Chapter 1 Test Bank

BUSINESS COMBINATIONS
Multiple Choice Questions LO1 1. Research and development is a driver of business combinations for all of the following reasons except? a. b. c. d. LO2 2. A business combination in which a new corporation is created and two or more existing corporations are combined into the newly created corporation is called a: a. b. c. d. 3. merger. purchase transaction. pooling-of-interests. consolidation. Lower operating costs Acquisition of intangible assets Operating loss carryforwards Reduced business risk of acquiring lines

established

product

A business combination occurs when a company acquires an equity interest in another entity and has: a. b. c. d. at least 20% ownership in the entity. more than 50% ownership in the entity. 100% ownership in the entity. control over the entity, irrespective of the percentage owned.

4.

FASB favors consolidation of two entities when a. One acquires at least 20% equity ownership of the other. b. One acquires between 20% and 50% equity ownership in the other. c. One acquires two thirds equity ownership in the other. d. One gains control over the entity, irrespective of the equity percentage owned.

LO3 LO4 1

5.

Michangelo Co. paid accountants and lawyers $100,000 in order to acquire Florence Company. Michangelo will treat the $100,000: a. an expense for the current year. b. a prior period adjustment to retained earnings. c. additional cost to investment of Florence on the consolidated balance sheet. d. a reduction in paid-in capital.

6.

Picasso Co. issued 10,000 shares of its $1 par common stock, valued at $400,000, to acquire shares of Bull Company in an all-stock transaction. Picasso paid the investment bankers $35,000. Picasso will treat the investment banker fee as: a. b. c. d. an expense for the current year. a prior period adjustment to Retained Earnings. additional goodwill on the consolidated balance sheet. a reduction in paid-in capital.

7.

Durer Inc acquired Sea Corporation in a business combination and Sea Corp went out of existence. Sea Corp developed a patent listed as an asset on Sea Corps books at the patent office filing cost. In recording the combination: a. fair value is not assigned to the patent because the research and development costs have been expensed by Sea Corp. b. Sea Corps prior expenses to develop the patent are recorded as an asset by Durer at purchase. c. the patent is recorded as an asset at fair market value. d. the patent's market value increases goodwill.

8.

In an acquisition, the company whose assets are acquired: a. will go out of existence. b. will become a subsidiary of the acquiring company. c. will be dissolved along with the acquiring company to form a new corporation. d. None of the above are correct.

9.

According to FASB Statement 141, which one of the following items may not be accounted for as an intangible asset apart from goodwill? a. b. c. d. a production backlog talented employee workforce noncontractual customer relationships employment contracts 2

10.

When negative calculation,

goodwill

occurs

in

business

combination

a. The negative goodwill is considered an impairment. b. The value is allocated first to reduce proportionately (according to market value) non-current assets, then to non-monetary current assets, and any negative remainder is classified as a deferred credit. c. allocated first to reduce proportionately (according to market value) non-current assets, and any negative remainder is classified as an extraordinary gain. d. allocated first to reduce proportionately (according to market value) non-current, depreciable assets to zero, and any negative remainder is classified as a deferred credit. 11. With respect to goodwill, an impairment a. Will be amortized over the remaining useful life. b. Is a two step process which analyzes each business unit of the entity. c. Is a one step process considering the entire firm. d. Occurs when asset values are adjusted to fair value in a purchase. Use the following information in answering questions 12 and 13. Manet Corporation exchanges 150,000 shares of newly issued $1 value common stock with a fair market value of $25 per share for of the outstanding $5 par value common stock of Gardner Inc Gardner is then dissolved. Manet paid the following costs expenses related to the business combination: Costs of special shareholders meeting to vote on the merger Registering and issuing securities Accounting and legal fees Salaries of Manets employees assigned To the implementation of the merger Cost of closing duplicate facilities Costs of special shareholders meeting to vote on the merger 12. 6,000 $14,000 9,000 15,000 11,000 7,000 par all and and

In the business combination of Manet and Gardner: a. the costs of registering and issuing the securities are included as part of the purchase price for Gardner. b. only the salaries of Manet's employees assigned to the merger are treated as expenses. c. all of the costs except those of registering and issuing 3

the securities are included in the purchase price of Gardner. d. only the accounting and legal fees are included in the purchase price of Gardner. 13. In the business combination of Manet and Gardner a. all of the items listed above are treated as expenses. b. all of the items listed above except the cost of registering and issuing the securities are expensed. c. the costs of registering and issuing the securities are deducted from the fair market value of the common stock used to acquire Gardner. d. only the costs of closing duplicate facilities, the salaries of Manet's employees assigned to the merger, and the costs of the shareholders' meeting would be treated as expenses. LO5 14. Which of the following methods would does FASB consider best in Statement 142 in the evaluation of goodwill impairment? a. b. c. d. 15. Senior executive estimate Financial analyst forecasts Market value Present value of future cash flows discounted at the firms cost of capital

Raphael Company paid $2,000,000 for the net assets of Paris Corporation and Paris was then dissolved. Paris had no liabilities. The fair values of Paris assets were $2,500,000. Pariss only non-current assets were land and equipment with fair values of $160,000 and $640,000, respectively. At what value will the equipment be recorded by Raphael? a. b. c. d. $0 $240,000 $400,000 $640,000 assumed in a purchase

16.

According to FASB 141, liabilities acquisition will be valued at: a. b. c. d.

estimated fair value. historical book value. current replacement cost. present value using market interest rates.

17.

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

18.

Goodwill arising from a business combination is: a. charged to Retained Earnings after the acquisition is completed. b. amortized over 40 years or its useful life, whichever is longer. c. amortized over 40 years or its useful life, whichever is shorter. d. never amortized.

19.

The founders of an acquired company are granted a contingent payment for three years after the acquisition based on those years earnings: a. The acquirer typically recognizes the payment as goodwill when the contingency is resolved and payment is given. b. The acquirer typically recognizes the payment as goodwill when the contingency is resolved. c. The acquirer typically includes the expected payments based on future earnings as goodwill at acquisition. d. The acquirer typically amortizes contingencies over the applicable award period.

20.

The first step in assigning the cost of an acquired company is to determine the fair values of all identifiable assets and liabilities. According to FASB Statement 141, the current replacement costs be the values for which of the following: a. b. c. d. both raw materials and finished goods inventories. plant and equipment and finished goods inventories. plant and equipment and raw materials inventories. land and plant and equipment.

Exercises LO2 Exercise 1 On January 2, 2005 Bison Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Deer Corporations outstanding common shares. Bison paid $15,000 to register and issue shares. Bison $10,000 for the direct combination costs of the accountants. The fair value and book value of Deer's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows: Bison Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $5 par Paid-in capital Retained Earnings Total Liabilities & Equities $ 150,000 320,000 500,000 350,000 4,000,000 $5,320,000 $1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000 $ Deer 120,000 400,000 500,000 250,000 1,500,000 $2,770,000 $ 300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Required:

1. Prepare Bison's general journal entry for the acquisition of 2. Prepare Bison's general journal entry for the acquisition of

Deer assuming that Deer survives as a separate legal entity. Deer assuming that Deer will dissolve as a separate legal entity.

LO2 Exercise 2 On January 2, 2005 Altamira Company issued 80,000 new shares of its $2 par value common stock valued at $12 a share for all of Lascaux Corporations outstanding common shares. Altamira $5,000 for the direct combination costs of the accountants. Altamira paid $10,000 to register and issue shares. The fair value and book value of Lascaux's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2005 is as follows:

Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $2 par Paid-in capital Retained Earnings Total Liabilities & Equity

Altamira $ 75,000 160,000 200,000 175,000 1,500,000 $2,110,000 $ 100,000 700,000 600,000 450,000 260,000 $2,110,000

Lascaux $ 60,000 200,000 250,000 125,000 750,000 $1,385,000 $ 155,000 330,000 250,000 50,000 600,000 $1,385,000

Required:

1. Prepare Altamira's general journal entry for the acquisition of

Lascaux assuming that Lascaux survives as a separate legal entity.

2. Prepare Altamira's general journal entry for the acquisition of

Lascaux assuming that Lascaux will dissolve as a separate legal entity.

LO4

Exercise 3 Dolmen Corporation purchased the net assets of Carnac Inc on January 2, 2005 for $280,000 and also paid $10,000 in direct acquisition costs. Carnac's balance sheet on January 2, 2005 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets $ 90,000 180,000 20,000 30,000 40,000 $360,000 Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total liab. & equity $ 35,000 80,000 10,000 215,000 20,000 $360,000

Fair values agree with book values except for inventory, land, and equipment, that have fair values of $200,000, $25,000 and $35,000, respectively. Carnac has patent rights valued at $10,000. Required: Prepare Dolmen's general journal entry for the cash purchase of Carnac's net assets.

LO4 Exercise 4 The balance sheets of Palisade Company and Salisbury Corporation were as follows on December 31, 2004: Current Assets Equipment-net Buildings-net Land Total Assets Current Liabilities Common Stock, $5 par Paid-in Capital Retained Earnings Total Liabilities and Stockholders' equity Palisade 260,000 440,000 600,000 100,000 $1,400,000 100,000 1,000,000 100,000 200,000 $1,400,000 $ Salisbury 120,000 480,000 200,000 200,000 $1,000,000 120,000 400,000 280,000 200,000 $1,000,000 $

On January 2, 2005 Palisade issued 60,000 of its shares with a market value of $40 per share in exchange for all of Salisbury's shares, and Salisbury was dissolved. Palisade paid $20,000 to register and issue the new common shares. It cost Palisade $50,000 in direct combination costs. Book values equal market values except that Salisburys land is worth $250,000. Required: Prepare a Palisade balance sheet after the business combination on January 1, 2005.

LO4

Exercise 5 Paradise Inc purchased the net assets of Sublime Company on January 2, 2005 for $160,000 and also paid $5,000 in direct acquisition costs. Sublime's balance sheet on January 2, 2005 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets $180,000 180,000 30,000 30,000 30,000 $450,000 Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total liab. & equity $ 25,000 90,000 10,000 225,000 100,000 $450,000

Fair values agree with book values except for inventory, land, and equipment, that have fair values of $200,000, $25,000 and $35,000, respectively. Solitaire has patent rights valued at $10,000. Required: Prepare Paradise's general journal entry for the cash purchase of Sublime's net assets.

LO4 Exercise 6 On January 2, 2005 Tennessee Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Alaska Companys outstanding common shares in a purchase acquisition. Tennessee paid $15,000 for registering and issuing securities and $10,000 for other direct costs of the business combination. The fair value and book value of Alaska's identifiable assets and liabilities 10

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

Cash Inventories Other current assets Land Plant assets-net Total Assets Accounts payable Notes payable Capital stock, $5 par Paid-in capital Retained Earnings Total Liabilities & Equities

Tennessee $ 150,000 320,000 500,000 350,000 4,000,000 $5,320,000 $1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000

Alaska 120,000 400,000 500,000 250,000 1,500,000 $2,770,000 $ $ 300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Required: Prepare a balance sheet for Tennessee Corporation immediately after the business combination. LO4&5 Exercise 7 New York Corp. purchased the net assets of Arizona Company on January 2, 2005 for $200,000 and also paid $5,000 in direct acquisition costs. Arizona's balance sheet on January 2, 2005 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets $ 90,000 180,000 30,000 30,000 30,000 $360,000 Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total liab. & equity $ 27,000 88,000 15,000 215,000 15,000 $360,000

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

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

11

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

LO5 Exercise 8 Book values and fair values of Portrait Corporations assets and liabilities at January 2, 2005, are shown below:

Assets Other current assets Inventories Land Buildings-net Equipment-net

Book Fair Values Values $ 250,000 $ 250,000 300,000 380,000 200,000 400,000 600,000 480,000 460,000 460,000 $1,810,000 $1,970,000 $ 190,000 $ 190,000 600,000 540,000 1,000,000 20,000 $1,810,000 $1,970,000

Liabilities and Equities Current liabilities 7% Bonds payable Common stock Retained earnings

Palette Corporation acquires all of the outstanding common voting stock of Portrait for $1,400,000 cash and Portrait Corporation then goes out of existence. Required: Prepare a schedule to allocate the $1,400,000 investment cost Portraits assets and liabilities on January 2, 2005. to

12

LO5 Exercise 9 In a business combination on January 2, 2005 Horus Inc issues 20,000 shares of its $5 par common for all of the outstanding stock of Namar. Namar is dissolved. Horus pays $60,000 for direct combination costs and $40,000 to register its securities. Horus stock has a market price of $60 on January 2, 2005. Balance sheet information for both firms on January 2, 2005 is as follows Horus Cost $ 240,000 100,000 200,000 160,000 1,350,000 $2,000,000 $ Namar Namar Cost Fair Value $ 20,000 $ 20,000 60,000 60,000 180,000 200,000 40,000 200,000 400,000 700,000 $700,000 $ 50,000

Cash Inventories Accounts receivable Land Plant assets-net Total assets Notes payable Capital stock, $5 par Paid-in capital Retained earnings Total Liabilities & Equities Required:

400,000 $ 100,000 1,000,000 200,000 400,000 100,000 200,000 300,000 $2,000,000 $700,000

Prepare journal entries to record the business combination.

LO 5
Exercise 10 Balance sheet information for Sphinx Company at January 1, 2005, is summarized as follows: Current assets Plant assets $ $ 230,000 450,000 680,000 Liabilities $ Capital stock $10 par Retained earnings $ 300,000 200,000 180,000 680,000

Sphinxs assets and liabilities are fairly valued except for plant assets that are undervalued by $50,000. On January 2, 2005, Pyramid Corporation issues 20,000 shares of its $10 par value common stock 13

for all of Sphinxs net assets and Sphinx is quotations for the two stocks on this date are: Pyramid common: Sphinx common: Butler pays the combination: $28.00 $19.50 fees and costs in

dissolved.

Market

following

connection $10,000 5,000 6,000

with

the

Finders fee Costs of registering and issuing stock Legal and accounting fees Required:

1. Calculate Pyramids investment cost of Sphinx Corporation. 2. Calculate any goodwill from the business combination.

14

15

Solutions:
Multiple Choice Questions 1 6 11 16 Exercise 1 1. General journal entry recorded by Bison for the acquisition of Deer (Deer survives as a separate legal entity): Investment in Roger Common stock Paid-in capital Investment in Roger Paid-in capital Cash 2. 1,900,000 10,000 15,000 500,000 1,400,000 25,000 A D B D 2 7 12 17 d b b c 3 8 13 18 d d c d 4 9 14 19 b b c a 5 10 15 20 c d b c

General journal entry recorded by Bison for the acquisition of Deer (Deer dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Accounts payable Notes payable Common stock Paid-in capital 95,000 400,000 500,000 250,000 1,500,000 100,000

300,000 660,000 500,000 1,385,000

Exercise 2 1. General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux survives as a separate legal entity): Investment in Lascaux Common stock Paid-in capital Investment in Lascaux Paid-in capital 960,000 100,000 860,000 5,000 10,000 16

Cash 3.

15,000

General journal entry recorded by Altamira for the acquisition of Lascaux (Lascaux dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Accounts payable Notes payable Common stock Paid-in capital 60,000 200,000 250,000 125,000 750,000 55,000

155,000 330,000 100,000 850,000

Exercise 3 General journal entry for the purchase of Carnac's net assets: Accounts receivable Inventory Land Building Equipment Patent Goodwill Current liabilities Long-term debt Cash Exercise 4 The stockholders' equity section for Palisade Corporation subsequent to its acquisition of Salisbury Corporation on January 1, 2005 will appear as follows: Palisade Corporation Balance Sheet January 1, 2005 Current Assets Equipment-net Buildings-net Land Goodwill Total Assets Current Liabilities Common Stock, $5 par Paid-in Capital 90,000 200,000 25,000 30,000 35,000 10,000 15,000

35,000 80,000 290,000

310,000 920,000 800,000 350,000 180,000 $2,460,000 220,000 1,150,000 890,000 17

Retained Earnings Total Liabilities and Stockholders' equity Exercise 5

200,000 $2,460,000

General journal entry for the purchase of Sublime's net assets: Accounts receivable Inventory Current liabilities Long-term debt Cash Extraordinary gain Exercise 6 Tennessee Corporation Balance Sheet January 1, 2005 Assets: Cash $ 245,000 Inventory 720,000 Other current assets 1,000,000 Total current assets 1,965,000 Land Plant assets-net Goodwill Total L.T. assets Total assets 600,000 5,500,000 100,000 6,200,000 $8,165,000 Liabilities: Accounts payable Notes payable Total liabilities $1,300,000 1,960,000 3,260,000 90,000 200,000 35,000 80,000 165,000 10,000

Equity: Common stock ($5 par) 2,500,000 Paid-in capital 2,385,000 Retained earnings 20,000 Total equity 4,905,000 Total liab.& eq. $8,165,000

Exercise 7

1. Allocation schedule for Arizona's net assets.

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

Allocation Schedule for Non-current Assets 18

Non-current Asset Land Building Equipment Patent Total 2.

Fair Value $ 25,000 30,000 35,000 10,000 100,000

% of Total Fair Value 25 30 35 10 100

Allocable $ Amount 30,000 30,000 30,000 30,000 30,000

$ Amount Allocated 7,500 9,000 10,500 3,000 30,000

General journal entry for the purchase of Arizona's net assets: 90,000 200,000 7,500 9,000 10,500 3,000

Accounts receivable Inventory Land Building Equipment Patent Current liabilities Long-term debt Cash Exercise 8 Item Purchase Cost Book Value Cost in excess of book Market in excess of book Inventory Land Building net 7% Bonds Identifiable Differences Goodwill Exercise 9 Item Purchase Cost Book Value Cost in excess of book Market in excess of book Accounts Receivable Land Plant Assets net

27,000 88,000 205,000

Allocated Fair Value 1,400,000 1,020,000 380,000 80,000 200,000 -120,000 60,000 220,000 160,000

Allocated Fair Value 1,260,000 600,000 660,000 20,000 160,000 300,000 19

Notes Payable Identifiable Differences Goodwill Investment Paid-in capital Common stock Paid-in capital Cash 1,260,000 40,000

50,000 530,000 130,000

100,000 1,100,000 100,000

Cash Inventories Accounts Receivable Land Plant assets Goodwill Notes payable Investment Exercise 10 Requirement 1

20,000 60,000 200,000 200,000 700,000 130,000 50,000 1,260,000

FMV of shares issued by Pyramid: 20,000 x $28.00= Finders fees Legal and accounting fees Total acquisition cost for Sphinx Corporation: Requirement 2 Investment cost from above: Less: Fair value of Sphinxs net assets ($680,000 of total assets plus $50,000 of undervalued plant assets minus $300,000 of debt) Equals: Goodwill from investment in Sphinx:

$ $

560,000 10,000 6,000 576,000

576,000 430,000 146,000

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