CH01SMF

CHAPTER 1
CORPORATE EXPANSION AND ACCOUNTING FOR BUSINESS COMBINATIONS
ANSWERS TO QUESTIONS - PART I
Q1-1 (a) A statutory merger occurs when one company acquires another company
and the assets and liabilities of the acquired company are transferred to the
acquiring company; the acquired company is liquidated, and only the acquiring
company remains.
(b) A statutory consolidation occurs when a new company is formed to acquire the
assets and liabilities of two combining companies; the combining companies
dissolve, and the new company is the only surviving entity.
(c) A stock acquisition occurs when one company acquires a majority of the
common stock of another company and the acquired company is not liquidated; both
companies remain as separate but related corporations.
Q1-2 Continuity of ownership requires that voting shareholders of the

combining companies emerge as shareholders of the combined entity. Continuity of
ownership is considered the primary factor in determining whether purchase or
pooling of interests accounting is to be used in recording a business
combination.
Q1-3 Goodwill arises when purchase accounting is used and the fair value of
the compensation given to acquire another company is greater than the fair value
of its identifiable net assets. Goodwill is recorded on the books of the
acquiring company when the net assets of the acquired company are transferred to
the acquiring company and recorded on the acquiring company's books. When the
acquired company is operated as a separate entity, the amount paid by the
purchaser is included in the investment account and goodwill, as such, is not
recorded on the books of either company. In this case, goodwill is only reported
when the investment account of the parent is eliminated in the consolidation
process.
Q1-4 The purchase of a company is viewed in the same way as any other purchase
of assets. The acquired company is owned by the acquiring company only for the
portion of the year subsequent to the combination. Therefore, earnings are
accrued only from the date of purchase forward.
Q1-5 None of the retained earnings of the subsidiary should be carried forward
under purchase treatment. Thus, consolidated retained earnings is limited to the
balance reported by the acquiring company.
Q1-6 Some companies have attempted to establish the corporate name as a symbol
of quality or product availability. An acquiring company may be fearful that
customers will be lost if the company is liquidated. Debt covenants are likely
to require repayment of virtually all existing debt if the acquired company is
liquidated. The cost of issuing new debt may be prohibitive. A parent-subsidiary
relationship may be the only feasible means of proceeding if it is impossible to
acquire 100 percent ownership of an acquired company. When the acquiring company
does not plan to retain all operations of the acquired company, it may be easier
to dispose of the portions not wanted by leaving them in the existing corporate
shell and later disposing of the ownership of the company.
Q1-7 Negative goodwill is said to exist when a purchaser pays less than the
fair value of the identifiable net assets of another company in acquiring its
ownership. This difference normally is treated as a pro rata reduction of all of
the acquired assets other than cash and cash equivalents, trade receivables,
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
inventory, financial instruments that are required by U.S. generally accepted
accounting principles (GAAP) to be carried on the balance sheet at fair value,
assets to be disposed of by sale, and deferred tax assets.
Q1-8 Additional paid-in capital reported following a business combination

recorded as a purchase is the amount previously reported on the acquiring
company's books plus the excess of the fair value over the par or stated value
of any shares issued by the acquiring company in completing the acquisition.
Q1-9 Purchase treatment must be used. A company issuing preferred shares in an

acquisition has not met the requirement for an exchange of voting common shares
and cannot report the business combination as a pooling of interests.
Q1-10 A purchase is treated prospectively. None of the financial statement data

of the acquired company is included along with the financial statement data of
the acquiring company for periods prior to the business combination.
Q1-11 When purchase treatment is used, all costs incurred in purchasing the
ownership of another company are capitalized. These normally include items such
as finder's fees, the costs of title transfer, and legal fees associated with
the purchase.
Q1-12 When the acquiring company issues shares of stock to complete a business
combination recorded as a purchase, the excess of the fair value of the stock
issued over its par value is recorded as additional paid-in capital. All costs
incurred by the acquiring company in issuing the securities should be treated as
a reduction in the additional paid-in capital. Items such as audit fees
associated with the registration of securities, listing fees, and brokers'
commissions should be treated as reductions of additional paid-in capital when
stock is issued. An adjustment to bond premium or bond discount is needed when
bonds are used to complete the purchase.
McGraw-Hill/Irwin
ANSWERS TO QUESTIONS - PART II
Q1-13 Under purchase treatment, the assets and liabilities of the acquired
company are recorded at their fair values and goodwill commonly is recognized.
The assets and liabilities of the acquired company are carried forward at their
book values under pooling treatment and the retained earnings of the acquired
company normally is carried forward.
Q1-14 In concept, there is no change in ownership when pooling treatment is

applied and therefore the retained earnings of the individual companies should
be combined when the ownership is combined.
Q1-15 If a business combination is treated as a pooling, the earnings of both

the acquiring company and the acquired company for the entire year would be
included in the income of the combined company for the year. Earnings for the
full year are combined because the companies are viewed as always having been
combined.
Q1-16 When pooling of interests treatment is used, consolidated retained

earnings cannot exceed the sum of the retained earnings balances of the separate
companies immediately before the combination.
Q1-17 The additional paid-in capital in a pooling of interests is equal to the

additional paid-in capital of the issuing company together with that of the
other combining company, with the total adjusted for change in the total par or
stated value of the stock outstanding. The adjustment to additional paid-in
capital depends on whether the total par or stated value of shares held by the
stockholders of the acquired company increases or decreases as a result of the
exchange of shares. When the total par or stated value of the shares issued by
the issuing company at the time of the business combination is less than the par
or stated value of the shares acquired, the amount reported as additional paid-
in capital increases by the difference. When the total par or stated value
increases, additional paid-in capital decreases.
Q1-18 Pooling is treated retroactively and prior financial statements of the

companies are combined and reported as if the companies had always been together.
Q1-19 None of the costs are capitalized. In a pooling, there is no change of

ownership and therefore all costs incurred must be charged to expense in the
period they are incurred.
Q1-20 All costs associated with issuing common shares in a pooling should be
treated as an expense in the period the costs are incurred. As a result, there
should be no adjustment to additional paid-in capital for such costs.
McGraw-Hill/Irwin
SOLUTIONS TO CASES
C1-1 Reporting Alternatives and International Harmonization
a. In the past, when goodwill was capitalized, U.S. companies were required to
systematically amortize the amount recorded, thereby reducing earnings, while
companies in other countries were not required to do so. Recent changes in
accounting for goodwill have substantially eliminated this objection.
b. In most business combinations, one company targets another company for

acquisition. The fact that stock rather than cash or some other type of
consideration is used to effect the combination does not change the basic nature
of the acquisition. The substance of nearly all business combinations is that
one company purchases another, and, accordingly, purchase accounting should be
used for nearly all combinations. Pooling might be reserved, as it is in some
countries, for those rare instances in which no one company in a business
combination can be identified as the acquirer.
c. U. S. companies must be concerned about accounting standards in other

countries and about international standards (i.e., those issued by the
International Accounting Standards Committee). Companies operate in a global
economy today; not only do they buy and sell products and services in other
countries, but they may raise capital and have operations located in other
countries. Such companies may have to meet foreign reporting requirements, and
these requirements may differ from U. S. reporting standards. Thus, many U. S.
companies, and not just the largest, may find foreign and international
reporting standards relevant if they are going to operate globally.
McGraw-Hill/Irwin
C1-2 Goodwill and the Effects of Purchase versus Pooling of Interests
Treatment
a. The nature of goodwill is not completely clear and is the subject of some
disagreement. In general, goodwill is viewed as the collection of all those
factors that allow a company to earn an excess return; that is, all those hard-
to-identify intangible qualities that permit a firm to earn a return in excess
of a normal return. Goodwill is identified with the firm as a whole and
generally is considered as being not separable from the firm. Goodwill
presumably arises from bringing together a particular set of resources that
produces higher earnings than could the individual resources or other similar
collections of resources. Factors contributing to excess earnings often are
considered to include superior management, outstanding reputation, prime
location, special economies, and many other factors. Some would argue that, if
these factors can be identified, they each should be treated separately rather
than being lumped together in a single "catch-all" account called goodwill.
The primary characteristics of an asset are that it represents (1) probable

future benefits (2) controlled by a particular entity (3) resulting from past
transactions or events. If one company purchases another company and is willing
to pay more for that company than the fair value of its net identifiable assets,
this implies the existence of some set of factors, generally called goodwill,
that is expected to contribute future benefits to the combined company in the
form of higher earnings. Thus, the first characteristic of an asset would seem
to be present in goodwill. If these factors arose as a result of past
transactions or events, the third characteristic is present. Whether a
particular entity can control the factors leading to excess earnings is a matter
of some debate, especially when it may be difficult to identify the factors.
Nevertheless, at least some portion of those factors generally is viewed as
being under at least partial control of the particular entity. Current
accounting practice assumes all three elements are present and treats goodwill
as an asset. Because of a lack of objectivity leading to measurement problems,
goodwill may not be recognized in all situations where it is thought to exist.
In particular, "self-developed" goodwill is not recognized.
Goodwill is recorded only when one or more identifiable assets are acquired in a
purchase-type transaction, usually in a business combination. As with other
assets, goodwill is recorded at its historical cost to the acquiring company at
the time it is purchased. Its historical cost to the acquiring company in a
business combination is computed as the excess of the total purchase price paid
(for the stock or net assets of the acquired company) over the fair value of the
net identifiable assets acquired.
b. The FASB recently changed accounting for goodwill. Under the new standard,
goodwill will not be amortized in any circumstance. The carrying amount of goodwill
is reduced only if it is found to be impaired or was associated with assets to be
sold or otherwise disposed of.
McGraw-Hill/Irwin
c. C1-2 (continued)
c. On a balance sheet prepared subsequent to a business combination treated as

a pooling, the assets and liabilities of the acquired company will be reported
based on book values prior to the combination. Subsequent to a purchase-type
combination the assets and liabilities of the acquired company are reported
based on their fair values at the date of combination. Some contra accounts,
such as accumulated depreciation, will be carried forward under pooling
treatment but are not carried forward under purchase treatment. Further, stock
issued by the acquiring company in the combination is recorded based on the book
value of the net assets or stock acquired in a pooling. The fair value of the
stock issued is used in a purchase. Finally, the retained earnings balance of a
company acquired in a pooling normally is carried over, in whole or in part, to
become part of the retained earnings of the combined company, while such is not
the case in a purchase-type combination.
On an income statement prepared for the combined company subsequent to a

combination, depreciation, amortization, and some other expense items often are
higher under purchase treatment than under pooling. This occurs because the fair
values of the assets recorded in a purchase-type combination often are higher
than the book values recorded in a pooling. Because of the higher asset values
in a purchase-type combination, any depreciation or amortization based on these
amounts subsequent to the combination also will be higher. Similarly, some
liabilities may have fair values lower than their book values, and any resulting
amortization of discount or premium would result in higher expenses under
purchase accounting than under the pooling approach. In addition, the income
statement prepared at the end of the year in which the combination takes place
will include the revenues and expenses for both combining companies for the
entire year if the combination is treated as a pooling; if the combination is
treated as a purchase, the income statement will include the acquiring company's
revenues and expenses for the entire year, but those of the acquired company
only from the date of combination.
d. Pooling is likely to result in higher income being reported by the combined

company in the year of the combination for the reasons given in part c.
McGraw-Hill/Irwin
C1-3 Differences between Purchase and Pooling of Interests
[AICPA Adapted]
a. (1) In a pooling of interests, the recorded amounts of the assets and

liabilities of the separate companies generally become the recorded amounts of
the assets and liabilities of the combined corporation. The existing basis of
accounting continues. A pooling of interests transaction is regarded as an
arrangement among stockholder groups, with the ownership of all groups
continuing. Because ownership remains substantially the same, the combination is
not viewed as an event significant enough to require a change in the basis of
accounting.
(2) In a pooling of interests, the registration fees and direct costs related
to effecting the business combination should be deducted in determining the net
income of the resulting combined corporation for the period in which the
expenses are incurred.
(3) In a pooling of interests, the results of operations for the year in which
the business combination occurred should be reported as though the companies had
been combined as of the beginning of the year.
b. (1) In a purchase, the acquiring corporation should allocate the cost of the
acquired company to the assets acquired and liabilities assumed. All
identifiable assets acquired and liabilities assumed in the business combination
should be recorded at their fair values at date of acquisition. The excess of
the cost of the acquired company over the sum of the amounts assigned to
identifiable assets acquired less liabilities assumed should be recorded as
goodwill. A purchase transaction is regarded as a bargained transaction (i.e., a
significant economic event that results from bargaining between independent
parties); such an event normally establishes a new basis of accounting.
(2) In a purchase, the registration fees related to securities issued in

effecting the business combination are a reduction of the otherwise determinable
fair value of the securities, usually treated as a reduction of paid-in capital.
The direct costs related to effecting the business combination are included as
part of the acquisition cost of the acquired company.
(3) In a purchase, the results of operations for the year in which the business
combination occurred should include income of the acquired company after the
date of acquisition by including the revenues and expenses of the acquired
company based on the cost to the acquiring corporation.
McGraw-Hill/Irwin
(4) C1-4 Business Combinations
It is very difficult to develop a single explanation for any series of events.

Merger activity in the United States is impacted by events both within our
economy and those around the world. As a result, there are many potential
answers to the questions posed in this case.
a. The most commonly discussed factors associated with the merger activity of
the nineties relate to the increased profitability of businesses. In the past,
increases in profitability typically have been associated with increases in
sales. The increased profitability of companies in the past decade, however,
more commonly has been associated with decreased costs. Even though sales
remained relatively flat, profits increased. Nearly all business entities appear
to have gone through one or more downsizing events during the past decade. Fewer
employees now are delivering the same amount of product to customers. Lower
inventory levels and reduced investment in production facilities now are needed
due to changes in production processes and delivery schedules. Thus, less
investment in facilities and fewer employees have resulted in greater profits.
Companies generally have been reluctant to distribute the increased profits to

shareholders through dividends. The result has been a number of companies with
substantially increased cash reserves. This, in turn, has led management to look
about for other investment alternatives, and cash buyouts have become more
frequent in this environment.
In addition to high levels of cash on hand providing an incentive for business

combinations, easy financing through debt and equity also provided encouragement
for acquisitions. Throughout the nineties, interest rates were very low and
borrowing was generally easy. With the enormous stock-price gains of the mid-
nineties, companies found that they had a very valuable resource in shares of
their stock. Thus, stock acquisitions again came into favor.
McGraw-Hill/Irwin
C1-4 (continued)
b. Establishing incentives for corporate mergers is a controversial issue. Many

people in our society view mergers as not being in the best interests of society
because they are seen as lessening competition and often result in many people
losing their jobs. On the other hand, many mergers result in companies that are
more efficient and can compete better in a global economy; this in turn may
result in more jobs and lower prices. Even if corporate mergers are viewed
favorably, however, the question arises as to whether the government, and
ultimately the taxpayers, should be subsidizing those mergers through tax
incentives. Many would argue that the desirability of individual corporate
mergers, along with other types of investment opportunities, should be
determined on the basis of the merits of the individual situations rather than
through tax incentives.
Perhaps the most obvious incentive is to lower capital gains tax rates.
Businesses may be more likely to invest in other companies if they can sell
their ownership interests when it is convenient and pay lesser tax rates.
Another alternative would include exempting certain types of intercorporate
income. Favorable tax status might be given to investment in foreign companies
through changes in tax treaties. As an alternative, barriers might be raised to
discourage foreign investment in United States thereby increasing the
opportunities for domestic firms to acquire ownership of other companies.
c. In an ideal environment, the accounting and reporting for economic events

would be accurate and timely and would not influence the economic decisions
being reported. Any change in reporting requirements that would increase or
decrease management's ability to "manage" earnings could impact management's
willingness to enter new or risky business fields and affect the level of
business combinations. Greater flexibility in determining which subsidiaries are
to be consolidated, the way in which intercorporate income is calculated, the
elimination of profits on intercompany transfers, or the process used in
calculating earnings per share could impact such decisions. The processes used
in translating foreign investment into United States dollars also may impact
management's willingness to invest in domestic versus international alternatives.
d. One factor that may have prompted the greater use of stock in business
combinations recently is that many of the earlier combinations that had been
effected through the use of debt had unraveled. In many cases, the debt burden
was so heavy that the combined companies could not meet debt payments. Thus,
this approach to financing mergers had somewhat fallen from favor by the mid-
nineties. Further, with the spectacular rise in the stock market after 1994,
many companies found that their stock was worth much more than previously.
Accordingly, fewer shares were needed to acquire other companies.
McGraw-Hill/Irwin
C1-5 Reasons for Business Combinations
a. The answers to this part will depend on the particular companies chosen by
the students. Much of the information for this part of the case can be obtained
from 10-K and 8-K filings with the Securities and Exchange Commission, found
through the EDGAR (Electronic Data Gathering, Analysis, and Retrieval system)
database on the Internet (www.sec.gov). Several major combinations that have
occurred in the recent past include McDonnell Douglas and Boeing
(aerospace/defense), NationsBank and Bank of America (banking), and SBC
Communications and Ameritech (telecommunications). The combination of McDonnell
Douglas and Boeing was a merger and was accounted for as a pooling of interests.
Boeing exchanged 1.3 shares of its common stock for each share of McDonnell
Douglas common stock outstanding. When NationsBank merged with BankAmerica in
1998, it exchanged 1.1316 shares of its common stock for each share of
BankAmerica common stock outstanding. The combination was accounted for as a
pooling of interests. In the 1999 combination of SBC Communications and
Ameritech, which involved an exchange of 1.316 shares of SBC common stock for
each share of Ameritech common stock, Ameritech was merged with a subsidiary of
SBC and became a wholly owned subsidiary of SBC. The combination was treated as
a pooling of interests.
b. In the defense industry, the end of the cold war and subsequent reductions
in defense spending have had a considerable effect on companies. The number of
major defense contractors has shrunk significantly, with only a few large
companies remaining in the industry, along with a number of smaller companies.
With the reduction in defense spending leaving too few major contracts to
support a number of large companies, large defense contractors were forced to
merge to remain strong. In banking and financial services, important factors
leading to increased merger activity include deregulation and the globalization
of capital flows. Many of the previous restrictions on banks relating to branch
banking, interstate banking, and the types of services banks can offer have been
eliminated. As a result, many banks are expanding and moving into types of
financial services they had not previously provided, such as security brokerage
and mutual funds. In the field of telecommunications, technology has been the
primary factor resulting in change, although deregulation also has had an
impact. Many companies are merging so they can move into new geographic areas
and can provide a full range of communication services, including local and
long-distance phone service, cellular phone service, cable and satellite
television service, and internet connections.
c. Companies in the defense industry are less likely to be involved in major

combinations in the future because most of the large companies have already
merged. Any further consolidation of the industry might be viewed as
anticompetitive by the government. In banking and financial services, future
mergers are virtually certain because of the large number of banks still
attempting to move into different financial services and geographic areas, and
brokerage firms attempting to increase geographic coverage and expand available
capital. In telecommunications, the rapid pace of technological change and the
changing regulatory situation will certainly lead to future business
combinations.
McGraw-Hill/Irwin
C1-6 Planning for Acquisitions: Cisco Systems and Quaker Oats
The answers to this case can be obtained from the homepages for Cisco Systems
(www.cisco.com) and Quaker Oats (www.quakeroats.com) and from the annual filings
of the companies (Form 10-K) with the Securities and Exchange Commission, found
through the EDGAR (Electronic Data Gathering, Analysis, and Retrieval system)
database on the Internet (www.sec.gov). Numerous articles also can be found
detailing the acquisitions of both Cisco Systems and Quaker Oats, especially
Quaker Oats' history with Snapple; many of these articles are available on the
Internet and on the Lexis/Nexis database, or other electronic databases.
a. Cisco Systems is in the business of providing networking solutions for its

customers, especially with respect to the Internet. It provides a wide range of
leading edge, high technology products and services relating to all aspects of
information network connections.
b. The Quaker Oats Company’s goal, as stated on its homepage, is “to be the
undisputed leader in the food and beverage industry.” While previously Quaker
Oats indicated a focus on the beverage and grain-based food arenas, it now
appears to view the entire field of packaged foods as its area of operations.
c. Cisco Systems describes recent business acquisitions on its homepage and

provides detail about how each fits into its core business. In addition, the
company's Form 10-K describes how its acquisitions, investments, and alliances
have contributed to its range of products and how these fit within its business
plan. It also provides a detailed description of its methodical approach to
satisfying its need for new or enhanced products and solutions.
d. Quaker Oats' overall business seems less well defined than that of Cisco
Systems. In addition, no specific discussion of Quaker Oats’ approach to
investments and acquisitions can be found that justifies them in terms of the
company's overall mission, although individual acquisitions have been justified
to the press (e.g., The acquisition of Snapple was to help make the company the
leading provider of healthful beverages). In addition, a summary of Quaker Oats'
acquisitions and divestitures indicates a pattern of buying and later selling
(e.g., Brookstone Company, Fisher-Price) that seems to lack coherence.
e. Cisco Systems has fared very well over the past few years. Cisco indicates
that it is number one or two in every market segment that it serves. Its revenues
have grown from $69 million in 1990 to $6.4 billion in 1997 to $18.9 billion in
2000, although revenue growth fell off somewhat with the economic slowdown in
2001. Many of Cisco's current products have come from its business acquisitions.
On the other hand, the acquisition of Snapple by Quaker Oats was not at all
successful. Snapple encountered large losses after its acquisition by Quaker
Oats, and Quaker Oats was never able to find a strategy for stemming the losses.
Finally in 1997, Quaker Oats sold the $1.7 billion dollar acquisition for $300
million to Triarc Companies (owner of Mistic and Royal Crown soft drinks). In
2001, Quaker Oats entered into a merger agreement with Pepsico.
C1-7 Companies Built through Business Combinations: MCI WorldCom and

Citigroup
McGraw-Hill/Irwin
a. MCI WorldCom Inc. is one of the largest communications companies in the
world and one of the largest providers of Internet access and services.
Citigroup is a financial services holding company; through its subsidiaries, it
provides a broad range of financial services to consumer and corporate customers
in 101 countries and territories.
b.,c. Sanford Weill and John Reed were, until recently, both Chairmen and Co-
Chief Executive Officers of Citigroup; John Reed left Citigroup in 2000. This
unusual management arrangement came about as a result of the 1998 merger of
Traveler’s Group Inc. and Citicorp. At the time of the merger, John Reed headed
Citigroup. Sanford Weill was Chairman of Travelers, having put it together in
its form at the time it merged with Citigroup. In 1986, Weill acquired the
consumer-credit division (Commercial Credit) of Control Data Corporation. In
1986, he also acquired Primerica Corp., parent company of brokerage firm Smith
Barney, and combined it with Commercial Credit under the Primerica name. The
company also acquired A.L. Williams insurance company and purchased Drexel
Burnham Lambert's retail brokerage offices. In 1992, the company acquired a 27
percent share of Travelers Insurance. In 1993, the company acquired Shearson
brokerage group from American Express and later purchased the remaining 73
percent of Travelers; the combined company was renamed Travelers Group. In 1996,
the company purchased Aetna's property and casualty insurance business, and, in
1997, the company acquired Salomon Inc. Both stock and cash have been used in
the various acquisitions. The acquisition of Travelers in two stages was
accounted for as a purchase, and the acquisition of Salomon, which was effected
with an exchange of stock, was accounted for as a pooling of interests. The
merger of Travelers and Citicorp was accounted for as a pooling of interests.
Bernard Ebbers is the Chief Executive Officer of MCI WorldCom. In 1983, he and
three friends bought a small phone company which they named LDDS (Long Distance
Discount Services); he became CEO of the company in 1985 and has guided its
growth strategy ever since. In 1989, LDDS combined with Advantage Co., keeping
the LDDS name, to provide long-distance service to 11 Southern and Midwestern
states. LDDS merged with Advanced Telecommunications Corporation in 1992 in an
exchange of stock accounted for as a pooling of interests. In 1993, LDDS merged
with Metromedia Communications Corporation and Resurgens Communications Group,
with the combined company maintaining the LDDS name and LDDS treated as the
surviving company for accounting purposes (although legally Resurgens was the
surviving company). In 1994, the company merged with IDB Communications Group in
an exchange of stock accounted for as a pooling. In 1995, LDDS purchased for
cash the network services operations of Williams Telecommunications Group.
Later in 1995, the company changed its name to WorldCom, Inc. In 1996, WorldCom
acquired the large Internet services provider UUNET by merging with its parent
company, MFS Communications Company, in an exchange of stock. In 1997, WorldCom
purchased the Internet and networking divisions of America Online and CompuServe
in a three-way stock and asset swap. In 1998, the Company acquired MCI
Communications Corporation for approximately $40 billion, and subsequently the
name of the company was changed to MCI WorldCom. This merger was accounted for
as a purchase. In 1998, the Company also acquired CompuServe for 56 million MCI
WorldCom common shares in a business combination accounted for as a purchase. In
1999, MCI WorldCom acquired SkyTel for 23 million MCI WorldCom common shares in
a pooling of interests.
C1-8 Assignment of the Difference between Cost and Book Value
a. Negative goodwill arose from Centrex’s Home Building subsidiary’s 1997

combination transaction with Vista Properties. Centrix has been amortizing the
negative goodwill as a reduction of costs and expenses over a seven-year period.
McGraw-Hill/Irwin
b. Compaq Computer, Analog Devices, and Mylan Laboratories write off to expense
the amounts paid for in-process research and development in the periods they
purchase other companies and assign part of the purchase price to the in-process
research and development results of those companies. Although these in-process
research and development results have considerable value to the purchasing
companies, given the large dollar amounts assigned to them, the costs are not
capitalized as assets. The justification for expensing these costs immediately
is that FASB Statement No. 2 requires research and development expenditures be
expensed as incurred, although it does not specifically address the issue of the
in-process research and development costs of companies purchased in a business
combination. The FASB will undertake a comprehensive review of the treatment of
research and development costs in the near future.
McGraw-Hill/Irwin
SOLUTIONS TO EXERCISES -- PART I
E1-1 Multiple-Choice Questions on Recording Business Combinations

[AICPA Adapted]
1. a
2. c
3. d
4. d
5. d
6. b
E1-2 Multiple-Choice Questions on Reported Balances [AICPA Adapted]
1. d
2. d
3. c
4. c
5. d
E1-3 Stock Acquisition
Journal entry to record the purchase of Tippy Inc., shares:
Investment in Tippy Inc., Common Stock 986,000

Common Stock 425,000
Additional Paid-In Capital 561,000
$986,000 = $58 x 17,000 shares
$425,000 = $25 x 17,000 shares
$561,000 = ($58 - $25) x 17,000 shares
McGraw-Hill/Irwin
E1-4 Balances Reported under Purchase Treatment
a. Stock Outstanding: $200,000 + ($10 x 8,000 shares) $280,000
b. Cash and Receivables: $150,000 + $40,000 190,000
c. Land: $100,000 + $85,000 185,000
d. Buildings and Equipment (net): $300,000 + $230,000 530,000
e. Goodwill: ($50 x 8,000) - $355,000 45,000
f. Additional Paid-In Capital:

$20,000 + [($50 - $10) x 8,000] 340,000
g. Retained Earnings: 330,000
E1-5 Goodwill Recognition
Journal entry to record acquisition of Spur Corporation net assets:
Cash and Receivables 40,000

Inventory 150,000
Land 30,000
Plant and Equipment 350,000
Patent 130,000
Goodwill 55,000
Accounts Payable 85,000
Cash 670,000
McGraw-Hill/Irwin
E1-6 Negative Goodwill
Journal entry to record acquisition of Sorden Company net assets:
Cash and Receivables 50,000

Inventory 200,000
Land 91,000
Discount on Bonds Payable 16,000
Bonds Payable 580,000
Computation of negative goodwill
Purchase price $564,000

Fair value of assets acquired $650,000
Fair value of liabilities assumed (50,000)
Fair value of net assets acquired 600,000
Negative goodwill $ 36,000
Assignment of negative goodwill to noncurrent assets
Reduction for Assigned

Asset Fair Value Negative Goodwill* Valuation
Land $100,000 $36,000 x (100/400) $ 91,000
Plant and Equipment 300,000 $36,000 x (300/400) 273,000
$400,000 $364,000
*Based on relative fair values.
McGraw-Hill/Irwin
E1-7 Computation of Fair Value
Amount paid $517,000

Book value of assets $624,000
Book value of liabilities (356,000)
Book value of net assets $268,000
Adjustment for research and development costs (40,000)
Adjusted book value $228,000
Fair value of patent rights 120,000
Goodwill recorded 93,000 441,000
Fair value increment of buildings and
equipment $ 76,000
Book value of buildings and equipment 341,000
Fair value of buildings and equipment $417,000
E1-8 Computation of Shares Issued and Goodwill
a. 15,600 shares were issued, computed as follows:
Par value of shares outstanding following merger $327,600

Paid-in capital following merger 650,800
Total par value and paid-in capital $978,400
Par value of shares outstanding before merger $218,400
Paid-in capital before merger 370,000 (588,400)
Increase in par value and paid-in capital $390,000
Divide by price per share  $25
Number of shares issued 15,600
b. The par value is $7, computed as follows:
Increase in par value of shares outstanding

($327,600 - $218,400) $109,200
Divide by number of shares issued  15,600
Par value $ 7.00
c. Goodwill of $34,000 was recorded, computed as follows:
Increase in par value and paid-in capital $390,000

Fair value of net assets ($476,000 - $120,000) (356,000)
Goodwill $ 34,000
McGraw-Hill/Irwin
E1-9 Combined Balance Sheet under Purchase Treatment
a. Purchase balance sheet based on $60 market price:
Adam Corporation and Best Company

Combined Balance Sheet
January 1, 20X2
Cash and Receivables $ 240,000 Accounts Payable $ 125,000

Inventory 460,000 Notes Payable 235,000
Buildings and Equipment 840,000 Common Stock 244,000
Less: Accumulated Additional Paid-In
Depreciation (250,000) Capital 556,000
Goodwill 75,000 Retained Earnings 205,000
$1,365,000 $1,365,000
Computation of goodwill
Total purchase price ($60 x 8,000 shares) $480,000

Fair value of net identifiable assets
($490,000 - $85,000) (405,000)
Goodwill $ 75,000
b. Purchase balance sheet based on $48 market price:

January 1, 20X2

Retained Earnings 205,000
$1,269,000 $1,269,000
Fair value of buildings and equipment $240,000

Fair value of total assets acquired $490,000
Less: Fair value of liabilities assumed (85,000)
Fair value of net assets acquired $405,000
Value of shares issued in acquisition (384,000)
Negative goodwill assigned against
noncurrent assets (21,000)
Valuation of Best's noncurrent assets
included in balance sheet $219,000
McGraw-Hill/Irwin
E1-10 Recording a Business Combination
a. Deferred Merger Costs 54,000

Deferred Stock Issue Costs 29,000
Cash 83,000
Cash 70,000
Accounts Receivable 110,000
Inventory 200,000
Land 100,000
Buildings and Equipment 350,000
Goodwill (1) 84,000
Bond Premium 5,000
Additional Paid-In Capital (2) 211,000
Deferred Merger Costs 54,000
(1) Computation of goodwill:
Market value of shares issued

($14 x 40,000) $560,000
Merger costs 54,000
Fair value of net assets acquired (530,000)
Goodwill $ 84,000
(2) Computation of additional paid-in capital:
Market value of shares issued

($14 x 40,000) $560,000
Par value of shares issued ($8 x 40,000) (320,000)
Additional paid-in capital
from issuing shares $240,000
Stock issue costs (29,000)
Additional paid-in capital recorded $211,000
McGraw-Hill/Irwin
E1-10 (continued)
b. Deferred Merger Costs 54,000

Cash 83,000
Cash 70,000
Inventory 200,000
Land (3) 83,111
Buildings and Equipment (3) 290,889
Bond Premium 5,000
Preferred Stock ($10 x 8,000) 80,000
(3) Computation of negative goodwill:
Market value of shares issued ($50 x 8,000) $400,000

Merger costs 54,000
Negative goodwill $ 76,000
Assignment of negative goodwill:

Item Fair Value Negative Goodwill Valuation
Land $100,000 $76,000 x (100/450) $ 83,111
Buildings and Equip. 350,000 $76,000 x (350/450) 290,889
$450,000 $374,000
(4) Market value of shares issued

($50 x 8,000) $400,000
Par value of shares issued ($10 x 8,000) (80,000)
Additional paid-in capital
from issuing shares $320,000
Stock issue costs (29,000)
Additional paid-in capital recorded $291,000
McGraw-Hill/Irwin
E1-11 Reporting Income
20X2: Net income = $6,028,000 [$2,500,000 + $3,528,000]

Earnings per share = $5.48 [$6,028,000 / (1,000,000 + 100,000)]
20X1: Net income = $4,460,000 [previously reported]

Earnings per share = $4.46 [$4,460,000 / 1,000,000]
SOLUTIONS TO EXERCISES -- PART II
E1-12 Multiple-Choice Questions on Recording Business Combinations

[AICPA Adapted]
1. d
2. c
3. c
4. c
E1-13 Multiple-Choice Questions on Pooling Treatment [AICPA Adapted]
1. b
2. d
3. d
4. a
5. a
6. c
McGraw-Hill/Irwin
E1-14 Stock Acquisition
Journal entry to record the acquisition of Tippy Inc., shares as a

pooling of interests:
Investment in Tippy Inc., Common Stock 850,000

$850,000 = $400,000 + $100,000 + $350,000
$425,000 = $25 x 17,000 shares
$75,000 = $100,000 - ($425,000 - $400,000)
$350,000 = Tippy's retained earnings
E1-15 Stockholders' Equity Amounts under Pooling Treatment
a. 8,000 shares issued:
Journal Entry Combined Stockholders' Equity

Net Assets 250,000 Common Stock $280,000
Common Stock 80,000 Additional Paid-In
Capital 30,000 Retained Earnings 470,000
Retained Earnings 140,000 $800,000
b. 12,000 shares issued:

Additional Paid-In Additional Paid-In
Capital 10,000 Capital 10,000
Common Stock 120,000 Retained Earnings 470,000
Retained Earnings 140,000 $800,000
c. 16,000 shares issued:

Additional Paid-In Retained Earnings 440,000
Capital 20,000 $800,000
McGraw-Hill/Irwin
E1-16 Recording Pooling of Interests
Current Assets 600,000

Plant and Equipment 1,610,000
Current Liabilities 110,000
Long-Term Debt 1,000,000

c. 1,100,000 shares issued:

Common Stock 1,100,000
McGraw-Hill/Irwin
E1-17 Combining Balance Sheets under Pooling Treatment
Regal Company and Sour Corporation

January 1, 20X1

Inventory 300,000 Common Stock
Land 110,000 ($10 Par Value) 380,000
Buildings and Equipment 1,100,000 Additional Paid-In
Less: Accumulated Capital 170,000
Depreciation (400,000) Retained Earnings 640,000
$1,250,000 $1,250,000
E1-18 Combined Balance Sheet under Pooling of Interests Treatment

January 1, 20X2

$1,130,000 $1,130,000
McGraw-Hill/Irwin
E1-19 Recording a Business Combination
Business Combination Expenses 83,000

Cash 83,000
Cash 70,000
Inventory 180,000
Land 100,000
Goodwill 20,000
Accumulated Depreciation 230,000
Bond Premium 10,000
(1) Computation of reduction in additional paid-in capital:
Par value of shares issued by

Blue Corporation ($8 x 40,000) $320,000
Par value of Sparse shares acquired (150,000)
Increase in par value of shares outstanding $170,000
Additional paid-in capital reported by Sparse (60,000)
Reduction in additional paid-in capital
reported by Blue Corporation $110,000
E1-20 Reporting Income
20X2: Net income = $6,720,000 [$2,500,000 + $692,000 + $3,528,000]

20X1: Net income = $5,760,000 [$4,460,000 + $1,300,000]

McGraw-Hill/Irwin
SOLUTIONS TO PROBLEMS - PART I
P1-21 Journal Entries-Purchase Treatment
Journal entries to record acquisition of TKK net assets under purchase

treatment:
(1) Deferred Merger Costs 14,000

Cash 14,000
Record payment of legal fees.
(2) Deferred Stock Issue Costs 28,000

Cash 28,000
Record costs of issuing stock.
(3) Cash and Receivables 28,000

Inventory 122,000
Goodwill 26,000
Notes Payable 63,000
Common Stock 96,000
Record purchase of TKK Corporation.
Values of shares issued ($22 x 24,000) $528,000

Legal fees 14,000
Total purchase price $542,000
Fair value of net assets acquired
($620,000 - $104,000) (516,000)
Goodwill $ 26,000
Computation of additional paid-in capital

Issue price in excess of par value ($22 - $4) x $18
Total $432,000
Less: Deferred stock issue costs (28,000)
Increase in additional paid-in capital $404,000
McGraw-Hill/Irwin
P1-22 Recording Business Combinations

Cash 60,000
Cash and Equivalents 41,000

Inventory 144,000
Land (1) 196,500
Buildings (1) 1,473,750
Equipment (1) 294,750
Short-Term Notes Payable 50,000
Common Stock-$2 Par 800,000
(1) Negative goodwill:

Total purchase price:
Value of stock issued ($4 x 400,000) $1,600,000
Merger costs 38,000
Total purchase price $1,638,000
($41,000 + $73,000 + $144,000
+ $200,000 + $1,500,000 + $300,000
- $35,000 - $50,000 - $500,000) (1,673,000)
Negative goodwill $ (35,000)
Allocation of negative goodwill:

Land $ 200,000 / $2,000,000 = .10
Buildings 1,500,000 / $2,000,000 = .75
Equipment 300,000 / $2,000,000 = .15
$2,000,000 1.00
Land $ 200,000 - ($35,000 x .10) = $ 196,500

Buildings 1,500,000 - ($35,000 x .75) = 1,473,750
Equipment 300,000 - ($35,000 x .15) = 294,750
(2) Additional paid-in capital: $778,000 = $800,000 - $22,000
McGraw-Hill/Irwin
P1-22 (continued)

Cash 60,000

Inventory 144,000
Land 200,000
Buildings 1,500,000
Equipment 300,000
Goodwill (1) 1,965,000
Common Stock-$2 Par 1,800,000
Additional Paid-In Capital (2) 1,778,000
(1) Goodwill:
Total purchase price:
Merger costs 38,000
($41,000 + $73,000 + $144,000 + $200,000
+ $1,500,000 + $300,000 - $35,000
- $50,000 - $500,000) (1,673,000)
Goodwill $1,965,000
(2) Additional paid-in capital:

$1,778,000 = [($4 - $2) x 900,000] - $22,000
McGraw-Hill/Irwin
P1-23 Purchase Treatment with Goodwill
a. Journal entry to record acquisition of Zink Company net assets:
Cash 20,000
Inventory 50,000
Patents 60,000
Goodwill 38,000
Cash 178,000
b. Balance sheet immediately following acquisition:
Anchor Corporation and Zink Company

February 1, 20X3
Cash $ 82,000 Accounts Payable $140,000

Accounts Receivable 175,000 Notes Payable 270,000
Inventory 220,000 Common Stock 200,000
Patents 140,000 Additional Paid-In
Buildings and Equipment 530,000 Capital 160,000
Less: Accumulated Retained Earnings 225,000
Depreciation (190,000)
Goodwill 38,000
$995,000 $995,000
c. Journal entry to record acquisition of Zink Company stock:
Investment in Zink Company Common Stock 178,000

Cash 178,000
McGraw-Hill/Irwin
P1-24 Negative Goodwill
Journal entries to record acquisition of Lark Corporation net assets:

Cash 5,000
Cash 50,000
Inventory 150,000
Buildings and Equipment (net) 240,000
Patent 160,000
Cash 565,000
Computation of negative goodwill

($700,000 - $30,000) (670,000)
Negative goodwill $100,000

Item Fair Value Negative Goodwill Valuation
Buildings and Equipment $300,000 $100,000 x (300/500) $240,000
Patent 200,000 $100,000 x (200/500) 160,000
$500,000 $400,000
McGraw-Hill/Irwin
P1-25 Journal Entries-Purchase Treatment
Journal entries to record acquisition of Light Steel net assets under

purchase treatment:
(1) Deferred Merger Costs 19,000

Cash 19,000
Record finder's fee and transfer costs.
(2) Deferred Stock Issue Costs 9,000

Cash 9,000
Record audit fees and stock registration
fees.
(3) Cash 60,000

Inventory 115,000
Land 70,000
Bond Discount 20,000
Goodwill 114,000
Record purchase-type merger with
Light Steel Company.
Value of shares issued ($50 x 12,000) $600,000

Finder's fee 10,000
Legal fees for asset transfer 9,000
$619,000
Goodwill $114,000
McGraw-Hill/Irwin
P1-26 Purchase at More than Book Value
a. Journal entry to record acquisition of Stafford Industries net assets:
Cash 30,000
Inventory 160,000
Land 30,000
Bond Discount 5,000
Goodwill 125,000
Common Stock 80,000
Ramrod Manufacturing and Stafford Industries

January 1, 20X2
Cash $ 100,000 Accounts Payable $ 60,000

Accounts Receivable 160,000 Bonds Payable $450,000
Inventory 360,000 Less: Discount (5,000) 445,000
Land 80,000 Common Stock 280,000
Buildings and Equipment 950,000 Additional
Less: Accumulated Paid-In Capital 560,000
Depreciation (250,000) Retained Earnings 180,000
Goodwill 125,000
$1,525,000 $1,525,000
P1-27 Business Combination
Journal entry to record acquisition of Toot-Toot Tuba net assets under

purchase treatment:
Cash 300
Inventory 35,000
Other Assets 25,800
Goodwill 86,500
Allowance for Uncollectibles 1,400
Mortgage Payable 50,000
Capital Stock ($10 par) 90,000
Premium on Capital Stock 405,000
P1-28 Combined Balance Sheet under Purchase Treatment
McGraw-Hill/Irwin
a. Purchase balance sheet:
Bilge Pumpworks and Seaworthy Rope Company

January 1, 20X3
Cash and Receivables $110,000 Current Liabilities $100,000

Inventory 142,000 Capital Stock 214,000
Land 115,000 Capital in Excess
Plant and Equipment 540,000 of Par Value 216,000
Goodwill 13,000
$770,000 $770,000
b. (1) Stockholders' equity with 1,100 shares issued
Capital Stock [$200,000 + ($20 x 1,100 shares)] $222,000

Capital in Excess of Par Value
[$20,000 + ($300 - $20) x 1,100 shares] 328,000
$790,000
(2) Stockholders' equity with 1,800 shares issued
Capital Stock [$200,000 + ($20 x 1,800 shares)] $ 236,000

[$20,000 + ($300 - $20) x 1,800 shares] 524,000
$1,000,000
Capital Stock [$200,000 + ($20 x 3,000 shares)] $ 260,000

[$20,000 + ($300 - $20) x 3,000 shares] 860,000
$1,360,000
McGraw-Hill/Irwin
P1-29 Incomplete Data Problem
a. 5,200 = ($126,000 - $100,000)/$5
b. $208,000 = ($126,000 + $247,000) - ($100,000 + $65,000)
c. $46,000 = $96,000 - $50,000
d. $130,000 = ($50,000 + $88,000 + $96,000 + $430,000 - $46,000 -

$220,000 - $6,000) - ($40,000 + $60,000 + $50,000 + $300,000 -
$32,000 - $150,000 - $6,000)
e. $78,000 = $208,000 - $130,000
f. $97,000 (as reported by End Corporation)
g. $13,000 = ($430,000 - $300,000)/10 years
P1-30 Incomplete Data Following Purchase
a. 14,000 = $70,000/$5
b. $8.00 = ($70,000 + $42,000)/14,000
c. 7,000 = ($117,000 - $96,000)/$3
d. $364,000 = ($117,000 + $577,000) - ($96,000 + $234,000)
e. $24,000 = $65,000 + $15,000 - $56,000
f. $110,000 = $320,000 - $210,000
g. $306,000 = ($15,000 + $30,000 + $110,000 + $293,000) -

($22,000 + $120,000)
h. $82,000 = $364,000 + $24,000 - $306,000
McGraw-Hill/Irwin
P1-31 Comprehensive Problem: Purchase Accounting
a. Journal entries on the books of Integrated Industries to record the

combination:
(1) Purchase Treatment:

Cash 135,000

Cash 42,000
Cash 28,000
Inventory 395,000
Long-Term Investments 175,000
Land 100,000
Rolling Stock 63,000
Patents 500,000
Special Licenses 100,000
Discount on Equipment Trust Notes 5,000
Discount on Debentures 50,000
Goodwill 244,700
Allowance for Bad Debts 6,500
Current Payables 137,200
Mortgages Payable 500,000
Premium on Mortgages Payable 20,000
Equipment Trust Notes 100,000
Debentures Payable 1,000,000
Additional Paid-In Capital-Common 2,298,000

Direct merger costs 135,000
Fair value of assets acquired $4,112,500
Fair value of liabilities assumed (1,702,200)
Fair value of net identifiable assets (2,410,300)
Goodwill $ 244,700
McGraw-Hill/Irwin
P1-31 (continued)
b. Journal entries on the books of HCC to record the combination:
Investment in Integrated Industries Stock 2,520,000

Cash 28,000
Inventory 381,000
Land 55,000
Patents 125,000
Gain on Sale of Assets and Liabilities 1,189,900
Record sale of assets and liabilities.
Common Stock 7,500

Additional Paid-In Capital-Common Stock 4,500
Treasury Stock 12,000
Record retirement of Treasury Stock:*
$7,500 = $5 x 1,500 shares
$4,500 = $12,000 - $7,500

Additional Paid-In Capital-Common 495,500
Additional Paid-In Capital-Retirement
of Preferred 22,000
Retained Earnings 1,410,000
Investment in Integrated
Industries Stock 2,520,000
Record retirement of HCC stock and
distribution of Integrated Industries Stock:
$592,500 = $600,000 - $7,500
$495,500 = $500,000 - $4,500
$1,410,000 = $220,100 + $1,189,900
*Alternative approaches exist.
McGraw-Hill/Irwin
SOLUTIONS TO PROBLEMS - PART II
P1-32 Recording Procedures under Pooling of Interests Treatment
a. Journal entry to record acquisition of Brown Company net assets:
Cash 10,000
Inventory 60,000
Land 8,000
Common Stock 40,000
Obscure Advertising and Brown Company

January 1, 20X1
Cash $ 85,000 Accounts Payable $145,000

Accounts Receivable 12,000 Common Stock 90,000
Inventory 130,000 Additional Paid-In
Land 13,000 Capital 2,000
Buildings and Equipment 250,000 Retained Earnings 93,000
Less: Accumulated
$330,000 $330,000
c. Journal entry to record acquisition of Brown Company stock:
Investment in Brown Company Common Stock 45,000

Common Stock 40,000
McGraw-Hill/Irwin
P1-33 Journal Entries-Pooling Treatment
b. Journal entries to record acquisition of TKK net assets under pooling of

interests treatment:
(1) Business Combination Expenses 42,000

Cash 42,000
Record expenses associated with
acquisition of TKK Corporation.
(2) Cash and Receivables 28,000

Inventory 94,000
Common Stock 96,000
Record pooling-type merger with TKK.
McGraw-Hill/Irwin
P1-34 Recording Business Combinations
Merger Expenses 60,000

Cash 60,000

Inventory 144,000
Land 200,000
Buildings 1,520,000
Equipment 638,000
Common Stock-$2 Par 800,000
(1) Additional paid-in capital

$525,000 = $325,000 + (1,000,000 - $800,000)
Merger Expenses 60,000

Cash 60,000

Inventory 144,000
Land 200,000
Buildings 1,520,000
Equipment 638,000
Common Stock-$2 Par 1,800,000
Retained Earnings (2) 50,000
(1) Additional paid-in capital:

Taylor's additional paid-in capital
(2) Retained Earnings:

$50,000 = $275,000 - ($1,800,000 - $1,000,000
- $325,000 - $250,000)
McGraw-Hill/Irwin
P1-35 Journal Entries-Pooling of Interests
Journal entries to record acquisition of Light Steel net assets under pooling
of interests treatment:
(1) Business Combination Expense 28,000

Cash 28,000
Record costs associated with the
acquisition of Light Steel Company.
(2) Cash 60,000

Inventory 60,000
Land 50,000
Record pooling-type merger with Light
Steel Company.
McGraw-Hill/Irwin
P1-36 Pooling Treatment
a. Journal entry to record acquisition of Stafford Industries net assets:
Cash 30,000
Inventory 100,000
Land 40,000
Common Stock 80,000
Ramrod Manufacturing and Stafford Industries

January 1, 20X2
Cash $ 100,000 Accounts Payable $ 60,000

Accounts Receivable 160,000 Bonds Payable 450,000
Inventory 300,000 Common Stock 280,000
Land 90,000 Additional Paid-In
Buildings and Equipment 1,000,000 Capital 80,000
$1,250,000 $1,250,000
McGraw-Hill/Irwin
P1-37 Business Combinations
a. Journal entry to record acquisition of Toot-Toot Tuba net assets under

pooling of interests:
Cash 300
Inventory 35,000
Other Assets 25,800
Allowance for Uncollectibles 1,400
Mortgage Payable 50,000
Computation of retained earnings deficit
Balance of Toot-Toot, as stated $ (71,200)

Write-down of inventory (43,500)
Increase in allowance for uncollectibles (800)
Adjusted retained earnings deficit of Toot-Toot $(115,500)
Note: Solution assumes that the allowance for uncollectible accounts receivable
should be adjusted to the estimated allowance and that inventory should be
reduced under the lower-of-cost-or-market rule whether or not a business
combination occurs.
McGraw-Hill/Irwin
P1-37 (continued)
b. Capital Stock ($10 par) $760,000

Retained Earnings (5,700)
Total $754,300
Computation of retained earnings deficit
Adjusted retained earnings deficit of Toot-Toot $115,500

Par value of Boogie shares issued $260,000
Par value of Toot-Toot shares acquired (100,000)
Increase in par value $160,000
Absorbed by premium on capital stock
of Toot-Toot (150,000)
Absorbed by reduction of premium on
capital stock of Boogie (1,000)
Amount charged to retained earnings 9,000
$124,500
Retained earnings of Boogie (118,800)
Retained earnings deficit of combined entity $ 5,700
c. Investment in Toot-Toot Stock 134,500

McGraw-Hill/Irwin
P1-38 Combined Balance Sheet under Pooling Treatment
a. Pooling of interests balance sheet:
Bilge Pumpworks and Seaworthy Rope Company

January 1, 20X3
Cash and Receivables $110,000 Current Liabilities $100,000

Inventory 130,000 Capital Stock 214,000
Land 110,000 Capital in Excess
Plant and Equipment 600,000 of Par Value 31,000
$720,000 $720,000
b. (1) Stockholders' equity with 1,100 shares issued

($20,000 + $5,000 - $2,000) 23,000
Retained Earnings ($240,000 + $135,000) 375,000
$620,000

($20,000 + $5,000 - $16,000) 9,000
Retained Earnings ($240,000 + $135,000) 375,000
$620,000

Retained Earnings [$240,000 + $135,000 - $15,000] 360,000
$620,000
Par value of shares issued $60,000

Par value of shares previously outstanding (20,000)
Increase in par value $40,000
Reduction of excess over par-Seaworthy (5,000)
$35,000
Reduction of excess over par-Bilge (20,000)
Reduction of retained earnings $15,000
McGraw-Hill/Irwin
P1-39 Comprehensive Problem with Incomplete Data
a. Value of shares issued in acquiring Flash Heating Company:
Increase in par value of shares ($240,000 - $200,000) $ 40,000

Increase in paid-in capital-purchase
($420,000 - $60,000) 360,000
Value of shares issued $400,000
b. Value of net assets held by Flash Heating Company:
Amount of total assets-purchase $1,130,000

Amount of Speedy Plumbers assets (650,000)
$480,000
Amount of total liabilities-purchase $ 220,000
Amount of Speedy Plumbers liabilities (140,000)
(80,000)
Fair value of Flash Heating net assets
plus goodwill $400,000
Less: Goodwill (55,000)
Fair value of Flash Heating net assets $345,000
c. Shares issued by Speedy Plumbers:
Par value of stock following acquisition $240,000

Par value of stock before acquisition (200,000)
Increase in par value $ 40,000
Par value per share  $5
d. Market price of Speedy Plumbers stock:
Value of shares computed in part a $400,000

Number of shares issued computed in part c  8,000
Market price per share $ 50
e. The full retained earnings balance of Flash Heating Company was carried
forward in the pooling case. Additional paid-in capital increased in the
pooling, which means there was no need to capitalize retained earnings.
McGraw-Hill/Irwin
P1-39 (continued)
f. Book value of net assets of Flash Heating Company:
Book value of combined assets-pooling $980,000

Book value of Speedy Plumbers assets (650,000)
$330,000
Book value of combined liabilities-pooling $220,000
Book value of Speedy Plumbers liabilities (140,000)
(80,000)
Book value of Flash Heating net assets $250,000
g. Increase in inventory value of Flash Heating Company:
Inventory valued at fair value-purchase $220,000

Inventory valued at book value-pooling (170,000)
Increase in value of Flash Heating inventory $ 50,000
h. Flash Heating working capital balance before acquisition:
Cash balance ($100,000 - $70,000) $ 30,000

Accounts receivable ($180,000 - $130,000) 50,000
Inventory-pooling ($170,000 - $100,000) 70,000
$150,000
Accounts payable ($60,000 - $40,000) (20,000)
Working capital at time of acquisition $130,000
McGraw-Hill/Irwin
P1-40 Incomplete Data for Purchase and Pooling
a. Inventory reported by Spice at date of combination:
Inventory reported following pooling $170,000

Inventory reported by Roto (100,000)
Inventory reported by Spice $ 70,000
b. Fair value of total assets reported by Spice:
Fair value of cash $ 20,000

Fair value of accounts receivable 55,000
Fair value of inventory 110,000
Buildings and equipment reported following purchase $570,000
Buildings and equipment reported by Roto (350,000) 220,000
Fair value of Spice's total assets $405,000
c. Market value of Spice's bond:
Book value reported by Spice $100,000

Bond premium reported following purchase 5,000
Market value of bond $105,000
d. Shares issued by Roto Corporation:

Par value of stock before acquisition 120,000
Increase in par value of shares outstanding $ 70,000
Divide by par value of per share  $5
e. Market price per share of stock issued by Roto Corporation:

Additional paid-in capital following acquisition 262,000 $452,000
Par value of stock before acquisition $120,000

Additional paid-in capital before acquisition 10,000 (130,000)
Market value of shares issued in acquisition $322,000
Divide by number of shares issued 14,000
Market price per share $ 23.00
f. Goodwill reported by Spice prior to the acquisition:
Goodwill reported using pooling treatment $70,000

Goodwill reported by Roto prior to acquisition (30,000)
Goodwill reported by Spice $40,000
McGraw-Hill/Irwin
P1-40 (continued)
g. Goodwill reported if the business combination is recorded as a purchase:
Market value of shares issued by Roto $322,000

Fair value of Spice's assets $405,000
Fair value of Spice's liabilities:
Accounts payable $ 30,000
Bond payable 105,000
Fair value of liabilities (135,000)
Fair value of Spice's net asset (270,000)
Goodwill recorded in business combination $ 52,000
Goodwill previously on the books of Roto 30,000
Goodwill reported $ 82,000
h. Retained earnings reported by Spice:
Retained earnings reported following pooling $210,000

Retained earnings reported by Roto (120,000)
Retained earnings reported by Spice $ 90,000
Note: Roto was able to carry all of Spice's retained earnings forward. This must
be the case because additional paid-in capital was increased under pooling.
i. Roto's retained earnings of $120,000 would be reported.
McGraw-Hill/Irwin
P1-40 (continued)
j. Additional paid-in capital reported by Spice prior to the combination:
Total reported liabilities and stockholders' equity $325,000

Accounts payable $ 30,000
Bonds payable 100,000
Common stock 50,000
Retained earnings:
Balance reported following pooling $210,000
Balance reported by Roto (120,000)
Balance reported by Spice 90,000
Total equity excluding paid-in capital (270,000)
Additional paid-in capital $ 55,000
Alternate calculation:
Additional paid-in capital following pooling $45,000

Reduction of additional paid-in capital for increase in
par value of shares outstanding:
Par value following acquisition $190,000
Par value reported by Roto before combination (120,000)
Par value of shares issued $ 70,000
Par value of Spice shares acquired (50,000)
Reduction of additional paid-in capital 20,000
Additional paid-in capital reported by Roto
prior to combination (10,000)
Additional paid-in capital reported by Spice $55,000
k. 1. Business Combination Expenses 26,800

Cash 26,800
2. Deferred Merger Costs 17,000

Cash 26,800
3. Goodwill previously computed $82,000

Deferred merger costs added to investment account 17,000
Total goodwill reported $99,000
4. Additional paid-in capital reported following combination $262,000

Deferred stock issue costs (9,800)
Total Additional paid-in capital reported $252,200
5. They would have no effect on the amounts reported as goodwill or additional

paid-in capital if pooling treatment is used. The full amount is charged to
business combination expense, as illustrated in part 1 above.
McGraw-Hill/Irwin
P1-41 Reporting Results of Operations
a. Pooling of interests:
20X1 20X2 20X3
Revenue $1,750,000 $2,000,000 $2,100,000
Net Income 600,000 620,000 700,000
Earnings per Share $4.80a $4.96b $5.60c
a $600,000 / 125,000 shares
b $620,000 / 125,000 shares
c $700,000 / 125,000 shares
Note that in a pooling the companies are viewed as always having been combined;
therefore, the shares issued in the combination are treated as always having been
outstanding.
b. Purchase:
20X1a 20X2 20X3
Revenue $1,400,000 $1,800,000b $2,100,000
Net Income 500,000 545,000c 660,000d
Earnings per Share $5.00 $4.84e $5.28f
a Separate figures for Amalgamated Transport only
b $2,000,000 - $200,000
c $620,000 - $55,000 - $20,000*
d $700,000 - $40,000*
e $545,000 / 112,500 shares**
f $660,000 / 125,000 shares
*Amortization of differential:
Total purchase price ($96 x 25,000 shares) $2,400,000
Net book value (2,000,000)
Differential assigned to equipment $ 200,000
Differential amortized 20X2

($200,000 / 5) x 1/2 year $20,000
Differential amortized 20X3
($200,000 / 5) $40,000
**Weighted average number of shares = (100,000 + 125,000) / 2
McGraw-Hill/Irwin
P1-42 Comprehensive Problem: Pooling of Interests
a. Journal entries on the books of Integrated Industries to record the combination:

Cash 135,000

Cash 42,000
Cash 28,000
Inventory 381,000
Land 55,000
Patents 125,000
Discount on Debentures 40,000
Additional Paid-In Capital-
Retirement of Preferred 22,000
Computation of additional paid-in capital-common
Par value of HCC stock acquired $600,000

Par value of Integrated Industries stock issued 180,000
Difference to combined additional paid-in capital $420,000
less HCC treasury stock retired (12,000)
HCC's additional paid-in capital-common 500,000
Credit to combined additional paid-in capital-common $908,000
McGraw-Hill/Irwin
P1-42 (continued)
b. Journal entries on the books of HCC to record the combination:
Investment in Integrated Industries Stock 1,330,100

Cash 28,000
Inventory 381,000
Land 55,000
Patents 125,000
Record exchange of assets and liabilities
for stock.
Common Stock 7,500

Additional Paid-In Capital-Common Stock 4,500
Treasury Stock 12,000
Record retirement of Treasury Stock.*

Additional Paid-In Capital-Retirement
of Preferred 22,000
Investment in Integrated
Industries Stock 1,330,100
Record retirement of HCC stock and
distribution of Integrated Industries Stock.
*Alternative approaches exist.
McGraw-Hill/Irwin

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CHAPTER 1

CORPORATE EXPANSION AND ACCOUNTING FOR BUSINESS COMBINATIONS

ANSWERS TO QUESTIONS - PART I

Q1-2 Continuity of ownership requires that voting shareholders of the

Q1-8 Additional paid-in capital reported following a business combination

Q1-9 Purchase treatment must be used. A company issuing preferred shares in an

Q1-10 A purchase is treated prospectively. None of the financial statement data

Q1-14 In concept, there is no change in ownership when pooling treatment is

Q1-15 If a business combination is treated as a pooling, the earnings of both

Q1-16 When pooling of interests treatment is used, consolidated retained

Q1-17 The additional paid-in capital in a pooling of interests is equal to the

Q1-18 Pooling is treated retroactively and prior financial statements of the

Q1-19 None of the costs are capitalized. In a pooling, there is no change of

C1-1 Reporting Alternatives and International Harmonization

b. In most business combinations, one company targets another company for

c. U. S. companies must be concerned about accounting standards in other

The primary characteristics of an asset are that it represents (1) probable

c. On a balance sheet prepared subsequent to a business combination treated as

On an income statement prepared for the combined company subsequent to a

d. Pooling is likely to result in higher income being reported by the combined

a. (1) In a pooling of interests, the recorded amounts of the assets and

(2) In a purchase, the registration fees related to securities issued in

It is very difficult to develop a single explanation for any series of events.

Companies generally have been reluctant to distribute the increased profits to

In addition to high levels of cash on hand providing an incentive for business

b. Establishing incentives for corporate mergers is a controversial issue. Many

c. In an ideal environment, the accounting and reporting for economic events

c. Companies in the defense industry are less likely to be involved in major

a. Cisco Systems is in the business of providing networking solutions for its

c. Cisco Systems describes recent business acquisitions on its homepage and

C1-7 Companies Built through Business Combinations: MCI WorldCom and

C1-8 Assignment of the Difference between Cost and Book Value

a. Negative goodwill arose from Centrex’s Home Building subsidiary’s 1997

E1-1 Multiple-Choice Questions on Recording Business Combinations

E1-2 Multiple-Choice Questions on Reported Balances [AICPA Adapted]

E1-3 Stock Acquisition

Journal entry to record the purchase of Tippy Inc., shares:

Investment in Tippy Inc., Common Stock 986,000

a. Stock Outstanding: $200,000 + ($10 x 8,000 shares) $280,000

b. Cash and Receivables: $150,000 + $40,000 190,000

c. Land: $100,000 + $85,000 185,000

d. Buildings and Equipment (net): $300,000 + $230,000 530,000

e. Goodwill: ($50 x 8,000) - $355,000 45,000

f. Additional Paid-In Capital:

g. Retained Earnings: 330,000

E1-5 Goodwill Recognition

Journal entry to record acquisition of Spur Corporation net assets:

Cash and Receivables 40,000

Journal entry to record acquisition of Sorden Company net assets:

Cash and Receivables 50,000

Computation of negative goodwill

Purchase price $564,000

Assignment of negative goodwill to noncurrent assets

Reduction for Assigned

*Based on relative fair values.

Amount paid $517,000

E1-8 Computation of Shares Issued and Goodwill

a. 15,600 shares were issued, computed as follows:

Par value of shares outstanding following merger $327,600

b. The par value is $7, computed as follows:

Increase in par value of shares outstanding

c. Goodwill of $34,000 was recorded, computed as follows:

Increase in par value and paid-in capital $390,000