CHAPTER 02 – CONSOLIDATION OF

FINANCIAL INFORMATION
PROBLEMS 2-20, 2-21, 2-27, 2-22

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What is a Business Combination?

 Business Combination: one company gains control of another, forming a single entity

 3 Types of Business Combinations

1. Statutory Merger (A + B = A)
2. Statutory Consolidation (A + B = New C)
3. Acquisition of the Shares (A + B = A + B)
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3 Types of Business Combinations

1. Statutory Merger (A + B = A)
 Only B dissolves (B cease to exist as a separate entity)
 Make a big journal entry on company A's books
 Put everything that belongs to company B on company A’s books
2. Statutory Consolidation (A + B = New C)
 Both A + B dissolve and create C
 Not common in real life
3. Acquisition of the Shares (A + B = A + B)
 Most frequent type of business combination
 Both companies continue to exist, neither company dissolves
 Create a consolidation worksheet
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Acquisition Method
1. Assets and Liabilities of acquired companies must be shown at fair value
2. Fair Value of Consideration Transferred – Fair Value of Net Assets = Goodwill
 Fair Value of Consideration Transferred consists of 3 components:
1) Cash
2) Stock
3) Contingent Performance Obligation
 We sell our company to someone else, but we are unhappy with the
purchase price so we propose: "if the net income will be $2 million for
each of the next 2 years, will you consider paying an extra $500,000?"
 Always use the PRESENT VALUE of the Contingent Performance Obligation
in the calculation of the Fair Value of Consideration Transferred
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Related Costs of Business Combinations

 Direct Combination Costs (aka professional service expense)
 Expensed as incurred
 Eg: fees with regards to attorneys, appraisers, accountants, investment bankers,
etc.
 Indirect Costs or Internal Costs
 Expensed as incurred
 Eg: secretarial and management time
 Stock Issuance Costs
 Costs to register and issue securities related to the acquisition reduce their fair
value.
 Results in a reduction of Additional Paid in Capital (APIC)
 This is not an expense
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R&D & Bargain Purchase

 In Process Research and Development
 Generally, Research & Development is expensed as incurred unless they affect
future years, but in a business combination, it is recorded as a non-current
intangible asset
 Bargain Purchase = Gain (on Income Statement)
 Also known as "Gain on Bargain Purchase"
 Happens when you pay less than fair value for a company
 Can happen because a company is in distress
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Problem 2-20
 The following book and fair values were available for Westmont Company as of March 1.

Chart 2-20

 Arturo Company pays $4,000,000 cash and issues 20,000 shares of its $2 par value common stock (fair
value of $50 per share) for all of Westmont's common stock in a merger, after which Westmont will cease
to exist as a separate entity. Stock issue costs amount to $25,000 and Arturo pays $42,000 for legal fees to
complete the transaction. Prepare Arturo's journal entry to record its acquisition of Westmont.
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P2-20 – Find the FV of Consideration Transferred

Chart 2-20 + Cash 4,000,000
+ Stock 1,000,000
+ Contingent Obligation 0
FV of Consideration Transferred 5,000,000
+ FV of Assets ?
- FV of Liabilities ?
- FV of Net Assets Acquired ?
Goodwill ?

 Cash --- 4,000,000 (given)

 “Arturo Company pays $4,000,000 cash…”
 Stock --- 1,000,000 = 20,000 shares x $ 50 fair value per share
 “…issues 20,000 shares of its $2 par value common stock (fair value of $50
per share) for all of Westmont's common stock in a merger.”
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P2-20 – Goodwill or Gain on Bargain Purchase?

Chart 2-20 + Cash 4,000,000
+ Stock 1,000,000
+ Contingent Obligation 0
FV of Consideration Transferred 5,000,000
+ FV of Assets 4,390,000
- FV of Liabilities 80,000
- FV of Net Assets Acquired 4,310,000
Goodwill 690,000

 Cash --- 4,000,000 (given)

 “Arturo Company pays $4,000,000 cash…”
 Stock --- 1,000,000 = 20,000 shares x $ 50 fair value per share
 “…issues 20,000 shares of its $2 par value common stock (fair value of $50
per share) for all of Westmont's common stock in a merger.”
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P2-20 – Prepare Arturo's journal entry to record its acquisition of Westmont.

Chart 2-20 +Cash 4,000,000
+Stock 1,000,000
+Contingent Obligation 0
FV of Consideration Transferred 5,000,000
+FV of Assets 4,390,000
-FV of Liabilities 80,000
- FV of Net Assets Acquired 4,310,000
Goodwill 690,000

Inventory 600,000
Land 990,000
Buildings 2,000,000
Customer relationships 800,000
Goodwill 690,000  Common Stock --- $40,000 =
Accounts Payable 80,000 20,000 shares x $2 par
Common Stock 40,000  “…issues 20,000 shares of
Additional paid-in capital 960,000
its $2 par value…”
Cash 4,000,000
 APIC --- $960,000 = 1,000,000 -
40,000
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P2-20 – Prepare Arturo's journal entry to record its acquisition of Westmont.

Inventory 600,000
Land 990,000
Buildings 2,000,000
Customer relationships 800,000
Goodwill 690,000
Accounts Payable 80,000
Common Stock 40,000

Additional paid-in capital 960,000

Cash 4,000,000

 “…Arturo pays
Professional Service Expense 42,000
Cash 42,000
$42,000 for legal fees
to complete the Additional Paid-in Capital 25,000
transaction.” Cash 25,000
 “Stock issue costs
amount to $25,000…”
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Problem 2-21
 The following book and fair values were available for Westmont Company as of March 1.

Chart 2-21

 Arturo Company pays $4,200,000 cash for all of Westmont's common stock in a merger, after which
Westmont will cease to exist as a separate entity. Stock issue costs amount to $25,000 and Arturo pays
$42,000 for legal fees to complete the transaction. Prepare Arturo's journal entry to record its acquisition
of Westmont.
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P2-21 – Goodwill or Gain on Bargain Purchase?

Chart 2-21 +Cash 4,200,000
+Stock 0
+Contingent Obligation 0
FV of Consideration Transferred 4,200,000
+FV of Assets 4,390,000
-FV of Liabilities 80,000

- FV of Net Assets Acquired - 4,310,000

Gain on Bargain Purchase (110,000)

 Cash --- 4,200,000 (given)

 “Arturo Company pays $4,200,000 cash…”
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P2-21 – Prepare Arturo's journal entry to record its acquisition of Westmont.

Chart 2-21 +Cash 4,200,000
+Stock 0
+Contingent Obligation 0
FV of Consideration Transferred 4,200,000
+FV of Assets 4,390,000
-FV of Liabilities 80,000

- FV of Net Assets Acquired 4,310,000

Gain on Bargain Purchase (110,000)

Inventory 600,000
Land 990,000
Buildings 2,000,000
Customer relationships 800,000
Accounts Payable 80,000
Cash 4,200,000
Gain on Bargain Purchase 110,000
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P2-21 – Prepare Arturo's journal entry to record its acquisition of Westmont.

Inventory 600,000
Land 990,000
Buildings 2,000,000
Customer relationships 800,000
Accounts Payable 80,000
Cash 4,200,000
Gain on Bargain Purchase 110,000

Professional Service Expense 42,000

Cash 42,000

 Given: “…Arturo pays $42,000 for legal fees to complete the transaction.”
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The Consolidation Worksheet

 Consolidation worksheet entries (adjustments and eliminations) are entered on the
worksheet only.
 Steps in the process:
1. Prior to constructing a worksheet, the parent prepares a formal allocation of the
acquisition date fair value similar to the equity method procedures.
2. Financial information for Parent and Sub is recorded in the first two columns of
the worksheet (with Sub’s prior revenue and expense already closed).
3. Remove the Sub’s equity account balances.
4. Remove the Investment in Sub balance.
5. Allocate Sub’s Fair Values, including any excess of cost over Book Value to
identifiable assets or goodwill.
6. Combine all account balances and extend into the Consolidated totals column.
7. Subtract consolidated expenses from revenues to arrive at net income.
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Problem 2-27
 Pratt Company acquired all of Spider, Inc.'s outstanding shares on December 31,
2015, for $495,000 cash. Pratt will operate Spider as a wholly owned subsidiary
with a separate legal and accounting identity. Although many of Spider's book
values approximate fair values, several of its accounts have fair values that differ
from book values. In addition, Spider has internally developed assets that remain
unrecorded on its books. In deriving the acquisition price, Pratt assessed Spider's
fair and book value differences as follows:
CHART 2-27A
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Problem 2-27
At December 31, 2015, the following financial information is available for consolidation:
CHART 2-27B

Note: Parentheses indicate

a credit balance.

Prepare a consolidated balance sheet for Pratt and Spider as of December 31, 2015.
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P2-27 – Find the Excess FV over BV

Explanation:
 Consideration transferred at fair value = 495,000
“Excess Fair Value over  “Pratt Company acquired all of Spider, Inc.'s outstanding shares on December
Book Value” --- Usually, 31, 2015, for $495,000 cash.”
excess fair value is caused  Book Value = 265,000
by undervalued or  All numerical figures below were given in Chart 2-27B of Problem 2-27
unrecorded assets. We  Spider’s Total Assets – Spider’s Total Liabilities = Book Value
must allocate this excess
 Total Assets (given) – (Accounts Payable + Notes Payable)
to such assets (see next
 350,000 – (25,000 + 60,000) = 265,000
slide). If any unexplained
excess remains after  Alternatively, add up all of Spider’s Shareholder Equity
allocation, we attribute it  Common Stock + Additional Paid-In Capital + Retained Earnings
to goodwill.  100,000 + 25,000 + 140,000 = 265,000
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P2-27 – Amortization Schedule & Goodwill (if any)

Allocation Calculations: FV BV FV-BV

Computer Software 70,000 20,000 50,000 undervalued
Equipment 30,000 40,000 (10,000) overvalued
Client Contracts 100,000 - 100,000 undervalued
In-process research and development 40,000 - 40,000 undervalued
Notes Payable (65,000) (60,000) (5,000) undervalued

Fair Values and Book Values were given from Chart 2-27A on the first slide of the problem!
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P2-27 – Entries S & A

Entry S
Common Stock-Subsidiary 100,000 Figures were given
Additional paid-in capital-Subsidiary 25,000 in Chart 2-27B
Entries “S” & “A”
shown here to Retained Earnings-Subsidiary 140,000
demonstrate Investment 265,000
worksheet on next
slide. More Entry A
information on
these entries to Computer Software 50,000 Journal Entry A
come in chapter 3! Client Contracts 100,000 figures were
calculated in
In-process research and development 40,000
previous slide.
Goodwill 55,000
Equipment 10,000
Notes Payable 5,000
Investment 230,000
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P2-27 – Consolidation Worksheet

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P2-27 – Prepare a consolidated balance sheet for Pratt and Spider as of

December 31, 2015.

All figures derived from the consolidated worksheet on previous slide.

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Problem 2-22
 Following are preacquisition financial balances for Padre Company and Sol Company as of December
31. Also included are fair values for Sol Company accounts.
CHART 2-22

Note:
Parentheses
indicate a credit
balance.
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Problem 2-22
 On December 31, Padre acquires Sol's outstanding stock by paying $360,000 in cash
and issuing 10,000 shares of its own common stock with a fair value of $40 per share.
Padre paid legal and accounting fees of $20,000 as well as $5,000 in stock issuance
costs.
 Determine the value that would be shown in Padre's consolidated financial
statements for each of the accounts listed.

1) Inventory 6) Revenues
2) Land 7) Additional paid-in capital
3) Buildings and equipment 8) Expenses
4) Franchise agreements 9) Retained earnings, 1/1
5) Goodwill 10) Retained earnings, 12/31
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P-22 – 5) Goodwill
Cash 360,000
Stock 400,000
0
Contingent Obligation  
FV of Consideration Transferred 760,000
FV of Assets 1,340,000
-FV of Liabilities 660,000  
- FV of Net Assets Acquired 680,000
Goodwill 80,000
5) Goodwill

EXPLANATION:
• Cash --- $360,000 (given)
• “On December 31, Padre acquires Sol's outstanding stock by paying $360,000 in cash…”
• Stock --- $400,000 = 10,000 shares x $40 FV per share
• “…issuing 10,000 shares of its own common stock with a fair value of $40 per share.”
• Fair Value of Assets & Fair Value of Liabilities
• add up all the assets of Sol Company at fair value (values given from Chart 2-22)
• add up all the liabilities of Sol Company at fair value (values given from Chart 2-22)
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P-22 – 7) Additional Paid-In Capital (Part 1)

• Stock --- $400,000
• 10,000 shares x $40 FV per share = $400,000
• “…issuing 10,000 shares of its own common stock with a fair value of $40 per share.”
 Common Stock --- $200,000 = 10,000 x $20 par
 Additional paid-in capital --- $265,000
 Calculation
 = ($10,000 shares x $40 FV per share) – (10,000 shares x $20 par)
 = $400,000 - $200,000
 = $200,000  this is what we will record in the acquisition entry
 But we still have to consider the stock issuance costs!!!
 “…$5,000 in stock issuance costs.”

Continue on the next slide!

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P-22 – 7) Additional Paid-In Capital (Part 2)

Stock Issuance Costs - “…$5,000 in stock issuance costs.”

Additional paid-in capital 5,000

Cash 5,000

Additional paid-in capital

70,000 given in chart 2-27
200,000 calculated previously
Stock issuance costs 5,000  
265,000 7) Additional paid-in capital
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P-22 – Consolidated Values of Other Assets

Padre Sol
BV BV FV parent BV + sub's FV
1) Inventory 410,000 210,000 260,000 670,000
2) Land 600,000 130,000 110,000 710,000
3) Building and equipment (Net) 600,000 270,000 330,000 930,000
4) Franchise agreements 220,000 190,000 220,000 440,000
Values taken from Chart 2-22
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P-22 – Journal Entries

Cash 120,000 given in chart 2-22
Accounts Receivable 300,000 given in chart 2-22
Inventory 260,000 given in chart 2-22
Land 110,000 given in chart 2-22
Building and equipment 330,000 given in chart 2-22
Franchise agreements 220,000 given in chart 2-22
Goodwill 80,000 given in chart 2-22
Accounts payable 120,000 given in chart 2-22
Accrued expenses 30,000 given in chart 2-22
Long-term liabilities 510,000 given in chart 2-22
Cash 360,000 given in word problem
Common Stock 200,000 Calculated previously
Additional paid-in capital 200,000 Calculated previously

Professional Service Expense 20,000 given in word problem

Cash 20,000

Additional paid-in capital 5,000 given in word problem Note: it is not

Cash 5,000 necessary to
create journal
entries for this
problem.
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P-22 – 6) Revenue & 8) Expenses

“Padre paid legal and accounting fees of $20,000…”
Professional Service Expense 20,000
Cash 20,000

CHART 2-22  6) Revenues = $960,000

 8) Expenses = $940,000
 $920,000 + $20,000 professional
services expense = $940,000

 Why not add up Padre’s BV and Sol’s FV

like we did for the other items?
 The parent will get all of the earnings
from the date of acquisition forward.
That is, they will only get future
earnings. They are not entitled to pre-
acquisition earnings.
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P-22 – Retained Earnings

 9) Retained earnings, 1/1 = $390,000
 given in Chart 2-22
 10) Retained earnings, 12/31 = $410,000
 Retained Earnings Beginning Balance + Revenues – Expenses = Retained Earnings, 12/31
 $390,000 + $960,000 - $940,000 = $410,000
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P-22 – Solution Summary

 Determine the value that would be shown in Padre's consolidated financial statements for each of the
accounts listed.
 Inventory --- $670,000
 Land --- $710,000
 Buildings and equipment --- $930,000
 Franchise agreements --- $440,000
 Goodwill --- $80,000
 Revenues --- $960,000
 Additional paid-in capital --- $265,000
 Expenses --- $940,000
 Retained earnings, 1/1 --- $390,000
 Retained earnings, 12/31 --- $410,000