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2. FASB ASC 805-10-65-1: The acquirers application of the recognition principle and
conditions may result in recognizing some assets and liabilities that the acquiree had not
previously recognized as assets and liabilities in its financial statements. For example, the
acquirer recognizes the acquired identifiable intangible assets, such as a brand name, a
patent, or a customer relationship, that the acquiree did not recognize as assets in its
financial statements because it developed them internally and charged the related costs to
expense.
3. FASB ASC 805-30-30-8 provides the following guidance relating to the transfer of assets
other than cash and stock: The consideration transferred may include assets or liabilities of
the acquirer that have carrying amounts that differ from their fair values at the acquisition
date (for example, nonmonetary assets or a business of the acquirer). If so, the acquirer
shall remeasure the transferred assets or liabilities to their fair values as of the acquisition
date and recognize the resulting gains or losses, if any, in earnings. However, sometimes the
transferred assets or liabilities remain within the combined entity after the business
combination (for example, because the assets or liabilities were transferred to the acquiree
rather than to its former owners), and the acquirer therefore retains control of them. In
that situation, the acquirer shall measure those assets and liabilities at their carrying
amounts immediately before the acquisition date and shall not recognize a gain or loss in
earnings on assets or liabilities it controls both before and after the business combination.
Bottom line if the asset will not remain with the consolidated group following the
acquisition, the acquirer can write up the asset before transfer and record the resulting gain
in income. And, if the asset remains with the consolidated entity post-acquisition, it cannot
be written up and no gain is recognized.
5. FASB ASC 805-20-55-6 provides the following guidance: The acquirer subsumes into
goodwill the value of an acquired intangible asset that is not identifiable as of the
acquisition date. For example, an acquirer may attribute value to the existence of an
assembled workforce, which is an existing collection of employees that permits the acquirer
to continue to operate an acquired business from the acquisition date. An assembled
workforce does not represent the intellectual capital of the skilled workforcethe (often
specialized) knowledge and experience that employees of an acquiree bring to their jobs.
Because the assembled workforce is not an identifiable asset to be recognized separately
from goodwill, any value attributed to it is subsumed into goodwill.
6. FASB ASC 805-20-55-7 provides the following guidance: The acquirer also subsumes into
goodwill any value attributed to items that do not qualify as assets at the acquisition date.
For example, the acquirer might attribute value to potential contracts the acquiree is
negotiating with prospective new customers at the acquisition date. Because those
potential contracts are not themselves assets at the acquisition date, the acquirer does not
recognize them separately from goodwill.
7. FASB ASC 805-20-55-25 provides the following guidance: The agreement, whether
cancelable or not, meets the contractual-legal criterion. Additionally, because the Subsidiary
establishes its relationship with Customer through a contract, not only the agreement itself
but also the subsidiarys relationship with the Customer meets the contractual-legal
criterion.
10. FASB ASC 805-10-55-35 provides the following guidance (the acquired company is
referenced as the Target): In this Example, Target entered into the employment
agreement before the negotiations of the combination began, and the purpose of the
agreement was to obtain the services of the chief executive officer. Thus, there is no
evidence that the agreement was arranged primarily to provide benefits to Acquirer or the
combined entity. Therefore, the liability to pay $5 million is included in the application of
the acquisition method.
11. FASB ASC 805-10-55-36 provides the following guidance (the acquired company is
referenced as the Target): In other circumstances, Target might enter into a similar
agreement with the chief executive officer at the suggestion of Acquirer during the
negotiations for the business combination. If so, the primary purpose of the agreement
might be to provide severance pay to the chief executive officer, and the agreement may
primarily benefit Acquirer or the combined entity rather than Target or its former owners.
In that situation, Acquirer accounts for the liability to pay the chief executive officer in its
postcombination financial statements separately from application of the acquisition
method.
13. The acquisition should be accounted for as a business combination, thus requiring
consolidation. It is not necessary for the business to have outputs (i.e., products and sales).
FASB ASC 805-10-55-4 defines a business as follows: A business consists of inputs and
processes applied to those inputs that have the ability to create outputs. Although
businesses usually have outputs, outputs are not required for an integrated set to qualify as
a business.
14. a. Assets and liabilities can be valued using any reasonable approach. Some common
approaches to the tangible assets and liabilities in this example include the following:
b. Before any portion of the purchase price can be allocated to the Goodwill asset, you
must first ask if you are acquiring any intangible assets that are not recorded on the
acquirees balance sheet. A complete listing is in Exhibit 2.12. FASB ASC 805 requires us
to make a positive assessment whether any of these intangible assets were valued by us
in arriving at our purchase price for the acquiree and, if so, we must assign that value to
the intangible assets acquired before any of the purchase price can be assigned to the
Goodwill asset.
c. Intangible assets are typically valued at the present value of expected future cash flows.
We must, first, project the cash flows to be derived from the intangible asset. Then, we
need to discount those expected cash flows using an appropriate discount rate. This is a
very subjective process, as both the estimate of future cash flows and the choice of the
appropriate discount rate are difficult. We must make a reasonable attempt, however,
to value these intangible assets using a reasonable and supportable methodology.
16. An indemnification asset represents the agreement by the seller to guarantee that the
acquirer will not suffer a loss as a result of the outcome of a contingency related to all or
part of a specific asset or liability. For example, the seller may indemnify the purchaser
against losses above a specified amount on a liability arising from a particular contingency,
such as a pending lawsuit.
The acquirer recognizes an indemnification asset at the same time that it recognizes the
indemnified item (the contingent liability, for example). In addition, both the
indemnification asset and the related liability are revalued subsequent to the acquisition
(FASB ASC 805-20-25-27 through 25-28 and FASB ASC 805-20-35-4).
a. Customer lists - a customer list acquired in a business combination normally meets the
separability criterion.
b. Order backlog - an order or production backlog acquired in a business combination
meets the contractual-legal criterion even if the purchase or sales orders are cancelable.
c. Customer Relationship - If an entity has relationships with its customers through sales
orders, they meet the contractual-legal criterion. Customer relationships also may arise
through means other than contracts, such as through regular contact by sales or service
representatives.
b. FASB ASC 805-20-25-2 provides the following guidance relating to planned restructuring
activities: To qualify for recognition as part of applying the acquisition method, the
identifiable assets acquired and liabilities assumed must meet the definitions of assets
and liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, at
the acquisition date. For example, costs the acquirer expects but is not obligated to
incur in the future to effect its plan to exit an activity of an acquiree or to terminate the
employment of or relocate an acquirees employees are not liabilities at the acquisition
date. Therefore, the acquirer does not recognize those costs as part of applying the
acquisition method. Instead, the acquirer recognizes those costs in its postcombination
financial statements in accordance with other applicable generally accepted accounting
principles (GAAP).
19. If financial statements are issued before the final allocations of the purchase can be made,
FASB ASC 805-10-55-16 allows us to use provisional amounts, that is, estimates of those
values. When the final allocation is made, we retrospectively adjust those amounts,
provided that the final measurement of all assets and liabilities is completed within one
year from the acquisition date. Also, during the measurement period, the acquirer can
recognize additional assets or liabilities if new information is obtained about facts and
circumstances that existed as of the acquisition date that, if known, would have resulted in
the recognition of those assets and liabilities as of that date.
20. A
a. No, a contingent liability for the employee litigation is not recognized at fair value on the
acquisition date because your attorney has determined that an unfavorable outcome is
reasonably possible, but not probable (ASC 450-20-25-2). Therefore, your company
would recognize a liability in the postcombination period when the recognition and
measurement criteria in ASC 450 are met.
b.
Expense related to contingent earnings liability 500,000
Contingent earnings liability 500,000
(to record the increase in the expected value of the contingent earnings
liability)
c.
Expense related to contingent earnings liability 3,000,000
Contingent earnings liability 2,000,000
Cash 5,000,000
(to record the increase in the value of the contingent earnings
liability)
22. A
Purchase price $5,000,000
Less: Fair value of assets acquired 5,000,000
Deferred tax liability (350,000) 4,650,000 ($1 million x 35%)
Goodwill $350,000
23. Answer: d
A business is An integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing a return in the form of dividends, lower costs, or
other economic benefits directly to investors or other owners, members, or participants. It
is not necessary that the investee company currently produce products or generate a
positive return. All that is necessary is that it
a. has begun planned principal activities,
b. has employees, intellectual property, and other inputs and processes that could be
applied to those inputs,
c. is pursuing a plan to produce outputs, and
d. will be able to obtain access to customers that will purchase the outputs.
Company A has a controlling financial interest in both Companies B (90%) and C (90% x 70%
= 63%). Therefore B and C should be consolidated with A.
25. Answer: b
By holding 12,000 shares, former company B shareholders will own 55% (i.e., 12,000 /
(10,000 + 12,000) of the common stock after the transaction, suggesting they control the
company and can elect controlling Board within the next two years.
26. Answer: d
Direct fees have no effect on recording the business combination; these costs are simply
expensed as part of operating expenses for the period in which they are incurred. The entry
is as follows:
Expenses 200,000
Payables or cash (for direct acqu. costs) 200,000
Costs of registering and issuing securities are deducted from contributed capital; thus, they
have no effect on the investment account. The fair value of the common stock that is issued
(i.e., $5,000,000 = 500,000 shares x $10/share) will equal the amount of the net assets that
will be recognized in a business combination. The entry is as follows:
27. Answer: a
29. Answer: d
In the case where (1) the fair value of the identifiable net assets of a subsidiary equals the
book value of identifiable net assets of the subsidiary, and there is no recorded goodwill or
bargain acquisition gain, then the investment account will equal the book value of net
assets of the subsidiary (i.e., which also equals the stockholders equity of the subsidiary).
Net assets equals $170,000 (i.e., CS, $10,000 + APIC, $150,000 + RE, $10,000).
30. Answer: d
AAP
Dr (Cr)
Receivables & Inventories 10,000
Land (5,000)
Property & Equipment 20,000
Goodwill 25,000
Liabilities 7,000
Total AAP 57,000
32. Answer: b
33. A Answer: c
34. A Answer: b
Goodwill = $39
36. a. Goodwill = $20 million - $7 million - $6 million - $5 million = $2 million. The acquisition
costs are expensed under GAAP (SFAS 141(R), 59).
b. Goodwill is not amortized like other intangible assets. Instead, it remains on the balance
sheet until management deems it to be impaired, at which time it is written down.
c. Allocating more of the purchase price to goodwill reduces the allocation to assets that
are depreciated or amortized and, therefore, reduces the depreciation and/or
amortization expense hitting their income statements subsequent to the acquisition.
37. a. The amounts relating to working capital, inventories and PPE assets are the fair values
of those assets on the acquisition date. These amounts reflect the book values of those
assets on Wyeths balance sheet plus the AAP, the difference between fair value and
book value. These are the amounts that will appear on the consolidated balance sheet
relating to Wyeth, and the reported amounts will be the sum of these values plus the
book value of these assets on Pfizers balance sheet on the acquisition date.
b. In-process research and development (IPRD) assets relate to the acquisition-date value
of research projects currently in process and during their developmental stages (i.e.,
before the research projects have reached technological feasibility). Under current
GAAP, investors value and recognize IPRD assets acquired in a business combination at
their fair values just like any other assets acquired (FASB ASC 350-30-30-1. After initial
recognition, tangible net assets used to support research and development activities
(e.g., R&D building and associated equipment) are accounted for in accordance with
their nature (i.e., they are depreciated/amortized). Intangible research and
development assets, on the other hand, should be considered indefinite-lived (i.e., not
amortized) until the associated research and development activities are either
completed (then, the intangible assets are amortized over the life of the related patent
or copyright) or abandoned (in which case they are written off in the year of
abandonment). Acquired intangible IPRD assets are included in the annual goodwill
impairment tests (FASB ASC 350-20-35-15).
On balance, it would appear that Company A is the acquirer. Its CEO will be the chief
executive of the combined entity, and, in three years, Company As Chairman will
become the new Company Chairman as well. During the interim, neither company can
control the strategic direction of the combined company since each elects one-half of the
Board of Directors.
b. The allocation of the purchase price is quite different for the two potential acquirers:
If Company A If Company B
is deemed to be is deemed to be
the Subsidiary the Subsidiary
Purchase Price $ 1.5 billion $ 1.5 billion
Tangible net assets (1.0 billion) (0.4 billion)
Identifiable intangible assets (0.3 billion) (0.6 billion)
Goodwill $ 0.2 billion $ 0.5 billion
If Company B is the acquirer and Company A is the subsidiary, more of the purchase
price will be allocated to the fair value of tangible net assets and identifiable intangible
assets. Both of these categories must be depreciated or amortized. As a result, more of
the purchase cost will hit the consolidated income statement (Goodwill is not
amortized, and becomes an expense only if impaired). Also, if Company B is the
acquirer, less Goodwill asset will be recognized. The choice of the acquirer is often not
an issue. But, when it is, it can be a significant one.
This analysis is made solely from a financial perspective. There are other significant
implications of the choice of the acquirer, including
The acquirer may get to name the combined company with its name or using its
name first.
The image of the combined company in the market place may be different
depending on which company is viewed as the acquirer.
The acquirers philosophies and modes of operation may dominate the combined
company.
The acquirer may get the choice of the home office.
The acquirers employees may feel a sense of superiority. Conversely, the
acquirees employees may feel like theyve been taken over. This can cause real
morale problems if not handled well.
b.
[E] Common stock 30,000
Retained earnings 45,000
Equity investment 75,000
(to eliminate the Stockholders Equity of the subsidiary on
the acquisition date)
40. a.
Equity investment 250,000
Cash 250,000
(to record the acquisition)
b.
[E] Common stock 50,000
Retained earnings 50,000
Equity investment 100,000
(to eliminate the Stockholders Equity of the subsidiary on
the acquisition date)
b. The Equity Investment account is comprised of the fair values of the net assets of the
subsidiary ($550,000, which happen to equal the book values) and the carrying amount
of the Goodwill asset ($100,000).
42. a.
[E] Capital stock and Retained earnings 8,795
Equity Investment 8,795
(to eliminate the stockholders equity of the subsidiary on the
acquisition date)
b. In-Process Research & Development (IPRD) is expensed in the [A] entry in part (a) as
required under previous GAAP. Under current GAAP, acquirers recognize IPRD assets
acquired in a business combination at their fair values just like any other assets acquired
(FASB ASC 350-30-30-1). After initial recognition, tangible net assets used to support
research and development activities (e.g., R&D building and associated equipment) are
accounted for in accordance with their nature (i.e., they are depreciated/amortized).
Intangible research and development assets, on the other hand, should be considered
indefinite-lived (i.e., not amortized) until the associated research and development
activities are either completed (then, the intangible assets are amortized over the life of
the related patent or copyright) or abandoned (in which case they are written off in the
year of abandonment). Acquired intangible IPRD assets are included in the annual
Goodwill impairment tests (FASB ASC 350-20-35-15).
43. a. No, this is the fair value of these assets. The [A] consolidation journal entry records the
difference between the fair value and the book value of these assets on the acquirees
acquisition-date balance sheet.
b.
[A] Customer contracts 1,942
Technology 1,501
Trademarks 74
Trade name 1,422
Goodwill 14,450
Equity Investment 19,389
(to record the intangible assets)
c. Amortizable intangible assets have a useful life and must be amortized over that useful
life. The cost of these assets is ultimately reflected as expense in the income statement.
To the extent that this portion of the purchase price is allocated to Goodwill, that cost
does not impact the income statement unless and until the Goodwill asset is deemed to
be impaired, at which time it is written down or off. SFAS 141(R) requires companies to,
first, allocate the purchase price to identifiable intangible assets before recognizing any
goodwill in the purchase.
d. HP does not feel that the Compaq trade name will be diminished in value over time, that
is, it will continue to generate cash flows indefinitely. Indefinite does not mean infinite.
The accounting significance of this distinction is that indefinite-lived assets must be
tested at least annually for impairment.
Income Indicates value for a subject asset Certain intangible assets such as
approach based on the present value of cash customer relationships, as well
flow projected to be generated by the as for favorable/unfavorable
asset contracts
b. The market approach (using comparable market prices for similar assets) and the cost
approach (using replacement cost) are the least subjective approaches. The income
approach (sometimes referred to as discounted cash flow or DCF approach) is the most
subjective approach as it involves both the projection of cash flows and the choice of an
appropriate discount rate. In its allocation of the purchase price for MCI to the assets
acquired and the liabilities assumed, a significant portion of the purchase price was
allocated to intangible assets using the income approach. This is not uncommon.
Remember this next time you look at a purchase price allocation table.
c. The allocation of the purchase price to net tangible and intangible assets is as follows:
b.
[E] Common stock 100,000
APIC 125,000
Retained earnings 775,000
Equity investment 1,000,000
(to eliminate the stockholders equity of the subsidiary
on the acquisition date)
c.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 405,000 $ 226,000 $ 631,000
Accounts receivable 1,280,000 348,000 1,628,000
Inventory 1,940,000 447,000 2,387,000
Equity investment 1,000,000 [E] 1,000,000 0
PPE, net 9,332,000 827,000 10,159,000
$13,957,000 $1,848,000 $14,805,000
b.
[E] Common stock 100,000
APIC 125,000
Retained earnings 775,000
Equity investment 1,000,000
(to eliminate the Stockholders Equity of the subsidiary
on the acquisition date)
c.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 3,082,500 $ 226,000 $ 3,308,500
Accounts receivable 1,280,000 348,000 1,628,000
Inventory 1,940,000 447,000 2,387,000
Equity investment 1,750,000 [E] 1,000,000 0
[A] 750,000
PPE, net 9,332,000 827,000 10,159,000
Patent [A] 200,000 200,000
Goodwill [A] 550,000 550,000
$17,384,500 $1,848,000 $18,232,500
d. We have recognized the Patent and Goodwill assets. Previously, these assets were
embedded in the Equity Investment account on the Parents balance sheet. In the
consolidation process, they are explicitly recognized.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 910,500 $ 201,600 $1,112,100
Accounts receivable 384,000 417,600 801,600
Inventory 582,000 536,400 1,118,400
Equity investment 2,200,000 [E] 1,200,000 0
[A] 1,000,000
PPE, net 2,799,600 992,400 [A] 500,000 4,292,000
License agreement [A] 250,000 250,000
Customer list [A] 100,000 100,000
Goodwill [A] 150,000 150,000
$6,876,100 $2,148,000 $7,824,100
b. We will report the License Agreement ($250,000), Customer List ($100,000), and
Goodwill ($150,000).
48. a.
Equity investment 2,100,000
Common stock 70,000
APIC 2,030,000
(to record the acquisition)
c.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 428,200 $ 189,400 $ 617,600
Accounts receivable 256,000 452,400 708,400
Inventory 388,000 581,100 969,100
Equity investment 2,100,000 [E] 1,300,000 0
[A] 800,000
PPE, net 9,666,400 1,075,100 10,741,500
Trademark [A] 200,000 200,000
Video library [A] 500,000 500,000
Patented technology [A] 100,000 100,000
$12,838,600 $2,298,000 $13,836,600
d. We have recognized three intangible assets in the consolidation process: the Trademark,
the Video Library, and Patented Technology. Previously, these assets were embedded in
the Equity investment account on the Parents balance sheet. In the consolidation
process, they are explicitly recognized.
b.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 783,300 $ 104,000 $ 887,300
Accounts receivable 384,000 696,000 1,080,000
Inventory 582,000 894,000 1,476,000
Equity investment 4,000,000 [E] 2,000,000 0
[A] 2,000,000
PPE, net 14,499,600 1,654,000 [A] 1,000,000 17,153,600
Customer list [A] 200,000 200,000
Brand name [A] 500,000 500,000
Goodwill [A] 895,000 895,000
$20,248,900 $3,348,000 $22,191,900
Value of consideration
(stock plus contingent consideration) $4,000,000
Less:
Fair value of net assets $3,700,000
Deferred income tax liability (595,000) 3,105,000
Goodwill $ 895,000
50. a. FASB ASC 805-10-25-13 through 25-19 permits companies to use provisional amounts,
and to retrospectively adjust those amounts when better information becomes
available, provided that the final measurement of all assets and liabilities is completed
within one year from the acquisition date.
b. In $millions
Equity investment 7,295
Cash 7,196
Common stock and APIC 99
d. FASB ASC 805-20-30-1 requires that, as of the acquisition date, The acquirer shall
measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree at their acquisition-date fair values, and FASB ASC 820-10-20
defines fair value as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement
date. Companies can estimate these fair values using a market approach, an income
approach, or a cost approach. Each of these approaches requires significant
estimates.
e. In-process research and development (IPRD) assets relate to the value of research
projects currently in process and during their developmental states (i.e., before the
research projects have reached technological feasibility) on the date of the acquisition.
These might include, for example, patents received or applied for, blueprints, formulas,
and specifications or designs for new products or processes, materials and supplies,
equipment and facilities, and perhaps even a specific research project in process.
f. If the acquisition-date fair value of the asset or liability arising from a contingency can be
determined during the measurement period, that asset or liability is recognized at the
acquisition date (FASB ASC 805-20-25-19).
g. Oracle credits the Equity Investment account for its book value of $7,295 million to
remove that account from the consolidated balance sheet. The offsetting debits and
credits will remove the beginning-of-year stockholders equity of Sun Microsystems, Inc.,
and recognizes, as reported assets and liabilities on the consolidated balance sheet, the
excess of the fair value of the acquired assets and liabilities assumed in excess of their
respective books values.