CHAPTER-1

ACCOUNTING FOR JOINT VENTURE

Definition & Meaning

*A joint venture is often defined as a contractual arrangement involving the cooperative efforts
and the utilization of the resources of two or more ventures to accomplish agreed goals.
Types of Joint venture
1. Jointly controlled entities
* A jointly controlled entity is a joint venture which involves the establishment of
corporation, partnership or other entity (create a separate entity) in which each venture has
an interest.
*The capital contribution on the participating ventures, profit sharing and operating policies of
the venture are governed by the joint venture arrangement.
* The entity has its own organizational structure and its legal form maybe either
corporation, partnership, or any other form of business organization.
*The entity operates in the same way as other entities, except that an arrangement between the
ventures establishes joint control over the activity of the entity.
*An example is when an entity commences a business in a foreign country in conjunction
with a government or other agency in that country, by establishing a separate entity which is
jointly controlled by the entity and the government or agency in the foreign country.
*A jointly controlled entity maintains its own accounting records and prepares and presents
financial statements in the same way as other entities in conformity with the appropriate
accounting standards
Methods of Accounting under Unincorporated Joint venture
Equity method
Proportionate share method
Under equity method verturers will separately record journal for
1. Recording Investment :
Investment in joint venture …….. xxx
Cash xxx

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2.Recording Investment income:
Investment in Joint venture ……. xxx
Investment income xxx
Under Proportionate share method Venturers will separately record journal for:
1. Recording investment:
Investment in joint venture …….. xxx
Cash xxx
2. Recording Investment income:
Investment in Joint venture ……. xxx
Investment income xxx
3. Recording proportionate share of assets, liabilities, expenses, revenue and to cancel investment
and investment income account
Assets ….(Proportionate share) xxx
Cost and expenses ,, xxx
Investment income ,, xxx
Liabilities ,, xxx
Revenue ,, xxx
Investment income xxx
Illustration : 1
A.Co and B.Co. entered in to an unincorporated joint venture, investing $400,000 each on
January 2,2010. Income or loss sharing equally. Details for the year 2010 follows:
Cost and expenses $1,500,000
Current Assets 1,600,000
Other Assets 2,400,000
Revenue 2,000,000
Long debt 1,900,000
Current liabilities 800,000
Prepare: In the record of Joint venture:
1. Income statement for AB co. Joint venture.
2. Statement of ventures capital
3.Balance sheet on Dec. 31, 2010

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4. Journal in the record of A.Co Under equity method
5. Journal in the record of B.co. Under Proportionate share method

Solution:

1. AB co. Joint venture

Income statement for the year ended Dec. 31,2010

Revenue $ 2,000,000
Less: Cost and expenses 1,500,000
Net Income 500,000
Division of Net income :
A.co. $250,000
B.co. 250,000

2. AB co.
Statement of venturer’s capital
For the year ended Dec.31,2010
A.co B.co Combined
Investment beginning $400,000 $400,000 $800,000
Net income 250,000 250,000 500,000
Venturer’s capital end 650,000 650,000 1,300,000

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AB co. Joint venture
Balance sheet
On December 31,2010
Assets Liabilities and Venturer capital
Current assets $1,600,000 Current Liabilities $800,000
Other assets 2,400,000 Long debt 1,900,000
Venturer capital
A.co 650,000
B.co 650,000 1,300,000
4,000,0004,000,000
4. Record of A.co (Equity method Journal)
Jan2. Investment in Joint venture (AB.co) 400,000
Cash 400,000

Dec.31. Investment in Joint venture (AB.co) 250,000

Investment income 250,000
5. Record of B.Co ( Proportionate share method )
Jan2. Investment in Joint venture (AB.co) 400,000
Cash 400,000
Dec.31. Investment in Joint venture (AB.co) 250,000
Investment income 250,000
Dec.31. Current Assets (1/2) 800,000
Other assets (1/2) 1,200,000
Cost and Expense (1/2) 750,000
Investment income 250,000
Current Liabilities (1/2) 400,000
Long debt (1/2) 950,000
Revenue 1,000,000
Investment in Joint venture 650,000

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 2. Jointly Controlled Operation
In this situation no separate entity is formed. Instead, parts of the venturers’ existing
enterprise work on a common project and coordinate their activities. The organizational structure
remains flexible. In some cases joint “project teams” are formed; in others responsibilities
are delegated as and when the need arises
3. Jointly Controlled Assets
Although these are not separate legal entities, the resources contributed by the
participating venturers are combined together for the purpose of a joint venture project
which is managed either by one venturer typically known as operator, or by a joint
management team. The joint venture agreements define the responsibilities and obligations,
of the operator, the interest of the parties etc.
Accounting by Joint Ventures
a) Full Consolidation method;
b)Equity method;
c)Proportionate consolidation method;
d)Expanded equity method
e)Cost method
A. Full Consolidation Method
The full consolidation method which ordinarily referred to as consolidation, is appropriate
under the circumstances where the investor controls the investee. The investee is a legal
entity in which the investment has been made.
B. Equity Method
The equity method is used when the investor has the ability to exercise “significant
influence” over the investee. A “significant influence” is normally presumed to exist when
the investor has 20% or more ownership interest in the investee.
C. Proportionate Consolidation Method
Under the proportionate consolidation method, an investor consolidates in its financial
statements its proportionate share of each asset, liability, revenue, and expense item of
aninvestee.
D. Expanded Equity Method
Under the expanded equity method, an investor presents its proportionate share of the

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assets, liabilities, revenues and expenses of the investee in its consolidated financial
statements, but as separate line items and without combining these amounts directly withits
"own" assets, liabilities, revenue and expenses.
E. Cost Method
Under the cost method, an investor records its investment at cost, and reports the
investment as a single line on its balance sheet. Profits earned by the investee are not
recognized in investor's accounts until such profits are distributed as dividends.

CHAPTER-2
ACCOUNTING FOR SALE AGENCIES AND PRINCIPAL; BRANCHES AND HEAD
OFFICES

Sales Agency and Branches

A technical distinction is commonly made between sales agencies and branches. Abranch office
usually has more autonomy and provides a greater range of services than a sales agency does,
although the degree differs from company to company. Sales agencies are established to display
merchandise and to take customers' orders, but they don't stock merchandise to fill customers'
orders or pass on customer credit. The sales agency is not a separate accountingor business
entity.
Accounting system for a Sales Agency
1. Creation of an agency working capital fund or establishment of imprest fund:
Agency working capital/Agency imprest fund xxx
Cash xxx
(To record transfer of cash to sales agency)
2. Transfer of sample inventory to sales agency:
Sample inventory - agency xxx
Merchandise Inventory (or purchases) xxx
(To transfer display merchandise to sales agency )
3.Replenishment of agency working capital/imprest fund at month or year-end:
Salaries expense xxx
Utilities expense xxx

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Advertising expense xxx
Miscellaneous expense xxx
Cash xxx
( To record expenses incurred by sales agency and replenishment of agency working
capital/imprest fund )
4.Adjustment of agency sample inventory at month or year-end
Advertising expense xxx
Sample inventory - agency xxx
( To adjust agency sample inventory to net realizable value and to charge the write-down to
advertising expense.)
These entries serve to account for agency expense transactions, cash and merchandise in
possession of agency personnel.
The entries identify plant assets of the sales agency (example, Mekelle Sales Agency)
separately. They also show sales, cost of sales (CGS), and expense information on an agency
basis, perpetual inventory system is assumed.

1.Purchase of Mekelle sales agency land and buildings:

Land - Mekelle sales agency xxx
Building - Mekelle sales agency xxx
Cash xxx
( Purchase of facilities for sales agency)
2.Creation of a sales agency working capital fund/establishment of agency imprest fund:

Mekelle sales agency working capital/imprest fund xxx

Cash xxx
(To record transfer of cash to Mekelle sales agency)
3.Transfer of display merchandise to sales agency:
Mekelle sales agency sample inventory xxx
Merchandise inventory xxx
(To record transfer of sample merchandise to sales agency)
4.Payment of salaries to employees of sales agency:
Salaries expense-Mekelle sales agency xxx
Cash xxx

(To record payment of salaries to sales agency employees.)

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5.Sales orders from sales agency are filled and customers are billed:
Accounts receivable xxx
Sales-Mekelle sales agency xxx
(To record credit sales made through Mekelle sales agency)
Cost of sales (CGS)- Mekelle sales agency xxx
Merchandise inventory xxx
(Cost of merchandise delivered to customers of sales agency)
6.Replenishment of agency's working capital fund/imprest fund at year end:
Advertising expense-Mekelle sales agency xxx
Utilities expense-Mekelle sales agency xxx
Other expenses-Mekelle sales agency xxx
Cash xxx
( To record replenishment of sales agency working capital/imprest fund )

7.Depreciation recorded on sales agency buildings:

Depreciation expense-Mekelle sales agency xxx
Accumulated depreciation-Mekelle sales agency xxx
(To record depreciation on sales agency buildings.)

8.Sample merchandise at sales agency adjusted to reflect shopwear:

Advertising expense-Mekelle sales agency xxx
Mekelle sales agency sample inventoryxxx
(To record adjustment of sample inventory to realizable value. )
9.Closing revenue and expense accounts to a separate income summary account:
Sales-Mekelle sales agency xxx
Cost of sales (CGS)- Mekelle sales agency xxx
Advertising expense-Mekelle sales agency xxx
Utilities expense-Mekelle sales agency xxx
Other expenses-Mekelle sales agency xxx
Depreciation expense-Mekelle sales agency xxx
Salaries expense-Mekelle sales agency xxx
Income summary-Mekelle sales agency xxx
(To close revenue and expense accounts to a separate income summary ledger
account for sales agency)

Accounting System for a Branch

It is possible to have various systems of accounting for branch operations. The accounting
system of a business enterprise may provide for a complete set of accounting records at each
branch (almost completely decentralized); policies of another enterprise may keep all
accounting records in the home office (highly centralized).

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CHAPTER-3

INSTALLMENT AND CONSIGNMENT CONTRACTS

Accounting for Installment Sales regarded gross profit related to the receivable, and debit
Doubtful Installment Receivable Expense for the difference. Thus, the doubtful installment
receivable expense is equal to the unrecovered cost included in the balance of the installment
receivable. However, in most cases a default by a customer leads to repossession of merchandise.
The doubtful installment receivable expense is reduced by the net realizable value of the
merchandise repossessed, and it is possible for the repossession to result in a gain.

Presentation of Installment Sales data in Financial Statements

Income Statement
If the accrual basis of accounting is used for all sales, the overall gross profit of the company will
be determined by simply adding the gross profit on sales for installment sales and regular sales.
However, if installment sales method is used for financial reporting purposes, the gross profit on
installment sales should be adjusted for deferred gross profits of installment sales of the current
year and this will give the realized gross profit for installment sales of the same period. This
amount should be added with the gross profit from regular sales to give total realized gross profit
of the company as a whole.
Balance Sheet
Although the collection period often extends more than a year beyond the balance sheet date,
installment receivables, net of deferred interest and carrying charges, are classifieds current
assets. A justification for this could be the normal operating cycle of the business enterprise.
Accounting for Consignments
The term consignment means a transfer of possession of merchandise from the owner to another
person who acts as the sales agent of the owner. Title to the merchandise remains with the
owner, who is called a consignor; the sales agent who has possession of the merchandise is
called a consignee. The relationship between the consignor & the consignee is that of principal
and agent. Consignees are responsible to consignors for the merchandise placed in their custody
until it is sold or returned.
Why Consignments (why not sale)?
There are different reasons why consignment is preferred to sales by the two parties to the
transaction. From the consignor's side:
- It could be easier to persuade dealers to stock the items on a consignment basis (as the dealers
may not be willing to purchase the merchandise outright).
- The consignor avoids the risk inherent in selling on credit to dealers of questionable financial
strength.
From the consignee's side
- The acquisition of merchandise on consignment rather than by purchase requires less capital
investment.
- Avoids the risk of loss if the merchandise cannot be sold.
Rights and Duties of the Consignee
Rights of Consignee
- To receive compensation for merchandise sold for the account of the consignor.

9
- To receive reimbursement for expenditures (such as freight and insurance) made in connection
with the consignment.
- To sell consigned merchandise on credit if the consignor has not forbidden creditsales.
- To make the usual warranties as to the quality of the consigned merchandise andto bind the
consignor to honor such warranties.
Duties of Consignee
- To give care and protection reasonable in relation to the nature of the consigned merchandise.
- To keep the consigned merchandise separate from owned inventories or be able to identify
the consigned merchandise. Similarly, the consignee must identify and segregate the
consignment trade accounts receivable from other receivables.
- To use care in extending credit on the sales of consigned merchandise and to be diligent in
setting prices on consigned merchandise and in collecting consignment trade accounts
receivable.
- To render complete reports of sales of consigned merchandise and to make appropriate and
timely payment to the consignor.

The Account Sales

The report rendered by the consignee is called an account sales; it includes the quantity of
merchandise received and sold, expenditures made, advances made, and amounts owed or
remitted. Payments may be made as portions of the consigned merchandise are sold or may not
be required until the merchandise either has been sold or has been returned to the consignor.
Accounting for Consignees
The consignment of the shipment of merchandise may be recorded by the consignee in any of
several ways. The objective is to create a memorandum record of the consigned merchandise; no
purchase has been made and no liability exists. The receipt of consignment could be recorded;
- by a memorandum notation in the general journal,
- by an entry in a separate ledger of consignment shipments, or
- by a memorandum entry in a general ledger account entitled Consignment In - followed by
name of consignor.
Example,

Assume that Shire Co. ships on consignment to Roha Co. 10 television sets to be sold at $400
each. Roha Co. is to be reimbursed for a total freight costs of $135 and is to receive a
commission of 20% of the stipulated selling price. After selling all the cosigned merchandise,
Roha Co. sends to Shire Co. an account sales similar to the one below, accompanied by a check
for the amount due:

Roha Co.
Gondar, Ethiopia

10
 Account sales
Aug. 31, 1999
Sales for account and risk of:
Shire Co.
Mekelle, Ethiopia

Sales; 10 TV sets @ $400

$4,000
Charges:
Freight costs $135
Commission (4,000 x 0.20) 800
935
Balance (remittance to consignor)
$3,065
Consigned TV sets on hand: none

Under this method (the later approach discussed above), the ledger account appears as
follows;
Consignment In - Shire Co.
Date Explanation Debit Credit Balance
Received 10 TV
sets to be sold
for $400 each at
a commission of
20% of selling
price.

The journal entries for the consignee to record the payment of freight costs on this shipment and
the sale of the television sets are as follows;

Consignment In - Shire Co 135

Cash 135

(To record payment of freight costs on shipment from consignor)

Cash 4,000

11
Consignment In - Shire Co. 4,000
(To record sale of 10 TV sets at $400 each)
The journal entry to record the 20% commission charged by the consignee consists of a debit to
the Consignment In ledger account and a credit to a revenue account, as follows;
Consignment In - Shire Co. 800
Commission Revenue 800
(To record commission of 20% earned on TV sets sold)

The payment of the consignee of the full amount owed is recorded by a debit to the Consignment
In ledger account and results in closing that account. The journal entry is as follows:

Consignment In - Shire Co. 3,065

Cash 3,065

(To record payment in full to consignor)

After the posting of this journal entry, the ledger account for the consignment appears as follows
in the consignee's accounting records:

Consignment In - Shire Co.

Date Explanation Debit Credit Balance
Received 10 TV sets to be
sold
for $400 each at a
commission of
20% of selling price
Freight costs 135 135 Dr
Sales (10 x $400) 4,000 3,865 Cr
Commission ($4,000 x 800 3,065 Cr
0.20) 3,065 -0-
Payment to consignor

Accounting for Consignors

When a consignor ships merchandise to consignees, it is essential to have a record of the location
of this portion of inventories. Therefore, the consignor may establish in the general ledger a
Consignment Out account for every consignee (or every shipment on consignment).
Illustration
The choice of accounting methods by a consignor depends on whether (1) consignment gross
profits are measured separate from gross profits on regular sales or (2) sales on consignment are
combined with regular sales without any effort to measure gross profits separate for the two
categories of sales. The journal entries required under these alternative methods of accounting
for consignment shipment now are illustrated, first under the assumption that gross profits on
consignment sales are measured separately, and then without a separate measurement of gross

12
profits. The assumed transactions for these illustrations already have been described from the
consignee's view point, but now are restated to include the data relating to the consignor. In all
remaining illustrations, assume that the consignor uses the perpetual inventory system.
Shire Co. (the consignor) shipped on consignment to Roha Co. (the consignee) 10 TV sets that
cost $250 each. The selling price was set at $400 each. The cost of packing was $30; all costs
incurred in the packing department were debited by Shire Co. to the Packing Expense ledger
account. Freight costs of $135 by an independent truck line to deliver the merchandise to Roha
Co. were paid by Roha. All 10 sets were sold by Roha for $400 each. After deducting the
commission of 20% and the freight costs of $135, Roha sent Shire Co. a check for $3,065, along
with the account sales (a report) illustrated earlier. The journal entries for the consignor,
assuming that gross profits on consignment salesare determined separately, and gross profits on
consignment sales are not determined separately, are summarized as shown in the next page. If
the consigned merchandise is sold on credit, the consignee may send the consignor an account
sales but no check. In this case the consignor's debit would be to Trade Accounts Receivable
rather than to the Cash ledger account. When sales are reported by the consignee and gross
profits are not measured separately by the consignor, the account credited is Sales rather than
Consignment Sales, because there is no intent to separate regular sales from consignment sales.
Similarly, the commission paid to consignees is combined with other commission expenses, and
freight costs applicable to sales on consignment are recorded in the Freight Out Expense ledger
account.
Shire Co.
Journal entries, ledger account, an income statement presentation for a completed
consignment
Explanations G.P Determined separately G.P Not determined
separately
(1) Shipments of Consignment Out - Roha Co. 2,500 Consignt Out Roha Co. 2,500
merchandise Inventories Inventories
costing$2,500 on 2,500 2,500
consignment;
consigned merchandise
is transferred to a
separate inventories
ledger account.
Consignor uses the
perpetual
inventory system.

Consignment Out - Roha Co. 30 No journal entry required;

(2) Packing expense of Packing expense 30 total packing expense is
$30 allocated to reported among operating
consigned merchandise; expenses.
this expense Cash 3,065
previously was Freight Out expense 135
recorded in the Commission Expense 800
Packing expense ledger Sales
account. 4,000

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 Cash 3,065
(3) Consignment sales Consignment Out - Roha Co. 135
of $4,000 reported Commission Exp. - Cost of goods sold 2,500
by consignee and Consignment sales 800 Consignt Out - Roha Co.
payment of $3,065 Consignment Sales 2,500
received. Charges by 4,000
consignee;
freight costs, $135;
commission,
$800.

(4) Cost of Cost of Consignment sales 2,665

consignment sales Consignment Out - Roha Co.
recorded, 2,665 Consignment Out - Roha Co.
$2,665 (=2,500 + 30 + 2,500
135) Consignment Out - Roha Co. 2,500
2,500 2,665
(5) Summary of 30
Consignment Out 135 _____ Included in total sales $4,000
ledger account: 2,6652,665 Included in cost of all goods
Consignment sales sold 2,500
(6) Presentation in the $4,000 Included in total packing
income statement: Less: Cost of const sales 2,665 expense 30
Commission 800 Included in total freight-out
3, expense 135
465 Included in total commission
Gross profit on consignment sales $ exp. 800
535

CHAPTER-4
BUSINESS COMBINATIONS
(Mergers and Acquisitions)

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MEANING AND TERMS USED IN BUSINESS COMBINATIONS

Two or more business enterprises or their net assets are brought under common control in a
single accounting entity. Mergers and Acquisitions are the other terms frequently applied to
denote Business Combinations. The FASB has suggested the following definitions for the terms
commonly used in the discussion of business combinations
Combinor

One of the constituent companies entering in to a business combination, whose owners as a

group, controls the ownership interest is known as Combinor. In other words company taking
initiation for combination and survives after combination. It is a corporation which distributes
cash or other assets or incurs liabilities to obtain the assets or stock of another company.
Combinee
A Constituent company other than the combinor in a business combination is known as
Combinee.

E.g. Company A and Company B combine, Company A survives and controls the combined
enterprise.

Constituent Companies - Company A & Company B

Combinor -Company A
Combinee -Company B

Classes of business combinations:

1. Friendly takeover
2. Hostile takeover

Why Business combination?

When business enterprises are combined competitionto some extent could be avoided. Although
a number of reasons have been cited the overriding one for combinors in recent years has been to
achieve growth. Other reasons often advanced in support of business combination are obtaining
new management strength. Expansion of product lines is another reason together with the
enjoyment of income tax advantages. It is also possible to diversify the products and to find
places in international markets when business expands.

Types of Business combinations

A.Horizontal Combination

Combination between companies producing the same type of products in the same industry.

A. Vertical Combination

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Combination between companies engaged in different stages of production & distribution
suppliers and customers but common product.

B. Conglomerate Combination

Combination between enterprises in unrelated industries or markets.

Methods for Arranging Business Combination

1Statutory Merger

In statutory merger, the board of directors of constituent companies approves a plan for the
exchange of voting common stocks or sometimes preferred stock, cash or long term debt of one
of the corporations which is surviving for all outstanding common stock of other corporations.
The survivor corporation issues its common stock or other consideration in exchange for all their
holdings , thus acquiring the ownership of those corporations . the other corporations are
dissolved and liquidated and thus ceases to exists as separate legal entities and their activities are
continued as a division of the survivor which owns the net assets of the liquidated corporations.

2Statutory Consolidation

In statutory consolidation, a new corporation is formed to issue its common stock for the
outstanding common stock of two or more existing corporations which are liquidated after
combination. The new corporation acquires the net assets of the defunct companies whose
activities maybe continued as divisions of the new corporation.

3Acquisition of common stock

One corporation acquires from the present stock holders a controlling interest in the voting
common stock of another corporation by issuing a consideration in the form of preferred or
common stock, cash or debt or combination thereof.
4Acquisition of Assets

One business enterprise may acquire from another business enterprise all or part of the assets or
net assets for a consideration which may be in the form of cash debt, preferred stock or common
stock or combination thereof. The selling enterprise may or may not continue as separate legal
entity or it may be dissolved and liquidated. It does not become an affiliate of the
combinor.When one corporation is purchasing another company, or when it is combining with
another company, the combinor company has to pay a particular amount combinee company. So
it is to decide an appropriate price to pay . It may be paid in the form of cash , debt securities or
number of common or preferred shares. It is generally determined in the following methods.
1. Capitalization of expected average annual earnings of the combine at a desired rate of return.
2. Determination of current fair value of combinee’s net assets including goodwill.

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Illustration on pooling of interest accounting
On December 31, 2010, Mason Company (The Combinee) was merged with Saxon Corporation
(The Combinor). Saxon company exchanged 150,000 shares of $10 par common stock (CFV $25
a share) for all 100,000 issued and outstanding shares of Mason company's non par $10 stated
value common stock. In addition Saxon company paid the following out-of -pocket cost
associated with Business combination.

Accounting Fee
For investigation of Mason Company $ 5,000
For SEC registration statement for Saxon C/S 60,000

Legal Fee
For the business combination 10,000
For SEC registration statement for Saxon C/S 50,000
Finder's fee 51,250
Printer's charges for SEC registration statement 23,000
SEC registration statement fee 750

$200,000

Immediately prior to the merger, Mason Company's Balance Sheet was as follows:

Mason Company (combinee)

Balance Sheet (Prior to business combination)
December 31, 2010

Assets Liabilities & Shareholder's Equity

Current Assets $1,000,000 Current Liabilities $ 500,000

Plant Assets 3,000,000 Long Liabilities 1,000,000
Other Assets 600,000 C/S no par $10 stated value 1,000,000
Excess Over Par 700,000
Retained Earnings 1,400,000

4,600,000 4,600,000

Saxon Corporation ( Survior)

Journal entries
December 31,2010
(Pooling type business combination – statutory merger)

Current assets 1,000,000

Plant Assets (net) 3,000,000
Other Assets 600,000

17
 Continued
Current liabilities 500,000
Long term debt 1,000,000
Common Stock,$10 Par 1,500,000
Excess Over Par 200,000
Retained earnings 1,400,000
( To record the merger with Mason company as pooling of interest )

Expense of business combination 200,000

Cash 200,000
( to record the payment of out of pocket cost)

Because of pooling type business combination is a combining of existing stock holder interests
rather than an acquisition of assets, an investment in mason company common stock ledger
account as employed in purchase accounting is not used in the forgoing journal . In this case
common stock issued by Saxon corporation must be recorded at par. (15000 x $10 =$1,500,000)
$ 200,000 credit in excess in excess of par is a balancing amount for the journal entry.

Acquisitions

In Purchase accounting , the Combinor acquires the assets including goodwill of combinee at
current fair value for cash or issuing debt security, preferred stock or common stock. According
to APB opinion No. 16, "Business combinations" set forth the concept of purchase accounting as
follows.
'Accounting for business combination by purchase method follows principles normally
applicable under historical cost accounting to record acquisitions of assets and issuance of
stock and to accounting for assets and liabilities after acquisition.' Itincludes the following.

Determination of combinor

In the process of business combination, the amounts of net assets of the combinor are not
affected and as such the combinor must be identified accurately.

Computation of cost ofCombinee

Includes amount of consideration paid by the Combinor, combinor's direct expense, &
Contingent consideration. APB opinion No.16 provides the following principles for allocating
cost of combinee in a purchase type business combination.
First, all identifiable assets acquired and liabilities assumed in a business combination should
assign a portion of cost of acquired company, normally equal to their values at date of
acquisition.

Amount of consideration

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This is the total amount of cash paid, the current fair value of other assets distribute, the present
value of debt securities Issued and current fair (or market) value of equity securities Issued by
the combinor.

1.5 Direct and Indirect Out-of -Pocket Cost

Some expenses are incurred when business enterprises are combined. Examples are legal fee,
accounting fee, finder's fee etc. Finders fee is paid to the finder, who investigated the combinee,
assisted in determining the consideration for the combination and otherwise rendered service to
bring the combination in to effect. A finder may an individual, organization or investment
banking firm. It is considered as direct expenses.
Salaries of officers of constituent companies involved in combination are recognized as indirect
out of pocket cost. Cost of registering with SEC, and issuing equity securities are not direct cost.
It is set off against the proceeds from the issue of securities. Cost of Registering with SEC, and
issuing debt securities in business combination are debited to debt securities. So direct expenses
will be debited to Investment account and Expenses in connection with SEC will be debited to
either excess over par account or concerned share capital account.For entering direct expense,
investment account will be debited and cash account will be credited. Like that for entering
indirect expense, excess over par will be debited and cash will be credited
1.6Valuation Differential
It is a term created during the process of business combination. There are different terms raised
like goodwill, revaluation increment, revaluation decrement, fair value of net assets acquired,
Book value of net assets acquired etc.Valuation differential is the difference between Acquisition
cost ( or Investment ) paid by the combinor and the Book value of net assets of combinee
acquired by the combinor. Or It is the sum of Goodwill and the Revaluation Increment. The
difference between the Acquisition cost (Investment) and Current Fair Value of Net Assets
acquired by the combinor is known as the value of GOOD WILL. The difference between
Current Fair Value of Net Assets of Combinee acquired and the Book value of the net assets of
Combinee is known as REVALUATION INCREMENT

E. g.

Suppose Negative goodwill is $10,000, and Current fair value of Plant assets $800,000, Value of
intangible assets $200,000. Then, Pro-ration

Ratio of Plant assets and Intangible assets = 8:2 or 4:1

Negative goodwill should be proportionally divided among Plant assets and Intangible assets
Plant Assets = 10,000x 8/10 =8000
Intangible assets = 10,000x2/10 =2000

When entering in the record of Combinor, current fair value of Plant assets should be reduced by
8,000 and intangible assets should be reduced by 2000.

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Purchase Accounting method with Goodwill and Negative Goodwill (Statutory Merger)

 As it is statutory, statutory merger is executed on the basis of the provisions of law.

 The Board of Directors of constituent companies approve the terms of plan of merger
in accordance with the law.

 The plan is exchange the voting common stock of one of the corporations (called the
survivor) for all the outstanding voting common stock of other corporations.

 The survivor issues its common stock or other consideration (sometimes preferred
stock, cash, or long term debt) to the stockholders of other corporations in exchange
for their holding.

 Thus the survivor acquires the ownership of combinee corporations.

 The corporations other than the survivor are then dissolved and liquidated and cease to
exist as separate legal entities and their activities are often continued as divisions of
survivor.

 The survivor owns the net assets of the liquidated corporations.

E.g. Corporation A and Corporation B Combines, corporation A Survives and issues
consideration to the owners of corporation B, and corporation B is liquidated.

STEP-1

ISSUE OF PURCHASE CONSIDERATION TO COMBINEE

Investment xxxx
Common Stock (C/S) xxxx
Excess Over Par (EOP) xxxx
Cash xxxx

(Payment of consideration in the form of C/S & Cash)

STEP-2

20
PAYMENT OF OUT OF POCKET COST BY COMBINOR

DIRECT OUT OF POCKET COST

Investment expenses xxxx

Cash xxxx

(Payment of direct out of pocket cost)

PAYMENT OF OTHER OUT OF POCKET COST

Excess Over Par xxxx

Cash xxxx

(Payment of out of pocket cost other than direct)

STEP-3

COMPUTATION OF GOODWILL OR NEGATIVE GOODWILL

Excess of Investment over the Current fair value of Net assets of combinee
=
Goodwill
Excess of Current Fair Value of Net Assets of combinee over the Investment
=
Negative Goodwill

STEP-4

RECORDING THE ACQUISITION OF NET ASSETS FROM THE COMBINOR

(In Current Fair Value-[CFV])

Assets (CFV) xxxx

Goodwill xxxx
Liabilities (CFV) xxxx
Investment xxxx

______________________________________________________________________
RECORD OF COMBINEE - Liquidating Journal (Book Value is recorded)
_______________________________________________________________________

Liabilities (Book Value) xxxx

Common Stock xxxx

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Excess Over Par xxxx
Retained Earning xxxx

Current Assets xxxx

Plant Assets xxxx
Other Assets xxxx

________________________________________________________________________
Illustration-1
On April 1, 2010, Company B (The combinee) was merged with Company A (the combinor).
Following is the Balance Sheet of company B just prior to business combination. Company B is
liquidated after combination.

Company B
Balance Sheet
April1, 2010

ASSETS LIABILITIES
Current Assets 800,000 Current liabilities 600,000
Plant Assets 4,000,000 Long Liabilities 1,200,000
Other Assets 200,000 C/S (no par $10
Stated value) 2,000,000
Retained Earnings 1,200,000
5,000,000 5,000,000

Company A (The combinor )Exchanged 200000 shares of its $10 par common stock (CFV$25)
a share . In addition Company A paid out of pocket expense as follows

Legal & Finder's fee $150,000

Other Combination expense 50,000
Total 200,000
The Current Fair Value of Company B's Assets and Liabilities were as follows
Current Assets $ 950,000
Plant Assets 4,500,000
Other Assets 250,000
Current Liabilities (600,000)
Long Liabilities (1,100,000)

Required:

Show Journal Entries

1. In the Record of Company A for Purchase type Business combination

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2. In the Record of Company B For Liquidation

Solution: Combinor's journal entries for purchase type business combination (statutory Merger.
COMPANY - A (combinor)
Journal Entries
April 1, 2010
________________________________________________________________________

1. Investment (200,000 x 25) 5,000,000

Common Stock (200,000 x 10) 2,000,000
Excess Over Par(200,000 x 15) 3,000,000

(To record merger with Company B as purchase)

-------------------------------------------------------------------------------------

2. Investment expenses 150,000

Excess Over par 50,000
Cash 200,000

(To record the payment of out-of-pocket cost,

Direct as investment and other as reduction of
Proceeds received from issue of C/S)
------------------------------------------------------------------------------------
3. Computation of Goodwill/ Negative goodwill

Excess of investment over the current fair value of net assets of combinee acquired
=
Goodwill

Investment = $5,000,000 + 150,000 = 5,150,000

CFV of net assets of combinee acquired

Assets Liabilities

Current Assets $ 950,000 Current Liabilities $ 600,000

Plant assets 4,500,000 Long liabilities 1,100,000
Other Assets 250,000

5,700,000 1,700,000

Current Fair Value of Net Assets:

$5,700,000 - 1,700,000 = 4,000,000

Investment 5,150,000

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CFV of Net Assets 4,000,000

Goodwill 1,150,000

4. Current Assets 950,000

Plant Assets 4,500,000
Other assets 250,000
Discount on long liabilities 100,000
Goodwill 1,150,000

Current Liabilities 600,000

Long liabilities 1,200,000
Investment 5,150,000

(Acquisition Entry: To allocate total cost of

Liquidated company B, to identifiable assets
And liabilities with remainder to Goodwill)
Note: CFV of Long liabilities is estimated to
Be only 1,100,000. So there is a
Reduction in liabilities of 100,000,
to be treated as discount on liabilities.
Liabilities reduce to be debited.
________________________________________________________________________

Recording Liquidation of Combinee

________________________________________________________________________

Company B (Combinee)
Journal Entry
April 1, 2010
_______________________________________________________________________

Current Liabilities 600,000

Long liabilities 1,200,000
Common Stock 2,000,000
Retained Earnings 1,200,000

Current Assets 800,000

Plant Assets 4,000,000
Other Current Assets 200,000
(To record liquidation of company B
On account of Merger with Company A)

CHAPTER-5

24
CONSOLIDATIONS
1.1. Distinction between consolidation and merger
In Statutory Consolidation, the combined entity takes the form of a newly created corporation
but in statutory merger one company survives and the other company is liquidated. In statutory
consolidation one of the constituent companies must be identified as combinor . Once combinor
has been identified, the new corporation records the net assets acquired from the combinor at
their carrying amount and the net assets acquired from the combinee are recorded by the new
corporation at their current fair values. The Old companies are liquidated
Purchase consideration in statutory consolidation:

In the case of statutory consolidation, the new company has to pay the consideration to the old
companies for their net asset acquired. In the above example ,Company A and Company B enter
in to statutory consolidation. A New company by name company C comes in to existence. If
constituent companies are identifying Company A as combinor, then its assets and liabilities
should be recorded in the new company’s record in carrying amount and Company B’s assets
and liabilities are recored in the new company’s record in Current Fair Value. The new company
issues the Purchase consideration to both companies.
Journal in connection with consolidation

STEP-1

ISSUE OF PURCHASE CONSIDERATION BY NEW COMPANY

Investment xxxx
Common Stock (C/S) xxxx
Excess Over Par (EOP) xxxx
Cash xxxx

(Payment of consideration in the form of C/S & Cash)

STEP-2

PAYMENT OF OUT OF POCKET COST BY NEW COMPANY

DIRECT OUT OF POCKET COST

Investment expenses xxxx

Cash xxxx

(Payment of direct out of pocket cost)

PAYMENT OF OTHER OUT OF POCKET COST

Excess Over Par xxxx

Cash xxxx

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(payment of out of pocket cost other than direct)

STEP-3
2.3.2COMPUTATION OF GOODWILL OR NEGATIVE GOODWILL

Excess of Investment by new company over the Current fair value of Net assets of combinee
And carrying amounts of net assets of combinor
=
Goodwill
The reverse is negative goodwill OR bargain purchase excess.
STEP-4

RECORDING THE ACQUISITION OF NET ASSETS FROM OLD COMPANIES

(Identified combinor’s in carrying amount and other companies in Current Fair Value)

Assets xxxx
Goodwill xxxx
Liabilities xxxx
Investment xxxx

_______________________________________________________________________

RECORD OF OLD COMPANIES Liquidating Journal (Book Value is recorded)

_______________________________________________________________________

Liabilities (Book Value) xxxx

Common Stock xxxx
Excess Over Par xxxx
Retained Earning xxxx

Current Assets xxxx

Plant Assets xxxx
Other Assets xxxx

Financial Statements in consolidation

Illustration 8.

Following are the condensed balance sheets of constituent companies involved in the purchase
type statutory consolidation on December 31,2010.

LAMSON CORPORATION AND DONALD COMPANY

Separate Balance sheets (Prior to business combination)
December 31, 2010

26
Lamson Donald
Corporation Company
________________________________________________________________________
Assets
Current Assets $ 600,000 $ 400,000
Plant Assets (net) 1,800,000 1,200,000
Other assets 400,000300,000
Total Assets2,800,0001,900,000

Liabilities & Share Holders Equity

Current Liabilities $400,000 $300,000
Long term debt 500,000 200,000
Common stock $10Par 430,000 620,000
Excess Over Par 300,000 400,000
Retained Earning 1,170,000380,000
Total Liabilities & Share Holders Equity 2,800,0001,900,000

The Current Fair Value of both companies liabilities were equal to carrying amounts. The current
fair value of identifiable assets were as follows for Lamson and Donald respectively.
Current asses $800,000 and $500,000
Plant assets 2,000,000 and 1,400,000
Other assets 500,000 and 400,000

On December 31, 2010 in a statutory consolidation approved by the share holders of both
constituent companies a new corporation , Lamdon corporation issued 74000 shares of no par
common stock with an agreed value of $60 a share based on the valuation of identifiable fair
value of net assets and goodwill. Good will for the purpose of determining the purchase
consideration is computed by the constituent companies $180,000 for Lamson Company and
$60,000 for Donald Company.
The directors of constituent companies mutually decided that company receiving more number
of shares in Lamdon Corporation to be the combinor.
Lamdon Corporation paid out of pocket expenses as follows
Legal and finders fee $110,000
Security fee and other charges 90,000

Required:

1. Show the number of shares issued to each constituent company

2. Journal in the record of Lamdon Corporation for purchase type statutory consolidation.

Solution

Computation of number of shares of common stock issued to each company

Note: The total purchase consideration given is 74000 shares; this is for Lamson and Donald. It
is asked to calculate the number of shares for each company. So it is to calculate the purchase

27
consideration due to each company. As purchase consideration is not separately given Current
fair value of net assets will be the value of purchase consideration.
Calculation of Current Fair Value of Net assets of Lamson company and Donald company.

Lamson Company Donald Company

Current Assets $ 800,000 $500,000
Plant assets 2,000,000 1,400,000
Other Assets 500,000 400,000
Good will 180,000 60,000
Current Liabilities (400,000) (300,000)
Long Term debt (500,000) (200,000)
Current Fair Value of Net assets $2,580,000 $1,860,000

Agreed value per share of Lamdon Corporation = $60

Number of shares to be issued to Lamson =$ 2,580,000/$60 = 43000 (Combinor)

Number of shares to be issued to Donald = $1,860,000/$60 = 31,000
Total shares = 74000
Journal entries for new corporation for purchase type business combination ( statutory
consolidation )
LAMDON CORPORATION
Journal entries
December 31,2010
1. Investment (74000 x 60) 4,440,000
Common stock 4,440,000
To record consolidation of Lamson
Corporation and Donald company
as purchase.
------------------------------------------------------------------------------------------------------------

2. Investment expenses 110,000

Common stock 90,000
Cash 200,000
To record the direct and indirect
Out of pocket cost.
----------------------------------------------------------------------------------------------------------
computation of Good will or negative goodwill

Excess of Investment by new company over the Current fair value of Net assets of combinee
And carrying amounts of net assets of combinor
=
Goodwill

Computation of Net assets

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 Lamson Company (combinor) Donald company Total
Carrying amountCurrent Fair Value
Current Assets 600,000 500,000 1,100,000
Plant Assets 1,800,000 1,400,000 3,200,000
Other Assets 400,000 400,000 800,000
Total 5,100,000
Current Liabilities (400,000) (300,000) (700,000)
Long debt (500,000) (200,000) (700,000)
Net Assets3,700,000

Good will = Investment – Net assets

4,550,000 – 3700,000
= 850,000
-----------------------------------------------------------------------------------------------------------
4. Current assets (600,000+500,000) 1,100,000
Plant Assets (1,800,000+1,400,000) 3,200,000
Other Assets (400,000 +400,000) 800,000
Good will 850,000

Current Liabilities(400,000+300,000) 700,000

Long term debt (500,000+200,000) 700,000
Investment (4,400,000+ 110,000)4,550,000
To allocate the cost of investment to identifiable
Assets and liabilities at carrying amount of the
Combinor and current fair value of the combinee.

29