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Flashcards in Business Combinations and Consolidations Deck (104):
1

Which one of the following is not a legal form of business combination?

  1. Consolidation.
  2. Merger.
  3. Pooling of interests.
  4. Acquisition.

Pooling of interests.

A pooling of interests is not one of the three legal forms of business combinations, which are: (1) merger, (2) consolidation, and (3) acquisition. A pooling of interests is a method of accounting for a business combination, but under GAAP, it cannot be used after June 30, 2001.

2

Under normal circumstances, what minimum level of voting ownership is considered to give the investor control over the investee?

  1. 10+%
  2. 20+%
  3. 50+%
  4. 100%

50+%

In the absence of circumstances that restrict an investor from exercising its ownership rights, owning 50+% of the voting securities will give the investor control over the investee. Since it has majority ownership, it can elect the Board of Directors of the investee and, thus, control the operations of the investee.

3

For business combinations, which one of the following statements correctly reflects the determination of the accounts and amounts for the entry to record the combination?

  1. Legal form determines both the entry accounts and entry amounts.
  2. Legal form determines the entry accounts; accounting method determines entry amounts.
  3. Legal form determines entry amounts; accounting method determines entry accounts.
  4. Accounting method determines both the entry accounts and entry amounts.

Legal form determines the entry accounts; accounting method determines entry amounts.

The legal form of a business combination determines the entry accounts (i.e., which accounts to debit and/or credit), and the accounting method (acquisition method) determines the amounts at which the entries will be made (i.e., fair value).

4

If, as a result of gaining control of another entity, the acquiring entity recognizes an investment in the acquired entity on its books, which of the following legal forms of business combination could have occurred?

  1. Merger   
  2. Consolidation  
  3. Acquisition

  1. Merger - NO 
  2. Consolidation - NO  
  3. Acquisition - YES

In an acquisition, the acquiring entity recognizes (debits) on its books as an investment in the acquired entity, but in a merger and in a consolidation, the assets and liabilities of the acquired entity/entities are recorded on the books of the acquiring entity, not an investment in the acquired entity. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities, with the acquired entity a subsidiary of the acquiring entity. In a merger and in a consolidation, at least one preexisting entity ceases to exist, and the assets and liabilities are recorded on the books of the surviving entity.

5

In which of the following legal forms of business combination are the assets and liabilities of an acquired entity or entities recorded on the books of the acquiring entity?

  • Merger   
  • Acquisition  
  • Consolidation

  • Merger - YES
  • Acquisition - NO
  • Consolidation - YES

In a merger and in a consolidation, the assets and liabilities of the acquired entity/entities are recorded on the books of the acquiring entity, but in an acquisition, the assets and liabilities of the acquired entity remain on the books of the acquired entity. In a merger and in a consolidation, at least one preexisting entity ceases to exist, and the assets and liabilities are recorded on the books of the surviving entity. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities.

6

In which of the following legal forms of business combination are two or more entities combined into one new entity?

  • Merger   
  • Consolidation   
  • Acquisition 

  • Merger - NO
  • Consolidation - YES  
  • Acquisition - NO

Only a legal consolidation results from the combination of two or more existing entities into one new entity. In a merger, one preexisting entity is combined into another preexisting entity; no new entity is formed. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities; no new entity is formed.

7

Topco owns 60% of the voting common stock of Midco and 40% of the voting common stock of Botco. Topco wishes to gain control of Botco by having Midco buy shares of Botco's voting stock. Which one of the following minimum levels of ownership of Botco must Midco have in order for Topco to have controlling interest of Botco's voting stock?

  1. 11%
  2. 17%
  3. 26%
  4. 50+%

11%

In order for Topco to gain control of Botco, it must own, either directly or indirectly, more than 50% of Botco's voting stock. Since it directly owns 40% of Botco's voting stock, it must acquire control over 10+% more. Also, since Topco owns 60% of Midco, it controls Midco. Therefore, if Midco acquires 11% of Botco, Topco will be able to exercise 51% of Botco's voting stock - 40% directly and 11% indirectly through its control of Midco.

8

If a business combination is effected through an exchange of equity interests, assuming all other factors are equal, which one of the following independent circumstances would not indicate the likely acquirer in a business combination?

  1. The combining entity whose owners have the larger portion of voting rights in the combined entity.
  2. The combining entity whose owners have the ability to select or remove a voting majority of the governing body of the combined entity.
  3. The combining entity whose debt-holders have the larger portion of the debt of the combined entity.
  4. The combining entity whose former management dominates the combined entity.

The combining entity whose debt-holders have the larger portion of the debt of the combined entity.

Because debt-holders do not have voting rights and cannot exercise control over an investee, the combining entity whose debt-holders have the larger portion of the debt of the combined entity by itself would not indicate that the entity is an acquirer in a business combination.

9

Which of the following statements concerning the acquisition date of a business combination is/are correct?

  • The acquisition date may be before the closing date.
  • The acquisition date may be on the closing date.
  • The acquisition date may be after the closing date.

  • The acquisition date may be before the closing date. - YES
  • The acquisition date may be on the closing date. - YES
  • The acquisition date may be after the closing date. - YES

All three statements are correct. The acquisition date may be before the closing date, on the closing date, or after the closing date, if by agreement or otherwise the acquirer gains control of the acquiree at an earlier or later date than the closing date.

10

When a new entity is formed to effect a business combination, which of the following statements, if any, is/are correct?

  • A legal consolidation has occurred.
  • The new entity is always the acquirer in the business combination.

  • A legal consolidation has occurred. - YES
  • The new entity is always the acquirer in the business combination. - NO

Statement I is correct; Statement II is not correct. When a new entity is formed to effect a business combination, a legal consolidation has occurred (Statement I), but the new entity is not always the acquirer in the combination (Statement II). If the new entity transfers cash or other assets or incurs liabilities to effect the combination, the new entity is likely the acquirer, but if the new entity issues equity interest to effect the business combination, one of the pre-existing combining entities must be the acquirer.

11

The acquisition date of a business combination is generally which one of the following?

  1. The effective date.
  2. The closing date.
  3. The settlement date.
  4. The recording date.

The closing date.

The acquisition date of a business combination is the date on which the acquiring entity obtains control of the acquired business; usually, it is also the closing date (of the business combination).

12

At the closing date of a business combination, goodwill was recognized. During the subsequent measurement period, additional identifiable assets were properly recognized as part of the business combination. If no other changes occurred during the measurement period, which one of the following would be the effect, if any, of the additional assets recognized on the amount of goodwill recognized in the combination?

  1. No change in the amount of goodwill recognized.
  2. An increase in the amount of goodwill recognized.
  3. A decrease in the amount of goodwill recognized.
  4. An increase or decrease in the amount of goodwill recognized, depending on the underlying reason(s) for the goodwill.

A decrease in the amount of goodwill recognized.

The recognition of additional identifiable assets would result in a decrease in the amount of goodwill initially recognized in a business combination. Since goodwill is basically the difference (residual) between the investment fair value and the fair value of the net identifiable assets acquired, an increase in the identifiable assets will result in a decrease in the amount of goodwill.

13

In which one of the following cases is Company A most likely to be the acquirer of Company B in a business combination?

  1. Company A owns 80% of Company B's long-term debt.
  2. Company A owns 40% of Company B's voting stock and 40% of Company C's voting stock, which owns 20% of Company B's voting stock.
  3. Company A owns 35% of Company B's voting stock and 60% of Company C's voting stock, which owns 20% of Company B's voting stock.
  4. Company A owns 40% of Company B's outstanding bonds and 20% of Company B's voting stock.

Company A owns 35% of Company B's voting stock and 60% of Company C's voting stock, which owns 20% of Company B's voting stock.

Generally, to be an acquirer, an entity must own, either directly or indirectly, more than 50% of the voting stock of another entity. In this case, Company A owns 35% of Company B directly and would control 20% indirectly, or a total of 55%. (Since Company A owns 60% of Company C, it has absolute control of C and could control C's 20% ownership of B.) Thus, Company A would control Company B and likely would be an acquirer in a business combination.

14

Which one of the following correctly describes the maximum length of the measurement period for a business combination?

  1. The acquisition date of the business combination.
  2. The end of the annual fiscal period in which the combination occurs.
  3. One year from the acquisition date of the combination.
  4. Indefinite, until all information about accounts and amounts is known.

One year from the acquisition date of the combination.

The measurement period may extend up to one year from the acquisition (closing) date of a business combination. The measurement period is the period after the acquisition date during which the acquirer may adjust any provisional amounts recognized as part of the business combination, and it may extend for as long as one year after the acquisition date.

15

Which of the following statements, if any, concerning the accounting for business combinations is/are correct?

  • All business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805, "Business Combinations."
  • The acquisition accounting requirements of ASC 805, "Business Combinations," are identical to those of IFRS #3, "Business Combinations."

NEITHER.

either statement is correct. No business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805 (Statement I). That pronouncement specifically excludes certain combinations, including the formation of a joint venture, the acquisition of assets that do not constitute a business, a combination between entities under common control, a combination between not-for-profit organizations, and the acquisition of a for-profit entity by a not-for-profit organization. In addition, the requirements of ASC 805 are not identical to those of IFRS #3 (Statement II). Differences exist between the two pronouncements in the areas of scope; the definition of control; how fair value, contingencies, employee benefit obligations, noncontrolling interest, and goodwill are measured; and disclosure requirements.

16

Which one of the following would be subject to the acquisition accounting requirements of ASC 805, "Business Combinations?"

  1. Formation of a joint venture.
  2. Acquisition of a manufacturing entity by a holding company.
  3. Acquisition of a for-profit entity by a not-for-profit organization.
  4. Combination of entities under common control.

Acquisition of a manufacturing entity by a holding company.

The acquisition of a manufacturing entity by a holding company would be subject to the acquisition accounting requirements of ASC 805. The formation of a joint venture, the acquisition of assets that do not constitute a business, a combination between entities under common control, a combination between not-for-profit organizations, and the acquisition of a for-profit entity by a not-for-profit organization are the only combinations specifically excluded from the scope of ASC 805.

17

The requirements of ASC 805, "Business Combinations," apply to all of the following business combinations except for which one?

  1. Combination between financial institutions.
  2. The acquisition of a foreign entity by a U.S. entity.
  3. Combination between not-for-profit organizations.
  4. The acquisition of a group of assets that constitutes a business.

Combination between not-for-profit organizations.

The requirements of ASC 805 do not apply to combinations between not-for-profit organizations (or to the formation of a joint venture, an acquisition of assets that do not constitute a business, a combination of entities under common control, or the acquisition of a for-profit entity by a not-for-profit organization).

18

Which of the following is/are acceptable methods to account for a business combination?

  • Purchase Method
  • Acquisition Method
  • Pooling of interests Method

  • Purchase Method - NO
  • Acquisition Method - YES
  • Pooling of interests Method - NO

Only the acquisition method is acceptable in accounting for a business combination. The purchase method and the pooling of interests method of accounting for a business combination are not acceptable methods. The pooling of interests method was eliminated in 2001 and the purchase method was changed to the acquisition method in 2008. Although the acquisition method is a variation of the purchase method, it has sufficiently different requirements that it is not identified as the "purchase method," but rather as the "acquisition method."

19

Which one of the following is not a characteristic associated with the concept of a "business" for the purposes of ASC 805, "Business Combinations?"

  1. Is an integrated set of activities and assets.
  2. Uses inputs and processes.
  3. Is intended to provide economic benefits to owners or others.
  4. Must be in the form of a separate legal entity.

Must be in the form of a separate legal entity.

For the purposes of ASC 805, a business does not have to be in the form of a separate legal entity. Specifically, a business is an integrated set of activities and assets that is capable of being conducted and managed through the use of inputs and processes for the purpose of providing economic benefits to owners, members, or participants. The concept of a "business" for the purposes of ASC 805 does not have to be in the form of a separate legal entity. Under this definition, a "business" may be a group of assets (or net assets) that constitute a business (e.g., a line of business) and does not have to be in the form of a separate legal entity.

20

Zipco, Inc. acquired 100% of the voting stock of Narco, Inc. with an acquisition date of March 31, 2009. During the following three months, Zipco learned the following:

  • A major credit customer of Narco had declared bankruptcy on March 1, 2009, but the adverse effect on Narco's accounts receivable had not been recognized in the amount of accounts receivable recognized in the acquisition date amounts.
  • Narco had a lawsuit against it that existed at the acquisition date of the combination but was not recognized on Narco's books or in the liabilities recognized at the acquisition date. Analysis determined that it was more likely than not that the party that brought the lawsuit would win a material judgment against Narco/Zipco.

Which of these items of new information, if any, should be recognized in accounting for the business combination?

BOTH.

The effects of both the reduced accounts receivable and the lawsuit liability would be recognized in accounting for the business combination. Since the effects on Narco's accounts receivable and the lawsuit liability both occurred before the acquisition date, both items would be recognized in accounting for the business combination and would be adjustments made during the measurement period. The effects would be to reduce accounts receivable (Item I) and to increase liabilities (Item II) in the final recording of the business combination.

21

The terms of a business combination can provide that former shareholders of the acquired firm may receive additional compensation based on post-combination earnings or post-combination market share price. Would additional compensation based on such earnings or market price be considered an additional cost of the business combination?

  • Based on Earnings
  • Based on Share Price 

  • Based on Earnings - NO
  • Based on Share Price - NO

Additional compensation to former shareholders of an acquired entity based on either post-combination earnings or post-combination share price would not be recognized as changes in the cost of the business combination. Changes in the fair value of contingent consideration resulting from occurrences after the acquisition date, including meeting earnings targets and reaching a specified share price, are not measurement period adjustments and do not enter into the cost of a business combination.

22

Which of the following statements concerning the acquisition of a business is/are correct?

  1. Most consideration transferred to effect a business combination should be measured at fair value.
  2. Contingent consideration should be included in the cost of an acquired business at fair value existing on the acquisition date.
  3. The cost of carrying out a business combination should be included in the cost of an acquired business.

1 and 2 Only.

Statement I and Statement II are correct; Statement III is not correct. Most consideration used to effect a business combination should be measured at fair value (Statement I). The only exception is when the consideration transferred remains under the control of the acquirer. Contingent consideration should be included in the cost of an acquired business at fair value as of the acquisition date (Statement II). The cost of carrying out a business combination should not be included in the cost of an acquired business (Statement III); most such costs should be expensed.

23

Changes in the fair value of contingent consideration transferred in a business combination resulting from occurrences after the acquisition date should be recognized as a gain or loss in the current income when the contingent consideration is classified as

  • An Asset or a Liability
  • An Equity Item

  • An Asset or a Liability - YES
  • An Equity Item - NO

Changes in the fair value of contingent consideration resulting from occurrences that occur after the acquisition date are recognized as gains or losses when the contingent consideration is classified as an asset or a liability. Contingent considerations classified as equity are not remeasured, and no gain or loss is recognized. The change in fair value of equity items is recognized as an adjustment within equity.

24

An obligation of an acquirer to pay contingent consideration to the former owners of an acquired entity in a business combination can be recognized as which of the following?

  • A Liability
  • An Equity Item

  • A Liability - YES
  • An Equity Item - YES

An obligation to pay contingent consideration in a business combination may be recognized by the acquirer as either a liability or as an equity item, depending on the nature of the obligation under the provisions of FASB #150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity."

25

On January 2, 2009, the beginning of its fiscal year, Zable, Inc. acquired all of the stock of Sideco, Inc. from its owners using the following forms and amounts of consideration to pay Sideco owners:

  • Cash $50,000
  • An investment in Loco, Inc. bonds which Zable had designated as held-for-trading, and which had a cost of $100,000 and a carrying amount of $102,000.
  • Land, with a cost of $50,000 and a fair value of $60,000.

Which one of the following is the total amount of consideration Zable paid to acquire Sidco?

A.  $200,000

B.  $202,000

C.  $210,000

D.  $212,000

$212,000

Generally, assets (and liabilities and equity) transferred as consideration in a business combination should be measured at fair value. When assets being transferred have a carrying value different than fair value, they should be adjusted to fair value before the transfer and a gain or loss recognized. Thus, the correct answer ($212,000) results from using the fair value of the bonds ($102,000) and the fair value of the land ($60,000), together with the cash ($50,000), or a total of $212,000 as the total consideration. In this case, since the assets are transferred to Sideco's former owners and not Sideco, the following would apply:

Cash would be transferred at face amount, $50,000, with no gain or loss.

The investment in Loco would be transferred at carrying value ($102,000), which is also fair value because the bonds are held-for-trading and would have been adjusted to fair value at December 31, 2008, with any gain or loss recognized at that time.

The land would be transferred at fair value, $60,000, and a $10,000 gain would be recognized in connection with the business combination.

Thus, the total consideration would be $212,000.

26

On January 2, 2009, the beginning of its fiscal year, Zable, Inc. acquired all of the stock of Sideco, Inc. from its owners using the following forms and amounts of consideration to pay Sideco owners:

  • Cash $50,000
  • An investment in Loco, Inc. bonds which Zable had designated as held-for-trading, and which had a cost of $100,000 and a carrying amount of $102,000.
  • Land, with a cost of $50,000 and a fair value of $60,000.

Which one of the following is the amount of gain or loss, if any, that Zable should recognize in connection with the transfer of these assets to Sideco owners?

  1.  0 - (no gain or loss).
  2. $ 2,000
  3. $ 10,000
  4. $ 12,000

$10,000

The amount of gain recognized in connection with the business combination would be $10,000. Generally, assets (and liabilities and equity) transferred as consideration in a business combination should be measured at fair value. When assets being transferred have a carrying value different than fair value, they should be adjusted to fair value before the transfer and a gain or loss recognized. In this case, since the assets are transferred to Sideco's former owners and not Sideco, the following would apply:

Cash would be transferred at face amount, $50,000, with no gain or loss.

The investment in Loco would be transferred at carrying value ($102,000), which is also fair value because the bonds are held-for-trading and would have been adjusted to fair value at December 31, 2008, with any gain or loss recognized at that time. So, no gain or loss would be recognized on January 2, 2009, in connection with the business combination.

The land would be transferred at fair value, $60,000, and a $10,000 gain would be recognized in connection with the business combination.

27

In which one of the following cases will a non-cash asset transferred as consideration in a business combination be measured at carrying value, not at fair value?

  1. The asset transferred is a non-monetary asset.
  2. The asset transferred is a non-depreciable asset.
  3. The asset transferred remains under the control of the acquiring entity.
  4. The asset transferred has a fair value less than the carrying value.

The asset transferred remains under the control of the acquiring entity.

When the transferred asset remains under the control of the acquiring entity, the asset is transferred at carrying value, not fair value; for example, when the acquirer transfers a non-cash asset (e.g., land) as consideration and the asset remains with the acquiree, over which the acquirer has control. Otherwise, all assets (and liabilities and equity) transferred as consideration in a business combination are measured at fair value, not carrying value.

28

Which one of the following payments by an acquirer in a business combination is most likely to be a part of the cost in recording a business combination transaction?

  1. Payment by the acquirer to settle a trade payable due to the acquired entity.
  2. Payment by the acquirer to the acquiree's management personnel to remain with the firm for one year following the business combination.
  3. Payment by the acquirer to the acquiree for a valid patent not previously recognized by the acquiree.
  4. Payment by the acquirer to reimburse the acquiree for cost it incurred in carrying out the business combination.

Payment by the acquirer to the acquiree for a valid patent not previously recognized by the acquiree.

Payment for a valid patent, even though not previously recognized by the acquiree, most likely would be a part of the business combination transaction. Since costs of developing a patentable item are expensed when incurred, the acquiree may not have recognized any asset associated with the patent, but the acquirer should record the patent acquired in a business combination at fair value.

29

On July 1, 2009, Lazer, Inc. acquired all of the assets, with a fair value of $400,000, and liabilities, with a fair value of $150,000, of Tipco, Inc. for $250,000 cash. In addition, Lazer paid $20,000 in legal and accounting fees for the combination and expects to pay $50,000 to close one of Tipco's plants and relocate its employees. Which one of the following is the total amount of consideration that Lazer paid for Tipco in the business combination?

  1. $250,000
  2. $270,000
  3. $300,000
  4. $320,000

$250,000

The total consideration paid by Lazer to acquire Tipco is $250,000, the cash paid. The other cost of carrying out the business combination ($20,000) and the expected cost of closing one of Tipco's plants and relocating its employees ($50,000) would not be part of the cost of the acquisition. The $20,000 legal and accounting fees will be expensed as cost of carrying out the combination. The expected cost of closing one of Tipco's plants and relocating its employees will not be recognized until there is an actual liability.

30

On July 1, 2009, Lazer, Inc. acquired all of the assets, with a fair value of $400,000, and liabilities, with a fair value of $150,000, of Tipco, Inc. for $250,000 cash. In addition, Lazer paid $20,000 in legal and accounting fees for the combination and expects to pay $50,000 to close one of Tipco's plants and relocate its employees. Which one of the following is the amount of liability that Lazer should recognize in recording the business combination?

  1. $- 0 - (no liability)
  2. $150,000
  3. $170,000
  4. $200,000

$150,000

Lazer will recognize $150,000 in liabilities, the fair value of the amount acquired from Tipco. The $20,000 legal and accounting fees will be expensed as cost of carrying out the combination. The expected cost of closing one of Tipco's plants and relocating its employees will not be recognized until there is an actual liability.

31

Which of the following kinds of intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity?

  • Future benefits that derive from legal rights
  • Future benefits that can be separately sold

  • Future benefits that derive from legal rights - YES
  • Future benefits that can be separately sold - YES

Intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity if they either have future benefits that arise from contractual or legal rights (e.g., trademarks, copyrights, franchise agreements, etc.) or are capable of being separately sold, transferred, licensed, rented, or exchanged (e.g., customer lists, databases, etc.).

32

Which of the following statements, if any, concerning a noncontrolling interest in an acquiree is/are correct?

  • I. The value assigned to a noncontrolling interest in an acquiree should be based on the proportional share of that interest in the net assets of the acquiree.
  • II. The fair value per share of the noncontrolling interest in an acquiree must be the same as the fair value per share of the controlling (acquirer) interest.

NEITHER.

Neither Statement I nor Statement II is correct. The value assigned to a noncontrolling interest in an acquiree would not be based simply on the proportional share of that interest in the net assets of the acquiree (Statement I), but rather on the separately determined fair value of the noncontrolling interest. The fair value per share of the noncontrolling interest in an acquiree does not have to be the same as the fair value per share of the controlling interest (Statement II), because there is likely to be a premium in value associated with having control of an entity that the noncontrolling interest would not enjoy.

33

On May 1, 2008, Hico, Inc. acquired 20% of the voting securities of Lowco, Inc. for $400,000 cash. The investment did not give Hico significant influence over Lowco and was classified as an available-for-sale investment. On July 1, 2009, Hico acquired the remaining 80% of Lowco's voting securities for $1,800,000 cash. At that time, Hico's original 20% investment in Lowco had a carrying value and a fair value of $450,000. Which one of the following is the amount of gain that Hico should recognize in July, 2009 net income as a result of the effect of the business combination on Hico's original investment in Lowco?

  1. $- 0 - (no gain)
  2. $40,000
  3. $50,000
  4. $400,000

$50,000

Because the original investment was treated as available-for-sale, between May 1, 2008, and July 1, 2009, it would have been adjusted to fair value ($450,000) and the increase recognized in other comprehensive income (not in net income). The cumulative entries would have been DR: Investment $50,000 and CR: Unrecognized Gain/Other Comprehensive Income $50,000. In connection with the combination, the $50,000 unrecognized gain in Accumulated Other Comprehensive Income would be reclassified and recognized as a gain in net income of the period. The $450,000 carrying amount/fair value of the original investment would be included as part of the total consideration used in acquiring Lowco.

 

34

Zooco, Inc. acquired 40% of the voting stock of Stubco, Inc. on September 1, 2008, and accounted for the investment using the equity method of accounting. On May 1, 2009, Zooco acquired an additional 20% of Stubco's voting stock to achieve a business combination. Which one of the following is the value Zooco should use to measure its original 40% investment in Stubco when recording the combination?

  1. Original cost, September 1, 2008.
  2. Carrying value, May 1, 2009.
  3. Fair value, May 1, 2009.
  4. 40% of Stubco's book value, May 1, 2009.

Fair value, May 1, 2009.

When a business combination is accomplished in stages (or steps), the fair value of the investment on the date of the combination is used to value the business combination. In this case, that would be the fair value on May 1, 2009. Any difference between the carrying value and the fair value on the acquisition date would be recognized as a gain or loss for the period.

35

Which of the following contingencies that exist on the acquisition date should be recognized by the acquirer in a business combination?

  • I. A contractual contingency to provide warranty services to prior customers of the acquiree.
  • II. An outstanding lawsuit against the acquiree for which an expert legal authority believes there is a 20% probability that the suit will be successful.

1 ONLY.

Item I would be recognized; Item II would not be recognized. Contractual contingencies (contingencies related to existing contracts) are recognized by the acquirer and measured at fair value. Noncontractual contingencies (contingencies that do not result from an existing contract), including lawsuits, are recognized only if it is more likely than not that the contingency will give rise to a liability (or an asset). A probability of 20% that the suit will be lost is not more likely than not, and the lawsuit would not be recognized.

36

Generally, which of the following items acquired in a business combination should be measured at fair value?

  • Identifiable Assets Acquired
  • Liabilities Assumed
  • Noncontrolling Interest

  • Identifiable Assets Acquired - YES
  • Liabilities Assumed - YES
  • Noncontrolling Interest - YES

Generally, identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree are measured at fair value. A few exceptions exist for selected assets and liabilities.

37

Which one of the following items acquired in a business combination is least likely to require that the acquirer reconsider the acquiree's classification?

  1. An investment classified as held-to-maturity by the acquiree.
  2. An investment classified as held-for-trading by the acquiree.
  3. A lease classified as a sales-type capital lease by the acquiree.
  4. A derivative instrument used for speculative purposes by the acquiree.

A lease classified as a sales-type capital lease by the acquiree.

In a business combination, an acquirer that obtains a lease contract should continue to classify the contract as established at the inception of the contract. The classification of a lease contract is established at the inception of the lease and would not change as a result of a transfer of ownership in a business combination.

38

Damon Co. purchased 100% of the outstanding common stock of Smith Co. in an acquisition by issuing 20,000 shares of its $1 par common stock that had a fair value of $10 per share and providing contingent consideration that had a fair value of $10,000 on the acquisition date. Damon also incurred $15,000 in direct acquisition costs. On the acquisition date, Smith had assets with a book value of $200,000, a fair value of $350,000, and related liabilities with a book and fair value of $70,000. What amount of gain should Damon report related to this transaction?

  1. $ 55,000
  2. $ 70,000
  3. $ 80,000
  4. $250,000

$70,000

Damon should report a $70,000 gain, calculated as:

  • Fair value of net assets acquired:
  •    Assets ($350,000) - Liabilities ($70,000)= $280,000
  • Cost of Investment:
  •    Stock (20,000 shares x $10/share)=$200,000
  •    Contingent consideration @ fair value=    10,000
  •    Total cost of investment=  210,000
  • FV of net assets > Cost of investment = Gain= $   70,000

39

On July 1, Dill, Inc. exchanged 10,000 shares of its common stock for all 20,000 shares of Ledo, Inc.'s outstanding common stock. Dill's stock is closely held and seldom traded; it has a par value of $10 per share and a book value of $12 per share. Ledo's stock is traded in an active market and has a par value of $5 per share, a book value of $8 per share, and a market price of $11 per share. Which one of the following amounts is most likely the appropriate value of Dill's investment in Ledo?

  1. $100,000
  2. $110,000
  3. $120,000
  4. $220,000

$220,000

Stock issued in a business combination should be measured at fair value. In some cases in which equities are exchanged, the fair value of the acquiree's stock may be a more reliable measure of the value of the transaction than can be determined for the acquirer's stock. In this question, that is the case. Since Dill's stock is closely held and seldom traded, it is less likely to be the basis for determining fair value than is Ledo's stock, which is traded in an active market. Therefore, the most likely value for the transaction would be the 20,000 shares of Ledo's stock that were obtained multiplied by the $11 market price of those shares, or 20,000 shares x $11 = $220,000.

40

f an acquiree elects to apply pushdown accounting, which of the following accounts of the acquiree cannot be recorded at acquisition date fair value?

  1. Goodwill.
  2. Property and Equipment.
  3. Common Stock.
  4. Bonds Payable.

Common Stock.

The acquiree cannot apply pushdown accounting to revalue its common stock to fair value as of the acquisition date.

41

In recording its acquisition of Lambda, Inc., Omega, Inc. properly recognized a contingent consideration liability of $28,000 associated with a possible payment based on a target amount of post-combination cash flow from operations. Shortly after the combination, but during the measurement period, the national economy experienced a significant downturn which made it unlikely that the target amount would be reached. As a consequence, at the end of Omega's fiscal period, the liability was properly revalued to a fair value of $9,000. Which one of the following is the amount of increase or decrease, if any, in the consideration paid to acquire Lambda that results from the change in the fair value of the contingent liability?

  1. $ - 0 - (no increase or decrease)
  2. $19,000 increase.
  3. $19,000 decrease.
  4. $9,000 decrease.

$ - 0 - (no increase or decrease)

A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change, not as an adjustment to the consideration paid to acquire the acquiree. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 - $9,000 = $19,000) and no change in the consideration paid will be recognized.

42

In recording its acquisition of Lambda, Inc., Omega, Inc. properly recognized a contingent consideration liability of $28,000 associated with a possible payment based on a target amount of post-combination cash flow from operations. Shortly after the combination, but during the measurement period, the national economy experienced a significant downturn which made it unlikely that the target amount would be reached. As a consequence, at the end of Omega's fiscal period, the liability was properly revalued to a fair value of $9,000. Which one of the following is the amount of gain or loss that will be recognized in income as a result of the reevaluation of the contingent liability?

  1. $ - 0 - (no gain or loss).
  2. $19,000 gain.
  3. $19,000 loss
  4. $9,000 loss

$19,000 gain.

A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 - $9,000 = $19,000).

43

Which one of the following items that was acquired in a business combination is most likely to be accounted for using post-combination accounting requirements specific for the item?

  1. Plant and equipment.
  2. Investments held-to-maturity.
  3. Contingency-based assets.
  4. Patents.

Contingency-based assets.

Assets (and liabilities) arising from contingencies are likely to be accounted for using specific post-combination accounting requirements. Those requirements provide that when new information is obtained about a contingency-based asset, it will be measured at the lower of (1) its acquisition-date fair value or (2) the best estimate of its future settlement amount.

44

Which of the following statements, if any, concerning a contingency that arises in a business combination is/are correct?

  • I. After an acquisition and until it is settled, a contingency that is a liability will be measured at no less than the fair value reported on the acquisition date.
  • II. After an acquisition and until it is settled, a contingency that is an asset will be measured at no less than the fair value reported on the acquisition date.

I ONLY.

Statement I is correct. After an acquisition, a contingency that is a liability will be measured and reported at the higher of the amount reported on the acquisition date or the amount that would be recognized if the requirements of FASB #5 were followed. Thus, such a liability would not be measured at less than the fair value on the acquisition date (Statement I). Statement II is not correct. After an acquisition, a contingency that is an asset will be measured at the lower of the amount reported on the acquisition date or the best estimate of its future settlement amount. Thus, such an asset would be measured at no more than, not at no less than, the fair value reported on the acquisition date.

45

When a bargain purchase occurs in a business combination, which of the following types of information must be disclosed in the period of the combination?

  1. I. The amount of gain recognized.
  2. II. The income statement line item that includes the gain.
  3. III. A description of the basis for the bargain purchase amount.

ALL THREE.

All three statements identify required disclosures. When a bargain purchase occurs in a business combination, the amount of the gain (Statement I), the income statement line item that includes the gain (Statement II), and a description of the basis for the bargain purchase amount (Statement III) must be disclosed.

46

Which of the following occurrences in a business combination, if any, identify circumstances that require extensive disclosures in the period of the combination?

  • I. The existence of a noncontrolling interest.
  • II. Achieving control in step acquisition.

  • I. The existence of a noncontrolling interest. - YES
  • II. Achieving control in step acquisition. - YES

Both Statements I and II identify circumstances that require extensive disclosures in the period of a combination. When there is a noncontrolling interest in the acquiree, the fair value of the noncontrolling interest at the acquisition date, and the valuation techniques and inputs used to measure that fair value, must be disclosed. When control is achieved in steps (or stages), the fair value of the equity held by the acquirer immediately before the combination, the amount of any gain or loss resulting from adjusting the interest to fair value, and the line item in the income statement where the gain or loss is reported must be disclosed.

47

Plant Company acquired controlling interest in Seed Company in a legal acquisition. Which one of the following could not be part of the entry to record the acquisition?

  1. Debit: Investment in Seed Company.
  2. Debit: Goodwill.
  3. Credit: Cash
  4. Credit: Common stock

Debit: Goodwill.

The entry that Plant will make to record its legal acquisition of Seed cannot include a debit to Goodwill. The entry Plant makes will debit (only) the Investment account and credit whatever form(s) of consideration is given (e.g., Cash, Bonds Payable, Common Stock, etc.). Goodwill cannot be debited at the time of the acquisition, though it may be recognized at the time of consolidation.

48

Under which one of the following circumstances will goodwill be recognized in a business combination carried out as a legal merger?

  1. Book value of net assets acquired > Cost of investment.
  2. Fair value of net assets acquired > Book value of net assets acquired.
  3. Fair value of net assets acquired > Cost of investment.
  4. Fair value of net assets acquired < Cost of investment.

Fair value of net assets acquired < Cost of investment.

Goodwill is recognized when the cost of the investment is greater than the fair value of net assets acquired (= the fair value of net assets acquired is less than the cost of the investment). In a legal merger, the goodwill would be recognized on the books of the surviving firm at the time of the business combination.

49

Pine Company acquired all of the assets and liabilities of Straw Company for cash in a legal merger. Which one of the following would not be recognized by Pine on its books in recording the business combination?

  1. Accounts receivable.
  2. Investment in Straw.
  3. Intangible asset - Patent.
  4. Accounts payable.

Investment in Straw.

Pine will not recognize on its books an investment in Straw. Because the business combination is a legal merger, Pine recognizes on its books almost all of Straw's assets and liabilities, not an investment in Straw. There can be no investment in Straw, because Straw will cease to exist.

50

Sayon Co. issues 200,000 shares of $5 par value common stock to acquire Trask Co. in an acquisition-business combination. The market value of Sayon's common stock is $12 per share. Legal and consulting fees incurred in relation to the acquisition are $110,000. Registration and issuance costs for the common stock are $35,000. What should be recorded in Sayon's additional paid-in capital account for this business combination?

  1. $1,545,000
  2. $1,400,000
  3. $1,365,000
  4. $1,255,000

$1,365,000

The calculation is:

  • Fair value (200,000 sh. x 12/sh.) $2,400,000
  • Par value (200,000 sh. x $5/sh) ($1,000,000)
  • Gross additional paid-in capital $1,400,000
  • Less: Registration and issuance costs $35,000
  • Net additional paid-in capital $1,365,000

The legal and consulting fees ($110,000) were paid in cash and would be expensed in the period incurred. The registration and issuance costs of the common stock are properly deducted from the additional paid-in capital derived from the issuance of the stock.

51

Which of the following statements concerning the primary beneficiary of a variable-interest entity is/are correct?

  • I. The primary beneficiary has the ability to direct the most significant economic activities of the variable-interest entity.
  • II. Only one entity can be the primary beneficiary of a variable-interest entity.
  • III. The investor that has the greatest equity ownership in a variable-interest entity will be the primary beneficiary of the entity.

1 and 2 ONLY.

Both Statement I and Statement II are correct; Statement III is not correct. By definition, the primary beneficiary of a variable-interest entity is the entity that is able to direct the most significant economic activities of the variable-interest entity (Statement I). Only one entity can be the primary beneficiary of a variable-interest entity, because only one entity will have the ability to direct the activities of the variable-interest entity that most significantly impacts its economic performance (Statement II).

52

Which one of the following is not a characteristic of a variable-interest entity?

  1. A variable-interest entity is thinly capitalized.
  2. The equity holders in a variable-interest entity control the entity.
  3. The risks and rewards associated with a variable-interest entity mostly accrue to the variable-interest holders.
  4. The value of a variable-interest entity depends on the net asset value of the variable-interest entity.

The equity holders in a variable-interest entity control the entity.

The equity holders in a variable-interest entity do not control the entity. Control of the activities and decision-making in a variable-interest entity generally resides with the variable-interest holders (not the equity holders) as established by agreement or other instrument.

53

In which one of the following cases is the subsidiary most likely to be reported as an unconsolidated subsidiary?

  1. The subsidiary is in an industry unrelated to the parent.
  2. The subsidiary has a fiscal year-end that is one month different from the parent's year-end.
  3. The subsidiary is in legal bankruptcy.
  4. The subsidiary has a controlling interest in another entity.

The subsidiary is in legal bankruptcy.

When a subsidiary is in bankruptcy, it is under the control of the bankruptcy court and, therefore, not under the control of the parent. When a parent cannot exercise financial and/or operating control of a subsidiary, the subsidiary would not be consolidated, but would be reported as an unconsolidated subsidiary by the parent.

54

Which of the following legal forms of business combination will result in the need to prepare consolidated financial statements?

  • Merger
  • Acquisition
  • Consolidation

  • Merger - NO
  • Acquisition - YES
  • Consolidation - NO

55

Penn, Inc., a manufacturing company, owns 75% of the common stock of Sell, Inc., an investment company. Sell owns 60% of the common stock of Vane, Inc., an insurance company.

In Penn's consolidated financial statements, should consolidation accounting or equity method accounting be used for Sell and Vane?

  1. Consolidation used for Sell and equity method used for Vane.
  2. Consolidation used for both Sell and Vane.
  3. Equity method used for Sell and consolidation used for Vane.
  4. Equity method used for both Sell and Vane.

Consolidation used for both Sell and Vane.

If one looked just at Penn's interest in Vane's result of 45% (75% x 60%), one might say that the equity method would be appropriate.

However, because Sell owns 60% of Vane, it controls Vane and would need to consolidate Vane. Because Penn owns 75% of Sell, it controls Vane and would need to consolidate Sell, which consolidated Vane. Thus, all three would be consolidated, making this response correct.

56

Which one of the following levels of voting ownership is normally assumed to convey significant influence over an investee?

  1. 0% - 10%.
  2. 20% - 50%.
  3. 50% - 100%.
  4. 100%.

20% - 50%.

Between 20% and 50% voting ownership of an investee normally is assumed to give the investor significant influence over the investee. Ownership of 20% to 50% of the voting stock of an investee may not give the investor significant influence over the investee if additional special circumstances exist, but normally, it does.

57

The choice of methods that a parent uses on its books to account for its investment in a subsidiary will affect the:

  • Consolidating Process
  • Consolidated Financial Statements

  • Consolidating Process - YES
  • Consolidated Financial Statements - NO

While the method a parent uses on its books to account for its investment in a subsidiary will affect the consolidating process, the choice of methods will not affect the final consolidated financial statements. The final consolidated financial statements will be the same regardless of the method used by the parent on its books; only the details of the process of developing those statements will be different. The primary difference will be in the nature of the investment eliminating entry on the worksheet.

58

Which one of the following methods, if any, may a parent use on its books to carry an investment in a subsidiary that it will consolidate?

  • Cost Method
  • Equity Method  

  • Cost Method - YES
  • Equity Method - YES

A parent may use the cost method, the equity method, or any other method on its books to carry an investment in a subsidiary that it will consolidate. The method that is used on its books will affect the consolidating process, but the final consolidated financial statements will be the same regardless of the method the parent uses on its books.

59

Which of the following statements, if any, concerning the preparation of consolidated financial statements is/are correct?

  • I. The consolidating process is carried out on the books of the parent entity.
  • II. The consolidated financial statements report two or more legal entities as though they are a single economic entity.

  • I. The consolidating process is carried out on the books of the parent entity. - NO
  • II. The consolidated financial statements report two or more legal entities as though they are a single economic entity. - YES

Statement I is incorrect. The consolidating process is not carried out on the books of the parent entity (or any other entity). The consolidating process takes place on worksheets and schedules that are separate from any set of books. Statement II is correct. The consolidated financial statements report two or more legal entities (a parent and its subsidiary/ies) as though they are a single economic entity. Because the entities are under the common economic control of the parent's shareholders, GAAP requires that consolidated statements be the primary form of financial statement disclosure.

60

Which one of the following kinds of accounts is least likely to be eliminated through an eliminating entry on the consolidating worksheet?

  1. Receivables.
  2. Investment.
  3. Goodwill.
  4. Payables.

Goodwill.

Goodwill may be recognized by the entry that eliminates the parent's investment in the subsidiary against the parent's share of the subsidiary's shareholders' equity, but goodwill will not be eliminated through an eliminating entry.

61

Which one of the following kinds of eliminations, if any, will be required in every consolidating process?

  • Intercompany Receivables/Payables
  • Intercompany Investment
  • Intercompany Revenues/Expenses 

  • Intercompany Receivables/Payables - NO
  • Intercompany Investment - YES
  • Intercompany Revenues/Expenses - NO

​An intercompany investment elimination will be required in every consolidating process (to eliminate the parent's investment against the subsidiary's shareholders' equity). Intercompany receivables/payables and intercompany revenues/expenses eliminations will not be required in every consolidating process. Those kinds of eliminations will be required only if the affiliated companies have engaged in intercompany transactions that resulted in such balances.

62

The results of the consolidating process are recorded in the books of the:

  • Parent
  • Subsidiary

  • Parent - NO
  • Subsidiary - NO

The results of the consolidating process (adjustments, eliminations, etc.) are not recorded on either the books of the parent or of any subsidiary. The consolidating process takes place on worksheets and schedules, and the results are presented in the form of consolidated financial statements. Some of the worksheet and schedule data is carried forward from period end to period end to facilitate the recurring consolidating process.

63

Under GAAP, which of the following can be issued as the primary form of public financial statement disclosure for a parent and its subsidiaries?

  • Parent only Statement
  • Separate Parent and Subsidiary Statements
  • Consolidated Statements

  • Parent only Statement - NO
  • Separate Parent and Subsidiary Statements - NO
  • Consolidated Statements - YES

Under GAAP, only consolidated financial statements may be issued as the primary form of public disclosure for a parent and its subsidiaries. Parent only statements and separate parent and subsidiary statements may not be issued in lieu of consolidated financial statements.

64

Ownership of 51% of the outstanding voting stock of a company would usually result in

  1. The use of the cost method.
  2. The use of the lower of cost or market method.
  3. The use of the equity method.
  4. A consolidation.

A consolidation.

This answer is correct. ASC Topic 810 states that consolidated financial statements should generally be prepared when there is greater than 50% ownership of the outstanding voting stock of the company, although unusual circumstances may arise in which reporting under the equity method or even the cost method is more appropriate.  (Note that consolidation may also refer to a form of business combination where two or more entities form a new entity.) The exhibit below illustrates the accounting treatment for equity investments.
 

Financial reporting% owned

  • FV or amortized cost 20%
  • Equity or fair value method 20-50%
  • Consolidated or equity 51-100%

65

On April 1, year 2, Union Company paid $1,600,000 for all the issued and outstanding common stock of Cable Corporation in a transaction properly accounted for as an acquisition.  The recorded assets and liabilities of Cable Corporation on April 1, year 2, were as follows:

  • Cash $160,000
  • Inventory $480,000
  • Property, plant and equipment (net) $960,000
  • Liabilities ($360,000)

On April 1, year 2, it was determined that Cable’s inventory had a fair value of $460,000, and the property, plant and equipment (net) had a fair value of $1,040,000.  What is the amount of goodwill resulting from the business combination?

  1. $0
  2. $ 20,000
  3. $300,000
  4. $360,000

$300,000

In an acquisition, the difference between the cost of an acquired company and the fair value of its net identifiable assets (fair value of tangible and identifiable intangible assets less liabilities) is recorded as goodwill.

The cost of the Cable Corp. is $1,600,000, and the fair value of its net assets is $1,300,000 ($160,000 + $460,000 + $1,040,000 − $360,000). Therefore, goodwill to be recorded is $300,000 ($1,600,000 − $1,300,000).

66

Nolan owns 100% of the capital stock of both Twill Corp. and Webb Corp. Twill purchases merchandise inventory from Webb at 140% of Webb’s cost. During year 2, merchandise that cost Webb $40,000 was sold to Twill. Twill sold all of this merchandise to unrelated customers for $81,200 during year 2. In preparing combined financial statements for year 2, Nolan’s bookkeeper disregarded the common ownership of Twill and Webb. By what amount was unadjusted revenue overstated in the combined income statement for year 2?

  1. $16,000
  2. $40,000
  3. $56,000
  4. $81,200

$56,000

When computing combined revenue, the objective is to restate the accounts as if the intercompany transaction had not occurred. Assuming that there was no sale between Twill and Webb, the correct amount of consolidated revenue would be the $81,200 sold to unrelated customers. Thus, unadjusted revenue is overstated by the $56,000 ($40,000 × 140%) intercompany revenue recognized by Webb.

67

If the parent uses the cost method to account for its investment in a subsidiary, the parent will recognize:

  1. the parent's share of the subsidiary's net income.
  2. the parent's share of the subsidiary's dividends.
  3. amortization of parent's excess cost of investment over the book value of the subsidiary.
  4. the parent's share of the subsidiary's net loss.

The parent's share of the subsidiary's dividends.

When a parent company uses the cost method to account for its investment in a subsidiary, the parent will recognize its share of the subsidiary's dividends declared as income to the parent.

68

On January 1, 20X1, Prim, Inc. acquired all the outstanding common shares of Scarp, Inc. for cash equal to the book value of the stock. The carrying amount of Scarp's assets and liabilities approximated their fair values, except that the carrying amount of its building was more than fair value. In preparing Prim's 20X1 consolidated income statement, which of the following adjustments would be made?

  1. Depreciation expense would be decreased, and goodwill would be recognized.
  2. Depreciation expense would be increased, and goodwill would be recognized.
  3. Depreciation expense would be decreased, and no goodwill would be recognized.
  4. Depreciation expense would be increased, and no goodwill would be recognized.

Depreciation expense would be decreased, and goodwill would be recognized.

Although the cost of the investment was equal to book values, the cost of the investment was greater than the fair values, because the carrying amount of Scarp's building was more than its fair value. For consolidated statement purposes, the building would be written down to its lower fair value, and the excess of cost over fair values would be assigned to recognize goodwill. Since for consolidated purposes the building has a lower fair value than its carrying value, the depreciation expense taken on the carrying value would be greater than the depreciation expense for consolidated purposes. Thus, depreciation expense would be decreased in the consolidating process, and goodwill would be recognized.

69

Assume that in acquiring a subsidiary, the parent determined there were several depreciable assets of the subsidiary that had a fair value less than book value. What effect will this fair value less than book value of the subsidiary's assets have on the following accounts in the preparation of consolidated statements?

  • Depreciable Assets
  • Depreciation Expense

  • Depreciable Assets - Decrease
  • Depreciation Expense - Decrease

Both accounts will be decreased. The investment eliminating entry on the consolidating worksheet will write down (decreasing on the worksheet) the value of depreciable asset, from book value to the lower fair value on the date of the combination. The decrease in depreciable asset value recognized on the worksheet will mean that the depreciation expense on the worksheet, brought on by the subsidiary, will overstate depreciation expense to the parent, resulting in a reduction (decreasing) depreciation expense for consolidated statement purposes.

70

Assume that in acquiring a subsidiary, the parent determined there were several depreciable assets of the subsidiary that had a fair value greater than book value. What effect will the excess fair value over book value of the subsidiary's assets have on the following accounts in the preparation of consolidated statements?

  • Depreciable Assets
  • Depreciation Expense 

  • Depreciable Assets - Increase
  • Depreciation Expense - Increase

The investment eliminating entry on the consolidating worksheet will write up (increasing on the worksheet) the value of depreciable asset, from book value to fair value on the date of the combination. The additional depreciable asset value recognized on the worksheet will then be depreciated on the worksheet, resulting in additional (increasing) depreciation expense.

71

Parco owns 100% of its subsidiary, Subco, which it acquired at book value. It carries its investment in Subco on its books using the equity method of accounting. At the beginning of its 2009 fiscal year, the investment in Subco account was $552,000. During 2009, Subco reported the following:

  • Net Income $42,000
  • Dividends Declared/Paid $12,000

There were no other transactions between the firms in 2009.

In preparing its 2009 fiscal year consolidated statements, which one of the following is the amount of the investment eliminating entry that Parco will make as a result of its ownership of Subco?

  1. $552,000
  2. $582,000
  3. $594,000
  4. $606,000

$552,000

The amount of an investment eliminating entry is the balance in the investment account as of the beginning of the period being consolidated. In this case, that was $552,000. If the parent uses the equity method to account for its investment in the subsidiary, the entries it makes during the year are reversed so that the investment account has its beginning of the year balance.

72

Parco owns 100% of its subsidiary, Subco, which it acquired at book value. It carries its investment in Subco on its books using the equity method of accounting. At the beginning of its 2009 fiscal year, the investment in Subco account was $552,000. During 2009, Subco reported the following:

  • Net Income $42,000
  • Dividends Declared/Paid $12,000

There were no other transactions between the firms in 2009.

In preparing its 2009 fiscal year consolidated statements, which one of the following is the amount of investment that Parco will have to reverse for 2009 as a result of its ownership of Subco?

  1. $12,000
  2. $30,000
  3. $42,000
  4. $54,000

$30,000

During 2009 Parco would recognize Subco's reported net income of $42,000 as equity revenue; the entry would be: DR: Investment in Subco and CR: Equity Revenue. The $12,000 dividends would not be recognized as equity revenue but rather as a liquidation of part of Parco's investment in Subco; the entry would be: DR: Dividends Receivable/Cash and CR: Investment in Subco. Therefore, the net amount of investment to be reversed would be $30,000, computed as +$42,000 - $12,000 = $30,000.

73

If a parent uses the equity method on its books to account for its investment in a subsidiary, which one of the following will result in an increase in the investment account on the parent's books?

  • Subsidiary Reports Income
  • Subsidiary Declares Dividend

  • Subsidiary Reports Income - YES
  • Subsidiary Declares Dividend - YES

Under the equity method, when a subsidiary reports income, the parent recognizes its share as:

  • DR: Investment
    • CR: Equity Income.

Therefore, the subsidiary's reported income increases the investment account. In addition, when a subsidiary declares a dividend, the parent recognizes its share as:

  • DR: Dividends Receivable/Cash 
    • CR: Investment.

Therefore, the subsidiary's dividends do not increase the investment account but rather decrease the investment account.

74

An example of a protective right is:

  1. Establishing operating procedures.
  2. Controlling the management overseeing the investee policies.
  3. Veto rights.
  4. The ability to purchase an additional interest in the entity in question.

Veto rights.

Protective rights protect the party holding the rights without given that party a controlling financial interest and include rights such as veto rights and the ability to remove the entity with the power to direct the activities of the VIE. Participating rights include the ability to block or participate in the actions of the reporting entity with the power to direct the VIE activities and include examples such as establishing operating procedures and controlling the management overseeing the investee policies.

75

During 2008, Popco acquired 80% of the voting stock of Sonco in a legal acquisition. Which one of the following is least likely to be a type of intercompany balance that results from transactions between Popco and Sonco during 2009?

  1. Receivable.
  2. Inventory.
  3. Goodwill.
  4. Revenue

Goodwill.

Goodwill will occur on the date of a business combination as a result of the parent paying more for its investment in a subsidiary than the fair value of identifiable net assets acquired. Goodwill does not occur as a result of operating period transactions between a parent and its subsidiaries.

76

Bell, Inc. owns 60% of Dart Corporation's common stock. On December 31, 20X6, Dart is indebted to Bell for a $200,000 cash advance. In preparing the consolidated balance sheet on that date, what amount of the advance should be eliminated?

  1. $-0-
  2. $80,000
  3. $120,000
  4. $200,000

$200,000

The amount to be eliminated is $200,000, which is the full amount of the intercompany receivable-payable resulting from the cash advance.

77

Cobb, Inc., has current receivables from affiliated companies on December 31, 20x5, as follows:

  • A $75,000 cash advance to Hill Corporation. Cobb owned 30% of the voting stock of Hill and accounts for the investment by the equity method.
  • A receivable of $260,000 from Vick Corporation for administrative and selling services. Vick is 100% owned by Cobb and is included in Cobb's consolidated financial statements.
  • A receivable of $200,000 from Ward Corporation for merchandise sales on credit. Ward is 40% owned by Cobb, which can exercise significant influence over Ward.

In the current assets section of its December 31, 20x5, consolidated balance sheet, Cobb should report accounts receivable from investees in the total amount of:

  1. $180,000
  2. $255,000
  3. $275,000
  4. $535,000

$275,000

The amount of accounts receivable reported by Cobb from investees is $275,000. The amount of receivable from Vick ($260,000) would be eliminated against the payable to Cobb as brought onto the consolidating worksheet from Vick's balance sheet. The amounts receivable from Hill ($75,000) and Ward ($200,000) would not be eliminated, because since Cobb does not have controlling interest in either firm, they would not be consolidated with Cobb. Both would be accounted for using the equity method of accounting, which does not eliminate intercompany receivables/payables. Since the amounts due from Hill ($75,000) and Ward ($200,000) would not be eliminated, they would show as accounts receivable in the consolidated balance sheet (total = $275,000).

78

Lion, Inc. owns 60% of Gray Corp.'s common stock. On December 31, 2005, Gray owes Lion $400,000 for a cash advance.

In preparing the consolidated balance sheet on that date, what amount of the advance should be eliminated?

  1. $400,000
  2. $240,000
  3. $160,000
  4. $0

$400,000

When consolidated statements are prepared, 100% of all reciprocal accounts are eliminated regardless of the ownership fraction. Thus, the whole $400,000 must be eliminated.

79

King, Inc. owns 70% of Simmon Co.'s outstanding common stock. King's liabilities total $450,000, and Simmon's liabilities total $200,000. Included in Simmon's financial statements is a $100,000 note payable to King. What amount of total liabilities should be reported in the consolidated financial statements?

  1. $520,000
  2. $550,000
  3. $590,000
  4. $650,000

$550,000

The consolidated financial statements should reflect 100% of the assets and liabilities of the subsidiary less any intercompany balances. Therefore the balance on the consolidated balance sheet should be: $450,000 + 200,000 - 100,000 = $550,000.

80

Pine Company acquired goods for resale from its manufacturing subsidiary, Strawco, at Strawco's cost to manufacture of $12,000. Pine subsequently resold the goods to a nonaffiliate for $18,000. Which one of the following is the amount of the elimination that will be needed as a result of the intercompany inventory transaction?

  1. $-0-
  2. $6,000
  3. $12,000
  4. $18,000

$12,000

Even though the intercompany inventory sale from Strawco to Pine was at no profit or loss (at Strawco's cost to manufacture), the intercompany sale and purchase, nevertheless, must be eliminated. Otherwise, consolidated sales and purchases (cost of goods sold) will be overstated. Therefore, the elimination related to the intercompany inventory transaction will be for $12,000, the cost of the sale from Strawco to Pine.

81

Which one of the following will occur on consolidated financial statements if an intercompany inventory transaction is not eliminated?

  1. An understatement of sales.
  2. An overstatement of sales.
  3. An understatement of purchases.
  4. An overstatement of accounts receivable.

An overstatement of sales.

If an intercompany inventory transaction is not eliminated in the consolidating process, consolidated financial statements would show an overstatement of sales. Sales would be overstated by the amount of the intercompany sales reported by the selling affiliate. All intercompany sales and related purchases must be eliminated, even if they do not result in a profit or loss.

82

The following are models to evaluate consolidation:

  • Voting Interest Entity Model
  • Variable Interest Model

  • Voting Interest Entity Model - YES
  • Variable Interest Model - YES

There are two models to evaluate if one entity should consolidate another entity: the voting interest entity model and the variable interest model. The voting interest entity model relies on one entity owning more than 50% of the voting interest in the other entity. The variable interest model relies on determination if one entity has the power to direct the activities of the other entity.

83

Assume that on January 2, Company P recognized a $3,000 gain on the sale of a depreciable fixed asset to its subsidiary, Company S. Company S will depreciate the asset using straight-line depreciation over the remaining three-year life of the asset. What amount of intercompany gain will be eliminated from P's retained earnings at the end of the year following the year of the intercompany fixed asset transactions?

  1. $- 0 -
  2. $1,000
  3. $2,000
  4. $3,000

$2,000

The amount of intercompany gain to be eliminated at the end of the year following the year of the intercompany fixed asset sale is $2,000. At the end of the year of the intercompany sale, depreciation taken by the buying affiliate on the $3,000 inter-company gain will be $1,000 ($3,000/3 years). As a consequence, $1,000 of the $3,000 intercompany gain will have been properly recognized, leaving only $2,000 to eliminate at the end of the second year. Depreciation expense taken on the intercompany gain for the second year will confirm another $1,000 of the intercompany gain, and depreciation expense taken on the intercompany gain for the third year will confirm the last $1,000 of the intercompany gain.

84

Water Co. owns 80% of the outstanding common stock of Fire Co. On December 31, 2005, Fire sold equipment to Water at a price in excess of Fire's carrying amount but less than its original cost. On a consolidated balance sheet on December 31, 2005, the carrying amount of the equipment should be reported at:

  1. Water's original cost.
  2. Fire's original cost.
  3. Water's original cost less Fire's recorded gain.
  4. Water's original cost less 80% of Fire's recorded gain.

Water's original cost less Fire's recorded gain.

The individual books of Water and Fire would record this transaction as if they were independent companies. Fire would remove the asset and record a gain. Water would put the asset on its books at cost.

The problem is that they are not independent companies, and therefore, no real sale took place. The gain that was recorded must therefore be eliminated on the consolidated books. The net result is that the asset will be on the books at Water's original cost less Fire's recorded gain.

85

For consolidated purposes, what effect will the intercompany sale of a fixed asset at a profit or at a loss have on depreciation expense recognized by the buying affiliate?

  • At a Profit
  • At a Loss

  • At a Profit - Overstate
  • At a Loss - Understate

An intercompany sale of a fixed asset at a profit will result in the buying affiliate overstating depreciation expense by the amount of depreciation taken on the intercompany profit, and an intercompany sale at a loss will result in an understatement of depreciation expense taken by the buying affiliate. When an intercompany sale of a fixed asset results in a loss, the carrying value of the asset will be understated by the amount of the loss. As a result, depreciation expense taken by the buying affiliate will be understated by the amount of depreciation that would have been taken on the intercompany loss.

86

An intercompany depreciable fixed asset transaction resulted in an intercompany gain. Which one of the following is least likely to be reflected in the consolidated financial statements prepared at the end of the period in which the intercompany transaction occurred?

  1. Consolidated income will be less than the sum of the incomes of the separate companies being combined.
  2. Consolidated assets will be less than the sum of the assets of the separate companies being combined.
  3. Consolidated depreciation expense will be more than the sum depreciation expense of the separate companies being combined.
  4. Consolidated accumulated depreciation will be more than the sum of accumulated depreciation of the separate companies being combined.

Consolidated depreciation expense will be more than the sum depreciation expense of the separate companies being combined.

Consolidated depreciation expense will be less, not more, than the sum of depreciation expense of the separate companies being combined. Because the intercompany transaction resulted in a gain, the buying affiliate will have the asset on its books with the intercompany gain included in its carrying value and will depreciate that value on its books. For consolidated purposes, that depreciation on the intercompany gain will be eliminated, resulting in less depreciation expense than the sum of the depreciation expense of the separate companies.

87

Zest Co. owns 100% of Cinn, Inc. On January 2, 1999, Zest sold equipment with an original cost of $80,000 and a carrying amount of $48,000 to Cinn for $72,000. Zest had been depreciating the equipment over a five-year period using straight-line depreciation with no residual value. Cinn is using straight-line depreciation over three years with no residual value. In Zest's December 31, 1999, consolidating worksheet, by what amount should depreciation expense be decreased?

  1. $0
  2. $8,000
  3. $16,000
  4. $24,000

$8,000

There are two ways to approach this solution. First, take the difference in carrying values 72,000-48,000 = 24,000. The 24,000 is the incremental amount Cinn carries the equipment over the carrying amount of Zest. The 24,000/3 = 8,000
OR, compute the depreciation for each company:
Cinn is 72,000/3 = 24,000
Zest is 80,000/5 = 16,000

Since Cinn is 100% owned by Zest, the equipment cannot be depreciated by a greater amount through an intracompany sale. The difference is 24,000 - 16,000 = 8,000.

88

On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.

Which one of the following is the net carrying value of Sico's total bond liability?

  1. $900,000
  2. $1,000,000
  3. $1,050,000
  4. $1,100,000

$1,100,000

A premium on a bond liability results from the sale of the bonds at a price in excess of par (face) value. Therefore, a premium would be added to par value to get net carrying value. Sico's premium on its bond liability ($100,000) should be added to the par (or face) value of its bond liability ($1,000,000) to determine the net carrying value of the liability. Thus, the answer should be $1,000,000 par value + $100,000 premium = $1,100,000 net carrying value.

89

On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.

Which one of the following is the amount of premium or discount on Pico's investment in Sico's bonds?

  1. $250,000 premium
  2. $100,000 premium
  3. $50,000 premium
  4. $50,000 discount

$50,000 discount

The premium or discount on a bond investment is the difference between the par value of the bonds and the price paid for the bonds in the market. If the price paid is more than par value, there is a premium on the bond investment. If the price paid is less than par value, there is a discount on the bond investment. In this case, the price paid for the investment ($200,000) is less than the par value of the bonds ($250,000) by $50,000. Therefore, there is a $50,000 discount on Pico's investment.

90

The following information pertains to shipments of merchandise from Home Office to Branch during 2007:

  • Home Office's cost of merchandise $160,000
  • Intracompany billing $200,000
  • Sales by Branch $250,000
  • Unsold merchandise at Branch on December 31, 2007 $20,000

In the combined income statement of Home Office and Branch for the year ended December 31, 2007, what amount of the above transactions should be included in sales?

  1. $250,000
  2. $230,000
  3. $200,000
  4. $180,000

$250,000

The amount that should be included in sales is the amount of sales with unrelated parties. In this case, that is the $250,000 sales by Branch to unaffiliated entities.

91

Nolan owns 100% of the capital stock of both Twill Corp. and Webb Corp.

Twill purchases merchandise inventory from Webb at 140% of Webb's cost. During 2004, merchandise that cost Webb $40,000 was sold to Twill. Twill sold all of this merchandise to unrelated customers for $81,200 during 2004. In preparing combined financial statements for 2004, Nolan's bookkeeper disregarded the common ownership of Twill and Webb.

  1. By what amount was unadjusted revenue overstated in the combined income statement for 2004?
  2. What amount should be eliminated from cost of goods sold in the combined income statement for 2004?

 

$56,000

  1. Since all the goods have been sold outside the combined entity, income recognition is correct.

    However, sales and cost of goods sold have been recorded at two different points (i.e., the sale from Webb to Twill and the sale from Twill to outsiders). To the combined entity, Webb's cost of merchandise (the original cost to the combined entity) is what is needed for cost of goods sold, and Twill's sales (the amount the merchandise was sold for outside the combined entity) is needed for sales.

    This means that the sale from Webb to Twill and the cost of goods recorded by Twill need to be eliminated. That amount is $56,000 (computed as $40,000 cost to Webb x transfer price to Twill of 140% of cost = $56,000).

  2. The amount at which Webb sold the inventory to Twill ($40,000 x 1.40 = $56,000) will be the amount of cost of goods sold to Twill and should be eliminated in combining the financial statements of Webb and Twill. The cost of goods to Webb ($40,000) is the cost from an unrelated entity and should be the cost of goods sold for the combined entity. Since both the $40,000 cost of goods to Webb and the $56,000 cost of goods to Twill will be on the combining worksheet, the cost of goods to Twill (from Webb) must be eliminated, leaving only the $40,000 cost from a nonaffiliate.

92

Grant, Inc. has current receivables from affiliated companies at December 31, year 2, as follows:

  • A $50,000 cash advance to Adams Corporation. Grant owns 30% of the voting stock of Adams and accounts for the investment by the equity method.
  • A receivable of $160,000 from Bullard Corporation for administrative and selling services. Bullard is 100% owned by Grant and is included in Grant’s consolidated statements.
  • A receivable of $100,000 from Carpenter Corporation for merchandise sales on open account. Carpenter is a 90% owned, unconsolidated subsidiary of Grant.   

In the current assets section of its December 31, year 2 consolidated balance sheet, Grant should report accounts receivable from investees in the total amount of

  1. $90,000
  2. $140,000
  3. $150,000
  4. $310,000

$150,000

The accounts receivable from investees to be reported on the balance sheet should only include the receivables from investees considered unconsolidated subsidiaries. The receivables from the unconsolidated subsidiaries ($50,000 + $100,000) would not be eliminated and, therefore, would be reported as receivables in the consolidated balance sheet. However, the $160,000 receivable from the consolidated subsidiary would be eliminated on the consolidated worksheet and thus not reported on the consolidated balance sheet.

93

On October 1, Company X acquired for cash all of the outstanding common stock of Company Y. Both companies have a December 31 year-end and have been in business for many years. Consolidated net income for the year ended December 31 should include net income of

  1. Company X for 3 months and Company Y for 3 months.
  2. Company X for 12 months and Company Y for 3 months.
  3. Company X for 12 months and Company Y for 12 months.
  4. Company X for 12 months; but no income from Company Y until Company Y distributes a dividend.

Company X for 12 months and Company Y for 3 months.

In an acquisition, the acquirer includes net income for the acquiree only from the date of acquisition (see ASC Topic 810).

94

Wagner, a holder of a $1,000,000 Palmer, Inc. bond, collected the interest due on March 31, year 2, and then sold the bond to Seal, Inc. for $975,000. On that date, Palmer, a 100% owner of Seal, had a $1,075,000 carrying amount for this bond. What was the effect of Seal’s purchase of Palmer’s bond on the retained earnings and noncontrolling interest amounts reported in the March 31, year 3 consolidated balance sheet?

  • Retained earnings
  • Noncontrolling interest

  • Retained earnings - $100,000 Increase
  • Noncontrolling interest - no effect

When Seal purchased the bonds from Wagner, the bonds were viewed as retired from a consolidated viewpoint since there is no longer any obligation to an outside party. Therefore, the consolidated entity would recognize a $100,000 gain ($1,075,000 carrying amount − $975,000 cash paid), which would increase net income, thus increasing consolidated retained earnings. This transaction has no effect on the noncontrolling interest, since the acquiree (Seal) has merely exchanged one asset for another (cash for investment in bonds).

95

On March 1, year 1, Agront Corporation issued 10,000 shares of its $1 par value common stock for all of the outstanding stock of Barcelo Corporation, when the fair market value of Agront’s stock was $50 per share.  In addition, Agront made the following payments in connection with this business combination:

  • Finder’s and consultant’s fees $20,000
  • SEC registration costs $7,000

Agront’s acquisition cost would be capitalized at

  1. $0
  2. $500,000
  3. $520,000
  4. $527,000

$500,000

Per ASC Topic 805 the finder’s and consultant’s fees should be expensed. The SEC registration costs should be netted against the additional paid-in capital account.

96

On January 2 of the current year, Peace Co. paid $310,000 to purchase 75% of the voting shares of Surge Co. Peace reported retained earnings of $80,000, and Surge reported contributed capital of $300,000 and retained earnings of $100,000. The purchase differential was attributed to depreciable assets with a remaining useful life of 10 years. Peace used the equity method in accounting for its investment in Surge. Surge reported net income of $20,000 and paid dividends of $8,000 during the current year. Peace reported income, exclusive of its income from Surge, of $30,000 and paid dividends of $15,000 during the current year. What amount will Peace report as dividends declared and paid in its current year’s consolidated statement of retained earnings?

  1. $8,000
  2. $15,000
  3. $21,000
  4. $23,000

$15,000

Peace will report only the dividend of the parent company in the consolidated financial statements. The dividends declared and paid by Surge will be eliminated in the consolidated worksheet entries. Therefore, this answer is correct because the dividends reported in the consolidated statement of retained earnings would be $15,000.

97

On September 29, year 2, Wall Co. paid $860,000 for all the issued and outstanding common stock of Hart Corp. On that date, the carrying amounts of Hart’s recorded assets and liabilities were $800,000 and $180,000, respectively. Hart’s recorded assets and liabilities had fair values of $840,000 and $140,000, respectively. In Wall’s September 30, year 2 balance sheet, what amount should be reported as goodwill?

  1. $20,000
  2. $160,000
  3. $180,000
  4. $240,000

$160,000

Wall Co. purchased 100% of the stock of Hart Corp. for $860,000.  The amount of goodwill that should be reported on the September 30, year 2 balance sheet would be the amount paid in excess of the FV of the net identifiable assets.  The FV of the net assets would be calculated by taking the FV of the assets and subtracting the FV of the liabilities. The FV of the net assets would be $840,000 – 140,000 = 700,000.  Goodwill will equal

$860,000    Consideration transferred

– 700,000    Less: Fair value of net identifiable assets

$160,000 

98

Company X acquired for cash all of the outstanding common stock of Company Y.  How should Company X determine in general the amounts to be reported for the inventories and long-term debt acquired from Company Y?

  • Inventories
  • Long-term debt

  • Inventories - Fair Value
  • Long-term debt - Fair Value

Under the acquisition method, the acquired assets and liabilities are reported at their fair values. Therefore, Company X should report Company Y’s inventories and long-term debt at their fair values.

99

Sayon Co. issues 200,000 shares of $5 par value common stock to acquire Trask Co. in a purchase-business combination. The market value of Sayon’s common stock is $12. Legal and consulting fees incurred in relationship to the purchase are $110,000. Registration and issuance costs for the common stock are $35,000. What should be recorded in Sayon’s additional paid-in capital account for this business combination?

  1. $1,545,000
  2. $1,400,000
  3. $1,365,000
  4. $1,255,000

$1,365,000

In a business combination accounted for as an acquisition, costs of registering securities and issuing common stock are netted against the proceeds and recorded in the additional paid-in capital account. Acquisition costs are expensed in the year the costs are incurred or the services are received, and the acquisition is recorded at the fair value of consideration given. Therefore, this answer is correct because the amount recorded in the additional paid-in capital account is equal to $1,365,000 [(200,000 shares × $7 per share) – $35,000 registration and issue costs].

100

On June 30, year 2, Needle Corporation purchased for cash at $10 per share all 100,000 shares of the outstanding common stock of Thread Company. The total appraised value of identifiable assets less liabilities of Thread was $1,400,000 at June 30, year 2, including the appraised value of Thread’s property, plant, and equipment (its only noncurrent asset) of $250,000. The consolidated income statement of Needle Corporation and its wholly owned subsidiary for the year ended June 30, year 2, should reflect

  1. A gain from bargain purchase of $400,000.
  2. Goodwill of $150,000.
  3. A deferred credit (negative goodwill) of $400,000.
  4. Goodwill of $400,000.

A gain from bargain purchase of $400,000.

Per ASC Topic 810, the excess of FV over acquisition cost is recognized as a gain from a bargain purchase in the period of acquisition.

  • Cost $1,000,000
  • FMV of identifiable assets and liabilities ($1,400,000)
  • Bargain purchase ($400,000)

101

Par Corp. owns 60% of Sub Corp.’s outstanding capital stock. On May 1, year 2, Par advanced Sub $70,000 in cash, which was still outstanding at December 31, year 2. What portion of this advance should be eliminated in the preparation of the December 31, year 2, consolidated balance sheet?

  1. $70,000
  2. $42,000
  3. $28,000
  4. $0

$70,000

Consolidated statements are prepared as if the acquirer and acquiree were one economic entity. From the point of view of the consolidated entity, the $70,000 is not payable to or receivable from any outside company. In other words, the consolidated entity does not have a receivable or payable. Therefore, the entire $70,000 payable on Sub’s books and the entire $70,000 receivable on Par’s books must be eliminated against each other. The level of ownership (60%) does not affect this elimination.

102

On November 30, year 2, Eagle, Incorporated purchased for cash at $25 per share all 300,000 shares of the outstanding common stock of Perch Company. Perch’s balance sheet at November 30, year 2, showed a book value of $6,000,000. Additionally, the fair value of Perch’s property, plant, and equipment on November 30, year 2, was $800,000 in excess of its book value. What amount, if any, will be shown in the balance sheet as "Goodwill" in the November 30, year 2 consolidated balance sheet of Eagle, Incorporated, and its wholly owned subsidiary, Perch Company?

  1. $0
  2. $700,000
  3. $800,000
  4. $1,500,000

$700,000

Per ASC Topic 810, in an acquisition of another company, goodwill is recorded as the difference between the cost of the acquired company plus the fair value of noncontrolling interests plus the acquisition date fair value of previously held interests in the acquiree less the fair value of its net identifiable assets. The cost of Perch Company is $7,500,000 (300,000 shares × $25), and the fair value of its net assets is $6,800,000 ($6,000,000 + $800,000). Thus, the resulting goodwill from this transaction will be $700,000 ($7,500,000 − $6,800,000).

103

During year 2 the Henderson Company purchased the net assets of John Corporation for $800,000. On the date of the transaction, John had no long-term investments in marketable securities, deferred assets, or prepaid assets and had $100,000 of liabilities.  The fair value of John’s assets when acquired were as follows:

  • Current assets$  400,000
  • Noncurrent assets  600,000

How should the $100,000 difference between the fair value of the net assets acquired ($900,000) and the cost ($800,000) be accounted for by Henderson?

  1. The $100,000 difference should be recorded as a gain in the period of acquisition.
  2. The noncurrent assets should be recorded at $500,000.
  3. The current assets should be recorded at $360,000, and the noncurrent assets should be recorded at $540,000.
  4. A deferred credit of $100,000 should be set up and then amortized to income over a period not to exceed 40 years.

The $100,000 difference should be recorded as a gain in the period of acquisition.

Per ASC Topic 810, a bargain purchase occurs when the fair value of net identifiable assets exceeds the acquisition cost. The bargain purchase is recorded as a gain on the date of acquisition.

104

Birk Co. purchased 30% of Sled Co.’s outstanding common stock on December 31, year 1, for $200,000. On that date, Sled’s stockholders’ equity was $500,000, and the fair value of its identifiable net assets was $600,000. Assume Birk Co. uses the equity method to account for this investment. On December 31, year 1, what amount of goodwill should Birk attribute to this acquisition?

  1. $0
  2. $20,000
  3. $30,000
  4. $50,000

$20,000

Investments between 20% and 50% of the outstanding stock are presumed to give the investor significant influence over the investee and as such should be accounted for under the equity method. Birk Co. purchased 30% of the outstanding common stock of Sled. Birk Co. is presumed to have significant influence over Sled and must account for this investment using the equity method. Under the equity method, any excess paid over the fair value of the net assets is considered goodwill. The total purchase price paid by Birk was $200,000 and the fair value of the net assets was $180,000 ($600,000 × 30%). Goodwill would be the difference between $200,000 and the $180,000. Goodwill is $20,000.