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									Week 2: Unit 2 - Lecture

Class live lecture notes – Chapter 2

In-class problems (below): 2-16, 2-20, and 2-26 (if time permits)

Beginning in 2009 accounting for business combinations changed: FASB ASC Topic
805, “Business Combinations” and Topic 810, “Consolidation.” These standards
require the acquisition method.

We will focus on the acquisition method, but briefly discuss the other methods used:
the purchase method and pooling of interests.

       I. Business combinations can be created in several different ways
              1. Statutory merger - only one of the original companies remains
              2. Statutory consolidation - a newly formed corporation
              3. Acquisition by one company of a controlling interest - both parties
              retain their separate legal incorporation
II. The Acquisition Method
          A. The acquisition method replaced the purchase method.
              1. All assets acquired and liabilities assumed in the combination are
              recognized and measured at their individual fair values (with few
              2. Any excess of the fair value of the consideration transferred over
              the net amount assigned to the individual assets acquired and
              liabilities assumed is recognized by the acquirer as goodwill.
              3. Any excess of the net amount assigned to the individual assets
              acquired and liabilities assumed over the fair value of the
              consideration transferred is recognized by the acquirer as a “gain on
              bargain purchase.”
          B. In-process research and development acquired in a business
          combination is recognized as an asset at its acquisition-date fair value.
III. The Purchase Method
          A. Used prior to December 15, 2008. It was distinguished by three
              1. One company was clearly in a dominant role as the purchasing
              2. A bargained exchange transaction took place to obtain control over
              the second company
              3. A historical cost figure was determined based on the acquisition
              price paid
   B. Purchase method may result in dissolution of the acquired company
   C. Purchase method may result in separate incorporation
IV. The Pooling of Interest Method (prohibited for combinations after June
   A. A pooling of interests is formed by the uniting of the ownership
   interests of two companies through the exchange of equity securities. The
   characteristics of a pooling are fundamentally different from either the
   purchase or acquisition methods.
Problem 2-16 The Acquisition Method [LO4, LO5, LO6, LO7]

Following are preacquisition financial balances for Padre Company and Sol Company as of
December 31. Also included are fair values for Sol Company accounts.

                                                           Sol Company
                                    Book Values   Book Values     Fair Values
                                      12/31         12/31           12/31
Cash                                $ 400,000     $ 120,000       $ 120,000
Receivables                           220,000       300,000         300,000
Inventory                             410,000       210,000         260,000
Land                                  600,000       130,000         110,000
Building and equipment (net)          600,000       270,000         330,000
Franchise agreements                  220,000       190,000         220,000
Accounts payable                     (300,000)     (120,000)       (120,000)
Accrued expenses                      (90,000)      (30,000)        (30,000)
Long-term liabilities                (900,000)     (510,000)       (510,000)
Common stock—$20 par value           (660,000)
Common stock—$5 par value                           (210,000)
Additional paid-in capital            (70,000)       (90,000)
Retained earnings, 1/1               (390,000)      (240,000)
Revenues                             (960,000)      (330,000)
Expenses                              920,000        310,000

On December 31, Padre acquires Sol’s outstanding stock by paying $360,000 in cash and
issuing 10,000 shares of its own common stock with a fair value of $40 per share. Padre
paid legal and accounting fees of $20,000 as well as $5,000 in stock issuance costs.

Determine the value that would be shown in Padre and Sol’s consolidated financial
statements for each of the accounts listed.
Problem 2-20 The Acquisition Method [LO4, LO5, LO7, LO8]

Pratt Company acquired all of Spider, Inc.’s outstanding shares on December 31, 2011, for
$495,000 cash. Pratt will operate Spider as a wholly owned subsidiary with a separate legal
and accounting identity. Although many of Spider’s book values approximate fair values,
several of its accounts have fair values that differ from book values. In addition, Spider has
internally developed assets that remain unrecorded on its books. In deriving the acquisition
price, Pratt assessed Spider’s fair and book value differences as follows:

                                              Book      Fair
                                             Values   Values
Computer software                           $ 20,000$ 70,000
Equipment                                      40,000   30,000
Client contracts                                    0 100,000
In-process research and development                 0   40,000
Notes payable                                (60,000) (65,000)

At December 31, 2011, the following financial information is available for consolidation:

                        Pratt                       Spider
Cash                     $        36,000             $         18,000
Receivables                      116,000                       52,000
Inventory                        140,000                       90,000
                                 495,000                             0
in Spider
                                 210,000                       20,000
                                 595,000                      130,000
                                 308,000                       40,000
                                       0                             0
Goodwill                               0                             0
                         $      1,900,000             $       350,000

                         $       (88,000)             $       (25,000)
                                (510,000)                     (60,000)
                                (380,000)                    (100,000)
paid-in                      (170,000)                     (25,000)
                             (752,000)                   (140,000)
                        $   (1,900,000)             $    (350,000)

Prepare a consolidated balance sheet for Pratt and Spider as of December 31, 2011.

Problem 2-26 Purchase Method [LO9] (if time permits)

Bakel Corporation has the following December 31 account balances:

Receivables               $ 80,000
Inventory                   200,000
Land                        600,000
Building                    500,000
Liabilities                (400,000)
Common stock               (100,000)
Additional paid-in capital (100,000)
Retained earnings, 1/1     (700,000)
Revenues                   (300,000)
Expenses                    220,000)

Several of Bakel’s accounts have fair values that differ from book value: land—$400,000;
building— $600,000; inventory—$280,000; and liabilities—$330,000. Homewood, Inc.,
obtains all of Bakel’s outstanding shares by issuing 20,000 shares of common stock having
a $5 par value but a $55 fair value. Stock issuance costs amount to $10,000.

(a) What is the purchase price in this combination?
(b)What is the book value of Bakel’s net assets on the date of the takeover?
(d)How does the issuance of these shares affect the stockholders’ equity accounts of
    Homewood, the parent?
(e) What allocations are made of Homewood’s purchase price to specific accounts and to
(f- If Bakel had in-process research and development assets (with no alternative future
) uses) valued at $60,000, how would the allocations in part (e) change?
(f- How is acquired in-process research and development typically reported on consolidated
) financial statements?
(j) If Homewood’s stock had been worth only $40 per share rather than $55, what
    allocations are made of Homewood’s purchase price to specific accounts?

TRY THESE for homework





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