assets of the subsidiary byan amount equal to the entire difference between the fair value and the book value of the net assetson the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjustedfor its share of the writeup or writedown of the net assets of the subsidiary.12.a)Under the parent company concept, noncontrolling interest is considered a liability of theconsolidatedentitywhereasundertheeconomicunitconcept,noncontrollinginterestisconsidered a separate equity interest in consolidated net assets.b)The parent company concept supports partial elimination of intercompany profit whereas theeconomic unit concept supports 100 percent elimination of intercompany profit.c)The parent company concept supports valuation of subsidiary net assets in the consolidatedfinancial statements at book value plusanamount equal to the parent company’s percentageinterest in the difference between fair value and book value. The economic unit conceptsupports valuation of subsidiary net assets in the consolidated financial statements at their fairvalue on the date of acquisition without regard to the parent company’s percentage ownershipinterest.d)Under the parent company concept, consolidated net income measures the interest of theshareholders of the parent company in the operating results of the consolidated entity. Under the

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1-3economicunitconcept,consolidatednetincomemeasurestheoperatingresultsoftheconsolidated entity which is then allocated between the controlling and noncontrolling interests.13.The implied fair value based on the price may not be relevant or reliable since the price paid is anegotiated price which may be impacted by considerations other than or in addition to the fair valueof the net assets of the acquired company.There may be practical difficulties in determining thefair value of the consideration given and in allocating the total implied fair value to specific assetsand liabilities.In the case of a less than wholly owned company, valuation of net assets at implied fair valueviolates the cost principle of conventional accounting and results in the reporting of subsidiaryassets and liabilities using a different valuation procedure than that used to report the assets andliabilities of the parent company.14.The economic entity is more consistent with the principles addressed in the FASB’s conceptualframework. It is an integral part of the FASB’s conceptual framework and is named specifically inSFAC No. 5as one of the basic assumptions in accounting.The economic entity assumption viewseconomic activity as being related to a particular unit of accountability, and the standard indicatesthat a parent and its subsidiaries represent one economic entity even though they may includeseveral legal entities.15.The FASB’s conceptual framework provides theguidance for new standards.The quality ofcomparability was very much at stake in FASB’s decision in 2001 to eliminate the pooling ofinterests method for business combinations. This method was also argued to violate the historicalcost principle as it essentially ignored the value ofthe consideration (stock) issued for theacquisition of another company.The issue of consistency plays a role in the recent proposal to shift from the parent concept to theeconomic entity concept, as the former method valued a portion (the noncontrolling interest) of agiven asset at prior book values and anotherportion (the controlling interest) of that same asset atexchange-date market value.16.Comprehensive income is a broader concept, and it includes some gains and losses explicitly statedby FASB to bypass earnings.The examples of such gains thatbypass earnings are some changes inmarket values of investments,someforeign currency translation adjustmentsandcertain gains andlosses, related to minimum pension liability.In the absence of gains or losses designated to bypass earnings, earnings and comprehensiveincome are the same.

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1-4ANSWERS TOBUSINESS ETHICS CASE1.The third item will lead to the reduction of net income of the acquired company beforeacquisition, and will increase the reported net income of the combined company subsequent toacquisition. The accelerated payment of liabilities should not have an effect on net income incurrent or future years, nor should the delaying of the collection of revenues (assuming thoserevenues have already been recorded).2.The first two items will decrease cash from operations prior to acquisition and will increase cashfrom operations subsequent to acquisition. The third item will not affect cash from operations.3.As the manager of the acquired company I would want to make it clear that my futureperformance (if I stay on with the consolidated company) should not be evaluated based upon afuture decline that is perceived rather than real. Further, I would express a concern thatshareholders and other users might view such accounting maneuvers as sketchy.4.a)Earnings manipulation may be regarded as unethical behavior regardless of which side ofthe acquirer/acquiree equation you’re on. The benefits that you stand to reap may differ,and thus your potential liability may vary. But the ethics are essentially the same.Ultimately the company may be one unified whole as well, and the users that are affectedby any kind of distorted information may view any participant in an unsavory light.b)See answer to (a).

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1-5ANSWERS TO EXERCISESExercise 1-1Part ANormal earnings for similar firms = ($15,000,000-$8,800,000) x 15% = $930,000Expected earnings of target:Pretax income of Condominiums, Inc.,2008$1,200,000Subtract: Additional depreciation on building ($960,00030%)(288,000)Target’s adjusted earnings,2008912,000Pretax income of Condominiums, Inc.,2009$1,500,000Subtract: Additional depreciation on building(288,000)Target’s adjusted earnings,20091,212,000Pretax income of Condominiums, Inc.,2010$950,000Add: Extraordinary loss300,000Subtract: Additional depreciation on building(288,000)Target’s adjusted earnings,2010962,000Target’s three year total adjusted earnings3,086,000Target’s three year average adjusted earnings($3,086,0003)1,028,667Excess earnings of target = $1,028,667-$930,000 = $98,667 per yearPresent value of excess earnings (perpetuity) at 25%:= $394,668 (Estimated Goodwill)Implied offering price = $15,000,000–$8,800,000 + $394,668 = $6,594,668.Part BExcess earnings of target (same as in Part A) = $98,667Present value of excess earnings (ordinary annuity) for three years at 15%:$98,6672.28323 = $225,279Implied offering price = $15,000,000–$8,800,000+ $225,279 = $6,425,279.Note: The sales commissions and depreciation on equipment are expected to continue at thesame rate, and thus do not necessitate adjustments.%,$2566798

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1-6Exercise 1-2Part ACumulative 5 years net cash earnings$850,000Add nonrecurring losses48,000Subtract extraordinary gains(67,000)Five-years adjusted cash earnings$831,000Average annual adjusted cash earnings$166,200(a)Estimated purchase price = present value of ordinary annuity of $166,200 (n=5, rate= 15%)$166,2003.35216 =$557,129(b)Less: Market value of identifiable assets of Beta$750,000Less: Liabilities of Beta320,000Market value of net identifiable assets430,000Implied value of goodwill of Beta$127,129Part BActual purchase price$625,000Market value of identifiable net assets430,000Goodwill purchased$195,000Exercise 1-3Part ANormal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000Excess earnings = $150,000–$120,000 = $30,000(1)Goodwill based on five years excess earnings undiscounted.Goodwill = ($30,000)(5 years) = $150,000(2)Goodwill based on five years discounted excess earningsGoodwill = ($30,000)(3.6048) = $108,144(present value of an annuity factor for n=5, I=12% is 3.6048)(3)Goodwill based on a perpetuityGoodwill = ($30,000)/.20 = $150,000Part BThe second alternative is the strongest theoretically if five years is a reasonable representation ofthe excess earnings duration. It considers the time value of money and assigns a finite life.Alternative three also considers the time value of money but fails to assess a duration period forthe excess earnings. Alternative one fails to account for the time value of money. Interestingly,alternatives one and three yield the same goodwill estimation and it might be noted that theassumption of an infinite life is not as absurd as it might sound since the present value becomesquite small beyond some horizon.Part CGoodwill = [Cost less (fair value of assets less the fair value of liabilities)],5000831,$

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1-7Or, Cost less fair value of net assetsGoodwill = ($800,000–($1,000,000-$400,000)) = $200,000

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2-1CHAPTER 2Note: The letter Aindicated for a question, exercise, or problem means that the question, exercise, orproblem relates toa chapterappendix.ANSWERS TO QUESTIONS1.At the acquisition date, the information available (and through the end of the measurement period)is used to estimate the expected total consideration at fair value.If the subsequent stock issuevaluation differs from this assessment, theExposure Draft (SFAS 1204-001)expected to replaceFASB Statement No. 141Rspecifies that equity should not be adjusted.The reason is that thevaluation was determined at the date of the exchange, and thus the impact on the firm’s equity wasmeasured at that point based on the best information available then.2.Pro formafinancialstatements(sometimes referredtoas“as if” statements)arefinancialstatements that are prepared to show the effect of planned or contemplated transactions.3.For purposes of the goodwill impairment test, all goodwill must be assigned to a reporting unit.Goodwill impairment for each reporting unit should be tested in a two-step process. In the firststep, the fair value of a reporting unit is compared to its carrying amount (goodwill included) atthe date of the periodic review. The fair value of the unit may be based on quoted market prices,prices of comparable businesses, or a present value or other valuation technique. If the fair valueat the review date is less than the carrying amount, then the second step is necessary. In thesecond step, the carrying value of the goodwill is compared to its implied fair value. (Thecalculation of the implied fair value of goodwill used in the impairment test is similar to themethod illustrated throughout this chapter for valuing the goodwill at the date of the combination.)4.Theexpected increase wasdue to the elimination of goodwill amortization expense.However, theimpairment loss under the new rules was potentially larger than a periodic amortization charge,and this is in fact what materialized within the first year after adoption (a large impairment loss).If there was any initialstock price impactfrom elimination of goodwill amortization, itwasonlyashort-term or momentum effect.Another issue is how the stock market responds to the goodwillimpairment charge.Some users claim that this charge is a non-cash charge and should bedisregarded by the market.However, others argue that the charge is an admission that the pricepaid was too high, and might result in a stock price decline (unless the market had already adjustedfor this overpayment prior to the actual writedown).

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2-2ANSWERS TOBUSINESS ETHICS CASEa and b. The board has responsibility to look into anything that might suggest malfeasance orinappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, andjudgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does thissend a message to other employees that ethical lapses are okay? Employees might feel that topexecutives are treated differently.ANSWERS TO EXERCISESExercise 2-1Part AReceivables228,000Inventory396,000Plant and Equipment540,000Land660,000Goodwill ($2,154,000-$1,824,000)330,000Liabilities594,000Cash1,560,000Part BReceivables228,000Inventory396,000Plant and Equipment540,000Land660,000Liabilities594,000Cash990,000Gain onBusiness Combination($1,230,000-$990,000)240,000

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2-3Exercise 2-2Cash$680,000Receivables720,000Inventories2,240,000Plant and Equipment (net) ($3,840,000 + $720,000)4,560,000Goodwill120,000Total Assets$8,320,000Liabilities1,520,000Common Stock, $16 par ($3,440,000 + (.50$800,000))3,840,000Other Contributed Capital ($400,000 + $800,000)1,200,000Retained Earnings1,760,000Total Equities$8,320,000Entries on Petrello Company’s books would be:Cash200,000Receivables240,000Inventory240,000Plant and Equipment720,000Goodwill*120,000Liabilities320,000Common Stock (25,000$16)400,000Other Contributed Capital($48-$16)25,000800,000* ($4825,000)–[($1,480,000–($800,000–$720,000)–$320,000]= $1,200,000–[$1,480,000–$80,000–$320,000] = $1,200,000–$1,080,000 =$120,000

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2-4Exercise 2-3Accounts Receivable231,000Inventory330,000Land550,000Buildings and Equipment1,144,000Goodwill848,000Allowance for Uncollectible Accounts($231,000-$198,000)33,000Current Liabilities275,000Bonds Payable450,000Premium on Bonds Payable($495,000-$450,000)45,000Preferred Stock (15,000$100)1,500,000Common Stock (30,000$10)300,000Other Contributed Capital($25-$10)30,000450,000Cash50,000Cost paid ($1,500,000 + $750,000 + $50,000) =$2,300,000Fair value of net assets (198,000 +330,000 +550,000 + 1,144,000–275,000–495,000) =1,452,000Goodwill =$848,000Exercise 2-4Cash96,000Receivables55,200Inventory126,000Land198,000Plant and Equipment466,800Goodwill*137,450Accounts Payable44,400Bonds Payable480,000Premium on Bonds Payable**45,050Cash510,000**Present value of maturity value, 12 periods @4%:0.6246$480,000 =$299,808Present value of interest annuity, 12 periods @ 4%:9.38507$24,000 =225,242Total present value525,050Par value480,000Premium on bonds payable$ 45,050*Cash paid$510,000Less: Book value of net assets acquired($897,600–$44,400–$480,000)(373,200)Excess of cash paid over book value136,800Increase in inventory to fair value(15,600)Increase in land to fair value(28,800)Increase in bond to fair value45,050Total increase in net assets to fair value650Goodwill$137,450

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2-5Exercise 2-5Current Assets960,000Plant and Equipment1,440,000Goodwill336,000Liabilities216,000Cash2,160,000Liability forContingentConsideration360,000Exercise 2-6The amount of the contingency is $500,000 (10,000 shares at $50per share)Part AGoodwill500,000Paid-in-Capital for Contingent Consideration500,000Part BPaid-in-Capital for Contingent Consideration500,000Common Stock($10 par)100,000Paid-In-Capital in Excess of Par400,000PlatzCompanydoesnot adjust the original amount recorded as equity.Exercise 2-71.(c)Cost (8,000 shares @ $30)$240,000Fair value of net assets acquired228,800Excess of cost over fair value (goodwill)$11,2002.(c)Cost (8,000 shares @ $30)$240,000Fair value of net assets acquired($90,000 +$242,000–$56,000)276,000Excess of fair value over cost (gain)$36,000Exercise 2-8Current Assets362,000Long-termAssets ($1,890,000 + $20,000) + ($98,000 + $5,000)2,013,000Goodwill*395,000Liabilities119,000Long-term Debt491,000Common Stock (144,000$5)720,000Other Contributed Capital(144,000($15-$5))1,440,000* (144,000$15)–[$362,000 + $2,013,000–($119,000 + $491,000)] = $395,000

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2-6Total shares issued+5000205000700$,$$,$= 144,000Fair valueof stockissued (144,000$15)= $2,160,000Exercise 2-9Case ACost (Purchase Price)$130,000Less: Fair Value of Net Assets120,000Goodwill$10,000Case BCost (Purchase Price)$110,000Less: Fair Value of Net Assets90,000Goodwill$20,000Case CCost (Purchase Price)$15,000Less: Fair Value of Net Assets20,000Gain($5,000)AssetsLiabilitiesRetainedEarnings (Gain)GoodwillCurrent AssetsLong-Lived AssetsCase A$10,000$20,000$130,000$30,0000Case B20,00030,00080,00020,0000Case C020,00040,00040,0005,000

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2-7Exercise 2-10Part A.2011:Step 1: Fair value of the reporting unit$400,000Carrying value of unit:Carrying value of identifiable net assets$330,000Carrying value of goodwill ($450,000-$375,000)75,000405,000Excess of carryingvalue over fair value$5,000The excess of carrying value over fair value means that step 2 is required.Step 2:Fair value of the reporting unit$400,000Fair value of identifiable net assets340,000Implied value of goodwill60,000Recorded value of goodwill($450,000-$375,000)75,000Impairment loss$15,0002012:Step 1: Fair value of the reporting unit$400,000Carrying value of unit:Carrying value of identifiable net assets$320,000Carrying value of goodwill ($75,000-$15,000)60,000380,000Excess offair value overcarrying value$20,000The excess of fair value over carrying value means that step 2 isnotrequired.2013:Step 1: Fair value of the reporting unit$350,000Carrying value of unit:Carrying value of identifiable net assets$300,000Carrying value of goodwill ($75,000-$15,000)60,000360,000Excess of carrying value over fair value$10,000The excess of carrying value over fair value means that step 2 is required.Step 2:Fair value of the reporting unit$350,000Fair value of identifiable net assets325,000Implied value of goodwill25,000Recorded value of goodwill($75,000-$15,000)60,000Impairment loss$35,000

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2-8Part B.2011:ImpairmentLoss—Goodwill15,000Goodwill15,0002012:No entry2013:ImpairmentLoss—Goodwill35,000Goodwill35,000Part C.SFAS No. 142specifies the presentation of goodwill in the balance sheet and income statement (ifimpairment occurs) as follows:•The aggregate amount of goodwill should be a separate line item in the balancesheet.•The aggregate amount of losses from goodwill impairment should be shown as aseparate line item in the operating section of the income statement unless some ofthe impairment is associated with a discontinued operation (in which case it isshown net-of-tax in the discontinued operation section).PartD.In a period in which an impairment loss occurs,SFAS No. 142mandates the following disclosuresin the notes:(1)A description of the facts and circumstances leading to the impairment;(2)The amount of the impairment loss and the method of determining the fair value ofthe reporting unit;(3)The nature and amounts of any adjustments made to impairment estimates fromearlier periods, if significant.Exercise 2-11a. Fair Value of Identifiable Net AssetsBook values $500,000–$100,000 =$400,000Write up of Inventory and Equipment:($20,000 + $30,000)=50,000Purchase price above which goodwill would result$450,000b.Equipmentwouldnotbe written down, regardless of the purchase price, unless it wasreviewed and determined to be overvalued originally.c.A gain would be shown if the purchase price was below $450,000.d. Anything below $450,000 is technically considered a bargain.e. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000).

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2-9Exercise 2-12ACash20,000Accounts Receivable112,000Inventory134,000Land55,000Plant Assets463,000Discount on Bonds Payable20,000Goodwill*127,200Allowance for Uncollectible Accounts10,000Accounts Payable54,000Bonds Payable200,000Deferred Income Tax Liability67,200Cash600,000Cost of acquisition$600,000Book value of net assets acquired($80,000 + $132,000 + $160,000)372,000Difference between cost and book value228,000Allocated to:Increase inventory, land, and plantassets to fair value($52,000 + $25,000 + $71,000)(148,000)Decrease bonds payable to fair value(20,000)Establish deferred income tax liability($168,00040%)67,200Balance assigned to goodwill$127,200ANSWERS TO PROBLEMSProblem 2-1Current Assets85,000Plant and Equipment150,000Goodwill*100,000Liabilities35,000Common Stock [(20,000 shares @ $10/share)]200,000Other Contributed Capital [(20,000($15–$10))]100,000Acquisition Costs Expense20,000Cash20,000Other Contributed Capital6,000Cash6,000To record the direct acquisition costs and stock issue costs* Goodwill= Excess of Consideration of $335,000 (stock valued at$300,000plus debt assumed of$35,000) over Fair Value of Identifiable Assets of $235,000 (totalassets of$225,000 plusPPEfairvalue adjustmentof$10,000)

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2-10Problem 2-2Acme CompanyBalance SheetOctober 1,2011(000)Part A.Assets (except goodwill) ($3,900 +$9,000 +$1,300)$14,200Goodwill (1)1,160Total Assets$15,360Liabilities ($2,030 +$2,200 +$260)$4,490Common Stock (180$20) +$2,0005,600Other Contributed Capital (180($50–$20))5,400Retained Earnings(130)Total Liabilities and Equity$15,360(1)Cost (180$50)$9,000Fair value of net assets acquired:Fair value of assets of Baltic and Colt$10,300Less liabilities assumed2,4607,840Goodwill$1,160

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2-11Problem 2-2(continued)PartB.Baltic2012:Step1: Fair value of the reportingunit$6,500,000Carrying value ofunit:Carrying value of identifiable netassets6,340,000Carryingvalue ofgoodwill200,000*Total carrying value6,540,000*[(140,000 x $50)–($9,000,000–$2,200,000)]The excess of carrying value over fair value means that step 2 isrequired.Step 2:Fair value of the reportingunit$6,500,000Fair value ofidentifiable net assets6,350,000Implied value of goodwill150,000Recorded value of goodwill200,000Impairment loss$50,000(because$150,000<$200,000)Colt2012:Step1: Fair value of the reportingunit$1,900,000Carrying value ofunit:Carrying value of identifiable netassets$1,200,000Carryingvalue ofgoodwill960,000*Total carryingvalue2,160,000*[(40,000 x $50)–($1,300,000–$260,000)]The excess of carrying value over fair value means that step 2 isrequired.Step 2:Fair value of the reportingunit$1,900,000Fair value ofidentifiable net assets1,000,000Implied value of goodwill900,000Recorded value of goodwill960,000Impairment loss$ 60,000(because$900,000<$960,000)Totalimpairment loss is $110,000.Journalentry:ImpairmentLoss$110,000Goodwill$110,000

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2-12Problem 2-3Present value of maturity value, 20 periods @ 6%:0.3118$600,000 =$187,080Present value of interest annuity, 20 periods @ 6%:11.46992$30,000 =344,098Total Present value531,178Par value600,000Discount on bonds payable$68,822Cash114,000Accounts Receivable135,000Inventory310,000Land315,000Buildings54,900Equipment39,450Bond Discount ($40,000 +$68,822)108,822Current Liabilities95,300Bonds Payable ($300,000 +$600,000)900,000Gain on Purchase of Business81,872Computation of Excess of Net Assets Received Over CostCost (Purchase Price)($531,178 plus liabilities assumed of $95,300 and $260,000)$886,478Less: Total fair value of assets received$968,350Excess of fair value of net assets over cost($81,872)Problem 2-4Part AJanuary 1,2011Accounts Receivable72,000Inventory99,000Land162,000Buildings450,000Equipment288,000Goodwill*54,000Allowance forUncollectibleAccounts7,000Accounts Payable83,000Note Payable180,000Cash720,000Liability for Contingent Consideration135,000*Computation ofGoodwillCash paid($720,000+$135,000)$855,000Total fair value of net assets acquired ($1,064,000-$263,000)801,000Goodwill$54,000

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2-13Problem 2-4(continued)PartBJanuary2, 2013Liability for Contingent Consideration135,000Cash135,000PartCJanuary2, 2013Liability for Contingent Consideration135,000Income from Change in Estimate135,000Problem 2-5Pepper CompanyPro Forma Balance SheetGiving Effect to Proposed Issue of Common Stock and Note Payable forAll of the Common Stock of Salt Company under Purchase AccountingDecember 31,2010AuditedPro FormaBalance SheetAdjustmentsBalance SheetCash$180,000405,000$585,000Receivables230,000(60,000)287,000117,000Inventories231,400134,000365,400Plant Assets1,236,500905,000(1)2,141,500Goodwill_________181,500181,500Total Assets$1,877,900$3,560,400Accounts Payable$255,900(60,000)$375,900180,000Notes Payable, 8%0300,000300,000Mortgage Payable180,000152,500332,500Common Stock, $20 par900,000600,0001,500,000Additional Paid-in Capital270,000510,000(2)780,000Retained Earnings272,000272,000Total Liabilities and Equity$1,877,900$3,560,400

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2-14Problem 2-5(continued)Change in CashCash from stock issue ($3730,000)$1,110,000Less: Cash paid for acquisition(800,000)Plus: Cash acquired in acquisition95,000Total change in cash$405,000Goodwill:Cost of acquisition$1,100,000Net assets acquired($340,000 +$179,500 +$184,000)703,500Excess cost over net assets acquired$396,500Assigned to plant assets215,000Goodwill$181,500(1)$690,000 + $215,000(2)($37-$20)30,000Problem 2-6Ping CompanyPro Forma Income Statement for the Year2011Assuming a Merger of Ping Company and Spalding CompanySales (1)$6,345,972Cost of goods sold:Fixed Costs (2)$824,706Variable Costs (3)2,464,0953,288,801Gross Margin3,057,171Selling Expenses (4)$785,910Other Expenses (5)319,3101,105,220Net Income$1,951,951$1,951,951–($952,640 + $499,900)== $2,497,0550.20Since $2,497,055is greater than $1,800,000 Ping should buy Spalding.(1) $3,510,100 + $2,365,800 = $5,875,9001.2.9 =$6,345,972(2) ($1,752,360.30) + ($1,423,800.30.70) =$824,706(3) $1,752,360.70=$2,464,095(4) ($632,500 + $292,100).85 =$785,910(5) $172,6001.85 =$319,31020.0411,499$1005103219008755,,$.,,$

Solution Manual For Advanced Accounting, 4th Edition - Page 23 preview image

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2-15Problem 2-7APart AReceivables125,000Inventory195,000Land120,000Plant Assets567,000Patents200,000Deferred Tax Asset ($60,000 x 35%)21,000Goodwill*154,775Current Liabilities89,500Bonds Payable300,000Premium on Bonds Payable60,000Deferred Tax Liability93,275Common Stock (30,000$2)60,000Other Contributed Capital (30,000$26)780,000Cost of acquisition (30,000$28)$840,000Book value of net assets acquired ($120,000 +$164,000 +$267,000)551,000Difference between cost and book value289,000Allocated to:Increase inventory, land, plant assets, and patents to fair value(266,500)Deferred income tax liability (35%$266,500)93,275Increase bonds payable to fair value60,000Deferred income tax asset (35%$60,000)(21,000)Balance assigned to goodwill$154,775Part BIncome Tax Expense (Balancing amount)148,006Deferred Tax Liability ($51,12535%)*17,894Deferred Tax Asset ($6,00035%)2,100Income Tax Payable ($468,00035%)163,800*Inventory:$28,000Plant Assets,10000100,$10,000Patents,8000105,$13,125Total$51,125

Solution Manual For Advanced Accounting, 4th Edition - Page 24 preview image

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3-1CHAPTER 3Note: The letter Aor Bindicated for a question, exercise, or problem means that the question, exercise,or problem relates to a chapter appendix.ANSWERS TO QUESTIONS1.(1)Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in anexchange of stock for stock in a complete takeover.(2)Effective control can be accomplished with more than 50% but less than all of the voting stockof a subsidiary; thus the necessary investment is smaller.(3)An individual affiliate’s legal existence provides a measure of protection of the parent’s assetsfrom attachment by creditors of the subsidiary.2.The purpose of consolidated financial statements is to present, primarily for the benefit of theshareholders and creditors of the parent company, the results of operations and the financial positionof a parent company and its subsidiaries essentially as if the group were a single company with oneor more branches or divisions. The presumption is that these consolidated statements are moremeaningful than separate statements and necessary for fair presentation. Emphasis then is onsubstance rather than legal form, and the legal aspects of the separate entities are therefore ignoredin light of economic aspects.3.Each legal entity must prepare financial statements for use by those who look to the legal entity foranalysis. Creditors of the subsidiary will use the separate statements in assessing the degree ofprotection related to their claims. Noncontrolling shareholders, too, use these individual statementsin determining risk and the amounts available for dividends. Regulatory agencies are concerned withthe net resources and results of operations of the individual legal entities.4.(1)Control should exist in fact, through ownership of more than 50% of the voting stock of thesubsidiary.(2)The intent of control should be permanent. If there are current plans to dispose of a subsidiary,then the entity should not be consolidated.(3)Majority owners must have control. Such would not be the case if the subsidiary were inbankruptcy or legal reorganization, or if the subsidiary were in a foreign country where politicalforces were such that control by majority owners was significantly curtailed.5.Consolidated workpapers are used as a tool to facilitate the preparation of consolidated financialstatements. Adjusting and eliminating entries are entered on the workpaper so that the resultingconsolidated data reflect the operations and financial position of two or more companies undercommon control.6.Noncontrolling interest represents the equity in a partially owned subsidiary by those shareholderswho are not members in the affiliationand should be accounted and presented in equity, separatelyfromtheparents’shareholdersequity.Alternativeviewshaveincluded:presentingthenoncontrolling interest as a liability from the perspective of the controlling shareholders; presentingthe noncontrolling interest between liabilities and shareholders’ equity to acknowledge its hybridstatus; presenting itas a contra-asset so that total assets reflect only the parent’s share; and

Solution Manual For Advanced Accounting, 4th Edition - Page 25 preview image

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3-2presenting it as a component of owners’ equity (the choice approved by FASB in its most recentexposure drafts).7.The fair, or current, value of one or more specific subsidiary assets may exceed its recorded value,or specific liabilities may be overvalued. In either case, an acquiring company might be willing topay more than book value. Also, goodwill might exist in the form of above normal earnings.Finally, the parent may be willing to pay a premium for the right to acquire control and the relatedeconomic advantages gained.8.The determination of the percentage interest acquired, as well as the total equity acquired, is basedon shares outstanding; thus, treasury shares must be excluded. The treasury stock account should beeliminated by offsetting it against subsidiary stockholder equity accounts. The accounts affected aswell as the amounts involved will depend upon whether the cost or par method is used to accountfor the treasury stock.9.None. The full amount of all intercompany receivables and payables is eliminated without regard tothe percentage of control held by the parent.10A. The decision inSFASNo.109andSFAS No. 141R[topics740and 805]is primarily a displayissue and would only affect the calculation of consolidated net income if there were changes inexpected future tax rates that resulted in an adjustment to the balance of deferred tax assets ordeferred tax liabilities. Prior toSFASNo.109andSFAS No. 141R, purchased assets and liabilitieswere displayed at their net of tax amounts and related figures for amortization and depreciationwere based on the net of tax amounts.With the adoption ofSFASNo.109andSFAS No. 141R,assets and liabilities are displayed at fair values and the tax consequences for differences betweentheir assigned values and their tax bases are displayed separately as deferred tax assets or deferredtax liabilities. Although the amounts shown for depreciation, amortization and income tax expenseare different underSFASNo.109andSFAS No. 141R, absent a change in expected future tax rates,the amount of consolidated net income will be the same.ANSWERS TO BUSINESS ETHICS CASEPart 1Even though the suggested changes by the CFO lie within GAAP, the proposed changes willunfairly increase the EPS of the company, misleading the common investorsand other users. It isevident that the CFO is doing it for his or her personal gain rather than for the transparency offinancial reporting. Thus, manipulating the reserve in this case comes under the heading ofunethical behavior. Taking a stand in such a situation is a difficult and challenging test for anemployee who reports to the CFO.Part 2The tax laws permit individuals to minimize taxes bymeans that are within the law like usingtaxdeductions, changing one's tax status throughincorporation, or setting up acharitable trustorfoundation. In the given case the losses reported were phony and the whole scheme was fabricatedto illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme.Although there is no reason to pay more tax than necessary, the lack of risk in these types ofshelters makes participation in such schemes of questionable ethics, at the best.

Solution Manual For Advanced Accounting, 4th Edition - Page 26 preview image

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3-3ANSWERS TO EXERCISESExercise 3-1a.Common Stock–Saltez160,000Other Contributed Capital-Saltez92,000Retained Earnings-Saltez43,000Property,Plant, and Equipment56,000Investment in Saltez351,000b.Common Stock–Saltez190,000Other Contributed Capital–Saltez75,000Property, Plant, and Equipment21,778($232,000/0.9-[$190,000+$75,000-$29,000])Retained Earnings–Saltez29,000Investment in Saltez232,000Noncontrolling Interest25,778c.Common Stock–Saltez180,000Other Contributed Capital–Saltez40,000Retained Earnings–Saltez4,000Investment in Saltez159,000Gain on Purchase of Business–Prancer**13,800Noncontrolling Interest (.2) ($198,750) + $3,450*43,200** The ordinary gain to Prancer is $159,000–(.80)($216,000) = $13,800* Noncontrolling interest reflects the noncontrolling share of implied value (.20 x $198,750, or$39,750), plus the NCI portion of the bargain (.20 x $17,250)NOTE: We know this is a bargain acquisition in part c because the investment cost of $159,000 impliesa total value of $198,750. Since this value is less than the book value of equity of $216,000[$180,000+$40,000-$4,000], the difference is a bargain of $17,250. This bargain is allocated betweenthe parent (this portion is reflected as a gain) and the NCI.Exercise 3-2Part AInvestment in Save(40,000$17.50)700,000Common Stock400,000Other Contributed Capital($700,000–$20,000–$400,000)280,000Cash20,000Part BCommon Stock–Save320,000Other Contributed Capital–Save175,000Retained Earnings–Save205,000Investment in Save700,000

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3-4Exercise 3-3Part AInvestment in Sun Company192,000Cash192,000Part BPRUNCE COMPANY AND SUBSIDIARYConsolidated Balance SheetJanuary 2,2011AssetsCash ($260,000 + $64,000–$192,000)$132,000Accounts Receivable165,000Inventory171,000Plant and Equipment(net)484,000Land ($63,000 + $32,000 + $28,333*)123,333Total Assets$1,075,333Liabilities andStockholders’EquityAccounts Payable$151,000Mortgage Payable111,000Total Liabilities262,000Noncontrolling Interest($192,000/0.90.1)$21,333Common Stock400,000Other Contributed Capital208,000Retained Earnings184,000TotalStockholders’Equity813,333Total Liabilities andStockholders’Equity$1,075,333*[$192,000/0.9–($70,000 + $20,000 +$95,000)] = $28,333Exercise 3-4Part AInvestment in Swartz Company ($601,500)90,000Common Stock ($201,500)30,000Other Contributed Capital ($401,500)60,000Other Contributed Capital1,700Cash1,700Part BComputation and Allocation of DifferenceParentNon-EntireShareControllingValueSharePurchase price and implied value$90,000090,000Less: Book value of equity acquired83,000*083,000Difference between implied and book value7,00007,000Goodwill(7,000)(0)(7,000)Balance-0--0--0-* $40,000 + $24,000 + $19,000 = $83,000

Solution Manual For Advanced Accounting, 4th Edition - Page 28 preview image

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3-5Exercise 3-4 (continued)Part CPeach Company and SubsidiaryConsolidated Balance SheetJanuary 1,2010AssetsCash($73,000 + $13,000-$1,700)$84,300Accounts Receivable114,000Inventory83,000Plant and Equipment138,000Land48,000Goodwill*7,000Total Assets$474,300Liabilities andStockholders’EquityAccounts Payable$84,000Notes Payable103,000Total Liabilities$187,000Common Stock($100,000 + $30,000)$130,000Other Contributed Capital($60,000 + $60,000-$1,700)118,300Retained Earnings39,000TotalStockholders’Equity287,300Total Liabilities andStockholders’Equity$474,300*Cost of investment less fair value acquired equals goodwillor ($90,000–$83,000 = $7,000).Recall that the book value of net assets equals the fair value of net assets in this problem.Exercise 3-5(1)Common Stock–Spruce900,000Other Contributed Capital–Spruce440,000Retained Earnings–Spruce150,000Land[$1,400,000/.90–($900,000 + $440,000 + $150,000-$100,000)]165,556Investment in Spruce Company1,400,000Treasury Stock100,000Noncontrolling Interest ($1,400,000/.90.10)155,556(2)Common Stock–Spruce900,000Other Contributed Capital–Spruce440,000Retained Earnings–Spruce150,000Land10,000Investment in Spruce Company1,160,000Treasury Stock100,000Gain on Purchase of Business-Pool*100,000Noncontrolling Interest[($1,050,000+$990,000+$180,000-$820,000) x .10]140,000* [$1,160,000–($1,050,000+$990,000+$180,000–$820,000) x .90] = $100,000

Solution Manual For Advanced Accounting, 4th Edition - Page 29 preview image

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3-6Exercise 3-6Part A$37,412Noncontrolling Interest=15%Noncontrolling Interest$249,412Implied Value** Implied Value = Parent’s value $212,000 + NCI $37,412= $249,412Common Stock-Shipley90,000Other Contributed Capital-Shipley90,000Retained Earnings-Shipley56,000Land$249,412-$236,00013,412Investment in Shipley Company212,000Noncontrolling Interest37,412Part BSHIPLEY COMPANYBalance SheetDecember 31, 2010Cash$15,900Accounts Receivable22,000Inventory34,600Plant and Equipment147,000Land($220,412-$13,412-$120,000)87,000Total Assets$306,500Accounts Payable$70,500Common Stock90,000Other Contributed Capital90,000Retained Earnings56,000TotalEquities$306,500Exercise 3-7Part A.Long-term receivable from subsidiary $500,000Current assets: interest receivable from subsidiary $50,000Part B.NoneExercise 3-8Investment in Shy Inc.[$2,500,000 + (15,000$40)]3,100,000Cash2,500,000Common Stock30,000Other Contributed Capital($40-$2)15,000570,000

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3-7Exercise 3-9Investment in Shy Inc.[$2,500,000 + (15,000$40)]3,100,000Cash2,500,000Common Stock30,000Other Contributed Capital($40-$2)15,000570,000Acquisition Expense97,000DeferredAcquisitionCharges90,000Acquisition Costs Payable7,000Exercise 3-10ANote: This solution assumes a difference between the basis of acquired assets for accounting and taxpurposes for this stock acquisition.Part AInvestment in Seely Company570,000Common Stock***95,000AdditionalPaid-in-Capital475,000***Note: Depending on the wording of this exercise, the credit may be cash instead of common stockand additional paid-in-capital. If cash is paid, the credit to cash is $570,000.Part BCommon Stock-Seely80,000Other Contributed Capital–Seely132,000Retained Earnings-Seely160,000Difference betweenImpliedand Book Value*228,000Investment in Seely Company570,000NoncontrollingInterest[($570,000/.95) x .05]30,000* [$570,000/.95–($80,000 + $132,000 + $160,000)]Inventory52,000Land25,000Plant Assets71,000Discount on Bonds Payable20,000Goodwill**127,200Deferred Income Tax Liability*67,200Difference between Cost and Book Value228,000*(.40($52,000+ $25,000+ $71,000+ $20,000))**228,000–[($52,000+ $25,000+ $71,000+ $20,000) x 60%]

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3-8Exercise 3-11AInvestment in Starless Company700,000Common Stock50,000Other Contributed Capital(($70–$5)10,000)650,000Becausethe combination is consummated as a stock acquisition, the entry on the books of the acquireris no different than in the absence of deferred taxes. However, in the elimination entries, a deferred taxliability will be recognized and the amount of goodwill will be altered accordingly.

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